Second Circuit Reaffirms Taxpayer’s Use of Protective Refund Claims
On September 9, 2013, the U.S. Court of Appeals for the Second Circuit issued a decision in AmBase Corp. v. United States, No. 12-3563 (2d Cir. 2013), affirming that the U.S. District Court for the District of Connecticut (District Court) had subject-matter jurisdiction over the taxpayer’s case based on the taxpayer’s use of a protective refund claim.
A taxpayer must satisfy a number of hurdles before commencing a tax refund action against the United States. Even a small foot fault can deprive the refund forum, such as the district court with subject-matter jurisdiction. Subject-matter jurisdiction in a refund forum is premised on two separate filings by the taxpayer. First the taxpayer must file an administrative claim for refund with the Internal Revenue Service (IRS). Once that claim for refund is denied (or six months has passed after the filing of the claim), then the taxpayer can file a refund suit in the District Court or the U.S. Court of Federal Claims. Under Section 6511 of the Internal Revenue Code the taxpayer has the later of three years from the time the tax return was filed or two years from the time the tax was paid to file the administrative claim. The three-year limitation is increased to seven years if the claim relates to a bad debt deduction. Section 6511(d)(1). The taxpayer then has from six months after the filing of the claim up until two years after the claim’s denial to file the refund suit. Section 6532. Section 301.6402-3 of the U.S. Department of the Treasury Regulations sets forth the formal requirements for filing a refund claim; however, as the Second Circuit noted, informal refund claims are also recognized as valid refund claims. See United States v. Kales, 314 U.S. 186 (1941). Protective claims are a type of informal claim a taxpayer may file. The Second Circuit cited to Chief Counsel Advisory 200848045, which explains “[p]rotective claims are filed to preserve the taxpayer's right to claim a refund when the taxpayer's right to the refund is contingent on future events and may not be determinable until after the statute of limitations expires.”
The specific requirements for filing a proper protective refund claim, are “designed both to prevent surprise and to give adequate notice to the Service of the nature of the claim and the specific facts upon which it is predicated, thereby permitting an administrative investigation and determination.” Alexander Proudfoot Co. v. United States, 454 F.2d 1379, 1383 (Ct. Cl. 1972) (quoting Union Pac. R.R. v. United States, 389 F.2d 437, 442 (Ct. Cl. 1968), cert denied, 395 U.S. 944 (1969)).
As long as the taxpayer timely files the informal protective refund claim, he or she may then file an amendment that relates back to “perfect” to the initial claim out of time. The Treasury Regulations require that the amendment be based on “one or more of the grounds set forth in a claim filed before the expiration” of the statute of limitations. Sec. 301.6402-2(b)(1), Admin. & Proc. Regs. See also St. Joseph Lead Co. v. United States, 299 F.2d 348, 350 (2d Cir. 1962) (“[T]he facts upon which the amendment is based would necessarily have been ascertained by the commissioner in determining the merits of the original claim”.).
AmBase Corp. v. United States
AmBase Corporation sought a tax refund for its 1989 tax year based on a net operating loss carryback (NOL carryback) from its 1992 tax year. The NOL carryback resulted from an amended calculation of AmBase’s affiliate, Carteret Savings Bank FA’s, 1992 bad debt deduction.
Toward the end of 1992, Carteret was seized by the Office of Thrift Supervision and put into a conservatorship of the Resolution Trust Corporation (RTC) because it had failed to satisfy capital requirements under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989. The receivership was transferred to the Federal Deposit Insurance Company (FDIC) in 1996. AmBase filed its 1992 consolidated federal income tax return on August 30, 1993, reporting Carteret’s tax items up until Carteret’s seizure; however, RTC did not provide AmBase with Carteret’s post-seizure records.
On March 14, 2000, AmBase filed an amended return for the 1992 tax year proposing to increase Carteret’s bad debt deduction. Also on March 14, 2000, AmBase filed an amended return for the 1989 tax year seeking to carry the NOL created on the 1992 tax return back to 1989 in order to create a refund. The IRS denied the claim and AmBase filed a complaint in the District Court on April 29, 2008.
During the proceedings, the parties agreed that under the general rules of Section 6511 AmBase had until March 31, 1998, to file the administrative claim for refund. AmBase argued that its March 14, 2000, refund claim was still timely because: (1) the bad debt deduction regulations required an amended return; (2) the March 14, 2000, refund claim related back to four earlier claims (an attachment to its original 1992 return, a note made in 1995 during a separate audit, a 1995 protective claim and a 1996 protective claim filed by the FDIC on Carteret’s behalf); and (3) that the seven-year period applied. The District Court initially dismissed all of the arguments, but after AmBase produced the 1996 FDIC protective claim filed on behalf of Carteret, the District Court found that the protective claim filed by the FDIC effectively bestowed subject matter jurisdiction on the District Court.
There are three requirements to an informal protective claim: (1) the informal claim must provide the IRS with notice that the taxpayer is seeking a refund; (2) the informal claim must describe the legal and factual basis for the refund; and (3) the informal claim must have some written element. See New Eng. Elec. Sys. v. United States, 32 Fed. Cl. 636, 641(1995) (citing American Radiator & Standard Sanitary Corp. v. United States, 162 Ct. Cl. 106, 318 F.2d 915 (1963)). The Internal Revenue Manual adds a further requirement that the informal claim must identify the specific year or years for which the refund is sought. IRM 184.108.40.206.2.6.5(2) (05-17-04).
The government contended that AmBase’s March 14, 2000, refund claim did not supplement the 1996 FDIC protective claim because the two claims have different factual bases. The Second Circuit disagreed. It reviewed the 1996 FDIC protective claim and found that it met the three necessary requirements of an informal claim and had put the IRS on notice of a possible future claim. The Second Circuit explained “[t]he 1996 FDIC claim addressed Carteret’s bad debts and its method of calculating the bad debt deduction, and it specifically noted potential operating losses and carrybacks.” Importantly, the Second Circuit recognized that an informal claim is not limited to the written component, instead “the focus is on the claim as a whole,” and under the circumstances, the facts relating to the March 14, 2000, refund claim “would have necessarily been ascertained” upon consideration of the 1996 FDIC protective claim. Therefore the Second Circuit affirmed the District Court’s subject-matter jurisdiction over the case.
Future of Protective Claims
Informal protective claims are alive and well. Protective claims fill an important role in protecting a taxpayer’s interest when the amount of the refund is unknown or may be contingent on future events. Protective refund claims have been successfully used to gain jurisdiction for many contingent refunds. Rupert v. United States, 358 F. Supp. 2d 421 (M.D. Pa. 2004) (taxpayers sought to establish the estate's right to deduct future payments of interest on a loan as they were paid and made certain; the validity of the protective refund was upheld, but the underlying tax refund was denied); Cooper v. United States, 84 AFTR 2d 99-6222 (W.D. N.C. 1999) (taxpayer’s trustee in bankruptcy filed a protective refund claim due to uncertainty of the outcome of litigation related to income from a stock sale).
More recently, protective refund claims have been filed by employers to preserve their ability to obtain refunds for employment tax paid (by the employer and employee) pending resolution of the question of whether severance payments made by an employer to employees whose employment has been involuntarily terminated because of the closing of the business constitute wages for the purposes of employment tax. The government is seeking certiorari following its loss in the U.S. Court of Appeals for the Sixth Circuit, and Quality Stores opposes it. The bankruptcy court, the U.S. District Court and the Sixth Circuit all held for the taxpayer (United States v. Quality Stores Inc., 693 F.3d 605 (6th Cir. 2012), aff'g 424 B.R. 237 (W.D. Mich. 2010)). However, the government won the same issue on appeal in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008). In order to preserve refund claims, employers filed protective claims identifying the issue and claiming refunds for an amount to be determined on behalf of themselves and the affected employees.