Ill. Lumber & Material Dealers Ass'n Health Ins. Trust v. United States

• Decision Date: 23 July 2015
• Docket Number: No. 14–2537.,14–2537.
• Parties: ILLINOIS LUMBER AND MATERIAL DEALERS ASSOCIATION HEALTH INSURANCE TRUST, Plaintiff–Appellee v. UNITED STATES of America, Defendant–Appellant.
• Court: U.S. Court of Appeals — Eighth Circuit

794 F.3d 907

ILLINOIS LUMBER AND MATERIAL DEALERS ASSOCIATION HEALTH INSURANCE TRUST, Plaintiff–Appellee

v.UNITED STATES of America, Defendant–Appellant.

No. 14–2537.

United States Court of Appeals, Eighth Circuit.

Submitted: March 10, 2015.

Filed: July 23, 2015.

Anthony T. Sheehan, argued (Gilbert S. Rothenberg, Jonathan S. Cohen, on the brief), Washington, DC, for appellant.

Thomas E. Brever, argued, Saint Anthony, MN, for Appellee.

Before WOLLMAN, BEAM, and LOKEN, Circuit Judges.

Opinion

LOKEN, Circuit Judge.

Illinois Lumber and Material Dealers Association Health Insurance Trust (“Illinois Lumber”) is a tax-exempt insurance trust operating under 26 U.S.C. (I.R.C.) § 501(c)(9). Illinois Lumber purchased life insurance policies issued by General American Mutual Holding Company (“GAMHC”), a mutual insurance company. In 2003, GAMHC began the process of demutualization, converting from an insurer owned by its policyholder members to one owned by stockholders. See generally Dorrance v. United States, 877 F.Supp.2d 827, 829–30 (D.Ariz.2012).¹ In September 2003, Illinois Lumber received a $1,474,442.30 liquidating distribution and a letter reporting that GAMHC had obtained a private ruling from the IRS that membership interests qualified as capital assets and “the entire amount of the initial distribution ... will constitute long-term capital gain.” Illinois Lumber reported the gain on its Unrelated Business Income Tax Return for fiscal year 2004 and paid a capital gains tax of $200,686. Illinois Lumber received additional GAMHC distributions of $285,647 and $213,567, which it reported as taxable capital gains on its fiscal 2006 and 2008 tax returns.

The IRS adopted the position that a policyholder's proprietary interest in a mutual insurance company has a tax basis of zero in Revenue Ruling 71–233, 1971–1 C.B. 113. In 2008, the Court of Federal Claims rejected that position. Fisher v. United States, 82 Fed.Cl. 780, 795–97 (2008). Illinois Lumber then filed refund claims for the capital gains taxes paid in 2004, 2006, and 2008. The IRS delayed ruling on the refund claims until the Federal Circuit affirmed the Court of Claims in Fisher v. United States, 333 Fed.Appx. 572 (Fed.Cir.2009). Citing the Federal Circuit's decision, the IRS allowed Illinois Lumber's refund claims for 2006 and 2008 and paid refunds of $42,847 and $32,035 in July 2010. However, in June 2011, the IRS denied Illinois Lumber's claim for a 2004 refund because the claim was not filed within the three year statute of limitations in I.R.C. § 6511(a).

After exhausting administrative appeals, Illinois Lumber brought this action seeking a refund of the alleged capital gains tax overpayment in fiscal year 2004. See 28 U.S.C. § 1346(a)(1). The district court denied the government's motion to dismiss for lack of jurisdiction because the claim was time-barred and granted Illinois Lumber's motion for summary judgment, concluding that the Internal Revenue Code's mitigation provisions, I.R.C. §§ 1311 –1314, apply and permit correcting the erroneous recognition of gain in 2004 that would otherwise be time-barred. See Ill. Lumber ... Health Ins. Trust v. United States, Civil No. 13–CV–715, 2014 WL 1757861 (D.Minn. Apr. 30, 2014). The government appeals. Reviewing the interpretation and application of the mitigation provisions de novo, we reverse.

I.

Generally, a taxpayer must file an administrative claim for refund with the IRS within three years of the time the tax return was filed or within two years of the time the tax was paid. I.R.C. § 6511(a). Because the United States cannot be sued without its consent, filing a timely refund claim with the IRS is a jurisdictional prerequisite to a tax refund lawsuit. See I.R.C. § 7422(a) ; Chernin v. United States, 149 F.3d 805, 813 (8th Cir.1998). Illinois Lumber's 2004 return was filed on July 25, 2004; no claim for refund was filed before November 23, 2008; therefore, its refund lawsuit was untimely.

Because the federal income tax applies to complex transactions and is reported and paid on an annual basis, the statute of limitations can result in severe inequities; “correction of an error may be barred by the limitations period before the proper treatment is determined and thus either the taxpayer or the public revenues may lose.” First Nat'l Bank of Omaha v. United States, 565 F.2d 507, 512 (8th Cir.1977). After federal courts struggled for decades to find equitable solutions to such dilemmas, Congress enacted the first mitigation provisions in 1938. The narrow purpose was to fashion a statutory remedy for situations in which—

under existing law, an unfair benefit would have been obtained by [either the taxpayer or the IRS] assuming an inconsistent position and then taking shelter behind the protective barrier of the statute of limitations. Such resort to the statute of limitations is a plain misuse of its fundamental purpose. The purpose of the statute of limitations to prevent the litigation of stale claims is fully recognized and approved. But it was never intended to sanction active exploitation, by the beneficiary of the statutory bar, of opportunities only open to him if he assumes a position diametrically opposed to that taken prior to the running of the statute.

S.Rep. No. 75–1567, at 49 (1938). The statute was complex and controversial when first enacted, has been amended frequently, and has spawned conflicting judicial interpretations that are hard to reconcile. See, e.g., Note, Sections 1311–15 of the Internal Revenue Code: Some Problems in Administration, 72 Harv. L.Rev. 1536, 1539 (1959).

The current mitigation provisions permit Illinois Lumber to obtain a refund of 2004 capital gains tax that would otherwise be barred by § 6511(a) if (1) there was a “determination” as defined in I.R.C. § 1313(a) ; (2) the determination fell within one of the “circumstances of adjustment” listed in I.R.C. § 1312 ; and (3) “the party against whom the mitigation provisions are being invoked [here, the Secretary of the Treasury] has maintained a position inconsistent with the challenged erroneous inclusion ... of income” in Illinois Lumber's 2004 return. O'Brien v. United States, 766 F.2d 1038, 1042 (7th Cir.1985) ; see I.R.C. § 1311 ; Taxeraas v. United States, 269 F.2d 283, 289 (8th Cir.1959) (“one claiming the benefits [of mitigation] must assume the burden of proving the existence of the prerequisites to its applicability”).

The first two requirements raise thorny interpretive issues that we need not resolve in this case. The parties agree that the only potentially applicable “circumstance of adjustment” is § 1312(7), which provides in relevant part:

(7) Basis of property after erroneous treatment of a prior transaction.—

(A) General rule.— The determination determines the basis of property, and in respect of any transaction on which such basis depends, or in respect of any transaction which was erroneously treated as affecting such basis, there occurred ... any of the errors described in subparagraph (C) of this paragraph.

* * * * * *

(C) Prior erroneous treatment.— With respect to a taxpayer described in subparagraph (B) ...

(i) there was an erroneous inclusion in, or omission from, gross income, [or]

(ii) there was an erroneous recognition, or nonrecognition, of gain or loss....

The legislative history and the Treasury Regulations provide examples of when a taxpayer may successfully invoke this circumstance of adjustment:

In 1931 the taxpayer received securities of corporation A having a fair market value of $5,000 in exchange for securities of corporation B which cost him $12,000. The taxpayer treated the exchange as one in which gain or loss was not recognizable and upon audit the return was accepted as filed. He sold the A securities in 1937 for $15,000 and reported $3,000 gain. After the statute of limitations had run on refund claims for 1931, the Commissioner asserted a deficiency for 1937 on the ground that the loss realized on the exchange in 1931 was erroneously treated as nonrecognizable, and that the basis for gain or loss upon the sale was $5,000, resulting in a gain of $10,000. The taxpayer and the Commissioner then entered into a closing agreement for 1937 in which the taxpayer agreed to the Commissioner's determination. To prevent the inconsistent resort to the lower basis resulting in complete denial of a deduction for the loss sustained in 1931, an adjustment would be made....

S.Rep. No. 75–1567, at 49 ; see Treas. Reg. § 1.1312–7, ex. 4. In general, commentators agree that, as one put it, “[t]he opacity of the mitigation provisions probably reaches its zenith with” the circumstance of adjustment in § 1312(7). John A. Lynch, Jr., Income Tax Statute of Limitations: Sixty Years of Mitigation—Enough, Already!!, 51 S.C.L.Rev. 62, 87 (1999). Another concluded that the basis provision “cries for amendment; and ... until amendment comes, we are likely to see some hard cases decided in harsh ways and others in total disregard of the statute.” Daniel Candee Knickerbocker, Jr., Mysteries of Mitigation: The Opening of Barred Years in Income Tax Cases, 30 Fordham L.Rev. 225, 258 (1961).

“Tax basis is the amount used as the cost of an asset when computing how much its owner gained or lost for tax purposes when disposing of it.” United States v. Woods, ––– U.S. ––––, 134 S.Ct. 557, 561, 187 L.Ed.2d 472 (2013) ; see I.R.C. § 1012. Consistent with that principle, courts have found that a policyholder's tax basis in the proprietary portion of a demutualized interest depends upon the initial acquisition of the interest, typically, when mutual insurance policy premiums were paid.See Fisher, 82 Fed.Cl. at 799 ; Dorrance, 877 F.Supp.2d at 837 ; Stephen J. Olsen, Chuck vs. Goliath: Basis of Stock Received in Demutualization of Mutual Insurance Companies, 9 Hous. Bus. & Tax L.J. 360, 382 (2009). Applying the awkward language of § 1312(7)(A) in this context is indeed perplexing.

Section 1313(a)(3)(B) provides that the Secretary's final...