Impact of Initial Exclusion from EIP of U.S. Citizens Filing Jointly with Non-Citizen Spouses

We welcome two students from the Georgia State University College of Law Philip C. Cook Low-Income Taxpayer Clinic as guest bloggers, Lauren Zenk and Lauren Heron, for a discussion of the latest developments in stimulus payment legislation as it relates to U.S. citizens who file jointly with non-citizens spouses. The Georgia State Clinic began working with the Harvard Clinic last October to file an Amicus Brief on behalf of the Center for Taxpayer Rights as the amicus. The Center sought to assist low-income taxpayers denied stimulus payments due to the non-citizen exclusion in the initial CARES Act legislation. This brief was mooted by the next round of legislation which provided: 1) U.S. Citizens who elect to file jointly with their non-citizen spouses can receive the stimulus payments for themselves and their eligible children, and 2) the value of the first stimulus payment can be issued as a credit on their 2020 tax return. Still, the initial eligibility exclusion that the clinics were preparing to argue against raises issues that may arise again in the future, and, should that occur, the authors thought that it would be useful to highlight the arguments they were preparing to make.  Keith

Congress enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) to respond to one of the worst public health crises this country has ever experienced. The CARES Act directed the Treasury Secretary to process the payments “as rapidly as possible.” 26 U.S.C. § 6428 (f)(3)(A). Initially excluded from these payments were most taxpayers without a Social Security Number (SSN), which the government argued included U.S. citizens with a SSN who elected to file jointly with their non-citizen spouse.  The result denied millions of American citizens, and their eligible children, benefits they desperately needed. Before the passage of the Omnibus Spending Bill in December of 2020, the U.S. citizens who were initially denied relief only had one identifiable remedy to receive the stimulus payment: file their 2020 tax return separately from their non-citizen spouse and receive the payment as a Recovery Rebate Credit.

However, this remedy would have been inadequate for two compelling reasons: First, filing MFS would cause them to lose favorable tax rates and certain credits available to low-income taxpayers; and second, they would have to wait until 2021 to receive the benefit of the payment during a period where the timeliness of relief was critical. The spending bill addressed the inadequacy of this remedy and provided that the U.S. citizens with non-citizen spouses and their families were “eligible individuals” for the credit. Still, only the U.S. citizen spouse and eligible children are counted for the credit, so these families are still receiving $600 less than similarly situated families. The spending bill also provided for retroactive payments for those families denied the first EIP under the Cares Act.

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The Statutory Ambiguity Question

Litigation was quickly brought to challenge the government’s interpretation in regard to the eligibility of U.S. citizen taxpayers married to non-citizen spouses.  The clinics were preparing to file an amicus brief that would argue against the government’s position that the CARES act excluded this class of U.S. citizens from eligibility.  The clinics approached their arguments from two perspectives: (1) demonstrating that the statutory language at issue was in fact ambiguous and should be read as including this class of taxpayers as being eligible for payments; and (2) specifically illustrating how the government’s interpretation would negatively impact low-income and economically vulnerable taxpayers and conflict the with the CARES Act’s legislative purpose.

The statutory interpretation argument focused specifically on the statutory language in 26 U.S.C. § 6428(g)(1)(B), which the government interpreted as requiring that married spouses filing jointly both have valid social security numbers in order for either to qualify for the stimulus payment.  This interpretation had the effect of punishing mixed-status families by denying American citizens and their eligible children the benefits they deserve.

Section 6428(a)(1) establishes that any individual with a SSN shall be allowed a $1,200 credit. Subsection (d) defines an “eligible individual” as any individual that is not a “nonresident alien individual,” a dependent, or “an estate or trust.” Therefore, any non-dependent with a SSN is plainly recognized as an eligible individual. Subsection (a)(1) states that “[i]n the case of an eligible individual, there shall be allowed as a credit . . . .an amount equal to the sum of . . . $1,200 ($2,400 in the case of eligible individuals filing a joint return).” The subsection’s parenthetical is limited to the narrow case of eligible individuals filing a joint return. The parenthetical does not encompass joint returns where a single party is an eligible individual, such as mixed-status filers. The SSN holder remains recognized as an eligible individual entitled to a credit of $1,200 under § 6428(a) for the purposes of emergency relief and economic stimulus.

Section 6428(g)(1) establishes the requirement that joint returns must include the SSNs of both spouses, but it is ambiguous whether this requirement applies to joint returns where only one spouse has a SSN. The provision states that, “No credit shall be allowed . . . to an eligible individual who does not include on the return of tax . . . (B) in the case of a joint return, the valid identification number of such individual’s spouse.” Subsection (B) presumes that the spouse on the joint return shall have an SSN. Therefore, it overlooks situations where one spouse simply does not have an SSN to provide. The language of section 6428(g)(1) may have been included as an administrative measure to ensure that all relevant information possessed by the tax filers is provided and to prevent $2,400 from going to a pair of an eligible and non-eligible individuals. The government’s reading of (g)(1) as establishing a circumstantial barrier preventing distribution of the payment is not the only possible reading of the section. Rather, the presence of an implicit waiver of subsection (g)(1)’s requirement to provide a spouse’s SSN on the joint return when a spouse does not possess an SSN is a valid interpretation of the passage.

At first blush, it appears that the government could successfully counter this argument by pointing out that the CARES Act expressly provided that members of the armed forces were exempted from the (1)(B) requirement that the other spouse provide a SSN where paragraph (1)(A) is satisfied, allowing these certain families to receive the full $2,400. The government would likely use this carve-out to argue that Congress knew how to make an exception and chose not to do so for the class of taxpayers at issue.  The military exemption does not fully clarify Section 6428(g)(1) as it applies to mixed-status filers. The CARES Act expressly exempts members of the armed forces from the requirements of (1)(B) when at least one spouse satisfies the requirements of paragraph (1)(A). The requirement of (1)(B) refers to joint returns, however, so this “Special Rule” allows military families to receive the $2,400. Section 6428 still ignores the possibility of an eligible individual, who is owed the $1,200 payment, but happens to file a joint return with an ineligible individual.

Courts must do their best, “bearing in mind the fundamental canon of construction that the words of a statute must be read in their context and with a view to their place in the overall statutory scheme,” to enforce the meaning of the statute. Utility Air Regulatory Group, 573 U.S. at 320. When reading subsection (g)(1) in concert with the rest of § 6428, ambiguity is evident.

Why this Still Matters for Low-Income Taxpayers

Thankfully, Congress got around to clarifying the legislative language, which removed any ambiguity and included this class of taxpayers in the class of individuals eligible for economic impact payments.  Whether you call the legislative fix an eligibility extension or a correction ambiguous language, it is difficult to ignore that some families were wrongfully denied relief at the height of the pandemic. The relief given is better late than never, but it still undercuts the initial purpose of the Act. In March 2020, the Bureau of Labor Statistics reported the unemployment rate increased by .9 percent, up to 4.4 percent, which was the largest “over-the-month” increase since 1974.  This statistic reflects 1.4 million Americans who became unemployed as a result of the pandemic outbreak. For these families that may currently be facing unemployment, a tax credit retroactively issued in 2021 is almost without purpose. Further, a Pew Research Center Survey found that lower-income American’s were experiencing job loss at a higher share and that only about one-in-four of these individuals/families said they had funds set aside that could cover three months of expenses in the case of job loss.  While over 130 million individuals did receive stimulus payments, the requirement that both spouses have a social security number allowed otherwise eligible individuals and their eligible children to fall through the cracks at a time where financial assistance is greatly needed, especially by low-income, vulnerable populations.

Had the statutory language not been changed and had the government persisted with its interpretation of the original CARES Act language, the remedy the government proposed for these excluded U.S. citizens and their dependents originally would have been to file their 2020 tax return separately from their non-citizen spouse. This potential remedy, however, would have been insufficient, because it would have placed taxpayers in the position of having to forego other tax benefits in order to obtain the economic impact payments.  The Internal Revenue Code (IRC) incentivizes the MFJ filing status by providing that taxpayers filing separately will often have higher tax rates and will be ineligible for certain deductions, exemption amounts, and credits that are allowed to those filing jointly. These differences can be especially punitive when the taxpayers are low-income. Unfortunately for low-income taxpayers in particular, a married filing separately filing status will reduce or eliminate the impact of the following tax credits and deductions, which low-income taxpayers commonly use. These include the child tax credit, additional child tax credit, exclusion of a portion of Social Security benefits, credit for elderly and disabled, deduction for college tuition expenses, student loan interest deduction, and credits incentivizing investments in higher education like the American Opportunity Credit and Lifetime Learning Credit. In many circumstances, low-income taxpayers rely on these credits to supplement their income and lift them above the poverty threshold and being forced to relinquish these benefits to obtain economic impact payments would have not made economic sense, defeating the CARES Act’s stated purpose.

It is tempting to say that these arguments have only academic interest because all’s well that ends well.  However, we believe that it is important to present these arguments to the practitioner community because of how often this type of statutory language is used and is interpreted by the government to exclude U.S. citizens married to non-citizen spouses from critical government benefits.  For instance, this exclusion was not unique to the CARES Act. In the 2008 global financial crisis, Congress used similar statutory language that the government interpreted as giving tax rebates to most American taxpayers, except for spouses of non-citizens without social security numbers. It does not take much imagination to think that, in the coming years, similar language might once again be used in future stimulus bills.  Finally, this exclusion affects low-income taxpayers who would otherwise be eligible for the Earned Income Tax Credit (EITC). The EITC gives preference to spouses who elect to file MFJ, where both spouses have a valid SSN, and eligible children. These taxpayers are entitled to large refundable credits, sometimes up to around $7,000. However, it has been widely accepted, perhaps uncritically, that this credit is unavailable to U.S. citizens filing jointly with their non-citizen spouse.

Conclusion

In the absence of a judicial venue to raise these sorts of arguments, it is important to raise them for discussion so that policy makers can consider the unintended consequences of their legislation. Hopefully, in the future, Congress and the IRS will take these considerations into account on the front-end of legislation, so vulnerable taxpayers are not excluded from legislation intended to assist families in the midst of economic crises. However, if this type of language is once again used in stimulus payments, we encourage practitioners to not accept the government’s interpretation at face value, as there are sound interpretative arguments that can be made on behalf of these taxpayers who deserve to be included in these stimulus and anti-poverty efforts.

A Look at Tax Provisions for Low-Income Americans in the American Rescue Plan Act

We welcome back guest blogger Omeed Firouzi, who works as a staff attorney at the Taxpayer Support Center at Philadelphia Legal Assistance.  Today’s post provides more substantive tax than most.  In the discussion of the tax break for unemployment insurance, Omeed picks up on comments made by frequent commenter Bob Kamman.  Keith

The American Rescue Plan Act, signed into law by President Joe Biden on March 11, 2021, provides immediate IRS-administered relief for millions of taxpayers and creates more potentially long-term changes that will impact low-income and middle-income taxpayers.

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NEW ECONOMIC IMPACT PAYMENTS

Already, the new $1.9 trillion COVID relief law has led to the distribution of $1,400 stimulus payments for millions of Americans. This round of economic impact payments total $1,400 per person, including per adult dependent (a group that was excluded from the first two rounds; undocumented parents can now obtain payments for their children who have Social Security numbers as well).

The income eligibility guidelines are similar to the last two rounds in that the full $1,400 payments go to single filers who make up to $75,000, married filing jointly filers who make up to $150,000, and head of household filers who make up to $112,500. There are smaller payments for single filers who make up to $80,000, married filers who make up to $160,000, and head of household filers who make up to $120,000. Anyone with a Social Security number authorized for work, who is not a nonresident immigrant and not a dependent, can get a payment.

Congress authorized the IRS to look to 2019 and 2020 returns to determine eligibility. This time, Congress also specifically authorized the IRS to make “additional payments,” through rolling eligibility determinations, for individuals who file 2020 returns that make them eligible for additional stimulus payment. Therefore, if a taxpayer has a 2019 return on record right now that makes them eligible for partial or no stimulus payment but then they file a 2020 return that makes them eligible for more stimulus payment, they should get the additional payment.

Beneficiary recipients (Social Security, SSI, VA, RRB recipients) will automatically get payments. The payments are again protected from offset for federal and state tax debts, debts to federal agencies, unemployment overpayments, and child support. Congress was unable to protect the payments from garnishment by private debt collectors but members of Congress are considering introducing legislation to remedy this issue.

Non-filers who don’t receive the aforementioned benefits qualify for these payments as well. If these individuals used the Expedited Filing Portal last year that created 2019 returns, they should get these payments as well – since 2019 return information is used for eligibility. We are still awaiting guidance as to whether such a portal will return this time, particularly in light of President Biden’s January 22 executive action. Already though, the IRS revived the “Get My Payment” tool on its website with an IRS EIP Information Center too (www.irs.gov/eip).

If an individual’s income dropped in 2021 such that they are eligible for more payment now than they were based on current information or if they have a child born in 2021, they can claim the additional stimulus payment as a refund on their 2021 return. Alternatively, if an individual’s 2019 return makes them eligible for payment but a 2020 return would make them ineligible, were it to be filed, they may want to wait to file the 2020 return until they receive the stimulus payment – and the law makes clear they won’t have to pay back any excess.

EXPANDED CHILD TAX CREDIT

One aspect of the American Rescue Plan Act that has gotten significant attention is the expanded Child Tax Credit (CTC). Only for tax year 2021, the law makes the CTC fully refundable and enlarges it to $3,600 for each child 0-5 years old and $3,000 for each child 6-17 years old, including children who are 17.

Notably, the expanded CTC may begin to impact families already starting around this summer. The law authorizes the IRS to make periodic, advance payments of half of the child tax credit from this summer until December 2021. If the payments are distributed monthly, it could mean that families receive $300/month or $250/month – a new monthly child allowance that, if made permanent, has the potential to reduce child poverty in half. The other half of the credit would then be claimed on a 2021 return. Significantly, the law also abolishes the minimum income earnings requirement for receipt of the expanded CTC thus bringing millions more within this safety net’s reach.

Further, the law directs the IRS to develop an “online information portal” where individuals can update their information for purposes of this credit. This portal could be vital because the distribution of the expanded CTC will be based on the most recent return, whether that be 2019 or 2020, available but since the enlarged benefit incorporates potential non-filers, the portal could be useful for them or for individuals whose children are born this year.

The full $3,600 or $3,000 will be available for single filers who make up to $75,000, married couples who make up to $150,000, and head of household filers who make up to $112,500. However, single filers who make up to $200,000 or married couples who make up to $400,000 can still access a $2,000 child tax credit. If one makes less than $40,000 as a single filer, $50,000 as a head of household filer, or $60,000 as a married filing jointly filer, they need not pay back any overpayment on a 2021 return.

UC TAX FORGIVENESS

Weeks ago, Senator Dick Durbin and Congresswoman Cindy Axne’s proposal to exempt from taxation the first $10,200 of unemployment compensation individuals received in 2020 appeared to be a longshot possibility. Negotiations over the federal weekly unemployment supplement and its duration though led to this provision’s inclusion in the final legislation. A major change in the middle of the tax filing season, this aspect of the law will avoid surprise, large tax bills for millions and will boost the finances of those who had tax withheld.

The IRS already has guidance on how to claim this $10,200 exclusion if you have not filed a return but it remains unclear what taxpayers who already filed should do. It is possible taxpayers will have to file superseding or amended 2020 returns. If so, it will be convenient that 1040-Xs can be filed electronically now but nevertheless, it could also add to the backlog of unprocessed returns. It is uncertain if the IRS will instead try to automatically refund individuals but recently, the same Democratic members of Congress who crafted the exclusion wrote to the IRS requesting as much

It should be noted that this tax forgiveness applies per person – so up to $20,400 of UC could be forgiven from tax for a married couple – and only applies for individuals making up to $150,000 in adjusted gross income. But there’s a potentially thorny issue of statutory interpretation at play: does the $150,000 AGI limit include your unemployment compensation in 2020? If a taxpayer received $10,200 in unemployment compensation as part of $150,001 in AGI in 2020, can they exclude the UC or not because their income is too high? If the taxpayer received more than $10,200 in UC (let’s say, $20,000) and that $20,000 put them above $150,000, how much of that is part of AGI that goes into determining eligibility for this forgiveness provision?

The statutory construction here is important as Section 9042 of the American Rescue Plan Act reads that Section 85 of the Code (the section that made unemployment compensation taxable) is amended by adding the special $10,200 tax forgiveness rule “if the adjusted gross income for such taxable year is less than $150,00.” The statute goes on to read “for purposes of [the paragraph describing the forgiveness], the adjusted gross income of the taxpayer shall be determined…without regard to this section.”

So far, in its guidance regarding this new forgiveness, the IRS seems to have taken the position that “without regard to this section” means that all of a taxpayer’s unemployment compensation is included in your AGI. If your AGI is above $150,000, even if without your unemployment compensation in 2020 you would’ve been eligible for this exclusion, you won’t be able to claim it, the Service says. Some observers agree but there appears to be disagreement among tax professionals as to this interpretation, particularly since it would seem to encourage married couples to file separate returns to lower their particular AGIs in order to each claim this benefit. It would be interesting to hear from members of Congress who crafted this language to ascertain their legislative intent.

EXPANDED EITC

For 2021 only, the law triples the maximum Earned Income Tax Credit for childless workers from $543 to $1,502 – a proposal long sought by President Biden’s economic adviser, Jared Bernstein. Childless workers who are not full-time students can now start getting the EITC at  age 19, former foster youth can start getting it age 18, and the upper age limit of 65 is gone – again, all for 2021. The “EITC lookback period” will be applicable for 2021 tax year too so individuals can use 2019 earned income if the latter is higher.

There are a few permanent changes to the EITC though. Married but separated individuals can receive the EITC for themselves (as if they are single essentially) if they meet certain criteria. The married person would have to live with a qualifying child for more than half of the year and not reside with their spouse for at least six months of the year or not live with their spouse by December 31 and have a separation agreement. Another permanent change is an increase in the limit on investment income to $10,000 that individuals can have in figuring EITC eligibility. Also, people are otherwise eligible for EITC can get a single-filer EITC if they are have children who don’t have Social Security numbers.

EXPANDED ACA ASSISTANCE

In addition to the UC tax forgiveness, another major change in the middle of the filing season has to do with Affordable Care Act Premium Tax Credits. For 2020 only, if an individual received more ACA premium tax credits than they should have based on their income and family information, they do not need to pay back the credits on their returns. If a taxpayer already filed their 2020 return, it is possible they may need to file an amended return. Again, this process could add to the processing backlog at the IRS but it will also mean relief for a lot of taxpayers.

Going forward, for 2021 and 2022, the law removes the 400 percent federal poverty line cap for ACA premium assistance. Premium assistance is also now more generous in that premiums for benchmark health plans are capped at 8.5 percent of household income and individuals who make up to 150 percent of the federal poverty line are eligible to pay zero premiums. For 2021 only, individuals who receive unemployment compensation in 2021 are eligible for zero premiums and also get lower out-of-pocket costs.

OTHER ITEMS

The law also expands the child and dependent care credit as it will now be fully refundable for 2021 and will increase to $4,000 for one individual or $8,000 for two or more individuals; the credit will also cover 50% of eligible expenses. Lastly, the law also excludes from taxation any student loan debt cancelation that occurs from December 31, 2020 to January 1, 2026. As such, if the President or Congress does cancel federal student loan debt, federal taxation of canceled debt income in such a scenario would not be of concern to individuals.

All told, these dramatic changes will be enormously impactful in the lives of clients of low-income taxpayer clinic practitioners. Practitioners like me will also surely be navigating questions and concerns about the implementation of these measures. The IRS will certainly have new hurdles to overcome in the process. Ultimately, one thing is clear: these are major changes that require our focus.

Why More Taxpayers Should Pursue Attorney’s Fees through Qualified Offers

Today we welcome back guest bloggers Maria Dooner and Linda Galler, who in this post urge representatives use the qualified offer provisions more often. Statistics that Maria and Linda received though FOIA show that surprisingly few cases result in attorneys fees given the volume of Tax Court litigation. Regular readers will be familiar with some of the reasons why this may be the case – we have discussed the hurdles to winning fees in many posts (e.g. here, here, and here). Taxpayers in the Ninth Circuit may have a slightly easier time thanks to the Knudsen precedent, but the road is not easy. However, as Maria and Linda explain, there are benefits to submitting a qualified offer even if it does not result in the government paying fees. Christine

Over the past decade, advancements in data collection and analytics at the Internal Revenue Service (IRS) have led to better insights into the world of federal tax administration. The agency has significantly relied on data to enhance both criminal investigation and civil enforcement.  The ability to access and analyze IRS data also can be valuable to practitioners who desire a better understanding of the use and impact of certain procedural provisions that benefit taxpayers.

As the authors of Chapter 18 in the upcoming 8th edition of Effectively Representing Your Client Before the IRS, we requested and obtained data from the IRS regarding the pursuit and recovery of attorney’s fees through IRC 7430.  This blog post summarizes that data and offers our observations and thoughts on using qualified offers (“QOs”) for strategic, rather than monetary, purposes.

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What the data show (and do not show)

There is very little data on the pursuit and recovery of attorney’s fees in tax disputes because the IRS only partially tracks it. For example, the IRS does not track the total number of cases in which recovery of administrative or litigation costs is sought under the general provisions of IRC § 7430. Nor does the IRS track or maintain any information on QOs (e.g., number of QOs submitted, number of QOs that resulted in settlement of the underlying case, number of QOs that resulted in an award, or whether an award was for administrative or litigation costs). Such information would be useful both to the government and to practitioners, and we were surprised to learn how little the IRS knows.

The IRS does track the number of cases in which the Office of Chief Counsel (Procedure and Administration) processed a payment of an award from the General Judgment Fund, which includes all cases in which attorney’s fees are awarded in cases before the U.S. Tax Court:

YearNumber of Cases
20158
201613
20177
201810
Attorneys’ Fee Awards in Tax Court Litigation

To place this data in context,  Chief Counsel reported approximately 25,000 cases for fiscal year 2018, 27,000 cases for fiscal year 2017, 30,000 cases for fiscal year 2016, and 32,000 cases for fiscal year 2015 in the U.S. Tax Court.  Consequently, the extremely low number of cases that resulted in an award of fees suggests that practitioners may be overlooking the ability to pursue an award of attorney’s fees and, we suspect, are greatly underutilizing QOs.

What is a qualified offer?

A QO is essentially a written offer made by the taxpayer to the government in a case involving the validity of a tax liability or refund. The taxpayer offers a specific amount (tax liability or refund) to resolve the taxpayer’s case. If the government rejects the offer and there is a court judgment that is equal to or more favorable (to the taxpayer) than the offer, the taxpayer can be awarded attorney’s fees. Thus, for those serious about recovering attorney’s fees, the amount detailed in a QO (which can be a dollar amount or a percentage of the adjustments at issue) should be a realistic estimate of what the taxpayer truly believes to be the correct liability or refund. Though it may be tempting, submitting an offer that is too favorable to the taxpayer (in terms of merit) will likely result in a quick rejection by the IRS and can be a waste of time for all parties.

In terms of timing, a taxpayer can submit a QO any time after they receive a notice of proposed deficiency (i.e., “30-day letter”), which provides rights to administrative review in Appeals.  While a taxpayer can submit a QO up until the day before trial begins, a taxpayer should submit a QO as soon as practical. (Under Reg. § 301.7430-7(a), a taxpayer is entitled to recover only fees incurred subsequent to the offer.) A QO is open for acceptance or rejection by the IRS for 90 days or until the date the trial begins, whichever is earlier. For QOs to be successful, taxpayers must exhaust all administrative remedies with the IRS and not unreasonably protract the proceedings, as well as satisfy a net worth requirement. 

What are the benefits of submitting a qualified offer?

As compared to pursuing costs and fees under the general provisions of IRC § 7430, QOs do not require proof that the government’s position was not substantially justified.  Proving a lack of substantial justification is often the main challenge in recovering attorney’s fees.  Therefore, a taxpayer who submits a QO (and receives a court judgment that is equal to or better than the offer), can expect a more straightforward path toward receiving an award.

The benefits of submitting QOs go beyond monetary compensation; a major benefit is quick case resolution. (The Internal Revenue Manual explicitly instructs Appeals Officers to expedite QOs.)  Efficient case resolution is equally important to LITC/pro bono and compensated attorneys.  For example, given the challenges facing the IRS at the moment, even cases with a predictable outcome can take a long time to make their way through the administrative process.  For clients of LITCs or pro bono counsel, refunds can be held up for lengthy periods, causing financial difficulties to taxpayers who ultimately will prevail.  Moreover, these cases take up unnecessary time and resources for tax professionals on both sides.  Indeed, LITCs and nonprofit organizations themselves are harmed by lengthy administrative processes; pro bono attorneys have less time and bandwidth to represent other clients while struggling to resolve what they reasonably thought were predictable cases. 

In Chapter 18 of the forthcoming edition of Effectively Representing Your Client Before the IRS,  we discuss in more detail the rules on how to submit a QO and when one is warranted.  Ultimately, we explain why QOs are the “easy way” to recover costs and fees and how they serve to encourage the settlement of tax disputes.  While a QO is not and should not be a panacea for every case, QOs should be considered in strong cases that encounter time-consuming challenges or delays in resolution through no fault of the taxpayer. 

Congress Enacts Law of Unintended Tax Consequences

We welcome back occasional guest blogger and frequent commenter, Bob Kamman.  Bob has a practice in Phoenix that provides both representation and return preparation.  Today, he comes to the rescue of the PT team that has struggled to produce content this past week due to other obligations and provides us with insights on some of the quirks created by the legislation designed to provide relief for taxpayers impacted by the pandemic.  Keith

As the latest Covid-relief legislation makes its way through the Congressional meat grinder, a couple of tax inequities continue to be overlooked. Maybe it’s not too late to correct them.

One is mostly of interest to college students and the low-income taxpayer clinics where they may seek help. The other might interest college professors considering a sabbatical year abroad.

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I) The Unemployment Trap

Many people who lost their jobs in 2020 qualified for federally-funded unemployment benefits that were more generous than those allowed by state programs. Recipients were paid $600 a week for up to 17 weeks, in addition to normal state benefits. Even college students with part-time jobs qualified, in many cases. It didn’t matter if they were under 24 years old, and still being claimed as dependents by their parents.

The $600 weekly checks ended on July 31, 2020, and would not resume until this year. Meanwhile, some people had continued eligibility for state benefits, and for other Covid-related compensation.

Enter the dreaded Kiddie Tax.

Since 1986, children with unearned income of more than a certain amount have been taxed on it at the same marginal rate as their parent(s). This prevented high-bracket adults from shifting investment income to their low-bracket kids. But back then, it only applied to children under age 14.

Congress eventually applied the law to older “children,” including full-time students up to age 23 who were not providing at least half of their support with their own earned income. Their earnings are taxed at the usual rates, but their unearned income is taxed at the higher parental rate. And unemployment is considered unearned income.

Tax practitioners this filing season are finding it not unusual for young unemployed college students to bring in Forms 1099-G showing five-figure amounts for unemployment compensation. If federal tax was withheld at all, it was mostly at a 10% rate. If $10,000 was received, $1,000 was withheld. But if the student must use the higher tax rate of, for example, 24%, the tax could approach $2,400 and the balance due IRS even after withholding, nearly $1,400.

If earned at a job and reported on a Form W-2, none of the $10,000 in wages would be taxed because of the $12,400 standard deduction.

Is this what Congress intended? Probably not.

Will it be fixed by pending legislation? Predictions are welcome in the Comments section below.

II. Welfare for Expatriates

If our unemployed students in the example above must pay IRS another $1,400 on their “unearned” unemployment compensation, what will the federal government do with it? Maybe, send it to one of their instructors.

Suppose you have a job offer from the Sorbonne to teach in Paris for a year at a salary of $180,000. Would it help, if the Treasury added another $1,400 tax-free? And that much for your spouse, also. That’s how the “Economic Impact Payments” have worked in the last two rounds.

They are based on AGI, after the exclusion for income earned abroad. That amount in 2021 is a maximum of $107,600. Then the $1,200 and $600 payments were not reduced unless this post-exclusion AGI exceeded $75,000 – or $150,000 on a joint return. All you must do to claim the exclusion is meet the “physical presence test:” stay overseas more than 330 days out of any 12-month period. (You also have to show that you have not kept your “tax home” in the United States, but for many academics those rules are not onerous.)

Paris is too expensive on $180,000 a year? Try Auckland. Cost of living in New Zealand is lower, and there is less virus around once they let you in.

Of course, educators are just a small minority of the Americans who benefit from this loophole. Half a million taxpayers claim the Section 911 exclusion each year, according to IRS estimates based on 2016 returns.

Are Covid disaster-relief payments for well-paid Americans living abroad what Congress intended? Probably not. A bipartisan group of 16 senators in early February sponsored a budget resolution amendment that promised to target stimulus checks to low- and middle-income families. It passed 99-1.

How simple would this be to fix, with a sentence that defines AGI as the amount before the foreign earned-income exclusion? Very.

Will that happen? Again, your predictions are welcome.

BBA, Partnerships and Schedule UTP

We welcome back Monte Jackel, Of Counsel at Leo Berwick. Since 2010, Schedule UTP has been used by certain corporations to report uncertain tax positions. In today’s post Monte discusses whether the BBA centralized audit partnership regime supports mandating Schedule UTP for partnerships. Monte discusses the history why partnerships were not originally required to furnish the form, as well as whether BBA subjects partnerships to additional financial reporting, and the current AICPA position on the latter issue. Les

For over a decade now, Schedule UTP has been mandated for corporations with $10 Million or more in assets and who maintain an audited financial statement and has one or more disclosable tax positions. See Schedule UTP Instructions. When initially issued a decade or so ago, the IRS indicated that similar reporting may be required of partnerships in the future. However, corporations with the requisite assets and financial statements who were partners in a partnership from which the return position arose were required to disclose that partnership position on the schedule as originally issued. 

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About a year or so later, it was reported that IRS Chief Counsel Wilkins had decided not to extend the schedule reporting to partnerships (See Jeremiah Coder, IRS Not Considering UTP Reporting for Passthroughs, Wilkins Says, 41 Ins. Tax Rev. 16, July 1, 2011, Wilkins Tax Notes Story) because, as the story quotes the former Chief Counsel, “the UTP reporting process relies heavily on the reporting that financial accounting rules already require of entities, Wilkins said. Thus, unless the accounting literature changes, the UTP reporting technique really doesn’t address positions that might exist in passthroughs, he said….For now the UTP reporting approach ‘does not fit that well with passthroughs as the accounting practices exist today,’ IRS Chief Counsel William J. Wilkins said.” 

ASC 740 applies only to business entities subject to income taxes. (See Alistair M. Nevius, Journal of Accountancy, June 1, 2011, ASC 740 excerpt.) If that is the case, then those entities would be subject to the financial accounting rules and maintain a financial statement. 

When the centralized audit partnership regime came into being in 2015, the question became whether partnerships subject to these new audit rules would now be subject to ASC 740 because the default position for partnerships subject to these new audit rules was that the partnership would pay an imputed underpayment (section 6225). This could then make those partnerships subject to federal income tax and subject to the accounting rules, and then perhaps the rationale for not subjecting partnerships to schedule UTP would no longer exist. Partnership reporting on Schedule UTP would presumably then help the selection of partnership tax returns for audit by the IRS, which has been one of their stated public goals. 

The potential impact of the centralized partnership audit regime on financial accounting was addressed by the AICPA in March 2018 (See AICPA Technical Practice Aids, TIS section 7200.09). In the case of partnerships subject to this centralized audit system, the question presented was whether the imputed underpayment that could be paid by the partnership was a federal tax imposed on the partnership directly in its taxpayer capacity or, alternatively, whether the tax underpayment is being made on behalf of the partners. If the former, the ASC 740 rules would apply and mandating a schedule UTP for partnerships could then make more sense. If not, then those financial reporting rules would not apply and schedule UTP reporting arguably should not then be extended to partnerships. 

In the public announcement issued by the AICPA, it was stated: 

“How should a partnership account for amounts it pays to the IRS for previous underpayments of tax, interest, and penalties? Said another way, does the underpayment represent an income tax of the partnership or the partners? 

“Reply — In accordance with paragraphs 226–229 of FASB ASC 740-10-55, if income taxes paid by the entity are attributable to the entity, they should be accounted for under the FASB ASC 740, Income Taxes, accounting model. If, however, the income taxes paid by the entity are attributable to the owners, they should be accounted for as a transaction with the owners….In the case of the IRS partnership audit regime, the collection of tax from the partnership is merely an administrative convenience on the part of the government to collect the underpayment of income taxes from the partners in previous periods. Accordingly, the income taxes on partnership income, regardless of when paid, should continue to be attributed to the partners and, therefore, the partnership would not apply the FASB ASC 740 accounting model to account for amounts it pays to the IRS for previous underpayments of tax, interest, and penalties. Rather, a payment made by the partnership under the IRS partnership audit regime should be treated as a distribution from the partnership to the partners in the financial statements of the partnership.”

Is this statement of position by the AICPA correct? Section 6221(a) of the Internal Revenue Code states in part that any tax attributable to an adjustment by the IRS of a partnership-related item shall be assessed and collected at the partnership level. And section 6225(a)(1) states that if there is such an adjustment, the partnership shall pay an amount equal to the imputed underpayment. The regulations at reg. §301.6221(a)-1(a) reaffirm this by stating that any such tax under chapter 1 of the Internal Revenue Code shall be assessed and collected at the partnership level. However, section 701 of the  Internal Revenue Code states clearly that “a partnership as such shall not be subject to the income tax imposed by [chapter 1]”, and this provision was not amended when the 2015 centralized partnership audit regime was enacted into law. 

Whether the imputed underpayment is indeed a tax imposed on the partnership and not on behalf of its partners is an important question. However, if the financial accounting treatment will determine any action by the IRS in extending Schedule UTP to partnerships, should it otherwise decide to do so, then the financial accounting treatment would be driving the federal income tax treatment and that does not seem appropriate. 

The centralized audit regime is so focused on partnership level adjustments and related matters that if applying schedule UTP to partnerships is determined to otherwise be a good idea, it should not be tied to the financial accounting treatment. 

Would extending schedule UTP to partnerships be a good idea? What has the experience been over the past decade or so on corporate reporting? It would seem that if partnership audits are going to be treated more seriously today, these reporting questions should be addressed and resolved. 

When the “Routine” Morphs into a “Ticket to Tax Court”

We welcome guest blogger Steve Jager.  Steve is a regular reader of PT with a commercial and a pro bono tax practice.  He devotes a lot of time to the LITC at California State University Northridge [known as the Bookstein LITC], serving as one of their “Tax Court Advisors”  and regularly working with clinic staff/students and clients in resolving issues. He is also a partner in private practice with the firm of Fineman West & Company, LLP.  Although licensed as a CPA, he has passed the test to practice before the Tax Court which a small percentage of practitioners pass each time the Court offers the test.

Steve brings us the story of one of his clients driven to Tax Court by the pandemic and the inability of the IRS to process its mail.  Steve’s case probably represents one of many in this situation where taxpayers receive a notice of deficiency (or notice of determination) not through any fault of their own or of the IRS but because the significant delays in processing mail cause the IRS system to move the case into the deficiency procedure process rather than allowing resolution at the administrative stage.  This by-product of the pandemic certainly occurred in pre-pandemic times but not to the extent of the current level of cases caused by the failure to match correspondence which could resolve the case with the taxpayer’s file.  This causes extra work for the practitioner which is not compensated in the current attorney fee structure, extra anxiety for the taxpayer (and costs) and extra work for Chief Counsel attorneys forced to work on cases that would have been resolved at a lower level.  Taking the case to Tax Court does buy a taxpayer the personal service of an attorney or paralegal rather than the impenetrable correspondence unit of a Service Center but at a high price for all.  Hopefully, the cost here will obtain for Steve’s client the desired result.  Because the client paid the tax prior to the mailing of the notice of deficiency, I expect the IRS will file a motion to dismiss.  Keith

I feared it could happen, but prayed it would not.  I knew the cogs in the IRS machinery were still churning out Notices, and I also knew that the IRS was not keeping up with all the correspondence it was creating with these Notices and I wondered what would happen IF an IRS failure to quickly process a reply to Notice CP2000 occurred…   And then it did. 

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Most of us are probably already familiar with the CP2000 Notice – that Notice that the IRS uses when a “routine matching” of the W2’s and 1099’s are matched up against the tax returns that are filed, and when there is a “mismatch,” the letter that is sent out to the Taxpayer is the CP2000, which assumes that the “mismatch” is unreported income (or an incorrectly deducted interest expense amount), and the IRS gives the taxpayer the opportunity to either pay the calculated tax or otherwise offer explanations as to why the “mismatches” are already reported or not taxable or correctly deducted, as the case may be.  So the possible responses from the Taxpayer (or his/her practitioner) would be either: (i) concession of the amount requested, with or without payment of the additional tax; or (ii) partial concession with a full explanation as to why the concession was only partial – i.e., agreeing with one or more, but not all of the adjustments proposed by the IRS; or (iii) no concession due to a full explanation as to why the proposed adjustments are not correct.    Under “normal” conditions [read that as prior to the pandemic], any of those responses made within 30 days would be considered and at least acknowledged by the IRS.  This, of course, would mean that someone at the Service Center has opened the mail, read the response and within those 30 days, has generated a reply letter back to the Taxpayer.  

But what happens now when the IRS is behind in opening mail, reading the correspondence and writing replies?

Well, it would appear that under the current conditions the CP2000 “machinery” is assuming there has been no response and “pulling the trigger” by issuing the Statutory Notice of Deficiency!  Yikes!  Once the IRS has issued a Statutory Notice of Deficiency, it is really hard to convince the IRS to rescind the Notice (made especially hard, once again, by the fact that the IRS is not running at full capacity), so the Taxpayer has little choice except to file a petition with the United States Tax Court.  Let me relate my own clients’ story.  

Let’s call these clients, Mr. and Mrs. Taxpayer.  When I prepared their 2018 income tax return, I was unaware that Mr. Taxpayer had begun receiving social security income during that tax year, and he did not give me the 1099 from the Social Security Administration, and I certainly did not know to ask him for it.  Therefore, that income was omitted from the tax return.  The IRS computer, however, when matching the social security administration payments against the tax returns, realized a “mismatch,” and a CP2000 was issued last October.  My client received the Notice and contacted me, whereupon we quickly figured out that the income should have been reported, but was not, so I instructed my client to write a check for the tax and the interest as calculated by the IRS.  My client wrote that check IMMEDIATELY, and mailed it with the correct payment stub to the address, as instructed by the IRS.    The IRS cashed the check within 7 days of its receipt, so we know they are still opening the mail quickly, but then things obviously break down.  Notwithstanding the fact that I have had to elevate this to the Tax Court (more on that in a moment), the truly insidious part of this now all-too-common saga, is that the IRS had apparently not credited the payment to the account for Mr. and Mrs. Taxpayer, which resulted in the Statutory Notice being issued!  Once the check was noted as received, I must ask why the IRS machinery wasn’t stopped?

Regardless of why this has happened despite Mr. and Mrs. Taxpayer’s compliance, the reality is that I have had to file a Petition in the Tax Court.  This was certainly not my first petition filed with the Court, but it is my first which was filed electronically, pursuant to the new DAWSON system which the Tax Court has been so excited to roll out.  Preparing the petition was exactly the same as before – that is to say that the Petitioner or practitioner still drafts the Petition as before, and merely uploads the petition as a pdf file, which is a fairly simple process.  Paying the $60 filing fee, which in the past would have been paid by writing a check out of my Client Trust Account, was fairly easy to do by establishing an account with Pay.gov.

Now that the Petition is filed and the IRS is “served,” relatively expensive IRS resources are going to be needed.  Since I have asked for the Trial to be conducted in Los Angeles, I believe that at least a paralegal will need to be conscripted into drafting the Answer to the Petition.   Once that has happened and the Commissioner and my clients are “at issue,” only then will I be able to offer the copy of Mr. and Mrs. Taxpayer’s canceled check to prove that they timely paid the tax that they conceded as soon as they were notified, plus interest.

In this case, my clients, Mr. and Mrs. Taxpayer, are fortunate.  They are being represented and I expect to resolve this case easily.   But how many other folks are there who are compliant, law-abiding taxpaying citizens who will also need to go through a similar ordeal on their own…  unless, of course, they find their way (and are eligible for services) by one of the many LITC clinics.  And for those who do not qualify for LITC Service?   How much will those folks need to pay a professional lawyer or qualified Tax Court practitioner if they wish to be represented?

Holding Transferees Liable Without a Transferee Assessment

We welcome back guest blogger Marilyn Ames my former colleague at Chief Counsel, IRS and my current colleague in updating the Saltzman and Book treatise, “IRS Practice and Procedure.”  You can find a detailed discussion of transferee issues in the treatise.  Keith

In yet another case involving an intermediary transaction tax shelter, the Eleventh Circuit Court of Appeals reaches back to a 1933 Supreme Court case to show how broad the government’s powers to reach transferees of a taxpayer’s assets are.  In United States v. Henco Holding Corp., 127 AFTR2d 2021-362, 2021 WL 165324 (11th Cir. 2021), the shareholders of a corporation arranged a transaction in which a third-party purchaser received the assets of a corporation, an intermediary received a fee for participating in the transaction, the shareholders received the net cash from the asset sale, and the government was left with an empty bag when the corporate taxpayer could not pay the capital gains tax on the sale, which occurred in 1997.  The Internal Revenue Service audited the return of the corporate taxpayer, Henco Holding Corporation, and after several extensions of the statute of limitations, issued a notice of deficiency to Henco in 2007 with respect to the sale transaction in an amount over $56 million. Henco defaulted on the notice of deficiency, but requested a collection due process hearing when the IRS began collection procedures. When the collection activity was sustained by Appeals and a notice of determination was issued, Henco then filed a petition with the Tax Court challenging both the collection action and the underlying tax liability. The Tax Court sustained both the assessments and the IRS collection action.

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With Henco having no assets from which to pay, the IRS eventually filed suit against Henco to reduce the tax claim to judgment and against the shareholders as transferees. Henco, having formally dissolved in 2012, did not appear and a default judgment was entered against it by the district court for the amount of its unpaid tax, penalties and interest in 2019. A judgment on a tax claim extends the statute of limitations on collection pretty much indefinitely, see post here, giving the government further time to hunt for a way to collect on its tax debt. (This is how the United States was able to try to collect from Al Capone decades after his death.) In this case, the hunt extended to the shareholders who received the proceeds from the sale of the assets, as the suit filed by the United States sought to recover the debt from those assets based on the Georgia fraudulent conveyance statute in effect at the time of the transaction.

The shareholders moved to dismiss the complaint against them, arguing that the Georgia statute of limitations for a fraudulent conveyance suit was only four years, a period that had run long before the suit was filed (given that the essentially defunct Henco spent years dragging out the audit and collection due process cases). The defendants also argued that the only way to recover from a transfer to them was through the use of IRC § 6901, the transferee liability statute, and the statute of limitations on assessment under Section 6901 had also run. The district court agreed that the suit against the shareholders should be dismissed, holding that an assessment had to be made against the transferee in order to collect from the transferee, and that Congress did not intend for the period in which an assessment could be made by a transferee to extend ten years or more.

With the United States once again holding an empty bag, it appealed to the Eleventh Circuit. The Appeals Court easily resolved the issue of the state statute of limitations binding the United States, noting that it has long been held that the federal government does not become subject to a state statute of limitations when it is acting in its governmental capacity and asserting a claim under its rights as the federal government. Turning to the main issue in the case – whether an assessment against the shareholder/defendants was necessary in order to proceed against them, the Eleventh Circuit relied on the Supreme Court case of Leighton v. United States, 289 US 506 (1933) to reject the shareholders’ position. In Leighton, the Supreme Court discussed the predecessor to Section 6901, Section 280 of the Revenue Act of 1926, and noted that prior to the enactment of the predecessor to Section 280, the United States could proceed in an equity proceeding against transferees to recover from assets transferred by the taxpayer. Addressing the question of whether Congress had made Section 280 an exclusive remedy for recovery, requiring an assessment under the transferee procedures of Section 280, the Supreme Court noted that while the meaning of Section 280 was not without uncertainty, “the right of the United States to proceed against transferees by suit since the act of 1926 has been definitely recognized.” The Leighton court concluded that an assessment under Section 280 was not necessary to collect from transferees.

In Henco, the Eleventh Circuit reached the same conclusion, stating that the language of Section 6901 was nearly identical to the provisions of Section 280 of the Revenue Act of 1926. In addition to holding that the procedures under Section 6901 are not the exclusive means of collecting from transferees, the Henco court further supported its position with the case of United States v. Galletti, 541 US 114 (2004), which addressed the question of whether partners in a partnership had to be individually assessed for the United States to recover a tax debt owed by the partnership from the partners. In Galletti, the Supreme Court held that separate assessments were not required, as “it is the tax that is assessed, not the taxpayer.” Holding that it was bound by both Leighton and Galletti, the Eleventh Circuit stated that it was undisputed that there was a timely assessment made against Henco, and that the United States could attempt to collect from the shareholders as transferees of the taxpayer under the relevant state law.

This is not the end of this saga, however, as the Eleventh Circuit merely reversed the dismissal of the shareholder/defendants and remanded the case to the district court for further proceedings. The United States must still prove that the shareholders are transferees liable under the Georgia statute in effect at the time of the transaction, now more than two decades ago. Then, the United States must hope the shareholders still have the money and didn’t lose it in the great recession, the pandemic downturn or just having a good time. Given the propensity of these defendants to drag things out, at the end of all this, the United States may still be left with an empty bag.

Complications With Rolling Credit Elect Transfers – Part 2

Bob Probasco returns with Part Two of his examination of rolling credit elect transfers and their treatment for interest purposes. Christine

In Part 1, I discussed the result in Goldring v. United States, 2020 U.S. Dist. LEXIS 177797, 2020 WL 5761119 (E.D. La. Sept. Sep. 28, 2020) and started laying the framework for a critique of the decision.  That included the treatment of credit elect transfers (CETs), which is now pretty much settled law.  Now we’ll take a look at previous cases with the specific scenario at issue in Goldring – rolling CETs – for which the results have been mixed.

Treatment of rolling CETs for interest purposes

FleetBoston Fin. Corp v. United States, 483 F.3d 1345 (Fed. Cir. 2007) is the only Circuit Court decision clearly on point, for now.  (Rolling CETs were also involved in Marsh & McLennan Cos. v. United States, 302 F.3d 1369 (Fed. Cir. 2002), but the taxpayer agreed with the government’s position later adopted in FleetBoston and the case addressed a different statutory provision, so the court did not have to decide this issue.)  It concluded that interest computation should take into account only the first CET, from the year at issue, and ignore subsequent (rolling) CETs.  Under that approach, the underpayment interest assessed against the Goldrings would be entirely valid.

In re Vendell Healthcare, 222 B.R. 564 (Bankr. M.D. Tenn. 1998), Otis Spunkmeyer, Inc. v. United States, 2004 WL 5542870 (N.D. Cal. 2004), and the dissent in FleetBoston follow the use of money principle from Avon Products and progeny.  The balance in the year at issue doesn’t become “due and unpaid” until the CET amount actually provides the taxpayer with a benefit in a subsequent year – either applied to an estimated tax installment to avoid the addition to tax or included in an overpayment that is refunded instead of transferred to the next year.  Under that approach, the Goldrings would be entitled to a full refund of the underpayment interest.

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FleetBoston disagreed with Vendell and Spunkmeyer, concluding that they

disregard both the account-specific meaning of the term “paid” in the Internal Revenue Code and the regulatory scheme under which a credit elect overpayment will be deemed to reside in the tax account for the succeeding year, even if it is not needed to pay estimated tax in that year. 

In other words, the use of money principle is a tool of statutory construction but cannot override the specific terms of the statutes enacted by Congress. 

Who’s right?

The FleetBoston interpretation may be correct, but I don’t think either the Code or the regulatory scheme are as clear as the Federal Circuit thought they are.  FleetBoston distinguished Vendell and Spunkmeyer in part because of “the account-specific meaning of the term ‘paid’ in the Internal Revenue Code.”  But the issue in these cases is when underpayment interest under section 6601(a) begins running, the “last date prescribed for payment,” not when it stops, “the date paid.”  As discussed in Part 1, Avon Products, Inc. v. United States, 588 F.2d 342 (2nd Cir. 1978) concluded that the beginning date was not clearly addressed by the statute and effectively re-wrote it; the IRS acquiesced in not only the holding but also the reasoning.  That suggests it would be feasible and permissible to re-write it again to address rolling CETs.

The relevant part of the regulatory language, which is the same in both § 301.6402-3(a)(5) and § 301.6611-1(h)(2)(vii), says only that “such amount shall be applied as a payment on account of the estimated income tax for such [succeeding] year or the installments thereof.”  The regulations were enacted back in 1957 and didn’t address when underpayment interest on a subsequently determined deficiency would run.  (I found nothing helpful in the Federal Register when the proposed and final regulations were issued; I doubt if the IRS thought about issues with subsequently determined deficiencies at that time.)  That was worked out through cases and revenue rulings, not regulations.  Even Revenue Ruling 99-40 doesn’t specifically address situations where the CET is not needed at all for estimated tax installments and is rolled to the next year rather than refunded. 

The parties in Goldring argued a lot about the interpretations of cases and rulings, and whether they should apply here.  The disagreement seems to flow from fundamentally different frameworks for thinking about CETs, both in general and with rolling CETs, in this context.

Government perspective – it’s a matter of accounting 

From the perspective of the government (and the FleetBoston court), the focus is on the fact that money has been transferred from one year to another year – the particular year to which the overpayment was first transferred.  The statute and regulations are clear.  The subsequent CETs and the other years are irrelevant.  This has intuitive appeal.  Generally, interest is computed on each tax year independently.  Independence of each tax year is a foundational principle for many purposes in our system and the language in the regulations for CETs is consistent with that perspective.  The initial CET is irrevocable and anything that happens thereafter (a subsequent CET) is not related to the original CET.  If a deficiency arises in the original year of the overpayment, you figure out the effective date of the transfer to the succeeding year, using the approach developed in the cases and summarized in Revenue Ruling 99-40.  If the election on the original year’s return is made before the due date of the return for the succeeding year, which it almost always is, the transfer (a “payment” in the succeeding year) would be effective no later than the due date of that return.

That amount of money is sitting in only one tax year at any point in time.  This is generally how the IRS would record it on account transcripts.  Under this interpretation, in the Goldring case, the amount at issue would be:

  • Included in the account for the 2010 tax year from April 15, 2011, until transferred out on April 15, 2012
  • Transferred into the account for the 2011 tax year on April 15, 2012, and remaining there until transferred out on April 15, 2013
  • Transferred into the account for the 2012 tax year on April 15, 2013, and remaining there until transferred out on April 15, 2014
  • Etc.

In other words, the Code doesn’t offset the 2010 deficiency against the overpayment in 2011 (or subsequent years) as a result of the CET.  The Avon Products decision was not a broad interest netting solution; it just addressed when the transfer between years is considered to take place.

Taxpayer’s perspective – prevent inequitable results

From the perspective of the taxpayer (as well as Vendell, Spunkmeyer, and the FleetBoston dissent), the language is ambiguous enough to allow a construction to meet the policy objectives of Congress.  Avon Products and its progeny, combined with other Code provisions such as sections 6601(f) and 6611(b)(1) and the global interest netting regime of section 6621(d), evidence a strong desire by Congress to avoid “interest arbitrage” results that might be unfair to taxpayers when there are both overpayments and underpayments outstanding.  Global interest netting protects taxpayers from paying underpayment interest at a higher rate than received for overpayment interest on equivalent balances outstanding at the same time.  The same principle should protect all taxpayers from paying underpayment interest during periods when there was an equivalent overpayment balance outstanding for which the taxpayer doesn’t receive interest at all.

Section 6621(d) only allows, by its terms, netting of overpayments on which interest is allowable and underpayments on which interest is payable.  If not for the fact that overpayments that the taxpayer elects to CET to the following year do not earn overpayment interest, that section would give the Goldrings the result they ask for.  But excluding CETs from the reach of section 6621(d) was not necessarily Congress’s intention.  I haven’t done a comprehensive review of the legislative history, but I suspect that limiting section 6621(d) to overpayments on which interest is allowable and underpayments on which interest is payable was only intended to maintain certain restricted interest provisions that give the government an incentive to act quickly. 

For that matter, was the regulation providing that an overpayment transferred by CET does not earn overpayment interest the best decision?  Section 6402(b) is a broad specific grant of authority to issue regulations.  But this was also an exception to the general rule of section 6611(a).  The provision makes some sense, given the solution in Avon Products and progeny, if the taxpayer does not continue to roll over CETs.  The IRS could have written the regulation to address rolling CETs in a way that would conform to the Congressional purpose of disallowing government interest arbitrage.

Avon Products and its progeny have an effect very similar to netting.  Prior to those decisions, the IRS treated the original overpayment in those situations (on which interest was not allowable because it was used for a CET) and the subsequently determined deficiency as separate and independent transactions.  Thus, until the CET was effective, there was – for the same year – an overpayment transaction that didn’t earn interest at all and an underpayment transaction for which the IRS charged interest.  Avon Products combined the two transactions into a single balance before computing interest, what I term “annual interest netting.” 

Notably, the final result of this line of cases and rulings did not treat the CET as effective based on an artificial date, such as the date the return was filed for the overpayment year or the unextended filing due date of the overpayment year.  Instead, the CET was effective only when the taxpayer got a benefit from having the money in the succeeding year.  The current IRS practice limits the effective date of the CET to no later than the unextended filing due date for the succeeding year.  Why should it be limited that way, if the taxpayer receives no benefit in the first succeeding year and instead rolls the amount over to the next year? 

Even if the government’s accounting perspective is respected, is the application of it necessarily immutable?  The CET from Year 1 to Year 2 creates a “negative payment” in Year 1 and a payment in Year 2.  The CET from Year 2 to Year 3 creates a “negative payment” in Year 2 and a payment in Year 3.  Can we consider the payment in Year 2 (from Year 1’s CET) and the “negative payment” in Year 2 (from Year 2’s CET) to have simply offset to eliminate both?  Perhaps.

Where do we go from here?

The government’s position prevailed in FleetBoston, the only Circuit Court decision on the issue of rolling CETs to date.  Vendell, Spunkmeyer, and the FleetBoston dissent held for taxpayers on this issue.  The Goldring decision ruled for the government in a fairly cursory manner and it has now been appealed.

I’m not sure which of the opposing position will prevail in the Fifth Circuit.  I suspect the interpretation in FleetBoston will prevail.  But there are certainly arguments for the taxpayers’ position.  We have an example, over the past couple of years, of a single Circuit Court decision on an issue that might have seemed durable – but wasn’t, once other Circuit Courts eventually considered the issue.  We’ll see whether that happens here.