Unabated, On an Erroneous Refund

The tale of Luther Herbert Alcorn, III, 139 T. C. 4, filed 8/9/12, is a comedy of errors, ending in unabated interest. Judge Wells traces the errors, from Lute’s misplaced 1040-ES payment through IRS’ ignoring his note and double-crediting his ES payment, to Lute’s not noticing that his refund was $4 grand too much.

Lute filed timely and included his $4 grand 1040-ES payment, but he put it on the wrong line, line 62, “withholding”, lumped in with his other withholding, and not line 63, “previous overpayment applied plus 1040-ES”. I can feel Lute’s pain; I made a similar mistake myself one year, withholding from an IRA distribution didn’t get properly credited, so my refund was too small, and I spent the best part of a year trying to get that omelet unscrambled, fortunately without interest or a subsequent year’s deficiency resulting.

But Lute wasn’t so lucky. Lute attached a note to his 1040, stating his $4G estimated was included in the withholding amount. IRS argued they had no time to read billets doux from taxpayers, but their own Manual says “‘Examine all attachments to the return’ and ‘all taxpayer-initiated correspondence must be responded to within 30 days.’ Internal Revenue Manual pt. 3.11.3.3.7 (Jan. 1, 2008).” 139 T. C. 4, at p. 16. (Footnote omitted.)

Lute’s note wasn’t a model of clarity, but Judge Wells said it could have tipped IRS off that Lute’s 1040-ES payment was already included in the computations in his return.

IRS double-credits the $4K, sends Lute a big refund, but then IRS wakes up, discovers the erroneous refund, asks for and gets its money back. Lute asks for and gets abatement of the late payment penalty IRS imposed, because Lute didn’t file or pay late, but when Lute asks for abatement of interest, IRS says “Since the tax information shown on your original return was incorrect or incomplete, this is considered a contributing factor in the issuance of the refund, and therefore does not qualify for the removal of the interest charge under the Tax Reform Act of 1986.” 139 T. C. 4, at p. 5.

Now for the law; since nobody disputes the facts, this is a pure question of law (summary judgment). Sections 6404(e)(1) and 6404(e)(2) are the basic rules. Section 6404(e)(1) is the famous IRS managerial or ministerial delay; Section 6404(e)(2) is the mandatory interest abatement for erroneous refunds less than $50K unless taxpayer error caused the error. And each abatement period commences to run at different times, although they may overlap.

Naturally, Lute and IRS each claim the other made the mistake and they themselves were blameless, but Judge Wells says no: “Although neither party is willing to admit to making an error, it is clear to us that both parties made errors. Accordingly, we examine the statute to decide whether, on the basis of the facts and the errors committed by both parties, respondent abused his discretion in denying petitioner’s request for abatement of interest.” 139 T. C. 4, at p. 9.

IRS claims this is not an erroneous refund, but overstated withholding. That doesn’t fly, because the plain language of Section 6602 and Section 7405 relegates IRS to a civil action for recoupment of the erroneous refund, and not deficiency, followed by lien and levy, because there was no underpayment of tax.

So the question for Judge Wells is whether IRS abused its discretion by denying Lute the refund under Section 6404(e)(2), where the magic language is “the taxpayer in any way caused the erroneous refund.” Judge Wells notes that Northern District of Ohio once ordered a refund where the taxpayer contributed to the erroneous refund, and later the Court of Federal Claims, relying on the N.D. Ohio case, found IRS had made a serious error in addition to that taxpayer’s erroneous claims; but Tax Court refuses to follow those cases, because both fail to explain how the words “in any way” don’t mean in any way.

Judge Wells finds in Section 6404(e)(1) that IRS has discretion to abate interest, so that Section 6404(e)(2) likewise gives IRS discretion to abate, even though the statute doesn’t say so.

“For instance, some erroneous refunds will also result in deficiencies, and, for those deficiencies, the Commissioner is authorized by section 6404(e)(1) to abate interest on a deficiency caused by an error or delay ‘if no significant aspect of such error or delay can be attributed to the taxpayer’. That limitation authorizes abatement even if the taxpayer is somewhat at fault for the error or delay, as long as the taxpayer’s fault is not a significant aspect of the error or delay. Consequently, the section 6404(e)(1) limitation is not as restrictive as the limitation under section 6404(e)(2), which reserves mandatory abatement for those situations where the taxpayer has not ‘in any way caused’ the error. If a taxpayer committed some minor fault that contributed to the Commissioner’s issuance of an erroneous refund but that was nonetheless overwhelmingly the Commissioner’s error, and, if that refund resulted in a deficiency, the Commissioner clearly would be authorized to abate interest pursuant to section 6404(e)(1) for the period after the Commissioner contacted the taxpayer in writing. However, if section 6404(e)(2) is read to restrict abatements on erroneous refunds to only those situations where the taxpayer did not cause the erroneous refund ‘in any way’, then the taxpayer would be ineligible for abatement pursuant to section 6404(e)(2). Because that result seems incongruous, we conclude that the ‘in any way caused’ limitation under section 6404(e)(2) applies only to the mandatory nature of section 6404(e)(2) and does not restrict the Commissioner’s authority to abate interest with respect to erroneous refunds.” 139 T. C. 4, at pp. 19-20. And IRM pt. 20.2.7.5 (Mar. 9, 2010) states that IRS has discretion to abate interest under Section 6404(e)(2) even for refunds greater than $50K.

So did IRS abuse its discretion? No. Lute did make the mistake that set the train of events in motion, and when he got the refund check he should have noticed something was wrong.

“In respondent’s (IRS’) January 28, 2011, letter denying petitioner’s request to abate the interest on petitioner’s excess refund, respondent explained that, because an error on petitioner’s return contributed to the issuance of the refund, petitioner did not qualify for interest abatement. We cannot conclude that it was an abuse of discretion for respondent to decline to abate interest because of petitioner’s mistake on his Form 1040. That determination is consistent with the limitations regarding taxpayer fault in both section 6404(e)(1) and (2). Additionally, we note that petitioner should have been aware that respondent had issued an erroneous refund when he received a much larger refund than he expected because the May 11, 2009, letter and tax statement explained that respondent had changed the amount of estimated tax reported on petitioner’s return. That explanation should have alerted petitioner to respondent’s error and prompted petitioner to contact respondent to inquire about the refund, as petitioner did when he received respondent’s August 30, 2010, letter telling petitioner that he owed money. On the basis of the foregoing, we conclude that respondent did not abuse his discretion when he denied petitioner’s request for abatement of interest with respect to the erroneous refund.” 139 T. C. 4, at pp. 23-24.

Sorry, Lute, but thanks for the lesson.