Should You File a Protective Refund Claim for the Transition Tax While Waiting for the US Supreme Court? Moore Might Mean More! 

Part I of my blog post set out the background and discussed the debate over Internal Revenue Code Section 965  “transition tax” or “mandatory repatriation tax” enacted in 2017. The Supreme Court recently decided to review the 9^th Circuit case of Moore v. United States bringing this controversial tax back into the spotlight.  The Court will determine whether the realization of income is a constitutional requirement for Congress to impose a tax, perhaps overturning the US Court of Appeals for the Ninth Circuit which held that realization of income is not a requirement.

While we wait for the Court to decide on this hot constitutional issue, what can taxpayers who have paid the transition tax do to preserve their chance of a refund in the event of a favorable outcome? That is the subject of today’s post.

Possibility of Filing Protective Refund Claims

Given the uncertainty surrounding the constitutionality of Section 965, taxpayers may be considering whether to file protective refund claims. A protective refund claim is essentially a precautionary measure to preserve the taxpayer’s rights to a refund in the event of a favorable court decision or legislative change.

Filing such claims initially involves reviewing the statute of limitations for the year or years the taxpayer has paid in the Section 965 transition tax.  Many taxpayers paid the full transition tax with the 2017 tax return. Others paid the tax in installments over 8 years, as permitted by the law.  Taxpayers and the Internal Revenue Service (IRS) may extend the statute of limitations by signing a mutual agreement (this typically happens in an audit) and thus, there is another group of taxpayers who have extended the statute of limitations with regard to a particular tax year or years.

How does the statute of limitations apply to each of these different groups when it comes to filing a protective refund claim for the transition tax?

Here’s the law in a nutshell:

Section 965(k) provides the IRS 6 years to assess any transition tax that is owed.  However, this 6-year statute only favors the IRS. Taxpayers seeking a refund are bound to Section 6511 which deals with refund claims. Pursuant to Section 6511(a) a taxpayer must file a refund claim by the later of 3 years of filing the tax return, or 2 years of paying the tax.

Lost Opportunity

Under the general refund claim rule, taxpayers that paid the full transition tax on their 2017 income tax return filed in 2018 (or 2018 tax return, filed in 2019, if they report on a fiscal year that is not a calendar year) will not be able to claim a refund. The time for claiming the refund expired in 2021 (or 2022 for fiscal year filers).  Normally refund claims must be filed within 3 years of filing the tax return or 2 years from the date the tax was paid so these taxpayers are out of luck.

Moore  May Mean More for Some

With respect to 2 groups of taxpayers, however, Moore may mean more if the Court rules favorably.

As mentioned, the time to file a refund claim can be extended.  If the taxpayer has extended the statute of limitations by signing a waiver of the statute with the IRS, Section 6511(k) gives the taxpayer an additional 6 months after the expiration of the extended statute of limitations to file the refund claim. Taxpayers who extended the statute of limitation should examine the prospect of filing protective refund claims.

Similarly, those taxpayers who decided to pay the transition tax in installments over 8 years, may also be able to file refund claims for tax amounts paid within two years of claim filing.   Most of the transition tax was payable in the later part of the installment period, so larger refunds might be possible.

Remember, protective refund claims are possible not only for federal tax purposes, but also state income tax purposes.  Get the right tax professional to assist on this issue so that all bases are covered.

What are the Tax Risks?

Filing such protective claims is not without risks.  A taxpayer has possible tax and penalty exposure if positions claimed on the originally filed tax returns are uncertain.  This risk can be mitigated as a general matter by carefully timing when to file the protective claim for refund (for example, filing it when there is say, one week left to run on the general 3-year statute of limitations).  This small window will not give the IRS much time to audit and adjust one’s taxes before the statute expires.

If you are uncertain whether you might qualify for protective relief, my colleagues have decades of experience with refund claims, assessing risks with other positions taken on the original return and are very familiar with the nuances of the transition tax. Expert help is available to assist you in understanding potential implications of Moore and filing protective refund claims.

Posted September 7, 2023

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