Grab Bag: Mitigation Rules (Trusts and Determinations)

Mitigation doesn’t get covered too often on PT, mostly because it doesn’t come up too often in published cases or guidance.  I wrote about it with regard to a failed attempt by taxpayers to use the provisions to assist with refunds in cases of tax paid on the sale of shares in life insurance companies after the companies had demutualized.   Over the last few months, another case and some IRS guidance was published.  The case is not extraordinary, but highlights one area where mitigation is available.  The second item is more interesting, which is Chief Counsel advice, and indicates a stipulated settlement is not a “determination” for purposes of the mitigation rules.

Before getting to the specifics, I have recreated a paragraph out of the second part of the post on demutualization and mitigation, which summarizes the concept behind mitigation.

As our readers know, Section 6511(a) imposes a three year statute of limitations.  It is a somewhat arbitrary cutoff, notions of fairness be damned, but useful for the administration of the tax system.  There are some statutory provisions in the Code that address unfair results of double taxation, or double non-taxation, in very specific stated circumstances outside of the limitations period.  The income tax mitigation provisions, found in Sections 1311 to 1314, have not been heavily covered in PT before.  Aspects of these provisions can be complicated (and the new edition of SaltzBook will have an updated Chapter 5 covering the material in depth),  but the general idea is that neither a taxpayer nor the government should be able to take opposite positions before and after the statute of limitations closes to their benefit.  Inconsistency is the key, and that allows the aggrieved party to potentially open a closed year.


Costello v. Comm’r: Trust, Beneficiary? Someone Must Pay

Costello v. Comm’r fits fairly neatly within the framework of the mitigation provisions.  The facts boil down to an IRA was payable to a trust.  The trust made distribution of that income to each beneficiary, and took a distribution deduction for the amount distributed thereby eliminating income at the trust level.  Each beneficiary received a K-1 and reported the income on his or her Form 1040 and paid the tax.  On audit of the 1041 (that doesn’t happen often), the IRS determined tax was due at the trust level, and the SOL was extended and the trustee consented to the assessment.  Shortly thereafter, the IRS determined the beneficiaries did not have to pay the tax, and refunded the same.  After the trust paid the tax due, the SOL passed on the beneficiaries’ returns.  The trust then requested a refund by filing an amended 1041X, which the IRS granted.  This was not subsequently challenged, so presumably the IRS determined the amended return (which was probably similar to the original) was correct.  The IRS then attempted to collect the tax due from the beneficiaries, but was blocked by the SOL.

The mitigation provisions allow for opening the SOL in limited circumstances.  There are very specific statutory requirements, all of which will not be discussed here.  There first must be a determination that the situation fits within the statute.  Double exclusion of income between related parties is one area that qualifies under Section 1312(3).  Related party is defined under Section 1313, and includes  a trust and beneficiary .  Here, the taxpayers argued that the beneficiaries never took an inconsistent position, as required under Section 1311, because it was the actions and mistakes of the Service that caused the issue. Essentially, the beneficiaries were passive in all prior years until requesting the refund, so they were not inconsistent in positions.  The Tax Court disagreed and found the position was inconsistent and the IRS was entitled to recoup the refunded amount to the beneficiaries.  It is worth noting, the application of “inconsistent position” is not consistent in all cases and before all courts.  It is not inconceivable that there is case law contrary to his holding.

Stipulated Settlement Not a “Determination” For Mitigation

The Service has released CCA 201622032, which provides the Service’s position on whether or not a stipulated settlement agreement entered onto the record by the Tax Court is a “determination” for an open year.  In the advice, a taxpayer submitted Form 1041s, which were untimely unless mitigation applied.  The value of assets had been reported on a Form 706, which was challenged and litigated by the Service.  That value was used as the basis for reporting gains on the Form 1041.  The litigation resulted in a stipulated settlement agreement, which changed the values and would have resulted in a refund on the Form 1041.

Although a Tax Court decision would be a “determination”, the Service position was that “simply because the taxpayers have met the requirements in form regarding what constitutes a determination does not mean that they have met the substantive requirements.”  As an example, the Service highlights that a Tax Court decision for the same year may not be a determination that could open mitigation because perhaps it applies to a different topic or isn’t something mitigation is available for (seems like that would fail in logic).  The Service highlights Fruit of the Loom, 72 F3d 1338 (7th Cir. 1996) for the proposition that administrative settlements are not determinations under Section 1313, which is again not directly on point.

I bet you could formulate a quality argument against the Service on this.  I also wonder if practitioners should negotiate in terms into the stipulated settlement agreement stating that the some aspects are determinations for the mitigation provisions.

Demutualization and the Mitigation Provisions — Part II

Yesterday, I posted the first part of this post, discussing the Illinois Lumber case, and the differing opinions on the treatment of basis in stock received from demutualized insurance companies.  Today’s post will focus on how the taxpayer attempted to use the mitigation provisions to get around the statute of limitations when it requested a refund of tax paid on a sale prior to the IRS changing its position on the treatment of the basis.

Mitigation – Reducing harm—in just a few situations.

As our readers know, Section 6511(a) imposes a three year statute of limitations.  It is a somewhat arbitrary cutoff, notions of fairness be damned, but useful for the administration of the tax system.  There are some statutory provisions in the Code that address unfair results of double taxation, or double non-taxation, in very specific stated circumstances outside of the limitations period.  The income tax mitigation provisions, found in Sections 1311 to 1314, have not been heavily covered in PT before.  Aspects of these provisions can be complicated (and the new edition of SaltzBook will have an updated Chapter 5 covering the material in depth),  but the general idea is that neither a taxpayer nor the government should be able to take opposite positions before and after the statute of limitations closes to their benefit.  Inconsistency is the key, and that allows the aggrieved party to potentially open a closed year.


Specifically, for the case at hand, Illinois Lumber argued that under Section 1313(a) there was a determination that fell within one of the circumstances listed under Section 1312, and the “party against whom the mitigation provisions are being invoked [here, the Secretary of the Treasury] has maintained a position inconsistent with the challenged erroneous inclusion of income”.  These would be the requirements for Section 1311(a) and (b) to apply, which would allow Illinois Lumber to open the time-barred year and obtain a refund for the tax it paid pursuant to the Service’s incorrect position. In addition, though, one of the paragraphs in Section 1312 would also have to apply, and the Service and the taxpayer agreed that only Section 1312(7) could apply in Illinois Lumber, which states:

(7)  Basis of property after erroneous treatment of a prior transaction.

(A)  General rule. The determination determines the basis of property, and in respect of any transaction on which such basis depends, or in respect of any transaction which was erroneously treated as affecting such basis, there occurred, with respect to a taxpayer described in subparagraph (B) of this paragraph , any of the errors described in subparagraph (C) of this paragraph .

(B)  …

(i)  the taxpayer with respect to whom the determination is made,…

(C)  Prior erroneous treatment. …

(ii)  there was an erroneous recognition, or nonrecognition, of gain or loss, …


Seems so simple.   Here, the taxpayer paid tax in a prior year based on the IRS’s published guidance that no basis was allocated to the stock.  Subsequently, the IRS reversed its position, and stated basis could be allocated to the stock, and the taxpayer attempted to obtain a refund, which the IRS denied because it was outside of the statute of limitations.  The only real issue was whether the IRS had been inconsistent, otherwise the Section would have applied.

Inconsistency – Inconsistent Court Cases, but here the 8th Says no

At the District Court level, the taxpayer prevailed, finding the Service had taken an inconsistent position by allocating no basis to the shares and then subsequently acquiescing to the Fischer holding.  The 8th Circuit didn’t view these clearly different positions as being “inconsistent” as required by the statute.

The Court did note that many commentators have indicated Section 1313(7) is the most problematic of the mitigation provisions (which are all fairly confusing).  That language was not really what the holding was about though.

In reviewing the “determination” relating to 2004 by the Service, the Eighth Circuit held that the determination had nothing to do with the basis of the property, how it was allocated, or who was taxed, as required under Section 1312(7)(A).  Instead, that determination was that the claim was untimely under the statute of limitations.  Further, as stated by the Court:

In our view, the answer to the mitigation question in this case becomes clear when we focus on the third prerequisite, an “inconsistency” that provides the party invoking the statute of limitations an advantage by “assum[ing] a position diametrically opposed to that taken prior to the running of the statute.” S. Rep. No. 75-1567, at 49, codified in § 1311(b)(1). There was no such inconsistency by the government in this case. First, the IRS did not actively change its longstanding position that mutual policyholders’ proprietary interests have a zero basis when an insurance company demutualizes. The Secretary simply acquiesced in the Federal Circuit’s rejection of that position. Second, focusing on the basis issue, the government gained no “unfair tax advantage by taking one position at the time of the acquisition of property and an inconsistent position at the time of its disposition.” S. Rep. No. 75-1567, at 50.

The Court looked to Brigham v. United States, 470 F2d 571 (Ct. Cl. 1972), which held:

The Revenue Ruling was, in effect, an acquiescence with the Brown decision of the United States Supreme Court…. The function of the ruling was acquiescence, not command…. The Commissioner has not attempted to exploit the statute of limitations by adopting an inconsistent stance for an open year. The Commissioner, to the contrary, has merely acceded to the plaintiffs’ demand for the open year. … In the factual pattern before us, adjustments for one year do not have a consequential effect on other years …. After a change in the interpretation of the law, the taxpayers are attempting to reopen closed years ….

The Court concludes with the following:

Had Illinois Lumber timely challenged the IRS’s position, as the taxpayer did in Fisher, it would have obtained a refund of the capital gains tax in 2004, as well as in 2006 and 2008. Having slept on its rights in 2004 beyond the applicable statute of limitations, it may not use the mitigation provisions to “awaken the sleeping dog.”

Although the conclusion by the 8th Circuit may be correct, I dislike somewhat the closing lines, although I am probably being too picky about the language. The part that bothers me is the reference to having to handle this like Fischer.  In this instance, the taxpayer is attempting to use the mitigation provisions to open the period after the statute, but the IRS had not changed its position as regard the specific taxpayer (it was not timely given the opportunity).  The refund request relating to 2004 essentially stated, “the law has changed, so I want my money back (especially because you gave it back for other years).”  There was no subsequent transaction. Or, as Prof. Timothy Todd phrased it in his post for Forbes, “[t]he case demonstrates the need for an actively maintained inconsistent position – not a mere ‘favorable change in, or reinterpretation of, the income tax laws.’”

For the mitigation provisions to apply, however, the taxpayer did not have to challenge the case to SCOTUS (which Fischer was willing to do), and they could have “slept” on these rights, but still used the mitigation provisions if the facts fell within the statute.  For instance, the taxpayer paid tax on the capital gains related to the sale of the interests in the shares. What if the taxpayer then sold the life insurance policy, which would generally result in capital gain for the difference of the basis and the sale price, and the IRS took the position that the basis should have been allocated to the shares and could not now be allocated to the policy?  That, I believe, would allow for mitigation.

Demutualization and the Mitigation Provisions — Part I

Anyone want to start a really bad band with me that plays songs about tax law?  That could be the name.  We’d be a hit on the accounting firm picnic circuit, although we might steal some work from the Traveling Helverings (not that I’m implying they are bad, like my band would be).

In July last year, Illinois Lumber & Material Dealers v. United States was decided by the Eighth Circuit, and I started rewriting a post I had started when the District Court decided the case in 2014.  The case is very interesting procedurally, dealing with the use of the tax mitigation provisions found in Sections 1311 to 1314 by taxpayers to reopen years outside of the statute of limitations where tax had been paid on the sale of stock received in the demutualization of insurance companies.  I recently assisted Les in revising content for Chapter 5 of SaltzBook dealing with the mitigation of the statute of limitations (which will be included in the new edition coming soon-shameless plug #1).  Writing about the case also allows me to highlight the fact that the Eighth Circuit cited perhaps the most engaging, entertaining, and educational law review article ever written on the topic of the sale of stock in a demutualized insurance company, Chuck vs. Goliath: Basis of Stock Received in Demutualization of Mutual Insurance Companies (shameless plug #2 – I wrote the article in 2009).

In the post below, I’ll discuss the Illinois Lumber case, and a few others, which are reviving the issue of the treatment of basis with demutualized insurance companies, which now likely has a split in the circuits.  I’ll then discuss the mitigation provisions and how the IRS has been found not to have taken an inconsistent position for obtaining relief – even though its positions were diametrically opposite.

First, The Facts


The plaintiff in this case was a voluntary employee benefit plan (“VEBA”), which held life insurance.  As a VEBA, it was exempt from tax unless it had unrelated business income.  Prior to ’03, Illinois Lumber obtained a membership interest, presumably by buying insurance, in Great American Mutual Holding Company, which demutualized in 2003 (more on that below).  In 2004, 2006, and 2008, Illinois Lumber obtained over $1.5MM in distributions in exchange for its membership interest.  In 2008, as discussed below, the IRS acquiesced to a court holding that reversed the Service’s position on the tax treatment of demutualization of insurance companies, allowing basis to be allocated to the shares/membership units in the insurance companies.  In 2008, Illinois Lumber amended its returns, and obtained refunds on tax paid for the 2006 and 2008 returns.  The 2004 statute of limitations for refund claims had already passed, and the IRS disallowed the refund claim, indicating the statute of limitations had passed, but if it had not, the Service would have refunded the tax…well, at the time it would have, but now the applicable circuit for appeal might matter.  Before discussing the mitigation issues, let’s take a detour to explain demutualization and the current landscape.

Demutualization – Sounds made up.

Insurance companies can generally be created as either stock companies or mutual companies.  Stock companies have shareholders as the owners, who benefit from the profits of the company.  In mutual insurance companies, the insurance policy holders are the “owners”, and any dividends of profits are applied to premiums or cash value in policies.  Sometimes, for tax or other business reasons, a mutual insurance company will become a stock insurance company in a process called demutualization, where the policy holders are provided shares in the company (in a tax free distribution).  Prior to 2009, the Service took the position that there was no basis in the shares received.  Taxpayers, however, felt that was unfair, and that some portion or all of the policy premiums paid should have been allocated to the stock as basis.  Folks debated whether the basis should be allocated to the shares as they were sold, while others advocated for a proportionate allocation based on the FMV of the policy and the shares.

This disagreement moved to the courts, and in 2009, the Court of Appeals for the Federal Circuit in Fisher v  United States affirmed in an unpublished opinion the Court of Federal Claims which held under the open transaction doctrine the taxpayers should only pay gain on the shares after all basis had been used.  333 Fed. Appx. 572 (Fed. Cir. 2009).  The IRS acquiesced shortly thereafter.  Some taxpayers who had previously paid tax on the sale of shares filed refunds, but others were outside of the statutory period.  A dilly of a pickle (which some hoped to remedy with mitigation).

Naively, I thought the acquiescence by the IRS to the decision in Fisher meant this debate was over.  Two recent Ninth Circuit cases have held that members have no basis in the shares received in a demutualization, so upon the sale the entire amount is subject to capital gains tax.   Dorrance v. US and Reuben v. US were decided in December 2015 and January 2016, respectively.  Dorrance involves Bennett Dorrance, a name those of us in the Philly area are familiar with, as one of the heirs to the Campbell’s Soup fortune.  As he is a billionaire, it is unsurprising that when he sold the shares he received in the demutualization, the gain was roughly $2.2MM (assuming no basis).

The Dorrances sought a refund in ’07, which the IRS did not act on, so the taxpayers took it to the District Court.  The District Court determined that he (they) are/were entitled to a partial refund, allocating basis based on a formula off the IPO value and the amount paid on the policies, and both sides appealed.  In an unfortunate turn of events, the Ninth Circuit did not cite my law review article.  If this goes to SCOTUS, and you know a law clerk, please forward this post to them.  Together, we can get SCOTUS to cite me (the article doesn’t really say anything earth shattering, but I’ll take a citation to general background info).

The Ninth Circuit rejected the open transaction doctrine (recoup all basis first as sales occur), and the allocation of basis between the economic rights (my fave).  Instead, the Ninth Circuit indicated the Dorrances did nothing to meet their burden that they had made a payment for their stake in the membership rights, and therefore no basis could be allocated.

Circuit split!  Hopefully, SCOTUS takes this up, and reads our blog!

Obviously, I am a super cool guy (I write for a tax procedure blog).  So, it should come as a surprise to no one that I elected to purchase life insurance from a mutual insurance company, because a portion of what I was buying was an ownership right that would reinvest in my policy (or I would get stock eventually in a demutualization).    I did intentionally buy that right, but I’m not sure how I would prove that.

This was all a bit substantive, but somewhat procedural.  Part II will focus on the mitigation provisions that Illinois Lumber tried to use to obtain a refund for the closed tax year.

Summary Opinions — For the last time.

This could be our last Summary Opinions.  Moving forward, similar posts and content will be found in the grab bags.  This SumOp covers items from March that weren’t otherwise written about.  There are a few bankruptcy holdings of note, an interesting mitigation case, an interesting carryback Flora issue, and a handful of other important items.


  • Near and dear to our heart, the IRS has issued regulations and additional guidance regarding litigation cost awards under Section 7430, including information regarding awards to pro bono representatives. The Journal of Accountancy has a summary found here.
  • The Bankruptcy Court for the Southern District of Florida in In Re Robles has dismissed a taxpayer/debtor’s request to have the Court determine his post-petition tax obligations, as authorized under 11 USC 505, finding it lacked jurisdiction because the IRS had already conceded the claim was untimely, and, even if not the case, the estate was insolvent, and no payment would pass to the IRS. Just a delay tactic?  Maybe not.  There is significant procedural history to this case, and this 505 motion was left undecided for considerable time as there was some question about whether post-petition years would generate losses that could be carried back against tax debts, which would generate more money for creditors.  This became moot, so the Court stated it lacked jurisdiction; however, the taxpayer still wanted the determination to show tax losses, which he could then carryforward to future years (“establishing those losses will further his ‘fresh start’”).  The Court held that since the tax losses did not impact the estate it no longer a “matter arising under title 11, or [was] a matter arising in or related to a case under title 11”, which are required under the statutes.
  • The Tax Court in Best v. Comm’r has imposed $20,000 in excess litigation costs on an attorney representing clients in a CDP case. The Court, highlighting the difference in various courts regarding the level of conduct needed, held the attorney was “unreasonable and vexations” and multiplied the proceedings.  Because the appeal in this case could have gone to the Ninth Circuit or the DC Circuit, it looked to the more stringent “bad faith” requirements of the Ninth Circuit.  The predominate issue with the attorney Donald MacPherson’s conduct appears to have been the raising of stated frivolous positions repeatedly, which the Court found to be in bad faith.
  • And, Donald MacPherson calls himself the “Courtroom Commando”, and he is apparently willing to go to battle with the IRS, even when his position may not be great…and the Service and courts have told him his position was frivolous. Great tenacity, but also expensive.  In May v. Commissioner, the Tax Court sanctioned him another seven grand.
  • The Northern District of Ohio granted the government’s motion for summary judgement in WRK Rarities, LLC v. United States, where a successor entity to the taxpayer attempted to argue a wrongful levy under Section 7426 for the predecessor’s tax obligation. The Court found the successor was completely the alter ego of the predecessor, and therefore levy was appropriate, and dismissal on summary judgement was proper.
  • I’m not sure there is too much of importance in Costello v. Comm’r, but it is a mitigation case. Those don’t come up all that frequently.  The mitigation provisions are found in Sections 1311 to 1314 and allow relief from the statute of limitations on assessment (for the Service) and on refunds (for taxpayers) in certain specific situations defined in the Code.  This is a confusing area, made more confusing by case law that isn’t exactly uniformly applied.  The new chapter 5 of SaltzBook will have some heavily revised content in this area, and I should have a longer post soon touching on mitigation and demutualization in the near future.  In Costello, the IRS sought to assess tax in a closed year where refunds had been issued to a trustee and a beneficiary on the same income, resulting in no income tax being paid.  Section 1312(5) allows mitigation in this situation dealing with a trust and beneficiary.  There were two interesting aspects of this case, including whether the parties were sufficiently still related parties where the trust was subsequently wound down, and whether amending a return in response to an IRS audit was the taxpayer taking a position.
  • The First Circuit has joined all other Circuits in holding “that the taxpayer must comply with an IRS summons for documents he or she is required to keep under the [Bank Secrecy Act], where the IRS is investigating civilly the failure to pay taxes and the matter has not been referred for criminal prosecution,” and not allowing the taxpayer for invoking the Fifth Amendment. See US v. Chen. I can’t recall how many Circuit Courts have reviewed this matter, but it is at least five or six now.
  • The District Court for the District of Minnesota in McBrady v. United States has determined it lacks jurisdiction to review a refund claim for taxpayers who failed to timely file a refund request, and also had an interesting Flora holding regarding a credit carryback. The IRS never received the refund claim for 2009, which the taxpayer’s accountant and employee both testified was timely sent, but there was not USPS postmark or other proof of timely mailing, so Section 7502 requirements were not met.  Following an audit, income was shifted from 2009 to other years, including 2008.  This resulted in an outstanding liability that was not paid at the time the suit was filed, but the ’09 refund also generated credits that the taxpayer elected to apply to 2008.  The taxpayers also sought a refund for 2008, arguing the full payment of the ’09 tax that created the ’08 credit should be viewed as “full payment”, which they compared to the extended deadline for refunds when credits are carried back.  The Court did not find this persuasive, and stated full payment of the assessed amount of the ’08 tax was needed for the Court to have jurisdiction over the refund suite under Flora.  Sorry, couldn’t find a free link.
  • The IRS lost a motion for summary judgement regarding prior opportunity to dispute employment taxes related to a worker reclassification that occurred in prior proceeding. The case is called Hampton Software Development, LLC v. Commissioner, which is an interesting name for the entity because the LLC operated an apartment complex.  The IRS argued that during a preassessment conference determining the worker classification the taxpayer had the opportunity to dispute the liability, and was not now entitled to CDP review of the same.  The Court stated the conference was not the opportunity, as the worker classification determination notice is what would have triggered the right under Section 6330(c)(2)(B), and such notice was not received by the taxpayer (there was a material question about whether the taxpayer was dodging the notice, but that was a fact question to be resolved later).  The Hochman, Salkin blog has a good write up of this case, which can be found here.
  • The IRS has issued additional regulations under Section 6103 allowing disclosure of return information to the Census Bureau. This was requested so the Census could attempt to create more cost-efficient methods of conducting the census.  I don’t trust the “Census”.  Too much information, and it sounds really ominous.  That is definitely the group in Big Brother that will start rounding up undesirables, and now they have my mortgage info.
  • The Service has issued Chief Counsel Notice 2016-007, which provides internal guidance on how the results of TEFRA unified partnership audit and litigation procedures should be applied in CDP Tax Court cases. The notice provides a fair amount of guidance, and worth a review if you work in this area.
  • More bankruptcy. The US Bankruptcy Court for the Eastern District of Virginia has held that exemption rights under section 522 of the BR Code supersede the IRS offset rights under section 533 of the BR Code and Section 6402.  In In Re Copley, the Court directed the IRS to issue a refund to the estate after the IRS offset the refund with prepetition tax liabilities.  The setoff was not found to violate the automatic stay, but the court found the IRS could not continue to hold funds that the taxpayer has already indicated it was applying an exemption to in the proceeding.   There is a split among courts regarding the preservation of this setoff right for the IRS.  Keith wrote about the offset program generally and the TIGTA’s recent critical report of the same last week, which can be found here.