The effect of a restriction imposed on the IRS as part of an agreement to extend the statute of limitation was the matter before the court in the case of Hamilton v. United States, US DC Colorado, Civil Action No. 13-cv-00051-REB-KMT, 117 AFTR 2d ¶ 2016-341.

Quite often a taxpayer will be asked by the IRS to extend the statute of limitations on assessing tax during an exam or, as in this case, while the matter is pending before appeals.

As most are aware, if the taxpayer refuses to consent to the extension the IRS will normally simply issue a Notice of Deficiency proposing to assess tax assuming all items remaining in dispute are resolved 100% against the taxpayer, forcing the taxpayer to file a petition in Tax Court. So most often (though not always) prudence suggests that the taxpayer consent to the statute extension.

A taxpayer may request that the extension be limited only to issues already raised in the exam, a condition the IRS often will agree to. In this case such a restricted consent to extend the statute had been entered into while the case was at Appeals.

The consent, filed on Form 872, contained the following language at issue in this case:

Robert S. Hamilton and the Commissioner of the Internal Revenue consent and agree to the following:

. . . .

(3) The amount of any deficiency assessment is to be limited to that resulting from: . . . (b) any adjustments to charitable contributions.

The taxpayer and the IRS were unable to arrive at a resolution at Appeals, with the IRS issuing a Notice of Deficiency denying entirely the claimed charitable contributions.

The taxpayer decided not to contest the matter in Tax Court, rather paying the proposed deficiency and then filing a suit for refund in United States District Court.

The taxpayer was asking the District Court to rule that, due to the restrictions contained in the consent to extend the statute, the IRS could not redetermine taxes on any other issue in the District Court case.

The District Court agreed with the IRS that the Form 872 was no longer relevant to this case, and it’s due to the fact that the taxpayer has chosen to start a separate action for refund rather than going through the procedures to contest the Notice of Deficiency.

As the Court explains:

When the IRS has issued a Notice of Deficiency, the taxpayer may challenge that determination in the Tax Court, and he is not required to pay the purported deficiency until the Tax Court determines the matter. See Guthrie v. Sawyer, 970 F.2d 733, 735 (10th Cir. 1992).[i] By contrast, to bring an action seeking a refund in federal district court, the taxpayer must pay the full amount of income tax assessed. See Flora v. United States, 357 U.S. 63, 75, 78 S.Ct. 1079, 1086, 2 L.Ed.2d 1165 (1958), aff'd on rehearing, 362 U.S. 145, 80 S.Ct. 630, 4 L.Ed.2d 623 (1960); Ardalan v. United States, 748 F.2d 1411, 1413 (10th Cir. 1984).

This distinction is critical because it underscores the difference between what occurs in the two proceedings. At the agency level, the IRS assesses the tax to be paid. When the taxpayer seeks a refund, he perforce already has paid the assessment. He thus must then establish that he has overpaid tax. In re Borgman, 698 F.3d 1255, 1260 (10th Cir. 2012); Dye v. United States, 121 F.3d 1399, 1407 (10th Cir. 1997). Proof of that ultimate issue requires the taxpayer to demonstrate both that the amount of tax assessed is incorrect and that the correct amount of tax owed is less than the amount paid. Dye, 121 F.3d at 1408; Sprint Nextel Corp and Subsidiaries v. United States, 779 F.Supp.2d 1184, 1185 (D. Kan. 2011).

Thus the taxpayer now has to demonstrate that he/she has overpaid tax, rather than the IRS demonstrate an underpayment of tax. Effectively the matter starts with a “blank slate” with the IRS able to raise evidence outside merely that of the validity of the claimed charitable contributions to show there was no tax overpayment.

The opinion gives the generally applicable rule, citing the Lewis case, as follows:

Under the rule first announced in Lewis v. Reynolds, 284 U.S. 281, 52 S.Ct. 145, 76 L.Ed. 293 (1932), the determination of the correct amount of tax owed must be made by reference to the entire amount owed, regardless whether the statute of limitations for assessment has expired:

[T]he ultimate question presented for decision, upon a claim for refund, is whether the taxpayer has overpaid his tax. This involves a redetermination of the entire tax liability. While no new assessment can be made, after the bar of the statute has fallen, the taxpayer, nevertheless, is not entitled to a refund unless he has overpaid his tax. The action to recover on a claim for refund is in the nature of an action for money had and received and it is incumbent upon the claimant to show that the United States has money which belongs to him.

. . . .

While the statutes authorizing refunds do not specifically empower the Commissioner to reaudit a return whenever repayment is claimed, authority therefor is necessarily implied. An overpayment must appear before refund is authorized. Although the statute of limitations may have barred the assessment and collection of any additional sum, it does not obliterate the right of the United States to retain payments already received when they do not exceed the amount which might have been properly assessed and demanded.

Id., 52 S.Ct. at 146 (citation and internal quotation marks omitted). In other words, the agency is not required to refund any assessment for tax that was in fact owed. That determination cannot be made in a vacuum — it must consider the entirety of the tax liability.

[i] The process was explained by the Tenth Circuit in Guthrie:

The notice of deficiency begins the interaction between the taxpayer and the IRS. Upon the determination that a tax deficiency exists, I.R.C.§ 6212 (1988) authorizes the IRS to send a notice of the deficiency to the taxpayer at his last known address. Under I.R.C.§ 6213, the taxpayer ordinarily has ninety days after the mailing of the notice of deficiency to file a petition in the Tax Court challenging the deficiency determination. If the taxpayer goes to Tax Court, he may obtain a redetermination of deficiency, which amount is not assessed or required to be paid until the Tax Court decision has become final. See I.R.C.§§ 6213(a), 6215. The notice of deficiency is thus the "ticket" to the Tax Court that allows the taxpayer to challenge the tax assessment before paying it.

If the taxpayer does not go to Tax Court within ninety days, the IRS is authorized to assess the deficiency against the taxpayer, who must pay upon notice and demand. See I.R.C. § 6213(c).

Guthrie, 970 F.2d at 735.