On April 15, 2008, the US Supreme Court reversed the Court of Appeals for the Federal Circuit (473 F. 3d 1373 (2007)) and held that under the Internal Revenue Code a taxpayer must timely file a refund claim with the IRS before suing for a refund of a tax assessed--even a tax assessed in violation of the US constitution (Clintwood Elkhorn Mining Co., 101 AFTR 2d 2008-1612, April 15, 2008).

For decades, three coal companies paid taxes on coal exports under Code section 4121 before it was held unconstitutional in relation to coal exports. The taxpayers filed administrative refund claims for the most recent prior periods (the statute of limitations had not expired), and the IRS refunded the taxes paid with interest. For taxes paid in earlier periods that were statute-barred under the Code, the companies sued for a refund in the Court of Federal Claims and did not file refund claims with the IRS. The US Supreme Court unanimously concluded that a taxpayer suing for a refund of taxes could not proceed under an alternative statute if the Code's time limits for refund actions were not met. The Code requires that a taxpayer file a refund claim with the IRS before commencing suit, generally within three years from the date when the return was filed or, if no return was filed, within two years from the date when the tax was paid.

The specific issue in the case may be somewhat obscure, but the decision has a much broader application. For example, the decision is a reminder to Canadians in the process of selling US real estate. Under the Code, a non-US person is taxable on the gain from the sale of a US real property interest, which generally includes an interest in US real property held not solely as a creditor, whether held directly or through certain entities (such as ownership in fee simple, co-ownership, leasehold interests, time-sharing interests, life estates, remainders, and reversionary interests). To ensure that the IRS can collect the tax, the purchaser generally must deduct and withhold 10 percent of the gross sales proceeds, not just of the gain. Thus, even a sale yielding a tax loss may trigger withholding unless an exception applies and a FIRPTA withholding certificate is granted. The purchaser must report the sale to the IRS and remit the amount withheld within 20 days of the sale.

Given the currently depressed state of the Florida real estate market, and depending upon when a Canadian investor purchased the property, a sale may generate an insignificant gain or even a loss. A Canadian investor-seller who is not properly advised and does not obtain a withholding certificate may need to file a US income tax return to obtain a refund of overwithholding. The Clintwood decision is a reminder that the return's filing must be timely or the refund is lost. The preferable route is to obtain a withholding certificate before the sale. A certificate may be issued on various grounds, but the primary one is the appropriateness of reduced withholding when the normal withholding would exceed the tax liability on the transaction. For example, if a Canadian individual sells his Florida home for US$500,000, US$50,000 withholding is normally mandated unless a certificate is issued. If the property's basis is US$480,000, the US$20,000 gain at the preferential long-term capital gain rate of 15 percent yields a tax liability of only US$3,000. To obtain a refund of the US$47,000 overpaid tax, the seller must timely file a US income tax return. Prior planning to obtain a withholding certificate prevents cash flow and filing inconveniences.

Leslie R. Kellogg
Hodgson Russ LLP, Buffalo