On Offsets and Posted Dates

We welcome guest blogger Caleb Smith.  Caleb has worked on tax returns and tax transcript issues for several years.  Before law school he worked for Prepare and Prosper as a Tax Program Manager for their VITA program.  At Lewis and Clark Law School he participated in the excellent low income taxpayer clinic there run by my former colleague, Jan Pierce.  Most recently Caleb has been working at Mid-Minnesota Legal Aid in their tax clinic.  Next month he will join me as the new fellow at the Harvard Tax Clinic.  Keith

When is an offset not a § 6402 offset? After the recent Tax Court memorandum opinion, Luque v. Commissioner, the answer seems to be only “when the offset didn’t actually happen.” And because of the nearly wholesale prohibition on Tax Court review of § 6402 offsets codified at § 6512(b)(4), checking to see if the offset actually happened is about as far as the court will go. The opinion serves as an illustration of the pitfalls many taxpayers face in getting to court, while also offering a look into the arcana of IRS transcript posted dates. Indeed, this latter endeavor appears to be the main objective of Judge Halpern in issuing the opinion.

read more...

The facts of the case are fairly commonplace: taxpayer files a 2011 return showing a refund and the refund is credited in its entirety against a 2009 tax liability. In this instance, after the refund was credited the IRS issued a NOD for 2011, thus allowing the taxpayer into Court to argue (1) that the offset did not arise under § 6402 and (2), even if it did, the offset never actually was credited to 2009.

Prior to issuing the opinion the Court had essentially dashed the hopes that the liability giving rise to the offset, the 2009 liability, could be reviewed (i.e. didn’t arise under § 6402) in an earlier court order. It could be noted that the judge issuing the opinion, Judge Halpern, has been involved with previous cases questioning what is and is not an offset (found here with more insight on the matter provided by the First Circuit in appeal found here). But even though the Tax Court cannot “restrain or review” a § 6402 offset by examining if the taxpayer really owes the taxes being paid through the offset under § 6512(b)(4), Judge Halpern noted that it can look to see if the offset actually happened.

As this is usually a fairly straightforward inquiry (either the taxpayer had funds credited to a prior year or they didn’t), the import of the opinion seems to be elsewhere. Indeed, what appears to motivate the Court was the educational opportunity for tax practitioners in better understanding how IRS official records work. Judge Halpern almost explicitly acknowledges this rationale:

“On March 29, 2016, we issued an order concerning the motions in which we addressed and rejected petitioners’ jurisdictional argument. We, did not, however, dispose of the motions. Instead, we ordered respondent to address seeming anomalies between his representations and entries on the official records he submitted in support of his motion. Because there may be general interest in respondent’s reconciliation of those seeming anomalies […] we use this opportunity to make that reconciliation public.” [Emphasis added.] Luque at *3 – 4.

I’ll admit that as someone who frequently pores over IRS transcripts I counted myself as an enthusiastic member of the “general interest” Judge Halpern referred to. And yet, after reading the opinion, I couldn’t help but feel that the more important aspects of the decision remained elsewhere. But more on that later.

My naïve hope was that the opinion would give more insight on the meaning of IRS transaction codes. In my experience, the codes can be extraordinarily misleading or arbitrary. As one example, the notation “additional tax assessed” often does not mean that additional (i.e. “more”) tax was assessed, or even that any assessment action took place at that time. I have had one IRS employee tell me over the phone that the “additional tax assessed” transaction code is sometimes used as a “placeholder” just to show that some action was taken on the account… even where clearly no assessment action took place because the ASED had run years ago and the balance continued to show $0. The mind fairly boggles.

The opinion did not much address such things. However, if you are looking for insight on posted dates and cycle numbers you are in luck. I won’t spoil you with the mechanics (some may say, minutia) of their complete inner workings. You can read that for yourself at pages *12 – 14. I will, however, provide the general take-away points.

First of all, a “posted date” is the effective date of the transaction, which is either the actual date the transaction processing was finalized or the date it is deemed to have occurred by law (like withholding always being credited as paid on the last day to timely file). Meanwhile, a “cycle number” pertains to the dates the IRS actually processed the transaction. In the transcripts that are readily available to taxpayers and practitioners, the “cycle number” field is often left blank. This has never bothered me much because on the account transcript alone the cycle number is mostly useless: it leads off with a year (e.g. 2012) and ends with a number that appears to mean nothing. In Luque, for example, the cycle number was 201219, which corresponded to transactions taking place in 2012 over the month of… May. The 19, as far as I can tell, only has meaning if you have access to an IRS list of 2012 cycle numbers with their corresponding dates, as the IRS Appeals Officer does. With access to that list, you can then glean when the transaction was actually processed by the IRS: a three-step procedure concluding, in most cases, with the effective “posting date” (see above) unless there is an otherwise designated effective date.

This is all to say that cycle numbers are unlikely to matter much unless you are playing a game of inches (likely in a statute of limitations scenario). It also serves as a reminder that the law has numerous artificial constructs for when something is deemed to have actually taken place (like when you are deemed to have paid in withholding). Reconciling anomalies in these dates on the IRS records (when the return was filed, when the return was processed, and when the withholding was credited) was the reason the Court felt the matter was not resolved simply by saying “it was a § 6402 offset, and we have no jurisdiction to review those.”

Yet I am actually not convinced that the timing matters so much as to warrant much inquiry in this case. If the IRS can show that the 2009 liability on the books is $4,223 less (the amount of the 2011 credit), can a slight discrepancy in dates really do so much as to call into question if an offset actually occurred at all? Judge Halpern almost acknowledges as much, stating “Although the question of whether the overpayment reported on petitioners’ 2011 return was credited to their 2009 account is more important than precisely when that credit was allowed, the ambiguity in the dates […] called into question the reliability of the respondent’s certifications as evidence that the credit was, in fact, allowed.” Luque at *9. [Emphasis in original.] Of course, the exact date matters quite a bit if the liability causing the offset may have had the CSED run (or if the date to file a refund claim is close). But those issues both involve investigating the propriety of the offset: something § 6412(b)(4) does not allow. The date the offset occurred is essentially moot as far as the Tax Court should be concerned. It may matter, but it would presumably be litigated in a refund suit in district court.

And there, I think, is the lesson behind the opinion: what would be the victory to the taxpayer if the Court found the records so shoddy as to hold that an offset didn’t occur? I imagine the Court could find that the taxpayer is due that amount… which the IRS could promptly credit as an offset. For the Tax Court to do anything else (that is, compel the IRS not to offset) would be a violation of both § 6512(b)(4) and § 6402 since the choice to offset is committed to the IRS’s discretion. Thus, as Judge Halpern intimated, the greater point of the opinion may well be the education of taxpayers and (more likely) practitioners on the mysteries of IRS transcripts such that the issue can be resolved administratively when errors do arise. Failure to actually credit an offset certainly seems to be in the province of TAS, and a tax practitioner is better able to see when such errors arise (or don’t arise) if they have greater knowledge of the transcripts showing them. Indeed, in most cases it is doubtful that the Tax Court will even be able to review if an offset occurred: Luque was fortuitous in that both offset and NOD (i.e. ticket to tax court) occurred for the same tax year.

And that, in turn, allows us to close on what I believe to be the most important point is lurking behind this all: the difficulties of getting to court at all if you are low-income seeking to challenge an ancient, but sizeable, tax debt. Under § 6512(b)(4) when an offset occurs, the taxpayer better look elsewhere than Tax Court to challenge the propriety of the offset. That “elsewhere” is a refund action in federal district court. At least, it ought to be. The restrictions of Flora’s full-pay rule (discussed, among other times, here and here) and § 6512(b)(4) means that when a taxpayer has a substantial past tax debt that current year refunds will never full pay, the taxpayer can pretty much count on losing a refund they may desperately need for the foreseeable future. (Practitioners, of course, should be aware that the IRS offset for past federal income taxes is discretionary, and would do well to acquaint themselves with Offset-Bypass Procedures, discussed here in cases where the taxpayer is suffering hardship.)

Thus, under Flora and § 6512(b)(4), an offset applied to what may well be an inflated underlying liability will continue to haunt the taxpayer with little chance for judicial review. In such situations, the law seems to give short shrift to the right of the taxpayer to “pay no more than the correct amount.” The statutes as written give the Tax Court no power other than to ensure that at least the offset is properly credited to the earlier year… or give us practitioners the tools to read the transcripts and determine exactly when that happened for ourselves.

 

IRS Offset Program

We have written before about the IRS offset program, here, including not only offsets by the IRS to satisfy liabilities owed to it by individuals receiving a refund but also the offset of federal tax refunds to pay many other types of state and federal debts.  On March 31, 2016, the Treasury Inspector General for Tax Administration (TIGTA) issued a report critical of the way the IRS is handling the offset program and calling for updates in the system. The report deserves some attention because of the importance of offset to the overall collection system of the IRS.

read more...

The offset provisions are found in IRC 6402. The basic rule is that the IRS may offset any refund due to a taxpayer against any outstanding federal tax debt. I use the word “may” because the IRS does have some discretion in deciding whether to offset and that discretion manifests itself in the offset bypass refund (OBR) program discussed previously that allows certain individuals with a hardship to obtain all or a portion of their refund despite having outstanding federal tax debt. The OBR procedure will not, however, allow a taxpayer to bypass the offset of their refund against one of the other debts included in agreements with the IRS such as child support, student loans or state tax obligations.

The TIGTA report naturally focuses on problems with the IRS offset program rather than other state and federal debts and identifies a few problems. It is interesting to look at the problems because in doing so we also learn more about how the program works. Most of the problems involve situations in which the offset crosses some boundary, e.g., offsetting a Form 1040 refund against a business debt. Because of the amount of money involved and the ease of collecting through offset rather than other enforced collection methods, solving these problems should be a priority for the IRS. The report focuses on the years 2011 to 2013. For those years the amount of the offset from individual refunds to individual debts averaged about $7 billion – a decent amount of money. The report did not talk about this type of offset very much because it is routine and the offset process works well here.

I would like the IRS to send a notice when it makes an offset that says something like, “You filed a return claiming a refund of $X which the IRS has allowed; however, you are not receiving your 2015 income tax refund of $X because we took $X to pay off your outstanding income tax liability for 2014 in the amount of $Y. Even though we applied $X to your 2014 liability, you still owe $Z for 2014.”  This type of offset is an in house offset that does not need to go through Treasury’s Financial Management Services. The IRS controls the information. It should provide the taxpayer as much information as possible so the taxpayer can plan for the future and can explain the problem in detail should they go for assistance concerning the debt. I would especially like it if the letter to provide more detail when the refund is offset to a non-IRS liability such as a student loan. I would like the letter to say “you are not receiving your 2015 income tax refund of $X because we have offset that refund to partially satisfy your obligation on your student loan. After the offset of your 2015 refund, your student loan has an outstanding balance of $Y.” I know I live in a dream world and this was not the focus of the TIGTA report but it would be nice to focus a bit on the information provided to the person whose refund is offset. By providing detailed information about what has happened, the individual will be better prepared to deal with the consequences of the offset.  I can only say that at the clinic we have a number of clients who come in each year seeking to find out what happened to their refund and it takes some digging to find out.  The IRS does provide some data but I would like it to provide more.

The report focuses on the problems the IRS is having making offsets of individual refunds to pay off business tax debts. The IRS cannot take an individual refund and apply it to pay off the debt of a corporation in which the individual owns stock but can offset the individual refund against a business debt of a sole proprietorship. For example, if I am due a refund of $X for 2015 and my sole proprietorship failed to pay employment taxes for 2014 of $Y, the IRS can take my refund and apply it against the employment taxes of the sole proprietorship. The dollar amounts of the individual income tax refunds of offsets of this type are much smaller than the offsets of individual refunds to individual liabilities. The amounts ranged from $16 million in 2011 to just under half that in 2013. TIGTA identified that the IRS misses many refund opportunities for offset here because “the IRS’s current process does not effectively identify sole proprietors with business tax debt.” The businesses use an EIN for the employment tax returns rather than the SSN of the sole proprietor. The IRS must match the EIN against its database in order to find the corresponding SSN. TIGTA identified 53,672 individual taxpayers who received approximately $74.5 million in tax refunds in 2013 that could have been offset. The IRS is using a process developed in the 1980s and TIGTA recommended use of a new process that would capture the data necessary to effect these offsets. The IRS agreed but said that to do so would require resources it did not currently have. Consequently, it does not sound as though this change will happen anytime soon.

I do not know the priorities of the IRS. This is low hanging fruit. It requires programming changes which requires computer resources. The use of the resources would eliminate the need for some resources in ACS or field collection to get back the money the hard way. This seems like a good catch by TIGTA and something that should go relatively high on the IRS list of changes it should make. Putting resources in capture money it already has instead of working hard to get a taxpayer to pay over money would always seem like a high priority item.

In addition to the problem of capturing refunds to satisfy the sole proprietor debts of individuals for employment taxes, TIGTA identified problems in capturing refunds when the liability for the debt is coded non-master file instead of master file. We should do a post on how the IRS classifies its accounts and explaining more about the distinction between master file and non-master file. I welcome input from a guest blogger on this issue. In broad terms, most accounts start in master file but sometimes unusual things happen on an account which requires that the IRS move the debt to non-master file accounts. Non-master file accounts can be hard to monitor for the IRS and create confusion when a taxpayer or a representative looks at a master file transcript for a period with known liabilities and sees a zero balance due because the account has transferred to non-master file status. The problems that plague individuals looking at these accounts also impede the IRS when it seeks to make an offset and TIGTA found numerous examples, some with large liabilities, in which the IRS failed to make an available offset. In some of these accounts the taxpayer owed a fair amount of money. The IRS agreed with TIGTA and has taken steps to correct its system to capture these refunds although with respect to some accounts additional programming is needed and may take some time to complete.

TIGTA found that in some instances the IRS offset refunds of individuals and used the money to satisfy the liabilities of limited liability (LLC ) companies. TIGTA identified $780,474 in incorrect offsets. LLCs are distinct from sole proprietorships and the offset in this situation was wrong. Interestingly, the IRS agreed to fix this problem and send refunds to the effected taxpayers. Contrast this with its action concerning low income taxpayers against whom it assessed hundreds of thousands of penalties incorrectly, according the Tax Court, where the IRS refuses to fix its mistake. The IRS seems willing to fix mistakes it (including TIGTA) finds but less willing to fix mistakes found by courts even though it concedes it will not litigate the issue further.

This TIGTA report bears at least a skim if you have concerns about the offset of your client’s funds because it provides some detail on the process. This is an efficient process that could become even more efficient in the future.

A Different Type of Offset Fight – Illegal Exaction

In Greene v. United States, the Court of Federal Claims determined that the IRS could offset a federal tax refund against a criminal fine.  Mr. Greene filed a joint return for 1990 with his then wife, Sandy.  They reported a tax liability of $8,870.  Their withholding credits exceeded that amount so they received a small refund.  Subsequently, the IRS audited their return and determined that they had forgotten to report an additional $888,497 of income.  Ms. Greene was determined to be an innocent spouse.  The IRS came back and assessed additional liabilities including the fraud penalty against Mr. Greene.

On September 1, 2005, Mr. Greene was convicted of evasion of the payment of taxes and subscribing to a false tax declaration. The district court entered a judgment against him imposing a 70 month prison sentence and a $500,000 fine.  In 2012, Mr. Greene settled a tax refund suit that was distinct from the criminal action and received a $437,423 tax refund for 1995.  The IRS offset this refund to satisfy the $500,000 fine.  He brought suit to reverse the offset and obtain his refund.  This was not a refund suit in the traditional sense but rather a suit over the correctness of the offset of the refund.  The IRS allowed the refund but then, according to Mr. Greene, made an illegal exaction.

read more...

Mr. Greene brought suit to recover the refund amount based on the legal theory of illegal exaction. Tax professionals are accustomed to offset under IRC 6402 but the federal government has broader offset powers as well partially discussed in an earlier post.  In looking to determine whether it had jurisdiction over this matter, the Court of Federal Claims looked to the Tucker Act which is the principal statute governing its jurisdiction.  The Tucker Act waives sovereign immunity for claims against the United States if the claim is found, inter alia, in the Constitution or a federal statute.  The Tucker Act itself does not provide for remedies but provides jurisdiction.  Here, the plaintiff pointed to “illegal exaction” as the basis for the Court’s jurisdiction and for relief.  Illegal exaction “involves money that was improperly paid, exacted, or taken from the claimant in contravention of the Constitution, a statute or a regulation.”

The Court said that “the prototypical illegal exaction claim is a tax refund suit alleging that taxes have been improperly collected or withheld by the government.” However, a taxpayer may allege an illegal exaction claim not grounded in tax refund.  The Court cited to Section 6402(g) stating “[n]o action brought against the United States to recover the amount of any such reduction [of a tax refund by an offset] shall be considered to be a suit for refund of a tax.”  The reason that a suit seeking to set aside an offset is not a suit for refund is that the IRS has granted the refund and the granting of the refund created the basis for making the offset.  So, a taxpayer unhappy with the offset of a refund is not fighting with the IRS about the refund.  Rather, it is fighting with the federal government about the taking of the refund and applying it somewhere else instead of sending it to the taxpayer.  When the federal government offsets a refund and applies it to another tax year, then the refund provisions are implicated with respect to the other tax year.  If, however, it applies the refund to something other than taxes then the general offset provisions set forth in 31 USC 3720A are implicated and the individual can bring an action arguing that the provisions of that title were not met as the offset occurred.

The Court stated that to invoke its jurisdiction under the Tucker Act “a claimant must demonstrate that the statute or provision causing the exaction itself provides, either expressly or by necessary implication that the remedy for its violation entails a return of money unlawfully exacted.”   Here, it found that 31 USC 3720A “necessarily implies a monetary remedy if the Government perpetrates an illegal exaction pursuant to [its] authority [because] … absent a monetary remedy, a litigant has no recourse to cover wages unlawfully garnished or income tax refunds unlawfully offset.”  The Court pointed out that although the Flora rule requires full payment in order to sue for a tax refund claim, “a plaintiff who alleges an illegal exaction claim based on an offset need not have fully paid the tax liability for this court to have jurisdiction” citing Ibrahim v. United States, 112 Fed Cl 333, 336 (2013).

Mr. Greene argued that in making this offset the government did not follow the requirements of 31 USC 3720A because it failed to notify him of the proposed offset, failed to allow him 60 days to present evidence that his fine was not past due, it failed to properly certify the debt and it failed to make reasonable efforts to obtain payment of the debt from him. You can see from these arguments and from looking at the statute that the basis for making an illegal exaction argument does not turn on whether the underlying liability to which the payment was applied was a valid debt.  Mr. Greene did not argue that he did not owe the $500,000 fine.  Rather, he argued that the IRS did not go through the proper steps before it got the Treasury Department to make this offset, viz., it failed “to notify him of the proposed offset; to allow him sixty days to present evidence that all or part of the fine was not past due; to certify the debt; and to make a reasonable effort to obtain payment of any debt.”

The IRS filed a motion to dismiss based on lack of subject matter jurisdiction and the parties filed cross motions for summary judgment. The IRS argued that it did provide Mr. Greene with notice before the offset occurred and with notice after it occurred.  The IRS also argued that the debt was certified.  It said that it referred the matter to the Treasury Offset Program in 2006 and that it certified the debt annually each year thereafter.  The IRS next argued that the judgment in the criminal case allowed it to levy or execute on his property even if he were paying according to the schedule of payments imposed by the judgment.  Finally, the IRS argued that even if it committed a procedural foot fault, return of the proceeds was not the appropriate remedy and further that if the court awarded Mr. Greene a monetary judgment as a result of any procedural error the IRS would be required by 31 U.S.C. 3728 to offset that monetary judgment as well.

The court next provides a fairly detailed description of the DOJ system for collecting on judgments. This section is of the opinion is worth reading if you want a primer on the steps DOJ takes when entering judgments into its computer system and generating notices.  Many parallels exist between this system and the IRS computer system for assessing and recording collection action.  Although the DOJ system did not contain copies of the precise letters sent to Mr. Greene the testimony of the DOJ employees convinced the court that it entered his information correctly and appeared to have followed the correct procedures.  The court agreed with the government that the debt was past due at the time of the offset because the judgment order required immediate payment and specifically allowed the IRS/DOJ to take steps to collect it if it were not immediately paid.  With respect to the damages Mr. Greene requested, the court found that it appeared the IRS had complied with all of the requirements of the notice statute, that even if it had not complied the court had no basis for returning the proceeds or ordering a monetary judgment.

The case is instructive concerning the process of offset where the IRS is getting the benefit of offset to satisfy a judgment. The court walks through the statutory requirements and provides a map for others to follow if they feel the government has not properly performed an offset in these circumstances.  In the end, this type of case appears extremely difficult to win which is why so few of these cases make it to published opinions.

Is A Claimed Refund the Taxpayer’s Property? Tax Court Holds Yes in the Estate Tax Context

Earlier this month in Estate of Badgett v Commissioner, the Tax Court had occasion to consider whether over $400,000 in an unpaid refund attributable to a 2011 tax return was considered part of Russell Badgett’s estate when he died in March 2012, prior to the filing of Badgett’s 2011 individual income tax return. The case raises an important estate tax issue, and I will describe it below. However it caught my attention because of its possible implications when IRS holds refunds without notifying or explaining its actions, a practice we have heard about in past posts such as Freezing the Refunds of Our Guests. In this post I will describe the Badgett case and also explain why its rationale may have significance in areas removed from the estate tax context, including ensuring fair treatment for individuals who claim refunds.

read more...

In Badgett the taxpayer died in March 2012, prior to filing his 2011 individual return. When the executor filed the 2011 individual return, it reflected a substantial overpayment and requested a refund of over $400,000, and also applied a small amount of the overpayment to Badgett’s estimated individual income taxes for 2012. After the executor filed the 2011 individual return in May 2012, the IRS issued the $400,000 plus refund to the estate, and applied a small portion of the overpayment to the 2012 year. When the estate filed its estate tax return in December of 2012, it did not include the refund from Badgett’s 2011 1040 as part of the estate’s gross value, nor did the estate tax return reflect the small amount of refund attributable to Badgett’s 2012 1040. IRS examined the estate, and proposed a deficiency attributable to the estate’s not including the refunds in the gross estate.

The Tax Court decided that the estate should have included the refunds attributable to both the 2011 and 2012 individual returns as part of the estate’s gross estate. In so doing it worked its way through the thicket of Kentucky state law and some cases which on the surface appear to support the estate’s position that the refund should not be part of the gross estate.

The Issue: Estate Tax and Overpayments

To start the Tax Court framed the estate tax issue. It noted that Section 2031(a) provides that “[t]he value of the gross estate of the decedent shall be determined by including to the extent provided for in this part, the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated.”

It then looked to Section 2033, which provides that “[t]he value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death.”

This teed up the issue: was the claimed but unpaid refund part of Badgett’s property at the time of his death?

The estate looked to Kentucky law (Badgett’s residence), which provided that “property must be in existence on the tax assessment date to be subject to tax and cannot be a mere possibility or expectancy.” To that end, its view was that the “overpayment does not create a right to an income tax refund” and that “there is no property interest until the refund has been declared by the Government.”

As further support, the estate looked to cases that considered the issue in light of the offset powers of Section 6402, which provides as follows:

In the case of any overpayment, the Secretary, within the applicable period of limitations, may credit the amount of such overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment and shall, subject to [ offsets for past due child support, state tax and certain other federal debts] refund any balance to such person.

There were two cases that relied in part on Section 6402’s offset powers in finding that an overpayment did not constitute a property interest, one in the bankruptcy context and the other in the estate tax context. The bankruptcy case was In re Piggot, a bankruptcy case in which the “IRS sought to offset an unpaid dischargeable tax debt of the debtors (husband and wife) incurred in 1996 and 1998 against a “potential” tax overpayment they made in 2004.”

In that case, the bankruptcy court found that the debtors’ tax overpayment was not a property interest, stating: “[T]he court is convinced that the tax law that holds that an overpayment is not the same as a refund is correct. Since an overpayment is not credited to the debtor until after offsets have occurred, if the IRS chooses to make such offset, there is no property interest in a debtor until the refund has been declared.”

In the estate tax context there was a Third Circuit case affirming the Tax Court which likewise found that the overpayment was not property. Estate of Bender v. Commissioner, 827 F.2d 884 (3d Cir. 1987), aff’g in part, rev’g in part 86 T.C. 770 (1987):

[Bender] was an estate tax case in which the testator had unpaid Federal tax liabilities for years other than those involving the tax overpayments. The Court of Appeals for the Third Circuit concluded that the testator did not have a property interest in the tax overpayments for purposes of calculating his gross estate. The court held that the IRS’ discretionary power to offset the testator’s tax overpayments against his unpaid liabilities meant that the estate could not compel the IRS to issue a tax refund for the years for which the testator overpaid his taxes; therefore, the tax overpayments “never attained the status of independent assets for estate tax purposes.”

In Badgett the Tax Court distinguished Bender and Piggot because of the presence in those cases of “undisputed and unpaid tax liabilities.” This is where tax procedure enters the picture. Under Section 6402 IRS has discretion to apply the overpayment to satisfy the debt or issue a refund; absent the liabilities the statute says the IRS “shall” issue the refund. Looking to Section 6402 as the key to the case, the Tax Court noted it “reached a different conclusion in another case where a deceased taxpayer had no tax liabilities to which a tax overpayment could be offset. Estate of Chisolm v. Commissioner, 26 T.C. 253 (1956). As such, in Chisolm it found “that the full value of the deceased taxpayer’s viable but unasserted income tax refund claim was an asset of the estate”:

The entire taxes on the income of Harvey [the deceased taxpayer] and his wife for 1950, as disclosed on the return filed for that year, were paid by Harvey. He was dead at the time the return was filed and of course did not join in filing it. However, the type of return that was filed for that period is immaterial as is the crediting of the overpayment as requested on that return. The fact is that Harvey had overpaid not only his own taxes but those of himself and his wife. The resulting overpayment was really his. It was valuable property and a part of his estate at the time he died. It was includible in his estate under section 811(a) [a precursor to the current section 2033], and incidently would have been includible in his estate even if it represented jointly held property since he had supplied the entire consideration therefor. * * *

There were a couple of other post-Chisolm Tax Court cases where there was no offsetting liability when the Tax Court also held that the refund was part of the gross estate. To the Tax Court, Chisolm and those cases controlled:

We believe it proper to herein follow the holdings in these cases. Simply stated, if no offsetting liability exists, section 6402(a) is clear: The statute mandates that the IRS “shall” refund any balance to the taxpayer. In the matter herein, there is no indication that decedent was subject to any liability or obligation against which the IRS could offset his overpayments. The status of the tax refund is more than a mere expectancy; the estate has the right to compel the IRS to issue a refund for the years for which decedent overpaid his tax. Thus, we hold that the overpayments in question attained the status of independent assets for estate tax purposes; they constitute decedent’s property for estate tax purposes.

When is an Overpayment Property of the Taxpayer? Other Contexts

The estate tax issue is interesting enough, and that alone would warrant a PT post. What tipped the scales for me, however, is the discussion in the opinion concerning the nature of the taxpayer’s interest in the overpayment. The estate argued that “a taxpayer has ‘no legal right’ to a tax refund unless and until the taxpayer files a successful suit within the permitted statutory periods against the IRS for that tax refund after meeting all conditions precedent.” The estate cited to a number of cases that it alleged supported its view, including the 1996 Lundy Supreme Court case where the Court held that the Tax Court lacks jurisdiction to award a refund of tax paid more than two years prior to the IRS mailing a taxpayer a deficiency notice where the taxpayer failed to file a  return. The Tax Court in Badgett was not persuaded that those cases supported the estate’s argument:

These cases do not support the estate’s contention. Rather, they merely discuss the requirements imposed on a taxpayer of prosecuting a tax refund action.

We therefore hold that decedent had property interests in the values of his 2011 and 2012 Federal income tax refunds and consequently the refunds are included in the value of decedent’s gross estate for Federal estate tax purposes.

In the International Taxpayer Rights Conference two weeks ago I gave a talk on a paper I am writing considering both legal on nonlegal ways to counter agency actions that deprive taxpayer rights. On the legal side, I pointed to three main areas, administrative law, constitutional law and organic agency statutes. Constitutional law and in particular procedural due process have at times been like the red-headed stepchild in this list, though perhaps that may change.  The presence of a property interest is essential when one considers what protections are due when the government takes actions that may deprive access to that property right. Procedural due process under the 5th Amendment generally requires that individuals receive adequate notice and the opportunity for a hearing prior to the deprivation of a protected interest. It is always an uphill struggle when arguing that IRS procedures may trigger a procedural due process challenge, in part because the Supreme Court in cases stemming from the 19th century has held that in certain exceptional areas (including tax) a postdeprivation hearing may be sufficient process when essential government needs must be satisfied. In addition, there is some uncertainty as to when a property interest arises in the context of applications for benefits in the nontax context, though recent cases suggest that applications for benefits where the government does not exercise meaningful discretion in determining eligibility may trigger a property inteterest worthy of constitutional protection. Those cases have bearing in considering procedural protections that should attach to returns claiming refundable credits.

The Badgett distinction between cases where the IRS knows about undisputed and unpaid liabilities and other scenarios may be important not just for the estate context in which it arises. Badgett suggests that absent undisputed liabilities to which the Service can use its offset powers, taxpayers have a property interest in the receipt of refunds claimed on returns. We have discussed in PT how on occasion IRS sits on refunds or fails to adequately explain why it chooses to not issue a refund. In addition, the National Taxpayer Advocate has on multiple occasions (such as here in a 2013 report) criticized IRS for failing to issue refunds when the taxpayer’s return preparer may have engaged in abusive and illegal behavior and altered a return to ensure that the preparer rather than the taxpayer gets funds that rightfully belong to the taxpayer. Relatedly I have criticized the lack of adequate explanation or defined standards and process to challenge the IRS’s imposing a ban on individuals who IRS has claimed have recklessly or fraudulently claimed an EITC, actions that may inhibit taxpayers from receiving and even claiming refunds to which they may be entitled to receive.

In past papers I have criticized the rationale in older Supreme Court cases that take a narrow view of procedural due process in the tax context, in part due to those cases’ overstatement of the government interest and failure to consider the individual interest in prompt payment and procedures to help ensure that the government does not erroneously deprive people of property. The individual interest is even more enhanced when Congress for better or worse uses the Code to deliver benefits in the form of refundable credits. I think recent examples of IRS sitting on refunds and freezing them without adequately explaining itself raise at a minimum fairness concerns and may in fact trigger a relook at some of the constitutional underpinnings of IRS procedures. While the IRS has a strong interest in ensuring integrity, minimizing overclaims and detecting fraud, framing as Badgett does overpayments as property of the taxpayer should remind the IRS in other contexts that it needs to more carefully consider individuals’ interests. If it does not the courts will likely force the issue.