Equitable Recoupment Denied Aggrieved Misclassified Taxpayer

A computer technician named Ohan Karagozian (work performer) was for many years classified by his work provider (Coty USA, LLC) as an independent contractor.  When the work provider terminated his services in 2008, the work performer filed an unemployment compensation claim despite the fact that Karagozian had, for the years 2002 – 2007, filed his tax returns as a Schedule C independent contractor and paid both income tax and SE tax for those years.  If you have never seen this in your practice, stay tuned---you will, I guarantee it!

Karagozian’s state Dept. of Labor (NY) did not deny his claim.  Instead, they determined that the work performer had been misclassified by the work provider and an employee-employer relationship existed for the years 2002 – 2007.  Now, you know what that means.  Someone (the work provider – Coty) did not include the work performer (Karagozian) when they reported wages subject to state unemployment tax each year.  Once it became clear to Karagozian that something was not right, he filed an SS-8 form with the IRS and asked for a determination of his status for those years---was he an employee or was he an independent contractor for federal purposes?



You would think that good things were about to happen for Karagozian.  His filing and the affirmative (you are/were an employee) response from the IRS triggered a subsequent letter - you may need to amend your income tax returns for those six years!  Well, Karagozian responded by amending his 2008 return to reclassify his self-employment income for the year of termination as wages.  As a result, the SE tax of $3,475 which was due on the original return was abated.  This reduced his assessed but unpaid tax liability to $25,115.  Not a good situation to be in (apparently he did not make estimated tax payments).

To make matters worse, Karagozian made no attempt to amend any of the earlier years which were (at that time) not time-barred, so he allowed the statute of limitations to run its course and concentrated on tax year 2008, although concentrated may be an inappropriate way to describe his attitude when, on March 23, 2011, an IRS employee requested a payment plan.  The taxpayer responded that he did not wish to discuss payment options at that time, apparently thinking that this would shift the IRS collection effort into low gear.  It did not.

When IRS collection efforts continued, Karagozian filed a petition in Tax Court on May 3, 2011 stating:  “I do understand that I owe certain taxes on monies I declared as income of my 2008 income tax return and definitely want to make payments toward same, but just don’t know how to calculate.”  As you can well imagine, that did not impress the IRS and they moved for summary judgment (there is no genuine dispute as to any material fact and we are entitled to a favorable decision as a matter of law).  As stated in the Court’s discussion portion of the case – “When a motion for summary judgment is properly supported, the nonmoving party [in this case Karagozian] may not rest upon the mere allegations or denials of his pleading but must set forth specific facts showing there is a genuine issue for trial.”  Tax Court Rule 121(d).

Karagozian argued that Coty was liable for the taxes not withheld from his “wages” during 2008.  While the Court agreed that this was so, the Court stated that the taxpayer was also liable.  Citing T. C.. Memo 1997-521 (Goins v. Comm.) the Court stated that “The failure of an employer to withhold income tax does not relieve the employee of his or her obligation to pay the tax.”  This reasoning also applied, said the Court, to the FICA/Medicare tax not withheld.

However, Karagozian thought that he had a fallback position.  What about those erroneously paid SE taxes for the years 2002 – 2007?  Now that there was a retroactive determination that he had been misclassified, there should be an available offset.  Even though the years were otherwise time-barred, the doctrine of equitable recoupment [IRC Sec. 6214(b)] should apply.  When asserted by the taxpayer, “…the equitable recoupment doctrine permits a taxpayer to raise a time-barred claim in order to reduce or eliminate the money owed on the timely claim.”

Sounds good in theory, but there was a big problem in the facts and circumstances applicable to Karagozian.  The tax due was assessed for 2008.  The potential refund or overpaid amounts applied to earlier years.  The IRS had not audited or otherwise adjusted 2002 – 2007, nor had Karagozian filed overpayment claims (i.e. amended returns).  He did nothing.  The IRS did nothing.

The doctrine of equitable recoupment requires an item or taxable event to have been inconsistently subjected to two taxes---effectively a double tax---and the inequity should be dealt with by allowing one tax (now abated in a time-barred year) to offset the tax  applicable as a result of the change in tax circumstances.  Karagozian’s dilemma was that he sought to open six time-barred years in order to create an offset against a seventh year’s unpaid assessment.  The Court would not allow this approach, citing Rothensies v. Electric Storage Battery Co.  329 U.S. 296 (1946), and concluded that income taxes are assessed on an annual bases and each year is the origin of a new liability.  Lacking any equitable offset for 2008, the taxpayer’s petition was denied.

-Ohan Karagozian v. Commissioner, T.C. Memo 2013-164 (7/8/2013).