Benefits of protective refund claims.

A "protective" claim for refund can be a valuable tool for the proactive tax professional. While a proper protective claim does not include all the information necessary to establish the taxpayer's right to recover an overpayment, it will be accepted as valid for limitations purposes.

Under Sec. 6402(a), the IRS may allow a credit or refund after the expiration of the limitations period only if a claim has been timely filed (i.e., filed within three years from the time the return was filed or two years from the time the tax was paid, whichever period expires later). Regs. Sec. 301.6402-2 sets forth the basic requirements that must be satisfied by claims for credit or refund, including protective claims. These include a requirement that the claim set forth in detail each ground on which a credit or refund is claimed and facts sufficient to apprise the Service of the exact basis for the claim.

Except when regulations impose additional requirements for claims relating to a particular kind of tax, a refund claim is valid if it complies with the basic requirements. In GCM 38786, the IRS stated the most important requirement "is that the claim state the grounds [for the credit or refund] and supporting facts"; thus, a claim setting forth only a general or "shotgun" basis is not sufficient. However, GCM 38786 went on to say, "this requirement should be interpreted liberally. So long as the claim apprises the Service of the essential nature of the claim, it should be seen as satisfying this requirement."

The situations in which a tax practitioner should consider filing a protective claim typically arise when expiration of the refund statuute is looming and:

1. the taxpayer is unable to submit supporting information that establishes its actual right to a refund,

2. the taxpayer is unable to quantify the claim precisely, i.e., calculate the exact amount of the claimed overpayment,

3. there is pending litigation on the issue involved in the protective claim, the results of which may substantially affect whether the Service allows the claim,

4. an expected change to the Code or the regulations may have a substantial impact on the decision whether to allow the claim, or

5. the IRS has proposed changes in a tax year under examination that would, if sustained, create an overpayment in another tax year.

GCM 38786 provides that when the taxpayer is unable to submit the information needed to establish the taxpayer's right to recover the overpayment with a refund claim (situation 1, above), the taxpayer should be allowed a "reasonable period of time" in which to furnish the necessary evidence. It goes on to state that if the information is not so furnished and if the Service does not obtain the information on its own, the claim may be disallowed. The "defect" in situation 2 (i.e., the lack of a bottom-line overpayment amount) technically is not a defect at all, since such a calculation is not one of the requirements set forth in the regulations for a valid claim. Nevertheless, to the extent a taxpayer wishes to submit such a calculation, the rationale of the quoted passage from GCM 38786 arguably should support allowing the taxpayer a reasonable amount of time to make the submission.

When the filing of a protective claim is engendered by pending litigation (or by situation 4 or 5 above), GCM 38786 acknowledges that "the interests of both the Service and the taxpayer may be served by delaying action on the claim. Thus, it would be reasonable for the Service to delay action on such a 'protective' claim until after the pending litigation [or legislative/regulatory change or examination] was resolved." When there is a substantial possibility that the pending litigation will resolve whether the taxpayer is entitled to a refund, the GCM states there is "no reason why action on the claim should not be delayed as long as reasonably possible" and that "such a 'protective' claim may be held in abeyance until the pending litigation is resolved." If, instead of delaying action, the IRS simply disallowed the protective claim, the taxpayer might be forced to file a refund suit because the two-year statute of limitations for doing so runs from the date the claim is disallowed (Sec. 6532(a)).

The Service has wide leeway in the way it handles refund claims. It can act expeditiously on them--although there is no statutory or regulatory requirement that it do so--or, as discussed, it can choose to delay action indefinitely. Therefore, although technically not required, it is generally advisable to explain and prominently note the protective nature of a protective claim on the claim itself and in a cover letter. Further, the taxpayer should request explicitly that the IRS not act on the claim until, e.g., the Tax Court case captioned ABC Corp., Docket No. XXX, is resolved.