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TEFRA + LCU = Confusion, Part 1


We welcome back guest blogger Bob Probasco for a three-part series inspired by the Federal Circuit’s recent 2-1 decision tossing General Mills’ refund claim as untimely under TEFRA, although the claim would have been timely under the standard timeframes of section 6511. Part 1 sets the stage and examines the majority’s reasoning. Christine

On April 23, 2020, the Court of the Appeals for the Federal Circuit issued its decision in General Mills, Inc. v. United States, 957 F.3d 1275 (Fed. Cir. 2020), aff’g 123 Fed. Cl. 576 (2015).  The taxpayer’s refund suit sought recovery of $6 million of excessive underpayment interest it had paid to the IRS.  The court ruled for the government and dismissed the case.  It’s an unusual case, with aspects I had never dealt with before, so I thought Procedurally Taxing readers might enjoy it.  Fair warning, though: the TEFRA partnership audit procedures are complicated, as are the “large corporate underpayment” (LCU interest, or “hot interest”) provisions of the Code.  When they intersect, turbulence is likely.

The Facts

The case involved two sets of tax returns and audits: those for the General Mills (“GMI”) corporate tax returns and those for partnership tax returns for General Mills Cereals, LLC (“Cereals”).  Different members of the GMI consolidated group were partners in Cereals, so the tax returns—and any audit adjustments—for Cereals flowed through to GMI.  The IRS audited the 2002-2003 tax returns (both corporate and partnership) and later the 2004-2006 tax returns (same).  Although there are some slight differences between the audits for those two periods, for simplicity I will focus on the 2002-2003 tax returns.

Audits began for both GMI and Cereals in 2005 for these years.  The IRS issued a 30-day letter for the GMI audit on June 15, 2007, asserting proposed deficiencies of more than $143 million for 2002 and almost $83 million for 2003.  The partners in Cereals entered into settlement agreements in July 2010.  On August 27, 2010, the IRS issued a “notice of computational adjustment” to GMI, identifying additional underpayments, resulting from the Cereals audit, of about $16 million for 2002 and more than $33 million for 2003. 

The IRS assessed additional taxes, penalties, and interest resulting from the Cereals audit in September 2010.  GMI paid all outstanding balances for these years, including interest, on April 11, 2011.  The IRS sent GMI detailed interest computation schedules for these years, apparently for the first time, on April 18, 2011 and April 20, 2011.  The schedules reflected that the IRS began charging a higher underpayment interest rate (“hot interest”) on July 15, 2007.  GMI filed refund claims on March 28, 2013, arguing that the higher interest rate should not have begun until September 26, 2010.  As a result, the IRS had accrued almost $6 million too much interest.  GMI then filed this refund suit on January 30, 2014.

The “hot interest” issue underlying the claim is intriguing and I was looking forward to reading the court’s analysis of it.  But the opinion focuses instead on the jurisdictional TEFRA provision that formed the basis of the government’s motion to dismiss.  I’ll have more discussion of the hot interest issue in Part 3.  But because the taxpayer lost on the jurisdictional issue, we will have to wait for another day for a court decision on the merits issue.

The Jurisdictional Question—TEFRA Computational Adjustments

Framework

A preliminary reminder:  the TEFRA provisions—Subtitle F, Chapter 63, Subchapter C—were stricken and replaced with a new regime for partnership audits, by the Bipartisan Budget Act of 2015.  References herein to specific Code sections are to the TEFRA versions, not the BBA versions.

As we all remember, TEFRA established unified partnership audit proceedings, with special rules for assessments of partners based on any resulting adjustments to the partnership tax return.  The changes to the partners’ tax liabilities to reflect the partnership adjustments are called “computational adjustments,” section 6231(a)(6).  Computational adjustments were initially understood as falling into two categories, depending on whether a partner-level determination was required.  If no such partner-level determination was required, the IRS simply assessed any additional amounts due.  (Mechanical applications, such as recalculating an itemized deduction for medical expenses, were not considered “determinations.”)  If a partner-level determination was necessary, the IRS had to issue a notice of deficiency, providing an opportunity for judicial review. 

The two categories became three with the Taxpayer Relief Act of 1997.  Penalties had been identified as a problem.  There might be necessary partner-level determinations to address penalty defenses.  Litigating those defenses (including defenses by indirect partners) in a partnership-level proceeding was not considered feasible but removing all penalties to deficiency proceedings was not an ideal approach either.  Thus, whether a penalty generally applied would be resolved in a partnership-level proceeding.  The IRS could then proceed to assessment without a deficiency proceeding, requiring partners to raise partner-level defenses in a refund claim/suit.  So the categories were:

  • Adjustments for which a partner-level determination was not required (immediate assessment allowed).
  • Adjustments for which a partner-level determination was required, other than penalties, additions to tax, and additional amounts (deficiency proceeding required).
  • Adjustments for penalties, additions to tax, and additional amounts (immediate assessment allowed).

Those were specified in section 6230(a).  Although that section didn’t address interest, the IRS did, by regulation.  Treas. Reg. § 301.6231(a)(6)-1(b) provides that a “computational adjustment includes any interest due with respect to any underpayment or overpayment of tax attributable to adjustments to reflect properly the treatment of partnership items.”  The IRS treats such adjustments of interest as computational adjustments that can be assessed immediately.

Claims Arising Out of Erroneous Computations

For computational adjustments that are assessed directly and cannot be challenged in a deficiency proceeding in Tax Court, section 6230(c) provides an opportunity for challenge.  The taxpayer may file a refund claim for erroneous computations that:

  • Are necessary to apply the results of a settlement, final partnership administrative adjustment (if not challenged in Tax Court), or a Tax Court decision challenging the FPAA. 
  • Impose any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item.

These refund claims “shall be filed within 6 months after the day on which the Secretary mails the notice of computational adjustment to the partner.”  Thereafter, a refund suit can be brought within the period specified in section 6532(b) for refund suits.  And section 6511(g) provides that section 6230(c) applies, rather than section 6511, with respect to tax attributable to partnership items.

I’ve actually never dealt with a section 6230(c) refund claim before and perhaps others haven’t either.  This case was a good reminder of the different limitation period.  But it’s particularly fascinating because of a quirk introducing when dealing with interest resulting from a TEFRA proceeding.

Application in GMI’s Case

The Notices GMI Received

Let’s start with the communications at the conclusion of the Cereals (partnership) audit, as those were relevant to the basis for the motion to dismiss.  The IRS and GMI executed a settlement agreement on July 27, 2010.  It addressed “any deficiency attributable to partnership items, penalties, additions to tax, and additional amounts that relate to adjustments to partnership items, as set forth in the attached Schedule of Adjustments (plus any interest provided by law.)”  The same “any interest provided by law” language also appeared elsewhere in the settlement agreement, but there was no reference to hot interest or even the amount of interest that would result.

On August 27, 2010, the IRS sent a cover letter with Form 5278, Statement—Income Tax Changes.”  That form included a line for “Balance due or (Overpayment) excluding interest and penalties” with a corresponding dollar amount.  No amount was shown for interest, but the cover letter stated that the IRS “will adjust your account and figure the interest.”  Still no reference to hot interest.  The IRS assessed the tax deficiencies plus interest (including hot interest) on September 3, 2010, but no schedule showing how the amount of interest had been computed was sent to GMI at this time. 

On April 18, 2011, the IRS sent GMI an interest computation schedule for each of the four years, showing that hot interest began running on June 15, 2007—the date of the notice of proposed deficiency for the corporate audit.  The IRS sent another interest computation schedule for one of the years on April 20, 2011.

GMI paid the additional taxes and interest (including hot interest) on April 11, 2011.  It then filed refund claims on March 28, 2013, within the traditional two-year period after the payment in section 6511, and then this refund suit.  The government filed a motion to dismiss, arguing that the six-month period of section 6230(c) applied and therefore the refund claims were filed too late.

The Majority Opinion

GMI’s attorneys did a very professional, thorough job of identifying arguments that the refund claims were timely.  The majority opinion in the Federal Circuit shot them all down.

The notices received did not qualify as “computational adjustments.”  The majority’s response: Treas. Reg. § 301.6231(a)(6)-1(b) specifically included interest in the scope of computational adjustments and GMI did not challenge the validity of the regulation.  The Court of Federal Claims also cited several cases, including the Tax Court and other Circuit Courts, that it concluded supported the conclusion that interest is a computational adjustment.

However, I think (and the dissent may have agreed) the validity of the regulation is not clear.  And I don’t find the cases cited by the Court of Federal Claims very persuasive either.  Stay tuned for further discussion in Part 2.

Refund claims for “computational adjustments” only cover computation errors, not the legal error that GMI alleged.  The majority relied on the fact that section 6230(b) addressed “mathematical and clerical errors appearing on partnership returns,” implying that section 6230(c) must refer to a different class of errors.  It also cited a Seventh Circuit that reached the same conclusion, for the same reason. 

This isn’t entirely persuasive either.  An alternative, and to my mind more persuasive, distinction would be that section 6230(b) concerns mathematical or clerical errors on the partnership return while section 6230(c) concerns errors in a computational adjustment to make the partner’s return consistent with a substantive adjustment to the partnership return in a TEFRA proceeding.  Two entirely different things, aren’t they?  And most direct assessments (other than interest) without deficiency proceedings can only be challenged based on: (a) mathematical errors in allocating the change in tax liability; or (b) partner-specific penalty defenses.

The section 6230(c) refund claim provision applies only to adjustments necessary to apply the settlement, but the partnership audit and settlement did not address how hot interest should be computed.  GMI pointed out that (a) the partnership settlement agreements did not cover any aspect of how interest would be computed and (b) a global settlement agreement had explicitly carved out any implication that GMI had agreed to interest computations.  The court’s response focused on the boilerplate language “any interest provided by law.” 

I don’t consider this persuasive either.  Can you imagine a settlement agreement concerning the underlying tax liability that, instead of identifying the specific adjustments, said “any adjustments to income or expenses provided by law”?   Of course not.  That’s not a “settlement” in any normal sense of the word.  Similar boilerplate language about interest abounds in tax controversy but I’ve always considered that as intended simply to avoid any implication, by omission, that the parties had agreed that interest would not apply.  I don’t think boilerplate language like that has ever been interpreted to mean that the parties had settled on the resulting computation.  The fact that interest was “clearly contemplated” doesn’t mean that it was settled.

Section 6511 also applies and is an alternative available to taxpayers.  Here, the court relied on the general principle that a narrower, specifically drawn statute pre-empts a broader provision.  That’s generally true, although it may not always apply. 

For policy reasons, the section 6230(c) refund claim provision should not apply to claims that are entirely due to a partner’s unique factual circumstances.  This seems one of GMI’s less persuasive arguments, and the court simply pointed out there was no authority to support this position.

Section 6230(c) only applies to refund claims that are attributable to partnership items and the “applicable date” that GMI was disputing is not a partnership item.  As with the preceding item, this was a difficult argument and the court disagreed that a “partnership item” was a general requirement for all these refund claims.  Although the court did not go into detail, there is a structural argument.  The only reference to “partnership item” in that provision is in section 6230(c)(1)(A)(i), which relates to a computational adjustment to make the partner’s return consistent with the partnership return.  That sounds very much like making the partner’s return consistent with the partnership return as filed.  By comparison, section 6230(c)(1)(A)(ii) addresses computational adjustments relating from a TEFRA audit—settlement, FPAA, or court decision.  Section 6230(c)(1)(A)(i) would cover GMI’s situation, and it does not mention “partnership item.”  Neither does section 6230(c)(2), which governs the refund claims, mention “partnership item.” 

The notices received by GMI did not provide adequate notification of the determination.  The Court of Federal Claims seemed to consider even the initial notice on July 27, 2010, to have provided adequate notification.  It relied on GMI’s acknowledgement that “interest is generally the type of item that is ‘implicit in a computation of tax with respect to settled items so that it need not be expressly computed or even identified in the notice of computational adjustment that applies to the settlement.’”  Interest may be straight-forward in other contexts but certainly was not here. 

However, the Federal Circuit relied instead on the interest computation schedules received in April 2011 as providing adequate notice.  From the court’s description, it appears those did make it clear that hot interest would be applied and what applicable date would apply.  GMI argued those were still insufficient because they didn’t mention the six-month limitation period in section 6230(c) or even that a jurisdictional period was being triggered.  In addition, the schedules didn’t mention the TEFRA proceeding or segregate interest arising from the corporate audit for that arising from the Cereals audit.  The court simply rejected those as not required elements of a notice of computational adjustment.

And so, the majority dismissed the case for lack of jurisdiction.  Unless/until the issue comes up in another circuit, that decision will stand.  But it’s not necessarily the correct decision.  In Part 2, I’ll briefly summarize the dissent and then add some further thoughts on how the framework applied by the majority is arguably not the best way to think about these types of adjustments.  A different conceptual framework could lead to a decision in the taxpayer’s favor.



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