122 T.C. No. 6
UNITED STATES TAX COURT
THOMAS E. JOHNSTON and THOMAS E. JOHNSTON, SUCCESSOR IN INTEREST
TO SHIRLEY L. JOHNSTON, DECEASED, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent*
THOMAS E. JOHNSTON, Petitioner v. COMMISSIONER OF INTERNAL
REVENUE, Respondent
Docket Nos. 26005-96, 2266-97. Filed February 11, 2004
Ps made a qualified offer, pursuant to sec. 7430,
I.R.C., to resolve Ps’ tax liabilities for the 1989,
1991, and 1992 tax years. R accepted Ps’ qualified
offer, without negotiation.
Thereafter, Ps sought to reduce the amounts stated
in the qualified offer by the amount of net operating
losses (NOLs) sustained in the 1988, 1990, 1993, and
1995 tax years. R refused to allow such a reduction,
claiming that R’s acceptance of Ps’ qualified offer
prevented Ps from reducing the agreed-upon amounts.
*
This opinion supplements our opinion in Johnston v.
Commissioner, 119 T.C. 27 (2002).
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Held: The parties entered into a contract to
settle the docketed cases, as evidenced by Ps’
qualified offer and R’s acceptance of that offer.
Held, further, Ps are not now allowed to reduce
the amounts stated in the qualified offer for the years
at issue by the amount of NOLs sustained in the 1988,
1990, 1993, and 1995 tax years.
Lorraine G. Howell and Kenneth M. Barish, for petitioners.
Nicholas J. Richards and Kevin W. Coy, for respondent.
SUPPLEMENTAL OPINION
NIMS, Judge: Respondent determined the following
deficiencies and penalties with respect to petitioners’ Federal
income taxes:
Penalties
Petitioner Year Deficiency Sec. 6662(a) Sec. 6663
Thomas E. Johnston and * 1989 $1,546,160 $309,232 $1,159,620
* * Shirley L. Johnston,
Deceased
Docket No. 26005-96
Thomas E. Johnston 1991 289,396 -- 217,047
Docket No. 2266-97 1992 341,908 -- 256,431
By answer respondent also asserted increased deficiencies and
penalties in docket Nos. 26005-96 and 2266-97.
These consolidated cases are presently before the Court on
respondent’s motion for summary judgment filed on September 2,
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2003. Petitioners filed an opposition to respondent’s motion,
and respondent filed a reply to petitioners’ opposition.
The issue for decision is whether respondent’s acceptance of
petitioners’ qualified offer precludes petitioners from reducing
the amounts stated in the qualified offer for the years at issue
by the amount of net operating losses (NOLs) sustained in the
1988, 1990, 1993, and 1995 tax years. We express no opinion as
to whether the claimed NOLs are valid for Federal income tax
purposes. Solely for the purpose of this adjudication, we assume
that the claimed NOLs are valid.
Unless otherwise indicated, all section references are to
sections of the Internal Revenue Code in effect at all relevant
times, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
Background
These cases were set for trial on a special trial calendar
to commence on March 3, 2003. On January 31, 2003, petitioners
made a qualified offer, pursuant to section 7430, to resolve
petitioners’ tax liabilities for the 1989, 1991, and 1992 tax
years. Petitioners’ qualified offer stated, in part:
Pursuant to Internal Revenue Code (“IRC”) Section
7430(g) and * * * Section 301.7430-7T(c)[Temporary
Proced. & Admin. Regs., 66 Fed. Reg. 727 (Jan. 4,
2001)], this letter shall constitute the above-
referenced taxpayer’s [sic] qualified offer to resolve
all adjustments at issues in the matters listed above.
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The taxpayer’s [sic] qualified offer is as follows
according to the case docket number and tax years
involved:
Docket No. Tax Year Amount of Qualified Offer
26005-96 1989 $ 35,000
2266-97 1991, 1992 $ 70,000
$105,000
This $105,000 offer is made as a qualified offer
for purposes of IRC §7430(g). Therefore, in making the
offer, the taxpayer is aware that his offer is to
resolve all adjustments in the court proceeding. Such
offer will fully resolve the taxpayer’s [sic] liability
as to those adjustments.
By letter dated February 10, 2003, respondent accepted
petitioners’ qualified offer, without negotiation.
After respondent accepted petitioners’ qualified offer,
petitioners raised with respondent the issue of reducing the
agreed-upon amounts by applying NOLs from the 1988, 1990, 1993,
and 1995 tax years.
On February 14, 2003, the Court held a conference call with
counsel for the parties. Counsel for the parties informed the
Court that the parties had reached a basis for settlement and
that there remained the issue of whether petitioners are allowed
to reduce the agreed-upon amounts for the 1989, 1991, and 1992
tax years by applying NOLs from the 1988, 1990, 1993, and 1995
tax years.
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On March 19, 2003, the parties filed a stipulation of
settled issues, which reserved the issue of whether petitioners
“can offset tax deficiencies * * * through net operating loss
carry forwards or carrybacks.”
On April 22, 2003, which was after respondent had accepted
petitioners’ qualified offer, petitioners filed an amendment to
petition in each docket in which petitioners claimed deductions
for the NOLs in question. After the supplemental pleadings were
closed, respondent filed the subject Motion for Summary Judgment,
which petitioners now challenge.
Discussion
I. Summary Judgment
Petitioners do not challenge as a procedural matter
respondent’s motion for summary judgment, see Rule 121(a) and
(b), and it appears that all prerequisites for summary
adjudication have been satisfied, id.; Rule 121(d).
II. Contentions of the Parties
Respondent contends that respondent’s acceptance of
petitioners’ qualified offer completely resolved the issue of
petitioners’ liabilities for the 1989, 1991, and 1992 tax years.
Respondent asserts that petitioners are not now able to raise new
issues relating to their 1989, 1991, and 1992 liabilities.
Petitioners contend that petitioners’ qualified offer
included only items in dispute in the cases at the time the offer
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was made. Petitioners argue that because the issue of the NOLs
was not in dispute when they made the qualified offer, the
qualified offer was exclusive of the amounts related to the NOLs.
Consequently, petitioners contend that they are entitled to
reduce the agreed-upon amounts for the 1989, 1991, and 1992 tax
years by applying NOLs from the 1988, 1990, 1993, and 1995 tax
years.
III. Analysis
The parties agree that petitioners’ offer, as stated in
their January 31, 2003, letter, was a qualified offer within the
meaning of section 7430(g). In now seeking to reduce the agreed-
upon settlement amounts for the 1989, 1991, and 1992 tax years by
the NOL amounts, petitioners are in effect asking us to treat the
settlement amounts as though they resulted from a court decision
in which various issues were resolved, but where entry of
decision awaited the availability, if any, of various NOLs. See,
e.g., Gen. Signal Corp. & Subs. v. Commissioner, 104 T.C. 248
(1995). We must therefore decide whether an agreement reached by
way of the qualified offer provision may be dealt with in the
manner petitioners request, and thus should be treated
differently from the way this Court treats settlement agreements
reached outside the parameters of the qualified offer provision.
Section 7430 provides for the award under certain
circumstances of administrative and litigation costs to a
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taxpayer. An award of administrative and litigation costs may be
made where the taxpayer (1) is the “prevailing party”, (2) has
exhausted available administrative remedies (in the case of
litigation costs), (3) did not unreasonably protract the
administrative or judicial proceeding, and (4) claimed reasonable
costs. Sec. 7430(a), (b)(1), (3), (c). One way for a taxpayer
to establish that the taxpayer is the prevailing party is by a
comparison of the amount of the last qualified offer with the
portion of the judgment attributable to the adjustments at issue
when that qualified offer was made. Sec. 7430(c)(4)(E); sec.
301.7430-7T(b)(3), Temporary Proced. & Admin. Regs., 66 Fed. Reg.
727 (Jan. 4, 2001).
Section 7430(c)(4)(E) and (g) provides, in part, as follows:
SEC. 7430(c). Definitions.--For purposes of this
section--
* * * * * * *
(4) Prevailing party.--
* * * * * * *
(E) Special rules where judgment less than
taxpayer’s offer.--
(i) In general.--A party to a court proceeding
meeting the requirements of subparagraph (A)(ii)
shall be treated as the prevailing party if the
liability of the taxpayer pursuant to the judgment
in the proceeding (determined without regard to
interest) is equal to or less than the liability of
the taxpayer which would have been so determined if
the United States had accepted a qualified offer of
the party under subsection (g).
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* * * * * * *
(g) Qualified Offer.--For purposes of subsection
(c)(4)--
(1) In general.--The term “qualified offer” means a
written offer which--
(A) is made by the taxpayer to the United
States during the qualified offer period;
(B) specifies the offered amount of the
taxpayer’s liability (determined without regard to
interest);
(C) is designated at the time it is made as a
qualified offer for purposes of this section; and
(D) remains open during the period beginning on
the date it is made and ending on the earliest of
the date the offer is rejected, the date trial
begins, or the 90th day after the date the offer
is made.
The legislative history of section 7430 provides insight
into the purpose of section 7430:
The Committee believes that settlement of tax
cases should be encouraged whenever possible.
Accordingly, the Committee believes that the
application of a rule similar to FRCP 68 [rule 68 of
the Federal Rules of Civil Procedure] is appropriate to
provide an incentive for the IRS to settle taxpayers’
cases for appropriate amounts, by requiring
reimbursement of taxpayer’s costs when the IRS fails to
do so. [S. Rept. 105-174, at 48 (1998), 1998-3 C.B.
537, 584.]
Additionally, we have previously stated that “The purpose
underlying the qualified offer provision of section 7430(c)(4)(E)
* * * is to encourage settlements by imposing litigation costs on
the party not willing to settle.” Gladden v. Commissioner, 120
T.C. 446, 450 (2003).
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As the very purpose of the qualified offer provision is to
encourage settlements, we conclude that there is no persuasive
reason why a settlement reached by way of the qualified offer
provision should be treated any differently from the way this
Court treats settlement agreements reached outside the parameters
of the qualified offer provision.
As contracts, settlements are governed by general principles
of contract law. Dorchester Indus. Inc. v. Commissioner, 108
T.C. 320, 330 (1997), affd. without published opinion 208 F.3d
205 (3d Cir. 2000). Settlement of an issue before the Court does
not require any particular method or form and can be accomplished
by letters of offer and acceptance. Id. Settlement agreements
are effective and binding once there has been an offer and an
acceptance; filing the agreement with the Court is not required
for the agreement to be effective and binding. Id. at 338.
We are convinced that the proposed figures conveyed to
respondent’s counsel by way of the January 31, 2003, letter from
petitioners’ counsel constitute the definite and material terms
of an offer to settle the docketed cases, and we so hold. The
terms of that offer were accepted by respondent, as evidenced by
the February 10, 2003, letter. We believe that the parties
entered into a contract to settle the docketed cases, and we so
hold.
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Petitioners contend that temporary regulations promulgated
under section 7430 support their position that new issues may be
raised after an agreement is reached if the agreement is reached
by way of the qualified offer provision. We reject this
contention.
Section 301.7430-7T(c)(3), Temporary Proced. & Admin. Regs.,
66 Fed. Reg. 728 (Jan. 4, 2001), provides, in part:
A qualified offer specifies the offered amount if it
specifies the dollar amount for the liability of the
taxpayer * * *. This amount must be with respect to
all of the adjustments at issue in the administrative
or court proceeding at the time the offer is made and
only those adjustments. The specified amount must be
that amount, the acceptance of which by the United
States will fully resolve the taxpayer’s liability, and
only that liability, (determined without regard to
adjustments stipulated by the parties to be fully
resolved through another pending court or
administrative proceeding, or interest, unless interest
is a contested issue in the proceeding) for the type or
types of tax and the taxable year or years at issue in
the proceeding.
Thus, the regulation contains three requirements: (1) The
offered amount must specify the dollar amount for the liability,
(2) the offered amount must be with respect to all adjustments at
issue and only those adjustments, and (3) the offered amount must
be an amount that will fully resolve the taxpayer’s liability for
the type(s) of tax and tax year(s) at issue.
Petitioners focus on the second requirement of this
regulation, arguing that the language “and only those
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adjustments” prohibits taxpayers from including in the offered
amount any items that were not in dispute at the time the
qualified offer was made.
Respondent argues that petitioners misinterpret the
regulatory language. Respondent argues that the plain language
of the third requirement, which provides that the offered amount
be that amount which will fully resolve the taxpayer’s liability,
prevents taxpayers from raising new issues once a qualified offer
is accepted. Hence, respondent argues that petitioners’
interpretation of the second requirement conflicts with the third
requirement. As an alternative to petitioners’ interpretation of
the second requirement, respondent argues that the second
requirement is primarily concerned with the consequences of the
rejection of a qualified offer. As respondent notes, if new
issues are raised after the rejection of a qualified offer, the
amount of liability attributable to those new issues is not
considered when comparing the amount of an eventual judgment to
the amount of the last qualified offer. Sec. 7430(c)(4)(E); sec.
301.7430-7T(b)(3), Temporary Proced. & Admin. Regs., 66 Fed. Reg.
727 (Jan. 4, 2001).
Respondent argues that, in order to comply with the third
requirement, if petitioners wanted to apply the NOLs to reduce
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the liabilities set forth in the qualified offer, petitioners
should have at least stated that the offered amount was subject
to reduction by application of NOLs. We agree with respondent.
Petitioners’ interpretation of the regulation renders the
third requirement meaningless. In order to give effect to the
third requirement, an offered amount must be one that will fully
resolve a taxpayer’s liability for the type(s) of tax and tax
year(s) at issue. If taxpayers were allowed to reduce the amount
of the qualified offer after the qualified offer was made, then
the qualified offer would not be one that, if accepted, would
fully resolve the taxpayer’s liability, thus giving no effect to
the third requirement. In the current case, petitioners’
qualified offer would not fully resolve their liabilities for the
type of tax and tax years at issue if petitioners were now able
to apply the NOLs to reduce the offered amount.
Additionally, the fact that the NOLs were not in dispute at
the time the qualified offer was made is a matter of petitioners’
own doing. Petitioners admittedly raised the issue of the NOLs
for the first time after the agreement was entered into. In
petitioners’ Opposition to Respondent’s Motion for Summary
Judgment, petitioners state that, immediately upon acceptance of
the qualified offer by respondent, petitioners “reminded”
respondent that petitioners had several years of tax loss
carryforwards and carrybacks.
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Petitioners could have included the NOLs among the
“adjustments at issue in the administrative or court proceeding”
by the simple expedient of moving to amend their petitions to
claim the NOL deductions before, rather than after, making their
qualified offer. Had that motion been made and granted, which
under the postulated conditions would appear to have been likely,
cf. Cloes v. Commissioner, 79 T.C. 933 (1982), the NOLs would
have become an “adjustment at issue” for purposes of this court
proceeding. Instead of moving to amend the petitions before
making the qualified offer, petitioners waited until after
respondent accepted the qualified offer to move to amend their
petitions to claim the NOL deductions. These motions to amend
their petitions made after their qualified offer was accepted are
obviously too late. As we stated in Korangy v. Commissioner,
T.C. Memo. 1989-2, affd. 893 F.2d 69 (4th Cir. 1990): “The time
for petitioners to make a thorough examination of their case is
prior to the date of trial, not subsequent to their execution of
a settlement agreement.”
Petitioners assert that it would have been premature to
raise the issue of the NOLs prior to arriving at the agreement,
which included taxable income for the years in issue. Contrary
to this assertion, petitioners could have pleaded the NOL
deductions as an alternative position. Rule 31(c) allows
pleading in the alternative, and the Court generally requires it.
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See also Cloes v. Commissioner, supra at 937; Vest v.
Commissioner, T.C. Memo. 1995-188, affd. without published
opinion 89 F.3d 839 (7th Cir. 1996).
In a situation similar to the one here, the taxpayers in Yoo
Han & Co. v. Commissioner, T.C. Memo. 1991-308, attempted to
claim a number of deductions, including a net operating loss
carryback deduction by the corporate taxpayer, after reaching a
settlement agreement with the Commissioner. The taxpayers in
that case also claimed that it would have been premature to claim
the net operating loss carryback prior to arriving at the
settlement that increased their taxable income. In that case, we
declined to insert into the settlement agreement terms that the
taxpayers for whatever reason failed to include. Id.
Additionally, respondent made concessions by accepting the offer,
and “we will not force further concessions upon respondent.” Id.
We conclude that respondent’s acceptance of petitioners’
qualified offer fully resolved the issue of petitioners’
liabilities for the 1989, 1991, and 1992 tax years. Petitioners
are not now allowed to add additional terms to that agreement by
applying NOLs from other years to reduce the agreed-upon amounts.
One final note. On December 29, 2003, the Commissioner
published final regulations, pursuant to section 7430, that
relate “to the qualified offer rule, including the requirements
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that an offer must satisfy to be treated as a qualified offer
under section 7430(g)”. Preamble to sec. 301.7430-7, Proced. &
Admin. Regs., 68 Fed. Reg. 74848 (Dec. 29, 2003). We note that
the final regulations added Example 4 to sec. 301.7430-7(e),
Proced. & Admin. Regs., which briefly discusses whether a
taxpayer may reduce the amount the taxpayer will pay pursuant to
a qualified offer, after the offer is accepted by the
Commissioner, by applying net operating loss carryovers. The
language of Example 4 is as follows:
Example 4. Offer must resolve full liability. Assume
the same facts as in Example 1, except that A makes a
qualified offer that is accepted by the IRS. After the
offer is accepted, A attempts to reduce the amount A
will pay pursuant to the offer by applying net
operating loss carryovers to the years in issue.
Because the net operating losses were not at issue when
the offer was made, A’s offer was a qualified offer.
Whether A is entitled to apply net operating losses to
reduce the amount stated in the offer will depend upon
the application of contract principles, local court
rules, and, because net operating losses are at issue,
section 6511(d) and related provisions.
As stated, Example 4 was not part of the temporary regulations.
See sec. 301.7430-7T(e), Temporary Proced. & Admin. Regs., 66
Fed. Reg. 728 (Jan. 4, 2001). The final regulations are
applicable to qualified offers made after December 24, 2003.
Sec. 301.7430-7(f), Proced. & Admin. Regs. Petitioners’ offer
was made before that date.
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We have considered all of the other arguments made by the
parties, and to the extent that we have not specifically
addressed them, we find them to be without merit.
To reflect the foregoing,
An appropriate order granting
respondent’s motion for
summary judgment will be issued,
and decisions will be entered
under Rule 155.