Perkins Case Raises Variance and Issue Preclusion In Context of Taxation of Native Americans

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The case of Perkins v United States raises interesting procedural issues, including collateral estoppel (also known as issue preclusion) and variance. Earlier this month a federal district court judge adopted the magistrate judge’s recommendation to deny the government’s motion for summary judgment in a refund suit involving a Native American tribe member who along with her husband ran a trucking and gravel extraction business. 

The magistrate’s recommendation situates the dispute: 

The federal income taxation of American Indians is not a sexy topic.” John Lentz, When Canons Go to War in Indian Country, Guess Who Wins? Barrett v. United States: Tax Canons and Canons of Construction in the Federal Taxation of American Indians, 35 Am. Indian [pg. 2018-5250] L. Rev. 211, 211 (2011). Neither is gravel. Yet the two topics have come together in this case to present a question that no prior case has had to answer directly. When Indians extract gravel from Indian land through an Indian-owned sole proprietorship, is the resulting income exempt from federal income tax based on treaties that promise the “free use and enjoyment” of land or protection from “all taxes”? And even if the Court answers in the affirmative, have plaintiffs Fredrick Perkins (“Fredrick”) and Alice J. Perkins (“Alice”) made enough of a showing of business income and expenses that treaty protection would make a practical difference on their 2010 federal income tax return? 

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The substantive issues relate to the Canandaigua Treaty and the Treaty of 1842. Native Americans, like other citizens, are subject to tax on income unless a treaty provides otherwise.  The Perkins and the IRS have been fighting about whether the treaties exempt income they earned in their gravel business in 2008, 2009 and 2010. The 2008 and 2009 years were the subject of a deficiency case in Tax Court. In 2018 the Tax Court, in a reviewed opinion that generated a dissent by Judge Foley, held that the treaties did not exempt their income from the gravel business from US income tax. The Perkins have appealed that decision to the Second Circuit. 

The 2010 year is the subject of a refund suit in federal court in New York. The magistrate’s recommendation, adopted by the district court judge last month, explicitly disagrees with the Tax Court’s analysis and finds that the treaties do provide an exemption for the income though the taxpayers’ entitlement to a refund awaits a jury trial that would establish the amount of tax exempt gravel income and allocable expenses. 

This creates the somewhat odd situation where two different courts have reached differing views on the same substantive issue with respect to the same taxpayer. 

Rather than dig into the substantive treaty issue in this post I will discuss the procedural issues that last month’s federal district court opinion raises.

Issue Preclusion (Collateral Estoppel)

In federal district court, the government pointed to the Tax Court decision in its favor. In doing so, the government argued that the taxpayers should be prevented from relitigating the same issue, basing its argument on collateral estoppel. That doctrine prevents parties from relitigating an issue that has been previously litigated and subject to a final determination. The district court disagreed, noting that there has yet to be a final decision, given that the Perkins appealed the Tax Court decision and that the decision “does not become final until a petition for certiorari is denied, the time to file such a petition expires, or the Supreme Court issues a mandate.”

In addition, the district court noted that the magistrate’s recommendation preceded the Tax Court opinion, and collateral estoppel prevents litigation in a subsequent case.

Variance

One other procedural issue in the case warrants highlighting.  In objecting to the magistrate’s report, the government raised variance. The variance issue arose because during discovery the government established that the Perkins’ failed to report fully gross receipts from the part of the business that the parties agreed was not covered by the treaties’ exemption.  The Perkins responded by acknowledging the underreporting but also establishing that they underclaimed expenses relating to the taxable portion of the business.

As a refresher, the variance doctrine means that the argument raised in a refund suit must have been made in the claim. As the district court noted, the “variance doctrine does not require exact precision; if the issue raised in court is derived from or is integral to the ground timely raised in the refund claim, it `may be considered as part of the initial ground.” (internal cites omitted).

The refund claim the Perkins submitted focused on the application of the treaties and whether the treaties exempted a portion of their income from the gravel business: 

As enrolled members of the Seneca Nation of Indians (the “Nation”), the taxpayers have been given permission by the Nation to sell gravel from [the] property on the Nation’s territory, in exchange for royalty payments made to the Nation. Under the Supremacy Clause, the [IRS] may not tax income derived directly from the land protected by federal treaties. The taxpayers correctly reported these sales as exempt from federal taxation. The IRS, however, determined the income to be taxable. Taxpayers have paid the taxes and now seek a refund.

In rejecting the government’s variance argument, the district court emphasized that the Perkins’ were not basing their claim to a refund on their entitlement to deduct expenses, and they had properly teed up the treaty issue in their claim:

Cutting through all the back and forth, the crux of the plaintiffs’ claim is that their gravel income was improperly taxed. That issue was fully presented in their refund claim to the IRS. The IRS had a full opportunity to investigate all aspects of their claim for a refund; as the plaintiffs observe, however, the IRS chose not to “examine the 2010 income or business expenses, and did not request or review any receipts, statements, workpapers, or other records.” 

Because the plaintiffs’ theory as to why they are entitled to a refund has not changed, their claim is not barred by the variance doctrine. And the fact that the IRS has now come up with a new reason why the plaintiffs were taxed in the correct amount (or even less than they should have been) does not change that.

While the Perkins’ claim did not identify their entitlement to deduct expenses, the expenses themselves were not the reason why the Perkins’ claimed to have made an overpayment:

Stated another way, the plaintiffs are not now alleging a new reason why they are entitled to a refund; rather, they are responding to the defendant’s argument why they are not. The plaintiffs claimed that they were due a refund for reason A. The defendant responded that even if the plaintiffs were correct about A, they had no claim because of B. The plaintiffs then said that the defendant was wrong about B because of C. That does not mean that the plaintiffs are raising A and C in support of their claim; rather, they are raising A and using C as a response to defense argument B. That is not a variance by any definition.

Conclusion

The longstanding dispute for the 2010 year now moves to trial.  For the 2008 and 2009 years, the Second Circuit heard oral argument earlier this spring. The earlier years involved deficiencies of hundreds of thousands of dollars. The 2010 year involves just under $7,000.  The disparity in amounts at issue likely explains why the Perkins decided to bifurcate the cases, as the Flora full payment rule likely left Tax Court as the only forum for 2008 and 2009.  As a practical matter, the outcome of the live Second Circuit case will control whether the treaties promise of the “free use and enjoyment” of land insulates the Perkins from income tax on the earnings from their gravel extraction business.

Leslie Book About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

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