U.S. v. Dieter H. Klohn, (DC Fl 05/06/2011) 107 AFTR 2d ¶2011-809
A district court has rejected an individual's attempt to use the doctrine of equitable recoupment to setoff one trust fund recovery penalty by another time-barred overpaid one because the penalties involved totally separate entities.
Observation: The doctrine of equitable recoupment allows a party litigating a tax claim in a timely proceeding to recoup in that same proceeding a related and inconsistent, but time-barred, tax claim arising from the same transaction.
Background on trust fund recovery penalty. Under Code Sec. 6672(a), if an employer fails to properly pay over its payroll taxes, IRS can seek to collect a trust fund recovery penalty (TFRP) equal to 100% of the unpaid taxes from a “responsible person,” i.e., a person who: (1) is responsible for collecting, accounting for, and paying over payroll taxes; and (2) willfully fails to perform this responsibility.
Background on time limit for refund claims. Under Code Sec. 6511(a), a taxpayer must file a claim for credit or refund of an overpayment “of any tax imposed by this title in respect of which tax the taxpayer is required to file a return” within three years from the time the relevant return is filed, or two years from the time the tax is paid, whichever period expires later. (Code Sec. 6511(a)) No credit or refund is allowed if a claim is not filed within these time limits. (Code Sec. 6511(b))
Background on equitable recoupment. The doctrine of equitable recoupment prevents unjust enrichment and works as a setoff when invoked by the taxpayer to recover taxes paid twice, or by IRS to prohibit tax avoidance. It applies if “a single transaction constitutes the taxable event claimed upon and the one considered in recoupment.” The single transaction also must be subject to two taxes based on inconsistent legal theories. The amount claimed in recoupment must be barred by the statute of limitations, while the asserted deficiency by IRS (or the refund claimed by the taxpayer) must be timely. In addition, if the transaction involves two or more taxpayers, equitable recoupment will not be available unless a sufficient identity of interest exists so that the taxpayers should, in equity, be treated as a “single taxpayer.”
Facts. The case involved an action by IRS to reduce tax owed by Dieter Klohn to judgment. Originally, IRS said that Klohn was liable for: (1) a TFRP for the period ending Sept. 30,’91; (2) a TFRP for the period ending Mar. 31,’92; (3) income tax for’87; and (4) income tax for’88. In his response, Klohn sought a refund of monies he claimed were illegally applied to an improperly assessed and invalid TFRP for the tax period ending on Sept. 30,’91. He asked the Court to apply these monies to the Mar. 31,’92 TFRP assessment, which he agreed was valid.
After the action was commenced, IRS conceded the income tax issues as well as the refund claim to the extent of payments made within two years of Klohn's administrative claim for refund. At issue was the remaining $27,219 that was improperly collected by IRS, but which fell outside the two year statute of limitations period that applies to tax refund claims under Code Sec. 6511.
Klohn was an entrepreneur who owned two steel companies in Boston, Massachusetts, before going bankrupt in’92 and moving to Jacksonville, Florida. He was the president and sole owner of KSK Engineering Corporation (KSKEC) and he was the president and 70% owner of KSK Steel Erector Company (KSKSEC). Previously, the court found that (with respect to both companies) Klohn was responsible for collecting, truthfully accounting for, and remitting the unpaid employment taxes that were the subject of the action.
No equitable recoupment. The Court observed that Klohn was seeking to apply the doctrine of equitable recoupment to two separate transactions: (1) a TFRP arising from the operation of KSKSEC in’91; and (2) a TFRP tax arising from the operation of an entirely different entity, KSKEC, during’92. It stressed that under applicable case law, a claim for equitable recoupment will lie only where the government has taxed a single transaction, item, or taxable event under two inconsistent theories. The Court found that Klohn's claim did not meet this test because the liabilities at issue were separate and distinct, and arose from the operation of two different corporations. The Court said that IRS had not taken an inconsistent position with respect to the amount of tax due and owing on a single transaction, nor had it subjected Klohn to double taxation on a single transaction. Accordingly, it held that Klohn was not entitled to any setoff by virtue of the doctrine of equitable recoupment.
References: For equitable recoupment, see FTC 2d/FIN ¶T-5200; United States Tax Reporter ¶65,144; TaxDesk ¶803,048.
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