Interest netting finally has become a reality. On July 22, 1998, President Clinton signed H.R. 2676,(1)(*). The "Internal Revenue Service Restructuring and Reform Act of 1998," which includes "interest netting," generally for interest accruing after date of enactment. Taxpayers have a window of opportunity, however -- until December 31, 1999 -- to request that interest netting be applied to interest accrued in periods prior to the date of enactment. This article reviews the legislation and describes some actions that should be taken by taxpayers to maximize the benefits of global interest netting.
Under prior law, if a taxpayer had an underpayment of tax from one year and an overpayment of tax from a different year that were outstanding at the same time, the IRS typically "offset" the overpayment against the underpayment and applied the appropriate rate of interest to the resulting net underpayment or overpayment. If either the underpayment or overpayment had been satisfied, however, the IRS would not typically offset the two amounts, but rather would assess or credit interest on the full underpayment or overpayment at the statutorily mandated underpayment or overpayment rate. This had the effect of assessing the underpayment at the higher underpayment rate and crediting the overpayment at the lower overpayment rate. This resulted in a net interest charge to the taxpayer, even if the amounts of the overpayment and underpayment were the same.
Example: The Government owes a corporate taxpayer
$10 million for 1995 and the taxpayer owes
the Government $10,000,000 for 1996. As of March
15, 1997, when the 1996 tax liability became due,
there is a mutual indebtedness between the Government
and the taxpayer until such amounts are
refunded or paid, respectively. If the debts are not
offset or netted, however, the taxpayer could pay
a whopping 4-1/2 percent differential ($450,000 a
year) on the interest it pays on the $10 million it
owes for 1996 as compared with the interest it
receives on the $10 million the Government owes
the taxpayer for 1995 even though there is no true
net debt (as of March 15, 1997) owed to the Government.(2)
Congress previously directed the IRS to implement the most comprehensive netting procedures that are consistent with sound administrative practice. The Taxpayer Bill of Rights 2(3) required the Treasury Department to submit a report to the congressional tax-writing committees on: (1) the legal and policy issues relating to the netting of interest of federal overpayments and underpayments; and (2) the administrative practices of IRS in that regard. On April 18, 1997, the Treasury study was released. The study concluded that "global" interest netting would be consistent with the intent expressed by Congress. The study added, however, that additional legislation was necessary to achieve this policy goal. It continued that because of administrative difficulties associated with global net ting, such netting should be authorized only if certain limitations were imposed. The following restrictions were recommended:
(1) Global interest netting should be implemented legislatively through an interest equalization approach rather than a credit/offsetting approach. This approach would not involve the offsetting of credits between years; rather, the interest rate would be adjusted to the extent taxpayers and IRS have overlapping periods of indebtedness. In effect, if the taxpayer is charged one rate on a $1 million deficiency for a two-year period, the taxpayer would receive the same rate on a $1 million overpayment to the extent that the $1 million deficiency and overpayment exist during the same time period (i.e., there is a period of mutual indebtedness.) The study further stated that at least one of the tax years involved must be a non-zero balance tax year.
(2) Global interest netting should be limited to income taxes only. The study stated that allowing global netting across different kinds of taxes would be difficult to administer and require significant additional resources. The necessity of locating and analyzing additional data for inclusion of these additional types of taxes in the calculations would increase the complexity of the netting regime.
(3) Global interest netting should apply only to tax years that are not barred by statute. The study stated that since principal amounts of underpaid or overpaid taxes in barred years are not considered in adjusting taxpayers' other tax year accounts, it does not make sense to consider the interest that was charged or paid with respect to those underpayments or overpayments. The administrative difficulties of including barred years in the computations were also cited. The study further stated that limitations on IRS computer systems, particularly relating to barred years, would increase the difficulty of interest netting computations if the barred years were considered. The availability of prior IRS interest computations was also cited as...