Q&A: Net Investment Income (III) Tax Protective Refund Claims

Our July 7 article, “Net Investment Income (III) Tax Protective Refund Claims”, discussed  the potential filing of protective claims for the 2016 tax year.   Based on questions we have received so far, this article provides some additional insight on this topic.


What does the opportunity to file a protective claim pertain to?

The Supreme Court recently agreed to hear appeals regarding the constitutionality of the Affordable Care Act (“ACA”). The appeals are contesting that with the elimination of the individual mandate to purchase health care from the ACA by the Tax Cuts and Jobs Act in 2017 (“TCJA”), the ACA was no longer constitutional. The Supreme Court is expected to rule on the matter by 2021. Because the statute of limitations on the 2016 tax year will close before a final decision is rendered in this case, taxpayers may need to file a protective claim for refund. A protective claim for refund informs the IRS to keep the tax year open (generally for refund purposes only) until the court case is decided. Please be advised that under normal circumstances, the statute of limitations on 2016 income tax returns filed prior to July 15 would have expired; however, due to a recent change resulting from COVID-19, taxpayers were given until July 15 to act if 2016 returns were filed prior to or on July 15.

Many of our clients chose to file the protective claims and afford themselves the opportunity to file an amended return to claim a refund for taxes paid in the event they are determined to be unconstitutional.


Do I still have time to file the protective claim for 2016?

In the event you chose not to file a protective claim or if you filed your 2016 income tax return after July 15, 2017 you have 3 years from the date you filed your extended return to file a protective claim. For example, if you filed your 2016 return on August 10, 2017, you have until August 10, 2020 to file the protective claim for 2016. In addition, if the Supreme Court does not provide a ruling before April 15, 2021, protective claims for 2017 may also be required to be filed.


What is the probability of the ACA tax being declared unconstitutional and ultimately eliminated retroactively in the opinion of the author?

Many folks are indicating that the chances of the 2016 taxes imposed under the ACA being ruled unconstitutional and subsequently refunded are remote – some saying less than 10% chance. In order for the taxes to become refundable, the Supreme Court would in theory need to rule that the change in law making the penalty zero dollars would make the individual mandate under ACA unconstitutional. In addition, they would need to rule that the law is unconstitutional retroactively to a date prior to the amendment to the penalty (i.e. sometime between 2010’s ACA and change to penalty under TCJA).

The past few months have shown us that anything is possible, but probable is the key question when weighing whether filing a protective claim makes sense. We believe that the chances are indeed possible; however, from a probability perspective it is more probable that the Supreme Court would rule that the tax is unconstitutional for the year the penalty was actually zero (and those thereafter) rather than years prior (i.e. 2016 in this case).


What items should be considered in making the determination of filing the protective claim or not?

The main item to keep in mind while making this determination is of course, the magnitude of the net investment income tax and/or additional .9% Medicare tax liabilities. In addition, in the event the Supreme Court rules in favor of taxpayers and the taxes ultimately become refundable, a taxpayer would need to file an amended return for the 2016 tax year in order to claim a refund for that year. If an amended return were to be filed, the IRS may look at the entire return for that year. Moreover, if the IRS were to discover any item(s) on the return that would result in an increase in tax, they would not be able to assess tax. However, the risk would remain that the IRS would reduce the requested refund to the account for the increase in tax.

In addition, the IRS also reserves the right to examine the same issue giving rise to the increase in tax (if applicable) for other tax years whose statutes remain open. Alternatively, in the event the taxes are ruled unconstitutional retroactively (again, very remote chance), the IRS could automatically refund ACA taxes paid in prior years, which would mean amended returns would not be required to be filed.


Should you have any questions or issues with regards to filing a protective claim, please reach out to your Sax advisor, or Craig Cassano – Sax Tax Director at [email protected].