Protective Refund Claims: Preserving the Right to a Tax Refund
When is a protective refund claim available? Taxpayers often face uncertain outcomes in litigation or business transactions, giving rise to contingent tax refund claims. For example, if a pending lawsuit ends in a favorable result, it may create new law that gives the taxpayer a more favorable tax position in an earlier year—creating a right to a tax refund. A taxpayer may even be waiting for a hoped-for change in the tax laws that will result in a retroactive right to a refund. But what if the taxpayer’s right to a refund claim will not become clear until after the statute of limitations expires on their ability to file a claim for refund with the IRS?
A protective refund claim may be the solution.
What is a Protective Refund Claim?
Protective refund claims preserve a taxpayer’s right to claim a tax refund when the taxpayer’s right to the refund is contingent on future events that may not occur until after the statute of limitations expires. The “protective claim” concept is not contained in the Code or Treasury regulations but is instead established by case law.
A protective refund claim is an informal claim, formal claim, or amended return for credit or refund typically based on expected changes in the Code, regulations, legislation or current litigation. Claims identifying a pending court case or decision (as a contingency) are generally considered protective claims.
In order to be effective and recognized by the IRS, a protective refund claim should comply with the rules established by applicable case law and administrative practice. For example, the claim must have a written component and must properly identify and describe the contingencies affecting the claim. The claim must also be sufficiently clear and definite to alert the Service to the essential nature of the claim and must identify a specific year or years for which a refund is sought. A protective refund claim may be ineffective if it does not comply with all of the requirements established by case law.
Protective Refund Claims: A Thumb-Nail History
The Supreme Court first considered an informal protective refund claim in United States v. Kales. There, the court embraced the concept of a protective refund claim—a claim for a tax refund contingent upon future events:
The fact that respondent had originally stated her claim in the future tense, saying that in the event of departmental revision of the valuation of the stock she ‘will insist’ on a higher valuation and ‘will claim the right to a refund’, does not in the circumstances of this case lend even grammatical support to the Government’s contention. Such a use of the future tense in stating a claim may, with due regard to the circumstances of making it, rightly be taken as an assertion of a present right. See Georgia, Florida & Alabama Ry. Co. v. Blish Milling Co., 241 U.S. 190, 197, 198, 36 S.Ct. 541, 544, 60 L.Ed. 948; cf. George Moore Ice Cream Co. v. Rose, supra, 289 U.S. at page 384, 53 S.Ct. at page 624, 77 L.Ed. 1265, reversing, 5 Cir., 61 F.2d 605. Here the claim is alternative and contingent upon future events. The statement that upon the happening of the contingency the claim will be prosecuted is not inconsistent with the present assertion of it. It is indeed an appropriate, if not the necessary phraseology for the present assertion of an alternative claim with respect to which a taxpayer in his presentation of an informal tax refund claim, should be in no less favorable position than the plaintiff in a suit at law who is permitted to plead his cause of action in the alternative.
United States v. Kales, 314 U.S. 186, 195–96 (1941).
In Kales the taxpayer filed a written protest of a jeopardy assessment that was later refunded after litigation. The issue concerned the tax basis of stock that was later sold. The taxpayer’s claim stated that if a previous determination of the value of the stock should be set aside or reopened, the taxpayer “would insist” that the value so determined was too low and that she should recover the taxes paid based on the incorrect value. The letter also advised that the taxpayer “will insist” that the stock was greatly undervalued and the taxpayer “will claim the right to a refund.” Following the litigation, which resulted in a judgment in favor of the taxpayer, she filed a formal claim for refund.
The Supreme Court held that the letter constituted a valid informal claim for refund:
When respondent filed her letter, the time within which a claim for refund could be filed was about to expire, and the occurrence of the contingencies on which a recovery could be had by respondent remained uncertain. But the Commissioner could have been left in no doubt that she was setting forth her right to a refund in the event of a departmental revision of its 1919 valuation of her stock. Her letter was present notice that, if the department insisted upon changing its original decision as to the 1913 value, she asserted that the stock had been undervalued and in consequence of the undervaluation she had a “right to a refund of said  tax to the extent of such excess.”
Id. at 195.
The Court of Claims discussed the requirements of an informal claim in American Radiator & Standard Sanitary Corp. v. United States, 318 F.2d 915, 162 Ct.Cl. 106 (1963). An informal claim must have “a written component … and should adequately apprise the Internal Revenue Service that a refund is sought and for certain years.” Id. at 920 (citations omitted). Further discussing these requirements, the court stated:
It is not enough that the Service have in its possession information from which it might deduce that a taxpayer is entitled to, or might desire, a refund; nor is it sufficient that a claim involving the same ground has been filed for another year or by a different taxpayer….
On the other hand, the writing should not be given a crabbed or literal reading, ignoring all the surrounding circumstances which give it body and content. The focus is on the claim as a whole, not merely the written component.
Id. (citations omitted).
The Supreme Court again addressed protective claims in Kellogg-Citizens Nat. Bank of Green Bay, Wis. v. United States, stating that “Protective claims are not unknown to federal tax practice . . . and [s]uccessive claims may be filed, defective claims cured, and informal claims turned into formal ones.” Kellogg-Citizens Nat’l Bank v. United States, 330 F.2d 635, 639 (Ct. Cl. 1964) (holding that taxpayers are expected to make every reasonable effort possible, including the filing of a protective claim, to hold open the statute of limitations and maintain their right to a potential claim for refund). See also Swietlik v. United States, 779 F.2d 1306, 1307 (7th Cir. 1985) (finding that when a refund claim is uncertain as to its mere existence or to its amount, filing a protective claim is an appropriate course of action)
To this day, protective refund claims play an important role in protecting taxpayers’ right to a future refund claim.
Protective Refund Claims: Relevant Statutory Provisions
There are a number of statutory provisions that are relevant to refund claims. In order to understand the role and context of a protective refund claim, it is helpful to have a basic understanding of those provisions. We have set out below several of the most relevant statutory and regulatory provisions:
Section 6402(a) of the Code provides that in the case of any overpayment, the IRS, within the applicable period of limitations, may credit the amount of the overpayment, including any interest allowed on it, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment and shall, subject to subsections (c), (d), and (e), refund any balance to such person.
Section 6511(a) of the Code provides that a claim for credit or refund of an overpayment of any tax in respect of which the taxpayer is required to file a return shall be filed within three years from the time the return was filed or two years from the time the tax was paid, whichever of such periods expires later, or if no return is filed by the taxpayer, within two years from the time the tax was paid.
Section 6511(b)(1) of the Code provides that no credit or refund shall be allowed or made after the expiration of the period of limitation prescribed in section 6511(a), unless a claim for credit or refund is filed by the taxpayer within such period.
Section 7422(a) of the Code provides that no suit or proceeding shall be maintained in any court for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected, until a claim for refund or credit has been duly filed with the Secretary, according to the provisions of law in that regard, and the regulations of the Secretary established in pursuance thereof.
Section 301.6402-2(b)(1) of the Regulations provides that no refund or credit will be allowed after the expiration of the statutory period of limitation applicable to the filing of a claim therefor except upon one or more of the grounds set forth in a claim before the expiration of such period. The claim must set forth in detail each ground upon which a credit or refund is claimed and facts sufficient to apprise the Commissioner of the exact basis thereof. The statement of the grounds and facts must be verified by a written declaration that it is made under penalties of perjury. A claim that does not comply with this requirement, according to such regulations, will not be considered for any purposes as a claim for refund or credit.
Section 301.6402-3(a)(5) provides that a properly executed individual, fiduciary, or corporation original income tax return or an amended return (on 1040X or 1120X if applicable) constitutes a claim for refund or credit within the meaning of section 6402 and section 6511 for the amount of the overpayment disclosed by the return (or amended return). A return or amended return shall constitute a claim for refund or credit if it contains a statement setting forth the amount determined as an overpayment and advising whether such amount shall be refunded to the taxpayer or shall be applied as a credit against the taxpayer’s estimated tax for the taxable year immediately succeeding the taxable year for which such return (or amended return) is filed.