An Update Concerning the Blog

CTG has not been posting recently due to a death in the family. CTG is hoping to resume posting next week.

Can The IRS Reduce Your Refund for Other Debt?

You file a tax return showing tax due (before withholdings) of $503.

You have withholdings of $1,214.

You therefore have a refund of $711 ($1,214 - $711).

The IRS takes your refund because you owe taxes for another year.

The IRS later audits your return. It turns out that you owe another $1,403.

Question:  Can you get back the $711 that went who-knows-where?

The tax lingo is the “right of offset.”

Here is Code section 6402(a):

(a)       General rule

In the case of any overpayment, the Secretary, within the applicable period of limitations, may credit the amount of such overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment and shall, subject to … refund any balance to such person.

The pace car in this area was Pacific Gas & Electric Co v U.S.

Pacific Gas & Electric had an overpayment for 1982 of almost $37 million. It filed for a refund, and the IRS included interest for sitting on PG&E’s money well into 1988. However, the IRS miscalculated and overpaid interest by approximately $3.3 million.

The IRS wanted its money back, but what to do?

In 1992 PG&E filed another refund on the same tax year!

So the IRS lopped-off $3.3 million as an “offset” for the earlier interest overpayment.

On to Court they went. There were tax-nerd issues, such as the tax years under dispute having closed under the statute of limitations. That issue did not concern the Court. What did concern the Court was whether the IRS was correct in shorting a tax refund by its previous overpayment of interest.

The IRS can clearly offset for a tax.

But was the interest paid PG&E the equivalent of a tax?

And the Court decided it was not:

·      Interest you (as a taxpayer) owe the IRS is considered a “deemed” tax thanks to Section 6601(e).

Any reference to this title (except subchapter B of chapter 63, relating to deficiency procedures) to any tax imposed by this title shall be deemed also to refer to interest imposed by this section on such tax.”

·      But there is no Code section going the other way - that is, when the IRS pays you interest.

PG&E won its case and kept the interest.

Back to our taxpayer.

He did not have a chance of having the IRS return the $711 it had previously applied to another tax year. What made his case interesting is that his offset year was audited, resulting in an addition to his tax.  It made sense that he would want his withholding to be applied to its proper tax year before the IRS went offsetting everything in sight.

It made sense but it was not the correct answer. The IRS’ authority to offset is quite broad.

BTW, the offset is not just for taxes. It can be for student loans or monies owed to state agencies (think child support).  The offset is not limited to your tax refund either: your federal retirement and social security can also be offset.

Is It Income If You Pay It Back?

You receive unemployment benefits.

You repay unemployment benefits.

Do you have taxable income?

To start with: did you know that unemployment benefits are taxable? I have long considered this a dim bulb in taxation. Taxing the little you receive as unemployment seems cruel to me.

Back to our question: it depends.

It depends on when you pay it back.

Let’s look at the Yoklic case.

Yoklic applied for unemployment benefits in 2012.  He received $3,360, and then the state determined that he was not entitled to benefits. The state sent him a letter in October, 2012 requesting repayment.

Yoklic sent a check in September, 2013.

And he left the unemployment off of his 2012 return. How could it be income, he reasoned, if he had to pay it back. It was more of a loan, or alternatively monies that he received and to which he was not entitled.

Makes sense.

But tax theory does not look at it that way.

Enter the “claim of right” doctrine. It is an oldie, tracing back to a Supreme Court case in 1932.

The problem starts with accounting periods. You and I file taxes every year, so our accounting period is the calendar year. Sometimes something will start in one period (say October, 2012) but not resolve until another period (say September, 2013).

This creates a tax accounting issue: what do you do with that October, 2012 transaction? Do you wait until it resolves (in this case, until September, 2013) before you put it on a tax return? What if it doesn’t resolve for years? How many years do you wait? Does this transaction hang out there until the cows come home?

Enter the claim of right. If you receive monies – and you are not restricted in how you can use the monies – then you are taxable upon receipt. If it turns out that you are restricted – say by having to repay the monies - then you have a deduction in the year of repayment.

If you think about it, this is a reason that a bank loan is not income to you: you are immediately restricted by having to repay the bank. There is no need to wait until repayment, as the liability exists from the get go.

Find a bag of money in a Brooks Brothers parking lot, however, and you probably have a different answer.

Unless you repay it by the end of the year. Remember: you have a deduction in the year of repayment. If you find the bag of money and the police require you to return it, then the income and deduction happen in the same year and they fizzle out.

What if you promise to return the bag of money by year-end, but you do not get around to it until January 5^th? You may have an argument here, albeit a weak one. You could reduce your promise to writing, say by signing a contract. That seems a better argument.

What did Yoklic do wrong?

He repaid the monies in the following year.

He had income in 2012.

He had a deduction in 2013.

The problem, of course, is that the 2012 income may hurt more than the 2013 deduction may help.

There is – by the way - a Code section that addresses this situation: Section 1341, aptly described as the “claim of right” section. It allows an alternate calculation to mitigate the income-hurt-more-than-the-deduction-benefited-me issue. We have talked about Section 1341 before, but let me see if I can find a fresh story and we can revisit this area again.