We are still working out logistics to get Christine Speidel full access to the blog site. In the meantime I introduce her most recent post which focuses on the distinction between giving a taxpayer credit and giving the taxpayer a refund. Keith
On April 4, 2018, the Eleventh Circuit ruled in Schuster v. Commissioner that a credit applied to a taxpayer’s account is not the same thing as a refund. This was bad news for the taxpayer.
Sometimes the IRS messes up when it applies payments, and mistakenly gives the taxpayer an account credit or a refund that the taxpayer did not deserve. If the error is discovered many years later, it can get complicated to figure out where the parties stand and which remedies are available to each.
Mr. Schuster’s case stems from an IRS error in 2005, when it applied an $80,000 check meant for his mother’s taxes to Mr. Schuster’s 2004 income tax account. If Mr. Schuster had requested a refund when he filed his 2004 tax return, the case would be very different and the outcome might have changed. Instead, Mr. Schuster’s tax returns for 2004 through 2007 asked that his refunds be applied to the following year’s estimated tax. (Line 77 on the current Form 1040)
In 2011, the IRS discovered its mistake and reversed the erroneous credit. Mr. Schuster had made payments (apart from the $80,000) that satisfied his tax liabilities for 2004 and 2005, but not for 2006. So, after the credit was reversed the IRS sent Mr. Schuster a bill for his 2006 balance due. The case came before the Tax Court on a CDP appeal of a notice of intent to levy.
The government has many mechanisms it can use to collect from taxpayers who owe money to the Treasury. One of these mechanisms is an erroneous refund suit under section 7405. An erroneous refund suit must be brought within 2 years of the refund, except in cases of fraud. IRC 6532(b). Mr. Schuster argued that the $80,000 credit applied in 2005 was an erroneous refund that started the 2-year clock running. He argued that the IRS effectively created an end-run around 7405 by using its administrative collection powers, and it should not be permitted to do that. For its part, the IRS argued that the error at issue was a “credit transfer” which did not implicate section 7405 at all. In the IRS’s view, the appropriate statute of limitations is found in section 6502, providing for a 10-year collection period following assessment of tax. Both the Tax Court and the Eleventh Circuit sided with the IRS.
From a taxpayer’s perspective one can understand how unfair this feels. The $80,000 would have been refunded to the taxpayer had he not elected to have it credited to his 2005 (and then 2006) liability. I imagine Mr. Schuster thought he was doing a good deed as a taxpayer by making that election. If he had received a refund check and then sent an estimated tax payment to the IRS, section 7405 would apply. Economically the taxpayer would be in the same position. But the tax code does not run on fairness or logic. Also, there are complications beyond the distinction between a refund and a credit.
In the 1990s there were seven circuit court cases that addressed whether the government could treat erroneous refunds as unpaid tax, and thereby use its administrative collection powers to recover the funds. The government lost those cases. The courts of appeals held that once a taxpayer has paid their assessed taxes, a subsequent erroneous refund does not re-open the liability, and therefore the erroneous refund cannot be treated as an unpaid tax liability to be collected administratively under the original assessment. See O’Bryant v. United States, 49 F.3d 340, 346 (7th Cir. 1995); Mildred Cotler Trust v. United States, 184 F.3d 168, 171 (2d Cir. 1999); Stanley v. United States, 140 F.3d 1023, 1027-28 (Fed. Cir. 1998); Singleton v. United States, 128 F.3d 833, 837 (4th Cir. 1997); Bilzerian v. United States, 86 F.3d 1067, 1069 (11th Cir. 1996); Clark v. United States, 63 F.3d 83, 87 (1st Cir. 1995); United States v. Wilkes, 946 F.2d 1143, 1152 (5th Cir. 1991). For example, in the O’Bryant case, the taxpayers fully paid their liability but the IRS accidentally credited the payment twice, and issued a refund check. The Court held that the IRS could not use its administrative lien and levy procedures to recoup the erroneous refund.
Unfortunately for Mr. Schuster, he had not actually paid all of his assessed taxes for 2006. The Tax Court opinion (by Judge Chiechi) cites the Clark and Wilkes cases for the proposition that a tax assessment can only be extinguished by a payment tendered by the taxpayer, and not by an IRS clerical error. (Refunds resulting from clerical errors are often referred to as nonrebate refunds.) Therefore, the court holds that the 2006 assessment was not extinguished by the $80,000 credit, and the IRS could use its administrative collection powers to pursue the balance. The Court further found that the erroneous credit was not a refund for purposes of section 7405, so the two-year time limit did not apply.
The Eleventh Circuit affirmed the Tax Court, under different (though not inconsistent) reasoning. The per curiam opinion is short and to the point. The court notes that the Code distinguishes between a refund and a credit in several places, and section 7405 specifically only refers to refunds. Therefore, following basic statutory interpretation principles, the Eleventh Circuit holds that section 7405 does not apply to erroneous account credits.
Is the lesson for taxpayers to eschew line 77 and always request their refund? This does not guarantee a windfall for the taxpayer as the government may act within the 2 years or it may be able to use other mechanisms to collect the funds, but it makes the government’s task more difficult especially if the taxpayer takes care to remit legitimate payments covering their assessment.