Kolom v. U.S.

Decision Date15 August 1986
Docket NumberNo. 85-5970,85-5970
Citation791 F.2d 762
Parties-5181, 86-1 USTC P 9471, 7 Employee Benefits Ca 2554 Aaron L. KOLOM and Serita Kolom, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
CourtU.S. Court of Appeals — Ninth Circuit

S. Zackary Samuels, Dolman, Wolfe & Linden, Los Angeles, Cal., for plaintiffs-appellees.

Gary R. Allen, Steven I. Frahm, Dept. of Justice, Washington, D.C., for defendant-appellant.

Appeal from the United States District Court for the Central District of California.

Before PREGERSON and BEEZER, Circuit Judges, and JAMESON, * District Judge.

JAMESON, District Judge:

Aaron L. and Serita 1 Kolom seek a refund for double payment of the federal minimum tax assessed upon their exercise of company stock options, an item of tax preference. The Internal Revenue Service (IRS) contends that the statute of limitations bars Kolom's claim for refund. The district court found that the claim was timely filed, based on the mitigation provisions of Sections 1311-1314 of the Internal Revenue Code of 1954 (IRC or Code), enacted to relieve the harsh effect of statutes of limitations in specified circumstances. The district court accordingly entered a summary judgment in favor of Kolom. This court modifies and affirms the district court judgment.

I. Background

Kolom was an officer and director of Tool Research and Engineering Corporation (Tool Research). During the taxable year 1972, Kolom exercised certain stock options he had received that year pursuant to an employee stock option plan sponsored by Tool Research. The stock option plan qualified for favorable tax treatment. The Code exempted from gross income the stock options' "bargain element"--the difference between the stock's fair market value and its option price. IRC Secs. 421-22, 26 U.S.C. Secs. 421-22. 2 Instead, the Code included the bargain element as an item of "tax preference" subject only to a "minimum tax." IRC Secs. 56, 57. 3

Kolom did not include the stock options' bargain element as an item of tax preference in 1972 because the stock was subject to a substantial resale restriction imposed by Sec. 16(b) of the Securities Exchange Act of 1934 (the Act). Section 16(b) required return to the company of any profits made on the sale of such stock within six months of the time the option was exercised. Kolom noted on his 1972 income tax return that he would defer reporting of the bargain element as a tax preference item until he could sell the stock and retain the profits. 4 Kolom included the stock options as a tax preference item in his 1973 income tax return. Calculating the fair market value of the shares six months after the options were exercised, Kolom paid a minimum tax of $8,097 for 1973.

The IRS twice reviewed Kolom's 1972 return. In January, 1975, the IRS District Director wrote Kolom that the revenue agent's report had been reviewed and accepted. In January, 1976, however, the IRS decided that Kolom should have paid the minimum tax in 1972, not 1973.

Kolom challenged the assessment of the minimum tax for 1972. He argued that the substantial restriction imposed by Sec. 16(b) of the Act prohibited assessment of the tax until 1973. The Tax Court ruled in favor of the IRS. Kolom v. Commissioner, 71 T.C. 235 (1978). This court affirmed in Kolom I, 644 F.2d 1282. 5

Kolom wrote the Commissioner of the IRS on February 11, 1982. Citing Kolom I, he requested a notice of assessment of the minimum tax due for 1972. In his letter Kolom stated, "We trust that this payment and interest [the minimum tax paid in 1973] will be subtracted from the amount due." During oral argument, counsel for the Government acknowledged that the IRS had received the letter and was aware of Kolom's request for a refund. The IRS, however, did not assess the tax due until May of 1983, one year and three months after the Supreme Court denied certiorari. 6 Kolom paid the full amount of the minimum tax, $43,792, plus interest, assessed for 1972, for a total of $86,485.49. 7 Two months later, on July 1, 1983, Kolom filed a formal claim for refund of the minimum tax paid in 1973.

The IRS did not refund the tax. Kolom filed this action for refund on June 5, 1984. The IRS admitted all allegations of the complaint, and moved to dismiss Kolom's complaint for lack of jurisdiction because Kolom had not filed an administrative claim for refund within the statutorily prescribed period. Kolom filed a motion for summary judgment. The district court held that the mitigation provisions, IRC Secs. 1311-1314, lifted the bar of the statute of limitations and granted summary judgment in favor of Kolom. The court found Kolom entitled to a refund of $8,097.

II. Contentions on Appeal

The Government contends that the district court erred in deciding that the mitigation provisions apply in the circumstances of this case, and that, even if they do otherwise apply, the taxpayers failed to file their refund claim within the extended period that would then be applicable. We also consider, alternatively, whether the doctrine of equitable recoupment supports recovery of the twice paid tax.

III. The Mitigation Provisions

Section 6511(a) of the Code provides that, ordinarily, a claim for refund of an overpayment of tax must be filed within three years of the date a taxpayer's return was filed or two years from the date the tax was paid, whichever is later. Section 6511(a) accordingly barred any claim for tax refund filed after April 15, 1977, unless the mitigation provisions lifted the time bar of this section.

The mitigation provisions extend the period of limitations to file a timely claim for refund for one year from the date a final determination is made. IRC Sec. 1314(b). Congress intended the mitigation provisions 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)....

O'Brien v. United States, 766 F.2d 1038, 1042 (7th Cir.1985) (emphasis added). This court has narrowly construed the requirements of the mitigation provisions. See United States v. Rigdon, 323 F.2d 446, 449 (9th Cir.1963); United States v. Rushlight, 291 F.2d 508, 514 (9th Cir.1961) (interpreting predecessor statute, IRC Sec. 3801 (1939)).

The mitigation provisions require that (1) a final "determination" be made, IRC Sec. 1313(a); (2) the error fall within one of the specified circumstances of adjustment, IRC Sec. 1312; and (3) the determination be inconsistent with that made in another year, IRC Sec. 1311(b). See Rigdon, 323 F.2d at 448; Rushlight, 291 F.2d at 515; O'Brien, 766 F.2d at 1042. We agree with the IRS that a final determination in this case was made when the Supreme Court denied certiorari in Kolom I on November 2, 1981, and that this determination is inconsistent with the taxpayers' reporting of tax preference in connection with the exercise of the options in 1973.

The Government's principal contention is that the mitigation provisions do not apply because the double payment of the minimum tax does not fit within one of the specified circumstances of adjustment listed in IRC Sec. 1312, specifically Sec. 1312(1). Section 1312(1) provides for application of the mitigation provisions if "[t]he determination requires the inclusion in gross income of an item which was erroneously included in the gross income of the taxpayer for another taxable year...." (Emphasis added). Kolom contends that since the minimum tax is an income tax it falls within Sec. 1312(1). The IRS urges that "gross income" is a term of art and must be construed consistently throughout the Code. 8

The Code specifically defines gross income. IRC Sec. 61. The Tenth Circuit in Gardiner v. United States, construing the mitigation provisions, adhered to this definition of gross income, and stated that "[t]he meaning of an item of gross income is, under Section 61 ..., limited to specific items and does not include everything that results in an increase in tax." 536 F.2d 903, 906 (10th Cir.1976) (emphasis in original).

The Code exempts the stock options' bargain element from inclusion in gross income. IRC Sec. 421(a)(1). See also Kolom I, 644 F.2d at 1285. The Code, however, does include the bargain element in the sum of tax preference items, IRC Sec. 57(a)(6), subject to a separate minimum tax, IRC Sec. 56. See supra note 3. Courts have held the minimum tax taxes income; but it taxes economic income only, not gross income. Wyly v. United States, 662 F.2d 397, 405 (5th Cir.1981) (citing H.R.Rep. 91-413, Pt. 1, 91st Cong., 1st Sess. 78 (1969-3 C.B. 200, 249), [1969] U.S.Code Cong. & Ad.News 1645, 1725). Accord Kolom I, 644 F.2d at 1287 (stock options confer economic benefit). Items of tax preference are not included in gross income. The Treasury Regulations clarify:

The items of tax preference [subject to minimum tax] represent income of a person which either is not subject to current taxation by reason of temporary exclusion (such as stock options) or by reason of an acceleration of deductions ... or is sheltered from full taxation by reason of certain deductions ... or by reason of a special tax.... The tax imposed by section 56 is in addition to the other taxes imposed by chapter 1.

Treas.Reg. Sec. 1.56-1(b).

Kolom relies on Karpe v. United States, 335 F.2d 454, 167 Ct.Cl. 280 (1964), cert. denied, 379 U.S. 964, 85 S.Ct. 655, 13 L.Ed.2d 558 (1965), and Gooch Milling and Elevator Co. v. United States, 78 F.Supp. 94, 111 Ct.Cl. 576 (1948). In Karpe, the court held that because a divorce property settlement directly increased/decreased the taxpayer's gross income, the determination affected an item of gross income. 335 F.2d at 460. In Gooch, the court similarly held that because inventory...

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