No Interest & Penalties on Restitution Assessments

Published Categorized as Federal Income Tax, Restitution Tax Assessment, Tax
No Interest & Penalties On Restitution Assessments
No Interest & Penalties On Restitution Assessments

The IRS can assess criminal restitution as if it is a tax tax. But can it assess interest and penalties on the restitution as it would a tax? The IRS policy is to do just that. The court addressed this in Klein v. Commissioner, 149 T.C. 341 (2017), concluding that the IRS policy violates the law.

Facts & Procedural History

The petitioners in this court case pleaded guilty to filing false returns for the 2003 to 2006 tax years. They were ordered to pay criminal restitution to the IRS. They paid the restitution in 2014 upon being released from prison.

The IRS then filed a lien for interest and penalties on the restitution and attempted to collect the amounts. The petitioners tried to convince the IRS that it was not entitled to assess interest and penalties on the restitution assessment. The IRS did not agree and litigation ensued.

IRS’s Ability to Collect Restitution as a Tax

Congress authorized the IRS to collect restitution for certain criminal sentences, such as sentences for tax fraud. This allows the IRS to use its revenue officers and collection tools to collect the unpaid restitution. The court determines the amount of the restitution, but the IRS collects it.

This often involves restitution orders the court enters after the individual accepts or enters into a plea agreement. The plea agreement and order will typically waive interest.

The IRS has consistently taken the position that its ability to treat the restitution as a tax liability, allows it to impose penalties and interest on the restitution as it would on a tax liability. That brings us to the issue in this case. Can the IRS charge interest and penalties on criminal restitution even though it is not actually a tax?

Interest & Penalties on Criminal Restitution Assessments

The court noted that there is no legal authority for the IRS to assess interest or penalties on criminal restitution assessments. The court refused to follow the IRS’s policies stated in its Internal Revenue Manual (“IRM”). The IRS often cites the IRM and the court frequently notes that the IRM is not the law and has no bearing on anything other than disciplinary matters for IRS employees who fail to follow the policies to carryout their duties.

According to the court, the Code merely allows the IRS to assess or record the restitution as a liability owed to the government for collection purposes. This does not allow the IRS to also assess interest and penalties on the restitution.

Interest & Penalties Should Not Apply

This issue has been controversial. It puts criminal defendants in a tough position, as they are subject to criminal restitution and subject to collection by the IRS and the Federal government. Worse yet, the restitution is often not ordered for years after the date of the offense.

As a result, if interest and penalties were to apply, they would be applied back retroactively several years in the past. Given the IRS’s policy of imposing interest and penalties, this has resulted in extraordinarily large balances the IRS collectors try to collect. The amounts can be so large that it puts criminal defendants in a position of never being able to pay off their criminal restitution.

Criminal Defendants Should File Refund Claims

Given this case, criminal defendants who paid interest and penalties to the IRS should now file administrative claims to recoup these amounts from the IRS.

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