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Overpayment, or Not?

Posted on Nov. 29, 2021

We welcome back guest blogger Bob Probasco. Today Bob untangles the issue of deposits versus payments in relation to stipulated decision documents filed with the Tax Court. The character of the taxpayer’s remittance matters here, as it determines whether they are entitled to overpayment interest. For those looking to make a deposit rather than a payment, the IRS gives detailed instructions in Rev. Proc. 2005-18, which Stephen discussed in a post here. Christine

A Tax Court memorandum opinion, dismissing the case for lack of jurisdiction, came out recently in Hill v. Commissioner, T.C. Memo 2021-121 (Oct. 25, 2021).  I almost didn’t read it, because lack of jurisdiction is usually clear-cut and (by definition) memorandum opinions don’t address novel or unsettled issues of law.  This sounded like something I could skip, without missing much.  But that would have been a mistake.

The jurisdictional issue was not quite as clear as I assumed, and the opinion included a lot of helpful little nuggets along the way.  Reminders of nuances that I rarely think about or skip when discussing a topic; or explanations of things that I’ve seen for years without giving them much thought.  When you read nuggets like that, you may think “Of course, that makes sense; why didn’t I think of that?”  This sometimes qualifies as a Blinding Flash of the Obvious, or, for persons of a certain age, perhaps a “V-8 moment.”  These nuggets were that for me anyway, and hopefully also for at least a few of the readers of Procedurally Taxing.

The parties had entered a stipulated decision in the case on July 19, 2019.  (Docket no. 794-18; the stipulated decision is not available in DAWSON.)  Then the petitioner filed a motion on August 14, 2020, to redetermine interest under section 7481(c) and Tax Court Rule 261.  Those rules allow the petitioner to challenge either (a) excessive underpayment interest assessed pursuant to the court’s decision and paid or (b) insufficient overpayment interest allowed on an overpayment determined by the court.  The first category was a good reminder for me of a nuance I occasionally skip when explaining procedure to students: underpayment interest is not subject to deficiency procedures but there is still a route to a refund suit in Tax Court for such amounts.

But this case involved the second category. The IRS had not paid any overpayment interest on a check received from the government for this case after the stipulated decision was entered, and the petitioner argued that it should have. A basic requirement of a motion to redetermine overpayment interest is that the court finds in its previous decision that the taxpayer made an overpayment. The stipulated decision, however, determined a gift tax deficiency but did not determine an overpayment. I was generally aware of this type of motion but somehow had never dealt with it before. So the opinion offered a useful explanation, but the conclusion that there was no jurisdiction seemed straight-forward.

Money Due to Petitioner, But . . . It’s Not an Overpayment

The jurisdictional issue was not as easy to resolve as I had assumed.  The petitioner did get a $3,473,750 check (without interest) because of the decision, but the court decided that there was no overpayment.  The gift tax deficiency for tax year 2011 was $6,790,000 but the petitioner had given the IRS a check for $10,263,750 back in 2012.  Why wasn’t that an overpayment??  Because the 2012 remittance was a deposit under section 6603, not a payment.  A deposit does not become a payment until it is used to pay a tax, which happens after the assessment, which happens after the Tax Court decision.

The petitioner didn’t argue that the 2012 remittance was a payment. That would have been very difficult to do, as the opinion cites multiple times that the petitioner had referred to it as a deposit and cited section 6603 specifically. The petition itself referred to “depositing” that amount and the petitioner alleged that it was “intended as a deposit pursuant to I.R.C. § 6603(a)” in the motion to redetermine interest. Apparently, the petitioner did not refer to the 2012 remittance as a payment until his reply to the IRS response to the motion.

He did, however, argue that the 2019 stipulated decision had in substance determined an overpayment. It was an ingenious argument (kudos to counsel) but ultimately unsuccessful. I’ll get to what that involved, and why the judge disagreed, after a brief digression.

Asking For the Return of a Deposit

When explaining the differences between “deposit” and “payment” to my students, I usually explain one key difference much the way the court did here. A taxpayer “could demand the immediate return of his deposit at any time” but could get back a payment “only by pursuing the IRS’ formal refund process, which could be lengthy.” That certainly is an important benefit, as the court points out, particularly when the statute of limitations for refund claims has expired. Of course, that is a slight simplification. Section 6603(c) says that the right of return on request is not absolute and does not apply “in a case where the Secretary determines that collection of tax is in jeopardy.” This was another nuance that I sometimes skip when explaining deposits; I hadn’t really given it much thought.  I have some questions/concerns about the process for jeopardy determinations, in this context or others, but that’s a topic for another day.

In this case, the petitioner requested in 2014 that the IRS return the deposit. Did the IRS return the deposit right away? No. It asked for additional information about the potential gift tax liability, citing the limitation on return when collection in jeopardy. (This may have sounded strange to some Texans – worry that a member of the extended Hunt family, as in “Hunt Oil Company,” would not be able to pay the tax?)

The IRS apparently resolved its concerns about ability to collect the tax, but it still did not return the deposit. The gift tax liability arose from a settlement of civil litigation in district court over division of wealth among family members. Under the settlement reached, the petitioner was required to assign his rights to installment payments from his father (total amount $30,675,000) to trusts for the benefit of his children. Because of the potential gift tax liability, the registry of the district court, rather than the taxpayer, issued the check for $10,263,750 payable to Treasury. The IRS eventually concluded that, if the petitioner insisted on return of the deposit, it would have to be returned to the district court registry instead. So the funds remained with the IRS.

In Substance, A Determination of an Overpayment?

OK, back to the jurisdictional argument. The stipulated decision stated that “there is a deficiency in gift tax due from petitioner for the calendar year 2011 in the amount of $6,790,000” and that “there are no deficiencies in gift tax due from, nor overpayments due to petitioner for the calendar years 2010 and 2015.” It said nothing about an overpayment for 2011.

The petitioner argued that a stipulation in the decision was, in substance, a determination of an overpayment. That stipulation provided for the $10,263,750 to be transferred from the 2012 tax year, where it was originally applied, to the 2011 tax year. It then went on to say: “It is further stipulated that the deficiency for the taxable year 2011 is computed without considering the prepayment credit of $10,263,750.” Since $10,263,750 is more than the $6,790,000 deficiency, that sure sounds like the court had determined an overpayment, doesn’t it?

The court pointed out two problems with that argument. The second problem was that the stipulation referenced the $10,263,750 as a “prepayment credit” rather than a payment. There could not have been an overpayment when the 2019 decision was entered, because “a deposit is not a payment of tax prior to the time the deposited amount is used to pay a tax,” and that doesn’t occur until after assessment. Even then, only the amount used to pay the tax becomes a payment; the remainder is an unused deposit that is returned to the taxpayer. No overpayment.

One thing that is not intuitively clear to most of my students is that “deficiency” is not the same thing as “amount the taxpayer owes.”  The Form 4549, Income Tax Examination Changes, in a notice of deficiency helps them to see the difference.  (We see the Form 4549 version more often than the Form 5278 version, but they’re very similar.)  At the bottom of page 1 of Form 4549, line 13 includes changes to certain amounts on the return that are subject to deficiency procedures.  Line 14 is the total deficiency.  Line 15 is for changes to that are not subject to deficiency procedures, but which affect how much the taxpayer owes.  And line 16 is the bottom-line amount that either the taxpayer owes the government, or the government owes the taxpayer.

Line 15, for our clinic clients, tends to be one of two different things: a frozen refund, or additional withholding because the Automated Underreporter program identified an information return not included on the return. That makes sense to students, that our client would owe less because more was withheld than reported on Form 1040 or the account transcript shows a balance due the taxpayer for a frozen refund.  Page 2 of Form 4549 helpfully lists other things that might be included there: taxes paid by a RIC or REIT on undistributed capital gains, excess Social Security, additional Medicare tax, and other timely payments.

The notice of deficiency, as with virtually all notices, is an opportunity for the IRS to “suggest” payment, so of course they tell the taxpayer how much to send. They include an estimated amount of interest on page 2 of Form 4549, for the same reason. But clinic clients don’t always catch that and may be needlessly worrying about having to pay the full amount of the deficiency when the actual amount due might be substantially less. But I digress.

The stipulation used the term “prepayment credits” but the court concludes that the deposit not only doesn’t affect the deficiency amount but also doesn’t create an overpayment, for the reasons stated above.

I realized something, while reading this opinion, about what I’ve been seeing on stipulated decisions for years. If something like a frozen refund or additional withholding resulted in an overpayment, there is no stipulation about that on page 2 of the decision. It’s not necessary, because if those adjustments created an overpayment, the amount of the overpayment is already stated on page 1 of the decision. The stipulation only appears if such adjustments reduce the balance due, but still leaves a balance due the government. I think I noticed and understood that subconsciously but had never thought about it consciously that way. So . . . “Blinding Flash of the Obvious.”

Above The Line versus Below The Line

I’ve always thought of those terms as differentiating deductions, whether one that reduces gross income to adjusted gross income or one that reduces adjusted gross income to taxable income – where the “line” is adjusted gross income. You likely do, too. As it turns out, those terms are also used to differentiate parts of stipulated decisions. In that case, the “line” is the judge’s signature at the bottom of page 1. As Judge Lauber explained, only the information “above the line” reflects determinations by the court. That’s all the court has jurisdiction to decide – the amount of the deficiency, the amount of any penalties, and the amount of any overpayment. The stipulations on page 2, “below the line,” are simply agreements between the parties. This was another “Blinding Flash of the Obvious” for me; if you asked me, I might have explained it properly, but I hadn’t really given it much if any conscious thought.

Most stipulations are routine items. The court can enter the decision. Any deficiency stated does not include underpayment interest, which will be assessed as provided by law.  Any overpayment stated does not include overpayment interest, which will be credited or paid as provided by law. For regular cases, the parties may stipulate that respondent can assess without waiting for the Tax Court decision to become final. And there may be stipulations of “prepayment credits” that reduce the amount owed by the petitioner but do not create an overpayment.

Since the stipulation that the petitioner relied on was “below the line,” the court (judge) hadn’t even determined that there was a deposit. This was the court’s first reason for rejecting the petitioner’s argument – not only was there no overpayment, but also the court had not made a determination even about the existence of the deposit.

But All Is Not Lost!

The petitioner got no relief from the court, but that’s not the end of the story. The IRS hadn’t previously paid any interest on the returned $3,473,750. While arguing the motion to redetermine interest, at least the IRS conceded that the petitioner was entitled to interest on the returned deposit, although at the lower interest rates applicable to section 6603 deposits. (That rate is 3% less than the rate for overpayments; from the fourth quarter of 2011 through the first quarter of 2016, it was 0%.) The IRS said that meant the interest payable would be $218,122 instead of the $1,267,323 that petitioner had claimed. At least it’s something.

For me, this “simple” dismissal for lack of jurisdiction in a memorandum opinion was a very good explanation/reminder/Blinding Flash of the Obvious!

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