Uncertainty in tax law is reaching unprecedented levels. In the past four years, taxpayers have managed dramatic tax reform, pandemic-fueled emergency tax legislation, rafts of new Treasury Regulations (and accompanying challenges to some regulations), and increased aggressiveness by certain tax authorities. Tax departments now must be nimbler than ever as they adjust to these changes while preparing for the prospect of even more.
One key tool at their disposal is the ability to file a refund claim. Filing a refund claim may appear as easy as filing a Form 1120X, Amended US Corporation Income Tax Return. It is rarely that simple. Between Internal Revenue Service processing delays and aggressive enforcement, obtaining a claimed refund can be far from routine. This article focuses on the tricks and traps for preparing, filing, and, if necessary, defending a refund claim.
What’s Required for a Refund Claim?
Treasury Regulations Sections 301.6402-2 and 6402-3 together prescribe how a taxpayer makes a refund claim, including when the claim may be filed, what forms to use, the location for filing, signature requirements, and other procedural matters. Refund claims for income tax are generally filed on an amended income tax return, such as Form 1120X.1 Refunds for other types of tax, such as employment and certain excise taxes, should be requested on amended returns for the relevant tax (for example, Form 941X for employment tax refund claims). Form 843, Claim for Refund and Request for Abatement, is used for certain situations not otherwise covered, such as claims for interest or penalties.
A refund claim must 1) set forth in detail each ground upon which the credit or refund is claimed; 2) present facts sufficient to apprise the IRS of the exact basis for the claim; and 3) contain a written declaration made under penalties of perjury. A general statement that a taxpayer is owed a refund, without explaining the grounds for the claim, is insufficient.2 If a claim provides the IRS with notice of the nature of the claim, the entities claiming the credit, and the legal theory for the refund claim, however, courts consider the claim valid.3 Further, if the IRS examines a refund claim that is facially insufficient, but the taxpayer provides the necessary information during the examination, the insufficiency is cured and the IRS waives any argument for invalidity.4
It is imperative that taxpayers include all of their potential grounds for refund in the claim, including any alternative or inconsistent arguments. The reason is that under the “variance doctrine,” the courts will not consider a ground for refund that the IRS did not have the opportunity to audit and consider at the administrative level. Taxpayers facing variance issues should consider whether any time remains on the statute of limitations to amend the refund claim or whether the taxpayer can show that the IRS considered an alternative ground for refund not included in the claim.
In a recent Chief Counsel Memorandum,5 the IRS announced new specificity “requirements” for it to consider a research credit refund claim valid. These requirements are that the claim:
- identifies all the business components to which the research credit claim relates for that year;
- identifies, for each business component, all research activities performed, all individuals who performed each research activity, and all the information each individual sought to discover; and
- provides the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses for the claim year (which may be done using Form 6765, Credit for Increasing Research Activities).
Starting January 10, the IRS now deems any claim for a research credit refund legally insufficient if it does not contain all these specific details and therefore may reject the claim without examination or consideration of the merits. The IRS has never before required such specificity, and in the past few refund claims contained such detailed information in the claim itself, so this represents a significant departure from prior practice.6 This may be a foretaste of increased IRS scrutiny of refund claims in other contexts.
Historically, taxpayers under examination were able to make claims informally with their exam teams, without necessarily having to file an amended return. For example, taxpayers under the Coordinated Industry Case program could disclose any items that would result in an adjustment, including items that would result in a refund, in a written submission to the Exam team without filing an amended return.7 Currently, under Publication 5125, Large Business & International (LB&I) taxpayers may make informal refund claims to the Exam team within thirty days of the opening conference. After that date, Publication 5125 requires any refund claim to be filed on an amended return.8
An informal claim must contain 1) a written request for a refund that 2) specifies the tax and the year for which the refund is sought and 3) provides sufficient notice to allow the government to investigate the claim.9 An informal claim, by its nature, does not satisfy all the requirements of a formal claim. It must, however, be sufficient to apprise the IRS of the nature of the claim and facilitate further investigation. An informal claim may therefore be perfected by providing sufficient information during an examination.10 The less detailed an informal claim is, however, the greater the risk that the IRS may reject it as insufficient without initiating an examination.
Time Constraints for Filing Refund Claims
A refund claim must be filed within the statutory limitations period, which is generally the later of three years from the date the original tax return was filed or two years after the tax to be refunded was paid.11 However, certain refund claims have different statute periods. For example, taxpayers can file refund claims for foreign tax credits within ten years of the due date of the return for the year in which the foreign taxes were paid or accrued.12 Claims based on worthless securities or bad debts may be filed within seven years of the due date of the return for the year with respect to which the claim is made.13
Taxpayers who have signed Form 872, Consent to Extend the Time to Assess Tax, have up to six months after the expiration of the extended statute date for that tax year to file a refund claim.14 It is sometimes advisable to wait to file refund claims until sometime during that six-month period. If a taxpayer has signed an extension as part of an audit for earlier tax years, it may not be too late to file a refund claim for those earlier years even if the audit has closed. Given the extended nature of LB&I Division examinations in recent years, timely refund claims may sometimes be filed many years after the original return was filed.
What About Statutes of Limitations About to Expire?
Sometimes a taxpayer’s right to a refund depends on future events that may not occur until after the statute of limitations to file a refund claim expires. In these situations, taxpayers should consider filing a protective claim for refund to preserve the taxpayer’s right to later claim a refund after the contingency is resolved.
For example, resolving foreign tax disputes, like tax disputes with the IRS, may take more than ten years. As noted above, the statute of limitations for filing refund claims for an overpayment attributable to foreign taxes is ten years from the due date of the federal income tax return (excluding extensions) for the tax year to which the foreign tax relates, not the year in which the tax is ultimately paid.15 Not uncommonly, a foreign tax dispute is resolved, and an accompanying foreign tax payment made, after the ten-year statute of limitations has expired.
Other situations where taxpayers may bump up against the statute of limitations for filing refund claims for unresolved contingencies include periods when potential changes in the tax law through legislation, regulation, or current litigation are pending, and when the IRS has proposed an adjustment in one tax year that would result in an overpayment for another tax year if the adjustment is sustained. Taxpayers facing these situations may file protective claims.
Valid protective claims can be formal or informal. Some taxpayers file protective claims using Form 1120, US Corporation Income Tax Return, with “Protective Claim” written across the top of the first page. Other protective claims are informal (that is, submitted other than on the standard IRS forms). “[A] valid protective claim need not state a particular dollar amount or demand an immediate refund, but it must be sufficient to put the Service on notice that a tax refund is sought, focus the Service’s attention on the merits of the claim, and identify the specific years for which a refund is sought.”16
Specifically, a protective claim for refund should 1) fully advise the IRS of the grounds on which the credit or refund is claimed, 2) contain sufficient facts to apprise the IRS of the basis of the claims, 3) describe and identify the contingencies affecting the claim, 4) state the year for which the claim is being made, 5) be verified by a written declaration under penalties of perjury, and 6) be filed before the expiration of the period of limitations. The protective claim may also include language such as “the amount of the refund that will be requested by the company is contingent upon the resolution” of the contingencies described in the protective claim.
After filing the protective claim,17 the taxpayer will sometimes18 receive a letter from the IRS Protective Claims Coordinator “advising [the taxpayer that the IRS] determined the protective claim for refund filed . . . to be valid.” This letter often informs the taxpayer that the protective claim has been “placed in suspense pending the outcome of the litigation or contingency described in your claim.” The IRS Protective Claims Coordinator may follow up by sending Form 14779, Follow Up for Protective Claims, which inquires whether the taxpayer desires to “continue” or “discontinue” the protective claim filed. The form also requests that the taxpayer provide an “[e]xplanation for discontinuance” or the “[c]urrent status” of the contingency cited in the claim. It is advisable to respond to such requests.
When the contingency has been resolved, taxpayers should promptly “perfect” their protective claim by filing a claim for refund.
Does the “Postmark Rule” Apply?
Section 7502 sets forth what is commonly called the “postmark rule,” whereby the timely mailing of tax returns, refund claims, amended returns, payments, etc., serves as evidence of timely filing. Specifically, Section 7502(a)(1) provides that: “[i]f any return, claim, statement, or other document required to be filed, or any payment required to be made, within a prescribed period or on or before a prescribed date under authority of any provision of the internal revenue laws is, after such period or such date, delivered by United States mail to the agency, officer, or office with which such return, claim, statement, or other document is required to be filed, or to which such payment is required to be made, the date of the United States postmark stamped on the cover in which such return, claim, statement, or other document, or payment, is mailed shall be deemed to be the date of delivery or the date of payment, as the case may be” (emphasis added).
Therefore, under Section 7502, if 1) any return, claim, statement, or other document must be filed or any payment must be made by a certain deadline, and 2) the document or payment is delivered to the IRS after the deadline, then the date of mailing is considered the date of delivery or date of payment. The courts have long held that the postmark rule applies to amended returns,19 and the IRS has repeatedly acknowledged that the postmark rule applies to amended returns claiming a refund.
Sometimes taxpayers file amended returns that include elections and show tax due in one tax year in order to obtain a refund in another tax year. There is disagreement within the IRS as to whether the postmark rule applies to amended returns showing additional tax due. The most recent IRS Chief Counsel Advice located on this subject indicates that the postmark rule applies to all amended returns, including those showing additional tax due.20 Conversely, two older IRS advices refused to apply the postmark rule to amended returns showing additional tax owed.21 The negative IRS advices were based on the theory that amended returns showing additional tax due are generally not “required to be filed,” unlike claims for refund, whereby “taxpayers are required to file such returns in order to retrieve overpayments of tax.”
The authors are aware of at least one IRS service center and IRS appeals office that have followed the negative IRS advices and refused to apply the postmark rule to amended returns reporting additional tax owed. Until the courts resolve this dispute, the path of least resistance for taxpayers is to avoid relying on the postmark rule for amended returns showing additional tax due.
What Happens After Refund Claim Is Filed?
After a taxpayer files a refund claim, the IRS has several options. It could grant the claim and issue a refund. It could deny the claim outright. It could initiate an examination, which is conducted like an examination of an original return. Or it could do nothing.
Refund claims above $2 million ($5 million for C corporations) are subject to review by the congressional Joint Committee on Taxation. No refund can be paid until thirty days after the claim is submitted to the Joint Committee. As a practical matter, Joint Committee review can take much longer than thirty days, and the IRS will not issue any refund while that review is pending, potentially delaying a refund for weeks or months in large-dollar cases.
What If IRS Does Not Act on Refund Claim?
If the IRS has not acted on a refund claim, then a taxpayer may file a lawsuit in federal court (discussed below) to recover the refund when six months after the date of filing the refund claim has passed. Sometimes, filing the lawsuit will cause the IRS to examine the refund claim and act on it without requiring the taxpayer to fully litigate the case. The authors have resolved multiple refund claims with the government after filing a lawsuit without going through much of the litigation process. However, taxpayers who choose to file lawsuits should still be prepared to litigate the case if necessary.
If the refund claim involves a controversial issue and the taxpayer expects the IRS to deny the claim, then the taxpayer may request an expedited denial22 and/or include with the refund claim a written request that the IRS immediately disallow the claim. The IRS has discretion about whether to honor that request, however, so a taxpayer may have to wait the full six months before filing suit.
What Happens If Refund Claim Is Denied?
The IRS denies a refund claim by issuing a formal notice of claim disallowance, which must be sent by certified or registered mail. This notice starts the two-year statute of limitations period for filing suit, so taxpayers should note the date of the notice of claim disallowance. The notice must contain an explanation of the IRS’ reasons for denying the claim; however, these explanations are often merely summary.
After the IRS has formally denied a refund claim (or has not acted on it for six months, resulting in its being deemed denied), the taxpayer has the right to sue the United States for a refund in federal court. That suit must be brought within two years of the date of disallowance. Two refund forums are available: 1) the federal district court with jurisdiction over the taxpayer’s residence or principal place of business, and 2) the US Court of Federal Claims in Washington, D.C. The IRS is represented by trial attorneys from the US Department of Justice, Tax Division. A refund suit in federal court proceeds like any other civil case, including discovery and the potential for a jury trial if the case is in district court.
Jurisdiction for approving a settlement passes to the Attorney General in refund litigation. Although the views of the IRS are considered in any potential settlement, the Department of Justice has the final say on whether to concede or settle a refund suit. Our experience is that most cases are settled.
Can IRS Assess Penalties If It Denies a Refund Claim?
The IRS may impose a penalty for income tax refund claims “made for an excessive amount.”23 The penalty is twenty percent of the difference between the amount claimed and the amount allowed. For claims filed before December 18, 2015, a taxpayer may assert as a defense that the excessive claim has a reasonable basis; for claims filed on or after that date, the taxpayer must show that the excessive claim is due to reasonable cause. For noneconomic substance transactions, no reasonable basis or reasonable cause defense may apply. The IRS increasingly asserts Section 6676 penalties when it disallows corporate refund claims, particularly for research credit claims and claims under former Section 199.24
Can IRS Recover an Erroneous Refund?
Although taxpayers generally have no duty to correct an erroneous tax return, they do have the legal obligation to repay any refund to which they are not entitled. The IRS has three mechanisms to recover refunds issued in error: 1) if the statute of limitations for the tax year is open, the IRS may assess the tax under the usual deficiency procedures; 2) the United States can file suit in federal district court within two years after the refund is made (five years if the refund was induced by fraud or misrepresentation of material fact), even for closed years;25 and 3) the IRS may offset any refund due the taxpayer within the same period as the period for filing an erroneous refund suit.26 If a refund to be offset is for the same year and same tax that generated the erroneous refund, no time limit applies.27
Filing a refund claim is rarely as simple as filing a Form 1120X, Amended US Corporation Income Tax Return. Taxpayers must remain mindful of the procedural and strategic issues surrounding a refund claim, including the details required for a valid claim, the variance doctrine, statutes of limitations, when to file protective claims, current IRS enforcement priorities, and what happens after a claim is filed. Taxpayers who understand these nuances will be well prepared to move quickly when refund opportunities present themselves.
Robert J. Kovacev and Robert C. Morris are partners with Norton Rose Fulbright US LLP.
- Treasury Regulations Section 301.6402-3(a).
- Stoller v. United States, 444 F.2d 1391 (5th Cir. 1971).
- United States v. McFerrin, 492 F. Supp. 2d 695 (S.D. Tex. 2007); see also IA 80 Group, Inc. and Subsidiaries v. United States, 347 F.3d 1067, 1074 (8th Cir. 2003) (a refund claim is sufficient “if the basic issue is evident from the record, and the IRS is aware of the nature of the claim”).
- Harper v. United States, No. 19-55933, 2021 WL 732970 (9th Cir. February 25, 2021).
- Chief Counsel Memorandum 20214101F (October 15, 2021).
- These new requirements have been criticized for being overly burdensome and beyond the IRS’ authority, particularly when issued as a chief counsel memorandum instead of as a regulation promulgated under the requirements of the Administrative Procedures Act. An alert written by one of the authors of this article is available at www.nortonrosefulbright.com/en-bi/knowledge/publications/36686cb7/irs-announces-onerous-new-requirements-for-research-credit-refund-claims (October 22, 2021). The IRS is expected to issue clarifying guidance over the next several months.
- Rev. Proc. 94-69. The CIC program ended in 2019, and the IRS requested comments on whether to eliminate this procedure as obsolete. IRS News Release, “IRS Seeks Comments on Revenue Procedure 94-69,” August 19, 2020, www.irs.gov/newsroom/irs-seeks-comments-on-revenue-procedure-94-69.
- Certain types of claims, such as research credit refund claims, must always be made on an amended return. See Notice 2008-39. The authors’ experience is that, despite Publication 5125, some IRS examination teams may continue to accept informal refund claims even after thirty days have passed since the opening conference.
- PALA, Inc. Emps. Profit Sharing Plan & Tr. Agreement v. United States, 234 F.3d 873, 877 (5th Cir. 2000); New England Elec. Sys. v. United States, 32 Fed. Cl. 636, 641 (Ct. Cl. 1995).
- United States v. Kales, 314 U.S. 186, 194 (1941).
- Internal Revenue Code (hereinafter IRC) Section 6511(a).
- IRC Section 6511(d)(3).
- IRC Section 6511(d)(1).
- IRC Section 6511(c).
- See, for example, Albemarle Corp. & Subs v. United States, 797 F.3d 1011 (Fed. Cir. 2015); Cuba Railroad Company v. United States, 124 F. Supp. 182 (S.D.N.Y. 1954); Rev. Rul. 58-55, 1958-1 C.B. 266; IRS LAFA 20105001F (December 17, 2010).
- IRS, Office of the Chief Counsel, Field Attorney Advice 20125202F, December 28, 2012, www.irs.gov/pub/irs-lafa/20125202F.pdf.
- It is important to retain proof of timely filing. We also recommend providing your IRS examination team a copy of the protective claim if your company is under audit as well as requesting that the exam team acknowledge its receipt of the protective claim in writing.
- The IRS does not send confirming letters for all valid protective claims. Do not be alarmed if the taxpayer does not receive a letter from the IRS Protective Claims Coordinator.
- See, for example, Stocker v. United States, 705 F.3d 225 (6th Cir. 2013); Jacobson v. Commissioner, 73 TC 610 (1979).
- Chief Counsel Advice 201545017 (November 6, 2015).
- Chief Counsel Advice 201052003; SCA 1998-001 (June 12, 1997).
- IRS News Release IR-1600 (April 26, 1976).
- IRC Section 6676.
- For example, IR-2021-45 (explicitly threatening 6676 penalties for allegedly “improper” Section 199 claims).
- IRC Section 7405.
- Internal Revenue Manual 220.127.116.11(4).
- Internal Revenue Manual 18.104.22.168(5).