IRS may offset time-barred, unassessed interest against estate tax refund.

The Federal Circuit recently held that the IRS may offset previously unassessed interest against a refund of estate taxes when the statute of limitations (SOL) has barred assessment of the interest (Fisher, 4/10/96).

As representative of an estate, Gisele Fisher filed an estate tax return and paid the estate taxes in 1987. In 1990, the Service sent Fisher a notice of deficiency (largely based on an increase in the value of stock in a closely held corporation), which Fisher paid. In March 1991, the SOL for the assessment of tax expired without the IRS having assessed the tax or interest thereon. Fisher filed a refund claim for a portion of the taxes paid, which the Service denied in April 1991. She then filed suit in the Court of Federal Claims. In response, the IRS asserted that it was due interest on the deficiency, and claimed the right to offset the interest against any amount awarded to Fisher.

Early in the proceedings in the trial court, Fisher argued by motion that the Service could not offset interest against a refund of tax. The court noted that no interest offset was proper for interest on that portion of a deficiency ultimately refunded. However, the court left open the question of whether the IRS could offset interest on the valid portion of the deficiency against a partial refund of tax.

The Court of Federal Claims ultimately upheld Fisher's valuation of the stock and entered judgment for a refund of the amount of the deficiency related to the stock valuation. The Service sought to reduce Fisher's judgment by the interest on those items on which it had prevailed. The court found that the IRS was not entitled to offset the interest and entered judgment for Fisher, and the Service appealed.

The Federal Circuit determined that Lewis v. Reynold, 284 US 281 (1932), and Dysart, 340 F2d 624 (Ct. Cl. 1965), controlled, and that the IRS can offset a tax refund by any additional time-barred amounts the taxpayer owes for the year. In Lewis v. Reynold, the Supreme Court held that the Service could offset additional income tax owed against a refund of income tax for the same year even when the SOL barred assessment of the additional tax. Dysart applied Lewis to find that the IRS could offset a refund of a penalty by additional time-barred income tax determined to be owing for the same year.

The circuit court recognized that both Lewis and Dysart addressed offsets of additional income tax owed, but concluded that, for purposes of offset, additional interest owed should not be treated any differently from other components of tax liability. To this end, the court cited various provisions of the Internal Revenue Code that treat interest as an integral part of the liability; see Sec. 6601 (e) (interest on tax underpayments "shall be assessed, collected, and paid in the same manner as taxes" and that any reference "to any tax imposed by this title shall be deemed also to refer to interest imposed by this section on such tax") and Sec. 6601 (g) (the SOL on assessment and collection of the underlying tax governs the SOL on the assessment of interest on the tax).

Thus, the court rejected Fisher's argument that offset applies only to like items, i.e., only interest could offset interest. The court noted that in no previous case had a court held that the nature of a refund and the nature of an additional amount owed were required to be the same in order for the offset doctrine to apply. However, the court also noted that no other court had addressed the specific question of the Service's right to offset interest against a refund of tax. Nonetheless, other cases recognized the IRS's right to offset a refund by something other than the tax for which the taxpayer sought the refund. For example, the court cited Loftin & Woodward, Inc., 577 F2d 1206 (5th Cir. 1978), which held that a loss carryback could be offset by a late filing penalty; see also Allen, 11th Cir., 1995. Thus, the court held that the Service could offset a refund of Federal estate taxes by interest owed for the same year when the SOL barred assessment of the interest.

Fisher completes the list of those items within a tax year that may be offset against a claim for refund consistent with the terms of Lewis v. Reynold. The IRS may offset tax, interest and penalties that are otherwise time-barred against a claim for refund so long as the items fall within the same tax year.