Restrictions on the right of offset.

Most businesses assume they can apply the right of offset to net a receivable and payable. Recently the Federal Circuit Court of Appeals limited the government's right of offset.

Although Pacific Gas and Electric (PG&E) filed its 1982 tax return on time, it subsequently filed an amended return requesting a refund. In 1988 the government found PG&E was entitled to a refund plus interest but incorrectly calculated the amount of interest due. PG&E later filed another refund claim for 1982 based on carrybacks from 1984. The government agreed with the claim but offset (reduced) the refund by $3.37 million, the amount of excess interest the government had erroneously included earlier. PG&E filed a suit in the Court of Federal Claims for the full refund without offset. The lower court had allowed the offset even though it acknowledged the government was time-barred from suing to collect the overpaid interest. PG&E appealed.

Result. For the taxpayer. Basing its finding on Lewis v. Reynolds, the Court of Federal Claims stated that refunds are limited to the actual overpayment of tax. To calculate the overpayment the taxpayer must redetermine the entire tax even if the year is closed. Therefore PG&E redetermined its 1982 tax return liability Subsequent cases also allowed the government to reduce refunds by a time-barred deficiency (that is, a deficiency the government cannot collect because the tax year is closed). The Federal Circuit Court of Appeals, which considered PG&ES appeal, found that these cases "stand for the proposition that the government may offset against a tax refund claim any additional amounts the taxpayer owes with respect to the tax shown on the return even though the statute of limitations would bar assessing the additional amount owed." The appellate court distinguished Lewis and its progeny, which apply to cases involving assessable amounts such as tax deficiencies, tax penalties and deficiency interest, from this case. In PG&E, the government tried to offset overpaid interest, a nonassessable amount, rather than assessable tax from the year at issue.

Computing the interest due on a deficiency or refund requires complex calculations. If the government overpays interest on a refund for a closed year, it may not recover the amount by offset against a refund due from that year.

* Pacific Gas and Electric Co. v. United States, Fed. Cir., 417 F3d 1375 (2005).

Prepared by Edward J. Schnee, CPA, PhD, Hugh Culverhouse Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa