Goldring Is Back – With a Circuit Split

Last year, I wrote a couple of blog posts (here and here) about an order by the Eastern District of Louisiana: Goldring v. United States, 2020 U.S. Dist. LEXIS 177797, 2020 WL 5761119 (E.D. La. Sept. 28, 2020).  A significant amount was at issue, so the Goldrings appealed to the Fifth Circuit, which issued its decision recently: Goldring v. United States, 2021 U.S. App. LEXIS 29832, 2021 WL 4520343 (5th Cir. Oct. 4, 2021). 

The primary issue in the case was the proper treatment of a settlement award resulting from a 1997 cash-out merger of a privately held corporation in which Ms. Goldring owned shares.  Instead of taking the offered amount, she sued the company and its directors, asserting claims of unfair dealing and breach of fiduciary duty and seeking either the fair value of those shares or to retain her 15% stake.  The state court held that her shares were worth more than twice the amount she was offered in the merger. 

In 2010, she received a total award of almost $41 million, including $13,684,800 for the fair value of her shares, $26,252,741 for pre-judgment and post-judgment interest (“Interest Award”), and various other fees and costs.  The taxpayers reported the entire award on their 2010 tax return as a long-term capital gain.  The IRS audited the return, concluded that the Interest Award should have been reported as ordinary income, and assessed a deficiency of $5,250,549 plus interest in 2017.  The taxpayers challenged that deficiency in a refund suit, but both the district court and the Fifth Circuit ruled for the government on this issue.

But that’s not what I’m here to tell you about.  I’m here to talk about the procedural issue of how underpayment interest should be computed on that deficiency.

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The underpayment interest issue involved the treatment of “credit-elect transfers.”  The rule for this is relatively unknown, as it is set forth only in caselaw and a Revenue Ruling, rather than in the Code.  The plaintiffs in this case sought to expand the rule (a) beyond the situations in which it was first applied and (b) in a way that the only Circuit Court to have ruled on the question had rejected.  That earlier decision was FleetBoston Fin. Corp v. United States, 483 F.3d 1345 (Fed. Cir. 2007).  The district court in Goldring followed the majority decision in FleetBoston and granted summary judgment to the government.  The Circuit Court overruled the district court on this issue and ruled consistently with some lower court cases and the dissent in FleetBoston.

More details are available at the earlier blog posts, but for now here’s a simplified version of facts that would raise the issue:

  • Taxpayer files tax return for Year 1 (after requesting extension) on October 15th, showing tax liability of $220,000 and payments (withholding or estimated tax payments) of $270,000, for a net overpayment of $50,000. 
  • Taxpayer elects to have the $50,000 applied to estimated taxes for Year 2, instead of getting a refund.
  • IRS audits the Year 1 tax return and determines that the proper tax liability was $260,000 instead of $220,000, a $40,000 deficiency.

Section 6601(a) says that underpayment interest is imposed if the “amount of tax imposed . . . is not paid on or before the last date prescribed for payment.”  As of that last date prescribed, April 15th of Year 2, Taxpayer had paid $270,000 against the re-determined tax liability of $260,000.  Under a literal reading of the statute, the government can’t impose deficiency interest at all.  However, courts decided to interpret section 6601(a) to mean that interest started running when the tax was “due and unpaid.”  This itself was, of course, a favorable result for the government, which otherwise couldn’t collect any interest at all.

The tax became “unpaid” not on April 15th of Year 2, but when the $50,000 was applied to a different tax year.  On the effective date of the credit – equivalent to a refund for Year 1 and payment for Year 2 – the $50,000 left the account for Year 1 and was moved to Year 2.  At that point, the tax liability as redetermined is $260,000 and the payments, net of the credit, are only $220,000.  At that point, the tax is “due and unpaid” and underpayment interest starts running.

But what was the effective date of that credit to Year 2?  The date that the return for Year 1 was filed, making that election to apply the overpayment shown on the return to Year 2’s estimated taxes?  The date of the specific installment of Year 2’s estimated taxes that Taxpayer chose as where the overpayment should be applied?  Something else?  Eventually, the courts and the IRS reached a taxpayer-favorable rule, which was recorded in Revenue Ruling 99-40 :

When a taxpayer elects to apply an overpayment to the succeeding year’s estimated taxes, the overpayment is applied to unpaid installments of estimated tax due on or after the date(s) the overpayment arose, in the order in which they are required to be paid to avoid an addition to tax for failure to pay estimated income tax under sections 6654 or 6655 with respect to such year. 

. . .

When a taxpayer reports an overpayment on its income tax return, interest will be assessed on that portion of a subsequently determined deficiency for the overpayment return year that is less than or equal to the overpayment as of: (1) the date on which the Service refunds the overpayment without interest; or (2) the date on which the overpayment is applied to the succeeding year’s estimated taxes.

The assumption was that, if the transfer from Year 1 were not needed because Taxpayer’s other payments were sufficient to cover the Year 1 tax liability, the remainder would be refunded.  But what if it weren’t?  Let’s revisit that simple example.

  • Taxpayer files tax return for Year 1 (after requesting extension) on October 15th, showing tax liability of $220,000 and payments (withholding or estimated tax payments) of $270,000, for a net overpayment of $50,000. 
  • Taxpayer elects to have the $50,000 applied to estimated taxes for Year 2, instead of getting a refund.
  • Taxpayer doesn’t need the $50,000 to meet its obligations for estimated taxes in Year 2.  It is part of an overpayment for Year 2 that Taxpayer elects to have applied to estimated taxes for Year 3, instead of getting a refund.
  • Taxpayer doesn’t need the $50,000 to meet its obligations for estimated taxes in Year 3, either.  It is part of an overpayment for Year 3 that Taxpayer elects to have applied to estimated taxes for Year 4, instead of getting a refund.
  • IRS audits the Year 1 tax return and determines that the proper tax liability was $260,000 instead of $220,000, a $40,000 deficiency.
  • Taxpayer doesn’t need the $50,000 to meet is obligations for estimated taxes in Year 4, either.  It is part of an overpayment for Year 4 and the government applies $40,000 of the overpayment to pay the deficiency in Year 1.

That, in simplified form, is what the Goldrings did.  They anticipated that the IRS might conclude that the Interest Award was ordinary income, so they left money with the IRS to cover any eventual deficiency and avoid interest on that deficiency.  Making a deposit would have been a more certain way to avoid interest on the eventual deficiency, but that’s not what they did.

The caselaw and Revenue Procedure didn’t address this situation.  A few lower courts, and the dissent in FleetBoston, concluded that underpayment interest for the Year 1 deficiency wouldn’t start running until it was applied to Year 4 effective as of April 15th, 2015 – the last date prescribed for payment.  Under that approach, the amount of interest Taxpayer had to pay on the $40,000 deficiency was minimal.  The majority in FleetBoston, however, said once Taxpayer decides to transfer the $50,000 from Year 1 to Year 2, that amount should be treated as leaving the account for Year 1 and moving to the account for Year 2 no later than the date prescribed for payment for Year 2.  The district court in Goldring agreed with FleetBoston, but the Fifth Circuit didn’t.

The Fifth Circuit’s reasoning was not entirely clear.  I argued in the earlier blog posts on the district court decision that a ruling contrary to FleetBoston might be reasonable.  For example, a court might conclude that the previous line of rulings – a one-time application of the overpayment to estimated taxes for the following years – could be extended to situations when a taxpayer continuously rolls the amount forward for several years.  The earlier courts determined that the overpayment moved to Year 2 as of the date the taxpayer would receive a benefit (avoiding the penalty for failure to pay estimated taxes) in Year 2. If there was no benefit in Year 2, because it is neither used for estimated tax obligation nor refunded, the IRS treats the transfer from Year 1 as effective on the unextended filing date for Year 2.  Would the same principle apply to cover rollovers to Year 3, Year 4, etc.?  That is, is the money treated as remaining in the account for Year 1 – and the tax liability there is not “due and unpaid” – until the taxpayer receives a benefit in a future year, either by application to estimated taxes or refund?  Possibly, although that is not consistent with how these amounts are reported on Form 1040 for Year 1, Year 2, Year 3, etc.  But the Fifth Circuit did not rule narrowly in that way. 

The court focused on a broad statement of the purpose of interest.  “Under the use-of-money principle, a taxpayer is liable for interest only when the Government does not have the use of money it is lawfully due.”  Mentioning “use-of-money” is guaranteed to raise the hackles of DOJ Tax Division, which rejects taxpayer arguments to treat this as a broad equitable principle rather than a limited tool of statutory interpretation. 

I think the caselaw for the most part is consistent with DOJ Tax Division’s viewpoint.  Some of the so-called use-of-money cases have made broad statements such as that, but their actual holdings have been much narrower.  They involved either (a) determining the effective date of changes in tax liability, as later than when underpayment interest generally starts or (b) determining the effective date of changes in the amount paid.  Category (a) revolves around whether the change is due to “subsequent operational events”; category (b) involves crediting an overpayment to the following year’s estimated taxes, the first simplified example above.  Courts have for the most part used the principle to interpret specific statutory provisions in unusual circumstances, rather than as an all-purpose argument for equitable results.

The court did not think much of the government’s argument.  “Further, like the FleetBoston majority, the Government’s argument in this case fixates on theoretical migration of credit-elect overpayment funds from one tax year to another.”  I think describing it as “theoretical” is a bit much.  One of the long-standing, fundamental principles of tax administration is that tax liabilities and payments are accounted for separately by taxpayer, type of tax, and tax period.  Movement of funds, from one tax period to another, is subject to specific procedures and restrictions.  This treatment of credit-elect transfers is no more “theoretical” than applying any funds received from a taxpayer to the tax period the taxpayer specifies.

As support for its conclusion, the court stated that the government “completely ignores the simple, undisputed fact that the IRS was never deprived of its use of the money the Goldrings lawfully owed it at any point during the five-year underpayment interest assessment period.”  I think the court is effectively asserting a broad “netting” principle – that an overpayment in any tax year can be used to offset an underpayment in another tax year to reduce interest on the latter.

The problem with this argument is that the netting provision enacted by Congress has a narrower scope and arguably prohibits what the Fifth Circuit did in Goldring.  Section 6621(d) states:

To the extent that, for any period, interest is payable under subchapter A and allowable under subchapter B on equivalent underpayments and overpayments by the same taxpayer of tax imposed by this title, the net rate of interest under this section on such amounts shall be zero for such period.

This only applies, based on its literal terms, when interest is payable on the underpayment and allowable on the overpayment.  But the amounts transferred to Year 2, then Year 3, then Year 4 never would have accrued overpayment interest, under the regulations for such transfers.  (Second 6621(d) is really for the benefit of corporations, who for the same period might pay a higher interest rate on underpayments than the interest rate they receive on overpayments.)  You can argue for a broader application of netting between tax periods than provided by section 6621(d), but that conclusion is not necessarily easy to reach.  The question you have to answer:  If Congress didn’t intend to exclude that possibility, why did they include the limitation that interest must be payable on the underpayment and allowable on the overpayment?

I’m not opposed to the result per se, but I’m not convinced by the opinion.  I would prefer to see a more analytical approach along one or both of these lines – narrow expansion of the previous line of cases; or broad netting between tax periods.  I would prefer that the decision recognize and address the difficulties and limitations in reaching that answer, rather than rely on a broad equitable principle.  However, the courts decide these issues, not me, and the judges are normally generalists, rather than tax experts.  As the Fifth Circuit said in Cornelius v. Commissioner, 494 F.2d 465 (5th Cir. 1974):

Ours has been the more mundane assignment of contouring the codified curlicues of Subchapter S to the Code’s synoptic minutiae. Being mere mortals unendowed with cosmic tax wisdom, we have performed our task as well as our fallible mentalities and compositions will permit.

Where do we go from here?  The government filed a petition for a rehearing en banc on November 18th.  Based on the DOJ Tax Section’s opinion of “use-of-money,” I wasn’t at all surprised.  There is, of course, no guarantee that the court will grant a rehearing or that the en banc court would reach a different decision.

So, assuming the decision is not reversed by an en banc rehearing, we have a new circuit split.  In recent years we’ve seen a lot of activity with respect to a different interest issue for which a circuit split developed.  I doubt that we’ll see the same swift development here that we saw there; there are fewer of these “rolling credit-elect transfer cases” than taxpayers seeking to bring stand-alone suits for overpayment interest in district court.  But we’ll see.

When Is a Late Return Not Really “Late”?? – Part 2

Bob Probasco picks up from his post last week and continues discussing the tricky issue of when interest starts to accrue on refunds when the taxpayer may not have known that they had a return filing obligation on the due date of the return. Les

And now some observations and questions about that recent IRS legal memo on an overpayment interest issue.  The memo relied substantially on two cases addressing similar situations: MNOPF Trs. Ltd. v. United States, 123 F.3d 1460 (Fed. Cir. 1997) and  Overseas Thread Indus. v. United States, 48 Fed. Cl. 221 (2000).  (The Overseas Thread scenario is virtually identical to that in the memo.)  Normally, taxpayers receive overpayment interest from the filing due date of the return, if all payments that make up the overpayment were made by then.  These cases involved a statutory provision, Section 6611(b)(3), under which if the return is filed late, taxpayers do not receive overpayment interest before the date the return was filed. 

MNOPF established the principle that a return cannot be “late” if the taxpayer was not required to and did not file a tax return.  Overseas Thread addressed the situation of a foreign corporation that did not have a U.S. trade or business and therefore was not required to file an income tax return – but had to do so to claim a refund of excessive withholding tax on dividends from a U.S. source.  The court in that case determined that the tax return filed to claim a refund of an overpayment was only required by the normal filing date, and therefore late if not filed by then, if the taxpayer knew of the overpayment before the prescribed filing date.  Part I provided background on those two cases and the legal memo.  I think Overseas Thread and the memo leave a lot of questions, and they may be incomplete or even wrong.  Those rulings also could be applied much more broadly than the specific fact pattern they address. 

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What About Delays After Discovery?

Neither Overseas Thread nor the memo directly mentioned another obvious question.  Is the lack of knowledge, by the return due date, of a filing obligation a “blank check” for filing the return at a much later date?  In Overseas Thread, the delay between discovery of the filing obligation and filing the return was relatively short – at most from early October to mid-February.  What if TFI and OTI had waited another year or two to accrue additional interest?

The potential for a taxpayer to “park” money with the IRS at long as possible, earning interest at rates higher than the taxpayer could earn otherwise, may seem very counter-intuitive to those of us who deal with low-income taxpayers.  Their primary objective is getting a refund quickly, not the amount of interest payable.  But Treasury/IRS has expressed a similar concern in some contexts in the past.  (Perhaps that’s what Section 6611(b)(3) is all about – preventing such actions.  An alternative interpretation might be that it’s the flip side of the penalty of Section 6651(a) for filing a return late, which has no teeth when there was no balance due on the return.  I don’t think I’ve ever looked at the legislative history, and that might not explain it anyway.)

The analysis in Overseas Thread seems to allow this very behavior.  If the taxpayer didn’t know of the filing obligation by the normal return due date, Section 6611(b)(3) won’t apply.  Perhaps in another case with a longer delay between discovery of the filing obligation and filing the return, a court might impose a requirement to file within a reasonable time – but it might not.  If it did, that would further complicate the administration of Section  6611(b)(3).

Should The Determination of Whether a Return Was “Late” Depend on the Taxpayer’s Knowledge?

Les pointed out in his post that a knowledge standard – when the taxpayer realized there was an overpayment for that tax period – is extremely difficult to administer and a bright line rule would be much better.  I agree as a practical matter, but I also question whether a knowledge standard is appropriate from a theoretical perspective.  How exactly did Overseas Thread come up with the knowledge standard?

Essentially, it comes down to two provisions of a regulation, that the court was trying to reconcile.  The general rule under Section 6012 is that all corporations are required to file income tax returns “regardless of whether it has taxable income or regardless of the amount of its gross income.”  Treas. Reg. § 1.6012-2(a)(1).  One relevant provision in the regulation, Treas. Reg. § 1.6012-2(g)(2)(i)(a), creates an exception to the general rule:

A foreign corporation which at no time during the taxable year is engaged in a trade or business in the United States is not required to make a return for the taxable year if its tax liability for the taxable year is fully satisfied by the withholding of tax at source under chapter 3 of the Code.

But there’s an exception to the exception in Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2), which states that the preceding exception does not apply:

To a foreign corporation making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year

The court came up with the knowledge standard in an attempt to reconcile those two provisions without creating preposterous or odd results.  The odd result the court saw was that these foreign corporations would have to: (1) always file income tax returns, just because they might later determine that they had an overpayment; or (2) risk not maximizing the overpayment interest they receive.  Of course, taxpayers frequently face the question of whether to file protective claims as a deadline approaches.  And taxpayers often face consequences from delays.

As you read Part 1, you probably were thinking of United States v. Boyle, 469 U.S. 241 (1985), weren’t you?  The Court there held the taxpayer, who relied on an attorney to file an estate tax return, liable for a penalty for late filing.  Reliance on an advisor was not “reasonable cause” to avoid the penalty when the issue was the filing date for the return, as “[i]t requires no special training or effort to ascertain a deadline and make sure that it is met.”  But the Court also mentioned that reliance on a tax adviser might constitute reasonable cause, when the advice was that it was unnecessary to file a return.  I’ve made an argument like that in the context of gift tax.  It might apply here, where the issue was whether part of the distribution was a return of capital rather than a dividend.

But Boyle involved the failure to pay penalty, which has a reasonable cause exception.  There is no such statutory defense to interest.  (The taxpayer in Boyle conceded the interest assessed.)  The taxpayer’s knowledge or intent is very, very rarely relevant to the application of interest provisions.  Perhaps the temporary higher interest rate for a “tax motivated transaction,” or the distinction between a deposit and a payment, but what else?  There’s a good reason for this – interest is not a penalty, it’s simply a payment for the use of the other party’s money.  It’s based on objective criteria rather than the taxpayer’s state of mind.

Thus, I’m not sure whether the knowledge standard really makes sense in Overseas Thread (and by extension, in the legal memo).  I understand the court trying to reach an equitable result, but creating a difficult-to-administer standard is not an ideal solution.

What would a bright-line rule be?  Well, one straight-forward answer would be that Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) explicitly nullifies the exception to the filing requirement; therefore, the return was required, was late, and Section 6611(b)(3) applies.

Of course, that’s not the only possible bright-line rule.

Filing Obligation versus . . . ???

Take another look at Treas. Reg. § 1.6012-2(g)(2)(i)(a) and (b)(2).  I think the Overseas Thread court may have been thinking that they meant something along the lines of:

Normally, you don’t have to file a return under your circumstances but if we owe you money, you’d better file a return and you’d better do it timely!  We want to make sure we get the return by the usual deadline so that we can get your refund to you sooner!

Does that sound like the IRS to you?  Me neither (except when Congress is pushing for quick payments, such as with the economic impact statements and the Advance Child Tax Credit).  If your taxes withheld exceed your tax liability, the IRS is glad to refund that but their feelings aren’t hurt if you don’t ask for it.  And indeed, some taxpayers in that situation don’t bother with filing a return if the overpayment was relatively minor, and as far as know the IRS won’t follow-up to ask about it.

Arguably, Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) is better read as a claims submission rule.  It says that the exception to filing an income tax return for that foreign corporation does not apply:

To a foreign corporation making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year

Not “To a foreign corporation with an overpayment.”  Instead, “To a foreign corporation making a claim . . . for the refund of an overpayment.”  That suggests the proper interpretation would be, paraphrased broadly:

Normally, you don’t have to file a return under your circumstances, because as defined in the exception of § 1.6012-2(g)(2)(i)(a), your tax liability has been fully satisfied. If you choose to file a refund claim – the subject of § 301.6402-3 – though, you must do it on an income tax return form instead of Form 843.

That sounds more like the IRS, doesn’t it?  They won’t insist on a refund claim, but if you file one, please do it on the form for an income tax return or amended return, rather than Form 843.  Indeed, Treas. Reg. § 301.6402-3 allowed refund claims for income tax to be made on Form 843 for many years; that possibility was only eliminated for claims filed after 6/30/76.  Check out T.D. 7410, 1976-1 C.B. 384.  A technical memorandum from the IRS to the Assistant Secretary of the Treasury on 1/21/76, transmitting the T.D., made that purpose explicit.  Case law allowed taxpayers broad discretion regarding what would be considered a valid refund claim; that itself is further support for the conclusion that an income tax return on Form 1120-F was not required in Overseas Thread.  But the IRS could issue regulations to “encourage” taxpayers to file refund claims on tax returns rather than Form 843. 

As noted in Part 1, in the MNOPF case, the taxpayer originally claimed the refund on Form 843.  The IRS rejected that, stating: “A return must be filed to claim the refund, even if in past years you have received refunds by filing only Form 843 without a return.”

If Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) is only about how the refund claim is submitted, but not a requirement to file an income tax return, and caselaw recognizes refund claims that aren’t on income tax returns, arguably there is no obligation to file an income tax return.  Whether a refund claim is filed late is defined by Section 6511 rather than Section 6072.  The “return” therefore was not filed late and Section 6611(b)(3) does not apply. 

That seems like a plausible interpretation of the regulation, and personally I prefer it to that implied by Overseas Thread

Note that this wouldn’t apply broadly to any Form 1040 showing an overpayment.  There is a general obligation to file income tax returns that would apply unless Congress has explicitly stated an exception under which taxpayers need not file, such as Treas. Reg. § 1.6012-2(g)(2)(i)(a).  So, if I file my income tax return (requesting a refund) late, I’m still subject to Section 6611(b)(3) and won’t receive interest for the period before the return is received.

Is This Just About Foreign Corporations With No U.S. Trade or Business?

If it were, Overseas Thread and this legal memo would have relatively little impact.  But there are other situations in which taxpayers are excused from filing an income tax return, but still must do so to claim a refund.  Most common: an individual or married couple whose gross income is less than the sum of the basic standard deduction and exemption amount – unless they have at least a minimum amount of earnings from self-employment.  Sections 6012(a)(1) and 6017 set forth the filing obligations; unlike (domestic) corporations, individuals with no taxable income or self-employment income are excused from filing.  But they may file refund claims, because of withholding and/or refundable credits, and the IRS wants those to be filed on Form 1040. 

These taxpayers will usually know that they have an overpayment.  Most, particularly if they have large refundable credits, will file well before the normal filing deadline.  But if the overpayment is from a small amount of withholding, some may not bother until after the normal filing deadline, perhaps well after.  They would likely to lose under the knowledge standard of Overseas Thread, but under the alternative plausible interpretation above, they wouldn’t. 

How is the IRS handling these now?  I don’t know, but a bright-line rule based on whether the return was filed by the normal filing deadline would be much easier to program.  Of course, the amount of interest lost in these circumstances will be minimal in individual cases.  But I’m curious.  The next time one of my clinic clients has filed a tax return after the normal filing deadline, I may check the calculation of interest.    

When Is a Late Return Not Really “Late”?? – Part 1

Today guest poster Bob Probasco walks us through the case law and recent IRS memo addressing a foreign corporation which files a return after a normal due date because it only later realizes it has a filing obligation. The issue is one I recently discussed but in today’s first of two parts Bob digs deeper. Les

The IRS released a legal memo recently on an issue I had never thought of before.  Would a tax return by a foreign corporation claiming a refund, filed after the normal filing date, be considered “late,” when the corporation did not realize by the filing deadline that it had a filing obligation at all?  That has implications for how much interest the IRS must pay on the refund.  Les wrote a great post about it.  As I reviewed the memo and related cases, though, I had some nagging questions that Les didn’t have time to address.  (The memo was released on Friday and Les’s post was up early Monday, before I saw the memo itself on Tax Notes Today.)  So, here I am.

Part 1 provides some additional background from the previous court cases and then the recent IRS legal memo.  Part 2 then moves on to those questions – I always have questions – and some very tentative possible answers: this memo may not only be wrong but also apply more broadly than realized. 

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The legal memo follows two particularly relevant court cases, which provide a good background for the discussion.

MNOPF Trustees, Ltd.

MNOPF Trs. Ltd. v. United States, 123 F.3d 1460 (Fed. Cir. 1997) involved foreign entities that were trustees of pension funds of the British merchant marine.  (There were two different entities involved, but from here on I will just refer to “MNOPF.”)  It was a tax-exempt labor organization (Section 501(c)(5)), had no business income in the United States, and therefore was not required to file income tax returns.  However, it invested in securities of U.S. corporations and received dividend payments.  The custodian banks which received the payments withheld thirty percent and transmitted the withheld amount to the IRS, with an annual return on Form 1042.  The banks improperly withheld the 30% from MNOPF’s dividends, since it was tax-exempt; MNOPF filed refund claims on Form 843 in December 1987 for amounts withheld on dividends paid in 1985 and 1986.

The IRS rejected the Forms 843, stating “A return must be filed to claim the refund, even if in past years you have received refunds by filing only Form 843 without a return.”  The IRS also told MNOPF that it should file Form 1120-F.  MNOPF refused to do so, because it wasn’t a corporation, and instead filed Form 990-T, “Exempt Organization Business Income Tax Return,” in December 1989, although it did not have business income.  The IRS accepted that form and refunded the amounts withheld but paid overpayment interest only from the date it received the Form 990-T, because the return was filed late, relying on Section 6611(b)(3):

Notwithstanding paragraph (1) or (2) in the case of a return of tax which is filed after the last date prescribed for filing such return (determined with regard to extensions), no interest shall be allowed or paid for any day before the date on which the return is filed.

The Federal Circuit disagreed.  Treas. Reg. § 301.6402-3(a)(1) says: “In general, in the case of an overpayment of income taxes, a claim for credit or refund of such overpayment shall be made on the appropriate income tax return.”  The rest of the subsection encompasses both original income tax returns and amended tax returns as methods to make a refund claim.  But there was no “appropriate income tax return” for MNOPF since the regulation did not apply to tax-exempt organizations and MNOPF had no taxable liability.  The court concluded: “The Court of Federal Claims correctly held that a claim for refund is not a late-filed tax return when the organization is not required to and did not file a tax return.”  Therefore, overpayment interest would start running with the date of the overpayments, rather than the date MNOPF filed Form 990-T.  (Because MNOPF was tax-exempt, the date of the overpayment was the date that the custodian banks were required to file Form 1042.  That was the primary distinction between MNOPF and the next case.)

Overseas Thread Industries, Ltd.

Overseas Thread Indus. v. United States, 48 Fed. Cl. 221 (2000) moved to the subject very similar to that addressed by the IRS legal memo.  OTI was a foreign corporation with its principal office and headquarters in England and a United States subsidiary, TFI.  TFI made distributions to OTI in 1987, 1988, and 1989; at the time both TFI and OTI thought the distributions were taxable dividends.  TFI withheld five percent of the distributions, pursuant to the US-UK tax convention, and remitted the amount withheld to the IRS along with Form 1042.  OTI did not file an income tax return for those three years, because it was not engaged in a U.S. trade or business.

Sometime in the last quarter of fiscal year 1990 – roughly October through January – OTI determined that a portion of the distributions were non-taxable returns of capital, on which tax should not have been withheld.  TFI filed amended Forms 1042 at the end of January, and OTI filed Forms 1120-F in mid-February, reporting the amounts of the overpayments.  The IRS issued refunds in early 1992, but later demanded that OTI repay a portion of the associated interest, concluding that overpayment interest would start running only when the Forms 1120-F were filed in 1991, thereby treated as “late returns.” 

In its briefs for the cross motions for summary judgment, OTI argued that the returns were not “late.”.  That applies when the returns are not “required,” according to MNOPF.  OTI pointed to Treas. Reg. § 1.6012-2(g)(2)(i)(a), which creates an exception to the general rule that corporations must file income tax returns:

A foreign corporation which at no time during the taxable year is engaged in a trade or business in the United States is not required to make a return for the taxable year if its tax liability for the taxable year is fully satisfied by the withholding of tax at source under chapter 3 of the Code.

That makes sense.  The corporation is taxable on income that is not effectively connected with a U.S. trade or business at 30% (or lower if specified in a treaty).  The payor is required to withhold at that same amount.  The net amount will be $0; why require an income tax return??  (At least, that’s my recollection from my law school class on International Tax.  I haven’t really looked at that in the last 21 years.)

But the government, in its briefs, pointed to Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2), which states that the preceding exception does not apply:

To a foreign corporation making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year

The court concluded this was a “quandary” and stated its task as “to harmonize these provisions into a coherent whole that achieves the object of the regulation, yet does not yield preposterous or odd results.”  The government’s interpretation, though, leads to an odd result.  Foreign corporations that apparently qualify for the exception of Treas. Reg. § 1.6012-2(g)(2)(i)(a) would have to file a return at the filing due date anyway, simply because “an overpayment may be discovered in the future.” (emphasis added)  Failing to do so would “forfeit its ability to maximize interest on any resulting overpayment.”

The court’s solution: if the corporation were making a claim for refund “during the requisite filing period” it was required to file an income tax return by the normal deadline.  If the corporation “later discovers the existence of an overpayment after the close of the applicable income tax return filing period,” it would have to file a return to claim the refund but the return would not be considered a late-filed income tax return and Section 6611(b)(3) would not apply.  Apparently, the parties did not dispute when OTI discovered the overpayment, so the court’s solution decided the case in OTI’s favor.

The New IRS Legal Memo

I don’t think the memo really decided much beyond Overseas Thread.  It cited and quoted that case, along with MNOPF, and basically relied on those decisions.  The one thing perhaps new in the memo was that it was more explicit than Overseas Thread, in recognizing that the application of that rule might require information that the IRS might not have.  The field unit requesting advice did not specify that information, so the memo’s answer was not conclusive.

As Les pointed out in his post: “The knowledge standard raises significant challenges for tax administrators who may not be able to determine that knowledge on the face of a return.”  I agree whole-heartedly.  Particularly in cases like these, interest may be computed with minimal or no interaction with the taxpayer.  The computer may (?) automatically apply Section 6611(b)(3) based on the information available without anyone intervening to ask when the taxpayer became aware that there was an overpayment.  It would be up to the taxpayer to realize the IRS position was inconsistent with case law and claim additional interest.  I also would very much prefer a bright line rule.

In Part 2, I’ll turn to how the Overseas Thread court might have reached it decision without having to apply a knowledge standard.  I think that decision – or at least the rationale – arguably was wrong.  If so, that also suggests a particular direction in which the bright line rule should run.  Part 2 also addresses why this issue could affect many more taxpayers than foreign corporations without a U.S. trade or business.

Overpayment, or Not?

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

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

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

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

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

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

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

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

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

Asking For the Return of a Deposit

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

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

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

In Substance, A Determination of an Overpayment?

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

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

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

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

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

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

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

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

Above The Line versus Below The Line

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

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

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

But All Is Not Lost!

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

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

Complications from Extensions and Unprocessible Returns

Bob Probasco returns today with an important alert on overpayment interest. Christine

A few months ago, Bob Kamman flagged a number of surprising phenomena he’d observed recently, one of which related to refunds for 2020 tax returns.  Normally, when the IRS issues a refund within 45 days of when you filed your return, it doesn’t have to pay you interest.  That’s straight out of section 6611(e)(1).  Yet, taxpayers were getting refunds from their 2020 returns within the 45 day period and the refunds included interest.  As Bob explained, that was a little-known benefit of COVID relief granted under section 7805A.  Not only were filing and payment dates pushed back but also taxpayers received interest on refunds when they normally would not have.

On July 2, 2021, the IRS issued PMTA 2021-06, which raised two new wrinkles—one related to returns that were not processible; the other related to returns for which taxpayers had filed extensions.  How do those factors affect the results Bob described?

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Interest on Refunds Claimed on the Original Return

The general rule is that the government will pay interest from the “date of the overpayment” to the date of the refund.  Normally the “date of the overpayment” will be the last date prescribed for filing the tax return, without regard to any extension—April 15th for individuals—unless some of the payments shown on the return were actually made after that date.  But there are three exceptions applicable to refunds claimed on the original return: 

  • Under section 6611(b)(2), there is a “refund back-off period” of “not more than 30 days” before the date of the refund, during which interest is not payable.  In practice, this period is significantly less than 30 days.  See Bob Kamman’s post and the comments for details.
  • Under section 6611(b)(3), if a return is filed late (even after taking into account any extension), interest is not payable before the date the return was filed.
  • Under section 6611(e)(1), no interest is payable if the refund is made promptly—within 45 days after the later of the filing due date (without regard to any extension) or the date the return was filed.

Section 6611(b)(3) and (e)(1) affect when overpayment interest starts running, while section 6611(b)(2) affects when it ends.

Other Code provisions, however, may adjust this further.

When Is the Return Considered Filed?

This is where “processible” comes in.  Section 6611(g) says that for purposes of section 6611(b)(3) and (e), a return is not treated as filed until it is filed in processible form.  As the PMTA explains, a return that is valid under Beard v. Commissioner, 82 T.C. 766 (1984), may not be processible yet, because it omits information the IRS needs to complete the processing task.  IRM 25.6.1.6.16(2) gives an example of a return missing Form W-2 or Schedule D.  Those are not required under the Beard test, but the return cannot be processed “because the calculations are not verifiable.”  The PMTA also mentions a return submitted without the taxpayer identification number; still valid under the Beard test but the IRS needs the TIN to process it.

As a result, under normal conditions, if a valid but unprocessible return is filed timely, and a processible return is not filed until after the due date, the latter is treated as the filing date for purposes of section 6611(b)(3) and (e).  The return is late, so the taxpayer is not entitled to interest before the date the (processible) return was filed.  And the 45-day window for the IRS to issue a refund without interest doesn’t start until the (processible) return was filed.

And Now We Add COVID Relief

The previous discussion covered normal conditions, but today’s conditions are not normal  As we all recall, the IRS issued a series of notices in early 2020 that postponed the due date for filing 2019 Federal income tax returns and making associated payments from April 15, 2020, to July 15, 2020.  The IRS did the same thing for the 2020 filing season, postponing the due dates from April 15, 2021, to May 17, 2021.  (Residents of Oklahoma, Louisiana, and Texas received a longer postponement, to June 15, 2021, as a result of the severe winter storms.)

This relief is granted under authority of section 7508A(a)(1), responding to Presidential declarations of an emergency or terroristic/military actions.  For purposes of determining whether certain acts were timely, that provision disregards a period designated by Treasury—in effect, creating a “postponed due date.”  The acts covered are specified in section 7508(a) and potentially, depending on what relief Treasury decides to grant, include filing returns and making payments.  For the 2019 filing season, the IRS initially postponed the due date for payments and then later expanded that relief to cover the due date for filing tax returns.

(Yes, the section 7508A provision for Presidentially declared emergencies piggybacks on the section 7508 provision for combat duty.  As bad as the disruptions caused by COVID have been, I prefer them to serving in an actual “combat zone.”  Hurricane Ida, which I am also thankful to have missed, may be somewhere in between.  All get similar relief from the IRS.)

Section 7508A(a)(2) goes beyond determining that acts were timely.  It states that the designated period, from the original due date to the postponed due date, is disregarded in calculating the amount of any underpayment interest, penalty, additional amount, or addition to tax.  No penalties or underpayment interest accrue during periods before the postponed due date, just as they don’t accrue (in the absence of a Presidentially declared emergency) before the normal due date. 

That’s the right result, and section 7508A(a)(2) is necessary to reach it.  Section 7508A(a)(1) simply says that the specified period is disregarded in determining whether acts—such as payment of the tax balance due—are timely.  It doesn’t explicitly modify the dates prescribed elsewhere in the Code for those acts.  The underpayment interest provisions, on the other hand, don’t focus on whether a payment was timely.  Section 6601(a) says underpayment interest starts as of the “last date prescribed for payment” and section 6601(b) defines that without reference to any postponement under section 7508A.

What about overpayment interest on a refund?  Section 7508A(c) applies the rules of section 7508(b).  That provision tells us that the rule disregarding the period specified by Treasury “shall not apply for purposes of determining the amount of interest on any overpayment of tax.”  Great!  We won’t owe interest for that designated period—April 15, 2020 to July 15, 2020 for the first emergency declaration above—on a balance due, but we can potentially be paid interest for that period on a refund.

Section 7508(b) also states that if a postponement with respect to a return applies “and such return is timely filed (determined after the application of [the postponement]), subsections (b)(3) and (3) of section 6611 shall not apply.”  That certainly sounds reasonable with respect to 6611(b)(3); it’s a de facto penalty of sorts for filing late, but if you filed your 2019 tax return by July 15, 2020, that should be treated as though you had paid by the original due date of April 15, 2020. 

Section 6611(e)(1) is a little bit different.  It’s not a de facto penalty for late filing; it’s essentially (1) a recognition that processing returns and issuing refunds takes some minimal amount of time and (2) possibly a small incentive for the IRS to do that expeditiously.  But when Treasury grants relief after a Presidentially declared emergency, any refund issued from a timely return will include interest, unless some other provision overrides it.  That’s what Bob Kamman’s Procedurally Taxing post pointed out and explained. 

And Now, the PMTA

It appears that the PMTA is correcting earlier analysis.  I haven’t been able to track down any earlier guidance, but the PMTA refers to “our previous conclusions” and those differed from the conclusions in the PMTA.  The conclusions in the PMTA seem correct.  Summarized:

  1. If the IRS determined a postponed due date under section 7508A, a return filed by the postponed due date means section 6611(b)(3) and (e) do not apply.  The return need only be valid under the Beard test to be timely and trigger the provisions of section 7508A; it doesn’t need to be processible.  This is what the “previous conclusions” got wrong, apparently thinking that whether a return was timely for purposes of section 7508A depended on whether it was processible.  But section 6611(g) defines “timely” only for purposes of section 6611(b)(3) and (e), not section 7508A.  It doesn’t matter whether the return was timely filed for purposes of 6611(b)(3) and (e); section 7508A negated them.  The default rules below don’t apply.  Interest will run from the date of the overpayment and there is no exception for a prompt refund.
  2. If the IRS determined a postponed due date under section 7508A, but a valid return is not filed by the postponed due date, it doesn’t meet one of the requirements for sections 7508A(c)/7508(b)—that the return is timely filed by the postponed due date—so the default rules below apply. 

Default rules, if there was no section 7508A relief from Treasury, or the taxpayer did not file a valid return by the postponed due date.  Sections 7508A(c)/7508(b) have no effect, so sections 6611(b)(3) and (e) are in effect and the return is “filed” only when it is processible pursuant to section 6611(g).  Thus:

  • If a processible return is filed by the original due date (or extended due date if applicable) it is not late under section 6611(b)(3), so interest runs from the date of the overpayment.  If it is filed after the original due date (or extended due date if applicable) it is late under section 6611(b)(3), so interest runs from the date the processible return was filed.
  • Whether or not the processible return is filed late, no interest is payable at all if the IRS makes a prompt refund under section 6611(e).  The 45-day grace period starts at the later of the original due date (even if the taxpayer had an extension) or the date the return is filed. 

Note that a return filed after the postponed due date (July 15, 2020) but on or before the extended due (October 15, 2020, if the taxpayer requested an extension) is not timely for purposes of section 7508A.  As a result, sections 6611(b)(3) and (e) are not disregarded.  But it is timely for purposes of 6611(b)(3).  Interest runs from the date of the overpayment rather than the date the return is filed, but the taxpayer may still lose all interest if the IRS issues the refund promptly.

Although the PMTA doesn’t mention it, the “refund back-off period” of section 6611(b)(1) will apply in all cases.  That rule is not dependent on whether a return is processible or filed timely, and it is not affected by a Presidentially declared emergency.

Two Final Thoughts

First, I think the PMTA is clearly right under the Code.  That the IRS originally reached the wrong conclusion, in part, is a testament to the complex interactions of the different provisions and the need for close, attentive reading.  I double-checked and triple-checked when I worked my way through the PMTA.  This was actually a relatively mild instance of a common problem with tax.  Code provisions are written in a very odd manner.  They’re not intended to be understandable by the general public; they’re written for experts and software companies, and sometimes difficult even for them.  I suspect that people who work through some of these complicated interpretations would fall into two groups: (a) those who really enjoy the challenging puzzle; and (b) those who experience “the pain upstairs that makes [their] eyeballs ache”.  My bet is that (b) includes not only the general public and most law school students but also a fair number of tax practitioners.  Which group are you in?

Second, that (relative) complexity leads to mistakes.  I assume that these interest computations have to be done by algorithm.  There are simply too many returns affected to have manual review and intervention for more than a small percentage.  An algorithm is feasible but will require re-programming every time there’s a section 7508A determination, with changes from year to year.  Even when the law is clear, there is a lot of opportunity for mistakes to creep in.  (We’re seen some of those recently in other contexts, e.g., stimulus payments and advanced Child Tax Credit.)  Whether by algorithm or manual intervention, particularly given the change from the original conclusions, there’s a good chance that some refunds were issued that are not consistent with the correct interpreation and may not have included enough interest.  Is the IRS proactively correcting such errors?  If the numbers are big enough, it might be worth re-calculating the interest you received—it’s easier than you may think—and filing a claim for additional interest if appropriate.

The End of the Line for the Pareskys?

Guest blogger Bob Probasco returns today with perhaps his final update on the Paresky case. Christine

I’ve blogged about the Paresky case before (here, here,  here, and here).  The latest development, and probably the end of the line, came on Friday when the Eleventh Circuit issued its opinion.  The circuit court agreed with the district court, as well as the Second Circuit in Pfizer Inc. v. United States, 939 F.3d 173 (2d Cir. 2019), and the Federal Circuit in Bank of America Corp. v. United States, 964 F.3d 1099 (Fed. Cir. 2020).  District court jurisdiction for “tax refund suits” does not apply to stand-alone suits for additional overpayment interest.

Nothing about the decision was really surprising.  The contrary decision in E.W. Scripps Co. v. United States, 420 F.3d 589 (6th Cir. 2005) was always a strained interpretation of the jurisdictional statutes, and the trend has been moving away from that interpretation over the past few years.  The Eleventh Circuit evidently thought it was an easy case as well; Carl Smith pointed out to me that the decision came only 35 days after oral argument, compared to 17 months for the Pfizer decision.  That’s fast!  But I thought I would offer a few comments as we perhaps close this chapter.

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What was this dispute all about, again?? There are two provisions that might offer district court jurisdiction for a stand-alone case seeking additional interest from the government on tax overpayments.  28 U.S.C. § 1346(a)(1) covers claims for recovery of taxes, that is, tax refund suits.  28 U.S.C. § 1346(a)(2)—the “little” Tucker Act—covers claims against the government under the Constitution, Acts of Congress, regulations, contracts with the government, or non-tort damages.  The little Tucker Act is limited to claims of $10,000 or less, whereas the courts can hear tax refund suits for any amount.  Under 28 U.S.C. § 1491(a)(1), however, the Court of Federal Claims can hear Tucker Act claims for any amount.

Court also have, with very rare exceptions, concluded that a tax refund suit—even if that includes stand-along cases for additional overpayment interest—is subject to the 2-year statute of limitations (from the IRS denial of the administrative claim) in section 6532.  Tucker Act claims, however, fall under the general 6-year statute of limitations (from the date the cause of action accrued, generally when the overpayment was scheduled): 28 U.S.C. § 2401 for district courts or 28 U.S.C. § 2501 for the CFC.

In these cases—Scripps, Pfizer, Bank of America, and Paresky—the taxpayers were arguing that their cases fit under “refund suit” jurisdiction.  And the government was arguing strenuously that their claims only qualified for jurisdiction under the Tucker Act.  Thus, when the amount at issue was over $10,000, the CFC would be the only available forum.

If taxpayers can always go the Court of Federal Claims, why is this important to them??

I think it’s primarily a matter of forum-shopping.  Pfizer’s case involved an issue—interest payable when a refund check is lost and has to be re-issued—for which there was a favorable Second Circuit precedent: Doolin v. United States, 918 F.2d 15, 18 (2d Cir. 1990).  Bank of America’s case, on the other hand, appears to have been filed in Western District of North Carolina to avoid an unfavorable Federal Circuit precedent, specifically, Wells Fargo & Co. v. United States, 827 F.3d 1026 (Fed. Cir. 2016).  (I’m guessing here, but it seems very likely from looking at the pleadings that Wells Fargo would have been a huge incentive to avoid the Federal Circuit.)

For Pfizer and Bank of America, the courts’ decision were not fatal.  Pfizer could still hope for the same result in the CFC; at least, I’m not aware of any negative precedent there.  Bank of America may have lost a significant portion, but not all, of its claim by winding up in the CFC.

The Pareskys, though, were not forum shopping.  In fact, they initially filed suit in the Court of Federal Claims.  But they faced a statute of limitations problem.  By the time they filed suit, the 6-year statute of limitations for Tucker Act claims had expired.  So the CFC dismissed their case for lack of jurisdiction but transferred it to the Southern District of Florida at their request.  A refund suit, for which the statute of limitations had not yet expired, was their only hope.  (The Eleventh Circuit pointed out in a footnote that the Tucker Act statute of limitations had not expired yet when the IRS denied their refund claim, so they still had time to file in the CFC.  And, of course, they could have filed suit even while the refund claim was pending.  Alas, they did not.)

Does this result make sense from a policy perspective?

Debatable.  There are two conflicting policies involved here.  On the one hand, Congress wanted most—and all large—Tucker Act claims to go to the CFC, because claims against the federal government are their area of expertise.  Thus, the $10,000 limit on Tucker Act claims in district court; provide easier access to local courts, but only for smaller cases where the difficulty and expense of litigating in a far-off forum would be relatively harsher.

On the other hand, Congress wanted taxpayers to be able to bring all federal tax refund suits in their local forum.  That may have reflected a judgement that: (a) the relative expertise of the CFC is less of an issue; and (b) there may be a lot more tax refund suits than Tucker Act claims, so it’s better to spread those out. Which of those policies should rule when the suit at issue is for additional interest on federal tax overpayments?  Hard to say.  There are fewer of these cases than tax refund suits, and it may be beneficial to establish precedents that will apply uniformly to all taxpayers.  But the same rationales for district court jurisdiction without a dollar limitation for refund suits might apply to these suits as well.  I doubt if Congress collectively gave it much thought.  If they had, perhaps they would have been comfortable with district courts hearing these cases, just as Pfizer, Bank of America, and the Pareskys wanted.  But we now have three circuit courts that have decided that’s not what Congress enacted.

So, is this really the end of the line for the Pareskys?

They’re really very sympathetic plaintiffs.  The dispute arose out of their losing a lot of money in the Bernie Madoff Ponzi scheme and filing refund claims to recoup taxes because of the loss.  (Rather ironic that Mr. Madoff passed away between oral arguments and the decision, isn’t it?)  This decision is pouring salt on the wound.  But, alas, I don’t see much hope at all for them.  They might ask for an en banc review or file a cert petition with the Supreme Court.  But I think both would likely be rejected.  (DOJ Tax Division might like to see this case go to the Supreme Court, to overturn Scripps, but I seriously doubt if they could convince the Solicitor General to support granting cert.)  And even if an en banc review by the Eleventh Circuit or cert by the Supreme Court were granted, I would certainly expect them to reach the same decision.

As far as the issue in general, without a Supreme Court decision, we may still see some of these cases crop up occasionally in other circuits.  The score is still only 3–1 and if the money involved is enough and precedents dictate that a district court would be a more favorable forum, taxpayers may take a shot at it.  But if the issue comes before any of the nine circuits remaining that still haven’t addressed it, I expect they would wind up agreeing with the Second, Eleventh, and Federal Circuits.

TEFRA + LCU = Confusion, Part 3

In today’s post Bob Probasco concludes his three-part series on General Mills and the intersection of TEFRA and “hot interest.” Part One can be found here. Part Two, here. Christine

In Part 1, I described the decision by the Court of the Appeals for the Federal Circuit in General Mills, Inc. v. United States, 957 F.3d 1275 (Fed. Cir. 2020), aff’g 123 Fed. Cl. 576. (2015).  The taxpayer’s refund suit sought recovery of $6 million of excessive underpayment interest, but the court dismissed the case based on a jurisdiction issue from a special TEFRA provision.  I thought that the court made a crucial assumption, never clearly stated, as to the conceptual framework for adjustments resulting from a TEFRA proceeding.  Part 2 explained why an alternative framework, which would have supported the taxpayer’s position instead of the government’s, is not only possible but perhaps the best way to think about these issues.  Because the court dismissed the case for lack of jurisdiction, based on the TEFRA provision, we didn’t get a decision regarding the merits issue, concerning whether the IRS has assessed too much interest.  It’s an issue that I had never dealt with before and I think the IRS’s position may be wrong.  That’s what today’s post, Part 3, is about.

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Background

The case involved two sets of tax returns and audits: those for the General Mills (“GMI”) corporate tax returns and those for partnership tax returns for General Mills Cereals, LLC (“Cereals”).  Various members of the GMI consolidated group were partners in Cereals, so the partnership tax returns – and any audit adjustments – for Cereals flowed through to GMI.  The IRS audited the 2002-2003 tax returns (both corporate and partnership) and later the 2004-2006 tax returns (same).  Although there are some slight differences between the audits for those two periods, for simplicity I will focus on the 2002-2003 tax returns.

Audits began for both GMI and Cereals in 2005 for these years.  The IRS issued a 30-day letter for the GMI audit on June 15, 2007, asserting proposed deficiencies of more than $143 million for 2002 and almost $83 million for 2003.  The partners in Cereals entered into settlement agreements in July 2010.  On August 27, 2010, the IRS issued a document described as a “notice of computational adjustment” to GMI, identifying additional underpayments, resulting from the Cereals audit, of about $16 million for 2002 and more than $33 million for 2003.

The IRS assessed additional taxes, penalties, and interest resulting from the Cereals audit in September 2010.  GMI paid all outstanding balances for these years, including interest, on April 11, 2011.  The IRS sent GMI detailed interest computation schedules for these years, apparently for the first time, on April 18, 2011 and April 20, 2011.  The schedules reflected that the IRS began charging a higher underpayment interest on July 15, 2007.  GMI filed refund claims on March 28, 2013, arguing that the interest IRS accrued and assessed was almost $6 million too high.  GMI then filed this refund suit on January 30, 2014.

The Basis for GMI’s Refund Claim – LCU Interest The interest rate for large corporate underpayments (LCU) is governed by section 6621(c), as supplemented by Treas. Reg. § 301.6621-3, which increases the normal underpayment interest rate by 2% for a corporate taxpayer’s underpayments that exceed $100,000.  It was enacted in 1990, as part of the Omnibus Budget Reconciliation Act, and has typically been referred to by practitioners ever since as “hot interest.”  There are two key concepts in determining whether, and when, to apply hot interest: the “threshold underpayment” and the “applicable date.”

Threshold Underpayment

Whether hot interest applies is not, oddly enough, determined by comparing the underpayment balance to $100,000.  The regulation establishes a “threshold underpayment,” a term of art that appears only here.  Hot interest applies if that amount, rather than the underpayment balance, exceeds the $100,000 statutory requirement.  The threshold underpayment is defined as the correct amount of tax (excluding penalties and accumulated interest) less all payments made by the last date prescribed for payment.  Thus, it appears to be a cumulative amount rather than the result of a particular transaction such as an audit.  (But see below regarding “applicable date.”)  Once hot interest is triggered, the higher interest rate would apply to the entire underpayment balance going forward, including interest and penalties and any amounts subsequently assessed.  Under the IRS interpretation, hot interest would apply even if the actual underpayment balance declines below the $100,000 threshold as a result of payments.

The existence of a threshold underpayment is determined only when there is an assessment, not merely because of a proposed deficiency.  (Contrast the determination of the “applicable date” discussed below.)  If the taxpayer receives a 30-day letter or a notice of deficiency for $110,000 but the amount is reduced to $90,000 prior to assessment, the threshold underpayment is only $90,000 and hot interest does not apply.  But even if an amount greater than $100,000 is originally assessed, the regulation states that hot interest will not apply if a subsequent judicial determination reduces the tax liability (and therefore the threshold underpayment) below $100,000.

The regulation doesn’t specifically address whether a subsequent administrative determination reducing the tax liability (e.g., an abatement resulting from a refund claim) would reduce the threshold underpayment, potentially below $100,000.  Based on the definition of the threshold underpayment in the Code, it should – but I haven’t run across a ruling on this specific question.  The IRS has challenged whether an abatement reduces the threshold underpayment but to my knowledge only in the specific context of an NOL carryback.  The IRS lost, in Med James, Inc. v. Commissioner, 121 T.C. 147 (2003), but in that case the reduction from an NOL carryback was asserted as a counterclaim in a deficiency proceeding.  If the abatement had been granted in an administrative determination, the taxpayer might have had to pay and file a refund claim/suit to address the hot interest issue.

Determining the amount of the threshold underpayment is complicated enough that the IRS can easily make mistakes.  But if you look at the amounts above, it’s clear that GMI met the threshold underpayment requirement.  That is only one part of the answer, though.  To determine whether/when hot interest applies, the IRS also must determine the applicable date. 

Applicable Date

Interest on underpayments generally runs from “last date prescribed for payment,” typically the unextended return due date.  The higher rate for hot interest only applies “for periods after the applicable date.”  For assessments subject to deficiency proceedings, the applicable date is 30 days after the earlier of a “letter of proposed deficiency which allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals” (i.e., a 30-day letter) or the notice of deficiency.  That’s section 6621(c)(2)(A).

Section 6621(c)(2)(B)(i) is a special rule that applies to tax assessments not subject to the deficiency procedures; for such underpayments, the applicable date is 30 days after a letter or notice of the assessment or proposed assessment.  This would apply to certain taxes other than income tax.  This category also would include two common situations involving income tax: amounts shown on the original return but not paid on or before the last date prescribed for payment, and summary assessments for “mathematical or clerical errors.”

Although not explicitly addressed in the Code, the regulation includes within the scope of section 6621(c)(2)(B)(i) “underpayments attributable, in whole or in part, to a partnership item.”  For those, the applicable date would be the 30th day after the first letter or notice that notifies the taxpayer of an assessment of the tax.

The Code also identifies three exceptions under which a letter or notice that otherwise qualifies would not establish an applicable date and start hot interest running:

  • A 30-day letter or notice of deficiency that is withdrawn.
  • A 30-day letter or notice of deficiency for which the taxpayer pays the amount in full within 30 days after the letter or notice is sent.
  • Any letter or notice involving “small amounts,” that is, an amount that is not greater than $100,000 (as with threshold underpayment, excluding penalties and interest). 

As with threshold underpayments, the proper determination of the applicable date may be complicated and subject to error.  GMI believed that the IRS applied the law incorrectly and charged hot interest when it should not have.

IRS application and GMI’s argument

Interest at the normal underpayment interest rates generally (with some common caveats) begins as of the filing due date, without regard to extensions, rather than when the IRS made the assessments.  But the increased interest rate for hot interest starts only on the applicable date. What does that mean when there are multiple assessments, including adjustments flowing through from TEFRA audits?

The IRS position apparently is that hot interest starts, for the entire underpayment balance, as of the first applicable date for any component of that underpayment balance.  As noted above, GMI’s corporate audit resulted in a 30-day letter issued on June 15, 2007.  So the IRS interest calculations increased the interest rate starting on July 15, 2007, one month later, for the entire underpayment balance, including that attributable to the computational adjustments from the TEFRA audit.

GMI, on the other hand, read sections 6621(c)(2)(A) and (B)(i) as bifurcating the underpayments for these tax periods.  The portion of the underpayment attributable to the corporate audit and the portion of the underpayment attributable to the TEFRA audit would have separate applicable dates.  Hot interest for the portion of the underpayment attributable to the corporate audit might start as of July 15, 2007.  But the first letter or notice that notified GMI of an assessment of tax from the TEFRA audit was issued on August 27, 2010.  So hot interest for that portion of the underpayment shouldn’t start until September 26, 2010, more than three years later than the applicable date the IRS used. 

I think GMI’s position is certainly a reasonable interpretation.  The Code is, as almost always, ambiguous and the drafters may not even have considered this situation.  GMI’s particular situation, an assessment resulting from a corporate audit followed by an assessment resulting from a TEFRA audit, is not explicitly addressed anywhere in the 4-1/2 pages of regulations either.  There are six examples in the regulations, but none involve this situation.  Indeed, none of the examples even involve a partnership adjustment.

GMI pointed out that section 6621(c)(2)(A) already uses a “the earlier of” comparison between a 30-day letter and a notice of deficiency for which no 30-day letter was issued.  If Congress didn’t want to bifurcate the underpayments in a situation like GMI’s, why not simply include the provision regarding non-deficiency proceedings as 6621(c)(2)(A)(iii) instead of 6621(c)(B)(i)?  

I think it would be possible to carry the argument even further, arguing that hot interest applies only at the level of individual components of the underpayment balance, rather than the entire balance.  Other interest provisions apparently work that way, e.g., the “restricted interest” provisions in sections 6601(c) and 6611(e).  The references in section 6621(c) to letters or notices arising from specific adjustments, rather than to the entire underpayment balance, are very similar to the restricted interest provisions.  That arguably suggests the same approach of applying the special rule to components rather than the entire balance.

That interpretation could also be inferred from the exception in section 6621(c)(B)(iii), under which a letter or notice for a deficiency or assessment less than $100,000 does not start hot interest running.  Before that provision was added in 1997, hot interest would be triggered when the threshold underpayment from two or three separate transactions exceeded $100,000.  That’s reflected in Treas. Reg. § 301.6621-3(d), Example 2, which has not been revised to be consistent with the Code provision as amended in 1997.  What’s the purpose of section 6621(c)(B)(iii)?  Maybe it reflects a determination that hot interest should be applied only to individual transactions over $100,000, rather than a cumulative balance.  And maybe that implies that the applicable date should be determined separately for each of those transactions.

Further support is available from the exception in section 6621(c)(B)(ii), under which a letter or notice for which the taxpayer pays the amount in full within 30 days does not start hot interest running.  That looks very much like an incentive for quick payment, doesn’t it?  But if hot interest applies at the level of the entire underpayment balance rather than individual transactions, the incentive starts looking strange.  There is an extra incentive to pay quickly for the first deficiency/assessment that triggers hot interest, but that extra incentive goes away for the second, third, etc. deficiency/assessment.  Why would that be the case? I don’t recall ever seeing this issue before the Federal Circuit’s decision came out.  The case was filed in the Court of Federal Claims in 2014, and that court ruled in 2015, but I missed those at the time.  To my knowledge, this issue has not been addressed in any other cases.  (If anyone has seen it elsewhere, please let me know!)  So I was eager to see the court’s analysis.  Alas, there was none.  The case was dismissed for lack of jurisdiction, so we’re still waiting for the courts to rule on this issue.

TEFRA + LCU = Confusion, Part 2

In Part Two of this three-part series, Bob Probasco examines the dissenting view in the recent General Mills case out of the Federal Circuit. Part One can be found here. Christine

In Part 1, I described the decision by the Court of the Appeals for the Federal Circuit in General Mills, Inc. v. United States, 957 F.3d 1275 (Fed. Cir. 2020), aff’g 123 Fed. Cl. 576 (2015). The parties’ briefs on appeal can be read here: Opening Brief, Answer, and Appellant’s Reply. The taxpayer’s refund suit sought recovery of $6 million of excessive underpayment interest, but the court dismissed the case based on a jurisdiction issue from a special TEFRA provision.  I thought that the court made a crucial assumption, never clearly stated, as to the conceptual framework for adjustments resulting from a TEFRA proceeding. 

Part 2 explains why an alternative framework, that would have supported the taxpayer’s position instead of the government’s, is not only possible but perhaps the best way to think about these issues.  This case involved the intersection of TEFRA and the complex interest provisions of the Code.  The combination is messy. 

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Brief Recap of the Facts and the Majority’s Position The case involved partnership audits and adjustments for partnership tax returns for General Mills Cereals, LLC (“Cereals”).  Different members of the General Mills (GMI) consolidated group were partners in Cereals, so the tax returns—and any audit adjustments—for Cereals flowed through to GMI.  The IRS audited the 2002-2003 tax returns (both corporate and partnership) and later the 2004-2006 tax returns (same).  Although there are some slight differences between the audits for those two periods, for simplicity I will focus on the 2002-2003 tax returns.

Audits began for Cereals in 2005 for these years.  The partners in Cereals entered into settlement agreements in July 2010.  On August 27, 2010, the IRS issued a “notice of computational adjustment” to GMI, identifying additional underpayments resulting from the Cereals audit, of about $16 million for 2002 and more than $33 million for 2003. 

The IRS assessed additional taxes, penalties, and interest resulting from the Cereals audit in September 2010.  GMI paid all outstanding balances for these years, including interest, on April 11, 2011.  The IRS sent GMI detailed interest computation schedules for these years, apparently for the first time, on April 18, 2011 and April 20, 2011.  The schedules reflected that the IRS began charging a higher underpayment interest rate (“hot interest”) on July 15, 2007.  GMI filed refund claims on March 28, 2013, arguing that the higher interest rate should not have started until September 26, 2010.  It then filed this refund suit on January 30, 2014.

The government argued, and the majority agreed, that the relevant statute of limitations for such refund claims was the six-month period specified in section 6230(c)(2) for challenging erroneous computational adjustments rather than the two-year limitation period of section 6511.  As a result, the refund claims were filed untimely, and the case was dismissed for lack of jurisdiction.

The Dissent

The Federal Circuit’s decision was 2-1.  Judge Newman dissented and would have reversed the dismissal for lack of jurisdiction.  She thought section 6511, rather than 6230(c), applied to these refund claims.  Section 6231(a)(6) defines a computational adjustment as “the change in the tax liability of a partner which properly reflects the treatment under this subchapter of a partnership item.”  She concluded that the “payment of interest is not a ‘tax liability.’”  Further, “partnership item” should not be construed so “‘broadly as to cover claims that depend on the unique circumstances of an individual partner.’” (quoting Prochorenko v. United States, 243 F.3d 1359 (Fed. Cir. 2001)).  Thus, the refund claims were not correcting errors in computational adjustments of a partnership item; they were for refund of an overpayment of interest, to which the two-year limitation period in section 6511 apply.

Judge Newman found no hint in the TEFRA legislative history of any Congressional intent to truncate the two-year limitations period in section 6511.  She also quoted a 2001 Supreme Court case:  “[I]n cases such as this one, in which the complex statutory and regulatory scheme lends itself to any number of interpretations, we should be inclined to rely on the traditional canon that construes revenue-raising laws against their drafter.”

Possible Confusion Regarding the Conceptual Framework?

As I read the majority opinion and the applicable Code sections, it occurred to me that the analysis—as well as the regulation that defined resulting interest as a computational adjustment—rested in part on an assumption about the governing framework.  Specifically, the IRS, DOJ, and Court seem to think of adjustments to the partners’ returns as falling into two categories only:

  • Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 
  • Computational adjustments for which deficiency proceedings are not required.  This encompasses those for which partner-level determinations are not necessary. 

That seems consistent with the structure of former section 6230.  Section 6230(a)(2)(A) provides circumstances under which deficiency procedures apply and section 6230(a)(1) effectively is “everything else.”

The government puts interest in the second category, even though partner-level determinations are necessary.  (They certainly were in this case because the interest computations depended on information that was not part of the TEFRA proceedings.  The notice, and therefore applicable date used by the IRS, were part of the corporate audit.)  The decision to put interest into the second category perhaps was because interest doesn’t fit into the first category, which “shall apply to any deficiency attributable to . . ..”  Interest is not a tax liability and therefore is not included in the definition of deficiency and therefore does not fall within section 6230(a)(2)(A).  Where else can it be?  Only section 6230(a)(1).

But that is only the case if assessments of additional interest are computational adjustments.  The dissent concluded that interest assessments don’t fit within the definition of a computational adjustment.  An alternative framework would be that adjustments to partners’ returns, resulting from a partnership-level proceeding, fall into three categories:

  • Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 
  • Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 
  • Computational adjustments for which deficiency proceedings are required.  This encompasses (a) those for which partner-level determination are not necessary as well as (b) those for penalties, additions to tax, and additional amounts. 

In that case, the six-month period in section 6230(c)(2) only applies to the first two categories.  The third falls under the two-year period of section 6511 for normal refund claims.

This certainly seems as though it could have been what Congress intended.  Before TEFRA, we just had deficiency procedures and interest was not subject to those; it was just assessed after tax was assessed.  Did Congress intend partnership proceedings and computational adjustments to only address the same types of adjustments that deficiency proceedings covered—underlying tax, penalties, additions to tax, and additional amounts?  And then rely on the existing process for assessing interest, which is to simply assess it and require the taxpayer to pay and file a refund claim?  I haven’t done a deep dive into the legislative history, but that seems very plausible to me.  It’s also arguably the best interpretation under the definition of a computational adjustment quoted above in the discussion of the dissent.

There is a technical argument to the contrary that could support the majority’s position. 

  • Section 6601(e)(1) says that references to “tax” shall be deemed also to refer to interest, except for such references in subchapter B of chapter 63 (sections 6211-6216). 
  • So “tax” in section 6230(a)(2)(A) would include interest, but that section doesn’t mention “tax,” it refers to “deficiency”. 
  • And the reference to “tax” in section 6211(a), defining “deficiency,” doesn’t include interest.  Therefore, interest is not part of a deficiency. 

Thus, interest is included in the definition of a computational adjustment in section 6231(a)(6), which has a direct reference to “tax.”  But section 6230(a)(2)(A) has only an indirect reference (through section 6211) to tax, so interest is not included to the category of computational adjustments for which a deficiency proceeding is appropriate. 

But that’s highly technical and formal.  Common sense would say that—for purposes of the TEFRA provisions—if interest is not included in a deficiency for purposes of section 6230(a)(2)(A), it shouldn’t be included in a change to tax liability for the definition of computational adjustment in section 6231(a)(6).

The Court of Federal Claims opinion addressed this question, whether interest is incorporated in the definition of a computational adjustment, in more detail than the Federal Circuit’s decision.  The CFC didn’t rely entirely on the regulation and in fact suggested that would be insufficient by itself.  It cited several cases, some of which addressed a former version of section 6621(c), which increased the interest rate for “tax-motivated transactions” (TMT); the CFC, along with other courts, considered TMT interest analogous to hot interest.  But those cases never addressed the definition of computational adjustment, other than in the regulation.

For example, in N.C.F. Energy Partners v. Commissioner, 89 T.C. 741 (1987), the partnership sought to challenge penalties and TMT interest in its proceeding, although they were not asserted in the final notice of partnership administrative adjustment.  The IRS moved to dismiss those portions of the case for lack of jurisdiction.  The court concluded that additional findings of fact with respect to individual partners would be required, so those issues should not be addressed in the partnership proceeding.  The court did not directly interpret the definition of a computational adjustment, although it seemed to suggest that TMT interest would be addressed in a deficiency proceeding.

In White v. Commissioner, 95 T.C. 209 (1990), the IRS issued a notice of deficiency including TMT interest after the conclusion of the partnership proceeding.  The IRS moved to dismiss the interest determination from the deficiency proceeding.  The court agreed, 13-2 in a reviewed opinion.  That case, however, turned on the question of whether interest was included in a “deficiency.”  The court did not address how a later assessment of interest should be handled, as a computational adjustment or just a normal assessment of interest.

In Pen Coal Corp. v. Commissioner, 107 T.C. 249 (1996), the notices of deficiency had included tax, penalties, additions to tax, and additional amounts and had also determined that hot interest applied, without determining the amount.  The IRS sought to strike the interest determinations from the deficiency proceeding.  The court agreed, following White, but again did not interpret section 6231(a)(6).

Finally, in Olson v. United States, 172 F.3d 1311 (Fed. Cir. 1999), the taxpayers filed refund suits in the Court of Federal Claim.  They argued that various assessments (including TMT interest) resulting from a settlement of a partnership proceeding were invalid because they had received no notices of deficiency.  The CFC granted the government’s motion for summary judgement, concluding that notices of deficiency were not required and noting that no other basis for the refund was asserted.  The Federal Circuit agreed.  There was a brief reference to interest being included in the definition of a computational adjustment, but that mentioned only the regulation with no interpretation of the applicable Code section. 

Practical Considerations

The regulation stating that interest is included in a computational adjustment may have been influenced by an assumption—possibly shared by the DOJ and court—that interest computations are generally straight-forward and easy to verify.  If so, it might seem simplest to include interest in a computational adjustment not subject to deficiency procedures.  As with the allocation of the previously determined change in the underlying tax, errors would be rare but easily detected.  A computational adjustment, even with the abbreviated period within which to file a refund claim, would be a reasonable compromise.

However, while interest calculations for most taxpayers are indeed straight-forward and easy to verify, that is often not the case with large businesses who may have multiple changes to tax liability implicating several different issues of interest calculation.  Sometimes the law is not clear; other times the law is clear, but errors occur frequently.  Specialist firms provide taxpayers with reviews of interest computations to identify potential problems.  That process, however, can take a long time.

This also means that an abbreviated period within which to file refund claims relating to interest is not a good idea from a policy perspective.  The description in the Federal Circuit’s decision suggests that by the time GMI received the April 2011 interest computation schedules it had all the necessary information to identify the basis for a refund claim based on when hot interest rates should apply.  But that was more than six months after the August 2010 notice that the CFC considered the initial notice of computational adjustment.  It was even more than six months after the assessment of interest in September 2010.  I defy anyone to look at a lump sum assessment of interest for a large corporate taxpayer and be able to determine how that amount was calculated.

Even if the Federal Circuit decided that the April 2011 schedules were the initial notice of computational adjustment with respect to interest, six months is still not a lot of time within which to file a comprehensive refund claim covering all interest errors that might have been contained in those computations.  Rushing to file a refund claim based only on the issue concerning hot interest might have risked forfeiting claims based on other issues.

Thus, even if the correct legal determination were that the six-month period to file refund claims applied to computational adjustments relating to interest, it seems like a bad policy choice.

Conclusion  

Between the dissent, the alternative framework for classifying adjustments arising from a TEFRA proceeding, and the practical considerations, there seems to be at least a reasonable argument that interest should not be included in the definition of computational adjustments and not subject to the accelerated refund claim provisions of section 6230(c).  But that’s now what the regulation the IRS wrote say—and challenging the validity of the regulation would be difficult—and that’s not what the Federal Circuit decided.

This concludes the discussion of the TEFRA jurisdictional issue.  Part 3 addresses the substantive issue: exactly when the higher hot interest rate should have started.  It’s a complicated issue in these specific circumstances and, to my knowledge, has not yet been ruled on by any court.