Welcome to Luca!globe
FEDERAL TAXATION Current Issue!    Navigation Tips!
Main Menu
CPA Journal
Professional Libary
Professional Forums
Member Services


By Peter Medina, CPA, and
Susan Pick, Ernst & Young LLP

In September 1994, Rev. Proc. 94-60 was issued. This Rev. Proc. explains the rules used by IRS to compute interest on a deficiency when there was a previous refund on the account. Under "single-year netting" the taxpayer should pay no more interest than it receives for periods when amounts are due both to and from the IRS on the same tax year. This is particularly important for certain corporations because the rate differential between overpayments and underpayments may be as high as 4H percent.

The TRA '86 enacted the rate differential of one percent between overpayments and underpayments. The legislative history of that act states that the IRS should adopt and implement comprehensive netting procedures. Since 1986 there have been two other changes to the interest rates. First, the enactment of IRC Sec. 6621(c), the increase in underpayment rate for large corporate underpayments ("two percent hot interest") in OBRA '89, increased the differential to three percent for certain corporate underpayments in excess of $100,000. With the implementation of the General Agreement on Tariffs and Trade in 1994 (GATT), the interest rate on tax overpayments over $10,000 paid to a corporation was lowered by 1H percent. To date the only procedure dealing with the rate differential in one year is IRS Rev. Proc. 94-60.

Example. John Smith, an individual, timely files a Federal income tax return for 1991. Estimated tax payments total $100,000; tax on the return is $60,000. The refund was not issued until August 5, 1992, more than 45 days after the filing of the return, therefore the refund included interest of $866. In 1994, the IRS examined the 1991 return and determined the correct tax to be $75,000, resulting in a deficiency of $15,000.

The amount of interest charged on the $15,000 tax deficiency from April 15, 1992 to August 5, 1992 is $325, an amount equal to the interest paid to John by the IRS on the $15,000 tax refund. If interest on the $15,000 was computed at the deficiency interest rate, the amount of interest from April 15, 1992 to August 5, 1992 would have been $372. Therefore, John saved $47 using the netting rules during this period when the IRS paid John one percent less than it would charge.

Current IRS policy is to compute interest under this concept of single year netting. However, a "global netting" procedure is necessary to eliminate the inequity to taxpayers when overpayments and underpayments exist in more than one tax year. Simply described, global netting allows a taxpayer the benefit of considering overpayment and underpayment periods from different tax years (and/or types of taxes) in computing interest payable or receivable.

The following is an example of the economic detriment to taxpayers if global netting procedures are not applied.

A calendar-year corporate taxpayer is assessed an additional $1,500,000 as a result of an IRS examination for the 1986 tax year. The two percent hot interest rate applies to the deficiency after December 31, 1990. The taxpayer pays the deficiency plus interest, in the amount of $2,163,092, on September 10, 1995. The examination for 1987 is completed and the taxpayer is due a refund of $1,500,000. The refund plus allowable interest, in the amount of $1,331,925, is received on November 20, 1995.

For the period from March 15, 1988, to September 10, 1995, the IRS owes the taxpayer $1,500,000 for the 1987 year and the taxpayer owes the IRS $1,500,000 for that same period, plus interest from March 15, 1987 to March 15, 1988, for the 1986 year. In effect, there is a mutuality of indebtedness of $1,500,000.

If global netting procedures are used, the deficiency interest on the 1986 deficiency would be reduced to $337,991 and the allowable interest on the 1987 refund would be reduced to $42,335. The net interest owed by the taxpayer without global netting is $831,167 whereas the net interest liability with global netting is $295,656 ($337,991 ­ $42,335). The taxpayer suffers an economic detriment of $535,511 for the period March 15, 1988 to September 10, 1995, resulting solely from the rate differential which ranges from one percent to 4H percent.

The issue of global netting (between different tax years) has been argued in the courts. In 1994, the U.S. District Court, District of Minnesota found for the Northern States Power Company (NSP). The IRS appealed to the U.S. Court of Appeals, and the District Court decision was reversed [Northern States Power Company v. U.S., No. 95-1306MN, F.3d (8th Cir., January 2, 1996)]. The facts of the case are as follows. In 1990 NSP made a payment for the 1980, 1981, 1983, and 1984 tax years. In 1994 the IRS determined that 1981 and 1982 tax years were overpaid, but additional tax was to be assessed for the 1980, 1983, and 1984 years. The payment in 1990 was in excess of the amount due for the deficiency years. The District Court held "that NSP is entitled to have the interest on its tax refunds for 1980 through 1984 computed by netting the 1981 and '82 overpayments against the '80, '83, and '84 underpayments." The District Court stated that IRS should implement a netting procedure to eliminate the effect of the rate differential. On January 2, 1996, the Court of Appeals held that an overpayment could not be used as a credit to a liability which is already paid. This decision states "that the word 'liability' in IRC Sec. 6402 means 'outstanding liability,' one that is unpaid when the credit is made."

Until the IRS implements comprehensive netting procedures, we must not only consider the net tax effect of proposed IRS adjustments, but overall interest computations under various scenarios as well. The consideration of interest during an audit can be an overall benefit to the taxpayer's bottom line.

Since the rate differential created with the enactment of OBRA and GATT only affects the interest computation for corporations, the differential for an individual appears to be limited to one percent (the difference between regular overpayment and regular underpayments).

However, an individual taxpayer must include IRS interest received as income on his/her return. The same taxpayer does not receive a deduction for the interest expense paid to IRS. Therefore, there is more than just the basic economic difference, there are tax implications to consider as well. *


By Joel Steinberg, CPA, Richard A. Eisner & Co. LLP

Individuals who fail to make required payments of estimated tax are subject to penalties under IRC Sec. 6654. In general, the required installments of an individual's estimated tax are based on the tax shown on the return for the taxable year or the tax shown on the return for the preceding taxable year. How does the filing of an amended return affect the required estimated tax payments and the penalty for underpayment of estimated tax?

In Rev. Rul. 83-36, the IRS held that if an individual taxpayer files an amended return after filing the original return and before the due date for filing the original return (including extensions), the amended return would be considered to be "the return for the taxable year" for purposes of determining the underpayment penalty. For example, Mr. Jones filed his 1994 income tax return on March 1, 1995, showing a tax liability of $10,000. Jones had timely paid 1994 estimated taxes of $9,000. Then Jones files an amended tax return for 1994 on April 5, 1995, showing a tax liability of $11,000. Assuming that Jones' estimated tax payments did not equal or exceed his 1993 tax liability and that he did not meet any exceptions to the penalty,
he would be subject to an underpayment penalty since his estimated tax payments were less than 90% of "the
tax shown on the return for the
taxable year."

Conversely, Rev. Rul. 83-36 provides that if an individual taxpayer files an amended return after the due date of the return (including extensions), the amended return is not "the return for the taxable year." The tax shown on the amended return cannot be used for purposes of determining the underpayment penalty. In the example above, if Jones waited to file his amended return until May 1, 1995, he would not be subject to the underpayment penalty.

Individual taxpayers may meet their estimated tax requirements by paying a "safe harbor" amount which equals or exceeds 100% (110% for certain high-income taxpayers) of their tax liability for the preceding year. What is "the tax shown on the return for the preceding taxable year" when an amended return has been filed? The IRS has applied rules relevant to corporations to individuals. IRC Sec. 6655 provides the underpayment of estimated tax penalty for corporations. Certain corporations may use their preceding year's tax liability as a "safe harbor." In Evans Cooperage Co. v. United States, 712 F. 2d 199 (5th Cir. 1983), the court held that the tax shown on the original return filed for the preceding year is "the tax shown on the return for the preceding taxable year" rather than the tax shown on an amended return filed after the original due date. For example, Mr. Smith filed his 1994 income tax return on March 15, 1995 showing a tax liability of $15,000. Smith filed an amended return on April 10, 1995, showing a tax liability of $20,000. Assuming Smith can use the 100 percent "safe harbor," his 1995 estimated tax requirement is $20,000. If instead, Smith filed his amended return on April 25, 1995, he would need to pay only $15,000 for 1995 estimated taxes to be protected from underpayment penalties.

Taxpayers will not be assessed an additional underpayment penalty if the tax shown on an amended return, filed after the due date of their original return, indicates that there was an actual underpayment of estimated tax. Taxpayers who file an amended return showing a lower tax liability after the due date are not entitled to a refund of any underpayment penalty which may have been paid. These rules
similarly apply if the taxpayer's
liability is subsequently adjusted by
the IRS.

Notwithstanding the rules discussed above, Rev. Rul. 80-355 provides that if taxpayers file a joint return after the due date to replace separate returns originally filed by the due date, the tax liability shown on the amended return is to be used to determine the required estimated tax payments. *


By James E. Brennan, CPA, and Susan Pick, CPA, Ernst & Young LLP

A claim for refund related to certain pass-through entities is made on Form 8082, Notice of Inconsistent Treatment or Amended Return (Administrative Adjustment Request (AAR). This form may be filed by a partner, S corporation shareholder, REMIC residual interest holder, or tax matters person (TMP).

Generally, the AAR may be filed at any time within three years from the later of the unextended due date or the file date of the entity's return and before a Notice of Final Partnership Administrative Adjustment (FPAA) or Final S Corporation Administrative Adjustment (FSAA) for the tax year is mailed to the TMP.

If the claim is disallowed in full or in part or is not acted on by the IRS, a petition may be filed with the Tax Court, U.S. District Court, or Court of Federal Claims. According to IRC Sec. 6228, this petition must be filed within two years of the date the AAR was filed, but may not be filed until six months after such filing. This two-year period may be extended by written agreement between the IRS and TMP, acting on behalf of the entity, on Form 9248. For a partner or shareholder, who files
an AAR on his/her own behalf,
Form 9247 is used to extend the two year period.

It should be noted that the filing of an AAR claim, unlike the filing of an amended return on Form 1040X or 1120X, does not toll the statute until the claim is acted on by IRS. When an amended return is filed on Form 1040X or 1120X, the statutory period for the IRS to issue a refund does not expire until the IRS issues the refund or issues a certified notice of claim disallowance.

IRS inactivity when an AAR claim is filed could result in a "barred refund" due to a "blown statute." The taxpayer must maintain an awareness as to when a petition must be filed or statute extension signed, to avoid this potential trap for the unwary. The statute of limitation determination with respect to an AAR is independent of the flow-through taxpayer's statute.

In conclusion, any entity, partner, or shareholder that files a claim for refund on Form 8082 should keep in mind the statute implications. A petition must be filed or the appropriate statute extension must be executed before the two-year statute expires. The taxpayer cannot assume the IRS will allow the claim within the requisite two year period or offer to extend the statutory period. *


Edwin B. Morris, CPA

Rosenberg, Neuwirth & Kuchner

Contributing Editors:

Richard M. Barth, CPA

Robert L. Goldstein, CPA

Leipziger & Breskin

Joel Rothstein, CPA

Cantor Fitzgerald Securities

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

©2009 The New York State Society of CPAs. Legal Notices

Visit the new cpajournal.com.