SERVICE MODIFIES ITS STANCE REGARDING OVERPAYMENTS USED TO SATISFY FUTURE ESTIMATED TAX LIABILITY.

Rev. Rul. 88-98

ISSUE

In the situations described below, in which overpayments claimed on returns are refunded or credited and in which underpayments are subsequently established, from what date does the interest on the underpayments run?

FACTS

SITUATION 1. X corporation files its federal income tax returns on a calendar year basis. For 1983, X made timely estimated tax payments of 100x dollars. On March 15, 1985, X filed Form 7004, Application for Automatic Extension of Time to File Corporation Income Tax Return, and received a 6-month automatic extension of time to file. X paid 120x dollars with Form 7004.

On September 15, 1984, X filed Form 1120 for 1983 showing tax of 210x dollars and elected to have the overpayment of 10x dollars credited against its 1984 estimated tax. X requested that the 10x dollars be applied against the installment due on September 15, 1984. In 1985, the Internal Revenue Service examined X's 1983 return and determined that X's correct 1983 tax was 215x dollars, resulting in a deficiency of 5x dollars.

SITUATION 2. The facts are the same as in SITUATION 1 except that X did not indicate which installment the overpayment should be applied against. As a result, the Service applied the overpayment against the April 15, 1984, installment of estimated tax. Rev. Rul. 84-58, 1984-1 C.B. 254. The amount that was so applied to the April 15, 1984, installment was deemed paid on that date. See Rev. Rul. 77- 475, 1977-2 C.B. 476, as modified by Rev. Rul. 84-58.

SITUATION 3. The facts are the same as in SITUATION 1 except that X requested a refund of the 10x dollar overpayment shown on the return. The 10x dollars was refunded to X within 45 days, by a check dated October 9, 1984.

SITUATION 4. A, an individual, files federal income tax returns on a calendar year basis. In 1983, A made timely estimated tax payments of 100x dollars. On April 15, 1984, A filed Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, and received a 4-month extension of time to file. On August 15, 1984, A filed Form 1040, U.S. Individual Income Tax Return, showing tax due of 80x dollars. A requested a refund of the 20x dollar overpayment. The refund was made within 45 days, by a check dated September 14, 1984. In 1985, the Service examined A's 1983 return and determined that A's correct tax was 105x dollars, resulting in a deficiency of 25x dollars.

LAW AND ANALYSIS

Section 6601(a) of the Internal Revenue Code provides that if any amount of tax is not paid on or before the last date prescribed for payment, interest will be paid on the amount from such last date to the date paid.

Section 6601(b) of the Code provides rules for determining the "last date prescribed for payment." Under sections 6601(b)(1) and 6151(a), the date is determined without regard to any extension of time for payment or filing.

Section 6611(e) of the Code provides that if an overpayment of income tax is refunded either (1) within 45 days after the last date prescribed for filing the return of such tax (determined without regard to extensions of time for filing the return); or (2) in the case of returns filed after the last date prescribed for filing, within 45 days after the date the return is filed, no interest is allowed under section 6611(a) on the overpayment.

Section 301.6402-3(a)(5) of the Regulations on Procedure and Administration provides that a taxpayer may elect to apply all or part of the overpayment shown by its return to its estimated tax for the succeeding tax year by so indicating on its return. No interest is allowed on the portion of the overpayment credited. See section 301.6611-1(h)(2)(vii).

In Avon Products, Inc. v. United States, 588 F.2d 342 (2d Cir. 1978), the court considered facts similar to those in SITUATION 1. The question before the court was whether interest ran on the deficiency from the due date for payment of the tax that was underpaid or from the date (September 15) on which the taxpayer filed the return and on which was due the installment of the next year's estimated tax, to which the taxpayer elected to apply the overpayment shown on the return. The court interpreted section 6601(a) of the Code to mean that interest could only be charged when the tax was both due and unpaid, reasoning that interest was charged only for the loss of the use of money. Although the tax was due on the earlier date, it did not become unpaid until September 15, when the government was deprived of use of the money as a payment of the original year's tax.

In Rev. Rul. 83-112, 1983-2 C.B. 247, the Service announced that it would follow the decision in Avon Products. It interpreted the decision as standing for a rule that the earlier year's tax is considered unpaid, and the next year's estimated tax is considered paid, on the date a taxpayer files a return electing to credit the claimed overpayment. On similar reasoning, if a refund is made without interest under section 6611(e) of the Code, the ruling held that, for purposes of computing interest on a deficiency, the tax should be considered unpaid on the date the taxpayer files a return requesting the refund of the claimed overpayment.

Rev. Rul. 83-111, 1983-2 C.B. 245, following the same interpretation of the Avon Products decision, held that an overpayment is not a payment of the subsequent year's estimated tax liability, for purposes of computing the penalty for underpayment of estimated tax, until the date the taxpayer files a return electing the credit.

Rev. Rul. 84-58 revoked Rev. Rul. 83-111 and holds that when a taxpayer elects to have an income tax overpayment credited against the next year's estimated tax, the Service will apply the overpayment against the first installment of estimated tax due on or after the date the overpayment arose, unless the taxpayer requests that it be applied against a later installment.

The Tax Reform Act of 1984, section 413, 1984-3 (Vol. 1) C.B. 301, provides that the application of the Code with respect to the crediting of an overpayment against estimated tax shall be determined without regard to Rev. Rul. 83-111 and with full regard to the rules before Rev. Rul. 83-111. The legislative history provides that "[w]here the credit is made to an estimated tax payment arising prior to the election [to so credit the overpayment], interest on any overpayment will not be payable, and interest on any underpayment which arises because of a deficiency in tax for the prior year will run from the date the credit is effective." H.R. Rep. No. 98-432, Pt. 2, 98th Cong., 2d Sess. 1489-90 (1984).

The Service has reconsidered Rev. Rul. 83-112 and has concluded that Rev. Rul. 83-112 partially misinterpreted the reasoning behind the holding in Avon Products. Under the facts of that case, September 15 was significant primarily because that was the date the credit was effective as a payment of the next year's estimated tax, not because it also happened to be the date that the return was filed and the credit elected. The date that the taxpayer gained the benefit of the funds as a payment on account of the succeeding year's estimated tax determines the date the prior year's tax became unpaid for purposes of section 6601(a) of the Code. This interpretation of the Avon Products rule is consistent with Rev. Rul. 84-58 and section 413 of the Tax Reform Act of 1984.

Accordingly, the Service will continue to follow the Avon Products decision. In doing so, it will interpret section 6601(a) of the Code to mean that, in the absence of statutory or regulatory indication to the contrary, interest should only be charged from the point a tax is both due and unpaid. If an amount that was originally paid with respect to the tax is subsequently credited against a different obligation, the date on which the first tax is both due and unpaid is not necessarily the filing date of the request for the credit but rather the date as of which the credit is effective as a payment of the other obligation, even when that date precedes the date of the credit election. In the case of a refund made without interest under section 6611(e), the date on which the tax is both due and unpaid is the date when the amount in question is refunded, even when that date is subsequent to the date of the claim for refund.

HOLDINGS

When a taxpayer claims an overpayment on a return filed on the original due date or on a return filed with an extension, and the claimed overpayment is applied in full against an installment of the next year's estimated tax, interest on a subsequently determined deficiency for the earlier year runs from the due date of that installment on that part of the deficiency that is equal to or less than the claimed overpayment and from the original due date on the remainder. When a taxpayer claims an overpayment on a return filed on the original due date or on a return filed with an extension, and the claimed overpayment is refunded in full without interest, interest on a subsequently determined deficiency runs from the date of the refund check on that part of the deficiency that is equal to or less than the claimed overpayment, and from the original due date on the remainder.

In SITUATION 1, interest runs from September 15, 1984.

In SITUATION 2, interest runs from April 15, 1984.

In SITUATION 3, interest runs from October 9, 1984.

In SITUATION 4, interest runs from April 15, 1984, until September 14, 1984, on 5x dollars, and from September 14, 1984, on the sum of 25x dollars and the interest that had accrued on the 5x dollars.

The result in any situation involving an individual taxpayer would be the same whether the overpayment resulted from withholding under section 31 of the Code or from estimated tax payments.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 83-112 is modified and superseded.

DRAFTING INFORMATION

The principal author of this revenue ruling is Gail Winkler of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling contact Ms. Winkler on (202) 566-5985 (not a toll-free call).