The statute of limitations can bar a claim for refund. What happens if that means the government is going to collect tax twice for the same event?
In T.C. Memo. 2018-55 (Emery Celli Cuti Brinckerhoff & Abady, P.C.), the taxpayer, a law firm, mistakenly paid employment taxes under an incorrect federal employer identification number due to a change in business form.
On January 16, 1999, after a change in partners, the firm began to operate as a professional corporation instead of as the limited liability partnership it had been before. The new professional corporation made five payroll tax deposits during 1999 using the federal employer identification number of the prior partnership. The partnership filed a payroll tax return for the first quarter of 1999 showing the deposits.
The professional corporation did not file a payroll tax return for the first quarter of 1999 until 2006, when the IRS sent a letter asking for it.
The taxpayer explained the mix-up and asked that the overpayment on the partnership payroll return be credited to the professional corporation.
The IRS said the overpayment could not be applied to the professional corporation because the statute of limitations had expired. In addition, the IRS said both entities were still active, and offsetting the amounts would not be appropriate.
The taxpayer said that by denying the transfer of the overpayment, the IRS would be collecting tax twice for the same taxable event.
The tax court looked to the doctrine of equitable recoupment to reach a decision. The doctrine of equitable recoupment prevents an inequitable windfall to a taxpayer or to the government that would otherwise result from the inconsistent tax treatment of a single transaction, item, or event affecting the same taxpayer or a sufficiently related taxpayer. Under the doctrine, a taxpayer can avoid the bar of an expired statutory limitations period.
In simpler form, when one transaction is subject to two taxes based on inconsistent treatment, neither the government nor the taxpayer (or related taxpayers) can be unjustly enriched, even if the statute of limitations for the collection or payment of the tax has expired.
Four elements have to be established for the doctrine to apply.
(1) The overpayment or deficiency for which recoupment is sought by way of offset is barred by an expired period of limitations;
(2) The time-barred overpayment or deficiency arose out of the same transaction, item, or taxable event as the overpayment or deficiency before the court;
(3) The transaction, item, or taxable event has been inconsistently subjected to two taxes;
(4) If the transaction, item, or taxable event involves two or more taxpayers, there is sufficient identity of interest between the taxpayers subject to the two taxes that the taxpayers should be treated as one.
Here are the arguments for each element.
Element 1. The statute of limitations
Section 6511(a) of the internal revenue code provides that refund claims must be filed within the later of three years from the date the return was filed or two years from the date the tax was paid.
The partnership had not filed a refund claim for any overpayment of employment taxes for the first quarter of 1999. The partnership’s latest employment tax deposit for that quarter was made on March 31, 1999, and received a few days after, and the partnership timely filed a Form 941 for that quarter.
Element 2. Same transaction, item, or taxable event
The taxpayer contends that the partnership’s time-barred overpayment, and the professional corporation’s underpayment, of employment tax for the first quarter of 1999 arose out of the same transaction or taxable event.
The IRS says there are two taxable events:
(1) the assessment of employment taxes in May 1999 based on the partnership’s “voluntary payment” and
(2) the assessment of employment taxes in May 2006 based on the professional corporation’s self-reported liability on the Form 941 it filed in March 2006.
Element 3. Inconsistently subjected to two taxes
The partnership paid employment taxes on the theory that it was the payor of wages to the law firm’s employees for the foregoing period.
The IRS seeks to collect employment taxes (plus penalties and interest) from the professional corporation on the theory that the professional corporation was the payor of the same wages during the same period.
Element 4: Identity of interest
The partnership and the professional corporation were separate legal entities with distinct employer identification numbers during the first quarter of 1999. Each was owned by the same four individuals during that period.
The IRS said (and the taxpayer agreed) that both entities were still active.
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Element 1. Statute of limitations.
It is clear that any claim for a refund of the partnership’s employment tax overpayment for the first quarter of 1999 is time barred. Thus, the professional corporation has established the existence of a time-barred overpayment.
Element 2. Same transaction, item, or taxable event.
(The court says) The IRS misconstrues what constitutes a taxable event for this purpose.
In the court’s view, the taxable event in the case of employment taxes is not the IRS’s assessment of tax but instead the employer’s payment of wages, which in general triggers the employer’s obligation to withhold and/or to pay social security taxes, hospital taxes, and income tax withholdings—the employment taxes at issue in this case.
Thus the taxable event here was the payment of wages to the employees of the law firm during the latter 75 days of the first quarter of 1999 (i.e., wage payments made after the first payment of wages on January 15, 1999).
Thus, the components of the time-barred overpayment and the employment tax liability that the IRS seeks to collect in each instance arose from the same taxable event.
Because the employment taxes that the IRS seeks to retain and to collect, respectively, arose from the same payments of wages to the same employees during the same taxable period, we conclude that the requirement that the two taxes arise from the same taxable event has been satisfied.
Element 3. Inconsistently subjected to two taxes
The taxable event here–the payment of aggregate wages to the law firm’s employees during the latter 75 days of the first quarter of 1999–has been taxed twice on inconsistent theories.
The partnership has paid employment taxes on the theory that it was the payor of wages to the law firm’s employees for the foregoing period, and
The IRS now seeks to collect employment taxes (plus penalties and interest) from the professional corporation on the inconsistent theory that the professional corporation was the payor of the same wages during the same period.
Thus, the professional corporation has demonstrated satisfaction of the third element for application of equitable recoupment.
Element 4: Identity of interest
Courts may in certain circumstances permit a taxpayer to recoup an erroneously paid tax that the taxpayer did not pay himself.
But the payor of the tax and the recipient of the recoupment must have a sufficient identity of interest such that they should be treated as a single taxpayer in equity.
Though the partnership and the professional corporation were separate legal entities with distinct employer identification numbers during the first quarter of 1999, each was owned by the same four individuals during that period.
Consequently, the burden of double taxation in this situation would be borne by the same individuals.
Therefore, the professional corporation has demonstrated sufficient identity of interest with the partnership to allow the professional corporation to recoup the employment tax for the first quarter of 1999 that the partnership overpaid.