Temp. Regs. Expand IRS Offset Authority

Editor: Greg A. Fairbanks, J.D., LL.M.

The IRS has issued temporary regulations under Sec. 6411 relating to the computation and allowance of tentative carryback adjustments (i.e., tentative refunds) (TD 9355). The temporary regulations also serve as the text for proposed regulations (REG-118886-06). In general, the temporary regulations provide that the IRS can credit or reduce a tentative refund by unassessed liabilities determined in a notice of deficiency or identified in a proof of claim in a bankruptcy proceeding. (See Temp. Regs. Secs. 1.6411-2T and 1.6411-3T.) These regulations effectively change an IRS position that has been in effect for 30 years. In connection with the temporary regulations, the Service has also issued three revenue rulings relating to this issue: two that provide examples of how the IRS’s crediting rights work and one that specifically revokes the 30-year-old position. (See Rev. Ruls. 2007-51, 2007-52, and 2007-53.)

Background

The general rules covering the IRS’s authority to refund or credit overpayments are found in Secs. 6402(a) and 6411(b). Under Sec. 6402(a), the Service may credit the amount of any overpayment, including interest, against any tax liability of the person who made the overpayment and refund the balance (subject to certain other nontax debts). Likewise, Regs. Sec. 301.6402-1 provides that the IRS may credit any overpayment of tax against an outstanding liability for any tax owed by the person with the overpayment.

Sec. 6411(a) permits a taxpayer to apply for a quick refund of taxes by carrying back a net operating loss (NOL), a net capital loss, or an unused business credit to a prior tax year for which taxes were paid. Corporations (other than S corporations) use Form 1139, Corporation Application for Tentative Refund, to apply for a quick refund. Form 1139 must be filed within 12 months after the end of the tax year in which the NOL, net capital loss, or unused credit arose. The corporation must file its in come tax return for the tax year no later than the date the Form 1139 is filed. 

Sec. 6411(b) provides that within 90 days from the date that the Form 1139 is filed, the Service may make a limited examination of the application to discover omissions and computational errors and to determine the amount of the decrease in tax (refund). If there are no omissions or errors, the refund is then applied against certain items, including any tax or installment “then due” from the taxpayer. Any amount not so credited is refunded to the taxpayer.

Previous IRS Position

Since neither Sec. 6402(a) nor Sec. 6411(b) define “outstanding liability” or any tax “then due,” respectively, questions were sometimes raised, especially by agents during the examination pro cess, as to whether the IRS can credit an overpayment or tentative carryback adjustment against an unassessed liability. Notwithstanding these questions, until the temporary regulations and the related revenue rulings were issued, the IRS’s position on crediting a tentative refund against an unassessed liability was well settled. Specifically, in Rev. Rul. 78-369, the IRS held that an application for tentative refund from the carryback of an NOL timely filed on Form 1139 (or Form 1045, Application for Tentative Refund, for individuals) must be allowed provided the application contains no omissions or computational errors, even though, in the carryback year, a deficiency had been proposed. This taxpayer-friendly revenue ruling was sufficient to dissuade even the most aggressive revenue agent from pursuing the issue. See also General Counsel Memoranda 35225, 36521, and 38768 for consistent conclusions. 

Temporary Regulations

The temporary regulations, which are effective for Forms 1139 submitted on or after August 27, 2007, provide that the IRS may credit or reduce the tentative refund by certain unassessed liabilities. Specifically, Temp. Regs. Sec. 301.6411-3T(d)(iii) provides that the tentative refund may be reduced by unassessed liabilities determined in a statutory notice of deficiency, un assessed liabilities identified in a proof of claim filed in a bankruptcy proceeding, or other unassessed liabilities in rare and unusual circumstances. The preamble to the temporary regulations notes that the IRS intends to adopt procedures re quiring IRS National Office review be fore a credit or reduction of a tentative refund by an unassessed liability that con stitutes a rare and unusual circumstance.

Therefore, under the temporary regulations, an unassessed liability determined in a statutory notice of deficiency or identified in a proof of claim effectively becomes a tax then due for purposes of Sec. 6411(b). This interpretation, however, appears to be inconsistent with Sec. 6213, which generally prohibits the IRS from assessing and collecting on a deficiency determined in a notice of deficiency (for a year not before the court) during the 90-day period the taxpayer has to file a petition in the Tax Court, or, if a petition has been filed, until the decision of the Tax Court becomes final.

Rev. Rul. 2007-53

The preamble to the regulations provides that the temporary regulations “clarify” the rules relating to tentative refunds being reduced by certain un assessed tax liabilities. However, in light of Rev. Rul. 78-369, these regulations appear to represent a change of position. Consistent with this being a change of position rather than a mere clarification, in conjunction with the temporary regulations, the IRS issued Rev. Rul. 2007-53, which revokes Rev. Rul. 78-369. The revenue ruling states that “the Internal Revenue Service has determined that Rev. Rul. 78-369 is inconsistent with the regulations under section 6411 of the Internal Revenue Code.”

Rev. Ruls. 2007-51 and 2007-52

Also in connection with the temporary regulations, the IRS issued Rev. Ruls. 2007-51 and 2007-52. Each of these revenue rulings provides examples detailing the crediting authority of the Service under Secs. 6402 and 6411 when there is an unassessed liability. Rev. Rul. 2007-51 covers unassessed liabilities determined in a notice of deficiency, and Rev. Rul. 2007-52 deals with unassessed liabilities identified in a bankruptcy proof of claim.

Rev. Rul. 2007-51 provides examples of how the Service will credit an overpayment against unassessed tax liabilities for which a notice of deficiency has been sent to the taxpayer. The ruling states that for purposes of the crediting provisions of Sec. 6402(a), a tax liability for a tax year arises no later than the date on which the Service sends a notice of deficiency to the taxpayer that identifies the nature and amount of the tax liability. Therefore, consistent with the temporary regulations, an unassessed liability determined in a statutory notice of deficiency effectively becomes a tax then due for purposes of Sec. 6411(b), and the Service can credit a carryback adjustment under Sec. 6411(b).

Rev. Rul. 2007-52 provides examples of how the Service will credit an overpayment against unassessed tax liabilities that are identified in a proof of claim filed in a bankruptcy case. This ruling states that under Sec. 6411(b), the IRS may credit a tax decrease resulting from a tentative carryback adjustment against a tax liability identified in a bankruptcy proof of claim. According to the ruling, a proof of claim filed by the Service in the bankruptcy case represents a specific administrative determination of the nature and amount of the tax debt. Therefore, in the bankruptcy context, the IRS maintains that it has the authority to make credits under Secs. 6402(a) and 6411(b) against income tax liabilities identified in a proof of claim in a bankruptcy case.

Observation

In reaching the above conclusions, both revenue rulings acknowledge that neither Sec. 6402 nor the regulations specify when any liability arises for purposes of determining when the IRS may credit an overpayment. Similarly, the revenue rulings provide that neither Sec. 6411(b) nor the regulations specify when a tax liability is then due for purposes of determining when the IRS can credit a carryback adjustment. However, both rulings summarily state:

Although sections 6402(a) and 6411(b) do not require a deficiency determination or assessment as a prerequisite to the Service crediting an overpayment or a carryback adjustment to a tax liability, the Service generally does not make such credits until the tax liability is determined with specificity.

Rev. Rul. 2007-51 then provides that when the Service issues a notice of deficiency, it has determined the tax liability with specificity. Likewise, Rev. Rul. 2007-52 provides that when a taxpayer is a debtor in bankruptcy, a proof of claim filed by the IRS represents a specific administrative determination of the claim’s nature and is entitled to a presumption of regularity.

The position articulated in the temporary regulations and associated revenue rulings with respect to the IRS’s ability to credit a tentative adjustment against an unassessed liability represents a significant departure from the IRS’s longstanding practice. Moreover, such conclusions may even be contrary to the Internal Revenue Code and the Bankruptcy Code. As such, it is possible that the IRS’s position could be challenged. Nevertheless, when advising clients about submitting claims or Forms 1139 (or Forms 1045 for individuals), it is now important to ascertain whether any unassessed liabilities exist that may reduce or eliminate a refund. 

EditorNotes

Greg A. Fairbanks, J.D., LL.M., works for Grant Thornton LLPWashington, DC

Unless otherwise indicated, contributors are members of or associated with Grant Thornton LLP.

If you would like additional information about these items, contact Mr. Fairbanks at (202) 521-1503 or greg.fairbanks@gt.com.