When a business disputes a tax assessment issued by a state or local revenue authority, the fundamental strategic question it must eventually confront is this: Should we litigate the matter or pursue a settlement? While this decision may seem straightforward on its face, it is anything but. The tension between pursuing a principled stand—perhaps even seeking a favorable legal precedent—and managing costs, resources, risk exposure, and collateral consequences creates a complex matrix of competing priorities.

In the realm of state and local tax (SALT), where guidance is often sparse, statutes are increasingly complex, and administrative practices vary wildly by jurisdiction, there is rarely a clear-cut answer. Each dispute must be analyzed within the context of the specific legal issue, the forum in which the dispute will be resolved, the financial and reputational stakes involved, and the business’s broader goals and risk appetite.

This article presents a comprehensive and methodical exploration of the key considerations that inform the decision to litigate or settle a state tax matter, drawing on best practices from seasoned practitioners and recurring patterns seen in multistate tax disputes.

Assessing the Legal Merits: How Strong Is the Case?

Before any decision about settlement or litigation can be made, taxpayers must engage in a substantive legal analysis of the issues at hand. This process begins by determining the relative strength of the taxpayer’s position under the governing statutes, administrative regulations, and relevant case law.

Key questions include:

• Is the legal issue well-developed, or is it novel or unsettled?

• Is there a published revenue ruling, notice, or technical assistance memorandum supporting the state’s position?

• Does the taxpayer’s position rest on a plain reading of the statute, or does it require a broader interpretive argument?

• Are there similar cases pending in the same jurisdiction—or others—that may influence the outcome?

• How do courts in the relevant state treat agency deference?

• If the dispute hinges on factual findings, are those facts clearly documented and verifiable, or subject to interpretation?

In many state tax matters—especially those involving digital goods and services, apportionment, or nexus—the law may be ambiguous or underdeveloped, making the merits of litigation harder to assess in binary terms. Even strong technical arguments can falter if the taxpayer is battling against an entrenched administrative interpretation or a judge with limited SALT experience.

Understanding the Financial Equation: The Economics of Tax Litigation

Litigation is inherently resource-intensive. Beyond legal fees and expert costs, the process demands significant internal time and energy from tax, legal, and sometimes finance or operational teams. Therefore, a financial analysis is essential.

Consider the following:

• What is the total amount at issue, including back taxes, penalties, and accrued interest?

• Is the issue prospective, such that an unfavorable outcome would lead to repeated exposure in future years?

• Could a successful challenge reduce the effective tax rate on a multi-state or multi-entity basis?

• What is the cost of litigating to resolution, including outside counsel, experts, and appeals?

• Are there reserve considerations that affect how the matter is reported under ASC 740 or similar standards?

• How reasonable is the state’s settlement offer, both in financial terms and in terms of precedent or compromise?

It may sometimes make economic sense to litigate a weak issue with low dollar value if it poses significant collateral risks, or if the state’s settlement posture is unreasonably rigid. Conversely, even strong cases may be better resolved through settlement if the administrative burden, reputational risk, or opportunity cost of litigation outweighs the potential benefit.

Selecting the Right Forum: Jurisdictional Nuance Matters

A taxpayer’s success—or failure—may hinge not only on the strength of its position but also on where the case is litigated. State tax disputes may be heard by:

• Administrative tribunals (e.g., tax appeals commissions)

• Courts of general jurisdiction

• Specialized tax courts

• Hybrid forums with limited discovery or appellate rights

Critical questions include:

• Is the forum known to be taxpayer-friendly or deferential to agencies?

• Is the decision publicly reported, and if so, how might publicity affect broader business interests?

• Will a constitutional claim require a forum with broader jurisdiction than an administrative agency can offer?

• Does the forum impose a “pay-to-play” requirement, such that tax must be paid or bonded before proceeding?

• How long will the process take from initial filing to final resolution, and are there interim costs (e.g., cash outlay, reputational harm) to consider?

In multistate disputes, the litigation strategy may also consider venue shopping for favorable jurisdictions, depending on where the company has operations or where the issue is most likely to arise again.

Internal Alignment: Business Objectives and Risk Appetite

Tax litigation decisions are rarely made in a vacuum. Business units, legal departments, investor relations teams, and even senior executives may have views on the risks and benefits of litigation. This internal calculus often determines the threshold for acceptable exposure, as well as how aggressively to defend or compromise.

Key considerations include:

• What is the company’s institutional philosophy on litigation? Is it seen as a last resort, or as a normal part of doing business?

• What are the political implications of challenging a state—especially a state where the company is headquartered or has major operations?

• Is the issue related to a prior acquisition or spinoff, and do indemnification clauses or escrow terms determine who bears the cost of litigation?

• If the issue is prospective, can the company change its structure, product offerings, or tax positions to mitigate exposure without litigation?

• In sales tax matters, can the tax be passed through to consumers without reputational or pricing fallout?

For public companies, the need to communicate risks to shareholders, disclose litigation in filings, and navigate public scrutiny adds another layer of complexity.

The Collateral Impact of Litigation: One Case, Many Consequences

Tax litigation can have ripple effects far beyond the issue at stake. These collateral consequences may include:

• Impact on other state tax filings: Positions taken in one case may conflict with filings in another state.

• Precedent value: A loss in one case may set a binding or persuasive precedent that negatively affects the company in the future—or that others in the industry may try to use against it.

• Discovery risks: Documents or positions disclosed during litigation may be accessed in later audits or through public records requests.

• Regulatory impacts: The arguments advanced in a tax dispute could affect the company’s position in unrelated regulatory contexts.

This is why tax and legal teams must approach litigation strategically—not just as an isolated battle, but as a component of a broader risk and compliance profile.

Using a Structured Evaluation Framework

To bring consistency and transparency to the litigate-or-settle decision, some tax departments use internal decision matrices or scorecards. These tools allow stakeholders to rate key considerations on a scale, apply weightings, and identify when litigation is advisable, tolerable, or avoidable.

Sample matrix categories include:

• Legal merits

• Financial exposure

• Forum risk

• Business disruption

• External optics

• Precedent value

• Collateral impact

• Likelihood of a favorable settlement

While imperfect, these tools help ensure that decisions are evidence-based, repeatable, and not driven by emotion or inertia.

Conclusion: Strategic Litigation Starts with Strategic Thinking

There is no universal rule for whether a taxpayer should litigate or settle a state tax matter. What matters is that the decision is made deliberately—with a clear-eyed view of the legal merits, financial implications, operational realities, and broader organizational goals.

In some cases, litigation is the only way to resolve an ambiguous or unjust policy. In others, settlement may offer certainty and closure at a reasonable cost. The best outcome is not always the biggest win—it’s the one that aligns most effectively with the company’s legal position, risk tolerance, and business vision.

© 2025 Jeanette Moffa. All Rights Reserved.