We previously discussed the Internal Revenue Service’s (IRS) surprising position that for taxpayers making an election under Internal Revenue Code (Code) Section 965(h) to pay the transition tax over 8 years through installment payments, any overpayments of 2017 tax liabilities cannot be used as credits for 2018 estimated tax payments or refunded, unless and until the overpayment amount exceeds the full 8 years of installment payments. The IRS’s position has affected many taxpayers, and practitioners have expressed their concerns to the IRS.
On June 4, 2018, the IRS responded to these concerns. Rather than changing its position, the IRS has doubled down; however, the IRS has taken the small but welcome step of allowing some penalty relief for taxpayers affected by the earlier guidance as set forth in new Questions and Answers 15, 16 and 17.
Based on discussions with the IRS, it appears that the IRS’s position is based on the view that it has broad authority under Code Section 6402 to apply overpayments against other taxes owed, and that Code Section 6403 requires an overpayment of an installment payment to be applied against unpaid installments. Thus, the IRS maintains that the Code Section 965 tax liability is simply a part of the tax year 2017 liability, and it is, except for Code Section 965(h) and a timely election thereunder, payable and due by the due date of the 2017 tax return. Any future installments for the Code Section 965 liability are, in the IRS’s view, not part of a tax for a future tax year that has yet to have been determined, as the tax has already been self-assessed by the taxpayer for 2017. Accordingly, the IRS views any overpayments as being applied within the same tax period to the outstanding Code Section 965 tax owed by the taxpayer even though taxpayers making a timely Code Section 965(h) election are not legally required to make additional payments until subsequent years.
We continue to believe that the IRS’s position on this issue is incorrect. There are several arguments, both technical and as a matter of tax policy, as to why the IRS should not be able to keep taxpayers’ money for several years when Congress has expressly permitted payment of a liability over a multi-year period. The statutory scheme enacted by Congress regarding the transition tax is different from the circumstances under which Code Section 6402 and 6403 potentially apply, and a close reading of those sections casts substantial doubt on their application in the present situation. The IRS’s position also ignores the negative impacts on taxpayer cash flow and the fact that some taxpayers may have to borrow or use lines of credit to maintain operations absent the ability to obtain credits or refunds. The purpose of Code Section 965(h) was precisely to avoid these problems. Therefore, to the extent there is any conflict, Code Section 965(h) should trump Code Sections 6402 and 6403.
We are continuing to explore options for taxpayers affected by the IRS’s position and will provide further updates in the future. In the meantime, please contact one of the authors or your regular McDermott lawyer if you are affected by the IRS’s position and would like to further discuss these issues.