Arc Elec. Const. Co. v. C.I.R., 345

• Decision Date: 24 January 1991
• Docket Number: D,No. 345,345
• Citation: 923 F.2d 1005
• Parties: -512, 91-1 USTC P 50,064 ARC ELECTRICAL CONSTRUCTION CO., Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. ocket 90-4049.
• Court: U.S. Court of Appeals — Second Circuit

Page 1005

923 F.2d 1005

67 A.F.T.R.2d 91-512, 91-1 USTC P 50,064

ARC ELECTRICAL CONSTRUCTION CO., Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 345, Docket 90-4049.

United States Court of Appeals, Second Circuit.

Argued Oct. 4, 1990.

Decided Jan. 24, 1991.

David I. Pincus (Shirley D. Peterson, Asst. Atty. Gen., Gary R. Allen, Mary Frances Clark, Attorneys, Tax Div., Dept. of Justice, Washington, D.C., of counsel), for respondent-appellant.

Paul Friedman, New York City, for petitioner-appellee.

Before CARDAMONE and PRATT, Circuit Judges, and MUKASEY, District Judge. ^*

CARDAMONE, Circuit Judge:

The Commissioner of Internal Revenue (Commissioner or appellant) appeals from an order and decision of the United States Tax Court (Parr, J.) entered January 30, 1990 vacating its decision entered June 7, 1989. In its June 1989 decision the tax court found, inter alia, that taxpayer Arc Electrical Construction Co. (Arc or taxpayer) underpaid its taxes for 1974, and because the underpayment was due to fraud imposed a penalty of $27,884. On appeal the Commissioner challenges the tax court's reversal in January 1990 of its June 1989 penalty for fraud holding. Arc insists there was no underpayment and, even if there was, that it was not due to fraud.

This appeal has a Janus-like complexity because the facts reveal an overpayment and an underpayment of income taxes by the same taxpayer for the same tax year. It is not surprising that the tax court decided the case first one way, and later reversed itself and decided it the opposite way.

BACKGROUND

Arc filed a non-fraudulent corporate tax return for 1974. Its tax return for 1977 showed it was legitimately entitled to a new jobs credit in the amount of $100,000 and also showed total tax liability of $44,324. Taxpayer used $44,324 of the new jobs credit to reduce its tax liability to zero, carried the remainder--$55,676--back to 1974, and filed a Form 1139 (Corporate Application for Tentative Refund) seeking a "quick refund" for that amount. See Sec. 6411(a) of the Internal Revenue Code of 1954 (unless otherwise indicated statutory references are to the Internal Revenue Code of 1954). Arc obtained its $55,676 refund.

The Commissioner later determined that Arc had fraudulently overstated its cost of goods sold deduction for 1977 and--after factoring in the total new jobs credit--asserted a tax deficiency of $951,315 against taxpayer for that year. Appellant concluded that this underpayment was due to fraud and therefore asserted a fraud penalty for 50% of the amount of the deficiency, or $475,658, pursuant to Sec. 6653(b). The Commissioner further found that Arc had a deficiency for 1974, reasoning that the new jobs credit should not have been available to carry back to 1974, since had Arc stated its tax liability for 1977 honestly the credit would have been exhausted in that year. Appellant concluded that the 1974 deficiency was also due to fraud and asserted a fraud penalty of $27,838 for that year, 50% of the $55,676 refund. Arc sought review of the fraud penalties for the years 1974 and 1977 in the United States Tax Court, where it also claimed it had suffered an

embezzlement loss in its business of over $13 million in the year 1980.

A. The First Tax Court Proceeding

In the June 1989 proceeding the tax court held, inter alia, Arc liable for fraud penalties for 1974 and 1977. It also ruled that the taxpayer was the victim of a $6 million embezzlement scheme. See Arc Electrical Construction Co. v. Commissioner, 56 T.C.M. (CCH) 976 (1988). The parties then recomputed Arc's taxes. The Commissioner allowed the 1977 new jobs credit to be carried back to 1974, and with the benefit of this credit found that Arc had overpaid its taxes in 1974 by $31,769. At the same time, the Commissioner also assessed a fraud penalty of $27,838 for the earlier 1974 deficiency. This was based on an underpayment of $55,676 (the amount of the "quick refund" it obtained for tax year 1974) to which the 50 percent fraud addition was applied pursuant to Sec. 6653(b).

When the Commissioner's computations and rulings came before the tax court, it thought appellant's position was incongruous, given that the assessment of the fraud penalty for 1974 had been premised on disallowing the credit carryback. The tax court asked for an explanation. The Commissioner responded that the tax court's decision allowed Arc's 1980 embezzlement loss to be carried back to 1977, where it freed the new jobs credit that was then carried back to 1974, resulting in a $31,769 overpayment for the earlier year, but that the imposition of the fraud penalty on the underpayment of $55,676 was not affected.

Arc objected to this computation, agreeing it overpaid its taxes but contending it was not liable for the fraud penalty. The tax court was satisfied with the Commissioner's explanation, and therefore entered its June 7, 1989 decision finding that the taxpayer had overpaid its taxes for 1974 in the amount of $31,769, and imposed simultaneously a fraud penalty against Arc of $27,884 for the underpayment of $55,676 for the same year.

B. The Second Tax Court Proceeding

In the January 1990 proceeding--the subject of the instant appeal--the tax court, upon Arc's motion, vacated and set aside its June 7, 1989 order. It reaffirmed the $31,769 overpayment holding, but reversed itself on the fraud penalty and held instead that Arc was not liable for the 1974 penalty on the $55,676 refund. See Arc Electrical Construction Co. v. Commissioner, 58 T.C.M. (CCH) 1235 (1990). The tax court reasoned that though Arc was only able to apply the 1977 new jobs credit in 1974 because it fraudulently understated its 1977 tax liability--thereby creating a deficiency for 1974 because the credit should not have been available to be applied to that year--the jobs credit itself was legitimate and, therefore, the 1974 deficiency was not due to fraud. From this order and decision the Commissioner appeals. We reverse.

DISCUSSION

Two issues are presented for review: Arc contests the tax court's finding that there was an underpayment of $55,676 for 1974; the Commissioner contends that though the underpayment finding was correct, the tax court wrongly concluded that the underpayment was not due to fraud. Neither party disputes the tax court's ruling that Arc had overpaid by $31,769 its 1974 taxes.

I Underpayment of Tax

A. Is the New Jobs Credit a Rebate?

We must first decide whether Arc underpaid its 1974 taxes. The tax court found them underpaid by $55,676, the amount of Arc's quick refund based on the new jobs credit carryback. Arc advances two arguments in support of its assertion that there was no underpayment.

The first argument, focused on the definition of the term "rebates," requires an analysis of the statutory scheme implicated in this case. Section 6653(b) imposes a fraud penalty where "any part of any underpayment (as defined in subsection (c)) of tax is due to fraud." Section 6653(c) defines Arc contends that the term "the tax imposed by subtitle A" used, as just noted in Sec. 6211, should be read in harmony with its use in Sec. 11--the provision in subtitle A, entitled "Tax Imposed"--which imposes a tax on the taxable income of corporations. Thus construed, the determination of "the tax imposed by subtitle A" does not include items that do not affect taxable income; "rebates" are limited only to those items that diminish taxable income. Arc asserts that since its new jobs credit diminishes its tax liability rather than the taxable income on which tax is imposed, it cannot be a rebate and should not have been considered in the determination of whether there was an underpayment in 1974. With the new jobs credit excluded from the computation, Arc concludes, it does not have a deficiency. Hence, it cannot be liable for a fraud penalty under Sec. 6653(b).

an underpayment as a "deficiency" as defined in Sec. 6211(a). Section 6211(a), set forth in the margin, ¹ defines a deficiency using the following formula: a deficiency equals the correct tax imposed minus the total of the tax on the taxpayer's return minus prior assessments plus rebates. See Kurtzon v. Commissioner, 17 T.C. 1542, 1548 (1952); Midland Mortgage Co. v. Commissioner, 73 T.C. 902, 907 (1980). Section 6211(b)(2) defines a rebate as "so much of an abatement, credit, refund, or other repayment, as was made on the ground that the tax imposed by subtitle A ... was less than the excess of [the tax on taxpayer's return plus prior assessments] over the rebates previously made."

Credits, by definition, do not reduce taxable income, instead they diminish tax liability. See, e.g., B. Bittker & M. McMahon, Federal Income Taxation p 16-1 (1988); Martz v. Commissioner, 77 T.C. 749, 751-52 (1981). Thus, though taxpayer's position perhaps has a surface appeal, the conclusion it reaches runs counter to the statutory language and the case law. Arc's proposition that a new jobs credit is not a rebate because it "is not a deduction in arriving at taxable income" would necessarily apply to all credits. If Congress planned for this result, it would not have defined rebates as including "so much of an abatement, credit, refund, or other repayment ...," Sec. 6211(b)(2) (emphasis added), since credits would already be excluded. Congress, of course, did not add the word "credit" to its definition of rebates in a heedless fashion; in construing the tax code particularly, words used may not be considered surplusage. Rather, we believe Congress used the word "credit" because it wanted those credits that fall within Sec. 6211(b)(2)--including Arc's new jobs credit--to be considered rebates.

This conclusion is buttressed by the description of the term "the tax imposed by subtitle A" in Secs. 6211(b)(1) and (4). Those provisions state that "the tax imposed by subtitle A" shall be determined, for purposes of Sec. 6211(a), without regard to certain credits allowed in...