Federal Circuit: Lower Interest Rate on Refunds Applies to Nonprofit Corporations

(Parker Tax Publishing November 2019)

In a case of first impression, the Federal Circuit held that the interest rate provided in Code Sec. 6621(a)(1) for calculating the interest that applies to a tax refund owed to a "corporation" applies not just to for-profit corporations but also to nonprofit entities incorporated under state law. The Federal Circuit court joined the Second, Sixth, Seventh, and Tenth Circuits in concluding that a nonprofit entity that is incorporated under state law is a corporation under Code Sec. 6621(a)(1). Charleston Area Medical Center, Inc. v. U.S., 2019 PTC 407 (Fed. Cir. 2019).

Facts

Charleston Area Medical Center, Inc., and CAMC Health Education and Research Institute, Inc. (collectively, CAMCs), are non-stock, not-for-profit, Code Sec. 501(c)(3) organizations incorporated in West Virginia. Although generally exempt from federal income tax, the CAMCs are not exempt from taxes on wages from employment under the Federal Insurance Contributions Act (FICA). In 2010, the IRS determined that medical residents are exempt from FICA taxes and applied this determination retroactively. The IRS issued tax refunds to the CAMCs, which had paid FICA taxes on medical residents during 1995-2005.

Code Sec. 6621 establishes the rates for interest on tax overpayments and underpayments. Under Code Sec. 6621(a)(1), a lower interest rate applies to overpayments of tax by a corporation than applies to overpayments by noncorporate taxpayers. The IRS paid interest on the refunds of CAMCs' overpayments by applying the interest rate for corporations. The CAMCs thought that the IRS should have applied the higher interest rate for noncorporations and determined that, had the IRS done so, the CAMCs would have received approximately $1.9 million in additional statutory interest.

The CAMCs filed an action in a district court with a third entity, Wichita Center for Graduate Medical Education (Wichita), arguing that the higher rate for noncorporate taxpayers should have been applied. The district court dismissed CAMCs action for lack of venue, leaving Wichita as the only remaining taxpayer in the case. In 2017, the district court later granted summary judgment for the government, ruling that the term "corporation" in Code Sec. 6621(a)(1) includes nonprofit entities. Wichita appealed and the Tenth Circuit affirmed the district court's decision. In October 2017, the CAMCs and 290 other similarly-situated entities filed an action in the Claims Court. The Claims Court also held that a "corporation" for purposes of Code Sec. 6621(a)(1) includes nonprofit entities. The CAMCs appealed to the Federal Circuit.

Definition of Corporation

Code Sec. 6621 does include a definition of the term "corporation." Code Sec. 7701(a)(3) generally defines corporations to include associations, joint-stock companies, and insurance companies. The regulations under Code Sec. 7701 that were issued in 1960 and which remained in effect through 1996 (i.e., the Kintner regulations) treated unincorporated associations with certain characteristics as corporations for tax purposes. These characteristics included (1) associates, (2) an objective to carry on business and divide the resulting gains, (3) continuity of life, (4) centralization of management, (5) liability for corporate debts limited to corporate property, and (6) free transferability of interests. The Kintner regulations were replaced in 1997 with the current check-the-box regulations which apply a simpler classification approach. Under Reg. Sec. 330.7701-2(b)(1), a corporation means a business entity organized under a federal or state statute, if the statute describes or refers to the entity as incorporated or as a corporation.

Taxpayer's Arguments

The CAMCs argued that nonprofits are excluded from the definition of "corporation" for purposes of Code Sec. 6621(a)(1). According to the CAMCs, the categories of entities enumerated in Code Sec. 7701(a)(3) are all necessarily for-profit, and therefore do not cover nonprofits. The CAMCs reasoned that previous versions of Code Sec. 7701(a)(3) limited the definition of "corporation" to only for-profit entities and that the amendment resulting in the current version of that statute did not expand the meaning to include nonprofits. Under principles of statutory construction, the CAMCs argued that Code Sec. 6621(a)(1) had to be read symmetrically with the provisions in Code Sec. 6621(c)(3) governing underpayments, and that subsection defines "large corporate underpayment" as any underpayment of tax by a C corporation. The CAMCs also contended that the characteristics of a corporation laid out in the Kintner regulations contemplated the generation of profits and thus were directed at for-profit entities, and that they were the governing definition for "corporation" when Congress enacted Code Sec. 6621. Finally, the CAMCs pointed to IRS Notice 2018-12, in which the IRS announced its intention to issue regulations providing that the term "corporation" for purposes of Code Sec. 1061(c)(4)(A) does not include an S corporation. According to the CAMCs, Notice 2018-12 supported its argument for a narrow definition of "corporation."

Federal Circuit's Analysis

The Federal Circuit rejected the CAMCs' arguments and held that the term "corporations" in Code Sec. 6621(a)(1) includes nonprofit entities. First, the court noted that one of the entities enumerated in Code Sec. 7701(a)(3), associations, are not strictly for-profit entities and therefore inferred that the statute contemplates a broader definition of corporation that is not limited to for-profit entities. The court observed that in 1918, Congress amended the predecessor to Code Sec. 7701(a)(3) to remove the limiting phrase "organized in the United States for profit." According to the court, this change showed that Congress meant to expand the definition of a corporation to nonprofit entities.

However, the court determined that its analysis of Code Sec. 7701(a)(3) did not resolve the issue, so it considered the customary meaning "corporation" and concluded that under the historical, common law understanding of the term, nonprofit entities like the CAMCs could be corporations. The court further found that this ordinary meaning of "corporation" was consistent with its use in the Code. The court explained that there are three basic types of corporations addressed in separate subchapters the Code: nonprofits, C corporations, and S corporations, and in each subchapter, the covered entities are referred to as corporations. The court noted, for example, that in Code Sec. 501, nonprofit entities are generally exempt from federal income tax yet are still referred to as corporations. In the court's view, this demonstrated that Congress used the generic definition of "corporation" in Code Sec. 6621, which includes both for-profit and nonprofit entities.

The court rejected the CAMCs' argument that Code Sec. 6621(a)(1) had to be read symmetrically with Code Sec. 6621(c)(3), reasoning that principles of statutory construction cannot override the plain text of the statute. In the court's view, the CAMCs were making a policy argument that a taxpayer should not have to pay a higher interest rate for underpayments than the government pays for overpayments of taxes. The court said that outcome may seem unfair but is mandated by the text of the statute and can only be rectified by Congress. With respect to the Kintner regulations, the court observed that even if the CAMCs were correct that the characteristics listed in those rules seemed directed to for-profit entities, the purpose of those regulations was to aid in classifying entities that were not incorporated under state law but had certain other characteristics common to corporations and were thus still subject to tax. The court noted that the CAMCs were incorporated under state law and therefore would have been considered a corporation even under the Kintner regulations.

Finally, the court rejected the CAMCs' argument that Notice 2018-12 supported its interpretation. The court noted that the exclusion of S corporations from the definition of "corporation" referred to in Notice 2018-12 is solely for purposes of Code Sec. 1061. Moreover, the court said that the notice merely described regulations that had not yet been issued and that may never exist.

For a discussion of the rates used to compute interest on underpayments and overpayments of tax, see Parker Tax ¶261,520.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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