Good Review Case on Claims for Refund and Variance for Tax Procedure Students (9/14/13)

In Cencast Services, L.P. v. United States, 729 F.3d 1352 (Fed. Cir. 2013), here, the Federal Circuit (Judge Dyk) held that 

1.  "Cencast's liability for employment taxes under the Federal Unemployment Tax Act ('FUTA') and the Federal Insurance Contribution Act ('FICA') is determined by reference to the employees' "employment" relationships with the common law employers for which Cencast remits taxes (i.e., the production companies), and that the common law employers cannot decrease their liability by retaining entities such as Cencast to actually make the wage payments to the employees."

2.  Cencast is barred by the doctrine of variance from raising a theory in its refund suit not raised in its claim for refund.  The new argument was that some of the workers were independent contractors rather than employees.

First, it is useful to note the role served by Cencast and the other companies involved in the suit because it offers a small window into the movie production business.  Here is the background from the opinion:

The evolution of the motion picture and television industries over the past century has resulted in this tax case concerning FUTA and FICA tax liability. In the early part of the twentieth century, motion picture productions were primarily controlled by large, major motion picture and television studios, and production workers enjoyed long-term, continuous employment relationships with those studios. These studios paid wages to these employees, and, as the common law employers of these workers, were liable for employment taxes on those wages, and remitted those taxes directly to the Internal Revenue Service ("IRS"). 

Since the late 1970s, however, many smaller production companies have emerged and have created movies and television programs independently from the large studios. As a result of this trend, many production workers are now employed by several different production companies during the course of a year, rather than by a single large production studio. Thus, in any given year, a given production worker might earn wages from several production companies, all of whom (being common law employers) would be individually liable for employment taxes on those wages. The complex web of production companies and production workers that evolved made administration of payroll, benefits, collective bargaining agreements, and taxes increasingly difficult. 

Entities like Cencast, which are also known as payroll service companies ("Service Companies"), emerged to address these problems. Over the last twenty-five years, virtually all independent production companies have contracted with Service Companies for payroll and related services. Cencast and other Service Companies compute and pay compensation to production workers, report and pay compensation to multi-employer pension and benefit funds, provide post-production financial reporting, and pay employment taxes to the IRS. 

Although they contract with the Service Companies, production companies both hire and supervise the individual production workers—as they had done in the pre-Service Company era. In general, Cencast and other Service Companies have no role in selecting or supervising production workers. The only change is that entities like Cencast—and not the production companies—now pay the production workers and administer the production companies' payroll and employment tax obligations. It is undisputed in this case that Cencast is not the common law employer of production workers.

* * * * 

Between 1991 and 1996, Cencast paid over $7 billion in wages, on behalf of production companies, to hundreds of thousands of workers who worked on numerous different productions. Cencast also filed tax returns and remitted FUTA and FICA taxes to the federal government with respect to these employees. For the six tax years in question, Cencast remitted approximately $465 million in FUTA and FICA taxes as the employer contribution for the production worker employees. 

When Cencast filed its FUTA and FICA employment tax returns, it treated each employee as being in an "employment" relationship with Cencast rather than with the production companies.  When Cencast filed its FUTA and FICA employment tax returns, it treated each employee as being in an "employment" relationship with Cencast rather than with the production companies. This reduced the overall tax payments because of statutory caps on both FUTA and FICA taxes.   [I omit the details of how that reduction occurred, but it all turned upon whose employees these were -- the production companies' or the payroll service companies', Cencast here.] 

* * * * 

In 2001, the IRS assessed Cencast FUTA and FICA tax deficiencies for the 1991-1996 tax years totaling approximately $43.7 million for FUTA taxes and $15.6 million for FICA taxes. 

In November 2001, Cencast paid divisible portions of the IRS assessments totaling $637,000, representing additional tax owed with respect to some (but not all) Cencast employees for each of the 1991-1996 tax years. These payments entitled Cencast to file a claim for refund. See Flora v. United States, 362 U.S. 145, 175 n.38 (1960).

So that is how the case got to court.

Second, with that background, the Court held that the employees were the employees of the production companies rather than of the payroll service company (such as Cencast).  The Court's discussion is thick with citations and esoterica, but in the final analysis it turned upon whose employees they were and, under the facts, they were clearly the employees of the production companies.  Under the circumstances, this was the obvious conclusion, but the Court had to wade into the weeds to get there and explain why it is important.

Third, having lost on the main issue, Cencast fell back on an alternative issue to mitigate the damage.  The issue was that some of the persons treated as employees were really independent contractors.  "This claim was neither submitted to the IRS with Cencast's original refund claim nor originally asserted in the refund suit in 2003 nor asserted in Cencast's response to the government's counterclaims."

The trial court and the Court of Appeals held that, even under general rules of pleading that allow liberal amendments, the position was raised too late in the litigation process because it would be prejudicial to the Government because of the additional work it would require that would be disruptive to the process.  In this respect, as a further nuance, it appeared to both courts that Cencast unreasonably delayed raising the issue even after it was aware of it.  The Court concludes:

We conclude that the Claims Court did not abuse its discretion in denying Cencast's motion to amend its complaint as to the independent contractor theory. See Tamerlane, Ltd. v. United States, 550 F.3d 1135, 1147 (Fed. Cir. 2008) ("'The decision to grant or deny a motion for leave to amend . . . lies within the sound discretion of the trial court.'" (quoting Insituform Techs., Inc. v. CAT Contracting, Inc., 385 F.3d 1360, 1372 (Fed. Cir. 2004))).

So, it seems that litigation management requirements caused Cencast to lose its ability to claim a reduction in liability because some of the putative employees were independent contractors regardless of any other argument Cencast might make.

Third, although the litigation management holding would seem to have ended the case, the Court then discusses the scope of the original claim for refund (which did not mention the independent contractor argument), the Government's counterclaim for the unpaid assessed taxes and that Cencast could have put the issue in play in response to the counterclaim, and the effect of a later seizure by levy and refund claim (not the one that was the basis of the refund suit) with respect to that seizure which assert the independent contractor issue.

The Court holds that that Cencast had not properly presented and preserved the issue in either its original claim for refund that started this litigation in the Court of Federal Claims or in response to the Government's counterclaim on the unpaid divisible taxes.  The Court justifies that holding on the doctrine of variance -- i.e., the new claim is not within the scope of the claim for refund.  Note that the levy was for tax amounts already in play on the Government's counterclaim as to which Cencast failed to assert the position timely.  In effect, highly summarizing, the Court of Appeals essentially held that Cencast could not use the subsequent levy to bootstrap an untimely assertion in the original claim or in response to the original counterclaim.  So, not being able to bootstrap the raising of a new claim by subsequent events, the Court then addressed Cencast's argument that in all events the original claim subsumed this position so that it was not a substantial variance that would not be allowed under the variance doctrine.  The Court explained its holding on variance as to the original claim:

Cencast finally argues that its original 2002 refund claim was sufficient to preserve the independent contractor theory. The Claims Court rejected this argument, concluding that it lacked jurisdiction over the independent contractor theory based on the so-called "substantial variance" rule. See Cencast II, 94 Fed. Cl. at 441-42. We described this rule in Computervision Corp. v. United States, 445 F.3d 1355 (Fed. Cir. 2006). As we explained in Computervision, "[t]he Secretary by regulation requires that claims for refund 'set forth in detail each ground upon which a credit or refund is claimed and facts sufficient to apprise the Commissioner of the exact basis [of the refund claim].'" Id. at 1363 (quoting Treas. Reg. § 301.6402-2(b)(1)). This requirement "'is designed both to prevent surprise and to give adequate notice to the [IRS] of the nature of the claim and the specific facts upon which it is predicated, thereby permitting an administrative investigation and determination.'" Computervision, 445 F.3d at 1363 (quoting Alexander Proudfoot Co. v. United States, 454 F.2d 1379, 1383 (Ct. Cl. 1972)). Accordingly, new claims or theories raised subsequent to the initial refund claim are not permitted where they substantially vary from the theories initially raised in the original claim for refund. See Computervision, 445 F.3d at 1364 & n.8; Lockheed Martin Corp. v. United States, 210 F.3d 1366, 1371 (Fed. Cir 2000) ("[The] 'substantial variance' rule . . . bars a taxpayer from presenting claims in a tax refund suit that 'substantially vary' the legal theories and factual bases set forth in the tax refund claim presented to the IRS."). 

Now, here Cencast made some creative arguments.  Cencast argued that the doctrine of equitable recoupment permitted the claim despite the doctrine of variance.  Here is the argument and resolution articulated by the Court:

Cencast first argues that the equitable recoupment doctrine is an exception to the variance rule that permits it to use its independent contractor theory to offset any recovery the government may receive on its counterclaims. However, where the government files a counterclaim that places the entire balance of assessed tax in issue, we agree with the Claims Court that Cencast's right to assert a setoff with respect to the government's counterclaim recovery "exists only when the Government raises a new issue that the plaintiff could not have anticipated and, therefore, could not have . . . asserted as grounds for its [original] refund [claim]." Cencast II, 94 Fed. Cl. at 441. The principle underlying equitable recoupment, as articulated by the Ninth Circuit in a related context, is that "[i]t would be unfair to allow the Government to assert a new defense to a taxpayer's claim at pretrial and simultaneously to prevent the taxpayer from making appropriate responses to it, because the taxpayer had not previously anticipated the defense." Brown v. United States, 427 F.2d 57, 62 (9th Cir. 1970). However, where "the government does not raise a[] [new] offset issue . . . , a taxpayer could not raise any setoff." Union Pac. R.R. Co. v. United States, 389 F.2d 437, 447 (Ct. Cl. 1968). 

This principle—that equitable recoupment only applies when the government raises a new taxation theory in its counterclaims—is compelled by Supreme Court cases emphasizing that the doctrine applies where the government raises new and inconsistent theories of taxation. See United States v. Dalm, 494 U.S. 596, 605 n.5 (1990) ("[W]e have emphasized that a claim of equitable recoupment will lie only where the Government has taxed a single transaction, item, or taxable event under two inconsistent theories." (emphases added)); Rothensies v. Electric Storage Battery Co., 329 U.S. 296, 300 (1946) ("Whatever may have been said [in past cases] indicating a broader scope to the doctrine of recoupment, these facts are the only ones in which it has been applied by this Court in tax cases."); Bull v. United States, 295 U.S. 247 (1935) (permitting use of equitable recoupment defense where an executor initially paid an estate tax on certain funds, but the IRS subsequently treated the funds as taxable income of the estate). No new and inconsistent theories were raised by the government in its counterclaims. Accordingly, the equitable recoupment exception is inapplicable. 

Second Cencast argued that the Government had waived the variance argument.  Here is the argument and resolution articulated by the Court:

Cencast next argues that the waiver doctrine saves its independent contractor theory. Under this doctrine, where "the taxpayer files a timely formal claim but fails to include the specific claim for relief [i.e., the independent contractor theory], th[at] claim may nonetheless be considered timely if the IRS considers that specific claim within the limitations period." Computervision, 445 F.3d at 1365. Under some circumstances, the IRS's consideration is viewed as resulting in a waiver. See id.; see also Goulding v. United States, 929 F.2d 329, 332 (7th Cir. 1991) (noting that waiver may occur "if the IRS has sufficient knowledge  of the claim and makes a determination on the merits"). "The central purpose of the waiver doctrine is to prevent IRS agents from lulling taxpayers into missing the [limitations] deadline . . . ." Computervision, 445 F.3d at 1366 (alterations in the original) (quotation marks omitted). However, "the IRS cannot waive the requirements of its regulations by conduct outside of the limitations period." Id. at 1367. 

Here, with respect to Cencast's 2002 administrative claim, the relevant limitations period expired in 2004. See I.R.C. § 6511(a) (noting that the statute of limitations for a refund claim expires at the later of two years from the date the tax is paid or three years from the date the return is filed). Thus, the IRS's consideration must have occurred no later than 2004 for this exception to apply. Cencast argues that the IRS considered the independent contractor issue during the investigative proceedings that preceded its 2001 assessment, but this argument is without merit. While Cencast, during the administrative investigation, alerted the IRS that there were questions as to the independent contractor status and possibility of refund claims with respect to those employees, Cencast did not suggest that the independent contractor theory was a current issue, but merely that it was an issue that could be raised in the future. Cencast's submissions to the IRS during its investigation specifically stated that "the issue in the case at hand is not whether the workers are employees or independent contractors. [The taxpayer] has always treated the [production workers] as employees." J.A. 5488 (emphasis added). At the conclusion of the investigation, the IRS merely "accepted the determination that was made by the production companies and [Cencast]" that the production workers were common law employees. J.A. 10,775. 

Here, it is clear that, before the expiration of the limitations period, the IRS neither "consider[ed]" nor made a "determination of the merits" as to the scope or nature of any independent contractor overpayment. See Computervision, 445 F.3d at 1365; Goulding, 929 F.2d at 332. 

It is also clear that the IRS's actions here did not prevent Cencast from raising a timely administrative claim or lull it into missing a limitations deadline. See Computervision, 445 F.3d at 1365-67; see also United States v. Memphis Cotton Oil Co., 288 U.S. 62, 64-66, 71 (1933) (finding waiver where the IRS, after initially concluding that a refund was due on a claim, reversed its position and determined that the initial claim was improperly filed, after the limitations period expired for filing a corrected claim); Goulding, 929 F.2d at 333 (finding waiver where the IRS had considered the merits of the taxpayer's claim based on an "in-depth investigation" it had performed on a related claim, and declined to challenge the sufficiency of the taxpayer's claim until two years after the original claim was filed). No aspect of the IRS's alleged "consideration" prevented Cencast from raising the independent contractor theory before 2004. 

We agree with the Claims Court that, "[b]ecause [Cencast] did not assert the independent contractor status of [the] workers as a basis of [its] claim for refund and the answer to that question was not implicitly included in the agency's audit investigation," n10 the independent contractor status of employees was "beyond the scope" of what the IRS considered. Cencast II, 94 Fed. Cl. at 441. Thus, the waiver doctrine does not warrant further consideration of Cencast's independent contractor theory.
   n10 Cencast argued in its 2002 administrative claim that the IRS had misidentified the workers' common law employers. Now, on appeal, Cencast argues that assessment of this issue necessarily required the IRS to ascertain whether production workers were independent contractors or employees. However, as discussed above, the refund claims treated as settled fact that the production workers were employees. The issue was therefore not "implicitly included" in Cencast's claim, see Cencast II, 94 Fed. Cl. at 441. 

There is no exception to the substantial variance doctrine here that would permit Cencast to raise its independent contractor theory at this late date.

That is it!