Tax Court Thwarts Use of Rule 155 to Raise New Issues

Rule 155 Basics

Where the parties have made mutual concessions resolving certain issues, the Tax Court normally directs that decisions will be entered under Tax Court Rule 155(a). It provides that, “[w]here the Court has filed … its opinion … determining the issues in a case, it may withhold entry of its decision for the purpose of permitting the parties to submit computations … showing the correct amount to be included in the decision.”

Rule 155 calculations are designed to ascertain the bottom-line tax effect of the determinations made in the Tax Court’s opinion. If the parties’ calculations disagree, the court has discretion under Rule 155(b) to afford them an opportunity to be heard on these disagreements.

Captioned “Limit on Argument,” Rule 155(c) outlines the permissible scope of such argument. It provides that “argument under this Rule will be confined strictly to consideration of the correct computation of the amount to be included in the decision resulting from the findings and conclusions made by the Court.” A party may not use a Rule 155 calculation to seek reconsideration of the issues or matters disposed of by the Tax Court’s findings and conclusions. And, no argument will be heard upon or consideration given to any new issues.

The Rule 155 calculation process isn’t intended to be one by which a party can raise issues for the first time that hadn’t previously been addressed. Rule 155 calculations commonly include:

  • Mathematical adjustments triggered by the change of taxable income or adjusted gross income, and
  • Adjustments attributable to the percentage limit on contributions or medical deductions.

A new issue is generally an issue other than a purely mathematically generated calculation item.

The Case at Hand

In a previous decision, the Tax Court held that the taxpayers, three sisters, weren’t entitled to foreign tax credits under Sec. 901 for certain amounts paid to the U.S. Virgin Islands.

At issue in these cases were two categories of payments received by the Virgin Islands Bureau of Internal Revenue (VIBIR) during 2001 and 2002:

  1. Payments made directly to the VIBIR by them or their agents that accompanied their territorial tax returns filed with the VIBIR, and
  2. Estimated tax payments to the IRS, with federal income tax withheld from their wages, that were “covered into” the Treasury of the Virgin Islands pursuant to Sec. 7654(a).

Under Sec. 7654(a), the net collection of federal income tax for each tax year with respect to an individual who’s a bona fide resident of a U.S. possession will be covered into the treasury of the specified possession of which the individual is a bona fide resident.

The IRS and the taxpayers had executed stipulations of settled issues that resolved all but one of the issues involved in these cases. Shortly thereafter, they filed, and the Tax Court granted, a motion for leave to submit the cases for decision without trial under Rule 122.

In that motion, the taxpayers agreed that the only issue that remained for resolution was whether they were entitled to a foreign tax credit for any payments made to the U.S. Virgin Islands for 2001. The taxpayers agreed that these cases didn’t require a trial for submitting evidence because the parties had stipulated all evidence needed to resolve this issue.

Not Bona Fide Residents

In its opinion, the Tax Court ultimately rejected the taxpayers’ argument. First, it held that they’d failed to show that the amounts in question constituted “taxes paid” under Sec. 901(b)(1). Income taxes paid to foreign jurisdictions or U.S. possessions are creditable only to the extent that they’re compulsory amounts paid in satisfaction of legal obligations. The taxpayers had conceded that they weren’t bona fide residents of the Virgin Islands in 2001 and they had no Virgin Islands–source income for 2001. Because they had no legal obligation to pay Virgin Islands income tax, the amounts paid to the VIBIR didn’t constitute creditable foreign taxes.

Second, assuming for argument’s sake that the taxpayers had paid taxes to the Virgin Islands, the court held that any credit for 2001 would be barred by the Sec. 904 limitation, which generally limits the foreign tax credit to the U.S. tax imposed on the taxpayer’s foreign-source income. As the taxpayers had failed to establish that they had any taxable foreign-source income for 2001, their Sec. 904 limitation was zero.

Finally, the Tax Court explained that the overall statutory scheme demonstrates that Congress didn’t intend that Virgin Islands taxes paid by U.S. citizens or residents be creditable under Sec. 901. Accordingly, the taxpayers weren’t entitled to the claimed tax credits.

Inconsistent Calculations

During the litigation, the parties were ordered to submit calculations for entry of decision under Tax Court Rule 155. But their calculations disagreed. The IRS’s calculations matched almost exactly the deficiencies that the taxpayers had agreed would be due in the event the court rejected their position concerning the claimed foreign tax credits. On the other hand, the taxpayers submitted calculations showing deficiencies about 60% smaller than those calculated by the IRS. These differences reflected the taxpayers’ contention that the amounts paid to the VIBIR in 2001 and 2002, which the court had held weren’t “taxes paid” for Sec. 901 purposes, constituted state or local income taxes for which deductions should be allowed under Sec. 164(a). The taxpayers hadn’t advanced this alternative contention at any previous point in the litigation.

The taxpayers moved for leave to amend their petitions under Tax Court Rule 41(b)(1), setting forth another new legal argument and asserting that both new issues had been tried by consent. The taxpayers then filed a motion to reopen the record to permit the introduction of new evidence relating to their second new legal theory.

The Tax Court denied the taxpayer’s motion for leave to amend, essentially because their proposed amendments would be futile. Further, with respect to the second category of payments — those “covered into” the VIBIR — the court noted the existence of a jurisdictional question. Because the payments for which the taxpayers claimed withholding and related credits had been made more than three years before the mailing of the notices of deficiency, Sec. 6512(b) arguably deprived the court of jurisdiction to determine overpayments.

In their response to the order to show cause why the Tax Court shouldn’t enter decisions consistent with the IRS’s calculations, the taxpayers urged that the court would have jurisdiction to consider their new claims for withholding and related credits. The taxpayers further challenged the IRS’s position that these payments, once “covered into” the VIBIR, were no longer available to offset their U.S. tax liabilities. The taxpayers alleged that “secret agreements” existed between the IRS and the VIBIR governing such payments and that these agreements could be related to the tax law merits of their position. The taxpayers moved to reopen the record.

In response, the IRS denied that either of the new issues that the taxpayers sought to raise had been tried by consent, stating that it “did not expressly or implicitly consent to trial of the new matters raised in petitioners’ motion for leave to amend.” The agency also contended that the taxpayers’ motion should be denied in any event because it was futile. In addition, the IRS noted that the taxpayers were cash-basis taxpayers and that the payments their agents had made directly to the VIBIR were made in 2002. Thus, those payments couldn’t possibly give rise to deductions for 2001, the tax year in issue. Finally, the IRS contended that the payments that the agency had “covered into” the VIBIR, once removed from the taxpayers’ 2001 accounts, were no longer available to offset their 2001 U.S. income tax liabilities.

No New Issues

The Tax Court held that the taxpayers couldn’t raise new issues in a Rule 155 proceeding, and that their motion to reopen the record was accordingly denied. It stated that, when the taxpayers submitted these cases for decision without trial under Rule 122, they joined the IRS in representing that the only issue remaining for resolution was whether they were entitled to a foreign tax credit for any payments made to the U.S. Virgin Islands for 2001. That was the only legal issue addressed by the parties in their briefs or by the court in its opinion.

In submitting Rule 155 calculations, the parties were directed to calculate the tax deficiencies that flowed from the Tax Court’s rejection of the taxpayers’ claimed foreign tax credits, considering other concessions each party had made. In its calculations, the IRS did exactly that. The court concluded that the taxpayers, by contrast, sought to use their Rule 155 calculations to raise first one, and then two, legal issues that they hadn’t advanced at any previous point in the litigation. Both were “new issues” within the meaning of Rule 155(c).

The court reasoned that, if a matter was neither placed in issue by the pleadings nor addressed as an issue at trial or discussed by the Tax Court in its previous opinion — or if it would necessitate retrial or reconsideration — that matter may not be raised in the context of a Rule 155 computation. A matter qualifies as a “new issue” for purposes of Rule 155 where, to decide the issue, the court would have to reopen the record and conduct further proceedings to admit additional evidence. Proper judicial administration demands that there be an end to litigation and that bifurcated trials be avoided.

Rule 155 isn’t an opportunity for either party to get adjustments for issues not raised in the deficiency notice, in the pleadings in the pretrial memoranda or at trial. The Tax Court noted that it has rigorously enforced the bar against raising new issues in a Rule 155 proceeding. The court has found that a matter may be deemed a “new issue” in the Rule 155 context even if it has calculational aspects. For example, it has treated as “new issues” in a Rule 155 proceeding questions such as entitlement to a net operating loss carryback, the ability to use income averaging, a change to the useful life of a depreciable asset and the application of an accounting treatment.

Second Chance Unlikely

When going up against the IRS in court, it’s critical to make your case the first time around. As this decision shows, it’s unlikely — though not impossible — to get a second chance.