Tax Court allows IRS levy after erroneous refund caused by faulty assessment
Hough Beck & Baird Inc. v. Commissioner. United States Tax Court. No. 19128-24L. 2026.
If the IRS’s original assessment significantly understated a taxpayer’s actual liability, it can recover an erroneous refund by making a supplemental assessment and using its usual collection methods.
Holding
The Tax Court decided that the IRS was right to make a supplemental assessment under §6204 after it mistakenly set Hough Beck & Baird Inc.’s employment tax liability at zero. The court ruled in favor of the IRS and allowed the proposed levy.
Why It Matters
The decision confirms that the IRS need not file an erroneous refund suit under §7405 to recover money it mistakenly returned to a taxpayer.
The method of recovery depends on the source of the error. The IRS may use a supplemental assessment when the original assessment materially misstated the tax liability.
A different rule may apply when the IRS correctly assessed and fully collected the tax but later issued a refund because of an unrelated payment-processing or accounting error.
The decision gives the IRS access to the ordinary administrative collection process, including liens and levies, when a timely supplemental assessment corrects a materially defective original assessment.
The holding does not authorize reassessment of every erroneous refund. The IRS must identify a material defect in the original assessment and act within the applicable assessment period.
The decision is consequential because the Tax Court had not directly resolved when an IRS calculation error makes an assessment “imperfect” under §6204. The Court adopted the approach already used by the Second, Seventh, and Ninth Circuits.
At the same time, the outcome largely follows established appellate precedent. Hough Beck & Baird was based in Washington, so an appeal would ordinarily go to the Ninth Circuit. The Ninth Circuit had already approved a supplemental assessment in materially similar circumstances.
Key Facts
Hough Beck & Baird Inc. is a Seattle landscape architecture firm.
The company timely filed Form 941 for the quarter ending March 31, 2021. It correctly reported federal employment tax of $121,003 and made three deposits totaling the same amount.
The company did not claim an employment tax credit.
The IRS nevertheless treated the company as entitled to a credit. It assessed the company’s employment tax liability as zero and treated the $121,003 in deposits as an overpayment.
The IRS refunded $121,003 to the company, plus $89 of interest.
After learning about the refund, the company’s accountant contacted the IRS. An IRS representative stated that the refund resulted from COVID-related employee retention credits available to certain employers.
In May 2023, the IRS sent Letter 6552 stating that the company might have received a refund to which it was not entitled. The company did not respond or repay the amount.
On July 17, 2023, the IRS reversed the credit and made a supplemental assessment of $121,003. The IRS also charged $12,582 of interest as of that date.
The company did not pay the assessed balance.
In April 2024, the IRS issued a final notice of intent to levy. The company requested a collection due process hearing and disputed the underlying liability.
The IRS Independent Office of Appeals sustained the proposed levy. The company then petitioned the Tax Court.
Statutory Framework
Section 6201 authorizes the IRS to determine and assess taxes imposed by the Internal Revenue Code.
An assessment records the taxpayer’s liability in the government’s accounts. When the IRS rejects the liability shown on a return, it may calculate and record a different amount.
Section 6204 permits the IRS to make a supplemental assessment when an existing assessment is “imperfect or incomplete in any material respect.”
A supplemental assessment generally must comply with the three-year assessment limitation period under §6501.
After making a timely assessment, the IRS generally has ten years to collect the liability under §6502.
Section 7405 separately authorizes the government to file a civil action to recover an erroneous refund. Different limitation periods apply to those suits under §6532(b).
The dispute concerned which recovery mechanism applied. The company argued that the IRS had issued an erroneous refund after the tax was correctly assessed and paid. The IRS argued that its original assessment was materially defective because it recorded the liability as zero.
Arguments
Taxpayer argued:
The company correctly reported and fully paid its employment tax liability.
The original assessment was complete and accurate in all material respects.
The IRS later returned money that the company had already paid.
Once a correctly assessed tax has been paid, the liability is extinguished.
The refund created a separate erroneous refund claim rather than a continuing employment tax liability.
The government could recover the money only by filing a civil erroneous refund action under §7405.
Because the government did not file such an action, the IRS could not collect the amount through a levy.
Government argued:
The IRS did not correctly assess the company’s reported employment tax liability.
The IRS mistakenly applied a credit and assessed the liability as zero.
The zero assessment understated the actual liability by the entire $121,003 reported on the return.
That error made the original assessment imperfect in a material respect.
Section 6204 authorized the IRS to correct the error through a supplemental assessment.
The timely supplemental assessment supported the IRS’s administrative collection action.
Court’s Reasoning
The IRS recorded the company’s original employment tax assessment as zero. It did not merely issue a refund after correctly assessing the reported liability.
The zero assessment resulted from the IRS’s mistaken application of an employment tax credit that the company had never claimed.
The assessment understated the company’s liability by $121,003, which represented the full amount shown on the company’s return.
An assessment that records no liability when the taxpayer actually owes $121,003 contains a material defect.
Section 6204 does not limit supplemental assessments to taxpayer errors or newly discovered facts. The provision also applies when the IRS itself causes the material defect.
The Ninth Circuit’s decision in Brookhurst, Inc. v. United States closely matched the facts. There, the IRS mistakenly assessed employment taxes at an amount below the amount reported and paid, issued a refund, and later made a supplemental assessment. The Ninth Circuit upheld the reassessment and collection by levy.
The Seventh Circuit reached a similar result in United States v. Frontone. The IRS miscalculated the taxpayers’ liability, issued a refund, and later made an accurate supplemental assessment. The Court treated the continuing claim as one for the original tax liability.
The Second Circuit also recognized in Johnson v. United States that the IRS may use a supplemental assessment to replace an invalid or defective original assessment.
These cases establish that an IRS calculation error can make an assessment imperfect or incomplete in a material respect.
The company relied heavily on O’Bryant v. United States, but the Tax Court found that case materially different.
In O’Bryant, the IRS correctly assessed the negotiated tax liability and the taxpayers paid it in full. The IRS later posted the payment twice and issued a refund because its records incorrectly showed an overpayment.
The error in O’Bryant concerned the posting of a payment, not the assessment amount. The original assessment remained correct.
Hough Beck & Baird’s account presented the opposite sequence. The IRS first calculated and recorded the tax liability incorrectly, then issued a refund because the defective assessment created an apparent overpayment.
The distinction determines the available recovery mechanism. A refund caused by a defective assessment may support a supplemental assessment. A refund caused solely by a payment-posting error may require an erroneous refund action.
The company’s original payment did not extinguish the liability because the IRS returned the same amount after incorrectly recording the liability.
The ultimate source of the government’s claim remained the company’s first-quarter 2021 employment tax liability. The government was not attempting to collect a new or unrelated obligation.
The IRS made the supplemental assessment within the applicable assessment period.
The supplemental assessment therefore supported the proposed levy under the ordinary collection rules.
Result
The Tax Court granted the IRS’s motion for summary judgment, denied the company’s cross-motion, and sustained the proposed levy.
The Takeaway
Tax professionals should first figure out why the IRS issued an erroneous refund before assuming a lawsuit is needed. If the assessment was seriously wrong, the IRS may be able to fix it under §6204 and use its usual collection process.
This decision does not remove the difference between reassessments and erroneous refund lawsuits. The key difference now depends on the type of accounting error, not just on whether the taxpayer got money from the IRS.
List of Citations
§6201: Authorizes the IRS to determine and assess federal taxes.
§6203: Governs the method of assessment by recording the taxpayer’s liability.
§6204(a): Authorizes a supplemental assessment when an assessment is materially imperfect or incomplete.
§6501(a): Generally requires the IRS to assess tax within three years after the return is filed.
§6502(a)(1): Generally gives the IRS ten years after assessment to collect the liability by levy or Court proceeding.
§7405: Authorizes the government to bring a civil action to recover an erroneous refund.
§6532(b): Establishes the limitation period for erroneous refund suits.
United States v. Galletti, 541 U.S. 114 (2004): Explains that an assessment records the taxpayer’s liability in the government’s books.
Brookhurst, Inc. v. United States, 931 F.2d 554 (9th Cir. 1991): Upholds a supplemental assessment after the IRS materially understated employment tax and issued a refund.
United States v. Frontone, 383 F.3d 656 (7th Cir. 2004): Treats a refund resulting from an understated assessment as part of the original tax liability rather than as a separate refund claim.
Johnson v. United States, 123 F.3d 700 (2d Cir. 1997): Recognizes the IRS’s authority to make a supplemental assessment after a defective original assessment.
O’Bryant v. United States, 49 F.3d 340 (7th Cir. 1995): Distinguishes an erroneous refund resulting from a duplicate payment posting from a refund resulting from an incorrect assessment.
Estate of Wilbanks v. Commissioner, T.C. Memo. 1991-45: Applies §6204 when an earlier assessment omitted a material addition to tax.
Golsen v. Commissioner, 54 T.C. 742 (1970): Requires the Tax Court to follow controlling precedent from the appellate circuit to which the case is appealable.