The Tide Keeps Going Out, Carrying Overpayment Interest Suits Away from District Courts

We welcome back regular guest blogger Bob Probasco. Bob is the director of the Low Income tax Clinic at Texas A&M University School of Law. Prior to starting the clinic at Texas A&M, Bob had a long a varied career in different tax positions. Before law school, he spent more than twenty years in various accounting and business positions, including with one of the “Big Four” CPA firms and Mobil Oil Corporation. After law school and a year clerking with Judge Lindsay of the Northern District of Texas, he practiced tax law with the Dallas office of Thompson & Knight. He left T&K in 2014 and started a solo practice before switching to full time academia. Keith

We return to the jurisdictional dispute over taxpayer stand-alone suits claiming additional overpayment interest in excess of $10,000.  The latest development, a decision on July 2nd by the Federal Circuit in Bank of America v. United States, docket number 19-2357, continues a trend that I’ve been following for two years now.  Until recently, the only decision on this issue at the Circuit Court level was E.W. Scripps Co. v. United States, 420 F.3d 589 (6th Cir. 2005), which concluded that district courts can hear such claims.  For years, most lower courts followed the Sixth Circuit.  But recently the tide turned.  Here’s a timeline of recent cases illustrating the change.

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First, the lower courts follow Scripps and agree that district courts have jurisdiction over these claims:

  • October 31, 2016:  The Southern District of New York follows Scripps in Pfizer, Inc. v. United States, 118 A.F.T.R.2d (RIA) 2016-6405 (S.D.N.Y. 2016) and decides it has subject matter jurisdiction.  On May 12, 2017, the court dismissed the case for lack of jurisdiction for failure to timely file the refund suit.  Prior discussion here.  The taxpayer appeals.
  • July 1, 2019:  The Western District of North Carolina follows Scripps in Bank of America Corp. v. United States, 2019 U.S. Dist. LEXIS 109238, 2019 WL 2745856 (W.D.N.C. 2019), and denies the motion to transfer the case to the Court of Federal Claims.  Prior discussion here.  The government appeals.
  • August 30, 2019:  In the Southern District of Florida, the magistrate judge’s report and recommendation in Paresky v. United States, 2019 U.S. Dist. Lexis 149629, 2019 WL 4888689 (S.D. Fla. 2019) follows Scripps.  The magistrate judge concludes that the court has subject matter jurisdiction but recommends dismissal in part for failure to file timely refund claims. Prior discussion here.

And then a break, with cases now holding that only the Court of Federal Claims, not district courts, have jurisdiction over these claims:

  • September 16, 2019: The Second Circuit reverses the S.D.N.Y., in Pfizer, Inc. v. United States, 939 F.3d 173 (2d Cir. 2019) and concludes there is no subject matter jurisdiction.  Prior discussion here.  The court transfers the case to the Court of Federal Claims, docket number 19-1803. Plaintiff files a motion for summary judgment on April 30, 2020.
  • October 7, 2019:  The District of Colorado agrees with Pfizer, in Estate of Culver v. United States, 2019 U.S. Dist. LEXIS 173235, 2019 WL 4930225 (D. Colo. 2019).  The court transfers the case to the Court of Federal Claims, docket number 19-1941.
  • October 21, 2019:  In the Southern District of Florida, the district court judge in Paresky v. United States declines to adopt the magistrate judge’s report and recommendation and follows Pfizer, dismissing the case for lack of subject matter jurisdiction.  Prior discussion here.  The taxpayers appeal.
  • July 2, 2020:  The Federal Circuit agrees with Pfizer and reverses the WDNC, in Bank of America Corp. v. United States. It remands the case to the WDNC, to sever some of the claims and transfer them to the Court of Federal Claims.

So now we have the Sixth Circuit holding that district courts have jurisdiction over such suits while the Second and Federal Circuits disagree, with one more circuit court considering the issue.  Mr. and Mrs. Paresky’s case is currently pending in the Eleventh Circuit, docket number 19-14589.  Appellants filed their primary brief on May 27, 2020.  The government’s brief is due on July 27, 2020.

When only one circuit court has ruled on a difficult issue, district courts – even in other circuits – tend to follow that decision.  But once another circuit court disagrees, the better analysis tends to win out and lower courts change direction.  It’s possible that the magistrate judge in Paresky, and the district court in Bank of America, would have reached a different conclusion if they were deciding after Pfizer.  My guess is that the Eleventh Circuit will agree with the Second and Federal Circuits on this issue.  This is still a small sample size, but I suspect the tide has turned decisively.

Caveat:  Bank of America lost in the Federal Circuit but has a strong incentive (see below) to seek review by the Supreme Court.  Similarly, the government may want a ruling by the Supreme Court to overturn Scripps once and for all.  With a circuit split, and if both parties ask the Supreme Court to hear the case – well, the Court hates tax cases but might take this one.  If so, all bets are off.

How did we get here?

Before I get into the court’s decision, a brief reminder why Bank of America, appealed from the Western District of North Carolina, wound up in the Federal Circuit instead of the Fourth Circuit. The government had moved to dismiss the case, or in the alternative to transfer it to the Court of Federal Claims, on the basis that the district court did not have jurisdiction for such cases. The district court denied both alternatives, as the court concluded it had jurisdiction. However, if a district court issues an interlocutory order “granting or denying, in whole or in part, a motion to transfer an action to the United States Court of Federal Claims,” a party can make an interlocutory appeal and the Federal Circuit has exclusive jurisdiction. 28 U.S.C. § 1292(d)(4). The government could have done the same in Pfizer, when the district court ruled against it on the first motion to dismiss for lack of subject matter jurisdiction, but it chose not to do so. In the second motion to dismiss, based on failure to timely file the refund suit, the government did not request transfer, so Pfizer’s appeal was to the Second Circuit.

Statutory interpretation

The jurisdictional provision at issue in these cases is 28 U.S.C. § 1346(a)(1). It has no dollar limitation. That’s the statute we rely on when filing tax refund suits, so I think of it as “tax refund jurisdiction.”  The taxpayers in these cases argued that it also covers stand-alone suits for overpayment interest, although technically those are not refund suits.  The alternative jurisdictional provision for district courts, the “little Tucker Act” at § 1346(a)(2), provides jurisdiction for any claim against the United States “founded either upon the Constitution, or any Act of Congress, or any regulation of an executive department . . . .” but is limited to claims of $10,000 or less.  The comparable jurisdictional statute for the Court of Federal Claims, § 1491(a)(1), has no such limitation.  So, if § 1346(a)(1) covers stand-alone suits for overpayment interest, taxpayers can bring suit in either district court or the CFC.  If it doesn’t, and the claim exceeds $10,000, the only option is the CFC.

Here’s what § 1346(a)(1) says, with the relevant language italicized:

Any civil action against the United States for the recovery of any internal-revenue tax alleged to have been erroneously or illegally assessed or collected, or any penalty claimed to have been collected without authority or any sum alleged to have been excessive or in any manner wrongfully collected under the internal-revenue laws

The language is very similar to Section 7422(a), which sets forth requirements for tax refund suits.  Because those requirements – exhaustion of administrative remedies and a shorter statute of limitations than for the little Tucker Act – have frequently been held not applicable to these stand-alone overpayment interest suits, the government argues that § 1346(a)(1) doesn’t apply to such suits either.

Overpayment interest doesn’t fall within the first two categories because it is neither tax nor penalty.  But Scripps interpreted the third category, “any sum alleged to have been excessive,” as broad enough to cover overpayment interest suits.  After all, the Supreme Court had stated in Flora v. United States, 362 U.S. 145, 149 (1960): “One obvious example of such a ‘sum’ is interest.”  Scripps concluded that the amount was “excessive” if you looked at how much the government retained rather than collected and, more importantly, focused on the entire balance of the account rather just individual components such as the overpayment interest.  (I provided an illustration of this last point here.)  The comparison to section 7422(a) was inapt because section 7422(a) includes a qualifying header (“No suit prior to filing claim for refund”); § 1346(a)(1) does not and therefore could include both refund suits and “non-refund” suits.

Both the Second Circuit and the Federal Circuit disagreed completely with that analysis.  The comment in Flora, in context, referred to underpayment interest (which is assessed and collected) rather than overpayment interest (which is paid out).  The structure of § 1346(a)(1), including the first two categories in the list, and the use of the present-perfect tense “have been” made it clear that it referred to amounts that had been previously paid to, or collected by, the IRS.  And the statutory language mattered much more than the header for section 7422(a) versus lack of such for § 1346(a)(1).

Legislative history

Both parties in Bank of America also pointed the court to legislative history in support of their positions.  In its opening brief, the government pointed out that the final version of the provision was understood by courts to establish a narrow exception to the $10,000 limitation for “little Tucker Act” claims – only for tax refund claims.  The government also focused on the Supreme Court’s discussions of the legislative history in Flora v. United States, 357 U.S. 63 (1958), and Flora v. United States, 362 U.S. 145 (1960).

Here is a summary of the arguments in the taxpayer’s brief: 

  • The predecessor statutes to § 1346(a)(1) were designed to eliminate several distinctions and inequities.  For example, the earlier provisions (a) for district court jurisdiction, requiring suing the Collector and could not brought after he died; and (b) for Court of Claims jurisdiction, did not allow for awarding interest.  Thus, in some instances, a taxpayer would have no way to recover overpayment interest.  In a floor statement introducing an amendment to the Revenue Act of 1921, a Senator noted those issues and stated that the amendment was intended to eliminate the problems.
  • The Assistant Chief Counsel of the Bureau of Internal Revenue represented, in a 1953 Senate subcommittee hearing, his opinion that the language of § 1346(a)(1) already covered stand-alone overpayment interest suits.
  • In connection with that same hearing, Treasury later provided by letter a list of several cases in district court involving stand-alone claims for interest.    

In its reply brief, the government took issue with the taxpayer’s arguments based on legislative history:

  • The Senator who introduced amendments to the Revenue Act of 1921 was concerned about tax refund claims, on which overpayment interest might be paid, rather than stand-alone claims for overpayment interest.
  • It was not entirely clear that the Assistant Chief Counsel’s statement at the 1953 Senate subcommittee hearing concerned stand-alone claims for overpayment interest.  In any event, a witness from the ABA testifying at the same hearing disagreed with the Assistant Chief Counsel’s opinion that the existing statute covered stand-alone claims. 
  • None of the 14 cases listed on the letter from Treasury of district court litigation concerned jurisdiction under § 1346(a)(1) for stand-alone claims of overpayment interest, the issue in Bank of America.  Only six cases involved overpayment interest at all, of which: (a) two declined to exercise jurisdiction; (b) two didn’t question jurisdiction; and (c) two were based on different jurisdictional provisions and involved claims under $10,000.

This brief summary doesn’t do the arguments justice, of course.  For those interested in more details, I suggest a review of the parties’ briefs, which provide a detailed history of the evolution of the jurisdictional provisions.  I was impressed by the thoroughness of both sides’ work, scratching and clawing for anything they could find or infer in support of their respective positions.  They did the best possible with what little was out there.

I count myself among those who consider legislative history relevant in interpreting ambiguous statutes, and a good tax lawyer (or judge) can find ambiguity in almost anything if they want to.  Even so, I considered these examples unlikely to persuade a court that had not already decided for other reasons.  I went back and looked at some of the original sources when reading the district court decision and they didn’t persuade me in either direction.  The Federal Circuit didn’t seem impressed either.

Impact on Bank of America

When I originally looked at the case, I thought that “most” of Bank of America’s claim would be eliminated if it lost in the Federal Circuit.  The third amended complaint was for $163 million, of which $141 million related to interest netting.  The interest netting claims seemed particularly vulnerable if Bank of America had to litigate in the CFC (see below), based on a cursory review of the complaint.  Now that I’ve reviewed the motion to dismiss more carefully, it appears that “most” overstated the potential impact on Bank of America, although it’s still significant.

The benefits of interest netting – the section 6621(d) adjustments to eliminate the interest rate differential – can be effected two ways.  The government can pay additional overpayment interest to bring that rate up to the underpayment interest rate, or it can refund underpayment interest to bring that rate down to the overpayment interest rate. 

Over $95 million of the benefit from interest netting came from years in which the adjustments were for reductions/refund of underpayment interest. A claim for refund of excessive underpayment interest clearly fits with § 1346(a)(1); under section 6601(e)(1), underpayment interest is treated as tax, except that it is not subject to deficiency procedures. 

Thus, there would be no basis for transferring those claims to the CFC.  (There were small amounts of overpayment interest in those years, presumably interest on the claimed refund of underpayment interest rather than directly from interest netting.  That overpayment interest would not be a disallowed stand-alone claim for overpayment interest; it would be permitted under ancillary jurisdiction.)  The government sought to transfer only $67 million of the total complaint amount to the CFC, of which only $44 million involved interest netting.  Assuming that the non-interest netting claims are not at a particular disadvantage in the CFC, Bank of America’s loss from the Federal Circuit’s decision may be only $44 million, or even less.  Well, to the taxpayer losing the claim, “only” is an inappropriate adverb; that’s still a lot of money.

Interest netting

Most taxpayers are perfectly willing to litigate interest cases in the CFC.  The CFC judges tend to have more experience with interest issues and most large interest cases are litigated there instead of district courts. In fact, Bank of America has another interest netting case pending there now. Taxpayers tend to bring substantial stand-alone interest cases in district court only to: (a) take advantage of favorable precedent in that circuit; or (b) avoid unfavorable precedent in the Federal Circuit.  Pfizer was an example of the former.  It wanted to rely on a favorable precedent, Doolin v. United States, 918 F.2d 15 (2d Cir. 1990).  It won’t necessarily lose its case elsewhere; it might persuade the CFC to reach the same decision as the Second Circuit did in Doolin.  Based on the complaint, I suspect Bank of America is an example of the latter, in this case trying to avoid an unfavorable precedent regarding interest netting, Wells Fargo & Co. v. United States, 827 F.3d 1026 (Fed. Cir. 2016).  (Prior discussion here.) 

Wells Fargo involved interest netting claims between separate corporations that had merged.  The Federal Circuit decided that, in such contexts, interest netting is only permitted if the period of overlap (an underpayment balance for one period and an overpayment balance for another period) began after the date of the merger. Here’s an illustration:

Company A had a $2.5 million underpayment balance for its 2008 tax year outstanding from 3/15/2009.  Company B had a $2 million overpayment balance for its 2011 tax year outstanding from 3/15/2012.  If the balances were still outstanding until paid/refunded on 12/1/2016, there was a $2 million overlap from 3/15/2012 (when the second balance began) until 12/1/2016 (when both balances ended).  During that overlap period, there was an interest rate differential; corporations earned from 1% to 4.5% less on overpayments than they paid on underpayments, and in this scenario the difference would more likely be 4.5% than 1%. 

If the companies merged in 2010, $2 million of the respective balances could be netted to avoid that differential, for the entire period from 3/15/2012 to 12/1/2016.  But if the companies merged in 2013, under Wells Fargo those balances could not be netted at all.  I think a better interpretation of the law would allow interest netting for part of the overlap period, starting from the date of the merger.  But the CFC will rule based on Wells Fargo, not based on my interpretation.

As noted above, Bank of America’s claims that will now wind up in the CFC include $44 million of interest netting benefits.  I don’t know if the entire $44 million will be denied based on Wells Fargo.  But (a) those claims involve Merrill Lynch’s tax years 1987, 1990, 1991, 1999, 2002, 2003, 2005, 2006, and 2007 tax years; and (b) Merrill Lynch merged with Bank of America on October 1, 2013.  I didn’t try to review the interest computations attached to the motion to dismiss, but I anticipate Bank of America stands to lose the vast majority of the $44 million.  Worth a cert petition to the Supreme Court?

Impact elsewhere?

The above discussion concerns how this case impacts Bank of America and more broadly other companies that might prefer to bring stand-alone overpayment interest suits in district court.  That doesn’t mean the impact of this line of cases is limited to overpayment interest.  Pfizer and Bank of America identified a certain type of claim that arises under the Internal Revenue Code but is not a tax refund claim for purposes of jurisdiction.  This distinction might affect not only the available forum, which is what I’ve been focusing on here, but also other issues. For example, a “non-refund claim” under the little Tucker Act will not be subject to the requirement to exhaust administrative remedies and will have a different statute of limitation.

Are there other examples of “non-refund claims” arising under the Code?There may well be, and Carl Smith pointed out one prominent recent example that cited Pfizer. On June 19, 2020, the district court of Maryland decided in R.V. v. Mnuchin, 2020 U.S. Dist. LEXIS 107420 (D. Md. 2020), that the government had waived its sovereign immunity with respect to the CARES Act economic impact payments (EIPs).  The plaintiffs claimed jurisdiction under, among others, the little Tucker Act, § 1346(a)(2).  That jurisdiction requires a separate “money-mandating” statute, for which the plaintiffs pointed to section 6428.  The government argued that section 6428 is a tax statute; any challenge to the denial of a credit falls within the jurisdiction of § 1346(a)(1) instead of § 1346(a)(2) and is subject to the restrictions of section 7422.  The plaintiffs’ failure to exhaust administrative remedies was fatal to their claim. 

The court dismissed the government’s motion to dismiss without prejudice.  It stated: “The Government argues that 26 U.S.C. § 6428 is not a money-mandating statute because it is a tax statute.  True.  But the two are not mutually exclusive.”  It cited Pfizer for that proposition.  To put it another way, a tax statute authorizes refund claims, but it also may authorize claims that are not “tax refund claims” for purposes of § 1346(a)(1) and not subject to section 7422 but are money-mandating provisions sufficient to support a Tucker Act claim.

The Advance Premium Tax Credit under the Affordable Care Act would likely be another “non-refund claim.” As with the EIPs, it is reconciled on the taxpayer’s tax return, but it is paid in advance pursuant to a clear money-mandating statute. Michelle Drumbl points out that the U.S. at one time had an advance earned income credit and other countries currently have similar advance credits. If Congress ever enacted her proposal for a transition to periodic payments rather than when the tax return is filed, that would likely also qualify as a “non-refund claim.”

What about refundable credits that are not paid in advance? That might be a harder argument to make; it’s not clear whether there is a money-mandating provision other than section 6402(a), working with section 6401(b)(1). But “hard” doesn’t always mean “impossible.” I haven’t researched enough to know whether a taxpayer has ever tried filing suit for payment of refundable credits based on the little Tucker Act instead of § 1346(a)(1). It might be the only route for recovery for a taxpayer who filed a return claiming a refund (based on a refundable credit) more than three years after the due date. The six-year statute of limitations for a little Tucker Act suit might avoid the problem of the “look back” limitation of section 6511(b)(2). It might be worth a try if you have a client with the right facts.

After all, ten months ago we weren’t sure the government would convince a court that stand-alone overpayment interest suits are “non-refund claims” for which district court jurisdiction is only available under the little Tucker Act. Now, the government has won in the Second and Federal Circuits and seems to have momentum heading into the Eleventh Circuit.

Postscript

While I was working on this post, Jack Townsend posted on his blog concerning the Federal Circuit’s decision in Bank of America.  Jack’s observations are always worth reading.

Significant Changes For Tax Litigation

We welcome back frequent guest blogger Bob Probasco who writes about an announcement on Friday by the Tax Court setting forth the way forward in Tax Court cases.  The announcement does not tell us when the court will start holding trials again but now we have a process.  There is still much to unpack but Bob does a good job getting us started.  My first reaction is that the Court has produced a thoughtful way forward.  My one small disappointment in the path concerns the checklist “Getting Ready for Trial Checklist.”  I would have preferred the checklist include a line that pro se litigants should reach out to Low Income Taxpayer Clinics (LITCs) early to obtain assistance, but I suspect there may be more pre-trial conferences moving forward and that in those pre-trial conferences judges may make reference to the assistance taxpayers might receive from LITCs.  Keith

On Sunday, I was reviewing the Tax Court’s website and happened to notice a new press release that came out on Friday.  We’ve all seen previous changes to Tax Court operations as a result of COVID-19.  The court cancelled trial sessions, the clerk’s office closed, and the judges were working remotely, while encouraging the parties to continue trying to resolve cases.  Now the court is moving on to the next stage of adapting to the pandemic, as have other courts: remote trial sessions.

The press release itself was brief, just announcing the change and the issuance of orders with details:

The COVID-19 pandemic continues to present public health risks and challenges, particularly where multiple individuals come together in a courtroom. In response, and until further notice, Court proceedings will be conducted remotely. See Administrative Order 2020-02 regarding remote proceedings and Administrative Order 2020-03 regarding Limited Entries of Appearance. If you have any questions, contact the Public Affairs Office at (202) 521-3355.

Another press release the same day informed us that on June 1st the court will resume accepting requests for copies of documents from non-parties.  But the process will be more flexible than before; requests can be made by phone and received by email.  You won’t have to – because you can’t – visit the court building in person.

So, what all is changing and what is still unclear?  This is a preliminary, incomplete assessment – what stood out to me, based on a quick review.

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What we know so far

The decision to go to remote trial sessions is not surprising.  Most other courts are pursuing this as well, if they haven’t implemented yet.  The basic structure of remote trial sessions also will probably not be tremendously surprising if you’ve devoted much thought to it.  The court operated the way it did pre-COVID for (mostly) good reasons and those reasons would drive the design of remote sessions in a (mostly) foreseeable fashion.

Administrative Order 2020-02 moves the trial sessions to Zoom.  Parties scheduled for a particular trial session will receive, in the notice setting the case for trial, a meeting id and password.  Litigants will be able to access the trial session by computer without having a Zoom account; if they don’t have access to a computer, they apparently will be able to dial in by phone.  Just as non-parties are free to attend an in-person trial session, public access will be offered in the new regime.  That will be available by real-time audio; the court website will post dial-in information for each session.  (Presumably, the public access dial-in will only allow non-parties to listen, not to speak and participate.)

Some of the changes may have been harder to anticipate but will have significant effect on litigants.  The standing pretrial order (SPO) addresses these items, among others, specifically:

  1. Motions for summary judgment – no later than 60 days before the first day of the trial session.  This was not specified in the previous SPO, but is consistent with Rule 121.
  2. Motions related to discovery or stipulations – no later than 45 days before the first day of the trial session.  This was not specified in the previous SPO, but is consistent with Rule 70.
  3. Motions for Leave to File an Expert Report – no later than 30 days before the first day of the trial session.  This was not specified in the previous SPO, but is consistent with Rule 143(g).
  4. Motions for continuance – no later than 31 days before the first day of the trial session.  This was not specified in the previous SPO.  This seems stricter than Rule 133, which establishes only a presumption that a later motion would be deemed dilatory and denied.  Now parties would have to request an extension.
  5. Preparation for trial – the parties shall file either a Proposed Stipulated Decision, a Pretrial Memorandum, a Motion to Dismiss for Lack of Prosecution, or a Status Report, no later than 21 days before the first day of the trial session.  The Status Report appears designed only to report that the parties have settled but a Proposed Stipulated Decision could not be filed timely.  The previous SPO mentioned only a Pretrial Memorandum, if a basis for settlement had not been reached, no later than 14 days before the first day of the trial session.
  6. Stipulation of Facts – the parties shall file such no later than 14 days before the first day of the trial session.
  7. Proposed Trial Exhibits (not encompassed in the Stipulation of Facts) – may not be allowed into evidence unless filed not later than 14 days before the first day of the trial session.  This is consistent with the language in pre-trial orders for many years; however, the enforcement of this provision of the pre-trial order may become much more vigorous.

These requirements fall into three broad categories, all of which seemed designed to facilitate a quick, efficient calendar call.  There is only so much time you can spend in a Zoom meeting before your attention starts to flag.  First, simply making explicit in the SPO what was already in the Rules (items 1-3).  That seems to be the court trying to communicate those requirements to those who aren’t already familiar with the deadlines, hopefully only unrepresented taxpayers and not members of the tax bar.  Second, accelerating communications with the court from current timelines – the change from 14 days to 21 days before the trial session in item 5, and the stricter deadline in item 4. 

The third category establishes new deadlines for documents that sometimes were presented only at the calendar call itself: Motion to Dismiss for Lack of Prosecution (item 5), Stipulation of Facts (item 6), and unagreed trial exhibits (item 7).  Effectively, all documents will need to be filed in advance; handing the document to the trial clerk is no longer a simple process.  Along the same lines, Administrative Order 2020-03 requires representatives entering a limited appearance to file it electronically, unless exempt from e-filing requirements.  (There are also several other changes involving limited appearances from Administrative Order 2019-01, but that’s a topic for another day.)

The accelerated or new deadlines will take some getting used to for tax practitioners.  It may be significantly more difficult for petitioners, especially since the new Standing Pretrial Order for Small Tax Cases has similar requirements and deadlines.  The old Standing Pretrial Notice didn’t specify a deadline for the stipulation of facts and specified a Pretrial Memorandum only had to be submitted 7 days before the trial session.  And as we all know, very few unrepresented taxpayers filed a Pretrial Memorandum.

What don’t we know yet?

Probably a lot of things.  There are always a lot of problems that are not identified until after implementation of a new program and these changes certainly will encounter that.  The Tax Court judges put a lot of thought into these changes but it’s impossible to anticipate everything.  All you can do is prepare as best you can, implement, and then adapt when problems crop up.

But one “known unknown” did stand out to me on first reading Administrative Order 2020-02.  What do these changes mean for pro bono volunteers who attended in-person trial sessions to assist unrepresented taxpayers?

Pro bono volunteers don’t receive copies of the notice setting cases for trial unless they happen to already have a client scheduled for that trial session.  Will there be some process to disseminate the meeting id and password to them ahead of time?  Will they instead have to merely listen in through public access?  If so, how will they communicate to the judge or petitioners that they are present and available to assist?

Will separate Zoom meetings be set up, on the fly, to allow pro bono volunteers and petitioners to meet privately?  If so, who will match up this petitioner to that volunteer?  How will the meeting ids and passwords be communicated to them without allowing those listening in through public access to here and join the meeting?  How would the pro bono volunteer and petitioner invite Counsel into that private meeting in order to discuss possible settlement?

I assume the pro bono volunteers could, at the beginning of a private meeting, quickly e-file a limited entry of appearance and then gain access to documents filed in that case.  That would alleviate some of the problems associated with transferring documents between petitioner and volunteer.  Presumably that is one reason Administrative Order 2020-02 was issued concurrently with Administrative Order 2020-03.  Will someone e-filing a limited entry of appearance have immediate access to all documents on the docket?

This seems to have the potential to be a complicated, difficult process.  The court may have worked out these details already and we may hear more soon.  I’m currently part of groups working with IRS Counsel for two different Virtual Settlement Days, one for Dallas cases and the other for San Antonio and El Paso cases.  (Here is the Virtual Settlement Days Best Practices Guide, for those interested.)  Perhaps the process for those events can be adapted to the remote trial sessions. 

Or will the Virtual Settlement Days ultimately replace pro bono assistance at the trial sessions?  Particularly with the requirements in the new Standing Pretrial Orders, there will be an increasing need for assistance well in advance of the trial session.  That will be difficult to achieve; not all petitioners will independently contact a clinic based on the “stuffer notice” or request an appointment at a Virtual Settlement Day, even with the scarier Standing Pretrial Order.  But without early assistance, the Tax Court’s remote trial sessions will not work as effectively and low income, unrepresented taxpayers will be worse off.

Those are my observations and questions about the new regime.  What are yours?

Creating Tax Policy and Tax Procedure on the Fly

The current situation allows us to observe the creation of new tax procedures based on new polices in real time.  Listservs and web sites are alive with discussion of what to do as the IRS tries to figure out procedures in a matter of days after passage of legislation creating new and immediately applicable tax provisions in the middle of tax filing season with most of its employees sitting on the sidelines.  We all have empathy for the people at the IRS trying to push out procedures to address the new provisions while at the same time feeling frustration based on the lack of guidance. 

A recent exchange on the ABA Tax Section listserv for Pro Bono and Tax Clinics caught my eye as a good example of the types of issues practitioners seek to work out in order to guide clients.  Some of our recent posts written by Nina Olson, Carl Smith, Barbara Heggie and Bob Rubin also address these same types of concerns.  We welcome guest posts that raise procedural issues that need answers.  We hope that perhaps the blog can serve as another outlet for passing questions that need answering to those at the IRS trying hard to provide those answers. 

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It’s interesting, but not surprising, that many answers to the questions of procedure that require an immediate answer are driven not so much by policy as by computer capability.  Since the IRS has what some people might describe as a third world class computer system, some of the procedures that will apply will result from the quality, or lack thereof, of the computer system used by the IRS.  The computer capabilities at the IRS not only drive some of these decisions but are also hampering the IRS from having its employees work during this time when many are continuing to work from home.  Because many of the IRS employees do not have laptops they can use from home, they have been sent home not to work to help through this difficult time but just to sit.

Francine Lipman, William S. Boyd Professor of Law at University of Nevada, Las Vegas, William S. Boyd School of Law, writes first raising a few of the many unanswered questions concerning who will receive the rebates that the IRS will start sending out any day.

[w]e need guidance from US Treasury.

1) Will the IRS age adjust qualifying children to 2020? Or does a QC that is 16 in 2018 qualify for a $500 EIP if no 2019 tax return filed? And not qualify if a 2019 tax return is filed?

2) If one taxpayer claims a QC on her 2018 tax return and another claims the same QC on their 2019 tax return. What is the tie-breaker? 2019 > 2018? I do not believe they both get the $500 QC amount. What if someone else claims the QC in 2020?

3) If a taxpayer claims a 16 year old QC for 2018 and no 2019 tax return on record, will the 18 year old (former QC) nondependent get the full $1,200 when she files her 2020 income tax return or does she only receive $700 ($1,200 – $500)?

It seems to me that one long-standing rule of thumb that I believe will be applied to these EIPs is that the maximum amount of EIP per SSN will be $1,200. Thus, I believe these fact patterns will be interpreted to respect that long-standing guideline.

Responding to Francine, Bob Probasco, Director, Tax Dispute Resolution Clinic at Texas A&M University School of Law, responds.

Thanks, Francine.  There are those open questions and probably several others.

I suspect that the decisions – most of which have already been made or won’t be in time for advance refunds – will be driven by factors other than what makes sense from a tax law perspective.  They will be driven in part by:

● What has to be programmed now versus a year from now for processing 2020 tax returns

● Ease of programming in an antiquated system (Nina’s post on Procedurally Taxing, procedurallytaxing.com/…, Is particularly scary)

● What can be programmed and tested and have a relatively low likelihood of significant glitches when they flip the switch

That is, we need to think about these issues not just from a legal perspective and from looking at the desired results but also from a programming perspective, what can be accomplished.  That may turn out to be a bigger factor than equity and legal interpretation.

The IRS certainly was starting their programming efforts before the final legislation was enacted but I’m not sure how much of a jump they had.  And they’re aiming at sending out the first batch of payments (by direct deposit) in a week to 10 days.  That very likely means that the small teams of IT people and IRS attorneys and whoever else had to make very quick decisions without the normal level of vetting we expect for guidance.  They had no choice if they were going to meet the deadline.  They didn’t have time to think through and identify all the issues – heck, the experienced tax practitioners here are still identifying nuances and will be for quite some time – and some issues they identified may have been too difficult to program easily.

We can speculate, for example, whether the programming is structured to crunch all the information for all taxpayers, do cross-checks between different returns, before making the final decisions which returns get how much money.  That’s complex, but doable.  It might lead to inequitable results, of course. 

As a trivial example, right now when two divorced parents each claim the same qualifying child for the same tax year, the IRS may not identify the discrepancy and follow up until a year or so later.  At that point, there may be a correspondence exam and a long process – including Tax Court – before a final determination of which parent is entitled to claim the qualifying child.  Lots of due process.  We have a case like that now.  But in the context of the advance refunds, they need to make a determination before sending payments out this month.  There are only two choices that appear even feasible as a matter of programming.  A, apply the AGI tie-breaker rule automatically.  B, allow both parents the $500.  Alas, choice A (1) increases the complexity of the programming and (2) raises additional due process questions.  How does the losing parent challenge that?  That might be difficult to impossible other than through the audit process applied to the 2020 tax returns.  But that delays receipt of the money for someone who may really need it and may not even come up in 2020 if the qualifying child has “aged out.”  It also invites gaming the system, particularly since a parent who improperly claimed the qualifying child but got the $500 this month apparently would not have to give it back on the 2020 tax return.  (Is there an exception to the “no claw back” rule for improperly claiming a qualifying child, or was that primarily intended for changes in AGI?)

And I’m not at all sure what happens in that trivial example if the 2018 return was joint, parent A files a 2019 single return before the first batch of direct deposit advance refunds, and parent B files a 2019 single return after parent A receives the advance refund.  Is “first past the post” (in the horse racing, not electoral, sense) an equitable way to decide who gets the $500??

These kinds of issues abound.  The programming team won’t have identified all the issues, and won’t have identified all the nuances and potential problems arising from different solutions.  There’s no way they can/could in a very limited time.

They also will likely be pre-disposed to simple decision trees rather than complex, nuanced ones.  The latter is risky.  Several years ago, in my pre-law school career, I managed a small team (IT folks and accountants from the user group) on a systems development project.  That system was much more straight-forward than anything we’re talking about here and the volumes of data we were working with were several orders of magnitude less than what the IRS will be dealing with.  We spent over nine months on the project.  (Maybe more, this was at least 30 years ago and my memory is a little bit fuzzy.)  At the end, after extensive testing, we flipped the switch to go live – and it didn’t work.  The people at the IRS are a lot smarter than I am but the task they’re facing is also light years more difficult.  So I expect them to err on the side of simplicity rather than complexity/nuance.

A totally uneducated guess (and your guess is better than mine) for those examples you raised:

1. Seems the most likely to be addressed in the programming (not sure in which direction) if the age information is easily accessible from the Form 1040.  (I should know whether it is but I’m drawing a blank at the moment.)

2. Assuming they do a complete crunch of all the tax returns and cross-check before deciding the advance refund amounts – which itself is a herculean task – they can resolve that.  But it becomes a legal issue in addition to a programming issue, and either way they decide it will be subject to second-guessing.  What would be the logical basis for deciding one way or another?  I’m not sure there is one – it would have to be a fairly arbitrary choice.  They might even duck the question and give the credit to both; it will be – relatively speaking – a small subset of qualifying children, and overpaying might insulate them from a lot of criticism based on sympathetic taxpayers.  Then they will have more time to decide what to do when the 2020 tax return rolls around.

3. Depends on the resolution of #1?  I suspect that if this is an issue, they will take their time to decide what to do when the 2020 tax return rolls around.  This isn’t a decision that needs to be made this month.

And, one final thought.  We may not get “guidance” in the normal sense.  They’re making the decisions about the advance refunds – indeed, they already have.  We don’t need to know in order to apply for an advance refund in the normal sense of “apply.”  And I’m not sure they envision a mechanism for taxpayers to challenge the amount of their advance refunds.  In which case, we don’t need guidance in the normal sense for the challenge process.  All they do in the short term may be to tell us “if you can’t figure out how we arrived at the amount of the advance refund you received, here is our decision tree; but you can’t challenge it now.  We’ll provide more guidance in the next several months and by then it may have changed.”

Francine responded to Bob with the following brief message:

I agree 100% about [the] lack of forthcoming traditional “guidance.” Perfect is the enemy of the good here and the theory of second or even third, fourth best certainly applies now with a global pandemic and a corresponding economic free fall.

Thanks Bob and Francine for giving all of us issues to think about as we navigate how to guide clients in the absence of guidance from the IRS and thanks to everyone engaging in these types of discussions that may eventually impact decisions.  Thanks to the IRS employees working hard to implement legislation passed in the middle of the filing season and in the midst of extremely trying circumstances.  Do the best you can under a situation never faced before.

How Big Will My Recovery Rebate Be??

We welcome back guest blogger Bob Probasco.  Bob runs the tax clinic at Texas A&M but has many years of experience in accounting and law firms before taking on his current position.  This week we have been talking about offset and Bob raises another issue concerning offset that we have not discussed and that has not been discussed in the press concerning the CARES rebate.  We have made it clear that the CARES rebate passes by the normal offset provisions (except for child support) but Bob points out that maybe that overstates the way it will work.  Read on and let us know your thoughts.  Keith

PT has some recent outstanding posts by Carl Smith (Part I and Part II) and Nina Olson (Part I, Part II, and Part III) on the CARES Act, both generally and specifically concerning the Recovery Rebates (or “economic stimulus payments”).  If you haven’t read them yet, you should – I have a much better sense of the problems and likely results than I had before.  There has also been a lot of chatter recently on the Pro Bono & Tax Clinics community in ABA Connect, another great resource with very knowledgeable contributors from whom I’ve learned a lot.

Today, I want to discuss a question that I haven’t really seen mentioned elsewhere.  (Perhaps it has been, and I just haven’t been reading as widely as I’d like to during this hectic time.)  It concerns the amount of the advance refunds.  The impression many people have is that the advance refunds will only be offset against a taxpayer’s past-due child support obligations; otherwise, the taxpayer will receive the full amount. 

I’m not sure that’s correct.

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Section 2201(d) of the CARES Act states:

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) or by reason of subsection (c) of this section shall not be—

(1) subject to reduction or offset pursuant to section 3716 or 3720A of title 31, United States Code,

(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.

That sounds pretty good and has rightly been praised as a huge improvement over the 2008 stimulus payments. 

Carl’s Part II post discusses how the IRS was able to keep those 2008 payments under the terms of offers in compromise (OICs).  The Second Circuit approved.  I’m not entirely sure whether the terms of an OIC would take precedence over § 2201(d) of the CARES Act, but it might.  However, there’s another possible exception to § 2201(d), resulting from the structure of the advance refunds.

New § 6428(f)(1) states that taxpayers who were eligible individuals for their 2019 tax return “shall be treated as having made a payment against the tax for [the 2019 tax year] in an amount equal to” what would have been allowed as a refundable credit for 2019 if § 6428 had applied to 2019.   Section 6428(f)(3)(A) then goes on to say:  “The Secretary shall, subject to the provisions of this title, refund or credit any overpayment attributable to this section as rapidly as possible.”  That’s the actual authority to make the advance refunds and seems patterned after § 6402(a).

Treating the advance refund amount as a payment and then authorizing a refund of any overpayment is the same method used for the 2008 stimulus payments.  (Carl quotes the 2008 version of § 6428 in the comments of his Part I post.)  There are some obvious advantages of this method.  The stimulus payments are classified as tax refunds and therefore: (a) not taxable income and (b) not “resources” for eligibility determinations for benefits and assistance under Federal programs or State programs partially financed by Federal funds.

It also appears to have a possible drawback.  It works well if there is no balance outstanding for the 2019 (or 2018 if no 2019 tax return was filed) tax year.  The advance refund amount, treated as a payment, is the same as the overpayment.  It also works well if there was a frozen refund for 2019, as the frozen refund would not be “attributable to” Section 6428; only the advance refund amount would be refunded.  But what if there were a balance owed by the taxpayer for 2019?

Here’s a simple example.  Sam has filed a tax return for 2019, which the IRS uses to determine the advance refund amount.  Sam wanted to file the return in order to get an advance refund but was unable to pay the entire tax liability shown on the return.  There was a $2,000 balance owed to the government.  The advance refund amount for Sam is $1,200, so the IRS records a $1,200 payment in the 2019 tax year.  And there is no overpayment to be refunded; instead, there is now an $800 underpayment.  Sam receives no money now or when filing the 2020 tax return because the $1,200 has been offset against the 2019 tax liability. 

That seems inconsistent with the spirit of § 2201(d) of the CARES Act, doesn’t it?  This is a time to get money to people who desperately need it, not to recover amounts they owe.  Is this an unintended consequence, that the drafters did not anticipate?  But the same thing can happen on the 2020 return, if there is no advance refund – the refundable credit will not be refunded in full if the return shows a net amount due from the taxpayer before the credit.  So, a similar result with the advance refund may be intentional, or at least a result that the drafters knew about.

Maybe I’m missing something here.  If not, this may be an unpleasant surprise for those taxpayers it affects – hopefully few in number – after hearing the information that has been shared publicly about the rebate and advance refund provision.

Another Aftershock from Pfizer

Guest blogger Bob Probasco brings us a brief update on overpayment interest litigation. Christine

I have been writing here over the last year or so about concerning the issue of whether district courts have jurisdiction under 28 U.S.C. § 1346(a)(1) over standalone suits for additional interest on refunds under Section 6611. If so, there is no limit on the amount of the taxpayer’s claim. If instead jurisdiction over these suits falls under § 1346(a)(2), the “little” Tucker Act, it is limited to claims of $10,000 or less. As a result, taxpayers with significant claims would be forced to litigate in the Court of Federal Claims. The government believes these significant claims for overpayment interest should be litigated in the CFC. Some taxpayer prefers district court, often to either benefit from a favorable precedent in the applicable circuit court or to avoid an unfavorable precedent in the Federal Circuit.

Before September of this year, only one Circuit Court of Appeals had decided this issue. In E.W. Scripps Co. v. United States, 420 F.3d 589 (6th Cir. 2005), the court concluded that § 1346(a)(1) does grant jurisdiction for district courts over standalone suits for overpayment interest. Although the government (and several tax practitioners) disagree with the Scripps case, that was the majority consensus. See Bank of America Corp. v. United States, 2019 U.S. Dist. LEXIS 109238 (W.D.N.C. 2019) (collecting cases), which I discussed here. But then on September 16th this year, in Pfizer v. United States, 939 F.3d 173 (2d Cir. 2019), the court held that § 1346(a)(1) does not cover these suits. I discussed that decision here.

The Pfizer decision by the Second Circuit was a significant milestone, creating a circuit split. Pfizer also is having an impact on other courts considering the issue. In that October blog post, I mentioned that, three weeks after the Second Circuit’s decision in Pfizer, a district court followed Pfizer and decided that it did not have jurisdiction for an overpayment interest suit under § 1346(a)(1). That case was Estate of Culver v. United States, 2019 U.S. Dist. LEXIS 173235 (D. Colo. 2019), which resulted in a transfer to the Court of Federal Claims. Now the Southern District of Florida has ruled on the issue as well, in the Paresky case.

When I last discussed the Paresky case, the magistrate judge had issued her report and recommendation on August 30, 2019, concluding that § 1346(a)(1) does provide district court jurisdiction for that suit. The Second Circuit’s decision in Pfizer came out on September 16, 2019. And on October 21, 2019, the district court judge in the Paresky case issued her order, rejecting the magistrate judge’s recommendation and following Pfizer.

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The Paresky case was originally filed in the Court of Federal Claims, which found it lacked jurisdiction because the complaint was filed too late and transferred the case to the SDF. So, instead of transferring the case as in Estate of Culver, the SDF dismissed it. The Pareskys have no forum remaining and are out of luck unless they successfully appeal the decision.

The statute states that district courts have jurisdiction of:

Any civil action against the United States for the recovery of any internal-revenue tax alleged to have been erroneously or illegally assessed or collected, or any penalty claimed to have been collected without authority or any sum alleged to have been excessive or in any manner wrongfully collected under the internal-revenue laws.

Litigants sometimes argue over the meaning of “recovery” – is that limited to something that has been collected and the taxpayer seeks to get back? (If so, overpayment interest would not qualify, but courts have relied on alternative definitions.) But most of the argument concerns how overpayment interest might fit into one of the three categories in the statute – (1) tax erroneously or illegally assessed or collected; (2) any penalty collected without authority; or (3) any sum that was excessive or wrongfully collected. Overpayment interest is neither tax nor penalty; it is simply an amount owed by the government for its use of the taxpayer’s money.

Scripps concluded that “any sum” could include overpayment interest and that the sum was “excessive” because the government retained more of the taxpayer’s money than it should have by refunding the overpayment with no, or insufficient, interest. It supported that conclusion in part by a brief reference in Flora v. United States, 362 U.S. 145 (1960), stating that “any sum” could encompass interest. The district court in Pfizer and the magistrate judge in Paresky agreed with Scripps.

The Second Circuit disagreed with that analysis in Pfizer, calling the Scripps interpretation of “any sum alleged to have been excessive” a strained reading, and concluding that the reference in Flora was properly understood to concern deficiency interest rather than overpayment interest. (The two types of interest are treated very differently.) The district court judges in both Estate of Culver and Paresky found that more persuasive than Scripps.

As I mentioned in a previous post, most large dollar interest cases (both underpayment interest and overpayment interest), at least through 2014, were filed in the CFC rather than district court. That may have changed, as a body of precedent built up in the Federal Circuit and taxpayers tried to avoid it (as in Bank of America) or just preferred precedents in other circuits (as in Pfizer). The government is still vigorously arguing that § 1346(a)(1) does not cover standalone suits for standalone suits for additional overpayment interest. As anticipated, when the government filed its opening brief in its appeal of the Bank of America case to the Federal Circuit on November 4th, it mentioned Pfizer, Paresky, and Estate of Culver frequently.

Before Pfizer, there was an overwhelming majority consensus on this issue. But the number of cases that directly addressed it was relatively small. Sometimes an overwhelming majority can melt away quickly after just one circuit court reaches an opposite conclusion. It will be interesting to see over the next year or two if that occurs with this issue. There may be several opportunities. The Pareskys can appeal this latest ruling to the Eleventh Circuit; the Bank of America case is currently on appeal to the Federal Circuit; the Estate of Culver case might wind up in the Federal Circuit as well; and Pfizer could try to challenge the Second Circuit’s decision in the Supreme Court.

 

Overpayment Interest – Is the Tide Turning?, Part Two

Guest blogger Bob Probasco returns with the second of a two-part post on developments in overpayment interest litigation. Christine

In the last post, I discussed the latest developments in the Paresky and Pfizer cases.  The latter in particular was an important milestone that may change how courts approach the issue of district court jurisdiction for taxpayer suits seeking interest payable to them by the government on tax refunds.  This post turns to Bank of America, with some additional general observations.

These cases involve the interpretation of 28 U.S.C. § 1346(a)(1), which provides district court jurisdiction over tax refund suits.  Does it also offer jurisdiction for suits for overpayment interest, even though technically those are not refund suits?  The government says no, but taxpayers may argue it does, in order to escape the $10,000 dollar limitation for district court jurisdiction under the “little” Tucker Act, § 1346(a)(2).  If § 1346(a)(1) provides jurisdiction for these overpayment interest suits, which statute of limitations applies – the general six-year statute of limitations under § 2401 or the two-year statute of limitations for refund suits under section 6532(a)(1)?

As discussed in the last post, the report and recommendation by the magistrate judge in Paresky concluded that the Southern District of Florida had jurisdiction under § 1346(a)(1) but the suit should be dismissed because the refund claim was not filed timely.  We’re waiting to see what the district court judge thinks.  In Pfizer, we had the first Circuit Court decision to directly decide that § 1346(a)(1) does not provide jurisdiction for these kinds of suits, setting up a circuit split.  And in Estate of Culver, the District of Colorado adopted the Second Circuit’s reasoning in Pfizer.  It will be a while before we see what effect, if any, Pfizer has in the Bank of America case, where there has also been a new development.

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What is happening with Bank of America?

Bank of America filed this case in the Western District of North Carolina (WDNC), apparently to avoid an unfavorable precedent in the CFC (see here for details).  The bank’s interest netting case sought both recovery of underpayment interest and additional overpayment interest.  The government filed a motion to transfer the claims requesting overpayment interest to the CFC; in the alternative, to dismiss because § 1346(a)(1) does not cover suits for overpayment interest.  It also suggested that cases filed under § 1346(a)(1) would be subject to the Code refund claim requirement and statute of limitations, sections 7422 and 6532 respectively.  The WDNC denied the government’s motion on June 30, 2019, relying heavily on the Scripps decision.

An interlocutory appeal by the government to the Fourth Circuit seemed more probable than the alternative of waiting until a decision on the merits.  A transfer to the CFC would likely result in certain victory by the government for most of the amount at issue, so it certainly would make sense to challenge the jurisdictional ruling now.   Then I belatedly checked the docket for Bank of America and realized there was a third possibility that I hadn’t even counted upon (gratuitous reference for fellow baby boomers).  The government filed a notice of appeal on August 28, 2019 – not to the Fourth Circuit, but to the Federal Circuit. 

Appellate specialists are probably nodding their heads now and murmuring “of course.”  And they may have been rolling their eyes at my earlier speculation about an interlocutory appeal to the Fourth Circuit.  But, alas, I am not an appellage specialist and had never before encountered 28 U.S.C. § 1292(d)(4).  I now know that the Federal Circuit has exclusive jurisdiction for appeals of a district court interlocutory order granting or denying, in whole or in part, a motion to transfer an action to the CFC.  Before I ran across this provision, I assumed that the CFC and Federal Circuit would never have occasion to rule on a jurisdictional provision that applied only to district courts (more about that below).  But that assumption is apparently wrong.  The WDNC’s denial of the motion to transfer the case to the CFC was based on its determination that district courts do have jurisdiction under § 1346(a)(1) so that is presumably what the Federal Circuit will have to decide.

The government could also have appealed to the Federal Circuit in the Pfizer case, after the denial by the SDNY back in 2016 of the first motion to dismiss, but did not do so.  Perhaps it wanted to get a ruling on the separate statute of limitations issue.  But it may have just been a case of different strategies by different trial teams.  Pfizer was handled by the U.S. Attorney’s office for the SNDY; while Bank of America was handled by DOJ Tax Division, as was Paresky.

Is there a Supreme Court visit in the future?

We now have a circuit split between the Second (Pfizer) and the Sixth (Scripps).  But the government won in Pfizer, so the taxpayer would have to seek certiorari.  Pfizer may decide to proceed without the favorable Second Circuit precedent; it can still win in the CFC.  Bank of America seems more likely than Pfizer to go to the Supreme Court, since both parties have strong motivations.  The government wants to overrule Scripps and Bank of America would lose most of the value of its interest netting claim if forced to litigate in the CFC.  We’ll have to wait to see how Paresky and Estate of Culver proceed.

A comment on underlying policy

We all recognize the Tax Court’s relative expertise, compared to courts of general jurisdiction, on tax issues.  But there is also a difference in expertise between the CFC and district courts.  The district court jurisdictional structure demonstrates two different policy decisions, aiming in different directions.  The dollar limitation in § 1346(a)(2) – the “little” Tucker Act – was based on a judgement by Congress that the Court of Claims (now the CFC) would have more expertise with claims against the government, because that is a major part of its caseload compared to district courts.  Small claims could be pursued in district courts so that taxpayers wouldn’t have to litigate in far off Washington, D.C., but larger ones should be filed in the Court of Claims.

When the predecessor of § 1346(a)(1) was enacted, it also was subject to a dollar limitation but that limitation was later removed.  That was based on a judgement by Congress that tax refund suits were different from other claims against the government and taxpayers should always be able to litigate those locally instead of with the CFC.

Which of those policy judgements should apply to the specific questions of interest on overpayments and underpayments of tax?

Many years ago, Mary McNulty and I were tracking all significant interest cases (both overpayment interest and underpayment interest).  I recently looked back at the list as of five years ago.  It showed 5 cases filed in district courts and 63 filed in the CFC.  When you factor in the number of district court judges compared to the number of CFC judges, that ratio is orders of magnitude more experience by the CFC judges (as well as the Federal Circuit) with the specific, complex issues of interest.  Most taxpayers chose that forum, although as precedents built up and unresolved issues were narrowed, there may be more motivation for taxpayers to avoid unfavorable precedents in the CFC and Federal Circuit, as in Bank of America.

And a final comment on CFC jurisdiction

I’ve been focusing in all of these blog posts on district court jurisdiction.  But when I discussed Pfizer recently with Jack Townsend, he pointed out something in some of these opinions that I skipped over.  The courts occasionally referred to § 1346(a)(1) as granting jurisdiction to both the district courts and the CFC.  Early in my career, I read the provision that way but over the years I came around to the idea that the reference to the CFC is just a reminder rather than an actual grant of jurisdiction.  I don’t recall offhand ever seeing the CFC refer to that provision as the basis for its jurisdiction over a tax refund suit.  I mentioned that briefly in this blog post but it’s worth pointing out explicitly.

The structure of the statute strongly supports that interpretation.  Section 1346(a)(1) is part of Chapter 85 of Title 28, which is titled “District Courts; Jurisdiction.”  Chapter 91 covers the CFC’s jurisdiction.  The specific language “shall have original jurisdiction, concurrent with the United States Court of Federal Claims, of” appears in § 1346(a) and thus applies not only to § 1346(a)(1) but also to § 1346(a)(2).  The latter certainly doesn’t grant jurisdiction to the CFC for Tucker Act claims, since the CFC already has jurisdiction under § 1491.  And § 1346(a)(2) refers to “any other civil action or claim against the United States,” whereas § 1491 just says “any claim against the United States.”  That convinces me that tax refund suits, covered by § 1346(a)(1), are a “claim against the United States” encompassed within § 1491.

If that doesn’t convince you, Jack’s blog post has a footnote by Judge Allegra on the topic that should.

Overpayment Interest – Is the Tide Turning?, Part One

Today Bob Probasco returns with further updates on overpayment interest litigation, in a two-part post. We are grateful to Bob for following the issue closely and sharing his observations with us. Christine

In August, I wrote about the Bank of America case (here and here), and provided updates on the status of the Pfizer and Paresky cases, all of which addressed the question of district court jurisdiction for taxpayer suits seeking interest payable to them by the government on tax refunds.  Recently we’ve had developments in all three cases, plus one new case.  This post will cover Paresky and Pfizer.  Part Two will move on to Bank of America, speculation concerning where this issue may head next, and some general observations about jurisdiction and policy considerations.

Setting the stage

There are two district court jurisdictional statutes at issue in these cases. This first is 28 U.S.C. § 1346(a)(1). It has no dollar limitation. That’s the statute we rely on when filing tax refund suits in district court, so I usually refer to it as “tax refund jurisdiction.” However, some taxpayers argue that this provision also covers suits for overpayment interest, although technically those are not refund suits.  The government strongly opposes that interpretation and we’ve seen a lot of litigation over the issue recently.

The second is § 1346(a)(2), which provides jurisdiction for any other claim against the United States “founded either upon the Constitution, or any Act of Congress, or any regulation of an executive department . . . .” This is commonly referred to as “Tucker Act jurisdiction” and for district courts is limited to claims of $10,000 or less. The comparable jurisdictional statute for the Court of Federal Claims, § 1491(a)(1), has no such dollar limitation.  Practitioners often refer to § 1346(a)(2) as the “little” Tucker Act.

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There are also two different statutes of limitation potentially applicable. The general federal statute of limitations, § 2401 (for district courts or § 2501 for the Court of Federal Claims), requires that complaints be filed within six years after the right of action first accrues. In the Code, section 6532(a)(1) requires the taxpayer to file a refund suit no later than two years after the claim is disallowed.

A preliminary decision in Paresky

In the interest of space, I’ll just refer you back to the earlier blog post for the factual background on Paresky.  The taxpayers originally filed in the Court of Federal Claims (CFC).  That court concluded that it did not have jurisdiction over the suit because the applicable six-year statute of limitations in § 2501 began running in 2010 and had expired.  The Pareskys had previously requested that the court transfer the suit to the Southern District of Florida (SDF), in response to the government’s motion to dismiss, and the CFC agreed.  That would allow the Pareskys to try to persuade the SDF that § 1346(a)(1) covers claims for overpayment interest and that the two-year statute of limitations in section 6532(a)(1) applies.

After the transfer, the government quickly filed a motion to dismiss for lack of jurisdiction, arguing that § 1346(a)(1) did not apply and that the Pareskys’ claim exceeded the $10,000 limit for jurisdiction under the “little” Tucker Act.  On August 30, 2019, the magistrate judge issued her report and recommendation.  The report agreed with the Pareskys that § 1346(a)(1) covers claims for overpayment interest but also agreed with the government that taxpayers have to file an administrative refund claim within the time limitations set forth in the Code.  They had done so timely for the 2007 tax year but not for the earlier years.  The Pareskys argued for equitable estoppel based on the directions they had received from IRS personnel, but the judge was not convinced.  She concluded that equitable estoppel for the timely refund claim requirement is not available, based on the decision in United States v. Brockamp, 519 U.S. 347 (1997).  Technically, Brockamp involved an equitable tolling claim but the judge quoted a statement in the decision that suggested application to any equitable doctrines.

This is still a preliminary decision, not yet adopted by the district court judge in the case.  Both parties filed objections (on different grounds) to the report and recommendation on September 10, 2019; both parties filed a response to the other side’s objections on September 19, 2019; and the government then filed a reply on October 7th.  We’re still waiting to hear from the district court judge.  That decision may be complicated by the development in our next case.

A new decision in Pfizer

The IRS mailed refund checks to Pfizer within the 45-day safe harbor of section 6611(e).  The checks were never received, and the IRS eventually direct deposited a replacement approximately a year later, without overpayment interest.  The IRS takes the position that when the original refund check is issued timely but never received, the replacement refund still falls within section 6611(e).  (Some exceptions to this position are set forth in I.R.M 20.2.4.7.3.) Pfizer filed suit in the Southern District of New York (SDNY), asserting jurisdiction under § 1346(a)(1) to take advantage of the favorable Doolin v. United States, 918 F.2d 15 (2d Cir. 1990) precedent on the issue of interest on replacement refund checks. The government filed a motion to dismiss for lack of jurisdiction, arguing that district courts only have jurisdiction for standalone suits for overpayment interest under the “little” Tucker Act but the amount at issue exceeded the $10,000 limit. The court agreed with Pfizer and denied that motion to dismiss.  The court granted a second motion to dismiss, because the refund statute of limitations under section 6532(a)(1) had expired before suit was filed.  Pfizer argued that the general six-year statute of limitations in § 2401 applied.  But the court agreed with the government regarding the statute of limitations and dismissed the case.

In the first motion to dismiss, Pfizer requested that the case be transferred to the Court of Federal Claims (CFC) if the motion to dismiss were granted.  That was denied when the SDNY ruled that it had jurisdiction under § 1346(a)(1).  In the second motion to dismiss, Pfizer did not make the same request for transfer.  The government also did not recommend transfer.  But on appeal, Pfizer asked that the Second Circuit, if it affirmed the decision by the SDNY, transfer the case.  That would allow the case to proceed, as suit was filed within the six-year general statute of limitations for Tucker Act claims, although the Second Circuit precedent Pfizer wanted to rely on would not be binding in the CFC.  

The government argued that if the Second Circuit concluded that § 1346(a)(1) applies to suits for overpayment interest but affirmed the SDNY because of the statute of limitations issue, it should not transfer the case because it was not timely when originally filed in the SDNY.  This struck me as over-reaching.  The CFC does not apply the Code statute of limitations to these cases and under the CFC’s jurisdictional statute (more discussion below), it would have been timely filed.   The argument that transfer would not be in the interests of justice because Pfizer had successfully resisted transfer under the first motion of dismiss might carry more weight.  In any event, the government said that it would not oppose transfer if the Second Circuit concluded that § 1346(a)(1) does not apply to suits for overpayment interest.  That is the result the government was hoping for.

On September 16, 2019, the Second Circuit ruled – and the government got exactly what it was hoping for.  The court disagreed completely with the analysis by the district court and in E.W. Scripps Co. v. United States, 420 F.3d 589 (6th Cir. 2005).  The text in § 1346(a)(1) that those decisions relied on – “a sum alleged to have been excessive or in any manner wrongfully collected” – did not apply to suits for overpayment interest.  Read in harmony with the rest of the statute, that would “plainly refer to amounts the taxpayer has previously paid to the government and which the taxpayer now seeks to recover.”  Further, “any sum alleged to have been excessive or in any manner wrongfully collected” is written in present-perfect tense, indicating that “excessive” or “wrongfully collected” occurred in the past, that is, an assessment previously paid by the taxpayer.  Finally, dicta in Flora v. United States, 362 U.S. 145 (1960), stating that “any sum” would encompass interest, was clearly referring to underpayment interest based on the context.  The Second Circuit therefore transferred the case to the CFC.

Judge Lohier filed a concurrence to point out that if the district court had jurisdiction under § 1346(a)(1), it would have been subject to the Code statute of limitations and Pfizer would have lost anyway.  He rejected Pfizer’s attempt to disassociate § 1346(a)(1) and section 7422 of the Code.  Keith and Carl had filed an amicus brief arguing that even if the filing deadline in section 6532(a) applies, it is not jurisdictional and is subject to estoppel or equitable tolling arguments.  The judge rejected equitable tolling in a footnote due to the lack of an “extraordinary circumstance” but did not mention estoppel.  But it’s a footnote in a concurrence, so this is still an open question.

I found the statutory interpretation in this decision much more persuasive than that in Scripps, although the statute may be sufficiently ambiguous that other courts could reasonably disagree.  In any event, this is a significant milestone.  Before Pfizer, Scripps was the only other Circuit Court decision to have directly ruled on this issue.  (Sunoco, Inc. v. Commissioner, 663 F.3d 181, 190 (3d Cir. 2011) suggested the same interpretation, but that was dicta.)

What effect will this have on other cases?  On October 7th, in Estate of Culver v. United States, the district court for the District of Colorado also adopted the reasoning of the Second Circuit and transferred that case to the CFC.  Even district court decisions disagreeing with Scripps have been rare, so this may also be a sign that the tide is turning.  As with Bank of America, an immediate appeal of that order would go to the Federal Circuit.

As one might expect, the government quickly brought the Pfizer decision (on September 18th) and the Culver decision (October 7th) to the attention of the SDF in the Paresky case.  If the district court judge is influenced by Pfizer and rejects the magistrate judge’s report and recommendation, the Pareskys may have to appeal to the Eleventh Circuit and hope that court agrees with Scripps

It will be a while before we see what effect, if any, Pfizer has in the Bank of America case, where there has also been a new development.  I’ll turn to that in Part Two.

The EITC Ban – Further Thoughts, Part Three

Guest blogger Bob Probasco returns with the third and final post on the ban for recklessly or fraudulently claiming refundable credits. Part Three tackles the ban process.

The first two parts of this series (here and here) addressed judicial review of the EITC ban. The National Taxpayer Advocate’s Special Report on the EITC also made several recommendations about improvements during the Exam stage. The report is very persuasive (go read it if you haven’t already). In Part One, I quoted Nina’s preface to the report, which says that she is “hopeful that it will lead to a serious conversation about how to advance the twin goals of increasing the participation rate of eligible taxpayers and reducing overclaims by ineligible taxpayers.” Part Three is my small contribution to the conversation, concerning the ban determination process.

About that “disregard of rules and regulations” standard

The ban provision refers to a final determination that the taxpayer’s claim of credit was due to “reckless or intentional disregard of rules and regulations.” This standard seems to have been imported from section 6662, although there it covers not only reckless or intentional disregard but also negligent disregard. It seems a strange standard in this context, though.

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The accuracy-related penalty regulations, § 1.6662-3(b)(1), state that disregard of rules and regulations is not negligent, let alone reckless or intentional, if there is a reasonable basis for the return position. But the definition of reasonable basis, § 1.6662-3(b)(3), cross-references the types of authority, § 1.6662-4(d)(3)(iii), applicable to determining whether there was substantial authority for a return position. And those are legal authorities. Arguably, the “disregard of rules and regulations” standard – for the EITC ban as well as the accuracy-related penalty – carries with it an unexamined implication that the facts are known and indisputable; only the application of the law to those facts is at issue.

Such a standard may make a lot of sense with respect to the accuracy-related penalty, at least for sophisticated taxpayers with good records. Those of us who deal a lot with low-income taxpayers and the EITC, however, know that often the credit is disallowed because the taxpayer’s proof is not considered sufficient. It’s a factual dispute, rather than a dispute as to what the law means.

Osteen v. Commissioner, 62 F.3d 356 (11th Cir. 1995) has some interesting discussion of this distinction in the context of the substantial understatement penalty. The very first sentence of the case mentions “certain tax deductions attributable to their farming and horse breeding operations,” so we know that section 183 is going to be the focus. The taxpayers, both of whom were employed full-time, were breeding and raising Percheron horses with the expressed intent to train them, show them, use them to operate a horse-powered farm, and then sell them. The Tax Court opinion, 66 T.C.M. 1237 (1993), determined that the taxpayers did not have “an actual and honest objective of making a profit,” and the Eleventh Circuit concluded that the court’s determination was not clearly erroneous.

The penalty discussion took much longer than the analysis of the profit objective issue. The Tax Court had rejected the petitioners’ penalty defense, which was based on substantial authority, and that puzzled the Eleventh Circuit:

The application of a substantial authority test is confusing in a case of this kind. If the horse breeding enterprise was carried on for profit, all of the deductions claimed by the Osteens would be allowed. There is no authority to the contrary. If the enterprise was not for profit, none of the deductions would be allowed. There is no authority to the contrary. Nobody argues, however, not even the Government, that because the taxpayers lose on the factual issue, they also must lose on what would seem to be a legal issue.

The court reversed on the penalty issue and said that “substantial authority” for a factual issue is met if a decision in the taxpayers’ favor would not have been clearly erroneous:

If the Tax Court was deciding that there was no substantial authority because of the weakness of the taxpayers’ evidence to establish a profit motive, we reverse because a review of the record reveals there was evidence both ways. In our judgment, under the clearly erroneous standard of review, the Tax Court would be due to be affirmed even if it had decided this case for the taxpayers. With that state of the record, there is substantial authority from a factual standpoint for the taxpayer’s position. Only if there was a record upon which the Government could obtain a reversal under the clearly erroneous standard could it be argued that from an evidentiary standpoint, there was not substantial authority for the taxpayer’s position.
 
If the Tax Court was deciding there was not substantial legal authority for the deductions, we reverse because of the plethora of cases in which the Tax Court has found a profit motive in the horse breeding activities of taxpayers that were similar to those at hand.

For those interested in the “factual issue versus legal authority” question, there was also an interesting article by Bryan Skarlatos in the June-July 2012 issue of the Journal of Tax Practice & Procedure: “The Problem With the Substantial Authority Standard as Applied to Factual Issues.”

This is not directly applicable to the EITC ban but a similar approach seems reasonable. A determination in Exam to disallow the EITC often merely means “the taxpayer didn’t prove that she met the requirements,” rather than “the taxpayer didn’t meet the requirements.” But I suspect that some or many of those who make the ban determination proceed with an assumption, implicit if not explicit, that the former is the equivalent of the latter. If the taxpayer doesn’t meet her burden of proof, that may suffice for denying the credit in the conduct year but may not be enough to impose the ban for future years.

For example, one of the three scenarios in IRM 4.19.14.7.1 (7), used as a starting point to help determine whether the ban is appropriate, addresses situations in which the taxpayer provided insufficient documentation but “indicates they clearly feel they are eligible, and is attempting to prove eligibility and it is clear they do not understand.” In those circumstances, the technician is supposed to “[c]onsider the taxpayer’s lack of understanding” before asserting the ban. There is no reference to the relative strength or weakness of the support offered. That formulation strongly supports an assumption by the technician that (understanding the rules + insufficient documentation), rather than (understanding the rules + not meeting the requirements), is sufficient to assert the ban. If so, that’s a problem.

Recommendations for a revised ban recommendation process

The Office of Chief Counsel issued Significant Service Center Advice in 2002 (SCA 200245051), concluding that neither the taxpayer’s failure to respond to the audit nor a response that fails to provide adequate substantiation is enough by itself to be considered reckless or intentional disregard of rules and regulations. That conclusion is also set forth in IRM 4.19.14.7.1 (1): “A variety of facts must be considered by the CET [correspondence examination technician] in determining whether the 2-Year Ban should be imposed. A taxpayer’s failure to respond adequately or not respond at all does not in itself indicate that the taxpayer recklessly or intentionally disregarded the rules and regulations.”

But, as the Special Report points out, the guidance in IRM 4.19.14.7.1 (7) is erroneous and/or woefully inadequate for the CET’s. And research described in the National Taxpayer Advocate’s 2013 Annual Report to Congress showed an incredibly high error rate in the ban determination. The Special Report recommends that the IRS develop a ban examination process independent from the audit process, modeled on other means-tested programs, to improve accuracy and provide adequate due process protections. The report also mentions several recommendations from earlier annual reports. For example, in the 2014 Annual Report to Congress, the NTA recommended (again) that a single IRS employee be assigned to work any EITC audit in which the taxpayer calls or writes to respond.

The Special Report didn’t, and couldn’t, define the appropriate process in depth. That is something that the IRS, in consultation with TAS, will have to develop, and it may take a significant amount of time. But while we’re waiting for that, here are suggestions for some specific parts of a revised process that would be on my wish list.

First, the ban determination process should incorporate the concept of the strength of evidence for and against eligibility. The ban should be asserted only when the evidence against eligibility is significantly stronger than evidence for eligibility. The inability to provide evidence for eligibility is not equivalent to deemed evidence against eligibility. And some types of evidence against eligibility will be stronger or weaker than other types.

Second, the process for determining eligibility for the credit should expand the types of evidence that can be submitted and considered, which in turn will affect the relative strength of evidence to be considered during the ban determination phase. The standard audit request and the IRM 4.19.14-1 list focus on third-party documents. Third-party documents are strong evidence but they’re not the only evidence; they’re just the only evidence Exam seems to accept. The IRS experimented with allowing third-party affidavits in test cases from 2010-2013. Starting with tax year 2018, taxpayers can submit third-party affidavits (signed by both the taxpayer and the third party) to verify the residency of qualifying children (IRM 4.19.14.8.3). Why not for other aspects of the eligibility determination? Why not talk directly with the taxpayer and assess credibility?

This is a pet peeve of mine. It’s frustrating to receive a notice of deficiency (because the technician did not accept other types of evidence) and then get a full concession by the government in Tax Court (because the IRS attorney understands the validity of testimony as evidence). I like getting the right result but would prefer to avoid the need to go to Tax Court, delaying the resolution. As the Special Report points out, the IRS cannot properly determine whether to assert the ban without talking to the taxpayer. If a technician/examiner is talking to the taxpayer for that, and assessing their understanding of the rules and regulations, why not also accept verbal testimony (or statements by neighbors and relatives) and evaluate credibility, to accurately evaluate the strength of the evidence for eligibility and therefore the propriety of imposing the ban?

Conclusion

The Special Report would, if its recommendations were implemented, transform a critically important benefit to low-income taxpayers. Nina, Les, and the rest of the team did a fantastic job. It will be a long, hard fight to achieve that transformation but it will be worth it.