It may be worth your while to re-examine the benefit of interest netting as it applies to the amount of interest paid to and received from the IRS. Recent court decisions have expanded the meaning of “same taxpayer” by allowing interest netting between parents and their subsidiaries with different taxpayer identification numbers (TIN). Ultimately, you may find interest netting applies to underpayment-overpayment scenarios the IRS would have previously barred, and Interest Netting may be worth more than you think.
Background on Interest Netting
Corporate taxpayers pay interest on tax underpayments and receive interest from overpayments. Interest on underpayments is charged at a higher rate than that paid by the IRS for overpayments. The resulting interest differential means a taxpayer may owe no actual tax because of offsetting payments, yet still owe interest on the underpayment portion. This scenario is not uncommon for separately handled underpayments and overpayments resulting from differing tax types or tax periods.
Interest netting’s role is to produce a result that is more reasonable for the taxpayer. IRC Sec. 6621(d) was enacted in 1998 as a direct legislative response to the IRS’s sluggishness in remedying the differential’s inequity. Sec. 6621(d) eliminates the interest rate differential in overlapping periods of equivalent underpayments and overpayments by equalizing the interest rates for underpayments and overpayments (netting it to zero).
Changes to Interest Netting Requirements
To properly apply IRC Sec. 6621(d), the tax payer’s tax accounts must satisfy three conditions:
- Equivalent underpayments and overpayments
- For overlapping tax periods
- Paid by the “same taxpayer”
At least one leg, either the underpayment or overpayment, must have an open statute.
Since the enactment of Section 6621(d) in 1998, the IRS has sought to restrict the use of interest netting by adopting a narrow interpretation of the meaning of “same taxpayer” and requiring that both the statutes of limitations of both the underpayment and overpayment used in netting be open.
Courts have also expanded the meaning of “same taxpayer.” The IRS previously interpreted the term to mean having the same Tax Identification Number (TIN). But courts have held that taxpayers without the same TIN may still constitute the “same taxpayer.” In Magma Power and MidAmerican Energy Holdings v. United States, the U.S. Court of Federal Claims ruled that the parent and a subsidiary of a consolidated group were the “same taxpayer” to the extent the post-merger group’s overpayment was traceable to the subsidiary. Thus, the court allowed interest netting between the post-merger group’s overpayment and the pre-merger subsidiaries’ underpayment. The Federal Circuit Court of Appeals in Wells Fargo v. United States ruled the post-merger group was the “same taxpayer” as a pre-merger acquired subsidiary. It reasoned that a surviving corporation after a merger became liable for the acquired entity’s underpayments and was entitled to any overpayments.
The IRS ceased challenging the statute of limitations issue in 2012 after the U. S. Court of Appeals upheld a previous Tax Court decision in Exxon Mobil Corp. v. Commissioner of the Internal Revenue Service that only one leg of the overlapping indebtedness period had to be open. Reasoning in the case was that Congress intended that taxpayers should benefit from interest netting even if one leg of the overlapping period had expired, due to the IRS having the ability to adjust the interest computation for either the underpayment or overpayment leg to achieve net rate zero.
With these court holdings in mind, corporate taxpayers should look to interest netting as an effective remedial strategy.