On August 2, 2007, the North Carolina General Assembly ratified S. 242, An Act to Reform the Process for Administrative and Judicial Review of Disputed Tax Matters. The act completely restates the assessment and refund procedures of the Department of Revenue (DOR) and is generally effective on January 1, 2008. It replaces the current two-pronged alternatives for contesting tax liabilities with a unified procedure for contested assessments and refund claims.1
The most important changes in the process for contesting taxes are:
- The current alternative allowing taxpayers to pay • and sue and create a record de novo in court is eliminated for all practical purposes. The absence of an alternative to pay and sue is the signal divergence of the new process from both the current North Carolina system and the federal system, in which a taxpayer can always pay and sue in federal district court.
- There will be no reason to pay the tax in order to dispute an assessment, but when the dispute reaches the court level, the taxpayer must pay to continue to play.
- Refund claims and assessment protests will be funneled through a unified administrative review procedure.
- The record in the new administrative process will be created in a hearing before an administrative law judge, unlike the current process of creating the record in a hearing before the secretary of revenue.
- The North Carolina Business Court (currently three superior court judges who sit in three locations in the state) will hear all contested tax case appeals.
- The Tax Review Board is eliminated.
Through 2007, North Carolina taxpayers can either pay a tax and sue for its refund under N.C. Gen. Stat. § 105-2672 — which is the only choice if the taxpayer wishes to assert constitutional objections to the tax — or not pay and have a hearing before the secretary of revenue in which a record is created, on which a losing taxpayer may appeal first to the Tax Review Board and then to the superior court.
Effective January 1, 2008, a taxpayer contesting a proposed assessment or seeking a refund must proceed as shown in the chart below. The times for each step are estimates based on limits in the statute and assume a complex case.
Features of New Procedure
- Implements the preliminary review of refund claims by the DOR staff, which is effectively the equivalent of the field agent’s audit before the assessment of tax.
- Eliminates the current distinction between amended returns (which are supposed to lead to administrative review) and a N.C. Gen. Stat. § 105-267 claim for refund (which is supposed to lead directly to court); repeals N.C. Gen. Stat. § 105-267 and allows claims for refund to be made either by filing an amended return or a claim for refund.3 That means a taxpayer can no longer abandon an administrative appeal and pay the assessment and proceed directly to court; if the taxpayer does abandon a protest of an assessment and pays, the taxpayer must then pursue an administrative claim for refund.4
- Allows specifically for the DOR to use the administrative appeal process to gather more information from the taxpayer at each step (staff-level review and conference-level review) and purports not to “bind” the DOR to any decision, basis, or grounds it makes or states before its final decision based on the administrative law judge (ALJ) decision.5 Limits the refunds and assessments that can be based on a return filed to reflect federal determination of changes to those resulting from the federal adjustments.6
- Clarifies mailing/receipt rules — within 45 days after the mailing of the proposed assessment or proposed denial of refund, the DOR must receive the request for review.7
- Eliminates a taxpayer’s ability to post a bond for the tax when appealing to the court the administrative rejection of a protest to an assessment; the taxpayer must pay to go to court.8
- Curtails severely the right to obtain a de novo trial on a constitutional issue, which is now available (and required) only under N.C. Gen. Stat. § 105-267. In the future that can occur only when a taxpayer has suffered a dismissal of its ALJ appeal (“because the sole issue is the constitutionality of a statute and not the application of the statute”), has paid the tax and has filed the civil action within two years after the dismissal. Any case that makes it through that strict test must be filed in the business court.9
- Forces all appeals into Wake County Superior Court and gives the business court judge the power to decide that the case is not a complex business case, which evidently will result in it being handled as a normal Wake County Superior Court case on appeal from an ALJ.10
- Increases the role of the Department of Justice (DOJ) attorneys because of the need for them to represent the DOR at the ALJ hearings. According to the fiscal note with the act, the DOJ attorneys now are involved in only about two hearings per year before the secretary of revenue.11 However, the standard practice of the DOJ is for its attorneys to appear at all ALJ hearings.
The important elements of the standard ALJ proceedings and appeals under Chapter 150B, articles 3 and 4 are as follows:
- The review is not on the DOR’s record; rather, the record is created in the Administrative Office of the Courts (AOC) hearing — a change from the current procedure for administrative appeals, in which the record is created in the hearing before the secretary of revenue, and the appeal on that record goes through the Tax Review Board to the courts.
- During an ALJ review of a decision by the DOR, the taxpayer must prove by a preponderance of evidence that the DOR exceeded its jurisdiction (nexus cases) or acted erroneously (perhaps factual errors) or failed to act as required by law (misinterpreted statutes).12
- The DOR could move to dismiss the appeal for failure to state a claim on which relief can be granted, the ALJ could grant the motion, and the taxpayer could appeal that order directly to court; summary judgment procedures are also available.13
- Discovery is allowed under the Rules of Civil Procedure.14 However, the act repealed N.C. Gen. Stat. § 150B-28(b), which allowed an appellant to obtain agency records. The repeal was not intended to restrict appellants’ discovery, but rather to remove the inference that there could not be discovery of internal agency procedures.
- The normal rules of evidence apply, “but when evidence is not reasonably available under the rules to show relevant facts, then the most reliable and substantial evidence available shall be admitted.”15
- Objections to evidence need not be made on the record in order to preserve them for purposes of review.
- Official notice may be taken of “facts within the specialized knowledge of the agency.”16
- The ALJ must give “due regard to the demonstrated knowledge and expertise of the agency with respect to facts and inferences within the specialized knowledge of the agency.”17
- A report of a law enforcement agency is admissible without testimony from personnel of the agency.18 Although it is unclear whether that provision was intended to include the DOR, it would seem likely because it enforces the criminal law.19 If so, that could have the curious result of DOJ attorneys having to appear at the ALJ hearings (because that is DOJ policy generally), but DOR staffers not having to appear.
- The ALJ decision is not final until the DOR adopts it. The DOR does not have to adopt it in whole, but may make different findings and conclusions if the decision is clearly contrary to the preponderance of the admissible evidence in the record. But if the DOR does not adopt the ALJ decision, it must provide complete explanations of its reasons; the parties may file exceptions and arguments with the DOR to prompt its rethinking of the ALJ decision.20
- The Office of Administrative Hearings will prepare the official record for purposes of appeal.21
- The superior court may reverse or modify the DOR’s decision if the substantial rights of the petitioner have been prejudiced because the DOR’s decision is:
- in violation of constitutional provisions;
- in excess of the statutory authority or jurisdiction of the DOR;
- made using unlawful procedure;
- affected by other error of law;
- unsupported by substantial evidence admissible under the statute, in view of the entire record as submitted; or
- arbitrary, capricious, or an abuse of discretion.22
- If the DOR does not adopt the ALJ decision, then the court’s standard and process of review are different — it reviews the record de novo and is not bound by any deference to the agency.23
- The reviewing court has complete freedom to substitute its judgment for that of the agency in all cases regarding questions of law and the interpretation of statutes.24
- On appeal from the trial court (the business court), the appellate courts are limited to determining if the trial court applied the proper standard of review,25 but regarding questions of law, the appellate court conducts a de novo review.26
DOR Failure to Act
N.C. Gen. Stat. § 241.14(c) states that if the DOR fails to act on a review request within nine months, as required by the statute, “that failure does not affect the validity of the proposed assessment.” Does that mean the taxpayer must pay the proposed assessment and then pursue an administrative claim for refund? If so, the DOR will have bought itself another nine months of delay. Under N.C. Gen. Stat. § 105-241.15, the taxpayer cannot appeal either an assessment or a refund claim to the ALJ until the taxpayer has exhausted its administrative remedies, defined as when the DOR issues a final determination after the conference. If the DOR does not issue a final determination and nine months have elapsed, and in the absence of a rule stating that the DOR’s failure to act constitutes a final determination, the taxpayer should appeal and argue that the DOR’s failure to act constituted an exhaustion of remedies and that the statutory definition of final determination is nonexclusive. Perhaps that is the meaning of “does not affect the validity of the proposed assessment,” but it is not entirely clear.
When would an ALJ dismiss an appeal because the sole issue is the constitutionality of a statute and not the application of a statute? Evidently, that attempts to draw the line between statutes that are facially burdens on interstate commerce, for example, or that are burdens as applied. It is not obvious why that is a proper line to draw. If the ALJ dismisses the petition for that reason and another reason, can the taxpayer pursue the de novo remedy?
N.C. Gen. Stat. § 105-241.16 states that a taxpayer who appeals from the ALJ decision must follow the procedures for mandatory business cases in N.C. Gen. Stat. § 7A-45.4(b); that section, which was also amended, allows but does not require a party to request designation as a complex business case. However, amended N.C. Gen. Stat. § 7A-45.4(a) adds contested tax appeals to the list of mandatory business cases. Evidently, that means the taxpayer must appeal to the business court. Presumably, the business court judge will determine that run-of-the-mill appeals of individuals will not be forced into the business court, and so those appeals will be assigned to regular superior court judges in Wake County, unless some other special designation is sought.
All ALJ hearings are open to the public.27 However, the act goes out of its way to require the secretary of revenue to redact identifying taxpayer information from a final decision before publication and to publish all such final decisions.28 The final decision is not the secretary’s first determination, which is the “final determination,” but is the decision the secretary must issue that either incorporates or modifies the ALJ decision. New N.C. Gen. Stat. § 150B31.1(e) says that the “record, proceedings, and decision” in a tax case are confidential until the final decision.
The resulting procedure partly replicates the current process whereby Tax Review Board hearings are technically open to the public, but in contrast, the Tax Review Board opinions bear the taxpayers’ names.29
Further Thoughts on the ALJ Process
Even though the ALJ process can replicate a lawsuit, there is reason to believe that the Office of Administrative Hearings will be able to arrive at decisions faster than the superior court can in a N.C. Gen. Stat. § 105-267 de novo lawsuit.
First, the Office of Administrative Hearings is likely to create simplified procedures for the noncomplex contested tax cases. Second, the Office of Administrative Hearings is particularly time-conscious and is implementing a new computer system to closely track the progress of all cases. Third, ALJs are very familiar with discovery in complex cases and should be able to administer discovery disputes efficiently. Fourth, the Office of Administrative Hearings case closure results have approximated the American Bar Association standards for resolution of 95 percent of cases within one year.
Complex contested tax cases may fall into the 5 percent category, but, like all other cases, they will be scheduled for hearing within five days after the petition is filed. If the case is not ready for hearing on the scheduled date, it is normally pushed back to the next month. The Office of Administrative Hearing’s goal is to complete cases within six to 12 months. The Office of Administrative Hearings can assign one judge to follow a complex case, in place of the usual rotating judge assignment.
The ALJs have a track record of independence from the administrative agencies and are willing to rule against the agencies.30
Miscellaneous Changes The act amended N.C. Gen. Stat. § 105-262(a) to eliminate the role of the Tax Review Board in reviewing DOR rules. Curiously, it added a statement saying that N.C. Gen. Stat. § 150B-1 and article 2A of Chapter 150B set out the procedure for the adoption of rules by the secretary of revenue. N.C. Gen. Stat. §150B-1(d)(4) relieves the DOR from the important notice and hearing requirements of article 2A. Presumably that relief still applies.
The new contested tax case procedures are not likely to be as attractive to taxpayers in complex cases as those taxpayers might have hoped. Although the assistant secretary of revenue will no longer be holding the hearing in which the record for appeal purposes is made, and the ALJs presumably will act with more independence, the ALJs still must give some deference to the DOR.
The act attempts to hold the DOR to a timetable in deciding appeals, but there are several gaps in that timetable that can leave taxpayers without a speedy remedy for seeking refunds. The DOR made sure that the act was larded with extra avenues for its information-gathering processes and for it to rethink its grounds for assessments, right up to just before the appeal to the business court.
Perhaps most importantly, taxpayers no longer can go directly to court and create a record de novo under normal civil procedure rules. Those rules are no picnic, but discovery conducted by the DOR cannot be avoided by going to the ALJ, because discovery can occur there too.
The ultimate trade-off for taxpayers in getting this reform is to give up flexibility of forum in exchange for obtaining an impartial administrative forum that can decide a tax contest before payment. The trade-off will prove fair only if (1) the DOR allows taxpayers to move quickly through its processes in cases in which the DOR knows it will not agree with the taxpayer and (2) the administrative forum proves to be taxpayer-friendly, knowledgeable and impartial.
If the taxpayer must appeal from the ALJ, it will have to pay, and the prepayment review abruptly ends.