Editor: Mary Van Leuven, J.D., LL.M.
The word "oops" does not appear in the Tax Cuts and Jobs Act or the Internal Revenue Code, but the complexity, ambiguity, and rushed development of the 2017 tax law have given rise to taxpayers slapping their foreheads and saying: "What was I thinking?"; "How did I miss that?"; or "Is there any way to turn back the hands of time and fix that?"
In most respects, the Code, anchored by the annual accounting period principle, is unforgiving in dealing with slap-your-forehead moments like those spawned by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97. Generally speaking, taxpayers cannot correct a costly mistake, oversight, or misjudgment.
Fortunately, there are circumstances in which taxpayers may indeed be able to "turn back the hands of time." This item provides a quick overview of several tools available to engage in tax time travel. Given the intricacies and nuances of each, prudence requires further research and due care.
Nearly everyone who has played a sport is familiar with the concept of the do-over. Whether it is an errant drive in golf, shooting an air ball in a game of H-O-R-S-E, or hitting the rotating windmill in miniature golf, mulligans, or do-overs, are common. The tax law has an analogue — the rescission doctrine.
A rescission of a contract is defined in Black's Law Dictionary as "annulling or abrogation or unmaking of the contract and the placing of the parties to it in status quo." Permitting the parties to walk away from or "unwind" a transaction can be advantageous, especially when it is prompted by a misunderstanding of the law or facts, the occurrence of unanticipated events, or the failure of anticipated events to occur.
The rescission doctrine was applied in the tax world by Penn v. Robertson, 115 F.2d 167 (4th Cir. 1940), and now resides in Rev. Rul. 80-58, which, relying on that case, holds that a successful tax "undo" has two prerequisites:
- The parties to the transaction must be returned to the status quo ante (i.e., the relative positions they would have occupied had no contract been made); and
- The rescission must be accomplished within the same tax year as the original transaction.
If a taxpayer cannot unwind the transaction before the end of the year, relief is not available. In contrast, if the rescission occurs by the end of the year, the taxpayer can be spared the adverse consequences of its original transaction, regardless of the motivation for the rescission.
Before 2012, the IRS issued a wide variety of private rulings blessing all manner of rescissions (including some having a principal purpose of tax reduction). In that year, the IRS announced that it would no longer issue rulings in the area. Under Section 3.02(8) of Rev. Proc. 2019-3, the no-ruling policy remains in effect. By virtue of Rev. Rul. 80-58 and depending on a taxpayer's risk appetite, however, the rescission doctrine may accord a taxpayer a chance for a tax mulligan.
Have you ever entered an online contest (say, to predict the winners of the Academy Awards or the NCAA basketball tournament) and, after you hit the send button, regretted some of your choices? Some contests allow you to log back on and change your entries up until the deadline. Your corrected entry supersedes your first one. The tax law has an equivalent.
Since the Supreme Court's decision in Haggar Co. v. Helvering, 308 U.S. 389 (1940), taxpayers have been able to change the positions taken on their already-submitted returns by filing a second return, superseding the first. The precondition to doing this is straightforward: The superseding return must be filed before the due date — including timely filed extensions — for filing the initial return (see Internal Revenue Manual (IRM) §188.8.131.52.8(1); Rev. Rul. 78-256).
For example, assume a taxpayer filed a 2018 return before the IRS issued regulations or other guidance under a relevant provision of the TCJA. Assume further that the guidance (such as a new form) made a different treatment more appropriate (or beneficial) — or perhaps made the taxpayer regret an election made or a disclosure (with attendant Sec. 6662 penalty relief) forgone. The concept of a superseding return empowers the taxpayer to correct the error or oversight as long as the second return is filed before the due date (including any timely filed extension) of the original return.
Sometimes, of course, it is not the issuance of guidance (or the enactment of a technical correction) but the mere passage of time that makes the taxpayer covet a do-over. Thus, if you discover after filing the initial return that you had neglected to file all required Forms 5471, Information Returns of U.S. Persons With Respect to Certain Foreign Corporations (or submit all required information on that TCJA-expanded form), you could correct that oversight — and avoid penalties under Sec. 6038 or Sec. 6046 — by filing a superseding return. (Filing a qualified amended return under Regs. Sec. 1.6664-2(c)(2) might have the same ameliorative effect for a Sec. 6662 penalty.)
Experience teaches that the more time you have to file a superseding return, the greater the likelihood that you will catch errors, omissions, or other miscues. Thus, to maximize the time in which to discover errors or miscues on the initially filed return, a best practice for taxpayers would be to routinely request extensions of time to file returns — even if they plan to file their return by the original due date — to lengthen (to the extended due date) the time for filing a superseding return. (To ensure eligibility to file a superseding return, the extension request should be filed before the initial return is filed.)
Usually, having options is a good thing, but making the right choice is often complicated. Sometimes the poor quality of one's choice for tax purposes is instantly known; other times, its infirmity manifests itself only after the passage of time or the occurrence of intervening events (such as the enactment of the TCJA). This may be the case with check-the-box elections under Regs. Secs. 301.7701-1, -2, and -3.
Simply stated, the tax law's entity classification rules give taxpayers the option — by means of checking a box on Form 8832, Entity Classification Election — to classify certain types of entities as corporations, partnerships, or disregarded entities. While each taxpayer's structure is unique and generalizations are fraught with danger, before the passage of the TCJA, the difference between the corporate and individual tax rates, amplified by the essential nature of the Code's passthrough regime (i.e., the avoidance of the corporate tax altogether), made passthrough treatment almost a default. Taxpayers would routinely make check-the-box elections to secure that treatment. Significantly, Form 8832 need not be filed with the tax return, and the regulations provide that the election will be effective either on the date specified on the form or, if no date is specified, on the date it is filed, though the specified effective date cannot be more than 75 days before or 12 months after the filing date.
Prior-law conventional wisdom about choice-of-entity decisions, however, was upended by the 2017 tax law. Now, the lower corporate tax rate, coupled with the new GILTI (global intangible low-taxed income) and FDII (foreign-derived intangible income) regimes, may tilt the balance toward corporate status. And that is even without considering their interaction with other TCJA changes, including the BEAT (base-erosion and anti-abuse tax), business expense limitation provisions of Sec. 163(j), and the special deduction for passthroughs accorded by Sec. 199A, as well as many other, often interlocking, provisions of the Code.
Faced with the TCJA's myriad changes and the realization (because of the changes or otherwise) that its previous choice-of-entity status (or even its entire organizational structure) may no longer be optimal from either a business or tax perspective, a taxpayer could reasonably wonder, "Can I have a check-the-box do-over?" In many cases, the answer is "yes."
First, analogous to the rules for superseding returns, IRM Section 184.108.40.206.9 permits the withdrawal of an imprudent Form 8832 as long as the IRS receives the request to withdraw the check-the-box election before the due date of the initial tax return for the tax year the election is to become effective.
Alternatively, Rev. Proc. 2009-41 provides a mechanism for a taxpayer to perfect its entity classification by filing the required Form 8832 within three years and 75 days of the requested effective date contained in the late-filed election; the key to securing relief, however, is for the taxpayer to have filed all required federal returns in a manner consistent with the classification it intended to obtain. While this consistency requirement will put much TCJA second-guessing beyond the scope of the revenue procedure, it may be helpful in other situations.
Potentially more beneficial in the context of the TCJA-inspired do-overs, Regs. Sec. 301.7701-3(c)(1)(iv) allows a taxpayer to make an election to change an entity's classification, as long as it has been at least 60 months since a previous election to change the entity's classification was made. An election by a newly formed eligible entity that is effective on the date of formation is not considered a change in classification for these purposes. In other words, a pre-TCJA election to change an entity's classification can be wholly supplanted by a new one. Taxpayers should not be too quick to exercise this do-over option, however, because it would start the clock running on another five-year waiting period.
Another tool: Requests for Sec. 9100 relief
Check-the-box elections are not the only things that taxpayers miss or mess up on their returns. There are numerous other elections that taxpayers may make — or miss — at the time they file their tax returns. Confusion over, and the complexity of, the Code's election provisions are a primary reason that Regs. Secs. 301.9100-1 through 301.9100-3 provide rules permitting extensions of time for certain other late elections. The range of elections covered by the Sec. 9100 (and other) do-over provisions is extensive, including the use of the last-in, first-out inventory method, Sec. 338(g) and (h)(10) elections; dual-consolidated-loss agreements (see Regs. Sec. 1.1503(d)-1(c)); gain-recognition agreements under Sec. 367(a) (see Regs. Sec. 1.367(a)-8(p)); Foreign Investment in Real Property Tax Act statements (see Rev. Proc. 2008-27); and the timely documentation of success-based fees.
A detailed description of the procedures for obtaining Sec. 9100 relief is beyond the scope of this item, but the following summary illustrates their potential for enabling tax time travel when a taxpayer fails to make a desired election by the time prescribed in the Code or applicable regulations. Generally speaking, Sec. 9100 relieffalls into two categories — automatic relief (under Regs. Sec. 301.9100-2) and discretionary relief (under Regs. Sec. 301.9100-3).
Automatic relief is conditioned on the taxpayer's taking corrective action within a specified period (within either six or 12 months of the due date of the associated return). The elections covered by the 12-month provisions are specified in the regulations and helpfully do not necessarily require the timely filing of the tax return. The six-month provisions apply to other statutory and regulatory elections as long as (1) the election was due on the same date the return was due, including extensions, and (2) the associated return was in fact filed by that due date. Automatic relief under the six-month procedure is not available, however, if the specified due date for making the election is the due date of the return excluding extensions.
Securing discretionary Sec. 9100 relief is more cumbersome. First, it is available only for elections whose due dates are set by regulation (not by statute). Second, it will be granted only when the taxpayer can demonstrate, via the filing of one or more required affidavits and otherwise, that the taxpayer acted reasonably and in good faith and that granting relief will not prejudice the interests of the government (e.g., granting relief would result in a taxpayer's having a lower tax liability in the aggregate for all tax years affected by the election).
The regulations set forth the specific requirements for demonstrating reasonable cause and good faith and expressly confirm that a request for discretionary relief constitutes, and must satisfy the procedural requirements for, a private letter ruling, including the payment of a user fee. (See Rev. Proc. 2019-1, §5.03, for specific guidance.)
Tax time travel is possible
Mistakes happen, but life — and the tax law — sometimes afford the opportunity to reset the clock, undo the error, and avoid the costs and consequences of having made it. Securing relief under the procedures discussed in this item may not always be possible, but sometimes it is. Timely knowledge of the available tools to undo the errors, oversights, or misjudgments — and both their latitude and limitations — can empower a taxpayer with a chance to secure a better result.
Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C.
For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or firstname.lastname@example.org..
Contributors are members of or associated with KPMG LLP. These articles represent the views of the author(s) only, and do not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.