In today’s post guest contributor Monte Jackel, Of Counsel, Leo Berwick, discusses IRS guidance that may be too taxpayer friendly. Les
On April 22, 2021, the IRS issued Revenue Procedure 2021-20. This guidance obsoletes Rev. Proc. 2020-51 to reflect the recent change in the law allowing deductions for PPP expenses even though there was a reasonable expectation of reimbursement in the year the expenses were paid or incurred. See Rev. Rul. 2020-27, obsoleted by Rev. Rul. 2021-2.
In the subject revenue procedure, the IRS provided a safe harbor for taxpayers who, for their 2020 tax year, followed the guidance then applicable under Rev. Rul. 2020-27 and did not claim its PPP expenses as deductions for that year. In lieu of filing an amended return or an AAR (for a partnership), the revenue procedure allows the deductions to be taken in the following tax year (2021).
Regulation §1.461-1(a)(3), not cited in Rev. Proc. 2021-20, states:
Each year’s return should be complete in itself, and taxpayers shall ascertain the facts necessary to make a correct return. The expenses, liabilities, or loss of one year generally cannot be used to reduce the income of a subsequent year. A taxpayer may not take into account in a return for a subsequent taxable year liabilities that, under the taxpayer’s method of accounting, should have been taken into account in a prior taxable year. If a taxpayer ascertains that a liability should have been taken into account in a prior taxable year, the taxpayer should, if within the period of limitation, file a claim for credit or refund of any overpayment of tax arising therefrom. Similarly, if a taxpayer ascertains that a liability was improperly taken into account in a prior taxable year, the taxpayer should, if within the period of limitation, file an amended return and pay any additional tax due….
This regulation was not cited or discussed or distinguished in the subject revenue procedure. It was ignored.
read more...Somewhat similar type relief was provided in the predecessor to this revenue procedure, Rev. Proc. 2020-51, that was obsoleted in Rev. Proc. 2021-20. However, that revenue procedure allowed deductions to be taken in the 2021 tax year if the application for forgiveness of the PPP loan was not allowed and, thus, the expenses paid or incurred in the 2020 tax year would have been allowed. Once again, the purpose was to avoid requiring taxpayers to file an amended return or AAR but, arguably unlike the current revenue procedure, authority has allowed deductions to be taken in a later year (such as a loss sustained in a prior year where the expectation for reimbursement is eliminated in a later year) where the restrictions no longer exist. See, e.g., §1.165-1(d). On the other hand, an argument can be made that the 2020 revenue procedure was also ultra vires.
Even if the revenue procedure is ultra vires, how, if at all, can it be challenged? If the revenue procedure was anti-taxpayer, then the taxpayer could either not pay the tax and challenge it in court or pay the tax and sue for a refund. There would be no pre-enforcement challenge in those cases under current law due to the Anti-Injunction Act absent a favorable opinion by SCOTUS in the pending CIC Services case or a new statute allowing such challenges. This is all quite difficult to do. If, on the other hand, the guidance is pro-taxpayer, who will have standing to challenge the guidance? The answer under the law as of this writing is that no one will have standing to challenge the guidance. See a letter to the editor of Tax Notes by Michael Schler where he states:
“The problem, as I have pointed out previously, is that anti taxpayer regulations can be freely challenged by taxpayers, but pro-taxpayer regulations are invulnerable to challenge because of the lack of anyone with standing. I do not believe this makes for a balanced tax system.”
It would appear that Rev. Proc. 2021-20 is inconsistent with Reg.§1.461-1(a)(3) and cannot stand. And yet, who will challenge the revenue procedure? Most likely no one. But, in the words of some, “this is not anyway to run a railroad”.
This sure is no way to run a railroad. But neither was the bullheaded insistence by the IRS in 2020 that the actual or even anticipated forgiveness of a PPP loan in a future year made anything non-deductible. As I and others had pointed out, there was a good technical argument, possibly a winning argument, against the IRS position, which, coupled with the reasonable likelihood that Congress would step in to ensure that the IRS did not subvert Congress’s intention, made it sensible to take those deductions despite the IRS position to the contrary.
More broadly, some so-called erroneous pro-taxpayer IRS positions are worse than others. As these things go, this one is sloppy but not terrible, since there is already a mechanism to claim the benefit of the deductions by amending the return, and for many, if not almost all, taxpayers, the net result of claiming the deduction for the following year comes out in the same place. More pernicious, however, are regulations or other guidance that are favorable to a certain group of taxpayers and not others, where the others have justifiable commercial reason to complain and where, as a practical matter, the most sensible relief is to declare the favorable position void but it is impractical to find anyone withstanding to do that.
Monte – Thanks very much for highlighting this very troublesome issue. I’ve been troubled by some IRS actions in recent years that seemed to appropriately resolve practical problems in implementing what appeared to be badly written or poorly thought-through legislative language – but in ways that clearly seemed at odds with the statutory language. How do you think this problem can be remedied?
Ron
The decision in FHE Oil 49 F.2d 238 (5th Cir. 1945) invalidated a Treasury Regulation sua sponte. But Congress promptly passed legislation to restore a deduction for intangible drilling costs. In Larsen, the Tax Court considered the check the box regulations. So there is some room for a court to find a regulation invalid.
Partnership and S-corporation returns would seem to provide the greatest opportunity for a taxpayer challenge. A partner who has left a non-BBA partnership, or an S corporation shareholder, who has left the entity at the end of 2020, and who will not receive the benefit of deductions for expenses incurred in 2020, may file Form 8082 and claim the deduction in 2020. That would force the IRS either to let the same deductions be claimed by multiple taxpayers, or to defend (or abandon) the Rev. Proc.
What I am trying to figure out is why IRS is paying interest on refunds on 2020 returns that were filed on or before April 15. These are refunds issued last week or this week. One practitioner reported $3 “and change” on a $10,000+ refund, with the return e-filed April 15 and the payment deposited April 23. I have a client whose refund scheduled to be deposited April 28 will include $1.31 interest. The return was filed in March but processing was delayed because apparently IRS claims that he did receive the $1,100 EIP in January that he does not recall. (Might have been a debit card.)
Those receiving interest are not going to complain, at least until IRS asks for it be paid back. But what about those of us whose tax money supports overpayment interest? Couldn’t the money be better spent on enforcement?
Some of my least favorite taxpayer friendly rulings are the ones related to Bernie Madoff, such as Revenue Ruling 2009-09 and Revenue Procedure 2009-20. My clients with theft losses that are not covered by these rulings have to follow the law, which means no loss allowed until there is no (further) reasonable prospect of recovery. Explaining to clients why they must follow that rule and why Madoff victims didn’t have to follow that rule always sticks in my craw.