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RAR’S –
TIMING IS
EVERYTHING
Moderator
Fred Nicely (Council on State Taxation)
Presenters
Marilyn A. Wethekam, Horwood Marcus & Berk, Chicago, IL
Steven P. Spaletto, Deloitte, Indianapolis, IN
April 23, 2015 – COST 2015 Spring Income Tax Conference
TOPICS COVERED
Overview of IRS Procedures
Reporting of Federal Changes
Protective Claims for Refund
Common Practices
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POLLING QUESTION – HOW OFTEN DO YOU HAVE TO DEAL
WITH FILING AMENDED STATE TAX RETURNS AFTER AN IRS
AUDIT?
A. IT IS A
CONTINUOUS
PART OF MY JOB
B. I HAVE TO DEAL
WITH IT EVERY
COUPLE OF YEARS
C. I’VE DEALT WITH IT
ONCE OR TWICE
D. I’M HERE BECAUSE
MY FIRST ONE IS
COMING UP!
It is a co ntinu ous part of .. I have to de al wi th it eve.. I’ve deal t with it on ce or ... I’m here beca use my fir st...25%
25%
25%
25%
/ / 4POLLING QUESTION – WHAT HAS BEEN YOUR EXPERIENCE IN
FILING AMENDED STATE INCOME TAX RETURNS AFTER AN IRS
AUDIT?
A. IT WAS A
NIGHTMARE
B. OKAY, EXCEPT
FOR ONE OR
TWO STATES
C. ALL WENT WELL
D. MY COMPANY
HAS TO FILE
AMENDED STATE
RETURNS?
It was a night mar e Oka y, ex cept for on e or t.. All we nt we ll My com pan y ha s to file. ..25%
25%
25%
25%
IRS
PROCEDURES
OVERVIEW OF IRS PROCEDURES
STATUTE OF LIMITATIONS FOR ASSESSMENT
General Rule: 3 years after taxpayer has filed its
return
Extended SOL in the following circumstances:
• 6 years if omission of more than 25% OF GROSS INCOME
• No deadline if don’t file return or file false or fraudulent return.
• Extended deadline if IRS and taxpayer agree in writing to
extend the period of limitations (Forms 872, Fixed Period
Consent, and Form 872-A, Special Consent (Open-Ended);
either may be restricted to one or more specific issues).
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OVERVIEW OF IRS PROCEDURES
CONSEQUENCES OF
SIGNING FORM 870
Taxpayer waives their right to notice of
deficiency and IRS will assess tax
immediately.
Taxpayer is ordinarily precluded from
contesting the adjustments by filing a
petition with the Tax Court, but it does
not prevent taxpayer from seeking a
refund.
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OVERVIEW OF IRS PROCEDURES
TYPES OF WAIVERS
Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency
in Tax Acceptance of Overpayment (discussed above).
Form 870-AD, Offer to Waive Restrictions on Assessment and Collection of Tax
Deficiency (Appeals Division).
DIFFERENCES BETWEEN 870 AND 870-AD
Form
870
‐
AD
Form 870
Can
the case
be
reopened?
No
Yes
Effective
Upon
IRS Acceptance
Execution by
Taxpayer
Taxpayer prevented
from
filing
refund
claim?
Yes
No
Can IRS
make
an
additional
assessment?
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OVERVIEW OF IRS PROCEDURES
CLOSING AGREEMENTS
(SETTLEMENT AGREEMENTS
AUTHORIZED BY THE
INTERNAL REVENUE CODE)
Form 866, Agreement as to Final
Determination of Tax Liability, provides
for finality as to tax liability
Form 906, Closing Agreement on Final
Determination Covering Specifics
Issues, provides finality as to specific
matters.
The Closing Agreement is final and
conclusive, and binds both parties to
the matters agreed upon (absent
fraud/malfeasance).
OVERVIEW OF IRS PROCEDURES
UNAGREED CASES ON AT APPEALS
If unable to reach satisfactory settlement at Appeals,
then Appeals will prepare a 90-day letter, and the
taxpayer will have 90 days to file a petition with the
Tax Court for redetermination
CASES DOCKETED BEFORE TAX COURT
If a case under consideration in Appeals is docketed
in the Tax Court and an agreement is reached as to
the issues involved, the disposition of the case is
made by stipulation of the agreed deficiency filed with
the Tax Court.
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OVERVIEW OF IRS PROCEDURES
STATUE OF LIMITATIONS ON REFUNDS/CREDITS
Generally, a claim for refund/credit must be filed within the later of 3 years from
the date the taxpayer’s return was filed or 2 years from the date the tax was
paid.
SOL may be extended when the IRS and taxpayer have agreed to extend the
period of assessment by filing Form 872, Consent to Extend the Time to
Assess Tax. In these cases, the period for filing a claim will not expire prior to
6 months after the expiration of the period in which the assessment can be
made.
JOINT COMMITTEE CASES
Refunds or credits in excess of $2,000,000 cannot be made by the IRS until a
report is submitted to and reviewed by the Joint Committee on Taxation, which
is composed of 10 members of Congress.
Refunds or credits may not be made until 30 days after the report is submitted.
REPORTING
FEDERAL
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REPORTING FEDERAL CHANGES
ISSUES
What constitutes a federal change or a final
determination?
When and how do I file?
Scope of State Review
Secondary Imports of RARs
POSSIBLE CONSEQUENCES OF NOT TIMELY
REPORTING
Negligence and failure to file penalties
Additional interest
Loss of refunds, deductions or offsets
Inaccurate attributes/carryovers
Increased scrutiny by state revenue agencies
Statutes remain open until filed
Financial statement impact – ASC 740 reserves
REPORTING FEDERAL CHANGES
WHAT CONSTITUTES A
FEDERAL CHANGE?
Generally defined as a change to
taxable income, but can also
encompass a change to federal
tax, e.g., foreign tax credits
WHAT CONSTITUTES A FINAL
DETERMINATION?
Generally not defined in most
states.
Partial Settlements?
Potential Interpretations of Final Determination Signing an 870‐ AD Signing 870Date Tax Court
Enters Order Subject to No Further Appeal Assessment Date Filing Federal Amended Returns Date a Payment is Made or Refund Issued First (or Last)
of a Series of
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DEFINITION OF FINAL DETERMINATION
AK HI ME RI VT NH MA NY CT PA NJ DC DE WV NC SC GA FL IL IN OH MI WI KY TN AL MS AR LA TX OK MO KS IA MN ND SD NE NM AZ CO UT WY MT WA OR ID NV CA VA MD
State statute defines “Final Determination” States with no definition or vague definition of “Final Determination”
N/A
Source: COST Updated State Tax Administration Scorecard
Note
OH: No state CIT, municipal income tax (post-2015)
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REPORTING FEDERAL CHANGES
SPECIFIC EXAMPLES OF “FINAL DETERMINATION”
State
Final Determination
Definition
California
I.R.S.
Assessment
Date
Colorado
First
of
a
series of
events
New
Hampshire
Last
of
a
series of
events
Texas
Date
all
administrative
appeals
with
the
IRS
are
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REPORTING FEDERAL CHANGES
INDIANA
If there is a modification to federal tax return or federal tax liability, taxpayer
must notify Department of such change within 180 days of such modification
• Taxpayer must file refund within 6 months of such modification
• Does the term “modification” include Notice of Proposed Adjustment and 30-day letter?
> Are these proposed or final adjustments?
Had taken the position that 6 month period for filing a refund claim based on
federal change starts upon taxpayer’s receipt of the IRS adjustment
• Included Notice of Proposed Adjustment and 30-day letter
Taxpayers contended that the 30-day letter and proposed adjustments are not
final and not a federal “modification”
State has since dropped the issue
TIME LIMITS FOR REPORTING FEDERAL TAX CHANGES
AK HI ME RI VT NH MA NY CT PA NJ DC DE WV NC SC GA FL IL IN OH MI WI KY TN AL MS AR LA TX OK MO KS IA MN ND SD NE NM AZ CO UT WY MT WA OR ID NV CA VA MD
Report Changes within 30 days Report Changes within 60 days Report Changes within 90 days
Report Changes within 120 days Report Changes within 180 days or longer
No statutory time limit to report federal changes
No Corporate Income Tax
Notes
CA: Within 6 months IA: 60 days for payment, 180 days for refund NH: Within 6 months NY: 120 days for combined reports
OH: No state CIT; post-TY 2015, 60 days for amended municipal income tax returns OK: Within one year OR: 60 days if Portland/Multnomah County PA: Within 6 months (Tax Years pre-2013, 30 days)
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REPORTING FEDERAL CHANGES
TIME LIMITS FOR REPORTING FEDERAL CHANGES
Different limits for reporting federal changes
• New York
> 90 days for separate return filers (RAR and non-RAR) > 120 days for combined filers (RAR), N.Y. Tax Law Sec. 211(3).
DEFICIENCY V. REFUND
Illinois – Is there a difference in the time for reporting?
Iowa – Refund must be filed within 6 months of final federal audit adjustment
Maryland
• Deficiency must be reported within 90 days • Refund must be filed within 1 year
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REPORTING FEDERAL CHANGES
HOW TO FILE FEDERAL CHANGES
Most states laws mandate the use of applicable form
Original return marked “Amended”
• Alabama – Form 20C with “Amended Return” box checked
• Alaska – Recently announced Form 611X no longer accepted Sample bullet two-B (1)
Amended return form (Year Specific v. Generic)
Special forms for reporting federal changes
• Pennsylvania – Form 128C (RAR and Non-RAR when Official Notice of Settlement has not yet been issued); Form RCT-101 for other Non-RAR
Spreadsheet Calculations
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REPORTING FEDERAL CHANGES
Common areas of state/federal non-conformity:
• IRC §199 (domestic production activities deduction)
• IRC §108(i) (elective COD income deferral)
• IRC §179 (bonus depreciation election)
• Other accelerated or bonus depreciation
• Subpart F (foreign income from controlled foreign corporations)
• Adjustments to loss carrybacks
> Most states never allowed carrybacks of NOLs
> State NOLs determined independently of federal NOLs
• Federal tax credits
REPORTING FEDERAL CHANGES
SCOPE OF STATE REVIEW UPON NOTICE OF FEDERAL
CHANGES
Issues for consideration
• Does the federal change affect issues relating to apportionment?
> Timing and recognition of revenues – does the sales factor have to be adjusted? > Impact on compensation – do the adjusted federal items have an impact on the payroll
factor?
> Impact on lease payments – do the changes adjust the amount of lease deductions for real property that are allowed and impact the property factor?
• Is the state audit of federal changes limited only to federal changes or is the
entire state return reopened to state audit (with a new SOL)?
> Some states clearly limit income tax adjustments when the state’s normal SOL has expired to just those adjustments impacted by the changes made by the IRS.
• Example of States: Alabama, Iowa, and Mississippi
> Other states keep the period open for adjustment for non-IRS changes to also be addressed.
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POLLING QUESTION – WHEN REQUIRED TO FILE AN AMENDED
STATE TAX RETURNS AFTER AN IRS AUDIT AND THE STATE’S
NORMAL STATUTE OF LIMITATIONS TO AUDIT HAS EXPIRED,
SHOULD NON-IRS ADJUSTMENTS BE ALLOWED?
A. ONLY IF IT IS ONE
SIDED IN MY FAVOR
(NOT THE STATE)
B. NO, BOTH SIDES
SHOULD BE LIMITED
TO THE IRS
ADJUSTMENTS
C. YES, BOTH SIDES
SHOULD MAKE
ADJUSTMENTS TO
GET TO THE
“CORRECT” AMOUNT
Only if it is on e sid ed in m... No, both side s sho uld be ... Yes, both sides shoul d m.. .33%
33%
33%
/ / 24REPORTING FEDERAL CHANGES
STATUTE OF LIMITATIONS- WHEN FILED.
When timely reporting federal changes, state statutes
provide a statute of limitations on the state’s ability to issue an assessment.
The period of time varies from state to state, but on average
a state has 1 to 2 years from the date the federal change is reported to issue an assessment, though some states like California have 4 years to issue an assessment.
STATUTE OF LIMITATIONS- WHEN NOT FILED.
When a taxpayer does not report a federal change, states
generally take the position that an assessment may be issued at any time or at least within a certain period of time
after the federal determination is discovered
.
• For example, TX says that failure to notify the department of federal change allows the Department to assess within 1 year from the date that the final determination is discovered and provides for an additional 10% penalty of the tax that should have been reported in addition to all other penalties.
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REPORTING FEDERAL CHANGES
STATUTE OF LIMITATIONS- WHEN NOT FILED.
MI- Provides that failure to notify the department of a federal change is
considered fraud and will be assessed at any time within 2 years of the
discovery of the fraud and will include penalties.
MN- Provides that failure to notify the department of a federal change allows
the department to assess tax within 6 years after the report should have been
filed.
CA- Provides that failure to notify the department of a federal change allows
the department to assess tax at any time. State has four years from the date it
receives “sufficiently detailed” information to apply the federal changes to
California return.
• Sufficiently-detailed” information is defined as enough information to allow state to compute the resulting California tax change.
• If all the SOLs have expired, CA may issue the assessment based on the open-ended statute law. However, if claim for refund is not timely filed within two years of the final federal determination the statute would bar the refund and the overpayment cannot be offset against any amounts due.
REPORTING FEDERAL CHANGES
SECONDARY IMPACTS OF RARS
What if federal change results in an overpayment of state taxes? Credits or
refunds.
• Governed by statutes. SOLs may prohibit a refund but taxpayer should always be entitled to a credit for overpayments. (Tax policy view articulated by many courts is that a SOL limiting refunds is necessary to provide government with ability to appropriate budget for the current years while a credit can be projected and taken into account in later years.)
• City of Phila. v. City of Phila. Tax Rev. Bd. (to the use of Keystone Health Plan East,
Inc.), Pa. Ct of Common Pleas for Phila. County No. 03671 (1stJud. Dist. – Civil) (Dec.
27, 2012)
State modifications
• Some states require reporting of changes that resulted from audit adjustments in other states (similar to federal changes)
• RAR for consolidated group could require multiple notices for members of group in separate return states:
> Problems with separate-entity state filings and federal consolidated limitations (e.g., contributions, NOLs, etc.)
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REPORTING FEDERAL CHANGES
SECONDARY IMPACTS
OF RARS
Changes to franchise tax
base
• Do federal changes have impact on net worth base?
> Pennsylvania – book income adjustment?
Do changes affect other
taxes?
• Sales and use –
> Timing and recognition of revenue
> Classification of revenue sources – intangible v. tangible property sales (taxable v. non-taxable)?
PROTECTIVE
CLAIMS FOR
REFUND
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PROTECTIVE CLAIMS FOR REFUND
WARNING: Watch state SOLs – especially when filing Federal 1120x
Filing for State Protective
Claims for Refund May be
Appropriate When: Filing for State Protective
Claims for Refund May be
Appropriate When:
At federal level, taxpayer
has competent authority to
rely on the position from
another jurisdiction At federal level, taxpayer
has competent authority to
rely on the position from
another jurisdiction
Taxpayer is challenging the
issue at the federal level Taxpayer is challenging the
issue at the federal level
Taxpayer files a federal
amended return requesting
a refund to preserve the
right to refund upon
adjustment Taxpayer files a federal
amended return requesting
a refund to preserve the
right to refund upon
adjustment
OTHER
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OTHER CONSIDERATIONS
Starting point following dollar-value settlement of original return audit
Offsetting refunds against deficiencies
Interest and penalties: If federal deficiency reported, do interest and
penalties run from the date of:
• Filing of the original federal/state return?
• The notice to the state of the federal change?
• Interest examples:
> Florida: Interest accrues from filing date of the original state return.
> Pennsylvania: Interest accrues 30 days after the taxpayer receives notice of the final federal determination.
• State underpayment penalties likely still apply
> California Large Corporation Underpayment Penalty
> Strict liability 20% penalty for underpayments of $1 million or more
.
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OTHER CONSIDERATIONS
TAX AMNESTY AND FEDERAL CHANGES
Overlap of tax amnesty, notification and overpayment
or deficiency matters generally are not contemplated
in tax amnesty programs
• Is taxpayer entitled to a refund of taxes he agreed not to dispute due
to amnesty agreement?
>
Conway-Transportation Services, Inc., v. Hamer
, 2013 IL App (1
st)
11-3410-U, Ill. Ct. of Appeals (4
thDiv.) (Jan. 17, 2013.)
• Taxpayer is subject to amnesty penalties due to failure to report:
> Metropolitan Life Insurance v. Department of Revenue, Illinois
COMMON
PRACTICES
COMMON PRACTICES
When in doubt about whether to report any federal change to the states, be conservative and report the changes sooner rather than later.
Use the state prescribed return form and fill out all state forms as completely as possible
Use certified or registered mail to file returns.
Review the states SOL to determine if it is open for more than just federal changes and look for opportunities to offset.
Be aware of state amnesty programs and provisions.
When appropriate, ask the state taxing authority to offset overpayments and underpayments.
Follow-up on all refund claims.
Be aware of the statute of limitations on all notices and adjustments.
When making payment, specifically request that it be applied to tax first, then interest in order to avoid interest continuing to accrue on the tax deficiency.
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