Unlucky Friday the 13th: No Refunds this Year for Taxpayers Who Defer Paying Mandatory Repatriation Tax?

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Today we welcome back guest poster Tom Greenaway and his colleague Mike Zima. Tom is a principal, and Mike is a senior manager, in KPMG’s Tax Controversy Services practice. We are fortunate to gain their insights as they describe the approach IRS is taking to overpayments and mandatory repatriation liabilities this filing season. These issues primarily affect our nation’s largest taxpayers. Keith

With last year’s tax reform, Congress gave taxpayers the option to pay their section 965 mandatory repatriation liability in installments over eight years. The IRS has issued guidance on the reporting and payment of section 965 liabilities in the form of several different Notices and Q&As on the Service’s website.  

On April 10, 2018, the Service Q&As directed taxpayers to make two separate payments: (1) a payment towards non-section 965 liability; and (2) a payment towards section 965 liability paid by check or money order and labeled “2017 965 Tax.” Except for U.S. citizens living outside of the United States and Puerto Rico, both payments were due at the due date of the taxpayer’s income tax return, without extensions. For calendar-year taxpayers, that date was April 17, 2018. 

On Friday, April 13, 2018, one of the last business days before the filing deadline, the Service updated its section 965 Q&As to inform taxpayers that no refunds or credits of 2017 tax payments will be processed unless and until the amount of payments exceeds the entire 2017 income tax liability, including all amounts to be paid in installments under section 965(h) in subsequent years. This means that any overpayments will be applied to the deferred section 965 liability before being refunded.

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Example 

For example, say you owe $1,000 in 2017 income taxes before considering mandatory repatriation, and your section 965 mandatory repatriation tax liability is $500. Congress gave taxpayers the option to pay that $500 mandatory repayment liability in eight annual installments of increasing amounts, an option most taxpayers plan to select for obvious cash flow reasons. The first installment, which was due on April 17, 2018, is eight percent of the $500, or $40. Let’s further assume that you made $1,200 in estimated payments for 2017—more than enough to cover both the normal tax liability and the first section 965(h) installment payment. 

Until April 13, most taxpayers had assumed that if their 2017 estimated tax payments and credits totaled more than their regular tax liability plus the first section 965 installment ($1,040 in my example), any excess payments would be refunded or available to be used as a credit towards 2018 estimated taxes ($160 in my example: $1,200 – $1,040 = $160). That assumption is wrong, based on the Friday-the-13th administrative guidance posted on the IRS website. 

Instead, IRS will take any overpayment reported on the 2017 Form 1120 and apply it to the deferred section 965(h) balance, leaving little or nothing left to be applied to 2018 (nothing in my example).

Authority 

The IRS is on solid technical ground. It is a bedrock principle of tax procedure that taxpayers are only entitled to a refund or a credit if they pay more in taxes than they owe. See Lewis v. Reynolds, 284 U.S 281 (1932). As a technical matter, individuals and other calendar-year taxpayers owe their total section 965 liability on April 17, 2018, even if they defer payment by electing into the statutory installment plan. (The section 965 inclusion also increases Subpart F income in the last taxable year of a deferred foreign income corporation which begins before January 1, 2018. See I.R.C. § 6403.) On the other hand, when and if IRS applies overpayments to deferred mandatory repatriation liabilities, IRS will undermine the deferral election Congress granted taxpayers. 

The Problem & Taxpayer Responses

The big problem is that IRS announced this guidance on one of the last business days before the tax deadline. Cash flow is important to all taxpayers. Until Friday, April 13, thousands—if not millions—of taxpayers had been banking on using their 2017 overpayments for things other than pre-paying what they thought were deferred section 965 tax liabilities. Many thoughtful and conservative taxpayers subject to section 965 responding to the initial set of Q&As IRS issued in March paid more in estimated taxes than they thought they would owe, just in case, thinking that any overpayments would be available for refund late this year when they filed their tax returns. Those taxpayers will be disappointed.

Billions of dollars hang in the balance. The Joint Committee on Taxation estimated that taxpayers would defer payment of more than $250 billion in mandatory repatriation liabilities.

The day after IRS revised its Q&As, on April 14, KPMG recommended that corporate taxpayers adversely affected by the Service’s late-breaking guidance should consider filing Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax, no later than April 17, 2018 in order to preserve the effect of their section 965(h) installment election. That narrow window is now closed.

Frozen Forms 4466

Moreover, we recently learned that the Service has halted the processing of Forms 4466 in cases where taxpayers have told IRS they will have a section 965 liability.

Prepayments of tax liabilities are generally considered tax payments. See Ott v. United States, 141 F.3d 1306, 1309 (9th Cir. 1998). Section 6513(b)(1) provides that estimated taxes are “deemed to have been paid” on the original due date of the return for the tax to which the prepayment relates. See Baral v. United States, 528 U.S. 431 (2000).  Nevertheless, the tax law has always drawn a distinction between tax payments and deposits. See, e.g., Rosenman v. United States, 323 U.S. 658, 662 (1945). Courts look to a taxpayer’s intent when deciding whether a remittance is a payment or a deposit. See Zeier v. IRS, 80 F.3d 1360 (9th Cir. 1996); Ewing v. United States, 914 F.2d 499, 502-03 (4th Cir. 1990); Ameel v. United States, 426 F.2d 1270, 1273 (6th Cir. 1970); Fortugno v. Commissioner, 353 F.2d 429, 435 (3rd Cir. 1965); Lewyt Corp. v. Commissioner, 215 F.2d 518, 522-523 (2d Cir. 1954), aff’d in part and rev’d in part on another issue, 349 U.S. 237 (1955); Risman v. Commissioner, 100 T.C. 191 (1993). “Whether a remittance to the Service is a payment, or is a general deposit whose recovery would not be statutorily barred, may be a matter of intent and circumstance.” David v. United States, 132 F.3d 30 (1st Cir. 1997) (unpublished).

The Congressional purpose supporting section 6425 is “to allow a corporation to apply for a quick refund or, more technically, an adjustment of overpayment of estimated tax, immediately after the close of its taxable year.” S.Rep. No. 1014, 90th Cong., 2d Sess. (1968) at 800. Before the process of applying for a quick refund was created, corporations often waited more than eight months after the close of a tax year before they could obtain refunds of excessive estimated tax payments. See Phico Group, Inc. v. United States, 692 F. Supp. 437, 440 (M.D. Pa. 1988). The quick refund process was designed to ease the burden on corporations required to make estimated tax payments. S.Rep. No. 1014, 90th Cong., 2d Sess. (1968) at 800.

Section 6425(b)(2) provides that the Service, “within the 45-day period after the return has been filed, may credit the amount of the adjustment against any liability in respect of an internal revenue tax on the part of the corporation and shall refund the remainder to the corporation.” Congress’ use of the word “shall” signifies the mandatory obligation section 6425(b) imposes on the Service to refund the amount claimed on Form 4466. Moreover, Treas. Reg. section 1.6425-3(e) provides that if the Service allows the Form 4466 adjustment, it may first credit the amount of the adjustment against any liability in respect of an internal revenue tax on the part of the corporation which is due and payable on the date of the allowance of the adjustment before making payment of the balance to the corporation. The Service may not apply any portion of the adjustment to a tax that is not due and payable as of the date of the filing of the Form 4466.

We are unaware of any authority that enables IRS to freeze the processing of properly-filed Forms 4466. KPMG Washington National Tax and Tax Controversy Services are engaged in coordinated efforts to persuade the Service to release quickie refunds requested on 2017 Forms 4466 on several different fronts: with IRS Service Centers, through the IRS Taxpayer Advocate, with IRS leadership, and through industry channels.

Conclusion

IRS is doing the best it can under tough conditions. But last-minute guidance disrupts settled plans, and IRS is on thin ice freezing the processing of timely- and properly-filed Forms 4466.

 

Comments

  1. Bob Kamman says:

    Friday the 13th? I thought at first this involved that day last week. Mandatory repatriation? I thought at first this involved the passport revocation for tax delinquents. But it gradually came back to me. There was also a Friday the 13th just before the 1040 filing deadline this year. And there was something in that December 2017 tax law involving foreign profits. (An IRS website page calls it the “Tax Reform Act of 2017, P.L 115-97, enacted on December 22, 2017,” which is a new one on me.)

    And yes, April 15 (or this year, April 17) is now the due date for corporation returns, except for the 1120-S, whose shareholders have an April 15/17 due date for their 1040s. Except for the 1120-S, the former due date of March 15 is now ancient history, like Caesar’s Ides of March. I thought most corporations request extensions, but that may just be my experience with “very small business” returns with no overseas funds to bring back home.

    Correct me if I am wrong. The policy behind this new law was to encourage foreign earnings to be repatriated and invested for “job creation,” which at one point was in the title of the 2017 act. The policy behind allowing payments to be spread over many years was to make more funds available for this immediately. The businesses who are hurt by grabbing their 2017 refunds are likely to be those whose profits turned out to be less than expected because of adverse economic conditions. For them, the likelihood of “job elimination” is greater, and therefore so is their need for tax refunds.

    As pointed out, this problem affects our largest taxpayers. But inasmuch as IRS could do it to the greatest of these, they could do something like it to all of us. Cf. Matthew 25:45.

    Congress enacted a “technical correction” for the farmers who would otherwise be subject to a “silo tax.” Has no one pointed out to lawmakers that accelerating tax collections is contrary to the policy they endorsed? Maybe the problem can be fixed before the next Friday the 13th. Unfortunately, that doesn’t come until September 2019.

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