By Steven C. Colburn and Ted D. Englebrecht

In Brief

Timely Filing

Claims for refunds must be filed within three years of filing a tax return or within two years of paying the tax, whichever period expires later.

In Lundy, a taxpayer filed a return and claim for refund with the Tax Court after receiving a deficiency notice from the IRS two and one-half years after the tax return was due. The tax due was covered completely by withholding taxes. For purposes of determining date of payment, the IRC says this means the tax was paid on the due date of the return.

The Supreme Court ruled that since no tax return had been filed prior to receiving the deficiency notice, there was no date to use for purposes of the three-year look-back period. Since the taxes were deemed paid more than two years prior to filing the claim, it held the Tax Court lacked jurisdiction to award a refund.

The issue was which look-back period should be applied--if the three-year period is used, the claim for refund is sustained. If the two year rule is applied, there is no such luck

Filing a refund claim for overpaid taxes is not a problem for most taxpayers. Generally, taxpayers may file such claims within three years of the date the return was filed or two years from the date the tax was paid, whichever is later. However, a recent ruling by the U.S. Supreme Court (Comm. v. Lundy, 77 AFTR 2d, 96-406) denied a refund to a taxpayer who waited until receiving a deficiency notice from the IRS before filing his return. The court held that the three-year look-back period did not apply because the taxpayer had failed to file a return by the date of the notice of deficiency. Thus, the taxpayer, by default, was limited to a refund of taxes paid within two years of the date of the deficiency notice. This decision overturned a ruling by the Fourth Circuit Court of Appeals that held the Tax Court was in error when it applied a two-year look-back period rather than a three-year period.

Applicable Code Provisions

Limitation Periods on Refunds. The provisions determining when taxpayers may file claims for refunds and the periods for which such refunds may be granted are found in IRC sections 6511 and 6512. IRC section 6511(a) governs when claims for refunds may be filed with a district court or court of Federal claims. Such claims must be filed within three years of filing a tax return or within two years of paying the tax, whichever period expires later. If the taxpayer did not file a tax return, the claim for refund must be filed within two years of paying the tax.

If a taxpayer files a claim for refund within three years of filing a tax return, the taxpayer may be refunded all taxes overpaid during the three years before the claim was filed, including filing extensions. Alternatively, if the claim were filed within two years of the date of paying the tax and more than three years after filing the return, or if no return was filed, the refund is limited to taxes paid within two years of the filing of the claim.

The Tax Court's ability to grant a refund of overpaid taxes is governed by IRC section 6512(b). The Tax Court may grant a refund of taxes it determines were paid "within the period which would be applicable under section 6511(b)(2)" if the taxpayer had filed a claim for refund (whether or not paid) on the date the deficiency notice was mailed.

Time When Return Is Deemed Filed and Taxes Deemed Paid. Under IRC section 6513(a), for purposes of IRC Sec. 6511, any return filed before the last day prescribed for filing such a return is considered to have been filed on the last day prescribed. Furthermore, taxes paid or withheld before the prescribed filing date are deemed paid as of such filing date.

The Lundy Decision

Facts. Robert Lundy and his wife had more withheld from their gross wages in 1987 than their Federal income taxes. However, the Lundys did not file a timely income tax return by April 15, 1988. Neither did they file a claim for refund for those overpaid taxes during the succeeding two and one-half years. The IRS sent Lundy a deficiency notice on September 26, 1990, for $13,806 for 1987. The Lundys mailed their 1987 return on December 22, 1990, claiming an overpayment of $3,537. They filed a petition with the Tax Court on December 28, 1990, seeking a redetermination of the claimed deficiency and a refund.

Position of the IRS. The IRS claimed the Tax Court lacked jurisdiction to award a refund in this case. It argued that when a taxpayer fails to file a tax return before the date the IRS mails that taxpayer a deficiency notice, the Tax Court may only award a refund for taxes actually paid within two years of the date of mailing of the notice of deficiency. The IRS maintained that, under IRC section 6513(b)(1), the Lundys' withheld taxes were deemed paid on April 15, 1988, more than two years before the date the notice of deficiency was mailed. As a result, the Tax Court lacked the authority to grant the Lundys' refund request.

Lower Court Rulings. The Tax Court agreed with the IRS and denied the Lundys' request for a refund. Because the taxpayers had not filed a tax return by the date of mailing of the deficiency notice, the court held that the three-year look-back period did not apply and the taxpayers' refund was limited under IRC section 6512(b)(3)(B) to taxes paid within two years of the date of the notice of deficiency.

The Fourth Circuit reversed the Tax Court, holding that the three-year look-back period applied, and thus, the Tax Court had the authority to grant a refund of overpaid taxes.

Supreme Court Position. The Supreme Court reviewed the provisions of IRC sections 6511(b) and 6512(b)(3) noting that, in contrast to the requirements of the district and claims courts, a timely filing of a refund claim is not a prerequisite for bringing suit in the Tax Court. As a result, taxpayers seeking a refund of overpaid taxes from the Tax Court are not required to have filed a timely claim with the IRS. They need only show the taxes to be refunded were paid within the applicable look-back period.

In addition, the court felt that the provisions of IRC sections 6512(b)(3)(B) were "straightforward" in directing the Tax Court to IRC sections 6511(b)(2) that require it to apply either a three-year or a two-year look-back period. To decide which look-back period applies, the Tax Court must consult IRC section 6511(a) and determine whether a hypothetical claim filed on the date of mailing of a deficiency notice would be filed within three years of the date the return was filed. The court also provided that if such a claim were filed within three years of the date of filing of the return, the three-year look-back period would apply.

According to the Supreme Court, the main issue was whether a claim filed on the date of the mailing of the deficiency notice would have been filed [per IRC section 6512(b)(3)(B)] within three years from the date the return was filed. The Supreme Court reasoned that if the taxpayer had not filed a tax return by the date the deficiency notice was mailed, there was no date from which to measure whether or not a claim for refund had been mailed within three years of the date of filing the return. Consequently, a claim for refund filed on the date of mailing of the deficiency notice could not have been filed within three years of the date of the return.

The court noted that the provisions of sections 6501(a) and 6503(a)(1) generally require the IRS to mail a notice of deficiency within three years of the date the tax return is filed. Thus, if the taxpayer filed the return on time, a claim for refund mailed on the date of the mailing of a notice of deficiency would necessarily be mailed within three years of the filing date of the return. Therefore, these code sections, when combined with sections 6512(b)(3)(B) and 6511(b)(2), will usually ensure that the taxpayer may obtain a return of taxes, against which the IRS is asserting a deficiency.

Applying this analysis, the judiciary determined that a taxpayer who had previously filed a timely tax return could actually use IRC section 6512(b)(3)(B) to obtain a refund through the Tax Court, without first filing a timely claim for refund from the IRS, when such a request might be denied by the district or claims courts. The court held that IRC section 7422(a) requires the taxpayer to file a timely claim for refund with the IRS before suing for refund in the courts. Therefore, a taxpayer suing for refund in a district court could be denied such a refund on the grounds the taxpayer had not first filed a claim for refund with the IRS within the applicable two- or three-year period.

Furthermore, under regulations section 301.6402-2(b)(1) the taxpayer is required to notify the IRS of the exact grounds upon which the claim for refund is based. IRC section 6512(b)(3)(B) allows the taxpayer to obtain a refund through the Tax Court without first satisfying these provisions by assuming a claim for refund that stated the grounds for such a refund had been filed with the IRS on the date the deficiency notice was mailed.

Impact of Decision

Delinquent Filers. While noting how timely filers may benefit in the Tax Court from IRC section 6512(b)(3)(B), the Supreme Court held that delinquent filers were not so fortunate. According to the court, the taxpayer's entitlement to a refund hinges upon when the IRS mails the notice of deficiency. The Tax Court is required to measure the look-back period from the date the IRS mails the notice of deficiency, rather than the date on which the taxpayer mails the refund claim. Thus, if a taxpayer has not filed a tax return by the date of mailing of the deficiency notice, the three-year look-back period does not apply, and the Tax Court must look back two years from the date of the mailing of the deficiency notice.

Refund Periods. The Fourth Circuit had ruled that Lundy was entitled to a three-year look-back period because the Lundy's refund claim was filed within three years of the date for filing the return. The Supreme Court noted that the Fourth Circuit's decision could lead to inequities probably not intended by Congress by limiting a timely filer to a shorter refund period than a delinquent filer. Under the Fourth Circuit's interpretation, the look-back period for determining refunds is determined exclusively by reference to the actual date on which the taxpayer filed the claim for refund. As a result, a taxpayer who filed a tax return on time could be precluded from obtaining a refund of such taxes if the taxpayer's claim for refund was filed more than three years after the date of filing the tax return. This situation could occur if the IRS mailed the taxpayer a deficiency notice shortly before the expiration of the three-year period for filing a timely claim for refund and the taxpayer did not discover he or she was entitled to a refund until after litigation had commenced in the Tax Court. Under such circumstances, it would not have been possible for the taxpayer to file a timely claim for refund within three years of the date of the filing of the tax return as required under IRC section 6511(b)(2)(A). As a result, the taxpayer would be limited to a refund of taxes paid within two years prior to the mailing of the notice of deficiency under IRC section 6511(b)(2)(B). If the taxpayer's taxes were paid by the due date of the filing of the return, no taxes would have been paid within two years of the date of filing the refund claim and there would be no refund.

A taxpayer who filed late, on the other hand, could file a claim for refund with the return more than three years after the return's due date and still be eligible for a refund. While this rule might eliminate the inequities perceived by the Fourth Circuit of the two-year look-back period, the court felt that a greater inequity would result by denying refunds to timely filers who had not previously filed a claim for refund with the IRS. The court felt that such timely filers were protected by IRC section 6512(b)(3)(B) by being able to obtain a refund through the Tax Court without first having to file a timely refund claim.

Alternative Argument by Lundy

Lundy Position. Lundy offered an alternative argument that would avoid the inequity described above, but which was also rejected by the Supreme Court. According to Lundy, the "claim" required by IRC Sec. 6512(b)(3)(B) to be filed within three years of the filing of the return to obtain a look-back period of three years could be filed with the return. Furthermore, Lundy argued that under Regulations section 301.6402-3(a)(1), there is no way to file a claim for refund with the IRS other than on a tax return. Therefore, Congress must have intended the claim described in IRC section 6512(b)(3)(B) to be a claim filed on a return.

Lundy's argument would result in a three-year look-back period for the taxpayer for Tax Court cases regardless of when the claim for refund was filed. If the taxpayer filed by the statutory due date (April 15), the IRS would be required to mail the notice of deficiency within three years of the return date. Accordingly, the claim referred to by IRC section 6512(b)(3)(B) would have been filed within three years of the return and the look-back period would be three years. If the taxpayer does not file a timely return but files a return in response to an IRS deficiency notice, the "claim" under IRC section 6512(b)(3)(B) would also be filed within three years of the return because it would be deemed as filed with the return. Either way, the taxpayer would realize a look-back period of three years.

Supreme Court's Rationale. In rejecting Lundy's argument, the court noted that it was bound by the language used by Congress when it drafted IRC section 6512(b)(3)(B). Furthermore, the term "claim for refund" as used in IRC section 6512(b)(3)(B) is not defined in the IRC. However, the court interpreted the wording of IRC section 6512(b)(3)(B) to mean that a claim for refund could be filed separately from a tax return. Specifically, IRC section 6512(b)(3)(B) states that the Tax Court has the jurisdiction to award a refund of taxes to the extent the taxpayer would be entitled to such a refund "if on the date of the mailing of a notice of deficiency a claim had been filed." (Emphasis added.)

IRC section 6511(a) was found to be the most authoritative evidence that Congress contemplated that a claim for refund could be filed separately from the tax return. Under that section, the taxpayer must file a claim for refund within two years of the time the tax was paid "if no return was filed by the taxpayer." Thus, a taxpayer may file a claim for refund without even filing a tax return. The court noted that it would make no sense for Congress to have enacted these provisions if it had intended that a claim for refund could only be filed with a tax return. The fact that IRC section 6696 separately defines "return" and "claim for refund" was cited as further support for the court's conclusion.

The court also refused to accept that Congress intended the word "claim" to take on different meanings in different parts of IRC section 6511. Case law was cited as authority, under the "normal rule of statutory construction," for interpreting identical words used in different parts of the same statute as having the same
meaning.

Lundy cited reg. section 301.6402-3(a)(1) as support for his interpretation of the statute. The court noted that this regulation actually was consistent with its interpretation, not Lundy's. This regulation provides that a claim must, "in general," be filed with a return. Such wording left open the possibility, the court reasoned, that a claim could be filed without including it with a return. In fact, the court had previously ruled that, as long as a claim fairly advised the IRS of the nature of the taxpayer's claim, such claim does not have to formally comply with the statutes' and regulations' requirements.

Policy-Based Arguments

Having failed to sway the court with his first argument, Lundy set forth two policy-based arguments in favor of a three-year look-back period.

Refund Through Tax Court. The first argument claimed that Congress enacted IRC section 6512(b)(3)(B) to preserve a taxpayer's right to pursue a refund through the Tax Court. Thus, the application of a two-year look-back period runs counter to that intent.

The court agreed with Lundy that the intent behind IRC section 6512(b)(3)(B) was to permit taxpayers who might otherwise be barred from filing an administrative claim with the IRS to seek a refund in the Tax Court. The provision that the refund period be determined assuming the claim for refund was filed on the date of the mailing of the notice of deficiency would generally allow for a three-year look-back period assuming the return was timely filed.

However, it was also apparent, according to the court, that Congress intended to prevent taxpayers from qualifying for refunds in certain situations. The fact that Congress incorporated both two-year and three-year look-back periods in that section was viewed as evidence that Congress did, in fact, intend for both periods to be applied depending upon the facts and circumstances.

Tax Court vs. Other Courts. Lundy further claimed the court's interpretation of the statute results in unequal limitation periods for refund suits filed in the Tax Court when compared to the limitation periods for suits filed in district courts or court of Federal claims. The claim for refund filed by Lundy with his tax return on December 28 would, according to Lundy, have been timely for district court purposes because it was filed within three years of the time the return was filed as required by IRC section 6511(b)(1). Thus, the three-year look-back period of IRC section 6511(b)(2)(A) would apply.

This argument was answered by the court stating that even if different limitation periods do apply in the various courts, it is not up to the court to change that situation. The court noted that the rules affecting litigation in the Tax Court quite often are different from rules affecting litigation in district courts or court of Federal claims. For example, taxpayers are required to first pay any assessed deficiency before bringing suit in district court. Such is not the case with suits brought before the Tax Court. In addition, the Tax Court is required to assume a taxpayer seeking a refund has filed a claim stating the grounds upon which the Tax Court finds there will be an overpayment. However, a taxpayer seeking a refund in district court must file a claim specifically stating the grounds for refund.

The court concluded by stating that it is bound by the language of the statutes as written. Furthermore, even if the interpretation by Lundy might result in fairer, more consistent tax rules, the court does not have the authority to make such changes in the law. That prerogative is left to Congress. Congress, through its legislative powers, created differences in litigation rules between the various courts, and only Congress has the power to change such laws.

Having rejected all arguments set forth by Lundy, the Supreme Court held for the IRS. It found the applicable look-back period in this case was two years measured from the date of the mailing of the notice of deficiency. As a result, the Tax Court lacked the authority to award a refund of his overpaid taxes to Lundy. The judgment of the Fourth Circuit Court of Appeals was reversed.

Warning

Most taxpayers do not have to run the labyrinth of complexity contained in Lundy to obtain refunds. Nonetheless, the complexity contained in IRC sections 6511 & 6512, Regulations section 301.6402-3(a)(1), and numerous judicial decisions does point out several traps for the unwary in obtaining refunds. Specifically, the IRC provides for different limitation periods for refund suits filed in the Tax Court, district courts, and court of Federal claims. As a result, taxpayers must realize that when they have failed to file a return by the date of the notice of deficiency, a two-year look-back period will apply rather than three years in
Tax Court proceedings. Moreover, the Supreme Court has noted that it cannot change the statutory rules between courts, notwithstanding the inequities that might result. Specifically, the court felt that these changes were the sole province of Congress. Thus, it appears the discrepancy in refund periods between the Tax Court and the district and claims courts will continue. Taxpayers should be advised of these differences and plan their filing and refund claims accordingly.

The ruling in Lundy should serve as a warning to taxpayers of the critical importance of filing a timely Federal income tax return. In addition to helping the taxpayer avoid penalties (and possibly interest) for filing late, a timely-filed tax return will help the taxpayer establish a date from which to measure the timeliness of the filing of a claim
for refund. *