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Overpayment of Estate's Nondeferred Taxes Can Be Applied to Deferred Portion.
(Parker Tax Publishing July 1, 2014)

While Code Sec. 6402 requires the IRS to refund to the taxpayer any "balance" of over paid taxes, an estate had no balance to refund where it made an estimated estate tax payment and indicated it was going to defer estate tax under Code Sec. 6166; the overpayment of estimated taxes used for the nondeferred portion could then be applied to reduce the deferred portion. Estate of McNeely v. U.S., 2014 PTC 279 (D.C. Minn. 6/12/14).

On December 8, 2009, the Estate of Donald McNeely filed IRS Form 4768, requesting an extension of time in which to file the estate's federal tax return. An estimated tax payment of $2,492,088 accompanied the extension request. In a cover letter, the estate also announced its intention to seek deferred estate tax treatment under Code Sec. 6166. The IRS replied in February alerting the estate can it only request a deferred payment election when a timely Form 706 estate tax return is filed. On June 9, 2010, the estate filed its estate tax return. Because the decedent's interest in his closely-held businesses exceeded thirty-five percent of the adjusted gross estate, the estate sought to pay estate tax on a deferred basis, pursuant to Code Sec. 6166. In addition, based on the estate's revised calculations in Form 706, the estate determined that the correct tax on the non-deferred portion of the federal estate tax - assuming that the IRS granted the Code Sec. 6166 request - was $512,223. Because it had previously estimated and paid $2,492,088, the estate requested a refund of $1,979,865. The estate noted that this would leave a balance of $8,613,651 on the deferred portion of the federal estate tax.

On August 2, 2010, the IRS responded, acknowledging that the estate's Code Sec. 6166 request was pending. The IRS also denied the estate's request for a refund, saying that Code Sec. 6403 required that the overpayment be credited against the unpaid installments. The IRS noted that the unpaid installments would be due 12/9/2014 through 12/9/2023. Thus, the IRS said, the $1,979,861 overpayment would be used beginning 12/9/2014 against the unpaid installments due. According to the IRS, under Code Sec. 6403, no refund was allowable until the total payments exceed the tax due.

The estate objected to the IRS's denial of a refund because it had directed the estimated tax payment to be applied to the "non-deferred portion of the federal estate tax." Further, the estate argued that Code Sec. 6403 did not apply to the non-deferred portion of the federal estate tax because it applies only to overpayments of taxes payable in installments. A final determination letter from the IRS said that, under Code Sec. 6402 and Code Sec. 6403, any overpayment had to be applied to reduce the balance of remaining estate tax due and could not be refunded. Courts have held that Code Sec. 6403 applies to Code Sec. 6166 estate tax deferred installment payments.

When an overpayment of tax occurs, the IRS has the authority under Code Sec. 6402 to credit the overpayment to certain other taxes and obligations owed by the taxpayer and to refund any balance to the taxpayer. In the case of a tax payable in installments, Code Sec. 6403 provides that if the taxpayer has paid as an installment of the tax more than the amount determined to be the correct amount of the installment, the overpayment is credited against the unpaid installments, if any. If the amount already paid, whether or not on the basis of installments, exceeds the amount determined to be the correct amount of the tax, the overpayment must be credited or refunded as provided in Code Sec. 6402.

Before a district court, the estate argued that Code Sec. 6403 did not apply to the overpayment of the nondeferred portion of its federal estate tax liability because the estate paid it before making the Code Sec. 6166 election. In addition, the estate said that Code Sec. 6402 required a refund of the overpayment, rather than a credit, in recognition of the estate's special rights to defer payment under Code Sec. 6166. The estate cited three decisions from other district courts in support of its position that the IRS improperly exercised its discretion to credit the overpayment. In each case, the taxpayer elected to defer estate tax payments under Code Sec. 6166. All three estate taxpayers made overpayments based on IRS valuation errors and were denied refunds. In each case, the respective courts granted a refund, rather than a credit to the taxpayers' future installments. According to one of the courts, Code Sec. 6166 creates a very valuable right for taxpayers and the proper application of Code Sec. 6402 is to credit overpayments against taxes then due but not to liabilities which by law come due in the future.

The district court held that the McNeely estate was not entitled to a refund. According to the court, Code Sec. 6402 and its related regulations demonstrate that Congress granted the IRS discretionary authority to apply overpayments to any tax liability. While Code Sec. 6402 also requires the IRS to refund any "balance" to the taxpayer, at the time the estate made its estimated payment, its net tax liability was over $9 million. As such, the estate paid $1,979,861 against the more than $9 million tax liability. Thus, there was no balance to refund. Moreover, the court said, even if Code Sec. 6403 were determined to be the applicable statute, the result would be the same because, if the amount of the overpayment exceeds the full amount of the tax due whether on the basis of installments or otherwise the IRS may either credit or refund the overpayment, as provided in Code Sec. 6402.

The McNeely court addressed and distinguished the Estate's cited cases, first noting that the Ninth Circuit reached the opposite conclusion. In Estate of Bell v. Comm'r, 928 F.2d 901 (9th Cir. 1991), court held that an overpayment of Code Sec. 6166 installments was governed by Code Sec. 6403, which permitted the IRS to credit overpayments against unpaid installments. The court found that Code Sec. 6403 was "clear and unambiguous" and observed that Code Sec. 6166 contained no specific language to negate the effect of Code Sec. 6403 in the case of overpayments.

Furthermore, the district court noted that in Estate of Shapiro v. Comm'r, 111 F.3d 1010 (2d Cir. 1997), the Second Circuit attempted to reconcile the holdings of the district court and Ninth Circuit cases. According to the Second Circuit, the district court cases which found in favor of the estates could, in fact, be reconciled with Estate of Bell by drawing out the implicit distinction: when the overpayment of a Code Sec. 6166 installment is voluntarily made (e.g., is the result of a mistake on the part of the taxpayer), it will be credited against outstanding installments under Code Sec. 6403, but when the overpayment is both the result of erroneous or wrongful conduct on the part of the government and made under protest by the taxpayer, it will be refunded to the taxpayer in order to preserve the taxpayer's statutory right to defer payment under Code Sec. 6166.

For a discussion of the special rule for installment payments of estate tax relating to interests in a closely held business, see Parker Tax ¶228,930. (Staff Editor Parker Tax Publishing)

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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