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Rush for NOL Carryback Cash Hits IRS Roadblock

Posted on May 6, 2020
Marjorie M. Margolies
Marjorie M. Margolies
Gary B. Wilcox
Gary B. Wilcox
Brian W. Kittle
Brian W. Kittle
Christian Choi
Christian Choi

Brian W. Kittle is a partner in Mayer Brown’s tax controversy and transfer pricing practice in New York, Gary B. Wilcox is a partner in the firm’s Washington office and a member of the tax controversy and transfer pricing practice, Marjorie M. Margolies is a tax controversy and transfer pricing partner in Mayer Brown’s Chicago office, and Christian Choi is an associate in the firm’s New York office and a member of the tax controversy and transfer pricing practice. The authors are grateful for helpful assistance from Lucas Giardelli, a New York partner in the firm’s tax transactions practice.

In this article, the authors argue that the IRS’s administrative position on overpayments and section 965 lacks a legal basis and will undermine the net operating loss carryback relief provided under the coronavirus relief legislation.

It is possible that Blondie was speaking from the perspective of the IRS in its hit song “One Way or Another”:

One way or another, I'm gonna find ya

I'm gonna get ya, get ya, get ya, get ya

This perspective seems to be driving the IRS’s administrative position that undermines the net operating loss carryback relief Congress recently provided in the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136). In April 2018 the IRS adopted an administrative position that in a year (2017 for calendar-year taxpayers) in which a taxpayer has elected to pay its section 965 transition tax liability over eight annual installments, the taxpayer’s excess tax payments (for example, excess estimated tax) must be applied against future installments of section 965 transition tax before any refund (or other use) of those excess tax payments is made. And while that position continues to thwart taxpayers from receiving much-needed cash as a result, the stakes of the IRS’s position are now raised because it will prevent taxpayers from receiving refunds from NOL carrybacks to 2017 (or, in some cases involving fiscal-year taxpayers, 20181) to the extent of any future section 965 installments.

The IRS’s administrative position is not grounded in section 965’s plain language or its legislative history. Instead, it relies on a slim and underdeveloped legal analysis under sections 6402 and 6403 that, in our view, is erroneous. An overpayment determined under section 6402 from an NOL carryback to 2017 or 2018 should not be reduced by a future installment tax liability under section 965 that is not currently due. Nor should an overpayment of regular tax liability arising from an NOL carryback be regarded as an overpaid installment of tax within the meaning of section 6403. The flaws in the IRS’s administrative position are made clear by the express language in section 965(h)(3), which limits the acceleration of future transition tax installments to specified defined events (for example, the taxpayer’s sale of substantially all its assets). Notably, none of those events is an overpayment of regular tax liability.

It is our hope that the IRS or Congress will act to correct the agency’s harmful administrative position given that cash flow is critical to corporate taxpayers that are taking measures to protect their employees’ jobs. Doing so would be consistent with decades of law interpreting sections 6402 and 6403, as well as Congress’s intent in the Tax Cuts and Jobs Act for taxpayers to be able to spread their section 965 tax over eight years without interest. It also would carry out congressional intent in the CARES Act for taxpayers to monetize their 2018, 2019, and 2020 NOLs through the five-year carryback relief without facing unnecessary roadblocks.2

I. Background of Five-Year NOL Carryback Relief in CARES Act

On March 27 President Trump signed into law the CARES Act. In addition to providing healthcare support and general economic relief to businesses and workers affected by the coronavirus, the CARES Act provides tax relief to both corporate and noncorporate taxpayers by adding a five-year carryback period and temporarily repealing the 80 percent limitation for NOLs arising in 2018, 2019, and 2020.3

For carrybacks, two special rules apply to a year in which there was a section 965 inclusion. First, the CARES Act adds section 172(b)(1)(D)(iv), which provides that if an NOL is carried back to a section 965 inclusion year, the taxpayer will be treated as having made an election under section 965(n). This means that if a taxpayer’s 2017 year is a section 965 inclusion year, an NOL carryback will not be applied to reduce 2017 taxable income that is attributable to the mandatory repatriation income inclusion under section 965. Generally, this provision benefits taxpayers because section 965 income was taxed at rates that were lower than other rates to which income was subjected. This benefit allows taxpayers to use the NOL carryback against highly taxed income.

Second, under section 172(b)(1)(D)(v)(I), if one or more years in the carryback period are a section 965 year, the taxpayer may elect to exclude all section 965 inclusion years from the carryback period. For example, assume a calendar-year corporate taxpayer has an NOL in 2019 but had taxable income in 2014 through 2018. If there is no election to forgo carrybacks for 2019, the 2019 NOL will be carried back to 2014, then to 2015, and so on, depending on taxable income. If the taxpayer’s 2017 year is a section 965 inclusion year, the taxpayer could elect to exclude 2017 from the carryback, in which case the 2019 NOL would be carried back to 2014, 2015, 2016, and 2018, but not 2017.

II. New Spotlight on IRS Position on Section 965 Installment Payments

The IRS’s administrative position surprised taxpayers that had made more estimated tax payments than necessary in 2017 or 2018 and expected refunds of them. That position may not have been challenged by taxpayers until now because those excess payments of regular tax were not sufficiently material at the time to justify engaging in resource-intense litigation. The COVID-19 pandemic has altered that landscape: Taxpayers in need of cash may find that the refund procedures obstruct their ability to turn their NOL carryback adjustments (by tentative request or formal refund claim) into cash. What’s more, they will have to consider the effect of the pre-TCJA corporate tax rate and the TCJA rate in making these important decisions.

For example, assume a taxpayer has a 2017 section 965 inclusion year for which a section 965(h) installment election was made and has a 2019 NOL. Assume further that the taxpayer’s NOL will be partially absorbed against taxable income in 2014, 2015, and 2016, and that the remainder will be fully absorbed in 2017 and 2018. If the taxpayer makes no election to exclude 2017 from the five-year carryback, the expected refund attributable to the carryback to 2017 is squarely in the cross hairs of the IRS administrative position. If the taxpayer elects to exclude 2017, any refund in 2018 attributable to the NOL carryback will not be applied against future installments of the 2017 section 965 tax liability.4 However, the value of the NOL carryback will be significantly reduced to the extent that it is used in any tax year beginning after December 31, 2017.5 This is because the TCJA reduced the corporate tax for tax years beginning after December 31, 2017, from 35 percent to 21 percent. Thus, any election made to forgo an NOL carryback to 2017 out of concern about the IRS administrative position could be very costly to the taxpayer.

III. Background of the IRS’s Administrative Position

In March, April, and June of 2018, the IRS published and updated a list of questions and answers concerning section 965.6 In March the IRS stated that a taxpayer “should make two separate payments as follows: one payment reflecting tax owed without regard to section 965 of the Code, and a second, separate payment reflecting tax owed resulting from section 965 of the Code.” This statement implied that payments related to the section 965 tax would be tracked separately from regular tax liabilities. As a result, many taxpayers with overpayments of their regular tax liability were expecting refunds.

Then, on April 13, 2018, the IRS issued its administrative position in additional guidance (FAQs 13 and 14) that effectively abandoned the bifurcated approach announced in March by stating: “The IRS will apply 2017 estimated tax payments first to a taxpayer’s 2017 net income tax liability described under section 965(h)(6)(A)(ii) (its net income determined without regard to section 965), and then to its tax liability under section 965, including those amounts that are subject to payment in installments pursuant to section 965(h).” If the taxpayer’s estimated tax payments for its regular tax liability for 2017 exceed the sum of its regular tax liability and the first installment payment of section 965 tax, the taxpayer is not entitled to a refund “unless and until the amount of payments exceeds the entire unpaid 2017 income tax liability, including all amounts to be paid in installments under section 965(h) in subsequent years.”7 The IRS later adopted this position in the Internal Revenue Manual,8 and restated it in recent CARES Act guidance (FAQ 4).9

The only explanation offered by the IRS for its administrative position is found in chief counsel advice (PMTA 2018-016) dated August 2, 2018. In that informal and non-precedential guidance, the IRS relies on Estate of Bell10 to support its view that (1) “Section 6403 does not permit the Service to refund any excess installment payment to the taxpayer prior to there being an overpayment of the entire liability as provided in section 6402,” and (2) “there is no overpayment under section 6402 until the entire 2017 tax liability is paid, including all the installments of the deferred payment.”

As discussed in Section VI, the court in Estate of Bell viewed an overpaid installment of estate tax as an overpayment within the meaning of section 6402, and it applied the overpayment against the remaining installments based solely on an application of section 6403. The court did not hold that future estate tax installments exceeding the overpaid installments prevent the overpaid installments from constituting an overpayment under section 6402. If that were true, there would have been no need for the court to consider section 6403. Estate of Bell merely confirms that the refund of a section 6402 overpayment may be subject to a restriction under section 6403 — but that is only if section 6403 applies.For section 965 installments, section 6403 could possibly apply only if the section 965 installment itself had been overpaid, and then only to the extent of the overpaid amount of the installment. It should not apply to an overpayment of regular tax liability that exists wholly apart from future section 965 installments.

IRS counsel’s discussion of section 6402 also misses the mark. After citing Liberty Glass11 for the proposition that “overpayments are payments that exceed the amount properly due,” counsel explains that it is appropriate to accelerate future installments to offset an overpayment because section 965 does not defer the full recognition of income in the section 965 inclusion year, and therefore it does not “defer the tax liability.” Rather, it “only permits a deferral of the payment of that liability if the shareholder elects to do so.” Thus, counsel is saying that the mere existence of a tax liability to pay in the future — even though the IRS otherwise has no rights to collect on that liability in the current year12 — can prevent an overpayment of current-year taxes from being refunded. No attempt was made to reconcile this position with the Liberty Glass holding that overpayments may be offset by only those liabilities that are “properly due.”

IV. Background of Overpayment Statutes and Regulations

To understand why the IRS’s administrative position is incorrect, we must first explore three code provisions — sections 6401, 6402, and 6403 — and their relationship with each other. Each provision has remained substantially the same since its inclusion in the 1954 code.13 And Treasury regulations interpreting these three provisions, issued in 1955, are still substantially the same today.14 We consider the background of these three code provisions next, in addition to analogous overpayment provisions (sections 6425 and 6411) and section 965(h).

A. Section 6401 — Amounts Treated as Overpayments

Section 6401(a) states that “the term ‘overpayment’ includes that part of the amount of the payment of any internal revenue tax which is assessed or collected after the expiration of the period of limitation properly applicable thereto.”15 Section 6401(b) and the regulations thereunder specify that the term “overpayment” includes excessive credits.16

Section 6401(a) originated in section 607 of the Revenue Act of 1928.17 Its purpose was to confirm that any payment by a taxpayer of a barred tax liability, whether voluntary or involuntary, automatically becomes an overpayment and subject to mandatory refund. Courts later clarified that if a payment of tax is made within the statutory period for assessment and collection, it is not an overpayment under section 607 just because the IRS was late in assessing the tax.18 Courts and the IRS have applied the same interpretation to section 6401(a).19

B. Section 6402 — Authority to Make Credits or Refunds

Section 6402(a) provides that Treasury may credit the amount of an “overpayment,” including any interest allowed thereon, “against any liability” and shall refund the balance.20 The section 6402 regulations modify the term “any liability” to refer to “any outstanding liability in respect of any internal revenue tax.”21

The two key terms or phrases in section 6402 and regulations thereunder are “overpayment” and “any outstanding liability.” In general, an “overpayment” is determined by comparing the taxes paid for a year with the taxes owed for that year, and an “outstanding liability” — which is typically a tax liability from a different year — is considered an offset only once it is determined that there is an overpayment. Taxes paid in installments present a unique question of whether unpaid installments owed in later years are considered part of the tax liability for the year in question or outstanding liabilities or, alternatively, are, in the absence of an acceleration event, viewed as future liabilities that are not yet due.

1. Meaning of ‘overpayment.’

Starting with “overpayment,” the first question is whether that term is limited to the items described as overpayments in section 6401. It is not. Courts and the IRS agree that the items in section 6401 are not the only types of overpayments.22

Court opinions and IRS guidance confirm that, apart from the statutory definition of overpayment in section 6401, the code and Treasury regulations do not define the term “overpayment” for section 6402 purposes. Fortunately, however, the Supreme Court has defined the term as “any payment in excess of that which is properly due.”23 In Liberty Glass,24 the Court stated:

Such an excess payment may be traced to an error in mathematics or in judgment or in interpretation of facts or law. And the error may be committed by the taxpayer or by the revenue agents. Whatever the reason, the payment of more than is rightfully due is what characterizes an overpayment. [Emphasis added.]25

Notably, the Court’s definition of overpayment was in reference to section 322(a) of the Revenue Act of 1928, which provided that an overpayment of tax shall “be credited against any income, war-profits, or excess-profits tax or installment thereon then due from the taxpayer, and any balance of such excess shall be refunded immediately to the taxpayer.” Even though the words “then due” were deleted in 1954 when section 6402 replaced section 322, courts and the IRS regularly cite the Liberty Glass definition as controlling for section 6402 purposes.26 This makes sense because the “rightfully due” requirement in the Liberty Glass definition is inherently part of the overpayment definition and refers to tax due “for the period in question.”27

2. Meaning of ‘any outstanding liability.’

The courts and the IRS typically have interpreted the phrase “any outstanding liability” in the context of whether it includes a tax liability from a different tax year. That is because any offsetting amount from the same tax year already would have been taken into account in determining whether an overpayment exists.

Even though section 6402 refers only to “any liability,” courts and the IRS recognize that the “outstanding liability” phrase in the section 6402 regulations is the operative requirement.28 At the same time they recognize that there is no definition of outstanding liability for section 6402 purposes.29

As discussed earlier, predecessors of section 6402 referred to tax liabilities “then due,” but those words were deleted in 1954 when section 6402 was enacted. The importance of the phrase “then due” in the pre-1954 statutes arose in cases in which the IRS credited an overpayment for one year against an unagreed deficiency for another year. The courts held that the IRS could credit the overpayment if the deficiency was then due, and it was then due if the IRS had issued a notice of deficiency even though there was not yet an assessment of the deficiency.30 It is significant to note that the IRS now regards the “then due” requirement as an inherent component of section 6402 and an explicit component of section 6411(b)(regarding tentative carrybacks), and the key to offsetting an overpayment with a deficiency from another year is not whether the deficiency has been assessed but whether it is “then due.”31

C. Section 6403 — Overpayment of Installment

Section 6403 provides that for a tax payable in installments, if the taxpayer pays as an installment more than the “correct amount of such installment,” the overpayment will be credited first against the unpaid installments.32 Then it specifies that “if the amount already paid, whether or not on the basis of installments,” exceeds the “correct amount of the tax,” the overpayment will be credited or refunded as provided in section 6402.33

The first sentence of section 6403 clearly refers only to an overpaid installment payment. It does not address excess payments of regular tax liability that exist wholly apart from whether a taxpayer paid more than the correct amount of an installment. The unpaid installments refer to future installments not yet due.34

We believe the second sentence of section 6403 must be read in the context of the first. That is, the phrase “amount already paid, whether or not on the basis of installments,” refers only to amounts paid toward the tax that is the subject of installment payments. The phrase “correct amount of the tax” refers only to the correct amount of the tax that is the subject of installment payments. Finally, the term “overpayment” refers to the amounts paid with reference to the correct amount of tax that is the subject of the installment payments. This position is supported by authorities holding that section 6403 does not apply to estimated tax payments made before the return is filed and the deferral election is made.35

D. Other Analogous ‘Overpayment’ Provisions

It is reasonable to expect that a court would interpret the phrase “any liability” in section 6402 consistent with other crediting provisions such as section 6411 or 6425. Section 6411(b) provides that any decrease in tax resulting from a tentative carryback must first be applied against any unpaid amount of the tax decreased, and then against any unsatisfied amount of tax for the tax year preceding the tax year in which the carryback item arose. Finally, any remainder “shall, within [the] 90-day period, be either credited against any tax or installment thereof then due from the taxpayer, or refunded to the taxpayer” (emphasis added). It would not make sense for a section 6402 refund claim to be offset against the entire unpaid section 965 liability if a section 6411 tentative carryback adjustment would only be offset against any outstanding installments that are “then due.”36

Section 6425 permits a corporation that overpaid its estimated tax for the year to apply for a quick refund if the overpayment is at least $500 and 10 percent of the expected tax liability. The overpayment is the excess of the estimated income tax the corporation paid during the tax year over the final income tax liability expected for the tax year, at the time the application is filed. Section 6425(b)(2) provides that the IRS may credit the overpayment “against any liability.” Similar to section 6402, the statute does not itself refer to any “liability then due.” However, reg. section 1.6425-3(e) interprets “any liability” to mean “any liability . . . which is due and payable on the date of allowance” (emphasis added). As a matter of statutory continuity, it would not make sense for the phrase “any liability” to mean something different in section 6402 from what it means in section 6425. If that were so, a corporation could obtain a refund of estimated tax in a section 6425 setting that it could not obtain if it waited to file a return before asking for the refund.37

V. Flora Full Payment Rule

U.S. district courts obtain jurisdiction (concurrent with the Court of Federal Claims38) to hear refund suits from 28 U.S.C. section 1346(a)(1), which refers to “any civil action or claim against the United States for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected.”39 The Supreme Court in Flora40 interpreted this provision to require that a claimant pay the entire tax liability “for the taxable period in question” as a condition precedent to filing a refund suit.41 The application of the full payment rule to the “taxable period in question” is consistent with how “overpayment of tax” has been interpreted by the courts; that is, it is typically defined by reference to the particular tax year for which an overpayment is claimed.42

The application of the full payment rule to tax installments not due until subsequent tax years has arisen, to our knowledge, in two situations. The first is when the taxpayer has entered into a written agreement with the IRS to pay “any tax in installment payments,” under section 6159. Those cases are not applicable in evaluating the IRS’s administrative position in a situation in which the taxpayer does not expressly agree to apply any refunds to the installment liability.43 The second situation involves the estate tax installment payments under section 6166.

A group of IRS rulings and cases primarily in the Federal Circuit has interpreted the full payment rule in Flora to require payment of the entire estate tax liability, including all remaining installments payable under section 6166, before a refund action for estate tax may be maintained.44 These authorities do not rely on an analysis of section 6403 when, among other things, either the estate allegedly was ineligible for section 6166 installments45 or the alleged overpayment relates to the nondeferred portion of the estate tax liability.46

The Federal Circuit’s decision in Rocovich,47 generally considered the chief case on point, held that the remaining installments had to be paid for the claims court to have subject matter jurisdiction, because the “estate tax is not a divisible tax” as it “arises from a single event” and “exceptions to the full payment rule have been recognized by the courts only where an assessment covers divisible taxes.”48 This decision does not even mention section 6402 or otherwise discuss whether an overpayment existed.49

The only case of which we are aware that analyzes the overpayment issue under section 6402 and comes to an adverse decision is Estate of McNeely,50 a Minnesota federal district court case. The estate claimed a refund for an overpayment of the nondeferred portion of the estate tax. The IRS agreed that the nondeferred portion had been overpaid, but it denied the refund by crediting it against the unpaid installments on the deferred portion. First, the court established that section 6402, rather than section 6403, was the operative statute because the estate had not been approved for section 6166 installments when the nondeferred payment was made. Then the court reasoned that it was unnecessary to determine whether the nondeferred payment was an overpayment under section 6402 because even if it was, the deferred portion was an outstanding liability under reg. section 301.6402-1 that could be offset against the nondeferred payment.

In contrast to those cases, there is a trio of federal district court decisions holding that neither section 6402 nor section 6403 required full payment of an estate tax liability before a refund could be awarded.51 In these cases the taxpayer had paid estate tax in an amount exceeding what was currently due under the agreed schedule of section 6166 installment payments, but less than the entire estate tax liability.

In Snyder,52 the court analyzed the issue exclusively under section 6402 and refused to apply an overpayment of the nondeferred estate tax against the remaining deferred estate tax liability, stating that under section 6402 and reg. section 301.6402-1, the term “liability” or “outstanding liability” refers only to “taxes then due” and does not include “liabilities which by law, become due in the future.”53 To hold otherwise would “deprive the taxpayer of the deferred payment benefit under section 6166.”54 The court believed it was “inconceivable that Congress intended such a result.”55

It is anyone’s guess what a particular federal district court would do if faced again with an alleged overpayment of nondeferred estate tax while deferred installments remain unpaid. The IRS changed its position on the refund jurisdiction multiple times before it eventually settled into a hard-line position that all the deferred installments must be paid before an alleged overpayment of nondeferred estate tax can be refunded.56 After Congress overruled Rocovich and Abruzzo57 by enacting section 7422(j) in 1998,58 the IRS began asserting (as in Estate of McNeely) that even if the court has refund jurisdiction, the taxpayer must still prove an overpayment under section 6402 to recover a refund, and none exists until all the deferred installment are paid.59

The Justice Department maintained for many years that the full payment rule does not apply when the estate is eligible to make, and is timely making, section 6166 installments.60 In Abruzzo, decided in 1991, the Justice Department filed a brief in which it agreed with the estate that a refund action was permitted despite the nonpayment of future installments, but the claims court nevertheless, sua sponte, reached its own adverse decision.61 Yet it appears that the Justice Department was no longer following that policy when it litigated Center Heights62 and Estate of McNeely.

VI. Authorities Addressing Interaction of Sections 6403 and 6166

There is another string of authorities that analyze whether an alleged overpayment of a section 6166 installment must be offset against the entire estate tax liability, solely on the basis of section 6403. The principal authority is the Ninth Circuit decision’s in Estate of Bell,63 holding that section 6166 installments are subject to section 6403.

In Estate of Bell, the taxpayer and the IRS finally agreed on an estate value after going back and forth, resulting in the taxpayer having paid an amount of estate tax that exceeded not only what the section 6166 installments then due would have been based on the agreed value, but also the entire estate tax liability. The parties disagreed, however, on whether the “overpayment” should be refunded currently or applied toward the future, corrected section 6166 installments that were not yet due.

The Tax Court began its analysis by acknowledging that the estates had made overpayments of their installments under section 6402, with the sole issue being whether section 6403 reduced those overpayments.64 Viewing section 6166 deferral as “a matter of legislative grace,” the Tax Court believed that section 6166 “should be given a strict and narrow construction.”65 Then, looking to the plain meaning of the words used in section 6403, it held that if a taxpayer’s installment payment under section 6166 “exceeds the installment then due, such excess is ‘credited against the unpaid installments, if any,’ pursuant to section 6403.”66 In affirming the Tax Court, the Ninth Circuit adopted the Tax Court’s rationale, holding that section 6403 is “clear and unambiguous,” and “Congress did not intend to negate the clear mandate of section 6403 when an overpayment is made on a section 6166 installment.”67

Estate of Bell’s application is limited in scope. It applies only to overpaid installment payments made after the section 6166 election is validly made. It characterizes the overpaid installment payments as overpayments under section 6402 and moves on to limit the refund of them under section 6403. Later decisions citing Estate of Bell have described its limited application.68

VII. The Inapplicability of Section 6166 Case Law

The IRS states in the Internal Revenue Manual regarding “section 965 excess remittances” that it “does not have authority to issue a refund or apply a credit elect until the taxpayer has fully paid their entire tax liability for the year . . . including the deferred payment amounts.”69 That is a disturbing statement. There is, of course, plenty of authority for concluding that the deferred payment amounts are not applied to offset an overpayment of federal income tax until such time as those amounts are “due.” If by “authority” the IRS means section 6403 and Estate of Bell, it has been ill-advised. If by “authority” it is referring to a handful of other section 6166 cases in the Federal Circuit and a few district courts holding that the Flora full payment rule is not satisfied unless all the deferred payment amounts are paid, the IRS is not carefully thinking through the differences between section 6166 and section 965, as well as the differences between estate tax and income tax generally.

Both section 6166 and section 965 have provisions that accelerate the unpaid installments under some circumstances, but they have a critical difference in wording. Section 6166(g) simply says that upon the acceleration event, the tax payable in installments “shall be paid upon notice and demand.” Section 965(h)(3) says that upon the acceleration event, “the unpaid portion of all remaining installments shall be due on the date of such event” (emphasis added). This is a clear indication by Congress that in the absence of an acceleration event, the unpaid installments scheduled to be paid in later years are not due in the current year.70 Thus, the IRS’s offset of the excess tax payments (for example, as the result of estimated tax payments or NOL carrybacks) against unpaid, future section 965 installments is an offset against a tax liability that is not “due,” in contravention of both the Supreme Court’s definition of overpayment under section 6402 and Congress’s intent under section 965(h) that these installments are not due in the absence of an acceleration event.

Even if the IRS believes it can ignore the Supreme Court’s holding that any liabilities offsetting a section 6402 overpayment must be “properly due,” it cannot ignore the literal language of the code. Unlike the estate tax area, the income tax area permits taxpayers to obtain a tentative refund under section 6411 for NOL carrybacks rather than file a formal refund claim under section 6402. Under section 6411(b), the IRS is required to determine the decrease in tax attributable to the carryback and then, after applying the decrease to satisfy any unpaid tax for the carryback year and the year immediately preceding the NOL year, the remainder must “be either credited against any tax or installment thereof then due from the taxpayer, or refunded to the taxpayer” (emphasis added). When the IRS denies a tentative refund by offsetting an overpayment of regular income tax with future section 965 installments that are not yet due, it is acting contrary to unequivocal statutory language.

Another indication of the difference between the two code sections is that interest is charged on section 6166 installments, but there is no interest charged on the seven deferred section 965 installments. Congress made it clear in the TCJA legislative history that “the timely payment of an installment does not incur interest.”71 The lack of an interest charge results because section 965(h)(2) provides that the seven installments after the section 965 inclusion year are not payable until the return dates in those subsequent seven years. By forcing an acceleration of the future installments to offset an overpayment, the IRS is taking away the taxpayer’s time value of money benefit that Congress intended to provide.

The IRS should also consider other obvious differences between estate tax and income tax. An estate tax focuses on one date (the date of the decedent’s death) and one return, whereas an income tax focuses on an annual accounting period and annual returns.72 Even if an acceleration of installment payments into the year of the estate tax return were considered appropriate, that would not justify taking the same position for an income tax return. It violates the established concept that the code imposes income tax liability based on a fixed, annual accounting period, and it conflicts with how the courts and IRS define overpayment in the income tax context by reference to the current tax year in question.73

VIII. Conclusion

Despite the murkiness of the cases in the section 6166 area, it is clear that the IRS has misapplied the applicable statutory provisions and judicial principles in arriving at its conclusions in PMTA 2018-16, in reliance on Estate of Bell, that: (1) “Section 6403 does not permit the Service to refund any excess installment payment to the taxpayer prior to there being an overpayment of the entire liability as provided in section 6402,” and (2) “there is no overpayment under section 6402 until the entire 2017 tax liability is paid, including all of the installments of the deferred payment.”

First, section 6403 does not apply because an overpayment of regular tax liability arising from excess estimated taxes or an NOL carryback does not constitute an overpayment of a section 965 installment. Section 6403 could apply only to the extent that a taxpayer actually overpaid the section 965 installment itself and was seeking a refund of that overpayment before the future installments were paid.

Second, Estate of Bell is not authority for the IRS’s position that the excess of tax payments over the sum of regular tax liability and the section 965 installment due for the year is not an overpayment under section 6402 until after the excess is applied to pay down future section 965 installments. Estate of Bell, if anything, supports the taxpayer’s position that the excess is a section 6402 overpayment. The decision merely holds that section 6403, when it applies, can prevent a refund from a section 6402 overpayment when future installments are outstanding. But in the situations we are addressing, section 6403 has no application.

Third, the IRS’s position that there is no section 6402 overpayment until all future section 965 installments are paid flies in the face of judicial interpretations of the section 6402 regulations to the effect that overpayments cannot be offset by liabilities that are not yet due for the tax year in question. Nor can it be reconciled with collateral code provisions unique to the income tax overpayments — namely, sections 6411 and 6425 — that provide expressly by statute or regulations that only liabilities due and payable for the year in question are taken into account.

The IRS should not be withholding cash refunds arising from either excess estimated taxes or an NOL carryback on such a slim, undeveloped, and frankly incorrect legal analysis of sections 6402 and 6403. If the IRS believes its interpretation of these code sections is correct, it should propose regulations and provide taxpayers an opportunity for comment. But letting so many dollars ride on a Large Business and International Division FAQ and an internal advice memorandum is inappropriate. The importance of this issue has been compounded by the CARES Act’s five-year carryback relief. If the IRS does not act quickly to withdraw this administrative position, Congress should step in and clarify the law, as it proposed to do in the initial draft of the CARES Act.

FOOTNOTES

1 For example, if a U.S. parent company with a calendar tax year owns a controlled foreign corporation with a November 30 tax year, the parent’s section 965 transition tax liability will arise in its 2018 year.

2 The original Senate Republican version of the CARES Act released on March 19 (S. 3548), in proposed section 2208, included a retroactive technical correction to the TCJA that would have prevented the IRS from pursuing its administrative position. We understand that this proposal was dropped because of Senate Democrats’ political opposition to the correction of TCJA errors and not because of any objection to the proposal’s substance.

3 For a detailed discussion of the NOL relief provided in the CARES Act, see Gary B. Wilcox at al., “CARES Act Adds Five-Year Carryback Period and Suspends 80 Percent Limitation for 2018, 2019 and 2020 Net Operating Losses,” Mayer Brown (undated).

5 This is slightly more complicated if a corporation’s tax year does not begin on January 1, 2018. See Notice 2018-38, 2018-18 IRB 522.

6 IRS, “Questions and Answers About Reporting Related to Section 965 on 2017 Tax Returns,” FAQ 10 (Mar. 13, 2018).

7 Id.

8 See, e.g., IRM sections 20.1.3.2.7.2.2, 21.6.4.4.21, and 21.7.4.4.25.4.

10 Estate of Bell v. Commissioner, 928 F.2d 901 (9th Cir. 1991), aff’g 92 T.C. 714 (1989).

11 Jones v. Liberty Glass Co. v. Commissioner, 332 U.S. 524, 531 (1947) (emphasis added).

12 The IRS has no right to collect the future section 965 installments until they become due in later years, absent an acceleration event. In fact, the IRS procedures provide that a notice and demand for each installment will be issued to taxpayers shortly before each subsequent return due date. IRM sections 21.6.4.4.21.7.1, 21.7.4.4.25(14), and 21.7.4.4.25.8.

13 Section 6402 has been amended several times to add several nontax items for which a tax refund can be offset. Each provision had a similar predecessor provision in earlier income tax laws. The Revenue Act of 1918 included sections 250 and 252, which were similar to sections 6403 and 6402, respectively. Those provisions were discussed in Blair v. Birkenstock, 271 U.S 348 (1926).

14 Reg. sections 301.6401-1, 301.6402-1, and 301.6403-1.

17 Gardner v. Commissioner, 38 T.C. 875 (1962).

18 E.g., Crompton & Knowles Loom Works v. White, 65 F.2d 132 (1st Cir. 1933).

19 E.g., Williams-Russell & Johnson Inc. v. United States, 371 F.3d 1350 (11th Cir. 2004); Ewing v. United States, 914 F.2d 499 (4th Cir. 1990); and Rev. Rul. 85-67, 1985-1 C.B. 364.

22 See, e.g., Estate of Baumgardner v. Commissioner, 85 T.C. 445 (1985); Bachner v. Commissioner, 109 T.C. 125 (1997); Estate of O’Neal v. United States, 291 F. Supp. 2d 1253 (N.D. Ala. 2003); ILM 201134018; and ECC 201316020.

24 Liberty Glass, 332 U.S. at 531.

25 Sunoco Inc. v. Commissioner, 663 F. 3d 181, 189 (3d Cir. 2011) (“Although the Internal Revenue Code does not define the term ‘overpayment,’ the Supreme Court has ‘read the word overpayment in its usual sense, as meaning any payment in excess of that which is properly due,’” citing Liberty Glass, 332 U.S. 524). See also United States v. Dalm, 494 U.S. 596, 609 n.6 (1990).

26 See, e.g., Sunoco, 663 F. 3d at 189.

27 The Supreme Court, in affirming the 10th Circuit’s Flora decision, described Liberty Glass as holding that there was no jurisdiction “because petitioner has not paid the entire assessment for the period in question” (emphasis added). Flora v. United States, 357 U.S. 63, 64 (1958), aff’d on rehearing, 362 U.S. 145 (1960). See also Estate of Akin v. United States, 43 F.3d 1487 (Cl. Ct. 1994).

28 Northern States Power Co. v. United States, 73 F.3d 764, 767 (8th Cir. 1996). Moreover, the legislative history of section 6402(a) refers to an “outstanding liability.” See H.R. Rep. No. 83-1337 (1954); S. Rep. No. 83-1622 (1954); and H.R. Rep. No. 83-2543 (1954) (Conf. Rep.). In FSA 1993-1012, the IRS said it recognized that while neither the legislative history nor the regulations “give further definition to what constitutes a ‘liability in respect of an internal revenue tax,’” the predecessor statutes of section 6402(a), which refer to tax “then due” from the taxpayer, “provide further insight into what constitutes ‘liability’ against which an overpayment may be credited.”

30 See, e.g., Noyes v. United States, 55 F.2d 870 (9th Cir. 1932); Tull & Gibbs Inc. v. United States, 48 F.2d 148 (9th Cir. 1931); and Cole v. Helvering, 73 F.2d 852 (D.C. Cir. 1934). Note that section 6215 provides that no assessment may occur until the Tax Court determines the amount of the deficiency if a petition is filed.

31 In Rev. Rul. 2007-51, 2007-37 IRB 573, the IRS discusses Rev. Rul. 54-378, 1954-2 C.B. 246, which suggested that an offsetting liability had to be both “assessed and then due,” and concluded that the real question of whether any liability is an “outstanding liability” for section 6402 purposes turns on whether it is due, and not on whether it has been assessed. The IRS treats a deficiency the same under both section 6402 and section 6411, even though the section 6402 regulations refer to “outstanding liability” and section 6411(b) refers to a tax or installment thereof “then due.”

32 Section 6403 states: “In the case of a tax payable in installments, if the taxpayer has paid as an installment of the tax more than the amount determined to be the correct amount of such installment, the overpayment shall be credited against the unpaid installments, if any. If the amount already paid, whether or not on the basis of installments, exceeds the amount determined to be the correct amount of the tax, the overpayment shall be credited or refunded as provided in section 6402.”

33 See id. Reg. section 301.6403-1 modifies the reference to “the unpaid installments” by instead referring to “any outstanding installments of such tax” and adds the term “due” after “correct amount of tax.”

34 See Estate of Bell, 92 T.C. at 719 (The IRS’s position was that under section 6403, the overpayments of installments should “be credited towards, the future, corrected section 6166 installments . . . which are, concededly, not yet due.”).

35 E.g., Estate of McNeely v. United States, No. 0:12-cv-01973 (D. Minn. 2014); and ILM 200141013. This reading is also grounded in the noscitur a sociis canon of construction.

36 See GCM 38768 (the IRS interprets section 6402 by reference to how the predecessor provision referring to “installment thereon then due” was interpreted by the courts, and by reference to the “tax . . . then due” language in section 6411(b)); and GCM 38480 (the IRS discusses how section 6402 should be interpreted consistently with section 6411(b)).

37 It was reported that right after the April 13, 2018, FAQs were issued, taxpayers were advised to file a Form 4466, “Corporation Application for Quick Refund of Overpayment of Estimated Tax,” before April 17, 2018 (the return filing date) to avoid the application of their estimated tax payments to unpaid section 965 installments. Reportedly, the IRS at first suspended the processing of these requests, presumably because it didn’t want to take an inconsistent position under section 6425. See Taxpayer Advocate Service, “NTA Blog: IRS Administration of the Section 965 Transition Tax Contravenes Congressional Intent and Imposes Unintended Burden on Taxpayers” (Aug. 16, 2018); and Treasury Inspector General for Tax Administration, “Implementation of the Tax Cuts and Jobs Act Deemed Repatriation Tax Presented Significant Challenges,” 2019-34-033 (May 22, 2019). We understand that the IRS has since processed those requests.

38 28 U.S.C. section 1491(a)(1) grants refund jurisdiction to the Court of Federal Claims.

39 Various requirements (e.g., the filing of a refund claim) and special rules for bringing a refund suit are set forth in section 7422.

40 Flora, 357 U.S. 63, aff’d on rehearing, 362 U.S. 145 (the Court held that full payment of the assessment must be made before a refund action may be commenced in a federal district court). The claims court, and before that the Court of Claims, have applied the same full payment requirement. Lambropolous v. United States, 18 Cl. Ct. 235 (1989). A credit of an overpayment is treated as a payment. Section 7422(d).

41 The Court in Flora recognized that its full payment rule is less onerous for so-called divisible taxes, such as some excise taxes or employee withholding taxes, when a refund suit can be brought based on assessed tax attributable to one transaction or one employee for a single tax period. See, e.g., Boynton v. United States, 566 F.2d 50, 52-54 (9th Cir. 1977).

42 See, e.g., General Electric Co. v. United States, 56 Fed. Cl. 488 (2003); and Burr v. Commissioner, T.C. Memo. 2002-69.

43 Cf. McKoin v. Commissioner, T.C. Memo. 2001-62; and Oppenheim v. United States, No. 07-852 (Fed. Cl. 2009).

44 See Rocovich v. United States, 933 F.2d 991 (Fed. Cir. 1991); Abruzzo v. United States, 24 Cl. Ct. 668 (1991); Center Heights Lumber Co. v. United States, No. EV 98-74-C-Y/H (S.D. Ind. 1999); Rev. Rul. 80-250, 1980-2 C.B. 278; Rev. Proc. 81-27, 1981-2 C.B. 548; ILM 200141013; TAM 200648028; and ECC 201226027.

45 E.g., Rocovich, 933 F.2d 991.

46 E.g., Center Heights, No. EV 98-74-C-Y/H; and TAM 200648028.

47 Rocovich, 933 F.2d 991.

48 Id. at 995 (“Congress, in section 6166, has merely permitted an estate to pay the single tax in installments with interest. As a result, the partial satisfaction of the tax by an installment payment under section 6166 does not satisfy the Flora full payment rule.”).

49 See also Abruzzo, 24 Cl. Ct. 668 (same); and Center Heights, No. EV 98-74-C-Y/H (same).

50 Estate of McNeely, No. 0:12-cv-01973.

51 Snyder v. United States, 630 F. Supp. 182 (D. Md. 1986); Eichheim v. United States, No. 86-M-1872 (D. Colo. 1988); and Gettysburg National Bank v. United States, No. 1:CV-90-1607 (M.D. Pa. 1992).

52 Abruzzo, 24 Cl. Ct. 668.

53 Snyder, 630 F. Supp. at 184.

54 Id. at 185.

55 Id. See also Eichheim, No. 86-M-1872, at *11 (Citing Snyder, the court observed “that to allow sections 6402 and 6403 to operate as the defendant claims they must would ‘totally negate the benefits’ of section 6166, to which both parties agree the plaintiff was entitled”); and Gettysburg, No. 1:CV-90-1607, at *39 (citing Eichheim, the court stated that the taxpayer’s “section 6166 election is valid, and is deserving of a refund and the opportunity to pay its tax debt in installments pursuant to that statute”).

56 GCM 35696; GCM 39839 (revoking GCM 35696); and GCM 39854 (modifying GCM 39839).

57 Abruzzo, 24 Cl. Ct. 668.

58 Section 7422(j) provides that nonpayment of deferred estate tax liability because of a section 6166 election generally does not prevent jurisdiction in the Court of Federal Claims and district courts to determine the liability or refund.

59 See, e.g., ILM 200141013; TAM 200648028; and ECC 201226027.

60 GCM 35696.

61 Defendant’s Brief Supporting Jurisdiction, at 6-7, Abruzzo, 24 Cl. Ct. 668 (filed July 8, 1991).

62 Center Heights, No. EV 98-74-C-Y/H.

63 Estate of Bell, 928 F.2d 901.

64 The Tax Court stated that section 6403 applies if the installment payment “exceeds the installment then due,” and here, after making the section 6166 election, the estate “‘paid as an installment of the tax more than the amount determined to be the correct amount of such installment.’” Estate of Bell, 92 T.C. at 714. The Tax Court asserted it had jurisdiction over these overpayments under section 6512(b).

65 Id. at 723.

66 Id. at 724.

67 Estate of Bell, 928 F.2d at 903.

68 Estate of Shapiro v. Commissioner, 111 F.3d 1010, 1013 (2d Cir. 1997) (“In short, Estate of Bell stands for the proposition that, consistent with the language of [section 6403], an overpayment of an estate tax installment payment under section 6166(a) shall be credited against any unpaid installments.”); Estate of Adell v. Commissioner, T.C. Memo. 2014-89 (Citing Estate of Bell, the Tax Court stated: “For a tax payable in installments, section 6403 provides that any overpayment of an installment must be applied first to any unpaid installments. If the amount of the overpayment exceeds the full amount of the tax due, then it may be credited or refunded as provided in section 6402.”).

69 IRM section 21.6.4.4.21.

70 Further, section 965(h)(2) provides that each installment after the section 965 inclusion year “shall be paid on the due date” of the return for that year. Treasury and the IRS have reinforced that “each succeeding installment payment is due on the due date (without regard to extensions) for the return for the taxable year following the taxable year with respect to which the previous installment was made.” Reg. section 1.965-7(b)(1)(iii) (emphasis added).

71 H.R. Rep. No. 115-466, at 611 (2017).

72 The Federal Circuit in Rocovich, 933 F.2d at 995, noted that exceptions to the full payment rule have been recognized “where an assessment covers divisible taxes,” but the “estate tax is not a divisible tax; it arises from a single event.”

73 See authorities cited supra note 27.

END FOOTNOTES

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