April 8, 2018

Applying Tax Overpayments to Later Years is Usually a Bad Idea

Houston Tax Attorney Blog

Houston Tax Attorney

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Instead of requesting a refund, taxpayers can ask the IRS to hold the overpayment and apply it to the taxpayer’s tax liability for the following year. These tax payment credits can result in significant headaches. The recent Schuster v. Commissioner, No. 17-11647 (11th Cir. 2018) case provides an example of why taxpayers should request refunds rather than having overpayments applied to later tax years.

The Facts & Procedural History

The facts and procedural history for the case are as follows.

The taxpayer wrote a check to the IRS to pay his mother’s tax liability. The IRS applied the check to the taxpayer’s own liability for 2004. This resulted in an overpayment for the taxpayer, which he chose to apply to his tax liability for 2005. The 2005 tax year resulted in a refund to him too, so he applied the credit to his 2006 tax liability.

In 2011, the IRS discovered its error from 2005 and reversed the credit to the taxpayer’s 2004 account. This resulted in adjustments to each year starting with 2004. The taxpayer’s payments and the overpayment were enough to satisfy the 2004 and 2005 liabilities, but not enough to satisfy the 2006 tax liability. So the IRS attempted to collect the 2006 tax liability.

The question for the court was whether the IRS was barred from collecting the taxpayer’s 2006 taxes when the taxes were due to a credit that was reversed in 2011, long after the time allowed for assessing taxes for the 2006 tax year had expired.

Refunding Overpayments vs. Crediting Overpayments

The Schuster case involved the rule that limits the time the IRS has to recoup erroneous refunds. The IRS only has two years from the date the taxpayer cashes a tax refund check to try to recoup those monies from the taxpayer. This is set out in Sec. 6352(b). The court concluded that this limitation does not apply to tax payment credits; it only applies to tax refunds.

In reaching this conclusion, the court noted various code section which distinguish between tax payment credits and refunds. While both involve the overpayment of tax, the code does in fact treat each one separately.

The implication from the case is that the IRS would have been time barred from recouping the monies in 2011 had the taxpayer requested a refund and he had cashed it. Because the taxpayer requested a credit to the next year’s tax liability instead of a refund, the IRS was able to make the adjustment and collect the tax–six years after its original error.

This is an extreme example of why it is often advisable to request refunds rather than tax payment credits.

Tax Payment Credit Headaches

The avoidance of administrative headaches is the more common reason for requesting refunds rather than tax payment credits.

As in the Schuster case, tax payment credits can trigger changes to other years, resulting in changes to quite a few tax years. This happens when the IRS audits and adjusts an earlier year, the taxpayer files an amended return for the originating year, or the taxpayer owes a balance for a prior or subsequent year and the IRS applies part of the overpayment as a credit to that year.

In each of these cases, the tax payment credits have to be adjusted and the adjustments can span several tax years.  The IRS’s systems are simply not set up to adequately track these credit issues. They are handled by IRS personnel manually and they are often hard to follow when reviewing IRS records.

At best, the ensuing administrative hassle to correct the cascading credit problem can take months to correct and can require quite a bit of effort to get fixed.

Given the choice, taxpayers are almost always better off asking for a refund now rather than having overpayments credited to later tax years.

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