Paul L. Caron

Monday, October 7, 2019

Lesson From The Tax Court: Payments v. Deposits

The only thing worse than overpaying ones tax liabilities is not realizing one has overpaid until it is too late to get the overpayment refunded.  Section 6511 requires taxpayers to ask the IRS for refunds of overpayments within the later of: (1) three years after the relevant return was filed; or (2) two years after the relevant payment was made.  If no return was filed, then the two year period applies.

Section 6511, however, only applies when there has been a payment in the first place.  Not every remittance to the IRS constitutes a payment.  Sometimes taxpayers send in money without intending it to be a payment.  For example, a taxpayer might send money to simply stop the running of interest while the taxpayer pursues a protest of the amount of tax owed.  The IRS and courts call those remittances “deposits.”  The good news is that returns of deposits are not subject to the limitation periods in 6511.  The better news is that if a taxpayer is entitled to their return, the government might have to pay interest. §6603.

Thus, it is useful to learn the difference between a payment and a deposit.  In Michael C. Worsham v. Commissioner, T.C. Memo. 2019-132 (Oct. 1, 2019) (Judge Colvin) the taxpayer thought that his remittances to the IRS were not payments because he made them long before the IRS assessed the relevant taxes.  Judge Colvin makes quick work of that argument.  Perhaps too quick.  There is more to the difference between payments and deposits than the timing of the remittance.  I still think the taxpayer’s remittances in this case still might have been deposits, depending on facts not contained in the opinion.  Details below the fold.

Law:  Deposits v. Payments

To know the law, ya gotta know the history.

From 1913 to 1918 taxpayers did not owe taxes until after the government assessed them.  The only obligation taxpayers had during those years was to file a timely return and self-report their relevant financial information and, if they chose, self-compute their taxes.  What are now the separate ideas of “returns processing” and “audit” were at that time one and the same.  All returns were audited as they were processed.  Taxpayers had to file their returns by March and the tax liabilities had to be assessed by June 30th.  The assessment lists then went to the 64 presidentially appointed Collectors who, along with their assistants, collected the assessed liabilities.  Until the assessment was made, taxes were simply not due and owing.  For those hungry for details, feel free to feast on my article Theory and Practice in Tax Administration, 29 Va. Tax Rev. 227 (2009).

All that changed in 1918 when Congress required taxpayers to start paying the tax liabilities no later then when they filed their returns.  That idea is codified in §6151(a)’s language that taxpayers must “without assessment or notice and demand from the Secretary, pay such the time and place fixed for filing the return."  When Congress created the tax withholding system in 1943, it added further statutory confirmation, now codified in §6513(b), that amounts withheld by an employer---or amounts sent in as estimated payments---would “be deemed to have been paid... on the 15th day of the fourth month following the close of his taxable year.”

Thus, under current law, assessments do not create tax liabilities.  Taxpayers become liable for income taxes at the close of their taxable year, whether or not the Service makes an assessment.  See e.g. Ewing v. United States, 914 F.2d 499, 502-03 (4th Cir. 1990), cert. denied 111 S. Ct. 1683 (1991) (rejecting taxpayer's argument that, prior to assessment, there can be no tax liability and therefore no "payment" of taxes).  This means taxpayers can send in payments of tax before an assessment is made.  Still, just because one can make a payment on a liability before an assessment did not mean that all remittances are payments.  To understand the problem, one must consider withholding.

In 1918 there was no withholding.  While taxpayers were now asked to pay taxes with their returns, there was some concern they may not put enough aside to do so.  In 1921, to encourage taxpayers to send in their money on time or early, Congress for the first time authorized the payment of interest on overpayments.  42 Stat. 227, 316 (sorry but I cannot find a public link).  In fact, the interest rate for refunds was some years deliberately made higher than the interest rate for underpayments.  At one point taxpayers could earn 6% interest on overpayments but owe zero interest on underpayments.  See Marsh McLennan Companies, v. United States, 302 F.3d 1369 (Fed. Cir. 2002) in note 6 where the court notes the historical problem that "a taxpayer who owes the Government money, upon which he is paying no interest, is collecting interest upon money which the Government owes him."  See also the Treasury’s Office of Tax Policy Report to Congress on Interest Netting, April 1997, at p. 7 (“At times between 1921 and 1935, the underpayment interest rates for estate taxes and excise taxes were raised to encourage taxpayers to pay those taxes promptly.”).

Taxpayers would take advantage of this by dumping money on the IRS.  If it turned out to be more than owed, great!  Then they were due interest that was competitive with banks.  This created a great deal of litigation about when taxpayers were truly sending in payments and when they were just guessing and messing around.  When taxpayers had acted timely to request a refund, they claimed they had made a payment and were entitled to interest.  But when taxpayers late in requesting the refund, they claimed they were just asking for their deposit to be returned and there was no time bar for that.  The Supreme Court tried to bring some method to the madness in what is still the leading case on distinguishing deposits from payments, Rosenman v. United States, 323 U.S. 658 (1945)(holding that a remittance attached to taxpayer’s tentative return and marked as being paid “under protest” was a deposit and not a payment).  More on Rosenman after I finish the history.

In 1943, Congress created the modern system of withholding in the Current Tax Payment Act of 1943, 57 Stat. 126 (again, no public link, sorry!)  As part of that statute, Congress created the language now codified in §6401. The Senate Finance Committee Report reprinted in 1943 C.B. 1314, 1339 explained how they were trying to help out the government by reducing the circumstances where "disorderly remittances" could be treated as payments deserving of interest:

“The doubts expressed as to the existence of an overpayment in case it ultimately turns out that there is no tax, your committee believes, should be put to rest, and to this end submits the amendment to section 3770 of the Code. In the view of your committee, the Code does not contemplate that liability for interest can be cast on the Government by merely dumping money as taxes on the collector, by disorderly remittances to him of amounts not computed in pursuance of the actual or reasonably apparent requirements of the Code, or not transmitted in accordance with the procedures set up by the Code, or by other abuses of tax administration. As to these, your committee believes that a proper application of existing law will enable the courts, in the future as generally in the past, to deny treatment as overpayments to these improper payments.”

The Law: Rosenman

The IRS takes the position that deposits “may be returned to the taxpayer even if the taxpayer did not request its return within the time prescribed in § 6511.” SCA 1998-009 at 5  Similarly, the IRS has long-standing procedures, currently contained in Rev. Proc. 2005-18, for how it will distinguish payments from deposits. The IRS positions, however, are not necessarily those of the courts, who do not agree among themselves for that matter.  To understand why, one must read the seminal case on this issue: Rosenman.  Or at least read my summary.

In Rosenman, an estate filed a tentative return and with it enclosed a remittance of $120,000 on the due date of the return.   The cover letter explained that the remittance was being made under protest, solely to stop the running of interest, and the estate did not really believe that it owed the tax it was reporting on the tentative return.  The IRS had not yet made an assessment, it credited the check in a suspense account.  When the estate later filed a final tax return reporting only $80,000 tax due, the IRS applied the money in the suspense account, leaving $40,000.  The IRS then audited the return and assessed a $50,000 deficiency.  It applied the $40,000 remaining in the suspense account and the estate paid the $10,000 balance and filed a refund claim.  By now more than three years had passed from the date that the estate made its initial remittance.  The lower courts held that the claim was untimely as to the $40,000. 

The Supreme Court reversed in an opinion that created more confusion than guidance.  That is because the Court gave three rationales for its holding that the refund claim was timely without saying which rationale controlled.

First, the Court stated the “taxpayer did not discharge what he deemed a liability nor pay one that was asserted.  There was merely an interim arrangement to cover whatever contingencies the future might define.”

Second, the Court seemed to suggest that there could be no payment before an assessment, noting that the “tax obligation did not become defined until April 1938” and that only then was “payment...then made by the application of the balance credited to the petitioners in the suspense account.”

Third, it seemed important to the Court how the IRS accounted for the remittance, by putting it in a suspense account.  “The Government does not consider such advances of estimated taxes as tax payments.... Accordingly, where taxpayers have sued for interest on the "overpayment" of moneys received under similar conditions, the Government has insisted that the arrangement was merely a "deposit" and not a "payment" interest on which is due from the Government if there is an excess beyond the amount of the tax eventually assessed.”

It is important to note that the the second rationale in Rosenman is only a factor.  Early on, some courts relied on the second rational to hold that any remittance made before an assessment was a deposit as a matter of law.  That’s wrong.  The Rosenman court explicitly said it was not considering the effect of the Current Payments Act of 1943 because the events at issue in the case occurred long before that legislation.  In 2000 the Supreme Court reemphasized that point by noting first the effect of the various statutory changes made by Congress in 1943 and then in 1966 and concluding that taxpayer certainly can make pre-assessment payments.  See Baral v. United States, 528 U.S. 431, 434 (2000)(concluding that the Tax Code explicitly authorizes payments before assessment). 

The difficulty comes in how to balance the three rationales, particularly the first and third.  The first focuses on the taxpayer’s intent.  The third focuses on the IRS’s actions in processing the remittance.  Most courts treat this as creating a facts and circumstances test for distinguishing deposits from payments.  For a good discussion and application see Winford v. United States, 970 F. Supp. 2d 548 (W.D. La. 2013)(reviewing multiple factors to find taxpayer’s remittance was deposit).

One important factor is when a taxpayer specifically designates the amount as being sent in protest.  Another is if the amount is so unrelated to any amount shown on a relevant return or other document that a court views it as “disorderly” or “dumping.” See e.g. Ewing v. United States, 914 F.2d 499, 504 (4th Cir. 1990)(“a payment results from the remittance by a taxpayer concomitant with the recognition of a tax obligation whether by filing with a return, resolution of a dispute by an agreement, as in this case, or otherwise.").  The Winford court gives other examples. 

In my review of the cases, the most important circumstance is whether taxpayers have used a particular form.  For example, most courts hold that remittances accompanying a Form 4868 (request for extension of time to file a return) are payments as a matter of law.  Ertman v. United States, 165 F.3d 204 (2nd Cir. 1999).  These courts reason that the requirement to remit the amount properly estimated as tax when requesting an extension of time to file the return, combined with § 6513(b)(1)’s rule that all estimated taxes are deemed to have been paid on the due date of the return means that taxpayers cannot characterize a remittance accompanying as a deposit, no matter what they do.

In 2004 Congress enacted §6603 to provide that the government will pay interest on remittances even when they were deposits.  The IRS issued Rev. Proc. 2005-18, to give some rules for implementing §6603 and to counter the new incentive for taxpayers to tag all remittances as deposits.  Along the way, the IRS has tried to create some bright lines on when it will treat remittances as deposits and not payments.  Remember, however, this is just a Rev. Proc.  It’s the third factor in Rosenman.  The first factor is still the taxpayer’s behavior, not the IRS’s treatment of the remittance.  And even under the Rev. Proc., facts and circumstances can help determine whether a remittance is a payment or a deposit. See §§4.01(2), 4.03, 4.04.

Facts and Lesson

This is a deficiency case where the IRS issued an NOD on December 8, 2016, assessing tax, interest and penalties against Mr. Worsham for tax years 2005, 2007, 2008, 2009, and 2010.   In Tax Court the IRS conceded Mr. Worsham had no 2009 liability and further conceded that he had no §6651(a)(2) failure to pay penalties, although it still sought to impose the §6651(a)(1) failure to file return penalties.

According to the opinion, Mr. Worsham started a law practice in 1998 in Baltimore.  According to this 2015 news story, Mr. Worsham is no longer in practice.  Judge Colvin writes that at some point in 2006 “petitioner discovered information which led him to conclude that he was not required to file Federal tax returns or pay Federal income tax.  As a result petitioner has not filed a personal Federal income tax return for any year since 2004.”  It appears, however, from the opinion that Mr. Worsham’s separately incorporated P.C. filed Forms 1120S in both 2007 and 2008.

What you need to know about the facts is that (1) Mr. Worsham personally filed no tax returns, but (2) made seemingly random remittances to the IRS.  Judge Colvin labels them “payments” without explanation and also links each one to a particular tax year, again without explanation.  Here is the list:

January 15, 2006: $2,000 for 2005;
April 15, 2006: $45,000 for 2005;
May 4, 2009: $4,000 for 2008;
April 15, 2010: 10,000 for 2009;
July 22, 2013: $30,000 for 2007; $25,000 for 2008; $20,000 for 2009; and $20,000 for 2010.

The opinion does not say when the IRS opened an examination, whether or when it sent Mr. Worsham an SFR package, or a 30-day letter, or a 90-day letter.  The opinion says the NOD was signed by an Appeals Officer, which suggests Mr. Worsham was contesting the various proposed deficiencies.  That the IRS proposed but later withdrew a proposed deficiency for 2009 suggests his contest may have had at least some merit.

During the Tax Court case, Mr. Worsham asks for the Tax Court to declare that “any tax overpayments he made for the years at issue will not be time barred if it is decided that he overpaid his tax for those years.”  The basis of his request is that a taxpayer cannot make a “payment” until the liability has been assessed. 

If all of his remittances were indeed payments, then the opinion’s quick disposition of this request is correct.  The applicable limitation period is two years from the date of the last payment.  The last payment was July 22, 2013.  Mr. Worsham made no actual or deemed refund request within two years of that date.  And the lesson point here is that yes indeedy you can make a payment before the liability is actually assessed.

But Judge Colvin’s opinion seems to assume the conclusion: that these remittances were payments. When I look at the random pattern of remittances, coupled with the non-filing of returns and his tax protestor arguments, I cannot help but wonder if these remittances were precisely the type of disorderly dumping that the courts have traditionally viewed as non-payments, a/k/a deposits. To use the Roseman language, it does not appear that any of these payments were intended by Mr. Worsham to “discharge what he deemed a liability nor pay one that was asserted.”  Instead, they seem “merely an interim arrangement to cover whatever contingencies the future might define.”  But I do not know the facts and circumstances beyond the bare recitations in the opinion.

Coda:  On the one hand, Mr. Worsham's argument fairly raises the payments v. deposits issue because he relies on old 5th Circuit precedent that focused on the second factor in Rosenman.   That precedent no longer supports a per se argument like the one Mr. Worsham made.  But if remittances are not payments, they are deposits.  And timing can still be a factor in a facts and circumstances test, which would be the right way to resolve the issue.   On the other hand, the issue seems premature.  We have no idea, at least from this opinion, how much Mr. Worsham's remittances may have been above or below his tax liabilities for the relevant years.  And then there is the IRS's ability to offset under 6402.  That, however, is grist for another lesson.  Perhaps we will learn it from a later iteration of Mr. Worsham's case, along with a §6673 lesson!

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law

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