IRS treatment of protective refund claims.

The concept of a "protective claim for refund" is well-established, even though the term does not appear in the Code or regulations. Protective claims are commonly filed when a taxpayer's right to a refund is contingent on future events (such as pending litigation or an expected statutory or regulatory change) that will not be resolved until after the statute of limitations (SOL) expires. A timely and proper protective claim will preserve the taxpayer's right to obtain a refund.

In other instances, a taxpayer will file a protective claim that specifically describes the grounds on which the taxpayer believes it is entitled to a refund, even though it cannot provide supporting information. For example, the taxpayer may be in the process of conducting a research credit study that will not be completed before the SOL expires. In such a case, the taxpayer could indicate its entitlement to a larger research credit under Sec. 41, even though it would not be able to quantify precisely the overpayment because the credit study is incomplete.

The protective claim is intended to preserve the taxpayer's right to a refund, and the overpayment amount can be stated as "$1.00 or such greater amount as is legally refundable." However, if the only obstacle to a refund is an unresolved contingency, the protective claim could specify an exact refund amount and also contain all of the other information that would be included on a regular claim for a refund.

Guidance on Filing Protective Claims

General Counsel Memorandum (GCM) 38786 describes various circumstances in which filing a protective claim would be appropriate when the expiration of the refund SOL is imminent. Those circumstances include (1) pending litigation that may substantially affect the IRS's decision whether to allow the claim and (2) an expected change in the Code or the regulations that may have a substantial effect on the IRS's decision whether to allow the claim.

However, GCM 38786 also contemplates the filing of protective claims when expiration of the refund SOL is imminent and the taxpayer is unable either to submit the supporting statements required by the regulations or to precisely quantify the claim (i.e., calculate the exact amount of the claimed overpayment).

According to GCM 38786, if the taxpayer cannot submit the supporting statements with the refund claim, it "should be allowed a reasonable period of time in which to furnish the necessary evidence." Also, "[i]f the information is not furnished within a reasonable period of time and if the Service does not obtain such information on its own, the claim may be disallowed." Nevertheless, there have been instances in which the IRS has formally disallowed protective refund claims when the taxpayer specifically described the grounds on which it believed it was entitled to a refund (e.g., entitled to a larger Sec. 41 research credit), but is unable to quantify precisely the overpayment amount because of an incomplete research credit study.

Incomplete Claims

In Service Center Advice memorandum (SCA) 199941039, the IRS sought to distinguish protective refund claims from what it calls "incomplete claims." The memorandum does not discuss GCM 38786, which includes the most comprehensive discussion of protective refund claims. Some support for the incomplete-claim concept can be found in Regs. Sec. 301.6402-3(a)(5), which provides "[a] return or amended return shall constitute a claim for refund or credit flit contains a statement setting forth the amount determined as an overpayment...."

Even if a taxpayer fails to set forth an exact overpayment amount on an intended protective claim, rendering the claim "incomplete" within the meaning of SCA 199941039, it arguably should be entitled to supplement the claim by quantifying the specific refund it is seeking and providing the supporting information. In that regard, under SCA 199941039, the Service's disallowance of a claim is not a final action unless the IRS fully considers all the grounds for the refund. Moreover, before issuing a disallowance, the IRS should (1) "request additional information as to the actual amount of the claim" or (2) "provide the taxpayer with a reasonable amount of time to supply information as to the actual amount of the claim and other necessary information."

At a minimum, the IRS should contact the taxpayer and, under threat of a claim disallowance, give a reasonable period for the taxpayer to provide additional supporting evidence. However, even when a claim is disallowed under such circumstances, GCM 38786 notes that the taxpayer "should be allowed to reopen the claim if it subsequently obtains the additional evidence needed to prove its right to a refund, provided that the Service has sufficient time to reconsider the claim prior to the expiration of the period of limitations prescribed in section 6532(a)."

FROM MICHAEL A. URBAN, J.D., MLT, WASHINGTON, DC