Retroactive Revenue Rulings

BY EDWARD J. SCHNEE

TAX CASE

As a general rule, taxpayers are required to follow—and the courts will enforce—published announcements, including revenue rulings, by the Treasury Department and the IRS. Recently, the Court of Federal Claims addressed the question of when revenue rulings are not enforceable.

Computer Sciences Corp. (CSC) maintained a 401(k) plan for its employees. Based on the generally accepted interpretation of revenue ruling 76-28, the company deducted contributions it made after yearend on its extended tax returns.

On June 11, 1990, CSC requested and received an extension until December 17, 1989, to file its 1989 tax return. On December 7 the IRS issued revenue ruling 90-105, which changed the deductibility of 401(k) contributions made after yearend. In addition, the ruling required taxpayers that had followed the now incorrect interpretation of revenue ruling 76-28 to change their accounting method to follow revenue ruling 90-10. By its terms, this ruling did not apply to taxpayers that had filed returns and deducted contributions before December 7, 1990.

CSC filed its tax return on December 17 and complied with the new revenue ruling. It then decided the ruling should not apply to its 1989 tax return and filed a refund claim. The IRS dismissed the claim and CSC sued for a refund, requesting partial summary judgment.

Result. For the taxpayer. The Court of Federal Claims said the taxpayer conceded revenue ruling 90-105 was a correct interpretation of the law. CSC’s challenge was to how the government chose to implement that ruling (lack of retroactivity and mandatory accounting- method change.)

IRC section 7805 authorizes the IRS to issue all necessary rules to enforce the code. The IRS also has the right to change its position. The fact that CSC relied on the prior interpretation to its detriment is irrelevant. The IRS has the power to make a change retroactive. (The Taxpayers Bill of Rights limits the IRS’s right to modify regulations retroactively for provisions enacted after July 30, 1996. However, the legislation does not apply to this case nor does it apply to revenue rulings.)

The right to change rules retroactively is not unlimited. The modification must be rational and not an abuse of discretion. A change may be an abuse of discretion if it results in similar taxpayers being taxed differently. Alternatively, failure to make a change retroactive could be an abuse if the result of that failure is different tax treatments for similarly situated taxpayers.

The court concluded that applying revenue ruling 90-105 only to taxpayers who had not filed by December 7 resulted in similar taxpayers’ being treated differently. The decision not to make the ruling retroactive was an abuse of discretion because the IRS presented no rational basis for the different treatment received by similar taxpayers (those who filed before and after December 7). The fact the taxpayers are in different industries does not make them dissimilar. Similarity is based on eligibility for the challenged deduction.

The court also ruled that CSC’s filing of its original return based on the new rule did not prevent it from successfully arguing the IRS had abused its discretion. Likewise, the court ignored the company’s change in accounting methods since the new revenue ruling had mandated it. CSC was entitled to follow the old rule for one more year.

When clients are confronted with new rules or with changes in existing rules, CPAs should help them determine whether applying these rules will result in similar taxpayers’ having different tax outcomes and whether that difference is an abuse of discretion.

Computer Sciences Corp. v. United States, 2001-2 USTC 50,635.

Prepared by Edward J. Schnee, CPA, PhD, Joe Lane Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.

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