There are times when tax deadlines are strict. They cannot be changed. The time period for filing a refund claim is an example.
Taxpayers generally have the later of three years from the filing of a return or two years from the payment of the tax to file a refund claim.
But what if the tax law requires tax be paid in one year based on an estimate and, in a later year, it is later discovered that the estimate was wrong? What if the estimate was computed correctly per the IRS rules, but the method for making the estimate is deficient? Can the taxpayer recoup the overpayment years later when it is discovered that the tax estimate was invalid?
Paying more tax than required seems inequitable, particularly when it was not possible to know that the tax was overpaid before the time for filing a refund expired. The court addresses this fact pattern in Koopman v. United States, No. 09-cv-333 T (Ct. Cl. 2020). While the plaintiffs in the case were not successful, the case could provide the Supreme Court with an opportunity to reconsider these rules. Specifically, the Supreme Court could review its stance on equitable tolling for tax refund claims.
Facts & Procedural History
The plaintiff was a pilot for United Airlines. He participated in United Airline’s non-qualified deferred compensation plan. He retired from United in 2000.
United Airlines filed a Chapter 11 bankruptcy in 2002 and its bankruptcy plan was approved by the court in 2006. The bankruptcy plan discharged United Airline’s obligation to pay the plaintiff under its non-qualified deferred compensation plan.
The result is that the plaintiff paid tax on $348,136.83 worth of non-qualified deferred compensation, of which he received only $166,657.17.
The plaintiff filed a refund claim in 2007, which was denied by the IRS.
The plaintiff brought this suit in the claims court to obtain a refund of the tax overpayment.
About Non-Qualified Deferred Compensation Plans
Non-qualified deferred compensation plans are contracts. They are contracts issued by employer to pay employees an amount in the future.
These plans allow the employer to defer paying out the funds. They also allow the employee to defer paying income taxes on the awards.
For many, these plans can be a significant part of the taxpayer’s tax planning. They are beneficial if the recipient has already maxed out their qualified plan contributions (such as 401(k) contributions) and plans on being in a lower income tax bracket when they retire. This combination allows a current year tax deduction for the 401(k) contributions and allows the recipient to count the deferred compensation as taxable income in the first year of retirement. The 401(k) income–and tax on the income–will be spread over many years.
These general concepts factor in the income tax treatment for non-qualified deferred compensation plans. The employment taxes are much smaller, but different. They are the subject of this article.
Employment Taxes on Non-Qualified Deferred Compensation
Employment taxes are imposed on non-qualified deferred compensation income at the later of the date when either:
- services are performed or
- there is no substantial risk of forfeiture of the rights to such amount.
For the risk of forfeiture, the regulations say that:
an amount deferred is considered reasonably ascertainable on the first date on which the amount, form, and commencement date of the benefit payments attributable to the amount deferred are known, and the only actuarial or other assumptions regarding future events or circumstances needed to determine the amount deferred are interest and mortality.
In most cases, as was the case here, this results in the recipient paying employment tax on the compensation on the date of retirement.
The amount of the income is based on an actuarial projection. The projection does not account for the probability of the employer’s default.
So if the employer does default, as United did in this case, the taxpayer will have overpaid his employment taxes.
The Statute of Limitations for Refund Claims
The court had little difficulty dismissing the case based on the statute of limitations.
Section 6511 sets out the general rule that a refund claim has to be filed within the later of three years from the time the return was filed or two years from the time the tax was paid.
This time limitation had long passed in this case. United Airlines filed the tax returns in 2000 and 2001. It paid the taxes in 2000 and 2001. Thus, the plaintiff had to file a refund claim by 2004. He filed his refund claim in 2007.
What About Equitable Tolling?
State laws generally provide a “discovery rule” for statute issues. These rules say that the time period for filing a claim does not start until the basis for the claim is discovered.
The court in this case says that “[n]or is there a “discovery rule” for section 6511(a) timing requirements. The fact “that a taxpayer does not learn until after the limitations period has run that a tax was paid in error, and that he or she has a ground upon which to claim a refund, does not operate to lift the statutory bar.”
The court also refused to apply equitable tolling. Equitable tolling is akin to a discovery rule. Equitable tolling holds an otherwise barred statute open.
Equitable tolling is described by the Supreme Court in cases like United States v. Brockcamp, 117 S. Ct. 849 (1997) and United States v. Beggerly, 524 U.S. 38 (1998). These cases suggest that the courts can in fact apply a discovery rule if they find a Congressional intent to equitably toll the limitations period.
The Supreme Court refused to allow equitable tolling for refund claims in Brockamp. The court in the current case is bound by Brockamp. The plaintiff may ask the Supreme Court to reconsider. The facts in the current case could warrant revisiting that decision. The plaintiff here computed a tax based on an actuarial estimate. To the extent the estimate was wrong, it would seem to warrant an exception to the refund limit in 6511.
The Tax Mitigation Rules
You might also be wondering whether the plaintiff can adjust their current year instead of obtaining a refund for an older barred year? The tax mitigation rules do provide for this.
The tax mitigation provide a tax benefit in the current year in lieu of the older barred year. This is possible as taxes are incurred every year. Compare that to a state law claim that may arise only once in a lifetime. There aren’t liabilities that will arise each year that can be offset. Unfortunately, the tax mitigation provisions do not apply to employment taxes. So the tax mitigation rules provide no remedy in this case.
When the tax mitigation rules do not apply, the next step is to see if equitable recoupment may apply. Equitable recoupment is similar to the tax mitigation rules. It reduces the open year tax deficiency or refund by the amount of tax from the erroneous treatment in the barred year. While equitable recoupment isn’t limited to income taxes, the courts have said that it cannot be used by taxpayers to obtain refunds. It is merely to offset current year tax. Thus, the claim would have to be filed by United Airlines, the employer, in this case and the amounts recovered paid by United Airlines to the plaintiff in this case.