Is a substitute for return a return? Understanding the statute of limitation for credits and refunds

Editor: Mo Bell-Jacobs, J.D.

Sec. 6511 outlines the limitations on a claim for credit or refund of an overpayment of any tax. Where the taxpayer does not file a required return and the IRS prepares a return on behalf of the taxpayer under Sec. 6020(b), the issue arises of whether the substitute for return starts the running of the statute of limitation on claims for refund under Sec. 6511. This item examines this issue and the potential position that such a substitute for return (SFR) does not constitute a return that triggers the statute of limitation on claims for refund under Sec. 6511.

SFR procedures

Sec. 6020 grants the IRS the authority to prepare and execute a return on a taxpayer’s behalf. Where a taxpayer fails to file a required return or submits a false or fraudulent return, Sec. 6020(b)(1) authorizes the IRS to prepare an SFR on the taxpayer’s behalf using information already in its possession or other available information. The IRS then assesses the tax reflected on the SFR.

The IRS most commonly uses these SFR procedures when a taxpayer has failed to file a required return, and one or more third parties have reported income to the taxpayer for the tax year at issue. Once an SFR authorized under Sec. 6020(b)(1) is prepared and executed by the IRS, Sec. 6020(b)(2) deems the SFR “prima facie good and sufficient for all legal purposes.” However, a question may arise of whether an SFR is considered a return for purposes of the statute of limitation on claims for refund.

Sec. 6511 limitations on credit or refund claims

Sec. 6511(a) provides that where the tax is one for which a return is required, a claim for credit or refund must be filed within three years of the time the return was filed or two years from the time the tax was paid, whichever period expires later. Where no return is filed, the claim for refund must be filed two years from the time the tax was paid. Therefore, filing a timely claim is the essential first step to obtaining a credit or refund of an overpayment.

Sec. 6511(b) provides lookback periods limiting the amount of credit or refund allowed, depending on the date the return for the tax period in question was filed. If a claim is filed within three years of filing the return, the taxpayer is entitled to a refund of taxes paid within the three years immediately preceding the filing of the claim, plus any extension of time for filing the return (Sec. 6511(b)(2)(A)). If the claim for refund is not filed within the three-year period, a taxpayer is entitled to a refund of only those taxes paid during the two years immediately preceding the filing of the claim (Sec. 6511(b)(2)(B)). Thus, properly determining the date a return was filed for any given tax period dictates whether a taxpayer’s claim for credit or refund is allowable under Sec. 6511 and whether the claim may be limited to the taxes paid within the two years immediately preceding the claim.

Where an SFR and the refund statute of limitation collide

As mentioned above, Sec. 6020(b)(2) states that a return executed by the IRS is “prima facie good and sufficient for all legal purposes.” Courts have been required to examine the parameters of this clause in a variety of contexts.

Unlike Sec. 6501(b)(3), which explicitly states that an SFR executed pursuant to Sec. 6020(b) does not start the running of the period of limitation for the purpose of tax assessment and collection, many other Code sections, including Sec. 6511, do not include such straightforward provisions. Generally, in cases determining whether a return constitutes a return that starts the statute of limitation on claims for credit or refund, the return that starts the running of the three-year Sec. 6511(a) statute is the return in which the taxpayer reports or is required to report the income (Greene, 191 F.3d 1341 (Fed. Cir. 1999)).

In Healer, 115 T.C. 316 (2000), the Tax Court concluded that an SFR does not constitute a return for purposes of the Sec. 6511 statute of limitation on a claim for credit or refund. The court relied not only on the assessment statute language found in Sec. 6501(b)(3) but also on a series of decisions that narrowly interpreted Sec. 6020(b)(2)’s statement that all SFRs are “prima facie good and sufficient for all legal purposes.” The court in Healer relied heavily on an earlier Tax Court case, Flagg, T.C. Memo. 1997-297, which characterized Sec. 6020 authority to create an SFR primarily as a recourse for the IRS where a taxpayer fails to file a return. However, Flagg gives weight to the fact that Sec. 6020 neither requires an SFR to be filed nor relieves taxpayers of their obligation to file a return.

Flagg also highlighted a number of cases in which an SFR was not deemed good and sufficient for legal purposes despite the language in Sec. 6020(b). Federal appeals courts across the country have ruled that an SFR was not a return when determining whether an election to file jointly was prohibited by Sec. 6013(b) (Millsap, 91 T.C. 926 (1988)); a taxpayer willfully failed to file a return (Stafford, 983 F.2d 25 (5th Cir. 1993), and Powell, 955 F.2d 1206 (9th Cir. 1992)); or a tax liability was eligible for discharge in bankruptcy (Bergstrom, 949 F.2d 341 (10th Cir. 1991)).

Based on Healer and the other cases cited above, a taxpayer’s nondelegable duty to file a tax return, coupled with practical consideration of the intended purpose of Sec. 6020 SFR authority, the courts support the proposition that an SFR filed pursuant to Sec. 6020(b) is prima facie good and sufficient for all purposes where the IRS’s authority to prepare a return, determine the tax liability on such return, and make assessments based upon that return is at issue. However, courts have limited the application of Sec. 6020(b) in other contexts, including cases involving the statute of limitation on a claim for refund or credit.

IRS internal guidance is consistent with the holding in Healer. The Internal Revenue Manual (IRM) states that SFR reconsideration claims are original returns and instructs employees to apply the refund statute expiration date (RSED) rules to the date the original return filed by the taxpayer is received (see IRM §4.13.5.4.6 (Dec. 16, 2015)). Therefore, a taxpayer may be eligible to file a claim for refund at any time if the only return present is an SFR filed pursuant to Sec. 6020(b). There is evidence that this may remain true even where the taxpayer signs the SFR audit report or otherwise ratifies a return made pursuant to Sec. 6020(a) (see Rev. Rul. 2005-59, also Millsap, 91 T.C. 926, 938 (“the substitute returns in this case, prepared by respondent under section 6020(b), do not preempt or preclude the petitioner’s right to contest the deficiency determined by respondent”), and IRM §4.12.1.10.3(1)).

A double-edged sword

While it is favorable to taxpayers to take the position that an SFR does not constitute a return for purposes of the statute of limitation on credits and refunds, it should be noted that this result could also be advantageous to the IRS in limited circumstances. Should a taxpayer’s original return disclose additional income that was not included in the SFR assessment, any additional tax arising from the additional income may be assessed by the IRS without running afoul of the assessment statute outlined in Sec. 6501. IRM provisions inform IRS employees of their ability to assess additional tax under such circumstances (see IRM §4.12.1.5.4(2)).

Advocating for clients

Based on the reasoning outlined in Healer, an SFR filed by the IRS on behalf of a taxpayer under the authority of Sec. 6020(b) likely does not constitute a return for purposes of determining whether the limitations imposed by Sec. 6511 apply to a taxpayer’s claim for credits or refunds. It is important for tax practitioners to be aware of the rules and prior court analysis concerning the statute of limitation on claims for credit and refunds for a tax year where an SFR is present in order to effectively advocate for clients, particularly in the event that the IRS misinterprets Sec. 6020(b).

Editor Notes

Mo Bell-Jacobs, J.D., is a senior manager with RSM US LLP. Contributors are members of or associated with RSM US LLP. For additional information about this item, contact Tiffany Mosely, J.D., LL.M. (Tiffany.Mosely@rsmus.com), Los Angeles.