Samuel C. Dysart and Alma R. Dysart v. The United States

340 F.2d 624, 169 Ct. Cl. 276, 15 A.F.T.R.2d (RIA) 205, 1965 U.S. Ct. Cl. LEXIS 43

• Court: United States Court of Claims
• Decided: January 22, 1965
• Docket: 61-63
• Status: Published

Opinions

LARAMORE, Judge.

This is a suit for the refund of $4,-548.48 collected as a penalty for the year 1954 for an underestimation of income-. tax. The government, although it concedes that the imposition of the penalty was erroneous, nevertheless was denied taxpayers’ claim for refund since it has asserted an offset exceeding, the .amount sought due to an alleged income tax deficiency for the year 1954. The .taxpayers, by this motion for summary judgment, seek to strike the government’s setoff. It is also admitted that the statute of limitations bars the Commissioner of Internal Revenue from making an additional assessment predicated on the alleged error. Taxpayers’ claim is in the amount of $4,548.48 plus statutory interest. The government’s setoff is in the amount of approximately $130,000, although it is cognizable only to the extent of reducing taxpayers’ claim to zero. The sole issue presented by this motion is whether in a suit for refund where both the taxpayers’ claim and the government’s setoff concern the same tax¹ for the same year by the same taxpayers, the right of the government to assert such a defense is an unconditional right (as the government contends), or whether, as taxpayers contend, such a right is subject to the court’s discretion after evaluating the “equities” involved in each particular case. . -

In late 1954, taxpayers received payment of a judgment in the amount of $359,094.56 in a patent infringement suit. The suit concerned an invention which marked a major advance in the state of the art in the adding machine industry. In 1919, the invention was orally assigned by the inventor (taxpayers’ father) to his company, The Dalton Adding Machine Company. The •company was subsequently acquired by Remington Rand, Inc., which repudiated the agreement. After a patent was issued in 1935, extensive negotiations for settlement were conducted by the inventor’s widow without success. Suit was filed in 1937 and protracted litigation •continued until two judgments were paid, one in 1954 and one in 1957.

Late in December 1954, taxpayers received payment of the proceeds of their share of the first judgment. At that time, taxpayers, who had not filed a declaration of estimated tax for 1954, were living in Havana, Cuba. After receiving the unusual lump-sum income, they filed their joint income tax return and paid the tax shown to be due thereon to the District Director of Internal Revenue in Baltimore, Maryland. The return and payment were received by the. District • Director on January 19, 1955, four days after January 15, 1955,. which fell on a Saturday. On December 22, 1956, after an audit of the return, the Internal Revenue Service took the position that the taxpayers had reasonable cause for failure to file a declaration of estimated tax for 1954. However, it assessed a penalty against taxpayers for underestimation of the 1954 tax. This action was based on 26 U.S.C. (I.R.C.1939) § 294(d) (2) (1952 Ed.) and Treasury Regulation 111, § 29.294-l(b) (3) (A), which in effect provided that in the event a taxpayer failed to file the required declaration of estimated tax, the amount of the estimated tax for the purposes of section 294(d) (2) was zero. On June 18, 1958, the regulation was held invalid by the Sixth Circuit in Acker v. Commissioner, 258 F.2d 568, and the decision was affirmed by the Supreme Court on November 16, 1959, Commissioner v. Acker, 361 U.S. 87, 80 S.Ct. 144, 4 L.Ed.2d 127 (1959).

In their 1954 income tax return, taxpayers treated the proceeds of the judgment as capital gains on the ground that all substantial rights in the invention had been transferred by the inventor. Taxpayer, Samuel C. Dysart, had two sisters who also received payments from the 1954 judgment, and they treated the proceeds in the same way. The returns were audited in three separate revenue districts which accepted the taxpayers’ treatment of the proceeds of the judgment. However, the Internal Revenue Service found that the judgment included interest from the date the patent was issued to the date of judgment and held that the interest should be taxed as ordinary income. The taxpayers conceded the issue, and a deficiency was assessed and paid with respect to the taxes due on the interest.

In 1957, a final judgment covering the last three years of the patent’s life was rendered in favor of the Dysart family. Taxpayers also reported the amount paid on this judgment as capital gain in their 1957 income tax return, but this treatment was challenged by the Internal Revenue Service. After taxpayers had filed a petition in the Tax Court, the suit was settled on the basis that taxpayers would pay 60 percent of the assessed deficiency.

On October 16, 1958, after the favorable decision by the Court of Appeals for the Sixth Circuit (but before the Supreme Court’s opinion) in the Acker case, supra, taxpayers filed a timely claim for refund of the penalty assessed on their 1954 return. On June 20, 1960, about six months after the Supreme Court’s decision in the Acker case, the Internal Revenue Service abandoned its previous grounds for disallowance of the refund of the penalty but asserted that the judgment damages, reported as capital gain in the 1954 return, should have been taxed as ordinary income and that, although the statute of limitations barred the deficiency, it should be used as a setoff against the refund due taxpayers. This suit followed after formal denial of the claim for refund.

Taxpayers argue that the government’s defense of setoff or equitable recoupment must be judged by - equitable principles and as a result of the government’s inequitable conduct in this case, recoupment should be denied.

At the outset it should be pointed-out that the defense of recoupment in a refund suit should not be confused with, the broader and more fundamental defense of lack of overpayment of the particular tax involved in the suit for refund, traceable to the landmark decision by the Supreme Court in Lewis v. Reynolds, 284 U.S. 281, 52 S.Ct. 145, 76 L.Ed.. 293 (1932). The former involves attempts to set off tax liability from one year against that for another year after the statute of limitations has run² or where attempts are made to set off the-tax liability of one taxpayer against that of a second taxpayer.³ This type of defense has been commonly referred to as-“equitable recoupment.” In these situations where the challenged item arose in-a year other than in suit or where different parties are involved, the defense may only be maintained where a single- or same transaction is involved.⁴

On the other hand, where both the taxpayer’s claim and the government’s setoff concern the same tax for the same year by the same taxpayer, the government’s right to raise such a defense is unconditional and need not meet the “same transaction” requirement of the equitable recoupment defense. Here the right of the government is based on-the broader principle that a taxpayer is-not entitled to a refund unless he has in-fact overpaid the particular tax, while in“equitable recoupment” the right to raise-such a defense is based on the more limited principle that a party should not. gain the protection of the statute of limitations where he has given a different tax treatment to ’the same transaction-in different years.⁵ Although the origin of these defenses may be traced to equitable principles, the right to raise a. setoff is not subject to equitable considerations as taxpayers contend. We believe that both the government and the Individual taxpayer have the legal right to raise a setoff without having to appeal to the court’s discretion or to its evaluation of the particular equities. We find support for this conviction in the fact that Congress has chosen to incorporate the doctrine of “equitable recoupment” into our revenue laws by what is now commonly known as the mitigation provisions, sections 1311-1315 of the Internal Revenue Code of 1954. In so doing, Congress has enumerated a series of requirements which have to be met before these sections become operative and recoupment allowed. It is significant that none of these requirements are based on equitable considerations. If the requirements are met, there is no room for the court to look at the “equities” involved in each particular case and prevent their operation. We believe the same rationale should apply to the broader and more fundamental defense of lack •of overpayment raised by the setoff defense involved in the instant case.

The crucial factor in this refund suit is that both the taxpayers’ claim and the government’s setoff concern the same tax (income tax) for the same year (1954) by the same taxpayer. The government seeks the opportunity to balance against the $4,548.48 income tax penalty for 1954 (now admitted to have been erroneously collected) other income tax for 1954 which these taxpayers are said to have failed to report and pay. The established doctrine of setoff in tax cases gives the government that right. There is no room, in this situation, to deny the government its right of setoff because the taxpayers’ claim is relatively small, or the government’s counter-demand will put them to a burdensome trial, or because the underlying facts (leading to liability in 1954) are old and complex, or the Internal Revenue Service had a previous opportunity to assess the underpaid tax. To uphold the government’s right to maintain the defense in this case, it is sufficient that the set-off involves the same type of tax, payable by these taxpayers, for the same year as the taxpayers’ claim.

The theory of setoff for tax purposes seems to us to insist upon this result. In a refund action, the taxpayer cannot recover unless he has overpaid his tax. It is not enough that he can prevail on the particular items on which he sues, for he may have underpaid with respect to other components entering into that tax. Only if the overall balance moves hi’s way can he recover. His entire tax liability under the particular tax return is therefore open for redetermination. The setoff is one mechanism by which the government alleges that, looking at the particular tax as a whole, the taxpayer has not in fact overpaid his tax. See Missouri Pacific Railroad Co. v. United States, Ct.Cl., 338 F.2d 668, No. 40-63, decided November 13, 1964, slip op., pp. 2-3, and cases cited.

The Supreme Court has never suggested that — in a refund suit in which the setoff involves the same tax, the same year, and the same taxpayer — the court may, or should, weigh “equities” to decide whether it would be fair, in the individual circumstances, to permit the government to assert the defense. Lewis v. Reynolds, 284 U.S. 281, 52 S.Ct. 145, 76 L.Ed. 293 (1932), the taproot of this branch of recoupment, was just such a case; the Supreme Court agreed with the court below (284 U.S. at 283, 52 S. Ct. at 146) that:

“ * * * the ultimate question presented for decision, upon a claim for refund, is whether the taxpayer has overpaid his tax. This involves a redetermination of the entire tax liability. While no new assessment can be made, after the bar of the statute has fallen, the taxpayer, nevertheless, is not entitled to a refund unless he has overpaid his tax. The action to recover on a claim for refund is in the nature of an action for money had and received and it is incumbent upon the claimant to show that the United States has money which belongs to him.”

The Court added flatly (ibid.):

“While the statutes authorizing refunds do not specifically empower the Commissioner to reaudit a return whenever repayment is claimed, authority therefor is necessarily implied. An overpayment must appear before refund is authorized. Although the statute of limitations may have barred the assessment and collection of any additional sum, it does not obliterate the right of the United States to retain payments already received when they do not exceed the amount which might have been properly assessed and demanded.”

There is not the slightest indication in the opinion that the Commissioner of Internal Revenue could not have made the correct computation within the limitations period; it appears, rather, that he changed his mind as to one deduction he had previously allowed and another which he had once rejected. Nevertheless, those circumstances, so similar to the ones at bar, did not deter the Court from laying down the unqualified rule that “an overpayment must appear before refund is authorized.”

The Supreme Court has neither weakened nor departed from this rule which is a corollary of the basic postulate of the tax setoff. In Rothensies v. Electric Storage Battery Co., 329 U.S. 296, 67 S.Ct. 271, 91 L.Ed. 296 (1946), involving equitable recoupment as opposed to the defense of setoff, the Court did declare that the doctrine of equitable recoupment should not be broadly applied, but the instances to which the Court referred all had to do with taxes for different years, to disparate kinds of taxes, ■or to separate taxpayers. There is nothing in the opinion qualifying or limiting the defense of lack of overpayment where the refund claim and the setoff both relate to the same tax, for the same year, payable by the same taxpayer.⁶

Similarly, the lower court rulings do not sanction the weighing of individual “equities” to deprive the government of the defense in such a case, nor do they reveal any distaste for setoff in that situation. Of the decisions called to our attention, those rendered in cases like this one — involving the setoff situation where you have the same tax, the same year, the same taxpayer — all ⁷ allow the setoff to be asserted, as a matter of right, without reluctance and without evaluation of such particular circumstances as the Treasury’s delay, the burden on the taxpayer, or the hardship of disproving the setoff. Cuba R.R. Co. v. United States, 254 F.2d 280, 282 (2d Cir. 1958);⁸ United States v. Pfister, 205 F.2d 538, 541-542 (2d Cir. 1953); Tait v. Safe Deposit & Trust Co., 70 F.2d 79, 82 (4th Cir. 1934); Champ Spring Co. v. United States, 47 F.2d 1 (8th Cir. 1931); Globe Gazette Printing Co. v. United States, 13 F.Supp. 422, 425, 82 Ct.Cl. 586, 591-592 (1936), cert. denied, 298 U.S. 682, 56 S.Ct. 952, 80 L.Ed. 1403; Western Maryland Ry. Co. v. United States, 131 F.Supp. 873, 889-890, 897 (D.Md., 1955), aff’d per curiam, 227 F.2d 576 (4th Cir.1955), cert. denied, 351 U.S. 907, 76 S.Ct. 696, 100 L.Ed 1443 (1956); First National Bank of Miami v. United States, 235 F.Supp. 331 (S.D. Fla., 1964); cf. Roybark v. United States, 104 F.Supp. 759, 761-762 (S.D. Cal., 1952), aff’d 218 F.2d 164, 165 (9th Cir.1954). These opinions proceed on the essential principle that a taxpayer suing for a refund of a tax for a particular year must show that, in actuality, he overpaid that tax.

Almost all of the lower court cases on which taxpayers rely, clearly were concerned with the equitable recoupment defense involving separate taxes or separate tax years or different taxpayers.⁹ The one possible exception is an unclear summary ruling by a district court which, if pertinent, is, in our opinion, plainly wrong on its own ground.¹⁰

Moreover, even if equitable considerations are used to bar the government, taxpayers’ main complaint here is lack of diligence or laches, which factor we think should not be determinative in tax litigation. In Lewis v. Reynolds, supra, the Commissioner of Internal Revenue had the same opportunity to calculate the correct tax within the limitations period, but setoff was allowed without question. That is likewise true of almost all of the cases, cited above, which have permitted setoff. The delay here was not extraordinary, as these cases go, nor was it, in our opinion, unconscionably troublesome to the taxpayers. If the taxpayers’ view is to be followed, the setoff defense will be severely limited in tax suits, if not eliminated, even in those areas in which it has been regularly allowed up to now. Diligence does not piar that prime a role, either for the government or the taxpayer. In Bowcut v. United States, supra, 287 F.2d at 657, upholding recoupment by a taxpayer despite unexcused failure to file a timely claim for refund, the court pointed out. that the taxpayer’s diligence as to his-, legal rights is not controlling. It should', likewise not be controlling against the-government.

For these reasons, we deny taxpayers’' motion for summary judgment and remand the case to a Trial Commissioner of this Court for further proceedings under the principle and procedure of Missouri Pacific Railroad Co. v. United States, Ct.Cl., 338 F.2d 668, No. 40-63, decided November 13, 1964.

1 . In this case, the recoupment involves the same taxpayers and the same, tax year as the principal claim; the' tax penalty is an addition to the tax, 20 U.S.C. (I.R.C.1939) § 294 (1952 Ed.) and as such is considered as part of the income tax for the taxable year. See Rev.Rul. 50-492, 1950-2 Cum.Bull. 949.

2 . E.g., McEachern v. Rose, 302 U.S. 56, 58 S.Ct. 84, 82 L.Ed. 46 (1937).

3 . E.g., Stone v. White, 301 U.S. 532, 57 S.Ct. 851, 81 L.Ed. 1265 (1937).

4 . See Bull v. United States, 295 U.S. 247, 55 S.Ct. 695, 79 L.Ed. 1421 (1935) (this case is sometimes cited as the originator of this doctrine); Rothensies v. Electric Storage Battery Co., 329 U.S. 296, 67 S. Ct. 271, 91 L.Ed. 296 (1946).

5 . The same rationale applies where the-same year is involved but you have related taxpayers. Stone v. White, supra.

6 . McEachern v. Rose, 302 U.S. 56, 57, 59, 58 S.Ct. 84, 82 L.Ed. 46 (1937), involved different and unconnected tax years.

7 . With one possible exception, see footnote 10, infra.

8 . In the Cuba Railroad ease, Judge Learned Hand, pointing out that the refund claim was for a credit for 1942 on the taxpayer’s income tax and the set-off was for a deduction allowed on the taxpayer's income tax for the same year, said: \

“We do not believe that Rothensies v. Electric Storage Battery Co., supra, meant to hold, when the refund and the set-off both depend upon what were the proper deductions in the same year, that the transactions which determine those deductions must be so narrowly connected. On the contrary, when the taxpayer seeks a refund for a credit mistakenly denied, he must be content to allow Ms tax for the same year to be corrected because of errors through which he has profited.”

9 . United States v. Bowcut, 287 F.2d 654 (9th Cir. 1961) (taxpayer claimed to be precluded from recoupment by “dean hands” doctrine; different taxes — estate tax and income tax'); Wood v. United States, 213 F.2d 660 (2d Cir. 1954) (different taxable years); Ford v. United States, 276 F.2d 17, 149 Ct.Cl. 558, 567-569 (1960) (different taxes — estate tax and income tax); Pond’s Extract Co. v. United States, 134 F.Supp. 476, 479, 133 Ct.Cl. 43, 44, 48-50 (1955) (different taxes for different years); McNaghten v. United States, 17 F.Supp. 509, 84 Ct. Cl. 349 (1937) (different taxpayers— beneficiaries of a trust and the trustees); Lyman v. United States, 22 F.Supp. 14 (D.Mass., 1938) (different taxpayers — beneficiaries of a trust and the trustees). In O’Connor v. United States, 76 F.Supp. 962, 966-968 (S.D.N.Y., 1948), the court held that there was no merit to the government’s defense of recoupment, not that the government was barred from raising the defense.

10 . The short findings in LaFollette v. United States, 176 F.Supp. 192 (S.D. Cal., 1959) do not clearly show whether the setoff arose out of the same taxable year or an earlier period. In any event, the only reason given in the-court’s summary conclusions for denying the setoff is that limitations had run.. That is almost always true in recoupment cases (see Lewis v. Reynolds, supra), and by itself obviously furnishes-no sufficient ground for rejecting the defense. There are some decisions (Routzahn v. Brown, 95 F.2d 766 (6th Cir. 1938); Weiler v. United States, 191 F.Supp. 601 (N.D.Pa., 1961); Dupont v. United States, 28 F.Supp. 122 (D.Del., 1939) ) denying leave belatedly to raise a defense of setoff which the government had failed to interpose at the-proper time. These cases turn on the considerations of judicial administration concerned with the delayed amendments of pleadings and the belated raising' of new issues — not with any general discretionary power over tax setoffs.