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Goldring Is Back – With a Circuit Split

Posted on Jan. 7, 2022

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

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

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

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

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

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

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

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

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

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

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

. . .

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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