S Shareholder's Amended Filings Satisfied Requirement to Identify Inconsistencies with Return

(Parker Tax Publishing October 2018)

The Ninth Circuit held that the sole shareholder of an S corporation in involuntary bankruptcy, who filed for a refund based on a claimed overstatement of income on the S corporation return filed by the bankruptcy trustee, satisfied the requirement in Code Sec. 6037 to provide a statement identifying the inconsistency between the corporate and the shareholder returns by including a statement that described how his income flowed from the corporation and stating his disagreement with the return filed by the trustee. Rubin v. U.S., 2018 PTC 313 (9th Cir. 2018).

Background

Thomas Rubin was the sole shareholder of Focus Media, Inc. (Focus), an S corporation. In 2000, Focus experienced serious financial difficulties when some of its largest customers became concerned about its possible misuse of funds and sued to prevent additional disbursements. Focus was eventually enjoined from collecting its unpaid receivables. Later in 2000, creditors put Focus into involuntary bankruptcy. A bankruptcy trustee was appointed and advised the bankruptcy court that Focus's receivables were worthless.

The bankruptcy trustee filed Focus's 2000 S corporation tax return. According to Rubin, the trustee incorrectly accounted for over $66 million of cancellation of indebtedness (COD) income and $23 million of bad debt expenses that Focus was entitled to write off. Rubin filed his personal tax return and paid his taxes based on the income reported in the Focus return filed by the trustee for 2000. Rubin later filed an amended return for 2000, however, and for the two preceding years.

With his amended returns, Rubin included a statement describing how his income flowed from Focus and stating his disagreement with the return filed for Focus by the trustee. He attached a pro forma amended Form 1120S, U.S. Income Tax Return for an S Corporation, which reflected the different treatment of Focus's COD income and bad debt expenses. He also attached a pro forma Schedule K-1 showing the income he contended should have been reported to him based on the revised numbers in his pro forma return for Focus. Rubin claimed refunds for 1998 and 1999 based on carrying losses back to those years, again based on the revised figures in the pro forma 2000 Focus return. Rubin claimed refunds of approximately $2.5 million for 1998, $595,000 for 1999, and $6.9 million for 2000.

The IRS disallowed all of Rubin's amended return refund claims. In doing so, the IRS did not indicate that the rejection was based on any failure by Rubin to identify inconsistencies between his returns and Focus's, nor did the IRS suggest any uncertainty or confusion about what Rubin was claiming or what his filings reported. All of the reasons provided by the IRS were based on the merits of Rubin's claims.

In 2016, Rubin sued for the refunds in a district court. The district court granted the government's motion to dismiss Rubin's claims, concluding that Rubin had not filed with his amended returns a statement identifying the inconsistency with Focus's return. Rubin appealed to the Ninth Circuit.

Analysis

Code Sec. 6037(c) generally provides that an S corporation shareholder must report income and loss consistently with what the S corporation reported on its return. However, under Code Sec. 6037(c)(2)(A), if a shareholder's treatment of an item is inconsistent with the S corporation's return, the consistency requirement does not apply provided the shareholder files a statement identifying the inconsistency.

Observation: Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request, is used by S corporation shareholders to report items differently from the way the S corporation reported them. Rubin did not file a Form 8082, but the district court did not rest its decision on that basis, and the government abandoned that argument on appeal.

The IRS argued that Rubin's amended filings did not constitute a statement identifying the inconsistency. According to the IRS, Rubin's filings identified only how his amended returns differed from his original returns, not how his amended returns differed from Focus's returns. The Ninth Circuit interpreted the IRS's position to be that Rubin should have included figures reported on the Focus return with the pro forma returns included the amended filings. The IRS further argued that requiring it to compare the filed Focus return with Rubin's pro forma return would be unduly burdensome because Rubin's filings spanned over 20 pages. The IRS contended that as a policy matter, finding in Rubin's favor would encourage S corporation shareholders not to disclose inconsistencies between their returns and the corporate returns. The IRS argued that the filing of administrative claims would be rendered an exercise in futility, because the IRS would have to defend against refund actions in court based on arguments it was directed to disregard at the administrative level.

The Ninth Circuit held that Rubin's filing satisfied the statement requirement in Code Sec. 6037(c)(2)(A) because it found that in practical terms, the amended filings succeeded in identifying the inconsistencies with the previously filed returns sufficiently for the IRS to understand them and reject them on the merits. Although Rubin did not file a Form 8082, the court based its reasoning primarily on the fact that Rubin's filings in practice complied with the Form 8082 requirements. The court explained that Form 8082 asks the taxpayer to list the relevant amount either from the Schedule K-1 or the taxpayer's return, the amount the taxpayer is reporting, and the difference between the two. In the court's view, Rubin provided this information, and nothing in Form 8082 required the taxpayer to report figures taken directly from the corporation's return as the IRS suggested.

The Ninth Circuit disagreed with the IRS's assertion that requiring it to compare the filed Focus return with Rubin's pro forma return would be unduly burdensome. According to the court, the fact that Rubin's Focus filing was 22 pages did not impose a burden that the IRS could not reasonably accomplish, particularly given the size of the claimed refund. The court explained that in fact, the IRS would be expected to review returns and that is actually what it did. In the court's view, a two page pro forma Schedule K-1 accompanied by a two page statement explaining the inconsistencies did not impose an oppressive task on the IRS, even under Code Sec. 6037 standards.

The Ninth Circuit rejected the IRS's policy argument because it found that Rubin did not argue he was exempt from the requirement to identify the relevant inconsistencies. The court was likewise not convinced that its ruling would render administrative claims futile. The court found that the IRS was not directed to disregard any arguments at the administrative level; to the contrary, it considered Rubin's returns on the merits, and was able to do so because the return included a statement that sufficiently identified the relevant inconsistencies.

For a discussion of the S corporation return consistency requirement, see Parker Tax ¶36,525.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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