Income Tax

Signed 5/6/02








Petitioners, ) Appeal No. 01-1397


v. ) Account No. #####

) #####




COMMISSION, ) Audit Period: 1998


Respondent. ) Judge: Davis




G. Blaine Davis, Administrative Law Judge


For Petitioner: PETITIONER 2


For Respondent: Mr. John C. McCarrey, Assistant Attorney General

Mr. Dan Engh, Auditing Division

Mr. Steve Nelson, Auditing Division



This matter came before the Utah State Tax Commission for an Initial Hearing pursuant to the provisions of Utah Code Ann. §59-1-502.5 on April 8, 2002.

In October 1997, a child was placed with the Petitioners for adoption. The legal proceedings finalized the adoption in 1998, but most of the adoption expenses were paid in 1997. When they filed their 1997 return, their accountant told them that they were not allowed to claim any of the adoption expenses until the adoption was final. Since the adoption was not final until April 1998, Petitioners did not claim any of their expenses for the adoption until they filed their 1998 tax return. When Petitioners claimed the adoption credit on their 1998 income tax return, it was claimed in conformity with federal tax law, which allows an adoption credit during the year the adoption is finalized. Then if adoption expenses are paid during or after the tax year in which the adoption is finalized, the credit is allowed for the tax year in which the expense is paid or incurred. Petitioners acted in good faith and relied on the advice of two different accountants.

On August 10, 2001, Respondent issued a statutory notice of audit change in which it denied the adoption expense deduction to Petitioners. Petitioners then attempted to file an amended 1997 Utah state income tax return claiming the credit, but the amended return was disallowed due to the running of the statute of limitations. The three-year statute of limitations on the 1997 return expired before Petitioners received the statutory notice of audit change on their 1998 income tax return. Petitioner argued that had the state of Utah audited their records earlier, they would have been able to file an amended return claiming the adoption expenses.

At the time Petitioners filed their 1998 income tax return, they were unaware that the adoption expenses are required to be deducted in the tax year the expenses were incurred pursuant to Utah Administrative Code Rule R865-9I-48 (E) which states, “qualified adoption expenses must be deducted in the tax year in which the expenses are paid by the party incurring the expenses.” Accordingly, under Utah law the Petitioners were required to claim the 1997 expenses on their 1997 tax return.

In the past, a Utah income tax return for a tax year that was beyond the statute of limitations could not be modified to reflect a deduction that was taken in the wrong year. However, the Utah Tax Commission is in the process of amending this policy to reflect the equitable recoupment doctrine.

Under the equitable recoupment doctrine, the following requirements must be met:

1.        A payment of tax was made in a year that is now barred by the statute of limitations;

2.        An assessment of tax has now been made arising out of the same transaction, item, or taxable event as the one that gave rise to the overpayment;

3.        The transaction, item or taxable event has now been inconsistently subjected to two taxes; and

4.        If the transaction, item or taxable event involves two or more taxpayers, there is sufficient identity of interest that they should be treated as one.

If all of these criteria have been met, the time-barred overpayment may be offset against the claimed deficiency.

Petitioners made an error when they filed their 1997 return. They incorrectly failed to include adoption expenses incurred during the year because their accountant instructed them that the expenses could not be deducted until the adoption was final. As a result, $$$$$ of adoption expenses were disallowed in the tax year 1998. Petitioners are now being assessed additional tax of $$$$$ plus interest on their return. This deficiency is the result of the same taxable event and it results in Petitioners being unable to deduct the 1997 adoption expenses because the statute of limitations has run on amending their return. Accordingly, the doctrine of equitable recoupment should apply.


The taxable income on a Utah Individual Tax return is the same amount as the Federal Taxable income with modifications, subtractions and adjusted as set forth in §59-10-114. Utah Code Ann. §59-10-112.

Utah Code Ann. §59-10-114 (2) (c) provides a deduction from income of: “the amount of adoption expenses which, for purposes of this Subsection (2) (c), means any actual medical and hospital expenses of the mother of the adopted child which are incident to the child’s birth and any welfare agency, child placement service, legal, an other fees or costs relating to the adoption.”

Utah Administrative Code Rule R865-9I-48 (E) provides “qualified adoption expenses must be deducted in the tax year in which the expenses are paid by the party incurring the expenses.”

The doctrine of equitable recoupment is applicable to a limited number of circumstances.


In Bull v. United States, 295 U.S. 247 (1935) the doctrine of equitable recoupment was first adopted. In that case, the executor of an estate included some partnership distributions in the taxable estate and paid estate tax. Four years later, the IRS determined that those payments should have been included in the estate’s income tax return and assessed an income tax deficiency. The IRS refused to allow a credit for the estate taxes paid. The taxpayer paid the income tax deficiency and filed a timely claim for refund. The Supreme Court allowed a credit for the excess estate taxes paid on the ground that a tax deficiency is essentially a claim by the government for a debt. If the taxpayer has overpaid other taxes on the same transaction, there is, in reality, no debt. In the Court’s words:

If the claim for income tax deficiency had been the subject of a suit, any counter demand for recoupment of the overpayment of estate tax could have been asserted by way of defense and credit obtained notwithstanding the statute of limitations had barred an independent suit against the government therefore. This is because recoupment is in the nature of a defense arising out of some feature of the transaction upon which the plaintiff’s action is grounded. Such a defense is never barred by the statute of limitations so long as the main action itself is timely.

In a more recent decision, the court found that equitable recoupment is used to offset mutual debts, when one debt is time barred and both debts arise out of the same transaction. Woelffer v. Happy States of Amer., Inc., 626 F. Supp. 499, 503 (N.D. Ill. 1985). Accordingly, taxable debts that are enforceable and not barred by the statute of limitations may be offset by a previous unclaimed tax credit arising out of the same transaction where the taxpayer failed to claim the credit prior to the expiration of the statute of limitations.

This doctrine may also prevent some refunds. The government can utilize equitable recoupment to reduce a taxpayer’s timely claim for refund of an overpayment by the amount of the deficient tax for a previous year which tax should have been collected, but cannot be collected due to the running of the statute of limitations on the previous deficiency. See Stone v. White, 301 U.S. 532 (1937); Tech Adv. Mem. 8,552,005 (Aug. 28, 1985). In the Stone case, a trust paid the income it received to its sole beneficiary and also paid tax on that income. After the statute of limitations had run on the government’s right to assert a tax against the beneficiary, the trust filed a timely refund claim, asserting that the beneficiary, not the trust, was the proper taxpayer. The Court held that because of the identity of interest between the trust and the beneficiary, the Government could invoke equitable recoupment to assert its claim against the beneficiary as a defense to the refund claim.

The Court has also held that the doctrine is only a “shield” and not a “sword.” In other words, it can be raised as a defense to an assessment, but will not create jurisdiction for a refund claim when there is no timely case before the court. In United States v. Dalm, 494 U.S. 596(1990), the taxpayer, the administrator of her employer’s estate, had received gifts from her employer’s brother because he believed his brother “wanted her to share in the estate.” She paid a gift tax on some of those receipts. The IRS later argued that those receipts were additional taxable income for administering the estate. The case was settled, for a substantial additional tax payment. The taxpayer then sought a refund of the gift tax. The IRS denied the refund because it was barred by the statute of limitations. The Supreme Court upheld the denial, because there was no existing case in which a court could have jurisdiction. The estate tax claim was time-barred and the income tax claim had been settled. The Court seemed to acknowledge, however, that either the IRS or a court could have granted a credit if Dalm had claimed it when disputing the income tax liability.

Accordingly, if a taxpayer has overpaid taxes in one area and then is found to be deficient in another area, the time-barred overpayment may be used to offset the claimed underpayment.


Based upon the foregoing, the Commission instructs the Respondent to reopen the file and revise the audit in accordance with the doctrine of equitable recoupment. It is so ordered.

This decision does not limit a party's right to a Formal Hearing. However, this Decision and Order will become the Final Decision and Order of the Commission unless any party to this case files a written request within thirty (30) days of the date of this decision to proceed to a Formal Hearing. Such a request shall be mailed to the address listed below and must include the Petitioner's name, address, and appeal number:

Utah State Tax Commission

Appeals Division

210 North 1950 West

Salt Lake City, Utah 84134

Failure to request a Formal Hearing will preclude any further appeal rights in this matter.

DATED this 6th day of May , 2002.




G. Blaine Davis

Administrative Law Judge




The Commission has reviewed this case and the undersigned concur in this decision.

DATED this 6th day of May , 2002.


Pam Hendrickson R. Bruce Johnson

Commission Chair Commissioner




Palmer DePaulis Marc B. Johnson

Commissioner Commissioner