Source: https://procedurallytaxing.com/category/erroneous-refund/
Timestamp: 2019-04-21 08:23:46+00:00

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Today’s returning guest blogger is Sean Akins. Sean is a partner at Covington & Burling, LLP. His practice includes representing corporations, partnerships, and individuals in tax controversy matters. Sean is a co-author of Kafka, Cavanagh & Akins: Litigation of Federal Civil Tax Controversies and a co-author of Effectively Representing Your Client Before the IRS, Chapter 7, Litigation in the Tax Court. Sean is also a Nolan Fellow (2014-2015) of the Section of Taxation of the American Bar Association, and an Associate Member of the J. Edgar Murdock American Inns of Court (U.S. Tax Court).
Taxpayers who have been paid refunds by the IRS can breathe a little easier following last week’s decision in the Starr International case. Prior rulings in Starr have been covered by Les Book here, here, and here. This most recent, and perhaps final, aspect of the case relates to the application of the extended five-year period of limitations in erroneous refund actions brought by the Government.
In Starr’s case, the Government asserted that an erroneous refund action brought four years after a refund was paid to Starr was timely because section 6532(b)’s extended five-year period of limitations applied. The reason? According to the Government, Starr knew or should have known it was not entitled to the refund, and so when Starr filed its refund claim reporting on the face of the return that it was owed approximately $21 million, that representation constituted a misrepresentation of material fact that triggered the extended limitations period. The Government posited that Starr should have instead reported on the face of the return a $0 refund, and then later explained in the attached statement of facts and grounds that it was actually seeking a $21 million refund.
The district court, citing an amicus brief filed in the case by (shameless plug) Les Book, Fred Murray, and myself [Editor’s note: Sean was the principal drafter], rejected the Government’s argument, and held that no misrepresentation of material fact exists when a taxpayer reports on the face of the tax return the amount of refund to which the taxpayer reasonably believes it is entitled.
In 2007, Starr, a Swiss company, sought from the United States Competent Authority (“USCA”) a determination that it was entitled to a reduced rate of withholding on stock dividends it received. In 2010, the USCA denied that request, which lead Starr to file two claims for refund: one for its 2007 tax year, filed on an amended Form 1120-F, and one for its 2008 tax year, filed on an originally filed Form 1120-F. In 2011, the IRS granted and paid the 2008 refund claim, but took no action on the 2007 refund claim. Rather than seek immediate court review of the 2007 refund claim, Starr waited until 2014 to file suit. By that time, two important statutes of limitations had expired: (i) the three-year period within which the IRS could have assessed a deficiency of tax for the 2008 tax year, and (ii) the two-year period within which the IRS could have initiated an erroneous refund action to claw-back the refund it had previously paid.
After Starr filed suit with respect to the 2007 tax year refund, the Government counterclaimed, seeking a return of the $21 million the Government alleged was erroneously paid. The Government argued that the extended five-year period of limitations applied, rather than the standard two-year period. In order to secure the lengthier period of limitations, the Government was required to show that “the refund was induced by fraud or misrepresentation of a material fact.” Section 6532(b).
The Government asserted that Starr had misrepresented material facts in three ways: (i) Starr reported on line 9 of the Form 1120-F that it was entitled to a $21 million refund; (ii) Starr failed to notify the USCA that it was filing the 2008 refund claim; and (iii) Starr did not expressly notify the IRS service center that the service center lacked jurisdiction to issue a refund.
The district court rightly rejected all three of these as constituting misrepresentations of material fact, but I’ll focus on the first as the most significant of the bunch.
The Government argues that Starr’s “representation on line 9 of its return that it was due a refund of over $21 million was a misrepresentation of material fact.” In the Government’s view, even if Starr had to file the request to preserve its ability to seek judicial review of the USCA’s treaty benefits determination, it should have either requested $0 or left line 9 of the form blank. According to the Government, taking “this precaution would have allowed [Starr] to litigate the merits of the USCA denial determination in court” without inducing the Ogden Service Center to actually issue the refund.
Based on the foregoing, the Court rejected the notion that Starr had misrepresented a material fact, and found the extended period of limitations for an erroneous refund action inapplicable.
Because the district court found that there was no misrepresentation of material fact, it was not required to evaluate whether any such misrepresentations induced the IRS to issue the $21 million refund. Notwithstanding this point, it’s worth noting that the Government claimed to have been induced to issue the refund, at least in part, because Starr’s refund claim was voluminous and the IRS lacked the resources to review such a lengthy tax return. Indeed, the Government had argued that Starr “had no basis to have ‘reasonably expected’ that the Service Center would review the over 100-pages of attachments” to its return. Reply in Support of the United States’ Motion for Summary Judgment on the Counterclaim at p. 7.
This is a troubling argument for the Government to make. Starr not only told the IRS, in its attached statement of facts and grounds, that the USCA had previously considered and rejected Starr’s treaty benefits request, but it also attached to its return the letter from USCA denying those treaty benefits. A review of these materials, even a cursory one, would have informed a service center agent that the refund claim should likely have been denied.
Yet it is these very documents the Government points to when arguing that Starr had buried a strained service center in voluminous detail, thereby inducing it to pay a $21 million refund rather than examine the return. Ironically, had Starr failed to make those disclosures, and had the service center paid the refund, Star would likely have faced a stronger argument from the Government that it had misrepresented material facts by failing to include those disclosures.
In short, the Government’s argument that Starr’s disclosures contributed to the service center issuing a refund is a troubling one, as it seeks to punish a taxpayer for over-disclosing, rather than under-disclosing, a return position.
Week late, and more than a buck short, here is last week’s Summary Opinions. This week had a lot of really interesting procedure items, including the Clarke summons case being decided by SCOTUS, which Les covered here, and the final Circ. 230 regulations, which Michael Desmond covered for us here. I still have my disclaimer in my email auto-signature. Have to get around to that someday.
We also had the pleasure of welcoming Professor Andy Grewal (great professor, excellent scholar, but, most importantly, he named “Summary Opinions”) as a guest poster, where he discussed TEFRA jurisdiction and sham partnerships. Thanks to both our guest posters. As always, I will blame that wonderful content for bumping Summary Opinions all the way to the end of the week (but in reality, my day job got in the way).
Jack Townsend’s Federal Tax Procedure Blog and Federal Tax Crimes Blog had a nice write up of US v. Carlson, which reviewed the plaintiff’s liability for the Section 6701 aiding and abetting understatement penalty. Jack’s post focuses on the government’s standard of proof, which the 11th Cir. said was clear and convincing. Jack follows that up with a good discussion on extending this rationale to FBAR willfulness.
Hom getting tired of coming up with bad puns for Mr. Hom (not really, I love them). So, our favorite online gambler/tax procedure renegade, John Hom, lost yet another tax procedure case in district court. Mr. Hom had accounts with various online poker companies outside of the US, which Mr. Hom failed to disclose on timely filed FBARs. Mr. Hom contested the filing requirements and penalties by arguing the accounts weren’t bank accounts or other financial accounts. The court quickly dispatched these claims by indicating the accounts fall within the definitions. Best/worst line from case, “The Court has tried to appoint a free lawyer for defendant—but no one would take the case.” This was done probably because the issue was novel, and potentially far reaching. Jack Townsend has a strong write up of the case here. If the online poker account is the equivalent of a bank account, how far does the statute reach?
Our hammer lobbing (if you actually read all of our comments, that may make sense, otherwise it’s an inside joke, which I’ll try not to do often) frequent reader/commenter, Bob Kamman, tipped us to YRC Regional Trans v. Comm’r, which is a refund jurisdiction case, where the Tax Court told the Service to scram – because procedure says so. The facts are somewhat complicated, as this is an NOL refund involving an acquisition where the target company’s subsequent NOL was carried back to the purchaser’s prior tax years. But, boiled down, YRC had an NOL for 2008. That was carried back for a tentative refund for 1999 on the purchaser’s books. IRS issued a refund check on Sept. 30, 2009 for $351k and change. Both parties agreed that was a rebate refund under Section 6211(b)(2). On April 2, 2010, the Service issued another check in a similar amount of $357k and change. Taxpayer said thank you very much and deposited the second check.
Simple so far, but this will require a second paragraph. Sometime later, the Service decreased the 2008 NOL, resulting in the 1999 carryback refund decreasing by around $64k. The Service then increased that deficiency by the second erroneous refund amount. What is really at question is whether or not the second refund was a rebate refund or a nonrebate refund, and how the Service can go about recovering each. The Court has a good discussion on this point. Essentially, an IRS error in issuing two refunds, regardless of the underlying reason, is a nonrebate refund. Nonrebate refunds can only be obtained under Section 7405 procedures, which the Tax Court has held it does not have jurisdiction over. Assuming the Service is not time barred, they could bring this in other federal courts. In addition to bringing this suit in the appropriate courts, the Service also takes the position that it can offset this type of nonrebate erroneous refund against future refunds (based on common law principals, not the Code). See CCA 200137051. I have never looked into that issue, and would not agree to that position until I had researched it further. I believe Keith is going to write some additional commentary on this, and another erroneous refund case from last week that was brought to our attention by a good friend to the blog.
In Ruscitto v. U.S., an MJ recommended summary judgment in favor of the feds in a case where the income tax refund of a husband and wife was applied against hubby’s TFRP. Wife argued that a portion of the refund was due to her, as her income from her Form 1099-C (cancellation of debt) gave rise to a portion of the income. The Court found the claim was untimely, and could not review the claim.
SCOTUS has held that inherited IRAs are not retirement funds under 11 USC 522(b)(3)(C), meaning they are not exempt from the bankruptcy estate. See Clark v. Rameker. Keith hopes to provide insight on this in the coming days or weeks.
In honor of Fathers’ Day, Going Concern has a post about paternity leave. My wife has always given me a hard time about how long I took off after each of our daughters was born. She claims cumulative total, I took off one day. Two months ago she found out my firm has a paid paternity leave of six weeks…she was not thrilled.
I should have asked Keith about this case before writing it up, as his knowledge of taxes and bankruptcy is far superior to mine, but In Re: Pugh struck me as interesting. In the case before the Eastern District of Wisconsin Bankruptcy Court, the debtor entered into Chap 13 bankruptcy (keep your assets, but have to pay your debts over 5 years), and entered into a repayment plan on July 30, 2013. The Chap 13 plan provided that the debtor “would retain any net federal and state refunds”. Following the plan, the Service audited the debtor’s 2011 return, resulting in a deficiency which was provided to the court. The debtor then filed a 2013 return, requesting a refund, which the Service used to offset against the 2011 deficiency. The taxpayer took exception, since the plan said she was to receive refunds and the 2013 tax year occurred after the filing of the bankruptcy petition. The Court noted that when the debt and refund are both prepetition, the Service does not need to seek relief from the automatic stay; however, here the refund was post-petition. The Court highlighted the split on this issue, with some courts holding the Service has the right to offset under Section 6402(a), leaving the “net refund” to be calculated after the setoff. Others have held Section 6402 does not lift the stay, and the assets must pass to debtor or, at the least, the Service must ask permission before making an offset such as this. The court in Pugh sided with the first set of cases, holding the power under the Code trumped the bankruptcy stay. These cases seem to arise somewhat frequently. I suspect we will see some additional Circuit Court guidance in the near future.
Government is back up and running, which is good. Service is back in business, and Tax Court has reopened and is rescheduling matters. Coverage can be found here and at Tax Girl here. PTIN renewal for 2014 may have to be postponed until later this year or until 2014 due to the government shut down (***reader Bob Kamman pointed out the original post may have been incorrect; read the comments below for further discussion***). Don’t Mess With Taxes hypothesizes the shutdown could impact filing next year.
Forbes contributor Joe Harpaz has a post on innovation and tax policy found here. This is more tax policy than procedure, but we are fans of that also. The article outlines recent research into the most innovative companies based on patents, and connections between the geographic locations of those companies and the applicable government’s tax policy on R&D.
More from the Forbes tax blog, which has a post on a study showing that taxpayers with a balance due are more likely to cheat than those who are owed a refund, which can be found here. Mr. Reilly describe this “stupinomics” (his term for loss aversion and behavior economics—which probably could apply to a much broader range of economic transactions) phenomena, which most tax preparers probably assumed to be the case. Even though all tax planners state it is bad planning to give the Service an interest free loan and overpay, I always do it, because I know I will be ticked off when I have to cut the Treasury a check on April 15. This is based on the same idea. Owing makes us angry, refunds are fun. It is not hard to see a few ways to use this to reduce fraud (assuming the report is true, and I have not reviewed any aspect of it beyond this article), but those would likely meet resistance.
An article can be found here discussing the IRS guidance issued in January of 2013 regarding the use by tax preparers of tax or other information obtaining when preparing returns to solicit other business. The article is by Thomas Manisero of Wilson Elser. It is not very long, and does not delve too far into this area, but does highlight something practitioners often do not think much about and the somewhat simple solution (obtaining consent) to the issue.
Here is a synopsis of Vandenheede v. Vecchio, which was decided on October 1, 2013. I read a summary last week, and did not initially pick up on anything of interest. The summary from Bryan Cave showed it was fairly interesting, where the Sixth Circuit affirmed the lower court’s granting of a motion for summary judgment of the case when a recipient of funds from a trust had sued the co-trustees for filing fraudulent information returns under Section 7434. The trustees treated distributions to this woman as income from a trade or business, and 1099’d her. She felt the payments were reimbursements for her and her husband’s living expenses, and the Form 1099s were fraudulent. The case was dismissed because the trustees were held to not be the “filer” of the Form 1099s since the income and deductions of the trust were required to be placed on the settlor/husband’s personal income tax return. Here is the Sixth Circuit’s opinion.
SCOTUS denied the taxpayer’s petition for certiorari in Knappe v. United States, where a taxpayer was seeking to demonstrate reasonable cause under Section 6651 by relying on an accountant or attorney who erroneously advised the taxpayer on the due date of a Form 706. I am going to write more about this case during this week, and have some comments on the handful of other cases on this same topic that have been reported over the last year.
Jack Townsend uses bad words again, which I like, in describing a bull$h*! or not-BS tax shelter decision in the Santander Holdings USA case, which can be found on his tax procedure blog here. The post lifts language from the case to describe the tax shelter, but what is more important is the discussion of substance over form doctrine, with the Judge in Santander holding that it “is a legal question, to be answered by judges, not economists,” and did not put any weight on Government’s expert testimony. This will be an interesting holding moving forward, as most other Courts appear to rely somewhat heavily on the expert opinions in determining substance over form. If you read Mr. Townsend’s post, you should also read Richard Jacobus’ comment to the point. He highlights his other perceived issues with the holding, which are insightful.
The Service lost a motion for summary judgment in Suntrust Mortgage Inc. v. US in the District Court of Maryland, where the Service tried to stop a mortgage holder’s quiet title action to determine priority over the Service’s lien. Order can be found here. The mortgage company’s argument as to title is that that equitable subrogation protects its mortgage on the property because the borrower used the new mortgage to pay off two prior mortgages. This issue has yet to be decided. The motion the Government lost was a 12(b)(6) motion, arguing sovereign immunity or, in the alternative, this was not a proper use of a quiet title action. The Court stated sovereign immunity had been waived as to quiet title matters, and the question was if “an action by a non-taxpayer to establish the priority of his mortgage lien over the government’s tax lien a ‘quiet title’ action under the statute.” The Court found the majority rule is that this was a permissible action.
And, I’ve found the answer to why my client’s don’t donate more to charity. Thanks to TaxProfBlog.
There is an amazing amount of tax discussion regarding lap dances, such as Philly’s amusement tax being blocked from applying to such amusements found here (thanks to MauledAgain) and the attempt of a New York club to exempt its dances from the sale and use tax based on an exception for the dramatic arts found here. Not really tax procedure related, but appealing to readers’ more prurient interests is sure to drive up page views.
And, of course, the best stuff on the internet: Les posted twice on the Kuretski case, the most recent can be found here, which is generating some interesting discussion on our blog and on others; and, Keith posted on the Frazier erroneous refund case here, and has a good discussion of the intersection of bankruptcy and tax.
A recent erroneous refund case provides an opportunity to talk about some similarities and differences between that statute and “regular” fraud cases. On August 27, 2013, United States Magistrate Judge Paige Gossett entered an opinion determining that Gloria Frazier received a $51,060.00 erroneous refund on February 16, 1999.
The first thing that caught my eye here was the timing of the refund. It was issued more than 14 years ago. How, I wondered, could a decision favorable to the Government appear in an erroneous refund case that long after the issuance of the refund? The first difference between the fraud provision in erroneous refund cases and in “regular” tax cases is the fixed time frame for bringing the erroneous refund suit – five years after the refund. Any suit brought within five years after February 16, 1999, should have been decided by a magistrate judge long before the end of 2013. The judge explained why the opinion came out so long after the erroneous refund with a cryptic reference to multiple bankruptcy filings by the defendant.
The bankruptcy aspects of the case deserve discussion.
I did not research Ms. Frazier’s bankruptcy filing history but the case provides a glimpse at a provision of the automatic stay that most tax lawyers do not see. Upon the filing of a bankruptcy petition, the automatic stay stops, or stays, the actions described in the eight subparagraphs of B.C. section 362(a). Tax lawyers frequently see Tax Court cases stayed by B.C. 362(a)(8). Tax practitioners involved in collection cases regularly see collection stopped by a bankruptcy filing because of B.C. 362(a)(6). Although the Court does not explicitly say so, the Frazier case involves the stay of B.C. 362(a)(1), which stops the commencement or continuation of a proceeding against the debtor that could have been commenced before the filing of the bankruptcy petition. Seeing (a)(1) in action to stay a tax case provides a rare opportunity because the IRS, through the Tax Division of the Department of Justice, brings so few affirmative suits and those suits infrequently intersect with bankruptcy.
The discharge issue here will turn on the application of the exception to discharge found in BC 523(a)(1)(C), which provides that tax debts are excepted from discharge (not discharged) if “the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” Did Ms. Frazier make a fraudulent return when she filed the return resulting in the erroneous refund? The decision in the erroneous refund case would not seem to provide the same collateral estoppal benefits that a civil or criminal fraud penalty case would since the language of erroneous refund statute mentions either fraud or material misrepresentation. The court appeared to decide the case on the material misrepresentation prong of the test for extending the erroneous refund statute of limitations.
Even if fraud existed in the filing of the claim for the refund, the preparer of the return, rather than Ms. Frazier, may have perpetrated the fraud. If the fraud in the refund claim stems from the actions of the preparer rather than the debtor, the application of the exception to discharge under BC 523(a)(1)(C) may not apply. This type of derivative fraud, which the Tax Court approved as keeping open the statute of limitations in Allen v. Commissioner and which Les recently wrote about concerning the BASR v. United States case, may not apply to prevent the discharge of a debt. Given Ms. Frazier’s apparent willingness to use the bankruptcy process, this case may offer the opportunity to see how the erroneous refund provision keeping open the statute of limitations where fraud or material misrepresentation exist mesh with the exception to discharge provision for attempting to evade or defeat the tax.
I will write separately about the more traditional tax aspects of the Frazier case.

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