Erroneous refund of interest does not support innocent-spouse relief

The Tax Court held that a taxpayer was not entitled to Sec. 6015(f ) equitable innocent-spouse relief for an erroneous refund of interest because Sec. 6015(f ) relief is available only for unpaid taxes or deficiencies, and an erroneous refund of interest is not an unpaid tax or deficiency.

Background

In December 1985, the IRS made a jeopardy assessment for the years 1981–1983 against Catherine and Dominick LaRosa. A day after doing so, the IRS levied on the couple’s assets and seized them. Under an agreement between the IRS and the LaRosas, the seized assets were placed in escrow until their tax liabilities for those years were determined.

In 1990, the LaRosas reached a settlement agreement with the IRS for their 1981–1985 tax years. The agreement stated the LaRosas underpaid their taxes in 1981, 1982, and 1983 and owed $9.7 million in tax, penalties, and interest for those years. However, the parties agreed the LaRosas had overpaid their tax for 1984 and 1985 and were owed $6.1 million in tax and interest for those years. The LaRosas agreed in the settlement to pay the net amount due. After they did so, the assets in escrow were released.

In 1993, the LaRosas filed a refund claim, asserting that they were due a refund of overpaid interest. In 1994, the IRS issued them a refund, which consisted of Sec. 6601 underpayment interest and Sec. 6111 overpayment interest, after taking into account the timing of the various underpayments and overpayments, the jeopardy assessment, and the escrow. The IRS later determined that the LaRosas had not overpaid interest for the years in question and that the refund of interest to them was erroneous.

The IRS sued the LaRosas under Sec. 7405 in district court to recover the refund. The district court agreed with the IRS that the LaRosas were not entitled to the refund and ordered them to repay it (LaRosa, 993 F. Supp. 907 (D. Md. 1997)). The Fourth Circuit affirmed the district court’s decision (LaRosa, 155 F.3d 562 (4th Cir. 1998)). Subsequently, the IRS obtained a lien on the LaRosas’ property.

In 2017, a district court granted the IRS’s request to reopen the case and to renew the lien. The IRS then filed a request to foreclose on the lien. In response, Catherine LaRosa submitted a request with the IRS for equitable innocent-spouse relief under Sec. 6015(f ) from her and her husband’s tax liabilities for 1981–1985. The IRS declined to process the request, stating in a letter that there was no unpaid tax or deficiency for the years in question and that a liability arising from an erroneous refund of interest is not eligible for equitable innocent-spouse relief.

Catherine LaRosa then filed a petition with the Tax Court challenging the IRS’s determination. In response, the IRS moved to dismiss the case for lack of jurisdiction, arguing that the court lacked jurisdiction under Sec. 6015(f ) to consider her request for equitable innocent-spouse relief because there was no unpaid tax or deficiency for the years in issue.

Jurisdiction

The Tax Court held that in the case of an individual who requests Sec. 6015(f ) equitable innocent-spouse relief, the filing of a timely petition with the Tax Court confers jurisdiction on the court regardless of the merits of the underlying claim for relief.

The court found that under Sec. 6015(e)(1), the court has jurisdiction over a taxpayer’s case if the taxpayer (1) submitted a request to the IRS for Sec. 6015(f ) equitable innocent-spouse relief and (2) filed a timely petition with the Tax Court with respect to the IRS’s determination regarding that request, whether or not a deficiency has been asserted against the taxpayer. Catherine LaRosa had submitted a request for equitable innocent-spouse relief with the IRS and had filed a petition with the Tax Court with respect to that request, so the court held it had jurisdiction over the case.

The court noted that while this decision resolved the IRS’s motion to dismiss for lack of jurisdiction, it did not resolve the motion’s substance, which was whether it should find as a matter of law that LaRosa was ineligible for Sec. 6015(f ) innocent-spouse equitable relief. To reach this issue, the court recharacterized the IRS’s motion to dismiss for lack of jurisdiction as a motion for summary judgment in the case on that issue.

The Tax Court’s decision

The Tax Court held that Sec. 6015(f ) equitable innocent-spouse relief is available only for unpaid taxes or deficiencies and that an erroneous refund consisting only of interest does not give rise to an unpaid tax or a deficiency. Therefore, it held that Catherine LaRosa was not eligible for relief under Sec. 6015(f ).

Sec. 6015(f )(1) states that equitable innocent-spouse relief will be granted if, taking into account all the facts and circumstances, it is inequitable to hold an individual liable for any unpaid tax or any deficiency and innocent-spouse relief is not available to the individual under Sec. 6015(b) or Sec. 6015(c). Accordingly, the Tax Court held that for LaRosa to qualify for Sec. 6015(f ) equitable innocent-spouse relief, the claim for relief must be for an unpaid tax or deficiency.

The IRS argued that LaRosa did not qualify for Sec. 6015(f ) innocent-spouse relief because her claim was based on an erroneous refund of interest, which is not an unpaid tax or deficiency. LaRosa argued that she was entitled to relief under Sec. 6015(f ) because the erroneous refund the LaRosas received constituted an unpaid tax because the refund suit the IRS filed under Sec. 7405 was an action for the recovery of a tax or, alternatively, that the erroneous refund constituted an unpaid tax or deficiency because the refund the LaRosas received was a rebate refund.

In support of her first argument, LaRosa pointed to the language of Sec. 7405(b), which specifically authorizes a suit to collect a refund of tax. Because the IRS sought to recover the LaRosas’ erroneous refund of interest through a suit under Sec. 7405, Catherine LaRosa reasoned that the recovery of an erroneous refund of interest by a Sec. 7405 suit resulted in an unpaid tax liability.

The Tax Court found that LaRosa’s reliance on Sec. 7405(b) was misplaced. While a Sec. 7405 suit is an avenue for the IRS to recover an erroneous refund of tax, success in such a suit does not necessarily create an unpaid tax. Thus, the fact that the LaRosas’ erroneous refund was collected through a Sec. 7405 suit did not make it an unpaid tax.

Instead, the Tax Court found that whether an erroneous refund was an unpaid tax turned on whether the erroneous refund in question is a rebate or nonrebate refund. As the court explained, once a tax liability has been paid in full, a refund suit creates an unpaid tax or deficiency only if the suit is to collect an erroneous rebate refund, which is a refund based on a substantive recalculation of a taxpayer’s tax liability. A refund suit does not create an unpaid tax or deficiency if the suit is to collect a nonrebate refund, which is a refund issued because of clerical or computer errors that do not involve the recalculation of a tax liability.

The Tax Court determined that the LaRosas’ refund was not a rebate refund because it did not involve any portion of their underlying tax liabilities for the years in issue. The LaRosas had paid their tax liabilities in full for the years in question, and the refund did not involve a recalculation of their tax liabilities for the years in issue but merely corrected a perceived clerical error in computing interest. Also, the LaRosas’ underlying tax liabilities were not adjusted, and no portion of their underlying liabilities was refunded.

Catherine LaRosa alternatively argued that under Sec. 6601, a liability for statutory interest is treated the same as the tax on which it accrues. Thus, the IRS’s refund of interest to the LaRosas should be treated as the tax on which the interest accrued.

The court found, however, that Sec. 6601 does not apply to overpayment interest, so overpayment interest is not treated as a tax under the statute. Also, although underpayment interest is generally treated as a tax under Sec. 6601, the statute specifically states that underpayment interest is not treated as a tax for purposes of what is a rebate. Accordingly, the court held that an erroneous refund consisting solely of interest, whether the interest is overpayment or underpayment interest, is not a rebate refund and does not give rise to an unpaid tax or deficiency.

Because Sec. 6015(f ) equitable innocent-spouse relief applies only to an unpaid tax or deficiency, and the Tax Court had determined the LaRosas’ erroneous refund of interest was not a rebate refund and did not give rise to an unpaid tax or deficiency, the court held that Catherine LaRosa did not qualify for Sec. 6015(f ) equitable innocent-spouse relief.

Reflections

The LaRosas claimed that they were entitled to the refund of interest at the heart of this case because the IRS had improperly assessed interest on their tax debt during the period after the LaRosas’ assets were levied on and seized until they were released from escrow. After many years of legal wrangling over the interest issue, in 2007 the Federal Circuit held that neither a levy on property nor the property’s escrow is a payment of tax that stops the accrual of interest (LaRosa’s International Fuel Co., 499 F. 3d 1324 (Fed. Cir. 2007)). Accordingly, the LaRosas were not entitled to the refund of interest they had received in 1994.

LaRosa, 163 T.C. No. 2 (2024)