United States: Illinois Appellate Court Holds Refund Request For Portion Of Estimated Payment Made Under Amnesty Program Rules Was Timely

The Illinois Appellate Court has held that a taxpayer's refund request of a good faith estimated payment made to the Department of Revenue through its participation in the 2003 amnesty program was within the applicable statute of limitations.¹ The taxpayer, undergoing a federal audit during the amnesty program, followed the Department's emergency amnesty program rules by submitting a good faith estimate of the Illinois tax that it expected to owe as a result of the audit. When the taxpayer received the final audit determination after the close of the amnesty period, the taxpayer discovered that it had overpaid the Department. Therefore, the taxpayer made a refund claim for the amount of the overpayment. The Appellate Court determined that the refund claim was timely because it satisfied the requirements for a longer two-year statute of limitations period applicable only to taxpayers that are required to report federal adjustments.

2003 Tax Amnesty Program

In 2003, to encourage taxpayers to come forward with undisclosed liabilities and to generate revenue for the state, Illinois enacted a Tax Delinquency Amnesty Act.² The Amnesty Act provided amnesty to taxpayers who paid tax liabilities that were due and owing for any period ending after June 30, 1983 and prior to July 1, 2002.³ To participate, taxpayers were required to make their full payment during the amnesty period, which ran from October 1, 2003 to November 15, 2003.⁴

The Amnesty Act also imposed a double interest penalty upon any taxpayer with a tax liability eligible for amnesty who failed to satisfy the tax liability during the amnesty period.⁵

The Department promulgated emergency rules that implemented the amnesty program. These rules gave taxpayers under either a state or federal audit during the amnesty period the opportunity to participate in the program by making a "good faith estimate" of the amount of Illinois liability due.⁶ Although the rules generally prohibited taxpayers from seeking a refund, there was a limited exception for taxpayers with a final determination from the IRS or the federal courts.⁷

Taxpayer Filed Refund Request for Overpayment of Estimated Tax

Prior to the amnesty period, the Internal Revenue Service (IRS) audited the taxpayer for the 1997 tax year. On the last day of the amnesty period, November 17, 2003, the federal audit had not yet concluded, and the taxpayer participated in the amnesty program by filing a first amended 1997 return with a good faith estimate of the additional Illinois liability that would be due after the close of the audit.

When the IRS completed the audit in August 2004, after the amnesty period ended, it determined that the taxpayer's federal taxable income, while greater than its taxable income reported on its original return, was less than its estimate on its first amended return. As a result, the good faith estimate payment to the Department exceeded the taxpayer's Illinois tax due. Therefore, on November 29, 2004, the taxpayer filed a second amended 1997 return, requesting a refund. The Department denied the refund request based on its position that the "refund was not filed timely." The taxpayer responded by filing a protest and request for hearing.

Administrative Law Judge and Circuit Court Denied Refund

The administrative law judge (ALJ) issued a recommendation for disposition, concluding that the taxpayer was not entitled to the tax refund because it failed to request the refund within one year of when the tax was paid or within three years of filing the original tax return as required under the general statutory provision limiting a refund claim.⁸ Moreover, the ALJ determined that the taxpayer was not entitled to the extended two-year limitations period that only applies to refunds based on federal changes that are required to be reported to the Department under Illinois law.⁹

The ALJ found that the federal change at issue was not one that was "required to be reported" or a "final federal change"¹⁰ since the initial good faith estimate was made by the taxpayer and not the IRS. The second amended return, in effect, was not a required report of a final federal change because it did not reflect the difference between the federal taxable income reported on the original return and the federal taxable income determined by the audit, an "increase" in the appropriate taxable income. Unlike a decrease in taxable income, an increase does not entitle the taxpayer to a refund because there is no "overpayment." In addition, the ALJ determined that the taxpayer was not entitled to the refund because the amount sought exceeded the limitation on allowable refunds under the statute providing for refunds resulting from federal changes.

The taxpayer subsequently requested a rehearing and after the request was denied, the taxpayer timely filed a complaint in the circuit court of Cook County. The circuit court affirmed the Department's decision and the taxpayer appealed. On appeal, the issue was whether the taxpayer was entitled to a refund of a portion of its good faith estimated payment.

Appellate Court Held Taxpayer Entitled to Refund of Overpayment

The Appellate Court held that the taxpayer was entitled to the refund of its Illinois tax overpayment. According to the Appellate Court, the required reporting of a federal change triggered the extended two-year statute of limitations. As required by statute, the taxpayer had reported the federal change within 120 days; the audit determination was made in August 2004 and the taxpayer filed its second amended return on November 29, 2004.

Also, the Court refuted the Department's arguments that the taxpayer's payment was an "underpayment" which precluded the possibility of a refund. It pointed out that the statute providing for refunds due to federal changes made no reference to a "final federal action" and rather, only referred to a "notification of an alteration ... required by Section 506(b)."¹¹ Furthermore, if it were not for the taxpayer's good faith estimated payment and a final federal action, there would be no dispute.

Since the Court decided there was a proper "notification of an alteration," the next step was to "give effect" to the alteration. Giving effect to the alteration in this matter meant that payment under the first amended return needed to be considered. Ignoring the additional payment under the first amended return, as the Department suggested, would ignore the taxes actually paid. In addition, no statutory language supported the view that the first amended return, in this type of scenario, should be disregarded.

The taxpayer's good faith estimate was affected by the alteration as required to be reported under Illinois law, and as a consequence, the resulting refund met the requirements for the two-year statute of limitations because there was an "overpayment resulting ... from recomputation of the taxpayer's net income ... for the taxable year after giving effect to the item or items reflected in the alteration required to be reported."¹² Thus, the Appellate Court found clear error in the Department's decision and ruled that the taxpayer's request for a refund was timely.

Commentary

It is interesting to note that the Appellate Court reached its holding in the taxpayer's favor despite its application of the "clearly erroneous" standard.¹³ This standard of review has been a point of contention among parties bringing forth matters decided at the administrative level since it requires the reviewing court to adopt a "definite and firm conviction that a mistake has been committed" in order to reverse the administrative decision.¹⁴ Nonetheless, the Appellate Court in this case reversed the administrative decision, which may give less weight to the view that the clearly erroneous standard equates to an affirmation on appeal.

Absent the Appellate Court's decision on this matter, the effective denial of the taxpayer's refund claim would have been egregious given the fact that the taxpayer followed the Department's emergency rules when it made its good faith estimated payment of tax in its first amended return.¹⁵ A denial of a refund would have penalized the taxpayer for its attempt to comply with the tax law. Moreover, ignoring the first amended return would allow for the Department's unjust enrichment at the expense of a taxpayer who was following its rules. The Illinois Department of Revenue has indicated that it is not going to appeal this decision.

Footnotes

1 Con-Way Transportation Services, Inc. v. Hamer, Illinois Appellate Court, First District, No. 1-11-3410, Jan. 17, 2013 (unpublished opinion).

2 35 ILL. COMP. STAT. 745/10.

3 Id.

4 Id.

5 35 ILL. COMP. STAT. 735/3-2(f).

6 86 ILL. ADMIN. CODE tit. 86 § 521.105(k), (l).

7 86 ILL. ADMIN. CODE tit. 86 § 521.105(l).

8 The taxpayer had paid the good faith estimate on November 17, 2003 and did not file the refund claim until November 29, 2004. 35 ILL. COMP. STAT. 5/911(a).

9 35 ILL. COMP. STAT. 5/911(b).

10 35 ILL. COMP. STAT. 5/506(b).

11 35 ILL. COMP. STAT. 5/911(b). 35 ILL. COMP. STAT. 5/506(b), as referenced in the statute, requires taxpayers to notify the Department of federal income tax changes that affect the computation of state income tax.

12 Id.

13 The Court stated that the Department's prior ruling was a mixed question of law and fact and as a result, the clearly erroneous standard applied.

14 United States v. United States Gypsum Co., 334 U.S. 364, 395 (1948).

15 In contrast, with respect to the state's 2010 amnesty program, the Department issued final regulations that specifically permit a taxpayer who overpaid an "estimated liability" while undergoing an audit to make a refund claim. However, according to the regulations, participation in the 2010 amnesty does not toll the statute of limitations for the refund claim.

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