In a recently published Chief Counsel Advice, the IRS chief counsel’s office offered advice to taxpayers participating in its amnesty programs regarding the issue of whether refunds for past overpayments of tax can be used to offset additional taxes or penalties triggered under the program.

Before we get to the advice, let’s first review the amnesty programs that could potentially be affected by the conclusions made in the published advice.

Offshore Voluntary Disclosure Program (OVDP)

The OVDP is designed for U.S. expats who are concerned that their failure to report income, and failure to disclose foreign financial accounts, might be viewed by the IRS as willful and therefore seek to avoid harsh civil penalties and potential criminal penalties. Under the OVDP, U.S. expats are required to file original or amended tax returns and FBARs for the prior 8 years. A taxpayer who complies with the program will have to pay back taxes with interest.

However, in lieu of all other penalties that may apply to the undisclosed foreign assets and entities, including the FBAR penalty, a “miscellaneous offshore penalty” of 27.5% (which can be increased up to 50% in certain cases) is imposed and calculated based on the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the period covered by the voluntary disclosure.

The Streamlined Procedures

The more popular and advantageous of the IRS amnesty programs is the Streamlined Procedures. Under this program, a late filer can come clean with the IRS with potentially no penalties by filing tax returns, with all required information returns, for the prior 3 years, and any delinquent FBARs for the prior 6 years.

In order to qualify for the Streamlined Procedures, a taxpayer must demonstrate in a written statement that the past non-compliance was not willful.

Chief Counsel Advice 201719026 (May 12, 2017)

In the Chief Counsel Advice, the IRS presented the following scenario:

A taxpayer enters the OVDP program for which the disclosure period is tax years 2003 through 2010. For tax years 2003 through 2007 and 2009 and 2010, the taxpayer reports additional income and tax on amended returns, which take into account income earned overseas. But the amended return submitted for tax year 2008 includes a large loss, resulting in an overpayment for that tax year. The taxpayer then requests that the overpayment for tax year 2008 be credited against increases in tax for the other tax years in the disclosure period or the miscellaneous offshore penalty.

Under the Internal Revenue Code’s statute of limitations rules, the IRS is prohibited from crediting or refunding any overpayment unless the taxpayer has timely filed a claim for refund or credit of such amount – which is within three years from the time the original return was filed or two years from the time the tax was paid, whichever is later. As such, the issue becomes whether the statute of limitations rules prevent the OVDP participant from utilizing the 2008 overpayment as a credit against the additional tax owed under the OVDP program.

Under these facts, the IRS advised that whether a taxpayer is entitled to have any overpayment credited against a liability for another tax year or against the miscellaneous offshore penalty depends on whether that taxpayer filed a timely claim for refund or credit (i.e., whether the amended return filed under the OVDP program was filed within three years of the 2008 return’s original filing). If the claim was filed within the statute of limitations period, the claim is timely and the taxpayer is entitled to a credit for the overpayment of amounts paid. If the claim for refund was not timely filed, the IRS is prohibited from crediting it against liabilities for other tax types or periods.

Interestingly, the IRS also noted that as a condition of entering the OVDP program, participants are required to submit agreements to extend the statute of limitations on assessment for each of the eight tax years included in the disclosure period. As such, if a taxpayer and the IRS entered into an agreement extending the taxpayer’s 2008 period of limitations on assessment during the 3-year period, then the taxpayer’s claim for refund or credit would be timely as long as it was filed within six months of the expiration of the period within which assessment may be made pursuant to the agreement.