Juliet R. El v. Commissioner

The $15,000 Glitch: Rebate vs. Nonrebate

A $15,764 windfall landed in Juliet El's bank account due to an IRS computer error. When the IRS sought to claw it back via a Notice of Deficiency, El challenged the agency's right to use that procedure. The core of the dispute: whether the erroneous refund constituted a "rebate" based on a substantive recalculation of her tax liability, or a non-rebate refund stemming from a simple clerical error. The Tax Court sided with the IRS, confirming the deficiency and setting the stage for a showdown over a key jurisdictional point when dealing with negative tax.

From $1,400 to $17,000: The Transcription Error

The case arose from a seemingly simple error in processing El's 2020 tax return. El, assisted by a tax preparer, had filed a timely Form 1040, U.S. Individual Income Tax Return, reporting income consisting of $6,881 in wages and $16,623 in unemployment compensation. She correctly claimed her son as a qualifying child and, using Schedule 8812, Additional Child Tax Credit (ACTC), determined her eligibility for a $1,400 ACTC. She included this schedule with her return, claiming the $1,400 credit.

El's return initially calculated federal income tax due of $488, which was reduced to zero due to the nonrefundable portion of the Child Tax Credit. Factoring in withholding of $958, she reported an overpayment of $5,271 and requested a refund of that amount. This overpayment consisted of the $1,400 ACTC, a $2,913 Earned Income Credit, and the $958 in excess withholding.

Instead of the $5,271 refund requested, El received $21,035 via direct deposit around March 24, 2021. The extra $15,764 was the result of an IRS computer error. While processing Schedule 8812, the IRS system erroneously adjusted the ACTC amount. The computer incorrectly determined El was entitled to an ACTC of $17,164 – a figure that matched her earned income reported on the same schedule. Based on this adjustment, the IRS increased El’s total refundable credits to $20,077 and her total overpayment to $21,035. The IRS later caught the mistake and, on July 21, 2023, mailed El a Notice of Deficiency for $15,764.

The Procedural Wall: Defining the Error

...64 was the result of an IRS computer error. While processing Schedule 8812, the IRS system erroneously adjusted the ACTC amount. The computer incorrectly determined El was entitled to an ACTC of $17,164 – a figure that matched her earned income reported on the same schedule. Based on this adjustment, the IRS increased El’s total refundable credits to $20,077 and her total overpayment to $21,035. The IRS later caught the mistake and, on July 21, 2023, mailed El a Notice of Deficiency for $15,764.

The legal dispute centered on the type of refund issued. El argued that the $15,764 refund was a "nonrebate" refund, resulting from a mere clerical error. If deemed a nonrebate refund, the IRS could not use deficiency procedures to recover the funds, but would instead be required to file a lawsuit under Section 7405. Section 7405 provides the IRS the ability to commence a civil action in federal district court to recover an erroneous refund. Conversely, the IRS contended that the refund constituted a "rebate" because it resulted from a recalculation of El’s tax liability, even if that recalculation was incorrect.

The Tax Court's analysis hinged on the definition of a "rebate" under Section 6211(b)(2). This section defines a rebate as a refund provided "on the ground" that the tax imposed is less than the amount shown on the return. The court reasoned that even though the initial error was a computer glitch, the IRS system did perform a "substantive recalculation" when it erroneously determined El's entitlement to the Additional Child Tax Credit (ACTC). This recalculation, however flawed, formed the basis for the refund.

The court further clarified that the term "nonrebate" essentially means "not a rebate." It emphasized that the critical question is whether the refund stemmed from a recalculation of the tax imposed, not the nature of the underlying error. Because a substantive recalculation occurred, the court sided with the IRS.

Negative Tax and the Deficiency Formula

The taxpayer argued that since her return and the Notice of Deficiency both stated that the amount of federal income tax determined for the 2020 tax year was zero, no deficiency could be due. She reasoned that no recalculation was possible since her reported tax due and her corrected tax liability matched. However, the court disagreed, pointing to Section 6211(b)(4), which addresses the disallowance of refundable credits.

Section 6211 defines a "deficiency" as the amount of tax imposed versus the amount shown on the return. Historically, this only applied when there was a positive tax owed. However, Congress, through the Technical and Miscellaneous Revenue Act of 1988, amended Section 6211(b)(4) to address situations where taxpayers claimed refundable credits, like the Earned Income Tax Credit (EITC) under Section 32 and the Additional Child Tax Credit (ACTC) under Section 24(d), even when they had little or no tax liability. The legislative history indicated that Congress wanted to allow taxpayers to challenge the disallowance of these credits in Tax Court, even if no "tax" in the traditional sense was owed.

To achieve this, Section 6211(b)(4) mandates that these refundable credits be treated as "negative amounts of tax" for purposes of calculating the deficiency. This means that even if the "tax imposed" is a negative number (due to refundable credits exceeding gross tax liability), a deficiency can still exist if the IRS determines that the correct amount of refundable credits is less than what the taxpayer claimed. As the Tax Court explained, the excess of the tax shown on a return over rebates made can result in a negative number, allowing the Commissioner to issue a deficiency notice even when that amount is at all times less than zero.

The court then applied the formula defined in Section 6211. Section 6211(b)(4) refers back to the general deficiency formula in Section 6211(a) but modifies it to account for negative amounts of tax. Specifically, Section 6211(b)(4)(B) dictates that the negative amount of tax imposed arises from "any excess of the sum of such credits as shown by the taxpayer on [her] return over the amount shown as the tax by the taxpayer on such return (determined without regard to such credits)."

In El's case, this calculation was straightforward: zero federal income tax calculated on the return less the $4,313 of refundable credits El was entitled to, resulting in a negative $4,313. Section 6211(b)(4)(A) provides a similar calculation: "any excess of the sum of the credits allowable under sections 24(d) . . . [and] 32 . . . over the tax imposed by subtitle A (determined without regard to such credits)." The IRS's erroneous belief that El's ACTC should have been $17,164 stemmed from the mistaken belief that her Earned Income Credit should have been increased by $15,764.

The court illustrated the deficiency calculation with the following formula, based on the stipulated facts:

Tax Imposed - Tax Reported - Rebate = Deficiency -$4,313 - (-$4,313 - $15,764) = Deficiency -$4,313 + $20,077 = $15,764

Therefore, even though El's tax liability was zero, the erroneous rebate of $15,764 created a deficiency under Section 6211 due to the application of Section 6211(b)(4).

The Cost of Correction

In sum, the Tax Court sided with the IRS. Because the refund stemmed from the mistaken belief that El's Earned Income Credit should have been increased by $15,764, the court held that this constituted a rebate under Section 6211. As a result, the erroneous refund could be recovered through a Notice of Deficiency. The court determined the deficiency was valid, and El owed the IRS $15,764. The court illustrated the deficiency calculation with the following formula, based on the stipulated facts:

Tax Imposed - Tax Reported - Rebate = Deficiency -$4,313 - (-$4,313 - $15,764) = Deficiency -$4,313 + $20,077 = $15,764

Therefore, even though El's tax liability was zero, the erroneous rebate of $15,764 created a deficiency under Section 6211 due to the application of Section 6211(b)(4). Tax professionals should note that even refunds generated by computer errors can be treated as rebates subject to deficiency procedures, especially when they relate to the calculation of refundable credits. This underscores the IRS's power to correct such errors through deficiency notices, placing the burden on taxpayers to challenge the adjustments in Tax Court.