Refund Claims and Section 7508A – Progress!

Background

Why was this a problem? Because of the COVID emergency declaration and IRS responses, most taxpayers had until July 15, 2020, to file their 2019 tax returns and until May 17, 2021, to file their 2020 tax returns. And most taxpayers have been conditioned to assume, from multiple reminders over the years, a general rule that they must file refund claims (including filing an original return claiming a refund) within three years of the original filing due date to receive that refund. Thus, some were likely to assume that they had until July 15, 2023, to file refund claims for the 2019 tax year. Before Notice 2023-21 was issued, that was not a safe assumption, and still isn’t for some taxpayers.

This problem was identified more than a year ago. The National Taxpayer Advocate submitted her 2021 Annual Report on January 12, 2022. The Purple Book included a legislative recommendation (starting at page 30) to address problems with the interaction between section 7508A and refund claims. Notice 2020-23 allowed taxpayers with 2019 tax returns due on April 15, 2020, to be filed as late as July 15, 2020. As a result, refund claims for 2019 would satisfy the section 6511(a) deadline if filed within three years after the return was filed, potentially (I’ll come back to this adverb later) as late as July 15, 2023.

Unfortunately, even when a refund claim is filed by the section 6511(a) deadline, section 6511(b)(2)(A) limits the amount of the recovery to the amounts paid within “3 years plus the period of any extension of time for filing the return.” Section 7508A doesn’t extend the deadline for filing returns. It suspends or postpones it. Thus, a refund claim for 2019 filed on July 15, 2023, could only recover amounts paid by the taxpayer (including refundable credits) by July 15, 2020. Most payments (including income tax withholding and estimated tax payments) and refund credits for the 2019 tax year are deemed to have been paid as of April 15, 2020. As a result, that timely filed refund claim might result in no recovery. In effect, we would be forcing taxpayers to file the refund claim earlier than the section 6511(a) deadline and most taxpayers wouldn’t realize that.

I looked at the Purple Book suggestion back in January 2022 and concluded that there were some arguments, even before Notice 2023-21, to protect the unwary taxpayer. TL;DR summary: section 7508A(a)(3) arguably provided the IRS the authority to provide relief regarding the lookback rule, and Regulation § 301.7508A-1(f), Example 5 provided an example where the suspension period was disregarded in determining the lookback period. But that example was of a situation in which the section 7508A suspension period included the section 6511(a) deadline; it didn’t address situations in which the suspension period under section 7508A included the deadline for filing the original return. Could you make an argument for the latter even without legislative or regulatory change? Sure, but it might not succeed and taxpayers without representation wouldn’t even know to make that argument if their refund claim were denied.

Notice 2023-21 – details

The new Notice takes a straightforward approach to solving the problem. As with the previous COVID questions, it defines Affected Taxpayers and then specifies the relief. Affected Taxpayers are:

• “any person with a Federal tax return filing or payment obligation that was postponed by Notice 2020-23 to July 15, 2020”
• “any person with a Federal tax return filing or payment obligation that was postponed by Notice 2021-21 to May 17, 2021”

Notice 2020-23 applied to filing and payment obligations due, including as a result of a valid extension, on or after April 1, 2020, and before July 15, 2020; Notice 2021-21 was more narrowly focused on filing and payment obligations normally due on April 15, 2021, or June 1, 2021, but didn’t take into account extensions. (This is a vast over-simplification; it’s always best to carefully parse any such notices.)

Essentially, under Notice 2023-21, all individual taxpayers for both years are Affected Taxpayers and some entities are Affected Taxpayers with respect to the 2019 tax returns. The relief granted was to disregard the two different suspension periods in determining the beginning of the lookback period. But the two different suspension periods were stated in separate sentences and the relief granted was qualified as “relating to the tax for which the return filing or payment due date was postponed.”

That last phrase, I assume, was because the lookback period for individual taxpayers filing a refund claim for the 2019 tax year included both suspension periods. The IRS apparently decided that they should be allowed to disregard the first suspension period (4/1/2020 – 7/15/2020) but not the second suspension period (4/15/2021 – 5/17/2021).

I was particularly interested in how this relief affected a couple of our clients who had not yet filed their original 2019 tax returns, which would show overpayments. The only example in Notice 2023-21 wasn’t very helpful, as it involved a taxpayer who filed the 2019 tax return on June 22, 2020. The notice doesn’t specify anywhere that relief was not available who had not filed their original returns by the postponed due date, but the absence of “no” doesn’t always mean “yes.” But the description on the IRS website did say “yes” to this question.

Some observations

I began looking at this with a vague impression that the interaction of Notice 2020-23 (suspending the period for filing and payment obligations for the 2019 tax year) and Notice 2023-21 (disregarding the suspension period for purposes of determining the lookback period for refund claims) might lead to some strange results. After close reading of Notice 2023-21, it seems to have been very well drafted. I think it achieves the IRS’s immediate goals, in terms of resolving issues of a specific, nationwide emergency that affects imminent (normal) deadlines for refund claims. The NTA is still advocating for a solution that is statutory, permanent, and inclusive of all section 7508A relief. Tax professionals would like the same thing. But Notice 2023-21, if nothing more, has been a useful exercise in starting to work through the complexity.

However, I still have a few concerns.

Policy choice leading to (somewhat) strange results?

A suspension of the section 6511(a) deadline for filing refund claims – such as was included in Notice 2020-23 for the 2016 tax year, normally due 4/15/2020 – automatically results in disregarding the suspension period when determining the lookback period. That’s in the regulation above, which relies on language that mirrors section 7508A(a)(3). That keeps the two deadlines in sync, so that a timely filed return followed by a timely filed refund claim will always be able to recover the maximum amount.

A suspension of the deadline for filing the tax return would – once the principles of Notice 2023-21 are implemented more broadly by regulation or legislation – automatically result in disregarding the suspension period when determining the lookback period. A suspension of the deadline for filing the tax return, however, would not change the section 6511(a) deadline. The two deadlines would not be in sync.

You can see that in looking at the effect on three different hypothetical taxpayers. Consider A, B, and C, all of whom are Affected Taxpayers for purposes of Notice 2023-21. A filed his 2019 return on 4/15/2020; B filed her 2019 return on 6/1/2020; and C filed his 2019 return on 7/15/2020. All three returns were filed timely because of Notice 2020-23. For all three returns, the lookback rule allows a refund claim filed by 7/15/2023 to reach all payments and refundable credits. Yet section 6511(a) requires that A must file his refund claim by 4/15/2023; B must file her refund claim by 6/1/2023; and C can file his refund claim as late as 7/15/2023. In effect, C is rewarded for filing his return later than A and B filed theirs.

The Code includes several provisions to ensure that a timely filed refund claim, following a timely filed return, can recover all payments and refundable credits:

• Amounts paid before the filing due date are deemed to have been paid as of the filing due date.
• An extension of the filing due date results in an extension of the deadline for filing a refund claim and of the lookback period.
• The lookback period is also adjusted for several special circumstances leading to a later deadline for filing a refund claim – e.g., section 6511(d)(1)(B), (2)(A), (3)(B), and (4)(A).

Notice 2023-21 does not do the same thing, because it disregards the suspension period with respect to section 6511(b) but not with respect to section 6511(a). This leads to a relatively rare situation in which section 6511(b) would not limit the amount of a refund, but section 6511(a) would preclude any refund at all.

I assume this was a deliberate choice; the example in Notice 2023-21, as well as the description on the IRS website, both state that refund claims must be filed within three years of the date they filed the original return, with an outer limit of July 15, 2023. The argument for the IRS choice here may be that, in the example above, taxpayers A and B evidently didn’t need the postponed due date. The counter-argument might be that we don’t apply the same principle with respect to the original due date. For the 2022 tax year, for example, taxpayers could file returns as early as January 23, 2023, but would still have until April 15, 2026, to file refund claims.

I perhaps would have preferred a different policy choice here. In part to treat taxpayers equally with respect to COVID relief that was made available to everyone, not just those who needed extra time. In part because of the potential for misunderstanding. Let’s turn to that topic.

Communicating to taxpayers

I commend the IRS for their efforts to publicize the effects of Notice 2023-21, as well as many others who have been spreading the word. But I still have some concerns about whether that message will be received by taxpayers, particularly since most of them do not read the IRS website, let alone Notice 2023-21. They get their information (condensed and simplified) from other sources and don’t always read closely for the details.

For example, one of our clients – with a more sophisticated understanding than most taxpayers – heard about the postponement of the filing date for 2019 tax returns to July 15, 2020. Unfortunately, he did not catch the qualification, that the postponement was for acts due between Apri1 1, 2020, and July 15, 2020. That took care of his personal tax return but he and his wife also had a small partnership. The partnership return was still due March 15, 2020, and he filed late. There was no partnership activity or taxable income to pass through to their Form 1040 but the partnership was hit with a $1,640 penalty under section 6698(a)(1). (The IRS refused to abate the penalty but there was still a happy ending when the IRS eventually issued Notice 2022-36, a general abatement of penalties for late filing.)

We will almost certainly have similar misunderstandings with some aspects of this relief that may not be intuitively clear for some taxpayers, despite all of our best efforts. If they reach out to tax professionals, we can explain in the context of their particular facts, but some won’t until it’s too late.