In Lewis v. Reynolds, 284 U.S. 281 (1932), here,modified in 284 U.S. 599 (1932), the Supreme Court held that, in a refund suit, the Government can raise a previously unasserted basis for denying a taxpayer a refund. The notion is that, in a refund suit, the issue is whether the taxpayer overpaid the tax and therefore is entitled to a refund. If there is some other basis to conclude that the taxpayer did not overpay the tax, the taxpayer is not entitled to a refund. The issue usually arises after the IRS has audited an issue and assessed a deficiency. The taxpayer pays the assessed tax and sues for refund, asserting that the taxpayer does not owe tax with respect to that issue. Lewis v. Reynolds holds that, in that refund suit, the Government can assert any other basis that shows the taxpayer is not entitled to a refund for that year or is entitled to less than the taxpayer assert. This is often referred to as a setoff.
The setoff concept is important in tax practice. One significant issue is what the Government must do to assert the setoff. This issue arose in a recent case, Lockheed Martin Corp. v. United States, 973 F. Supp. 2d 591 (D. Md. 2013), where the Court addressed the pleading requirements for the Government to raise the setff as a defense. In Lockheed, the Government pled the following under a caption titled "Second Defense":
Should the Court determine that Plaintiff raised a meritorious argument that would otherwise establish that Plaintiff overpaid its taxes, the United States is entitled to reduce that overpayment based on any additional tax liabilities that the Plaintiff may owe, whether or not previously assessed or alleged. The United States is entitled to such reduction because the redetermination of the Plaintiff's entire federal income tax liability for the litigated tax years is at issue in this refund suit.Note that the Government pleads nothing except its theoretical right to the setoff.
Of course, the taxpayer in a refund suit does not want the Government to be able to assert the right to a setoff at all. And, the theoretical assertion of the right may raise concern that the Government will use the refund suit litigation to re-audit in search of something to setoff. So, in Lockheed, the taxpayer moved to strike that portion of the pleading, alleging that setoff should be pled like an affirmative defense, which, as Lockheed read the cases, would prohibit this type of conclusory pleading without a factual basis for the claim. The Government argued that, although labeled a defense, it is not an affirmative defense at all, but merely goes to the issue of whether this taxpayer has proved that it is entitled to the refund the taxpayer claims. The Court does not engage on this theoretical difference between a setoff and an affirmative defense, but treats the setoff as being subject to the affirmative defense pleading requirements.
Focusing on those pleading requirements for affirmative defenses, the Court notes that there is a split of authority over whether any notice of factual predicate for the legal claim is required to be pled. The Court first identifies the split of authority and then turns to rationale for the majority and minority views as follows:
