Crop Associates v. Commissioner

113 T.C. No. 15

• Court: United States Tax Court
• Decided: September 14, 1999
• Docket: 12532-90
• Status: Unknown

Opinion

113 T.C. No. 15

UNITED STATES TAX COURT

CROP ASSOCIATES - 1986, W. KEITH OEHLSCHLAGER, A PARTNER OTHER THAN THE TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 12532-90. Filed September 14, 1999.

The tax matters partner, intervenor, has moved to file amendment to petition, which would add to the petition the affirmative defense of equitable recoupment. R objects on various grounds. We agree with R that equitable recoupment is not a partnership item and that granting the motion would suprise and substantially disadvantage R. The motion will be denied. Held: Equitable recoupment is not a partnership item; held, further, R would be surprised and substantially disadvantaged were we to grant the motion.

Steven R. Mather, for intervenor.

William H. Quealy and Alice M. Harbutte, for respondent. - 2 -

OPINION

HALPERN, Judge:

I. Introduction

This case involves a petition for the readjustment of

certain partnership items reported on the 1986 tax return of Crop

Associates-1986, a limited partnership with its principal place

of business in Coachella, California (the partnership). The

petition was filed by a partner other than the tax matters

partner. Frederick H. Behrens is the tax matters partner, and,

on June 28, 1999, we allowed Mr. Behrens to intervene in the

case. On July 14, 1999, Mr. Behrens (intervenor) moved for leave

to file amendment to petition (the motion and the amendment,

respectively). The amendment would add to the petition the

affirmative defense of equitable recoupment. In support of that

defense, the intervenor avers:

a. In 1986, the Partnership deducted a farming expense [which deduction respondent has disallowed].

b. In 1987, the Partnership reported as income an amount equal to the farming expense taken in 1986.

c. The [1986 farming expense] * * * and offsetting adjustment for 1987 arise out of a single transaction, i.e., a farming contract.

d. This single transaction is subject to two taxes based on inconsistent legal theories.

e. Respondent’s position is that taxes paid for 1987 are statutorily barred from refund. - 3 -

Rule 41 addresses amended and supplemental pleadings.1

Under the circumstances here existing, Rule 41(a) provides that a

party can amend his pleading only by (1) written consent of the

adverse party or (2) leave of Court, and such leave shall be

given freely when justice so requires. Respondent has not

consented to the amendment and objects to the motion. Respondent

objects to the motion on the grounds that (1) the Court generally

lacks jurisdiction to consider the defense of equitable

recoupment, (2) this is a partnership proceeding and, since

equitable recoupment is not a partnership item, it is not an

appropriate item for the Court to consider, and (3) granting the

motion will cause a substantial disadvantage to respondent.

We assume, arguendo, that respondent's first objection lacks

merit. See Estate of Branson v. Commissioner, 113 T.C. ___

(1999); Estate of Mueller v. Commissioner, 101 T.C. 551 (1993),

affd. on other grounds 153 F.3d 302 (6th Cir. 1998). We agree,

however, with his last two objections. Our reasons for agreeing

with his last two objections are as follows.

II. Equitable Recoupment

To "recoup" is to get back the equivalent of something lost.

The American Heritage Dictionary 1511 (3d ed. 1992). The

1 Hereafter, unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. - 4 -

doctrine of equitable recoupment is a judicially created doctrine

that precludes the unjust enrichment of a party to a lawsuit and

avoids a wasteful multiplicity of litigation. See Estate of

Mueller v. Commissioner, supra at 551-552. As applied for the

benefit of a taxpayer, the doctrine provides that, in some cases,

a claim for a refund of taxes barred by a statute of limitations

may, nevertheless, be recouped against a tax claim of the

Government. See Bull v. United States, 295 U.S. 247, 258-263

(1935). Equitable recoupment is in the nature of a defense

arising out of some feature of the transaction upon which the

claim for taxes is grounded. See id. at 262. The doctrine is

applied only where a single transaction constitutes the taxable

event claimed upon and the one considered in recoupment. See

Rothensies v. Electric Storage Battery Co., 329 U.S. 296, 299-300

(1946).

Recently, we listed the elements necessary to sustain the

defense of equitable recoupment:

A claim of equitable recoupment requires: (1) That the refund or deficiency for which recoupment is sought by way of offset be barred by time; (2) that the time-barred offset arise out of the same transaction, item, or taxable event as the overpayment or deficiency before the Court; (3) that the transaction, item, or taxable event have been inconsistently subjected to two taxes; and (4) that if the subject transaction, item, or taxable event involves two or more taxpayers, there be sufficient identity of interest between the taxpayers subject to the two taxes so that the taxpayers should be treated as one. * * *

Estate of Branson v. Commissioner, supra at ___ (slip op. at 15).

III. Analysis - 5 -

A. Appropriateness to Partnership Proceeding

1. Principal Provisions of the Code

This case was commenced under the provisions of subchapter C

(sections 6221 through 6234), chapter 63, subtitle F of the

Internal Revenue Code (subchapter C). Section 6221 provides:

“Except as otherwise provided in this subchapter, the tax

treatment of any partnership item shall be determined at the

partnership level.” The term “partnership item” is defined in

section 6231(a)(3):

The term “partnership item” means, with respect to a partnership, any item required to be taken into account for the partnership’s taxable year under any provision of subtitle A to the extent regulations prescribed by the Secretary provide that, for purposes of this subtitle, such item is more appropriately determined at the partnership level than at the partner level.

Section 6226(f) delineates our jurisdiction to determine

partnership items:

A court with which a petition is filed in accordance with this section shall have jurisdiction to determine all partnership items of the partnership for the partnership taxable year to which the notice of final partnership administrative adjustment relates and the proper allocation of such items among the partners.

A “computational adjustment” (computational adjustment) is

the change in the tax liability of a partner that properly

reflects the treatment under subchapter C of a partnership item.

Sec. 6231(a)(6). Generally, the deficiency procedures set forth

in subchapter B, chapter 63, subtitle F of the Internal Revenue

Code (the deficiency procedures) do not apply to the assessment

and collection of any computational adjustment. See sec.

6230(a)(1). - 6 -

The term “affected item” means “any item to the extent such

item is affected by a partnership item.” Sec. 6231(a)(5). If a

change in a partner’s tax liability with respect to an affected

item requires a partner-level determination, then, to that extent

(and to that extent only), it is a computational adjustment

subject to the deficiency procedures. See sec. 6230(a)(2)(A)(i);

sec. 301.6231(a)(6)-1T(a), Temporary Proced. & Admin. Regs.,

52 Fed. Reg. 6790-6791 (Mar. 5, 1987).

2. Partnership Items

A partnership, as such, is not subject to the income tax;

rather, persons carrying on business as partners are liable for

income tax in their separate or individual capacities. See sec.

701. Nevertheless, subchapter C describes a set of procedures

whereby the tax treatment of items of partnership income, loss,

deductions, and credits are determined at the partnership level

in a unified proceeding rather than in separate proceedings with

the partners. Our role in that unified proceeding is limited by

section 6226(f) to the determination (and allocation) of

partnership items. We have no authority under section 6226(f) to

determine anything else, not any affected item, and not the tax

liability of any partner.

As discussed supra in section II, equitable recoupment is in

the nature of a defense to a claim for payment. If, following

this proceeding, respondent does make a claim for payment, it

will be from the partners of the partnership (the partners),

following an assessment of a tax liability resulting from a - 7 -

computational adjustment. See sec. 301.6231(a)(6)-1T, Temporary

Proced. & Admin. Regs. (discussing computational adjustments,

including when the deficiency procedures apply), 52 Fed. Reg.

6790-6791 (Mar. 5, 1987). Section 301.6231(a)(3)-1, Proced. &

Admin. Regs., implements section 6231(a)(3) by providing a list

of partnership items. Equitable recoupment is not among the

items on that list, and, therefore, it is not a partnership item.

For a defense of equitable recoupment to succeed, however, the

partners will have to establish certain partnership items. Each

partner will also have to prove that he or she has made a time-

barred overpayment of tax, and that is not a partnership item.

See sec. 301.6231(a)(3)-1, Proced. & Admin. Regs.

Notwithstanding our limited jurisdiction under section 6226(f),

we may consider affirmative defenses in connection with the

determination of partnership items. See Rule 39; Columbia Bldg.

Ltd. v. Commissioner, 98 T.C. 607, 611 (1992) (considering

affirmative defense of statute of limitations in a section 6226

partnership case on the same basis as in a deficiency case);

Amesbury Apartments, Ltd. v Commissioner, 95 T.C. 227, 241 (1990)

(considering affirmative defense of statute of limitations in

section 6226 partnership case). Nevertheless, since certain

partner-level determinations are necessary elements to the

defense of equitable recoupment, consideration of that defense in

this proceeding seems inconsistent with our limited jurisdiction

under section 6226(f). In light of respondent’s position,

discussed in the next section of this report, that equitable - 8 -

recoupment is an affected item, we need not further discuss that

point.

3. The Partners’ Remedies

Intervenor argues that, unless we conclude that equitable

recoupment is a partnership item, the partners will be barred

from defending against any computational adjustment on account of

subsections (a)(1) and (c)(1) and (4) of section 6230, which,

according to intervenor, (1) render the deficiency procedures

inapplicable to computational adjustments except in the case of a

deficiency attributable to affected items requiring partner-level

determinations and (2) restrict refund suits to claims arising

out of erroneous computations and the like.

In respondent’s memorandum in support of his objection to

the motion, respondent states: “The defense of equitable

recoupment is an affected item requiring determinations at the

individual partner level.” With respect to the facts of this

case, respondent states in his objection:

Any defense of equitable recoupment requires an inquiry at the individual partner level to determine whether there is a deficiency in income tax with respect to an individual partners [sic] that would result (by means of computational adjustment) from the Court’s determination at the partnership level the [sic] for the year at issue and if so, whether there is any amount to be recouped in a subsequent year.

In Powell v. Commissioner, T.C. Memo. 1997-560, the

taxpayers petitioned the Court in response to the Commissioner’s

notices determining deficiencies attributable to certain affected

items (the affected items were additions to tax). Previously,

the Commissioner had made computational adjustments, which had - 9 -

given rise to deficiencies in tax (and additional interest under

section 6621(c)) that had been assessed against the taxpayers.

In addition to assigning error to the Commissioner’s

determination of the affected items, the taxpayers assigned error

to the Commissioner’s prior assessments and to the deficiencies

that gave rise to those assessments. Among other errors assigned

by the taxpayers was the Commissioner’s failure to allow

equitable recoupment in determining the deficiencies previously

assessed. The Commissioner moved to dismiss with respect to the

claim for equitable recoupment on the ground that we lacked

jurisdiction to redetermine the taxpayers’ tax for the years in

issue “to the extent that the amounts assessed * * * are

attributable to the proper reporting of partnership items.” As

the Court noted, the taxpayers had conceded: “we do not have

jurisdiction over the computational assessments in this

proceeding”. We concluded: “Accordingly, the doctrine of

equitable recoupment does not apply.”

In this proceeding under section 6226, it is not appropriate

for us to determine whether the defense of equitable recoupment

is an affected item requiring partner-level determinations. We

can consider whether in fact the defense of equitable recoupment

is an affected item requiring partner-level determinations if and

when a computational adjustment is made, a notice of deficiency

is issued, and a proper petition is filed. Cf. Carmel v.

Commissioner, 98 T.C. 265 (1992). - 10 -

4. Conclusion

Since the amendment would add to the petition the defense of

equitable recoupment, which is not appropriate to this

proceeding, that is a sufficient ground on which to deny the

motion.

B. Substantial Disadvantage

1. Introduction

Although respondent’s second objection describes a

sufficient ground to deny the motion, we proceed to consider

respondent’s third objection, since it provides an independent

and equally persuasive reason to deny the motion.

Respondent argues that, even if equitable recoupment is a

partnership item or is otherwise appropriate for consideration in

this proceeding, the motion should be denied because of the

substantial disadvantage that respondent would be put under on

account of the amendment. Respondent points out that the

petition was filed over 9 years ago and the case is scheduled for

trial at a special session of the Court to commence on October 4,

1999. The motion was made on July 14, 1999. Respondent claims:

“The facts surrounding the items on this return will be

difficult, at best, to determine. As a result of the tax matters

partner’s long delay in waiting to raise the issue, respondent is

unduly prejudiced.” Intervenor responds that there is no

prejudice to respondent “because all of the relevant facts - 11 -

pertaining to the partnership item determinations have been known

to respondent for many years.”

2. The Requirements of Justice

We must freely give leave to amend a pleading when justice

so requires. See Rule 41(a). Justice does not require leave to

amend a pleading, however, when giving such leave will surprise

and substantially disadvantage an adverse party. See, e.g.,

Estate of Horvath v. Commissioner, 59 T.C. 551, 555 (1973).

3. Discussion

Intervenor has failed to persuade us that justice requires

us to grant him leave to make the amendment. We have set forth

supra in section II the elements necessary to sustain the defense

of equitable recoupment. Those elements involve facts well

beyond those raised by petitioner’s assignments of error in the

petition. They involve facts concerning other years of the

partnership and items that are not partnership items. For

instance, nothing in the petition would alert respondent that

payments of tax by the partners for their 1987 tax year might be

placed in issue. Many of the facts necessary to rebut the

amendment were established well over 10 years ago, and, even if

respondent was once in possession of evidence of those facts,

intervenor has failed to show us that such evidence is readily

available to respondent today. Moreover, by the date respondent

had obeyed our order to respond to the motion (August 4, 1999),

the period for discovery had almost run. See Rule 70(a)(2) - 12 -

(discovery, including the filing of motions to compel discovery,

shall be completed 45 days prior to trial). We have already

denied intervenor’s motion for a continuance.

Since respondent would be surprised and substantially

disadvantaged were we to grant the motion, that is sufficient

reason for us not to do so.

IV. Conclusion

Intervenor’s motion for leave to file amendment to petition

shall be denied.

An appropriate order will be

issued.