Zero Determined Not to Represent a Liability for Purposes of C Corporation Required Estimated Tax Payments Based on Prior Year's Taxes

Does filing a tax return that reflects a tax liability of $0.00 represent the filing of “a return for a preceding taxable year showing a liability for tax”—or, to put it simply, is $0 a liability for tax?  That was the issue that the U.S. District Court for the Central District of California addressed in the case of Cal Pure Pistachios, Inc. v. United States, 115 AFTR 2d ¶2015-643.

The issue was whether the taxpayer, a C corporation, could escape a penalty for underpayment of estimated taxes using the “prior year’s tax” exception under IRC §6655(d). 

The general rule for the “prior year’s tax” exception for C corporation provides that the required annual payment of estimated taxes will be the lesser of:

  • 100% of the tax shown on the return for the current year or
  • 100% of the tax shown on the return for the preceding tax year [IRC §6655(d)]

However, IRC §6655(d) goes on to state that the prior year’s tax exception will not apply if either:

  • The preceding taxable year was not a taxable year of 12 months or
  • The corporation did not file a return showing a liability for that prior year.

In this case the taxpayer’s return for the prior year reflected a total tax, before payments, of $0.00.  Thus, the taxpayer reasoned, no estimated tax payments were due for the year in question.

However the IRS disagreed, billing the taxpayer for underpayment penalties and interest of nearly $96,000.  The taxpayer paid this amount and then sued for a refund in District Court.

The key question is simple—is “$0.00” a liability for these purposes?  The taxpayer had filed a return that covered 12 months that reflected $0.00 total tax. 

The IRS argued that zero is not a liability—rather, it indicates an assertion of a lack of a liability for the year in question.  The IRS also pointed out that Congress did not include similar language in the parallel provisions that are applicable to individuals or S corporations in the IRC.  In the IRS’s view this indicates that Congress specifically meant to deny “protection” to C corporations that showed no taxes due when the time came to make estimated tax payments for the following year.

The taxpayer argued that this produces an absurd result—had the corporation shown a $1.00 or even $0.05 tax liability for the prior year it would have escaped any penalties (the penalty on $1 would have been, rounded down to whole dollars, $0).  But because Cal Pure Pistachios, Inc. had $1 less in taxes imposed than this hypothetical corporation, it was now on the hook for nearly $96,000.

Absurd or not, the Court sided with the IRS.  The Court quipped that “Even if it were reasonable to surmise that Cal Pure would ever owe only $1 or $.05 in tax, ‘[t]he IRS's understanding of the terms of the Code is entitled to considerable deference.’”  The Court also goes on to note that merely because the Code produces harsh results that doesn’t change the fact that the law must be applied as written.

Although the Court did not say so, it also seems likely the IRS would assert that the alternative interpretation the taxpayer sought would render the phrase “showing a liability” meaningless in the statute—and statutory construction generally seeks to avoid such a result.

Advisers do need to note that Congress did not use the same statute or identical language in shaping the various estimated tax payment and exception rules for different entities.  And, at least in this case, the IRS claims that such differences indicate we should expect different rules to apply.