                       T.C. Memo. 2010-269



                      UNITED STATES TAX COURT



          HAIM REVAH AND LUCINDA REVAH, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

                 YAAKOV J. REVAH, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 23331-08L, 24076-08L.   Filed December 9, 2010.



     Edward M. Robbins, Jr., and Cory Stigile, for petitioners.

     Elaine T. Fuller, for respondent.



                        MEMORANDUM OPINION


     COHEN, Judge:   Petitions were filed in response to notices

of determination sent to (1) Haim and Lucinda Revah (case at

docket No. 23331-08L) and (2) Yaakov J. Revah (case at docket No.

24076-08L) that sustained proposed levy actions with respect to
                                - 2 -

petitioners’ unpaid Federal income taxes for 1997 and 1998.    The

cases were consolidated for briefing and opinion.    Pursuant to

section 6330(d), petitioners seek review of respondent’s

determinations to proceed with the collection of their 1997 and

1998 Federal income tax liabilities and the assessed additions to

tax.    Unless otherwise indicated, all section references are to

the Internal Revenue Code, and all Rule references are to the Tax

Court Rules of Practice and Procedure.

                             Background

       All of the facts have been stipulated, and the stipulated

facts are incorporated as our findings by this reference.

Petitioners resided in California at the time they filed their

petitions.    Petitioners Haim Revah (Haim) and Yaakov Revah

(Yaakov) are brothers (petitioners).

       The case at docket No. 23331-08L involves deficiencies in

Federal income tax that were assessed with respect to Haim’s 1997

and 1998 tax returns that designated his filing status as married

filing separately.    Collection of Haim’s tax liability from the

assets and income of Mrs. Revah is permitted under California

community property law to the extent such assets and income are

community property.    See Ordlock v. Commissioner, 533 F.3d 1136,

1138-1139 (9th Cir. 2008), affg. 126 T.C. 47 (2006).
                               - 3 -

     The case at docket No. 24076-08L involves deficiencies in

Federal income tax that were assessed with respect to Yaakov’s

1997 and 1998 tax returns.

Audit of Revah Holdings, Inc., and Petitioners

     During 1997 and 1998, petitioners were each 50-percent

shareholders of Revatex, Inc., and SMJ American Manufacturing

Co., Inc., both S corporations.   In 1998, petitioners each became

50-percent shareholders of Indigo Concepts, Inc., an S

corporation.   During 1999, petitioners incorporated Revah

Holdings, Inc., and were each 50-percent shareholders through

2001.   Revah Holdings, Inc., filed Forms 1120S, U.S. Income Tax

Return for an S Corporation, for tax years 1999 and 2000 on a

consolidated basis with Revatex, Inc., SMJ American

Manufacturing, Co., Inc., and Indigo Concepts, Inc.

     During 2001 through 2005, the Internal Revenue Service (IRS)

audited the 1999 and 2000 tax returns of Revah Holdings, Inc.,

and petitioners, as shareholders.   The IRS examiner determined

adjustments with respect to Revah Holdings related to inventory

and bad debt that resulted in increases to the 1999 and 2000

reported income.   The inventory adjustment increased the amount

of ending inventory for 2000 and thus the 2001 beginning

inventory.   A deduction for an uncollectible receivable in 2000

was disallowed because the examiner determined that the debts

became uncollectible in 2001 rather than 2000.   Thus, as the
                               - 4 -

examiner acknowledged, because the adjustments were timing

matters, the 2001 reported income would be reduced when

adjustments were made.   Accordingly, petitioners’ representative

advised the examiner that amended returns would be filed for

2001.

     The audit adjustments to Revah Holdings flowed through to

petitioners’ individual tax returns and resulted in a decrease in

the net operating losses (NOLs) that petitioners had reported on

their previously filed tax returns and had carried back to 1997

and 1998.   These NOL reductions resulted in determined tax

deficiencies for petitioners for 1997 and 1998.

     Petitioners accepted the results of the audit, and

accordingly their representative executed Forms 4549, Income Tax

Examination Changes, on their behalf, agreeing to tax

deficiencies for 1997 and 1998.   The Forms 4549 stated:

     I do not wish to exercise my appeal rights with the
     Internal Revenue Service or to contest in the United
     States Tax Court the findings in this report.
     Therefore, I give my consent to the immediate
     assessment and collection of any increase in tax and
     penalties, and accept any decrease in tax and penalties
     shown above, plus additional interest as provided by
     law. * * *

Haim agreed to deficiencies of $1,862,036 for 1997 and $236,928

for 1998.   Yaakov agreed to deficiencies of $1,862,036 for 1997

and $236,903 for 1998.

     In November 2005, Revah Holdings filed an amended tax return

for 2001 in accordance with the IRS examiner’s adjustments that
                                 - 5 -

reported a net decrease in income.       As a result of the

adjustments to Revah Holdings’ return, on November 8, 2005,

petitioners each filed amended tax returns to claim NOLs and also

filed resulting refund claims.    These amended tax returns and

refund claims were for 2001 as well as 1996 and 1997 because

petitioners were seeking to carry back the NOLs to offset income

from the earlier years and claim the resulting refunds.       The 1997

refund claims were accepted after audit, but the 1996 and 2001

claims were denied as untimely.    See sec. 6511(d)(2)(A).

     Accordingly, the IRS sent refund claim denial letters

informing petitioners that they had the right to appeal the

decisions to the IRS Appeals Office and/or file suit with the

appropriate U.S. District Court or with the U.S. Court of Federal

Claims within 2 years of the dates of the letters.       Petitioners

protested the denial of their 1996 refund claims but did not file

suit in response to the claim denials.

Petitioners’ Protests of the Refund Claim Denials

     Petitioners’ 1996 refund claim denial protests were assigned

to the same IRS Appeals officer.    Because petitioners’ 1996

amended returns were being audited as a result of the Revah

Holdings examination, the Appeals officer waited for the audit

results before considering the protests.       The IRS examiner

auditing petitioners’ amended 1996 returns determined that

petitioners did not qualify for relief as they requested under
                                - 6 -

the mitigation provisions or the doctrine of equitable recoupment

and sustained the refund claim denials.

     After review and evaluation of petitioners’ case files, the

Appeals officer sustained the IRS examiner’s disallowance of the

refund claims.    The Appeals officer noted in the Appeals case

memo that equitable recoupment did not apply because income had

not been subjected to two taxes based on inconsistent theories.

Petitioners were informed by letters sent in January 2008 that

the Appeals Office sustained the disallowance of the 1996 refund

claims.

Section 6330 Proceedings

     In December 2007, the IRS sent each petitioner a Notice of

Intent to Levy and Notice of Your Right to a Hearing with respect

to the outstanding 1997 and 1998 income tax liabilities.    In

response, each petitioner submitted a timely Form 12153, Request

for a Collection Due Process or Equivalent Hearing.    Petitioners’

collection due process (CDP) proceedings were assigned to

different Appeals officers.

     Haim Revah

     The Appeals officer handling Haim’s CDP proceeding obtained

a copy of the Appeals case memo prepared by the Appeals Office

with respect to the refund claim denial.   A letter dated May 22,

2008, informed Haim that he was precluded from raising the
                               - 7 -

underlying liability because of the opportunity to do so at the

prior proceeding.

     On July 29, 2008, the Appeals officer held a CDP conference

with Haim’s representatives.   During the conference, one of

Haim’s representatives stated that he agreed that the 1996 refund

claim was time barred and asserted that equitable recoupment

should apply to permit Haim to offset his 1997 and 1998 income

tax liabilities against the time-barred 1996 refund.   The Appeals

officer responded that equitable recoupment cannot be applied in

CDP proceedings and is not a collection alternative.   No

penalties had been assessed with respect to 1998 when the

conference was held.

     During the CDP proceedings, Haim’s representatives also

raised the issue of abatement of a failure to pay addition to tax

for 1997.   Haim’s representative supplied the Appeals officer

with a copy of a letter Haim’s accountant had previously

submitted to the IRS on his behalf requesting abatement of an

assessed addition to tax under section 6651(a), claiming

reasonable cause.   The IRS had imposed the failure to pay

addition to tax because Haim failed to pay the tax liabilities as

agreed.   The addition to tax was not imposed retroactively from

the original due date of the tax but was imposed after the tax

liability had been agreed upon and the IRS had sent a notice of

balance due.
                              - 8 -

     On August 27, 2008, the Appeals Office sent a notice of

determination to Haim and Lucinda Revah sustaining the levy with

respect to Haim’s 1997 and 1998 tax liabilities.    The memorandum

attached to the notice stated that Haim’s representatives had

continued to raise the underlying liability issue by arguing the

doctrine of equitable recoupment even though there had been a

prior opportunity to dispute the underlying liabilities.    The

Appeals officer noted further that the accounting errors

(including those of the S corporation) cannot be reasonable cause

for penalty abatement.

     The notice of determination further explained that

          The proposed levy action is deemed appropriate in
     this case because Mr. & Mrs. Revah are not interested
     in any collection alternatives and did not propose any
     alternative to resolve their liabilities. The proposed
     levy action thus balances the need for efficient
     collection of taxes with Mr. & Mrs. Revah’s legitimate
     concern that any collection action be no more intrusive
     than necessary.

     Yaakov Revah

     The Appeals officer handling Yaakov’s CDP proceeding

obtained a copy of the Appeals case memo prepared by the Appeals

Office with respect to his refund claim denial.    The Appeals

officer informed Yaakov’s representative that only arguments

regarding Yaakov’s 1996 refund claim that had not been raised

during the previous Appeals Office hearing would be heard.

Yaakov’s representative informed the Appeals officer that he was
                                 - 9 -

not seeking a collection alternative and therefore financial

information was not being supplied.

     On July 29, 2008, the Appeals officer held a CDP conference

with Yaakov’s representatives.    During the conference, one of

Yaakov’s representatives stated that he agreed with the Appeals

Office’s determination that the 1996 refund claim was time barred

and asserted that the Appeals Office had the authority to apply

equitable recoupment as a defense to collection.    The Appeals

officer informed Yaakov’s representatives that equitable

recoupment was not a collection alternative.    There were no

assessed additions to tax with respect to 1998 when the

conference was held.

     Abatement of a failure to pay addition to tax for 1997 was

not discussed during the CDP conference.    However, Yaakov’s

representative supplied the Appeals officer with a letter dated

September 28, 2005, requesting abatement of a failure to pay

addition to tax, claiming reasonable cause, that Yaakov’s

accountant had previously submitted to the IRS in response to a

notice of Federal income tax due regarding the 1997 tax

liability.   A letter dated September 8, 2008, informed Yaakov

that his addition to tax abatement request was denied because he

did not meet reasonable cause criteria.    The letter noted that

the failure to pay addition to tax had been imposed because he

failed to pay the 1997 tax liability as agreed and that the
                                  - 10 -

addition to tax was not retroactively charged from the original

due date of the tax.

     The IRS sent a notice of determination to Yaakov on

September 17, 2008, sustaining the levy with respect to his 1997

and 1998 tax liabilities.       The memorandum attached to the notice

stated in part that

     the taxpayer was precluded from raising the equitable
     recoupment issue for period 1996 under the CDP hearing
     because the issue was raised and considered at a
     previous Appeals hearing and the taxpayer’s * * *
     [representative] meaningfully participated in the
     hearing * * *.

          *      *          *         *      *      *       *

          Taxpayer has not proposed a collection alternative
     that would satisfy the tax liability. Therefore,
     Collection’s plan to levy balances the need for the
     efficient collection of tax with the legitimate concern
     of the taxpayer that any collection action be no more
     intrusive than necessary. * * *

                                Discussion

     Under section 6330(c)(2)(A) a taxpayer may raise any

relevant issue at a CDP hearing, including challenges to “the

appropriateness of collection actions”, and may make “offers of

collection alternatives, which may include the posting of a bond,

the substitution of other assets, an installment agreement, or an

offer-in-compromise.”   The taxpayer may also challenge the

existence and amount of the underlying tax liability if no notice

of deficiency was received or the taxpayer did not otherwise have
                              - 11 -

an opportunity to dispute such tax liability.    Sec.

6330(c)(2)(B).

     For purposes of section 6330(c)(2)(B), a taxpayer who has

waived the right to challenge the proposed assessments by signing

Form 4549 is deemed to have had the opportunity to dispute the

underlying tax liability and is precluded by such waiver from

challenging the underlying tax liability in the CDP hearing or

before this Court.   Aguirre v. Commissioner, 117 T.C. 324, 327

(2001); see also Lance v. Commissioner, T.C. Memo. 2009-129.

Accordingly, petitioners were not entitled to contest the

underlying tax liabilities for 1997 or 1998 at their respective

CDP hearings.

     Section 6330(c)(3) provides that the determination of the

Appeals officer shall take into consideration the verification

presented by the Secretary that the requirements of applicable

law and administrative procedure have been met; the issues raised

by the taxpayer; and whether the proposed collection action

balances the need for the efficient collection of taxes with the

legitimate concern of the taxpayer that any collection action be

no more intrusive than necessary.

     Where the underlying tax liability is properly at issue in

the hearing, we review that issue on a de novo basis.     Goza v.

Commissioner, 114 T.C. 176, 181-182 (2000).     However, where the

underlying tax liability is not at issue, we review the
                              - 12 -

determination for abuse of discretion.    Nicklaus v. Commissioner,

117 T.C. 117, 120 (2001).   To establish an abuse of discretion,

the taxpayer must prove that the decision complained of is

arbitrary, capricious, or without sound basis in fact or law.

Giamelli v. Commissioner, 129 T.C. 107, 111 (2007) (citing

Woodral v. Commissioner, 112 T.C. 19, 23 (1999)); see Keller v.

Commissioner, T.C. Memo. 2006-166, affd. in part and vacated in

part, 568 F.3d 710 (9th Cir. 2009).    In reviewing for abuse of

discretion, we generally consider only arguments, issues, and

other matters that were raised at the CDP hearing or otherwise

brought to the attention of the Appeals Office.    Giamelli v.

Commissioner, supra at 115; Magana v. Commissioner, 118 T.C. 488,

493 (2002).

     Petitioners argue that it was an abuse of discretion for the

Appeals Office not to consider the application of equitable

recoupment during the CDP proceeding.    Petitioners assert that

consideration of equitable recoupment in the context of reviewing

their protests of the refund claim denials “has no bearing on

whether they are entitled to equitable recoupment relief as a

defense to collection” and that “any prior review of equitable

recoupment in a refund context should not deprive Appeals of

jurisdiction.”   Petitioners assert that equitable recoupment

should be applied because they:

     have been whipsawed and they have not been able to
     exhaust their administrative remedies to address this
                               - 13 -

     whipsaw in a meaningful manner. By assessing
     deficiencies in 1997 and 1998 resulting from the 1999
     and 2000 examinations [of Revah Holdings], and also by
     denying the amended 2001 returns and refund claims
     seeking these deductions, the Service is taxing the
     same item/transaction twice.

     Section 6214(b) provides that this Court “may apply the

doctrine of equitable recoupment to the same extent that it is

available in civil tax cases before the district courts of the

United States and the United States Court of Federal Claims.”

The doctrine of equitable recoupment is a judicially created

doctrine that, under certain circumstances, allows a litigant to

avoid the bar of an expired statutory limitation period.     The

doctrine prevents an inequitable windfall to a taxpayer or to the

Government that would otherwise result from the inconsistent tax

treatment of a single transaction, item, or event affecting the

same taxpayer or a sufficiently related taxpayer.     Equitable

recoupment operates as a defense that may be asserted by a

taxpayer to reduce the Commissioner’s timely claim of a

deficiency or by the Commissioner to reduce the taxpayer’s timely

claim for a refund.    When applied for the benefit of a 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.   See Rothensies v. Elec. Storage Battery

Co., 329 U.S. 296, 299-300 (1946).      Equitable recoupment cannot

be used offensively to seek a money payment, but may be used
                               - 14 -

defensively to offset an adjudicated deficiency.   United States

v. Dalm, 494 U.S. 596, 611 (1990).

     As a general rule, the party claiming the benefit of an

equitable recoupment defense must establish that it applies.

Rules 39, 142(a); Menard, Inc. v. Commissioner, 130 T.C. 54, 62

(2008).   Thus, a taxpayer who raises equitable recoupment as a

defense must establish that it applies by satisfying three

elements:

     First, a single transaction must be the taxable event
     to be considered in recoupment. Second, the single
     transaction must be subject to two taxes based upon
     inconsistent legal theories. Finally, the statute of
     limitations must bar recoupment, while either the
     government’s asserted deficiency or the taxpayer’s
     claim for a refund must be timely. * * *

Catalano v. Commissioner, 240 F.3d 842, 844 (9th Cir. 2001),

affg. T.C. Memo. 1998-447.

     Petitioners assert that

     by rejecting as untimely Petitioners’ individual refund
     claims flowing through from the 2001 amended Form 1120S
     for Revah Holdings (as well as the corresponding
     shareholder returns and carryback claims for 1996 and
     2001), Respondent is subjecting the same items
     (inventory and uncollectible receivable) to two,
     inconsistent taxes. * * * By assessing deficiencies in
     1997 and 1998 resulting from the 1996 and 2000
     examinations, while rejecting amended 2001 returns and
     refund claims seeking these deductions, Respondent is
     attempting to tax the same item or transaction twice.

     Equitable recoupment does not apply if the multiple bases

for a tax assessment are not inconsistent.   Cf. Bull v. United

States, 295 U.S. 247 (1935) (holding that where partnership
                              - 15 -

profits had already been subject to estate tax, they could not be

further subject to income tax); Estate of Branson v.

Commissioner, 264 F.3d 904, 917 (9th Cir. 2001) (holding that a

single item was subjected to two taxes inconsistently where stock

was taxed both as corpus of estate and income to beneficiaries),

affg. 113 T.C. 6 (1999).

     The audit adjustments of Revah Holdings for its years 1999

and 2000 related to inventory and bad debt that flowed through to

petitioners’ individual tax returns.   These adjustments resulted

in a decrease in the reported NOLs that had previously been

carried back to earlier years including 1997 and 1998.   When

these NOLs were initially applied, the tax liabilities for those

earlier years were reduced and petitioners had overpayments.

After the audit adjustments occurred and petitioners were

assessed tax deficiencies for 1997 and 1998, they submitted

amended returns for 1996, 1997, and 2001 to claim NOLs and

resulting refunds.   Respondent rejected as untimely the amended

returns for 1996 and 2001 and the corresponding submitted refund

claims.

     We have noted previously that when an NOL is claimed in the

wrong year, it is not allowable and there is no inconsistent

legal theory subjecting petitioners to two taxes.   See Farmer v.

Commissioner, T.C. Memo. 1998-327 (finding no inconsistent

position when a taxpayer erroneously carried forward an NOL
                              - 16 -

without properly electing to forgo the carryback period under

section 172(b)(3) and was disallowed both the loss carryforward

in a timely deficiency proceeding and a credit or refund from the

prior years to which the losses should have originally been

carried back).   The audit adjustments of Revah Holdings are

timing matters and resulted in NOL claims that flowed through to

petitioners’ individual tax returns.    Petitioners’ inability to

use the NOLs to reduce tax liabilities is not the result of the

inequitable application of inconsistent theories of taxation as

contemplated by the equitable recoupment doctrine.    Petitioners

simply failed to make their claims within the period allowed by

statute.   Respondent has not applied two taxes based on

inconsistent theories of taxation.

     Petitioners contend that the Court should remand the cases

to the Appeals Office because equitable recoupment was not

properly considered as a defense to collection during the CDP

proceedings.   We have the discretion to remand a case to the

Appeals Office for consideration of a matter that was

inadequately considered in the CDP hearing, and there are

circumstances in which a remand is appropriate to clarify a

verification under section 6330(c)(1).    See Hoyle v.

Commissioner, 131 T.C. 197 (2008).     Without addressing whether it

was an abuse of discretion for the Appeals Office not to consider

equitable recoupment as a defense to collection, we note that the
                                - 17 -

Appeals Office’s failure to do so constitutes harmless error

because equitable recoupment does not apply.      Thus, we conclude

that a remand to Appeals for a further hearing is not necessary

and would not be productive.    See Perkins v. Commissioner, 129

T.C. 58 (2007); Lunsford v. Commissioner, 117 T.C. 183, 189

(2001).

Addition to Tax

     Section 6651(a)(3) imposes an addition to tax for failure to

pay any amount, in respect of any tax required to be shown on a

tax return which is not so shown, within 21 calendar days, or 10

business days when the amount exceeds $100,000, from the date of

notice and demand of payment.    This addition to tax is imposed

unless the taxpayer establishes that the failure to pay was due

to reasonable cause and not willful neglect.       Id.; see Burke v.

Commissioner, T.C. Memo. 2009-282.       According to the regulations:

     A failure to pay will be considered to be due to
     reasonable cause to the extent that the taxpayer has
     made a satisfactory showing that he exercised business
     care and prudence in providing for payment of his tax
     liability and was nevertheless either unable to pay the
     tax or would suffer an undue hardship * * * if he paid
     on the due date. * * *

Sec. 301.6651-1(c)(1), Proced. & Admin. Regs.

     Respondent determined that petitioners are liable for an

addition to tax under section 6651(a)(3) because they have not

paid the amounts owed according to the forms they signed agreeing

to income tax deficiencies resulting from the audit of Revah
                              - 18 -

Holdings.   Petitioners requested abatement of the addition to

tax, on the basis of reasonable cause.   Respondent denied their

requests.

     Petitioners argue that it was an abuse of discretion for the

Appeals Office not to grant their abatement requests on

reasonable cause grounds.   Petitioners assert that because their

accountant took a position that ultimately no tax would be owed,

no additions to tax should accrue (additions to tax were assessed

before petitioners’ amended returns were filed).   Petitioners

assert that they relied on their accountant and that “it was

reasonable, prudent, and consistent with ordinary business care

for Petitioners to rely on their advisor’s advice when addressing

the taxes in dispute.”

     At no time have petitioners claimed that they were either

unable to pay the tax or would suffer undue hardship if they

paid.   Nor have they otherwise established that they had

reasonable cause under section 301.6651-1(c), Proced. & Admin.

Regs.   Petitioners are liable for the additions to tax under

section 6651(a)(3) for 1997, and respondent’s decisions not to

abate the additions to tax was not an abuse of discretion.

     We conclude that petitioners have not shown that it was

arbitrary, capricious, or without sound basis in fact or law for

the Appeals Office to sustain respondent’s plans to levy

regarding petitioners’ unpaid tax liabilities and additions to
                              - 19 -

tax for the years in issue.   We have considered the other

arguments of the parties, and they are either without merit or

need not be addressed in view of our resolution of the issues.

     To reflect the foregoing,


                                         Decisions will be entered

                                    for respondent.
