IRS narrowly interprets scope of interest netting rules.

Despite Congress's intent to have interest netting apply as broadly as possible, the IRS has interpreted the interest netting rules narrowly, to the disadvantage of many taxpayers. On Mar. 29, 1999, the Service issued Rev. Proc. 99-19 to provide guidance on the interest netting provisions under Sec. 6621(d), as added by the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98). Rev. Proc. 99-19 establishes procedures for applying this provision to interest periods beginning before July 22, 1998 (i.e., using quarterly interest periods, to interest accruing before Oct. 1, 1998). Simply stated, the interest netting rule is "to the extent that, for any period, interest is payable ... and allowable ... on equivalent underpayments and overpayments by the same taxpayer ..., the net rate of interest ... on such amounts shall be zero for such period."

The scope of the revenue procedure is limited to the three conditions set forth in the IRSRRA '98: (1) any applicable statute of limitations (SOL) has not expired with regard to either a tax underpayment or overpayment, (2) the taxpayer reasonably "identifies and establishes" the periods for which the zero net rate applies and (3) the taxpayer requests application of the zero net rate by Dec. 31, 1999. This language, which was not codified, is the exclusive rule for applying the zero net interest rate to interest periods beginning before July 22, 1998.

SOL Requirement

The awkward language in the IRSRRA '98 concerning the SOLs raised the question of whether the SOL for both the tax years of the overpayment and the underpayment had to be open, or whether Sec. 6621(d) would apply retroactively if only one were still open. The IRSRRA '98 states that Sec. 6621(d) applies retroactively, "[s]ubject to any applicable statute of limitations not having expired with regard to either a tax underpayment or a tax overpayment ..."

Initially, the IRSRRA '98 did not contain specific language for which limitations periods were required to be open for the zero net rate to apply retroactively. The legislative history indicates, however, that Congress intended the netting provisions to apply as broadly as possible and would require only one limitations period to be open. The Senate Finance Committee Report states that "the Committee continues to expect that the Secretary will implement the most comprehensive interest netting procedures that are consistent with sound administrative practice, and not only those affected by this provision." The zero net rate would apply retroactively if "the statute of limitations has not expired with respect to either the underpayment or overpayment...." In addition, the Joint Committee report (i.e., the Bluebook) states that the zero net rate would apply to periods before the date of enactment if "as of the date of enactment, a statute of limitations has not expired with respect to the underpayment or overpayment...."

Because no specific language related to the limitations periods, Congress attempted to clarify the interest netting provisions in the Omnibus Consolidated and Emergency Supplemental Appropriations Act for Fiscal Year 1999, by including the language "[s]ubject to any applicable statute of limitations not having expired with regard to either a tax underpayment or a tax overpayment."

Despite Congress's intent to have the zero net rate apply as broadly as possible, Rev. Proc. 99-19 interprets this language narrowly, taking the position that both applicable limitations periods must be open on July 22,1998, for Sec. 6621(d) to apply retroactively. The revenue procedure, however, takes a broader approach, looking to the effective date of the IRSRRA '98 to determine whether the limitations periods were open. In addition, the applicable limitations periods are defined with reference to the interest, rather than the tax. Thus, the limitations period for underpayment interest, determined under Sec. 6511, is the later of three years from the date the return was filed or two years from the time the interest was paid; the limitations period for overpayment interest is the six-year period for filing suit under 28 U.S.C. Sections 2401 and 2501.

Reasonable Identification Requirement

To request that the Sec. 6621 zero net rate apply to interest periods beginning before July 22, 1998, the taxpayer should file Form 843, Claim for Refund and Request for Abatement, with the IRS Service Center where the taxpayer filed its most recent income tax return. The notation "Request for Net Interest Rate of Zero Under Rev. Proc. 99-19" should be included on the top of the form. (The revenue procedure contains detailed instructions on how to complete Form 843.) If the return for one of the years is "under consideration" by the IRS, however, the taxpayer is not required to file Form 843. The taxpayer may, instead, furnish a letter or written statement to the office considering the return, supplying information that includes the type of tax and the potential overlapping period. The Service has not yet determined the level of specificity required.

The IRS has indicated that it will issue further guidance on the application of the zero net rate to interest periods both before and after July 22, 1998.

FROM NANCY M. GALIB, J.D., LL.M., WASHINGTON, DC