Recent developments to consider when filing formal and informal claims for refund.

• Author: Kafka, Gerald A.

Corporate taxpayers are filing more claims for refund--often on an informal basis--and two recent developments significantly affect the procedural and strategic considerations that govern the filing of such claims. Although practical reasons, such as the discovery of new facts or the publication of new taxpayer-favorable authority, often dictate the reporting of a position on a claim for refund instead of an original tax return, there are numerous strategic reasons for this course of conduct as well. A refund claim is not subject to the accuracy-related and fraud penalties under sections 6662, 6662A, and 6663 of the Internal Revenue Code of 1986, as amended. In addition, refund claim positions are not subject to the same disclosure obligations as positions reported on an original return, e.g., disclosure under Financial Accounting Standards Board Interpretation No. 48 (ASC 740-10), on Schedule M-3 ("Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More"), or on new Schedule UTP ("Uncertain Tax Position Statement").

Because of the computational and other reporting burdens associated with filing a formal Form 1120X, most corporate taxpayers use the device of an "informal claim," which typically consists of a one- or two-paragraph explanation without accompanying tax computation that is submitted by hand to a revenue agent during the course of an audit. That an informal claim can provide a valid jurisdictional basis for a refund as long as it satisfies certain informational requirements, or the Internal Revenue Service waives the technical deficiencies as to form and content by considering the merits of the claim, is well established. From a taxpayer's perspective, an informal claim minimizes the time and expense of preparing a formal refund claim and is often encouraged--if not requested--by revenue agents.

There are two developments that corporate taxpayers should consider when preparing to file formal and informal refund claims.

(1) Several of the U.S. Courts of Appeals and the U.S. Court of Federal Claims have recently upheld the government's position that an informal claim is jurisdictionally inadequate if the taxpayer does not "perfect" the claim (by filing a complete formal refund claim) before the IRS rejects it, unless there is unequivocal evidence that the IRS has waived the technical deficiencies in an informal claim by considering it on the merits.

(2) On May 25, 2007, Congress enacted section 6676 of the Code to impose a penalty on any taxpayer who files a refund claim for an "excessive amount" (defined as the disallowed portion of the claim) unless the taxpayer has a "reasonable basis" for such amount. Although the IRS has not published Treasury Regulations or any other guidance under section 6676, there have been reports that the IRS has aggressively asserted the new penalty, which is equal to 20 percent of the disallowed amount.

The recently circumscribed perfection requirement and new section 6676 penalty complicate the process of filing formal and informal claims for refund. In the absence of administrative guidance on the circumstances in which the IRS will assert the section 6676 penalty, it remains uncertain whether the IRS will assert the penalty only against formal claims or, alternatively, against informal claims, too. If the IRS pursues the latter approach, taxpayer will find themselves in the awkward position of arguing that their disallowed, informal claims were jurisdictionally inadequate, an argument that the government has historically made in motions to dismiss refund suits premised on an informal claim. This suggests a strategy by taxpayers to mitigate the risk of a section 6676 penalty by filing an informal claim and waiting to perfect it until after the IRS has indicated it is predisposed to allow the claim. This approach would allow a taxpayer time to evaluate the merits of the informal claim, its likelihood of proceeding to litigation, and other considerations that may affect whether the taxpayer wants to receive a formal claim disallowance and, with it, exposure to a section 6676 penalty.

Judicial Decisions Requiring Perfection of an Informal Claim for Refund

The requirement that a taxpayer file a timely claim for refund to recover a tax refund is statutory. (1) By contrast, the form and content of a refund claim are governed by the Treasury Regulations, (2) and courts have long held that a taxpayer need not file a formal refund claim in the manner prescribed by the regulations where (i) the taxpayer files an informal claim that satisfies the essential informational requirements of the regulations, (3) or (ii) the IRS waives any technical deficiencies by considering the merits of an informal claim. (4) Recently, courts have held that in those situations where the IRS has not waived the technical deficiencies, an informal claim is insufficient for jurisdictional purposes if the taxpayer did not perfect the claim.

1. Traditional Requirements for an Informal Claim

   There are "no set rules ... as to what constitutes an adequate informal claim," and "each case must be determined based on its own unique set of facts." (5) The courts, particularly the U.S. Court of Federal Claims, have historically required that an informal claim (i) provide notice to the IRS that the taxpayer is asserting a right to a refund, (6) (ii) include a description of the legal and factual basis for the refund, (7) and (iii) have a written component. (8) The underlying purpose of these requirements is to put the IRS on "notice of what the taxpayer is claiming and that [the taxpayer] is in fact making a claim for refund." (9)

2. The Perfection Requirement

   Recently, several Circuits and the Court of Federal Claims

   have held that, in addition to the above requirements, a taxpayer must perfect an informal claim after the lapse of the statutory period but before the IRS has rejected the claim. A taxpayer perfects an informal claim by filing a "formal claim that remedie[s] any defects in the informal claim." (10) The principal cases may be summarized in chronological order, as follows:

   * Fifth Circuit. In PALA, hw. Empl. Profit Sharing Plan and Trust Agreement v. United States, the Fifth Circuit held that the taxpayer's letter to the IRS, which provided "ample notice" of a right to a refund, did not constitute an informal claim in part because it "was not subsequently amended by a formal claim." (11)

   * Eighth Circuit. After stating that an "informal claim ... must have been followed by a formal claim that remedied any defects in the informal claim," the Eighth Circuit found that the taxpayers in Kaffenberger v. United States properly perfected their informal claim (which had been made on an automatic extension request directing the IRS to apply a refund of their estimated tax overpayments for the tax year in question to the subsequent year) by filing a late original return (which was prepared by the IRS) for the tax year in question. (12)

   * Ninth Circuit. Finding "no evidence that [the taxpayer] made a technically-deficient claim within the statutory period," the Ninth Circuit stated in Commissioner v. Ewing that "any such informal claim 'must have been followed by a formal claim that remedied any defects in the informal claim.'" (13)

   * Seventh Circuit. In Greene-Thapedi v. United States, a pro se taxpayer sued for refund of a 1999 overpayment that the IRS had applied against a 1992 tax liability, and after the district court held that "her Tax Court petition concerning her 1992 taxes ... and the refund claim for her 1999 overpayment" constituted a "sufficient informal claim for refund of her 1992 overpayment," the Seventh Circuit reversed on the ground that the taxpayer's "subsequent failure to file a formal claim barred the court from exercising any jurisdiction over the claim." (14)

   * Court of Federal Claims. Although the taxpayer's facsimile transmittal and telephone conversations with the IRS in Pennoni v. United States "were sufficient to meet the criteria for an informal claim," the Court of Federal Claims held that it "lack[ed] subject matter jurisdiction to consider his claim" because "the [taxpayer] failed to perfect his informal claim for a refund by filing a formal claim with the IRS." (15)

   District courts in the Second and Fourth Circuits have likewise held that a taxpayer must perfect an informal claim. (16)

   The courts have relied on three principal grounds for requiring perfection. First, the courts have cited Kales v. United States, the seminal case on informal claims, in which the Supreme Court stated:

   This Court, applying the statute and regulations, has often held that a notice fairly advising the Commissioner of the nature of the taxpayer's claim, which the Commissioner could reject because too general or because it does not comply with the formal requirements of the statute and regulations, will nevertheless be...