Lesson From The Tax Court: The Refund Lookback Period Trap

Collection Due Process (CDP) hearings are generally all about collection.  Thus, if a taxpayer says that the IRS failed to apply an available credit to the tax at issue, that is a proper issue to bring up in a CDP hearing.  In Amr M. Mohsen v. Commissioner, T.C. Memo. 2021-99 (Aug. 11, 2021) (Judge Kerrigan), the taxpayer said the IRS should have applied an overpayment credit from a previous year to the tax sought to be collected.  The reason that the claimed credit was not available to be used is the lesson for today: there were no payments within the refund lookback period.  Oh, snap!  The trap!  Details below the fold. 

Law:  The §6511(a) Limitation Periods For Refund Claims
Many taxpayers think that if they overpay their taxes the IRS will automatically send them a refund.  Nope. Taxpayers who think they have overpaid their taxes must ask the IRS to issue the refund.  The reason that most taxpayers think this is automatic is because a Form 1040 that reports an overpayment is treated as a claim for refund of that overpayment.  But if a taxpayer later decides they paid too much, they need to ask.  And they must do so within a certain time for the IRS to even consider the refund claim.  The limitation periods are found in §6511(a).  Limitation periods are, by their nature, arbitrary, foreclosing both just and unjust claims.  For a sad example, see Little People's School v. United States, 842 F.2d 570 (1st Cir. 1988) (non profit organization filed too late to recover erroneously assessed and paid employment taxes).

The length of the §6511(a) limitation period can be either 2 or 3 years.  The general rule is that a claim must be made “within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later, or if no return was filed by the taxpayer, within 2 years from the time the tax was paid."

You see there are two potential periods.  Each has considerable nuances that are not relevant to today’s lesson.  But here is one relevant nuance:  what constitutes a “return” for purposes of creating the 3 year limitation period and what constitutes a “refund claim.”

Generally, the same document that constitutes a return also constitutes a claim for refund if it reports an overpayment.  See Treas.Reg. 301.6402-3(a)(1), (2).  For individuals, that means either the Form 1040 or Form 1040X.  Thus, a late-filed return will be considered a claim for refund if reflects an overpayment.  See Treas.Reg. 301.6402-(3)(a)(5).  And the IRS will also respond to more informal asks.  See e.g. IRM 21.5.3.2 (“Informal claims can include a letter or other document...requesting changes to obtain the correct and accurate reflection of his/her tax liability.”).  See generally IRM 25.6.1.10.2.6.3 (Informal Claims).  Today's case, however, involves a return so let's take a look at that.

One question that comes up is what happens when the “return” is not actually prepared by the taxpayer but is prepared by the IRS under its authority in §6020.  The answer is: it depends!  Section 6020 authorizes the IRS to prepare a return on behalf of the taxpayer and distinguishes between two types of “Substitutes For Returns” (SFRs).  Under § 6020(a) the Service prepares the SFR based on the taxpayer's "consent to disclose all information necessary for the preparation thereof" and the taxpayer signs the SFR document.  Under § 6020(b) the Service prepares the SFR without the taxpayer's consent or acknowledgment.

An SFR issued per §6020(a) is considered the taxpayer’s return for purposes of triggering the assessment limitation period and can therefore also be a valid claim for refund.  As a practical matter, a taxpayer need not provide "all" the information but does need to cooperate.  However, if the taxpayer does not cooperate and the SFR is issued per §6020(b), then the return is not treated as the return of the taxpayer cannot constitute a valid claim for refund.   See Simmons v. United States, 29 Fed. Cl. 136 (1993) (explaining that a §6020(b) return cannot constitute a refund claim because it does not contain the information needed to put the IRS on notice of an overpayment).  See also Rev. Rul. 2005-59 (distinguishing between §6020(a) and (b) SFRs).

Law: The §6511(b) Lookback Trap
There is a second limitation contained in §6511.  It is a limitation on the amount of overpaid tax that can be the subject of a refund claim.  This limitation basically piggybacks on the appropriate claim limitation rule to create an equivalent period of time where we look back to see what amounts have been paid.  Only amounts paid within the appropriate lookback period can be recovered.  Thus, if a taxpayer has previously filed a return and thus the refund claim is subject to the three year period, §6511(b)(2)(A) provides that “the amount of the credit or refund shall not exceed the portion of the tax paid within the period, immediately preceding the filing of the claim, equal to 3 years plus the period of any extension of time for filing the return.”  Similarly, if the taxpayer’s refund claim is subject to the 2 year limitation period in §6511(a), then §6511(b)(2)(B) provides that “the amount of the credit or refund shall not exceed the portion of the tax paid during the 2 years immediately preceding the filing of the claim.”

Thus, even if the taxpayer files a timely refund claim, you always need to check the appropriate lookback period to see if there is any money to get refunded!  For a great example, see Rev. Rul. 76-511, describing a situation where the claim was timely but there had been no payments made in the applicable lookback period and thus could be no recovery.

The same §6020 issue arises in calculating the appropriate lookback period here just as it does in calculating the appropriate claim limitations period.  In Healer v. Commissioner, 115 T.C. 316, 323 (2000), the Tax Court noted that even if a taxpayer had just signed the proposed SFR sent to her by the IRS, that would have created a return under 6020(a) which would have been sufficient to trigger the three year lookback period in 6511(b).  But since she did not sign the SFR, the court applied the two year lookback period to deny her refund claim.

This is the lookback trap that we learn about in today’s case.  Let’s take a look.

Facts
In 2002, Mr. Mohsen he filed for an extension of time to file is 2001 return.  Along with his extension he threw $43,000 at the IRS to pay his estimated taxes.

In 2003, Mr. Mohsen still had not filed his 2001 return.  So the IRS did it for him, preparing a Substitute for Return (SFR) per §6020.  The opinion treats this as a §6020(b) SFR but does not explain why.  The IRS apparently applied some but not all of the $43,000 to the liability.  It kept the rest.

On October 29, 2015, Mr. Mohsen got around to filing his 2001 return and also filed a formal claim for refund, claiming an overpayment of $49,000.  The IRS denied the claim on March 16, 2016.  Mr. Mohsen never sought judicial review.

In 2017, Mr. Mohsen got around to filing his 2004 return and asked that $10,000 of his 2002 payment be applied, with the remainder refunded to him.

The IRS declined to apply any amounts and instead started the collection process for the self-reported 2004 balance due of $10,000.  Part of that process, as we know, is to give the taxpayer an opportunity for a CDP hearing.  Mr. Mohsen asked for the CDP hearing and there argued, once again, that the IRS really should use part of the 2002 payment and give the rest back.  Only now he tried to claim that the payment was really a deposit and so was still available.

The IRS Office of Appeals sustained the proposal to levy Mr. Mohsen’s assets to collect the unpaid 2004 liability.  Mr. Mohsen timely petitioned the Tax Court.  And thus we get our lesson.

Lesson:  Without A Payment in the Lookback Period, A Timely Claim Is an Empty Claim
Judge Kerrigan first explains that the Tax Court does indeed have the power to order the IRS to apply an “available credit” to a liability it seeks to collect.  However, she is careful to note that “the mere claim of a credit is not an available credit and such a claim need not be resolved before the IRS can proceed with collection of the liability at issue.” Op. at 9 (quotes and citations omitted).  That is, the Tax Court cannot reopen closed years or even look at other years to independently determine whether a credit is available.

Here, Mr. Mohsen had filed a claim for refund of his 2002 payment on October 29, 2015, when he belatedly filed both his 2001 return and apparently filed a separate formal claim for the $43,000 (and then some) to be refunded.

Judge Kerrigan explains why the IRS properly denied that claim for refund.  There was no problem with the timeliness of the claim under §6511(a).  Mr. Mohsen had three years from October 29, 2015 to file a claim for refund and he, in fact, filed that claim on the same day he filed his return, October 29, 2015.

But Mr. Mohsen fell into the §6511(b) lookback trap.  That subsection tells us to use a three-year lookback period starting on the date of the refund claim.  Here, that was October 29, 2015.  Mr. Mohsen would be entitled to recover only payments made within that lookback period.  Here, there were none.

There is just no escaping the fact that, for whatever reason, Mr. Mohsen failed to act timely.  Whether his claim is just or unjust does not matter: the bar of the limitations period grants certitude, not mercy.

Comment 1 - Is it Really Too Late?
I noted that it was not clear whether the 2003 SFR prepared by the IRS was a §6020(a) or (b) SFR.  Here's why that might matter.  If it was a §6020(a) SFR then it would constitute a claim for refund and since the $43,000 was paid within two years prior, there would be no problem with the lookback limitation period.  There would be a problem, however, in that the IRS did not issue a refund.  Mr. Mohsen would need to go to court to get that done and would have two years from the date the IRS rejected the claim.  That two year period, however, is only triggered when the IRS issues an actual notice of disallowance or the taxpayer waives the right to such notice.  See discussion in CCA 200202069. Here, arguably, while the IRS rejected Mr. Mohsen's later claim for refund in 2015, the IRS never issued such a notice as to the 2003 SFR.  So if that SFR was treated as the relevant claim for refund, then arguably Mr. Mohsen would still be able to file suit to recover and the money would be available for offset.  However, if the 2003 SFR were a §6020(b) SFR, then it would NOT be treated as a claim for refund.  Based on her citation to Healy, Judge Kerrigan apparently viewed the SFR as a §6020(b) SFR.  And it most likely was, but it would be nice to nail that down.

Comment 2 - Equitable Recoupement?
Mr. Mohsen would also not be able to use the doctrine of equitable recoupment here.  That doctrine permits a taxpayer to force the IRS to offset an amount it seeks to collect from the taxpayer by an amount that the taxpayer would otherwise be entitled to claim but for the bar of a limitations period.  However, the purpose of the doctrine in tax law is “to prevent injustice where the Government has taxed a single transaction, item, or taxable event under two inconsistent theories."  See Wolfington v. Commissioner, T.C. Memo. 2014-45 (quotes and citations omitted).  Here, Mr. Mohsen’s claimed overpayment relates to different transactions and a different tax period than the liability sought to be collected.

Comment 3 - Is Healer Still Good Law?
Healer v. Commissioner, 115 T.C. 316, 323 (2000), is still good law because its holding is that a 6020(b) SFR is not sufficient to be a claim for refund.  But its dicta that if the taxpayers there had only signed a Form 870 or From 4549, then that would be treated as the taxpayer's return under  §6020(a) is definitely open to question now.  At the time, that was indeed the IRS's position.  But the IRS has since changed its mind, in a very poorly reasoned Revenue Ruling, Rev. Rul. 2005-59, that I roundly critiqued in Bryan Camp, The Function of Forms in the Substitute-for-Return Process, 111 Tax Notes 1511 (June 26, 2006).  While that unfortunate Rev. Rul. has been adopted in an unreported Magistrate Judge's opinion (United States v. Busch, Civil Action No. 4:17-CV-183-ALM-CAN (Judge Nowak, E.D. Tex.) (opinion signed 12/4/2017), I have not found it adopted elsewhere.  But neither has it been rejected, as it ought to be.

Bryan Camp’s is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to return each week to TaxProf Blog for another timely, if not timeless, Lesson From The Tax Court.