Potential pitfalls in the timing of filing refund claims

By Jennifer Potts, J.D., LL.M., Washington, and Howard Berman, J.D., New York City

Editor: Jacob Puhl, J.D., LL.M.

The complexities of filing a valid claim for refund or credit may lead to traps for the unsuspecting taxpayer. In two recent refund claim cases — NetJets Large Aircraft, Inc., No. 2:11-cv-1023 (S.D. Ohio 3/21/17), and Borenstein, 149 T.C. No. 10 (2017) — taxpayers fell victim to the intricacies of the refund claim limitation rules and, ultimately, were both denied a full refund. In both cases, the taxpayers failed to file timely refund claims, as statutorily required. In NetJets, the taxpayer failed to file a timely refund case for the full amount of the claimed refund; in Borenstein, the taxpayer's "hypothetical" refund claim fell outside of a statutory "third year" window. The following discussion of the relevant law and precedent established by NetJets and Borenstein highlights some of the nuances of the refund claim limitation provisions to help taxpayers avoid traps for the unwary.

Sec. 6511

Generally, under Sec. 6511(a), a taxpayer must file a claim for credit or refund within the period ending three years from the time the return was filed or two years from the time the tax was paid, whichever period ends later. If a taxpayer never filed a return, a claim for credit or refund must be filed within two years of the tax payment date.

Regardless of the plain language of Sec. 6511(a), complexities of a refund claim arise under the special rules of Secs. 6511(b)-(h); specifically, for purposes of the scope of this discussion, under the limitation provisions of Sec. 6511(b). Sec. 6511(b)(1) limits the timing of a refund claim; it prohibits a refund if the claim for that refund is filed outside of the limitation period. Sec. 6511(b)(2) limits the amount of a timely filed refund claim. Under Sec. 6511(b)(2), the limit on the amount of a refund claim depends on the timing of the filing of the claim. If the refund claim was filed during the three-year limitation period for filing a claim, the amount of the refund cannot exceed the portion of the tax paid within the period, immediately preceding the filing of the claim, equal to three years plus the period of any extension of time for filing the return (Sec. 6511(b)(2)(A)). Otherwise, if the refund claim is filed after the three-year limitation period, the amount of the refund cannot exceed the portion of the tax paid during the two years immediately preceding the filing of the claim (Sec. 6511(b)(2)(B)). If no claim is filed, the refund amount is limited the same as the limitations noted above, as if a claim was filed on the date the refund is allowed (Sec. 6511(b)(2)(A)).

In situations where taxpayers overlook the mechanics of the refund limitation provisions, harsh results, such as those presented in NetJets, can result. As further detailed below, applying Sec. 6511(b)(2)(B), the NetJets court held that, while the taxpayers timely filed a refund claim for the divisible portion of the tax paid, they failed to timely file subsequent refund claims for IRS-seized overpayments and, thus, were not entitled to a refund of those additional amounts.

NetJets

On Jan. 29, 2010, the IRS retroactively imposed assessments of the Sec. 4261 air transportation excise tax against NetJets for certain tax periods between 2003 and 2009. NetJets challenged the assessment by paying a divisible portion of the excise tax. Since an excise tax "represents an aggregate of taxes due on multiple transactions," it qualifies as a divisible tax and for an exception to the full payment rule, under which a taxpayer must pay the entire amount of an assessment before it can file suit challenging the assessment. (For the full payment rule, see Leeke, 737 F. Supp. 1013 (S.D. Ohio 1990); for the divisible tax exception, see University of Chicago, 547 F.3d 773 (7th Cir. 2008)). Under the exception for divisible taxes, a taxpayer only needs to pay the tax due for a single transaction to gain standing to challenge the entire assessment. After making its divisible payments, NetJets filed refund claims for each of the periods at issue. After the IRS denied each of those claims, NetJets filed suit for refund of the amounts paid on the IRS's retroactive assessments, as well as abatement of the unpaid portion of the assessments. While NetJets' refund suit was pending, the IRS seized overpayments from NetJets' later tax periods and applied the amounts toward the retroactive assessments at issue.

On Jan. 26, 2015, the district court determined that the IRS was not entitled to collect the air transportation excise tax from NetJets and dismissed the refund suit without outlining specific refund amounts. Subsequent to the court's determination, the dispute continued as to whether the refund included the overpayments seized and applied by the IRS after NetJets filed its refund claim and refund suit. Since NetJets had only made divisible payments, the government argued that the court's judgment served to refund only those amounts, and the subsequent seized overpayments were not refundable because NetJets had failed to file a timely refund claim for those specific seized amounts.

The government argued that NetJets failed to seek a refund of the additional overpayments in its refund suit complaint or in any filing before the court's entry of final judgment; thus, the overpayments were not included in the final judgment, and NetJets was precluded from recovering the overpayment amounts. NetJets responded that "[e]very . . . final judgment [other than a default judgment] should grant the relief to which each party is entitled, even if the party has not demanded that relief in its pleading," quoting Fed. R. Civ. P. 54(c). The government countered that sovereign immunity trumps Fed. R. Civ. P. 54(c), and it had not waived sovereign immunity because NetJets failed to satisfy the requirements of Sec. 7422, which provides that a tax refund suit may not be maintained in any court until a claim for refund or credit has been filed with the IRS. Since NetJets failed to timely file a refund claim under Sec. 6511 for the seized overpayments, the government argued that NetJets also failed to meet the requirements of Sec. 7422 for a valid tax refund suit.

Strictly applying the two-year lookback provision of Sec. 6511(b)(2)(B), NetJets would have had to file refund claims for the IRS-seized overpayments within two years of the dates when the IRS applied the overpayments to NetJets's outstanding excise tax liability. Since NetJets had not filed any such refund claims, by the time the court dismissed the case in January 2015, it was too late for NetJets to file them. The government further argued that NetJets should have filed new refund claims after the IRS applied the overpayments to the excise taxes, while continuing to challenge its liability for the air transportation excise tax in court.

While NetJets argued that the predecessor of Sec. 6511(b)(2)(B) was enacted as an accompaniment to the full-payment rule, which does not apply to excise taxes, the court found that Sec. 6511's plain language indicated that Congress intended Sec. 6511(b)(2) to limit refund claims irrespective of whether the claims relate to a divisible tax. The court also held that filing a refund claim does not become a superfluous task simply because the lawfulness of the underlying assessment has already been determined. Despite previously determining that the IRS was not entitled to collect the assessed air transportation excise tax, the same court held that NetJets was not entitled to a refund of the IRS-seized overpayments because of its failure to file timely additional refund claims.

Similarly, in Borenstein, discussed below, a taxpayer was denied a refund when the Tax Court determined that it lacked jurisdiction because of the intricacies of the refund claim provisions. In Borenstein, unlike the situation in NetJets, the IRS and the taxpayer actually agreed on the refund amount but disagreed as to whether the refund claim was proper.

Sec. 6512

When the Tax Court has jurisdiction over a deficiency case, Sec. 6512(b)(1) provides the court with the jurisdiction to determine the amount of an overpayment and refund it to the taxpayer upon a final Tax Court decision. However, the refund is limited by Sec. 6512(b)(3), so that a refund is disallowed unless the Tax Court determines in its decision that a tax payment (or portion of a tax payment) was made within one of three specific lookback periods:

  • "[A]fter the mailing of the notice of deficiency" (Sec. 6512(b)(3)(A) (emphasis added);
  • Within the period of limitation under Sec. 6511(b)(2), (c), or (d) and "if on the date of the mailing of the notice of deficiency a claim had been filed (whether or not filed) stating the grounds upon which the Tax Court finds that there is an overpayment" (Sec. 6512(b)(3)(B) (emphasis added)); or
  • Within the period of limitation under Sec. 6511(b)(2), (c), or (d) and "before the date of the mailing of the notice of deficiency," the tax payment had not previously been disallowed, had been disallowed but a timely refund suit could have been filed, or a refund suit had been filed and was within the Sec. 6532 period (Sec. 6512(b)(3)(C) (emphasis added)). As discussed below, the following language was later added to Sec. 6512(b)(3):

In a case described in subparagraph (B) where the date of the mailing of the notice of deficiency is during the third year after the due date (with extensions) for filing the return of tax and no return was filed before that date, the applicable period under subsections (a) and (b)(2) of section 6511 shall be three years.

Borenstein

Roberta Borenstein timely filed an automatic six-month extension request by April 15, 2013, extending the due date of her 2012 tax return to Oct. 15, 2013. She made tax payments totaling $112,000 toward her 2012 tax liability, which were deemed made on April 15, 2013. However, Borenstein failed to file her 2012 tax return by the extended due date of Oct. 15, 2013, or for many months afterward.

On June 19, 2015, the IRS issued a statutory notice of deficiency for Borenstein's 2012 tax year. On Aug. 29, 2015, before timely petitioning the Tax Court, Borenstein filed her delinquent 2012 income tax return, reporting a tax liability of $79,559. Based on this liability, Borenstein had an overpayment of $32,441.

Since Borenstein timely paid her 2012 tax liability, the IRS argued that she was not entitled to a refund of the 2012 overpayment when the refund claim (her 2012 tax return) was not filed until 2015, outside of the two-year lookback period of Sec. 6511(b)(2)(B) (see McGregor, 225 Ct. Cl. 566 (1980), stating the filing of a return reporting an overpayment generally constitutes the filing of a claim for refund; see also Regs. Sec. 301.6402-3(a)(1)). Sec. 6511(b)(2)(B) provides that if the claim is not filed within the three-year period, the amount of the credit or refund must not exceed the portion of tax paid during the two years immediately preceding the filing of the claim. However, Borenstein timely filed a petition to the Tax Court and argued that she was entitled to a refund under Sec. 6512(b)(3)(B).

In general, for a nonfiler who will not have filed a return (if at all) until after a notice of deficiency was mailed, Sec. 6512(b)(3)(B) requires application of the Sec. 6511(b)(2)(B) two-year lookback period because the hypothetical refund claim specified in Sec. 6512(b)(3)(B) was not filed within the three-year lookback period, as explained in Lundy, 516 U.S. 235 (1996). In response to Lundy, Congress amended Sec. 6512(b)(3) to provide a three-year lookback period (rather than a two-year lookback period) in certain circumstances when a return is not timely filed.

As amended, Sec. 6512(b)(3) provides:

In a case described in subparagraph (B) where the date of the mailing of the notice of deficiency is during the third year after the due date (with extensions) for filing the return of tax and no return was filed before such date, the applicable period under subsections (a) and (b)(2) of section 6511 shall be 3 years. [Emphasis added.]

Under Sec. 6512(b)(3)(B), Borenstein's hypothetical refund claim was deemed to have been filed on the date when the notice of deficiency was mailed, June 19, 2015. Since the hypothetical refund claim was filed before the 2012 return was filed, the refund claim was filed outside of the three-year lookback period of Sec. 6511(b)(2)(A). Additionally, since Borenstein's 2012 payments were deemed paid on April 15, 2013, her hypothetical refund claim filed on June 19, 2015, was outside of the two-year lookback period of Sec. 6511(b)(2)(B). However, with the amendment to Sec. 6512(b)(3) for delinquent filers, Borenstein argued that a three-year lookback period should still apply to her refund.

Borenstein claimed that, in the amendment clause, "with extensions" modifies "the third year" or, alternatively, modifies "3 years," such that her refund claim would be timely. The Tax Court rejected Borenstein's interpretation in favor of a "plain language" interpretation, which it had employed in several previous cases involving Sec. 6512(b)(3) (see, e.g., Petty, T.C. Memo. 2010-63; Zarky, 123 T.C. 132 (2004); Butts, T.C. Memo. 2015-74). Under a plain-language interpretation, the court held that "with extensions" modifies "due date." As such, the due date (with extensions) for Borenstein's 2012 tax return was Oct. 15, 2013, and the "third year" after Oct. 15, 2013, began on Oct. 15, 2015, and ended on Oct. 14, 2016. The Tax Court determined that Borenstein was not eligible for any of the three-year lookback periods of Sec. 6512(b)(3) because the IRS did not mail the notice of deficiency "during the third year after the due date (with extensions) for filing of the return of tax," which began on Oct. 15, 2015; the IRS mailed the notice of deficiency on June 19, 2015, during the second year, rather than the third year, after the extended due date for her return.

The Tax Court lacked jurisdiction to award a refund of Borenstein's 2012 overpayment because she neither filed her 2012 income tax return before the notice of deficiency was issued nor paid her tax liability during the two years before the mailing of the notice of deficiency (her "hypothetical" refund claim).

Impactful limitations

It is noteworthy that the Tax Court explained in its opinion that it was sympathetic to the taxpayer, such that, as a result of its plain-meaning interpretation of Sec. 6512(b)(3), the taxpayer was not entitled to a refund of the stipulated overpayment. Like the NetJets ruling, the result in Borenstein shows the significant and somewhat punitive impact of the statutory refund limitation provisions. In NetJets, even after the court held that the taxpayer was not subject to the excise tax, the same court held that the taxpayer was not entitled to a full refund of payments the IRS had seized to pay the improper assessment because the taxpayer had not filed a timely claim. Similarly, in Borenstein, because the IRS had mailed its notice of deficiency before the third year of the statute, the taxpayer was denied a refund of her overpayments because she did not file her return claiming the overpayment in a timely manner. Both NetJets and Borenstein emphatically serve as examples of the dominance of the refund limitation rules and highlight the risks that taxpayers face if they are unaware of and fail to comply with those rules.

Remember that the general thrust of the current independence requirement is for external reviewers to avoid conducting periodic reviews in circumstances where a potential conflict of interest might compromise their integrity. If a reviewer winds up in a position where he or she must evaluate the work product of a present colleague, even a distant one, it is likely best to decline the work.

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. Deloitte, its affiliates and related entities, shall not be responsible for any loss sustained by any person who relies on this publication.

EditorNotes

Jacob Puhl is a manager in the Tax Policy Group of Deloitte Tax LLP’s Washington National Tax group.

For additional information about these items, contact Mr. Puhl at 202-220-2767 or jpuhl@deloitte.com.

Unless otherwise noted, contributors are members of or associated with Deloitte Tax LLP.

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