How a Credit is not the Same as a Refund

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We are still working out logistics to get Christine Speidel full access to the blog site. In the meantime I introduce her most recent post which focuses on the distinction between giving a taxpayer credit and giving the taxpayer a refund. Keith

On April 4, 2018, the Eleventh Circuit ruled in Schuster v. Commissioner that a credit applied to a taxpayer’s account is not the same thing as a refund. This was bad news for the taxpayer.

Sometimes the IRS messes up when it applies payments, and mistakenly gives the taxpayer an account credit or a refund that the taxpayer did not deserve. If the error is discovered many years later, it can get complicated to figure out where the parties stand and which remedies are available to each.

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Mr. Schuster’s case stems from an IRS error in 2005, when it applied an $80,000 check meant for his mother’s taxes to Mr. Schuster’s 2004 income tax account. If Mr. Schuster had requested a refund when he filed his 2004 tax return, the case would be very different and the outcome might have changed. Instead, Mr. Schuster’s tax returns for 2004 through 2007 asked that his refunds be applied to the following year’s estimated tax. (Line 77 on the current Form 1040)

In 2011, the IRS discovered its mistake and reversed the erroneous credit. Mr. Schuster had made payments (apart from the $80,000) that satisfied his tax liabilities for 2004 and 2005, but not for 2006. So, after the credit was reversed the IRS sent Mr. Schuster a bill for his 2006 balance due. The case came before the Tax Court on a CDP appeal of a notice of intent to levy.

The government has many mechanisms it can use to collect from taxpayers who owe money to the Treasury. One of these mechanisms is an erroneous refund suit under section 7405. An erroneous refund suit must be brought within 2 years of the refund, except in cases of fraud. IRC 6532(b). Mr. Schuster argued that the $80,000 credit applied in 2005 was an erroneous refund that started the 2-year clock running. He argued that the IRS effectively created an end-run around 7405 by using its administrative collection powers, and it should not be permitted to do that. For its part, the IRS argued that the error at issue was a “credit transfer” which did not implicate section 7405 at all. In the IRS’s view, the appropriate statute of limitations is found in section 6502, providing for a 10-year collection period following assessment of tax. Both the Tax Court and the Eleventh Circuit sided with the IRS.

From a taxpayer’s perspective one can understand how unfair this feels. The $80,000 would have been refunded to the taxpayer had he not elected to have it credited to his 2005 (and then 2006) liability. I imagine Mr. Schuster thought he was doing a good deed as a taxpayer by making that election. If he had received a refund check and then sent an estimated tax payment to the IRS, section 7405 would apply. Economically the taxpayer would be in the same position. But the tax code does not run on fairness or logic. Also, there are complications beyond the distinction between a refund and a credit.

In the 1990s there were seven circuit court cases that addressed whether the government could treat erroneous refunds as unpaid tax, and thereby use its administrative collection powers to recover the funds. The government lost those cases. The courts of appeals held that once a taxpayer has paid their assessed taxes, a subsequent erroneous refund does not re-open the liability, and therefore the erroneous refund cannot be treated as an unpaid tax liability to be collected administratively under the original assessment. See O’Bryant v. United States, 49 F.3d 340, 346 (7th Cir. 1995); Mildred Cotler Trust v. United States, 184 F.3d 168, 171 (2d Cir. 1999); Stanley v. United States, 140 F.3d 1023, 1027-28 (Fed. Cir. 1998); Singleton v. United States, 128 F.3d 833, 837 (4th Cir. 1997); Bilzerian v. United States, 86 F.3d 1067, 1069 (11th Cir. 1996); Clark v. United States, 63 F.3d 83, 87 (1st Cir. 1995); United States v. Wilkes, 946 F.2d 1143, 1152 (5th Cir. 1991). For example, in the O’Bryant case, the taxpayers fully paid their liability but the IRS accidentally credited the payment twice, and issued a refund check. The Court held that the IRS could not use its administrative lien and levy procedures to recoup the erroneous refund.

Unfortunately for Mr. Schuster, he had not actually paid all of his assessed taxes for 2006. The Tax Court opinion (by Judge Chiechi) cites the Clark and Wilkes cases for the proposition that a tax assessment can only be extinguished by a payment tendered by the taxpayer, and not by an IRS clerical error. (Refunds resulting from clerical errors are often referred to as nonrebate refunds.) Therefore, the court holds that the 2006 assessment was not extinguished by the $80,000 credit, and the IRS could use its administrative collection powers to pursue the balance. The Court further found that the erroneous credit was not a refund for purposes of section 7405, so the two-year time limit did not apply.

The Eleventh Circuit affirmed the Tax Court, under different (though not inconsistent) reasoning. The per curiam opinion is short and to the point. The court notes that the Code distinguishes between a refund and a credit in several places, and section 7405 specifically only refers to refunds. Therefore, following basic statutory interpretation principles, the Eleventh Circuit holds that section 7405 does not apply to erroneous account credits.

Is the lesson for taxpayers to eschew line 77 and always request their refund? This does not guarantee a windfall for the taxpayer as the government may act within the 2 years or it may be able to use other mechanisms to collect the funds, but it makes the government’s task more difficult especially if the taxpayer takes care to remit legitimate payments covering their assessment.

 

 

 

 

 

 

 

 

 

 

 

Comments

  1. Norman Diamond says:

    “Mr. Schuster’s case stems from an IRS error in 2005, when it applied an $80,000 check meant for his mother’s taxes to Mr. Schuster’s 2004 income tax account.”

    Does this mean a check, i.e. Mr. Schuster’s mother sent a payment and didn’t get credit for it? Surely she would have a dispute with the IRS in 2005 or 2006. Why wasn’t the error caught quickly?

    Or does this mean a credit, i.e. Mr. Schuster’s mother was supposed to get a credit from somewhere, but she didn’t know about it, so she didn’t complain?

    “If Mr. Schuster had requested a refund when he filed his 2004 tax return, the case would be very different and the outcome might have changed. Instead, Mr. Schuster’s tax returns for 2004 through 2007 asked that his refunds be applied to the following year’s estimated tax.”

    I think this must mean that Mr. Schuster asked for his credits to be applied, not his refunds. I read somewhere that the difference is crucial ^_^

    For Mr. Schuster to request a credit to be applied, doesn’t his return have to specify the amount of credit to be applied? Did he specify an amount which he knew he had not been entitled to be credited? Or did the IRS alter the amount of credit that it applied, to be $80,000 more than the amount that he asked for? If the IRS made the alteration, did they fail to send him a notice? Whatever the answers are, it seems some party acted fraudulently.

    “In the IRS’s view, the appropriate statute of limitations is found in section 6502, providing for a 10-year collection period following assessment of tax.”

    There was an asessment of tax? Was it preceded by a Notice of Deficiency and a waiting period of 150 or 90 days depending on Mr. Schuster’s residence?

    “The court notes that the Code distinguishes between a refund and a credit in several places,”

    That is most definitely true. For example a taxpayer’s withholding is a credit to the taxpayer’s account regardless of whether the IRS acts to obey the law or whether (see TIGTA) an embezzler credits it to her own account. But the IRS doesn’t have to refund the credit unless it wants to or unless a court orders it. Unfortunately these cases usually end up in courts where the IRS doesn’t participate, the DOJ gets to overturn IRS administrative actions, and the court lacks jurisdiction to review them.

    “Is the lesson for taxpayers to eschew line 77 and always request their refund?”

    For dishonest taxpayers the answer is surely yes, but for honest taxapyers I wonder. Did Mr. Schuster’s mother act honestly but regret choosing to apply a credit instead of getting a refund?

    • Guest Blogger Guest Blogger says:

      Thanks for your comments, and for the reminder to always be careful about language. We can only speculate about some of the questions you raise, unless someone with personal knowledge of the situation chooses to share more of the background and facts. From the court decisions we know the taxpayer actually sent money to the IRS in 2005 to pay his mother’s liability. There is no suggestion that Mr. Schuster’s mother engaged in any wrongdoing, and there were no “credit” complications with the 2005 payment (or with the mother’s taxes at all, from what we know).

      We don’t know why the IRS took so long to discover the misapplied payment, or why Mr. Schuster’s mother did not notice her balance due. Many taxpayers do not read correspondence from the IRS, even when they do not have someone else helping with their finances. That Mr. Schuster sent the payment could indicate that his mother was unable to do so. On the IRS side, perhaps it took many years for a revenue officer to be assigned to the mother’s case. This is complete speculation.

      We don’t have access to Mr. Schuster’s tax returns to see what amount was on line 77 each year. I do not think there was necessarily fraud. Taxpayers do not always keep good records of their estimated taxes or other credits. It is possible that Mr. Schuster’s preparer got an account transcript and used the figure on the transcript for the estimated tax payments. It is also possible that the IRS corrected the amount reported on line 65 to match its records, and then corrected the amount on line 77 to match the new overpayment amount. Correcting estimated tax payments does not even rise to the level of a math error, according to the IRM. (21.5.4.3.1 (07-07-2017)) The taxpayer would only get a CP12 notice.

      You also asked if a Notice of Deficiency was sent. That question gets at the crux of this case. Assessments of tax were made when Mr. Schuster filed returns, under section 6201(a)(1). (Often called a self-assessment.) The question in this case was: if the IRS reverses an erroneous credit, can the IRS then use its administrative levy powers to collect the suddenly-unpaid original assessment? The notice of intent to levy in this case was based on the 2007 “self-assessment” of Mr. Schuster’s 2006 income tax liability. That passed muster with the Tax Court and the Eleventh Circuit.

      Christine Speidel

  2. Norman Diamond says:

    “From the court decisions we know the taxpayer actually sent money to the IRS in 2005 to pay his mother’s liability. There is no suggestion that Mr. Schuster’s mother engaged in any wrongdoing”

    Of course there is no suggestion that Mr. Schuster’s mother engaged in wrongdoing. I didn’t think of the possibility that the payment check which was intended for Mr. Schuster’s mother was sent by Mr. Schuster himself. Maybe both taxpayers were unaware of the IRS’s misapplication of the payment.

    “It is possible that Mr. Schuster’s preparer got an account transcript” …

    … and relied on the transcript. That’s understandable. Courts rely on IRS transcripts too, even after being shown how IRS transcripts contradict each other. The word needs to get out that those transcripts are useless.

    “Correcting estimated tax payments does not even rise to the level of a math error, according to the IRM. (21.5.4.3.1 (07-07-2017)) The taxpayer would only get a CP12 notice.”

    OK, it looks like CP12 is for a clerical error and it might comply with the statute on mathematical and clerical errors. It would be interesting to find out if the IRS sent one to Mr. Schuster’s mother.

    “(Often called a self-assessment.)”

    Right, a self-assessment doesn’t have to be preceded by a Notice of Deficiency and a waiting period. I think we can infer that the IRS did not make an assessment.

    But if Mr. Schuster’s preparer relied on an IRS transcript, it still seems to me the IRS would have to give some kind of notice before proceeding to an intent to levy.

  3. “Does this mean a check, i.e. Mr. Schuster’s mother sent a payment and didn’t get credit for it?”

    It would have to be, no? It certainly seems that mom would be deemed to have made an estimated payment in 2011, the year the IRS found the mistake and “reversed” Mr. Schuster’s credit. And the IRS should have reversed it right onto mom’s 2004 tax return (or mom’s 2005 tax return, that aspect isn’t totally clear). (This assumes IRS didn’t also give credit to mom beforehand). Presuming mom had already (timely) filed a 2004 tax return (which might be a big presumption), and assuming mom’s 2004 liability had already been satisfied, here she sits with an $80,000 illegally collected “amount.”

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