Interest Due Back from 2002 When Tax Exempt Determined in 2013 to be Retroactively Lost

The Tax Court ruled that when an entity has its tax-exempt status retroactively revoked, interest is due on any underpaid tax for the years that the entity now has a tax liability from the date a return would have been originally due for an entity that did not have exempt status.  In CreditGuard of America, Inc. v. Commissioner, 149 TC No. 17 the Tax Court rejected the taxpayer’s view that interest should not begin to run until the date it was finally determined the entity was not tax exempt.

The issue of the retroactive loss of the organization’s exempt status back to 2002 had previously been decided in a stipulated Tax Court decision entered on November 30, 2012, based on an examination the IRS had begun in 2003 but not concluded until February of 2012.  The total tax determined to be due from the taxpayer was $216,547.

The IRS began accruing interest in its computation of interest due going back to March 17, 2003, the original due date for the Form 1120 now due from the entity.  The IRS did not claim that the taxpayer was negligent and was not assessing any penalty for failure to pay the tax due.

The taxpayer argued that it could not have known in March of 2003 that a tax liability existed, and that in fact the matter was not determined until nearly a decade later.  The opinion notes:

Petitioner notes that it was tax exempt during 2002, that it correctly filed Form 990 for that year, and that it had no obligation to file Form 1120 until its tax exemption was revoked. It accordingly contends that the starting date for paying interest is governed by section 6601(b)(5), captioned “Last date for payment not otherwise prescribed.” That section provides that, “[i]n the case of taxes payable by stamp and in all other cases in which the last date for payment is not otherwise prescribed, the last date for payment shall be deemed to be the date the liability for tax arises.”

The Tax Court found both that IRC §6601(b)(5) was not applicable and, even if it had been, it would not have changed the date on which the interest computation began.  The Court held:

Section 6601(b)(5) by its terms is inapplicable here. It applies only to taxes payable by stamp and other taxes for which “the last date for payment is not otherwise prescribed.” The tax involved here is the corporate income tax. The last date for payment of the corporate income tax is “otherwise prescribed,” namely, by section 6072(b). For a calendar year corporate taxpayer in 2002, that date was March 17, 2003.

Even if section 6601(b)(5) applied, it would not help petitioner. Petitioner’s corporate income tax liability for 2002 did not “arise” on February 1, 2012, when the IRS mailed the letter revoking petitioner’s tax-exempt status. Nor did it arise on November 30, 2012, when this Court entered a decision determining a deficiency of $216,547 for 2002. And it did not arise on March 13, 2013, when the IRS assessed that tax.

Rather, by virtue of the retroactive revocation of petitioner’s tax-exempt status to January 1, 2002, its corporate income tax liability arose during 2002, the calendar year for which it had become a “corporation subject to tax under subtitle A.” Sec. 6012(a)(2); see Helvering v. Morgan’s, Inc., 293 U.S. 121, 127 (1934) (defining taxpayers’ taxable year as “the twelve months’ accounting period for which they were bound to report income and pay taxes”). And petitioner’s liability for payment of that tax arose on March 17, 2003, the due date of its Form 1120 for 2002. In contending that it had no tax liability for 2002 until 2012, petitioner is ignoring the fact that its tax-exempt status was revoked, not prospectively, but retroactively to January 1, 2002. Retroactive revocation is not just a slap on the wrist; it has real tax consequences.

The Court also found that computing interest back to that date was consistent with the reason interest is charged on tax underpayments, noting:

Underpayment interest is designed to compensate the Government for the period during which the taxpayer has enjoyed use of the Government’s money. “Interest, in tax cases as in others, is merely compensatory; it is not a penalty.” Vick v. Phinney, 414 F.2d 444, 448 (5th Cir. 1969). Under this use-of-funds rationale, “a taxpayer who initially failed to satisfy his tax liability is obligated to pay interest on the taxes due from the date the tax return should have been filed, regardless of whether the failure to pay resulted from the taxpayer’s miscalculation or the [G]overnment’s redetermination.” Brookhurst, Inc. v. United States, 931 F.2d 554, 558 (9th Cir. 1991).

By executing a stipulated decision in the prior deficiency case, petitioner has agreed that it had a corporate income tax deficiency of $216,547 for 2002. It has had use and enjoyment of that $216,547 from March 17, 2003, until now. It has supplied no reason, in law or logic, why it should not have to pay interest as any other corporate taxpayer would have to do.