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Fighting Back: Taxpayers Challenge State Tax Assessments Based on Contingent-Fee Transfer Pricing Audits

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In today’s economic environment, it is no secret that many states face significant budget shortfalls. In response to these circumstances, certain state treasury departments have begun to propose new income tax assessments based on transfer pricing studies that they have “outsourced” to third-party audit firms, often on contingent-fee terms. These arrangements, however, have left many taxpayers concerned. A state department of revenue’s combination of broad powers to propose adjustments and enjoyment of significant deference from state trial courts has traditionally been tempered by an expectation that the department will carefully exercise its discretion in making its assessment. But taxpayers are left wondering whether this powerful check on what otherwise might be arbitrary or capricious assessments is effectively abandoned where that state turns to a third-party, operating without transparency and on a contingent-fee basis, to pursue assessments under a highly technical area of the law (i.e., transfer pricing) with which the state department of revenue may, itself, have only limited experience.

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