ON APPEAL FROM THE UNITED STATES TAX COURT (T.C. No. 584-76)
Before Gibbons and Higginbotham, Circuit Judges, and Ziegler, District Judge.*fn*
This appeal by taxpayers from a decision of the Tax Court requires consideration of the interrelationship between the limitation on assessment and collection of tax in 26 U.S.C. § 6501 (1976) and the mitigation and adjustment provisions of the Internal Revenue Code, 26 U.S.C. §§ 1311-1314 (1976), dealing with maintenance of inconsistent positions. Specifically, we must determine whether, when a taxpayer makes an overpayment of taxes in one year the Commissioner can make an assessment of taxes for a year which was already time-barred at the time the overpayment was made. The Tax Court held that such an assessment was proper.*fn1 We conclude that the Tax Court misconstrued sections 1311 and 1312 of the Code, and we reverse.
I. Facts and Proceedings in the Tax Court
William J. and Sara M. Kappel filed joint federal income tax returns for the years 1954 and 1955. At issue in this appeal is their liability for additional income tax for 1954. Prior to that year William J. Kappel was an officer, director, and employee of four corporations, each of which maintained a separate employees' pension plan. Each pension plan had a separate trust, and each was funded by the corporation. The trustee contracted for separate annuity contracts on each participating employee through different life insurance companies. Besides being a participating employee, Kappel was one of several trustees in each plan. Beginning in 1954, and continuing in 1955, Kappel, as trustee, caused the annuity policies held in trust for his benefit to be surrendered to the issuing insurance company in exchange for their cash surrender value. Kappel then caused the cash surrender proceeds to be reinvested in deferred annuities of which members of his family were named as beneficiaries.*fn2 The Kappels did not report receipt of the cash surrender value of the policies on their federal income tax returns for either year. Those returns were audited some time thereafter. The revenue agent who conducted the audit proposed an adjustment increasing the Kappels' 1955 income by $276,039.40, representing the cash surrender value of annuity policies surrendered both in 1954 and in 1955. It was the revenue agent's theory that all the proceeds had been distributed, or made available, to Kappel in 1955, not in 1954. The Kappels protested the 1955 adjustment and requested reconsideration by the Appellate Division of the Internal Revenue Service, contending that $65,459.06 of the $276,039.40 had been distributed, or made available, in 1954, rather than 1955. The Appellate Division agreed that $50,100 had been made available in 1954, and therefore limited the increase in their 1955 income tax to $225,939.40. When the Kappels did not agree to the proposed adjustment, insisting on a further reduction of $15,365.06, the Commissioner, on December 31, 1962, issued a statutory notice of deficiency for the year 1955 for tax on additional income in the amount of $225,939.40. On that date the statute of limitations in section 6501 was still open for 1955, but barred assessment or collection for 1954. The Kappels paid the deficiency and filed a refund claim for 1955, claiming that the disputed $15,365.06 in income was not distributed, or made available, to Kappel in that year. When no refund was forthcoming within six months, they filed suit in the United States District Court for the Western District of Pennsylvania for the disputed amount. The government filed an answer, but no counterclaim. After a trial the district court held that the $15,365.06 was not taxable in 1955 because it had been received in 1954.*fn3 The district court judgment became final on November 4, 1974.*fn4
On November 3, 1975, one day short of a year after the judgment in the refund suit became final, over twelve years after the payment of the 1955 deficiency was made, and over seventeen years after the section 6501 limitation period had run on the return for 1954, the Commissioner issued a statutory notice of deficiency for that year for tax on additional income of $15,365.06. This time, instead of paying and suing for a refund, Mrs. Kappel Courtley and William J. Kappel's estate resorted to the Tax Court. They contended that the statutory notice of deficiency was time-barred, and that, in any event, the final judgment in their suit for refund barred what they considered to be a compulsory counterclaim. The Tax Court rejected both contentions.
II. Effect of the Mitigation Provisions
Section 1311 of the Internal Revenue Code provides for the correction of the effect of certain errors in the treatment of income or deductions under circumstances specified in section 1312 when because of the operation of a law, such as the statute of limitations in section 6501, such a correction would not otherwise be permitted. In most cases falling within these mitigation provisions correction of the effect of the error on a closed year can be made only if either the Commissioner, or the taxpayer, has taken a position in another taxable year which is inconsistent with the erroneous treatment of the item in the closed year. Section 1311 permits correction of the effects of an error only if: 1) there has been a "determination", as defined in section 1313, excluding the item of income, or allowing the deduction, in one year; 2) there has occurred a circumstance of adjustment described in section 1312; and 3) one of the conditions necessary for adjustment listed in section 1311(b) has been met. If all three statutory requirements are satisfied the Commissioner may issue a statutory notice of deficiency for the closed year within one year of the determination. 26 U.S.C. § 1314(b) (1976).
The Commissioner contends that there was a determination as defined in section 1313(a)(1) when the judgment in the suit for refund of the overpayment of 1955 taxes became final. That section defines "determination" to include:
(1) (A) . . . judgment . . . by any court of competent jurisdiction, which has become final.
Since the judgment in the Kappel refund suit for the overpayment of 1955 taxes became final three hundred sixty-four days before the statutory notice for 1954, section 1313(a)(1) and section 1314(b) appear to be satisfied. But as we noted above, the requirements of sections 1311, 1312, and 1313 are conjunctive. The taxpayers contend that the conjunctive requirements have not been met. They urge that the applicable circumstance of adjustment is that found in section 1312(3)(B):
The determination requires the exclusion from gross income of an item not included in a return filed by the taxpayer and with respect to which the tax was not paid but which is includible in the gross income of the taxpayer for another taxable year . . . .
Depending upon the time frame one chooses for looking at past events, that subsection describes the taxpayer's situation rather precisely. The determination in the refund suit required the exclusion from gross income for the taxpayers' 1955 tax year of a $15,365.06 income item. This item, moreover, was not included in the taxpayers' 1955 tax return, on the ground that it was properly includable in their 1954 tax return. However, the tax on that income item was not paid in 1954. Relying on that close ...