Opinion
Lloyd E. Anderson, of Washington, D. C. (Charles D. Hamel and Hamel, Parks&sSaunders, all of Washington, D. C., on the brief), for plaintiff.
Joseph H. Sheppard, of Washington, D. C., and Frank J. Wideman, Asst. Atty. Gen., for the United States.
Before BOOTH, Chief Justice, and GREEN, LITTLETON, WILLIAMS, and WHALEY, Judges.
Plaintiff seeks to recover $8,342.08, overpayment of income tax paid for 1925, with interest. The Commissioner of Internal Revenue determined, and the facts in this case show, that this amount was overpaid as a tax for the year in question. The Commissioner refused to refund the same and rejected a claim for refund therefor.
The Commissioner held and the defendant here contends that recovery cannot be had on the ground that prior to the filing of the claim plaintiff made an offer of $1,510 in compromise of the last two installments amounting to $6,834.68 shown on the return on the ground of insolvency and lack of funds with which to make any further payment, which offer was accepted by the Commissioner with the approval of the Secretary of the Treasury.
Plaintiff's answer to this is that the compromise offer with reference to the last two installments shown in the 1925 return was made by plaintiff and considered and accepted by the Commissioner under the mutually mistaken assumption that there was a liability to the government in respect of which he made the compromise offer when, as a matter of fact and law, there was no such liability and the compromise offer was therefore without consideration. Plaintiff makes two alternative contentions: First, that in any event the offer in compromise related only to the last two unpaid installments of the tax erroneously shown on the return amounting to $6,834.68 and that the Commissioner should have refunded the first two installments of $6,832.08 erroneously shown to be due on the return and paid prior to the time plaintiff became insolvent and submitted the offer of settlement with respect to the remaining installments; and, second, that the compromise offer, which was made and accepted, was for $1,500, but the Commissioner varied the terms thereof by accepting the same for $1,510.
Special Findings of Fact.
1. During 1925 and for many years prior thereto plaintiff was senior partner of the firm of Morgan, Livermores&sCo., of New York, owning a 50 per cent. interest therein and being entitled to that amount of any net profits of the partnership. As one of the two general partners of the firm, he had general supervision of the partnership business and was actively engaged therein.
2. During 1925 and for several years prior thereto the partnership had in its employ an office manager, who was in charge of the bookkeeping department and all accounting matters of the partnership, as well as the preparation of all data and information, including annual statements relating to the financial condition of the business.
3. The partnership was a member of the New York Stock Exchange and the office manager of the partnership furnished to the exchange all information requested by it in answer to questionnaires furnished during 1925 and prior years. The office manager also prepared and filed the income tax return of the partnership for 1925 and certain prior years. During 1925 and for at least five years prior thereto the partnership did not employ outside auditors or accountants or other agents to examine its books for the purpose of determining its financial condition, but relied entirely upon the statements and information prepared and furnished by its office manager who had supervision and charge of its bookkeeping department.
4. During 1925 debts due the partnership, of which plaintiff was a member, aggregating more than $425,164.81 were determined by plaintiff and the other member of the partnership to have become worthless in that year and such debts were charged off on the books of the company. Each one of the debts, was carefully examined and investigated and the determination of worthlessness was based upon knowledge of the debtors' financial condition and additional information which the partnership obtained with reference to the possibility of any collection thereon. In addition to this determination by the members of the partnership, they placed a large number of such accounts, aggregating a very substantial sum, in the hands of their attorneys for investigation and collection. After a thorough investigation and efforts to make collection, counsel for the partnership reported to the members thereof the result of their investigation, showing that such accounts were wholly worthless, that no collection thereof could be made, and that nothing could be collected on any judgments obtained by suit.
5. Debts aggregating $425,164.81, due the partnership, became worthless during the year 1925 and were duly determined to be worthless and charged off during that year. When these worthless accounts were charged off, they were entered in an account designated 'Losses charged to reserve for contingencies.' This account was an undivided profits account of the partnership, but when the income tax return of the partnership for 1925 was prepared by the office manager and subsequently filed the worthless debts so charged off were not shown as deductions from gross income and no amount was shown as a deduction for 1925 on that account in this return. The reason for the error was that the worthless debts which had been charged off and entered in the account designated 'Losses charged to reserve for contingencies' were not charged to the profit and loss account of the partnership. Plaintiff and his partner executed the partnership return without knowledge that the amount of the debts determined to be worthless and charged off in 1925 had been omitted as a deduction from gross income but, on the contrary, believed that all allowable deductions had been taken and that the return reflected the correct taxable net income of the partnership. This partnership return showed a net income taxable to the partners of $70,847.43. In truth, however, the partnership sustained an actual loss of at least $185,209.44, as subsequently determined and allowed by the Commissioner. Based upon this erroneous partnership return for 1925 plaintiff and his partner, Mr. Livermore, prepared and filed their individual income tax returns for 1925, each of which showed income of $35,423.51 from the part nership. Inasmuch as the partnership, in stead of having earned profits, had sustained a loss no income was taxable to or received by the partners. On the contrary, each partner was entitled to deduct in his individual return $92,604.72, being his proportionate share of such loss. Plaintiff, therefore, had a net loss of $38,701.89 which, if the partnership return had been correctly prepared, would have been shown on his individual return instead of the net income and tax reported.
Plaintiff's 1925 return was filed May 3, 1926, within the time allowed by an extension and showed a total tax of $13,670.94. Upon receipt thereof by the plaintiff, the tax computed and shown thereon by plaintiff was formally assessed May 7, 1926, together with $11.33 as interest. The first two quarterly installments of tax shown upon the return were paid in amounts of $2,000 on March 17, 1926, the date on which a tentative return had been filed, $1,406.41 tax and $11.33 interest on May 29, 1926, and $3,417.34 on June 17, 1926.
6. In the spring of 1926 the New York Stock Exchange instructed the partnership to curtail its operations and suspend trading entirely in August 1926. A composition was entered into as of August 31, 1926, with the principal creditors of the firm whereby the firm's assets were turned over to two trustees for liquidation.
7. Plaintiff became wholly insolvent before the dates on which the last two installments, aggregating $6,834.68, shown upon his return were payable. He was practically without assets or income and his outstanding liabilities amounted to more than $601,476.23. In addition to this plaintiff was responsible on other debts and notes amounting to $956,127.38 over and above his capital of $350,000 invested in the business, which was a total loss. No further payments were therefore made on account of the last two installments shown on the return. However, plaintiff did not know until March 1928 that he had no taxable income from the partnership for 1925 and that the amounts which he had paid as a tax, as well as the remaining installments shown on the return, were not due the government. This was four months after the compromise offer hereinbefore mentioned was made and accepted by the Commissioner. Neither did the Commissioner know that plaintiff had no taxable income and that no tax was due for 1925. Both parties proceeded on the mistaken assumption that the partnership had earned a net profit for 1925; that the plaintiff had received the taxable income shown in his return; and that the tax computed thereon by plaintiff was due the government.
8. In the spring of 1926 the partnership of which plaintiff was a member entered into negotiations with certain parties for the acquisition of new capital, and for the purpose of preparing and furnishing such parties a statement of the business and the affairs of the partnership it employed a firm of certified public accountants to make a complete examination and audit of the books and records of the partnership and determine its financial condition. The business of the partnership soon thereafter passed into the hands of the trustees for liquidation. A further audit was made, but plaintiff was not advised of the erroneous statement in the partnership income for 1925 until 1928.
9.» October 25, 1926, plaintiff filed with the collector at New York an offer of compromise of the 'Last two quarters for 1925, $6,834.68, tax due September 15 and December 15, 1925,' as shown on the return theretofore filed. He urged as ground for the acceptance of this offer the fact that the firm of Morgan, Livermore & Co. had gone into liquidation and that his entire capital was a total loss. The sum tendered by plaintiff was in the amount of $10, which was received and deposited by the collector with the Federal Reserve Bank. In reply to this offer the Commissioner advised plaintiff that before any offer in compromise could receive favorable consideration it would be necessary for plaintiff to furnish a statement as of recent date of the book and for-sale value of his assets, together with a statement of his liabilities, the amounts and effective dates of all liens held by secured creditors, present business and occupation, and income, and plaintiff's future prospects. The Commissioner further advised that in any event the offer was insufficient and that, for this reason, it was rejected, and that the case would proceed as if no offer had been made. Plaintiff proceeded to prepare a statement of the information stated by the Commissioner to be necessary to the consideration of any offer of compromise of the amount of the last two installments shown on the return for 1925, showing his complete insolvency, and requested favorable consideration of the offer theretofore made. The Commissioner declined further to consider the offer on the ground that the amount tendered was insufficient and, on April 18, 1927, the plaintiff wrote the Commissioner as follows: 'With reference to the unpaid balance of my 1925 income tax, I hereby offer in settlement of same the sum of $1,500. I would respectfully ask that I be permitted to pay this amount in the following manner: $500 immediately, $500 on July 1st next, and $500 on October 1st, 1927. I am asking for this consideration in view of the fact that I have not the funds available to make this offer immediate cash, without borrowing this amount, which, under the circumstances, it is difficult for me to do.' The Commissioner replied that he would not consider the offer unless the full amount thereof was deposited with the collector. Thereafter plaintiff filed with the collector a second offer of compromise of the 'Last two quarters for 1925, $6,834.68,' 'Tax due September 15th and December 15th, 1926,' depositing therewith the sum of $1,500 with the request that it be accepted in satisfaction of the amount stated, and, as in the case of the first compromise offer, asserted as grounds for the acceptance thereof the fact that the firm had gone into liquidation and that his entire capital, including his 1925 income, was a total loss. Upon consideration of this offer the Commissioner, with the consent of the Secretary of the Treasury, on November 12, 1927, approved and accepted the amounts of $10 and $1,500, totaling $1,510, in compromise of plaintiff's 'liability incurred through failure to pay balance of the tax for the year 1925.' Thereupon plaintiff was advised in a letter from the General Counsel of the Bureau of Internal Revenue that the Commissioner had considered the proposition submitted through the collector 'as a compromise of liability incurred through failure to pay balance of additional income tax for the year 1925,' and had decided, with the advice and consent of the Secretary of the Treasury, to close the case by acceptance of $1,510 in compromise of that liability.
10. At the time of the offer to compromise the last two installments of the tax shown on plaintiff's return for 1925 and at the time of the acceptance thereof, no claim for any adjustment of plaintiff's tax liability for that year had been made to the Commissioner or any of his representatives and no dispute or controversy with reference thereto existed at that time or prior thereto. The Commissioner had not proposed any additional tax for 1925 at or prior to the time of the making or the acceptance of the compromise offer with respect to the last two installments of the tax shown on the return for that year. Nor had the Commissioner made an investigation or audit to determine whether the partnership or plaintiff had any taxable income for 1925 or whether any tax was due the government by plaintiff for that year.
11. The certified public accountants employed by the partnership to make an examination and audit of its books and financial condition, as hereinbefore mentioned, determined that during 1925 the partnership sustained losses aggregating $370,000. As a part of their investigation the accountants examined the partnership income-tax return for 1925. Upon finding that the partnership had reported a net income in excess of $70,000, these figures were checked against the partnership books and records. They found that the profit and loss account of the books showed a net income for that year of the amount stated but, upon further examination of the books, it was ascertained that charges for worthless debts and other losses had been made on the books by placing the same in the undivided profits account rather than in the income and profit and loss account and that these accounts for worthless debts and losses aggregated in excess of $590,000. These worthless debts and loss accounts had not been taken into the income account of the partnership nor were they taken as deductions in the partnership return for 1925, having been entirely omitted. Plaintiff and his partner, Mr. Livermore, were advised in 1928 for the first time of the true situation with reference to the incorrectness of the partnership return and of their individual income tax return for 1925. Plaintiff's former partner had likewise included in his individual income tax return for 1925 one-half of the erroneous net income shown in the partnership return and had paid the full amount of the tax shown on his return to be due. Upon the receipt of advice as to the true situation respecting the partnership income, plaintiff and Mr. Livermore on March 15, 1928, prepared and filed claims for refund of the taxes paid by them for 1925 and prior years. The refund claim filed by plaintiff was for an aggregate of $25,352.33, taxes paid for 1923, 1924, and 1925, the amount claimed for 1925 being the total amount paid to the government on account of the erroneous income and tax shown in his return for that year.
12. On February 23, 1929, the Commissioner advised plaintiff that 'your claim for the refund of $25,352.33 income tax for the years 1923, 1924, and 1925 has been examined and that portion applicable to the year 1925 will be rejected pro forma, for the reason that such year was closed by compromise under section 3229, Revised Statutes (26 USCA § 158). The compromise effected an adjustment of the whole matter in its entirety.' Formal rejection of the claim as to 1925 occurred March 13, 1929. Upon the filing of said claims for refund by plaintiff and his partner, and during the year 1928, an agent of the Bureau of Internal Revenue attached to the office of the internal revenue agent in charge at New York made an audit and examination of the partnership returns for 1923 to 1925, inclusive, and the records of the partnership and of the former members thereof for the purpose of determining the true facts with relation to the claims for refund filed. This audit covered the years 1923, 1924, and 1925, for which claims were made for the allowance of deductions for losses sustained and for debts determined to be worthless and charged off during those years. As a result of this audit the examining internal revenue officer and the internal revenue agent in charge at New York determined that the partnership return for 1925 included no deduction whatever for worthless debts determined to have been worthless and charged off on the books of the partnership during that year and that the deductions allowable on account of worthless debts which had been properly determined to be worthless and so charged off were more than sufficient to offset any and all other income received by plaintiff during 1925. The internal revenue agent allowed and recommended a deduction for 1925 of $256,056.87 on account of debts determined to be worthless and charged off by the partnership during that year. Thereafter the Commissioner of Internal Revenue made an examination and audit of the returns of the partnership and of the individual partners for the years involved in connection with the report of the investigating agent and determined that the partnership income for 1925 had been overstated and should be decreased in the amount of $256,056.87. Accordingly he determined and decided that the partnership, instead of having had a net income, had sustained a loss of $185,209.44; that plaintiff, instead of having received income from the partnership for 1925, was entitled to a deduction of $92,604.72, which was his proportionate share of the losses sustained. Had plaintiff taken the deduction to which he was entitled, and which he would have taken but for the mistake made by the office manager in preparing the partnership return, his 1925 return would have shown a net loss sustained for that year and no tax whatever. As a result of this final determination by the Commissioner plaintiff was allowed refunds for 1923 and 1924, but notwithstanding his decision that plaintiff had no taxable net income from the partnership or from any other source for 1925 and owed no tax for that year, the Commissioner refused to refund any portion of the amount paid for 1925 on the ground that that year had been compromised under section 3229 of the United States Revised Statutes and that such settlement operated as a complete bar to recovery of any portion of the total amount paid. Plaintiff's partner, Mr. Livermore, was allowed a refund of the taxes paid by him for 1925 based upon the erroneous partnership income shown in his return.
LITTLETON, Judge.
This suit is for the recovery of an admitted overpayment in respect of the tax of plaintiff for 1925. The amount sought to be recovered is $8,342.08, being the total of the overpayment made of the first two installments of a tax erroneously shown to be due by plaintiff on his return for that year amounting to $6,832.08 and $1,510 deposited with the collector of internal revenue in connection with two offers of compromise of the remaining two unpaid installments shown on the return aggregating $6,838.86. The amount offered in settlement of the last-mentioned amount was covered into the treasury by the collector upon the Commissioner's acceptance thereof. Whether the offer made by plaintiff and the acceptance thereof by the Commissioner of an amount less than the aggregate of the last two installments of the tax shown in the return as a compromise of what both parties erroneously assumed to be the balance of plaintiff's tax liability for 1925 bars recovery of all or any portion of the amount paid by plaintiff constitutes the main question in the case.
Counsel for the defendant relies upon the rule that a compromise settlement is binding and conclusive and precludes further inquiry by the court into the matter to which it relates. We agree that this is the general rule but it is subject to certain exceptions, one of which is that a contract or compromise entered into under a mutual mistake is not binding and may be modified or set aside. Under the facts in this case we are of the opinion that the compromise settlement in this case was entered into under a mutual mistake of fact, was without consideration, and is, therefore, not a bar to plaintiff's right to recover the overpayment in question. Plaintiff showed the amount in question as a tax upon the return which he had filed and the Commissioner assessed the same as a matter of formal procedure in the Bureau of Internal Revenue by signing the list upon which the collector had entered the amount shown on the return, which he forwarded in the customary and usual course to the Commissioner. But there had never been a determination by the Commissioner or any one acting for him that the amount thus shown by plaintiff as a tax was in fact legally due. Likewise neither party to the transaction knew that plaintiff had erroneously set forth in his return as income an amount which was not taxable income to him under the true facts and the provisions of the taxing act. The records of the partnership, of which plaintiff was a member, truthfully showed, as the Commissioner subsequently determined, that plaintiff had no income from the partnership for 1925. By reason of an error in the preparation of the partnership tax return by the office manager of the business upon whom plaintiff relied, and due to certain erroneous information furnished plaintiff with reference to the net income of the partnership and his distributive share thereof, plaintiff reported to the Commissioner that he owed a tax of $13,670.94 when in truth he had no taxable net income and owed no tax. Instead of having any net taxable income plaintiff had a net loss of $38,701.89. Before the full amount of the tax thus erroneously returned was paid, the brokerage business, in which plaintiff was a partner with P. W. Livermore, suspended operations and was placed in the hands of trustees for liquidation and plaintiff became hopelessly insolvent. He was therefore unable to make any further payments to the collector on account of the amount shown in his return for 1925. His partner was not so unfortunate and although he had erroneously reported an amount as income from the partnership equal to that reported by the plaintiff, he paid the remaining amount shown on his return to be due as a tax for 1925 and, subsequently, was refunded the entire amount.
Before the plaintiff or the Commissioner ascertained the true facts with reference to plaintiff's correct income and his true tax liability for 1925, plaintiff submitted an offer in compromise of the balance shown on his return which both parties mistakenly assumed to be due. The offers of compromise were made and acted upon by the Commissioner under the authority of section 3229, United States Revised Statutes, chapter 3, United States Code, title 26, § 158 (26 USCA § 158), which authorizes the Commissioner, with the consent of the Secretary of the Treasury, to compromise any civil case arising under the internal revenue laws. This section also sets forth that whenever a compromise is made in any case there shall be placed on file in the Commissioner's office the opinion of the Solicitor of Internal Revenue, with his reasons therefor, with a statement of the tax imposed by law in consequence of neglect or delinquency of the person against whom the tax is assessed and the amount paid in accordance with the terms of the compromise. There is no provision that such a settlement may not be inquired into and modified or set aside for proper cause. Compromise settlements under this section must, therefore, be judged by the principles announced in the decided cases involving compromises and settlement agreements.
The language of the section shows that it contemplated a compromise of a tax liability for an amount less than that imposed by law. Therefore it is clear, we think, that a compromise settlement of a case based upon an assumed liability that does not in fact or in law exist, and which is entered into under a mutual mistake, is not binding and does not bar the refund or recovery of the overpayment made in a case in connection with which the compromise was offered and accepted. Unconscious ignorance by both parties of a fact material to the contract or belief in the present existence of a thing material to the contract constitutes a mutual mistake of fact.
In Colorado Millings&sElevator Co. v. Howbert (C. C. A.) 57 F. (2d) 769, 771, the court held that a compromise offer made by a taxpayer and accepted by the Commissioner does not bar recovery if such compromise was made under a mutual mistake as to a material fact, and said: 'A compromise is a contract, and compromises are favored in the law Such a contract is subject to construction by a court as to its meaning and validity and consideration. Big Diamond Mills Co. v. United States (C. C. A.) 51 F. (2d) 721, and cases cited. Where a settlement is entered into or a compromise is made under a mutual mistake as to a material fact, relief may be had. 12 C. J. 351, § 49 and cases cited. A mutual mistake of fact generally affords relief from the performance of contracts, and a contract of compromise stands in this regard upon the same plane as other agreements. If one party knows of the mistake and keeps silent, the party who is misled by the mistake is entitled to have the settlement vacated. Armours&sCo. v. Renaker (C. C. A.) 202 F. 901. We may reasonably infer that in the instant case there was a mutual mistake which resulted in the computation of interest in the amount of $50,103.42. If the true and correct amount of the taxes had been determined instead of the erroneous assessment, a lesser sum would have been agreed upon, as the pleading in the cause embodying the offer in compromise clearly shows that the offer was the payment of interest at the rate of one-half of one per cent. per month upon the true amount due. The mutual mistake of a material fact, as disclosed by the second amended complaint, is sufficient in law to have afforded appellant relief from the compromise and to have entitled it to the return of the sum paid by it excessively as interest.'
In Road Improvement Dist. No. 4 of Conway County, Ark., v. Wilkerson (C. C. A.) 5 F. (2d) 416, the court held that a settlement of a case by the payment of an amount less than that which was really due under a mutual mistake of fact could not stand, and allowed recovery. In that case it appeared that a final settlement was made and an amount paid to the construction company based upon final estimates for the work which had been made by the engineer for the person for whom the work had been performed, and on the mistaken assumption by both parties that such estimate was correct. It afterwards developed that there were such errors and mistakes in the final estimate as to destroy its integrity. The court said at page 419 of 5 F. (2d): 'A settlement, by whatever term it may be designated, based upon a mutual mistake of material facts, may be corrected or set aside. 1 Corpus Juris, p. 570, § 105, states the rule as follows: 'An accord and satisfaction entered into and executed through mutual mistake of fact is not binding and may be rescinded. The general rule that a contract made upon an assumed state of facts as to which there was a mutual mistake may be rescinded applies to every form of contract including accord and satisfaction.' * * * This is an action in equity. The master has found that the appellant is indebted to appellee in the sum of $50,624.52. There is evidence to sustain this finding. A court of equity should not permit a plea of accord and satisfaction to work an injustice, if there is escape therefrom. Substantial equities of the parties require payment of what is due. If the construction company has performed this work, and furnished material to the extent which the master finds under the evidence, but has not been paid because of a mutual mistake as to the final estimate, there is no reason why, because of technical defenses, it or its trustee should be deprived of payment for work performed and material furnished. As the final estimate is based on mutual mistake, and as such errors are found in it as to destroy its integrity, the case stands in equity as if no final estimate had been made. If there is no final estimate there is no basis of settlement. The alleged accord and satisfaction is based on the final estimate and falls with it.' Likewise in the case at bar the settlement was based upon an assumed liability that did not exist, and since the alleged compromise was based on that incorrect assumption, the compromise must fall with it. See, also, Moehlenpah v. Mayhew, 138 Wis. 561, 119 N.W. 826; Richardson Lumber Co. v. Hoey et al., 219 Mich. 643, 189 N.W. 923; Jackman v. Northwestern Trust Co., 87 Or. 209, 170 P. 304, and Tarbox v. Tarbox, 111 Me. 374, 89 A. 194.
The facts in this case distinguish it from the cases cited and relied upon by the defendant. Judgment will be entered in favor of plaintiff for $8,342.08 which interest as provided by law. It is so ordered.