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Non-profits, Corporate Interest Rates, the Birth of a Blog, and Lite Mayo

Posted on Apr. 27, 2016

This post is about the recent Maimondies case from the Second Circuit, and what is a “corporation” for corporate interest rates, but it will be helpful to take a quick detour to review the underlying issue in the Mayo Foundation case, as it sets up the issue before the Second Circuit in Maimondies.  Most of the focus on Mayo Foundation v. US, at least on our blog, was on the procedural aspects of the case, but there was an important substantive issue underlying the challenge to the regulations, which I sometimes forget about.  The issue was whether or not medical students who worked more than 40 hours a week were ineligible for an exemption to FICA taxes. Treasury issued regulations in 2004 saying such students were not exempt, and FICA taxes had to be withheld.  The Supreme Court upheld the regulations (although perhaps a bittersweet victory for the Service, as the holding may have eroded at the notion of tax exceptionalism in administrative law).  After the SCOTUS win, the Service decided to allow refunds for claims of tax that was paid prior to the effective date of the 2004 regulations, April 1, 2005.

Maimonides Medical Center is a nonprofit (under Section 501(a)/501(c)(3)) corporation running a teaching hospital near Prospect Park in Brooklyn, which had one such claim.  It, like all similar institutions, had many med students/residents that fell into this exception to the exception to the FICA taxes.  I am sure MMC is very humane, and those residents worked barely over 40 hours a week, but whether just one hour over, or more likely sixty hours over, the exception to the exemption was implicated.  In 2010, the IRS agreed that MMC could obtain a refund for the FICA taxes from 1999 through the beginning of 2005, prior to the effective date of the regulations.  MMC had previously timely filed a refund claim, which remained outstanding until that date.

The Service calculated the refund, and the interest due.  MMC was cool with the calculation of the refund amount of tax, but disagreed with the IRS interest calculation- probably feeling a bit like the Service was trying to screw them on the interest rate, while they were trying to save the non-hipster Brooklyn residents (I assume they aren’t serving hipsters, because this is close to Park Slope, which is too expensive for hipsters).  Why, because it was getting next to nothing in interest, similar to a Fortune 100 company that had overpaid, and much less than a nonprofit LLC that had overpaid the same amount.

Another quick, but very important, side note. A couple of years ago, when LBJ was President, Robert Wagner was busting up Tammany Hall in NYC, and The Zombies had a #1 hit in She’s Not There, a truly wonderful woman gave birth to a baby boy at MMC, and took him home, where he grew up close to the family’s Book Lumber Yard (which definitely was not serving hipsters at the time).  So, MMC was essentially the birthplace of this blog.  Of greatest importance, a lot of people are missing that woman this week, and our love, thoughts, and prayers go out to the entire Book family.  Hopefully, all of this hasn’t made me too biased towards MMC’s position.

The key issue is that the IRS applied the corporate interest rates, specifically the large corporate overpayment rate, to the overpayment, instead of the more friendly non-corporate interest rates.  We touched on this case in SumOp when it was at the District Court level, where I wrote:

[MMC] argued it was not a corporation for purposes of the overpayment interest rate under Section 6621…[and] that the Service IRM indicates that “corporations” are defined by the return they file, which does not include not-for-profits, and the Service has previously issued refunds using the non-corporate rate.  The Court stated the IRM cannot be used as precedent, or trump other regulations that would indicate the contrary.   [MMC] also argued that the check-the-box regulations were not clear on the classification of it as a corporation, so it should be afforded “special treatment”, which is allowed in limited circumstances. The Court did not find this persuasive, and held it was a business entity, the default treatment of which was a corporation.

That quick blurb did not really do justice to the underlying issue, which, especially on appeal to a Circuit Court, is worth some additional time.  Here, the question of what is a corporation for interest rates actually hinges on interesting statutory construction more so (at least to the Circuit Court) than policy, although that also comes into play.  Before looking at the holding and rationale in MMC, a quick review of the applicable interest rate rules would be helpful.

Section 6621 outlines the applicable rates, and when each applies, and states, in pertinent part:

(1)  Overpayment rate.

The overpayment rate established under this section shall be the sum of—

(A)  the Federal short-term rate determined under subsection (b) , plus

(B)  3 percentage points (2 percentage points in the case of a corporation).

To the extent that an overpayment of tax by a corporation for any taxable period (as defined in subsection (c)(3), applied by substituting “overpayment” for “underpayment”) exceeds $10,000, subparagraph (B) shall be applied by substituting “0.5 percentage point” for “2 percentage points”. [emph. added].

(2)  Underpayment rate.

The underpayment rate established under this section shall be the sum of—

(A)  the Federal short-term rate determined under subsection (b) , plus

(B) 3 percentage points.

This is somewhat complicated by Section 6621(c)(1), which deals with large corporate underpayments, and states:

(1)  In general.

For purposes of determining the amount of interest payable under section 6601 on any large corporate underpayment for periods after the applicable date, paragraph (2) of subsection (a) shall be applied by substituting “5 percentage points” for “3 percentage points”. [emph. added].

And, the definition of large corporate underpayment, is found under Section 6621(c)(3), and states:

(A)  In general. The term “large corporate underpayment” means any underpayment of a tax by a C corporation for any taxable period if the amount of such underpayment for such period exceeds $100,000. [emph. added].

As stated above, the underpayment rate for corporate and non-corporate taxpayers is different, and large corporate underpayment and overpayments have another set of interest rates.  It seems pretty clear (at least no one has litigated it yet), that individuals, trusts, estates, partnerships, and LLCs are all not corporations, and subject to the non-corporate interest rates.  Where it gets complicated is whether the corporate interest rates apply to s-corporations, not-for-profit corporations, and c-corporations, and whether that occurs just in small overpayments/underpayments, or also in large corporate overpayments or underpayments.

For a large corporate underpayment, the answer seems to be clear in the statute, as it specifies in the definition that it only applies to c-corporations.  So, what does corporation mean otherwise?  In this post, we will just cover MMC and the treatment of non-profit corporations,  but the analysis is probably instructive with s-corporations, where the case law is currently somewhat split, an issue we describe in some detail in Saltz/Book in Chapter 6, a chapter I had a major hand in rewriting about a year or so ago.  See Eaglehawk Carbon Inc. v. US, (Fed Cl. 2015); Garwood Irr. Co. v. Comm’r, 126 TC No. 12 (2006).

In Maimonides Medical Center v. United States, MMC argued that “corporation” under Section 6621(a)(1) should be restricted to only refer to a for-profit corporation, largely on policy grounds that a non-profit should be subjected to the more taxpayer friendly provisions.  Further, it argued that it was arbitrary to treat a nonprofit corporation differently from a nonprofit operating as another entity, such as a trust or LLC (which is true, but there are lots of arbitrary Code provisions).  The Second Circuit was not persuaded by these arguments, and held that a not-for-profit corporation was still a “corporation” under the general dictionary definition, and the definitional provisions of Section 7701(a).  In addition, the Second Circuit found there were various other Code Sections where the term corporation applied to both for profit and not-for-profit corporations, and, absent language indicating otherwise, it was appropriate to treat a not-for-profit corporation as a “corporation” under Section 6621 (with the exception of a large corporate underpayment, which is restricted to only C-corporations).   I do not question the analysis on this point, but I do wonder if the drafters actually intended to have a corporation exempt under 501(c)(3) burdened by the less favorable interest rates.  I am not sure the reasoning for such a policy.

The Court then turned to the large corporate overpayment issue, which is more complicated and interesting, and where the MMC argument is the same general argument that s-corporations have made claiming they should not be subject to the less favorable large corporate overpayment interest rate. Section 6621(a)(1)(B) provides the overpayment rates for normal overpayments and for large corporate overpayments, and uses only the term “corporation”.  The hanging paragraph at the bottom, however, makes reference to Section 6621(c)(3), dealing with large corporate underpayment, and states:

To the extent that an overpayment of tax by a corporation for any taxable period (as defined in subsection (c)(3), applied by substitute “overpayment” for “underpayment”) exceeds $10,000, [the interest rate] shall be applied by substituting “.05 percentage point” for “2 percentage points”.

As stated above, Section 6621(c)(3) defines “large corporate underpayment” as “any underpayment of a tax by a C corporation for any taxable period if the amount of such underpayment for such period exceeds $100,000.” (emph. added).   MMC argued the that the parenthetical in Section 6621(a)(1)(B) modified the term “corporation” to be restricted to C-corporation due to the reference in Section 6621(c)(3), but the Court disagreed, and held that the parenthetical modified only the term “taxable period”, which was immediately before the parenthetical and defined under Section 6621(c)(3)(B).  The Second Circuit indicated this was the more appropriate statutory construction based on the placement of the modifier, and the use of the term “corporation” throughout Section 6621(a) without designation.   However, as also indicated above in Garwood Irrigation v. Commissioner, the Tax Court reviewed this same hanging paragraph, and come to the conclusion, based on the statute and the legislative history, that “corporation” was intended to apply only to S-corporations, and not S-corporations for these purposes.  So, the law in this area is unsettled.

It is probably safe to assume that an S-corp will be treated as a corporation for the normal corporate overpayment and underpayment rates, and a not-for-profit may also.  The Service will certainly treat them as such.  For large corporate underpayment, it appears only c-corporations are stuck with the higher rate.  For large corporate overpayments, the trend is to include all types of corporations, but there is a split on the interpretation of that hanging paragraph.  I’m sure we will see more to come.

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