Tax Court allows double tax benefit.

• Author: Goldberg, Michael

The Tax Court effectively allowed a taxpayer a tax benefit for a cost he never incurred due to some careless auditing by the IRS. Davoli, TC Memo 1994-326, involved an employee expense reimbursement received in 1987. Davoli incurred certain employee business expenses in 1983, 1984 and 1985. He expected his employer to reimburse these expenses, but the employer had not yet done so (because of cash shortages during those years). Davoli's 1985 tax return was previously audited by the Service and the expenses were allowed as deductions.

In 1987 (the year under review), Davoli received reimbursement from his employer for the expenses incurred and deducted in 1983 through 1985. Davoli excluded the reimbursement from income, apparently relying on the authority of Rev. Rul. 80-348. That ruling stated that reimbursed expenses were not deductible and the reimbursement was not includible in gross income. The IRS claimed the 1987 reimbursement was includible in income, essentially arguing that since Davoli received a tax benefit from the expense, he should include the reimbursement in income. Alternatively, the Service claimed Davoli must be taxed on the reimbursement under the "duty of consistency" (also called the quasi-estoppel) doctrine.

The Tax Court rejected the tax benefit argument, holding that that rule applies only when the original deduction was proper under applicable law. It stated that the tax benefit rule "does not allow the Commissioner to increase a taxpayer's income by the amount of a deduction taken improperly in a year now closed by the statute of limitations." The court did note, however, that several circuit courts have criticized or rejected this "erroneous deduction" exception.

The court then reviewed the three elements that trigger the application of the duty of consistency doctrine:

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