If they don’t process your prior return, there’s no overpayment to apply. Let’s say your overpayment was a thousand or few thousand and you try to apply it. You’ll get billed for the overpayment that you wanted applied since they have never processed the prior return to know what you have available.
I hear what you are saying. Just not sure that position, if taken by the IRS, would hold up in court.
If the IRS cannot prove their position, then any penalties or interest would be disregarded.
Obviously, we have to keep records of everything.
Remember the line from “The Firm”: “I don’t care about an audit, they just better not win.”