Tax Court may apply equitable recoupment to Medicare taxes.

• Author: Beavers, James
• Position: PROCEDURE & ADMINISTRATION

The Tax Court held that where it has original jurisdiction to redetermine a deficiency, it also may apply the doctrine of equitable recoupment, even if it does not have jurisdiction over the type of tax at issue.

Equitable Recoupment Doctrine

The equitable recoupment doctrine is a judicially created doctrine that in certain circumstances allows a litigant to avoid the bar of an expired statutory limitation period (Bull, 295 US 247 (1935)). It was created to prevent a taxpayer or the IRS from receiving an inequitable windfall due to the inconsistent tax treatment of a single transaction, item, or event affecting the same taxpayer or a sufficiently related taxpayer. When applied for the benefit of a taxpayer, the equitable recoupment doctrine allows a taxpayer to recoup the amount of a time-barred tax overpayment by allowing the overpayment to be applied as an offset against a deficiency.

Background

Joseph Menard was the controlling shareholder and CEO of Menards, Inc. (Menards), a corporation that operates a chain of hardware stores in the Midwest. In a consolidated case, the Tax Court found that Menards was not entitled to a business expense deduction for a significant portion of the compensation it paid to Mr. Menard for 1998 because the compensation was unreasonable, was not paid entirely for personal services, and was properly characterized as a disguised dividend to Mr. Menard. In conjunction, the Tax Court held that Mr. Menard owed tax on certain expenses paid by the corporation on his behalf that were constructive dividends to him.

The plaintiffs (Menards and Mr. Menard) and the IRS subsequently filed with the Tax Court their computations of the tax deficiency owed by Menards and Mr. Menard. The respective computations of the combined deficiency differed by approximately $200,000. This represented the amount that the plaintiffs claimed Menards had overpaid in FICA hospital insurance tax (Medicare tax) for Mr. Menard, taking into account the compensation that the Tax Court had recast as dividends. The plaintiffs claimed they were entitled to offset the amount of the Medicare tax overpayment against their amount of income tax due under the doctrine of equitable recoupment and that the Tax Court was authorized by Sec. 6214(b) to make such an offset.

The IRS argued that Sec. 6214(b) limits the Tax Court's authority to apply the doctrine of equitable recoupment to taxes over which the Tax Court has original jurisdiction. Therefore...