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Stephens v. United States

United States Court of Appeals, Federal Circuit

March 9, 2018

WILTON R. STEPHENS, JR., CAROL M. STEPHENS, Plaintiffs-Appellants
v.
UNITED STATES, Defendant-Appellee

         Appeal from the United States Court of Federal Claims in No. 1:15-cv-00153-TCW, Judge Thomas C. Wheeler.

          Craig S. Lair, Rose Law Firm, Little Rock, AR, argued for plaintiffs-appellants. Also represented by Byron Jansen Walker.

          Anthony T. Sheehan, Tax Division, United States Department of Justice, Washington, DC, argued for defendant-appellee. Also represented by David A. Hubbert, Jonathan S. Cohen.

          Before Newman, Wallach, and Chen, Circuit Judges.

          Chen, Circuit Judge

         Appellants Wilton R. Stephens, Jr., and Carol M. Stephens (collectively, the "Stephenses") sued the United States (Government) in the U.S. Court of Federal Claims ("Claims Court"), seeking a refund of federal income taxes and interest. The Government filed a motion to dismiss for lack of subject matter jurisdiction pursuant to Rule 12(b)(1) of the Rules of the Court of Federal Claims, arguing that the Stephenses failed to file a timely tax refund claim with the Internal Revenue Service (IRS). The Claims Court denied the Government's motion to dismiss. See Stephens v. United States, 127 Fed.Cl. 660, 660 (2016). The Government filed a motion for reconsideration, which the Claims Court also denied. App'x 3.[1]After the Government requested that the Claims Court certify the case for interlocutory appeal, the Claims Court sua sponte "t[ook] another look at the applicable case law and statutory provisions" and granted the Government's motion to dismiss. Stephens, 127 Fed.Cl. at 660-61. We affirm.

         Background

         The Stephenses filed joint federal income tax returns for tax years 1995, 1996, and 1997. During these tax years, Mr. Stephens was a shareholder of SF Holding Corporation ("SF"), a subchapter S corporation.[2] See generally I.R.C. §§ 1361 et seq. S corporations generally do not pay federal income taxes. See I.R.C. § 1363(a). Instead, they pass their tax items through to their shareholders, who report those items on individual tax returns. See I.R.C. § 1366. The Stephenses reported passthrough income arising out of investments in SF. At least some of this income was classified as "passive activity" income on the Stephenses' tax returns.[3] In addition, the Stephenses reported passive activity losses (which may be deducted from passive activity income) and passive activity credits (which may be claimed against taxes allocable to passive activities). See I.R.C. § 469(d).

         The IRS audited SF's returns and the Stephenses' individual returns for 1995 and 1996. Those tax years were subject to the audit provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97-248, 96 Stat. 324 (codified in scattered sections of Title 26 of the U.S. Code). Under TEFRA, the IRS had to complete its audit of SF's returns before it could apply any corporate-level adjustments to the pass through items on the Stephenses' individual returns and finalize its audit of the individual returns. Because of amendments to the Tax Code, the Stephenses' 1997 return was not subject to TEFRA and was audited separately from the 1995 and 1996 returns.

         In April 2003, the IRS sent a notice proposing to disallow certain of the Stephenses' passive activity loss deductions and passive activity credits for 1995 and 1996. As detailed in a subsequent notice of deficiency, the IRS concluded that Mr. Stephens had materially participated in some of SF's activities. This material participation meant that income arising from such activities would be considered nonpassive rather than passive, as originally reported by the Stephenses. The passive activity deductions and credits could not be used to offset tax liability arising from nonpassive income. See I.R.C. § 469(d).

         On December 3, 2007, the corporate audit of SF concluded with a closing agreement that covered only corporate-level adjustments. Completion of the SF audit permitted the IRS to finalize its audit of the Stephenses' 1995 and 1996 returns. On March 24, 2008, the IRS again proposed the disallowance of the Stephenses' 1995 and 1996 passive activity loss deductions and credits in the same amounts proposed in April 2003. On January 21, 2009, the IRS sent the Stephenses a notice of deficiency for 1995 and 1996, again in the same amounts proposed in April 2003 and March 2008. The Stephenses did not contest the notice of deficiency and paid the amount specified by the IRS on January 6, 2010. The limitations period for 1995 and 1996 expired two years later on January 6, 2012. The Stephenses never filed a formal refund claim for 1995 or 1996.

         The Stephenses allege that they believed they could carry over their now-disallowed passive activity losses from 1995 and 1996 to 1997 to reduce their income taxes by an amount approximately equal to the increase in their 1995 and 1996 taxes. On July 25, 2006, the Stephenses entered into an agreement with the IRS to extend the deadline for filing a refund claim for 1997 until June 30, 2008. On October 8, 2009, over a year after the June 30, 2008 deadline, the Stephenses mailed an amended tax return for 1997 to the IRS. The amended return sought to carry over the 1995 and 1996 passive activity losses to 1997.

         In November 2011, the Stephenses sent a letter regarding their amended return for 1997 in which they invoked the mitigation provisions of the Tax Code. See I.R.C. §§ 1311-1314 (mitigation provisions). These provisions, in specified circumstances, "permit a taxpayer who has been required to pay inconsistent taxes to seek a refund of a tax the recovery of which is otherwise barred by [I.R.C.] §§ 7422(a) and 6511(a)." United States v. Dalm, 494 U.S. 596, 610 (1990). I.R.C. § 7422(a) states that no suit for the recovery of any tax alleged to have been erroneously collected may be brought until a "claim for refund or credit has been duly filed" with the IRS. I.R.C. § 6511(a) specifies the limitations period for filing a refund claim.[4] There is no dispute that the limitations period in which the Stephenses could have filed a timely refund claim for 1997 had long expired, on June 30, 2008. See Open. Br. 14 ("The period for filing a claim for refund for 1997 expired on June 30, 2008.").

         On March 15, 2012, the IRS sent a notice proposing to disallow the Stephenses' refund claim for 1997 because it was untimely and because the mitigation provisions did not save the claim. On April 12, 2012, the Stephenses filed an administrative appeal of the proposed disallowance, in which they invoked, inter alia, equitable recoupment in addition to mitigation in an effort to save their untimely refund claim. "Equitable recoupment is a judicially created doctrine . . . used as a defense allowing redress against a timely claim that results in the double inclusion or double exclusion of items, when the correction of such items would be barred by the statute of limitations." 2 Mertens Law of Fed. Income Taxation § 14:3 (2018) (hereinafter, "Mertens") (citing Bull v. United States, 295 U.S. 247 (1935)). The IRS rejected the Stephenses' administrative appeal because their refund claim was untimely and neither mitigation nor equitable recoupment applied.

         The Stephenses filed suit in the Claims Court. In their complaint, the Stephenses contended that the amended 1997 return that they filed in October 2009 (which would have been an untimely filing for that year) was actually an informal refund claim for tax years 1995 and 1996. It is undisputed that the limitations period for filing a refund claim for 1995 or 1996 did not expire until after the Stephenses filed their amended 1997 return in October 2009. The Stephenses asserted two grounds for relief set out in separate counts in the complaint: (1) statutory mitigation and (2) equitable recoupment.

         The Government moved to dismiss for lack of subject matter jurisdiction, arguing, inter alia, that the Stephenses had not filed a timely refund claim for 1997 and had not filed any refund claim for 1995 or 1996 (refuting the Stephenses' claim that their amended 1997 return qualified as an informal claim for the earlier two years). The Claims Court initially denied the Government's motion, treating the timely filing of a refund claim as merely "an element of the [Stephenses'] cause of action" rather than a jurisdictional prerequisite. The Government filed a motion for reconsideration, which the Claims Court initially denied. The Government moved to certify the case for interlocutory appeal. On August 2, 2016, the Claims Court sua sponte reconsidered its prior rulings and granted the Government's motion to ...


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