Eagan v. United States

United States Court of Appeals
United States Court of Appeals
For the First Circuit
For the First Circuit

No. 95-2073

MICHAEL K. EAGAN
Plaintiff - Appellant,

v.

UNITED STATES OF AMERICA,

Defendant - Appellee.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Joseph L. Tauro, U.S. District Judge]

Before

Stahl, Circuit Judge,

Aldrich, Senior Circuit Judge,

and Lynch, Circuit Judge.

Peter L. Banis with whom Ley & Young, P.C., Lawrence P.

Heffernan, H. Bissell Carey, III, and Robinson & Cole were on brief

for appellant.
Bridget M. Rowan, Attorney, Tax Division, U.S. Department of

Justice, with whom Loretta C. Argrett, Assistant Attorney General,

Donald K. Stern, United States Attorney, Gary R. Allen, and Kenneth L.

Greene, Attorneys, Tax Division, U.S. Department of Justice, were on

brief for appellee.

March 29, 1996

STAHL, Circuit Judge. Michael K. Eagan appeals
STAHL, Circuit Judge.

from the grant of summary judgment in favor of the government

in his action seeking a refund of taxes paid on an early

withdrawal from his former company's retirement plan. In a

separate and previous tax refund suit, Eagan and the Internal

Revenue Service ("IRS") stipulated that in 1987 Eagan, a life

insurance salesman, did not qualify as a statutory employee

of the company sponsoring the retirement plan. In the

present suit, Eagan argues that his participation in the plan

violated the requirement that the plan operate for the

exclusive benefit of employees, thus disqualifying the plan

for tax purposes and rendering contributions to the plan

taxable.

With ingenuity, Eagan argues that because the

contributions were taxable when made, his withdrawals from

the plan cannot be taxed, and therefore he is due a refund.

Conveniently for Eagan, the applicable statute of limitations

now bars the assessment of tax on most of the contributions

to the plan. Thus, if Eagan's argument is accepted, he would

have the best of both worlds: the ability to avoid tax on

most of the original contributions and on the subsequent

withdrawals.

The district court, unmoved by Eagan's plea,

rejected that result. It ruled that the Commissioner of

Internal Revenue had the discretion to ignore any

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disqualifying effect on the plan of Eagan's participation as

a non-employee. Accordingly, the court granted summary

judgment for the IRS on Eagan's refund claim, and this appeal

ensued. We now affirm the district court, although on a

different ground. We hold that the duty of consistency bars

Eagan from taking a position in one year to his advantage,

and then later, after correction is barred by the statute of

limitations, taking a contrary position to his further

advantage.

I.
I.

BACKGROUND
BACKGROUND

During the relevant tax years, Eagan was a life

insurance agent, earning commissions from a number of

insurers. He had agreed, however, in a "Career Contract for

Full-Time Agents" with Massachusetts Mutual Life Insurance

Company ("Mass Mutual"), that solicitation of Mass Mutual

policies would be his "principal business activity."

The Internal Revenue Code classifies a "full-time

life insurance salesman" as an employee1 of the insurer for

whom they sell full time, subject to employment tax

withholding and eligible to participate in the insurer's tax-

1. Individuals deemed to be employees by statute, whether or
not they fit the common law definition of employee, are often
called "statutory employees," and various IRS forms,
instructions, and regulations refer to them that way. See,

e.g., IRS Form W-2 Wage and Tax Statement; IRS Instructions

for Schedule C Profit or Loss From Business.

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deferred retirement plans. See I.R.C. 3121(d)(3)(B),

7701(a)(20). Mass Mutual maintains retirement plans for its

employee-agents, and the IRS determined2 the plans were

qualified for tax-favored treatment under section 401(a) of

the Internal Revenue Code (26 U.S.C., hereafter "I.R.C.").

Based on Eagan's representation in the "Career Contract for

Full-Time Agents," Mass Mutual treated Eagan as a statutory

employee and contributed portions of his compensation to a

qualified retirement plan, the Mass Mutual Agents 401(k) Plan

("the 401(k) plan"). Under this arrangement, taxation was

deferred on the portion of Eagan's compensation that Mass

Mutual contributed to the 401(k) plan and on any income

earned on those contributions, see I.R.C. 401(k), 402(a),

and 501(a), but tax would eventually be due when Eagan

withdrew funds from the plan, see I.R.C. 402(a), 72(t).

Mass Mutual contributed to the 401(k) plan on

Eagan's behalf from 1981 until 1992, when his contract with

Mass Mutual was terminated. On his tax returns, Eagan

consistently treated himself as a statutory employee, and

treated the 401(k) plan as qualified, excluding from income

the contributions made on his behalf in 1987, 1988, and 1989.

In 1989, Eagan withdrew $4,682 from the 401(k) plan, and he

reported and paid income tax on that withdrawal on his 1989

2. In 1986, the IRS issued a determination letter to Mass
Mutual finding the retirement plan at issue here to be
qualified for tax benefits under I.R.C. 401(a).

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tax return, filed in August 1990. Because Eagan was not yet

59 years old when he withdrew the funds, he was also liable

for, and paid, the ten percent additional tax on early

distributions under I.R.C. 72(t). In April 1992, Eagan

filed an amended tax return for 1989, claiming that he was

not subject to any tax on the withdrawal from the 401(k)

plan. The IRS disallowed Eagan's refund claim, and Eagan

responded by filing the instant tax refund suit in the United

States District Court for the District of Massachusetts,

claiming a refund of $1,755.81 for the taxes on the 1989

withdrawal from the 401(k) plan.

II.
II.

EAGAN'S REFUND CLAIM
EAGAN'S REFUND CLAIM

The rationale for Eagan's refund claim is somewhat

complicated and rather brash. We spell it out in detail.

The linchpin of the claim is Eagan's contention that he was

not a full-time insurance agent for Mass Mutual during 1987,

1988, and 1989. In an earlier tax refund suit, Eagan sought

to recover FICA tax3 withheld from his Mass Mutual

compensation in 1987 and later years, on the theory that he

was not subject to FICA tax as a non-employee. Eagan v.

United States, No. 92-10786-T (D. Mass. filed Apr. 3, 1992)

3. "FICA" is the acronym for the Federal Insurance
Contribution Act, which requires the withholding from wages
of an employment tax to fund Social Security benefits.
I.R.C. 3101.

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("Eagan I"). Eagan and the IRS stipulated in Eagan I that

Eagan was not a full-time agent for Mass Mutual in 1987 and

thus not a statutory employee of Mass Mutual under I.R.C.

3121(d)(3)(B). As a non-employee, Eagan was not subject to

FICA withholding on his Mass Mutual compensation, and

accordingly he received a refund of his 1987 FICA tax in

Eagan I; the IRS also issued an administrative refund of his

FICA taxes for 1988-1992.

Eagan's position in this suit is that the

stipulation in Eagan I that he was not a Mass Mutual employee

also had implications for his participation in the Mass

Mutual 401(k) plan. He argues that under the statutory

scheme, a qualified tax-deferred retirement plan must inure

to the exclusive benefit of the employees of the plan

sponsor. See I.R.C. 401(a)(2). Because he was not an

employee in 1987, he claims, his participation in the plan

violated this "exclusive benefit rule," rendering the plan

not qualified for tax benefits. See id. Eagan then argues

that because the plan was not qualified in 1987, Mass

Mutual's contributions to the plan on his behalf were taxable

to Eagan as would be other compensation for his services.

See I.R.C. 402(b). Moreover, income earned on contributed

funds would also be taxed when earned, not tax-deferred. See

I.R.C. 61(a)(15). He concludes that if the contributions

and income thereon had been taxed when earned, there would be

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no further tax due when "after-tax" funds were eventually

withdrawn.

Thus, Eagan contends he is due a refund on the

taxes he paid in connection with his early withdrawal in

1989. Since the statute of limitations4 bars the IRS from

assessing tax on most of the contributions Mass Mutual made

to the plan on Eagan's behalf, Eagan, if successful in this

claim, would avoid tax completely -- both on contributions to

the plan and on withdrawals from the plan.5

The district court rejected Eagan's refund claim in

a terse one-page order. The court pointed out that the IRS

had previously issued a determination letter that the Mass

Mutual 401(k) plan was qualified, and although the

Commissioner "has authority to issue a corrective

determination [that the plan was no longer qualified because

of Eagan's participation] with retroactive application, she

has not done so in her discretion." Finding no abuse of

discretion, the court deferred to the Commissioner's

decision, and consequently granted summary judgment for the

government.

4. A three-year statute of limitations, I.R.C. 6501(a),
would apply to Eagan's non-payment of tax on the
contributions to the 401(k) plan, as we explain in part III
of this opinion.

5. Under his theory, Eagan would, however, owe tax on any
contributions and income earned on his plan assets in tax
years within the three-year statute of limitations.

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III.
III.

ANALYSIS
ANALYSIS

Our review of summary judgments is plenary. Levy

v. FDIC, 7 F.3d 1054, 1056 (1st Cir. 1993). We are free to

affirm the district court's ruling on any ground supported in

the record. Id.

The district court granted summary judgment for the

government, ruling that the Commissioner of Internal Revenue

had the discretion not to revoke her prior determination that

the Mass Mutual 401(k) plan was a qualified plan, and thus

effectively to ignore the disqualifying effect, if any, that

Eagan's participation may have had on the plan. The district

court, however, did not cite any case, statute, or regulation

as authority for its ruling. The court apparently accepted

the government's main argument in its memorandum supporting

summary judgment, but the authorities cited by the government

are not directly on point. While the Commissioner probably

has the authority to consider a 401(k) plan qualified in

spite of the erroneous participation of one non-employee, we

need not reach that question in order to affirm the summary

judgment. Nor do we reach the question whether Eagan's

participation rendered the plan disqualified under the

statutory framework, but we note our considerable skepticism

of this argument. We believe there is a more direct basis on

which to affirm the decision below.

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The duty of consistency estops Eagan from now

seeking a refund by asserting that his participation in the

401(k) plan was improper. As we recently observed, the

"`duty of consistency' prevents a taxpayer who has already

had the advantage of a past misrepresentation -- in a year

now closed to review by the government -- from changing his

position and, by claiming he should have paid more tax

before, avoiding the present tax." Lewis v. Commissioner, 18

F.3d 20, 26 (1st Cir. 1994) (citing Beltzer v. United States,

495 F.2d 211, 212-13 (8th Cir. 1974) and Jacob Mertens, Jr.,

The Law of Federal Income Taxation 60.05 (1992)). The duty

of consistency is a type of equitable estoppel, also known as

"quasi-estoppel." Id., 18 F.3d at 26; Mertens, supra,

60.05. The duty of consistency arises when the following

elements are present: "(1) a representation or report by the

taxpayer; (2) on which the Commission[er] has relied; and (3)

an attempt by the taxpayer after the statute of limitations

has run to change the previous representation or to

recharacterize the situation in such a way as to harm the

Commissioner." Herrington v. Commissioner, 854 F.2d 755, 758

(5th Cir. 1988), cert. denied, 490 U.S. 1065 (1989). When

these requirements are met, "the Commissioner may act as if

the previous representation, on which he relied, continued to

be true, even if it is not. The taxpayer is estopped to

assert the contrary." Id. The elements of the duty of

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consistency are present in this case. First, there was a

misrepresentation by the taxpayer. Eagan represented on his

1987, 1988, and (original) 1989 tax returns that, as a full-

time insurance agent for Mass Mutual, he was a statutory

employee eligible to participate in the Mass Mutual 401(k)

plan. Eagan made that representation to the IRS by: (1)

submitting with his return for each of those years his Mass

Mutual Form W-2 indicating that he was a statutory employee;

(2) excluding each year from gross income the compensation

contributed to the 401(k) plan; (3) excluding from gross

income the earnings on his account balance in the plan; and

(4) treating the withdrawal from the 401(k) plan as a

premature withdrawal from a qualified plan and paying the

associated tax and penalty. Eagan also represented to Mass

Mutual in his "Career Contract for Full-Time Agents" that his

"principal business activity" was solicitation of Mass Mutual

business, and Mass Mutual relied on that representation in

issuing Eagan's W-2 forms and by contributing to the 401(k)

plan on his behalf. We now know, based on the stipulation in

Eagan I, that these representations were incorrect.

Eagan argues that his misrepresentations to the IRS

were about a matter of law, not fact, and that therefore the

duty of consistency does not arise. In Lewis, we noted that

the duty of consistency "seems to apply when the earlier

taxpayer position amounts to a misstatement of fact, not of

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law." 18 F.3d at 26 (emphasis added). But in Lewis, we did

not examine the fact-or-law issue in any depth, and we

certainly made no holding on that point. See id. We now

adopt the approach of the Fifth Circuit in Herrington that

the duty of consistency applies to "a mixed question of fact

and law, concerning which the taxpayer[] had more information

than the Commissioner at the time the initial representations

were made." 854 F.2d at 758.

The question whether Eagan was a statutory employee

of Mass Mutual is primarily factual. The inquiry depends on

the facts of Eagan's particular situation, including the time

and effort Eagan devoted to Mass Mutual relative to other

insurers and any non-insurance business pursuits. See 26

C.F.R. 31.3121(d)-1(d)(2) and -1(d)(3)(ii). In this case,

as in Herrington, the question was not a pure question of

law, but rather "at best a mixed question of fact and law."

Id. Therefore, we reject Eagan's argument that the duty of

consistency does not apply to his misrepresentation.

Second, the IRS relied on Eagan's

misrepresentation, accepting his returns as filed and

allowing the statute of limitations to run. See id. There is

no suggestion that the IRS was unreasonable in accepting

Eagan's returns at face value or that the IRS should have

known that Eagan was not a full-time life insurance salesman

for Mass Mutual.

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Third, Eagan has recharacterized himself as a non-

employee in 1987, 1988, and 1989, and thus entitled to a

refund for the taxes on his 1989 withdrawal, but the statute

of limitations bars the IRS from taxing most of the

contributions made to the 401(k) plan and the earnings

thereon. Section 6501(a) of the Internal Revenue Code

provides that taxes must be assessed within three years after

the return is filed. Eagan states in his brief that for the

government to prevail on the duty of consistency defense, it

must show that, at the time of Eagan's recharacterization,

the statute barred reassessment of his 1987 income taxes.6

He concedes, and we agree, that it is immaterial that his

1988 and 1989 taxes were still open to reassessment when he

filed an amended 1989 return on April 14, 1992,

recharacterizing himself as a non-employee in order to claim

a refund.7 Because Eagan filed his 1987 tax return on

6. In a letter attached to Eagan's amended 1989 return,
Eagan asserted that "during the years in which amounts were
deducted from commissions earned by him and paid by the
Massachusetts Mutual Life Insurance Company, he did not meet
the definition of `full-time insurance salesman' as contained
in Section 7701(a)(20)." The record indicates that Eagan
began to participate in the 401(k) plan in 1981. Thus, it
appears that the IRS is also barred from reassessing years
before 1987 when Eagan may have improperly participated in
the 401(k) plan. However, the parties apparently have
focused on 1987 because Eagan and the IRS stipulated in Eagan

I that he failed to meet the definition of "full-time

insurance agent" in 1987.

7. Conceivably, the relevant time of recharacterization was
when Eagan filed his claim for a FICA tax refund, which was
eventually litigated as Eagan I. Arguably, the FICA claim

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September 26, 1988, the three-year statute on 1987 taxes ran

out more than six months before Eagan recharacterized his

employment status in his amended 1989 return. As a result,

the IRS is barred from taxing the contributions made in 1987

and earlier years, and therefore the third element of the

duty of consistency is satisfied.

Eagan argues that the six-year statute of

limitations of I.R.C. 6501(e) applies, not the three-year

limitation of section 6501(a). We reject that argument. The

six-year limitation contained in section 6501(e) applies

where the taxpayer omits an item from gross income that

exceeds twenty-five percent of the gross income stated in the

return. Eagan asserts that his 1987 gross income was $4,432,

and since the omission in that year exceeded twenty-five

percent of that amount, the six-year limitation should apply.

But Eagan's argument fails to recognize that "gross income"

of a trade or business is specially defined in I.R.C.

6501(e)(1)(A)(i) as "the total of the amounts received or

accrued from the sale of goods or services." In 1987, Eagan

was taxed as a trade or business. He reported $73,180 of

put the IRS on notice of Eagan's recharacterization at an
earlier point than did the income tax refund claim. Eagan
does not make this argument, however, and the record does not
indicate the date when Eagan filed his FICA refund claim with
the IRS. The Eagan I refund suit was filed in district court

on April 3, 1992, only eleven days before the income tax
refund claim at issue here, and that eleven day difference
does not alter the outcome.

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income, earned both as a statutory employee8 of Mass Mutual

and as an independent contractor for other insurance

companies, on Schedule C of Form 1040, entitled "Profit or

Loss from Business." Schedule C was the proper place to

report that income, and by reporting it as business income,

Eagan was able to deduct a variety of business-related

expenses such as office rent, supplies, wages for employees,

etc., that are generally not deductible by a taxpayer who is

not engaged in a trade or business. Eagan clearly fell

within the I.R.C. 6501(e)(1)(A)(i) special definition of

"gross income" for a trade or business, and his gross income

was therefore $73,180 for the limited purpose of applying the

statute of limitations.

Although the record is somewhat unclear as to the

total amount omitted from his 1987 taxable income due to his

improper participation in the 401(k) plan, it appears to be

less than $5,000, and in any event there is no assertion by

Eagan that it is more than twenty-five percent of $73,180.

Contrary to Eagan's assertion, the three-year statute of

limitation of section 6501(a) applies.

IV.
IV.

CONCLUSION
CONCLUSION

8. The instructions to Schedule C require a taxpayer who
received income as a statutory employee to report that income

on Schedule C, rather than on line 7 of Form 1040 where a
typical employee's salaries and wages are reported.

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We conclude that all of the elements of the duty of

consistency are met in this case. Having earlier

misrepresented himself as a statutory employee in order to

enjoy tax-deferred retirement plan contributions, Eagan is

estopped from now claiming he was never an employee in order

to enjoy tax-free withdrawals.9 As the Eighth Circuit aptly

put it:

It is no more right to allow a party to
blow hot and cold as suits his interest
in tax matters than in other
relationships whether it be called
estoppel, or a duty of consistency, or
the fixing of a fact by agreement, the
fact fixed for one year ought to remain
fixed in all its consequences.

Beltzer, 495 F.2d at 212-13. Or, to paraphrase the hackneyed

aphorism, Eagan cannot retain his cake and consume it as

well. The decision of the district court is affirmed.

9. We recognize that Eagan's 1989 withdrawal was subject to
the ten percent additional tax on early distributions, a tax
that would not apply if Eagan was taxed on the original
contributions as if made to a non-qualified plan. In our
view, however, it is not inequitable that Eagan should be
subject to this tax. Eagan enjoyed the economic benefit of
deferring for many years the tax on the plan contributions,
earning income on the portion of the contributed funds that
would otherwise have been paid to the IRS.

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