TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Saturday, October 14, 2017

Lesson From Tax Court: The Downside of Easy Tax Exemption Approval

These would seem to be fat times for organizations that want tax-exempt status. As everyone and their little dog seems to know, Service resource constraints have made recognition as a tax-exempt organization “virtually automatic” for most applicants on the front end. Even the National Taxpayer Advocate complained that it was too easy for organizations to obtain approval.

This week’s lesson from the Tax Court is that the upside of easy approval on the front end may carry a significant downside on the back end. In the reviewed opinion Creditguard of America, Inc. v. Commissioner, 149 T.C. No. 17, Judge Lauber expressed the Tax Court’s opinion that when the Service revokes an organization’s tax exempt status retroactive to a given year, interest starts running from that retroactive year’s return due date, and not just from the date when the Service made its determination to revoke or actually assessed the tax liability. Why is this such a downside? Because the very resource constraints that make for easy application approval on the front end also create significant delays in completing examinations on the back end. In the Creditguard case, the examined year was 2002, the audit was opened in 2003, completed in 2012 and the resulting deficiency assessed in 2013. And now it’s 2017. That’s a lotta interest. More below the fold.

The Service approved Creditguard’s application to operate as a 501(c)(3) organization in 1993. In 2003, the Service selected opened an examination to see whether to revoke Creditguard’s tax exempt status for the 2002 tax year. For reasons that are not clear in the opinion, the Service took some 9 years to complete the examination. The resulting a determination letter issued in February 2012 and revoked Creditguard’s tax-exempt status for 2002 and for all subsequent tax years. Creditguard did not contest the findings but also did not file a form 1120 for 2002 so the Service kindly created a Substitute for Return and offered Creditguard the opportunity to contest that in Tax Court. Creditguard filed a Tax Court petition and then conceded the determination and consented to a deficiency of some $212,000 for 2002. The consent document agreed to by the Service and Creditguard said that interest would be assessed “as provided by law.”

The Service assessed the deficiency in 2013 and also assessed interest on the deficiency as if the interest ran from the March 2003 due date for the 2002 return that Creditguard should have filed. Creditguard refused to pay the assessed interest. It thought interest should run from the 2013 assessment date because 6601(b)(5) says that in cases where “the last date for payment is not otherwise prescribed” interest runs from “the date the liability for tax arises”

Creditguard first argued the last day for payment was not prescribed in its case because it had properly filed a Form 990 for 2002 only in 2012 did it learn it would have to pay taxes for 2002. Second, Creditguard also argued that its 2002 tax liability did not “arise” until the Service assessed the deficiency in 2013.

The Tax Court rejected both arguments. First, the Court explained why the last day for payment was, in fact, “otherwise prescribed.”

Petitioner is a corporation. Upon revocation of its tax-exempt status retroactively to January 1, 2002, it became obligated to file a corporate income tax return on Form 1120 for 2002. Under section 6601(a), interest runs from the “last date prescribed for payment.” Under section 6151(a), the “last date prescribed for payment” is the date “fixed for filing the return.” Because the date fixed for filing petitioner’s 2002 Form 1120 was March 17, 2003, these provisions indicate that petitioner must pay interest on the unpaid tax “for the period from such last date to the date paid.” See sec. 6601(a).

Second, the Tax Court explained the distinction between a liability and an assessment. An assessment is just the recordation of a liability. Creditguard’s liability to pay its taxes “arose” on the due date of the return it should have filed. That was the point of the retroactive revocation.

...by virtue of the retroactive revocation of petitioner’s tax-exempt status to January 1, 2002, [Creditguard’s] corporate income tax liability arose during 2002, the calendar year for which it had become a “corporation subject to tax under subtitle A.” Sec. 6012(a)(2); see Helvering v. Morgan’s, Inc., 293 U.S. 121, 127 (1934). (defining taxpayers’ taxable year as “the twelve months’ accounting period for which they were bound to report income and pay taxes”). And petitioner’s liability for payment of that tax arose on March 17, 2003, the due date of its Form 1120 for 2002. In contending that it had no tax liability for 2002 until 2012, petitioner is ignoring the fact that its tax-exempt status was revoked, not prospectively, but retroactively to January 1, 2002.

By executing a stipulated decision in the prior deficiency case, petitioner has agreed that it had a corporate income tax deficiency of $216,547 for 2002. It has had use and enjoyment of that $216,547 from March 17, 2003, until now. It has supplied no reason, in law or logic, why it should not have to pay interest as any other corporate taxpayer would have to do.

Bottom line, as well-stated by Judge Lauber: “Retroactive revocation is not just a slap on the wrist; it has real tax consequences.”

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