Business Should Review Interest Netting in Light of Wells Fargo Case

In Wells Fargo & Company v. United States, No. 2015-5059, the United States Court of Appeals for the Federal Circuit considered whether a business that has merged with another business can obtain refunds for interest the prior business entity paid to the IRS. The court’s broad reading of the interest netting statute may allow some businesses to claim significant refunds.

About Interest Netting

Interest accrues on taxes that are owed to the government. The government pays interest on tax payments it ends up refunding to taxpayers. This can result in the taxpayer owing interest to the IRS for one year and the IRS owing the taxpayer interest for another tax year. This can be a significant problem for business taxpayers, as the interest rate on underpayments for businesses is generally higher than the rate on overpayments.

Congress addressed this by enacting Sec. 6621 to allow the business to net the interest amounts. This interest netting rule often results in the taxpayer having paid too much interest to the IRS or the IRS having assessed too much interest.

The IRS does not voluntarily net interest in most cases. It is up to taxpayers to review their over and underpayments to make this determination. Many businesses, particularly large businesses, review this issue every few years to see if they paid too much interest to the IRS. They then file refund claims to recoup the overpaid interest.

The “Same Taxpayer” Requirement

One of the difficulties in computing the refund amount is how to net the interest paid by the business and owing to the business when it has acquired another business or been acquired by another business. Section 6621 only allows interest netting by the “same taxpayer.” The question is often whether the old and new businesses can net interest payments they made with interest that is owing to one or more of the businesses.

This raises the question as to what the “same taxpayer” means. The United States Court of Appeals for the Federal Circuit addressed this in Wells Fargo.

The lower court in Wells Fargo essentially concluded that principles of merger law made all merged corporations the “same taxpayer” under the statute, regardless of the timing of the payments or the prior identities of the corporations making them. As such, the lower court ruled in Wells Fargo favor and allowed its claims.

The IRS did not agree. It filed an appeal and argued that the phrase “same taxpayer” refers to the taxpayers making the underpayments and overpayments having the same Taxpayer Identification Number (“TIN”) at the time of the payments. The IRS noted that an acquired businesses ability to net interest ends with a merger, as it loses its TIN after the merger. So a pre-merger overpayment and underpayment by an acquired business cannot be netted with a payment by a post-merger entity.

In the alternative, the IRS also argued that the word “same” requires the court to look at whether they have “an identity of ‘relevant essentials.’” With this argument, the IRS noted that the two entities were incorporated under different names, held principle offices in different states, filed different tax returns, and operated with significant geographic differences.

The appeals court held that Sec. 6621 provides that the taxpayer must be the same at the time when the overpayments and underpayments are made. The appeals court then considered the facts, concluding that some of the overpayments and underpayments were not made by the same entity.

With one of the refund claims, the appeals court in Wells Fargo, the court noted the timing aspect of these rules. The entity that made the underpayment at the time of the underpayment has to be the “same taxpayer” as the entity who made the overpayment at the time of the overpayment. The court made this observation about this refund claim: “First Union made the underpayment and Old Wachovia made the overpayment. The two companies later merged. Thus, at the respective times of the overpayment and underpayment, there were two distinct taxpayers: First Union and Old Wachovia.”

With regard to another refund claim, the court sided with Wells Fargo. This was based on a review of the legislative history of Sec. 6621 and its precursor, which lead the court to conclude that the interest netting rules are to be read broadly. With this refund claim, the court held that an acquired corporation that makes an overpayment before a merger is the “same taxpayer” for the purposes of Sec. 6621 as the post-merger surviving entity that has absorbed the acquired corporation.

What Does It Mean?

Businesses may not have applied this broad reading in determining whether they are entitled to interest netting refunds given that this case was on appeal. As a result, many businesses may have limited their refund claims or not filed claims pending the outcome of this case. Other businesses may have simply applied a more narrow reading of the statute. Businesses should review their interest netting options in light of this case.