Court Holds That IRS Waited Too Long to Recover Excess Interest via Refund Offset

(Parker Tax Publishing April 2023)

The Court of Federal Claims held that the IRS improperly withheld refunds it provided to a taxpayer in 2020 as offsets against excess overpayment interest it paid to the taxpayer in 2017 because the offset was effected after the expiration of the two-year statute of limitations under Code Sec. 6532(b). The court also held that the IRS's retention of excess overpayment interest through an offset is not a valid exercise of the common law right of recoupment. Kyocera AVX Components Corp. v. U.S., 2023 PTC 69 (Fed. Cl. 2023).

Background

In 2016, Kyocera AVX Components Corp. (AVX) filed refund claims with the IRS for tax years 2007 and 2008. AVX requested the refunds on the basis of net operating losses incurred in tax year 2014 and carried back to 2007 and prior years, and on the basis of certain carryforward tax credits. AVX claimed it was due a refund of more than $13 million for tax year 2007 and claimed a $5.6 million refund for tax year 2008.

In 2017, the IRS notified AVX that it had decided to allow some portions of the refund claims for tax years 2007 and 2008. It issued refund payments to AVX in 2017 for the allowed amounts. In addition, the IRS provided AVX with almost $1.8 million in overpayment interest for tax years 2007 and 2008. Overall, the IRS made payments to AVX in 2017 totaling $10.5 million for 2007 and $3.7 million for 2008.

AVX continued to pursue the allowance of more of its refund claims for tax years 2007 and 2008 which, as noted, it based on certain tax credits. On October 23, 2019, the IRS agreed to allow an additional $2.4 million refund for 2007 and $2.2 million for 2008.

In the course of preparing to make these additional refund payments, however, the IRS discovered that it had erred when calculating the overpayment interest due AVX in connection with the refund payments it provided in 2017. As a result, it had paid AVX $1.34 million more than it was entitled to receive. In addition, the IRS discovered that in 2017 it had refunded roughly $60,000 in excessive deficiency interest. When the IRS issued the additional refund payments in 2020, it withheld $1.4 million from them to offset the overpayment interest it erroneously provided AVX in 2017 as well as the excess deficiency interest it had refunded.

In 2021, AVX filed a complaint in the Court of Federal Claims, requesting a refund of the $1.4 million that the IRS withheld in 2020. AVX filed a motion for judgment on the pleadings. In its motion, AVX argued that the two-year statute of limitations under Code Sec. 6532(b) on suits to recover erroneous refunds barred the IRS from reducing AVX's 2020 refunds to recover the $1.34 million in overpayment interest that the IRS paid it three years earlier. AVX contended that the offsets were illegal under Pacific Gas & Electric v. U.S (PG&E), 417 F.3d 1375 (Fed. Cir. 2005), in which the Federal Circuit held that the IRS's ability to offset erroneously paid statutory interest against a taxpayer's refund claim is subject to the two-year statute of limitations under Code Sec. 6532(b).

The government argued that this case was factually distinguishable from PG&E. It pointed out that the 1988 and 1992 refunds in PG&E originated from separately filed refund claims covering the 1982 tax year. Further, in PG&E, according to the government, the IRS "fully resolved" the first refund claims in 1988. The taxpayer later filed "additional refund claims," the government noted, and in 1992, the IRS issued a "subsequent refund" against which it offset the excessive overpayment interest from four years earlier. In contrast, the government argued, AVX filed a single refund claim for 2007 and a single refund claim for 2008. Also, in this case, according to the government, the payments the IRS made in 2017 were only "interim" in nature, and AVX's 2007 and 2008 claims were not finally resolved until 2020. The government characterized the 2017 and 2020 payments as merely components of the same, ongoing refund claims. In that context, the government argued that it would be illogical to bar the IRS from correcting errors made in processing those same claims. Alternatively, the government contended that the IRS's offset constituted an exercise of the common law right of recoupment. This argument was available to the government because the Federal Circuit expressly declined to address the applicability of the equitable recoupment doctrine in PG&E.

Analysis

The Court of Federal Claims held that AVX was entitled to a refund under PG&E because the IRS's offset to recover the excess overpayment interest was barred two-year limitations period under Code Sec. 6532(b). The court also held that the offset was not authorized under the common the law right of recoupment.

The court noted that in PG&E, the Federal Circuit distinguished a line of cases which recognize the IRS's right - without regard to any applicable limitations period - to offset a tax liability against a refund otherwise due for the same tax year. The Federal Circuit explained that the right of offset that emerged from these cases was based on the recognition that the IRS has no obligation to issue a refund when the taxpayer still owes taxes for the same tax year. In PG&E, the Federal Circuit concluded that the rationale for permitting offsets beyond the limitations period does not apply where the IRS seeks to offset a debt that is not a tax liability component or assessable. According to the Federal Circuit, when the IRS provides a taxpayer too much overpayment interest, the taxpayer owes the excess payment amount to the government because they have been unjustly enriched by it, not because they have not paid their taxes. Offsetting excessive overpayment interest against a tax refund, the court observed, was instead akin to a cause of action by the government in a suit to recover the erroneous interest and therefore, the two-year statute of limitations applies.

The Court of Federal Claims found that the distinctions the government drew between the taxpayer's refund claims in PG&E and AVX's claims seemed contrived. However, the court said that more to the point, PG&E did not turn on the manner in which the refund claims in that case were presented or resolved. In the court's view, the Federal Circuit's decision centered on the nonassessable nature of the overpayment interest that the IRS paid the taxpayer when it granted the first of the refund claims.

Turning to the government's equitable right of recoupment argument, the court explained that recoupment is an offset involving debts arising out of the same transaction. Because the right is in the nature of a defense arising out of some feature of the transaction upon which the plaintiff's action is grounded, it is not barred by the statutory limitations periods as long as the main action itself is timely. The court noted that in this case, AVX filed refund claims based on the fact that it overpaid its taxes for 2007 and 2008. The court observed that the government's assertion that it was entitled to recover the excess statutory interest it paid AVX in 2017 was not a defense to AVX's claim that it overpaid its tax liabilities. Nor, in the court's view, were the erroneous calculation of overpayment interest and the events that formed the basis for AVX's refund claims part of the same transaction. The court also noted that, since the Supreme Court first recognized the right of recoupment in tax cases, it has upheld its application in only two such cases: Bull v. U.S., 295 U.S. 247 (1935), and Stone v. White (301 U.S. 532 (1937). The court found that in both cases the doctrine applied where a single transaction or taxable event had been subjected to two taxes on inconsistent legal theories, and what was mistakenly paid was recouped against what was correctly due. However, the court found that in this case, the government's claimed right of recoupment did not involve any taxable event or taxable transaction at all, nor did it involve the taxation of a single transaction based on two inconsistent theories.

With respect to the excess deficiency interest paid to AVX, the court found that this offset was not subject to the statute of limitations because deficiency interest is part of a taxpayer's tax liability. Such interest, the court explained, is therefore taken into account in determining whether an overpayment exists and whether the IRS in fact owes a refund. Thus, the court concluded that the IRS could offset deficiency interest against a taxpayer's refund claim for the same tax year even though the statute of limitations prohibits the IRS from assessing the outstanding interest.

For a discussion of the IRS's right to offset overpayments against unpaid taxes, see Parker Tax ¶260,520. For a discussion of the statute of limitations on suits by the government to recover excess refunds, see Parker Tax ¶261,180.

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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