Couple Escapes Penalty after Falsely Claiming Refundable Tax Credits and Rebates
(Parker Tax Publishing November 20, 2013)
In a recent Tax Court case, a couple was hit with a penalty for claiming refundable tax credits to which they were not entitled. In Rand v. Comm'r, 141 T.C. No. 12 (11/18/13), the Tax Court was presented with the issue of whether or not those refundable credits must be taken into account when determining the amount shown as tax on a return for purposes of calculating the accuracy-related penalty under Code Sec. 6662. The taxpayers in Rand claimed a tax refund of over $7,000 based on those refundable credits. Both parties agreed that the correct amount of tax liability was $144, but disputed how the accuracy-related penalty under Code Sec. 6662 should be calculated. Specifically, the disagreement was over the number that should be used as the amount shown as tax on the return for purposes of computing the penalty. In a huge win for taxpayers, the court concluded that the correct number on which to base the penalty was zero.
OBSERVATION: With respect to the IRS's argument that the court was letting the couple off easy, the court noted that the IRS could have slapped the taxpayers with penalties for false or excessive claims for credits under Code Sec. 32(k) and Code Sec. 6676, which most likely would have been upheld.
Married taxpayers Yitzchok Rand and Shulamis Klugman filed a joint return for 2008 on which they reported approximately $18,000 of adjusted gross income. This income was reduced to zero by various deductions. The couple reported self-employment tax of $144, resulting in a total tax of $144. The total tax of $144 was reduced, below zero, by refundable tax credits. The couple claimed an earned income credit of $4,824, an additional child tax credit of $1,447, and a recovery rebate credit of $1,200. After taking into account the refundable credits, Rand and Klugman claimed an overpayment of $7,327, and that amount was refunded to them.
Subsequently, the IRS issued a notice of deficiency in which it determined that the couple was not entitled to the earned income credit, the child tax credit, or the recovery rebate. The IRS also determined that an accuracy-related penalty under Code Sec. 6662 applied. The IRS and the couple agreed that a penalty would apply if the Tax Court determined that there was "an underpayment of tax required to be shown on the return" within the meaning of Code Sec. 6662(a).
Under Code Sec. 6662, an accuracy-related penalty may apply to any portion of an underpayment of tax required to be shown on a return. The penalty is 20 percent of the portion of the underpayment. The term "underpayment" is defined by Code Sec. 6664(a) and consists of the following four components:
(1) the tax imposed;
(2) the amount shown as the tax by the taxpayer on his return;
(3) amounts not so shown previously assessed (or collected without assessment); and
(4) the amount of rebates made.
Three Different Theories
In addition to briefs presented by the IRS and Rand and Klugman, an amicus brief was presented by the Cardozo Tax Clinic, an organization that is part of Cardozo Law School and that represents low-income taxpayer in tax matters. Each brief had its own theory as to the correct amount that should be the amount shown as tax on the return for purposes of calculating the penalty under Code Sec. 6662.
With respect to the four components that make up the term "underpayment" as defined in Code Sec. 6664, all three briefs agreed that the first component (i.e., the tax imposed) was $144. They also agreed that the third and fourth components were zero. The dispute centered on the second component, the amount shown as the tax by the taxpayer on the return.
The IRS contended that the statutory phase "the amount shown as the tax" is ambiguous as to whether the amount includes the three refundable credits that the couple claimed on their 2008 return. The IRS urged the Tax Court to consult the definition of this phrase in Reg. Sec. 1.6664-2(c) and interpret the regulation to require that the couple's claims for the three credits be included in the computation of the amount shown as tax on their return. The IRS argued that its interpretation of the regulation should be afforded deference under the principle that an agency's interpretation of its own ambiguous regulation must be afforded deference. According to the IRS, the amount shown as tax on the return should be reduced by the refundable credits claimed on the return. Under this approach, the amount shown as tax on the return is ($7,327).
Rand and Klugman argued that the amount shown as tax on the return is calculated without regard to refundable credits. They argued that the provisions in the Code allowing tax credits clearly distinguish between credits and the taxes against which credits are applied. They cited the child tax credit provision in Code Sec. 24(a), which provides a "credit against the tax imposed by this chapter." The couple said this means that the additional child tax credit they claimed was not part of the tax shown on their return. Under this approach, they argued that the amount shown as tax on the return would be $144.
The couple also observed that in defining the amount of tax shown on the return for calculating a deficiency, Code Sec. 6211(b)(4) provides that the difference between (1) the refundable credits claimed on the return and (2) the amount shown as tax on the return (as determined without regard to refundable credits) is taken into account as a negative amount of tax. Because Congress did not enact a similar provision for the calculation of an underpayment, Rand and Klugman contended that Congress must have intended that refundable credits be excluded from the tax shown on the return in underpayment calculations.
The Cardozo Tax Clinic argued in its brief (and Rand and Klugman argued in the alternative) that the amount shown as tax on the return is reduced by the refundable credits but not below zero. Under this approach, the amount shown as tax on the return would be zero. The Clinic said that the tax shown on a return cannot be negative when calculating an underpayment because Congress purposefully declined to incorporate a provision like Code Sec. 6211(b) in the definition of an underpayment.
Tax Court Rejects IRS Position
The Tax Court looked to the definition of "underpayment" in Code Sec. 6664 and, relying on the principles of statutory construction, concluded that refundable credits must be taken into account when determining the amount shown as the tax by the taxpayer.
The court went on to say that, where the same words or phrase appear within a text, they are presumed to have the same meaning. The phrase "the amount shown as the tax by the taxpayer" appears three times in the Code. Two of those passages are related: the definition of a "deficiency" under Code Sec. 6211 and the definition of an "underpayment" under Code Sec. 6664. The court observed that, although not explicitly linked today, the definition of a "deficiency" under Code Sec. 6211 and the definition of an "underpayment" under Code Sec. 6664(a) are linked by history. Before amendment in 1989, the term "underpayment" was defined with an explicit cross-reference to the definition of a "deficiency." Thus, at one time, the terms "underpayment" and "deficiency" were coextensive. Although they are linked by history, the court stated, the fact remains that in 1989 Congress uncoupled these terms.
Despite detaching the definition of an "underpayment" from the definition of a "deficiency," the court noted that the legislative history of the 1989 amendment provides a standard definition of "underpayment" for all of the accuracy-related penalties. Given that Code Sec. 6211(a)(1)(A) and Code Sec. 6664(a)(1)(A) use the same phrase and that the two provisions are contextually and historically related, the court turned to Code Sec. 6211(a)(1)(A) to assist in interpreting if the credits could reduce the amount shown as tax by the taxpayer.
The court noted that while Code Sec. 6211(b)(4) specifically provides that certain refundable credits could be taken into account as negative amounts of tax, there is no counterpart to Code Sec. 6211(b)(4) in Code Sec. 6664. The court thus concluded that excess earned income credits, additional child tax credits, and recovery rebate credits do not result in a negative tax for purposes of calculating the amount shown as the tax by the taxpayer on his return. As a result, the penalty imposed on Rand and Klugman under Code Sec. 6664 was zero because the tax required to be shown on the return was zero.
While 10 Tax Court judges joined in the majority opinion, another five dissented. In one dissenting opinion, the judges took issue with the fact that the language of the Code refers to an amount "shown" on the return, but that the zero amount used by the majority was not "shown" anywhere. The dissent also noted that the IRS and the majority computed an amount that consisted of tax reduced by excess refundable credits, but that the plain meaning of the statutory language restricts the analysis to "tax" that is shown on the return, and the statutory language gives no warrant for injecting excess credits into the equation. The dissent also admonished the court's reliance on Code Sec. 6211(b)(4) in defining "tax shown" on the return (for purposes of an underpayment), saying that the approach relied too heavily on principles of statutory construction.
(Parker Tax Publishing Staff Writers)
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