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When Is a Late Return Not Really “Late”?? – Part 2

Posted on Dec. 6, 2021

Bob Probasco picks up from his post last week and continues discussing the tricky issue of when interest starts to accrue on refunds when the taxpayer may not have known that they had a return filing obligation on the due date of the return. Les

And now some observations and questions about that recent IRS legal memo on an overpayment interest issue. The memo relied substantially on two cases addressing similar situations: MNOPF Trs. Ltd. v. United States, 123 F.3d 1460 (Fed. Cir. 1997) and Overseas Thread Indus. v. United States, 48 Fed. Cl. 221 (2000). (The Overseas Thread scenario is virtually identical to that in the memo.) Normally, taxpayers receive overpayment interest from the filing due date of the return, if all payments that make up the overpayment were made by then. These cases involved a statutory provision, Section 6611(b)(3), under which if the return is filed late, taxpayers do not receive overpayment interest before the date the return was filed.

MNOPF established the principle that a return cannot be “late” if the taxpayer was not required to and did not file a tax return. Overseas Thread addressed the situation of a foreign corporation that did not have a U.S. trade or business and therefore was not required to file an income tax return – but had to do so to claim a refund of excessive withholding tax on dividends from a U.S. source. The court in that case determined that the tax return filed to claim a refund of an overpayment was only required by the normal filing date, and therefore late if not filed by then, if the taxpayer knew of the overpayment before the prescribed filing date. Part I provided background on those two cases and the legal memo. I think Overseas Thread and the memo leave a lot of questions, and they may be incomplete or even wrong. Those rulings also could be applied much more broadly than the specific fact pattern they address.

What About Delays After Discovery?

Neither Overseas Thread nor the memo directly mentioned another obvious question. Is the lack of knowledge, by the return due date, of a filing obligation a “blank check” for filing the return at a much later date? In Overseas Thread, the delay between discovery of the filing obligation and filing the return was relatively short – at most from early October to mid-February. What if TFI and OTI had waited another year or two to accrue additional interest?

The potential for a taxpayer to “park” money with the IRS at long as possible, earning interest at rates higher than the taxpayer could earn otherwise, may seem very counter-intuitive to those of us who deal with low-income taxpayers. Their primary objective is getting a refund quickly, not the amount of interest payable. But Treasury/IRS has expressed a similar concern in some contexts in the past. (Perhaps that’s what Section 6611(b)(3) is all about – preventing such actions. An alternative interpretation might be that it’s the flip side of the penalty of Section 6651(a) for filing a return late, which has no teeth when there was no balance due on the return. I don’t think I’ve ever looked at the legislative history, and that might not explain it anyway.)

The analysis in Overseas Thread seems to allow this very behavior. If the taxpayer didn’t know of the filing obligation by the normal return due date, Section 6611(b)(3) won’t apply. Perhaps in another case with a longer delay between discovery of the filing obligation and filing the return, a court might impose a requirement to file within a reasonable time – but it might not. If it did, that would further complicate the administration of Section 6611(b)(3).

Should The Determination of Whether a Return Was “Late” Depend on the Taxpayer’s Knowledge?

Les pointed out in his post that a knowledge standard – when the taxpayer realized there was an overpayment for that tax period – is extremely difficult to administer and a bright line rule would be much better. I agree as a practical matter, but I also question whether a knowledge standard is appropriate from a theoretical perspective. How exactly did Overseas Thread come up with the knowledge standard?

Essentially, it comes down to two provisions of a regulation, that the court was trying to reconcile. The general rule under Section 6012 is that all corporations are required to file income tax returns “regardless of whether it has taxable income or regardless of the amount of its gross income.” Treas. Reg. § 1.6012-2(a)(1).  One relevant provision in the regulation, Treas. Reg. § 1.6012-2(g)(2)(i)(a), creates an exception to the general rule:

A foreign corporation which at no time during the taxable year is engaged in a trade or business in the United States is not required to make a return for the taxable year if its tax liability for the taxable year is fully satisfied by the withholding of tax at source under chapter 3 of the Code.

But there’s an exception to the exception in Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2), which states that the preceding exception does not apply:

To a foreign corporation making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year

The court came up with the knowledge standard in an attempt to reconcile those two provisions without creating preposterous or odd results. The odd result the court saw was that these foreign corporations would have to: (1) always file income tax returns, just because they might later determine that they had an overpayment; or (2) risk not maximizing the overpayment interest they receive. Of course, taxpayers frequently face the question of whether to file protective claims as a deadline approaches. And taxpayers often face consequences from delays.

As you read Part 1, you probably were thinking of United States v. Boyle, 469 U.S. 241 (1985), weren’t you? The Court there held the taxpayer, who relied on an attorney to file an estate tax return, liable for a penalty for late filing. Reliance on an advisor was not “reasonable cause” to avoid the penalty when the issue was the filing date for the return, as “[i]t requires no special training or effort to ascertain a deadline and make sure that it is met.” But the Court also mentioned that reliance on a tax adviser might constitute reasonable cause, when the advice was that it was unnecessary to file a return. I’ve made an argument like that in the context of gift tax. It might apply here, where the issue was whether part of the distribution was a return of capital rather than a dividend.

But Boyle involved the failure to pay penalty, which has a reasonable cause exception. There is no such statutory defense to interest. (The taxpayer in Boyle conceded the interest assessed.) The taxpayer’s knowledge or intent is very, very rarely relevant to the application of interest provisions. Perhaps the temporary higher interest rate for a “tax motivated transaction,” or the distinction between a deposit and a payment, but what else? There’s a good reason for this – interest is not a penalty, it’s simply a payment for the use of the other party’s money. It’s based on objective criteria rather than the taxpayer’s state of mind.

Thus, I’m not sure whether the knowledge standard really makes sense in Overseas Thread (and by extension, in the legal memo). I understand the court trying to reach an equitable result, but creating a difficult-to-administer standard is not an ideal solution.

What would a bright-line rule be? Well, one straight-forward answer would be that Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) explicitly nullifies the exception to the filing requirement; therefore, the return was required, was late, and Section 6611(b)(3) applies.

Of course, that’s not the only possible bright-line rule.

Filing Obligation versus . . . ???

Take another look at Treas. Reg. § 1.6012-2(g)(2)(i)(a) and (b)(2). I think the Overseas Thread court may have been thinking that they meant something along the lines of:

Normally, you don’t have to file a return under your circumstances but if we owe you money, you’d better file a return and you’d better do it timely! We want to make sure we get the return by the usual deadline so that we can get your refund to you sooner!

Does that sound like the IRS to you? Me neither (except when Congress is pushing for quick payments, such as with the economic impact statements and the Advance Child Tax Credit). If your taxes withheld exceed your tax liability, the IRS is glad to refund that but their feelings aren’t hurt if you don’t ask for it. And indeed, some taxpayers in that situation don’t bother with filing a return if the overpayment was relatively minor, and as far as know the IRS won’t follow-up to ask about it.

Arguably, Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) is better read as a claims submission rule. It says that the exception to filing an income tax return for that foreign corporation does not apply:

To a foreign corporation making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year

Not “To a foreign corporation with an overpayment.” Instead, “To a foreign corporation making a claim . . . for the refund of an overpayment.” That suggests the proper interpretation would be, paraphrased broadly:

Normally, you don’t have to file a return under your circumstances, because as defined in the exception of § 1.6012-2(g)(2)(i)(a), your tax liability has been fully satisfied. If you choose to file a refund claim – the subject of § 301.6402-3 – though, you must do it on an income tax return form instead of Form 843.

That sounds more like the IRS, doesn’t it? They won’t insist on a refund claim, but if you file one, please do it on the form for an income tax return or amended return, rather than Form 843. Indeed, Treas. Reg. § 301.6402-3 allowed refund claims for income tax to be made on Form 843 for many years; that possibility was only eliminated for claims filed after 6/30/76. Check out T.D. 7410, 1976-1 C.B. 384. A technical memorandum from the IRS to the Assistant Secretary of the Treasury on 1/21/76, transmitting the T.D., made that purpose explicit. Case law allowed taxpayers broad discretion regarding what would be considered a valid refund claim; that itself is further support for the conclusion that an income tax return on Form 1120-F was not required in Overseas Thread. But the IRS could issue regulations to “encourage” taxpayers to file refund claims on tax returns rather than Form 843.

As noted in Part 1, in the MNOPF case, the taxpayer originally claimed the refund on Form 843. The IRS rejected that, stating: “A return must be filed to claim the refund, even if in past years you have received refunds by filing only Form 843 without a return.”

If Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2) is only about how the refund claim is submitted, but not a requirement to file an income tax return, and caselaw recognizes refund claims that aren’t on income tax returns, arguably there is no obligation to file an income tax return. Whether a refund claim is filed late is defined by Section 6511 rather than Section 6072. The “return” therefore was not filed late and Section 6611(b)(3) does not apply.

That seems like a plausible interpretation of the regulation, and personally I prefer it to that implied by Overseas Thread.

Note that this wouldn’t apply broadly to any Form 1040 showing an overpayment. There is a general obligation to file income tax returns that would apply unless Congress has explicitly stated an exception under which taxpayers need not file, such as Treas. Reg. § 1.6012-2(g)(2)(i)(a). So, if I file my income tax return (requesting a refund) late, I’m still subject to Section 6611(b)(3) and won’t receive interest for the period before the return is received.

Is This Just About Foreign Corporations With No U.S. Trade or Business?

If it were, Overseas Thread and this legal memo would have relatively little impact. But there are other situations in which taxpayers are excused from filing an income tax return, but still must do so to claim a refund. Most common: an individual or married couple whose gross income is less than the sum of the basic standard deduction and exemption amount – unless they have at least a minimum amount of earnings from self-employment.  Sections 6012(a)(1) and 6017 set forth the filing obligations; unlike (domestic) corporations, individuals with no taxable income or self-employment income are excused from filing. But they may file refund claims, because of withholding and/or refundable credits, and the IRS wants those to be filed on Form 1040.

These taxpayers will usually know that they have an overpayment. Most, particularly if they have large refundable credits, will file well before the normal filing deadline. But if the overpayment is from a small amount of withholding, some may not bother until after the normal filing deadline, perhaps well after. They would likely to lose under the knowledge standard of Overseas Thread, but under the alternative plausible interpretation above, they wouldn’t.

How is the IRS handling these now? I don’t know, but a bright-line rule based on whether the return was filed by the normal filing deadline would be much easier to program. Of course, the amount of interest lost in these circumstances will be minimal in individual cases. But I’m curious. The next time one of my clinic clients has filed a tax return after the normal filing deadline, I may check the calculation of interest.   

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