Koss v. United States ( 1995 )

Opinions of the United
1995 Decisions States Court of Appeals
for the Third Circuit
11-7-1995
Koss v United States
Precedential or Non-Precedential:
Docket 95-1154
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UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 95-1154
DAVID A. KOSS;
FREYA B. KOSS,
Appellants
v.
UNITED STATES OF AMERICA
On Appeal from the United States District Court
for the Eastern District of Pennsylvania
(D.C. Civil No. 93-06965)
Argued October 10, 1995
BEFORE: GREENBERG, LEWIS, and ROSENN, Circuit Judges
(Filed: November 7, 1995)
David A. Koss (argued)
300 East Lancaster Avenue
The Wynnewood House
Wynnewood, PA 19096
Attorney for Appellants
Loretta C. Argett
Assistant Attorney General
Gary R. Allen
Kenneth L. Greene
Sara Ann Ketchum (argued)
Attorneys Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044
Michael R. Stiles
United States Attorney
615 Chestnut Street
Philadelphia, PA 19106-4476
1
Attorneys for Appellee
OPINION OF THE COURT
GREENBERG, Circuit Judge.
I. FACTUAL & PROCEDURAL BACKGROUND
This matter is before the court on an appeal by
taxpayers in a suit involving claims for income tax adjustments
and refunds. The facts are not in dispute, and we set them forth
as found by the district court. Appellant David A. Koss, a
member of the Pennsylvania bar since 1957, agreed with a client
in 1971 to perform legal services in exchange for stock in Video
Systems Corp. In 1973, a dispute between Koss and his client
over the number of shares to be paid Koss escalated into a court
action. In January 1974, the parties reached a settlement in
which Koss would receive 22,000 shares on February 1, 1974, as
well as the proceeds from the intended sale of an additional
20,000 shares. The 22,000 shares were not registered under the
Securities Act of 1933, so their sale to the public was
restricted.
In their 1974 federal income tax return, Koss and his
wife, appellant Freya Koss, reported the value of the 22,000
shares as $4,400 of gross ordinary income. In 1977, the Internal
Revenue Service started examining the Kosses' 1974 return.
However, in 1977 the shares became worthless. While this
examination was pending, the Kosses filed a federal income tax
2
return for 1977 which did not claim a loss sustained on the
22,000 shares of Video Systems stock received in 1974.
On December 5, 1980, the IRS asserted an income tax
deficiency of $48,788.05 against the Kosses for 1974.1 The
deficiency was attributable to the IRS placing the fair market
value of the 22,000 shares of Video Systems stock at $110,000
rather than $4,400. On February 28, 1981, the Kosses timely
petitioned the United States Tax Court for a redetermination of
this asserted deficiency. Ultimately, the Tax Court upheld the
IRS and determined that the Kosses owed $48,788.05. We affirmed
the decision of the Tax Court. Koss v. Commissioner, 57 T.C.M.
(CCH) 882 (1989), aff'd, 908 F.2d 962 (3d Cir. 1990). The Tax
Court decision became final on September 23, 1990, when the time
for petitioning for certiorari expired.
On August 3, 1991, the Kosses filed an amended tax
return for 1977 indicating that the 22,000 shares of Video
Systems stock had become worthless. Accordingly, they requested
an adjustment of their income tax liability and a refund of the
$899.07 in tax they paid for that year. On that same date, the
Kosses also filed an amended tax return for 1974 that requested
an adjustment based on the carryback of the net operating loss
incurred in 1977 due to the worthlessness of the 22,000 shares.
At that time, they paid a tax of $2,148.41 for 1974, which they
computed was the amount due after application of the carryback
1
We take this figure from the Tax Court opinion. In its brief
the government indicates the figure was $47,788.05.
3
loss. The IRS disallowed the requested adjustments on November
21, 1993.
On December 27, 1993, the Kosses brought this action
for recovery of the $899.07 and for allowance of the requested
adjustments on their 1974 return. The district court entered
summary judgment in favor of the government on December 21, 1994.
It reasoned that the complaint was barred by the statute of
limitations in 26 U.S.C. § 6511 and could not be salvaged by the
mitigation sections at 26 U.S.C. §§ 1311-14. The Kosses then
timely appealed, asserting that the district court had
jurisdiction under 28 U.S.C. § 1346(a)(1) (civil action against
United States for recovery of tax allegedly erroneously or
illegally assessed or collected) and 26 U.S.C. § 7422 (civil
action for refund). We have jurisdiction pursuant to 28 U.S.C.
§1291 and exercise plenary review. See Pleasant Summit Land
Corp. v. Commissioner, 863 F.2d 263, 268 (3d Cir. 1988), cert.
denied, 493 U.S. 901, 110 S.Ct. 260 (1989).
II. DISCUSSION
A. Limitations on Jurisdiction
The United States "is immune from suit, save as it
consents to be sued . . . and the terms of its consent to be sued
in any court define that court's jurisdiction to entertain the
suit." United States v. Testan, 424 U.S. 392, 399, 96 S.Ct. 948,
953 (1976) (quoting United States v. Sherwood, 312 U.S. 584, 586,
61 S.Ct. 767, 769 (1941)). Thus, although 28 U.S.C. § 1346(a)(1)
provides that the district court has jurisdiction over "[a]ny
4
civil action against the United States for the recovery of any
internal-revenue tax alleged to have been erroneously or
illegally assessed or collected . . . under the internal-revenue
laws," other statutory provisions placing requirements or
restrictions on such actions limit and determine the scope of
this grant of jurisdiction. United States v. Dalm, 494 U.S. 596,
601, 110 S.Ct. 1361, 1364 (1990).
The statute of limitations in 26 U.S.C. § 6511 is one
such limitation on jurisdiction. The basic rule is as follows:
Claim for credit or refund of an overpayment
of any tax imposed by this title in respect
of which tax the taxpayer is required to file
a return shall be filed by the taxpayer
within 3 years from the time the return was
filed or 2 years from the time the tax was
paid, whichever of such periods expires the
later . . . .
26 U.S.C. § 6511(a). Where, however, the claim for credit or
refund relates to an overpayment of income tax on account of bad
debts or worthless securities, the limitations period is "7 years
from the date prescribed by law for filing the return for the
year with respect to which the claim is made." 26 U.S.C.
§6511(d)(1). A claim for credit or refund of tax brought after
the expiration of the limitations period is outside the district
court's jurisdiction. United States v. Dalm, 494 U.S. at 602,
110 S.Ct. at 1365.
In this case, the Kosses seek an adjustment of their
1977 income tax liability and a refund of $899.07 from the tax
they paid upon filing their 1977 income tax return on or before
April 15, 1978. Under section 6511(d)(1), the applicable statute
5
of limitations expired seven years after that date, or April 15,
1985. Consequently, the refund claim filed on August 3, 1991, is
barred by the statute of limitations.
Further, under 28 U.S.C. § 1346(a)(1), a taxpayer
filing suit for an income tax refund must pay the full amount of
the tax prior to filing the suit. Thus, in Flora v. United
States, the Supreme Court concluded that "§ 1346(a)(1), correctly
construed, requires full payment of the assessment before an
income tax refund suit can be maintained in a Federal District
Court." 362 U.S. 145, 177, 80 S.Ct. 630, 647 (1960); see also
Psaty v. United States, 442 F.2d 1154, 1158 (3d Cir. 1971). This
requirement defeats the Kosses' claim for an adjustment to their
1974 income tax liability. As described above, the IRS asserted
a deficiency of $48,788.05 against them for 1974. The Kosses
filed a petition with the Tax Court for a determination, which
determination became final on September 23, 1990. Although the
Kosses have not paid the deficiency of $48,788.05, they seek to
adjust their tax liability for 1974 based on (1) the IRS's
determination that the 22,000 shares were worth $110,000 in 1974;
(2) the loss of that amount in 1977 due to the worthlessness of
the stock; and (3) the carryback of the net operating loss
resulting from the loss incurred in 1977. The Kosses have
labelled their claim as one for an adjustment of their 1974 tax
liability, but the net effect they seek is a credit to be applied
to the outstanding deficiency. Because they have not paid the
full amount of the asserted deficiency, however, their claim
6
cannot be brought in the district court under 28 U.S.C.
§1346(a)(1).
As the government correctly points out, this is a no-
win argument for the Kosses. If they did not pay the full
assessment for the year 1974, they could not bring the claim
under 28 U.S.C. § 1346(a)(1). If they did pay it, their current
claim would still be barred by the statute of limitations found
in section 6511(d)(2)(A):
If the claim for credit or refund relates to
an overpayment attributable to a net
operating loss carryback . . . , in lieu of
the 3-year period of limitation prescribed in
subsection (a), the period shall be that
period which ends 3 years after the time
prescribed by law for filing the return
(including extensions thereof) for the
taxable year of the net operating loss . . .
which results in such carryback . . . .
26 U.S.C. § 6511(d)(2)(A) (emphasis added). The net operating
loss is alleged to have occurred in 1977; the tax return for that
year was required to be filed by April 15, 1978. The Kosses
filed their 1977 return on or before April 15, 1978, and thus
they had three years, or until April 15, 1981, to bring this
claim to adjust their 1974 tax liability. Since they did not
bring the claim until 1991, it is time-barred.
Moreover, the government argues correctly that the
claim to adjust the 1974 tax liability is also barred by section
6512(a), which provides:
Effect of petition to Tax Court. -- If the
Secretary has mailed to the taxpayer a notice
of deficiency under section 6212(a) (relating
to deficiencies of income, estate, gift, and
certain excise taxes) and if the taxpayer
7
files a petition with the Tax Court within
the time prescribed in section 6213(a)
. . . , no credit or refund of income tax for
the same taxable year . . . in respect of
which the Secretary has determined the
deficiency shall be allowed or made and no
suit by the taxpayer for the recovery of any
part of the tax shall be instituted in any
court . . . .
26 U.S.C. § 6512(a). Under this section, filing a petition to
the Tax Court to challenge an asserted deficiency bars the
taxpayer from bringing a suit in any other court for the recovery
of any part of the tax for that taxable year. See, e.g.,
Solitron Devices, Inc. v. United States, 862 F.2d 846, 848 (11th
Cir. 1989) (section 6512(a) bars any action for taxes for same
taxable year in respect of which taxpayer petitioned Tax Court);
First Nat'l Bank v. United States, 792 F.2d 954, 956 (9th Cir.
1986) (district court has no jurisdiction over redetermination of
estate tax liability previously established in Tax Court), cert.
denied, 479 U.S. 1064, 107 S.Ct. 948 (1987); Bowser v.
Commissioner, 559 F.2d 1207, No. 76-1031, 1977 WL 25925, at *1
(3d Cir. June 10, 1977) ("§ 6512(a) operates as a limitation on
the general jurisdictional grant of 28 U.S.C. § 1346[.]"); Elbert
v. Johnson, 164 F.2d 421, 424 (2d Cir. 1947) ("It is not the
decision which the Tax Court makes but the fact that the taxpayer
has resorted to that court which ends his opportunity to litigate
in the District Court his tax liability for the year in
question."); see also United States v. Dalm, 494 U.S. at 606, 110
S.Ct. at 1367 (noting that taxpayer's petition in Tax Court on
income tax liability precluded relitigation of same in district
court).
8
When the IRS notified them of the deficiency for 1974,
the Kosses did not pay the tax and seek a refund in the district
court. Rather, they petitioned the Tax Court for a determination
which ultimately became final against them. Consequently, they
are barred by section 6512(a) from bringing any suit in any court
to litigate their tax liability for 1974. We realize that when
the Video Systems stock became worthless in 1977, the Kosses
believed that the shares had been worth only $4,400 rather than
$110,000 in 1974, and that they believe that they therefore could
not have asserted a $110,000 loss in the Tax Court. Nevertheless,
the fact that the Kosses are advancing issues that were not
presented to the Tax Court and perhaps could not have been
considered by that court cannot change our conclusion. "[T]he Tax
Court's jurisdiction, once it attaches, extends to the entire
subject of the correct tax for the particular year." Erickson v.
United States, 309 F.2d 760, 767 (Cl. Ct. 1962). Even in cases
where the issues raised by taxpayers in the district court could
not have been litigated in the Tax Court because they arose from
facts occurring after the Tax Court's decision, courts regularly
hold that the petition to the Tax Court bars a subsequent suit in
the district court. See, e.g., Solitron Devices, Inc. v. United
States, 862 F.2d at 849; United States v. Wolf, 238 F.2d 447, 451
(9th Cir. 1956); Elbert v. Johnson, 164 F.2d at 424.
B. Mitigation of Effects of Limitations
9
In certain instances, the effects of the statute of
limitations may be mitigated.2 26 U.S.C. §§ 1311-14. While
these mitigation provisions are remedial and should be given a
liberal interpretation, the party invoking them has the burden of
showing that mitigation is permitted. O'Brien v. United States,
766 F.2d 1038, 1042 (7th Cir. 1985) (citing Olin Mathieson Chem.
Corp. v. United States, 265 F.2d 293, 296 (7th Cir. 1959)).
Section 1311(a) allows for the correction of certain
types of errors:
General rule. -- If a determination (as
defined in section 1313) is described in one
or more of the paragraphs of section 1312
and, on the date of the determination,
correction of the effect of the error
referred to in the applicable paragraph of
section 1312 is prevented by the operation of
any law or rule of law, other than this part
and other than section 7122 (relating to
compromises), then the effect of the error
shall be corrected by an adjustment made in
the amount and in the manner specified in
section 1314.
26 U.S.C. § 1311(a). Section 1313 defines "determination" to
include "a decision by the Tax Court or a judgment, decree, or
other order by any court of competent jurisdiction, which has
become final." 26 U.S.C. § 1313. The Kosses claim the Tax
Court's decision to value the shares at $110,000 and the 1974 tax
2
Though this point is by no means clear, we will assume without
deciding that, notwithstanding the Kosses' failure to pay the
1974 tax assessment in full, and notwithstanding their
institution of the Tax Court proceeding for that year, if the
mitigation provisions were by their terms applicable here, we
could apply them to grant the Kosses relief. In this regard, we
note that the government's brief does not contend expressly that
these procedural hurdles render the mitigation provisions
inapplicable for 1974.
10
deficiency at $48,788.05 falls within this definition of
"determination."
The Kosses contend that this determination further is
described in section 1312(7)(A), which provides in relevant part:
(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, with
respect to a taxpayer described in
subparagraph (B) of this paragraph, any of
the errors described in subparagraph (C) of
this paragraph.
26 U.S.C. § 1312(7)(A). They further contend that the
determination resulted in an error described in section
1312(7)(C)(ii):
(C) Prior erroneous treatment. -- With
respect to a taxpayer described in
subparagraph (B) of this paragraph --
. . . .
(ii) there was an erroneous recognition,
or nonrecognition, of gain or loss . . . .
26 U.S.C. § 1312(7)(c)(ii). In particular, the Kosses argue that
there was an erroneous nonrecognition of the loss of $110,000 on
their 1977 return, and that this error was not rectifiable at the
time of the determination due to the expiration of the statute of
limitations in section 6511. Br. at 11-12.
The problem with this argument is that the error they
specify was not due to the determination by the Tax Court of the
1974 basis of the shares. The nonrecognition in the 1977 return
of the loss of the value of the shares was caused by the Kosses'
failure to declare that they had any loss at all. Thus, if they
had declared in their 1977 return the loss of the value of
11
securities (which they claimed to be worth $4,400), then the Tax
Court's determination would have caused an error of
nonrecognition of a loss of $110,000 less $4,400, or $105,600. In
any event, this causal factor cannot help the Kosses, because
section 1312(7)(A) does not describe an error that is caused by
or is the result of a determination. O'Brien, 766 F.2d at 1043.
Section 1312(7)(A) requires that the error described in
subparagraph (C) occur, not as a result of the determination, but
"in respect of any transaction on which such basis depends, or in
respect of any transaction which was erroneously treated as
affecting such basis." A "transaction on which . . . basis
depends" refers to "'the transaction in which the property was
acquired, and the basis of the property at the time of
disposition can be said to depend on [or is determined by] such
transaction.'" O'Brien, 766 F.2d at 1043 n.5 (quoting United
States v. Rushlight, 291 F.2d 508, 517 (9th Cir. 1961)).
In O'Brien, 766 F.2d 1038, the Court of Appeals for the
Seventh Circuit faced similar issues. There, the taxpayer
received shares of stock as a gift made in contemplation of
death. The relevant estate filed an estate tax return in 1974
that valued the stock at about $215 per share. The IRS
challenged this valuation, and the matter was litigated in the
Tax Court. In 1975, the corporation at issue was liquidated, and
the taxpayer reported the resulting capital gain on his 1975
federal income tax return predicated on a basis of $215 per
share. The IRS did not dispute this 1975 return. In 1980, the
Tax Court finally entered a stipulated order setting the value of
12
the stock at about $280 per share at the time of the original
owner's death. In 1981, the taxpayer filed a refund claim for
the overpayment of capital gains tax that was based on the lower
basis figure, but the IRS denied the claim as untimely because
more than three years had passed since the filing of the 1975
return and more than two years had passed since the taxpayer had
paid the tax which he sought refunded. The taxpayer then filed a
refund action in the district court and attempted to invoke the
mitigation provisions involved in this case to avoid the statute
of limitations bar. The Court of Appeals for the Seventh Circuit
held that the mitigation provisions did not apply. Specifically,
the court held that the error of overpayment of capital gains tax
was not "in respect of" the transaction, which was the transfer
of the shares by the taxpayer's father and his subsequent death.
Id. at 1043. The court explained that this error occurred "'in
respect of' the 1975 liquidation transaction and did not occur
'in respect of' the [father's] transfer and subsequent death."
Id.
As the government points out, the error alleged here,
the nonrecognition of loss resulting from the worthlessness of
the stock in 1977, similarly was not "in respect of any
transaction on which such basis depends." 26 U.S.C. §1312(7)(A).
The basis of the shares in the determination depended on the
transaction in which David Koss acquired them in 1974. The basis
of the shares did not depend on their becoming worthless in 1977.
Thus, the error in failing to recognize the shares' loss in value
13
did not occur "in respect of" their acquisition by David Koss in
1974.
The Kosses further argue that because the shares
eventually became worthless, the basis of the shares also had to
be adjusted downward according to 26 U.S.C. § 1016(a)(1) and,
therefore, the loss of the value of the shares in 1977 was a
transaction on which the basis of the property depended. Reply
Br. at 7. We cannot accept this analysis, however, because it
ignores the first part of section 1312(7)(A):
The determination determines the basis of
property, and in respect of any transaction
on which such basis depends, . . . there
occurred . . . any of the errors . . . .
26 U.S.C. § 1312(7)(A) (emphasis added). The determination did
not purport to ascertain the basis of the shares for all time. It
only sought to determine the basis of the shares in 1974 so that
the Kosses' taxable income and tax liability for 1974 could be
determined. Clearly, the basis of the shares in 1974 depends
only on their value at the acquisition by the Kosses and not on
the shares' subsequent loss in value in 1977. In addition, while
the Kosses allege that they "reduced the basis of the Video stock
in 1977 by $4,400," reply br. at 7, as required by Section
1016(a)(1), it is not clear that they did so, for they did not
deduct this loss on the 1977 return, and section 1016(a)(1)
refers only to a reduction in basis for losses "for which
deductions have been taken by the taxpayer in determining taxable
income for the taxable year or prior taxable years." 26 U.S.C.
§1016(a)(1).
14
Finally, even if the Kosses' claim could satisfy the
general rule of section 1311(a), they fail to meet the additional
"[c]onditions necessary for adjustment" listed in section
1311(b). Only the condition in section 1311(b)(1) is arguably
applicable in this case:
(1) Maintenance of an inconsistent position.
-- Except in cases described in paragraphs
(3)(B) and (4) of section 1312, an adjustment
shall be made under this part only if --
(A) in case the amount of the adjustment
would be credited or refunded in the same
manner as an overpayment under section 1314,
there is adopted in the determination a
position maintained by the Secretary, or
(B) in case the amount of the adjustment
would be assessed and collected in the same
manner as a deficiency under section 1314,
there is adopted in the determination a
position maintained by the taxpayer with
respect to whom the determination is made,
and the position maintained by the Secretary
in the case described in subparagraph (A) or
maintained by the taxpayer in the case
described in subparagraph (B) is inconsistent
with the erroneous inclusion, exclusion,
omission, allowance, disallowance,
recognition, or nonrecognition, as the case
may be.
26 U.S.C. § 1311(b)(1). This condition is the heart of the
mitigation provisions and serves to limit their application
mostly to cases in which inconsistent tax treatment results in
harsh results that cannot be rectified due to the expiration of
the limitations period. See O'Brien, 766 F.2d at 1041.
The Kosses assert that the IRS maintained inconsistent
positions by arguing in its deficiency assertion, filed in 1980
15
and conclusively determined in 1990, that the basis of the shares
in 1974 was $110,000 while also accepting the Kosses' 1977 return
(filed in 1978) which did not declare a loss of the $110,000. We
do not view these acts of the IRS as inconsistent. Although it
may be true that the Kosses could not have known when filing
their 1977 return that the shares were originally worth $110,000,
and that they therefore had lost $110,000 in value, the fact
remains that they did not declare a loss at all in their 1977
return. Consequently, the IRS accepted their 1977 return without
notice that the shares were worthless. Surely, the IRS is not
required to verify the value of the capital assets of all
taxpayers each year to make sure they have not become worthless.
Thus, its acceptance of the 1977 return that did not declare such
a loss, at whatever value, is not inconsistent with its
successful position in Tax Court that the shares had a basis of
$110,000 to the Kosses in 1974.
The Kosses are correct in arguing that section
1311(b)(1) does not require the taxpayer to disclose the loss or
the reason for the nonrecognition of loss in the return for the
year of the error. Br. at 14. This claim, however, is not the
issue. The issue is whether the IRS maintained inconsistent
positions. The answer is that the IRS could not have maintained
inconsistent positions because when the Kosses filed their 1977
return they did not declare that the shares became worthless in
that year and, thus, they did not put the IRS on notice of that
fact. If the shares had not been worthless in 1977, the Kosses
would not have been allowed to recognize in their 1977 return any
16
loss or gain in value of the shares unless they disposed of them.
Had they done so, their 1977 return would have been the same as
the one they actually filed.
In sum, the Kosses' claims are barred either by the
statute of limitations or by their failure to pay the full
assessed tax, and the mitigation provisions regretfully offer
them no relief. These claims were thus not within the district
court's jurisdiction and were dismissed properly.
C. Equitable Recoupment
The Kosses also brought a claim for equitable
recoupment to offset the loss in the value of the shares. The
district court concluded that it also did not have jurisdiction
to entertain the equitable recoupment claim because it did not
have jurisdiction over the other time-barred claims. Koss v.
United States, No. 93-6965, slip op. at 5 (E.D. Pa. Dec. 21,
1994). Under United States v. Dalm, 494 U.S. at 608-10, 110
S.Ct. at 1368-69, equitable recoupment cannot be the sole basis
of jurisdiction over claims for tax credit or refund. Thus, a
court can consider an equitable recoupment claim only if it has
jurisdiction on other grounds.
On appeal, the Kosses argue that although the 1977 tax
year may be closed irrevocably due to the statute of limitations,
the 1974 tax year, which was before the Tax Court, remains open
and thus could be under the jurisdiction of the district court
for purposes of equitable recoupment. Br. at 18. To that end,
the Kosses state that they are not seeking here "to revive an
untimely affirmative refund claim," but "to offset a timely claim
17
of the [IRS] for tax assessed" for the year 1974 relating to the
stock. Br. at 19. But, as we discussed above, the Kosses'
resort to the Tax Court deprived the district court of
jurisdiction over the 1974 tax year. Thus, even if the 1974 tax
year remained open, it would be open only for the Tax Court and
not for the district court or any other court.
III. CONCLUSION
We cannot close this opinion without making an
additional observation. It is, of course, commonplace to note
that the Internal Revenue Code is remarkably complicated. In
this case, these complications have cost the Kosses dearly.
Indeed, at oral argument we were told that their debt to the IRS
now exceeds $300,000 because of the inclusion of interest. Yet
it is very possible that, but for the operation of the non-
substantive, highly technical procedural provisions that have
been applied, they would not owe this money. We are disturbed by
the harsh result. Perhaps the Kosses, under the unusually
oppressive circumstances here, still may obtain administrative
relief from the IRS, or some other authority. However, we have
no alternative and are constrained to affirm the final judgment
of the district court of December 21, 1994.
18