Life happens. We all experience it. There are times when life events can result in tax returns being filed late.
Our tax laws offer little in way of leniency when this happens. The IRS will assess late filing penalties. Worse yet, amounts that were already timely paid to the IRS may not be refunded to the taxpayer. The IRS keeps the overpayments–putting them into an “excess collections” account.
The recent Schwartz v. Commissioner, T.C. Memo. 2022-125, provides an opportunity to consider “excess collections” and one of the ways to recoup amounts the IRS transfers to excess collections.
Facts & Procedural History
This case involves unfiled tax returns for the 2006, 2007, 2010, 2011, and 2012 tax years and a multi-year divorce proceeding.
The divorce court ordered the taxpayer and his spouse to pay $150,000 as an estimated payment for their 2005 tax liability. Half of this amount was credited to the taxpayer’s IRS account and a half to the now ex-wife’s IRS account.
The taxpayer thought he could not file income tax returns until the divorce was concluded. He wrote to and called the IRS to explain this several times.
In 2011, the divorce proceeding concluded and the taxpayer filed his income tax returns. The 2005 return did not have an unpaid balance in excess of the $75,000 estimated payment the taxpayer had already made. Thus, the returns reported the excess of the $75,000 as a credit carryforward to the next tax year, the remaining to the next tax year, etc. There was enough to have the 2005 tax overpayment applied to several years.
On the 2005 tax return, the IRS applied part of the $75,000 estimated payment for the taxpayer to zero out the 2005 tax liability, but the IRS applied the rest of the balance to an excess collections account. The IRS then disallowed the credit carryforwards for each year.
The IRS attempted to collect the unpaid taxes by issuing a levy notice, to which the taxpayer filed a collection due process hearing request. This case involves a review of how the IRS Appeals Office handled the CDP Hearing case.
About Excess Collections
The general rule is that taxpayers have to file refund claims for overpayments within the later of three years from the date the return was filed or two years from the date the tax was paid.
If no original tax return was filed, as in this case where there were unfiled tax returns, the taxpayer has to file a refund claim within two years from the date the tax was paid.
When a taxpayer files an original tax return after having missed the original tax return filing deadline, the IRS does not have to refund any overpayment reported on the return for any payment that was made two years or more from the date of the tax return filing. These funds are said to be applied to an “excess collections” account.
When I worked for IRS Appeals, the IRS explained to me that the excess collections account is an account that is not tracked on the IRS’s or the government’s books. It is money that the IRS does not have to account for as it is money that does not exist. I am not aware of any authority for this, but if this is a gift to the U.S. Treasury, one is left to wonder whether the taxpayer can claim a charitable deduction in the year in which the funds are credited to excess collections.
We have had some luck requesting a bypass refund for clients in these situations.
Instead of taking these positions, taxpayers usually argue that they did file a timely refund claim–an informal refund claim.
The Informal Refund Claim
One way to get money back in excess collections situations is to show that the taxpayer’s prior communications qualify as an informal refund claim. The informal refund claim is a concept that is found in various court cases.
The court in this case summarizes the law as follows:
It has long been recognized that a writing which does not qualify as a formal refund claim nevertheless may toll the period of limitations applicable for refunds if (1) the writing is delivered to the Commissioner before the expiration of the applicable period of limitations, (2) the writing in conjunction with its surrounding circumstances adequately notifies the Commissioner that the taxpayer is claiming a refund and the basis therefor, and (3) either the Commissioner waives the defect by considering the refund claim on its merits or the taxpayer subsequently perfects the informal refund claim by filing a formal refund claim before the Commissioner rejects the informal refund claim.
There are no bright-line rules as to what constitutes an informal claim. Rather, each case must be decided on its own particular set of facts. The relevant question is whether the Commissioner knew or should have known that a refund claim was being made.
This is contrary to the regulations, which say that a refund claim “shall be made on the appropriate income tax return.”
In the present case, the taxpayer wrote a letter to the IRS on March 28, 2008, that explained that he was going through a divorce and would file his tax returns after the divorce was over and it mentioned the $75,000 overpayment.
The IRS Appeals Office concluded that this letter was not an informal refund claim as it did not notify the IRS that he was seeking a refund in 2005 or to apply the overpayment to subsequent tax years.
The court did not agree with IRS Appeals:
In the letter petitioner associated his payment with taxable year 2005, referenced “returns” for 2005 through 2008, and requested that his payment be “credited toward the tax liability associated therewith once they are filed.”
The court concluded that the letter was a timely-filed informal claim for refund and, as a result, the payment should be applied to the 2005-2008 tax years and not to an excess collections account.
As this case shows, taxpayers who file late returns should consider whether any communications they have had with the IRS rise to the level of being an informal refund claim.
This case also shows how important it is to respond to IRS collection notices when situations like this arise. If the taxpayer did not have the right to judicial review by way of the CDP hearing, he likely would find no relief with the IRS. The IRS would just disregard his communications. He would then have to file suit in U.S. District Court (or the Federal Claims Court), which is often cost-prohibitive given the amounts in dispute.