Seventh Circuit Reverses in King Interest Abatement Case

Last week the Seventh Circuit reversed the Tax Court in King v Commissioner, holding that the Tax Court was incorrect in concluding that the Service abused its discretion in not abating the late Mr. King’s interest that accrued on employment tax liabilities. We have discussed the case before, most recently with Carl reviewing the oral argument in Interest Abatement Based on “Unfair” Assessment and Stephen discussing the Tax Court opinion in A Pro Se King Royally Wins Interest Abatement on Employment Taxes

I will excerpt heavily from our prior posts and the Seventh Circuit opinion and offer a few observations.


The Issue and Tax Court Resolution

As Carl and Stephen discussed, this was an odd interest abatement case, arising through CDP and applying Section 6404(a) rather than the explicit interest abatement provision found in Section 6404(e). The dispute centered on interest that the IRS charged that was attributable to unpaid employment taxes and in part erroneous information that the IRS had given King. An IRS employee told King it would grant him an installment agreement; it later decided that King’s collection potential was too high to warrant an installment agreement. King paid the tax but argued that he should not have paid the interest that ran from the date of the erroneous information about the installment agreement until his later payment as he would have paid earlier had he known he was not going to be given an installment agreement.

Carl discussed how the employment tax context took this case out of the explicit interest abatement regime in Section 6404(e) and how it came to Tax Court via CDP:

King is an employment tax Collection Due Process (CDP) case based on a notice of federal tax lien (NFTL).  The only issue left in the case on appeal is interest abatement under IRC § 6404(a).  That’s not a typo for § 6404(e).  § 6404(e) allows abatement of interest with respect to taxes that are deficiencies (income, estate, and gift), not employment taxes, where there have been unreasonable IRS errors or delays.  By contrast, § 6404(a) provides: “The Secretary is authorized to abate the unpaid portion of the assessment of any tax or any liability in respect thereof, which–(1) is excessive in amount, or (2) is assessed after the expiration of the period of limitation properly applicable thereto, or (3) is erroneously or illegally assessed.” While § 6404(a) abatement clearly authorizes abating tax, the IRS agrees that “any liability in respect” of the tax includes interest.

Stephen set out King’s argument and the Tax Court’s resolution of the case:

Mr. King claimed that the interest was excessive because of the various delays created by the IRS.  The Service position on this matter is that “excessive” is essentially a restatement of the third option of “erroneously or illegally assessed.”  The Service has lost on this matter before in the Tax Court in H&H Trim & Upholstry v. Commr, TC Memo 2003-9, and Law offices of Michael BL Hepps v. Comm’r, TC Memo 2005-138, so this is not breaking new ground, but good reinforcement of a taxpayer friendly ruling.  The Tax Court in the previous cases had interpreted “excessive” to “include the concept of unfairness under all of the facts and circumstances.”  A bit broader than simply erroneously or illegally assessed.   In H&H Trim, the taxpayer was able to show the interest would not have accrued “but for” the Services dilly-dallying.  In King, the Service argued that the prior case law was incorrect, but also argued that the taxpayer could have made a voluntary payment to stop the interest and was requesting an installment agreement, which would have incurred interest.  The Court essentially held that the taxpayer showed he would have perfected the installment agreement and paid it the underlying amount more quickly but for the IRS taking its sweet time and failing to follow its own IRM procedures in responding to the taxpayer’s IA request (albeit imperfect), and abatement was therefore appropriate.  As to the voluntary payment, the Tax Court stated that Section 6404(a) has no language barring abatement when a portion of the error or delay could have been attributable to the taxpayer (Section 6404(e) has that language).  Even if the taxpayer could have made the payment, the failure to do so did not alleviate the IRS’s requirement to abate

Seventh Circuit Reverses

In a relatively brief opinion, after getting over a mootness hurdle (King died shortly after the appeal was lodged) the Seventh Circuit reversed the Tax Court, giving three reasons:

The first is the vagueness of “unfairness” as a criterion for abatement; the word is an invitation to arbitrary, protracted, and inconclusive litigation.

Second, extending as it does an invitation to taxpayers to delay paying taxes, the nebulous standard of “unfairness” could result in a significant loss of tax revenues.

And third, we’ll see that the Tax Court’s approach is inconsistent with a valid regulation promulgated by the Treasury Department.

Judge Posner, no fan of vague standards or multiple factors, was explicit in his dislike of using unfairness as a standard and Tax Court precedent that so allowed:

Elaborating the first point briefly, we note the embroidery that the Tax Court, quoting from its earlier opinion in H & H Trim & Upholstery Co. v. Commissioner, T.C. Memo. 2003‐9, at *2, wove into its opinion in the present case on the basis of its touchstone of “unfairness under all of the facts and circumstances”—its belief that the “word ‘excessive’ takes into account the concept of what is fair, or more appropriate here, unfair,” and its approving references to a dictionary’s definition of “excessive” as “whatever notably exceeds the reasonable, usual, proper, necessary, just, or endurable” (what on earth is “endurable” doing in this list?) and to “just” as meaning “equitable” and “equitable” as meaning “fair.” This terminological potpourri can provide no guidance to taxpayers, their advisers, IRS agents, or the Tax Court. It’s a monkey wrench tossed into the machinery of tax collection.

The opinion also has a nod to Chevron and agency deference, as Judge Posner explains in discussing the third reason why the Seventh Circuit thought the Tax Court was wrong:

The Supreme Court has said that “filling gaps in the Internal Revenue Code plainly requires the Treasury Department to make interpretive choices for statutory implementation at least as complex as the ones other agencies must make in administering their statutes.” Mayo Foundation for Medical Education & Research v. United States, 562 U.S. 44, 56 (2011). The interpretive choice in this case is found in the regulation defining the statutory term “excessive in amount” to mean “in excess of the correct tax liability.” 26 C.F.R. § 301.6404–1(a), Treas. Reg. § 301.6404–1(a). As there is no indication that the IRS is misinterpreting its regulation, there is no need for us to consider the possible inroads that recent Supreme Court decisions have made into “Auer deference” (judicial deference to agencies’ interpretations of their own regulations), inroads discussed for example in Michael P. Healy, “The Past, Present and Future of Auer Deference: Mead, Form and Function in Judicial Review of Agency Interpretations of Regulations,” 62 Kansas Law Review 633 (2014).

Some Brief Thoughts

This was a case that mattered a lot to IRS for the broader precedent, as the amount of interest at issue was minimal. As Carl discussed, this case went up to the Seventh Circuit without the benefit of a taxpayer brief or oral argument. Some background on the interest abatement provisions makes this perhaps not as clear as Judge Posner concludes. In 1986, where Congress enacted the first interest abatement provision, Congress wrote then that it intended the provision at subsection (e) to be used in situations where an error or delay in performing a ministerial act resulted in the imposition of interest, and the failure to abate interest “would be widely perceived as grossly unfair”.  S. Rep. 99-313, 1986-3 (Vol. 3) C.B. 1, 208.  Later in 1998, Congress inserted the word “unreasonable” before “error or delay” to provide a judicial review standard, but did not say that the prior legislative history language about unfairness was now obsolete.  Indeed, in King, Judge Posner quoted from H & H Trim, which quoted a dictionary definition of “excessive” as including “whatever notably exceeds the reasonable” (i.e., is unreasonable).

If interpreting “excessive” in 6404(a) as “unfair” would be unworkable, it seems odd that “unfair” is exactly what Congress thought the courts should be looking to as a standard for review of interest abatement cases under Section 6404(e).  If he is correct that “the vagueness of ‘unfairness’ as a criterion for abatement; [is that] the word is an invitation to arbitrary, protracted, and inconclusive litigation”, then perhaps the opinion should discuss how such a criteria has operated for 30 years without a problem to tax administration in Section 6404(e).

It is possible that this is not the last of time we will see this issue. I am aware that practitioners have used an H&H Trim unfairness argument successfully at times with counsel to generate abatements, even on case involving income taxes. We will see whether the Tax Court will stick to its guns on this issue. The Service appeal and victory in this case is a pretty good indicator that the Service is now focused on and opposed to such arguments.


Federal Circuit takes Wells Fargo Stage Coach Down the Middle Path – “Same Taxpayer” for Interest Netting in Corporate Mergers

Just about two years ago, I wrote about the Court of Federal Claims holding in Wells Fargo v. United States, which can be found here.  The government took the case on appeal to the Federal Circuit, which handed down a very important decision regarding interest netting in the context of corporate mergers.  We discuss the ways the courts and IRS have wrestled with the netting rules in the updated Saltz/Book chapter 6, which  I recently revised and updated to include the latest developments, including the lower court holding (and, imminently, this holding).  A few other online outlets have covered this, but I think it is still worth adding our thoughts, even if a few weeks late.

The Federal Circuit’s holding was not as taxpayer friendly as the Court of Federal Claims holding, but it still is significantly better, and I believe more sound, than the IRS position on the matter.  I’ve recreated a bit of my prior post as background, which will be followed with a discussion of the Federal Circuit’s holding, including some helpful stripped down examples from the holding as to how the netting works:


The Facts – Together we’ll go far…to get some tax benefits.

So, this case involves bank mergers (and lots of them) that Wells Fargo has been involved with over the last 15 years; all of which were statutory mergers.  Following the actual mergers is a little confusing, and the specifics of those mergers are not that important to the holding [sjo updated note: this statement is less true with the Federal Circuit holding, as you will see below].   What does matter is the issue, as stated by the Court, which was:

It concerns whether plaintiff…Wells Fargo…is entitled to net the interest paid on certain tax underpayments owed by Wells Fargo or its predecessor…First Union…, with the interest owed by the United States to Wells Fargo on overpayments made by First Union or other companies acquired by Wells Fargo through various corporate mergers.

Positions and the law.

Section 6621(d) was enacted in 1998 to allow overpayment and underpayment interest rates to be netted against each other at a zero percent interest rate when the “same taxpayer” has overpayments and underpayments of tax.  Corporate overpayments and underpayments, otherwise, would be at different rates.  The key issue before the court was the definition of “same taxpayer”.

Wells Fargo argued that the “same taxpayer” was both the predecessors and the surviving corporation of statutory mergers, so that the surviving entity could benefit from the tax attributes of all prior corporations.  The IRS argued for a more narrow view of “same taxpayer”, stating that a taxpayer is only the same if it has the same taxpayer identification number before and after the merger.

The Service had previously been successful with this position in Magma Power and Energy East, and had repeatedly taken this position in rulings and Counsel Advice.

And the Court of Federal Claims says…

The Court of Federal Claims took the taxpayer friendly, and I believe correct, approach to the issue, and held that a TIN is not fully determinative of legal status in the merger context.  The Court stated that because Energy East and Magma involved fully separate but affiliated corporations, they did not control the Wells Fargo case.  The Court further stated:

In a merger, the acquired and acquiring corporations have no post-merger existence beyond the surviving corporation; instead, they become one and the same by operation of law, and thereafter the surviving corporation is liable for the pre-merger tax payments of both the acquired and acquiring corporations.

As stated above, this went to the Federal Circuit, which affirmed the Court of Federal Claims in part and reversed in part.  As a brief summary, the Federal Circuit held TINs were not determinative, and neither was the fact that the two entities became one eventually. The key to the Federal Circuit was the timing of when the underpayment and overpayment occurred, which it indicated was the actual holding of Energy East.

The parties to the case agreed to three specific fact patterns, which the Court included in its holding.  I have taken out the specific names, but you can find those names and graphical reproductions of the same in the holding.  I think these will be helpful in explaining the holding.  The examples are:

  1. In 1993, Company A had an overpayment. In 1999, Company B had an underpayment.  In 2001, Companies A and B merged pursuant to a statutory merger under Section 368(a)(1)(A).
  2. In 1993, Company A had an overpayment. Between 1993 and 1999, Company A merged with four other companies under Section 368(a)(1)(A) and (2)(D).  Company A survived in each merger, and in 1999 had an underpayment.
  3. In 1992, Company A had an overpayment. In 1998, Company A merged with Company B under Section 368(a)(1)(A). In 1999, Company B, the surviving company, made an underpayment.

Each party largely advocated the same positions, although Wells Fargo incorporated much of the Federal Claims holding into its arguments.  Based on the TIN argument advanced by the Service, the Service conceded interest netting in example two above, leaving only examples one and three.

The Federal Circuit held that interest netting would not apply in example one, but it would in example three.   The Federal Circuit looked to its holding in Energy East for the analysis of the statute regarding the timing.  It stated the fact that “different corporations” generated the overpayment and underpayment was of less importance…depending on the timing.  Under Section 6621(d) the Court highlighted the language, “for any period…interest is payable…on equivalent underpayments and overpayments by the same taxpayer…”   Meaning, the two entities could not have been separate in the period where the underpayment and overpayment were generated subsequently brought together, but could be different if the sequence was the merger occurring prior to the later underpayment or overpayment.

The Federal Circuit held in example 1 above, Company A and Company B had their overpayment and underpayment each separately prior to the merger, when each was a distinct taxpayer.  In this instance, “the payments were both made before the merger, and thus the payments were made by two separate corporations…[and] do not meet the “same taxpayer” requirement under [Section] 6621(d).”  The subsequent unity does not invalidate the required timing to the Federal Circuit.

The holding in example 3 provided the most interesting analysis.  The question boiled down to whether pre-merger A was the “same taxpayer” as post-merger B,  more akin to Wells Fargo’s general position.  This analysis followed somewhat the Court of Federal Claims’ holding.  The Federal Circuit found that the legislative history, tax treatment in similar situations, and general laws of mergers leaned in favor of treating the acquired corporation being “absorbed” by the continuing one and stepping into its shoes.  This allowed the treatment as the same taxpayer for later underpayments/overpayments.  Company A had an underpayment, was then absorbed by Company B, which then had an underpayment – same taxpayer due to merger.

This is a very technical argument, and it will be interesting to see if the Service continues the TIN argument in other courts, as it has not met with much success and the Federal Circuit is fairly influential.  It is also interesting why, based on the holding in three, the eventual unity doesn’t cause the netting from the time of merger forward but not prior periods (perhaps it does, and I misunderstood the holding).  In any event, all corporations that have engaged in mergers should be going through and making sure interest netting has occurred in a minimum under examples two and three above (and possibly one if you are in a different circuit and like litigating).

Interest Abatement Based on “Unfair” Assessment

Frequent guest blogger Carl Smith writes about an interest abatement case recently argued before the 7th Circuit. The fact that it arises in a Collection Due Process case, that the taxpayer fully paid the liability yet continued with the interest abatement argument, that the Tax Court has found it has no jurisdiction to order a refund in a Collection Due Process case and that the taxpayer passed away before the 7th Circuit argument create an interesting backdrop for a potentially broad reaching interest abatement determination. Keith

This is an update to a case on which Stephen posted when the Tax Court rendered its opinion last July. Oral argument was heard in the Seventh Circuit in an appeal in the case on May 27, 2016.

King is an employment tax Collection Due Process (CDP) case based on a notice of federal tax lien (NFTL).  The only issue left in the case on appeal is interest abatement under IRC § 6404(a).  That’s not a typo for § 6404(e).  § 6404(e) allows abatement of interest with respect to taxes that are deficiencies (income, estate, and gift), not employment taxes, where there have been unreasonable IRS errors or delays.  By contrast, § 6404(a) provides: “The Secretary is authorized to abate the unpaid portion of the assessment of any tax or any liability in respect thereof, which–(1) is excessive in amount, or (2) is assessed after the expiration of the period of limitation properly applicable thereto, or (3) is erroneously or illegally assessed.” While § 6404(a) abatement clearly authorizes abating tax, the IRS agrees that “any liability in respect” of the tax includes interest.

In H & H Trim & Upholstery Co. v. Commissioner, T.C. Memo. 2003-9, the Tax Court held that interest on a tax liability could be abated under § 6404(a) when the amount seemed “unfair”, since anything that was unfair was “excessive in amount”.  In King, the Tax Court granted interest abatement under section § 6404(a) for a period of less than two months — involving, by my estimate, just over $200 of interest abated.  The government was so hopping mad about losing King (and the existence of H & H Trim), that it appealed King to the Seventh Circuit, arguing that § 6404(a) abatement could never apply to interest that was correctly calculated.  The government clearly doesn’t care about the $200 in this case, but wants to get a ruling from some appellate court that taxpayers can’t use § 6404(a) as an end run around the limitations in § 6404(e).  No other appeals court has ever considered interest abatement under § 6404(a).


The taxpayer was an elderly solo practitioner lawyer who had one or more employees over a number of quarters that the IRS audited.  After the audit was completed and certain proposed adjustment amounts were reduced, the taxpayer agreed to the assessment of employment tax audit changes by signing a Form 2504 showing about $50K in tax and penalties for all the quarters combined.  Shortly before sending in the signed Form 2504, he sent two letters to the Revenue Agent saying he would like to pay in installment over 60 months, but not specifying the amount he proposed to pay each month.  The IRS assessed the employment taxes and penalties and led him to believe that he was going to be put on an installment agreement, but he never was.  After being referred to the Taxpayer Advocate Service (TAS) about a months after the date of assessment, TAS told him that the reason he was not put on an installment agreement was both because he had not stated the amount of monthly payment he wanted to make and he had to submit financial information.  When he did eventually submit financial information, the IRS concluded that he had enough assets to pay in full, if he would just sell off some illiquid assets.  So, the IRS did not give him an installment agreement.

The IRS filed an NFTL, and the taxpayer requested a CDP hearing in which he sought an installment agreement and sought abatement of the interest and penalties.  When the IRS denied him any relief in the notice of determination, he appealed to the Tax Court.  Early on during the case, though, he managed to get a reverse mortgage, and he paid off the tax, penalty, and interest assessments in full.  But, he did not concede that the CDP case was moot.  He still sought penalty abatement under § 6404(f) and interest abatement under §§ 6404(a) or (e).

In King v. Commissioner, T.C. Memo. 2015-36, the Tax Court first noted that it had no overpayment jurisdiction in CDP, citing Greene-Thapedi v. Commissioner, 126 T.C. 1, 12 (2006).  So, the CDP portion of the case in which the taxpayer had, in his petition, complained about not getting an installment agreement was now moot.

Next, the court noted that under its jurisdiction at § 6404(h), it can only resolve disputes about interest, not penalties.  Thus, it had no power to review the IRS’ failure to abate penalties under § 6404(f).

Third, the court noted that interest abatement under § 6404(e) couldn’t apply in King’s case because that subsection does not apply to employment taxes, only such taxes that can give rise to a “deficiency” — i.e., income, estate, gift, and certain excise taxes.

However, the court considered the notice of determination in the case as one denying interest abatement under § 6404(a) — over which the court had jurisdiction — even though at this point, the taxpayer, if successful, would be getting a refund.

King sought interest abatement for three different periods, citing H & H Trim for the proposition that interest should be abated if it was “unfair” under the circumstances.  The IRS argued that H & H Trim was incorrect and that interest abatement under § 6404(a) should only be done if there was some procedural defect in its assessment, the assessment was late under the statute of limitations, or the numerical calculation of the interest was excessive.

The Tax Court stuck by its H & H Trim ruling and gave interest abatement for one of the three periods.  In the period in which King was successful, the Tax Court held that it was “unfair” for interest to accrue from the date of assessment of the liabilities to the date the TAS employee explained to the taxpayer that the taxpayer needed to supply financial information.  The court thought that the IRS employee who originally told the taxpayer that he was going to get an installment agreement should have communicated the problems with the original proposal on or before the date of the assessment.

Even though the amount of interest abated here was only about $200 by my estimate, the DOJ filed an appeal with the Seventh Circuit, wanting to nip in the bud other taxpayers arguing for interest abatement under § 6404(a) simply because the amount assessed was “unfair”.  No Circuit court has ever ruled on this issue.  H & H Trim had not been appealed.  Nor had the IRS appealed another Tax Court opinion that followed H & H Trim, Law Offices of Michael B.L. Hepps v. Commissioner, T.C. Memo. 2005-138.

In the Seventh Circuit, before any briefing was done, the taxpayer died.  His wife, who was not a party to the case, was invited to take over in the case for him, but she did not respond to a letter from the Seventh Circuit.  So, only the DOJ filed a brief.  On May 27, 2016, a one-sided oral argument was held before a three-judge panel that included Judge Posner.  The audio of the oral argument is freely available on the Seventh Circuit’s website, Docket No. 15-2439.

Judge Posner was the only judge who asked questions. His main concern was to give meaning to the words “excessive in amount” in § 6404(a)(1) that was independent of “is erroneously or illegally assessed” in § 6404(a)(3). The DOJ attorney argued that “erroneously or illegally assessed” might mean that internal steps to authorize assessment had not been completed – i.e., procedural defects other than the statute of limitations – while “excessive in amount” might mean, in the case of interest, that the wrong rate or time period had been used in the calculation, leading to an excessive amount of interest having been assessed. Thus, there was no need to interpret “excessive in amount” as “unfair”.

Judge Posner also got into a colloquy with the DOJ attorney about the interplay between §§ 6404(a) and (e).  Although this was not a case where § 6404(e) interest abatement could have applied (since subsection (e) doesn’t apply to employment taxes), the attorney warned that if subsection (a) (which could apply to any tax) applied to “unfair” assessments of interest, then a person who, say, was seeking interest abatement under subsection (e) for interest on income taxes could use (a) abatement as an end run around the limitations of (e) that (1) prevent abatement where a taxpayer contributed to the delay and (2) limit interest abatement to cases of unreasonable errors or delays in IRS employees performing ministerial or managerial acts.

It sounded like the DOJ attorney cleared up all of Judge Posner’s questions, but I am not positive that the IRS will win this case.


Non-profits, Corporate Interest Rates, the Birth of a Blog, and Lite Mayo

This post is about the recent Maimondies case from the Second Circuit, and what is a “corporation” for corporate interest rates, but it will be helpful to take a quick detour to review the underlying issue in the Mayo Foundation case, as it sets up the issue before the Second Circuit in Maimondies.  Most of the focus on Mayo Foundation v. US, at least on our blog, was on the procedural aspects of the case, but there was an important substantive issue underlying the challenge to the regulations, which I sometimes forget about.  The issue was whether or not medical students who worked more than 40 hours a week were ineligible for an exemption to FICA taxes. Treasury issued regulations in 2004 saying such students were not exempt, and FICA taxes had to be withheld.  The Supreme Court upheld the regulations (although perhaps a bittersweet victory for the Service, as the holding may have eroded at the notion of tax exceptionalism in administrative law).  After the SCOTUS win, the Service decided to allow refunds for claims of tax that was paid prior to the effective date of the 2004 regulations, April 1, 2005.

Maimonides Medical Center is a nonprofit (under Section 501(a)/501(c)(3)) corporation running a teaching hospital near Prospect Park in Brooklyn, which had one such claim.  It, like all similar institutions, had many med students/residents that fell into this exception to the exception to the FICA taxes.  I am sure MMC is very humane, and those residents worked barely over 40 hours a week, but whether just one hour over, or more likely sixty hours over, the exception to the exemption was implicated.  In 2010, the IRS agreed that MMC could obtain a refund for the FICA taxes from 1999 through the beginning of 2005, prior to the effective date of the regulations.  MMC had previously timely filed a refund claim, which remained outstanding until that date.

The Service calculated the refund, and the interest due.  MMC was cool with the calculation of the refund amount of tax, but disagreed with the IRS interest calculation- probably feeling a bit like the Service was trying to screw them on the interest rate, while they were trying to save the non-hipster Brooklyn residents (I assume they aren’t serving hipsters, because this is close to Park Slope, which is too expensive for hipsters).  Why, because it was getting next to nothing in interest, similar to a Fortune 100 company that had overpaid, and much less than a nonprofit LLC that had overpaid the same amount.

Another quick, but very important, side note. A couple of years ago, when LBJ was President, Robert Wagner was busting up Tammany Hall in NYC, and The Zombies had a #1 hit in She’s Not There, a truly wonderful woman gave birth to a baby boy at MMC, and took him home, where he grew up close to the family’s Book Lumber Yard (which definitely was not serving hipsters at the time).  So, MMC was essentially the birthplace of this blog.  Of greatest importance, a lot of people are missing that woman this week, and our love, thoughts, and prayers go out to the entire Book family.  Hopefully, all of this hasn’t made me too biased towards MMC’s position.

The key issue is that the IRS applied the corporate interest rates, specifically the large corporate overpayment rate, to the overpayment, instead of the more friendly non-corporate interest rates.  We touched on this case in SumOp when it was at the District Court level, where I wrote:

[MMC] argued it was not a corporation for purposes of the overpayment interest rate under Section 6621…[and] that the Service IRM indicates that “corporations” are defined by the return they file, which does not include not-for-profits, and the Service has previously issued refunds using the non-corporate rate.  The Court stated the IRM cannot be used as precedent, or trump other regulations that would indicate the contrary.   [MMC] also argued that the check-the-box regulations were not clear on the classification of it as a corporation, so it should be afforded “special treatment”, which is allowed in limited circumstances. The Court did not find this persuasive, and held it was a business entity, the default treatment of which was a corporation.

That quick blurb did not really do justice to the underlying issue, which, especially on appeal to a Circuit Court, is worth some additional time.  Here, the question of what is a corporation for interest rates actually hinges on interesting statutory construction more so (at least to the Circuit Court) than policy, although that also comes into play.  Before looking at the holding and rationale in MMC, a quick review of the applicable interest rate rules would be helpful.

Section 6621 outlines the applicable rates, and when each applies, and states, in pertinent part:

(1)  Overpayment rate.

The overpayment rate established under this section shall be the sum of—

(A)  the Federal short-term rate determined under subsection (b) , plus

(B)  3 percentage points (2 percentage points in the case of a corporation).

To the extent that an overpayment of tax by a corporation for any taxable period (as defined in subsection (c)(3), applied by substituting “overpayment” for “underpayment”) exceeds $10,000, subparagraph (B) shall be applied by substituting “0.5 percentage point” for “2 percentage points”. [emph. added].

(2)  Underpayment rate.

The underpayment rate established under this section shall be the sum of—

(A)  the Federal short-term rate determined under subsection (b) , plus

(B) 3 percentage points.

This is somewhat complicated by Section 6621(c)(1), which deals with large corporate underpayments, and states:

(1)  In general.

For purposes of determining the amount of interest payable under section 6601 on any large corporate underpayment for periods after the applicable date, paragraph (2) of subsection (a) shall be applied by substituting “5 percentage points” for “3 percentage points”. [emph. added].

And, the definition of large corporate underpayment, is found under Section 6621(c)(3), and states:

(A)  In general. The term “large corporate underpayment” means any underpayment of a tax by a C corporation for any taxable period if the amount of such underpayment for such period exceeds $100,000. [emph. added].

As stated above, the underpayment rate for corporate and non-corporate taxpayers is different, and large corporate underpayment and overpayments have another set of interest rates.  It seems pretty clear (at least no one has litigated it yet), that individuals, trusts, estates, partnerships, and LLCs are all not corporations, and subject to the non-corporate interest rates.  Where it gets complicated is whether the corporate interest rates apply to s-corporations, not-for-profit corporations, and c-corporations, and whether that occurs just in small overpayments/underpayments, or also in large corporate overpayments or underpayments.

For a large corporate underpayment, the answer seems to be clear in the statute, as it specifies in the definition that it only applies to c-corporations.  So, what does corporation mean otherwise?  In this post, we will just cover MMC and the treatment of non-profit corporations,  but the analysis is probably instructive with s-corporations, where the case law is currently somewhat split, an issue we describe in some detail in Saltz/Book in Chapter 6, a chapter I had a major hand in rewriting about a year or so ago.  See Eaglehawk Carbon Inc. v. US, (Fed Cl. 2015); Garwood Irr. Co. v. Comm’r, 126 TC No. 12 (2006).

In Maimonides Medical Center v. United States, MMC argued that “corporation” under Section 6621(a)(1) should be restricted to only refer to a for-profit corporation, largely on policy grounds that a non-profit should be subjected to the more taxpayer friendly provisions.  Further, it argued that it was arbitrary to treat a nonprofit corporation differently from a nonprofit operating as another entity, such as a trust or LLC (which is true, but there are lots of arbitrary Code provisions).  The Second Circuit was not persuaded by these arguments, and held that a not-for-profit corporation was still a “corporation” under the general dictionary definition, and the definitional provisions of Section 7701(a).  In addition, the Second Circuit found there were various other Code Sections where the term corporation applied to both for profit and not-for-profit corporations, and, absent language indicating otherwise, it was appropriate to treat a not-for-profit corporation as a “corporation” under Section 6621 (with the exception of a large corporate underpayment, which is restricted to only C-corporations).   I do not question the analysis on this point, but I do wonder if the drafters actually intended to have a corporation exempt under 501(c)(3) burdened by the less favorable interest rates.  I am not sure the reasoning for such a policy.

The Court then turned to the large corporate overpayment issue, which is more complicated and interesting, and where the MMC argument is the same general argument that s-corporations have made claiming they should not be subject to the less favorable large corporate overpayment interest rate. Section 6621(a)(1)(B) provides the overpayment rates for normal overpayments and for large corporate overpayments, and uses only the term “corporation”.  The hanging paragraph at the bottom, however, makes reference to Section 6621(c)(3), dealing with large corporate underpayment, and states:

To the extent that an overpayment of tax by a corporation for any taxable period (as defined in subsection (c)(3), applied by substitute “overpayment” for “underpayment”) exceeds $10,000, [the interest rate] shall be applied by substituting “.05 percentage point” for “2 percentage points”.

As stated above, Section 6621(c)(3) defines “large corporate underpayment” as “any underpayment of a tax by a C corporation for any taxable period if the amount of such underpayment for such period exceeds $100,000.” (emph. added).   MMC argued the that the parenthetical in Section 6621(a)(1)(B) modified the term “corporation” to be restricted to C-corporation due to the reference in Section 6621(c)(3), but the Court disagreed, and held that the parenthetical modified only the term “taxable period”, which was immediately before the parenthetical and defined under Section 6621(c)(3)(B).  The Second Circuit indicated this was the more appropriate statutory construction based on the placement of the modifier, and the use of the term “corporation” throughout Section 6621(a) without designation.   However, as also indicated above in Garwood Irrigation v. Commissioner, the Tax Court reviewed this same hanging paragraph, and come to the conclusion, based on the statute and the legislative history, that “corporation” was intended to apply only to S-corporations, and not S-corporations for these purposes.  So, the law in this area is unsettled.

It is probably safe to assume that an S-corp will be treated as a corporation for the normal corporate overpayment and underpayment rates, and a not-for-profit may also.  The Service will certainly treat them as such.  For large corporate underpayment, it appears only c-corporations are stuck with the higher rate.  For large corporate overpayments, the trend is to include all types of corporations, but there is a split on the interpretation of that hanging paragraph.  I’m sure we will see more to come.



Calculating Interest When the IRS Makes a Restitution Based Assessment

The case of United States v. Janean Del’Andrae provides further insight into what happens when the IRS makes an assessment based on a restitution order.  We have talked about restitution based assessments previously here and here.  This relatively new basis for assessment came into being with the passage of the Firearms Excise Tax Improvement Act of 2010 and the creation of IRC 6201(a)(4) allowing assessment based on restitution orders in criminal cases.  Some of the kinks are still being worked out and this case illustrates one of the kinks.  The district court’s decision to award attorney’s fees in this context confuses me and other aspects of the opinion confuse me.  That confusion may make for a confusing and disjointed post and I apologize.  The facts developed in the opinion do not seem to warrant an attorney’s fees award against the government here but I will circle back to that at the end.  Getting to the result of what interest the taxpayer owes following a restitution based assessment provides the most important aspect of this case.


As the Court explains in the case, the new basis for assessment did not immediately cause the IRS to make assessments using this procedure. The IRS waited for instructions from its lawyers on what to do and those instructions initially came out in Chief Counsel Notice 2011-18.  Two years later in Chief Counsel Notice 2013-12 additional guidance was provided.  The Court states that “procedures for the assessment process were not officially developed until the Chief Counsel Notice 2013-12 was issued on July 31, 2013.”  That statement does not make sense to me because the 2013 notice does not deal with assessment procedures but rather with the process of how to handle a restitution case in litigation.  I think the Court may have misstated the purpose of this notice and the timing of the procedures for dealing with restitution based assessments.  The Notice issued in 2011 deals much more directly with assessment procedures.  Both of these notices are Chief Counsel notices designed to give guidance to Chief Counsel lawyers and not necessarily to the IRS.

Here, the taxpayer’s restitution order occurred in 2012. The delay of the IRS in implementing procedures for restitution assessments creates problems that ultimately lead to the award of attorney’s fees against the IRS but I am uncertain that the Court quite got the timing right in attributing the problem to the 2013 notice.  The place to focus on IRS procedures is not notices issued by Chief Counsel’s office but changes to the Internal Revenue Manual.  Here, the provisions for restitution based assessments first appeared in IRM 5.19.23 on June 6, 2014, and IRM 4.8.6 in October 7, 2014.  The new IRM provisions followed the Interim Guidance on Criminal Restitution Procedures issued in SBSE 04-0214-0013 dated February 5, 2014 Except for how this impacts the decision on attorney’s fees, it is not especially relevant but does create more confusion in trying to follow the opinion.

Janean Del’Andrae pled guilty to one count of tax evasion. The opinion is not clear about the count to which she pled or how many counts with which she was charged.  The IRS charged that she not only evaded her personal income taxes for the year 2005 but also that she participated in evading the taxes of Del-Co Western Corporation, a company in which she and her husband were officers.  The court makes a passing reference to payroll taxes but the remainder of the opinion seems to make it clear the evasion of corporate income taxes was the problem.  The sentencing court ordered restitution in the amount of $138,509.50 calculated to cover the corporate taxes for 2004 ($49,845.37) and 2005 ($38,307.13) as well as her individual income taxes for 2005 ($48,357.00).  The judgment against her was entered on July 11, 2012, and she stroked a check that day for the full amount of the restitution (making her an unusual defendant, most of whom do not have the money to pay the tax at this stage of their case) and tendered it to the clerk of court.  On September 17, 2012, the IRS received the payment.

The opinion does not state what happened next but maybe nothing happened. On September 12, 2014, the court granted defendant’s Motion to Enforce Plea Agreement and issued an order requiring the IRS to give the defendant credit for the restitution payment.  The order required the IRS to credit the payment on July 11, 2012 even though it took the court over 60 days to deliver the check to the IRS.  It appears the IRS was significantly delayed in making the assessment probably because it took the IRS a long time to develop the assessment procedures for restitution based assessments.  I agree that the defendant should get credit from the date of payment but wonder how the payment of the interest on the money for those 60 days was credited between the judicial and executive branches.

The court states that the IRS eventually assessed the appropriate amount of taxes. It also assessed interest on the taxes from the due date of the returns until July 11, 2012, when it gave credit to the defendant and the corporation for the payment of the taxes.  The assessment of interest occurred without using the deficiency procedures which seems appropriate under these circumstances.  The defendant continued to dispute the correct amount of the corporate liability for 2005 so the IRS did not assess the liability for that period.  One of the problems with this opinion is that the Court’s description of events does not use the terms that one might expect or use them with sufficient precision to allow me to know exactly what happened.  It is clear, however, that in March 2015 the corporation made a payment towards its 2013 liability.  In doing so it overpaid the 2013 liability by $65,917.  The IRS latched onto the overpayment and used it toward additional corporate and personal tax liabilities.  The use of this overpayment creates the focus of the litigation.  Defendant filed a motion for an order to show cause seeking answers concerning the application of the payments.  The balance of the opinion essentially focuses on how the IRS did and should have used the overpayment and why its actions were right or wrong.

The restitution order contemplated that the IRS would charge interest and penalties but did not order the payment of these amounts or spell them out in any way. The defendant argues that the IRS should not assess interest for the time prior to the date of the restitution order.  The defendant further argues that the IRS should follow deficiency procedures in order to assess interest on a tax liability determined by a restitution order.  The IRS argues that interest runs from the due date of the return for restitution payments as it does for all liabilities and further argues that the use of deficiency procedures is unnecessary to assess interest on the amount listed in a restitution order.  The court agreed with the IRS that interest on restitution assessments need not follow the deficiency procedure but may occur in the same manner as the assessment of the underlying tax assessed pursuant to the restitution procedure.

The second issue concerns the application of the overpayment on the 2013 corporate taxes to the personal liability of the defendant. The court says that the IRS argued that the application of a corporate payment to the personal liability of the individual is proper because “Defendant [the individual] and Del-Co are jointly and severally liable for the tax and related interest that Defendant evaded.”  The court further states that the IRS argued, “the joint and several liability arises because Defendant agreed to pay restitution for the loss caused by her evasion of Del-Co’s taxes.”  I am unconvinced that the IRS argued the case in the way described by the court.  If it did I am confused.  It is possible the IRS made an alter ego argument.  Whatever was argued, the court found that the defendant and the corporations were not jointly and severally liable and that the IRS should not take payments on the corporate account and apply them to the individual liability.  If the IRS position reflects a legal conclusion that every time an individual is convicted and restitution is ordered based on corporate and individual liabilities this type restitution order allows it to move money between the individual and corporate accounts, then this decision represents a repudiation of that position.  If the IRS was simply arguing here that, based on these facts, the finances of the corporation and the individuals merged, the IRS lost a factual argument.

After reaching this conclusion the Court found that “because the IRS delayed the application of Defendant’s restitution payments and may have improperly applied Del-Co’s overpayment to Defendant’s tax account, the Defendant incurred unnecessary costs to clarify the IRS’s actions” and therefore costs and attorney’s fees were ordered against the United States. The delay in applying the payments here seems to have resulted from the implementation of a new statute and did not harm petitioners.  I do not see that as a basis for awarding fees.  To the extent that the IRS inappropriately applied the payment of the corporation, I feel the court should have provided more information about the steps that were taken to fix the wrongful application before the court proceeding as a prerequisite to the award of attorney’s fees.

I take away from this case the reinforcement of the IRS position that interest may be assessed on restitution assessments in the same summary manner as the assessment of the tax itself. The application of payments issue, if it reflects a legal position asserted by the IRS in restitution cases, represents a victory for taxpayers.  Because I am unconvinced that the IRS was arguing this as a legal matter, I think that the application of payments issue is simply a factual determination that must be determined on a case by case basis.  There will be many more cases exploring the restitution assessment procedure as this becomes more common.  I hope they offer a clearer view of what the parties presented but even in the murky view offered by this case, the issue of interest in restitution cases gets a little clearer.

An Update on the Lawsuit Against Bank of America for Failing to Issue Accurate Interest Information Statements (Part 2)

In yesterday’s post David Vendler updated us on the developments in Smith v Bank of America, a case involving allegations that Bank of America systematically underreported mortgage interest on modified loans Today, David digs deeper into the legal argument underlying the claim against the bank. David asks that anyone who feels that any bank has misreported their interest on Form 1098 or income on Form 1099 to please contact him.  Les

What is Interest? A Review of Some Key Authorities

The Supreme Court has unequivocally held that the word “interest” in tax statutes is unambiguous. It means “the amount which one has contracted to pay for the use of borrowed money.” Old Colony R. Co. v. Comm’r. of Internal Revenue, 284 U.S. 552, 560-561 (1932). See also Deputy v. du Pont, 308 U.S. 488, 497 (1940)). Section 6050H does not contain any exceptions, exclusions, or other type of qualifying language excluding particular kinds of “interest.” Indeed, Congress’s inclusion of the word “aggregate” in the language of the statute is clear evidence that all types of interest are to be totaled together at the end of the year and included in the recipient’s Form 1098 reporting.


Copeland v. C.I.R., 2014 WL 5483046 (Tax Ct. 2014), mentioned in Les’ earlier blog post and which he separately blogged In Living With Your Decisions: Delinquent Mortgage Debt also expressly holds that pre-loan modification interest retains its character as mortgage interest even after a loan modification and is therefore deductible by taxpayers in the year of repayment:

Through the loan modification agreement, the $30,273 in past-due interest on petitioners’ mortgage loan was added to the principal [“capitalized”]. Because petitioners did not pay this interest during 2010 in cash or its equivalent, they cannot claim a deduction for it for 2010. They will be entitled to a deduction if and when they actually discharge this portion of their loan obligation in a future year”(emphasis added).

The principal of tax law that Copeland relies upon is not new. The Tax Court in Motel Corporation v. Comm. of Internal Revenue, 54 T.C. 1433 (1970) found in the context of late-paid interest that it retained its character as interest. As that court put it: “we can perceive no reason why defaulted interest should be transformed into principal for purposes of tax law.” In the context of a “negative amortization” pay option ARM loans, the Tax Court in Smoker v. C.I.R., 2013 WL 645265 (Tax Ct. 2013) also squarely held that deferred interest does not lose its character as mortgage interest simply because it is capitalized and added to principal; rather, capitalized interest is deductible in the year of payment.

Revenue Ruling 77-135, governing the treatment of deferred interest paid on “Graduated Payment Mortgages” (“GPMs”), also supports the position that capitalized mortgage interest does not lose its character as mortgage interest simply by being added to principal. GPMs are negative amortization loans like that which was at issue in Smoker, but instead of offering the customer an “option” to pay less than the interest due in any given month, they instead provide for a fixed schedule of payments which, in the early years of the mortgage, are for less than the interest actually due, but as the mortgage term continues, the payments “graduate” to recover the interest that was previously deferred. Revenue Ruling 77-135 explicitly holds that for cash basis taxpayers like the overwhelming majority of taxpayers, “…when the amount of the payments has increased to the extent that it now exceeds the current interest charge owed, the excess… will be treated as discharging first that part of the unpaid balance of the loan that represents accumulated interest carried over from prior years and will be included in income by the mortgagee and deducted by the mortgagor as interest at that time” (emphasis added).

We have argued that since there is already a revenue ruling applying the principle that capitalization of interest does not change its character as interest, and since section 6050H unambiguously requires that all types of interest be “aggregated” as part of the Form 1098 reporting calculation, there is no reason for the Service to provide any further “guidance” in response to the MBA’s and ABA’s “questions.” The answer is plain for all to see.

The Service Itself Has Essentially Accepted Our Position in Related Issues

Indeed, this is exactly what the Service found when it enacted 26 C.F.R. Section 1.221-2(h) – capitalized student loan interest (post-2004) should be reported on Form 1098-E along with current interest in the year in which it is paid. The Treasury Department’s stated rationale for its determination that capitalized student loan interest should be reported on Form 1098-E in the year in which it is paid is exactly the same as we have been arguing all along here, namely that:

“Courts have defined the term ‘interest,’ for income tax purposes, as compensation paid for the use or forbearance of money. See, e.g., Deputy v. Du Pont, 308 U.S. 488 (1940). Consistent with this definition, the final regulations provide that capitalized interest is deductible as qualified education loan interest… Under the final regulations, a payment generally first applies to interest that has accrued and remains unpaid as of the date the payment is due and then applies to the outstanding principal.

See 69 FR 25489-02, 2004 WL 972762 *25490.

There is absolutely nothing to logically distinguish the reporting treatment of capitalized interest in the student loan context and the treatment of capitalized interest in the mortgage/loan modification context. Therefore, even if there was still some question of ambiguity remaining after Revenue Ruling 77-135 as to the treatment of capitalized interest, after 2004 no bank could reasonably claim that it needed further “guidance” on whether to report the payment of capitalized interest on an informational return.

Back to Why the Bankers’ Views are Wrong

The American Bankers Association’s letter repeatedly, and misleadingly, uses the term “new loan” with reference to loan modifications. It does so because where a borrower truly obtains a new loan, then all of the pre-existing interest is paid off and there is no question of reporting payments of pre-existing interest. But a loan modification is not a “new loan.” It is a modification of an existing loan. And, in a loan modification, pre-existing interest is not paid off, but is capitalized and thus cannot be made to simply “disappear” for the bank’s convenience.

It is a “fundamental proposition of tax law that in determining the tax treatment of a transaction, substance governs form.” Gregory v. Helvering, 293 U.S. 465, 470 (1935). In fact, it was based on this very premise that Copeland held that loan “modifications” are not “new notes” for purposes of calculating mortgage interest:

[P]etitioners ask us to recharacterize their loan modification transaction. Instead of having modified the terms of their existing loan, petitioners say they should be treated as if they had obtained a new loan from a different lender and used the proceeds of that loan to pay both the principal of the Bank of America loan and the past-due interest… Contrary to petitioners’ “substance over form” argument, the transaction they hypothesize is not economically equivalent to the transaction in which they engaged… In any event, it is well established that taxpayers must accept the tax consequences of the transaction in which they actually engaged, even if alternative arrangements might have provided more desirable tax results.

The American Bankers Association (“ABA”) likewise should not be allowed to recharacterize the loan modification transactions in which its members “actually engaged” into “new loans.” Loan modification agreements all make very clear that the transaction is not intended to create a “new note,” but is intended to “amend” and/or “supplement” the original note. They also all require their borrowers to continue to comply with all of the requirements of the original notes except for the specifically modified provisions. But what really puts the lie to the ABA’s “new loan” claim is that the loan modification agreements themselves expressly declare that they are not to be so construed. For example, Bank of America’s loan modification form states that “Nothing in this agreement shall be understood or construed to be a satisfaction or release in whole or in part of the Note (referring to the original note) and Security Instrument (referring to the original deed of trust).” Bank of America also, notably, continues to use the same “old” loan number post modification and we are certain other lenders do as well. There is no way given the text of the loan modification agreements that any borrower would ever anticipate that banks would take the position that the agreements they signed were modifications in every respect except that they were entering into “new loans” for the purpose of pre-existing interest. Nor did any of the loan modification agreements advise borrowers that the banks would not be reporting this interest on Form 1098 and that they would effectively be giving up their mortgage deduction or, at the very least, forcing them to battle with the Service every year because their stated deductions would not match the Form 1098 issued by their lender.

Further demonstrating that plaintiffs’ loan modifications are not “new notes” is that no new Truth in Lending Act (TILA) disclosures under 15 U.S.C. §§ 1631, 1632, 1635 and 1638 are given to loan modification recipients. 12 C.F.R. § 226.20 requires that new TILA disclosures must be given when a lender enters into a subsequent transaction with an existing borrower; it provides that where the subsequent transaction amounts to replacing the original obligation with a “new obligation,” then the subsequent transaction is a “refinancing” and new TILA disclosures must be provided. The Official Staff Interpretation, Supp. I to 12 C.F.R. § 226.20(a) confirms that only “the cancellation of [the original] obligation and the substitution of a new obligation amount to a refinancing.” And that:

A refinancing is a new transaction requiring a complete new set of disclosures. Whether a refinancing has occurred is determined by reference to whether the original obligation has been satisfied or extinguished and replaced by a new obligation, based on the parties’ contract and applicable law. The refinancing may involve the consolidation of several existing obligations, disbursement of new money to the consumer or on the consumer’s behalf, or the rescheduling of payments under an existing obligation. In any form, the new obligation must completely replace the prior one.”   (Emphasis added).

Thus, while the ABA members could certainly have offered their borrowers in distress “new loans”, the fact is that they chose the entirely different route of loan modification and they did so for their own interest. Having done so, they should be made to live with that choice.

Bank of America has tried to rely on Revenue Ruling 70-647, 1970-2 C.B. 38 as a justification for foisting onto borrowers the responsibility for tracking payments of the interest they owed prior to their loan modification’s taking effect. That Revenue Ruling states that where a:

lender accepts a new note (emphasis added) in payment of remaining principal and interest due on an existing note,… it is incumbent on the individual to keep his own record of [his payments of the part of the new loan balance that is interest accrued on the original loan].

This is clearly the source of the ABA “new” loan language. But quoting a phrase does not necessarily make it fit; by its very terms, the Ruling applies only where “a lender accepts a new note in payment, i.e. in full satisfaction of the remaining principal and interest due on [an] existing note.” (Emphasis added). Indeed, the phrase “new note” as a restriction appears no fewer than 6 separate times in the text of the short Revenue Ruling.Since the ABA’s letter involves loan modifications and not “new notes,” Revenue Ruling 70-647 has no application to the loan modification issue presented by the ABA letter.


As can be seen from all of the above, there is overwhelming existing authority pointing to the conclusion that: (1) 26 U.S.C. Section 6050H unambiguously requires recipients of more than $600 in mortgage interest to report the “aggregate” amount of the interest they receive during the calendar year, i.e. the sum of all types of interest they receive; (2) capitalizing mortgage interest and adding it to principal does not change its character as mortgage interest such that, just as with student loans, payments of capitalized interest must be reported on Form 1098 when it is paid; and (3) loan modifications do not present any exception to this rule; they are not new loans, but are just what they purport to be: modifications of existing loans. Neither the ABA nor MBA letters offer any authority that would support an alternative view. We have argued therefore that there is thus no need for further “guidance” on what is a well-worn set of principles of tax law.

However, we have argued that if the IRS determines to issue some sort of “guidance,” it should not make it a “get out of jail free card” for the banks. While the banks would like a prospective-only guidance of the type issued back in 2004 with regard to how to treat capitalized student loan interest, there is absolutely no reason to do that in this case where the law has been clear (since at least that time) that capitalized interest is still interest and thus should be reported.

Taxpayers have suffered greatly because of what is at least incompetence, and more likely simply a decision that tracking such interest was too expensive to bother with for the banks. Indeed, the only reason the MBA and ABA are bothering with this issue now is because we caught its members doing it wrong. We are thus hopeful that the IRS will not simply aid the banks in the currently pending litigation by declaring an ambiguity in the law that it has itself said in 2004 does not exist.

Finally, we have argued to the IRS that whatever it decides to do, its action should do whatever it can to allow tax-payers to obtain the benefit of the billions of dollars in tax deductions that at least some of the ABA/MBA member banks have chosen (and “chosen” is a very deliberate word) to deny them out of their desire for expediency and cost reduction.

An Update on the Lawsuit Against Bank of America for Failing to Issue Accurate Interest Information Statements

One of the most viewed posts last year was one that discussed a lawsuit alleging that Bank of America intentionally and systematically understated millions of dollars in homeowners’ mortgage interest payments following loan modifications. Today is the first of a two- part post by the lead lawyer on the case, David Vendler, a partner at Morris Polich & Purdy LLP. In this post, David updates us on developments in the case and related cases. In tomorrow’s post, David walks through in detail his legal arguments that underlie the claim that the bank has underreported interest.

David is an accomplished attorney who has been lead counsel in a number of high profile class action lawsuits. The charges in the Bank of America case relate to fundamental issues of tax administration, including whether consumers can rely on information returns that financial institutions issue. This post and tomorrow’s post show us that perhaps consumers and preparers may need to think twice about whether they can rely on those statements. In addition, there may be a need for millions of consumers to amend prior years’ returns when the returns include interest deductions when banks have modified loans. As David describes, the district court case that I originally discussed last year was dismissed, and now is on appeal. Related cases though are percolating, and it is likely as David describes the IRS and courts may be weighing in soon. Les

We are writing to update your blog on the status of our case against Bank of America, N.A. involving its failing to include on Forms 1098 customer payments of deferred interest in the loan modification context. As your readers will recall, the question at the heart of the case is whether 26 U.S.C. 6050H requires banks and mortgage servicing companies to report on Forms 1098 borrower repayments of interest that were owed at the time of a loan modification and which have been are “wrapped into” the “new principal” of the loan post-modification.


An example was given in the earlier blog post that well illustrates the issue. Assume a homeowner facing financial distress has a $600,000 principal balance on a 15-year mortgage. At the time of the modification, the homeowner also owes $60,000 in delinquent interest. Post modification, the homeowner ends up with a 30-year mortgage and owes $660,000. That amount consists of the original principal plus the $60,000 in back interest. Our view is that the entirety of the borrowers’ post-modification payments should be applied first to retiring the $60,000 of pre-modification interest, and that those amounts should be reported on Form 1098. Bank of America and many other banks have taken the position that they are not going to report the repayment of this interest at all.

Our position is that pre-loan-modification interest retains its character as interest post-modification and that therefore 26 U.S.C. Section 6050H requires that the borrowers’ post-loan modification payment of that interest must be reported on Form 1098. We further take the position that under the “interest before principal” payment allocation provisions that exist in all standard mortgage agreements, the borrowers’ post-loan-modification payments should be first applied to retire any pre-modification interest. Only then, should payments be allocated to retiring interest accrued post-modification and principal. See Prabel v. Commissioner, 91 T.C. 1101, 1113 (1988), affd. 882 F.2d 820 (3d Cir.1989) (courts generally have “deferred to the loan agreements between debtors and creditors where the agreements make specific provision for the accrual or allocation of loan payments between principal and interest.”)

Last year, our case against Bank of America got thrown out by the district court (that dismissal is  here). The ground for the district Court’s opinion was that the IRS supposedly has “exclusive enforcement” jurisdiction over 26 U.S.C. Section 6050H. We have appealed that ruling and briefing on that appeal will be complete next month. Argument will likely take place sometime in 2017. In the months since our case against Bank of America was thrown out, two other district courts in similar cases have explicitly refused to follow the Bank of America decision and have found these other Form 1098 cases “cognizable” in court; those opinions are found here and here. In our view, these subsequent decisions by two different federal judges bode well for our chances before the 9th Circuit. But there are also other movements afoot that will have ramifications on this issue (and our appeal) within this year.

Although the IRS refused all of our entreaties to become involved with this issue (made through the Office of the Taxpayer Advocate), two banking industry submissions – made pursuant to Rev. Proc. 2003-36 on September 15, 2015 and October 15, 2015 by the Mortgage Bankers Association (“MBA”) (MBA letter here) and American Bankers Association (“ABA”) (ABA letter here) – have apparently gotten the IRS to finally take notice. Specifically, on January 7, 2016, the IRS as part the IRS’ Industry Issue Resolution Program issued a curt statement stating it had agreed to accept two issues for consideration: (1) whether Section 6050H requires reporting of pre-loan-modification interest and (2) whether deferred interest in the negative amortization loan context should be reported.

Not surprisingly, neither the AMA’s and MBA’s letters claim that such interest should not be reported, but instead seek that the IRS issue a prospective-only rule that would (at least potentially) eliminate their members’ liability for having failed to report such interest in past years. We responded with our own submissions here in which we urged that the there is no need for “guidance” since there is a mountain of legal authority that already exists pointing inexorably to the conclusions: (1) that the payment of previously deferred mortgage interest must be reported on Form 1098 by the recipient of that interest in the year of actual payment and (2) that an intervening loan modification does nothing to change this.

We also pointed out that the only reason the ABA and MBA were seeking “guidance” is that some of its members are seeking to have the IRS help them avoid exposure in litigations like ours for their having improperly reported the mortgage interest payments of millions of Americans. Specifically, we stated that they are hoping to be able to create their own precedent so they can argue in Court that the IRS’s issuance of some sort of “prospective” “guidance” proves that an ambiguity existed in the law such that their under-reporting of interest was “reasonable.” However, we argued that the mere fact that some banks are reporting interest in a manner that is contrary to well-established law does not mean that there is an ambiguity in the reporting requirements. It just means that those banks are doing it wrong.

The real truth is that some ABA member banks (like Bank of America) chose expediency over compliance because tracking deferred interest is costly. But accuracy lies at the core of section 6050H. Clearly, any rule that promotes a schism between the amount of interest that a borrower pays to a lender from the amount of interest that lender reports on Form 1098 crosses purposes with the intent of section 6050H (this is not to say that the amount of interest deducted by the taxpayer will always match the amount of interest reported on Form 1098. For instance, a borrower might pay less than $600 in interest and thus not receive a Form 1098, but that borrower could still deduct the interest that he or she did pay). Because taxpayers, their tax preparers, and the IRS all routinely rely on the amounts contained on the lender-issued Form 1098, if pre-existing interest is not reported on Form 1098, most borrowers (and their tax preparers) would never even know: (1) there is a pre-existing interest balance that can be deducted, or (2) how to allocate their mortgage payments to determine in which tax-year they have repaid the prior interest balance. While this may be “good” for the treasury, it is inconsistent with the principle that everyone pays only the amount of tax they are required to pay under the tax code.

These problems all completely disappear if banks simply report the “aggregate” amount of interest (both current and pre-existing) that they actually receive as is mandated by the unambiguous language of § 6050H (recipients of “interest” on “any mortgage” are required to report on Form 1098 (to the IRS and to the payer) the “aggregate” amount of “interest” “received” during the calendar year if that amount “aggregates” to over $600). If that happens, then the taxpayer will deduct the proper amounts and the Form 1098 will have served its raison d’être by helping the IRS to verify that the amounts deducted are proper.

In tomorrow’s post we will discuss the legal issues underlying how banks are supposed to report interest.

Procedure Grab Bag

Or an interesting limitations case and a limiting interest TAM.

The last SumOp got a little lengthy, so I pulled out two items to trim it down.  The first I also thought deserved slightly more explanation, as the facts were complicated and the IRS somewhat reversed course on a position.  The second case deals with an untimely refund in a quirky situation.

  • The first tax procedure item is TAM 201548019, which highlights one way that  overpayment and underpayment interest can be complicated.  The issues and conclusion were as follows:


I. Under Section 6611, does interest accrue on a general adjustment overassessment when the Service has simultaneously determined that there is an increase in tax due to adjustments to carrybacks from subsequent years, where the net effect of these increases and decreases is an overassessment?

II. If interest is allowed pursuant to Section 6611 on the general adjustment overassessment, to what date does such interest accrual run?


I & II. Yes. Overpayment interest is allowable on the portion of the overpayment used to satisfy the underpayment from the date of said overpayment to the due date of the loss year return.

The applicable facts are that taxpayer filed a return for tax year 1, and timely paid the tax due.  In a subsequent year the taxpayer filed a tentative refund based on a net operating loss carry back from a future year 2.  The Service issued a refund based on the claim.  Later, on audit, the NOL was largely disallowed from year 2, causing a potentially increased assessment for year 1, which was less than the original refund amount.  The IRS also adjusted the original return for tax year 1 for other reasons, resulting in an original net overassessment and refund even after the reduced NOL.


The taxpayer took the position that interest was due on the full overpayment amount until the tentative refund was issued based on the NOL (no interest was paid when the refund was generated by the NOL).  The IRS rejected this position somewhat.  It was willing to pay interest on the full amount, but not until the erroneous refund date.  The TAM states the IRS position is that interest on the total overpayment amount from year 1 runs until the due date of the loss year return, when the incorrect credit was generated and deemed applied.  The TAM states this is because Section 6611(b) only allows interest on an overpayment when there is a refund or an amount is credited.   Here, the Service determined the amount of refund in question was not “refunded” following the audit, and was instead applied against an outstanding underpayment from the erroneous refund generated by the incorrect NOL carryback.  The date the NOL was generated, the credit date, is the date used by the Service, instead of the actual refund date arising from the incorrect NOL carryback.  The TAM points out that neither refund nor credit are defined in the statute, and walks through the Service’s analysis of why the payment here is a credit.  The Service also stated that its prior similar TAM (201123029) was not binding and that the analysis was incorrect; specifically that an overpayment that was not in fact refunded could be considered refunded.   It will be interesting to see if something percolates through the courts with this fact pattern.

  • The second item is a tax procedure case out of the Middle District of Florida.  US v. Bates is as interesting as crippled valet, John Bates, but with tax procedure and not scheming servants. The taxpayer was a pilot who worked for an airline that went bankrupt.  Pursuant to the bankruptcy, the airline ceased paying retirement payments.  Prior to the order ceasing the retirement payments, the airline had prepaid FICA taxes on a portion of the amount that was going to be paid to the taxpayer, but the underlying income was never paid.    The taxpayer sought a refund of the withheld taxes, which was granted by Appeals.  The Service later sought to recoup what it deemed an erroneous refund, as it believed the refund request was outside the statute of limitations.

The payment was made in January of 2004.  Mr. Bates filed his refund claim on January 28, 2008.  He was denied, and went to Appeals.  While that was occurring, in May of 2009, another pilot filed suit in the Federal Claims Court seeking a refund of the FICA taxes, and claiming to represent himself and other pilots, including Bates (he was not a lawyer).  The Court tossed the claim for all plaintiffs except Kooperman, because he couldn’t represent others before the court.  In April of 2010, Appeals ok’d the entire refund to Bates.  In May of 2010, the Court order was vacated, and all claims were stayed to allow the non-Kooperman plaintiffs to get a lawyer instead of a pilot.  Bates, having a refund, did not pursue the claim.   In January 2011, the Service requested the refund back, stating the refund was erroneous because it was untimely, but also because Bates was a plaintiff at the time in the Kooperman case.  The United States in June of 2012 then sought to remove Bates from the Kooperman case because he had already received the refund.  Sticking it to him on both ends. That motion was opposed by Bates and is still pending.

Both parties agreed the refund was made, and the erroneous refund claim was timely, so the only question was whether the refund was erroneous.  Bates (having lawyered up) argued the request was timely, he was not a plaintiff, and even if he was, the government can’t recoup a refund issued by Appeals in settlement of an issue.  On the last issue, the Court relied on Johnson v. United States, 54 Fed. Cl. 187 (Fed. Cl. 2002), which held Appeals cannot issue refunds on untimely claims.

As to the timing, both parties agreed that the original refund request was outside of the stated time period in Section 6511(a).  Bates argued, however, that there was no basis for a refund until after the bankruptcy court held that Bates would not receive retirement payments under the plan.  Apparently, Bates did not have sufficient statutory grounds for this position, as the court stated it was essentially an argument for equitable tolling.   I really should have pulled the briefs, as I would assume there would be some Code or Bankruptcy Code argument to be made that the statute was suspended until all facts were available (even if it was a losing one).

The Court apparently has not been following Carl Smith’s various strong posts on equitable tolling.  The Court held that the results were unusual for Bates and harsh, but that it lacked authority to apply equitable tolling and cited to Vintilla v. United States, 931 F.2d 1444 (11th Cir. 1991).  The Court also noted it lacked the authority to grant interest abatement on the erroneous refund, as the taxpayer requested, even though Appeals had mistakenly issued the refund, and that authority was vested with the Department of Treasury, which can only be reviewed by the Tax Court. See Section 6404(h).