In a taxpayer win, the Ninth Circuit recently reversed the Tax Court and held equitable recoupment was not time barred. Revah v. Comm’r, No. 11-70211 (9th Cir. Sept. 17, 2014) (unpublished opinion). Relying on longstanding precedent, the Ninth Circuit held the taxpayers were not statutory barred from applying for equitable recoupment because it’s permitted even with respect to an untimely refund claim. Thus, even though the taxpayers failed to timely file their refund claims, “untimeliness is not a ground upon which the tax court may deny equitable recoupment.” Id.
Equitable recoupment is a judicial doctrine that applies where one transaction or event is subject to two taxes based on inconsistent theories. The equitable recoupment doctrine “allows a litigant to avoid the bar of an expired statutory limitation period” and “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.” Menard, Inc. v. Comm’r, 130 T.C. 54, 62 (2008). To establish equitable recoupment a taxpayer must prove: (1) the overpayment or deficiency for which recoupment is sought by way of offset is barred by an expired period of limitation, (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, and (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. Id. at 62-63. In practice, taxpayers often have difficulty mounting arguments of equitable recoupment against the IRS, although the Government typically has more success in this area.
The IRS audited and made adjustments to the Revahs’ 1999 and 2000 tax returns related to inventory and bad debt, and resulting in a decrease in the net operated losses the taxpayers reported on their 1997 and 1998 returns. The taxpayers accepted the adjustments assuming that, as the examiner acknowledged, they would be able to reduce income in 2001 through amended returns. After the exam and in 2005, the taxpayers filed amended returns in accordance with the examiner’s adjustments, but the refund claims were denied as untimely. The taxpayers petitioned the Tax Court for relief asserting the equitable recoupment doctrine. The Tax Court (Judge Cohen) found the taxpayers’ inability to use the NOLs to reduce tax liabilities was not the result of the inequitable application of inconsistent theories of taxation contemplated by the equitable recoupment doctrine, and thereby denied the petition. The Ninth Circuit reversed and remanded in favor of the doctrine’s application, illustrating that there is hope for future taxpayers seeking to offset current IRS liabilities with past credits under the doctrine.