The Ninth Circuit held that a taxpayer's amended return filings satisfied the requirement for a statement of inconsistency in Sec. 6037(c)(2).
Thomas Rubin was the sole shareholder of the S corporation Focus Media Inc. In 2000, Focus was experiencing serious financial difficulties, which resulted in its creditors' putting the company into involuntary bankruptcy.
The bankruptcy trustee found that Focus's receivables were worthless. On Focus's bankruptcy return for 2000, the trustee reported $66.7 million of cancellation-of-indebtedness (COI) income and a write-off of $23.1 million of bad debt expenses. Rubin filed his 2000 individual tax return using the information reported on the Focus return and paid the taxes that return showed were due.
Rubin later regretted this decision. He believed that the net income for Focus was substantially overstated on its return, which had caused him to make personal income tax payments that were substantially more than he actually owed. Thus, he filed an amended individual return for 2000 that showed a loss, based on the income and expenses that he believed should have been passed through to him by Focus in 2000.
With his amended return, Rubin included a statement that described how his income flowed from Focus and stated that he disagreed with the tax return filed for Focus by the bankruptcy trustee. He also attached a pro forma amended tax return for Focus for the 2000 tax year, which reflected the different treatment of bad debt expenses and the COI income. In addition, he attached a pro forma Schedule K-1, Shareholder's Share of Income, Deductions, Credits, etc., showing the income he contended should have been reported to him based on the revised numbers in the pro forma Focus return.
Besides filing an amended return for 2000, Rubin also filed amended returns for 1998 and 1999 that included a carryback of the loss from 2000. In total, on the three amended returns Rubin claimed a refund of over $10 million.
The IRS rejected Rubin's tax refund claims for all three years. In doing so, the IRS did not indicate that the rejection was based on Rubin's failure to identify inconsistencies between his tax returns and Focus's returns, and the IRS did not indicate that it had any uncertainty or was confused about what Rubin was claiming or what was reported on his amended returns. Rather, the reasons the IRS gave for rejecting the refund claims were all based on the merits of the claims.
In response Rubin filed a refund suit in district court. The district court dismissed Rubin's case, finding that he had failed to file a statement identifying the inconsistency with the return the bankruptcy trustee filed for Focus, as required by Sec. 6037(c)(2)(A). Rubin appealed the district court's decision to the Ninth Circuit.
Ninth Circuit's Decision
The Ninth Circuit overruled the district court and held that Rubin had complied with the requirement in Sec. 6037(c)(2)(A) that a shareholder of an S corporation file a statement of inconsistency if the shareholder does not report an item or items on his or her individual return consistently with how those items are reported on the S corporation return. The court found that Rubin's amended return filings provided the necessary information for the IRS to identify the inconsistencies and understand them.
Sec. 6037(c)(1) requires a shareholder of an S corporation to report income and loss of the S corporation consistently with what the corporation reported on its return. Under an exception to this rule in Sec. 6037(c)(2)(A), a shareholder may file a return reporting an item that is inconsistent with the S corporation return if the shareholder files a statement with the IRS that identifies the inconsistency. Since Rubin's amended returns were not consistent with the information reported on Focus's 2000 return, the Ninth Circuit found that Rubin was required to file a statement of inconsistency.
The court explained that when Rubin filed his amended returns, he included documents that contained a great deal of information about the differences between his returns and the return that Focus filed for 2000. He attached a two-page statement to the 2000 amended return, the first page of which included two lists — one that was a summary of the changes to income in the return and the other that was a summary of the changes to itemized deductions. The second page had a four-paragraph narrative that explained that the amendments to the original returns were the result of Rubin's recalculation of what should have been reported on the Focus return by the bankruptcy trustee.
To show his calculations, Rubin also included a pro forma amended Form 1120S, U.S. Income Tax Return for an S Corporation, with his return filings based on what he contended should have been reported on the return, as well as a revised Schedule K-1, listing what he contended should have been reported to him by Focus based on the amounts in the pro forma return for Focus. Rubin also attached explanatory statements to the 1998 and 1999 amended returns. The statement for 1998 showed the effect of the net operating loss (NOL) carryback to 1998 from 2000. The statement for 1999 was a chart showing the effect of the NOL carryover from 1998.
The IRS did not argue that it was unable to understand the revisions Rubin proposed in his amended returns and, at oral argument, acknowledged that Rubin's filings permitted the IRS to perceive the inconsistencies between the return filed for Focus by the bankruptcy trustee and the pro forma return prepared by Rubin. As the Ninth Circuit stated, "In practical terms, then, the amended filings by Rubin succeeded in identifying the inconsistencies with the previously filed returns sufficiently for the Government to understand them and to reject them on the merits."
The IRS, however, argued that Rubin's returns did not identify the right inconsistencies. It asserted that Rubin only identified how his amended returns were different from his original returns, not how his amended returns were different from Focus's S corporation return. The Ninth Circuit said that it appeared that the IRS was arguing that Rubin would have satisfied the statement-of-inconsistency requirement if he had included in his statements with the return a chart showing the relevant amounts reported on the Focus return versus the corresponding amounts on Rubin's pro forma Focus return. Because he did not, the IRS argued that the amended returns must be rejected, even though the IRS "necessarily understood" that Rubin's refund claims were based on the Focus return differences.
The Ninth Circuit disagreed with the IRS, stating, "Section 6037 does not exalt form over substance in that manner." In support of its conclusion, the court pointed to Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request, which is the form provided by the IRS for S corporation shareholders to report inconsistent treatment of tax items. Reviewing the form, the court found that Rubin had provided the information that the form instructs a taxpayer to provide, and it does not direct or require the taxpayer to report amounts taken directly from the S corporation return.
Among other things, the IRS also argued that requiring it to compare the filed Focus return with the pro forma Focus return Rubin submitted would have been unduly burdensome, pointing out that the return was over 20 pages long. The Ninth Circuit scoffed at this argument, noting that, given the size of the claimed refund, reviewing the submission did not impose such a large burden that "the IRS could not reasonably accomplish its duty."
In district court, the IRS argued that Rubin's amended returns should be rejected simply because he did not file a Form 8082 to identify the inconsistent treatment in his return. However, the district court, while it discussed this argument in its order, did not base its decision on it, and the IRS abandoned the argument in the Ninth Circuit, so the court did not directly address it. Although, as in Rubin's case, one is not always required to do things the way the IRS prefers, he might have been able to avoid having the IRS raise the issue of whether he had made a statement of inconsistency if he had simply included a Form 8082 for 2000 that incorporated the statements he filed with the amended returns.
Rubin, No. 16-56633 (9th Cir. 9/24/18)