Fordham Law Review Volume 65 Issue 2 Article 11 1996 Equitable Recoupment: Revisiting an Old and Inconsistent Remedy Camilla E. Watson Follow this and additional works at: https://ir.lawnet.fordham.edu/flr Part of the Law Commons Recommended Citation Camilla E. Watson, Equitable Recoupment: Revisiting an Old and Inconsistent Remedy , 65 Fordham L. Rev. 691 (1996). Available at: https://ir.lawnet.fordham.edu/flr/vol65/iss2/11 This Article is brought to you for free and open access by FLASH: The Fordham Law Archive of Scholarship and History. It has been accepted for inclusion in Fordham Law Review by an authorized editor of FLASH: The Fordham Law Archive of Scholarship and History. For more information, please contact [email protected]. Equitable Recoupment: Revisiting an Old and Inconsistent Remedy Cover Page Footnote Associate Professor, University of Georgia School of Law. I wish to thank Brookes Billman, Walter Hellerstein, Margaret V. Sachs, and Alan Watson for their helpful comments on an earlier draft of this Article. I also wish to thank Patricia Bryant and David Gunderson for their research assistance. This article is available in Fordham Law Review: https://ir.lawnet.fordham.edu/flr/vol65/iss2/11 EQUITABLE RECOUPMENT: REVISITING AN OLD AND INCONSISTENT REMEDY Camilla E. Watson* TABLE OF CONTENTS INTRODUCTION ................................................. 692 I. RELATED EQUITABLE REMEDIES AND THEIR USE IN FEDERAL TAX LITIGATION ............................. 699 A. Estoppel and Quasi-Estoppel........................ 700 B. Equitable Tolling .................................... 708 C. Election ............................................. 708 D. Duty of Consistency................................. 710 II. RECOUPMENT AND SETOFF ............................. 713 A . Setoff ............................................... 714 B. The Equitable Recoupment Decisions of the Supreme Court ...................................... 717 1. Bull v. United States ............................ 717 a. The Nature of the Remedy .................. 719 b. Bull Contrasted With Lewis ................. 721 2. Stone v. W hite .................................. 722 a. The Balance of Equities..................... 723 1) Public Policy ............................ 724 2) The Actions of the Party Seeking Recoupment ............................ 724 3) The Actions of the Opposing Party: Are There Factors for or Against the Use of Recoupment? .... 725 b. Elements Applied in Stone .................. 725 3. McEachern v. Rose ............................. 726 4. Rothensies v. Electric Storage Battery Co ........ 731 III. SUBSEQUENT CASES AND THE RESULTING ELEMENTS .. 734 A. Single Transaction................................... 735 1. Ford v. United States ............................ 736 2. Wilmington Trust Co. v. United States ........... 739 B. Single Taxpayer or Identity of Interest ............... 743 C. Two Different Taxes ................................. 744 IV. EQUITABLE RECOUPMENT UNDER PROPOSED NEW ELEMENTS .............................................. 747 A. Is There an Adequate Legal Remedy? ............... 748 * Associate Professor, University of Georgia School of Law. I wish to thank Brookes Billman, Walter Hellerstein, Margaret V. Sachs, and Alan Watson for their helpful comments on an earlier draft of this Article. I also wish to thank Patricia Bryant and David Gunderson for their research assistance. 692 FORDHAM LAW REVIEW [Vol. 65 B. Is There an Inconsistent Theory of Taxation, as a Matter of Law, by the Opposing Party on a Single Transaction Producinga Double Tax, or a Double Benefit, on the Same Dollars?....................... 753 1. Inconsistency ................................... 753 2. Single Transaction .............................. 754 3. Identity of Interest .............................. 758 C. Does a Consideration of the Equities Favor the Application of Recoupment? ........................ 758 1. Unjust Enrichment ............................. 761 2. Is There a Defense to the Application of the Rem edy? ....... ................................ 763 a. Laches ...................................... 763 b. Unclean Hands ............................. 765 V. THE USE OF RECOUPMENT BY THE GOVERNMENT ...... 766 VI. PROCEDURAL AND JURISDICTIONAL PROBLEMS ......... 771 A. Equitable Recoupment as a Defense ................. 773 B. The Tax Court and Equity Jurisdiction.............. 775 C. Administrative Claims and Settlements .............. 781 VII. RECENT CASES AND COMMENTS: CONTINUING CONFUSION ............................................. 782 A. Hall v. United States ............................... 782 B. Fairley v. United States ............................. 784 CONCLUSION ................................................... 786 "It will not do to decide the same question one way between one set of litigants and the opposite way between another."' INTRODUCTION The federal tax system operates in a paradoxical way. On the one hand, it functions as a system of voluntary compliance,' but, on the other hand, it is based on statutory rules, many of which are so complex and intricate that they are comprehensible only to a tax ex- pert.3 Because of this paradox and the important role of the system in 1. Benjamin N. Cardozo, The Nature of the Judicial Process 33 (1921), quoted in Estate of Carter v. Commissioner, 453 F.2d 61, 64 (2d Cir. 1971). 2. Although this is the popular belief, there are contrary views. See, e.g., Kenneth L. Harris, On Requiring the Correction of Error Under the Federal Tax Law, 42 Tax Law. 515, 515 (1989) (arguing that the system is actually one of coercion because of the legal obligations to file and to pay, and because of the system of penalties that serve as a backup to these obligations); Tom Herman, Tax Report: A Special Sum- mary and Forecastof Federaland State Tax Developments, Wall St. J., June 29, 1994, at Al (quoting statement of IRS Chief Margaret Milner Richardson who referred to a sarcastic letter she received because she frequently refers to the tax system as "volun- tary": "He told me I must be from Mars if I really believe the U.S. has a voluntary tax system"). 3. See 26 U.S.C. §§ 1-9722 (1994) [hereinafter I.R.C.]. 1996] EQUITABLE RECOUPMENT 693 the functioning of the federal government, it is crucial that the public perceive the system to be fair.4 Thus, general principles are incorpo- rated into the statutory scheme that are designed to promote fairness while the system is preserved as an all-important source of revenue. One example of such a principle is the statute of limitations.5 The statute bars both the government and the taxpayer from asserting a6 claim against the other after the expiration of a specified time period. The policy behind such a time bar is not only fairness but also admin- istrative efficiency. From the government's perspective, the statute of limitations af- fords a final determination of revenue available for a particular period without threat of a refund claim by the taxpayer. From the taxpayers' perspective, the statute eliminates the duty to maintain records indefi- 4. See generally M.H. Hoeflich, Of Reason, Gamesmanship, and Taxes: A Juris- prudentialand Games TheoreticalApproach to the Problem of Voluntary Compliance, 2 Am. J. Tax Pol'y 9, 11-12 (1983) (arguing that tax reform is necessary not just to increase revenues, but "to deal with the widespread perception amongst the public that... the wealthy are able to avoid their fair share of the tax burden"). 5. See generally Charles W. Davis, Playing Safe with Statutes of Limitations, 16 N.Y.U. Ann. Inst. Fed. Tax'n 453 (1958) (discussing the application of the statute of limitations in federal tax cases). The statute may run in favor of either the taxpayer or the government. Although it is designed to be a neutral final settlement, in the public interest, the statute is generally construed strictly in favor of the government. Id. at 453; accord Badaracco v. Commissioner, 464 U.S. 386, 398 (1984) ("[W]hen courts construe a statute of limitations, [they] 'must receive a strict construction in favor of the Government.' (quoting E.I. DuPont de Nemours & Co. v. Davis, 264 U.S. 456, 462 (1924))); see also Bowers v. New York & Albany lighterage Co., 273 U.S. 346. 350 (1927) ("[T]he public interest should not be prejudiced by the default or negli- gence of public officers."). 6. The general statutory period for assessment is three years from the later of the due date of the return or the date the return is filed. I.R.C. § 6501(a)-(b) (1994). The statutory period for filing a claim for refund or credit of an overpayment is the later of three years from the date the return is filed or two years from the date of payment. I.R.C. § 6511(a) (1994); see also Commissioner v. Lundy, 116 S. Ct. 647, 657 (1996) (holding that two-year period applies if taxpayer receives a notice of deficiency and has not yet filed a return); Richards v. Commissioner, 37 F.3d 587, 590-91 & n.7 (10th Cir. 1994) (discussing jurisdictional distinctions between the Tax Court and the Fed- eral District Court of initially filing a return within three years after payment), cert. denied, 116 S. Ct. 813 (1996); Nunziato v. United States, No. Civ. 95-30205, 1996 VL 437538, at *2 (D. Mass. May 7, 1996) (distinguishing the two-year and three-year stat- utory periods). Under some circumstances, however, the normal statutory period may be extended. See eg., I.R.C. § 6501(e)(1)(A) (1994) (providing six-year period for omission of sub- stantial item of income);