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McKenzie v. Internal Revenue Service

United States District Court, Third Circuit

December 18, 2013



ROBERT C. MITCHELL, Magistrate Judge.

Currently before the Court is a motion for summary judgment, filed by Defendant, the United States of America (ECF No. 28).[1] For the reasons that follow, the motion will be granted. Plaintiffs, Trevor G. McKenzie and his wife Althea McKenzie, brought this action seeking to have the Internal Revenue Service (IRS) apply an alleged 2007 net operating carryback loss to offset their 2005 income tax liability and to have the IRS recalculate their tax liability for 2006, 2007, 2008, 2009, 2010 and 2011, which would result in tax refunds due to them for these years. The United States moves for summary judgment on the grounds that: 1) because Trevor McKenzie admits to overstating the 2007 income tax deductions, there are no amounts available to carryback to 2005; 2) Plaintiffs have already carried back all net operating losses from 2007 to 2005 to which they are entitled; and 3) Plaintiffs should not be granted leave to amend their complaint to claim a different refund amount ($5, 389) than was contained in their administrative claim filed with the IRS ($21, 750).

Plaintiffs respond that the whole point of bringing this case was to get the IRS to answer the question of why his returns did not match. They further note that they relied upon Taxpayer Advocates to assist them with calculating amounts and the IRS refused to explain its position until compelled to do so by this Court's directive at a Case Management Conference. Finally, they indicate that they would like to amend their complaint to allege a short-term capital loss deduction of $42, 090.22, rather than a net operating loss deduction of $21, 750 or $5, 389. In its reply brief, the United States argues that the substantial variance doctrine applies with even more force given that Plaintiffs have not only changed the amount of refund sought but the legal theory upon which they seek it.


In 2007, Trevor McKenzie was the President and the sole shareholder of Cosmopolitan Mortgage, Inc. ("Cosmopolitan"), an S-Corporation. (U.S. First Set Req. for Admis. by Plaintiff Trevor G. McKenzie ¶ 1; McKenzie Dep. at 25:5-7.)[2]

On April 8, 2008, Trevor McKenzie filed a 2007 corporate income tax return (Form 1120) on behalf of Cosmopolitan with the IRS. (ECF No. 28 Ex. 1 ¶ 2; McKenzie Dep. at 25:8-11.) On its 2007 corporate income tax return, Cosmopolitan reported an ordinary business loss in the amount of $128, 474. (ECF No. 28 Ex. 1 ¶ 3; McKenzie Dep. at 25:12-15; Cosmopolitan 2007 Corporate Income Tax Return, line 21.[3]) Cosmopolitan issued Trevor McKenzie a Schedule K-1 (Shareholder's Share of Income, Credits, Deductions, etc.) reporting an ordinary business loss for 2007 attributable to him in the amount of $128, 474. (McKenzie Dep. at 25:16-20; ECF No. 28 Ex. 4.) To date, Cosmopolitan has not amended its 2007 tax return to claim a net loss greater than $128, 474. (ECF No. 28 Ex. 1 ¶ 5; McKenzie Dep. at 25:21-23.)

On April 28, 2008, Plaintiffs filed a joint individual income tax return (Form 1040) with the IRS for the year 2007. (ECF No. 28 Ex. 1 ¶ 6; McKenzie Dep. at 25:24-26:8; ECF No. 28 Ex. 5.) The return indicates that it was "self-prepared."

On Schedule E, line 32 of their 2007 tax return, Plaintiffs reported a loss associated with Cosmopolitan in the amount of $150, 224 - not the $128, 474 loss that Cosmopolitan reported on its corporate tax return, and which Cosmopolitan reported on the K-1 issued to Trevor McKenzie. (ECF No. 28 Ex. 1 ¶ 7; ECF No. 28 Ex. 5, Schedule E, line 32.) The difference between these two amounts is $21, 750 ($150, 224 less $128, 474), which is the exact amount that Plaintiffs initially sought in this refund suit. (See ECF No. 1, Compl. ¶ 19; ECF No. 14, Pls.' Resp. to U.S. Mot. to Dismiss, ¶¶ 16-19 & Attach. 1 at 4.)

Plaintiffs derived the $150, 224 amount by combining the $128, 474 ordinary business loss associated with Cosmopolitan, a $20, 965 capital loss, and "some other tax deductible expenses." (U.S. First Set of Interrogatories to Plaintiff Trevor G. McKenzie ¶¶ 6, 9-10.)[4]

At the June 11, 2013 Case Management Conference, the United States was instructed to briefly provide Plaintiffs with the Government's written position as to why they were not entitled to carryback $21, 750 in net operating losses (NOLs) for 2007 to offset their 2005 tax liability. (ECF. No. 11.) On June 17, 2013, counsel for Defendant wrote to Plaintiffs explaining the United States's position. After noting the discrepancy between the amount of loss reported on the corporate tax return ($128, 474) and the amount reported on the individual tax return ($150, 224), counsel observed that:

In addition, on September 23, 2008, you both filed a Form 1045,

Application for Tentative Tax Refund, to carryback the NOL form 2007 to offset your 2005 tax liability by $21, 254. The IRS accepted this application and, on February 9, 2009, abated your 2005 tax liability by $21, 254. In this litigation, however, you are taking the position that you are entitled to an additional $21, 750 in NOLs for 2007, but you have not provided any basis to prove this claim. It is the United States' position that all NOLs from 2007 have already been carried back to 2005 and that there are no additional NOLs which can be carried back to 2005.

(ECF No. 28 Ex. 6 at 2.)

At his deposition on August 27, 2013, Plaintiff Trevor McKenzie admitted he "made a mistake" in preparing his and his wife's joint 2007 income tax return asserting that they incorrectly claimed a $20, 965 short-term capital gains loss to which they were not entitled. (McKenzie Dep. at 26:3-27:22.) McKenzie asserts that "what should have happed is a [$]3, 000 credit against that number... a [$]3, 000 credit that it ...

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