Watch the Refund Statute of Limitations on OVDP Payments Related to Income Tax (11/16/13)

The 2012 OVDP FAQ 25, here, requires that the full package include various documents (amended returns for the 8-year period, etc.).  Contemporaneously (or before) the taxpayer should send the following to a separate address (from  the 2012 OVDP FAQ):

A check payable to the Department of Treasury in the total amount of tax, interest, accuracy-related penalty, and, if applicable, the failure to file and failure to pay penalties, for the voluntary disclosure period must be sent along with information identifying the taxpayer name, taxpayer identification number, and years to which the payment relates to the following address.

If the taxpayer does not opt out of the OVDP penalty structure, there are no glitches in this payment system that I am aware of.  If the taxpayer opts out, however, and the IRS has posted the remittances as payments to years that, by the time of the resolution of the opt out, are closed for refund claims, the IRS takes the position that it cannot refund any tax, penalty or interest overpaid -- either overpaid with the original return or the payment under FAQ 35.

The reason for this position is that Section 6511(a) and (b), here, preclude the refund.  Readers can read the statute itself at the link.  The following is my explanation of the two statutes of limitations on refunds from the current draft of  my Federal Tax Procedure Book (footnotes omitted):

First, there is a statute of limitations for filing the claim for refund.  A claim for refund must be filed within three years from the date the return was filed or two years from the date the tax was paid, whichever is later, and, if no return is filed, within two years from the date of payment.  § 6511(a).  Read literally, this means that a taxpayer can file a return 40 years late and qualify under this first rule. I hope readers will instinctively say something must be missing here, for statutes of limitations do not normally allowing such lengthy lapses before the claim must be pursued.  The answer to that concern is in the second rule to which I now turn. 

Second, there is a statute of limitations on the amount of tax that can be refunded if the claim is timely under the first rule.  The IRS may only refund the amount of tax paid within three years  plus the period of any extension and, if the foregoing rule does not apply, then it may only refund the tax paid within two years of the date of the claim.  § 6511(b)(2).  This is called the “lookback” rule. 

The key for OVDP purposes is the second rule relating to possible refunds on the opt out arising from the FAQ 35 payments.  Taxpayers and practitioners should be alert to protect the refund statute of limitations for those payments and must act within the two year period from the date of payment.

Normally, a refund claim is filed on 1040X.  A "protective" claim for refund may be filed.  Again, from my Tax Procedure Book (footnotes omitted):

Finally, there is yet another potential work-around to an expiring refund statute that you should consider.  File a protective claim for refund stating as much about the claim as you can and ask the IRS to postpone action on the claim for some period of time when you expect the facts and circumstances to firm up to amend the timely filed but otherwise deficient claim.   You will have to tell the IRS a good story as to why it should postpone action and give them a reasonable time frame to postpone action.  

Thus appropriate 1040Xs can be filed and they can be filed protectively.

An agent told me this past week that my clients could protect the refund statute by my simply sending a single letter stating the claim, the years involved, and the basis for and amount(s) of the claim (i.e., the expiration of the assessment statute of limitations).  This would be treated as a protective informal claim and would be resolved when the opt out is finally resolved.

Here is my Federal Tax Procedure discussion of the informal claim (footnotes omitted):

Informal Claims. 

The statute requires a claim for refund.  Administrative necessity reflected in the regulations requires that the claim be formally presented.  Accordingly, claims should be presented with the proper forms (discussed above) and, where required by procedures, with any required accompanying information.  However, from time to time, courts will recognize informal claims as satisfying the statutory predicate for a claim for refund where the taxpayer has in fact presented a claim to the IRS and, in the court's view, the IRS did or should have considered the claim.  These cases are rare and are driven by unusual facts and equities. 

Broadly speaking, the components of an informal claim are:  (1) the IRS was on actual or constructive notice that the taxpayer was making a claim; (2) just as with a formal claim, the claim must adequately advise the IRS of the legal and factual basis for the claim; and (3) the claim must have a written component.  Some courts add the requirement that the IRS have either considered the informal claim or otherwise lead the taxpayer to believe that the claim was sufficient.  Simply because the IRS may have had somewhere in the system information indicating that the taxpayer might claim a refund does not meet the requirement for a claim.  The taxpayer must make the claim, even if informal, and there must be no doubt that he or she is making a claim.  And, finally, the informal claim must be “filed” within the applicable statute of limitations.  These are often fact intensive inquiries, ultimately resolved by common sense and fairness. 

For present purposes, I will expect you to know two things:  (1) you should always present your claims on a proper form for claiming the refund your client seeks and (2) if for some reason your client did not so present the claim, you should review the facts, with particular attention to whether the claim was informally presented to and considered by the IRS and the cases dealing with informal claims, to see if you can extract victory from the jaws of defeat.

An issue is whether the client wants to prepare the formal claims for refund in this particular instance.  I think we can rely upon the agent's express representation, confirmed in the letter, that the letter will be treated as a valid informal claim for refund.  Nevertheless, I will let the client make the choice.

I do recommend, however, that taxpayers and practitioners check this out if there is any possibility of opt out when the payments are made.  Focus on the dates of payments and, if still within the two year period from the date of the FAQ 35 payments, file claims for refund.  Be sure you file the claims in the right place.  If the agent handling the OVDP says that he or she will accept the claims, I think that will suffice (but for extra caution, you might file with the Service Center and copy the agent).  Be sure to mark on the document "Protective Claim for Refund" and indicate that you do not want it acted upon until the OVDP opt out is resolved.  Also, do a cover letter with the same information (belt and suspenders).

In the future, along with my FAQ 35 submissions, I will include a protective claim for refund, along with a request to defer action until the OVDP is resolved.  (I have amended my task list for the OVDP submissions to include the requirement for a protective claim for refund.)  Readers might consider doing that as well.   Indeed, if the IRS is reading this blog (I know some of the IRS people do), please consider amending FAQ 35 to recommend or even require protective claims for refund.

Finally, just a piece of information she gave me.  She said that early in the program beginning in 2009, the IRS was applying the payments to the earliest open year as a matter of administrative convenience rather than allocating the payments to particular years.  Where that was done, the required consent for the open year to which the payment was posted would, if timely countersigned, solve this problem (the consent extends both the assessment and the refund periods for open years).  Apparently, at least in some cases, they are now following the taxpayers' instructions as to the years of the payments and posting them accordingly.  This now creates the need to protect the refund statute of limitations.

Finally, for taxpayers who have not protected the statute of limitations, I suggest that you consider arguing that the program itself, along with the document and payment submission, as at least an informal informal or even claim for refund based on the income tax statute of limitations.  I have not filtered through all of the IRS's announcements on the program to try to "brief" that issue, but the clear implication of the program is that refunds will be given on opt out if for the closed years.  Hence, the taxpayers' submission of the payment and the related package should be equitably considered a protective claim if they opt out.  Certainly, by the time they opt out, the opt out clearly implies and often states the right to a refund for closed years.  (I so state in my opt out penalty mitigation letter.)