New Rulings Highlight Need to Review IRS Interest Computations

As we enter the last quarter of the tax year, planning and compliance are coming into sharper focus. Taxpayers often assume that the difficult part is over once their tax deficiency or refund is finally determined. But computing interest on the tax deficiency or refund involves nuanced legal and procedural considerations.

Recent case law continues to shape the landscape, emphasizing the importance of reviewing the IRS’s interest computations and knowing the key issues on the horizon. Four topics have emerged as high areas of interest for practitioners:

MRT installment payments and overpayment interest issues. In Pitney Bowes, Inc. v. United States, the company is seeking interest on overpayments held to pay future mandatory repatriation tax installment payments, and other taxpayers will likely do the same. Pitney Bowes elected to pay the Section 965 transition tax in installments over eight years with no interest charge, as allowed under Section 965(h)(1).

Pitney Bowes argues that the IRS improperly used its overpayments to satisfy tax its MRT installment payments that became due in future tax years. The IRS, in our view, wrongfully benefits from the use of the taxpayer’s money because it doesn’t pay overpayment interest on the amount used to satisfy future installments, when Congress specifically allowed installment payments to be made without an interest charge.

Taxpayers will continue to file returns reporting overpayments during the eight-year period for making MRT installment payments. If the IRS continues to not pay overpayment interest, more lawsuits will likely be filed.

‘Same taxpayer’ issues for netting interest. There is a difference of 4.5 percentage points between the interest rate that applies to a corporation’s underpayments and its overpayments. The government allows “interest netting” so taxpayers don’t unfairly pay underpayment interest in one period when the IRS has their money in another tax period.

The Internal Revenue Code’s Section 6621(d) permits netting only for overlapping underpayments and overpayments by the “same taxpayer.” In a simple case, the IRS allows interest netting between the tax periods of taxpayers with the same taxpayer identification number.

Harder cases involve interest netting between the tax periods of taxpayers with different TINs who become part of a consolidated group because of a merger or other acquisition. These cases continue to be litigated.

In Bank of America Corp. v. United States, the bank argued that it could net pre-merger underpayments and pre-merger overpayments because, after the merger, the “same taxpayer” was liable for the interest payable on the underpayments and entitled to interest allowable on the overpayments.

The US Court of Appeals for the Fourth Circuit rejected that argument in july and held that the same taxpayer must have made both the tax underpayments and overpayments.

The Fourth Circuit didn’t address Bank of America’s argument that a taxpayer doesn’t “make” an underpayment. Instead, it focused on whether the underpayments and overpayments were made “by” the same taxpayer. The court was concerned that allowing netting in this situation (pre-merger underpayments and overpayments) could produce abusive mergers, which ignores real-world considerations for doing a merger.

Taxpayers have had more success netting pre-merger overpayments and post-merger underpayments when the target corporation merges into the parent corporation. However, there continue to be open issues when the target corporation isn’t merged into and absorbed by the acquiror. If the target continues as a wholly-owned entity of the acquiror’s consolidated group and has a separate TIN, is netting allowed? The same underlying theory, supported by the consolidated return regulations, suggests yes.

The common parent corporation and each subsidiary that was a member of the group during any part of the consolidated return year is severally liable for the tax, and a refund made directly to and in the name of the parent discharges any liability of the government to any member with respect to such refund. However, this issue hasn’t been litigated yet.

Forums for overpayment of interest disputes. In Bank of America, the bank filed suit in the Fourth Circuit because it faced adverse precedent in the Federal Circuit. The Court of Federal Claim is the only other forum where the bank could have filed suit, and its controlling law is the Federal Circuit.

The bank didn’t prevail in its argument that a federal district court in the Fourth Circuit had jurisdiction over overpayment interest claims in excess of $10,000. The Court of Federal Claims has exclusive jurisdiction in such cases, because the taxpayer isn’t seeking the recovery of excessive amounts paid—it’s seeking the payment of additional amounts from the US.

A taxpayer must file a lawsuit within six years of when the overpayment is scheduled and isn’t required to file a refund claim because it’s not seeking a refund of amounts it paid. A taxpayer with claims of additional overpayment interest in excess of $10,000 in federal appeals courts that haven’t yet decided the jurisdictional issue in favor of the US must first file a refund claim, and then can sue six months later.

Courts have declined to hear cases in which taxpayers failed to first exhaust their administrative remedies, even if the case involves only overpayment interest. Because of the adverse precedent in the Federal Circuit on the same taxpayer issue and other interest issues, taxpayers continue to sue in other forums.

These other courts may decide the substantive interest issues more favorably to taxpayers, but taxpayers will first need to overcome the government’s likely jurisdictional challenge.

Covid-19 disaster declarations and interest suspensions. There is a straightforward interest suspension from April 15, 2020, to July 15, 2020, that applies to all taxpayers for tax year 2019. But there is an argument that underpayment interest for any tax year should be suspended from Jan. 20, 2020, through July 10, 2023, under Sections 7508 and 7508A and a recent Tax Court case, Abdo v. Commissioner.

Although the IRS is unlikely to agree to this, the potential for suspending interest for more than three years makes this issue worth pursuing.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Mary McNulty is a partner in the Dallas office of Holland & Knight and co-chair of its tax controversy team.

Lee Meyercord is a partner at Holland & Knight in Dallas and focuses her practice on tax controversy.

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