An Erroneous Tax Refund Check In The Mail

 

Let’s start with the Code section:

§ 6532 Periods of limitation on suits.

(b)  Suits by United States for recovery of erroneous refunds.

 

Recovery of an erroneous refund by suit under section 7405 shall be allowed only if such suit is begun within 2 years after the making of such refund, except that such suit may be brought at any time within 5 years from the making of the refund if it appears that any part of the refund was induced by fraud or misrepresentation of a material fact.

 

I have not lost sleep trying to understand that sentence.

But someone has.

Let’s introduce Jeffrey Page. He filed a 2016 tax return showing a $3,463 refund. In early May 2017, he received a refund check of $491,104. We are told that the IRS made a clerical error.

COMMENT: Stay tuned for more observations from Captain Obvious.

Page held the check for almost a year, finally cashing it on April 5, 2018.

The IRS – having seen the check cash – wanted the excess refund repaid.

Page wanted to enjoy the spoils.

Enter back and forth. Eventually Page returned $210,000 and kept the rest.

On March 31, 2020, Treasury sued Page in district court.

Page blew it off.

Treasury saw an easy victory and asked the district court for default judgement.

The court said no.

Why?

The court started with March 31, 2020. It subtracted two years to arrive at March 31, 2018. The court said that it did not know when Page received the check, but it most likely was before that date. If so, more than two years had passed, and Treasury could not pass Section 6532(b). They would not grant default. Treasury would have to prove its case.

Treasury argued that it was not the check issuance date being tested but rather the check clearance date. If one used the clearance date, the suit was timely.

The district court was having none of that. It pointed to precedence – from the Ninth Circuit Court of Appeals - and dismissed the case.

The government appealed.

To the Ninth Circuit Court of Appeals, ironically.

The Ninth wanted to know when a refund was “made.”

“within 2 years after the making of such refund …”

Is this when the refund is allowed or permitted or is it when the check clears or funds otherwise change hands?

The Ninth reasoned that merely holding the check does not rise to the threshold of “making” a refund.

Why, we ask?

Because Treasury could cancel the check.

OK. Score one for the government.

The Ninth further reasoned that the statute of limitations cannot start until the government is able to sue.

Why, we again ask?

Had Page shredded the check, could the government sue for nearly half a million dollars? Of course not. Well then, that indicates that a refund was not “made” when Page merely received a check.

Score two for the government.

The Ninth continued its reasoning, but we will fast forward to the conclusion:

… we hold that a refund is made when the check clears the Federal Reserve.”

Under that analysis, Treasury was timely in bring suit. The Ninth reversed the district court decision and remanded the case for further proceedings.

What do I think?

I see common sense, although I admit the Ninth has many times previously eluded common sense. Decide otherwise, however, and Treasury could be negatively impacted by factors as uncontrollable as poor mail delivery.

Or by Page’s curious delay in depositing the check.

Then again, maybe a non-professional was researching the matter, and it took a while to navigate to Section 6532 and its two years.

Our case this time was U.S. v Page, No 21-17083 (9th Cir. June 26, 2024).

Losing A Refund: Revisiting The Statute(s) of Limitations

 

I am thinking she got hosed.

I am looking at a district court decision. It involves Michelle Moy, and it remarkably bridges 2011 to the 2020 COVID year.

Let’s talk about it.

In May 2011 Moy was assessed $32,507 by the IRS because she failed to file a 2008 tax return. In this situation, the IRS may prepare a return for you (called a substitute for return) and proceed accordingly with collections activity.

COMMENT: It is rare that a substitute for return (SFR) will be to your advantage. The IRS will throw in all the positive numbers it can find, but it will not include negative numbers with the same zeal. It is almost always to your advantage to file a return rather than accept an SFR.

QUESTION: Here is an obscure practice question: when you file the 2008 return with an SFR already on file, is it considered an amended return? The answer is below.

Turns out that Moy had $20,447 in 2008 U.K. foreign taxes available for credit. Assuming that the foreign tax credit was available dollar-for-dollar, Moy owed $12 grand rather than the $32 grand the IRS wanted.

Seems easy enough. File the return. Pay the $12 grand plus interest and penalties and move on.

It appears Moy instead paid the $32 grand. She did not realize and overpaid.

I say that because she filed a claim for refund in April 2018. I presume the claim was for the $20 grand of foreign taxes.

In August 2018, the IRS bounced the claim as being outside the statute of limitations.

COMMENT: The statute for a refund claim is generally the latter of (a) three years from assessment date or (b) two years from the date of payment. Assessment here was in 2011, so the first period would have expired in 2014. Assuming she paid the $32 grand before April 2016, the second period would have also expired before she filed in April 2018.

Moy filed a protest with Appeals.

Appeals stalled, responding three times (in December 2019, February 2020, and March 2020), each time asking for another 60 days.

I think we all remember what happened in March 2020, so I withhold blame.

The IRS dismissed her appeal in January 2021, arguing that the statute of limitations for refund had expired.

In June 2023, Moy filed a lawsuit against the United States.

Confused yet?

Let’s sort this out.

What is happening is that there are two statutes of limitations coming into play here. In fact, it would be more accurate to say two and a half.

The first is the standard 3 years/2 years. This is the statute for filing a refund claim. In this context, Moy filing a 2008 return showing that foreign tax credit counts as a refund claim.

NOTE: In answer to our question above, Moy would file an original – not a an amended – 2008 return. The SFR is not considered a return for this purpose, so the first filing by the taxpayer would be considered the original filing.

Mind you, her 2008 filing was likely outside the 3/2 combo, so how did Moy argue that the statute for refund was still open?

Look at this pearl:

        § 6511 Limitations on credit or refund.

(d)  Special rules applicable to income taxes.

(3)  Special rules relating to foreign tax credit.

(A)  Special period of limitation with respect to foreign taxes paid or accrued. If the claim for credit or refund relates to an overpayment attributable to any taxes paid or accrued to any foreign country or to any possession of the United States for which credit is allowed against the tax imposed by subtitle A in accordance with the provisions of section 901 or the provisions of any treaty to which the United States is a party, in lieu of the 3-year period of limitation prescribed in subsection (a) , the period shall be 10 years from the date prescribed by law for filing the return for the year in which such taxes were actually paid or accrued.

 

Yep, the foreign tax credit gets its own 10 year statute of limitations. Let’s see, the 2008 return was due April 2009. Add ten years and we get April 2019. She filed a refund claim in April 2018. She appears to be within the statute period for filing a refund claim.

So why did the Court say she was out of statute?

There is one more statute of limitations to consider.

        § 6532 Periods of limitation on suits.

(a)  Suits by taxpayers for refund.

(1)  General rule.

No suit or proceeding under section 7422(a) for the recovery of any internal revenue tax, penalty, or other sum, shall be begun before the expiration of 6 months from the date of filing the claim required under such section unless the Secretary renders a decision thereon within that time, nor after the expiration of 2 years from the date of mailing by certified mail or registered mail by the Secretary to the taxpayer of a notice of the disallowance of the part of the claim to which the suit or proceeding relates.

 What does this mishmash mean?

This statute applies to the IRS and authorizes the IRS to pay a refund up to two years after disallowing a claim for refund.

When did the IRS disallow Moy’s refund claim?

In August 2018.

Add two years and you have August 2020.

When did Moy file suit?

In 2023.

The IRS is prohibited from issuing a refund.

To recap, the familiar 3/2 statute of limitations applies to a taxpayer filing a refund claim.

The second statute (2 years, no more, no less) applies to the IRS paying the refund claim.

Moy cleared the first.

She did not clear the second.    

Are there administrative options?

None that excites me.

Could she have done something differently?

While a long shot, she could have asked to extend the refund statute. The difficulty is that both sides must sign, and it can be difficult to find someone at the IRS with authority to sign.

Realistically, her best option was filing a refund suit with the district court or U.S. Court of Claims. I would much rather go to Tax Court – as that court has procedures for pro se taxpayers – but the Tax Court does not accept refund suits. You must owe the IRS to get your ticket punched on the Tax Court Express.

Moy was hosed. She went into COVID with a two year window to get her refund. Little could she anticipate IRS employees being sent home - meaning no access to correspondence mailed to IRS addresses, unprocessed returns and mail accumulating in trailers, the later shredding of such returns and mail, and the agency becoming near unreachable for extended periods “due to a high volume of calls.”

And those IRS letters asking for “another 60 days”?

You would have to get a court to allow equitable tolling. Notice that the IRS did not do so on its own power. They were quick to ask for another six months while processing Moy’s appeal, but they did not toll a single minute on the Section 6532 limitation on her refund.

Looking back, IRS Appeals should have included Form 907 with any refund claims assigned during the COVID era. Unfortunately, the IRS still has no policy or practice of doing this, so any responsibility for this tax obscurity falls fully on the taxpayer (and his/her tax representative). 

Our case this time was Moy v United States, Case No 23-cv-03151-PP (Northern District of California 2024).

Can A Taxpayer Be Responsible For Tax Preparer Fraud?

 

We are familiar with the statute of limitations. In general, the SoL means that you have three years to file a return, information important to know if you are due a refund. Likewise, the IRS has three years to audit or otherwise adjust your return, important to them if you owe additional tax.

The reason for the SoL is simple: it has to end sometime, otherwise the system could not function.  Could it be four years instead of three? Of course, and some states use four years. Still, the concept stands: the ferris wheel must stop so all parties can dismount.

A huge exception to the SoL is fraud. File a fraudulent return and the SoL never starts.

Odds are, neither you nor I are too sympathetic to someone who files a fraudulent return. I will point out, however, that not all knuckleheaded returns are necessarily fraudulent. For example, I am representing an IRS audit of a 2020 Schedule C (think self-employed). It has been one of the most frustrating audits of my career, and much of it is self-inflicted. I know the examiner had wondered how close the client was to the f-word; I could hear it in her word selection, pausing and voice. We spoke again Friday, and I could tell that she had moved away from that thought. There is no need to look for fraud when being a knucklehead suffices.

Here is a question for you:

You do not commit fraud but your tax preparer does. It could be deductions or credits to which you are not entitled. You do not look at the return too closely; after all, that is why you pay someone. He/she however did manage to get you the refund he/she had promised. Can you be held liable for his/her fraud?

Let’s look at the Allen case.

Allen was a truck driver for UPS. He had timely filed his tax return for the years 1999 and 2000. He gave all his tax documents to his tax preparer (Goosby) and then filed the resulting return with the IRS.

Mr. Goosby however had been juicing Allen’s itemized deductions: contributions, meals, computer, and other expenses. He must have been doing quite a bit of this, as the Criminal Investigations Division (CID, pronounced “Sid”) got involved.

COMMENT: CID is the part of the IRS that carries a gun. You want nothing to do with those guys.

Allen was a good guy, and he agreed with the IRS that there were bogus numbers on his return.

He did not agree that the tax years were open, though. The IRS notice of deficiency was sent in 2005 – that is, outside the normal three years. Allen felt that the tax years had closed.

He had a point.

However, look at Section 6501(c):

§ 6501 Limitations on assessment and collection.

(c)  Exceptions.

(1)  False return.

In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.

The Court pointed out that the law mentions a “false or fraudulent return.” It does not say that the fraud must be the taxpayer’s.

The year was open, and Allen owed the additional tax.

I get it. There is enough burden on the IRS when fraud is involved, and the Court was not going to add to the burden by reading into tax law that fraud be exclusively the taxpayer’s responsibility.

The IRS had helped its case, by the way, and the Court noticed.

How?

The IRS had not assessed penalties. All it wanted was additional tax plus interest.

I wish we could see more of that IRS and less of the automatic penalty dispenser that it has unfortunately become.

Allen reminds us to be careful when selecting a tax preparer. It is not always about getting the “largest” refund. Let’s be honest: for many if not most of us, there is a “correct” tax number. It is not as though we have teams of attorneys and CPAs sifting through vast amounts of transactions, all housed in different companies and travelling through numerous foreign countries and treaties before returning home to us. Anything other than that “correct” number is … well, a wrong number.  

Our case this time was Allen v Commissioner, 128 T.C. 4 (U.S.T.C. 2007).

Not Quite The Informal Claim Doctrine

 

I am looking at a district court opinion from Illinois.

I find the discussion of the numbers a bit confusing. It happens sometimes.

But there something here we should talk about.

We have recently discussed the tax concept of a “claim.” In normal-person-speak, it means you want the government to refund your money. The classic claim is an amended income tax return, but there can be claims for other-than-income taxes. It is its own niche, as using the wrong form can result in having your claim rejected.

Let’s look at the American Guardian Holdings case.

AGH filed its 2015 tax return on September 19, 2016.

Here are the numbers on the original tax return:     

	Original
Revenues	152,092,338
Taxable income	4,880,521
Tax	1,327,806

 The accountant found an error and amended the return on June 6, 2019.

			First
	Original		Original	Amended
Revenues	152,092,338		152,092,338	154,808,792
Taxable income	4,880,521		4,880,521	11,084,397
Tax	1,327,806		1,327,806	148,243
Refund				(1,179,563)

Let me see: The 2015 return would have been extended to October 15, 2016. The amended return was prepared June 6, 2019. Yep, we are within the statute of limitations.

Problem: AGH never sent the amended return.

Answer: AGH hired a new accountant.

The new accountant filed an amended return on September 19, 2019.

COMMENT: Still a few days left on the statute.

For some reason, the accountant incorporated the first amended (even though it had not been filed) into the second amended, resulting in the following hodgepodge:

		First		Second
		Original	Amended	Original	Amended
Revenues		154,808,792	141,773,572	154,808,792	?
Taxable income		11,084,397	7,446,746	11,084,397	?
Tax		1,327,806	148,243	1,327,806	0
Refund			(1,179,563)		(148,243)
Total refund					(1,327,806)

Huh? I would find that second amended confusing. On first impression it appears that AGH is filing a claim for $148,243, but that is incorrect. AGH was stacking the second amended on top of its first. AGH is filing a claim for $1,327,806, which is the entire tax on the original return.

Not surprisingly, the IRS also responded with “huh?” It could not process the second amended return because the “Original” numbers did not match its records.

AGH responded by filing yet another amended return (third amended). Mind you, at this point it was after October 15, 2019, and the statute of limitations was in the rear view mirror.

AGH did the following:

(1)  AGH explained that the new and shiny (third) amended return incorporated the previously (non-filed) first amended return and the second (actually filed) amended return. As a consequence, the “previously-filed amended return for 2015 should be discarded.”

COMMENT: NO! 

(2)  AGH further explained that it was filing Form 1120-PC (a specialized tax form for property and casualty insurance companies) as its third amended return rather than the Form 1120 originally filed because it had received permission to change its method of accounting.

COMMENT: NO!!

I am somewhat shocked at how deep a hole AGH had dug, and more shocked that it kept digging.

Let’s go through the wreckage:

(1)  AGH filed its (second) amended return/claim within the statute of limitations.

(2)  This creates an issue if the claim is imperfect, as one would be perfecting the claim AFTER the statute expires. Fortunately, there is a way (called the informal claim doctrine) that allows one to perfect a claim after the original filing date and still retain the benefit of that original date. 

(3)  The IRS immediately seized on the “previously-filed amended return for 2015 should be discarded” statement to argue that AGH had violated the informal claim doctrine.  If the second amended return was discarded, there was no timely-filed return to which the informal claim doctrine could attach. Fortunately, the Court decided that the use of the word “discard” did not actually mean what it sounded like. AGH dodged a bullet, but it should never have fired.

(4)  That leaves the third amended return, which was filed after the statute expired. AGH of course argued informal claim, but it had committed a fatal act by changing its method of accounting. You see, the informal claim allows one to clarify, document and explain whatever issue is vague or in dispute within the claim at issue. What one is not allowed to do is to change the facts. AGH had changed the facts by changing its method of accounting, meaning its third amended return could not be linked to the second via the informal claim doctrine.

(5)  Standing on its own, the third amended of course failed as it was filed after the statute had expired.    

This case is a nightmare. I am curious whether there was a CPA or law firm involved; if so, a malpractice suit is almost a given. If the work was done in-house, then … AGH needs to tighten up its hiring standards. The case reads like there were no adults in the room.

All is not lost for AGH, however.

Remember that AGH filed its second amended return within the statute of limitations.  The matter then went off the rails and the Court booted the third amended return.

But that leaves the second amended. Can AGH resuscitate it, as technically the Court dismissed the third claim but not necessarily the second?  It would likely require additional litigation and associated legal fees, and I would expect the IRS to fight tooth and nail. AGH would have to weigh the cost-benefit.

Our case this time was American Guardian Holdings, Inc v United States of America, No. 1:2023cv 01482, Northern District of Illinois.

Why You Always Use Certified-Mail For A Paper-Filed Return

Just about all tax returns are moving to electronic filing.

It makes sense. Our server sends a return to the government server, starting the automated processing of the return. Minimal manpower, highly automated, more efficient.

COMMENT: Electronic filing however does allow states and other filing authorities to include filing “bombs,” which can be very frustrating. We had a bomb recently with the District of Columbia. It could have been resolved – should have, in fact – but that would have required someone in D.C.  to answer our e-mail request or telephone call. Belatedly realizing this was a bar too high, we called the client to inform them of a change in plans. We would be paper filing instead.

Sometimes a state will say they never received a return. Our software maintains log events, such as electronic transmission of returns and their acceptance by the taxing authority. Tennessee has done this over the last few years as they updated some of their systems. Fortunately, the matter generally resolves when we present proof of electronic filing.

Do you remember when – not too many years ago – standard professional advice was to send tax returns using either certified or registered mail? That was that era’s equivalent of today’s electronic filing. We used to, back in the Stone Age, send our April 15^th individual extensions as follows:

·      Include multiple extensions per envelope. There could be several envelopes depending on the number of extensions.

·      Include a cover sheet detailing the extensions included in the envelope.

·      Certify the mailing of the envelope.

The problem with this procedure is that it could be abused. One could mail an empty envelope to the IRS, certifying the same. If any question came up, one could point to that envelope as “proof” of whatever. I do not know how often this happened in practice, but I recall having this very conversation with IRS representatives.

This reminds me of a recent case dealing with an issue arising from putting a paper-filed return in the mail. As we move exclusively to electronic filing, this issue will transition to history – along with rotary phones and rolodexes.

Let’s talk about the Pond case.

The IRS audited Stephen Pond’s return and made a mistake, concluding that Pond had underpaid his taxes. Pond paid the notice for tax due and interest on the 2012 tax year. The matter also affected 2013, so Pond overpaid his taxes for that year also. Pond’s accountant caught the mistake and filed for a refund for both years.

The accountant did the following:

(1)  He mailed the 2012 and 2013 tax refund claims in the same envelope to Holtsville, New York.

(2) He mailed a claim for refund of overpaid 2012 interest to Covington, Kentucky, which in turn forwarded the matter to Andover, Massachusetts.

Andover responded first. It wanted proof of the underlying 2012 filing (as the overpaid interest was for 2012). It took a while, but Pond eventually received his 2012 refund, including interest.

Time passed. There was no word about 2013. Pond contacted the IRS and was told the IRS never received the 2013 amended return.

COMMENT: While not said, I have a very good guess what happened. The IRS has had a penchant for stapling together whatever arrives in a single envelope. For years I have recommended separate envelopes for separate returns, as I was concerned about this possibility. It raised the cost of mailing, but I was trying to avoid the staple-everything-together scenario.

Pond sent a duplicate copy of his 2013 amended return.

Months went by. Crickets.

Pond contacted Holtsville and was informed that the IRS had closed the 2013 file.

Oh, oh.

A couple of weeks later Pond received the formal notice that the IRS was denying 2013 because it had been filed after statute of limitations had run.

Pond filed a formal protest. He filed with Appeals. He eventually brought suit in district court. The district court held against Pond, so he is now in Appeals Court.

This is tax arcana here that we will summarize.

     (1)  The general way to satisfy a statutory filing requirement is physical delivery.

(2)  Mail can constitute physical delivery.

a.    However, things can happen after one drops an envelope into the mailbox. The post office can lose it, for example. It would be unfair to hold someone responsible for a post office error, so physical delivery has a “mailbox” subrule:

If one can prove that an item was mailed, the subrule presumes that the item was timely delivered.

NOTE: Mind you, one still must prove that one timely put the item in the mail.

(3)  Congress codified the mailbox rule in 1954 via Section 7502. That section first included certified and registered mail as acceptable proof of filing, and the rule has been expanded over the years to include private delivery services and electronic filing.

(4) The question before the Court was whether Section 7502 supplanted prior common law (physical delivery, mailbox rule) or rather was supplementary to it.

a.    Believe it or not, the courts have split on this issue.

b.    What difference does it make? Let me give an example.      

There is an envelope bearing a postmark date of October 5, 20XX (that is, before the October 15^th extension deadline). The mail was not certified, registered, or delivered by an approved private delivery service.

If Section 7502 supplanted common law, then one could not point to that October 5 date as proof of timely filing. The only protected filings are certified or registered mail, private delivery service or electronic filing.

If Section 7502 supplemented but did not override common law, then that October 5 date would suffice as proof of timely mailing.

Let’s fast forward. The Appeals Court determined that Pond did not qualify under the safe harbors of Section 7502, as he did not use certified or registered mail. He could still prove his case under common law, however. Appeals remanded the case to the District Court, and Pond will have his opportunity to prove physical delivery.

My thoughts?

If you are paper filing – especially for a refund - always, always certify the mailing. Mind you, electronic filing is better, but let’s assume that electronic filing is not available for your unique filing situation. Pond did not do this and look at the nightmare he is going through.

Our case this time was Stephen K Pond v U.S., Docket No 22-1537, CA4, May 26, 2023.