There are some areas of law where principles of equity and good faith play a big role. By and large, tax law does not adopt these principles. The CreditGUARD v. Commissioner, 149 T.C. 17 (2017) case provides an example.
The case addresses whether the IRS is entitled to interest on a corporate tax liability when the corporation was a nonprofit in the earlier year when, in a much later year, the IRS retroactively revokes the corporation’s nonprofit status retroactive back to the earlier year.
The Facts and Procedural History
The taxpayer was a nonprofit corporation. The IRS audited the nonprofit tax return.
In 2012, over ten years after it was first recognized as a nonprofit, the IRS issued a final determination revoking its nonprofit status. It did so retroactive back to 2002.
This obligated the taxpayer to file corporate tax returns for the 2002 tax year. The taxpayer did not do so. The IRS filed substitute tax returns. Litigation ensued.
The parties settled the court case by agreeing that it was taxable as a corporation for the 2002 tax year. The IRS then assessed the income tax that was due and interest thereon. The question for the court was whether interest should begin to run in 2002 or in 2013.
Retroactive Revocation and Retroactive Interest
Interest runs from the date the tax is due. That is the general rule.
Income taxes are generally due when the tax return is required to be filed. These are the general rules. These rules would require the taxpayer in this case to pay interest retroactive back to 2013. This was the IRS’s position.
The taxpayer argued that it was tax exempt during 2002, that it correctly filed Form 990 for that year, and that it had no obligation to file Form 1120 until its tax exemption was revoked. The taxpayer was in part arguing for a reasonable cause exception. It was primarily a policy argument.
Court: Interest Runs from the Earliest Date
The court concluded that interest began to run in 2002.
The court alluded to the fact that there is no reasonable cause exception for interest. There is for failure to pay penalties, but not interest.
The court also noted that the taxpayer had agreed to interest being charged in the court settlement documents that it agreed to. This hints at the possible solution for this type of issue, namely, a taxpayer with this fact pattern might simply not agree to interest being charged. IRS Counsel will not agree to such a proposal, however, as the IRS almost never waives interest outside of traditional interest abatement claims.
The IRS might have allowed other items in lieu of waiving interest, however.
Other Retroactive Changes that Trigger Interest
It should be noted that this retroactive change that results in interest is not limited to nonprofit corporations that lose their tax exempt status. There are several other fact patterns where this same issue comes up.
For example, taxpayers may request a private letter ruling to change their tax filing status under the check-the-box regulations. This is often a partnership that had little income requesting to be treated as a corporation. The IRS will often grant these requests and they will do so retroactively back on or more years. Once this retroactive change is made, it will often trigger IRS notices demanding that the taxpayer pay penalties and interest for the late filing of the tax returns. The IRS issues these notices even though the taxpayer did not have the specific tax return filing obligation in the prior year(s). This is usually not discovered by taxpayers until after they have received the private letter ruling and submitted their tax returns–when the IRS sends a notice asking the taxpayer to pay the interest due.
Tax attorneys should be on the lookout for these retroactive changes that can trigger retroactive interest.