When Does Underpayment Interest Begin When IRS Retroactively Revokes Corporation’s Tax Exempt Status

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A recent case in Tax Court, CreditGuard of America v Commissioner, considers how interest on underpayments applies when there is a retroactive revocation of a corporation’s tax exempt status. In so doing it walks us though the provisions that impose interest on underpayments.

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I will simplify the facts to get to the issue. IRS began examining CreditGuard of America’s Form 990 for 2002 back in late December 2003. Fast forward (or slow forward) 9 years or so to February of 2012, and IRS retroactively revoked its tax exempt status for years starting January 1, 2002.

In revoking its status, IRS informed CreditGuard of America (CreditGuard) that it was obligated to file corporate income tax returns for years starting in 2002. When CreditGuard did not file its corporate income tax return for 2002, IRS helpfully filed a substitute for return and a statutory notice of deficiency. CreditGuard eventually petitioned the Tax Court and agreed to a stipulated decision for a deficiency of about $216,000. The stipulaion stated that “interest will be assessed as provided by law on the deficiency in income tax due from petitioner.”

IRS assessed the tax and interest of about $142,000 on the deficiency. In calculating the interest, the IRS used the start date of the underpayment interest as March 17, 2003, the due date of the 2002 corporate income tax return.

When CreditGuard did not pay the tax or interest, IRS commenced administrative collection and filed a notice of federal tax lien. In response, CreditGuard filed a CDP request seeking an offer in compromise, but also challenging the interest computation. According to CreditGuard, interest should have only run from 2012– the date of the IRS’s revocation of its tax exempt status.

The CDP case allowed the court to get to the merits of the interest issue. As a threshold issue, the court held that there was no prior opportunity to consider the interest calculation; while the Tax Court had limited jurisdiction to order a refund if the party in a case believes it has overpaid interest that does not give the court the power to determine the correct amount of interest in the first instance.

Once clearing that hurdle, the court turned to the interest issue, one of first impression in the Tax Court, leading to this being a division opinion. The taxpayer’s essential argument was straightforward: it had no obligation to file a corporate tax return in 2003; in fact that obligation only arose 9 years later when IRS revoked its status.

While there is a superficial appeal to CreditGuard’s argument, the Tax Court held that the statute mandates that interest ran from 2003:

Under section 6601(a), interest runs from the “last date prescribed for payment.” Under section 6151(a), the “last date prescribed for payment” is the date “fixed for filing the return.” Because the date fixed for filing petitioner’s 2002 Form 1120 was March 17, 2003, these provisions indicate that petitioner must pay interest on the unpaid tax “for the period from such last date to the date paid.” See sec. 6601(a).

To deflect that statutory reading, CreditGuard argued that the interest provisions that apply to “taxes not otherwise prescribed” under Section 6601(b)(5) applied to revocations. That section applies to taxes “payable by stamp and in all other cases in which the last date for payment is not otherwise prescribed.” For those taxes, the “last date for payment” is the date the liability for tax arises, a date that CreditGuard argued pushed the interest start date to 2012.

The Tax Court disagreed, holding that the corporate income tax was otherwise prescribed with a deadline (as per Section 6072(b)), and in any event, even if it were not, the liability for the tax arose during 2002, not when the IRS revoked its status or when it agreed to the stipulated decision in the Tax Court.

The part of the opinion addressing when the tax arose is a little like a dog chasing its tail, but as our good friend Professor Bryan Camp discusses in a thoughtful blogpost on Taxprof  it highlights the difference between a liability and an assessment. The liability arose back in the year the corporate income tax return should have been filed; the assessment that followed the Tax Court’s decision did not alter the essential time when the liability arose.

The opinion’s statement that retroactivity has real consequences is important. Its citation to Bergerco Can. v. U.S. Treasury Dep’t, Office of Foreign Assets Control, 129 F.3d 189, 192 (D.C. Cir. 1997) and its discussion of those consequences situate the nature of the court’s view of the issue and why the IRS position was right as policy matter:

To be sure, “until we devise time machines, a change can have its effects only in the future.” …. But the purpose of making a change retroactive is to suspend reality and invoke a counterfactual premise. Here, the premise is that petitioner was not in fact tax exempt during 2002 but rather was a corporation subject to the regular corporate income tax. Because petitioner did not actually pay that tax on the date prescribed for payment, it is liable for interest beginning on that date.

After the language cited above, the opinion does drop a footnote to Section 6501(g)(2), which provides that for sol purposes a corporation’s good faith filing of a Form 990 “shall be deemed the return of the organization” for purposes of starting the period of limitations on assessment.” That is an important point, as IRS cannot revoke status for stale tax years (absent the sol remaining open for other reasons). Yet, as the opinion notes, the interest provisions are designed to compensate the government for the use of money. By agreeing with the IRS that it should not have been tax exempt back in 2002, CreditGuard essentially agreed that it did not pay what it was required to pay had it properly reported its status in the first place. As a result, the court’s approach to make the government whole is consistent with the underlying purpose of the interest provisions.

Leslie Book About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. Jim Malone says

    Nice piece on this case. I was struck by how long it took to complete the exam here. Then I looked at another revocation case, and the decision was made in 2010 based on the 2002 and 2003 tax year. Partners in Charity v. Comm’r, 141 T.C. 151 (2013). I wonder if the two cases are outliers or if revocations take an unusually long time to process through exam.

  2. Raymond Cohen says

    If the IRS was dilatory,should CreditGuard be responsible for paying the interest?

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