Freezing the Refunds of Our Guests

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.


In an IRM Procedural Update issued January 30, 2015, IRM, 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 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 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.