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Grab Bag: Mitigation Rules (Trusts and Determinations)

Posted on Sep. 29, 2016

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.

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