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Complications With Rolling Credit Elect Transfers – Part 2

Posted on Feb. 5, 2021

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

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

Treatment of rolling CETs for interest purposes

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

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

FleetBoston disagreed with Vendell and Spunkmeyer, concluding that they

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

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

Who’s right?

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

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

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

Government perspective – it’s a matter of accounting

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

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

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

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

Taxpayer’s perspective – prevent inequitable results

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

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

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

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

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

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

Where do we go from here?

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

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

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