Boilerplate Provisions in Stipulated Decisions May Have “Interesting” Consequences

April 21, 2022 by 5 Comments

In my last post, I ran through the arguments a taxpayer may have against interest accruing when the IRS is “dilatory” in assessing tax that was assessed through a Tax Court decision. It was a fun and exciting jaunt through IRC § 6404(e) marred by a rather unfulfilling conclusion: IRC § 6404(e) interest abatement for “dilatory” IRS assessment might not get you where you want to go if your client is poor.

That seems unfair. But as my parents undoubtedly told me when I was a child, life is unfair.

Still, as lawyers we like to believe that we can mitigate some of that cosmic unfairness. Or, failing that, we like to believe we are just cleverer than we really are. I’ll let you be the judge which of those two buckets my following argument falls into…

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Let’s get away from IRC § 6404 for a moment. As Professor Bryan Camp recently detailed, there are a lot of different ways to lose on IRC § 6404 arguments.

Instead of the rocky, uninviting terrain of IRC § 6404(e), let us turn to the lush paradise that is IRC § 6601. Specifically, let us gaze upon IRC § 6601(c).

The provisions of IRC § 6404(e) were full of mushy terms like “ministerial or managerial act,” and “dilatory performance.” IRC § 6601(c), however, gives us nice, bright lines to work with. If the taxpayer waives the restrictions to assessment under IRC § 6213(d), the interest on the deficiency is suspended when the IRS fails to send “Notice and Demand for payment” within 30 days of the waiver.

Note that this code section generally comes up in examination, and not in litigation. In fact, the waiver of interest is commonly referred to as an “870 Waiver” by those in the know (i.e., Bob Probasco, to whom I am indebted on all issues relating to interest), because it is traditionally done through Form 870.

But we’re dealing with people that have decisions entered in Tax Court, not administratively with the IRS. Is there any way to get to IRC § 6601(c) without Form 870?

Maybe. Bear with me on this one.

One of the standard, boilerplate (and IRS insisted upon) provisions on the stipulated Tax Court decisions I enter into reads as follows:

“It is stipulated that, effective upon the entry of this decision by the Court, petitioner waives the restrictions contained in IRC § 6213(a) prohibiting assessment and collection of the deficiency (plus statutory interest) until the decision of the Tax Court becomes final.”

In other words, my Tax Court decisions enter into a section 6213(a) waiver. Am I out of luck because IRC § 6601(c) requires a waiver “under section 6213(d)” and my waiver occurs a mere three sub-paragraphs above that?

We should probably look at IRC § 6213(d) to get an idea. It is a short and fairly straightforward code provision:

“The taxpayer shall at any time (whether or not a notice of deficiency has been issued) have the right, by a signed notice in writing filed with the Secretary, to waive the restrictions provided in subsection (a) on the assessment and collection of the whole or any part of the deficiency.”

Arguments For and Against Tax Court IRC 6213(a) Waiver as IRC 6213(d) Waiver

IRC § 6213(d) really just asks two things:

(1) did the taxpayer waive the restrictions on assessment and collection in IRC § 6213(a), and

(2) did the taxpayer sign and file that waiver with the IRS?

The answer to the first question is an unequivocal “yes” in my Tax Court decision documents. The answer to the second question is not so clear.

Any time I enter into a stipulated decision to some degree I “sign and file” a document with the IRS. I definitely “sign” the document. But I much-less-definitely “file it” with the IRS. As an agreement (a signed stipulation between the parties) it is always countersigned by the IRS. So, I always “send” it to the IRS for them to take further action. Nonetheless, it is debatable whether I’m “filing” it with the IRS. Some would say I am only “filing it” with the Tax Court. But that term is not particularly well defined.

One other wrinkle. I somewhat-subtly substituted “IRS” for the word “Secretary” in the statute (e.g., “file with the Secretary”). Does that matter?

Generally, “Secretary” means the actual secretary of the Treasury (presently Janet Yellen), or their “delegate.” A delegate, in turn, means “any officer, employee, or agency of the Treasury Department duly authorized by the Secretary of the Treasury directly, or indirectly by one or more redelegations of authority[.]” See IRC § 7701(a)(11)(B).

In other words, the word “Secretary” refers to a really broad group of people within the IRS. That’s good news for my argument.

Bad news for my argument (maybe) is the Treasury Regulation on point: Treas. Reg. § 301.6601-1(d). That regulation provides that the suspension occurs after a “district director” determines a deficiency and the taxpayer files an agreement “with such internal revenue officer.” Those may well be more restrictive terms. At the very least, they seem to imply that the waiver must be filed in the administrative proceeding, since it is requiring that I file “with such internal revenue officer” (i.e., those involved in determining a deficiency). IRS Counsel is definitely not involved in determining the deficiency for my taxpayers. They come into play only after I’ve filed a petition challenging that prior determination.

What is one to do when the statutory language and regulations leave wiggle room? Look to the case law.

While contemplating the merits of my argument, one case in particular caught my attention: Corson v. C.I.R., T.C. Memo. 2009-95. In Corson the taxpayer apparently executed a section 6213(d) waiver as part of a stipulated settlement in litigation. The Tax Court found that this waiver, which was part of a stipulated settlement, did indeed suspend interest when the IRS took half-a-year to get around to sending a Notice and Demand letter.

That seems pretty much on all-fours with my argument, right?

Maybe.

It isn’t immediately clear to me how the waiver was executed. Was it just in the stipulated decision document? Was it an added Form 870 filed with the decision documents? Does that matter? I’d say it is at least enough of an opening to make an argument. And that opening expands in reading other cases on the topic. For example, in a later case the Tax Court specifically references Corson for the proposition “[g]enerally, the waiver is executed by filing a designated form, but the restrictions on assessment may be waived in other ways.” Hull v. C.I.R., T.C. Memo. 2014-36. So maybe no “designated form” was filed in Corson. Maybe the generic (but explicit) waiver of restrictions in IRC § 6213(a) is enough…

The Takeaways

I referred to the IRC § 6213(a) waiver as “boilerplate” and, in the title of this post, alluded to them being something of an afterthought for most practitioners. But what does the waiver really do?

The most obvious consequence of the waiver is that it speeds up the process for the IRS to assess and collect, by speeding up the “finality” of the Tax Court decision. Usually, the decision is not final until appeal rights have passed or been exhausted. See IRC § 7481. Since I don’t plan on appealing stipulated settlements, I have no problem bumping up the “finality” date of a Tax Court decision by waiving IRC § 6213(a) restrictions.

But shouldn’t there be some trade-off for this waiver of restrictions? What does the taxpayer get by letting the IRS assess and collect more quickly? Conceptually, it seems to me like the IRC § 6213(a) waiver filed in Tax Court is doing basically the same thing the Form 870 waiver is doing in examinations: speeding things up for the IRS. And when the IRS doesn’t act in a (remotely) timely manner on that taxpayer concession, it seems to me that the consequence should mirror that of the Form 870 waiver: a suspension of the accrual of interest for the IRS’s dilatory behavior.

The beauty of the argument, as I see it, is that I no longer have to prove “causation” when I import IRC § 6601(c) as my means for interest abatement: if the IRS doesn’t send the Notice and Demand on time, interest should be suspended, full-stop. This helps low-income taxpayers that can’t afford to just send blind-interest payments to the IRS. Maybe it will also help the IRS in getting those payments more quickly, too.

Filed Under: Abatement, Assessment, Interest

Losing Interest: Delayed IRS Assessments

April 20, 2022 by 2 Comments

Over the last two years I cannot count the number of times I’ve had to give extraordinarily unsatisfying advice to my clients. That advice being, “please wait.” Wait for the IRS to process your return. Wait for the refund to be issued. Wait for your Collection Due Process hearing.

Of course, waiting can carry a price. I’ve previously posted a bit about the time-value of money, and (especially for low-income taxpayers) the opportunity costs of waiting on a refund. Here, I’ll write about the potential costs to the government and potential arguments taxpayers may have against paying interest. To keep things (relatively) simple, I will be focusing only on IRS delays after Tax Court decisions.

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I’ve come across a lot of practitioners voicing concern about IRS delays in issuing refunds after a Tax Court decision. In those instances, practitioners are well-advised to review Tax Court Rule 260.

Less common (though not unheard of) is the complaint for those that end up owing after their trip to Tax Court. What happens when the parties settle on a deficiency, but the IRS never gets around to actually assessing that (agreed upon) amount? Bob Kamman experienced and posted on something close to this phenomenon (with a bit of a twist), giving the advice to reach out to the IRS counsel’s office to sort things out. In terms of getting the IRS to actually take action, that advice likely still holds, but what about a remedy for all the time you spent waiting?

From the outset, some may see this all as a non-issue. Regardless of the IRS delay in assessment, you can still send payment for the deficiency and maybe throw a little extra on top for the interest accrual you estimate to be due.

But it is important to remember how many people out there don’t have that “little extra” to throw on top. In 2016, approximately 63% of Americans couldn’t cover a $500 emergency. This is not just a problem in the abstract: I have clients that are living on such tight margins that the accrual of interest makes a big difference in their lives. This is all the more true given inflation and the (slight, but real) uptick in interest rates for tax. Perhaps there should also be some relief from the interest that accrues during a delay in assessment…

And perhaps there is…

Rule 260 Redux?

A quick note on where you won’t find relief.

Mere paragraphs above, I advised practitioners to review Tax Court Rule 260 when their clients are waiting on refunds from a Tax Court decision. Some of you no doubt found that Rule so engrossing that you read on to Rule 261… which deals directly with “proceedings to redetermine interest.” Is that where we should look for relief from interest where the IRS fails to assess and send a notice and demand for payment in a timely fashion?

Probably not.

Rule 261 pertains to cases where the Tax Court decision found an overpayment. Imagine two different taxpayers: one we’ll call “Flush” and one we’ll call “Strapped.” Both have identical tax issues, and both bring identical cases to Tax Court. Eventually, both Flush and Strapped reach a settlement with the IRS, agreeing to a deficiency amount less than what was in the Notice of Deficiency.

But here is where things diverge.

Prior to filing the petition, Flush sent in a deposit under IRC § 6603 for the amount listed on the Notice of Deficiency. Strapped, on the other hand, did not. In their stipulated decision documents, Flush will agree to both a deficiency and an overpayment (i.e., the amount by which the deposit for the original deficiency exceeds the agreed upon deficiency). Strapped, on the other hand, will only agree to a deficiency.

It is for taxpayers like Flush that Rule 261 (and IRC § 7481(c)) applies (you can see that situation in action in Hill v. C.I.R., T.C. Memo. 2021-121). But I am concerned with taxpayers like Strapped. What interest-related arguments might Strapped have?

Unreasonable Delay: The Seemingly Obvious Argument

When the Tax Court redetermines a deficiency, the IRS has to assess it. This seems pretty uncontroversial and is enshrined in IRC § 6215(a). If you double-checked my code citation, please note and underline the phrase “shall be assessed.”

If the IRS takes literally over a year to get around to assessing the tax after a final Tax Court decision, it has followed the statutory mandate… but in a sluggish way that perhaps ought to carry consequences. And a fitting consequence for wasting time would be forgoing the time-value of money during that wasteful period. In other words, abating interest.

And it so happens there is a code provision exactly on point for those sorts of issues: IRC § 6404(e), “Abatement of Interest Attributable to Unreasonable Errors and Delays by the Internal Revenue Service.” That sounds promising, particularly the provisions at IRC § 6404(e)(1)(B). What exactly do they entail?

First, the “unreasonable error or delay” has to involve an IRS employee “in performing a ministerial or managerial act.” Since we’re only focusing on assessing tax, let’s call this the “non-discretionary act” test.

Second, the delay in payment has to be “attributable” to the IRS employee being “dilatory” or erroneous. Let’s call this test the “causation” test.

Third, the taxpayer can’t have played a “significant” role in the error or delay. Let’s call this the “clean-hands” test.

Lastly, the period of abatement must come after the IRS has contacted the taxpayer, in writing, with respect to the deficiency. This is mostly a computational test that we don’t really need to worry about here. It will always be met where the interest at issue has accrued after a Tax Court decision finding a deficiency.

“Non-Discretionary Act” Test

The Treasury Regulations define a “ministerial act” as an act that “does not involve the exercise of judgment or discretion, and that occurs during the processing of a taxpayer’s case after all prerequisites to the act, such as conferences and review by supervisors, have taken place.” Treas. Reg. § 301.6404-2(b)(2). I’d say inputting the assessment of a deficiency, after a Tax Court decision has found that deficiency and is final, meets that test. This is especially true since the IRS is mandated to enter the assessment (the “shall be assessed” language of IRC § 6215(a)).

First test = passed.

“Clean-Hands” Test

What does it mean for a taxpayer (or someone sufficiently related to the taxpayer) to play a “significant role” in the delay? Most of the cases I found involved taxpayers filing incorrect forms or taking other actions that would make the IRS “ministerial or managerial” acts more difficult. There are also some cases where the taxpayers renege (or attempt to renege) on settlements, and generally contradict themselves while trying to vie for interest abatement. In other words, cases where the taxpayer did not have clean hands. See Mitchell v. C.I.R., T.C. Memo. 2004-277.

Assuming the taxpayer has done everything right up to the point of the Tax Court entering the decision document, they probably meet this test too…

“Causation” Test

Here is where things get tricky. The biggest obstacle is something that was alluded to earlier: arguably, you could have paid the tax (and stopped the interest) even without the IRS taking the ministerial acts to assess it. In other words, it was not the failure to perform a ministerial act that caused the interest accrual. It was simply the taxpayers’ failure to send in money.

There are at least a few cases that look at the causation issue and cut against the taxpayer. The worst (and in my opinion, least fair) line of Tax Court cases provide that there will be no abatement if there is no evidence that an earlier payment would have been made… for example, because the taxpayer is cash-strapped.

The Tax Court has expressly found that the IRS has the “discretion” not to abate tax if the taxpayer fails “to establish that he had the financial resources to satisfy the tax liability when the claimed error occurred.” See Hancock v. C.I.R., T.C. Memo. 2012-31, listing off cases supporting this proposition. In other words, extremely low-income taxpayers may be the least able to get interest abatement under this line of argument.

This may not always be the case and would likely be fact specific. But it is enough for me to have serious concerns about arguing under IRC § 6404(e) for interest abatement when the IRS delays in assessing tax for my clients.

Fortunately, there may be different line of argument that will get my clients relief. My next post will cover that proposition.

Filed Under: Abatement, Assessment, Interest

No Rehearing En Banc for Goldring: Is Supreme Court Review Possible?

March 25, 2022 by Leave a Comment

The last time we talked about Goldring v. United States, 15 F.4th 639 (5th Cir. Oct. 4, 2021), the taxpayers had won their case for a refund of deficiency interest, creating a circuit split with FleetBoston Fin. Corp v. United States, 483 F.3d 1345 (Fed. Cir. 2007).  On November 18th, the government petitioned for a rehearing en banc.

On March 2, 2022, after briefing by the parties in early December, the court denied the petition for rehearing en banc.  The court was polled, with seven judges (Smith, Stewart, Dennis, Haynes, Graves, Higginson, and Costa) voting for rehearing and ten judges (Owen, Jones, Elrod, Southwick, Willett, Ho, Duncan, Engelhardt, Oldham, and Wilson) voting against.  That may be the end of things, with taxpayers filing future cases in district courts rather than the Court of Federal Claims, hoping to repeat the Goldring result.

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It’s also possible that the government will consider filing a petition for a writ of certiorari, hoping to reverse.  For one thing, the government argued in its petition that there were more potential cases with this issue than I had anticipated.

The Chief Counsel, Internal Revenue Service, has advised us that nearly 4.4 million individual taxpayers have claimed successive credit elects in the past three years.  Chef Counsel estimates that approximately 25,000 of those individuals will have a later determined income-tax deficiency, and could file claims for refund of underpayment interest under the reasoning of the panel’s decision.  For corporate taxpayers, to whom the panel’s reasoning equally applies, Chief Counsel foresees roughly 2,000 potential refund claims, which could range into the multiple millions of dollars.  All of these claims must be manually processed, as the rule in this case would require the IRS to determine to what extent a taxpayer’s credit balances, year over year, offset a deficiency determination before interest can be computed on the difference.

Further, the panel’s opinion seemed to base the decision on a rationale with which the DOJ Tax Division strongly disagrees.  The panel started with a statement about the purpose of interest.  “Under the use-of-money principle, a taxpayer is liable for interest only when the Government does not have the use of money it is lawfully due.”  It later noted “the simple, undisputed fact that the IRS was never deprived of its use of the money the Goldrings lawfully owed it at any point during the five-year underpayment interest assessment period.”  But since the IRS held that money in accounts for other tax years, that sounds very much like a broad “netting” principle – that an overpayment in any tax year can be used to offset an underpayment in another tax year to reduce interest on the latter. 

The DOJ Tax Division, on the other hand, construes the use-of-money principle more narrowly, as an aid for interpretation when the statute is ambiguous rather than a broad equitable principle.  See a 2012 version of the DOJ Tax Division Settlement Reference Manual, specifically Appendix Y (Interest), page 2:

While case law is important in interpreting these statutes, interest liability may not be extended beyond what the statute prescribes. For example, the “use-of-money” principle is frequently invoked in tax cases.  This principle, which is stated to be the rationale for charging interest, is a useful guide for interpreting interest statutes where the statute is ambiguous or where the application of the statute to a particular fact situation is unclear.  Nonetheless, the use-of-money principle is not a principle of substantive law and (contrary to arguments sometimes advanced by taxpayers) cannot impose liability for interest that is beyond the scope of the Code’s interest provisions. 

This is the most recent version of the manual I was able to find online.  I’m not sure if there’s a more recent version, but I would be surprised if this attitude had changed in the past ten years.

I’ve heard/seen the attitude toward “use-of-money” arguments expressed somewhat more, shall we say, sharply or forcefully by at least one or two DOJ attorneys over the years.  And the statutory netting provision of section 6621(d) is written more narrowly than the result in Goldring, arguably demonstrating that Congress specifically decided against offering the netting benefit that the Goldrings argued for.  So, I wouldn’t be surprised if the DOJ attorneys here argued for a trip to the Supreme Court to try to overturn the Goldring result.  I’m just speculating, of course, but I’d love to be a fly on the wall in the “Room of Lies” that Keith described here and here.

Filed Under: Interest, SCOTUS Tagged With:

January 2022 Digest

February 1, 2022 by 2 Comments

A lot has happened in the tax world since the year began, then filing season began last week, and the ABA Tax Section 2022 Virtual Midyear Meeting began yesterday. There are no signs that things will slow down soon, except for (maybe) IRS notices.

Procedurally Taxing will continually provide comprehensive updates and information, but if you fall behind with your reading or struggle to keep up- I’ll be digesting each month’s posts from here on out.

January’s posts highlighted the NTA’s Report, the ongoing impact of the pandemic, and recent Circuit splits.

National Taxpayer Advocate’s Report

NTA Report Released: Essential Reading: The Report is available and contains new features, including an enhanced summary of the Ten Most Serious Problems and a change in the methodology used to determine the Most Litigated Issues.

What are the Most Litigated Issues and What’s Happening in Collection?: A closer look at the Most Litigated Issues. EITC issues are often petitioned but rarely result in an opinion, suggesting that most are settled before trial. In Collection, lien cases referred to the DOJ have declined substantially over the years corresponding with the decline in Revenue Officers and resources.

Who Settles Cases – Appeals or Counsel (and Why?): An analysis of data on the number of Tax Court cases settled by Appeals or Counsel. An increasing percentage of settlements are handled by Counsel, but why? Possible reasons and possible solutions are considered.

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Where Have Tax Court Deficiency Cases Come from in the Past Decade?: Most deficiency cases have come from correspondence exams of low- and middle-income pro se taxpayers. The focus of IRS examinations over the past decade has influenced the cases that end up in Tax Court. A shift in focus may be coming as IRS seeks to hire attorneys to specifically combat syndicated conservation easements, abusive micro-captive insurance arrangements and other tax schemes.

The Melt – Cases That Drop Away in Tax Court: Around 20% of Tax Court cases get dismissed each year- likely due, in part, to untimely filed petitions. Also due to a failure to prosecute, that is the petitioner abandoned the process somewhere along the way. Ways to address this issue are worth exploring, such as increasing access to representation and implementing a model utilized by the Veterans Court of Appeals.

Supreme Court Updates and Information

Who Qualifies as Press and the Boechler Supreme Court Argument Today: Being consider a member of the press comes with benefits, including the option to attend Supreme Court arguments with a press day pass when Covid-restrictions end. In lieu of being there in person, real-time broadcast links of Oral Arguments are made available on the Supreme Court website.

Transcript of Boechler Oral Argument: A link to the transcript of the Boechler Oral Argument is provided and Keith shares his in-person experiences observing the Supreme Court and the options available to others who are interested in doing so when Covid-restrictions end.

Pandemic-Related Considerations

Refund Claims and Section 7508A: A well-informed analysis of the disaster area suspensions under section 7508A and the refund lookback limits. Does the language in section 7508A allow for an extended lookback period? The IRS Office of Chief Counsel doesn’t think so, but TAS has recommended that Congress amend section 6511(b)(2)(A) for that purpose, and there is an argument that a regulatory solution is already available.

 Making Additional Work for Yourself and Others: The IRS has been cashing taxpayer payments without acknowledging receipt of the associated return. This improper recordkeeping resulted in the IRS sending CP80 notices to taxpayers requesting duplicate returns. This created more work for the IRS, practitioners, and clients. The IRS, however, recently announced it would stop doing this, as summarized directly below.

IRS Announces Stoppage of Notice to Paper Filers Who Remitted Payment and Tax Court Announces Continued Zooming: The IRS will stop requesting duplicate returns from paper filers who remitted payments with their original returns. Members of Congress also made specific requests to the IRS with the goal of providing relief to taxpayers until the IRS backlog is resolved, including temporarily halting automated collections, among other things. The Tax Court announced all February trial sessions will be by Zoom.

Practice and Procedure Considerations

“But I’ve Always Done It That Way!” Practitioner Considerations on Subsequent Year Exams: A TIGTA recommended change to IRS procedure may increase the audit risk for taxpayers who do not respond to audit notices. There is no blanket prohibition on telling clients about audit rates and general likelihoods of audit, so practitioners should be able to advise their clients of this potentially emerging risk and ways to avoid it.

New Rules in Effect for Refund Claims For Section 41 Research Credits Raise A Number of Procedural Issues: New rules for research credit refund claims require extensive documentation which increases costs and the risk of a deficient claim determination. Procedures for determinations were issued at the beginning of the month and have generated concern among practitioners because a determination cannot be challenged with a traditional refund suit and because the IRS modified regulatory requirements without utilizing formal notice and comment procedures.

Tax Court News

Tax Court Going Remote for the Remainder of January[and February]: January calendars (and now February, as mentioned above) scheduled in-person sessions have switched to remote sessions due to ongoing Covid-concerns.

Tax Court Orders and Decisions

The Tacit Consent Doctrine May Extend Far Beyond Signing a Joint Return: The Court in Soni v. Commissioner, allowed the tacit consent doctrine (where facts and circumstances led to finding of consent on the part of a non-signing spouse) to apply to returns, power of attorney authorizations and forms 872. The doctrine could be expanded in future cases, so it should be kept in mind when representing innocent spouses.

Timely TFRP Appeal?: The administrative 60-day deadline to respond to TFRP notices is discussed in an order requesting that the IRS supplement its motion for summary judgment. The origin of a deadline is important. Jurisdictional deadlines are different from administrative deadlines, and cases involving administrative deadlines can be reviewed for abuse of discretion.

Circuit Court Decisions

Eleventh Circuit finds Regulation Invalid under APA: The Eleventh Circuit, in Hewitt, calls into question who has the burden to show that a comment made during a notice and comment period: 1) was significant, and 2) consideration of it was adequate. The Tax Courts says it’s the taxpayer, the Eleventh Circuit says it’s the IRS, but what does this mean for everyone else?

The Fifth Circuit Parts Ways with the Ninth Circuit Regarding the Non-Willful FBAR Penalty: A difference in statutory interpretation results in a recent split between the Ninth and Fifth Circuits over whether the non-willful penalty under section 5321(a)(5)(A) should be assessed on a per-form or per-account basis. The Ninth Circuit held that legislative history, purpose, and fairness support a per-form penalty, but the Fifth Circuit held that Congress’ intent and the objective of the penalty support a finding that it’s per-account.

Goldring is Back with a Circuit Split: The Fifth Circuit addresses how underpayment interest should be computed on a later assessed deficiency when a taxpayer elects to credit forward an overpayment from an earlier filed return. It held “a taxpayer is liable for interest only when the Government does not have the use of money it is lawfully due.” This contrasts with other Circuits which have decided that the law allows the IRS to begin computing interest when an amount is “due and unpaid.”

Polselli v US: Circuit Split on Notice Rules for Summonses to Aid Collection: A recent Sixth Circuit decision continues a circuit split on a fundamental issue in IRS summons practice: does the IRS have to give notice when it issues a summons on accounts owned by third parties in the aid of collecting an assessed tax? The Sixth, Seventh and Tenth Circuits read section 7609 notice requirements and its exclusion without limitations, which contrasts with the Ninth Circuit’s more narrow interpretation.

D.C. Circuit Narrows Tax Court Whistleblower Award Jurisdiction: The D.C. Circuit overturns Tax Court precedent by holding that the Tax Court lacks jurisdiction over appeals of threshold rejections of whistleblower requests. Since all appeals of whistleblower cases go to the D.C. Circuit, the Tax Court is bound by the decision unless the Supreme Court takes up the issue. 

Liens and Judgments

Local Taxes and the Federal Tax Lien: The effect of the Tax Lien Act of 1966 was reiterated in United States v. Tilley.  Section 6323(a) sets up the first in time rule of law, but 6323(b) provides ten exceptions, including one for local property taxes, which allows a local lien to defeat a federal tax lien even when the local lien comes later in time.

Tax Judgments and Quiet Titles: Tax judgments can benefit the IRS beyond the 10-year federal collection statute of limitations. Boykin v. United States, like Tilley, involves real property held by nominal owners. The taxpayer brought suit to quiet title, the IRS counterclaimed that the money used to purchase the property was fraudulently transferred, and the taxpayer argued that a state statute of limitations prevented the IRS’s argument. The Boykin Court disagreed with the taxpayer relying upon Supreme Court precedent that state statutes do not override controlling federal statutes.

Bankruptcy and Taxes

Diving Beneath the Surface of In re Webb: An in-depth analysis of a technical bankruptcy issue that can impact taxes involving an election under section 1305, which allows postpetition tax claims to be deemed prepetition claims. The classification of the claims impacts whether a subsequent IRS refund offset violates a debtor’s rights.

Filed Under: Administrative Procedure Act (APA), Appeals, Bank Secrecy Act, Burden of Proof, Collection Due Process, Earned Income Credit, Equitable tolling, Exam, FBAR, Form 2848, Innocent Spouse, Interest, Judgment, Lien, Monthly Digest, Overpayment Interest, SCOTUS, Statutes of Limitation, Taxpayer advocate

Goldring Is Back – With a Circuit Split

January 7, 2022 by 4 Comments

Last year, I wrote a couple of blog posts (here and here) about an order by the Eastern District of Louisiana: Goldring v. United States, 2020 U.S. Dist. LEXIS 177797, 2020 WL 5761119 (E.D. La. Sept. 28, 2020).  A significant amount was at issue, so the Goldrings appealed to the Fifth Circuit, which issued its decision recently: Goldring v. United States, 2021 U.S. App. LEXIS 29832, 2021 WL 4520343 (5th Cir. Oct. 4, 2021). 

The primary issue in the case was the proper treatment of a settlement award resulting from a 1997 cash-out merger of a privately held corporation in which Ms. Goldring owned shares.  Instead of taking the offered amount, she sued the company and its directors, asserting claims of unfair dealing and breach of fiduciary duty and seeking either the fair value of those shares or to retain her 15% stake.  The state court held that her shares were worth more than twice the amount she was offered in the merger. 

In 2010, she received a total award of almost $41 million, including $13,684,800 for the fair value of her shares, $26,252,741 for pre-judgment and post-judgment interest (“Interest Award”), and various other fees and costs.  The taxpayers reported the entire award on their 2010 tax return as a long-term capital gain.  The IRS audited the return, concluded that the Interest Award should have been reported as ordinary income, and assessed a deficiency of $5,250,549 plus interest in 2017.  The taxpayers challenged that deficiency in a refund suit, but both the district court and the Fifth Circuit ruled for the government on this issue.

But that’s not what I’m here to tell you about.  I’m here to talk about the procedural issue of how underpayment interest should be computed on that deficiency.

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The underpayment interest issue involved the treatment of “credit-elect transfers.”  The rule for this is relatively unknown, as it is set forth only in caselaw and a Revenue Ruling, rather than in the Code.  The plaintiffs in this case sought to expand the rule (a) beyond the situations in which it was first applied and (b) in a way that the only Circuit Court to have ruled on the question had rejected.  That earlier decision was FleetBoston Fin. Corp v. United States, 483 F.3d 1345 (Fed. Cir. 2007).  The district court in Goldring followed the majority decision in FleetBoston and granted summary judgment to the government.  The Circuit Court overruled the district court on this issue and ruled consistently with some lower court cases and the dissent in FleetBoston.

More details are available at the earlier blog posts, but for now here’s a simplified version of facts that would raise the issue:

  • Taxpayer files tax return for Year 1 (after requesting extension) on October 15th, showing tax liability of $220,000 and payments (withholding or estimated tax payments) of $270,000, for a net overpayment of $50,000. 
  • Taxpayer elects to have the $50,000 applied to estimated taxes for Year 2, instead of getting a refund.
  • IRS audits the Year 1 tax return and determines that the proper tax liability was $260,000 instead of $220,000, a $40,000 deficiency.

Section 6601(a) says that underpayment interest is imposed if the “amount of tax imposed . . . is not paid on or before the last date prescribed for payment.”  As of that last date prescribed, April 15th of Year 2, Taxpayer had paid $270,000 against the re-determined tax liability of $260,000.  Under a literal reading of the statute, the government can’t impose deficiency interest at all.  However, courts decided to interpret section 6601(a) to mean that interest started running when the tax was “due and unpaid.”  This itself was, of course, a favorable result for the government, which otherwise couldn’t collect any interest at all.

The tax became “unpaid” not on April 15th of Year 2, but when the $50,000 was applied to a different tax year.  On the effective date of the credit – equivalent to a refund for Year 1 and payment for Year 2 – the $50,000 left the account for Year 1 and was moved to Year 2.  At that point, the tax liability as redetermined is $260,000 and the payments, net of the credit, are only $220,000.  At that point, the tax is “due and unpaid” and underpayment interest starts running.

But what was the effective date of that credit to Year 2?  The date that the return for Year 1 was filed, making that election to apply the overpayment shown on the return to Year 2’s estimated taxes?  The date of the specific installment of Year 2’s estimated taxes that Taxpayer chose as where the overpayment should be applied?  Something else?  Eventually, the courts and the IRS reached a taxpayer-favorable rule, which was recorded in Revenue Ruling 99-40 :

When a taxpayer elects to apply an overpayment to the succeeding year’s estimated taxes, the overpayment is applied to unpaid installments of estimated tax due on or after the date(s) the overpayment arose, in the order in which they are required to be paid to avoid an addition to tax for failure to pay estimated income tax under sections 6654 or 6655 with respect to such year. 

. . .

When a taxpayer reports an overpayment on its income tax return, interest will be assessed on that portion of a subsequently determined deficiency for the overpayment return year that is less than or equal to the overpayment as of: (1) the date on which the Service refunds the overpayment without interest; or (2) the date on which the overpayment is applied to the succeeding year’s estimated taxes.

The assumption was that, if the transfer from Year 1 were not needed because Taxpayer’s other payments were sufficient to cover the Year 1 tax liability, the remainder would be refunded.  But what if it weren’t?  Let’s revisit that simple example.

  • Taxpayer files tax return for Year 1 (after requesting extension) on October 15th, showing tax liability of $220,000 and payments (withholding or estimated tax payments) of $270,000, for a net overpayment of $50,000. 
  • Taxpayer elects to have the $50,000 applied to estimated taxes for Year 2, instead of getting a refund.
  • Taxpayer doesn’t need the $50,000 to meet its obligations for estimated taxes in Year 2.  It is part of an overpayment for Year 2 that Taxpayer elects to have applied to estimated taxes for Year 3, instead of getting a refund.
  • Taxpayer doesn’t need the $50,000 to meet its obligations for estimated taxes in Year 3, either.  It is part of an overpayment for Year 3 that Taxpayer elects to have applied to estimated taxes for Year 4, instead of getting a refund.
  • IRS audits the Year 1 tax return and determines that the proper tax liability was $260,000 instead of $220,000, a $40,000 deficiency.
  • Taxpayer doesn’t need the $50,000 to meet is obligations for estimated taxes in Year 4, either.  It is part of an overpayment for Year 4 and the government applies $40,000 of the overpayment to pay the deficiency in Year 1.

That, in simplified form, is what the Goldrings did.  They anticipated that the IRS might conclude that the Interest Award was ordinary income, so they left money with the IRS to cover any eventual deficiency and avoid interest on that deficiency.  Making a deposit would have been a more certain way to avoid interest on the eventual deficiency, but that’s not what they did.

The caselaw and Revenue Procedure didn’t address this situation.  A few lower courts, and the dissent in FleetBoston, concluded that underpayment interest for the Year 1 deficiency wouldn’t start running until it was applied to Year 4 effective as of April 15th, 2015 – the last date prescribed for payment.  Under that approach, the amount of interest Taxpayer had to pay on the $40,000 deficiency was minimal.  The majority in FleetBoston, however, said once Taxpayer decides to transfer the $50,000 from Year 1 to Year 2, that amount should be treated as leaving the account for Year 1 and moving to the account for Year 2 no later than the date prescribed for payment for Year 2.  The district court in Goldring agreed with FleetBoston, but the Fifth Circuit didn’t.

The Fifth Circuit’s reasoning was not entirely clear.  I argued in the earlier blog posts on the district court decision that a ruling contrary to FleetBoston might be reasonable.  For example, a court might conclude that the previous line of rulings – a one-time application of the overpayment to estimated taxes for the following years – could be extended to situations when a taxpayer continuously rolls the amount forward for several years.  The earlier courts determined that the overpayment moved to Year 2 as of the date the taxpayer would receive a benefit (avoiding the penalty for failure to pay estimated taxes) in Year 2. If there was no benefit in Year 2, because it is neither used for estimated tax obligation nor refunded, the IRS treats the transfer from Year 1 as effective on the unextended filing date for Year 2.  Would the same principle apply to cover rollovers to Year 3, Year 4, etc.?  That is, is the money treated as remaining in the account for Year 1 – and the tax liability there is not “due and unpaid” – until the taxpayer receives a benefit in a future year, either by application to estimated taxes or refund?  Possibly, although that is not consistent with how these amounts are reported on Form 1040 for Year 1, Year 2, Year 3, etc.  But the Fifth Circuit did not rule narrowly in that way. 

The court focused on a broad statement of the purpose of interest.  “Under the use-of-money principle, a taxpayer is liable for interest only when the Government does not have the use of money it is lawfully due.”  Mentioning “use-of-money” is guaranteed to raise the hackles of DOJ Tax Division, which rejects taxpayer arguments to treat this as a broad equitable principle rather than a limited tool of statutory interpretation. 

I think the caselaw for the most part is consistent with DOJ Tax Division’s viewpoint.  Some of the so-called use-of-money cases have made broad statements such as that, but their actual holdings have been much narrower.  They involved either (a) determining the effective date of changes in tax liability, as later than when underpayment interest generally starts or (b) determining the effective date of changes in the amount paid.  Category (a) revolves around whether the change is due to “subsequent operational events”; category (b) involves crediting an overpayment to the following year’s estimated taxes, the first simplified example above.  Courts have for the most part used the principle to interpret specific statutory provisions in unusual circumstances, rather than as an all-purpose argument for equitable results.

The court did not think much of the government’s argument.  “Further, like the FleetBoston majority, the Government’s argument in this case fixates on theoretical migration of credit-elect overpayment funds from one tax year to another.”  I think describing it as “theoretical” is a bit much.  One of the long-standing, fundamental principles of tax administration is that tax liabilities and payments are accounted for separately by taxpayer, type of tax, and tax period.  Movement of funds, from one tax period to another, is subject to specific procedures and restrictions.  This treatment of credit-elect transfers is no more “theoretical” than applying any funds received from a taxpayer to the tax period the taxpayer specifies.

As support for its conclusion, the court stated that the government “completely ignores the simple, undisputed fact that the IRS was never deprived of its use of the money the Goldrings lawfully owed it at any point during the five-year underpayment interest assessment period.”  I think the court is effectively asserting a broad “netting” principle – that an overpayment in any tax year can be used to offset an underpayment in another tax year to reduce interest on the latter.

The problem with this argument is that the netting provision enacted by Congress has a narrower scope and arguably prohibits what the Fifth Circuit did in Goldring.  Section 6621(d) states:

To the extent that, for any period, interest is payable under subchapter A and allowable under subchapter B on equivalent underpayments and overpayments by the same taxpayer of tax imposed by this title, the net rate of interest under this section on such amounts shall be zero for such period.

This only applies, based on its literal terms, when interest is payable on the underpayment and allowable on the overpayment.  But the amounts transferred to Year 2, then Year 3, then Year 4 never would have accrued overpayment interest, under the regulations for such transfers.  (Second 6621(d) is really for the benefit of corporations, who for the same period might pay a higher interest rate on underpayments than the interest rate they receive on overpayments.)  You can argue for a broader application of netting between tax periods than provided by section 6621(d), but that conclusion is not necessarily easy to reach.  The question you have to answer:  If Congress didn’t intend to exclude that possibility, why did they include the limitation that interest must be payable on the underpayment and allowable on the overpayment?

I’m not opposed to the result per se, but I’m not convinced by the opinion.  I would prefer to see a more analytical approach along one or both of these lines – narrow expansion of the previous line of cases; or broad netting between tax periods.  I would prefer that the decision recognize and address the difficulties and limitations in reaching that answer, rather than rely on a broad equitable principle.  However, the courts decide these issues, not me, and the judges are normally generalists, rather than tax experts.  As the Fifth Circuit said in Cornelius v. Commissioner, 494 F.2d 465 (5th Cir. 1974):

Ours has been the more mundane assignment of contouring the codified curlicues of Subchapter S to the Code’s synoptic minutiae. Being mere mortals unendowed with cosmic tax wisdom, we have performed our task as well as our fallible mentalities and compositions will permit.

Where do we go from here?  The government filed a petition for a rehearing en banc on November 18th.  Based on the DOJ Tax Section’s opinion of “use-of-money,” I wasn’t at all surprised.  There is, of course, no guarantee that the court will grant a rehearing or that the en banc court would reach a different decision.

So, assuming the decision is not reversed by an en banc rehearing, we have a new circuit split.  In recent years we’ve seen a lot of activity with respect to a different interest issue for which a circuit split developed.  I doubt that we’ll see the same swift development here that we saw there; there are fewer of these “rolling credit-elect transfer cases” than taxpayers seeking to bring stand-alone suits for overpayment interest in district court.  But we’ll see.

Filed Under: Interest Tagged With:

When Is a Late Return Not Really “Late”?? – Part 2

December 6, 2021 by 1 Comment

Bob Probasco picks up from his post last week and continues discussing the tricky issue of when interest starts to accrue on refunds when the taxpayer may not have known that they had a return filing obligation on the due date of the return. Les

And now some observations and questions about that recent IRS legal memo on an overpayment interest issue.  The memo relied substantially on two cases addressing similar situations: MNOPF Trs. Ltd. v. United States, 123 F.3d 1460 (Fed. Cir. 1997) and  Overseas Thread Indus. v. United States, 48 Fed. Cl. 221 (2000).  (The Overseas Thread scenario is virtually identical to that in the memo.)  Normally, taxpayers receive overpayment interest from the filing due date of the return, if all payments that make up the overpayment were made by then.  These cases involved a statutory provision, Section 6611(b)(3), under which if the return is filed late, taxpayers do not receive overpayment interest before the date the return was filed. 

MNOPF established the principle that a return cannot be “late” if the taxpayer was not required to and did not file a tax return.  Overseas Thread addressed the situation of a foreign corporation that did not have a U.S. trade or business and therefore was not required to file an income tax return – but had to do so to claim a refund of excessive withholding tax on dividends from a U.S. source.  The court in that case determined that the tax return filed to claim a refund of an overpayment was only required by the normal filing date, and therefore late if not filed by then, if the taxpayer knew of the overpayment before the prescribed filing date.  Part I provided background on those two cases and the legal memo.  I think Overseas Thread and the memo leave a lot of questions, and they may be incomplete or even wrong.  Those rulings also could be applied much more broadly than the specific fact pattern they address. 

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What About Delays After Discovery?

Neither Overseas Thread nor the memo directly mentioned another obvious question.  Is the lack of knowledge, by the return due date, of a filing obligation a “blank check” for filing the return at a much later date?  In Overseas Thread, the delay between discovery of the filing obligation and filing the return was relatively short – at most from early October to mid-February.  What if TFI and OTI had waited another year or two to accrue additional interest?

The potential for a taxpayer to “park” money with the IRS at long as possible, earning interest at rates higher than the taxpayer could earn otherwise, may seem very counter-intuitive to those of us who deal with low-income taxpayers.  Their primary objective is getting a refund quickly, not the amount of interest payable.  But Treasury/IRS has expressed a similar concern in some contexts in the past.  (Perhaps that’s what Section 6611(b)(3) is all about – preventing such actions.  An alternative interpretation might be that it’s the flip side of the penalty of Section 6651(a) for filing a return late, which has no teeth when there was no balance due on the return.  I don’t think I’ve ever looked at the legislative history, and that might not explain it anyway.)

The analysis in Overseas Thread seems to allow this very behavior.  If the taxpayer didn’t know of the filing obligation by the normal return due date, Section 6611(b)(3) won’t apply.  Perhaps in another case with a longer delay between discovery of the filing obligation and filing the return, a court might impose a requirement to file within a reasonable time – but it might not.  If it did, that would further complicate the administration of Section  6611(b)(3).

Should The Determination of Whether a Return Was “Late” Depend on the Taxpayer’s Knowledge?

Les pointed out in his post that a knowledge standard – when the taxpayer realized there was an overpayment for that tax period – is extremely difficult to administer and a bright line rule would be much better.  I agree as a practical matter, but I also question whether a knowledge standard is appropriate from a theoretical perspective.  How exactly did Overseas Thread come up with the knowledge standard?

Essentially, it comes down to two provisions of a regulation, that the court was trying to reconcile.  The general rule under Section 6012 is that all corporations are required to file income tax returns “regardless of whether it has taxable income or regardless of the amount of its gross income.”  Treas. Reg. § 1.6012-2(a)(1).  One relevant provision in the regulation, Treas. Reg. § 1.6012-2(g)(2)(i)(a), creates an exception to the general rule:

A foreign corporation which at no time during the taxable year is engaged in a trade or business in the United States is not required to make a return for the taxable year if its tax liability for the taxable year is fully satisfied by the withholding of tax at source under chapter 3 of the Code.

But there’s an exception to the exception in Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2), which states that the preceding exception does not apply:

To a foreign corporation making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year

The court came up with the knowledge standard in an attempt to reconcile those two provisions without creating preposterous or odd results.  The odd result the court saw was that these foreign corporations would have to: (1) always file income tax returns, just because they might later determine that they had an overpayment; or (2) risk not maximizing the overpayment interest they receive.  Of course, taxpayers frequently face the question of whether to file protective claims as a deadline approaches.  And taxpayers often face consequences from delays.

As you read Part 1, you probably were thinking of United States v. Boyle, 469 U.S. 241 (1985), weren’t you?  The Court there held the taxpayer, who relied on an attorney to file an estate tax return, liable for a penalty for late filing.  Reliance on an advisor was not “reasonable cause” to avoid the penalty when the issue was the filing date for the return, as “[i]t requires no special training or effort to ascertain a deadline and make sure that it is met.”  But the Court also mentioned that reliance on a tax adviser might constitute reasonable cause, when the advice was that it was unnecessary to file a return.  I’ve made an argument like that in the context of gift tax.  It might apply here, where the issue was whether part of the distribution was a return of capital rather than a dividend.

But Boyle involved the failure to pay penalty, which has a reasonable cause exception.  There is no such statutory defense to interest.  (The taxpayer in Boyle conceded the interest assessed.)  The taxpayer’s knowledge or intent is very, very rarely relevant to the application of interest provisions.  Perhaps the temporary higher interest rate for a “tax motivated transaction,” or the distinction between a deposit and a payment, but what else?  There’s a good reason for this – interest is not a penalty, it’s simply a payment for the use of the other party’s money.  It’s based on objective criteria rather than the taxpayer’s state of mind.

Thus, I’m not sure whether the knowledge standard really makes sense in Overseas Thread (and by extension, in the legal memo).  I understand the court trying to reach an equitable result, but creating a difficult-to-administer standard is not an ideal solution.

What would a bright-line rule be?  Well, one straight-forward answer would be that Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) explicitly nullifies the exception to the filing requirement; therefore, the return was required, was late, and Section 6611(b)(3) applies.

Of course, that’s not the only possible bright-line rule.

Filing Obligation versus . . . ???

Take another look at Treas. Reg. § 1.6012-2(g)(2)(i)(a) and (b)(2).  I think the Overseas Thread court may have been thinking that they meant something along the lines of:

Normally, you don’t have to file a return under your circumstances but if we owe you money, you’d better file a return and you’d better do it timely!  We want to make sure we get the return by the usual deadline so that we can get your refund to you sooner!

Does that sound like the IRS to you?  Me neither (except when Congress is pushing for quick payments, such as with the economic impact statements and the Advance Child Tax Credit).  If your taxes withheld exceed your tax liability, the IRS is glad to refund that but their feelings aren’t hurt if you don’t ask for it.  And indeed, some taxpayers in that situation don’t bother with filing a return if the overpayment was relatively minor, and as far as know the IRS won’t follow-up to ask about it.

Arguably, Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) is better read as a claims submission rule.  It says that the exception to filing an income tax return for that foreign corporation does not apply:

To a foreign corporation making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year

Not “To a foreign corporation with an overpayment.”  Instead, “To a foreign corporation making a claim . . . for the refund of an overpayment.”  That suggests the proper interpretation would be, paraphrased broadly:

Normally, you don’t have to file a return under your circumstances, because as defined in the exception of § 1.6012-2(g)(2)(i)(a), your tax liability has been fully satisfied. If you choose to file a refund claim – the subject of § 301.6402-3 – though, you must do it on an income tax return form instead of Form 843.

That sounds more like the IRS, doesn’t it?  They won’t insist on a refund claim, but if you file one, please do it on the form for an income tax return or amended return, rather than Form 843.  Indeed, Treas. Reg. § 301.6402-3 allowed refund claims for income tax to be made on Form 843 for many years; that possibility was only eliminated for claims filed after 6/30/76.  Check out T.D. 7410, 1976-1 C.B. 384.  A technical memorandum from the IRS to the Assistant Secretary of the Treasury on 1/21/76, transmitting the T.D., made that purpose explicit.  Case law allowed taxpayers broad discretion regarding what would be considered a valid refund claim; that itself is further support for the conclusion that an income tax return on Form 1120-F was not required in Overseas Thread.  But the IRS could issue regulations to “encourage” taxpayers to file refund claims on tax returns rather than Form 843. 

As noted in Part 1, in the MNOPF case, the taxpayer originally claimed the refund on Form 843.  The IRS rejected that, stating: “A return must be filed to claim the refund, even if in past years you have received refunds by filing only Form 843 without a return.”

If Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) is only about how the refund claim is submitted, but not a requirement to file an income tax return, and caselaw recognizes refund claims that aren’t on income tax returns, arguably there is no obligation to file an income tax return.  Whether a refund claim is filed late is defined by Section 6511 rather than Section 6072.  The “return” therefore was not filed late and Section 6611(b)(3) does not apply. 

That seems like a plausible interpretation of the regulation, and personally I prefer it to that implied by Overseas Thread. 

Note that this wouldn’t apply broadly to any Form 1040 showing an overpayment.  There is a general obligation to file income tax returns that would apply unless Congress has explicitly stated an exception under which taxpayers need not file, such as Treas. Reg. § 1.6012-2(g)(2)(i)(a).  So, if I file my income tax return (requesting a refund) late, I’m still subject to Section 6611(b)(3) and won’t receive interest for the period before the return is received.

Is This Just About Foreign Corporations With No U.S. Trade or Business?

If it were, Overseas Thread and this legal memo would have relatively little impact.  But there are other situations in which taxpayers are excused from filing an income tax return, but still must do so to claim a refund.  Most common: an individual or married couple whose gross income is less than the sum of the basic standard deduction and exemption amount – unless they have at least a minimum amount of earnings from self-employment.  Sections 6012(a)(1) and 6017 set forth the filing obligations; unlike (domestic) corporations, individuals with no taxable income or self-employment income are excused from filing.  But they may file refund claims, because of withholding and/or refundable credits, and the IRS wants those to be filed on Form 1040. 

These taxpayers will usually know that they have an overpayment.  Most, particularly if they have large refundable credits, will file well before the normal filing deadline.  But if the overpayment is from a small amount of withholding, some may not bother until after the normal filing deadline, perhaps well after.  They would likely to lose under the knowledge standard of Overseas Thread, but under the alternative plausible interpretation above, they wouldn’t. 

How is the IRS handling these now?  I don’t know, but a bright-line rule based on whether the return was filed by the normal filing deadline would be much easier to program.  Of course, the amount of interest lost in these circumstances will be minimal in individual cases.  But I’m curious.  The next time one of my clinic clients has filed a tax return after the normal filing deadline, I may check the calculation of interest.    

Filed Under: Interest, refund claim Tagged With:

When Is a Late Return Not Really “Late”?? – Part 1

December 3, 2021 by Leave a Comment

Today guest poster Bob Probasco walks us through the case law and recent IRS memo addressing a foreign corporation which files a return after a normal due date because it only later realizes it has a filing obligation. The issue is one I recently discussed but in today’s first of two parts Bob digs deeper. Les

The IRS released a legal memo recently on an issue I had never thought of before.  Would a tax return by a foreign corporation claiming a refund, filed after the normal filing date, be considered “late,” when the corporation did not realize by the filing deadline that it had a filing obligation at all?  That has implications for how much interest the IRS must pay on the refund.  Les wrote a great post about it.  As I reviewed the memo and related cases, though, I had some nagging questions that Les didn’t have time to address.  (The memo was released on Friday and Les’s post was up early Monday, before I saw the memo itself on Tax Notes Today.)  So, here I am.

Part 1 provides some additional background from the previous court cases and then the recent IRS legal memo.  Part 2 then moves on to those questions – I always have questions – and some very tentative possible answers: this memo may not only be wrong but also apply more broadly than realized. 

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The legal memo follows two particularly relevant court cases, which provide a good background for the discussion.

MNOPF Trustees, Ltd.

MNOPF Trs. Ltd. v. United States, 123 F.3d 1460 (Fed. Cir. 1997) involved foreign entities that were trustees of pension funds of the British merchant marine.  (There were two different entities involved, but from here on I will just refer to “MNOPF.”)  It was a tax-exempt labor organization (Section 501(c)(5)), had no business income in the United States, and therefore was not required to file income tax returns.  However, it invested in securities of U.S. corporations and received dividend payments.  The custodian banks which received the payments withheld thirty percent and transmitted the withheld amount to the IRS, with an annual return on Form 1042.  The banks improperly withheld the 30% from MNOPF’s dividends, since it was tax-exempt; MNOPF filed refund claims on Form 843 in December 1987 for amounts withheld on dividends paid in 1985 and 1986.

The IRS rejected the Forms 843, stating “A return must be filed to claim the refund, even if in past years you have received refunds by filing only Form 843 without a return.”  The IRS also told MNOPF that it should file Form 1120-F.  MNOPF refused to do so, because it wasn’t a corporation, and instead filed Form 990-T, “Exempt Organization Business Income Tax Return,” in December 1989, although it did not have business income.  The IRS accepted that form and refunded the amounts withheld but paid overpayment interest only from the date it received the Form 990-T, because the return was filed late, relying on Section 6611(b)(3):

Notwithstanding paragraph (1) or (2) in the case of a return of tax which is filed after the last date prescribed for filing such return (determined with regard to extensions), no interest shall be allowed or paid for any day before the date on which the return is filed.

The Federal Circuit disagreed.  Treas. Reg. § 301.6402-3(a)(1) says: “In general, in the case of an overpayment of income taxes, a claim for credit or refund of such overpayment shall be made on the appropriate income tax return.”  The rest of the subsection encompasses both original income tax returns and amended tax returns as methods to make a refund claim.  But there was no “appropriate income tax return” for MNOPF since the regulation did not apply to tax-exempt organizations and MNOPF had no taxable liability.  The court concluded: “The Court of Federal Claims correctly held that a claim for refund is not a late-filed tax return when the organization is not required to and did not file a tax return.”  Therefore, overpayment interest would start running with the date of the overpayments, rather than the date MNOPF filed Form 990-T.  (Because MNOPF was tax-exempt, the date of the overpayment was the date that the custodian banks were required to file Form 1042.  That was the primary distinction between MNOPF and the next case.)

Overseas Thread Industries, Ltd.

Overseas Thread Indus. v. United States, 48 Fed. Cl. 221 (2000) moved to the subject very similar to that addressed by the IRS legal memo.  OTI was a foreign corporation with its principal office and headquarters in England and a United States subsidiary, TFI.  TFI made distributions to OTI in 1987, 1988, and 1989; at the time both TFI and OTI thought the distributions were taxable dividends.  TFI withheld five percent of the distributions, pursuant to the US-UK tax convention, and remitted the amount withheld to the IRS along with Form 1042.  OTI did not file an income tax return for those three years, because it was not engaged in a U.S. trade or business.

Sometime in the last quarter of fiscal year 1990 – roughly October through January – OTI determined that a portion of the distributions were non-taxable returns of capital, on which tax should not have been withheld.  TFI filed amended Forms 1042 at the end of January, and OTI filed Forms 1120-F in mid-February, reporting the amounts of the overpayments.  The IRS issued refunds in early 1992, but later demanded that OTI repay a portion of the associated interest, concluding that overpayment interest would start running only when the Forms 1120-F were filed in 1991, thereby treated as “late returns.” 

In its briefs for the cross motions for summary judgment, OTI argued that the returns were not “late.”.  That applies when the returns are not “required,” according to MNOPF.  OTI pointed to Treas. Reg. § 1.6012-2(g)(2)(i)(a), which creates an exception to the general rule that corporations must file income tax returns:

A foreign corporation which at no time during the taxable year is engaged in a trade or business in the United States is not required to make a return for the taxable year if its tax liability for the taxable year is fully satisfied by the withholding of tax at source under chapter 3 of the Code.

That makes sense.  The corporation is taxable on income that is not effectively connected with a U.S. trade or business at 30% (or lower if specified in a treaty).  The payor is required to withhold at that same amount.  The net amount will be $0; why require an income tax return??  (At least, that’s my recollection from my law school class on International Tax.  I haven’t really looked at that in the last 21 years.)

But the government, in its briefs, pointed to Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2), which states that the preceding exception does not apply:

To a foreign corporation making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year

The court concluded this was a “quandary” and stated its task as “to harmonize these provisions into a coherent whole that achieves the object of the regulation, yet does not yield preposterous or odd results.”  The government’s interpretation, though, leads to an odd result.  Foreign corporations that apparently qualify for the exception of Treas. Reg. § 1.6012-2(g)(2)(i)(a) would have to file a return at the filing due date anyway, simply because “an overpayment may be discovered in the future.” (emphasis added)  Failing to do so would “forfeit its ability to maximize interest on any resulting overpayment.”

The court’s solution: if the corporation were making a claim for refund “during the requisite filing period” it was required to file an income tax return by the normal deadline.  If the corporation “later discovers the existence of an overpayment after the close of the applicable income tax return filing period,” it would have to file a return to claim the refund but the return would not be considered a late-filed income tax return and Section 6611(b)(3) would not apply.  Apparently, the parties did not dispute when OTI discovered the overpayment, so the court’s solution decided the case in OTI’s favor.

The New IRS Legal Memo

I don’t think the memo really decided much beyond Overseas Thread.  It cited and quoted that case, along with MNOPF, and basically relied on those decisions.  The one thing perhaps new in the memo was that it was more explicit than Overseas Thread, in recognizing that the application of that rule might require information that the IRS might not have.  The field unit requesting advice did not specify that information, so the memo’s answer was not conclusive.

As Les pointed out in his post: “The knowledge standard raises significant challenges for tax administrators who may not be able to determine that knowledge on the face of a return.”  I agree whole-heartedly.  Particularly in cases like these, interest may be computed with minimal or no interaction with the taxpayer.  The computer may (?) automatically apply Section 6611(b)(3) based on the information available without anyone intervening to ask when the taxpayer became aware that there was an overpayment.  It would be up to the taxpayer to realize the IRS position was inconsistent with case law and claim additional interest.  I also would very much prefer a bright line rule.

In Part 2, I’ll turn to how the Overseas Thread court might have reached it decision without having to apply a knowledge standard.  I think that decision – or at least the rationale – arguably was wrong.  If so, that also suggests a particular direction in which the bright line rule should run.  Part 2 also addresses why this issue could affect many more taxpayers than foreign corporations without a U.S. trade or business.

Filed Under: Interest, refund claim Tagged With:

Interest on Overpayments in the Absence of a Filing Obligation

November 8, 2021 by Leave a Comment

More often that I would like to admit when reviewing developments for the update to Saltzman and Book IRS Practice & Procedure I come across an issue that I had not thought about at all. In this round, with my colleague Marilyn Ames taking the lead we have been working on discussing a number of challenging and technical issues relating to interest, the subject of an entire chapter in the treatise.  One issue that jumped out at me was an IRS legal memo’s discussion of when interest on an overpayment accrues when a foreign corporation may have no obligation to file a US income tax return but eventually does so to claim a refund relating to withholding taxes. The issue centers on whether interest accrues from the due date of the return or the later date when the corporation filed a processable return.  The legal memo focuses on whether the taxpayer  knew it was entitled to a refund on the due date of the return and hence had to file a return to alert the IRS of the corporation’s claimed overpayment.

As with almost all interest issues, the matter is a bit technical so I will review the applicable provisions and briefly discuss the memo’s analysis.

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The facts in question in the legal memo involved the foreign corporation filing a tax return claiming a refund of the withheld tax after the due date of the 1120-F, the income tax return for foreign corporations. The corporation was not engaged in a US trade or business.

Generally under Section 6611 interest is paid on any overpayment of tax from the date of overpayment to a date that precedes the refund date by not more than 30 days. Withholding taxes are generally deemed as being paid on the due date of the return. Section 6611(b)(3) provides an exception to the general rule that interest accrues from the date of overpayment and provides when a return is filed after its due date “no interest shall be allowed or paid for any day before the date on which the return is filed.”

Regulation Section 1.6012-2(g) provides that a foreign corporation that is not engaged in a US trade or business is not required to file a return if its tax liability for the taxable year is fully satisfied by withholding. But the regulations also provide that if that foreign corporation believes it has overpaid its tax, it must file a return claiming the overpayment.

Is a return considered filed after the due date for interest purposes if the foreign corporate taxpayer did not have an obligation to file the return but for the claimed overpayment attributable to excess withholding?

The legal memo discusses a few cases that considered the issue, including Overseas Thread Industries (OTI), 48 Fed. Cl. 221, 230 (2000). In discussing Overseas Thread the memo notes that the “Court of Federal Claims reasoned that the proper interpretation of § 1.6012-2(g) is that the foreign corporation must file a return when claiming a refund, but that the return will not be considered late for purposes of section 6611(b)(3) if the foreign corporation did not know that it was owed a refund when the return was due.”

In applying that standard to the facts in the memo, the memo notes that it was unclear when the foreign corporation knew that the withholding would result in an overpayment of its US tax. If the taxpayer knew that the withholding exceeded its tax due before the due date (plus extension) then interest would accrue only upon the later filing of a processable return. If the taxpayer did not know that it was entitled to a refund of excess withholding at or before the due date, then the interest would accrue from the earlier due date.

Conclusion

While the difference between the due date and the date of actual filing might not be that long of a time, when the dollars are large enough the difference may be meaningful. There are some lurking issues, including what kind of proof will the IRS be looking for in evaluating when the interest begins to accrue.

The knowledge standard raises significant challenges for tax administrators who may not be able to determine that knowledge on the face of a return.  Also lurking if the parties disagree is the jurisdictional basis for standalone interest overpayment suits, an issue we and guest poster Bob Probasco have discussed many times in the context of the Pfizer case (see for example Pfizer Again – On to the Substantive Issue).

For what it is worth, I would prefer that the law reflect a bright line rule going in either direction. The approach reflected in the memo at least allows some compensation to taxpayers for the government’s use of the money, and also provides some incentive for non-US taxpayers to timely file returns. It does, however, open the door to disputes and suggests that non US corporate taxpayers engaged in a trade or business may wish to state when they knew that they had overpaid their US tax obligation.

Filed Under: Interest
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