IRS Expands Its Offset Authority

The Service has published three revenue rulings and proposed and temporary regulations that expand its ability under Sec. 6402(a) to offset overpayments against tax liabilities and its ability under Sec. 6411(b) to apply tentative carryback allowances against unpaid tax liabilities. The rulings appear in IRB 2007-37 (9/10/07).

Sec. 6402(a) provides that the IRS may credit the amount of any overpayment against any liability for an internal revenue tax and refund any balance to the person who made the overpayment. Regs. Sec. 301.6402-1 provides that credit may be made against “any outstanding liability.”

Sec. 6411(a) allows tentative carryback adjustments of the tax for tax years affected by a net operating loss (NOL), a business credit carryback, or a capital loss carryback. Under Secs. 6411(b) and Regs. Sec. 1.6411-3(d), the decrease in tax attributable to the carryback is to be applied first against any unpaid tax for the carryback year, then against any unsatisfied tax for the tax year immediately preceding the carryback tax year, and then credited against any tax then due from the taxpayer, with the balance, if any, refunded.

Rev. Rul. 2007-51

Rev. Rul. 2007-51 concludes that Sec. 6402(a) allows the Service to credit an overpayment against unassessed tax liabilities for which a notice of deficiency has been sent to the taxpayer. The ruling also concludes that Sec. 6411(b) allows the IRS to credit a decrease in tax resulting from a tentative carryback adjustment against unassessed taxes determined in a notice of deficiency.

Rev. Rul. 2007-51 presents two situations.

Example 1: P, a corporate taxpayer, filed its Form 1120, U.S. Corporation Income Tax Return, for the year ending December 31, 2004, on March 15, 2005, claiming a refund of $500,000. On April 15, 2005, the Service sent P a notice of deficiency for tax year 2003 in the amount of $1 million.

Rev. Rul. 2007-51 concludes that the $1 million tax liability determined in the notice of deficiency is an outstanding tax liability as of April 15, 2005, within the meaning of Regs. Sec. 301.6402-1. Therefore, under Sec. 6402(a), the IRS may credit the $500,000 overpayment for tax year 2004 against the $1 million tax liability.

Example 2: F, a corporate taxpayer, filed a Form 1139, Corporation Application for Tentative Refund, on March 15, 2005, carrying back an NOL from 2004 to 2002. The carryback generated a $250,000 tax decrease for tax year 2002. On April 15, 2005, the Service sent F a notice of deficiency for tax year 2003 in the amount of $1 million.

Rev. Rul. 2007-51 concludes that the $1 million tax liability determined in the notice of deficiency is an amount then due for purposes of Sec. 6411(b). Therefore, the ruling concludes that under Sec. 6411(b) the IRS may credit the $250,000 tax decrease that was generated from the NOL carryback against the $1 million tax liability for 2003.

Rev. Rul. 2007-51 reasons that Sec. 6402 and the regulations thereunder do not specify when a liability arises for purposes of determining when the Service may credit an overpayment. However, in the IRS’s view, a tax liability arises at the end of the taxpayer’s tax year and becomes due and owing at that time. Accordingly, Rev. Rul. 2007-51 asserts that the existence of an income tax liability generally arises when the liability is determined with specificity in a notice of deficiency and not at a later date when an assessment is made. Rev. Rul. 2007-51 also applies the same rationale for determining when a tax liability is then due to determine when the Service can credit a carryback adjustment under Sec. 6411(b).

Rev. Rul. 2007-51 also clarifies Rev. Rul. 54-378, which states that the IRS will credit any overpayment resulting from a partial allowance of a refund or credit against any tax assessed and then due from the taxpayer and refund the balance. Rev. Rul. 2007-51 states that the partial overpayment will be credited not only against assessed taxes but also against liabilities identified in a notice of deficiency.

Rev. Rul. 2007-52

Rev. Rul. 2007-52 concludes that Sec. 6402(a) authorizes the Service to credit an overpayment against unassessed tax liabilities that are identified in a proof of claim filed in a bankruptcy case. Similarly, this ruling also concludes 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 proof of claim.

Rev. Rul. 2007-52 addresses two situations.

Example 3: C, a corporate taxpayer, filed a petition for relief under Bankruptcy Code Chapter 11 on February 1, 2005. C filed its return for the year ending December 31, 2004, on March 15, 2005, reporting an overpayment and claiming a refund of $500,000. On April 15, 2005, the Service filed a proof of claim in the bankruptcy case identifying liabilities for C’s 2003 tax year in the amount of $1 million.

Rev. Rul. 2007-52 concludes that the $1 million liability identified on the proof of claim is an “outstanding liability” for purposes of Sec. 6402(a), and therefore the IRS can credit the $500,000 overpayment for 2004 against the $1 million tax liability identified on the proof of claim for 2003.

Example 4: M, a corporate taxpayer, filed a petition for relief under Bankruptcy Code Chapter 11 on February 1, 2005. M’s return for the year ending December 31, 2004, was filed on March 15, 2005, reporting a $750,000 NOL. Also on March 15, 2005, M filed an application for a tentative carryback adjustment, carrying the $750,000 NOL from 2004 back to 2003, generating a tax decrease for the 2003 tax year in the amount of $250,000, and requesting a refund. On April 15, 2005, the Service filed a proof of claim in the bankruptcy case identifying a $1 million liability for 2002.

The IRS asserts that it can credit the $250,000 tax decrease generated from the NOL carryback against the $1 million tax liability for 2002 identified on the proof of claim because it is an amount then due under Sec. 6411(b).

Rev. Rul. 2007-52 reasons that Secs. 6402(a) and 6411(b) do not require a deficiency determination or assessment as a prerequisite to the Service’s crediting an overpayment or a carryback adjustment to a tax liability and that the IRS can make credits when the tax liability is determined with specificity. In the context of a bankruptcy proceeding, a proof of claim filed by the Service represents a specific administrative determination of the nature and amount of the tax debt. A proof of claim is prima facie evidence of the claim’s validity and amount (Bankruptcy Rule 3001(f)) and is entitled to a presumption of regularity (i.e., a presumption that the IRS properly carried out its duties filing the proof of claim). Therefore, 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 proceeding.

Rev. Rul. 2007-53

Rev. Rul. 2007-53 revokesRev. Rul. 78-369 because Rev. Rul. 78-369 is inconsistent with proposed and temporary regulations under Sec. 6411 that were published in the Federal Register on August 27, 2007 (TD 9355 and REG-118886-06). Rev. Rul. 78-369 held that an application for a tentative refund must be allowed even if, in the year to which the loss is carried, there is a proposed deficiency that exceeds the amount of the loss. Rev. Rul. 78-369 is no longer valid because the temporary regulations “clarify” that when applying the tentative carryback allowance, the Service may credit or reduce the tentative adjustment by any unassessed liabilities determined in a statutory notice of deficiency (Temp. Regs. Sec. 1.6411-3T(d)).

Temp. Regs. Sec. 1.6411-3T

Temp. Regs. Sec. 1.6411-3T(d)(1)(iii) was amended to provide, consistent with Rev. Ruls. 2007-51 and 2007-52, that “unpaid amount of tax” for purposes of Sec. 6411 means an amount (not including an amount the time for payment of which has been extended under Sec. 6164) due and payable on or after the date of the allowance of the decrease, including any assessed liabilities, unassessed liabilities determined in a statutory notice of deficiency, unassessed liabilities identified in a proof of claim filed in a bankruptcy proceeding, and other unassessed liabilities in rare and unusual circumstances. The IRS intends to develop procedures for National Office review of whether a reduction of a tentative adjustment constitutes a rare and unusual circumstance.

Conclusion

It is questionable whether the IRS has the authority to expand its offset authority under Sec. 6402 in this manner. The new rulings and regulations are not the result of any change in law, either statutory or case law. Rev. Rul. 78-369, which has been outstanding for almost 30 years, has been revoked, and the underlying general counsel memoranda (GCMs 36521 and 35225), which analyze the legislative history of Sec. 6411 and require an outstanding assessment to perform an offset, have been overturned with very limited rationale or analysis. It remains to be seen whether these changes and the Service’s positions in this area will be sustained.