On May 19, 2020, the Tax Court issued a Memorandum Opinion in the case of Joseph v. Commissioner (T.C. Memo. 2020-65). The issue before the court in Joseph v. Commissioner was whether a petitioners’ concessions in a stipulation of settled issues regarding capital gain and income could subsequently be used by the IRS to amend the IRS’s answer to a Tax Court petition, and if so, whether the stipulation should be modified or set aside based upon the tax consequences of the IRS’s amended position.
Brief Background to Joseph v. Commissioner
The IRS issued a notice of deficiency for the petitioner’s 2011, 2012, and 2013 taxable years on the basis of substitutes for returns (SFRs) prepared under IRC § 6020(b)(1). Thereafter, the petitioner filed or otherwise provided the IRS with returns for those years in which the petitioner claimed deductions from partnerships and S corporations.
The parties executed a “stipulation of settled issues” in which the petitioner agreed that he had recognizable capital gain and other income for the years in issue in excess of the amounts taken into account in the SFRs. The IRS amended his answer to reflect those concessions. With few exceptions, the IRS did not allow the deductions the petitioner claimed from his partnerships and S corporations. The documentation that the petitioner submitted to substantiate those deductions consisted primarily of general ledgers and the bank statements from which they were prepared.
The petitioner argues that the parties’ stipulation regarding his capital gain should be modified or set aside because of the IRS’s disallowance of depreciation that, the petitioner claims, reduced the basis of the property whose sale gave rise to the gain.
The Stipulation of Settled Issues
Executed prior to trial, the stipulation of settled issues sets out the parties’ agreements to a number of issues raised in the initial notice of deficiency. Importantly, however, it also addressed (and the petitioner admitted to) a number of issues that were not raised in the initial notice of deficiency. The IRS moved to amend their answer, which was granted. The new answer proposed a new deficiency against the petitioner based upon a number of issues conceded (stipulated) in the stipulation of settled issues.
The petitioner argued that the parties’ stipulation regarding the amount of his 2013 capital gain was “limited by the acceptance of previous depreciation deductions.” Stated differently, the petitioner would not have stipulated to the amount of capital gain if he knew that the IRS was going to amend its answer to deny in toto his depreciation deductions, which had previously been agreed to by the parties. The Tax Court was, therefore, faced with the question as to whether “justice requires” allowing a modification of the parties’ stipulations concerning petitioner’s 2013 capital gain.
Tax Court Rule 91(e) provides that a stipulation will be treated as “a conclusive admission” by the parties to the stipulation, unless otherwise permitted by the Court or agreed upon by those parties. The Court will not permit a party to a stipulation to qualify, change, or contradict a stipulation in whole or in part, except where justice requires.
The Tax Court was sympathetic to the petitioner’s quandary, but not to the extent of throwing out the entire stipulation. The Tax Court found that the stipulation, viewed through the prism of the amended answer, would cause “double counting” of items of capital gain and income, thereby overstating his income. However, arithmetic errors in a stipulation that resulted in double counting of income, itself, would not have relieved the petitioner from the binding nature of the stipulation. See Korangy v. Commissioner, T.C. Memo. 1989-2, aff’d, 893 F.2d 69 (4th Cir. 1990).
In the present case, the IRS computed the increased deficiency for 2013 by treating $18,000 of stipulated capital gain as ordinary income. Thus, it was not a simple matter of “arithmetic errors” in the original stipulation that led the Court to modify the stipulation, it was an error made in the recalculation of the deficiency based on the stipulated facts that caused the double counting in the deficiency.
The Tax Court, however, rejected the petitioner’s request to modify the stipulation further by remedying the “inconsistent treatment” of a pass-through entity’s depreciation deductions, which ultimately affected the amount of increased capital gain in the amended answer. Specifically, the entity reduced the basis in a parcel of property based on depreciation deductions, which were agreed to in the IRS’s initial answer. In the amended answer, however, such deductions were disallowed, thereby increasing the petitioner’s ordinary income.
Although the Tax Court noted that the amended answer’s denial of depreciation deductions created an “undeniable inconsistency” in the IRS’s position, the Tax Court observed that the calculation of the petitioner’s capital gain “contains no proviso that it is attributable to a specific amount realized or adjusted basis.” Had petitioner relied on the (agreed-upon) depreciation deductions, the Tax Court opines, he should have noted that condition as part of the stipulation.
Because it is unclear from the record how much of the depreciation (denied in the determination contained in the amended complaint) was applied by the entity to reduce its basis in the property, the IRS contends that the record would have to be reopened to determine how the gain was calculated. This is where the court draws the line in the sand.
Because eliminating the double counting of income required no “further proceedings,” the Tax Court was willing to modify the stipulation. However, a modification of the stipulation that would lead to further proceedings, testimony, etc., was a step too far. For this reason, the Tax Court was unwilling to modify the stipulation as to the entity’s basis issue.
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Justice, it appears, does not require the Tax Court to open a proverbial can of worms.