Philadelphia & Reading Corporation v. United States

BECKER, Circuit Judge,

dissenting.

In the first of the four judicial opinions dealing with this controversy, Judge Marshall observed that “when the tax collector blunders ... the taxpayer will go free.” Philadelphia & Reading Corp. v. Beck, No. 73-C-3138, slip op. at 13, 1980 WL 1734 (N.D.I11. Aug. 29, 1980). Indeed! As the result of Mrs. Ballard’s blunder, perpetuated by her superior in the IRS Kansas City regional office, the taxpayer, notwithstanding that it ultimately got exactly what it bargained for in its dealings with IRS, will receive what Judge Cummings in the second opinion in this case, and Judge Wright in the third opinion, described as a “windfall.” Philadelphia & Reading Corp. v. Beck, 676 F.2d 1159, 1164 (7th Cir.1982); Philadelphia & Reading Corp. v. United States, 738 F.Supp. 143, 149 (D.Del.1990). And a windfall it is — one I calculate to be approximately $30 million ($10.5 million plus interest).

It may be that the world will little note nor long remember what happened to that $30 million, and that this case will be a painful and valuable lesson to the IRS that it must do unto the taxpayer as it (relentlessly) expects the taxpayer to do unto it. If so, the public’s business will be all the better for it. Judge Hutchinson has written a fine and forceful exposition of why this must all be so, and in order to put my dissenting views in proper perspective, I begin with a brief summary of the majority’s views.

First, the majority explains, with compelling logic, why neither lamentations such as I have uttered, nor appeals to rough justice (e.g., the taxpayer “got what it bargained for”), nor even resort to equitable principles, can change the result. As the majority opinion develops, applying equitable principles or rough justice to tax refund cases would do inestimable mischief to the rigorous statutory scheme embodied in IRC § 6213(a). Section 6213(a) requires the IRS to mail the taxpayer a notice of deficiency for each year’s underpayment; provides the taxpayer with a 90-day period following mailing of the notice within which to seek a redetermination of the deficiency in tax court; and prevents the IRS from assessing or collecting any tax due until expiration of the 90-day period or the conclusion of any judicial proceedings, whichever is later. In the majority’s view, unless some kind of equitable defense is available to the government (and in its view it is not), the IRS’s undisputed failure to observe the statutory requirements of § 6213(a), and the consequent illegality of its assessments, inters its defense to the refund suit.

Second, recognizing that the IRS argues on a contract theory as well as from the statute, the majority, albeit somewhat cursorily, rejects the IRS’s contract-based arguments as well. The majority reasons that the taxpayer’s putative waiver of its right to receive a deficiency notice was not effective because the IRS failed to satisfy, in the proper chronological sequence, the express condition contained in the qualified Form 870. In the majority’s view, that condition required an authorized representative of the IRS to sign the schedules of overassessments for the taxable years ending December 31, 1964 and December 31, 1967 before the IRS assessed the deficient taxes. As it turned out, the IRS got things backwards — the assessment of deficiencies preceded the scheduling of overas-sessments.

Although I agree with the other aspects of the majority’s discussion, and particularly its discussion of the statutory collection requirements, we part company on what I describe as the contract issue. I believe that the taxpayer and the IRS entered into a contract, embodied in the Form 870 qualified waiver, and that the IRS substantially performed its end of the bargain in timely fashion (ie., it did not materially breach its obligations). For this reason, amplified below, I would hold for the IRS, and deny the taxpayer’s claim for a refund.

When a taxpayer executes an IRS Form 870, styled “Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment,” the taxpayer and the IRS effectively create an alternative mechanism, supplanting the otherwise applicable statutory scheme, for the assessment and collection of deficiencies. This arrangement typically benefits both parties and generally accelerates resolution of the dispute. Such an agreement supplants the Internal Revenue Code provisions requiring that the IRS mail a notice of deficiency and observe a 90-day waiting period prior to assessment and collection of the deficiency, and obviates the need for the procedural step whereby the taxpayer may petition the tax court for redetermination of the deficiency. On the other side, the agreement preserves the taxpayer’s right to challenge the assessment in a refund suit, while ensuring that any interest it may owe on the deficiency ceases to accrue.¹

When a Form 870 contains a conditional or qualified waiver such as the one at issue here, a taxpayer facing both deficiencies and overassessments receives the additional assurance that the former will not be collected until the latter are available to offset them in whole or in part. In this case, the taxpayer was assured that its roughly $10.5 million deficiency would not be collected until the $6.5 million in overas-sessments was scheduled. This assurance was of considerable value to the taxpayer because the overassessments required the approval of the Joint Committee on Taxation, a process which this case suggests would probably have taken longer than the statutory requirements for assessing deficiencies.

As the majority details at length, the parties’ neat arrangement for supplanting the statutory procedures went somewhat askew when Mrs. Ballard assessed the deficiencies on June 22, 1973, well before the 1967 and 1964 overassessments were scheduled in August 1973 and October 1973, respectively. Indeed, the latter over-assessment followed not only the assessment of deficiencies, but also the expiration of the extended statute of limitations for assessing the deficiencies, which ran on September 30, 1973. Based on this ordering of the events, and by analogy to the statutory collection scheme under which an assessment issued prior to the mailing of a notice of deficiency is forever deemed illegal and void, the majority concludes that the IRS failed to satisfy the precondition contained in Form 870 and thus cannot rely on that document as the basis for assessing the taxes at issue here.

I disagree. The reasoning of the taxpayer and the majority regarding the contract issue falters, in my view, at two critical junctures. First, although it is undeniable that the assessments preceded both the mailing of a notice of deficiency and the scheduling of overassessments, and that for purposes of the statutory collection regime such a chronology renders the assessments forever void and illegal, I fail to see why a similar result must obtain under the separate assessment mechanism created by agreement of the parties and embodied in Form 870. The critical language of that document states:

This document shall be effective as a waiver of restrictions on assessment and collection with respect to taxable years ending December 31, 1965 and December 31, 1966 and the taxable period ending April 18, 1968, on the date the schedule of overassessments with respect to the taxable years ending December 31, 1964 and December 31, 1967 is signed by an authorized representative of the Internal Revenue Service.

As I understand this language, it is clear that the taxpayer did not waive statutory “restrictions on assessment” — i.e., its right to receive a notice of deficiency and its other statutory rights — until the specified overassessments were scheduled. Thus, I have no doubt that this language forbade the IRS from collecting on an assessment, absent the mailing of a notice of deficiency, before it scheduled the overassessments. However, once the overassessments were scheduled, I see nothing in this language that attaches any import to when the assessment was made, or, more particularly, whether the assessment preceded the scheduling of the overassessments. The agreement simply states that the taxpayer waives its otherwise applicable statutory pre-assessment rights on the day that a schedule of overassessments for the two specified years is signed. As of that date, as I read this agreement, the taxpayer renounces any interest in notices of deficiency, and in all else that typically precedes assessment. Nothing in this language leads me to believe, however, that on that date the taxpayer should care one way or the other about when, as a technical matter, the assessment was issued.

In short, it is my view that, although a notice of deficiency mailed after an assessment can never “rehabilitate” the illegal, premature assessment, there is nothing in the language of the qualification to this Form 870 that prevents a scheduling of overassessments from “rehabilitating” a premature assessment. The majority apparently assumes that a premature assessment is forever illegal and void both for purposes of the statutory assessment route and the contractual route embodied in the qualified Form 870. While this is clearly the correct result in regards to statutory assessment, I discern nothing to compel this conclusion with respect to the agreement of the parties. There is no doubt that the statute requires a notice of deficiency to be issued before an assessment is made, and there is no doubt that the Form 870 requires that the overassessments be scheduled before the taxpayer is deemed to have waived the right to a notice of deficiency. It seems to me, however, that the majority incorrectly merges these two propositions, and thus concludes that the overassessments had to be scheduled before the assessment was issued.

Second, the majority and the taxpayer ignore the fact that the IRS eventually did schedule the overassessments for both 1964 and 1967. Admittedly, the scheduling for 1964 was not accomplished until October 1973, one month after the extended statute of limitations for collecting the deficiencies had expired on September 30. This fact is problematic. The Form 870 at issue says nothing about how long the taxpayer intended for the arrangement to remain open to the IRS’s fulfillment of its conditions. And while it is arguable that it was open-ended, I think it more reasonable to conclude that the parties intended that the agreement would remain in force only until the statute of limitations had run on the statutory collection period.

In this case, however, I do not think that scheduling the 1964 overassessment after the expiration of the statute of limitations constitutes a material breach of the IRS’s required performance. The facts are (1) that the 1967 overassessment was scheduled in August 1973, well before the September 30, 1973 expiration of the statute of limitations; and (2) that the 1967 overas-sessment involved $6,237,660, whereas the 1964 overassessment was only $231,991. In other words, over 96% of the taxpayer’s overassessments were scheduled before the statute of limitations expired. The IRS’s failure to schedule timely the remaining 4% is, to my mind, immaterial. It is hornbook law that only a material breach of contract obligations will entitle the non-breaching party to relief.

In sum, I disagree with the majority that the qualified Form 870 required the IRS to schedule the overassessments before any assessment technically was issued. The agreement simply required that, at some time prior to the expiration of the statute of limitations, the IRS sign the specified overassessments. As of that date, the taxpayer waived all its statutory pre-assessment rights and submitted willingly to assessment. I believe further that, in the context of the entire Form 870 agreement and the millions of dollars involved, the post-expiration scheduling of the $231,991 overassessment for 1964 constituted, at most, an immaterial breach of the IRS’s required performance. I thus would hold that the IRS substantially performed its obligations under the qualified Form 870 in August 1973, more than one month prior to the expiration of the statute of limitations, when it signed the schedule for the taxpayer’s 1967 overassessment. Because the IRS did live up to its end of the bargain in a timely fashion, I believe this case is distinguishable from Steiner v. Nelson, 259 F.2d 853 (7th Cir.1958), Parsons Corp. v. United States, 835 F.2d 1435 (9th Cir.1987), and the other cases upon which the majority or the taxpayer rely.

I thus would affirm the judgment of the district court, although on different grounds. Hence, I respectfully dissent.

1 . Absent the filing of a waiver, interest due on a deficiency is computed from the due date for the payment of such tax until the date it is actually paid; the filing of a waiver suspends the accrual of interest from the thirtieth day after the filing of the waiver until the IRS issues a notice and demand for payment of the deficiency.