O'Brien v. U.S.

Decision Date28 June 1985
Docket NumberNo. 84-1809,84-1809
Citation766 F.2d 1038
Parties-5395, 85-2 USTC P 9492 Michael G. O'BRIEN, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.
CourtU.S. Court of Appeals — Seventh Circuit

Kenneth Greene, Asst. Atty. Gen., Tax Div., Dept. of Justice, Washington, D.C., for plaintiff-appellee.

David L. Higgs, Sutkowski & Washkuhn Assoc., Peoria, Ill., for defendant-appellant.

Before CUMMINGS, Chief Judge, ESCHBACH, Circuit Judge, and FAIRCHILD, Senior Circuit Judge.

CUMMINGS, Chief Judge.

This is an appeal from the judgment of the district court holding that the plaintiff taxpayer was entitled to a $7,367 (plus interest) refund of income taxes paid, notwithstanding the bar of the statute of limitations. Defendant United States argues that neither the mitigation provisions of the Internal Revenue Code of 1954, 26 U.S.C. Secs. 1311-1314, nor the doctrine of equitable recoupment remove the limitations bar, 26 U.S.C. Sec. 6511(a), to this refund suit. We agree, and for the reasons set forth below, reverse the district court's judgment.

I

The parties do not dispute the facts relevant to this action. Prior to his death on February 1, 1974, Joseph O'Brien, the sole shareholder of a closely held corporation (the "Corporation"), made gifts of shares of stock of the Corporation to his children, individually, including the plaintiff taxpayer Michael O'Brien. Joseph O'Brien also created three irrevocable trusts in favor of his three children, individually, and gave additional shares of the same stock to each trust. The transfers were made within two years of his death, so that all of the transferred stock was subject to recapture and inclusion in his estate as gifts made in contemplation of death. 26 U.S.C. Sec. 2035.

The estate of Joseph O'Brien filed a federal estate tax return on approximately November 1, 1974, in which the stock of the Corporation was valued at $215.7796 per share. The Internal Revenue Service ("IRS" or "the Service") audited the estate and disputed this valuation, apparently some time in late 1975, although the record is not clear on this point. The issue was submitted to the Tax Court for resolution. In January 1975, the Corporation was liquidated pursuant to an agreement for the sale of all corporate assets. For purposes of determining the resulting capital gain reportable on his 1975 calendar year federal income tax return, taxpayer used as his basis the $215.7796 per share value reported on the estate tax return. The IRS did not dispute this valuation and accepted payment of $7,367 in federal income tax on the gain arising from the liquidation. The estate tax controversy before the Tax Court remained pending throughout the liquidation process with the court ultimately entering a stipulated order on April 9, 1980, setting the value of the stock on the date of Joseph O'Brien's death at $280.10 per share.

In light of the result in the Tax Court, taxpayer filed a refund claim with the IRS alleging overpayment of his 1975 income taxes. The Service denied the claim on the basis that the statute of limitations 1 had run for the 1975 tax year on April 8, 1981, when the claim was filed, because "more than three years had passed since the filing of the Return, as well as more than two years after the payment of the tax for which the refund was sought." Stipulation of Facts, par. 18. O'Brien then filed this refund suit in the District Court for the Central District of Illinois, arguing that his refund claim was saved from the limitations bar by the mitigation provisions of the Internal Revenue Code and by operation of the doctrine of equitable recoupment. The district court agreed with the taxpayer on both points and entered summary judgment for the plaintiff in the

                amount of $7,367 along with interest and costs.   O'Brien v. United States, 582 F.Supp. 203 (C.D.Ill.1984).  The United States appeals
                
II

The sole issue in this case is whether the mitigation provisions or the doctrine of equitable recoupment remove the statute of limitations bar to plaintiff's claim. 2 The United States concedes that recovery is proper should the statute of limitations not apply to O'Brien's claim. 3 O'Brien, 582 F.Supp. at 204-205 (Stipulation of Facts, par. 18). We turn first to the mitigation provisions.

A. MITIGATION PROVISIONS

In certain circumstances involving inconsistent tax treatment the mitigation provisions of the Internal Revenue Code, 26 U.S.C. Secs. 1311-1314 (reproduced in the Appendix, infra ), allow both the government and the taxpayer to correct an error made in a prior closed tax year and to obtain an adjustment to tax liability despite the running of the ordinary period of limitations. They "represent an effort to meet in part the difficulties encountered in attempting to determine correctly the year in which such claims as depletion, depreciation and other expense deductions, as well as items of income should be reported." 2 J. MERTENS, THE LAW OF FEDERAL INCOME TAXATION Sec. 14.01, p. 2 (rev. ed. 1984). In Olin Mathieson Chemical Corp. v. United States, 265 F.2d 293, 296 (7th Cir.1959), this Court noted with respect to the provisions that "Congress did not intend to provide relief in all situations in which just claims are precluded by statutes of limitations" and recognized the need for limitations statutes despite the harsh results they sometimes cause to taxpayers and the government alike. While the "complicated and technical," Olin, 265 F.2d at 296, (and we might add convoluted) language of Secs. 1311 to 1314 4 appears at odds with The party invoking these Sections, here the taxpayer, carries the burden of proving that the specific requirements of the provisions are met. Id. In view of the provisions' equitable purpose, however, it is important that the mitigation provisions be given a liberal and remedial interpretation. See id. at 297; Chertkof v. United States, 676 F.2d 984, 990 (4th Cir.1982); Gooding v. United States, 326 F.2d 988, 993, 993 n. 9, 164 Ct.Cl. 197 (1964), certiorari denied, 379 U.S. 834, 85 S.Ct. 67, 13 L.Ed.2d 42. See generally Note, Sections 1311-15 of the Internal Revenue Code: Some Problems in Administration, 72 HARV.L.REV. 1536, 1543-1549 (1959) (describing the conflict between cases allowing a liberal construction of the provisions and those rendering a strict construction).

                those provisions' intended purpose--to "provid[e] for mitigation of some of the inequities under the Income Tax Laws caused by the Statute of Limitations and other provisions which now prevent equitable adjustment of various income hardships," H.R.REP. NO. 2330, 75th Cong., 3d Sess. 56 (1938)--we are obligated to recognize that the Sections "have the clear purpose of providing for adjustments to correct errors only under particular circumstances set forth in detail."   Olin, 265 F.2d at 296
                

A party qualifies for relief under the mitigation provisions if three requirements are met:

1) there is a "determination" as defined by Section 1313(a);

2) the "determination" falls within the specified "circumstances of adjustment" set forth in Section 1312; and

3) the party against whom the mitigation provisions are being invoked has maintained a position inconsistent with the challenged erroneous inclusion, exclusion, recognition or nonrecognition of income.

26 U.S.C. Sec. 1311.

With respect to the second requirement listed above, it also must be demonstrated that the taxpayer falls within one of the seven express categories or "circumstances of adjustment" listed in Section 1312. Taxpayer O'Brien solely alleges that his circumstances are covered by Sec. 1312(7) (entitled "Basis of property after erroneous treatment of prior transaction"). Section 1312(7), dealing with basis problems, has been described as entailing "by far the most difficult cases covered by [the mitigation provisions]." Maguire & Surrey, Section 820 of the Revenue Act of 1938, 48 YALE L.J. 509, 761 (1939). Indeed, in order to invoke Sec. 1312(7) the asserting party must prove existence of the following four additional conditions:

1) the relevant "determination" (see requirement # 1 above and Sec. 1313(a)) "determines the basis of property";

2) there exists a "transaction on which such basis depends" or a "transaction which was erroneously treated as affecting such basis";

3) "in respect of" the "transaction * * * there occurred" a described error (listed in Sec. 1312(7)(C)) which includes, for example, erroneous recognition and nonrecognition of gain or loss and erroneous inclusion or exclusion of gross income; and

4) the described error occurred "with respect to a [described] taxpayer" (listed in Sec. 1312(7)(B)).

26 U.S.C. Sec. 1312(7)(A).

After close scrutiny of taxpayer's predicament in relation to the numerous statutory requirements regarding basis problems, we are forced to conclude that taxpayer's situation is not covered by the mitigation provisions. Specifically, assuming satisfaction of all other prerequisites, the taxpayer, in statutory terms, fails to meet the third and fourth requirements of Sec. 1312(7)(A) (Appendix, infra) that the described error occur "in respect of" the "transaction on which * * * basis depends" and that the described error occur "with respect to a [described] taxpayer."

1. The Third Requirement of Sec. 1312(7)(A)

As noted above, the third requirement of Sec. 1312(7)(A) (as we have attempted to The district court did not consider the requirement, as we read the statute, that the described error occur "in respect of " (emphasis added) the basis-determining transaction. Plaintiff appears at one point to read the phrase "in respect of" out of the statute (Br. 18). Applying the language to the facts of this case, it is evident that the taxpayer does not satisfy the third requirement of Sec. 1312(7)(A). It cannot be said that in respect of the transfer of stock by the taxpayer's father and his subsequent death,...

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