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Limits on Tax Court's authority.

In a recent case, the Sixth Circuit Court of Appeals affirmed the limited jurisdiction of the Tax Court. It held the Tax Court could not use the doctrine of equitable recoupment to allow a time-barred refund to a taxpayer's estate. Equitable recoupment is used to relieve an inequity resulting from the inconsistent tax treatment of a transaction. (An income tax refund, for example, can be used to offset a deficiency in estate taxes.)

At the time of her death in 1986, the estate of Bessie I. Mueller included 8,924 shares of Mueller Co. stock. The estate filed a timely estate tax return that reflected a $1,505 per share value for the stock. Shortly after Mueller's death, the estate sold the stock for $2,150 per share. It computed the capital gain on the sale using a basis of $1,500 (a $5 per share difference from the estate valuation) and paid income taxes for 1986 on the reported amount.

The IRS subsequently assessed a deficiency against the estate based on the valuation of the stock. The IRS valued the stock for estate tax purposes at the sale price of $2,150 per share. The IRS alleged that this increase in value and other adjustments (including an unclaimed credit for tax on prior transfers) resulted in a tax deficiency of nearly $2 million.

The estate challenged the deficiency in Tax Court (TC Memo 1992-284), and in Estate of Mueller v. Commissioner (Mueller case I), the Tax Court held the Mueller stock to be worth $1,700 per share. The increased basis ($1,700) resulted in a taxable estate that was less than the IRS's revaluation and--combined with the allowance for the prior unclaimed credit--an overpayment.

While the higher stock valuation increased the value of the estate for estate tax purposes, it also resulted in a higher basis in the stock, less the gain on its sale, and an overpayment of the income tax for 1986. By the time of the court's decision, however, the statute of limitations had expired on the 1986 income tax return.

The Mueller estate claimed it was entitled to equitable recoupment of the overpayment of the income tax. In Mueller case II (101 TC 551 [1993]), the IRS challenged the Tax Court's jurisdiction to apply the doctrine. The court denied the IRS's motion.

In a third trial (107 TC 189 [1996]), the Tax Court held that the doctrine of equitable recoupment is restricted to use as a defense against an otherwise valid claim. Since the IRS had no valid claim for additional tax, the defense of equitable recoupment did not apply. Equitable recoupment can be used by the Tax Court only to decrease a deficiency and not to create or increase a refund.

The Mueller estate then filed an appeal with the Sixth Circuit to determine whether a taxpayer could assert equitable recoupment to use a time-barred overpayment of income tax to offset a timely charged deficiency in estate tax. The appeals court held that the Tax Court is a court of limited jurisdiction that does not have general equitable powers. The court dismissed the Muellers' appeal without deciding the issue of equitable recoupment or giving a ruling on the overpayment of income tax issue.

Observation. Tax advisers should advise their clients that Tax Court is a court of limited jurisdiction, and it does not have general equitable powers. Although the doctrine of equitable recoupment can be a remedy against inequities, the Tax Court lacks the authority to apply the doctrine.

--Tina Steward Quinn, CPA, PhD, assistant professor of accountancy, and Keith W. Smith, CPA, PhD, associate professor of accountancy, Arkansas State University, Jonesboro.
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Article Details
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Author:Smith, Keith W.
Publication:Journal of Accountancy
Geographic Code:1USA
Date:Jun 1, 1999
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