Better late than never. (TaxFiling).

Imagine it's September and a CPA is hired by an attorney to prepare delinquent 1999, 2000 and 2001 federal income tax returns for Del, a California resident. The CPA determines that Del's wage withholding exceeded his tax liability by $30,000 in 1999 and $15,000 in 2000. But in 2001, Del owes $50,000--not counting interest and penalties.

For the 1999 and 2000 tax years, Del filed extensions, stretching the respective due dates to Oct. 17, 2000 and Oct. 15, 2001. The CPA prepares the returns and asks the IRS to apply the $45,000 refunds for 1999 and 2000 as a partial offset to the 2001 tax liability.

All three delinquent returns are mailed to the IRS and postmarked Oct. 14, 2003. The IRS receives them four days later.

The CPA then learns that Del has retained an attorney after receiving a notice from the IRS stating that it had no record of receiving a return for 1999 and asking whether the taxpayer filed a return for that year. Del also was motivated to file by the recent IRS pledge to increase enforcement efforts against high-income nonfilers. [See IRS Fact Sheet 2002-12 (9/16/2002)]. However, Del is not under IRS examination or investigation when the returns are filed.

Are Del's refund claims timely? Yes, thanks to Omohundro v. U.S., 300 F.3d 1065 (Ninth Circuit 8/19/2002).

YOU'VE GOT MORE TIME

The court's decision to allow bad taxpayers--also known as nonfilers--as much as three years and six months (instead of two years) to get their money back on late-filed returns represents a significant pro-taxpayer change.

The decision overturned Miller v. U.S., 38 F.3d 473 (Ninth Circuit 1994), which said that in absence of a timely return, a taxpayer must file a refund claim within two years of the date of payment of the tax. [IRC Sec. 6511(a)].

Omohundro rejected Miller primarily because it ignored IRS Rev. Rul. 76-511, in which the IRS said that under IRC Sec. 6511(a), a refund claim is timely if it is filed within three years from the filing date, regardless of when the return is filed.

With a delinquent original return requesting a refund, the return is also the refund claim (per Treasury Reg. Sec. 301.6402-3(a)(5)), so the refund claim is treated as filed on the same day the return is filed--clearly within the three-year requirement.

This does not mean that late filers have an indefinite time to file a refund claim. A refund claim that is "timely" under Sec. 6511(a) may nonetheless be beyond the date necessary to recover any of the prior tax overpayments under Sec. 6511(b).

IRC Sec. 6511(b)(2)(A) declares that if the refund claim is filed within three years of filing the return, the amount of the allowable refund is limited to the amount paid within the period that is "equal to three years plus the period of any extension of time for filing the return."

Therefore, applying the rationale in Omohundro, Del's refund claim--filed Oct. 14, 2003--was timely (within the above stated period of three years and six months from the payment date) to recover his overpayments for both tax years 1999 and 2000.

Del's 1999 wage withholding tax is deemed paid for purposes of a refund claim on the 15th day of the fourth month after the close of the year in which the tax is withheld [Code Sec. 6513(b)(1)]--April 15, 2000. If Del had not filed extensions for 1999, the refund claim would be late.

Also working in favor of late filers is Weisbart v. U.S., 222 F.3d 93 (Second Circuit 2000), which confirmed the validity of extension applications for purposes of measuring the look-back period--even if the taxpayer never filed an original return during the requested extension period. Conversely, for purposes of calculating a failure to file penalty, the extension period for an expired extension is ignored.

OTHER TIME FACTORS

Can Del count the date of mailing--"the mailbox rule"--as the date of filing for a delinquent tax return/refund claim? Yes and no.

With a late tax return showing a tax underpayment, the mailbox rule is inapplicable. The date of receipt by the IRS is the date of filing. The mailbox rule applies only if the postmark falls on or before the prescribed date for the filing of the submission [Code Sec. 7502(a)(2)(A)].

However, in Weisbart, the court ruled that the mailbox rule applied to a delinquent tax return showing a tax overpayment. At trial, the IRS argued (and the district court agreed) that the prescribed period applicable to the delinquent tax return should apply to the refund claim, invalidating the mailbox rule. The appellate court, reversing the lower court, concluded that the refund claim itself was the "submission."

Because the refund claim was timely, the mailbox rule applied. Therefore, Del's 1999 and 2000 refund claims, but not his 2001 delinquent balance due return, are deemed filed as of the date they are mailed.

What if Del's 1999 return/refund claim were mailed Oct. 18, 2003, one day too late to receive a refund for 1999? Could that refund be applied as a first-quarter estimated tax payment for year 2000, pushing the tax payment ahead a year? No.

According to the Tax Court in Burr, TC Memo 2002-69, an overpayment in one year may be treated as a payment of tax for the succeeding year only where the claim for a credit of the preceding year's overpayment is made within the applicable period of limitations.

Is the IRS likely to recommend criminal prosecution of Del? No. Because of the voluntary disclosures, refunds in two of three back years and a small tax underpayment arising in a single year, criminal prosecution will likely not be recommended.

Recently, the IRS published its long-standing internal policy against recommendation of prosecution of taxpayers who voluntarily disclose their noncompliance. The IRS states that "voluntary disclosure will not automatically guarantee immunity from prosecution; however, a voluntary disclosure may result in prosecution not being recommended." (IR-2002-135).

VOLUNTARY DISCLOSURE POLICY

Is Del's disclosure voluntary, given that the IRS contacted him prior to the disclosure, and he was motivated by the IRS pledge to pursue high-income nonfilers? Under IR-2002-135, it seems so.

The IRS provides an example similar to Del where "the individual has received a notice stating that the IRS has no record of receiving a return for a particular year and inquiring into whether the taxpayer filed a return for that year." The IRS concludes that the subsequent filing of correct tax returns is voluntary "because the IRS has not yet commenced an examination or investigation of the taxpayer or notified the taxpayer of its intent to do so."

The IRS also concludes that a disclosure is voluntary where the taxpayer reports omitted income facilitated "through a widely promoted scheme which the IRS has begun a civil compliance project and already obtained information which might lead to an examination of the taxpayer."

The primary qualification for voluntary disclosure is the absence of a civil examination or criminal investigation of the taxpayer, but there are other factors that must be met. The disclosure must be accurate and the published voluntary disclosure policy does not apply to illegal source income.

TAXPAYER-FRIENDLY IRS GUIDANCE

Omohundro also underscores the importance of taxpayer-friendly IRS published guidance. On Oct. 17, the IRS chief counsel reminded chief counsel attorneys: "It has been a longstanding policy of the Office of Chief Counsel that we are bound by our published positions, whether in regulations, revenue rulings or revenue procedures, and that we will not argue to the contrary."

This guidance was prompted by recent judicial decisions, such as Omohundro, where the IRS' litigating position was contrary to its own published guidance.

Gary R. McBride, JD, LLM, CPA, is a professor in the graduate tax program at California State University, Hayward and is a former IRS special agent. You can reach him at [e-mail].