Summary

The Internal Revenue Service (IRS) has issued PMTA 2018-016, reaffirming its position that for taxpayers making an election under Internal Revenue Code (Code) Section 965(h) to pay the transition tax over eight years through installment payments, any overpayments of 2017 tax liabilities cannot be used as credits for 2018 estimated tax payments or refunded, unless and until the overpayment amount exceeds the full eight years of installment payments.

The IRS’s position has affected many taxpayers, and practitioners expressed their concerns to the IRS to no avail — we examine this surprising development in greater detail below.

In Depth

On August 8, 2018, the Internal Revenue Service (IRS) issued PMTA 2018-016 reaffirming its position that for taxpayers making an election under Internal Revenue Code (Code) Section 965(h) to pay the transition tax over eight years through installment payments, any overpayments of 2017 tax liabilities cannot be used as credits for 2018 estimated tax payments or refunded, unless and until the overpayment amount exceeds the full eight years of installment payments. PMTA 2018-016 relies on Code sections 6402 and 6403, and case law, for its position. This nonbinding legal advice from IRS Chief Counsel attorneys to IRS personnel marks the first time the IRS has provided to the public its reasoning on this subject. We have previously discussed this issue here and here, and, as discussed below, continue to believe that the IRS’s position is incorrect.

Code section 6402(a) provides that, in the case of any overpayment, the IRS may (within the applicable limitations period) credit the amount of such overpayment against any liability in respect of an internal revenue tax of the taxpayer who made the overpayment. Treas. Reg. § 301.6402-3(a)(6) provides that the IRS may credit any overpayment of income tax against any outstanding liability for any tax owed by the taxpayer making the overpayment. 

The IRS’s position is that payments in excess of the first installment amount due under Code section 965(h)(1) for 2017 are not “overpayments” because the entire transition tax is a 2017 tax liability. Thus, according to the IRS, absent an overpayment of the entire 2017 tax liability (which includes all eight installments of the transition tax) the IRS has no statutory authority under Code section 6402 to issue a credit or refund.

Code section 6403 provides:

In the case of a tax payable in installments, if the taxpayer has paid as an installment of the tax more than the amount determined to be the correct amount of such installment, the overpayment shall be 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 shall be credited or refund as provided in section 6402.

Similarly, the regulations under Code section 6403 provide that if any installment of tax is overpaid, the overpayment shall first be applied against any outstanding installments of such tax and if the overpayment exceeds the correct amount of tax due, the overpayment shall be credited or refunded as provided in Code section 6402 and the regulations thereunder.

The IRS’s position is that an election under Code section 965(h) to pay in eight installments makes the 2017 tax liability a tax payable in installments under the longstanding general principles of Code section 6403. According to the IRS, Code section 6403 does not set out the order in which excess payments are to be applied to remaining installments due and, therefore, the IRS will apply any excess amounts subsequent transition tax installment payments until such excess exceeds the amount of that installment due. The IRS relies on estate tax cases under Code section 6166 holding that overpayments of installments of estate tax must be applied to future installment payment obligations. The IRS has concluded that section Code 6403 does not permit the IRS to refund any excess installment payment prior to there being an overpayment of the entire liability as provided in section 6402.

On August 16, 2018, the National Taxpayer Advocate (NTA) posted IRS Administration of the Section 965 Transition Tax Contravenes Congressional Intent and Imposes Unintended Burden on Taxpayers.   The NTA expressed the position that Congress’ intent “seems pretty clear” in that taxpayer would have eight years to pay the transition tax liability with smaller payments amounts in early years and no interest due on any payments. The NTA indicated that the IRS’s interpretation in PMTA 2018-016 “sharply limits the value of Section 965(h), and in some cases, may even render it meaningless.” The NTA noted that it is common for large corporations to overpay their estimated taxes, including to minimize the risk they may become liable for underpayment interest. The NTA stated that while the IRS’s interpretation may be legally correct, members of the private sector have suggested that the IRS may be able to refund estimated taxes in certain situations (see below). Finally, the NTA noted that a request has been made to the IRS Office of Chief Counsel to re-examine this issue and consider alternative approaches.

In addition to the points made by the NTA, we note that Supreme Court precedent provides that an “overpayment” is defined as any payment in excess of that which is properly due. Future installment payments of the transition tax are not due in 2017; they are due in later years. This is consistent with Congress’ intent of allowing taxpayers to elect to pay the transition tax in eight backloaded, interest-free installments instead of all at once. It appears that the purpose of allowing taxpayers to make payments in eight installments was to lessen the liquidity burden of this one-time tax on a massive amount of foreign earnings. Further, Congress did not require that taxpayers pay interest on subsequent installment payment amounts (note that Code section 6601 generally requires interest on underpayments of tax).  Code section 965(h) is sui generis, and treating it like any other installment payment scenario clearly frustrates congressional intent.

With regard to PMTA 2018-016’s reliance on Code section 6403 and underlying case law under Code section 6166, Code section 965 is different from Code section 6166 in many respects. First, interest does not accrue on subsequent installment payments of the transition tax.  Second, taxpayers were required to make two separate payments to the IRS on April 17, 2018: one payment for the first installment of the transition tax and a separate payment reflecting tax owed without regard to the transition tax. Thus, for taxpayers that correctly calculated their Code section 965 transition tax liability, the first installment payment for the transition tax did not exceed the installment due. Finally, as noted above, Congress expressed its intent in allowing taxpayers to make eight installment payments (without interest) and presumably would not have intended that the rules in section 6403 should apply here.

PMTA 2018-016 does not address situations where taxpayers timely filed Form 4466, Corporation Application for Quick Refund of Estimated Tax, pursuant to Code section 6425. Our understanding is that the IRS is not processing some of those requests despite the statutory requirement (subject to certain exceptions) that they be acted upon within 45 days. It remains to be seen whether the IRS will issue additional guidance relating to this issue, as suggested by the NTA.

The IRS, by issuing PMTA 2018-016, has staked out its position (at least for situations not involving timely filed Forms 4466) and affected taxpayers will need to explore all options once their 2017 tax returns are filed.