In CreditGuard of America, Inc. v. Commissioner, 149 T.C. No. 17, the Tax Court has held that, as a result of the IRS retroactively revoking the tax-exempt status of CreditGuard of America, Inc. (Taxpayer) to 2002, interest on corresponding unpaid taxes should be calculated from the last date prescribed for payment of the Taxpayer's 2002 income tax — which was the date the Taxpayer's 2002 corporate income return (Form 1120) was due.

Facts

Taxpayer was incorporated in 1991 and received recognition as a tax-exempt Section 501(c)(3) organization from the IRS in 1993. In May 2003, Taxpayer filed its Form 990, Return of Organization Exempt from Income Tax, for its calendar year-end 2002 tax year. In December 2003, the IRS began an examination of Taxpayer's 2002 Form 990. In February 2012, at the conclusion of the examination and the succeeding administrative process, the IRS issued Taxpayer a final adverse determination letter revoking its tax-exempt status retroactively to January 1, 2002.

As a result of the retroactive revocation of tax-exempt status, Taxpayer became obligated to file a Form 1120, U.S. Corporate Income Tax Return, for 2002. When Taxpayer failed to file a Form 1120 for 2002 following the revocation, the IRS issued a substitute tax return. After Taxpayer failed to pay the tax on that substitute return, the IRS issued a notice of deficiency and Taxpayer filed a Tax Court petition. In that initial Tax Court case, the Court entered a stipulated decision that Taxpayer's 2002 income tax deficiency amounted to $216,547. The Court's decision further stipulated that interest be assessed on the deficiency "as provided by law."

On March 13, 2013, the IRS assessed the $216,547 deficiency plus interest in the amount of $142,185. In attempting to collect on the tax and interest, the IRS issued a notice of tax lien against Taxpayer. Subsequently, Taxpayer requested a Collection Due Process hearing with the IRS. After numerous telephone and e-mail exchanges, Taxpayer and a Settlement Officer from the IRS Appeals Office met and began to discuss the proper timing of the calculation of interest. The IRS computed the interest from the statutory due date then in effect for filing a 2002 calendar year Form 1120 — i.e., March 17, 2003. Taxpayer disputed the interest assessment, arguing that the earliest date for which the IRS could assess interest was the date on which it assessed the deficiency — i.e., March 13, 2013. Taxpayer also requested that the lien be removed. The IRS Settlement Officer rejected the arguments brought by Taxpayer on these matters. On December 17, 2015, the IRS sent petitioner a notice of determination sustaining its collection action. On January 19, 2016, Taxpayer petitioned the Tax Court a second time, which is the subject of this Alert.

In its second Tax Court petition, the Taxpayer asserted that the IRS unlawfully assessed interest, and that interest should have been calculated from the date the IRS mailed Taxpayer its final adverse determination letter (February 1, 2012). Taxpayer and the IRS filed cross-motions for summary judgment.

Analysis

The Court explained that Taxpayer became obligated to file a Form 1120 for 2002 when Taxpayer's exempt status was revoked. The Court added that interest on corresponding unpaid taxes runs from "the last date prescribed for payment" (Section 6601(a)(1)), which corresponds to the date for filing the return (Section 6151) — which, in this case, was March 17, 2003 (Section 6072(b)).

While before the Tax Court, however, Taxpayer argued that interest on its unpaid 2002 taxes should be computed starting from February 1, 2012, the date that the IRS mailed the letter revoking Taxpayer's exempt status. Taxpayer argued that it could not have paid its tax liability timely because it did not know on March 17, 2003, that this liability existed. Taxpayer further asserted that it was recognized as tax-exempt in 2002 and was not required to file a Form 1120 until its exemption was revoked. It contended that Section 6601(b)(5) should control. Section 6601(b)(5) provides, with respect to "taxes payable by stamp and in all other cases in which the last date for payment is not otherwise prescribed," the last date for payment shall be the date the liability arises. Taxpayer argued that the liability did not arise in March 2003.

The Court disagreed with Taxpayer, concluding that Section 6601(b)(5) did not apply. The Court explained that Section 6601(b)(5) applies to "taxes payable by stamp" and other taxes for which a date is not prescribed. The Court stated that a date was prescribed for 2002 corporate filers — March 17, 2003. Moreover, even if Section 6601(b)(5) did apply, the Court concluded that it would not help Taxpayer's case. The Court explained that Taxpayer's tax liability did not "arise" when the IRS revoked Taxpayer's exempt status, when the initial Tax Court-stipulated decision was rendered, or when the IRS assessed the deficiency. Rather, the Court determined that the liability arose as of the due date for corporate returns for calendar year 2002 — the year to which Taxpayer's exemption had been retroactively revoked.

The Court pointed out that the appropriate law is found in Section 6601(a)(1), which stipulates that interest on unpaid taxes is calculated from "the last date prescribed for payment" of the tax. Section 6151 generally states that taxes shall be paid at the time fixed for filing the corresponding return, determined without regard to any extension of time for filing the return. Under Section 6072(b), corporate returns for 2002 calendar-year filers were due on March 17, 2003 (because March 15, 2003, fell on a Saturday).

The Court explained that a retroactive revocation "is not just a slap on the wrist; it has real tax consequences." The underlying premise of the retroactive revocation was that Taxpayer was not in fact tax-exempt in 2002 and it had a tax obligation, which it did not pay on time. Accordingly, it now owed corresponding interest. The Court added that it doesn't matter that Taxpayer did not know that it had a tax liability at the time; interest assessments are not negligence penalties. Citing other authorities, the Court stated that interest payments are compensatory and not a penalty. Because Taxpayer should have paid taxes in 2002 but did not, the government should be restored to the position it would have been in had the payments been timely made.

Accordingly, the Court held that interest on the $216,547 deficiency should be calculated from March 17, 2003 (as asserted by the IRS). The Court added that Taxpayer "supplied no reason, in law or logic, why it should not have to pay interest as any other corporate taxpayer would have to do." The Court likewise dismissed Taxpayer's argument that the IRS Appeals settlement officer abused his discretion.

Implications

Generally, the IRS can only assess taxes within a three-year statute of limitations period (six years for a substantial omission of gross income) that begins running as of the later of the return due date or date the return is filed (see Section 6501(a)). Tax may be assessed at any time for a false or fraudulent return, a willful attempt to evade tax or when no return is filed. If the organization is under examination by the IRS, however, Section 6501(c)(4) allows the statute of limitations to be extended by written agreement between the IRS and the taxpayer, as long as the consent is executed while the statute of limitations is still open. For tax-exempt organizations, a good faith filing of Form 990, where the organization determines in good faith that it is a tax-exempt organization, is considered to be a filing of the tax return, and consequently will generally begin the statute of limitations period (see Section 6501(g)(2)).

This case is a stark example that organizations suffering retroactive revocation of tax-exempt status may be liable for taxes plus interest dating back many years for periods under examination. In the present case, because the dispute with the IRS lasted for many years following commencement of the IRS's examination of the 2002 year, the taxpayer was likely charged with interest calculated over 11 years for unpaid 2002 taxes. The ruling clearly demonstrates that the calculation of interest applies to the period that the organization is determined to be taxable and not the date the IRS issues its adverse determination revoking tax-exempt status. Organizations undergoing examinations involving revocation issues should be cognizant of this consequence should they not prevail in their dealings with the IRS.

Please contact your EY professional for further information.

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RELATED RESOURCES

— For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg.

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