If you receive a tax refund and the IRS later asks you to repay the refund, what do you do? Do you keep the refund or repay it?
This can be a very difficult question to answer.
This is particularly true if you believe that you have a legitimate basis for and entitlement to the tax refund.
The recent United States v. Page, No. CV-20-08072-PCT-JAT (D. Ariz. 2021) case explains that the answer depends on timing and which court has the power to hear your case.
Facts & Procedural History
The facts are simple in this case.
The IRS alleges that it mailed a $491,104.01 refund to the taxpayer in error. The IRS contacted the taxpayer and asked for the money back. The taxpayer paid back $210,000 and kept the rest.
The IRS then filed suit to recoup the erroneous refund. The taxpayer did not respond to the suit and the IRS asked for a default judgment.
About Erroneous Refund Claims
The IRS issues a staggering amount of erroneous refunds every year. The loss to the Federal government is significant.
This includes paying refunds that there is truly no basis for. Fraudulent refund claims submitted by prisoners are an example. With these claims, the prisoners are just hoping that their claims are not examined before checks are issued. This false-return scam has been going on for several decades now. The IRS has never been able to adequately address these refund claims.
The IRS’s erroneous refund claims also include legitimate tax claims that the IRS later decides to challenge. The later claims usually arise when the IRS conducts an audit for a later tax year and discovers an issue it does not agree with. This is usually a tax deduction or tax credit. If the taxpayer received a refund in one or more immediately prior years for the same tax deduction or tax credit, the IRS auditor will often start the process to ask for the refund for the prior year to be reversed.
These cases cannot be considered by the U.S. Tax Court. They have to be brought in the District Courts or Federal Claims Court.
The IRS’s Power to Recoup Erroneous Refunds
To recoup erroneous refunds, the IRS has to bring suit under Sec. 7405. Section 7405 just says that the U.S. government can file suit to recoup erroneous tax refunds. This provision is limited to recouping tax. It does not apply to refunds of refunds for other items, such as subsidies, rebates, penalties, interest, etc.
The IRS’s power to bring suit has strict time limits. These time limits are similar to those for taxpayers who seek to file tax refund claims. Section 7405 references Sec. 6532(b) for this:
Recovery of an erroneous refund by suit under section 7405 shall be allowed only if such suit is begun within 2 years after the making of such refund, except that such suit may be brought at any time within 5 years from the making of the refund if it appears that any part of the refund was induced by fraud or misrepresentation of a material fact.
Thus, the IRS has five years to file suit to recoup erroneous refunds that are due to fraud or misrepresentation. It only has two years to file suit for other refunds.
In the present case, the court considered the two year time period. Thus, the case did not involve a claim by the government that there was fraud or misrepresentation for the claim. This suggests that the taxpayer had some basis for its position.
Refund Received Date vs. Date Refund Check is Cashed
That brings us back to this case. The IRS mailed the check to the taxpayer on May 5, 2017. The taxpayer cashed the check on April 5, 2018. The government filed suit to recover the erroneous refund on March 31, 2020.
The taxpayer did not respond to the suit and the government moved for a default judgment. The court did not grant the default judgment. The court noted that the government filed its suit late. The court noted that the Ninth Circuit Court of Appeals, the court that has jurisdiction over an appeal from this court, has held that the two-year period for bringing suit starts on the date the taxpayer received the check.
The court did not accept the government’s argument that the date the check was cashed governs. The court reasoned that it was unreasonable to assume that the check took nearly a year for the post office to deliver the check to the taxpayer. Thus, the court assumed that the taxpayer received the check and more than two years had passed from this assumed date to the time the refund suit was filed.
This may seem like a taxpayer victory. It isn’t. The court opinion notes that there is a split in the circuit courts on this issue. While the Ninth Circuit has said that the date the taxpayer received the refund from the IRS governs, other circuit courts have said that the date the check clears the bank is the date that governs.
What this means is that the government is likely to appeal the decision and, thereby, present the case to the Ninth Circuit. This could be a great setup for the government given that the taxpayer might not even respond or participate in the appeal. It didn’t respond to the original suit.
The trial court went out of its way to set this case up for the appeals court to decide this issue. It did this by making the argument on behalf of the absent taxpayer. It could have easily just issued a default judgment and left it to the taxpayer to appeal or ask the court to reconsider.
What does this mean for taxpayers who receive refunds that the IRS could argue are erroneous? Before the Ninth Circuit Court decides this issue, those in the Ninth Circuit have a shorter period of time to wait to see if the IRS files suit to recoup the refund. They can simply hold on to the check and not cash it until it seems probable that the date the IRS has to file suit will expire. They should document the date they received the check as that is the date that starts the IRS’s refund period. Those outside of the Ninth Circuit need to focus on the date they cash the check.