In this article, we discuss some basic considerations for preparing a protective refund claim. These considerations are particularly relevant for taxpayers whose statutes of limitations for refund claims are expiring soon and who want to protect their rights before the Supreme Court of the United States issues its decision in Moore v. United States.
Moore raises the question of whether the Section 965 transition tax is an income tax within the meaning of the US Constitution’s 16th Amendment (and thus constitutional) or a non-income tax (and thus unconstitutional because the tax is not apportioned among the states, as required for non-income taxes). In Moore, the taxpayers owned approximately 11% of the stock of an Indian corporation. The Indian corporation reinvested its earnings and the Moores never received any distributions on their investment. Under Section 965, however, the Moores were deemed to have earned income from their investment and were taxed accordingly. If Section 965 were struck down as unconstitutional, taxpayers may be entitled to file a claim for refund if the statute of limitations is open. If a taxpayer’s statute of limitations will be expiring soon for the Section 965 inclusion year, they should consider filing a protective claim for refund.
PROTECTIVE CLAIM FOR REFUND: WHAT IS IT?
A protective claim (1) is a written claim for refund of taxes (2) that meets the substantive criteria for refund claims and (3) is contingent upon an expected future event (4) to determine the merits and sometimes the amount of the claim. In general, protective claims may be made informally or formally and are filed to protect a taxpayer’s right to refund should the statute of limitations for claims expire prior to the resolution of the contingency. Taxpayers should strive to file formal claims, except for situations in which the Internal Revenue Service (IRS) has explicitly indicated it will accept informal claims (e.g., within the first 30 days of a Large Business and International Division examination (IRM 18.104.22.168.1.1)). By filing formal claims, one generally avoids the risk of the IRS (or the US Department of Justice in litigation) arguing that a valid claim was never filed on grounds of lack of formality.
The IRS typically accepts protective claims that are based on expected changes in a current regulation, pending legislation or current litigation. (See IRM 22.214.171.124.7.3.). As in Moore, any claim based on a pending court case or decision should be accepted by the IRS as a protective claim so long as the other criteria for the claim are met.
There are several criteria a valid protective claim is required to meet. It must be:
- In writing
- Filed before the expiration of the statute of limitations (generally three years from when the original return is filed or two years from the time of payment)
- Detail each ground upon which a credit or refund is claimed and provide sufficient facts to support the taxpayer’s grounds
- Signed under penalties of perjury for formal claims (i.e., for corporations that submitted via Form 1120X)
- Filed with the appropriate IRS office. The IRS Service Center is typically where the original return is filed. If under examination, a claim (formal or informal) can be filed with the examining agent, however, good practice is also to file with the Service Center.
Whether formal or informal, it is recommended to include a clear legend on the document that says “PROTECTIVE CLAIM.”
WHAT IS THE CLAIM?
The precise claim would be for a refund of Section 965 tax as that is the tax at issue in Moore. But what if the Supreme Court decides that the tax is unconstitutional because all income tax requires a realization event experienced (either directly or constructively) by the actual taxpayer, as opposed to a separate entity controlled or owned by the taxpayer? Could your protective claim include, for example, a tax paid on subpart F income? What would be the ramifications of any such claim on other items in the return?
A FEW WORDS ON THE STATUTE OF LIMITATIONS
The statute of limitations for filing a claim for refund is generally three years from when the original tax return was filed. However, if you have been under audit, check your Form 872 as your extended statute for assessment also extends the statute for filing claims by six months. Taxpayers who opted to pay the tax in installments over eight years (with most of the tax payable later in the installment period) should also be able to file claims for any amounts paid within two years of the claim filing date. Thus, the statute of limitations for filing a claim for refund could still be open for all or part of the Section 965 tax amount.
Additionally, if the statute of limitations bars a claim and if Section 965 were struck down as unconstitutional, taxpayers might consider pursuing arguments that engage a court’s inherent equitable powers to toll the statute.
WHAT HAPPENS AFTER MOORE?
After the contingency is resolved, the IRS can act on the pending protective claim. The IRS will generally audit a refund claim in the same way it conducts a standard examination, including the issuance of Information Document Requests if needed. However, if an IRS examination disallows a claim by way of a statutory notice of disallowance under Section 6532(a)(1), a taxpayer has two years from the date of that notice to file a refund action in federal court. Upon disallowance, Appeals review will be offered; however, such review does not toll the two-year period within which to file suit. If the IRS does not act on a claim, a taxpayer can file suit in district court or the US Court of Federal Claims for a refund within six months of the claim filing date.