Estate of Mueller v. Commissioner

OPINION

Ruwe, Judge:^*

Respondent determined a deficiency of $1,985,624 in petitioner’s Federal estate tax. Respondent’s deficiency determination was primarily based on her assertion that the date-of-death value of shares of stock in the Mueller Co. was $2,150 per share, as opposed to $1,505 per share as reported on the estate tax return. The amount of the deficiency determined by respondent was the result of this increase in value and other adjustments not in issue, including respondent’s allowance of a credit for tax on prior transfers in the amount of $1,152,649, that had not been claimed by petitioner on its estate tax return. Petitioner petitioned this Court for a redetermination.¹

Petitioner subsequently filed an amended petition alleging that “The Commissioner erred in determining said Deficiency by disallowing recoupment against such [estate] tax amount for the income tax paid by the Bessie I. Mueller Trust * •* * on capital gains realized from the post-death sale of * * * Mueller Company common stock includable in the Decedent’s gross estate.” The Bessie I. Mueller Administration Trust (the trust) is the residuary legatee of decedent’s estate. After decedent’s death, the trust sold shares of Mueller Co. stock that were included in decedent’s gross estate. On its income tax return, the trust reported gain on the sale using a basis of $1,500 per share.² The trust’s basis in the stock is controlled by the value of the stock at decedent’s date of death. See sec. 1014(a)(1).³

In Estate of Mueller v. Commissioner, T.C. Memo. 1992-284 (Mueller I), we found that the date-of-death value of the Mueller Co. stock was $1,700 per share, as opposed to $1,505 per share as reported on petitioner’s estate tax return or $2,150 as determined by respondent in the notice of deficiency. As a result, it is now clear that the trust understated its basis and overstated its gain on the sale of Mueller Co. stock and, therefore, overpaid its income tax. However, the statute of limitations bars refund of the trust’s overpayment of income tax.

Respondent moved to dismiss petitioner’s claim for recoupment on the ground that we lacked jurisdiction to consider equitable recoupment. In Estate of Mueller v. Commissioner, 101 T.C. 551 (1993) (Mueller II), we held that this Court is authorized to entertain the affirmative defense of equitable recoupment in an action for redetermination of a deficiency and denied respondent’s jurisdictional motion. Id. at 561. However, we made no findings with respect to whether petitioner satisfied the requirements for applying equitable recoupment in this case.

It subsequently became clear that our opinion in Mueller I, which increased decedent’s taxable estate by less than the amount determined in the notice of deficiency, combined with respondent’s allowance in the notice of deficiency of the credit for tax on prior transfers, will result in a decision that there is no deficiency in petitioner’s estate tax.⁴ Indeed, petitioner is entitled to recover an overpayment of its estate tax, regardless of whether or not equitable recoupment applies in this case.⁵

The threshold issue we must address is whether petitioner may use equitable recoupment against respondent, where respondent has no valid claim for additional estate tax against which petitioner needs to defend.

Pursuant to the doctrine of equitable recoupment, “a party litigating a tax claim in a timely proceeding may, in that proceeding, seek recoupment of a related, and inconsistent, but now time-barred tax claim relating to the same transaction.” United States v. Dalm, 494 U.S. 596, 608 (1990). Equitable recoupment can be used as a defense by both taxpayers and the Government. Stone v. White, 301 U.S. 532 (1937). While recoupment claims are generally not barred by the statute of limitations if the main action is timely, use of recoupment based on an otherwise time-barred claim is limited to defending against the claim in the main action.⁶ Reiter v. Cooper, 507 U.S. 258, 264 (1993); United States v. Dalm, supra at 605; Stone v. White, supra at 538-539) Bull v. United States, 295 U.S. 247, 262-263 (1935); United States v. Forma, 42 F.3d 759, 765 (2d Cir. 1994);⁷ In re Greenstreet, Inc., 209 F.2d 660, 663 (7th Cir. 1954).⁸

Petitioner acknowledges that equitable recoupment is limited to defensive use. However, petitioner argues that it should be allowed to use equitable recoupment to defend against the additional tax that would have been due as a result of our valuation of decedent’s stock, assuming that respondent had not allowed the credit for prior transfers in the notice of deficiency. Petitioner would have us apply recoupment against a hypothetical tax liability on a transaction-by-transaction basis, regardless of whether there was a valid claim for additional tax liability against which to defend. On brief, petitioner describes this as an issue of first impression.

Respondent takes the position that equitable recoupment can be used by a taxpayer only as a defensive measure to reduce or eliminate a taxpayer’s actual liability for additional tax. Respondent argues that once it is clear that the taxpayer has no additional tax liability, there is no valid claim against which to defend. Respondent contends that to allow equitable recoupment of time-barred taxes to increase the overpayment that is already due petitioner is the same as permitting petitioner affirmatively to collect the time-barred overpayment of tax.

Respondent’s position finds support in Mueller II, where we stated:

the party asserting equitable recoupment may not affirmatively collect the time-barred underpayment or overpayment of tax. Equitable recoupment “operates only to reduce a taxpayer’s timely claim for a refund or to reduce the government’s timely claim of deficiency”. O’Brien v. United States, 766 F.2d 1038, 1049 (7th Cir. 1985). [Estate of Mueller v. Commissioner, 101 T.C. at 552.]

The opinion in O’Brien v. United States, 766 F.2d 1038, 1049 (7th Cir. 1985), also supports respondent’s position that equitable recoupment may be used only as a defense against the additional tax that would otherwise be due:

Recoupment * * * will permit a taxpayer to recoup an erroneously paid tax, the refund of which is time-barred, against a timely and correctly asserted deficiency by the government. The doctrine thus operates only to reduce * * * the government’s timely claim of deficiency; it does not allow the collection of the barred tax itself. In summary, the doctrine requires some validly asserted deficiency or refund against which the asserting party desires to recoup a time-barred refund or deficiency.

* * * * * * *

Attempts by taxpayers to utilize the doctrine to revive an untimely affirmative refund claim, as opposed to offset a timely government claim of deficiency with a barred claim of the taxpayer, have been uniformly rejected. * * *

[Id. at 1049; citation omitted.]

Likewise, in Brigham v. United States, 200 Ct. Cl. 68, 80-81, 470 F.2d 571, 577 (1972), the court explained the function of equitable recoupment as follows:

When its benefits are sought by the taxpayer, the function of the doctrine is to allow the taxpayer to reduce the amount of a deficiency recoverable by the Government by the amount of an otherwise barred overpayment of the taxpayer. * * *

Petitioner correctly points out that none of these cases, nor any others relied upon by respondent, specifically address the situation that confronts us; i.e., whether equitable recoupment applies where, in the main action, the Court finds that there is an increase in a taxable item, but because of another adjustment in the main action which is in the taxpayer’s favor (the allowance of the credit for prior transfers), there is no additional tax owed to the Government. Further examination of the origin and nature of equitable recoupment is, therefore, appropriate.

The doctrine of equitable recoupment in tax cases was first articulated in Bull v. United States, supra. The Commissioner had determined a deficiency in estate tax, which the estate paid. Thereafter, the Commissioner inconsistently determined that there was a deficiency in the income tax liability of the estate based on the same item. The taxpayer paid the income tax deficiency and brought suit for refund. It was ultimately determined that the additional income tax liability, as determined by the Commissioner, was correct, but that the additional estate tax liability determined by the Commissioner based on the same item was incorrect. The problem was that the additional estate tax had already been paid, and the statute of limitations barred any refund of the estate tax.

While no refund action could be brought for recovery of the estate tax, the Supreme Court recognized that if the taxpayer had been defending against a lawsuit by the Government for the additional income tax, the taxpayer would have been permitted, by the doctrine of recoupment,⁹ to raise time-barred claims arising out of the same transaction as a defense to the Government’s suit. But the taxpayer had filed the refund suit and was the plaintiff. The Government had already collected the'disputed income tax and was seeking no further relief against which the taxpayer had to defend. The Supreme Court, nevertheless, recognized that it was the Government that had initiated the controversy by making its income tax deficiency determination and that the taxpayer, although technically the plaintiff, was, in reality, defending against the Government’s determination.¹⁰ The Supreme Court therefore fashioned the doctrine of equitable recoupment to allow the taxpayer to defend against the Government’s claim for additional taxes. The Supreme Court explained this as follows:

If the claim for income tax deficiency had been the subject of a suit [by the Government], any counter demand for recoupment of the overpayment of estate tax could have been asserted by way of defense and credit obtained notwithstanding the statute of limitations had barred an independent suit against the Government therefor. This is because recoupment is in the nature of a defense arising out of some feature of the transaction upon which the plaintiffs action is grounded. Such a defense is never barred by the statute of limitations so long as the main action itself is timely.

The circumstance that both claims, the one for estate tax and the other for income tax, were prosecuted to judgment and execution in summary form does not obscure the fact that in substance the proceedings were actions to collect debts alleged to be due the United States. It is immaterial that in the second case, owing to the summary nature of the remedy, the taxpayer was required to pay the tax and afterwards seek refundment. This procedural requirement does not obliterate his substantial right to rely on his cross-demand for credit of the amount which if the United States had sued him for income tax he could have recouped against his liability on that score.

[Bull v. United States, 295 U.S. at 262-263; fn. ref. omitted.]

In Bull v. United States, supra, and United States v. Dalm, 494 U.S. at 602-605, the Supreme Court made it clear that the purpose of “equitable recoupment” was to replicate the role that “recoupment” would have played had the Government actually brought suit to collect the additional tax. It is instructive then to look at how recoupment would have applied if the Government had brought suit to collect the additional estate tax liability that it claimed as a deficiency in the instant case. The Government would have brought suit in the District Court against the taxpayer for the amount of additional estate tax that it claimed — $1,985,624. Assuming that the District Court found a $l,700-per-share value for the stock, as opposed to the $2,150 alleged by the Government, there would be a judgment that the taxpayer owed no tax debt to the Government.¹¹ As a result, the Government would totally lose its claim as plaintiff. Once the Government’s claim for additional tax was shown to be meritless, the purely defensive use of recoupment would not be available to allow the taxpayer to recover any portion of the time-barred overpayment of income tax. To allow recoupment in this situation would go beyond its exclusively defensive nature and beyond the District Court’s jurisdiction.¹²

In the instant case, as in Bull v. United States, supra, the Government’s claim for additional tax is embodied in its deficiency determination. However, as previously explained, when the stock is valued at $1,700 per share, there is no additional tax due. As a result, the Government does not have a valid claim for a tax debt, and there is no liability against which equitable recoupment can be used to defend.¹³

In Stone v. White, 301 U.S. 532 (1937), the Supreme Court allowed the Government to use equitable recoupment to defend against an income tax refund suit brought by a trustee. The Court ultimately held that the trustee had overpaid income tax and that the income in issue should have been taxed to the trust’s beneficiary. However, the statute of limitations barred assessment against the beneficiary. The tax on the beneficiary would have exceeded the amount of tax paid by the trust. The Government raised the equitable recoupment defense. The trust argued that the statute of limitations barred assessment against the beneficiary and that the beneficiary’s tax should not be considered. The Supreme Court allowed the equitable recoupment defense, stating:

The statutory bar to the right of action for the collection of the tax does not prevent reliance upon a defense which is not a set-off or a counterclaim, but is an equitable reason, growing out of the circumstances of the erroneous payment, why petitioners ought not to recover.

Here the defense is not a counter demand on petitioners, but a denial of their equitable right to undo a payment which, though effected by an erroneous procedure, has resulted in no unjust enrichment to the government, and in no injury to petitioners or their beneficiary. The government, by retaining the tax paid by the trustees, is not reviving a stale claim. Its defense, which inheres in the cause of action, is comparable to an equitable recoupment or diminution of petitioners’ right to recover. “Such a defense is never barred by the statute of limitations so long as the main action itself is timely.” Bull v. United States, 295 U.S. 247, 262 * * *

[Id. at 538-539.]

Even though the uncollected tax from the time-barred year exceeded the tax in the main action before the Court, the Government did not affirmatively recover the excess. To have done so would have allowed equitable recoupment to be used for more than defensive purposes.

In Rothensies v. Electric Storage Battery Co., 329 U.S. 296, 301-303 (1946), the Supreme Court indicated that it was unwilling to expand the doctrine of equitable recoupment beyond its established parameters, because to have done so would have infringed upon the statute of limitations.¹⁴ Petitioner’s position would also infringe upon the statute of limitations by allowing petitioner affirmatively to recover time-barred overpayments. Nevertheless, petitioner asks us to expand the application of equitable recoupment beyond what any court has ever done. In the final analysis, we agree with the following observation of the Court of Claims:

If the doctrine of recoupment were a flexible one, susceptible of expansion, it might well be applied in the instant case. But the teaching of Rothensies is that it is not a flexible doctrine, but a doctrine strictly limited, and limited for good reason. [Ford v. United States, 149 Ct. Cl. 558, 569, 276 F.2d 17, 23 (1960).]

Use of equitable recoupment is limited to defending against a valid claim. It allows an otherwise time-barred tax claim arising out of the same transaction to be used as a defense or credit against any additional tax ultimately found to exist in the main action.¹⁵ If all or part of the Government’s claim for additional tax is sustained, equitable recoupment can be used to reduce or eliminate it. However, once equitable recoupment of the time-barred tax overpayment completely eliminates the additional tax liability in the main action, equitable recoupment has served its restricted defensive purpose.¹⁶ Equitable recoupment cannot be used affirmatively to recover a tax overpayment, the refund of which is barred by the statute of limitations.

Where the Government claims that the taxpayer owes additional tax and the court finds that there is no additional tax due to the Government, there is nothing left to defend against.¹⁷ The additional estate tax liability that would have resulted from our valuation of the stock in decedent’s estate was less than the credit that respondent correctly allowed in the notice of deficiency. As a result, respondent has no valid claim for additional tax. Respondent’s claim for additional tax has been totally defeated, and petitioner is entitled to a decision that there is no deficiency and that it overpaid its estate tax. Any use of equitable recoupment at this point would not be defensive.

We hold that petitioner is not entitled to use equitable recoupment affirmatively to increase the amount of an overpayment it is entitled to recover. It follows that equitable recoupment has no application in this case. As a result of our disposition, we express no opinion regarding whether any of the other requirements for equitable recoupment have been satisfied.

An appropriate order will be issued.

Reviewed by the Court.

Cohen, Chabot, Swift, Jacobs, Gerber, Wright, Parr, Whalen, Chiechi, Foley, and Vasquez, JJ., agree with this majority opinion.

* This case was reassigned to Judge Robert P. Ruwe by order of the Chief Judge.

1 Decedent Bessie I. Mueller resided and was domiciled in Port Huron, Michigan, at the time of her death, and her will was admitted to probate by the Probate Court of St. Clair County, Michigan. John S. Mueller, the personal representative in this case of decedent’s estate and one of the two trustees of the administration trust, was a resident of Naples, Florida, when he filed the petition in this case. The estate’s other personal representative and the other trustee of the administration trust is Milton W. Bush, Sr., an attorney who resides in Port Huron, Michigan. The Michigan National Bank, which was engaged by the two trustees as their agent upon the death of decedent, has its principal corporate office in Michigan. Throughout the time relevant to this case, the administration trust has been administered in Michigan.

2 The record does not explain why the trust used a basis that was $5 per share less than the amount petitioner reported as the fair market value of the shares in the estate tax return.

3 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

4 This credit, which was not claimed on decedent’s estate tax return, was for property received by decedent from the estate of her stepson Robert E. Mueller. Allowance of this previously unclaimed credit was appropriate in determining the amount of the deficiency. See sec. 6211.

5 Both parties agree that there is no estate tax deficiency and that petitioner is entitled to a decision that it has overpaid its estate tax, regardless of any effect that the doctrine of equitable recoupment might have.

6 The term “main action” is used to denote the timely claim as opposed to the time-barred claim upon which the recoupment defense is based. See Reiter v. Cooper, 507 U.S. 258, 264 (1993); United States v. Dalm, 494 U.S. 596, 605 (1990); Stone v. White, 301 U.S. 532, 539 (1937); Bull v. United States, 295 U.S. 247, 262 (1935); United States v. Forma, 42 F.3d 759, 765 (2d Cir. 1994).

7 After reviewing cases involving recoupment, the Court of Appeals for the Second Circuit stated:

All of these cases conclude that “a party sued by the United States may recoup damages * * * so as to reduce or defeat the government’s claim * * * though no affirmative judgment * * * can be rendered against the United States.” In re Greenstreet, 209 F.2d at 663. [United States v. Forma, supra at 765.]

8 With respect to the limited defensive nature of recoupment, the Court of Appeals for the Seventh Circuit stated:

the government concedes that a party sued by the United States may recoup damages arising out of the same transaction, or where authorized, set off other claims, so as to reduce or defeat the government’s claim. That this is a correct conception of the law is apparent from United States v. United States Fidelity & Guaranty Co., 309 U.S. 506, at page 511 * * *; Bull v. United States, 295 U.S. 247, at page 262 * * *; United States v. Ringgold, 8 Pet. 150, 163-164 * * though no affirmative judgment over and above the amount of its claim can be rendered against the United States, United States v. Shaw, 309 U.S. 495 * * * [In re Greenstreet, Inc., 209 F.2d 660, 663 (7th Cir. 1954).]

9 Recoupment has been described as “the setting off against asserted liability of a counterclaim arising out of the same transaction. Recoupment claims are generally not barred by a statute of limitations so long as the main action is timely,” Reiter v. Cooper, 507 U.S. at 264.

10 See United States v. Dalm, 494 U.S. at 605, stating that in Bull v. United States, supra, “the proceeding between the executor and the Government was in substance an attempt by the Government to recover a debt from the estate.”

11 The combination of increasing the taxable estate and allowing the credit for prior transfers would produce the same result that we arrive at here — petitioner has no additional estate tax liability; rather, petitioner has overpaid its estate tax and would be entitled to a refund.

12 No suit or counterclaim can be brought against the United States where the subject of the suit or counterclaim is barred by the statute of limitations. This bar is jurisdictional in nature. A narrow exception is the availability of recoupment as a defense against an action brought by the United States. United States v. Dalm, supra at 608.

13 Equitable recoupment has been restricted to defending against an otherwise valid claim or cause of action. The Government’s claim or cause of action here is its assertion that petitioner is liable for additional estate tax. “In federal tax litigation one’s total income tax liability for each taxable year constitutes a single, unified cause of action, regardless of the variety of contested issues and points that may bear on the final computation.” Finley v. United States, 612 F.2d 166, 170 (5th Cir. 1980) (citing Commissioner v. Sunnen, 333 U.S. 591, 598 (1948)). The same reasoning applies to the estate tax. There is no distinction conceptually between the nature of a cause of action arising from estate taxes on the one hand and one arising from a single year’s income tax on the other. Estate of Hunt v. United States, 309 F.2d 146, 148 (5th Cir. 1962); see also Huddleston v. Commissioner, 100 T.C. 17, 25 (1993).

14 In Rothensies v. Electric Storage Battery Co., 329 U.S. 296, 301 (1946), the Supreme Court stressed the importance of a statute of limitations, stating:

It probably would be all but intolerable, at least Congress has regarded it as ill-advised, to have an income tax system under which there never would come a day of final settlement and which required both the taxpayer and the Government to stand ready forever and a day to produce vouchers, prove events, establish values and recall details of all that goes into an income tax contest. Hence, a statute of limitation is an almost indispensable element of fairness as well as of practical administration of an income tax policy.

We have had recent occasion to point out the reason and the character of such limitation statutes. “Statutes of limitation * * * are designed to promote justice by preventing surprises through the revival of claims that have been allowed to slumber until evidence has been lost, memories have faded, and witnesses have disappeared. The theory is that even if one has a just claim it is unjust not to put the adversary on notice to defend within the period of limitation and that the right to be free of stale claims in time comes to prevail over the right to prosecute them.” Order of Railroad Telegraphers v. Railway Express Agency, 321 U.S. 342, 348-9. * * *

15 See United States v. Dalm, 494 U.S. at 605.

16 See United States v. Timber Access Indus. Co., 54 F.R.D. 36 (D. Or. 1971). The defendant was entitled to an affirmative recovery against the Government on a separate counterclaim; however, recoupment against the Government was restricted to the amount that the Government was entitled to recover in the main cause of action initiated by the Government.

17 See Evans Trust v. United States, 199 Ct. Cl. 98, 106, 462 F.2d 521, 526 (1972), stating:

Furthermore, since the Government’s asserted deficiency was settled by a determination that no deficiency existed, plaintiff is attempting to use recoupment not in its traditional form as a defense to an asserted deficiency, but as an independent ground for reopening years now closed by the statute of limitations.