NTA Blog: Lookback Rule: The IRS Fixes the Refund Trap for the Unwary
January 23, 2023 – For tax year (TY) 2019, there were nearly 34 million returns filed between the postponed period of April 16, 2020, and July 15, 2020, and for TY 2020, there were nearly 29 million returns filed between the postponed period of April 16, 2021, and May 17, 2021.
For tax year (TY) 2019, there were nearly 34 million returns filed between the postponed period of April 16, 2020, and July 15, 2020, and for TY 2020, there were nearly 29 million returns filed between the postponed period of April 16, 2021, and May 17, 2021. Without IRS intervention, any claims for credit or refund filed during the postponed period three years later that included withholding or estimated taxes would have been denied because the withheld amount(s) would have been credited to the taxpayer’s account as of April 15, outside the three-year lookback period.
Good news: The IRS issued Notice XX addressing the mismatch between the time for filing a claim for credit or refund and the three-year lookback period caused by postponing certain filing deadlines for filing seasons 2020 and 2021, which would result in the denial of timely claims for credit or refund for those taxpayers who took advantage of the postponed deadlines and who had withholding or estimated payments. Taxpayers will never know this was a potential problem as the IRS did the right thing and proactively fixed the lookback period to eliminate challenges and refund denials for taxpayers.
I first raised this issue internally after the IRS postponed the filing date for the 2020 filing season (TY 2019 returns). On May 11, 2021, I posted a blog, in which I publicly suggested the IRS publish guidance to remedy this problem and submitted a recommendation to include in the U.S. Department of the Treasury/Internal Revenue Service Priority Guidance Plan. I also provided a legislative recommendation as to how Congress could remedy this issue for these tax years and for all future instances when the filing deadline is postponed. This notice resolves the issue for the 2020 and 2021 COVID-19 disaster relief, yet it does not provide relief for other disaster filing postponements.
Quick Refresher of the Problem
To provide taxpayers with some relief and assistance during the COVID-19 pandemic, the IRS exercised its authority under IRC § 7508A and postponed certain filing deadlines for both TYs 2019 and 2020. See Notice 2020-23 and Notice 2021-21. This accommodation came with unanticipated consequences for taxpayers who took advantage of the postponed filing deadlines and may later seek a claim for credit or refund because the period for filing the claim for credit or refund and the three-year lookback period would not align.
Under IRC § 6511(a), when taxpayers believe they have overpaid their taxes, they must file a claim for credit or refund with the IRS by the later of:
Three years from the date the return was filed, or
Two years from the date the tax was paid.
Under IRC § 6511(b), there are also limits on the amount the IRS may credit or refund even when the taxpayer has filed a timely claim. These limitations are commonly known as the two- or three-year lookback period. (For this discussion, only the three-year lookback period is relevant.)
The three-year lookback period is as follows: Taxpayers who file claims for credit or refund within three years from the date the original return was filed will have their credits or refunds limited to the amounts paid within the three-year period before the filing of the claim plus the period of any extension of time for filing the original return.
Typically, the periods for filing a claim for credit or refund and the three-year lookback periods align, but the postponements of certain filing deadlines for TYs 2019 and 2020 disrupted this alignment. When taxpayers file Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, the period of the extension is included in the three-year lookback period. Yet when the IRS exercises its authority under IRC § 7508A to postpone filing deadlines, such as the postponements provided during filing seasons 2020 and 2021, the period of the postponement is not included in the three-year lookback period. Thus, a postponement and an extension are not the same. Consequently, there is a mismatch between the period in which a claim for credit or refund can be filed and the three-year lookback period for those taxpayers who took advantage of the postponed filing deadlines for filing seasons 2020 and 2021.
(This is especially true for calendar year taxpayers because IRC § 6513(b) provides that any tax deducted and withheld on wages and any amounts paid as estimated tax are deemed to have been paid on April 15 in the year following the close of the tax year to which the tax is allowable as a credit.)
The following is an example of how a taxpayer may later be denied a credit or refund after taking advantage of the postponed filing deadlines for TYs 2019 or 2020.
Example: In 2019, a taxpayer had income tax withheld from his paycheck every two weeks. In 2020, the taxpayer timely filed his 2019 return on the postponed filing deadline of July 15. The taxpayer’s 2019 tax liability was paid through withholding, which was deemed paid on April 15, 2020, the original due date of the return. Based upon the filing deadline postponement to July 15, the taxpayer files a claim for refund on July 14, 2023. Under IRC § 6511(a), the claim for refund is timely, as it was filed within three years from the filing date of the original return. Under the three-year lookback period of IRC § 6511(b)(2)(A), however, the amount of the taxpayer’s refund is limited to payments made in the three years prior to filing the claim (i.e., payments made on or after July 15, 2020). The withholding deemed paid on April 15, 2020, falls outside that period (as would any estimated tax payments) so the refund amount will be limited to $0, effectively denying the taxpayer any refund. By contrast, if the taxpayer had requested an extension of time to file until October 15, 2020, the taxpayer would have had until October 16, 2023 (October 15, 2023, is a Sunday), to be eligible to receive a refund because the extension period is added to the three year lookback period.
This problem has been remedied by issuing Notice XX, in which the IRS exercises its authority under IRC § 7508A(a), to disregard the period of postponement for filing returns for TYs 2019 and 2020 to determine the beginning of the lookback period. Thus, under this notice, disregarding the postponed time period for all taxpayers who appropriately took advantage of it effectively deems these returns filed on April 15 of the affected years, restoring alignment between the claim for credit or refund period and the three-year lookback period.
A Permanent Solution Is Still Needed for All Disaster Relief Postponements
I am pleased the IRS addressed this issue for TYs 2019 and 2020. However, the relief offered in this notice is limited to only the COVID-19-related postponements and doesn’t offer a permanent solution for other disaster relief. Say, for example, a natural disaster affects a certain area of the country, and the IRS exercises its authority under IRC § 7508A by postponing the filing deadline for the affected taxpayers from April 15 to some later date. The same problem will arise for all other relief – taxpayers may be denied claims for credit or refund if the lookback period falls outside of the postponement date. Therefore, I have made a legislative recommendation for the last couple of years that would fix this problem permanently and prevent taxpayers from being harmed and falling into a trap for the unwary.
Conclusion
Issuing Notice XX has remedied an unintended consequence of the IRS’s good deed of providing taxpayers with more time to file their 2019 and 2020 returns during the COVID-19 pandemic. This will prevent unwary taxpayers from being denied a credit or refund to which they otherwise would have been entitled. However, this relief needs to be made permanent by amending IRC § 6511(b)(2)(A) in anticipation of any future circumstances in which the IRS exercises its authority and postpones filing deadlines for all disaster relief. This will provide a permanent solution every time the IRS provides disaster relief by postponing the filing deadline and thus ensure that taxpayers’ future claims for credit or refund won’t be denied for having taken advantage of this relief.
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