Principal Life -- A Masterpiece of Tax Procedure (11/29/13)

In my last Tax Procedure Class, we spent most of the class discussing Principal Life Ins. Co. v. United States, 95 Fed. Cl. 786 (Fed. Cl. 2010).  The Court's slip opinion is here; students can link to a nonofficial version (Harvard Caselaw Access Project) but with local page citations, here.  I do ask, however, that students download the actual case with the local page citations. 

The reasons I think the case is important are: (i) it is a tax procedure case; (ii) it is a tour de force tax procedure case; and (iii) it covers a lot of ground that we covered earlier in the class.  I promised the students that I would post a blog on the case in order to help them learn Tax Procedure and, even, study for the examination.  THIS POSTING IS NOT INTENDED AND SHOULD NOT BE USED AS A SUBSTITUTE FOR ACTUALLY READING AND STUDYING THE CASE.

Judge Allegra (Wikipedia here) introduces the case as follows:

"The procedural aspects of the tax laws are of overriding importance in many controversies," one commentator has noted, "eclipsing or making moot substantive issues such as the allowance of deductions or credits, recognition or deferral of income, and methods of accounting." Theodore D. Peyser, 627-3rd Tax Management Portfolio, "Limitations Periods, Interest on Underpayments and Overpayments, and Mitigation" at 1 (2010). At times, the questions spawned by these procedures take on an almost "metaphysical" cast, Baral v. United States, 528 U.S. 431, 436, 120 S. Ct. 1006, 145 L. Ed. 2d 949 (2000), like "when is taxable income taxed?" The ontology needed to solve such abstruse inquiries comes not from philosophical tomes, but from Chapters 63 through 66 of the Internal Revenue Code of 1986, which supply interfused rules mapping the contours of commonly-used, but frequently-misunderstood, tax concepts such as "assessment," "deposit," and "overpayment." 

Though the background provided by these rules can be numbing in its intricacy, the dispute presented by the cross-motions for summary judgment pending before the court can be stated simply: Plaintiff, Principal Life Insurance Company and Subsidiaries (plaintiff or Principal) argues that it is entitled to certain overpayments because its taxes were not timely assessed by the Internal Revenue Service (IRS). Defendant responds that the taxes in question were timely assessed and that even if they were not, they are not recoverable as an overpayment. Plaintiff is wrong; defendant is right. It remains to explain why.

KEY FACTS:

The key tax years are 1999 and 2000.  Let's assume that the taxpayer -- a large corporation -- was a calendar year taxpayer which, on extension, filed on 9/15 of each succeeding year -- i.e., 9/15/2000 for the 1999 return and 9/15/2001 for the 2000 return.  That would mean that the normal statute of limitations for assessment would expire on 9/15/2003 and 9/15/2004.

A number of years (some before 1999) were being audited, so apparently the IRS requested consents to extend the statute of limitations, Form 872 (date-certain consent), extending the assessment statute of limitations for 1999 and 2000 until 12/31/04.

On 12/29/04, the IRS issued a notice of deficiency for the years 1999 and 2000.  This was 2 days before the assessment statute of limitations period expired.  Did the IRS then have to actually assess by 12/31/04?  No.  For review, you will recall Section 6213(a)(1), here, has two relevant provisions:  (i) it grants the taxpayer 90 days to file a petition in the Tax Court and (ii) it provides "no assessment of a deficiency * * * shall be made * * * until such notice has been mailed to the taxpayer, nor until the expiration of such 90-day * * * period."  In order to protect the assessment statute of limitations during that key 90 day period of prohibition, Section 6503(a)(1), here, suspends the assessment statute of limitations "for the period during which the Secretary is prohibited from making the assessment  * * *, and for 60 days thereafter."   As noted, Section 6213(a) prohibits assessment for 90 days, so the statute is suspended for that 90 days and another 60 days -- 150 days total suspension.

That is, if the taxpayer does not petition the Tax Court.  Principal Life did not petition the Tax Court.

DETOUR:  For review, although Principal Life did not file a petition, if it had filed a petition, the prohibition on assessment continues until the Tax Court decision becomes final.  See § 6213(a) ("Except as otherwise provided in section 6851, 6852, or 6861 no assessment of a deficiency in respect of any tax imposed by subtitle A * * * shall be made * * * until such notice [of deficiency] has been mailed to the taxpayer, nor until the expiration of such 90-day * * * period, nor, if a petition has been filed with the Tax Court, until the decision of the Tax Court has become final.")  And § 7481, here, tells when the decision becomes final, but § 7485(a), here, lifts the prohibition on assessment when an appeal is taken unless a bond is filed.

So, let's compute the assessment statute of limitations based on the foregoing description of Section 6503(a).  The suspension period is:

+ 150 days from the date of the notice of deficiency (consisting of the 90 days while assessment is prohibited and the additional 60 days).  § 6503(a) .

There was 2 days left on the statute when the notice of deficiency issued, so it picks up when the extension expires.

+ 2 days left on the statute when the notice of deficiency was issued:

Total = 152 days from the date of the notice of deficiency.

So the statute would expire on 5/30/05, which is a Monday.  (Being a Monday, the suspension for a holiday or weekend would not apply.)

The IRS then assessed the tax on 5/27/05.

In the final analysis, that made the assessment timely.  But the journey in getting to that final conclusion is where the fun is.

With large dollars at stake -- over $300 million in tax and penalty, plus interest accrued from the due dates of the returns -- the taxpayer preferred some other analysis that would, it asserted, mean that the statute of limitations had closed by the assessment date 5/27/05 and that the taxpayer could be refunded the amount paid.

A couple of extra facts are required for the taxpayer's argument.

• On 1/13/05, the taxpayer wire transferred a remittance to the IRS and sent a contemporaneous letter designating the remittance as a deposit rather than a payment.  Students need not right now review the deposit / payment distinction as now incorporated in Section 6603, here, because they can do that at a later point in the blog  For present purposes, there is no question that the remittance was a deposit at the inception.  According to footnote 1, Principal Life made the deposit to stop the accrual of interest.  Note in this regard, that if a deficiency were ultimately sustained, the deficiency would easily be large enough to have the 2% interest add-on for "hot interest."
• On 1/28/05, the taxpayer sent the IRS a letter designating the deposit as payment.  The IRS did not act on that letter designation immediately.  Footnote 3, p. 789, in the decision indicates that the taxpayer intended to forego its right to litigate in the Tax Court and, instead, to litigate in a refund suit in the district court.  
• On 5/27/05, the IRS made the assessment and, consistent with procedures, applied the deposit as a payment.

The legal superstructure for the taxpayer's argument is as follows:

1. Section 6213(a) does, in fact, prohibit an assessment for 90 days if, as here, the taxpayer does not petition the Tax Court.
2. However, Section 6213(b)(4) provides "Any amount paid as a tax * * * may be assessed upon the receipt of such payment notwithstanding the provisions of subsection (a)."
3. So, the taxpayer argued, the IRS was not prohibited from making the assessment as of 1/28/05, the date the taxpayer instructed the IRS to treat the deposit as a payment.  That, the taxpayer argued, is the command of Section 6213(b)(4).
4. The IRS should be deemed to have made the payment on or around the date so instructed, in which case, the statute should expire 62 days after 1/28/05 or perhaps 1 or 2 days later.  62 days after 1/28/05 is 3/31/05, well before the assessment was made.  Even if a few days were allowed for the IRS to implement the taxpayer's payment instructions, the statute of limitations on assessment would have expired by the actual assessment date.
5. Checkmate, the taxpayer urged, and demanded a refund.

The IRS disagreed.  Judge Allegra held for the IRS.  Why?  The taxpayer's argument seems to be a straightforward analysis of the textual provisions, except perhaps the key construct that the IRS must be deemed to have applied the deposit as a payment upon instructions of the taxpayer.  Note in this regard that Section 6213(b)(4) requires payment in order to lift Section 6213(a)'s prohibition on assessment.  The actual payment per the IRS's internal processes did not occur until the date of assessment, 5/27/05.  But, the taxpayer urged, he had converted the deposit into a payment earlier regardless of what the IRS may have done as a ministerial act of following the taxpayer's instructions on 1/28/05.

So, let's go through the decision and see how Judge Allegra analyzed the argument.  To the students, I encourage you to read the opinion, for it has a lot of nuance that will not show up in my outline of the steps in the reasoning.

1. The basics (pp. 790-792).

a. Liability for the tax is not the same as assessment for the tax.  The assessment is merely the recording of the tax liability on the books. Liability precedes assessment.  Actually, the assessment is not even preclusive as to the liability.  A taxpayer can pay a tax that is assessed and then sue for refund.  But, the assessment permits the IRS to treat it is a tax liability and use its administrative collection tools to collect the amount assessed (plus interest).  The assessment serves a "collection propelling" function.  Further, the assessment creates a new statute of limitations -- this time for collection of the taxes assessed.

2. The Taxpayer's Key Argument is Questionable (pp. 792-796).

a. Sections 6213(a) and (b)(4) and Section 6503(a)(1). are covered, in basically the same terms as noted above.  Judge Allegra states the taxpayer's argument based on 6514(b) as noted above:  "Plaintiff presumes – albeit without supporting analysis or citations – that if the deposit in question was converted into a payment, the statute of limitations in section 6501 began running again under section 6503(a)(1) because the amount so paid could then be assessed under section 6213(b)(4)."  And, amazingly, the Government did not challenge the presumption.

b. But wait, Judge Allegra says, Section 6503(a)(1) "section 6503(a)(1) does not quite say that the running of the period of limitations is suspended only when the Secretary is prohibited from making an assessment."

c. Reading the relevant provisions together (see Judge Allegra's analysis), in the court's estimation, these provisions, taken together, raise the prospect that section 6503(a) suspends the statute of limitation on assessments for at least 150 days – until sixty days after the ninety days in which a Tax Court petition could be filed, and, if the Tax Court petition is filed, until the decision of the Tax Court is final. And this is so irrespective of whether a "payment" was effectuated during this suspension period."  This is the plain language interpretation of the regulation.  Reg. § 301.6503(a)-1(a)(1) ("Upon the mailing of a notice of deficiency for income * * * tax under the provisions of section 6212, the period of limitation on assessment * * * is suspended for 90 days after the mailing of a notice of such deficiency * * *, plus an additional 60 days thereafter.")  The Court found support in the regulation, but did not cite Chevron as lending further force to the straight-forward interpretation of the regulation.

d. And, that is where the Court ended up with a textual analysis of the statute, as seasoned by review of its legislative history.  The analysis is exceptional.

e. So, although concluding that Section 6503(a)(1)'s suspension applies for the full 90 day period in Section 6213(a) even if some event has occurred to give the IRS the power to assess, Judge Allegra declines to decide the case on that basis because defendant had not argued it.  Judge Allegra says, however, that the discussion -- although not the basis for decision -- lays a good foundation for considering the arguments that were made.

3. Did the Taxpayer's Letter Convert the Deposit into a Payment? (pp. 796-803)

a. Judge Allegra now goes through the traditional distinction between a deposit and a payment.  Judge Allegra begins with the key Rosenmann case and its judicial progeny we discussed in the class.  Rosenman v. United States, 323 U.S. 658 (1945).  This is a good review of that concept.  Judge Allegra then discusses Section 6603(a) designed to bring coherence to the deposit / payment distinction and its administration.  We studied Section 6603, here, also.

b. Judge Allegra dodges the issue of the retroactive application of a subsequent Revenue Procedure supporting the Government, by concluding that, based on his review of the statute and history as well as the Revenue Procedure extant at the key time (not the subsequent one),  the extant Revenue Procedure "anticipated that a deposit made after the completion of an examination would remain just that – a "deposit" – until at least the time expired for filing a Tax Court petition."  This would mean that the full Section 6213(a) ninety days would apply.  Judge Allegra rejected the taxpayer's argument that his expectations that the letter directing immediate treatment as payment were reasonable or, even if reasonable, carried the day.

4. The Overpayment Argument (pp. 803-808)
.
a. Nevertheless, even if the taxpayer's argument were correct that the 1/28/05 letter operated to transform the deposit into a payment which, along with its first argument would mean that the assessment was not timely, the taxpayer is still not entitled to have the "payment" refunded.  It is true that Section 6401)(b) states that ""[t]he term 'overpayment' includes that part of the amount of the payment of any internal revenue tax which is assessed or collected after the expiration of the period of limitations properly applicable thereto." Continuing, Judge Allegra says, "Read in isolation this subsection supports plaintiff's claim that, assuming arguendo the assessment here was untimely, an 'overpayment' occurred."  The argument is that a payment within the assessment statute of limitations which is not assessed until after assessment statute has expired creates an overpayment that must be refunded.  Judge Allegra concludes that the argument flies in the face of contextual statutory analysis, the legislative history and many decided cases.  Students need to read his analysis to see how a great mind with hard work gets it right.

5. The conclusion p; 808):

The assessment in question was timely. And, even if it was not, plaintiff is entitled to no refund under section 6401(a) of the Code. Instead, plaintiff will have to prove that it is entitled to a refund based on the merits of its claims.

Those wanting to pursue this issue further might want to consider New York Life Ins. Co. v. United States, 118 F.3d 1553 (Fed. Cir. 1997), cert. denied, 523 U.S. 1094 (1998), here, where the taxpayer made a large remittance within the assessment statute of limitations that the IRS treated as a payment, but the IRS failed to make the assessment timely.  The taxpayer there did not make the argument taxpayer made in Principal Life, but rather urged that the remittance was a deposit and therefore that the taxpayer could have the principal returned (without interest).  Note that, under the holding in Principal Life, a timely payment but untimely assessment precludes refund.  Hence, that is why New York Life was willing to leave interest on the table and go for only the principal as a deposit for which the statute was still open.