Background

The case involved two sets of tax returns and audits: those for the General Mills (“GMI”) corporate tax returns and those for partnership tax returns for General Mills Cereals, LLC (“Cereals”).  Various members of the GMI consolidated group were partners in Cereals, so the partnership tax returns – and any audit adjustments – for Cereals flowed through to GMI.  The IRS audited the 2002-2003 tax returns (both corporate and partnership) and later the 2004-2006 tax returns (same).  Although there are some slight differences between the audits for those two periods, for simplicity I will focus on the 2002-2003 tax returns.

Audits began for both GMI and Cereals in 2005 for these years.  The IRS issued a 30-day letter for the GMI audit on June 15, 2007, asserting proposed deficiencies of more than $143 million for 2002 and almost $83 million for 2003.  The partners in Cereals entered into settlement agreements in July 2010.  On August 27, 2010, the IRS issued a document described as a “notice of computational adjustment” to GMI, identifying additional underpayments, resulting from the Cereals audit, of about $16 million for 2002 and more than $33 million for 2003.

The IRS assessed additional taxes, penalties, and interest resulting from the Cereals audit in September 2010.  GMI paid all outstanding balances for these years, including interest, on April 11, 2011.  The IRS sent GMI detailed interest computation schedules for these years, apparently for the first time, on April 18, 2011 and April 20, 2011.  The schedules reflected that the IRS began charging a higher underpayment interest on July 15, 2007.  GMI filed refund claims on March 28, 2013, arguing that the interest IRS accrued and assessed was almost $6 million too high.  GMI then filed this refund suit on January 30, 2014.

The Basis for GMI’s Refund Claim – LCU Interest The interest rate for large corporate underpayments (LCU) is governed by section 6621(c), as supplemented by Treas. Reg. § 301.6621-3, which increases the normal underpayment interest rate by 2% for a corporate taxpayer’s underpayments that exceed $100,000.  It was enacted in 1990, as part of the Omnibus Budget Reconciliation Act, and has typically been referred to by practitioners ever since as “hot interest.”  There are two key concepts in determining whether, and when, to apply hot interest: the “threshold underpayment” and the “applicable date.”

Threshold Underpayment

Whether hot interest applies is not, oddly enough, determined by comparing the underpayment balance to $100,000.  The regulation establishes a “threshold underpayment,” a term of art that appears only here.  Hot interest applies if that amount, rather than the underpayment balance, exceeds the $100,000 statutory requirement.  The threshold underpayment is defined as the correct amount of tax (excluding penalties and accumulated interest) less all payments made by the last date prescribed for payment.  Thus, it appears to be a cumulative amount rather than the result of a particular transaction such as an audit.  (But see below regarding “applicable date.”)  Once hot interest is triggered, the higher interest rate would apply to the entire underpayment balance going forward, including interest and penalties and any amounts subsequently assessed.  Under the IRS interpretation, hot interest would apply even if the actual underpayment balance declines below the $100,000 threshold as a result of payments.

The existence of a threshold underpayment is determined only when there is an assessment, not merely because of a proposed deficiency.  (Contrast the determination of the “applicable date” discussed below.)  If the taxpayer receives a 30-day letter or a notice of deficiency for $110,000 but the amount is reduced to $90,000 prior to assessment, the threshold underpayment is only $90,000 and hot interest does not apply.  But even if an amount greater than $100,000 is originally assessed, the regulation states that hot interest will not apply if a subsequent judicial determination reduces the tax liability (and therefore the threshold underpayment) below $100,000.

The regulation doesn’t specifically address whether a subsequent administrative determination reducing the tax liability (e.g., an abatement resulting from a refund claim) would reduce the threshold underpayment, potentially below $100,000.  Based on the definition of the threshold underpayment in the Code, it should – but I haven’t run across a ruling on this specific question.  The IRS has challenged whether an abatement reduces the threshold underpayment but to my knowledge only in the specific context of an NOL carryback.  The IRS lost, in Med James, Inc. v. Commissioner, 121 T.C. 147 (2003), but in that case the reduction from an NOL carryback was asserted as a counterclaim in a deficiency proceeding.  If the abatement had been granted in an administrative determination, the taxpayer might have had to pay and file a refund claim/suit to address the hot interest issue.

Determining the amount of the threshold underpayment is complicated enough that the IRS can easily make mistakes.  But if you look at the amounts above, it’s clear that GMI met the threshold underpayment requirement.  That is only one part of the answer, though.  To determine whether/when hot interest applies, the IRS also must determine the applicable date. 

Applicable Date

Interest on underpayments generally runs from “last date prescribed for payment,” typically the unextended return due date.  The higher rate for hot interest only applies “for periods after the applicable date.”  For assessments subject to deficiency proceedings, the applicable date is 30 days after the earlier of a “letter of proposed deficiency which allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals” (i.e., a 30-day letter) or the notice of deficiency.  That’s section 6621(c)(2)(A).

Section 6621(c)(2)(B)(i) is a special rule that applies to tax assessments not subject to the deficiency procedures; for such underpayments, the applicable date is 30 days after a letter or notice of the assessment or proposed assessment.  This would apply to certain taxes other than income tax.  This category also would include two common situations involving income tax: amounts shown on the original return but not paid on or before the last date prescribed for payment, and summary assessments for “mathematical or clerical errors.”

Although not explicitly addressed in the Code, the regulation includes within the scope of section 6621(c)(2)(B)(i) “underpayments attributable, in whole or in part, to a partnership item.”  For those, the applicable date would be the 30th day after the first letter or notice that notifies the taxpayer of an assessment of the tax.

The Code also identifies three exceptions under which a letter or notice that otherwise qualifies would not establish an applicable date and start hot interest running:

• A 30-day letter or notice of deficiency that is withdrawn.
• A 30-day letter or notice of deficiency for which the taxpayer pays the amount in full within 30 days after the letter or notice is sent.
• Any letter or notice involving “small amounts,” that is, an amount that is not greater than $100,000 (as with threshold underpayment, excluding penalties and interest). 

As with threshold underpayments, the proper determination of the applicable date may be complicated and subject to error.  GMI believed that the IRS applied the law incorrectly and charged hot interest when it should not have.

IRS application and GMI’s argument

Interest at the normal underpayment interest rates generally (with some common caveats) begins as of the filing due date, without regard to extensions, rather than when the IRS made the assessments.  But the increased interest rate for hot interest starts only on the applicable date. What does that mean when there are multiple assessments, including adjustments flowing through from TEFRA audits?

The IRS position apparently is that hot interest starts, for the entire underpayment balance, as of the first applicable date for any component of that underpayment balance.  As noted above, GMI’s corporate audit resulted in a 30-day letter issued on June 15, 2007.  So the IRS interest calculations increased the interest rate starting on July 15, 2007, one month later, for the entire underpayment balance, including that attributable to the computational adjustments from the TEFRA audit.

GMI, on the other hand, read sections 6621(c)(2)(A) and (B)(i) as bifurcating the underpayments for these tax periods.  The portion of the underpayment attributable to the corporate audit and the portion of the underpayment attributable to the TEFRA audit would have separate applicable dates.  Hot interest for the portion of the underpayment attributable to the corporate audit might start as of July 15, 2007.  But the first letter or notice that notified GMI of an assessment of tax from the TEFRA audit was issued on August 27, 2010.  So hot interest for that portion of the underpayment shouldn’t start until September 26, 2010, more than three years later than the applicable date the IRS used. 

I think GMI’s position is certainly a reasonable interpretation.  The Code is, as almost always, ambiguous and the drafters may not even have considered this situation.  GMI’s particular situation, an assessment resulting from a corporate audit followed by an assessment resulting from a TEFRA audit, is not explicitly addressed anywhere in the 4-1/2 pages of regulations either.  There are six examples in the regulations, but none involve this situation.  Indeed, none of the examples even involve a partnership adjustment.

GMI pointed out that section 6621(c)(2)(A) already uses a “the earlier of” comparison between a 30-day letter and a notice of deficiency for which no 30-day letter was issued.  If Congress didn’t want to bifurcate the underpayments in a situation like GMI’s, why not simply include the provision regarding non-deficiency proceedings as 6621(c)(2)(A)(iii) instead of 6621(c)(B)(i)?  

I think it would be possible to carry the argument even further, arguing that hot interest applies only at the level of individual components of the underpayment balance, rather than the entire balance.  Other interest provisions apparently work that way, e.g., the “restricted interest” provisions in sections 6601(c) and 6611(e).  The references in section 6621(c) to letters or notices arising from specific adjustments, rather than to the entire underpayment balance, are very similar to the restricted interest provisions.  That arguably suggests the same approach of applying the special rule to components rather than the entire balance.

That interpretation could also be inferred from the exception in section 6621(c)(B)(iii), under which a letter or notice for a deficiency or assessment less than $100,000 does not start hot interest running.  Before that provision was added in 1997, hot interest would be triggered when the threshold underpayment from two or three separate transactions exceeded $100,000.  That’s reflected in Treas. Reg. § 301.6621-3(d), Example 2, which has not been revised to be consistent with the Code provision as amended in 1997.  What’s the purpose of section 6621(c)(B)(iii)?  Maybe it reflects a determination that hot interest should be applied only to individual transactions over $100,000, rather than a cumulative balance.  And maybe that implies that the applicable date should be determined separately for each of those transactions.

Further support is available from the exception in section 6621(c)(B)(ii), under which a letter or notice for which the taxpayer pays the amount in full within 30 days does not start hot interest running.  That looks very much like an incentive for quick payment, doesn’t it?  But if hot interest applies at the level of the entire underpayment balance rather than individual transactions, the incentive starts looking strange.  There is an extra incentive to pay quickly for the first deficiency/assessment that triggers hot interest, but that extra incentive goes away for the second, third, etc. deficiency/assessment.  Why would that be the case? I don’t recall ever seeing this issue before the Federal Circuit’s decision came out.  The case was filed in the Court of Federal Claims in 2014, and that court ruled in 2015, but I missed those at the time.  To my knowledge, this issue has not been addressed in any other cases.  (If anyone has seen it elsewhere, please let me know!)  So I was eager to see the court’s analysis.  Alas, there was none.  The case was dismissed for lack of jurisdiction, so we’re still waiting for the courts to rule on this issue.

Brief Recap of the Facts and the Majority’s Position The case involved partnership audits and adjustments for partnership tax returns for General Mills Cereals, LLC (“Cereals”).  Different members of the General Mills (GMI) consolidated group were partners in Cereals, so the tax returns—and any audit adjustments—for Cereals flowed through to GMI.  The IRS audited the 2002-2003 tax returns (both corporate and partnership) and later the 2004-2006 tax returns (same).  Although there are some slight differences between the audits for those two periods, for simplicity I will focus on the 2002-2003 tax returns.

Audits began for Cereals in 2005 for these years.  The partners in Cereals entered into settlement agreements in July 2010.  On August 27, 2010, the IRS issued a “notice of computational adjustment” to GMI, identifying additional underpayments resulting from the Cereals audit, of about $16 million for 2002 and more than $33 million for 2003. 

The IRS assessed additional taxes, penalties, and interest resulting from the Cereals audit in September 2010.  GMI paid all outstanding balances for these years, including interest, on April 11, 2011.  The IRS sent GMI detailed interest computation schedules for these years, apparently for the first time, on April 18, 2011 and April 20, 2011.  The schedules reflected that the IRS began charging a higher underpayment interest rate (“hot interest”) on July 15, 2007.  GMI filed refund claims on March 28, 2013, arguing that the higher interest rate should not have started until September 26, 2010.  It then filed this refund suit on January 30, 2014.

The government argued, and the majority agreed, that the relevant statute of limitations for such refund claims was the six-month period specified in section 6230(c)(2) for challenging erroneous computational adjustments rather than the two-year limitation period of section 6511.  As a result, the refund claims were filed untimely, and the case was dismissed for lack of jurisdiction.

The Dissent

The Federal Circuit’s decision was 2-1.  Judge Newman dissented and would have reversed the dismissal for lack of jurisdiction.  She thought section 6511, rather than 6230(c), applied to these refund claims.  Section 6231(a)(6) defines a computational adjustment as “the change in the tax liability of a partner which properly reflects the treatment under this subchapter of a partnership item.”  She concluded that the “payment of interest is not a ‘tax liability.’”  Further, “partnership item” should not be construed so “‘broadly as to cover claims that depend on the unique circumstances of an individual partner.’” (quoting Prochorenko v. United States, 243 F.3d 1359 (Fed. Cir. 2001)).  Thus, the refund claims were not correcting errors in computational adjustments of a partnership item; they were for refund of an overpayment of interest, to which the two-year limitation period in section 6511 apply.

Judge Newman found no hint in the TEFRA legislative history of any Congressional intent to truncate the two-year limitations period in section 6511.  She also quoted a 2001 Supreme Court case:  “[I]n cases such as this one, in which the complex statutory and regulatory scheme lends itself to any number of interpretations, we should be inclined to rely on the traditional canon that construes revenue-raising laws against their drafter.”

Possible Confusion Regarding the Conceptual Framework?

As I read the majority opinion and the applicable Code sections, it occurred to me that the analysis—as well as the regulation that defined resulting interest as a computational adjustment—rested in part on an assumption about the governing framework.  Specifically, the IRS, DOJ, and Court seem to think of adjustments to the partners’ returns as falling into two categories only:

• Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 

• Computational adjustments for which deficiency proceedings are not required.  This encompasses those for which partner-level determinations are not necessary. 

That seems consistent with the structure of former section 6230.  Section 6230(a)(2)(A) provides circumstances under which deficiency procedures apply and section 6230(a)(1) effectively is “everything else.”

The government puts interest in the second category, even though partner-level determinations are necessary.  (They certainly were in this case because the interest computations depended on information that was not part of the TEFRA proceedings.  The notice, and therefore applicable date used by the IRS, were part of the corporate audit.)  The decision to put interest into the second category perhaps was because interest doesn’t fit into the first category, which “shall apply to any deficiency attributable to . . ..”  Interest is not a tax liability and therefore is not included in the definition of deficiency and therefore does not fall within section 6230(a)(2)(A).  Where else can it be?  Only section 6230(a)(1).

But that is only the case if assessments of additional interest are computational adjustments.  The dissent concluded that interest assessments don’t fit within the definition of a computational adjustment.  An alternative framework would be that adjustments to partners’ returns, resulting from a partnership-level proceeding, fall into three categories:

• Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 

• Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 

• Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 

In that case, the six-month period in section 6230(c)(2) only applies to the first two categories.  The third falls under the two-year period of section 6511 for normal refund claims.

This certainly seems as though it could have been what Congress intended.  Before TEFRA, we just had deficiency procedures and interest was not subject to those; it was just assessed after tax was assessed.  Did Congress intend partnership proceedings and computational adjustments to only address the same types of adjustments that deficiency proceedings covered—underlying tax, penalties, additions to tax, and additional amounts?  And then rely on the existing process for assessing interest, which is to simply assess it and require the taxpayer to pay and file a refund claim?  I haven’t done a deep dive into the legislative history, but that seems very plausible to me.  It’s also arguably the best interpretation under the definition of a computational adjustment quoted above in the discussion of the dissent.

There is a technical argument to the contrary that could support the majority’s position. 

• Section 6601(e)(1) says that references to “tax” shall be deemed also to refer to interest, except for such references in subchapter B of chapter 63 (sections 6211-6216). 
• So “tax” in section 6230(a)(2)(A) would include interest, but that section doesn’t mention “tax,” it refers to “deficiency”. 
• And the reference to “tax” in section 6211(a), defining “deficiency,” doesn’t include interest.  Therefore, interest is not part of a deficiency. 

Thus, interest is included in the definition of a computational adjustment in section 6231(a)(6), which has a direct reference to “tax.”  But section 6230(a)(2)(A) has only an indirect reference (through section 6211) to tax, so interest is not included to the category of computational adjustments for which a deficiency proceeding is appropriate. 

But that’s highly technical and formal.  Common sense would say that—for purposes of the TEFRA provisions—if interest is not included in a deficiency for purposes of section 6230(a)(2)(A), it shouldn’t be included in a change to tax liability for the definition of computational adjustment in section 6231(a)(6).

The Court of Federal Claims opinion addressed this question, whether interest is incorporated in the definition of a computational adjustment, in more detail than the Federal Circuit’s decision.  The CFC didn’t rely entirely on the regulation and in fact suggested that would be insufficient by itself.  It cited several cases, some of which addressed a former version of section 6621(c), which increased the interest rate for “tax-motivated transactions” (TMT); the CFC, along with other courts, considered TMT interest analogous to hot interest.  But those cases never addressed the definition of computational adjustment, other than in the regulation.

For example, in N.C.F. Energy Partners v. Commissioner, 89 T.C. 741 (1987), the partnership sought to challenge penalties and TMT interest in its proceeding, although they were not asserted in the final notice of partnership administrative adjustment.  The IRS moved to dismiss those portions of the case for lack of jurisdiction.  The court concluded that additional findings of fact with respect to individual partners would be required, so those issues should not be addressed in the partnership proceeding.  The court did not directly interpret the definition of a computational adjustment, although it seemed to suggest that TMT interest would be addressed in a deficiency proceeding.

In White v. Commissioner, 95 T.C. 209 (1990), the IRS issued a notice of deficiency including TMT interest after the conclusion of the partnership proceeding.  The IRS moved to dismiss the interest determination from the deficiency proceeding.  The court agreed, 13-2 in a reviewed opinion.  That case, however, turned on the question of whether interest was included in a “deficiency.”  The court did not address how a later assessment of interest should be handled, as a computational adjustment or just a normal assessment of interest.

In Pen Coal Corp. v. Commissioner, 107 T.C. 249 (1996), the notices of deficiency had included tax, penalties, additions to tax, and additional amounts and had also determined that hot interest applied, without determining the amount.  The IRS sought to strike the interest determinations from the deficiency proceeding.  The court agreed, following White, but again did not interpret section 6231(a)(6).

Finally, in Olson v. United States, 172 F.3d 1311 (Fed. Cir. 1999), the taxpayers filed refund suits in the Court of Federal Claim.  They argued that various assessments (including TMT interest) resulting from a settlement of a partnership proceeding were invalid because they had received no notices of deficiency.  The CFC granted the government’s motion for summary judgement, concluding that notices of deficiency were not required and noting that no other basis for the refund was asserted.  The Federal Circuit agreed.  There was a brief reference to interest being included in the definition of a computational adjustment, but that mentioned only the regulation with no interpretation of the applicable Code section. 

Practical Considerations

The regulation stating that interest is included in a computational adjustment may have been influenced by an assumption—possibly shared by the DOJ and court—that interest computations are generally straight-forward and easy to verify.  If so, it might seem simplest to include interest in a computational adjustment not subject to deficiency procedures.  As with the allocation of the previously determined change in the underlying tax, errors would be rare but easily detected.  A computational adjustment, even with the abbreviated period within which to file a refund claim, would be a reasonable compromise.

However, while interest calculations for most taxpayers are indeed straight-forward and easy to verify, that is often not the case with large businesses who may have multiple changes to tax liability implicating several different issues of interest calculation.  Sometimes the law is not clear; other times the law is clear, but errors occur frequently.  Specialist firms provide taxpayers with reviews of interest computations to identify potential problems.  That process, however, can take a long time.

This also means that an abbreviated period within which to file refund claims relating to interest is not a good idea from a policy perspective.  The description in the Federal Circuit’s decision suggests that by the time GMI received the April 2011 interest computation schedules it had all the necessary information to identify the basis for a refund claim based on when hot interest rates should apply.  But that was more than six months after the August 2010 notice that the CFC considered the initial notice of computational adjustment.  It was even more than six months after the assessment of interest in September 2010.  I defy anyone to look at a lump sum assessment of interest for a large corporate taxpayer and be able to determine how that amount was calculated.

Even if the Federal Circuit decided that the April 2011 schedules were the initial notice of computational adjustment with respect to interest, six months is still not a lot of time within which to file a comprehensive refund claim covering all interest errors that might have been contained in those computations.  Rushing to file a refund claim based only on the issue concerning hot interest might have risked forfeiting claims based on other issues.

Thus, even if the correct legal determination were that the six-month period to file refund claims applied to computational adjustments relating to interest, it seems like a bad policy choice.

Conclusion  

Between the dissent, the alternative framework for classifying adjustments arising from a TEFRA proceeding, and the practical considerations, there seems to be at least a reasonable argument that interest should not be included in the definition of computational adjustments and not subject to the accelerated refund claim provisions of section 6230(c).  But that’s now what the regulation the IRS wrote say—and challenging the validity of the regulation would be difficult—and that’s not what the Federal Circuit decided.

This concludes the discussion of the TEFRA jurisdictional issue.  Part 3 addresses the substantive issue: exactly when the higher hot interest rate should have started.  It’s a complicated issue in these specific circumstances and, to my knowledge, has not yet been ruled on by any court.

The Facts

The case involved two sets of tax returns and audits: those for the General Mills (“GMI”) corporate tax returns and those for partnership tax returns for General Mills Cereals, LLC (“Cereals”).  Different members of the GMI consolidated group were partners in Cereals, so the tax returns—and any audit adjustments—for Cereals flowed through to GMI.  The IRS audited the 2002-2003 tax returns (both corporate and partnership) and later the 2004-2006 tax returns (same).  Although there are some slight differences between the audits for those two periods, for simplicity I will focus on the 2002-2003 tax returns.

Audits began for both GMI and Cereals in 2005 for these years.  The IRS issued a 30-day letter for the GMI audit on June 15, 2007, asserting proposed deficiencies of more than $143 million for 2002 and almost $83 million for 2003.  The partners in Cereals entered into settlement agreements in July 2010.  On August 27, 2010, the IRS issued a “notice of computational adjustment” to GMI, identifying additional underpayments, resulting from the Cereals audit, of about $16 million for 2002 and more than $33 million for 2003. 

The IRS assessed additional taxes, penalties, and interest resulting from the Cereals audit in September 2010.  GMI paid all outstanding balances for these years, including interest, on April 11, 2011.  The IRS sent GMI detailed interest computation schedules for these years, apparently for the first time, on April 18, 2011 and April 20, 2011.  The schedules reflected that the IRS began charging a higher underpayment interest rate (“hot interest”) on July 15, 2007.  GMI filed refund claims on March 28, 2013, arguing that the higher interest rate should not have begun until September 26, 2010.  As a result, the IRS had accrued almost $6 million too much interest.  GMI then filed this refund suit on January 30, 2014.

The “hot interest” issue underlying the claim is intriguing and I was looking forward to reading the court’s analysis of it.  But the opinion focuses instead on the jurisdictional TEFRA provision that formed the basis of the government’s motion to dismiss.  I’ll have more discussion of the hot interest issue in Part 3.  But because the taxpayer lost on the jurisdictional issue, we will have to wait for another day for a court decision on the merits issue.

The Jurisdictional Question—TEFRA Computational Adjustments

Framework

A preliminary reminder:  the TEFRA provisions—Subtitle F, Chapter 63, Subchapter C—were stricken and replaced with a new regime for partnership audits, by the Bipartisan Budget Act of 2015.  References herein to specific Code sections are to the TEFRA versions, not the BBA versions.

As we all remember, TEFRA established unified partnership audit proceedings, with special rules for assessments of partners based on any resulting adjustments to the partnership tax return.  The changes to the partners’ tax liabilities to reflect the partnership adjustments are called “computational adjustments,” section 6231(a)(6).  Computational adjustments were initially understood as falling into two categories, depending on whether a partner-level determination was required.  If no such partner-level determination was required, the IRS simply assessed any additional amounts due.  (Mechanical applications, such as recalculating an itemized deduction for medical expenses, were not considered “determinations.”)  If a partner-level determination was necessary, the IRS had to issue a notice of deficiency, providing an opportunity for judicial review. 

The two categories became three with the Taxpayer Relief Act of 1997.  Penalties had been identified as a problem.  There might be necessary partner-level determinations to address penalty defenses.  Litigating those defenses (including defenses by indirect partners) in a partnership-level proceeding was not considered feasible but removing all penalties to deficiency proceedings was not an ideal approach either.  Thus, whether a penalty generally applied would be resolved in a partnership-level proceeding.  The IRS could then proceed to assessment without a deficiency proceeding, requiring partners to raise partner-level defenses in a refund claim/suit.  So the categories were:

• Adjustments for which a partner-level determination was not required (immediate assessment allowed).
• Adjustments for which a partner-level determination was required, other than penalties, additions to tax, and additional amounts (deficiency proceeding required).
• Adjustments for penalties, additions to tax, and additional amounts (immediate assessment allowed).

Those were specified in section 6230(a).  Although that section didn’t address interest, the IRS did, by regulation.  Treas. Reg. § 301.6231(a)(6)-1(b) provides that a “computational adjustment includes any interest due with respect to any underpayment or overpayment of tax attributable to adjustments to reflect properly the treatment of partnership items.”  The IRS treats such adjustments of interest as computational adjustments that can be assessed immediately.

Claims Arising Out of Erroneous Computations

For computational adjustments that are assessed directly and cannot be challenged in a deficiency proceeding in Tax Court, section 6230(c) provides an opportunity for challenge.  The taxpayer may file a refund claim for erroneous computations that:

• Are necessary to apply the results of a settlement, final partnership administrative adjustment (if not challenged in Tax Court), or a Tax Court decision challenging the FPAA. 
• Impose any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item.

These refund claims “shall be filed within 6 months after the day on which the Secretary mails the notice of computational adjustment to the partner.”  Thereafter, a refund suit can be brought within the period specified in section 6532(b) for refund suits.  And section 6511(g) provides that section 6230(c) applies, rather than section 6511, with respect to tax attributable to partnership items.

I’ve actually never dealt with a section 6230(c) refund claim before and perhaps others haven’t either.  This case was a good reminder of the different limitation period.  But it’s particularly fascinating because of a quirk introducing when dealing with interest resulting from a TEFRA proceeding.

Application in GMI’s Case

The Notices GMI Received

Let’s start with the communications at the conclusion of the Cereals (partnership) audit, as those were relevant to the basis for the motion to dismiss.  The IRS and GMI executed a settlement agreement on July 27, 2010.  It addressed “any deficiency attributable to partnership items, penalties, additions to tax, and additional amounts that relate to adjustments to partnership items, as set forth in the attached Schedule of Adjustments (plus any interest provided by law.)”  The same “any interest provided by law” language also appeared elsewhere in the settlement agreement, but there was no reference to hot interest or even the amount of interest that would result.

On August 27, 2010, the IRS sent a cover letter with Form 5278, Statement—Income Tax Changes.”  That form included a line for “Balance due or (Overpayment) excluding interest and penalties” with a corresponding dollar amount.  No amount was shown for interest, but the cover letter stated that the IRS “will adjust your account and figure the interest.”  Still no reference to hot interest.  The IRS assessed the tax deficiencies plus interest (including hot interest) on September 3, 2010, but no schedule showing how the amount of interest had been computed was sent to GMI at this time. 

On April 18, 2011, the IRS sent GMI an interest computation schedule for each of the four years, showing that hot interest began running on June 15, 2007—the date of the notice of proposed deficiency for the corporate audit.  The IRS sent another interest computation schedule for one of the years on April 20, 2011.

GMI paid the additional taxes and interest (including hot interest) on April 11, 2011.  It then filed refund claims on March 28, 2013, within the traditional two-year period after the payment in section 6511, and then this refund suit.  The government filed a motion to dismiss, arguing that the six-month period of section 6230(c) applied and therefore the refund claims were filed too late.

The Majority Opinion

GMI’s attorneys did a very professional, thorough job of identifying arguments that the refund claims were timely.  The majority opinion in the Federal Circuit shot them all down.

The notices received did not qualify as “computational adjustments.”  The majority’s response: Treas. Reg. § 301.6231(a)(6)-1(b) specifically included interest in the scope of computational adjustments and GMI did not challenge the validity of the regulation.  The Court of Federal Claims also cited several cases, including the Tax Court and other Circuit Courts, that it concluded supported the conclusion that interest is a computational adjustment.

However, I think (and the dissent may have agreed) the validity of the regulation is not clear.  And I don’t find the cases cited by the Court of Federal Claims very persuasive either.  Stay tuned for further discussion in Part 2.

Refund claims for “computational adjustments” only cover computation errors, not the legal error that GMI alleged.  The majority relied on the fact that section 6230(b) addressed “mathematical and clerical errors appearing on partnership returns,” implying that section 6230(c) must refer to a different class of errors.  It also cited a Seventh Circuit that reached the same conclusion, for the same reason. 

This isn’t entirely persuasive either.  An alternative, and to my mind more persuasive, distinction would be that section 6230(b) concerns mathematical or clerical errors on the partnership return while section 6230(c) concerns errors in a computational adjustment to make the partner’s return consistent with a substantive adjustment to the partnership return in a TEFRA proceeding.  Two entirely different things, aren’t they?  And most direct assessments (other than interest) without deficiency proceedings can only be challenged based on: (a) mathematical errors in allocating the change in tax liability; or (b) partner-specific penalty defenses.

The section 6230(c) refund claim provision applies only to adjustments necessary to apply the settlement, but the partnership audit and settlement did not address how hot interest should be computed.  GMI pointed out that (a) the partnership settlement agreements did not cover any aspect of how interest would be computed and (b) a global settlement agreement had explicitly carved out any implication that GMI had agreed to interest computations.  The court’s response focused on the boilerplate language “any interest provided by law.” 

I don’t consider this persuasive either.  Can you imagine a settlement agreement concerning the underlying tax liability that, instead of identifying the specific adjustments, said “any adjustments to income or expenses provided by law”?   Of course not.  That’s not a “settlement” in any normal sense of the word.  Similar boilerplate language about interest abounds in tax controversy but I’ve always considered that as intended simply to avoid any implication, by omission, that the parties had agreed that interest would not apply.  I don’t think boilerplate language like that has ever been interpreted to mean that the parties had settled on the resulting computation.  The fact that interest was “clearly contemplated” doesn’t mean that it was settled.

Section 6511 also applies and is an alternative available to taxpayers.  Here, the court relied on the general principle that a narrower, specifically drawn statute pre-empts a broader provision.  That’s generally true, although it may not always apply. 

For policy reasons, the section 6230(c) refund claim provision should not apply to claims that are entirely due to a partner’s unique factual circumstances.  This seems one of GMI’s less persuasive arguments, and the court simply pointed out there was no authority to support this position.

Section 6230(c) only applies to refund claims that are attributable to partnership items and the “applicable date” that GMI was disputing is not a partnership item.  As with the preceding item, this was a difficult argument and the court disagreed that a “partnership item” was a general requirement for all these refund claims.  Although the court did not go into detail, there is a structural argument.  The only reference to “partnership item” in that provision is in section 6230(c)(1)(A)(i), which relates to a computational adjustment to make the partner’s return consistent with the partnership return.  That sounds very much like making the partner’s return consistent with the partnership return as filed.  By comparison, section 6230(c)(1)(A)(ii) addresses computational adjustments relating from a TEFRA audit—settlement, FPAA, or court decision.  Section 6230(c)(1)(A)(i) would cover GMI’s situation, and it does not mention “partnership item.”  Neither does section 6230(c)(2), which governs the refund claims, mention “partnership item.” 

The notices received by GMI did not provide adequate notification of the determination.  The Court of Federal Claims seemed to consider even the initial notice on July 27, 2010, to have provided adequate notification.  It relied on GMI’s acknowledgement that “interest is generally the type of item that is ‘implicit in a computation of tax with respect to settled items so that it need not be expressly computed or even identified in the notice of computational adjustment that applies to the settlement.’”  Interest may be straight-forward in other contexts but certainly was not here. 

However, the Federal Circuit relied instead on the interest computation schedules received in April 2011 as providing adequate notice.  From the court’s description, it appears those did make it clear that hot interest would be applied and what applicable date would apply.  GMI argued those were still insufficient because they didn’t mention the six-month limitation period in section 6230(c) or even that a jurisdictional period was being triggered.  In addition, the schedules didn’t mention the TEFRA proceeding or segregate interest arising from the corporate audit for that arising from the Cereals audit.  The court simply rejected those as not required elements of a notice of computational adjustment.

And so, the majority dismissed the case for lack of jurisdiction.  Unless/until the issue comes up in another circuit, that decision will stand.  But it’s not necessarily the correct decision.  In Part 2, I’ll briefly summarize the dissent and then add some further thoughts on how the framework applied by the majority is arguably not the best way to think about these types of adjustments.  A different conceptual framework could lead to a decision in the taxpayer’s favor.