Freezing the Refunds of Our Guests

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PT is excited to put up its 500th post today.  We thank you for following us on this journey into the nooks and crannies of tax procedure.

Today we welcome first time guest blogger Sonya Miller.  Sonya was my student and clinic co-worker at Villanova where she obtained her LLM.  Villanova’s LLM program has tuition assistance for students who work 20 hours per week in the clinic while studying for their LLM.  Sonya was one of the amazing recruits to Villanova as a result of this program.  (If you know someone seeking an LLM that also wants tax controversy experience, tell them to check out the program.)  She clerked after her LLM and is now starting a new tax clinic herself.  She writes to talk about a group of cases that her clinic has encountered as it starts up.

Refund freezes are not a new thing.  For those practicing in the earned income tax credit (EITC) area, you know that the IRS routinely freezes the refunds of individuals seeking the refundable EITC.  So, the IRS does not just pick on guests but freezes refunds of other vulnerable citizens.  The IRS usually engages in freezing refunds where it feels vulnerable itself because sending out the refund will be the last it sees of those dollars and the circumstances surrounding the claim suggest that the taxpayer may not qualify for the requested amount.  The decision to freeze may make perfect sense as a tactic to avert inappropriate revenue loss; however, the lack of communication to the affected individuals coupled with the blunt rather than surgical use of the tactic lands the IRS once again in the doghouse. 

Taxpayers have remedies although they may not be easy remedies to pursue.  For those who read the recent post on bypassing normal channels at the IRS, take a look at the excellent comments it has drawn suggesting additional strategies.  In effect Sonya is exercising the strategy suggested by one commentator – publicity of the problem.  The other commentator suggests litigation and that soon will be available to Sonya’s clients.

It can be easy to forget that a tax return is a refund claim.  If the IRS freezes a taxpayer’s refund for more than six months, the door to the district courts swings open.  This is a strategy that Rob Nassau who directs the tax clinic at Syracuse has employed for frozen EITC refunds.  The next post from Sonya may describe the best procedure for bringing suits in these cases and her dealings with the Department of Justice Tax Division.  Keith

 

The Federal Tax Clinic at the University of South Dakota School of Law began operations this fall. We are aware of a group of nonresident taxpayers (taxpayers that fall under the rules for aliens temporarily present in the United States as students, trainees, scholars, teachers, researchers, exchange visitors, and cultural exchange visitors) who had their 2014 refunds frozen. Their refunds were the result of Form 1042-S (Foreign Person’s US Source Income Subject to Withholding) withholdings. The taxpayers were not aware of why their refunds had been delayed. We believe that they are among the many nonresident taxpayers whose refunds the IRS began systemically freezing this year.

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In an IRM Procedural Update issued January 30, 2015, IRM 21.8.2.12.2.3, the Service advises that beginning January 1, 2015, it will systemically freeze a taxpayer’s entire refund where the taxpayer filed Form 1120-F and any portion of the refund is supported by a Form 1042-S. The freeze lasts up to 168 days, during which time Compliance will check the validity of the refund. If Compliance finds that the refund is not valid, the IRS will extend the freeze. If a taxpayer calls the IRS inquiring into the status of the refund, then the Service will advise the taxpayer that “[t]he IRS will need additional time to process your return. Please allow IRS up to six months from the original due date or the actual filing date of the return whichever is later to receive your refund.”  The IRM provides that no notices will be generated regarding the systemic freeze. However, if taxpayers call the IRS and claim hardship as the result of not having received their refund, the IRS will refer them to the Taxpayer Advocate Service. Although IRM 21.8.2.12.2.3 presumably applies only to taxpayers filing Form ll20-F, i.e. foreign corporations, it appears that the IRS is also applying the IRM to systemically freeze the refunds of individuals who filed Form 1040NR.

After inquiring into the status of one refund (the taxpayer filed Form 1040NR), the IRS advised us that there was a 168-day hold on the refund because of the taxpayer’s Form 1042-S. IRM 21.8.2.12.2.3 is the only IRS literature we have found that references a 168-day freeze for refunds supported by a Form 1042-S, which causes us to conclude that the IRS is likely applying this IRM, meant for Forms 1120-F, to Forms 1040NR. Additionally, similar to the language found in the IRM, the IRS has posted a statement to its website advising taxpayers who filed a Form 1040NR with Form 1042-S that the Service will need up to six months from the due date of the return or the date the return is received, whichever is later, to process the return and issue any refund.

In a follow up communication, the IRS advised us that it issued 3064C Letters to the nonresident taxpayers in mid-September 2015 (about five months after the taxpayers filed their returns) informing them that the Service needed more time to process the returns. We have not seen these letters. However, it is our understanding that the IRS does not address why the taxpayers’ refunds have been frozen or what the taxpayers can do to expedite the process. Prior to these letters, the IRS had not made any attempt to individually notify the taxpayers of the refund delays. As Yogi Berra is quoted to have said, “It’s déjà vu all over again.” The IRS has a significant history of silently freezing refunds.

The National Taxpayer Advocate (NTA) raised the issue of frozen refunds in her Annual Report to Congress as early as 2003 and as recently as 2013. In her 2005 Report the NTA listed Criminal Investigation Refund Freezes as one of the most serious problems within the IRS. Criminal Investigation Refund Freezes are a part of the Questionable Refund Program, which was “designed to identify fraudulent returns, to stop the payment of fraudulent refunds and to refer identified fraudulent refund schemes to Criminal Investigation (CI) field offices.” Although we believe the systemic freeze of refunds supported by a Form 1042-S is more likely the result of proposed Treasury Regulations detailed in IRS Notice 2015-10 than the result of the Questionable Refund Program, the same concerns regarding taxpayer rights noted in the NTA’s 2003, 2005, and 2013 Annual Reports applies.

Notice 2015-10 proposes regulations that affect the treatment of claims for refund and credits made by taxpayers subject to withholding rules under I.R.C. §§1441 – 1443 and §§1471 – 1472. The proposed regulations will allow the IRS to deny refunds to the extent that withholding agents have not deposited the correct amount of withholdings under I.R.C. §6302 and to the extent that reported withholdings are fictitious. As with cases in the Questionable Refund Program, the IRS is understandably concerned about the potential for fraud. This is especially true for withholdings reported on Form 1042-S because both the claimant and the withholding agent may be outside of the United States, making recovery of erroneously issued refunds nearly, if not actually, impossible.

Nevertheless, the problem with systemically freezing taxpayer refunds to investigate the validity of the refunds is that inevitably the “innocent” get caught in a net meant for “bad” actors. Regarding withholdings reported on Form 1042-S, the IRS acknowledges in Notice 2015-10 that perhaps there should be an exception for withholding agents who have a history of compliance or where the refund claimed is de minimis. However, judging from the frozen refunds, it appears that the IRS currently is not applying any such exceptions. If it were, we would think that the withholding agent in many of these cases—e.g., domestic withholding agents that are subject to IRS jurisdiction and have an excellent record of tax compliance (such as U.S. educational institutions), would be excepted from lengthy queries or that the taxpayers’ refunds (sometimes just a few hundred dollars each) would be viewed as de minimis.

The NTA has repeatedly emphasized the IRS’ need to implement proactive handling and management procedures to notify taxpayers that their refunds have been frozen and to provide a reason for such action and an opportunity to address the issue so that the refund claim may be resolved as expeditiously as possible. In 2006 the New York Times reported that the IRS would begin notifying taxpayers regarding frozen refunds, quoting then Commissioner Mark W. Everson as saying “I believe that appropriate notification should be given when refunds are frozen … Honest taxpayers expecting a refund deserve to be treated fairly.” Since then Mr. Everson’s belief that taxpayers deserve to be treated fairly has been made a priority, if not a reality. The Taxpayer’s Bill of Rights gives taxpayers the right to be informed, the right to quality service, the right to challenge the IRS’ position and be heard, and the right to a fair and just tax system. A systemic freeze of taxpayers’ refunds without prompt notice infringes upon these rights. A vague letter to the taxpayer requesting more time to review the return five months after the IRS has already frozen the taxpayer’s refund does not amount to fair treatment.

Comments

  1. Sonya Miller says:

    In addressing these frozen refund cases the Federal Tax Clinic at University of South Dakota School of Law submitted a Systemic Advocacy Management System (SAMS) report to the Taxpayer Advocate Service. As a result of submitting the report we learned today that the National Taxpayer Advocate is aware of the problem detailed in this post and raised the issue in her FY 2016 Objectives Report To Congress (http://www.taxpayeradvocate.irs.gov/2016objectivesreport). We hope that this post highlights and objectifies the NTA’s concern regarding the proposed changes to the treatment of withholdings for nonresident taxpayers.

  2. Bob Kamman says:

    In South Dakota, all refund checks are likely to be frozen unless retrieved promptly from the mailbox. But here is the IRM part added in May, concerning Forms 1042-S that explains “we have 180 days to hold on to the money without paying interest, so that’s what we are going to do.” IRS would deny this has anything to do with the prediction yesterday that the Treasury will run out of cash by early November.

    21.8.1.11.14.2 (05-01-2015)
    FATCA – Programming Beginning January 2015 Affecting Certain Forms 1040NR (TC 810–3 -E Freeze)

    Beginning January 1, 2015 all Forms 1040NR with a refund supported by a Form 1042-S (CRN 330) will have that portion of the refund systemically frozen for up to 168 days. All other refundable credits that exceed the amount of the tax will be refunded or offset normally. See paragraph 4 below for examples.

    No notices will be generated to the taxpayers regarding the systemic freeze, which may result in telephonic or written inquiries referring to the frozen credits. However math error and offset notices will continue to generate normally.

    Note:

    Under the Hiring Incentives to Restore Employment (HIRE) Act enacted March 18, 2010, IRS has up to 180 interest free days to review IRC Chapters 3 and 4 credits.

    The 168 day freeze period begins from the later of the return due date or the date the complete return including all necessary documentation was actually filed.

    Example:

    A complete refund 1040NR is filed in January. The Chapter 3 or 4 credit portion of the refund (CRN 330) will be held until October if the return due date is April 15th.

    Example:

    A complete refund 1040NR is filed in May for a return due in April. The Chapter 3 or 4 credit portion of the refund (CRN 330) will be held until November.

    [more examples follow at]

    http://www.irs.gov/irm/part21/irm_21-008-001-cont02.html#d0e9188

    Meanwhile, Treasury is just a minor player in the game of “screw the aliens.” See the major mistakes recently made by Justice and Homeland Security.

    https://www.washingtonpost.com/national/immigrants-say-about-face-on-visas-costs-them-millions/2015/09/30/14d42706-67d7-11e5-bdb6-6861f4521205_story.html

  3. To all our distinguished “guests,” I must give a heartfelt…”Boo Hoo!” I say it’s best that the IRS (and both the DOJ and DHS) “screw the alien” before the alien screws us–again.

    I wonder if Ms. Miller first inquired into whether our laws authorized the “students…scholars…exchange visitors, and cultural exchange visitors” to work in this country. To me, any returns filed by those “guests” are inherently suspicious.

    These days, the filing of Forms 1040NR with Forms 1042-S by some of our nation’s other “guests” are a red-flag for fraud. But our non-resident alien friends need not fret about our nation’s unfairness:

    If their refund claims are legitimate, then will we not pay them 123 days worth of interest to compensate them for their inconvenience?

  4. Bob Kamman says:

    No, we will not pay them interest, because Congress passed a bill that the President signed allowing an interest-free period of 180 days.

    I am not aware of immigrants who are not authorized to work, filing a 1040NR after receiving a 1042S from employers. It should also be noted that not just wage withholding is reported on that form, and that human beings who have never been to this country and never will be our guests may nevertheless have to file a 1040NR. Even xenophobes should sympathize with them.

    • Bob, you are right again. I.R.C. § 6611(e)(4) provides that–

      “In the case of any overpayment resulting from tax deducted and withheld under chapter 3 or 4, paragraphs (1), (2), and (3) shall be applied by substituting “180 days” for “45 days” each place it appears.”

      That means our “guests” must wait 180 days to get interest on a refund while we citizens still get interest after 45 days. I feel even better now.

      Surely you are aware of immigrants who are not authorized to work filing fraudulent Forms 1040NR based on their “employers'” equally fraudulent Forms 1042-S? Oh, I forgot to ask:

      You knew the 180 day interest free refund period for Chapter 3 and 4 withholdings contained in I.R.C. § 6611(e)(4) arose from the HIRE Act of 2010. Perhaps, then, you can tell us what may have prompted the President and the 2010 Congress (Democrat-controlled in each house) to so “screw the alien?”

      phobia: “an IRRATIONAL fear [of something…or of someone].

  5. Bob Kamman says:

    The problem is NOT individuals from other countries who are employed here, legally or otherwise. The problem, discovered at least as early as 2010 in a TIGTA report that reviewed returns from 2007 and 2008, is that no one was looking at Forms 1042-S submitted by overseas “taxpayers” and matching them up with actual payments received from the alleged issuers.

    Why should there be reverse matching? After all, we don’t do it with W-2 forms. But the potential for fraud had been discovered by the rest of the world. For example, a 1042-S from Nigerian Prince Enterprises could be attached to a Form 1040NR filed by Rodion Raskolnikov of St. Petersburg not Florida. The withholding shown could be substantial. TIGTA’s sample found 22 returns from just one country that claimed a total of $428,000 in excessive refunds. That’s a lot of foreign aid.

    After Congress allowed IRS more time to issue 1040NR refunds without paying interest, things were supposed to get better. According to the TIGTA report:

    ==On January 28, 2010, the IRS started manually reviewing all Form 1040NR returns with refunds greater than $[redacted]. Through May 12, 2010, the IRS reviewed 1,745 returns and held the refunds on 94 of these returns. A total of more than $8.1 million in refunds was claimed on these returns for an average of almost $87,000 per return. The IRS will use the 180-calendar day period to verify that these taxpayers are entitled to the refunds claimed.

    The IRS has established special handling procedures for returns identified in its manual review process as needing further investigation before a refund is issued. All selected returns are coded with Computer Condition Code “O”, which establishes an “X” freeze on the tax period. The Freeze Code “X” will prevent the refund from generating for 26 weeks. This allows time for the IRS to conduct an investigation and verify a refund claim.==

    https://www.treasury.gov/tigta/auditreports/2010reports/201040121fr.html#inaccurate

    TIGTA also claimed that “IRS is developing training material and correspondence letters for the examiners who will be working the Form 1040NR inventory.” Apparently no one developed a letter for the people within our own borders legally, who are helping find a cure for cancer or maybe just forming lifelong opinions about our government that they will take home and share with others for the next 50 years or so.

    IRS will probably argue that they just don’t have enough people down there in Texas (these returns are processed in Austin) to keep up with all the work.

    Why should we care? Think about it. If you want to go to the Olympics next year, your Brazilian visa will cost $160, unless you are a citizen of some country other than the United States (in which case, it costs much less or is free). That’s because we charge Brazilian tourists, who spend millions of dollars here, the same amount for their tourist visa. It’s all about reciprocity. I think there has been some discussion of the Golden Rule lately. How we treat citizens of other countries, often turns out to be how those countries treat our citizens. And in many cases, there are a lot more of us there, than there are of them here.

    • An excellent post, Bob. The tax refund theft problem is apparently worse than either you or I believed.

      Professor Miller identified the problem as:

      “We are aware of a group of nonresident taxpayers (taxpayers that fall under the rules for aliens temporarily present in the United States as students, trainees, scholars, teachers, researchers, exchange visitors, and cultural exchange visitors) who had their 2014 refunds frozen.”

      From what she wrote, I don’t understand Professor Miller’s concern as being the machinations of those such as “Nigerian Prince Enterprises” or Mr. “Raskolnikov.”

      It seems, however, that the IRS is working on the cure to the cancer injected into our body politic by our not-so-distinguished guests. May those guests come to share a life-long opinion that the citizens of this nation are not ones with whom to trifle.

  6. Several of my clients are WTA professional tennis players from foreign countries. I have filed 1040NR forms for them and the IRS has placed holds of 168 days on their refunds with no notice. Their earnings and ID’s are public record. This is an embarrassment to our country not to refund money to these public figures.

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