In Goldring v. United States, No. 20-30723, the United States Court of Appeal for the Fifth Circuit held that the Internal Revenue Service (IRS) improperly assessed underpayment interest because the agency had the continuous use of sufficient credit-elect overpayments to satisfy the taxpayer’s deficiency, reversing a district court’s decision.
William and Jane Goldring reported a litigation award from a Delaware state lawsuit on their 2010 income tax return as a long-term capital gain. However, part of the award represented interest, and the couple realized that the IRS might subsequently deem that portion to be ordinary income taxable at a higher rate. Thus, the Goldrings overpaid their 2010 tax by an amount that would cover any later-determined deficiency for 2010 caused by the recharacterization of the interest. The couple elected on their 2010 tax return to credit the overpayment forward to their estimated 2011 tax liabilities— an action known as a “credit-elect overpayment.” The Goldrings continued to make credit-elect overpayments on their 2011 through 2016 tax returns, maintaining overpayment balances sufficient to cover any potential deficiency for the 2010 tax year.
In 2017, the IRS issued the Goldrings a notice of deficiency for 2010 that determined an underpayment based on treating the interest portion of the award as ordinary income, which the couple did not contest. The IRS retroactively satisfied the deficiency using the couple’s credit-elect overpayment from 2016.
For the period from April 15, 2011, through April 15, 2012, the IRS determined that the Goldrings’ credit-elect for the 2010 tax year overpayment offset the 2010 deficiency and did not charge underpayment interest. However, the 2010 overpayment was deemed to be applied to the couple’s 2011 tax liabilities on April 15, 2012, and no longer available for offset against the 2010 deficiency moving forward. As a result, the IRS assessed underpayment interest from April 16, 2012, until it was satisfied on April 15, 2017.
The Goldrings contested the assessment of underpayment interest from April 16, 2012, through April 15, 2017. Applying the use-of-money principle and citing opinions from other jurisdictions, the Fifth Circuit Court of Appeals concluded that the IRS improperly assessed underpayment interest against the Goldrings for this period because the IRS had continuous use of sufficient credit-elect funds in an amount sufficient to satisfy the 2010 deficiency throughout that five-year period.
The issue was one of first impression in the Fifth Circuit. Thus, the court turned to other jurisdictions for guidance.
Generally, section 6601(a) allows the IRS to collect underpayment interest from the due date of a tax liability until the deficiency is satisfied. The IRS argued that section 6402(a)-(b) and section 6513(d) permitted the agency to assess the interest against the Goldrings. Section 6402(a)-(b) permits the IRS to either credit an overpayment to the following year or refund the overpayment to the taxpayer. Section 6513(d) provides that credit-elect overpayment is applied toward a taxpayer’s liabilities for the next year and that no refund or credit of the overpayment is permitted for the year in which it arises. The IRS’s position relied upon the unavailability of a credit-elect overpayment for application to prior years. However, the Court of Appeal disagreed with this position, holding that these provisions do not address underpayment interest or section 6601(a).
Instead, the Fifth Circuit followed the reasoning used by the Second Circuit Court of Appeals in the case of Avon Prod., Inc. v. United States, 588 F.2d 342 (2d Cir. 1978). In that case, the Second Circuit stated that interest is intended to compensate the government, and it starts running when a tax becomes due and unpaid. Applying the use-of-money principle, which holds that a taxpayer is liable for interest only when the IRS does not have use of money it is lawfully due, the Avon court found that a tax is not considered “unpaid” and section 6601(a) underpayment interest may not run during any period the IRS possesses enough credit-elect overpayment funds to satisfy a later-determined tax deficiency. Avon, 588 F.2d at 343–46; see Manning v. Seely Tube & Box Co., 338 U.S. 561, 566 (1950) (use of money principle). Following Avon, other district courts have applied the use-of-money principle to reach similar holdings. May Department Stores Co. & Subsidiaries v. United States, 36 Fed. Cl. 680 (1996); Sequa Corp. v. United States, No. 95 CIV. 2086 (KMW), 1999 WL 628286 (S.D.N.Y. June 8, 1999); In re Vendell Healthcare, Inc., 222 B.R. 564 (Bankr. M.D. Tenn. 1998); Otis Spunkmeyer, Inc. v. United States, No. C 02-05773 MJJ, 2004 WL 5542870 (N.D. Cal. Aug. 10, 2004). Applying the use-of-money principle, the Avon court ruled that a tax is not considered unpaid and underpayment interest may not be imposed when the IRS possesses sufficient overpayment to cover a later-determined deficiency.
The Fifth Circuit noted that the IRS was never deprived of its use of the money the Goldrings lawfully owed at any point during the disputed five-year underpayment interest assessment period. Instead, the IRS had continuous use of the Goldrings’ credit-elect overpayment funds in an amount sufficient to satisfy the 2010 deficiency throughout the five-year period. Under the use of money principle, therefore, the IRS could not properly assess interest for that period.