Waiting Too Long For Refund Of Excess Withholdings

It happens when someone fails to file with the IRS. It might be a “sleeping dog” rationalization, but people will allow a string of tax years to go unfiled, even if some of those years have refunds rather than tax due.

This is a trap, and I saw it sprung earlier this year on a widow. It was unfortunate, as she still has kids at home and could use the money.

The trap is that tax refunds are not payable after a period of time. The Code wants closure on tax matters. The IRS has three years to audit you. You in turn have three years to request a refund. These are general rules, and there are relief valves for the unusual situation: the IRS can request you to voluntarily extend the statute, for example, or you can file a protective claim if your three years are running out.

Let’s look at the Golden case.

Michael Golden did not file his 2015 tax return. In fact, he waited so long that the IRS prepared a return for him (called a substitute for return or SFR). The IRS does not spot a taxpayer any breaks when they do this (no itemized deductions or head of household status, for example). The IRS instead is trying to get a taxpayer’s attention, prompting them to file a return and opt back into the system. In April 2021 (five years after the return was actually due) the IRS issued its notice of deficiency (NOD, sometimes referred to as SNOD). The SNOD is the IRS trying to perfect its assessment prior to sending the account to Collections for their tender mercies. The SNOD showed tax due.

A few days after receiving the SNOD, Golden filed his 2015 tax return. It showed a refund.

Of course.

Golden wanted his refund. The IRS said it could not issue a refund.

There is a technical rule.  

Here it is:

         Section 6511(a)  Period of limitation on filing claim.

Claim for credit or refund of an overpayment of any tax imposed by this title in respect of which tax the taxpayer is required to file a return shall be filed by the taxpayer within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later, or if no return was filed by the taxpayer, within 2 years from the time the tax was paid. Claim for credit or refund of an overpayment of any tax imposed by this title which is required to be paid by means of a stamp shall be filed by the taxpayer within 3 years from the time the tax was paid.

Tax law can be tricky, but there are two rules here:

(1) The default period is three years (to coincide with the statute of limitations). The period starts on April 15 (when the return is due) and ends 3 years later, unless one requested an extension, in which case the default period also includes the extension (normally to October 15).

(2) Refuse to go along with the default rule and you might trigger the second rule: only taxes paid within two years of filing can be refunded.

As a generalization, you do not want the second rule. Why limit yourself to taxes paid within two years when you can have taxes paid within three years (and the extension period, if an extension was requested).

The IRS was also looking at this shiny:

Section 6511(b) Limitation on allowance of credits and refunds.

(1)  Filing of claim within prescribed period.

No credit or refund shall be allowed or made after the expiration of the period of limitation prescribed in subsection (a) for the filing of a claim for credit or refund, unless a claim for credit or refund is filed by the taxpayer within such period.

Notice that Congress included the phrase “shall be allowed.” Another way to say this is that – if you do not fit within the three-year test or the two-year test – your refund claim “shall” not be allowed. This was the IRS position: hey, we do not have much discretion here.

Let’s review the dates for Golden.

We are talking about his 2015 return. The return was due April 15, 2016. Add three years. Let’s be kind and add three years plus the extension. His three years clock-out on October 15, 2019. Three years will not get you to a refund.

The two year rule is even worse.

Golden argued fairness. He was working in the private sector as well as the Navy Reserve, and the demands therefrom made his life “extremely difficult.” In tax terms, this argument is referred to as “equity.” Some courts can consider equitable arguments, but the Tax Court is not one of them.

Here is the Court:

          We sympathize with petitioner’s predicament.

The Supreme Court has made clear that the limitations on refunds of overpayments prescribed in section 6512(b)(3) shall be given effect, consistent with Congress’s intent as expressed in the plain text of the statute, regardless of any perceived harshness to the taxpayer. See Commissioner v. Lundy, 516 U.S. at 250–53. Because Congress has not given us authority to award refunds based solely on equitable factors, we are compelled to grant respondent’s Motion for Summary Judgment.”

It was not a total loss for Golden, however. Since he did file a return, the IRS reduced his 2015 tax due to zero. He did not owe anything. He could not, however, recover any overpayment. He left that 2015 refund on the table.

What do you do if you are caught in a work situation like Golden? It is not a perfect answer, but file with the information you can readily assemble. Pay someone to prepare the return (within reason, of course). Hey, maybe you missed interest on a small money market account or took the standard deduction when itemized deductions would have given you a smidgeon more. The IRS will let you know about the first one (computer matching), and if there is enough money there you can amend later (the second one). At least you will get your basic refund claim in.

Our case this time was Golden v Commissioner, T.C. Memo 023-103.

Abatement Versus Refund

 

I was contacted recently to inquire about my interest in a proceduralist opportunity.

That raises the question: what is a proceduralist?

Think about navigating the IRS: notices, audits, payment plans, innocent spouse claims, liens and so on.  One should include state tax agencies too. During my career, I have seen states become increasingly aggressive. Especially after COVID – and its drain on state coffers - I suspect this trend will only continue.

I refer to procedure as “working the machine.” This is not about planning for a transaction, researching a tax consequence or preparing a tax return. That part is done. You have moved on to something else concerning that tax return.

Less glamorously, it means that I usually get all the notices.

Let’s go procedural this time.

Let’s talk about the difference between an abatement and a refund.

Mr Porporato (Mr P) filed a return for 2009. He owed approximately $10 grand in taxes.

He did not file for 2010 or 2011. The IRS prepared returns for him (called a Substitute Return), and he again owed approximately $10 grand for each year.

COMMENT: He had withholding but he still owed tax for each year. He probably showed have adjusted his withholding, but, then again, he went a couple of years without even filing. I doubt he cared.

The IRS came a-calling for the money, and Mr P requested a Collection Due Process hearing.

COMMENT: I agree, and that is what a CDP hearing is about. Mind you, the IRS wants to hear about payment plans, but at least you have a chance to consolidate the years and work-out a payment schedule.

There was chop in the water that we will not get into, other than Mr P’s claim that he had a refund for 2005 that was being ignored.

So what happened with 2005?

Mr P and his (ex) wife filed a joint 2005 return on June 15, 2006.

Then came a separation, then a divorce, then an innocent spouse claim.

Yeeessshhh.

He amended his 2005 return on March 29, 2010. The amended return changed matters from tax due to a tax overpayment. The IRS abated his 2005 liability.

There you have the first of our key words: abatement.

Let’s review the statute of limitations (SOL). You generally have three years to file a tax return and claim your refund, if any. Go past the three years and the IRS keeps your refund. There are modifiers in there, but that is the general picture. We also know the flip side of the SOL: the IRS has three years to examine your return. Go past three years and the IRS cannot look at that year (again, with modifiers). Why is this? It mostly has to do with administration. Somewhere in there you have to close the matter and move on.

Let’s point out that Mr P amended his 2005 return after more than three years. The IRS still reversed his tax due.

Can the IRS do that?

Yep.

Why?

An IRS can abate at any time. Abatement is not subject to the restrictions of the SOL.

Abatement means that the IRS reducing what it wants to collect from you.

But the result was an overpayment.

Mr P wanted the IRS to refund his 2005 overpayment – more specifically, to refund via application of the overpayment to later tax years with balances due.

This is not the IRS reducing what it wants to collect. This is in fact going the other way: think of it as the IRS writing a check.

Wanting the IRS to write a check ran Mr P full-face into the statute of limitations. He filed the 2005 amended outside the three-year window, meaning that the SOL on the refund was triggered.

I get where Mr P was coming from. The IRS cut him slack on 2005, so he figured he was entitled to the rest of the slack.

He was wrong.

And there you have the procedural difference between an abatement and a refund. The IRS has the authority to reduce the amount it considers due from you, without regard to the SOL. The IRS however does not have the authority to write you a check after the SOL has expired.

Another way to say this is: you left money on the table.

Our case this time was Porporato v Commissioner (TC Summary Opinion 2020-24).

An Expiring Six Figure Tax Refund

We had an unusual client situation this 2020 tax-season-that-refuses-to-go-away.

It involved a high earner and a private plane.

More specifically, buying a private plane.

The high earner bought the plane in 2016, which meant there was a dollar-for-dollar depreciation deduction if the plane was successfully placed in business use. While that may sound simple enough, there is a high wall in the tax Code (specifically, Section 280F(d)(6)(C)(ii)) that one has to scale. The IRS is onto wealthy taxpayers buying a plane for “business” use, using it also for personal reasons and reporting relatively minimal income for that personal use under the SIFL rules.

COMMENT: Think of the SIFL rules as picking up mileage-rate income for your personal use of a company car.

It took a while to resolve the issues involved in this return. We prepared and the client filed his 2016 return in 2020. We filed on paper, as it was too late to electronically file. Going into COVID, mind you, when soon there would be no one at the IRS to open the mail. In fact, at one point the IRS estimated that it had over 10 million pieces of unopened mail to process.

Not the best-case scenario, but I was not immediately concerned.

Until our client received an IRS letter that the period for claiming a 2016 tax refund was about to expire.

That amount was six figures.

Let’s talk about the tax statute of limitations.

There are different sides to the statute of limitations.

In general, we know that there is a three-year statute for the IRS to look at one’s return. If you filed, for example, your 2016 tax return on April 15, 2017, the IRS has until April 15, 2020 (barring unusual circumstances) to look at and change your return.

The technical term for any additional taxes is “assessment”, and the IRS has 10 years to collect any taxes assessed. You there have a second limitations period.

But what if the IRS owes you?

Let’s say that you have a refund for 2016. You are in no hurry to file, because there is nothing for the IRS to chase down. You have a refund, after all.

That three-year statute flips and can now be your enemy.

You have to claim that refund within three years.

What if you don’t?

Then you lose it.

You had better file that 2016 tax return by April 15, 2020.

Let’s go tax nerd here.

Technically, there are two limitations periods running concurrently. You have to meet both of them to get to your refund.

(1)  You have to file a refund claim within three years of filing the return.

There is some technical mumbo-jumbo here. Since you never filed a return, the filing serves as both a return and a claim (for refund). You would easily meet the three-year test as filing the return also counts as filing a claim. You did both at the same time.

That, however, is not the problem.

(2)   Taxes paid within the preceding three-year period are recoverable.

The taxes for 2016 were considered paid-in as of April 15, 2017 (when the return was due). As long as you get that return/claim in by April 15, 2020, you are good, right?

Who was not working on April 15, 2020?

The IRS, that‘s who.

Nor many CPA firms. If CPAs were working, odds are they were working in a diminished capacity.  

Still, our return was filed before April 15, 2020, so was there need to be concerned that it was sitting in a trailer with millions of other returns?

And didn’t many deadlines got extended to July 15, in any event?

That answer is fine until the client begins to panic. Did the period run out on April 15? Is the period running out on July 15? ARE YOU SURE?

My partner was anxious: should we call the IRS? Should we file another claim? Should we request an extension of the statute?

Ixnay on that last one, champ.

We had one more card to play.

Guess what extends the three-year lookback period for recoverable taxes?

An extension, that’s what, and our client had one for 2016.

No matter what, our client’s lookback period for taxes goes through October 15, 2020. The client has three years and six months to get to those taxes.

I am, by the way, a fan of routine extensions for tax returns of complexity. COVID has given me another reason why.

Happy client.

Crazy year.