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Interest Computation and Something Else

Posted on July 17, 2019

Guest blogger Bob Probasco returns with a lesson on tax overpayments, taking us through a helpful comparison between overpayment rules and those applicable to wrongful liens and levies. It isn’t always simple to properly characterize a claim. Christine

At the end of June, the IRS released CCA 201926001, addressing a question regarding computation of overpayment interest. The fact pattern was a bit out of the ordinary, so I understand why a field attorney might want clarification. The answer that the interest specialist reached seems reasonable as a practical matter. However, there are some complications and issues that the CCA didn’t address or even acknowledge. The interest computation discussion in the CCA was fairly straightforward and might not warrant discussion here by itself; I found the other questions more intriguing.

The interest computations

The issue was stated as: “Whether interest is allowable on the refund of a remittance made by a non-liable spouse that the Service incorrectly applied to the liable spouse’s tax liability?” You can probably anticipate the fact pattern.

  • Husband and Wife 1, who divorced in Year 7, had joint tax liabilities for multiple earlier years.
  • Husband married Wife 2 in Year 9, when the joint tax liabilities of Husband and Wife 1 were still outstanding.
  • Husband and Wife 2 bought real property in Year 11.
  • The Service filed a Notice of Federal Tax Lien with respect to Husband’s joint tax liability, which attached to the real property that Husband and Wife 2 had purchased.
  • Husband and Wife 2 wanted to sell the property, so they sought a certificate of discharge of the lien, in return for payment equal to the value of the government’s interest in the property. They sold the property in Year 13.

So far, so good. But the IRS’s Conditional Commitment to Discharge (Letter 403) overstated the amount to be paid, as almost the full amount of the sales proceeds rather than only Husband’s half-interest. Alas, no one noticed and corrected the error in time, so the title company sent the full amount of the sale proceeds to the IRS. The IRS received and applied the proceeds against the joint tax liabilities for Years 1 and 2 of Husband and Wife 1, sometime after April 15th of Year 13.

Later in Year 13, Wife 2 realized that her half-interest in the sale proceeds had been applied to tax balances for which she was not liable, and she filed a claim for refund. On the same date she filed the refund claim, she also filed a request for assistance with the Taxpayer Advocate Service.

The IRS agreed that Wife 2 was entitled to get the money back and prepared to issue a refund in Year 14. But before the IRS issued the refund, it determined that Husband and Wife 2 also had unpaid joint tax liabilities, for Years 12 and 13. So the IRS credited some of Wife 2’s money to those balances. As we all know, when a taxpayer makes an overpayment of her tax liability, the IRS has the authority under Section 6402(a) to offset it against any other outstanding tax liability, e.g., for another year, and only refund the amount (if any) left over. There apparently was still a remaining amount to be repaid to Wife 2, which had not yet been refunded.

Now we get to the advice provided in the CCA: how much overpayment interest should the IRS pay to Wife 2 on that money applied to Years 12 and 13, or refunded? That was a fairly straight-forward analysis. Because Wife 2 had no liability for Years 1 and 2, to which the sales proceeds were applied, she had an overpayment. Interest on an overpayment is allowable under Section 6611. Interest begins on the date of the overpayment, regardless of whether the overpayment is credited to another liability or refunded. Here, that was the date that the proceeds from the sale of the real property were received and applied to Husband and Wife 1’s tax liabilities, sometime after April 15th of Year 13.

For the portion of the overpayment that was credited to Husband and Wife 2’s liability for Year 12, interest stops on the due date of that return, or April 15th of Year 13. Because the date of the overpayment was after that date, there would be no overpayment interest on the amount applied to the liability for Year 12. But there would be overpayment interest on the amount applied to the liability for Year 13, for the period from the date of the overpayment to April 15th of Year 14. For the remainder of the overpayment, to be refunded to Wife 2, interest runs from the date of the overpayment to a date no more than 30 days before the date of the refund check.

Pretty straight-forward and you may be wondering why a CCA was needed. Or you may have noticed that the issue as stated wasn’t how to determine the amount of allowable interest, but whether interest was allowable. And perhaps you raised the same question I did:

Did Wife 2’s share of the sale proceeds, improperly applied to Husband and Wife 1’s joint tax liabilities, really result in an “overpayment”?

Overpayment or something else?

First things first. Why might it be important to know whether the amount at issue is classified as an overpayment? Three important Code sections that apply to overpayments come to mind. The person making the overpayment can bring suit to compel the IRS to refund it, with a particular statute of limitations and a requirement to first exhaust administrative remedies. The IRS can, instead of refunding the overpayment, credit all or a portion against outstanding tax liabilities for other periods by the same person. With certain exceptions, the government pays interest to the person who made the overpayment when refunding or crediting it.

The Code doesn’t expressly define what an overpayment is. Generally, it’s considered to arise when a taxpayer pays more than the correct amount of the tax liability. But Wife 2 falls into a category that is sometimes referred to as “persons other than taxpayers” or “third parties” – that is, persons who make payments (voluntarily or involuntarily) of other persons’ tax liabilities. In at least some circumstances, those payments are not treated the same way as overpayments for purposes of judicial review, offset, or interest.

If the IRS had levied against the sales proceeds, that would be a wrongful levy. Judicial review is available, either before or after property has been surrendered or sold and without the requirement to exhaust administrative remedies, through a suit in district court (Section 7426(a)(1)). Wrongful levy suits have to be brought within two years of the levy, but if the third party makes an administrative claim under Section 6343(b), the period is extended to the earlier of 12 months after the administrative claim was filed or six months from the date of disallowance. A wrongful levy suit, rather than a refund suit, is the exclusive judicial remedy. Sections 6343 and 7426 refer to the return of property or payment of a judgment, rather than refund of an overpayment. Sections 6343(c) and 7426(g) are specific interest provisions, separate from Section 6611 but applying the overpayment rate from Section 6621.

Of course, the IRS had not levied Wife 2’s property. The IRS merely required payment in return for a discharge of the lien, allowing Husband and Wife 2 to sell the real property. The situation was very similar to that in United States v. Williams, 514 U.S. 527 (1995), where the plaintiff was coerced to authorize payment from the sale proceeds in order to convey clear title. She later submitted a refund claim and, when it was denied, filed a refund suit. The Court concluded that the amount the plaintiff sought to recover was an overpayment and that she could do so by a refund suit. This holding was based largely on the fact that there was no other feasible judicial remedy.

But in the Internal Revenue Service Restructuring & Reform Act of 1998, Congress enacted Sections 6325(b)(4) and 7426(a)(4) to address the problem noted in Williams. The owner of the property can deposit money equal to the amount determined by the IRS as the value of the government’s interest in the property (or furnish an acceptable bond) and the IRS “shall” – instead of “may” as in Section 6325(b)(3) – discharge the lien. The IRS “shall” refund the deposit, with interest at the overpayment rate of Section 6621, to the extent that it determines either that the value of the government’s interest was lower than previously determined or that it can satisfy the outstanding liability from other property. And just in case the IRS doesn’t agree or is slow to respond, the owner of the property can file suit in district court, to re-determine the amount of the government’s interest in the property, within 120 days after the certificate of discharge is issued. The IRS has concluded that this is the judicial remedy for an allegedly wrongful lien; a refund suit, as in Williams, is no longer an option. Most courts that have considered the issue have agreed with the IRS; Munaco v. United States, 522 F.3d 651 (6th Cir. 2008) is a good example and cites others.

How do the above provisions related to wrongful levies and wrongful liens line up against the three key aspects of how the Code treats overpayments?

Judicial review

There is a much shorter period of time to file suit for wrongful levy or wrongful lien, than the statute of limitations for a refund suit, which arguably can stay open indefinitely if the refund claim is never disallowed. A refund suit is not available for wrongful levies and liens. It certainly makes sense to require action by the third party promptly. Once the IRS collects from the third party, collection actions against the person who is actually liable for the tax may cease. A challenge by the third party does not toll the statute of limitations for collection and if the collection from the third party is held invalid, the IRS will want to go back to the liable party.

However, in the fact pattern of the CCA, the shorter statute of limitations for a wrongful lien suit might not have been a constraint. Wife 2 did file Form 911, Request for Taxpayer Advocate Service Assistance. In addition to the salutary effect on IRS personnel of the possibility of a Taxpayer Assistance Order, under Section 7811(d) the request itself suspends any relevant statute of limitations pending any relief that TAS might order. This was recently addressed in a wrongful levy case, Rothkamm v. United States, 802 F.3d 699 (5th Cir. 2015). (Note, however, that tolling under section 7811(d) is not automatically tracked by the IRS, and the National Taxpayer Advocate has recommended repealing the provision.)

Offset against other tax liabilities

For wrongful levies, Section 6343 refers to the return of property, rather than refund of an overpayment, and does not mention offset against other tax liabilities. For wrongful liens, Section 6325(b)(4) refers to the refund of a “deposit” and again does not mention offset against other tax liabilities. (The term “deposit” is explicitly distinguished from the term “payment” in other contexts; the former must be returned, regardless of the statute of limitations for refunds, on request without requiring proof of an overpayment.) And Section 7426 refers to payment of judgements, again without any mention of crediting the judgement amount against other tax liabilities. None of these provisions references Section 6402(a). A definitive court ruling would be nice but even without it I think the best interpretation of the statutory framework is that there is no right to unilaterally offset recoveries from a wrongful levy or lien against other liabilities the taxpayer may have.

Not allowing the IRS to offset these remedies for wrongful levies or liens against a third party also makes sense. The existence of an overpayment by the party liable for the tax does not imply any error or wrongful action by the IRS; a wrongful levy or lien does. Further, offset could be abused by the IRS to avoid the consequences of such error or wrongful action as well as procedural safeguards for collection actions in those other years.

An example, albeit extreme, of such abuse in a different context is described in Kabbaby v. Richardson, 520 F.2d 334 (5th Cir. 1975). Local police arrested the plaintiff and found cocaine, a substantial amount of cash, and assorted weapons and pieces of jewelry in his car. The police notified the IRS, which issued a termination assessment and seized the property. The IRS later abated the assessment, presumably because of previous court decisions invaliding such assessments when the IRS did not issue a subsequent notice of deficiency. But the IRS refused to return the property because it was an “overpayment” and could be credited to the plaintiff’s unsatisfied tax liabilities for other years. The court rejected that argument. The termination assessment without appropriate factual foundation was an abuse of authority. Allowing the IRS to keep the property would give the IRS an advantage and defeat procedural safeguards. Some other courts have disagreed; these are not always sympathetic plaintiffs.

Interest

Interest is payable on recovery of a wrongful levy or deposit to challenge a wrongful lien, as well as on a judgement resulting from judicial review in district court. However, Sections 6325, 6343, and 7426 contain separate interest provisions – with references to the overpayment interest rate in Section 6621 – rather than simply stating that Section 6611 applies. The amounts may be the same but other interest provisions, such as “restricted interest” and interest netting, may not apply to interest paid pursuant to Sections 6325, 6343, and 7426.

Based on these differences in judicial review, authority to offset, and interest, I think there’s a very strong case that Wife 2’s share of the sale proceeds, paid by mutual mistake in order to discharge the lien, was not an overpayment.

If this was not an overpayment, what effect does that have?

Obviously, the fair result is that Wife 2 can recover her share of the sale proceeds. But if the IRS had resisted, it’s not entirely clear whether Wife 2 was legally entitled to any relief at all. She apparently didn’t use the process set forth in Section 6343(b)(4). When she and Husband sought a certificate of discharge, she didn’t request a substitution of value as a deposit to be held by the IRS pending a determination whether the value of the government’s interest in the property included her half-share. If she had noticed the error in time, she might have done that or even obtained a revised Letter 403. It appears that she and Husband instead made a payment under Section 6343(b)(2), with a later refund claim. If Sections 6343(b)(4) and 7426(a)(4) really are the exclusive remedies for a wrongful lien, the IRS might have been able to push back successfully. Perhaps a court would decide that a refund claim and suit under Williams should still be available, but it seems unlikely.

Assuming that the IRS did the right thing and agreed that she should get her share of the sale proceeds back, though, could the IRS unilaterally offset part of that against her and Husband’s tax liabilities Year 12 and 13? I’m not aware of any case law specifically on point but for the reasons described above I think Section 6402(a) doesn’t apply to such amounts and the IRS has no authority to make such offsets unilaterally. Husband and Wife 2 may have consented to that offset, because they wanted to resolve the liabilities or didn’t want to force the IRS to jump through the procedural hoops for a levy, but the CCA doesn’t mention anything about that. Other taxpayers might not want to give up the cash.

What about interest computation with respect to the credits to Husband and Wife 2’s tax liabilities for Years 12 and 13? The CCA’s answer is reasonable but how can you evaluate whether it’s legally correct? Section 6325(b)(4)(B) doesn’t provide the answer because it also doesn’t provide for offset against other tax liabilities.

Conclusion

Tax law is not always clear – as Bayless Manning ponders in Hyperlexis and the Law of Conservation of Ambiguity: Thoughts on Section 385, 36 Tax Law. 9 (1982):

Consider the United States Constitution. The Constitution is open-ended, generalized and telescopic in character. What has it spawned? Pervasive ambiguity and unending litigation.

Contrast the extreme counter-model of law, the Internal Revenue Code and its festooned vines of regulations. The Code and regulations are particularized, elaborated and microscopic in character. What have they spawned? Pervasive ambiguity and unending litigation.

I might have reached the same answer as in the CCA. Sometimes a reasonable answer based on analogy is the best that can be achieved. The final result seems fair.

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