Aaron L. and Serita 1 Kolom seek a refund for double payment of the federal minimum tax assessed upon their exercise of company stock options, an item of tax preference. The Internal Revenue Service (IRS) contends that the statute of limitations bars Kolom’s claim for refund. The district court found that the claim was timely filed, based on the mitigation provisions of Sections 1311-1314 of the Internal Revenue Code of 1954 (IRC or Code), enacted to relievе the harsh effect of statutes of limitations in specified circumstances. The district court accordingly entered a summary judgment in favor of Kolom. This court modifies and affirms the district court judgment.
I. Background
Kolom was an officer and director of Tool Research and Engineering Corporation (Tool Research). During the taxable year 1972, Kolom exercised certain stock options he had received that year pursuant to an employеe stock option plan sponsored by Tool Research. The stock option plan qualified for favorable tax treatment. The Code exempted from gross income the stock options’ “bargain element” — the difference between the stock’s fair market value and its option price. IRC §§ 421-22, 26 U.S.C. §§ 421-22. 2 Instead, the Code included the bargain element as an item of “tax preference” subject only to a “minimum tax.” IRC §§ 56, 57. 3
*764 Kolom did not include thе stock options’ bargain element as an item of tax preference in 1972 because the stock was subject to a substantial resale restriction imposed by § 16(b) of the Securities Exchange Act of 1934 (the Act). Section 16(b) required return to the company of any profits made on the sale of such stock within six months of the time the option was exercised. Ko-lom noted on his 1972 income tax return that he would defer reporting of the bargain element as a tax preference item until he could sell the stock and retain the profits. 4 Kolom included the stock options as a tax preference item in his 1973 income tax return. Calculating the fair market value of the shares six months after the options were exercised, Kolom paid a minimum tax of $8,097 for 1973.
The IRS twice reviewed Kolom’s 1972 return. In January, 1975, the IRS District. Director wrote Kolom that the revenue agent’s report had been reviewed and accepted. In January, 1976, however, the IRS decided that Kolom should have paid the minimum tax in 1972, not 1973.
Kolom challenged the assessment of the minimum tax for 1972. He argued that the substantial restriction imposed by § 16(b) of the Act prohibited assessment of the tax until 1973. The Tax Court ruled in favor of the IRS.
Kolom v. Commissioner,
Kolom wrote the Commissioner of the IRS on February 11, 1982. Citing Kolom I, he requested a notice of assessment of the minimum tax due for 1972. In his letter Kolom stated, “We trust that this payment and interest [thе minimum tax paid in 1973] will be subtracted from the amount due.” During oral argument, counsel for the Government acknowledged that the IRS had received the letter and was aware of Kolom’s request for a refund. The IRS, however, did not assess the tax due until May of 1983, one year and three months after the Supreme Court denied certiorari. 6 Kolom paid the full amount of the minimum tax, $43,792, plus interest, assessed for 1972, for a total of $86,485.49. 7 Two months later, on July 1, 1983, Kolom filed a formal claim for refund of the minimum tax paid in 1973.
*765 The IRS did not refund the tax. Kolom filed this action for refund on June 5, 1984. The IRS admitted all allegations of the complaint, and moved to dismiss Kolom’s complaint for lack of jurisdiction because Kolom had not filed an administrative claim for refund within the statutorily prescribed period. Kolom filed a motion for summary judgment. The district court held that the mitigation provisions, IRC §§ 1311-1314, lifted the bar of the statute of limitations and granted summary judgment in favor of Kolom. The court found Kolom entitled to a refund of $8,097.
II. Contentions on Appeal
The Government contends that the district court erred in deciding that the mitigation provisions apply in the circumstances of this case, and that, even if they do otherwise apply, the taxpayers failed to file their refund claim within the extended period that would then be applicable. We also consider, alternatively, whether the doctrine of equitable recoupment supрorts recovery of the twice paid tax.
III. The Mitigation Provisions
Section 6511(a) of the Code provides that, ordinarily, a claim for refund of an overpayment of tax must be filed within three years of the date a taxpayer’s return was filed or two years from the date the tax was paid, whichever is later. Section 6511(a) accordingly barred any claim for tax refund filed after April 15,1977, unless the mitigation provisions lifted the time bar of this section.
The mitigation provisions extеnd the period of limitations to file a timely claim for refund for one year from the date a final determination is made. IRC § 1314(b). Congress intended the mitigation provisions to
“provid[e] for mitigation of some of the inequities under the Income Tax Laws caused by the Statute of Limitations and other provisions which now prevent equitable adjustment of various income hardships,” H.R.Rep. No. 2330, 75th Cong., 3d Sess. 56 (1938)....
O'Brien v. United States,
The mitigation provisions require that (1) a final “determination” be made, IRC § 1313(a); (2) the error fall within one of the specified circumstances of adjustment, IRC § 1312; and (3) the determination be inconsistent with that made in another year, IRC § 1311(b).
See Rigdon,
The Government’s principal contention is that the mitigation provisions do not apply because the double payment of the minimum tax does not fit within one of the specified circumstances of adjustment listed in IRC § 1312, specifically § 1312(1). Section 1312(1) provides for application of the mitigation provisions if “[t]he determination requires the inclusion in gross income of an item which was erroneously included in the gross income of the taxpayer for another taxable year_” (Emphasis added). Kolom contends that since the minimum tax is an income tax it falls within § 1312(1). The IRS urges that “gross income” is a term of art and must be construed consistently throughout the Code. 8
The Code specifically defines gross income. IRC § 61. The Tenth Circuit in
Gardiner v. United States,
construing the mitigation provisions, adhered to this definition of gross income, and stated that “[t]he meaning of an
item
of gross income is, under Section 61 ..., limited to specific items and does not include everything that results in an increase in tax.”
The Code exempts the stock options’ bargain element from inclusion in gross income. IRC § 421(a)(1).
See also Kolom I,
The items of tax preference [subject to minimum tax] represent income of a person which either is not subject to current taxation by reason of temporary exclusion (such as stock options) or by reason of an acceleration of deductions ... or is sheltered from full taxation by reason of certain deductions ... or by reason of a spеcial tax_ The tax imposed by section 56 is in addition to the other taxes imposed by chapter 1.
Treas.Reg. § 1.56-l(b).
Kolom relies on
Karpe v. United States,
Unlike Karpe or Gooch, the stock options’ bargain element does not affect gross income. Because the Code excludes the bargain element from gross income, the bargain element does not even indirectly affect gross income. Neither do items of tax preference indirectly affect gross income. 9 The stock options’ bargain element, thus, is not аn item included in gross income under § 1312(1). The mitigation provisions do not afford Kolom relief from the statute of limitations.
IV. The Doctrine of Equitable Recoupment
The United States Supreme Court defined and refined the doctrine of equitable recoupment in a series of three cases:
Bull v. United States,
The doctrine of equitable recoupment 10 prevents unjust enrichment — it is *767 invoked either by the taxpayer to recover a twice paid tax or by the Government to prohibit tax avoidance. It works as a set-off. The Court has explained:
The essence of the doctrine of recoupment is stated in the Bull case: “recoupment is in the nature of a defense arising out of some feature of the transaction upon which the plaintiffs action is grounded.”295 U.S. 247 , 262 [55 S.Ct. 695 , 700]. It has never been thought to allow one transaction to be offset against another, but only to permit a transaction which is made the subject of suit by a plaintiff to be examined in all its aspects, and judgment to be rendered that does justice in view of the one transaction as a whole.
Rothensies,
Viewing the transaction in this case as a whole, we are persuaded that the circumstances surrounding Kolom’s sale of the stock options justify application of the doctrine of equitable recoupment. Kolom clearly identified his treatment of the stock options in his 1972 and 1973 tax returns.
Cf. United States v. Bowcut,
The doctrine of equitable recoupment applies if “a single transaction constitute^] the taxable event claimed upon and the one considered in recoupment.”
Rothensies,
In both
Bull
and
Stone,
each of these three criteria was met. Later cases, however, have declined to apply the doctrine of equitable recoupment when lacking any one of the criteria. The Court narrowly limits the doctrine’s applicatiоn to avoid seriously undermining the statute of limitations.
Rothensies,
In its petition for rehearing the Government correctly notes that the issues with respect to the doctrine of equitable recoupment were not considered in the initial briefs. The Government contends that in applying the doctrine to this case, the court *768 goes beyond the limited application of Bull and Stone. Specifiсally, it is argued: “[E]quitable recoupment constitutes only a defense to liability sought to be established in a timely action involving the transaction in question. It does not permit an independent action either by the Government to collect additional taxes, or by the taxpayer to claim a refund of an overpayment for a year in which the statute of limitations has run.” The Government misinterprets the circumstances of Bull and the consequent scope of the doctrine of equitable recoupment.
The circumstances of
Kolom
are similar to those in
Bull.
As in
Kolom,
the taxpayer in
Bull
had already twice paid tax on the profits accruing from his business, and in a separate action, the taxpayer sued the Government for a refund of the twice paid tax.
Bull,
The circumstance that both claims, the one for estate tax and the other for income tax, were prosecuted to judgment and execution in summary form does not obscure the fact that in substance the proceedings were actions to collect debts alleged to be due the United States. It is immaterial that in the second case, owing to the summary nature of the remedy, the taxpayer was required to pay the tax and afterwards seek refundment. This procedural requirement does not obliterate his substantial right to rely on his cross-demand for credit of the amount which if the United States had sued him for income tax he could have recouped against his liability on that score.
Id.
at 262-63,
The Government relies heavily on the Seventh Circuit’s decision in
O’Brien,
A recoupment claim need not be made during an action by the government for payment of a deficiency. It is proper for the taxpayer to pay the entire amount of the properly owed tax and later make a timely refund claim with regard to the properly owed tax raising the defense of equitable recoupment in respect of another time-barred overpayment. See, e.g., Bull,295 U.S. at 253, 262-63 ,55 S.Ct. at 697, 700-01 .
The circumstances here are more analogous to those in Bull than to the circumstances in O’Brien. This case arises from a “single transaction” and involves a “single taxpayer”.
As discussed above, the statute of limitations barred Kolom’s claim for refund of the tax paid in 1973, and the mitigation provisions did not lift the time bar. Yet the Government timely asserted a deficien
*769
cy for the year 1972.
See Kolom I,
V. Conclusion
We conclude that (1) the mitigation provisions do not apply to relieve the time bar because Kolom’s sale of the stock options did not affect gross income as required by IRC § 1312(1); and (2) under the doctrine of equitable recoupment Kolom is entitled to a refund for the tax paid in 1973. The district court judgment is accordingly modified and affirmed.
Notes
. Serita Kolom is a party solely because she and Aaron L. Kolom filed a joint federal income tax return in 1972.
. For a more detailed description of the stock option plan and its compliance with sections 421 and 422,
see Kolom v. C.I.R.,
. Section 56. Imposition of Tax.
(a) In General — In addition to the other taxes imposed by this chapter, there is hereby imposed for each taxable year, with respect to the income of every person, a tax equal to 10 percent of the amount (if any) by which—
(1) the sum of the items of tax preference in excess of $30,000, is greater than
(2) the sum of—
(A) the taxes imposed by this chapter for the taxable year ... reduced by the sum of the credits allowаble ... [and]
(B) the tax carryovers to the taxable year.
Section 57. Items of Tax Preference.
(а) In General — For purposes of this part, the items of tax preference are—
(б) Stock Options — With respect to the transfer of a share of stock pursuant to the exercise of a qualified stock option (as defined in section 422(b)) or a restricted stock option (as defined in section 424(b)), the amount by which the fair market value of the share at the time of exercise exceeds the option price.
. In his 1972 tax return, statement 9-Form 4625 Footnotes, Kolom explained:
During 1972 taxpayer exercised his option to purchase Tool Research Co. stock. The taxpayer is not treating this as preference income for the following reason:
Income Tax Regulation 1.57 — 1 (f)5 (i) states that there is no tax preference if the stock is disposed of in the year the option is exercised. By law, the taxpayer could not sell the stock in the year the option was exercised because all of his profit would belong to the corporation. The stock is being sold the year in which the taxpayer is first able to sell the stock. Because of the above reason and because the nature of the tax consequences are the same whether the taxpayer sold the stock in the year the option was exercised or the succeeding year, the item is not being treated as a tax preference item in 1972.
See Kolom I,
.
Kolom I
held that despite the restriction imposed on the sale of Kolom’s stock by § 16(b) of the Act, Kolom owed a minimum tax on the options’ bargain element in the year of exercise, 1972. Although the Supreme Court denied cer-tiorari, Justice Powell's dissent highlighted the inequities of the
Kolom I
holding. As a result, Congress passed an amendment excepting the options’ bargain element from minimum tax until after the lapse of the six month sale restriction of § 16(b) of the Act. IRC § 83(c)(3). This is the exact treatment Kolom accorded the exercise of his 1972 stock options. However, the amendment only applied to transfers made after December 31, 1981. Courts, addressing issues similar to those presented in
Kolom I,
now rule in favor of the taxpayer.
See generally McDonald v. CIR,
. Kolom speculates that the IRS delayed its assessment because it was unsure whether Congress would retroactively apply IRC § 83(c)(3) to the year 1972. Kolom further urges that IRC § 1314(b) required the IRS to assess the tax within one year from the date of the determination. The IRS, however, did not invoke the mitigation provisions in order to assess the tax. Rather, the IRS properly reopened Kolom’s 1972 and 1973 returns.
Kolom I,
. The fair market vаlue of the stock was substantially higher in 1972 than in 1973, thus accounting for the increased minimum tax assessment in 1972 — $43,792 as opposed to $8,097.
. Kolom argues that the IRS has conveniently changed its position from that in Kolom I. In Kolom I the IRS argued that the bargain element constituted economic income, not gross income. The IRS has not changed its argument in the instant case.
. At most, gross income indirectly affects the minimum tax assessed. The minimum tax calculation includes a subtraction of "taxes imposed for such year under Chapter 1 other than [certain enumerated taxes and credits]." Treas. Reg. § 1.56-l(b)(2). Gross income less deductions generally determines taxable income subject to tax under Chapter 1. Although gross income indirectly affects the minimum tax, the minimum tax does not affect gross income as required.
. On appeal Kolom does not specifically refer to the doctrine of equitable recoupment. He does, however, urge that equity requires relief. The doctrine of equitable recoupment is the method used by courts to afford equitable relief from the harsh effects of the Code’s statute of limitations. Kolom also made an equitable argument before the district court. Although the district court did not specifically consider .the doctrine of equitable recoupment, the doctrine is now considered based on the narrow exception that a reviewing court will consider such a question of law to prevent an injustice.
Hormel v. Helvering,
. In
Bowcut,
this court noted that some delay in asserting a right to a refund would not preclude a refund based on equitable recoupment.
. In O’Brien two events occurred. Property for estate tax purposes was undervalued, and the IRS asserted a deficiency for the undervaluation. In the meantime the property was sold, and gain reported based on the undervaluation. Had the correct value been used to report the gain, taxpayer would have paid less tax. After the IRS changed the value of the property in the estate, the first transaction, taxpayers tried to claim refund of the tax paid as gain on the sale of the property, the second transaction.