So, How Will the “Recovery Rebate” Refunds Work This Time? Part II

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This is the second of a two-part post on the portion of the CARES Act legislation that adopts, once again, “recovery rebate” credits and refunds.

In part I of this post, I discussed the principal provisions of section 6428 and the practical ways I expected the statute to be administered.  My administrative predictions are based on how the IRS administered two prior version of section 6428—in 2001 and 2008.

This post is to discuss two issues under the prior versions of section 6428 that led to litigation and how those issues have or have not been addressed by the current legislation.  The two issues are:

  1. Whether the IRS may apply the recovery rebate credits (including stimulus checks) under section 6402 to reduce certain outstanding debts; and
  2. Which taxable year is the stimulus check “for” for purposes of bankruptcy?

The answer to the first question is decidedly “no”, with one exception.

The answer to the second question is still open – at least outside the Second Circuit.

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In plain English, taxpayers never “pay” refundable credits to the IRS.  So, Congress did something to modify plain English.  Section 6401(b)(1) provides that the excess of all refundable credits over the income tax imposed “shall be considered an overpayment”.

Section 6402(a) allows (but does not require) the IRS to offset any overpayment of one tax against any other federal tax debt.

Section 6402(c) instructs the IRS to send to states – to reimburse them for paying out overdue child support – “the amount of any overpayment to be refunded to the person making the overpayment” who was obligated to, but who did not pay, the child support. 

One of the early cases establishing that overpayments attributable to refundable credits can be sent to states under section 6402(c) involved an earned income tax credit (EITC) for a taxpayer who had a new family, but who had failed to pay the required child support to his old family.  He contested the IRS taking his EITC, arguing that he was not “the person making the overpayment” because he had never paid the EITC to the IRS in the first place.  In Sorenson v. Sec’y of Treasury, 475 U.S. 851 (1986), citing section 6401(b)(1), the Court held that the taxpayer had made an overpayment and so his EITC overpayment could be collected for child support under section 6402(c). Since Sorenson, it is uncontested that overpayments from refundable credits can be taken under section 6402.

Section 6402(d) requires the IRS to send overpayments to other federal agencies who inform the IRS that the taxpayer owes the other agency money.

Section 6402(e) requires the IRS to send overpayments to states who notify the IRS that a state resident owes state income taxes.

Section 6402(f) requires the IRS to send overpayments to states who notify the IRS that a person “owes a covered employment compensation debt” to that state.

Both the 2001 and 2008 versions of section 6428 said nothing about section 6402.  Accordingly, the IRS felt required to send stimulus checks to other federal agencies or the states under subsections (c), (d), (e), and (f) of section 6402 and decided that it would offset any such overpayment against federal taxes under the permissive language of section 6402(a).  This was sad with respect to most of my low-income Cardozo Tax Clinic clients, but I knew there was nothing I could do about it.

However, in 2007, two of the clinic’s clients entered into offers in compromise (OICs) with the IRS.  In each OIC, there was a provision stating that, as additional consideration, the client offered “any refund, including interest, due to me/us because of overpayment of any tax or other liability” up to and including for the year in which the offer was entered into (i.e., 2007).  For both clients, the IRS took their stimulus check, treating the checks as relating to the 2007 taxable year.  And for one taxpayer, the IRS also took the 2007 EITC and additional child tax credit. 

I arranged for the taxpayers to file refund claims and sue for refund on the ground that, while concededly, refundable credits are overpayments for purposes of the Code, the language of OICs is in plain English and overrides the Code.  I argued that in plain English, refundable credits are not “refunds . . . because of overpayment”.  I also argued that, as far as the stimulus check, it related to the 2008 tax year – per the language of section 6428(a) – so it was outside the scope of the additional consideration language.

In Sarmiento v. United States, 812 F. Supp. 2d 137 (E.D.N.Y. 2011), aff’d in part and rev’d in part, 678 F.3d 147 (2d Cir. 2012), and Maniolos v. United States, 741 F. Supp. 2d 555 (S.D.N.Y. 2010), aff’d per order, 469 Fed. Appx. 56(2d Cir. 2012)), I lost both arguments (though a judge in the E.D.N.Y. had agreed with me that the stimulus check related to 2008). 

The Second Circuit held that plain English was not contemplated by the wording of the OIC, but, instead, Code-speak was, and Code-speak (section 6401(b)(1)) made refundable credits “overpayments”. 

The Second Circuit also held that the stimulus check related to the 2007 year, primarily because the legislation was passed in February 2008, before 2007 tax returns were due.  I thought the date of passage of the act legally irrelevant, since the 2007 returns had no entry for section 6428 credits and 2007 returns could have been filed in January or February 2008, prior to the date of enactment.

Even though it won my cases, the IRS was concerned that another Circuit might not come to the same conclusion, so it altered the additional consideration language for future OICs.  Today, the OIC additional consideration sentence reads: “The IRS will keep any refund, including interest, that I might be due for tax periods extending through the calendar year in which the IRS accepts my offer.”  Note the omission of the words “because of overpayment”.

In any case, these were the first Article III courts that had ruled on the issue of the year to which the stimulus check relates – i.e., the year whose tax information generated the checks or the year to which section 6428(a) says the credit is attributable.

But, it turns out that the year to which the stimulus check relates is no longer important for collection of IRS taxes from the stimulus check:  New CARES Act section 2201(d) provides:

(d) EXCEPTION FROM REDUCTION OR OFFSET.—Any credit or refund allowed or made to any individual by reason of section 6428 of the Internal Revenue Code of 1986 (as added by this section ) . . . shall not be— . . . (2) subject to reduction or offset pursuant to subsection (d), (e), or (f) of section 6402 of the Internal Revenue Code of 1986, or (3) reduced or offset by other assessed Federal taxes that would otherwise be subject to levy or collection.

As I read section 2201(d)(3), it prohibits collection of either the stimulus check or the credit under section 6428(a) for other federal taxes under section 6402(a) (though I don’t know why the statute makes no reference to section 6402(a)).  And all but the state child support offsets are also prohibited by the new statute.

I am delighted by this compromise.  It should be noted that when Senator McConnell first introduced his coronavirus legislation, the version of section 6428 appearing in that bill would have prohibited offset under sections 6402(d), (e), or (f), but would have allowed offsets for other federal taxes.  I complained of this publicly (in an article in Tax Notes Today Federal) and to a friend on the Joint Committee on Taxation staff.  I argued that now was not the time to be collecting old tax debts, but to be stimulating the economy.  The very people too poor to pay their back tax debts were no doubt also to be most in need of the checks to survive this crisis. Whether my advocacy had any effect, I have no idea.  I’d like to hope it did, even though this change probably cost the federal government several billion dollars that it would not otherwise have sent out.

The final issue that ended up in litigation regarding the 2001 and 2008 versions of section 6428 was whether, for purposes of bankruptcy, the advance check was “for” the taxable year on whose information it was calculated (2000 or 2007) or was “for” the taxable year of the stated credit (2001 or 2008).  There had been one ruling that the 2001 section 6428 check was for the taxable year 2001. In re Lambert, 283 B.R. 16 (9th Cir. BAP 2002).  But, bankruptcy courts split almost evenly over the taxable year as to which the 2008 stimulus check was for.  Compare In re Wooldridge, 393 B.R.  721 (Bankr. D. Idaho 2008) (check was for 2008); In re Schwenke, 102 A.F.T.R.2d 6355 (Bankr. D. Mont. Sept. 25, 2008) (same); with In re Alguire, 391 B.R. 252 (Bankr. W.D.N.Y. 2008) (check was for 2007); In re Smith, 393 B.R. 205, 208-209 (Bankr. S.D. Ind. 2008) (same).  I am no expert in bankruptcy, but I anticipate that there will be the same dispute concerning the new coronavirus stimulus check, and that the opinion of the Second Circuit in my cases, although influential, will not be the last word.

About Carlton Smith

Carlton M. Smith worked (as an associate and partner) at Roberts & Holland LLP in Manhattan from 1983-1999. From 2003 to 2013, he was the Director of the Cardozo School of Law tax clinic. In his retirement, he volunteers with the tax clinic at Harvard, where he was Acting Director from January to June 2019.

Comments

  1. Joshua oberholtzer says

    I’m just wanting to know if they’re going to be able to take the stimulus checks for back child support can anybody Give me any information on that

    • Carl Smith says

      Yes. As I said in the post, the IRS will take stimulus checks and use them to reimburse states that have paid out child support.

  2. Omeed Firouzi says

    I just want to clarify (assuming no child support owed): if you are owed a refund on your 2020 return but you owe federal taxes for a previous year, the IRS can still offset at least the portion of the 2020 refund that is not attributable to a CARES Act stimulus payment, right? That is the same for 2019 still, right? But if you in 2020 should’ve gotten a higher stimulus check than you received and then you reconcile that on ’20 return in 2021, at least that portion of the ’20 refund related to the stimulus check you can definitely keep, correct?

    • Carl Smith says

      I read the statute the same way you do. But, I can see ordering issues. Say, your tax liability for 2020 is $1,000 before payments and refundable credits, you made no payments (and had no withholding done), and are due an EITC of $2,000 and a 6428 credit of $500 more than the stimulus check that you received mid-2020. Imagine you owe over $10,000 of tax debt from earlier years. You thus have an overpayment for 2020 of $1,500. What is the order of applying the credits against your tax liability? One could argue $1,000 of the EITC satisfied your 2020 taxes, so $1,000 of the overpayment gets applied to old tax debt, and $500 gets mailed to you as a refund. But, if you start by applying $500 of 6428 credit to your 2020 tax liability, then $500 of EITC to that liability, you would have a $1,500 overpymaent all of which is from the EITC and is taken for old tax debt.

      My guess is that the IRS will program its computers to resolve this ordering issue without telling the public. It would be nice, though, if they issued a Rev. Proc. after notice and comment.

      • frank donahue says

        Carl. Your last statement reminded me of how the IRS applies payment in Trust Fund cases- always in the government’s best interests unless specifically directed to the TF portion!

  3. So, in layman’s terms, (bare bones) the stimulus checks are advances against 2020 tax returns, sub-tractable if you are due a refund, but not if you owe?

    • Carl Smith says

      Correct. You calculate the recovery rebate credit on your 2020 return, then subtract the stimulus check. If you are due more, you get it. If you were overpaid by the stimulus check, you don’t have to pay the excess back.

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