What happens when a claim for refund is pending during an audit that has yet to culminate in a notice of deficiency? A recent Tax Court order in McCormack v Commissioner (and timely post on the order by Lew Taishoff) highlights a procedure where IRS issues a denial of a refund claim and a statutory notice of deficiency in one combined letter. The combination document, if timely petitioned, triggers Tax Court deficiency and overpayment jurisdiction. Neither the blog nor Judge Holmes had previously considered the procedure, and it highlights the Tax Court’s overpayment jurisdiction as well as its general deficiency jurisdiction.
Here are facts, as recounted by Judge Holmes:
- Oct. 21, 2011 – petitioners file their 2010 Form 1040, U.S. Individual Income Tax Return,and pay the balance due. The amount shown on their return is presumably assessed.
- Aug. 24, 2012 – petitioners file a claim for a refund for their 2010 tax year.
- May 3, 2013 – respondent issues the notice both determining a deficiency and disallowing the claim for a refund.
- July 30, 2013 – petitioners file their petition in this court.
Judge Holmes was confused about the combined May 3 notice, stating that it “puzzled the Court because it had never before seen such a notice, and thinking this might not be a deficiency case at all it issued an order to the parties to show cause why the case shouldn’t be dismissed for lack of jurisdiction.”
The parties apparently pointed to IRM 4.8.9.15.2. and Section 6512. The IRM , which Judge Holmes cited to in the order, explains the following:
If the examination of a return and the claim for refund filed for the same year result in a deficiency and the taxpayer does not exercise any appeal rights, a notice of deficiency is issued. The following actions will be taken regarding the claim for refund issues. The taxpayer will be notified in the notice of deficiency that the claim has been considered. Immediately after the summary of the tax liability, or as an attachment to such forms, the following paragraph will be included: ”In making this determination of your (list year) tax liability, consideration has been given to your claim(s) for refund filed on (date). This is your notice of claim disallowance. If you choose not to petition the Tax Court, but still want to contest the disallowance, you may do so by filing such a suit with the United States District Court having jurisdiction or the United States Court of Federal Claims. The law permits you to do this within two years from the date of this letter.
Judge Holmes also explained that Section 6512 “contemplates treating the disallowed claim for a refund as a claim under our overpayment jurisdiction, so there is no problem with our jurisdiction. See IRC §6512(b)(3)(C)(i).”
The order also helpfully cites a Tax Court case from a few years ago, Fisher v Commissioner, which illustrated the Tax Court’s concurrent overpayment and deficiency jurisdiction. In that case, the taxpayer properly petitioned the Tax Court, both opposing the proposed deficiency and claiming a refund. IRS eventually conceded that the statute of limitations on assessment had expired and moved to dismiss for lack of jurisdiction the refund aspect of the case. In other words, IRS argued that subsequent actions can deprive the Tax Court of its refund jurisdiction. The Court declined, noting that “our jurisdiction does not depend on respondent’s ability to assess a deficiency.”
In light of the above, in McCormack, Judge Holmes stated that he “learned something new” and that the order to show cause was now discharged. This order highlights a little known nook of Tax Court jurisdiction, and I immediately thought of my days as clinic director, where many of my clients had filed original returns that also operated as refund claims due to refundable credits, such as an EITC. Those cases, however, are somewhat different procedurally. Typically, IRS when auditing refundable credit returns will not issue formal refund claim disallowances, but will disallow the credit exclusively through a notice of deficiency. The definition of deficiency includes the amount of disallowed EITC, so taxpayers when filing petitions to Tax Court can invoke traditional deficiency jurisdiction to trigger the possibility of an overpayment. We describe the evolution of the definition of deficiency in revised Saltzman Book Chapter 10.3[1] as follows:
In 1988, Congress enacted Section 6211(b)(4) to ensure that the term “deficiency” encompasses disallowances of refundable credits, essentially by treating the excess of refundable credits over tax imposed as a negative amount of tax. Thus, even a return with no liability but a disallowed refundable credit will result in there being an excess of tax imposed over tax shown on the taxpayer’s return.[citation omitted].
By IRS using deficiency procedures exclusively in refundable credit cases and not including the claim disallowance language from IRM 4.8.9.15.2.in stat notices, taxpayers who whiff on timely filing a petition ostensibly have an unlimited amount of time to file a refund suit in federal district court or the Court of Federal Claims. In the next few weeks I will discuss this a bit more and dig even deeper into some of the nooks and crannies of Tax Court jurisdiction when it comes to refundable credits, an area that is in need of some attention and possible reform.