There are situations where a taxpayer may be entitled to a federal tax refund, but the refund is based upon future contingent events that are not determinable at the present time. There are numerous situations where this can occur:
- There could be a pending tax audit, favorable results for which could flow-thru to the taxpayer.
- There could be a pending change in the tax laws, case law, or other legislation, that may impact, favorably, the taxpayer.
- There may be civil or criminal litigation in process that could also impact the taxpayer.
A claim for a tax refund must be filed within three years of the date that the original return was filed, or two years from the date that the tax was paid – whichever is later. There are some exceptions to this rule, but they are not common. Contingent events may not always be resolved within this statute of limitations
There is a way for a taxpayer to preserve a possible refund claim, extending the statute of limitations and allowing the necessary time for the contingency to be resolved. A Protective Claim preserves a taxpayers’ right to a refund until a contingent event is resolved.
The IRS can hold a Protective Claim in abeyance indefinitely. For example, a taxpayer had just resolved, favorably, criminal tax prosecution. The FBI had come in, six years earlier, and seized all of the taxpayers’ financial records. We were asked to prepare tax returns based on the data from these seized records for a tax year six years ago. The late-filed returns ended up with an unexpected large tax refund. The statutes had expired, and no Protective Claim had been timely filed. The taxpayer lost a large chunk of the refund.
A Protective Claim must be filed before the limitation period for a claim of refund has expired. The claim for refund is allowable only if, before the limitation period has run, the taxpayer provides IRS with sufficient detail and facts to apprise the IRS of the exact basis for the claim.
There is no specific form for filing this type of claim. The filing can be formal or informal. The claim must include the following:
- Identify fully, and clearly, the basis for which the claim (a credit or refund) is filed.
- The claim must include sufficient facts to apprise the IRS of the underlying reasons for the claim.
- The contingency, or contingencies, affecting this claim need to be fully described and identified.
- The year, or years, for which the claim is involved must be included.
- The amount of the contingent refund, if known or knowable, should be quantified.
- The claim must be signed, and dated, under penalty of perjury.
- The claim must be filed before the expiration of the statute of limitations.
The form of the claim can be a pro-forma tax return, prepared and included as part of the details noted above. The return must state “Protective Claim” written across the top of the first page.
The IRS may have difficulty with the administration of this type of claim, as it is not used very often. However, in specific situations, it can be a critical way for a taxpayer to preserve their right to collect a tax refund in the future. If you think you may have a situation that could benefit from filing a Protective Claim, contact your ShindelRock tax professional.