Fleishman, Joel L.

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Taxation -- Barred Claims -- Equitable Recoupment

University of North Carolina School of Law

NORTH CAROLINA LAW REVIEWVolume 36 | Number 3 Article 134-1-1958Taxation -- Barred Claims -- Equitable RecoupmentJoel L. FleishmanFollow this and additional works at: http://scholarship.law.unc.edu/nclrPart of the Law CommonsThis Note is brought to you for free and open access by Carolina Law Scholarship Repository. It has been accepted for inclusion in North Carolina LawReview by an authorized editor of Carolina Law Scholarship Repository. For more information, please contact law_repository@unc.edu.Recommended CitationJoel L. Fleishman, Taxation -- Barred Claims -- Equitable Recoupment, 36 N.C. L. Rev. 347 (1958).Available at: http://scholarship.law.unc.edu/nclr/vol36/iss3/13NOTES AND COMMENTScipal case, specific details should not be used to the exclusion of generalterms. General terms such as "out houses," "yard," and "garden" arecommon and have proved effective. 16JAMES W. KIRKPATRICK, JR.Taxation-Barred Claims-Equitable RecoupmentPlaintiff, as administratrix, paid estate tax on her deceased hus-band's estate. After the period of limitations on claim for refund ofthe estate tax had expired, the Commissioner assessed against the estatea deficiency assessment for income taxes and penalties. The plaintiffpaid same and sought a refund of estate tax to accord with the resultantdecrease of the taxable estate, but was denied recovery in the districtcourt' because of a three year statute of limitations on refund of estatetax.2 The plaintiff then brought suit for refund of income tax, seekingto recoup the estate tax overpayments against the income tax deficiencyassessments, a refund of which the statute of limitations had not yetbarred. The court allowed full recovery with interest.3The doctrine of recoupment, an equitable remedy of common laworigin, is the act of rebating a part of a claim on which one is sued, bymeans of a legal or equitable right resulting from a counterclaim arisingout of the same transaction. 4 In Bull v. United States,5 the first casein which this remedy was extended to federal taxation, the UnitedStates Supreme Court limited recoupment to situations arising out of"some feature of the same transaction upon which the plaintiff's claimis grounded."6 The basic problem in recoupment cases stems from thedifficulty in determining what constitutes the same transaction.Four times the Supreme Court has considered the matter of recoup-1" Here follow some examples of descriptions in search warrants that wereheld valid:"a certain dwelling house, barn, garage, outbuildings and sheds located at ... People v. Holton, 326 Ill. 481, 158 N.E. 134 (1927); "room, house, outhouse,yard, garden and appurtenances thereto . . . ." Rose v. State, 171 Ind. 662, 87N.E. 103 (1909); "building and all out buildings commonly known as . .. ."Thomson v. State, 196 Ind. 229, 147 N.E. 778 (1925); "one story frame houseand all outbuildings appurtenant thereto . . . " Goodman v. State, 201 Ind. 189,165 N.E. 755 (1929).1 Herring v. United States, 131 F. Supp. 536 (E.D.N.C. 1955).'Int. Rev. Code of 1939, § 910, 53 STAT. 138 (now INT. REv. CoDE OF 1954,§ 6511).United States v. Herring, 240 F.2d 225 (4th Cir. 1957).80 C.J.S., Set-Off and Counterclaim § 2 (1953).295 U.S. 247 (1935). Decedent's estate was substituted in decedent's placein a partnership and received income therefrom. The Commissioner first incor-rectly levied estate tax on the sum so received and, after suit for refund of thistax was barred, he levied income tax on the same sum. The Court allowed thetaxpayer to recoup the barred estate tax overpayment against the income tax de-ficiency correctly due on the sum.Old. at 262.1958]NORTH CAROLINA LAW REVIEWment in tax cases, twice allowing the remedy-Bull v. United Statesand Stone v. White7 -and twice denying it-McEachern v. Rose8and Rothensies v. Electric Storage Battery Co.9 The McEachern case,decided squarely on the basis of statutory provisions,' 0 presents a situa-tion similar to that in the Bull case, yet the statutes applied in the formerwere never mentioned in the latter opinion, though they were in effect atthe time involved. It is possible to argue that the McEachern andElectric Storage Battery cases do not present same-transaction situa-tions such as are found in the Bull and Stone cases.-' Literally thisis true in that in the latter two cases the taxable event was a singleone-the receipt of a sum of money by the taxpayer-while in the othertwo cases there was no such receipt of a single fund of money. But toadopt this criterion is to confine the doctrine of recoupment to an areawell within the boundaries established by the lower courts. Rather, theMcEachern case may be distinguished from the Bull case in that in theformer (1) recoupment was not pleaded, though the courts have heldthat, to be applied, it must be pleaded, 12 and (2) the Commissioner didnot introduce into evidence the amount sought to be recouped.' 8 Fur-thermore, the Court never mentioned the McEachern case in the ElectricStorage Battery decision, which leads one to suspect that the Court7301 U.S. 532 (1937). Testamentary trustees paid tax on trust income whichshould have been paid by the beneficiary. After the statute had run on an actionby the government to collect the tax from the beneficiary, the trustees brought anaction to recover their erroneous tax payment. The Court allowed the governmentto recoup the barred amount due from the beneficiary against the refund of theerreoneous payment by the trustees.8 302 U.S. 56 (1937). Decedent sold a block of stock and agreed to be paid inequal yearly payments. The administrator, plaintiff in this action, erroneouslyreported as income of the estate each installment in the year received, instead ofcumulating the remaining installments and reporting them as estate assets. Afterthe statute of limitations had run on the year in which the estate tax was paid, theplaintiff brought this action to recover the income tax paid as a result of reportingthe installments as yearly income. The Court refused to allow the government torecoup the barred estate tax deficiency of the earlier year against the refund of in-come tax paid in the later years.9 329 U.S. 296 (1946). Plaintiff paid excise tax which was not due under thestatute although assessed by the Commissioner. Subsequently the Commissionerrealized that the tax was illegal and refunded the amounts paid in years not yetbarred. Plaintiff owed income tax on this refund but sought to recoup the amountof barred excise tax overpayments against the income tax deficiency. The Courtdenied recoupment."0 If a tax may not be refunded or collected because barred by statutes oflimitations, a credit or debit therefor may not be made by the Commissioner.Revenue Act of 1928, §§ 607-609, 45 STAT. 874, 875 (now INT. REv. CODE OF1954, §§ 6401(a), 6514(a), (b)). "These provisions preclude the governmentfrom taking any benefit from the taxpayer's overpayment by crediting it againstan unpaid tax whose collection has been barred by limitation." 302 U.S. at 60.11329 U.S. at 299-300."Herring v. United States, 131 F. Supp. 536 (E.D.N.C. 1955); First Nat'lBank v. United States, 131 F. Supp. 647 (W.D.S.C. 1954); cf. Bull. v. UnitedStates, 295 U.S. 247, 263 (1935)." McConnell, The Doctrine of Recoupment in Federal Taxation, 28 VA. L.Rrv. 577, 594 (1942).(Vol. 36NOTES AND COMMENTSmay not regard McEachern as limiting the scope of recoupment. More-over, in the Eletcric Storage Battery case, the Court expressly statedthat its intention was to narrow the scope of the recoupment doctrine inthe tax field, and it rested the decision on the grounds that (1) therewere separate transactions here, and (2) the age of the barred claimwas too great.14 It is possible to infer from the language of the Courtthat the compelling reason for the denial of recoupment was that itwould be unwise policy to allow claims over twenty years old to beasserted in recoupment. 15 In any event, both cases denying recoupmentare frequently cited and are strongly relied upon by the lower courtsand the Commissioner to defeat recoupment even in situations wherethe remedy seemingly should be applied.' 6Recoupment is invariably applied where the fund of money is thesame in the main claim as in the one asserted in recoupment. Thissituation occurs most frequently where, as in the principal case, an estateis diminished by a deficiency income tax assessment after the estate taxthereon has been paid and suit is brought to recoup the barred estatetax overpayment against the income tax deficiency payment.' 7 Theremust always be some obligation on which the statute has not run againstwhich the barred estate tax overpayment may be recouped. 18 Bothclaims, moreover, must be between the same parties,' 9 except in thetrust situation hereinafter considered. Although there is no caseauthority to support such a position, the Commissioner has indicatedthat recoupment will not be allowed even where all of these require-ments are met.20The trust cases offer an interesting variant in that the parties to thetransaction are not literally the same. Nonetheless, the government inthe Stone case recouped a barred deficiency of the beneficiary againsta recovery by the trustees on the ground that any recovery by the latter14329 U.S. at 302-03.McConnell, Recoupment-Dead or Alive, 26 TAXES 1059, 1060 (1948).18 Rev.. Rul. 226, 1955-1 Cum. BUIL. 469.', United States v. Herring,, 240 F.2d 225 (4th Cir. 1957) ; Dunigan v. UnitedStates, 87 Ct. Cl. 404, 23 F. Supp. 467 (1938). Recoupment was denied inHerring v. United States, 131 F. Supp. 536 (E.D.N.C. 1955), and in a case citedtherein, First Natl Bank v. United States, 131 F. Supp. 647 (W.D.S.C. 1954),because the plaintiff brought suit for a refund of estate tax rather than arecoupment of an estate tax overpayment against the still open income tax. Contra,Reeves v. United States, 154 F. Supp. 673 (W.D. Pa. 1957).18 United States v. Frauenthal, 138 F.2d 188 (8th Cir. 1943) (estate decreasedby an obligation to a party other than the government)."Wells Fargo Bank & Union Trust Co. v. United States, 245 F.2d 524 (9thCir. 1957) (court refused to recoup a barred deficiency of a widow's estate againsta claim for refund due the widow's husband's estate, even though the beneficiariesof each were the same)."Rev. Rul. 226, 1955-1 Cum. Bu.LL 469.1958]NORTH CAROLINA LAW REVIEWwould inure automatically to the benefit of the former.2 ' Conversely,recoupment was not applied to offset a barred deficiency of the trusteesagainst an overpayment by the beneficiary. 22 Moreover, the settlor isconsidered a separate entity from both the trustee and the beneficiary,thus precluding recoupment.2 3 Although there is an early decision tothe contrary,24 it seems erroneous to consider all relations between thetrust and any other entity a single transaction merely because the trustinvolved is the same.The courts appear very reluctant to grant recoupment where therehas been procedurally inconsistent tax treatment of the same propertyas distinguished from essentially inconsistent treatment of the identicalfund of money as in the Bull case. Recoupment has been denied thegovernment where the taxpayer incorrectly treated the receipt ofproperty as a gift25 or as incidental to a tax-free reorganization,2 0 thusavoiding the payment of income tax in the year of receipt and then,after that year was barred, correctly viewing the receipt transaction soas to effect a substantial reduction in the capital gains tax due as aresult of subsequent sale. Likewise the government was not allowedto recoup the income tax due in several barred years of receipt againsta refund of income tax resulting from the incorrect cumulative report-ing of the income, theretofore unreported, in the current year.2 Butwhere the Commissioner approved taxpayer's erroneous method ofcomputing gain from liquidating dividends and subsequently reversed hisearlier decision, thereby causing an income tax overpayment in the nowbarred year of receipt and an income tax deficiency in open years, re-coupment was allowed the taxpayer. 28However, the taxpayer was not allowed to recoup the income taxhe would have saved in a now barred year if he had correctly reportedcertain deductions against the additional income tax owed because of adisallowance of the deduction in an open year,20 even though, in one21 Stone v. White, 301 U.S. 532 (1937); First Nat'l Bank v. United States,12 F. Supp. 301 (N.D. Ala. 1935).-"Lyman v. United States, 22 F. Supp. 14 (D. Mass. 1938)." Silverthau v. United States, 26 F. Supp. 242 (D. Conn. 1938).2 Lit v. United States, 18 F. Supp. 435 (E.D. Pa. 1937). The barred de-ficiency was a gift tax due on the establishment of the trust and the overpaymentwas in connection with an incorrect valuation of a reversionary interest in thetrust which settlor had at his death."5 Crawford v. Heiner, 23 F. Supp. 240 (W.D. Pa. 1938)."' American Light & Traction Co. v. Harrison, 142 F.2d 639 (7th Cir. 1944);Rotenberg v. Sheehan, 48 F. Supp. 584 (E.D. Mo. 1943), appeal dismissed, 144F.2d 992 (8th Cir. 1944).27 Grand Central Public Market v. United States, 22 F. Supp. 119 (S.D. Cal.1938), aff'd, 98 F.2d 1023 (9th Cir. 1938).2 Mills v. United States, 35 F. Supp. 78 (M.D.N.Y. 1940)."Wood v. United States, 213 F.2d 660 (2d Cir. 1954) ; Longyear Realty Co. v.Kavanagh, 156 F.2d 462 (6th Cir. 1946); Hall v. United States, 95 Ct. Cl. 539,43 F. Supp. 130, cert. denied, 316 U.S. 664 (1942).[Vol. 36NOTES AND COMMENTSof the cases,30 the Commissioner had refused to allow the deductionswhen they were properly put forth. But the government was allowedto recoup a barred corporate income tax deficiency resulting from the'taxpayer's deduction in a single year of tooling costs properly de-preciable over three years against the total overpayments of corporateincome tax which resulted from later assigning the deduction pro-portionately to the proper years which were still open. 3 1On one occasion the taxpayer was allowed to recoup barred over-payments resulting from an erroneously assessed excise tax against openincome tax deficiencies resulting from the refund of that portion of theexcise tax paid and not yet barred.32  In another case the taxpayer wasallowed to recoup an income tax deficiency in open years resulting froman erroneous allocation of an excess profits tax compromise.33 ' In thesetwo cases the courts reason that both deficiencies and overpayments arecaused by a single erroneous act, either by the Commissioner or thetaxpayer, and therefore arise out of the same transaction. This groundfor allowing recoupment was not considered in two subsequently de-cided, widely cited cases.3 4Recoupment is an equitable remedy and will be denied if the partyseeking to have it applied is guilty of fraud. 5 Nor may the remedybe applied by the Tax Court, since its jurisdiction is limited to thesingle year under consideration at that time.3 6  Furthermore, Xecoup-ment will not be granted if there is any other adequate remedy.37 Inthis regard it is interesting to note that for twenty years there have beenstatutory provisions apparently intended and able to rectify many ofthe situations described above, but the courts have not referred to-theseprovisions in the later recoupment cases.3880 Hall v. United States, supra note 29.1 Crosley Corp. v. United States, 229 F.2d 376 (6th Cir. 1956)." Dixie Margarine Co. v. Commissioner, 115 F.2d 445 (6th Cir. 1940).'" Pond's Extract Co. v. United States, 133 Ct. Cl. 43, 134 F. Supp. 476 (1955)." Rothensies v. Electric Storage Battery Co., 329 U.S. 296 (1946) ; LynchburgCoal & Coke Co. v. United States, 97 Ct. Cl. 517, 47 F. Supp. 916 (1942)."8J. J. Dix, Inc. v. Commissioner, 233 F.2d 436 (2d Cir. 1955); Elberl v.Johnson, 164 F.2d 421 (2d Cir. 1947). But see United States v. Herring, 240F.2d 225 (4th Cir. 1957), where fraud penalties were assessed." Commissioner v. Gooch Milling & Elevator Co., 320 U.S. 418 (1943).7 Wells Fargo Bank & Union Trust Co. v. United States, 245 F.2d 524, 536(9th Cir. 1957).8 Revenue Act of 1938, § 820, 52 STAT. 581 (now INT. REv. CODE OF 1954,§§ 1311-1314), which provides for the suspension of the bar of limitations on aclaim where the party in whose favor the statute has run seeks (1) a double in-clusion or exclusion of an item in or from gross income, (2) a double allowance ordisallowance of a deduction or credit, (3) the allowance or disallowance ofcorrelative deductions or inclusions for certain related taxpayers, or (4) a differentdetermination of basis after the erroneous treatment of a prior transaction. Inthe Wells Fargo case, supra note 37, the court stated one of its reasons for denyingrecoupment to be the existence of these provisions affording a statutory remedy.19581NORTH CAROLINA LAW REVIEWCONCLUSIONIn spite of frequent statements to the contrary, 9 the doctrine of re-coupment in federal taxation still lives, as evidenced by the manyrecent cases which employ it to effect an equitable result seeminglyotherwise unobtainable because of the specific language of the statutesbarring the claim. The taxes must arise out of the same transactionand the parties in interest must be the same. The longer the period oftime which the transaction covers, the more doubtful is the applicationof the doctrine by the courts. If fresh claims could be created by actof one of the parties in favor of the other to enable the creator to recoupbarred claims, the whole policy of barring claims would be defeated andno equities demand the application of the remedy.40 Like most otherproblems in law, questions such as "What constitutes a single taxableevent or the same transaction ?" and "How long is too long ?" may neverbe finally answered but can only be circumscribed by recurring decisions.JOEL L. FLEISHMANTort Claims Act-Distinction between Nonfeasance and MisfeasanceIn Flynn v. State Highway Commn,1 plaintiff's intestate was killedwhen the truck in which he was a passenger was wrecked as a resultof its wheel striking a hole in the road, causing its driver to lose con-trol. In plaintiff's action against the state for negligence in leaving theroad in disrepair, the Supreme Court affirmed the lower court, whichhad affirmed the Industrial Commission, holding that the Tort ClaimsAct covers only negligent acts by state employees and not negligentomissions. In reaching this decision the court stated:In order to authorize the payment of compensation, the IndustrialCommission's finding must include (1) a negligent act, (2) onthe part of a state employee, (3) while acting in the scope of hisemployment, etc. The first requirement is that the claimantshow a negligent act. Is a failure to repair a hole in the high-way caused by ordinary public travel a negligent act? The re-quirement of the statute is not met by showing negligence, fornegligence may consist of an act or an omission. Failure to actis not an act. We think it was the intent of the legislature topermit recovery only for the negligent acts of its employees, forthe things done by them, not for the things left undone. If theintent had been otherwise, it would have been easy to permitrecovery for the negligent acts and omissions of State employees.2" Wood v. United States, 213 F.2d 660, 661 (2d Cir. 1954)."0 St. Louis Union Trust Co. v. Finnegan, 53-1 CCH U.S. TAx CAS. 119299(E.D. Mo. 1953).1244 N.C. 617, 94 S.E.2d 571 (1956).21d. at 620, 94 S.E.2d at 572.[Vol. 36

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Taxation -- Barred Claims -- Equitable Recoupment

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