tag:blogger.com,1999:blog-33181919467860470212024-03-13T15:04:09.040-04:00Passive Activities and Other OxymoronsI have shifted to Forbes.http://blogs.forbes.com/peterjreilly/
This site is an archive of my pre-July 2011 posts and a repository of original source material that I referenced from Forbes.Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.comBlogger706125tag:blogger.com,1999:blog-3318191946786047021.post-71361725904542380812014-06-25T12:14:00.000-04:002015-09-29T18:55:33.630-04:00So You Want To Be A Tax Blogger?Many people get bitten by the blogging bug, but for most it is harmless dabbling. Many are called but few are chosen to dive into an obsessive activity that is a time sink of epic proportions. At least in the case of tax blogging, it is significantly less lucrative than the underlying professional activity. I have yet to hear of a tax blogger who has given up his or her day job. Although my resume might look like I've worked for different organizations, I've really only had one job.<br />
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<b>The Day Job</b><br />
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Herb Cohan, managing partner of Joseph B. Cohan and Associates hired me in November of 1979. Don Jeffery, Tax Practice Leader for the New England Cluster of Grant Thornton finally fired me effective May 1, 2013. He told me he was only following orders. That was the big difference with being in a national firm. In local and regional firms everybody is afraid of an ego-maniacal, possibly sociopathic, dictator of greater or lesser benevolence. At a national firm, everybody is afraid, but it is hard to put your finger on who they are afraid of. So without ever looking for a job I managed to be everything from staff accountant to partner in a large local CPA firm, equity partner in a medium than large regional firm and finally Managing Director (I was too old to start as a partner) in a not quite Big Four firm. Like Woody Allen said "90% of life is showing up".<br />
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I started this blog in December 2009. There were a number of things that I had written that nobody else was interested in publishing. I also had a habit of scanning almost all original source federal tax material for items that were of interest my firms tax practice. I figured I could share the wealth more widely and perhaps "build my brand". It's always easier to ask forgiveness than permission, so I did not share this brilliant branding strategy with firm management until I had been going for a couple of months. My managing partner at the time is a nice kid, but he is a graduate of the Citadel. You don't fly in the face of a managing partner who graduated from a military college (It counts Chesty Puller among its alumini) that was founded for the express purpose of training the young men of South Carolina to be prepared to put down slave revolts. He told me to stop, because he was worried about the exposure.<br />
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I continued sporadically for a few months writing about things other than taxes. Then I had a lucky break. I started negotiating with a guy in marketing who gave me a green light. Coincidentally the managing partner, the kid from the slave revolt repressing military college, decided that partners needed to be refreshed and instituted a sabbatical program. Eight weeks two partners a year. Eligibility was based on seniority in the firm. For the first time in thirteen years being one of the founding partners of the firm that merged Joseph B Cohan and Associated out of existence finally paid off. Prior to that the first item on the agenda whenever the executive committee met was how to make the deal worse for me (They denied that inference on my part, but never quite convinced me.)<br />
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I spent most of the eight weeks driving cross country with my sixteen year old son. One of the high points of the trip was getting my picture take in front of Flick's Bar in Hammond Indiana. If you don't grasp the significance of that, you wouldn't understand,. My son got sick of me after a while so I had to put him on a plane in LA and do the trek back alone. Thanks to the miracles of modern technology that gave me the chance to get this blog really going. Before long my readership numbered in the scores. I also formed the habit of picking up issues and following them. The tax issues surrounding gay marriage and the parsonage exclusion were two that go back to my earliest days of blogging.<br />
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I watched what other tax bloggers sometimes consumed with envy. Among them was Kelly Erb - Taxgirl or Taxgrrl as Joe Kristan calls her. I found the tax blogosphere a very welcoming place and formed online friendships with some of its most senior members including Robert Flach, the Wandering Tax Pro. Then Taxgirl moved to forbes.com. I worked my network and tried to find out what was involved in that. Thankfully, they liked my material enough to invite me to become a contributor.<br />
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From that point on I started using this blog as a parking place for original source material that I referenced from forbes.com It would also give people a sneak peak as to what I might be writing about in the next couple of weeks. Eventually I figured out how to get links to original source material without copying the cases into this blog and let it go moribund, but kept it as an archive of sorts.<br />
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This blog will continue as an archive, but all the substantive tax posts on it have been moved to <a href="http://ytmp.blogspot.com/">Your Tax Matters Partner</a> and non-tax posts have been moved to <a href="http://activepassivitiesandothermoronicoxen.blogspot.com/">We Are The Future Generations</a>. Forbes.com material will also be copied to those blogs over the next several weeks [Decades maybe. What a tedious project] for better indexing and cross-referencing. I may add other features.<br />
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<b>Your Big Opportunity</b><br />
<b><br /></b> I will be accepting guest posts on both of those blogs. In reality, it is not very hard to set up your own blog, but if you are only going to post sporadically, it can look a little silly. I am not now offering and never intend to offer any compensation whatsoever other than my gratitude. That an a nickel will get you, I don't know a nickel maybe. Still you might be able to make something out of it. Building your brand you know.<br />
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If you are interested contact me at <a href="mailto:peterreillycpa@gmail.com">peterreillycpa@gmail.com</a>. I usually find it easiest if your post is just included in the body of an e-mail rather than as some sort of an attachment.<br />
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If you actually want to start your own blog, blogspot makes it very easy for you, but you still might want to consider <a href="http://activepassivitiesandothermoronicoxen.blogspot.com/">Blogging For Dummies</a> which had some useful tips. It would probably be a good idea to learn html, but I have gotten by without it. I have learned that when I paste something and it looks weird I need to go into the html and delete all the odd things in <>. Look at what other bloggers in your field are doing and communicate with them. The tax blogosphere is actually pretty friendly. That is probably because none of us have figured out how to make a living from blogging. Actually doing tax work pays much much more than writing about it.<br />
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You can follow me on twitter <a href="https://twitter.com/peterreillycpa">@peterreillycpa.</a><br />
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For latest tax developments check me out on f<a href="http://www.forbes.com/sites/peterjreilly/">orbes.com.</a>Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com2tag:blogger.com,1999:blog-3318191946786047021.post-39444425816315303602012-08-12T16:28:00.000-04:002012-08-12T16:28:00.362-04:00Car Rental tax<h3>
AVIS BUDGET GROUP, INC., and THE HERTZ CORPORATION, Plaintiffs-Appellants,
v. CITY OF NEWARK, CITY COUNCIL OF THE CITY OF NEWARK, MAYOR OF THE CITY OF
NEWARK, and DIRECTOR OF FINANCE OF THE CITY OF NEWARK,
Defendants-Respondents.</h3>
<strong>Case Information: </strong>
<strong>Docket/Court: </strong>A-3801-10T4, Superior Court of New Jersey,
Appellate Division
<strong>Date Issued: </strong>08/01/2012 Argued March 13, 2012
<strong>Tax Type(s): </strong>Sales and Use Tax
On appeal from the Superior Court of New Jersey, Law Division, Essex County,
Docket No. L-6126-10.
John Longstreth (K & L Gates, LLP) of the District of Columbia bar,
admitted pro hac vice, argued the cause for appellants (Mark D. Marino and Mr.
Longstreth, of counsel and on the brief; Daniel A. Suckerman, on the brief).
Michael R. Griffinger argued the cause for respondents (GluckWalrath and
Gibbons, P.C., attorneys; Mr. Griffinger, Robert C. Brady, Fruqan Mouzon, Brian
P. McElroy, David A. Clark and Antonella Colella, on the brief).
<h3>
OPINION </h3>
NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE
DIVISION
<br />
<strong>APPROVED FOR PUBLICATION</strong>
Before Judges Carchman, Fisher and Baxter.
The opinion of the court was delivered by CARCHMAN, P.J.A.D.
This appeal requires us to consider the validity of Ordinance 6PFS-I 050510
(the Ordinance), enacted by defendant City of Newark (the City), <sup><a href="http://www.blogger.com/null" name="SRC 1"><a href="file:///C:/Users/Peter/Downloads/AVIS_BUDGET_GROUP__INC___and_THE_HERTZ_CORPORATION__Plaintiffs_Appellants__v__CITY_OF_NEWARK__CITY_C.htm#FN 1"><strong><span style="color: #145da4; font-size: xx-small;">1</span></strong></a></a></sup> levying a tax on all car rental
transactions within the City's Second and Third Industrial Zones, the latter of
which encompasses parts of Newark Liberty International Airport (the Airport).
Plaintiffs Avis Budget Group (Avis) and Hertz Corporation (Hertz) challenge the
Ordinance, asserting that it violates the Anti-Head Tax Act (AHTA), 49
<u>U.S.C.A.</u> § 40116, as well as 42 <u>U.S.C.A.</u> § 1983 and the Commerce
Clause of the United States Constitution, Article I, Section 8, Clause 3.
We conclude that the Ordinance is not a discriminatory tax or otherwise in
violation of the AHTA or the dormant Commerce Clause. We determine that the
Ordinance is a valid exercise of municipal authority. Accordingly, we affirm.
<h3>
I. </h3>
On July 28, 2009, the New Jersey Legislature enacted the New Jersey Economic
Stimulus Act of 2009, <u>N.J.S.A.</u> <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODNW&linkType=docloc&locId=nj40%3A48h-1&permaId=iSLCODNW%3A13535.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">40:48H-1</span></strong></a>
to -9, which, among other things, granted authority to certain municipalities to
tax motor vehicle rental transactions taking place in designated industrial
zones, specifically, zones within which commercial airports are located.
<u>N.J.S.A.</u> <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODNW&linkType=docloc&locId=nj40%3A48h-2&permaId=iSLCODNW%3A13536.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">40:48H-2.</span></strong></a>
The stated purpose of the legislation and the tax was to finance the
redevelopment of certain municipalities. <u>N.J.S.A.</u> <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODNW&linkType=docloc&locId=nj40%3A48h-1&permaId=iSLCODNW%3A13535.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">40:48H-1.</span></strong></a>
<u>N.J.S.A.</u> <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODNW&linkType=docloc&locId=nj40%3A48h-2&permaId=iSLCODNW%3A13536.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">40:48H-2</span></strong></a>,
the operative provision granting authority to tax, provides in relevant part:
<blockquote>
a. A municipality having a population in excess of 100,000 and
within which is located a commercial airport which provides for a minimum of 10
regularly scheduled commercial airplane flights per day, or a municipality in
which any portion of such an airport is located, by ordinance, may impose a tax
on the rental of motor vehicles on such rental transactions that occur within a
designated industrial zone of the municipality. Such tax shall be imposed on the
person, corporation, or other legal entity that is permitted the use of a motor
vehicle that it does not own for a period of time that is less than one year, in
exchange for the payment of a fee, and shall be collected on behalf of the
municipality by the person collecting such rental fee, in accordance with such
procedures as shall be established in the ordinance imposing the
tax.</blockquote>
The local motor vehicle rental tax rate imposed under an
ordinance adopted pursuant to this section shall not exceed five percent of the
total amount of the fee charged for the rental of the motor vehicle, excluding
any taxes and surcharges.
<br />
The City, which has a population in excess of 100,000 and “within which [the
Airport] is located,” qualified under this provision. On April 27, 2010, the
City Council, pursuant to <u>N.J.S.A.</u> <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODNW&linkType=docloc&locId=nj40%3A48h-2&permaId=iSLCODNW%3A13536.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">40:48H-2</span></strong></a>,
introduced an ordinance to tax car rental transactions. During a public meeting
to consider the proposed ordinance, council members informed the public that the
Ordinance was intended to tax “outsiders” at the Airport but not Newark
residents. Following the meeting, the Council passed the Ordinance, and the
Mayor signed it into law on May 7, 2010. It was published on May 14, 2010.
The Ordinance provides in relevant part:
<blockquote>
10:22A-3. IMPOSITION OF MOTOR VEHICLE RENTAL TAX.</blockquote>
There
is hereby imposed on the person, corporation or other legal entity that is
permitted the use of a motor vehicle that it does not own for a period of time
that is less than one year, in exchange for the payment of a fee, a tax of five
(5%) percent on the fee charged for the rental of such motor vehicle, excluding
any taxes and surcharges, in respect of rental transactions that occur within
the industrial zone. This tax is in addition to any other taxes or surcharges.
<br />
<blockquote>
10:22A-4. DESIGNATION OF INDUSTRIAL ZONE.</blockquote>
a. The City
hereby designates the following portion of the City as an “industrial zone” for
purposes of the motor vehicle rental tax authorized by the Act and this chapter,
such portion not exceeding, in the aggregate, fifty percent (50%) of the
territory of the City: All of the territory within the City which is, as of the
effective date of this ordinance, located [within] the “Second Industrial
District” and the “Third Industrial District[,]”[] as such areas are established
by Title XL, Chapter 2 of the Newark Municipal Code. The area so designated as
an industrial zone under this paragraph a. shall not be altered by any
subsequent revision of the City's zoning districts, but rather shall be amended
only by an ordinance expressly amending this ordinance in accordance with the
[A]ct. b. The City hereby determines that the industrial zone designated in
paragraph a. of this Section 10:22A-4 of the City constitutes an area having, or
intended to have, predominantly industrial, port, airport, and related uses.
<br />
The Third Industrial Zone encompasses parts of the Airport and the Port
Newark Marine Terminal. All of the ten rental car companies that are currently
affected by the Ordinance are located within the Third Industrial Zone.
Plaintiffs are two of the ten affected companies.
Plaintiffs challenged the validity of the Ordinance in the Law Division,
asserting that it violated State due process rights, was arbitrary, capricious
and unreasonable, and was contrary to the AHTA and the Commerce Clause. At the
hearing on the cross-motions for summary judgment, the parties focused on
whether the tax violated the AHTA. The City argued that the court could not
consider the issue since there was no private right of action to enforce the
AHTA. On the merits, it claimed that the Ordinance did not exclusively affect
Airport businesses because three rental car companies located in the Third
Industrial Zone were not located “at the Airport.” Plaintiffs countered that two
of the referenced “companies” were actually Avis parking lots where no rental
transactions occurred, and were unaffected by the tax, and the third, Action Car
Rental, was “at the Airport” because it serviced the Airport by shuttle bus from
an Airport hotel.
In a written opinion, Judge Michael R. Casale rejected the City's claim that
plaintiffs did not have a private right of action to enforce the AHTA, relying
on Interface Group, Inc. v. Massachusetts Port Authority, <a href="http://www.blogger.com/null" name="SLCSN:5398.7-1"></a>816 F.2d 9, 16 (1st Cir. 1987) , and Northwest Airlines,
Inc. v. County of Kent, <a href="http://www.blogger.com/null" name="SLCSN:5398.8-1"></a>955 F.2d 1054, 1058 (6th Cir.
1992), aff'd, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_92-97_01%2F24%2F1994&permaId=iSLACSFED%3A58.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">510
U.S. 355</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_92-97_01%2F24%2F1994&permaId=iSLACSFED%3A58.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">114
S. Ct. 855</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_92-97_01%2F24%2F1994&permaId=iSLACSFED%3A58.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">127
L. Ed. 2d 183 (1994)</span></strong></a> (deciding the questions presented on other grounds and
not reaching the issue of the implied right of action). He rejected contrary
decisions by the Seventh and Tenth Circuits in Southwest Air Ambulance, Inc. v.
City of Las Cruces, <a href="http://www.blogger.com/null" name="SLCSN:5398.12-1"></a>268 F.3d 1162, 1169 (10th Cir.
2001) , and Miller Aviation v. Milwaukee County Board of Supervisors, <a href="http://www.blogger.com/null" name="SLCSN:5398.13-1"></a>273 F.3d 722, 729 (7th Cir. 2001) . However, since
plaintiffs averred violations of 42 <u>U.S.C.A.</u> § 1983 in the complaint, the
trial court relied on Southwest, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.14-1"></a>268 F.3d at
1176 , to conclude that plaintiffs were not precluded from either enforcing the
AHTA or challenging the Ordinance.
Turning to the merits, the judge addressed the issue of whether the Ordinance
violated the AHTA. Citing Burbank-Glendale-Pasadena Airport Authority v. City of
Burbank, <a href="http://www.blogger.com/null" name="SLCSN:5398.15-1"></a>76 Cal. Rptr. 2d 297, 298 (Cal. App. 1998)
, the judge concluded that the Ordinance did not offend the AHTA:
<blockquote>
Here, the tax is not on air commerce; it is on the fee paid for
renting a car. Second, the tax is paid by the customer, not the businesses.
Third, the tax is not imposed exclusively on airport businesses, but rather it
must be paid by any rental car facility that is open or will open in the
qualified zones. Finally, the tax is payable by anyone who rents a car in the
designated zones, not only air travelers[;] and air travelers who wish to avoid
the tax can travel outside of the industrial zones and rent a car elsewhere. The
tax at issue herein is very similar to the tax upheld by the California Court of
Appeals [in <u>Burbank</u>] and is the type of tax authorized by 4[9]
<u>U.S.C.[A.]</u> § 40116(e)(1).</blockquote>
The court neither found a violation of the AHTA, nor a violation of the
Commerce Clause. The judge held: (1) where Congress has legislated, as it did in
enacting the AHTA, courts need not determine whether state action authorized by
the statute has violated the Commerce Clause; and (2) the statements City
Council members made during the public meeting did not affect the Commerce
Clause analysis when the City enacted the Ordinance “in strict compliance with
... [<u>N.J.S.A.</u> <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODNW&linkType=docloc&locId=nj40%3A48h-2&permaId=iSLCODNW%3A13536.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">40:48H-2</span></strong></a>].”
Finally, the judge determined that the City Council followed proper procedures
in enacting the Ordinance, and the Ordinance neither offended due process nor
was arbitrary, capricious or unreasonable. The court granted the City's motion
for summary judgment and dismissed plaintiffs' complaint. This appeal followed.
<h3>
II. </h3>
The City reiterates its argument that even if the tax violates the AHTA,
dismissal must be affirmed because there is no private right of action to
enforce the AHTA. Plaintiffs counter that even if there is no private right of
action, an AHTA violation may be remedied under 42 <u>U.S.C.A.</u> § 1983.
That the AHTA permits a private right of action is no longer a viable
argument. The AHTA is within the regulatory purview of the Department of
Transportation under the direction of the Secretary of Transportation (the
Secretary). <u>See</u> Northwest Airlines, Inc. v. Cnty. of Kent, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_92-97_01%2F24%2F1994&permaId=iSLACSFED%3A58.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">510
U.S. 355, 366-67</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_92-97_01%2F24%2F1994&permaId=iSLACSFED%3A58.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">114
S. Ct. 855, 863</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_92-97_01%2F24%2F1994&permaId=iSLACSFED%3A58.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">127
L. Ed. 2d 183, 195 (1994)</span></strong></a> (observing that the “Secretary of Transportation
is charged with administering ... the AHTA”); Township of Tinicum v. U.S. Dep't
of Transp., <a href="http://www.blogger.com/null" name="SLCSN:5398.20-1"></a>582 F.3d 482, 484 (3d Cir. 2009) (same);
Miller, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.21-1"></a>273 F.3d at 729-30 (same); Southwest,
supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.22-1"></a>268 F.3d at 1169-70 (same). Because the AHTA
is encompassed in the Federal Aviation Act (FAA), <sup><a href="http://www.blogger.com/null" name="SRC 2"><a href="file:///C:/Users/Peter/Downloads/AVIS_BUDGET_GROUP__INC___and_THE_HERTZ_CORPORATION__Plaintiffs_Appellants__v__CITY_OF_NEWARK__CITY_C.htm#FN 2"><strong><span style="color: #145da4; font-size: xx-small;">2</span></strong></a></a></sup> alleged violations of the AHTA are remedied through an
administrative process initiated by filing a complaint with the Secretary. 49
<u>U.S.C.A.</u> § 46101. <u>See also</u> 14 <u>C.F.R.</u> 16.1 (providing that
the FAA will determine disputes under AHTA except for challenges to fees by air
carriers against airport proprietors). Determinations by the Secretary on
questions involving the AHTA may be appealed to a federal district court. 49
<u>U.S.C.A.</u> § 46110.
The First and Sixth Circuits have held that Congress intended to create a
private right of action in the former AHTA, 49 <u>U.S.C.A.</u> § 1513, based on
the fact that that statute lacked an administrative enforcement scheme.
Interface, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.23-1"></a>816 F.2d at 16 ; Northwest
Airlines, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.24-1"></a>955 F.2d at 1058 . The United
States Supreme Court subsequently granted certiorari in <u>Northwest
Airlines</u>; although it did not consider whether the AHTA created private
rights of action, the Court disagreed with the First and Sixth Circuits'
construction of the AHTA when it observed that the AHTA was encompassed by the
FAA, which statute reflected an administrative enforcement scheme. Northwest
Airlines, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.25-1"></a>510 U.S. at 366-67, <a href="http://www.blogger.com/null" name="SLCSN:5398.26-1"></a>114 S. Ct. at 863, <a href="http://www.blogger.com/null" name="SLCSN:5398.27-1"></a>127 L.
Ed. 2d at 195 .
The Seventh and Tenth Circuits went further in rejecting <u>Interface</u> and
<u>Northwest Airlines</u>. These courts held that since the AHTA is included in
the FAA, <sup><a href="http://www.blogger.com/null" name="SRC 3"><a href="file:///C:/Users/Peter/Downloads/AVIS_BUDGET_GROUP__INC___and_THE_HERTZ_CORPORATION__Plaintiffs_Appellants__v__CITY_OF_NEWARK__CITY_C.htm#FN 3"><strong><span style="color: #145da4; font-size: xx-small;">3</span></strong></a></a></sup> Congress intended for
public enforcement of the AHTA and did not create a private right of action.
Miller, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.42-1"></a>273 F.3d at 729-31 ; Southwest,
supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.43-1"></a>268 F.3d at 1169-70 . Courts that have
considered the issue since the Supreme Court's decision in <u>Northwest
Airlines</u> have followed <u>Southwest</u> and <u>Miller</u>. <u>See</u> Air
Transp. Ass'n of Am. v. City of Los Angeles, <a href="http://www.blogger.com/null" name="SLCSN:5398.44-1"></a>844 F.
Supp. 550, 555 (C.D. Cal. 1994) (concluding that AHTA lacks private right of
action); Susquehanna Area Reg'l Airport Auth. v. Middletown Area Sch. Dist., <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSOS&linkType=docloc&locId=pa_1315c.d.2006_03%2F12%2F2007&permaId=iSLACSOS%3A28734.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">918
A.2d 813, 816</span></strong></a> (Pa. Commw. Ct. 2007) (same).
Other courts have rejected the claim that the AHTA may be enforced in state
court under Section 1983 based on the premise that the FAA provides a
comprehensive remedial scheme for AHTA violations that is sufficient to
foreclose Section 1983 actions. <u>See, e.g.</u>, New England Legal Found. v.
Mass. Port Auth., <a href="http://www.blogger.com/null" name="SLCSN:5398.46-1"></a>883 F.2d 157, 176 (1st Cir. 1989)
; Air Transp. Ass'n of Am. v. Public Util. Comm'n, <a href="http://www.blogger.com/null" name="SLCSN:5398.47-1"></a>833 F.2d 200, 207 (9th Cir. 1987), cert. denied, <a href="http://www.blogger.com/null" name="SLCSN:5398.48-1"></a>487 U.S. 1236, <a href="http://www.blogger.com/null" name="SLCSN:5398.49-1"></a>108 S. Ct.
2904, <a href="http://www.blogger.com/null" name="SLCSN:5398.50-1"></a>101 L. Ed. 2d 936 (1988) ; Montauk-Caribbean
Airways, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.51-1"></a>784 F.2d at 98 ; Air Transp. Ass'n,
supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.52-1"></a>844 F. Supp. at 559-60 . Even if a violation
of the AHTA could be remedied under 42 <u>U.S.C.A.</u> § 1983, a party would be
required to assert a violation of a federal right, not merely a federal law, “to
avail himself [or herself] of [Section] 1983.” Southwest, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.53-1"></a>268 F.3d at 1173 . In <u>Southwest</u>, the Tenth
Circuit held that the plaintiff airline could enforce the AHTA under Section
1983 because state and municipal taxation of airlines based on gross receipts, a
practice prohibited by the AHTA, would violate a federal right afforded to
airlines to be free of those taxes. <u>Id.</u> at 1173-74.
<u>Southwest</u> does not support a finding that airport businesses have a
federal right under the AHTA. Airport businesses have no right to be totally
free from state or local taxes based on gross receipts, and they remain subject
to nonexclusive taxes. In sum, we will not apply <u>Southwest</u> to car rental
companies at the Airport and find no basis for diverging from the overwhelming
authority holding that the AHTA may not be enforced in a suit under 42
<u>U.S.C.A.</u> § 1983.
The AHTA allows airport proprietors to levy reasonable rental, landing and
service fees from airline carriers for using airport facilities. Challenges to
the reasonableness of fees or charges must be brought before the Secretary.
<u>See</u> Miller, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.54-1"></a>273 F.3d at 725-26, 731
(noting that there is no private right of action in the AHTA to challenge the
fees Milwaukee County charged an airport hangar owner); Southwest, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.55-1"></a>268 F.3d at 1170 (holding that there is no private
right of action to challenge local ordinance that set fees at airport); Air
Transp. Ass'n, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.56-1"></a>844 F. Supp. at 555
(concluding that the Secretary has discretion to remedy unreasonable fees).
<sup><a href="http://www.blogger.com/null" name="SRC 4"><a href="file:///C:/Users/Peter/Downloads/AVIS_BUDGET_GROUP__INC___and_THE_HERTZ_CORPORATION__Plaintiffs_Appellants__v__CITY_OF_NEWARK__CITY_C.htm#FN 4"><strong><span style="color: #145da4; font-size: xx-small;">4</span></strong></a></a></sup> There is no private right of
enforcement under the AHTA.
<h3>
III. </h3>
Plaintiffs next argue that the Ordinance violates the AHTA by imposing a tax
on rental car companies at the Airport. Even though there is no private cause of
action, we will address the merits and review the trial court's grant of summary
judgment to defendants. We first identify the standard of review.
Our review of the grant or denial of summary judgment is de novo, using the
same legal standard as the trial court. Dugan Constr. Co. v. N.J. Tpk. Auth., <a href="http://www.blogger.com/null" name="SLCSN:5398.57-1"></a>398 N.J. Super. 229, 238 (App. Div.), certif. denied,
<a href="http://www.blogger.com/null" name="SLCSN:5398.58-1"></a>196 N.J. 346 (2008) ; Prudential Prop. & Cas.
Ins. Co. v. Boylan, <a href="http://www.blogger.com/null" name="SLCSN:5398.59-1"></a>307 N.J. Super. 162, 167 (App.
Div.), certif. denied, <a href="http://www.blogger.com/null" name="SLCSN:5398.60-1"></a>154 N.J. 608 (1998) . Summary
judgment is proper if, viewing the evidence in the light most favorable to the
nonmoving party, no genuine issue of material fact is disputed. Brill v.
Guardian Life Ins. Co. of Am., <a href="http://www.blogger.com/null" name="SLCSN:5398.61-1"></a>142 N.J. 520, 540
(1995); R. 4:46-2(c) . The trial court's factual findings are binding on appeal
when supported by adequate, substantial and credible evidence in the record.
Rova Farms Resort, Inc. v. Investors Ins. Co. of Am., <a href="http://www.blogger.com/null" name="SLCSN:5398.62-1"></a>65 N.J. 474, 484 (1974) . Conversely, the trial court's
conclusions of law “and the legal consequences that flow from established facts
are not entitled to any special deference.” Manalapan Realty, L.P. v. Twp. Comm.
of Manalapan, <a href="http://www.blogger.com/null" name="SLCSN:5398.63-1"></a>140 N.J. 366, 378 (1995) .
Under the Supremacy Clause, federal law is “the supreme Law of the Land[.]”
<u>U.S. Const.</u> art. VI, cl. 2. State laws that “'interfere with, or are
contrary to the laws of [C]ongress, made in pursuance of the [C]onstitution[,]'
are invalid.” Vail v. Pan Am Corp., <a href="http://www.blogger.com/null" name="SLCSN:5398.64-1"></a>260 N.J. Super.
292, 297 (App. Div. 1992) (quoting Wisconsin Pub. Intervenor v. Mortier, <a href="http://www.blogger.com/null" name="SLCSN:5398.65-1"></a>501 U.S. 597, 604, <a href="http://www.blogger.com/null" name="SLCSN:5398.66-1"></a>111 S.
Ct. 2476, 2481, <a href="http://www.blogger.com/null" name="SLCSN:5398.67-1"></a>115 L. Ed. 2d 532, 542 (1991) ). The
“focus of analysis is on the intent of Congress.” Miranda v. Fridman, <a href="http://www.blogger.com/null" name="SLCSN:5398.68-1"></a>276 N.J. Super. 20, 25 (App. Div.), certif. denied, <a href="http://www.blogger.com/null" name="SLCSN:5398.69-1"></a>138 N.J. 271 (1994) . Congressional intent may be
express or implied. <u>Ibid.</u>
To determine if a conflict exists between state and federal law, a court must
consider “'the relationship between [the] ... laws as they are interpreted and
applied, not merely as they are written.'” R.F. v Abbott Labs., <a href="http://www.blogger.com/null" name="SLCSN:5398.70-1"></a>162 N.J. 596, 618 (2000) (quoting Jones v. Rath Packing
Co., <a href="http://www.blogger.com/null" name="SLCSN:5398.71-1"></a>430 U.S. 519, 526, <a href="http://www.blogger.com/null" name="SLCSN:5398.72-1"></a>97 S. Ct. 1305, 1310, <a href="http://www.blogger.com/null" name="SLCSN:5398.73-1"></a>51 L.
Ed. 2d 604, 614 (1977) ).
Congress amended 49 <u>U.S.C.A.</u> § 40116(d), when it enacted the Federal
Aviation Administration Authorization Act of 1994 (FAAA), <u>Pub. L.</u> No.
103-305, 108 <u>Stat.</u> 1569 (1994), to include the following prohibition:
<blockquote>
(2) (A) A State, political subdivision of a State, or authority
acting for a State or political subdivision may not do any of the following acts
because those acts unreasonably burden and discriminate against interstate
commerce:</blockquote>
.... (iv) levy or collect a tax, fee, or charge, first
taking effect after August 23, 1994, exclusively upon any business located at a
commercial service airport or operating as a permittee of such an airport other
than a tax, fee, or charge wholly utilized for airport or aeronautical purposes.
<br />
<blockquote>
[49 <u>U.S.C.A.</u> § 40116(d).]</blockquote>
In the nearly twenty years since the enactment of this amendment, “43 States
and the District of Columbia” have levied taxes on airport car rental companies
by applying <u>non-exclusive</u> taxes to “all similar entities within that
taxing jurisdiction.” 157 <u>Cong. Rec.</u> H45, 2199 (daily ed. March 31, 2011)
(statements of Rep. Greg Cohen and Rep. Sam Graves). <sup><a href="http://www.blogger.com/null" name="SRC 5"><a href="file:///C:/Users/Peter/Downloads/AVIS_BUDGET_GROUP__INC___and_THE_HERTZ_CORPORATION__Plaintiffs_Appellants__v__CITY_OF_NEWARK__CITY_C.htm#FN 5"><strong><span style="color: #145da4; font-size: xx-small;">5</span></strong></a></a></sup>
In 2009, the Legislature enacted <u>N.J.S.A.</u> <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODNW&linkType=docloc&locId=nj40%3A48h-2&permaId=iSLCODNW%3A13536.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">40:48H-2</span></strong></a>,
which authorized qualifying municipalities to levy a tax on car rental
transactions that “occur within a designated industrial zone of the
municipality.” <u>Ibid.</u> The Legislature intended for <u>N.J.S.A.</u> <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODNW&linkType=docloc&locId=nj40%3A48h-2&permaId=iSLCODNW%3A13536.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">40:48H-2</span></strong></a>
to apply to “the City of Elizabeth and the City of Newark,” the two
municipalities in which sections of the Airport are located. Assembly
Appropriations Committee Statement to Assembly Bill No. 4048 (June 11, 2009).
The legislative history provides that car rental companies at the Airport
generated $132.7 million in revenue in the first nine months of the fiscal year
2009. <u>Ibid.</u>
We review the Ordinance against this background. In determining whether a
statute violates the AHTA, the Supreme Court has looked to the statute's purpose
and effect. <u>See</u> Aloha Airlines v. Dir. of Taxation, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_82-586_11%2F01%2F1983&permaId=iSLACSFED%3A158.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">464
U.S. 7, 13-14</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_82-586_11%2F01%2F1983&permaId=iSLACSFED%3A158.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">104
S. Ct. 291, 295</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_82-586_11%2F01%2F1983&permaId=iSLACSFED%3A158.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">78
L. Ed. 2d 10, 16 (1983)</span></strong></a> (“The manner in which the [Hawaii] ... [L]egislature
has described ... [the statute] cannot mask the fact that the purpose and effect
of [it] are to impose a levy upon the gross receipts of airlines.”). <u>See
also</u> Complete Auto Transit, Inc. v. Brady, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_76-29_03%2F07%2F1977&permaId=iSLACSFED%3A219.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">430
U.S. 274, 279</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_76-29_03%2F07%2F1977&permaId=iSLACSFED%3A219.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">97
S. Ct. 1076, 1079</span></strong></a> , <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_76-29_03%2F07%2F1977&permaId=iSLACSFED%3A219.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">51
L. Ed. 2d 326, 331 (1977)</span></strong></a> (noting that, in determining whether a tax
violates the Commerce Clause, the Court considers the tax statute's “practical
effect,” not its formal language).
<u>Burbank</u> provides assistance in our consideration of the issues before
us. In <u>Burbank</u>, the court considered whether a local parking tax levied
pursuant to a city ordinance was precluded by the AHTA. Burbank, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.82-1"></a>76 Cal. Rptr. 2d at 298 . The tax affected customers at
fifteen parking lots in the City of Burbank; however, three lots were within two
miles of the airport, and ninety percent of the tax revenues derived from
parking lots “at or near the airport.” <u>Ibid.</u> The court concluded that the
tax was not precluded by the AHTA, most notably 49 <u>U.S.C.A.</u> §
40116(d)(2)(A)(iv). The court said:
<blockquote>
First, the TPT [tax] is not a tax on air commerce. It is a tax on
the fee paid for short-term parking. The AHTA does not apply to taxes on airport
ground transportation services, such as parking facilities. Second, because the
TPT is paid by the customer, not the parking lot operator, it is analogous to
the “sales or use taxes” expressly permitted by the AHTA. Third, the TPT is not
imposed exclusively upon airport businesses, because it is collected by all
qualified parking lots in the City.</blockquote>
<blockquote>
[Burbank, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.83-1"></a>76 Cal. Rptr. 2d at 300
(citations omitted).]</blockquote>
<u>Susquehanna</u>, a more recent Pennsylvania decision, also upheld a
parking tax under the AHTA, for many of the same reasons provided in
<u>Burbank</u>:
<blockquote>
[P]arking patrons, not airport businesses, bear the burden of this
tax; a tax on parking transactions is not a head tax. The incidence of the tax
is the parking fee transaction, and the measure of the tax is on the transaction
fee itself. Further, it is undisputed here that non-airport parking transactions
are subject to the parking tax, and there is no exclusivity <u>sub
judice</u>.</blockquote>
<blockquote>
[Susquehanna, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.84-1"></a>918 A.2d at 816
.]</blockquote>
As in both <u>Burbank</u> and <u>Susquehanna</u>, here, the tax is not
“wholly utilized for airport or aeronautical purposes” under 49 <u>U.S.C.A.</u>
§ 40116(d)(2)(A)(iv). We must determine whether the City has imposed the tax
“exclusively upon any business [that is] located at [the Airport]” or is
“operating as a permittee of [the Airport][.]” 49 <u>U.S.C.A.</u> §
40116(d)(2)(A)(iv).
Judge Casale, relying on <u>Burbank</u>, held that the Ordinance did not
violate the AHTA because it levied a tax “on the fee paid for renting a car” and
“not on air commerce.” In finding that the AHTA did not apply to ground
transportation, the <u>Burbank</u> court cited Alamo Rent-A-Car, Inc. v. Palm
Springs, <a href="http://www.blogger.com/null" name="SLCSN:5398.85-1"></a>955 F.2d 30 (9th Cir. 1992) , which
analyzed the former AHTA, 49 <u>U.S.C.A.</u> § 1513, which statute applied only
to air transportation by aircraft. <u>Id.</u> at 31. <u>See also</u> Salem
Transp. Co. v. Port Auth. of N.Y. & N.J., <a href="http://www.blogger.com/null" name="SLCSN:5398.86-1"></a>611 F.
Supp. 254, 257 (S.D.N.Y. 1985) (rejecting claim by ground transportation
provider that a fee violated 49 <u>U.S.C.A.</u> § 1513). Two years after
<u>Alamo</u> was decided, Congress amended the FAA to prohibit taxes exclusively
levied on <u>any</u> business located at a commercial service airport. 49
<u>U.S.C.A.</u> § 40116(d)(2)(A)(vi). The current statute does not distinguish
between air and ground transportation.
The Law Division held that the Ordinance levied a tax not on a “business” at
the Airport, but on a consumer. The trial court reasoned that the tax was
permissible under the AHTA as “the type of [sales] tax” allowed by 49
<u>U.S.C.A.</u> § 40116(e)(1). This is consistent with the reasoning in
<u>Susquehanna</u>, where the court upheld a parking tax on parking transactions
at or near the airport because the “measure of the tax [was] on the transaction
fee” and was not a head tax. <u>Supra</u>, 918 <u>A.</u>2d at 817.
A state may levy “sales or use taxes on the sale of goods or services” that
do not violate subsection (d) of the AHTA. 49 <u>U.S.C.A.</u> § 40116(e)(1).
When subsection (e) is read in conjunction with subsection (d), the AHTA states
that a state or municipality is prohibited from levying any “sales or use taxes”
exclusively upon any business located at a commercial service airport. 49
<u>U.S.C.A.</u> § 40116(d)-(e). The relevant inquiry is whether there is a
meaningful distinction between the terms “consumer” and “business” under these
provisions.
We conclude that the AHTA's prohibition against taxes levied upon a business
does not extend to consumers. To be sure, Congress expressly precluded taxes
levied on consumers traveling in air commerce under 49 <u>U.S.C.A.</u> §
40116(b), but did not do so under 49 <u>U.S.C.A.</u> § 40116(d)(2)(A)(iv),
notwithstanding Congress' awareness that businesses, including airlines, could
pass on the taxes imposed on them to air travelers. <u>See</u> Niagara Frontier
Transp. Auth. v. E. Airlines, Inc., <a href="http://www.blogger.com/null" name="SLCSN:5398.87-1"></a>658 F. Supp.
247, 251 (W.D.N.Y. 1987) (stating that “Congress was aware that if the tax ...
were assessed to the airline, it would, in all probability, be passed on to the
airline passengers”).
In <u>Susquehanna</u>, the court explained:
<blockquote>
The difference then between a business privilege tax and a
transaction tax is not just the stated subject of the tax, but how the tax is
measured. A business privilege tax is a tax imposed on all of the gross receipts
from all of the businesses' activities anywhere, so long as the base of
operations within the political subdivision contributes to those activities
because the privilege of doing business is “far more than the sum of
transactions ... performed within the territorial limits of the taxing entity.”
A transaction tax, however, is imposed on the receipts from the designated
transactions that are actually performed within the taxing entity, because its
subject is only the transaction and not the privilege of engaging in a business
that allows the transaction to be consummated.</blockquote>
<blockquote>
[<u>Supra</u>, 918 <u>A.</u>2d at 818 (quoting Airpark Int'l I v.
Interboro Sch. Dist., <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSOS&linkType=docloc&locId=pa_j-208-1997_07%2F21%2F1999&permaId=iSLACSOS%3A27748.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">735
A.2d 646, 647</span></strong></a> (Pa. 1999) ).]</blockquote>
The statute provides that levying exclusive taxes on businesses located at an
airport is one of those acts that “unreasonably burden and discriminate against
interstate commerce[.]” 49 <u>U.S.C.A.</u> § 40116(d)(2)(A). Congress determined
that, like airlines, airport businesses are engaged in interstate commerce. This
is because airport businesses, like airlines, service air travelers and not
in-state users. <u>See</u> Denver v. Cont'l Air Lines, Inc., <a href="http://www.blogger.com/null" name="SLCSN:5398.89-1"></a>712 F. Supp. 834, 840 (D. Colo. 1989) (observing 49
<u>U.S.C.A.</u> § 1513 was intended to prohibit “the imposition of such local
taxes, fees, and charges that would be passed on to the flying public”). As the
Seventh Circuit noted in dicta in Indianapolis Airport Authority v. American
Airlines, Inc., <a href="http://www.blogger.com/null" name="SLCSN:5398.90-1"></a>733 F.2d 1262 (7th Cir. 1984) ,
customers of car rental companies located at airports are air travelers, and the
“rental fees” that are imposed upon those companies by airport proprietors are
similar to head taxes on air travelers:
<blockquote>
The parking lot is used by emplaning passengers and by people
picking up deplaning passengers. The car rental agencies are used by emplaning
and deplaning passengers, and likewise the food stands and newsstands. This
means that when the airport charges a rental fee to concessionaires it is as if
it were charging a landing fee to the airlines or imposing a head tax on the
passengers.</blockquote>
<blockquote>
[Id. at 1267-68.]</blockquote>
<u>See also</u> Southerland v. St. Croix Taxicab Ass'n, <a href="http://www.blogger.com/null" name="SLCSN:5398.91-1"></a>315 F.2d 364, 369 (3d Cir. 1963) (finding that the
airline passengers' prearranged transportation was part of the “interstate
journey,” and thus, an exclusive franchise granted to a taxicab company by the
Virgin Islands Territory to transport people to and from the airport was an
unreasonable burden on interstate commerce); Charter Limousine, Inc. v. Dade
Cnty. Bd. of Cnty. Comm'rs, <a href="http://www.blogger.com/null" name="SLCSN:5398.92-1"></a>678 F.2d 586, 589 (5th
Cir. 1982) (following <u>Southerland</u>).
Although the express language of the AHTA makes clear that a consumer is not
a “business,” the statute prohibits taxes upon consumers because such taxes
constitute taxes upon businesses located at airports. Here, car rental operators
have an obligation under the Ordinance to collect the tax, and the failure to do
so subjects them to penalties; consumers do not bear the whole obligation to
remit the tax. The Ordinance has been carefully drafted to not violate any
limitations imposed by the AHTA.
The trial court held that the tax was non-exclusive because it was similar to
the parking tax upheld in <u>Burbank</u>. There, the tax applied to every
parking lot in the City of Burbank, except for exempt lots used for medical
facilities, and metered and monthly parking. <u>Supra</u>, 76 <u>Cal. Rptr</u>.
2d at 298. Here, rental car companies in the City are not subject to the tax
unless they are located in either the Second or Third Industrial Zone, both of
which districts extended well beyond the boundaries of the Airport. In fact, the
record indicates that the industrial zones at issue together comprise over forty
percent of the area of the City, and the Airport occupies only a portion of the
Third Industrial Zone.
The AHTA does not define the term “exclusively.” As such, it is unclear
whether, in order to be deemed non-exclusive, a tax must apply to all, or only
some, of the like-kind businesses not located at an airport. The holding in
<u>Susquehanna</u> suggests that, unlike the tax in <u>Burbank</u>, a sales tax
is non-exclusive if it affects any non-airport transactions and need not affect
every like-kind business within the taxing jurisdiction. Susquehanna, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.93-1"></a>918 A.2d at 817 . The AHTA prevents the imposition of
taxes exclusively on airport businesses, but it does not preclude taxes that
<u>disproportionately affect</u> the airport businesses. A tax is non-exclusive
if it affects at least one business that is not located at an airport.
While all of the car rental companies affected by the tax here are located in
the Third Industrial Zone, either at or near the Airport, and they all service
the Airport in some capacity, they also provide car rental services for and
store rental cars to be used by customers at locations other than the Airport.
Significantly, the AHTA does not prohibit a tax on businesses <u>near</u> an
airport.
Here, the Ordinance does not apply only to the rental transactions that occur
at the Airport, even though all of the affected businesses are in the Third
Industrial Zone. As the trial judge noted:
<blockquote>
[T]he tax is payable to anyone who rents a car in the designated
zones, not only air travelers[;] and air travelers who wish to avoid the tax can
travel outside of the industrial zones and rent a car elsewhere.</blockquote>
We give little weight to the statements City Council members made at the
public hearing on adopting the Ordinance. We look to the adopted Ordinance first
rather than to the political process that may have generated it. Political
rhetoric will not overcome the language of the Ordinance. We recognize that the
State retains the power to impose a sales tax upon transactions near an airport,
which power will not be abridged absent clear and manifest congressional intent
in the AHTA to bar sales taxes imposed on a “consumer” of airport car rental
businesses under the circumstances presented here.
<h3>
IV. </h3>
Finally, we address the argument that the Ordinance violates the Commerce
Clause. We reject this claim.
Plaintiffs have failed to address the threshold question in the dormant
Commerce Clause analysis, which is whether Congress has exercised its plenary
power under the Commerce Clause in the field at issue. <u>See</u> Western &
S. Life Ins. Co. v. State Bd. of Equalization, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_79-1423_05%2F26%2F1981&permaId=iSLACSFED%3A190.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">451
U.S. 648, 652-53</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_79-1423_05%2F26%2F1981&permaId=iSLACSFED%3A190.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">101
S. Ct. 2070, 2075</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_79-1423_05%2F26%2F1981&permaId=iSLACSFED%3A190.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">68
L. Ed. 2d 514, 520 (1981)</span></strong></a> . <u>See also</u> National Fed'n of Indep. Bus. v.
Sebelius, 567 U.S. _______ , _______ S. Ct. _______ , <a href="http://www.blogger.com/null" name="SLCSN:5398.97-1"></a>183 L. Ed. 2d 450 (2012) (slip op. at 17-18)
(recognizing that Congress has broad authority under the Commerce Clause, not
confined to the regulation of commerce among the states, and extending to
activities that have a substantial effect on interstate commerce, including
activities that do so only when aggregated with similar activities of others).
Congress may authorize a state to engage in regulation that would otherwise
violate the dormant Commerce Clause by manifesting its “'unambiguous intent'” in
a federal statute to approve of the violation. Southwest, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.98-1"></a>268 F.3d at 1177 (quoting Wyoming v. Oklahoma, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_112_01%2F22%2F1992&permaId=iSLACSFED%3A80.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">502
U.S. 437, 458</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_112_01%2F22%2F1992&permaId=iSLACSFED%3A80.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">112
S. Ct. 789, 802</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_112_01%2F22%2F1992&permaId=iSLACSFED%3A80.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">117
L. Ed. 2d 1, 24-25 (1992)</span></strong></a> ). When Congress authorizes a state to act, courts
may not review the state taxes or other regulations for violations of the
dormant Commerce Clause. Merrion v. Jicarilla Apache Tribe, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_80-15_01%2F25%2F1982&permaId=iSLACSFED%3A183.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">455
U.S. 130, 154</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_80-15_01%2F25%2F1982&permaId=iSLACSFED%3A183.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">102
S. Ct. 894, 910</span></strong></a> , <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_80-15_01%2F25%2F1982&permaId=iSLACSFED%3A183.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">71
L. Ed. 2d 21, 40 (1982)</span></strong></a> .
In the AHTA, Congress expressly permitted states to tax airport businesses in
the manner provided in subsection (e). <u>See</u> Burbank, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.105-1"></a>76 Cal. Rptr. 2d at 301 (finding that the tax fell
within subsection (e) and was therefore “expressly permitted by the AHTA” and
did not violate the Commerce Clause).
We agree that the tax enabled by the Ordinance falls within the scope of
congressional authorization provided in the AHTA. Dormant Commerce Clause review
is therefore precluded. <u>See</u> Hughes v. Oklahoma, <a href="http://www.blogger.com/null" name="SLCSN:5398.106-1"></a>441 U.S. 322, 336, <a href="http://www.blogger.com/null" name="SLCSN:5398.107-1"></a>99 S.
Ct. 1727, 1736, <a href="http://www.blogger.com/null" name="SLCSN:5398.108-1"></a>60 L. Ed. 2d 250, 262 (1979)
(stating the analysis).
For the sake of completeness, we recognize that even if Congress had not
granted the City express permission in the AHTA, under a traditional dormant
Commerce Clause analysis, a tax that affects interstate commerce will be
sustained if it passes scrutiny under the test articulated in <u>Complete
Auto</u>. Our Court has followed the <u>Complete Auto</u> test, noting that
<blockquote>
[t]he [<u>Complete Auto</u>] test will sustain a state tax using a
formula apportionment method “[(1)] when the tax is applied to an activity with
a substantial nexus with the taxing State, [(2)] is fairly apportioned, [(3)]
does not discriminate against interstate commerce, and [(4)] is fairly related
to the services provided by the State.”</blockquote>
<blockquote>
[Whirlpool Props., Inc. v. Dir., Div. of Taxation, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCSN&linkType=docloc&locId=nj_a-25_07%2F28%2F2011&permaId=iSLCSN%3A4627.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">208
N.J. 141, 163 (2011)</span></strong></a> (quoting Complete Auto, supra, <a href="http://www.blogger.com/null" name="SLCSN:5398.110-1"></a>430 U.S. at 279, <a href="http://www.blogger.com/null" name="SLCSN:5398.111-1"></a>97 S.
Ct. at 1079, <a href="http://www.blogger.com/null" name="SLCSN:5398.112-1"></a>51 L. Ed. 2d at 331) .]</blockquote>
Here, the Ordinance applies to car rental activity that has a substantial
nexus to the City because the rental car agencies and the Airport are located in
the City, and customers “drive over City streets” to pick up and return the
rented car. Burbank, supra, Cal. Rptr. at 1225-26 . The tax is fairly
apportioned because the rental car transaction occurs within the City, and the
tax does not discriminate against interstate commerce because every person in
the City must pay the tax if a car is rented from either the Second or Third
Industrial Zone. Lastly, the tax would likely be reasonably related to the
services provided by the City because, as we have previously noted, customers
drive on the City's streets using the cars they have rented, and additionally,
their rights under the rental car contracts are protected by New Jersey law.
<u>See</u> Commonwealth Edison Co. v. Montana, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_80-581_07%2F02%2F1981&permaId=iSLACSFED%3A186.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">453
U.S. 609, 624-26</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_80-581_07%2F02%2F1981&permaId=iSLACSFED%3A186.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">101
S. Ct. 2946, 2957-58</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_80-581_07%2F02%2F1981&permaId=iSLACSFED%3A186.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">69
L. Ed. 2d 884, 899-900 (1981)</span></strong></a> (stating that where a general revenue tax does
not discriminate against interstate commerce and is apportioned to activities
occurring within the State, the tax is valid if reasonably related to the
benefits afforded by the State).
The Ordinance does not violate the Commerce Clause.
Affirmed. <br /><sup><a href="http://www.blogger.com/null" name="FN 1"><a href="file:///C:/Users/Peter/Downloads/AVIS_BUDGET_GROUP__INC___and_THE_HERTZ_CORPORATION__Plaintiffs_Appellants__v__CITY_OF_NEWARK__CITY_C.htm#SRC 1"><strong><span style="color: #145da4; font-size: xx-small;">1</span></strong></a></a></sup>
<br />
Additional defendants include the City Council of the City of Newark,
Mayor of the City of Newark and Director of Finance of the City of Newark.
<br /><sup><a href="http://www.blogger.com/null" name="FN 2"><a href="file:///C:/Users/Peter/Downloads/AVIS_BUDGET_GROUP__INC___and_THE_HERTZ_CORPORATION__Plaintiffs_Appellants__v__CITY_OF_NEWARK__CITY_C.htm#SRC 2"><strong><span style="color: #145da4; font-size: xx-small;">2</span></strong></a></a></sup>
<br />
<br />
Congress enacted the FAA in 1958. Federal Aviation Act of 1958 (FAA),
<u>Pub. L.</u> No. 85-726, 72 <u>Stat.</u> 731 (1958). In 1994, Congress
restructured the FAA through the Federal Aviation Authorization Act (FAAA).
<u>Pub. L.</u> No. 103-305, 108 <u>Stat.</u> 1569 (1994). <br /><sup><a href="http://www.blogger.com/null" name="FN 3"><a href="file:///C:/Users/Peter/Downloads/AVIS_BUDGET_GROUP__INC___and_THE_HERTZ_CORPORATION__Plaintiffs_Appellants__v__CITY_OF_NEWARK__CITY_C.htm#SRC 3"><strong><span style="color: #145da4; font-size: xx-small;">3</span></strong></a></a></sup>
<br />
<br />
The First Circuit also found that Congress did not intend to create
private rights of action within the FAA. Bonano v. E. Caribbean Airline Corp.,
<a href="http://www.blogger.com/null" name="SLCSN:5398.28-1"></a>365 F.3d 81, 84-86 (1st Cir. 2004) . <u>Bonano</u>
is consistent with holdings of the Second, Third, Ninth and Tenth Circuits that
the FAA does not contain private rights of action. Schmeling v. NORDAM, <a href="http://www.blogger.com/null" name="SLCSN:5398.29-1"></a>97 F.3d 1336, 1344 (10th Cir. 1996) ; G.S. Rasmussen
& Assoc., Inc. v. Kalitta Flying Serv., Inc., <a href="http://www.blogger.com/null" name="SLCSN:5398.30-1"></a>958 F.2d 896, 901-02 (9th Cir. 1992), cert. denied, <a href="http://www.blogger.com/null" name="SLCSN:5398.31-1"></a>508 U.S. 959, <a href="http://www.blogger.com/null" name="SLCSN:5398.32-1"></a>113 S. Ct.
2927, <a href="http://www.blogger.com/null" name="SLCSN:5398.33-1"></a>124 L. Ed. 2d 678 (1993) ; Montauk-Caribbean
Airways, Inc. v. Hope, <a href="http://www.blogger.com/null" name="SLCSN:5398.34-1"></a>784 F.2d 91, 97 (2d Cir.),
cert. denied, <a href="http://www.blogger.com/null" name="SLCSN:5398.35-1"></a>479 U.S. 872, <a href="http://www.blogger.com/null" name="SLCSN:5398.36-1"></a>107 S. Ct. 248, <a href="http://www.blogger.com/null" name="SLCSN:5398.37-1"></a>93 L. Ed.
2d 172 (1986) ; Wolf v. Trans World Airlines, Inc., <a href="http://www.blogger.com/null" name="SLCSN:5398.38-1"></a>544 F.2d 134, 137-38 (3d Cir. 1976), cert. denied, <a href="http://www.blogger.com/null" name="SLCSN:5398.39-1"></a>430 U.S. 915, <a href="http://www.blogger.com/null" name="SLCSN:5398.40-1"></a>97 S. Ct.
1327, <a href="http://www.blogger.com/null" name="SLCSN:5398.41-1"></a>51 L. Ed. 2d 593 (1977) . <u>See also</u>
Enyeart v. Minnesota, 408 F. Supp. 2d 797, 806-07 (D. Minn. 2006), aff'd, 218
Fed. Appx. 560 (8th Cir. 2007) (dismissing a complaint on the grounds that there
is no private right of action in the FAA). <br /><sup><a href="http://www.blogger.com/null" name="FN 4"><a href="file:///C:/Users/Peter/Downloads/AVIS_BUDGET_GROUP__INC___and_THE_HERTZ_CORPORATION__Plaintiffs_Appellants__v__CITY_OF_NEWARK__CITY_C.htm#SRC 4"><strong><span style="color: #145da4; font-size: xx-small;">4</span></strong></a></a></sup>
<br />
<br />
We do recognize limitations to the AHTA that are relevant here. AHTA
does not grant either the Secretary or federal courts exclusive jurisdiction to
decide the validity of a local tax ordinance, and state courts retain the
ability to hear issues of state tax administration. <u>See</u> 28
<u>U.S.C.A.</u> § 1341 (providing that federal district courts “shall not
enjoin, suspend or restrain the assessment, levy or collection of any tax under
State law” where a speedy and efficient remedy may be had in state courts).
<br /><sup><a href="http://www.blogger.com/null" name="FN 5"><a href="file:///C:/Users/Peter/Downloads/AVIS_BUDGET_GROUP__INC___and_THE_HERTZ_CORPORATION__Plaintiffs_Appellants__v__CITY_OF_NEWARK__CITY_C.htm#SRC 5"><strong><span style="color: #145da4; font-size: xx-small;">5</span></strong></a></a></sup>
<br />
<br />
Some members of Congress have viewed such a tax as exploiting a
“loophole” in the AHTA, thereby violating the spirit of the Act. During the
March 31, 2011 debate on the FAA Reauthorization and Reform Act of 2011,
Representatives Graves and Cohen proposed an amendment to the AHTA that, were it
adopted by Congress, would prohibit all but general sales taxes on car rental
companies at commercial airports. <u>Ibid. See also</u> H.R. Rep. No. 112-45
(2011). Despite this effort, Congress did not amend the AHTA to proscribe
non-exclusive taxes when it passed <u>H.R.</u> 658 as the FAA Modernization and
Reform Act of 2012, <u>Pub. L.</u> No. 112-95, 126 <u>Stat.</u> 11, 87 (2012).Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com1tag:blogger.com,1999:blog-3318191946786047021.post-53591237342454574152012-08-12T16:18:00.002-04:002012-08-12T16:18:56.476-04:00Montana Residence<h3>
MARK C. and JOAN E. SINNARD, Appellants, v. THE DEPARTMENT OF REVENUE OF THE
STATE OF MONTANA, Respondent.</h3>
<strong>Case Information: </strong>
<strong>Docket/Court: </strong>IT-2012-1, Montana State Tax Appeal Board
<strong>Date Issued: </strong>08/01/2012
<strong>Tax Type(s): </strong>Personal Income Tax
<h3>
OPINION </h3>
<h3>
FACTUAL BACKGROUND,CONCLUSIONS OF LAW,ORDER and OPPORTUNITY </h3>
<h3>
FOR JUDICIAL REVIEW </h3>
This case comes to us through a direct appeal by Taxpayers Mark C. Sinnard
and Joan E. Sinnard from an adverse decision of the Office of Dispute Resolution
(ODR) of the Department of Revenue (DOR). Michael W. Green, Crowley Fleck, PLLP,
represented Taxpayers and Teresa G. Whitney represented the DOR. The case was
heard on the record by agreement of the parties. Both parties submitted briefs
and materials and, by agreement of the parties, the ODR decision and transcript
were included in the materials considered by this Board.
<h3>
ISSUE </h3>
The issue presented is whether or not the Sinnards were residents of Montana
for the tax years 2005 through 2008 and were required to file resident income
tax returns during those years.
<h3>
FACTS PRESENTED </h3>
1. Mark Sinnard was employed by the 3M Corporation from 1974 until his
retirement in 2009. Mark was assigned to work in several foreign countries
during his career. Sinnards' Opening Brief, p.2.
2. When Mark's foreign service began, in 1995, in San Juan, Puerto Rico, the
Sinnard family moved there with their children. They filed resident tax returns
and obtained local driver's licenses. They also retained ownership of their home
in Minnesota, maintained Minnesota driver's licenses, filed nonresident
Minnesota tax returns, and voted in Minnesota elections. Sinnards' Opening
Brief, p.2.
3. With every foreign assignment, 3M allocated a fixed percentage of Mark's
income to the foreign country and the remaining portion to Minnesota,
representing the time he worked at company headquarters in that state. Sinnards'
Opening Brief, p.2.
4. Each year, while on “home leave” from their foreign assignments, the
Sinnards visited family in Minnesota and began annual summer vacations in
Montana. Sinnards' Opening Brief, p.2.
5. In 1998, 3M transferred Mark to Shanghai, China, and the Sinnards moved
there directly from Puerto Rico. They maintained their property, voter
registrations and tax filings with Minnesota and continued to spend summer
vacations in Montana. Sinnards' Opening Brief, pgs. 2 and 3.
6. In 2001, the Sinnards purchased a vacation property, consisting of a
double-wide trailer and land outside of Wilsall, Montana. They leased the land
to neighboring farmers for agricultural use and stayed at the property during
summer vacations. Sinnards' Opening Brief, p.3.
7. In 2002, 3M assigned Mark to Texas. The Sinnards purchased a home there,
obtained Texas driver's licenses and registered their vehicle there. They sold
their Minnesota home. Texas does not have an income tax, so they did not file a
state tax return. Their Montana vacations continued. Sinnards' Opening Brief,
p.3.
8. From 2002 to 2004, Mark purchased annual non-resident conservation and
fishing licenses from Montana Fish, Wildlife and Parks Department. DOR Opening
Brief, p.3.
9. In 2004, the Sinnards purchased additional land in Montana near Wilsall.
They built a cabin on the property which they leased. They filed non-resident
Montana tax returns reporting the rental income on their two properties.
Sinnards' Opening Brief, p.4.
10. The Sinnards registered two vehicles in Montana which they kept at the
Wilsall property. Sinnards' Opening Brief, p.4.
11. In 2004, Mark was reassigned to Singapore. The Sinnards sold their Texas
home when they moved abroad. They vacationed in Montana and obtained Montana
driver's licenses. They also registered to vote in Montana. Sinnards' Opening
Brief, p. 4.
12. In Singapore, the Sinnards obtained Singapore drivers licenses, filed
resident tax returns and US federal tax returns. They continued to file
nonresident Montana tax returns reporting the income from their rental property
and Minnesota income tax returns reporting the income Mark earned when assigned
to corporate headquarters in that state. Sinnards' Opening Brief, p. 5.
13. In 2005, Mark purchased a Montana resident conservation hunting license,
attesting that he was a resident of Montana and using his Montana driver's
license to substantiate his residency. DOR Opening Brief, p.3.
14. The Sinnards reported that they maintained a home in Wilsall, Montana, in
their federal tax returns for 2006, 2007, and 2008. DOR Opening Brief, p.2.
15. In 2006, 2007, and 2008, Mark again purchased a resident conservation
hunting license, attesting that he had been a Montana resident for two, three or
four years, respectively. DOR Opening Brief, p.4.
16. In 2008, the Sinnards voted by absentee ballot in Park County, Montana.
Sinnards' Opening Brief, p.5.
17. In 2010, the Sinnards received and completed a residency questionnaire
sent by the DOR. The form, completed by Joan in Mark's absence, stated that they
claimed Montana as their residence since 2005. ODR/Sinnard Exhibit A, DOR
Sinnard 000225.
18. Joan explained on that form: “Mark had a temporary assignment in
Singapore. Joan and Abby accompanied him. However, Montana is/was still
considered our residency. Due to Mark's employment with 3M in MN, he had to file
a MN tax return however he did not live there. All business in U.S. was as a MT
resident. No legal residence in Singapore — only MT.” ODR/Sinnard Exhibit A, DOR
Sinnard 000225 and 000227.
19. Joan testified in the ODR hearing that she was uncertain about the
meaning of the terms resident and residence in the questionnaire. Sinnards'
Opening Brief, p. 7, ODR Tr. 63:5-13.
20. In 2009, Mark retired from 3M and the Sinnards relocated to their Wilsall
property, upgrading it for permanent residency. Sinnards' Opening Brief, p.6.
21. The DOR informed the Sinnards in 2010 that they were determined to be
Montana residents for the tax years 2005-2008 and requested that they file tax
returns for those years. The Sinnards disputed that by filing a letter from
their tax accountant explaining their circumstances. Sinnards' Opening Brief, p.
7.
22. On December 13, 2010, the DOR sent an Audit Adjustment Notice and
Statement of Account assessing the Sinnards with Montana income tax liability,
Sinnards' Opening Brief, p.7.
23. Their taxability was upheld by the decision of the ODR following a
hearing and submission of materials. This appeal followed.
<h3>
Findings of Fact, Conclusions of Law and Discussion </h3>
The question at issue is whether the Sinnards are residents of Montana for
the tax years in question and therefore liable for taxes on income earned
outside Montana. '“Montana source income' means: (i) wages, salary, tips, and
other compensation for services performed in the state or while a resident of
the state.” <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mt15-30-2101%2818%29%28a%29&permaId=iSLCODAM%3A106513.1&tagName=PARA&endParm=y"><strong><span style="color: #145da4;">Section
15-30-2101 (18)(a), MCA</span></strong></a>.
The rules for determining residency under <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mt1-1-215&permaId=iSLCODAM%3A105131.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">§
1-1-215, MCA</span></strong></a>, state: Every person has, in law, a residence. In determining
the place of residence, the following rules are to be observed:
<dl>
<dd>(1) It is the place where a person remains when not called elsewhere for
labor or other special or temporary purpose and to which the person returns in
seasons of repose.
<dd>(2) There may be only one residence. If a person claims a residence within
Montana for any purpose, then that location is the person's residence for all
purposes unless there is a specific statutory exception.
<dd>(3) A residence cannot be lost until another is gained.
<dd>(7) The residence can be changed only by the union of act and intent.
</dd></dd></dd></dd></dl>
The Taxpayers claim that they did not establish Montana residency until 2009
when they moved to the Wilsall property following Mark's retirement. Prior to
that time, they came to Montana only for vacations, although they purchased two
parcels of land and kept a vehicle in Montana. They argue that their actions in
2004 of obtaining drivers' licenses and registering to vote do not meet the
statutory “union” test because they did not live in Montana.
The DOR contends that their actions did establish residency and that their
moving to Singapore mat same year did not terminate their Montana residency
because it was a temporary assignment and was known to be temporary from the
outset. It is important to note that the Sinnards do not claim to have been
resident anywhere else in the U.S. during the relevant time, having surrendered
other prior U.S. and foreign residences, sold their Texas property and
relinquished their Texas driver's licenses. Montana law, quoted above, states
that “every person has, in law, a residence.” <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mt1-1-215&permaId=iSLCODAM%3A105131.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">Section
1-1-215, MCA</span></strong></a>.
Much of the parties' argument is focused on interpreting the various actions
of the Taxpayers to indicate their intent. Intent is, of course, a key element
in determining residency and domicile. Changing residence requires a union of
action and intent under <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mt1-1-215%287%29&permaId=iSLCODAM%3A105131.1&tagName=SBSEC&endParm=y"><strong><span style="color: #145da4;">§
1-1-215(7), MCA</span></strong></a> and regulations state that residency “is determined in light
of all facts and circumstances.” <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLREG&linkType=docloc&locId=mt42.15.109%281%29&permaId=iSLREG%3A27898.1&tagName=RSBSEC&endParm=y"><strong><span style="color: #145da4;">ARM
42.15.109(1)</span></strong></a>.
Montana law, however, also contains a specific statutory section that appears
to be controlling in this situation: when a person claims a residence within
Montana for any purpose, then that location is the person's residence for all
purposes unless there is a specific statutory exception. <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mt1-1-215%282%29&permaId=iSLCODAM%3A105131.1&tagName=SBSEC&endParm=y"><strong><span style="color: #145da4;">Section
1-1-215(2), MCA</span></strong></a>.
Under Montana law, therefore, when the Sinnards registered to vote in
Montana, they held themselves out as residents of the state because only
residents can vote in our elections. <a href="http://www.blogger.com/null" name="SLCSM:7355.8-1"></a>Section
13-1-111(l)(c), MCA. Voting is certainly one of the most significant benefits of
citizenship and much of the legal commentary on the subject of residency and
domicile emphasizes its importance in proving an individual's intent. In
determining domicile, courts have cited the act of voting as one of the most
significant indicators of intent. Oglesby v. Williams, <a href="http://www.blogger.com/null" name="SLCSM:7355.9-1"></a>372 Md. 360, 373, <a href="http://www.blogger.com/null" name="SLCSM:7355.10-1"></a>812 A.2d
1061 (2002).
The Sinnards also represented themselves as residents in obtaining hunting
and fishing licenses in this state at a considerable discount from the rate
charged to non-residents. Montana law has a separate definition of residency for
purposes of obtaining hunting and fishing licenses in the state. <a href="http://www.blogger.com/null" name="SLCSM:7355.11-1"></a>Section 87-2-102, MCA. To qualify, a person must have
“physically resided in Montana as the person's principal or primary home or
place of abode for 180 consecutive days, file a Montana state income tax return
as a resident if required to file, license and title any vehicles in Montana
that the person owns and operates in Montana, and “if the person registers to
vote, the person registers only in Montana.” Section <a href="http://www.blogger.com/null" name="SLCSM:7355.12-1"></a>87-2-102(2) and (4), MCA. The resident hunting and
fishing licenses obtained by Mark Sinnard during the years in question clearly
required him to expressly agree that he was a resident.
Further, the Sinnards represented themselves as residing in Montana on their
Federal income tax returns each year at issue, and in 2010 they made those same
representations to the State of Montana when they completed a residency
questionnaire for the DOR stating that they had regarded Montana as their
residence since 2005. Joan Sinnard claims she failed to understand the terms
used in the questionnaire but her statements about their residency were clear,
simple and unequivocal. She clearly stated that they did not intend to be
Singapore residents and regarded Montana as their residence during the years at
issue. We find their representations indicate intent to be Montana citizens.
The Sinnards also obtained Montana driver's licenses in 2004 and maintained
those licenses while in Singapore, an act typical of those intending to reside
here rather than vacation here, and they do own two pieces of real property in
the state, so their physical connection to the state is also clear.
The Sinnards now claim that they established residency in Singapore which
would be considered inconsistent with residency in Montana during the years in
question. The facts, however, indicate strong and continuous ties with Montana,
most notably the fact that they voted here in 2008, four years after they claim
to have established residency in Singapore. “The controlling factor in
determining a person's domicile is his intent. One's domicile, generally, is
that place where he intends to be. The determination of his intent, however, is
not dependent upon what he says at a particular time, since his intent may be
more satisfactorily shown by what is done than by what is said.” Roberts v.
Lakin, <a href="http://www.blogger.com/null" name="SLCSM:7355.13-1"></a>340 Md. 147, 153, <a href="http://www.blogger.com/null" name="SLCSM:7355.14-1"></a>665 A.2d 1024,1027 (1995) . “Self-serving declarations
of the party...have but litde weight in a suit of this kind.” Elwert v. Elmrt,
<a href="http://www.blogger.com/null" name="SLCSM:7355.15-1"></a>196 Ore. 256, <a href="http://www.blogger.com/null" name="SLCSM:7355.16-1"></a>248 P. 2d
847 (1952) . In this case, the Sinnards' actions indicate that they regarded
themselves as Montana residents.
During the time they claim to be residents of Singapore, they also visited
the state annually, maintained their Montana driver's licenses and represented
themselves on at least three separate occasions as Montana residents on their
hunting and fishing license applications. They obtained Singapore driver's
licenses and participated in local schools and churches while there, but the
facts demonstrate they made no effort to make Singapore their permanent home.
According to their own statements, they regarded Singapore as a temporary
assignment similar in duration to the other temporary assignments from 3M,
generally of two or three years duration, and throughout their stay regarded
Montana as their residence, and surrendered other prior U.S. residences, selling
their Texas property and relinquishing their Texas driver's licenses. We find
their actions terminating their residency elsewhere but maintaining their
property and connections to Montana during their temporary stay in Singapore are
strong indications of their intent to be Montana residents.
The Montana tax residency statute is clear: when a person claims a residence
within Montana for any purpose, then that location is the person's residence for
all purposes unless there is a specific statutory exception. <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mt1-1-215%282%29&permaId=iSLCODAM%3A105131.1&tagName=SBSEC&endParm=y"><strong><span style="color: #145da4;">Section
1-1-215(2), MCA</span></strong></a>. There is no relevant statutory exemption in this matter.
The evidence shows the Sinnards claimed a residence within Montana for several
purposes. Further, the evidence is sufficient that the residency requirements
are clearly stated for those who apply for voter registration and
hunting/fishing licenses that we find it to be the intent of the Sinnards to be
residents of Montana as demonstrated by their filing those applications with the
state of Montana.
We conclude the statute is controlling and find that the Sinnards are
residents of Montana. While it is unfortunate that they neglected to pay income
tax, their residency required that they do so.
<h3>
Order </h3>
IT IS THEREFORE ORDERED by the State Tax Appeal Board of the State of Montana
that the Taxpayers' appeal and complaint be denied and the tax, interest, and
penalties, as assessed by the Department, are properly due and owing.
DATED this <u>1st</u> day of August, 2012.
<blockquote>
<blockquote>
BY ORDER OF THE STATE TAX APPEAL BOARD</blockquote>
</blockquote>
<blockquote>
<blockquote>
/s/</blockquote>
</blockquote>
<blockquote>
<blockquote>
KAREN E. POWELL, Chairwoman</blockquote>
</blockquote>
(SEAL)
<blockquote>
<blockquote>
/s/</blockquote>
</blockquote>
<blockquote>
<blockquote>
SAMANTHA SANCHEZ, Member</blockquote>
</blockquote>
<blockquote>
<blockquote>
/S/</blockquote>
</blockquote>
<blockquote>
<blockquote>
KELLY FLAHERTY SETTLE, Member</blockquote>
</blockquote>
NOTICE: You are entitled to judicial review of this Order in accordance with
<a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mt15-2-303%282%29&permaId=iSLCODAM%3A105688.1&tagName=SBSEC&endParm=y"><strong><span style="color: #145da4;">Section
15-2-303(2), MCA</span></strong></a>. Judicial review may be obtained by filing a petition in
district court within 60 days following the service of this Order.
<h3>
CERTIFICATE OF SERVICE </h3>
I certify that on this <u>1st</u> day of August, 2012, a true and correct
copy of the foregoing Order was served by placing same in the United States
Mail, postage prepaid, and addressed as follows: <pre>Michael W. Green
Attorney at Law
CROWLEY FLECK, PLLP
PO Box 797
Helena, Montana 59624-0797
Teresa G. Whitney
Tax Counsel
Montana Department of Revenue
Legal Services Office
PO Box 7701
Helena, MT 59604-7701</pre>
<blockquote>
<blockquote>
/s/</blockquote>
</blockquote>
<blockquote>
<blockquote>
DONNA EUBANK, paralegal assistant</blockquote>
</blockquote>
<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com2tag:blogger.com,1999:blog-3318191946786047021.post-830118851078394092012-08-12T16:16:00.002-04:002012-08-12T16:16:28.151-04:00Mileage<h3>
DUSTIN ROBISON, Petitioner and Appellant, v. MONTANA DEPARTMENT OF REVENUE,
Respondent and Appellee.</h3>
<strong>Case Information: </strong>
<strong>Docket/Court: </strong>11-0672; 2012 MT 145, Supreme Court of Montana
<strong>Date Issued: </strong>07/06/2012 Submitted on Briefs: May 23, 2012
<strong>Tax Type(s): </strong>Personal Income Tax
<h3>
Headnote</h3>
<strong>1. </strong><strong>TAXATION — INCOME TAXES — ASSESSMENT — Judicial
review — Scope and extent of review in general.</strong> District court reviews
a decision of State Tax Appeals Board (STAB) to determine whether STAB's
findings of fact are clearly erroneous and whether STAB correctly interpreted
the law.
<strong>2. </strong><strong>APPEAL AND ERROR — REVIEW — QUESTIONS OF FACT,
VERDICTS, AND FINDINGS — FINDINGS OF COURT — Conclusiveness in general — In
general — Clearly erroneous findings.</strong> A factual finding is clearly
erroneous if it is not supported by substantial evidence, if the trier of fact
misapprehended the effect of the evidence, or if a review of the record leaves
the reviewing court with the definite and firm conviction that a mistake has
been made.
<strong>3. </strong><strong>TAXATION — INCOME TAXES — ASSESSMENT — Judicial
review — Scope and extent of review in general.</strong> Supreme Court reviewing
a district court order affirming or reversing decision of State Tax Appeals
Board (STAB) employs the same standards as the district court, and determines
whether STAB's findings of fact are clearly erroneous and whether STAB correctly
interpreted the law.
<strong>4. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Deductions — In general.</strong> Tax deductions are a matter
of legislative grace and it is the taxpayer's burden to clearly demonstrate the
right to the claimed deduction.
<strong>5. </strong><strong>TAXATION — INCOME TAXES — ASSESSMENT — Evidence —
In general.</strong> Tax deductions are a matter of legislative grace and it is
the taxpayer's burden to clearly demonstrate the right to the claimed deduction.
<strong>6. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — In general.</strong> Traveling expenses are deductible if
the taxpayer can prove the expenses are: (1) reasonable and necessary; (2)
incurred while away from home; and (3) incurred in the pursuit of a trade or
business. .
<strong>7. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Necessity that expenses be incurred away from home;
determination of taxpayer's home.</strong> Traveling expenses are deductible if
the taxpayer can prove the expenses are: (1) reasonable and necessary; (2)
incurred while away from home; and (3) incurred in the pursuit of a trade or
business. .
<strong>8. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> Traveling expenses are
deductible if the taxpayer can prove the expenses are: (1) reasonable and
necessary; (2) incurred while away from home; and (3) incurred in the pursuit of
a trade or business. .
<strong>9. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — In general.</strong> For travel expenses to be deductible,
it is the job, not the taxpayer's pattern of living, that must require the
travel. .
<strong>10. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> For travel expenses to
be deductible, it is the job, not the taxpayer's pattern of living, that must
require the travel. .
<strong>11. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Temporary or indefinite employment.</strong> One exception
to the general rule that commuting expenses are non-deductible as traveling
expenses is when the taxpayer travels to a temporary, as opposed to indefinite,
job. .
<strong>12. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> One exception to the
general rule that commuting expenses are non-deductible as traveling expenses is
when the taxpayer travels to a temporary, as opposed to indefinite, job. .
<strong>13. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Temporary or indefinite employment.</strong> For purposes of
provision of Internal Revenue Code governing deduction of business expenses,
employment is generally temporary when it lasts for less than one year. .
<strong>14. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> For purposes of
provision of Internal Revenue Code governing deduction of business expenses,
employment is generally temporary when it lasts for less than one year. .
<strong>15. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Temporary or indefinite employment.</strong> Taxpayer is
generally allowed to deduct travel expenses related to temporary employment. .
<strong>16. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> Taxpayer is generally
allowed to deduct travel expenses related to temporary employment. .
<strong>17. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Temporary or indefinite employment.</strong> In determining
whether taxpayer is allowed to deduct business travel expenses, employment is
indefinite when the length of the employment is indeterminate. .
<strong>18. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> In determining whether
taxpayer is allowed to deduct business travel expenses, employment is indefinite
when the length of the employment is indeterminate. .
<strong>19. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Temporary or indefinite employment.</strong> In determining
whether taxpayer is allowed to deduct business travel expenses, employment which
merely lacks permanence is indefinite unless termination is foreseeable within a
short period of time. .
<strong>20. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> In determining whether
taxpayer is allowed to deduct business travel expenses, employment which merely
lacks permanence is indefinite unless termination is foreseeable within a short
period of time. .
<strong>21. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Temporary or indefinite employment.</strong> Taxpayer is not
allowed to deduct business travel expenses related to indefinite employment. .
<strong>22. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> Taxpayer is not allowed
to deduct business travel expenses related to indefinite employment. .
<strong>23. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Necessity that expenses be incurred away from home;
determination of taxpayer's home.</strong> For purposes of provision of Internal
Revenue Code governing deduction of business expenses, "home' does not have its
usual and ordinary meaning. .
<strong>24. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> For purposes of
provision of Internal Revenue Code governing deduction of business expenses,
"home' does not have its usual and ordinary meaning. .
<strong>25. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Necessity that expenses be incurred away from home;
determination of taxpayer's home.</strong> When a regularly employed taxpayer
maintains his personal residence within the general area of his employment, his
"tax home' will be his personal residence, such that business travel expenses
would be deductible. .
<strong>26. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> When a regularly
employed taxpayer maintains his personal residence within the general area of
his employment, his "tax home' will be his personal residence, such that
business travel expenses would be deductible. .
<strong>27. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Necessity that expenses be incurred away from home;
determination of taxpayer's home.</strong> When a taxpayer accepts employment
either permanently or for an indefinite period of time away from his personal
residence, his "tax home' will shift to the new location, the vicinity of his
new principal place of business; in this situation, the decision to retain a
former residence is a personal choice, and the expenses of traveling to and from
that residence are non-deductible personal expenses. .
<strong>28. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> When a taxpayer accepts
employment either permanently or for an indefinite period of time away from his
personal residence, his "tax home' will shift to the new location, the vicinity
of his new principal place of business; in this situation, the decision to
retain a former residence is a personal choice, and the expenses of traveling to
and from that residence are non-deductible personal expenses. .
<strong>29. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Necessity that expenses be incurred away from home;
determination of taxpayer's home.</strong> Taxpayer's employment in state was
indefinite, rather than temporary, and his "tax home' was his principal place of
business, rather than his personal residence, and thus, his business travel
expenses were disallowed; taxpayer was never told how long his work in state
would last, since taxpayer took indefinite employment away from his personal
residence his "tax home' consequently shifted to his place of business, and
expenses of traveling from camp to each drill site could not be differentiated
from any other worker's normal commuting expenses. .
<strong>30. </strong><strong>INTERNAL REVENUE — INCOME TAXES — DEDUCTIONS —
EXPENSES — Travel — Temporary or indefinite employment.</strong> Taxpayer's
employment in state was indefinite, rather than temporary, and his "tax home'
was his principal place of business, rather than his personal residence, and
thus, his business travel expenses were disallowed; taxpayer was never told how
long his work in state would last, since taxpayer took indefinite employment
away from his personal residence his "tax home' consequently shifted to his
place of business, and expenses of traveling from camp to each drill site could
not be differentiated from any other worker's normal commuting expenses. .
<strong>31. </strong><strong>TAXATION — INCOME TAXES — DEDUCTIONS, CREDITS,
AND EXEMPTIONS — Expenses — Trade or business.</strong> Taxpayer's employment in
state was indefinite, rather than temporary, and his "tax home' was his
principal place of business, rather than his personal residence, and thus, his
business travel expenses were disallowed; taxpayer was never told how long his
work in state would last, since taxpayer took indefinite employment away from
his personal residence his "tax home' consequently shifted to his place of
business, and expenses of traveling from camp to each drill site could not be
differentiated from any other worker's normal commuting expenses. .
<strong>32. </strong><strong>APPEAL AND ERROR — PRESENTATION AND RESERVATION
IN LOWER COURT OF GROUNDS OF REVIEW — ISSUES AND QUESTIONS IN LOWER COURT —
Necessity of presentation in general.</strong> The Supreme Court does not
address issues raised for the first time on appeal.
APPEAL FROM: District Court of the First Judicial District, In and For the
County of Lewis & Clark, Cause No. DDV 11-330, Honorable James P. Reynolds,
Presiding Judge
For Appellant: Thomas J. Stusek, Stusek Law Firm, P.C., Bozeman, Montana
For Appellee: Michelle R. Johnson, Amanda L. Myers, Teresa G. Whitney,
Special Assistant Attorneys General, Helena, Montana
<h3>
OPINION </h3>
Justice Michael E Wheat delivered the Opinion of the Court.
Petitioner Dustin Robison (Robison) appeals from an order of the First
Judicial District Court, Lewis and Clark County, which reversed the findings of
the State Tax Appeals Board (STAB) and reinstated the findings of the Montana
Department of Revenue (DOR). We affirm.
<h3>
BACKGROUND </h3>
This case concerns whether Robison is allowed to claim a deduction on his
Montana income taxes for certain mileage as a business travel expense. The facts
that follow are undisputed.
Robison resides in Billings, Montana. He was employed by Unit Drilling
Company (Unit) as a rig hand on oil rigs in the Big Piney/Pinedale area of
western Wyoming. When Robison began working in the Big Piney/Pinedale area in
2005, he did not know how long his employment there would last — for example, 1
week, or 5 years, or longer. Robison also did not know that his employment there
would be for a specific limited duration; for example, he did not know at the
outset that his employment there would terminate in 8 months. Robison said “Oil
rigs are designed to move. That's the principle that allows us to do what we do.
We rig up on a location. Once our hole is drilled, we have to move to the next
one. No telling where that will be.” Robison also stated that Billings is a good
place to live because it is central to several oil fields. As STAB found, it is
“uncontroverted” that Robison “never knew how long he would be employed at any
one site.” In reality, Robison was employed in the same Big Piney/Pinedale area
for over 3 years, from March of 2005 to early October of 2008.
While so employed, Robison worked a 7-day-on, 7-day-off schedule. As his
mileage logs reflect, he would drive his personal vehicle <sup><a href="http://www.blogger.com/null" name="SRC 1"><a href="file:///C:/Users/Peter/Downloads/DUSTIN_ROBISON__Petitioner_and_Appellant__v__MONTANA_DEPARTMENT_OF__REVENUE__Respondent_and_Appellee.htm#FN 1"><strong><span style="color: #145da4; font-size: xx-small;">1</span></strong></a></a></sup> from his residence in Billings to a
camp (provided and maintained by Unit for its workers) in the Big Piney/Pinedale
area. Then, during the 7 days he worked, he would drive from the camp to an oil
rig (or rigs) and back, until finally, at the end of the 7-day-on schedule,
Robison would drive from the rig location back to his residence in Billings.
Robison claimed this mileage as a business travel expense during tax years
20052008, and deducted it accordingly. In total, Robison claimed $78,812 in
business travel expenses for the 2005-2008 tax years. Robison was audited by the
DOR in 2009 after “reporting significant amounts of unreimbursed employee
business expenses claimed for extended periods.” The audit determined that
Robison's employment was indefinite, making his “tax home” the Big
Piney/Pinedale area of Wyoming; thus, the claimed business expenses were
actually personal commuting expenses and therefore disallowed. DOR determined
additional tax liability for the 2005-2008 tax years of approximately $7,000,
including penalties and interest. It appears that interest continues to accrue
on the balance the DOR claims is due.
Robison requested informal review by the DOR. The Field Unit Audit Manager
determined the initial audit was correct. Robison then appealed to the DOR's
Office of Dispute Resolution (ODR). After a full evidentiary hearing, the ODR
hearing examiner issued a lengthy and well-reasoned order affirming the audit
determination. The hearing examiner found Robison's employment in Wyoming was
indefinite, not temporary. Because Robison's employment was indefinite, his “tax
home” for purposes of the business travel expense deduction was the Big
Piney/Pinedale area of Wyoming, not Billings, Montana, his place of residence.
Therefore, none of the $78,812 claimed was allowed as a business travel expense.
Robison then appealed to STAB. The STAB appeal was confined to the ODR's
order, transcript, and exhibits. After review, STAB reversed the decision of the
ODR and found Robison's employment was temporary, that his “tax home” was in
Billings, and that all his business travel expenses were allowable deductions.
To reach this conclusion, STAB found that Robison's “tax home” was Billings
(based upon its reading of Coombs v. Commissioner, <a href="http://www.blogger.com/null" name="SLCSM:7311.2-1"></a>608 F.2d 1269, 1275 (9th Cir. 1979) ), and that Robison
“was not located in Wyoming for over a year, but actually made numerous
seven-day temporary business trips to Wyoming.” STAB also separately determined
that “[b]ecause the law is unclear, and can be subject to multiple
interpretations,” even if the deductions were not allowed, the “case is not an
appropriate one for the imposition of penalties and interest.”
The DOR then filed a petition for judicial review in the First Judicial
District Court, Lewis and Clark County. After briefing by the parties, the
District Court reversed STAB's determination and reinstated the decision of the
ODR hearing examiner. It found that STAB “misapprehended the effect of [the]
evidence and misapplied pertinent case law” in determining that Robison's
employment was temporary and that his “tax home” was in Billings, Montana. The
District Court also found STAB erred as a matter of law when it suggested, in a
footnote, that if Robison's “tax home” was in Wyoming, Montana could not impose
state income tax on him, and when it found that DOR should not impose penalties
and interest upon Robison.
Robison then obtained appellate counsel and filed the present, timely appeal.
Robison appeals only the “deductibility of certain business-related travel,
lodging, and meal expenses[.]” He does not appeal the District Court's
determination that STAB erred in suggesting Montana could not impose income tax
on him, nor does he appeal imposition of penalties and interest.
<h3>
STANDARD OF REVIEW </h3>
A district court reviews a STAB decision to determine whether STAB's findings
of fact are clearly erroneous and whether STAB correctly interpreted the law.
Puget Sound Energy, Inc. v. State, 2011 MT 141, ¶ 14, <a href="http://www.blogger.com/null" name="SLCSM:7311.3-1"></a>361 Mont. 39, 255 P.3d 171 . A factual finding is
clearly erroneous if it is not supported by substantial evidence, if the trier
of fact misapprehended the effect of the evidence, or if a review of the record
leaves the reviewing court with the definite and firm conviction that a mistake
has been made. Micone v. Department of Public Health and Human Services, 2011 MT
178, ¶ 10, <a href="http://www.blogger.com/null" name="SLCSM:7311.4-1"></a>361 Mont. 258, 258 P.3d 403 . We apply the
same standards when reviewing a district court's order affirming or reversing
STAB's decision. Puget Sound, ¶ 14 ; O'Neill v. Department of Revenue, 2002 MT
130, ¶ 10, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSM&linkType=docloc&locId=mt_00-791_06%2F18%2F2002&permaId=iSLACSM%3A19095.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">310
Mont. 148</span></strong></a>, 49 P.3d 43 .
<h3>
DISCUSSION </h3>
Before we discuss the issues in this case, we begin by laying out the legal
framework we must consider in a case such as Robison's.
Tax deductions are a matter of legislative grace and it is the taxpayer's
burden to clearly demonstrate the right to the claimed deduction. INDOPCO, Inc.
v. Commissioner, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSFED&linkType=docloc&locId=fed_90-1278_02%2F26%2F1992&permaId=iSLACSFED%3A79.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">503
U.S. 79, 84 (1992)</span></strong></a> ; Baitis v. Department of Revenue, 2004 MT 17, ¶ 28, <a href="http://www.blogger.com/null" name="SLCSM:7311.7-1"></a>319 Mont. 292, 83 P.3d 1278 ; GBN, Inc. v. Department of
Revenue, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSM&linkType=docloc&locId=mt_90-584_08%2F01%2F1991&permaId=iSLACSM%3A19165.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">249
Mont. 261, 266</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSM&linkType=docloc&locId=mt_90-584_08%2F01%2F1991&permaId=iSLACSM%3A19165.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">815
P.2d 595, 597 (1991)</span></strong></a> .
Under Montana law, in computing net income, <sup><a href="http://www.blogger.com/null" name="SRC 2"><a href="file:///C:/Users/Peter/Downloads/DUSTIN_ROBISON__Petitioner_and_Appellant__v__MONTANA_DEPARTMENT_OF__REVENUE__Respondent_and_Appellee.htm#FN 2"><strong><span style="color: #145da4; font-size: xx-small;">2</span></strong></a></a></sup> deductions are generally those permitted by <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=161&permaId=i8d2de41419d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. §§ 161</span></strong></a> and 211. <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mt15-30-2131%281%29%28a%29&permaId=iSLCODAM%3A106528.1&tagName=PARA&endParm=y"><strong><span style="color: #145da4;">Section
15-30-2131(1)(a), MCA</span></strong></a>. A deduction is generally allowed for all ordinary and
necessary business expenses. <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a>. <sup><a href="http://www.blogger.com/null" name="SRC 3"><a href="file:///C:/Users/Peter/Downloads/DUSTIN_ROBISON__Petitioner_and_Appellant__v__MONTANA_DEPARTMENT_OF__REVENUE__Respondent_and_Appellee.htm#FN 3"><strong><span style="color: #145da4; font-size: xx-small;">3</span></strong></a></a></sup> Montana has
specifically adopted this provision of the Internal Revenue Code. Magnuson v.
Montana State Board of Equalization, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSM&linkType=docloc&locId=mt_12412_07%2F16%2F1973&permaId=iSLACSM%3A19332.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">162
Mont. 393, 395</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSM&linkType=docloc&locId=mt_12412_07%2F16%2F1973&permaId=iSLACSM%3A19332.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">513
P.2d 1, 3 (1973)</span></strong></a> . Included in ordinary and necessary business expenses are
“traveling expenses (including amounts expended for meals and lodging other than
amounts which are lavish or extravagant under the circumstances) while away from
home in the pursuit of a trade or business[.]” <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162%28a%29%281%29&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=PARA&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162(a)(1)</span></strong></a>. Such travelling expenses are deductible if the taxpayer
can prove the expenses are: 1) reasonable and necessary; 2) incurred while away
from home; and 3) incurred in the pursuit of a trade or business. Commissioner
v. Flowers, <a href="http://www.blogger.com/null" name="SLCSM:7311.20-1"></a>326 U.S. 465, 470 (1946) .
In contrast, it is well settled that unless specifically provided by law,
expenses incurred in commuting to and from work are not deductible, but rather
are personal expenses. <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=262%28a%29&permaId=i9cc0d35019d711dcb1a9c7f8ee2eaa77&tagName=SBSEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 262(a)</span></strong></a>; Flowers, <a href="http://www.blogger.com/null" name="SLCSM:7311.22-1"></a>326 U.S. at 469-70 ;
Coombs, <a href="http://www.blogger.com/null" name="SLCSM:7311.23-1"></a>608 F.2d at 1275-76 ; Sanders v.
Commissioner, <a href="http://www.blogger.com/null" name="SLCSM:7311.24-1"></a>439 F.2d 296, 297 (9th Cir. 1971) .
“If, for personal reasons, one chooses to live far from the place of employment,
the resulting travel costs are nondeductible, personal expenses.” Kasun v.
United States, <a href="http://www.blogger.com/null" name="SLCSM:7311.25-1"></a>671 F.2d 1059, 1061 (7th Cir. 1982) .
For travel expenses to be deductible, it is “'the job, not the taxpayer's
pattern of living, [that] must require the travel.'” Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.26-1"></a>671 F.2d at 1061 (quoting Commissioner v. Peurifoy, <a href="http://www.blogger.com/null" name="SLCSM:7311.27-1"></a>254 F.2d 483, 486 (4th Cir. 1957), aff'd, <a href="http://www.blogger.com/null" name="SLCSM:7311.28-1"></a>358 U.S. 59 (1958) (per curiam) ).
Robison's case concerns the second prong of the test annunciated in
<i>Flowers</i> — was Robison “away from home” while working in Wyoming? To
answer this question, we must consider two distinct, yet inevitably intertwined
concepts — temporary or indefinite employment and a taxpayer's “tax home.” The
nature of Robison's employment will determine the location of his “tax
home.”<sup><span style="font-size: x-small;"><strong> </strong></span><a href="http://www.blogger.com/null" name="SRC 4"><a href="file:///C:/Users/Peter/Downloads/DUSTIN_ROBISON__Petitioner_and_Appellant__v__MONTANA_DEPARTMENT_OF__REVENUE__Respondent_and_Appellee.htm#FN 4"><strong><span style="color: #145da4; font-size: xx-small;">4</span></strong></a></a></sup> As discussed in detail
below, if Robison's employment in Wyoming was temporary, his tax home would be
his residence in Billings and his business travel expenses are deductible.
However, if Robison's employment in Wyoming was indefinite, his “tax home” is
his principal place of business (the Big Piney/Pinedale area of Wyoming) and his
business travel expenses are disallowed.
<h3>
The Nature of Robison's Employment </h3>
One exception to the general rule that commuting expenses are non-deductible
is when the taxpayer travels to a temporary, as opposed to indefinite, job.
Peurifoy v. Commissioner, <a href="http://www.blogger.com/null" name="SLCSM:7311.29-1"></a>358 U.S. 59, 60 (1958) ;
Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.30-1"></a>671 F.2d at 1061 ; Sanders, <a href="http://www.blogger.com/null" name="SLCSM:7311.31-1"></a>439 F.2d at 298 . “[I]t is not reasonable to expect
people to move to a distant location when a job is foreseeably of limited
duration. If, on the other hand, the prospect is that the work will continue for
an indefinite or substantially long period of time, the travel expenses are not
deductible.” Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.32-1"></a>671 F.2d at 1061 .
Employment is temporary when, at the time the job commences, termination is
foreseeable within a short period. Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.33-1"></a>671 F.2d
at 1060-61 . In 1992, Congress modified <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a> to define the “short period” language, adding that “[f]or
purposes of [the travel expense deduction], the taxpayer shall not be treated as
being temporarily away from home during any period of employment if such period
exceeds 1 year.” <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a>; Pub. L. No. 102-486, § 1938, 106 Stat. 2776, 3033 (1992).
Thus, for purposes of <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a>, employment is generally temporary when it lasts for less than
one year. Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.37-1"></a>671 F.2d at 1062 ; Boone v. United
States, <a href="http://www.blogger.com/null" name="SLCSM:7311.38-1"></a>482 F.2d 417, 420 (5th Cir. 1973) . A
taxpayer is generally allowed to deduct travel expenses related to temporary
employment. <i>See</i> Peurifoy, <a href="http://www.blogger.com/null" name="SLCSM:7311.39-1"></a>358 U.S. at 60 .
Employment is indefinite when the length of the employment is indeterminate.
Boone, <a href="http://www.blogger.com/null" name="SLCSM:7311.40-1"></a>482 F.2d at 419 . “[E]mployment which merely
lacks permanence is indefinite unless termination is foreseeable within a short
period of time.” Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.41-1"></a>671 F.2d at 1061 . A
taxpayer is not allowed to deduct business travel expenses related to indefinite
employment. <i>See</i> Peurifoy, <a href="http://www.blogger.com/null" name="SLCSM:7311.42-1"></a>358 U.S. at 60 .
Of particular interest in Robison's case is the treatment of quite similar
employment — work in the construction industry. In <i>Kasun,</i> a construction
worker argued his employment was temporary because he was not told how long his
job would last. Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.43-1"></a>671 F.2d at 1060 . The
Seventh Circuit rejected this argument, instead finding:
<blockquote>
[W]ork in the construction industry is, by its very nature,
impermanent. Workers move from job to job and often must seek employment at some
distance from their homes. Courts have not, however, found that these
characteristics distinguish construction work from other forms of
employment.</blockquote>
Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.44-1"></a>671 F.2d at 1062 (internal citations
omitted). The <i>Kasun</i> court refused to create an exception to <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=262&permaId=i9cc0d35019d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 262</span></strong></a> for construction workers. Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.46-1"></a>671 F.2d at 1062 n. 5 . Rather, it found that
construction workers, just like “suburban or exurban commuters,” must pay their
own commuting expenses. Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.47-1"></a>671 F.2d at 1062-63 .
Similarly, in <i>Commissioner v. Peurifoy,</i> construction workers argued
their employment was temporary because “they were not guaranteed a job for any
specific period nor were they told by the employer how long the work was
expected to last.” Peurifoy, <a href="http://www.blogger.com/null" name="SLCSM:7311.48-1"></a>254 F.2d at 485 . The
Fourth Circuit found that this demonstrated indefinite or impermanent
employment, not temporary employment:
<blockquote>
Work in the heavy construction industry, by its very nature, has a
degree of impermanence. Employment is usually for each job only and lasts no
longer than the need at that project for the particular skill of the individual
employee. Upon many of the larger projects, however, such need, and the actual
employment of an individual, may last for several, even many, years. Other
projects may be of comparatively short duration. It is also a characteristic of
the industry, as shown in the stipulations in this case, that upon larger
construction projects outside the larger metropolitan centers, the local supply
of the necessary skills must be greatly augmented by workers coming from other
places. Work in the industry, therefore, is, to some extent, transient as well
as impermanent.</blockquote>
<blockquote>
Construction workers are not the only ones, however, who find it
necessary or profitable to move or seek employment from place to place, and the
Tax Court, in its opinion in these cases, recognizes that the transient and
impermanent aspect of work in heavy construction does not itself distinguish
construction work from other employment or hold the answer to our problem.
Indeed these characteristics of the industry tend to strip from a remote
residence elements essential to its status as the sole 'tax home.'</blockquote>
Peurifoy, <a href="http://www.blogger.com/null" name="SLCSM:7311.49-1"></a>254 F.2d at 486 . Accordingly,
“[h]owever justified [a taxpayer] may be from a subjective or personal point of
view in maintaining a residence away from his post of duty, his travel and
maintenance expense at his post of duty is not an ordinary and necessary
business expense within the meaning of 23(a)(1)(A) [now <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a>] if the employment is of substantial or indefinite duration.”
Peurifoy, <a href="http://www.blogger.com/null" name="SLCSM:7311.51-1"></a>254 F.2d at 486-87 .
<h3>
The “Tax Home” Concept </h3>
The location of a taxpayer's “tax home” determines whether his business
travel expenses were incurred “away from home” under <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a>. For the purposes of <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a>, the term “tax home” does not mean “home” in the ordinary or
common sense of the word. Henderson v. Commissioner, <a href="http://www.blogger.com/null" name="SLCSM:7311.54-1"></a>143 F.3d 497, 499 (9th Cir. 1998) . A taxpayer's “tax
home” is not necessarily the place he or she lives (i.e. house, residence,
abode, etc.). When a regularly employed taxpayer maintains his personal
residence within the general area of his employment, his “tax home” will be his
personal residence. Coombs, <a href="http://www.blogger.com/null" name="SLCSM:7311.55-1"></a>608 F.2d at 1275 .
However, when a taxpayer accepts employment either permanently <i>or for an
indefinite period of time</i> away from his personal residence, his “tax home”
will shift to the new location — the vicinity of his new principal place of
business. Coombs, <a href="http://www.blogger.com/null" name="SLCSM:7311.56-1"></a>608 F.2d at 1275-76 (emphasis
added). In this later situation, “the decision to retain a former residence is a
personal choice, and the expenses of traveling to and from that residence are
non-deductible personal expenses.” Coombs, <a href="http://www.blogger.com/null" name="SLCSM:7311.57-1"></a>608 F.2d
at 1276 .
<h3>
Analysis </h3>
With this framework in mind, we now turn to Robison's case. Robison appears
to argue that his employment in Wyoming was at all times temporary. However, he
also alternately argues that for a time his employment was temporary, but then
became indefinite. Therefore, he argues the first year of his business travel
expenses should be allowed. The DOR argues the District Court correctly
concluded that at all times Robison's employment was indefinite, making none of
his business travel expenses deductable.
In reversing STAB, the District Court determined that Robison's employment
was “indefinite ... not temporary.” We agree. Just like the construction workers
in <i>Kasun</i> and <i>Peurifoy,</i> Robison did not know his employment would
terminate in a short period of time. Rather, he was never told how long his work
in Wyoming would last. This undoubtedly makes his employment indefinite. Kasun,
<a href="http://www.blogger.com/null" name="SLCSM:7311.58-1"></a>671 F.2d at 1062 ; Peurifoy, <a href="http://www.blogger.com/null" name="SLCSM:7311.59-1"></a>254 F.2d at 486-87 . It is true that Robison's
employment lacked permanence, but that alone does not make his employment
temporary. Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.60-1"></a>671 F.2d at 1061 . Employment is
only temporary if “termination is foreseeable within a short period of time.”
Kasun, <a href="http://www.blogger.com/null" name="SLCSM:7311.61-1"></a>671 F.2d at 1061 . Further bolstering the
conclusion that Robison's employment was indefinite is the language of <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a> - “the taxpayer shall not be treated as being temporarily away
from home during any period of employment if such period exceeds 1 year.”
Robison was employed in the same Big Piney/Pinedale area of Wyoming for over 3
years, well beyond the 1 year limitation in the statute.
The language of <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a> also precludes <i>any</i> of Robison's business travel expenses
from being deductable. The statute clearly states that “the taxpayer shall not
be treated as being temporarily away from home during <i>any</i> period of
employment if such period exceeds 1 year.” <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a> (emphasis added). Thus, Robison is not considered as being
temporarily away from home during any of his 3-plus years of employment in
Wyoming because his employment period exceeded 1 year. Contrary to Robison's
argument, this is not a case where Robison was told his employment was to be
terminated within a short period of time only to have his employment extended.
<i>See generally</i> Rev. Rul. 93-86, 1993-2 C.B. 71. It is undisputed that,
from the beginning, Robison “never knew” the length of his employment. His
employment was indefinite.
The District Court also found that STAB incorrectly interpreted <i>Coombs</i>
to hold that a taxpayer's “tax home” is his residence. We again agree.
<i>Coombs</i> does not stand for the proposition that a taxpayer's “tax home” is
his residence, only that in certain circumstances it can be. As applicable to
Robison's case, however, <i>Coombs</i> clearly states that when a taxpayer
accepts employment either permanently <i>or for an indefinite period of time</i>
away from his personal residence, his “tax home” will shift to the new location
— the vicinity of his new principal place of business. Coombs, <a href="http://www.blogger.com/null" name="SLCSM:7311.65-1"></a>608 F.2d at 1275-76 (emphasis added). This is precisely
what Robison did — he took indefinite employment away from his personal
residence. His “tax home” for the purposes of the business travel expense
deduction consequently shifted to the Big Piney/Pinedale area of Wyoming. As a
result, “the decision to retain a former residence is a personal choice, and the
expenses of traveling to and from that residence are non-deductible personal
expenses.” Coombs, <a href="http://www.blogger.com/null" name="SLCSM:7311.66-1"></a>608 F.2d at 1276 . Additionally,
because his “tax home” for the purposes of <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a> was the Big Piney/Pinedale area, the expenses of traveling from
camp to each drill site cannot be differentiated from any other worker's normal
commuting expenses. These commuting expenses are not deductable. <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=262%28a%29&permaId=i9cc0d35019d711dcb1a9c7f8ee2eaa77&tagName=SBSEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 262(a)</span></strong></a>; Flowers, <a href="http://www.blogger.com/null" name="SLCSM:7311.69-1"></a>326 U.S. at 469-70 ;
Coombs, <a href="http://www.blogger.com/null" name="SLCSM:7311.70-1"></a>608 F.2d at 1275-76 ; Sanders, <a href="http://www.blogger.com/null" name="SLCSM:7311.71-1"></a>439 F.2d at 297 .
Finally, Robison raises several arguments that were not raised below, such as
lodging and meal expenses. We do not address issues raised for the first time on
appeal. Hoff v. Lake County Abstract & Title Co., 2011 MT 118, ¶ 35, <a href="http://www.blogger.com/null" name="SLCSM:7311.72-1"></a>360 Mont. 461, 255 P.3d 137 (citing Peterman v.
Herbalife International, Inc., 2010 MT 142, ¶ 20, <a href="http://www.blogger.com/null" name="SLCSM:7311.73-1"></a>356 Mont. 542, 234 P.3d 898) .
<h3>
CONCLUSION </h3>
For the reasons stated above, we affirm the District Court.
<blockquote>
<blockquote>
/S/ MICHAEL E WHEAT</blockquote>
</blockquote>
We Concur:
/S/ MIKE McGRATH
/S/ PATRICIA COTTER
/S/ JAMES C. NELSON
/S/ BRIAN MORRIS <br /><sup><a href="http://www.blogger.com/null" name="FN 1"><a href="file:///C:/Users/Peter/Downloads/DUSTIN_ROBISON__Petitioner_and_Appellant__v__MONTANA_DEPARTMENT_OF__REVENUE__Respondent_and_Appellee.htm#SRC 1"><strong><span style="color: #145da4; font-size: xx-small;">1</span></strong></a></a></sup>
<br />
Unit did not provide company vehicles for rig hands, nor did it
reimburse them for travel expenses. <br /><sup><a href="http://www.blogger.com/null" name="FN 2"><a href="file:///C:/Users/Peter/Downloads/DUSTIN_ROBISON__Petitioner_and_Appellant__v__MONTANA_DEPARTMENT_OF__REVENUE__Respondent_and_Appellee.htm#SRC 2"><strong><span style="color: #145da4; font-size: xx-small;">2</span></strong></a></a></sup>
<br />
<br />
Net income means “the adjusted gross income of a taxpayer less the
deductions allowed by this chapter [Chapter 30].” <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mt15-30-2101%2819%29&permaId=iSLCODAM%3A106513.1&tagName=SBSEC&endParm=y"><strong><span style="color: #145da4;">Section
15-30-2101(19), MCA</span></strong></a>. The amount of tax due is determined based upon a
taxpayer's net income. <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mt15-30-2102&permaId=iSLCODAM%3A106514.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">Section
15-30-2102, MCA</span></strong></a>. <br /><sup><a href="http://www.blogger.com/null" name="FN 3"><a href="file:///C:/Users/Peter/Downloads/DUSTIN_ROBISON__Petitioner_and_Appellant__v__MONTANA_DEPARTMENT_OF__REVENUE__Respondent_and_Appellee.htm#SRC 3"><strong><span style="color: #145da4; font-size: xx-small;">3</span></strong></a></a></sup>
<br />
<br />
Deductions under <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=162&permaId=i8d32581e19d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 162</span></strong></a> are allowed by <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=TCODE&linkType=docloc&locId=161&permaId=i8d2de41419d711dcb1a9c7f8ee2eaa77&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">26
U.S.C. § 161</span></strong></a>. <br /><sup><a href="http://www.blogger.com/null" name="FN 4"><a href="file:///C:/Users/Peter/Downloads/DUSTIN_ROBISON__Petitioner_and_Appellant__v__MONTANA_DEPARTMENT_OF__REVENUE__Respondent_and_Appellee.htm#SRC 4"><strong><span style="color: #145da4; font-size: xx-small;">4</span></strong></a></a></sup>
<br />
<br />
We decline Robison's invitation to preliminarily determine his “tax
home” without reference to the nature of his employment.Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-83277019507337421922012-08-12T15:29:00.001-04:002012-08-12T15:29:54.224-04:00Missouri Propostions<h3>
RALPH BROWN, Appellant, v. MISSOURI SECRETARY OF STATE ROBIN CARNAHAN,
Respondent, MISSOURI STATE AUDITOR THOMAS SCHWEICH, Respondent, and MISSOURIANS
FOR HEALTH AND EDUCATION, DUDLEY MCCARTER, and PEGGY TAYLOR, Respondents.</h3>
<h3>
VICTOR ALLRED, Respondent/Cross-Appellant, v. ROBIN CARNAHAN, Respondent,
THOMAS A. SCHWEICH, Appellant/Cross-Respondent, and MISSOURI JOBS WITH JUSTICE,
Respondent/Cross-Appellant.</h3>
<h3>
PEGGY NORTHCOTT, et al., Respondents/Cross-Appellants, v. ROBIN CARNAHAN, et
al., Appellants/Cross-Respondents.</h3>
<h3>
TIFFANY FRANCIS, et al., Respondents/Cross-Appellants, v. ROBIN CARNAHAN, et
al., Appellants/Cross-Respondents, MISSOURIANS FOR RESPONSIBLE LENDING, et al.,
Appellants/Cross-Respondents.</h3>
<h3>
JOHN PRENTZLER, Respondent, ROBIN CARNAHAN, et al., Appellants, MISSOURIANS
FOR RESPONSIBLE LENDING, et al., Appellants.</h3>
<h3>
STEPHEN J. REUTER, Respondent, ROBIN CARNAHAN, et al., Appellants,
MISSOURIANS FOR RESPONSIBLE LENDING, et al., Appellants.</h3>
<strong>Case Information: </strong>
<strong>Docket/Court: </strong>SC92582; SC92564; SC92500; SC92571; SC92573;
SC92574, Supreme Court of Missouri
<strong>Date Issued: </strong>07/31/2012
<strong>Tax Type(s): </strong>Cigarette, Alcohol & Miscellaneous Taxes,
General Administrative Provisions
APPEALS FROM THE CIRCUIT COURT OF COLE COUNTY, The Honorable Daniel R. Green,
Judge, The Honorable Jon E. Beetem, Judge
<h3>
OPINION </h3>
PER CURIAM
The appeals consolidated in this opinion arise from lawsuits challenging
three proposed initiatives—a tobacco tax initiative, a minimum wage initiative,
and a payday loan initiative. <sup><a href="http://www.blogger.com/null" name="SRC 1"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 1"><strong><span style="color: #145da4; font-size: xx-small;">1</span></strong></a></a></sup>
The underlying suits sought to prevent the initiatives from appearing on
Missouri's ballot for the November 2012 election. Each of the cases challenges
the constitutional validity of section <a href="http://www.blogger.com/null" name="SLCSM:7352.2-1"></a>116.175,
<sup><a href="http://www.blogger.com/null" name="SRC 2"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 2"><strong><span style="color: #145da4; font-size: xx-small;">2</span></strong></a></a></sup> which directs that the state
auditor “shall assess the fiscal impact of” any proposed initiative petition and
prepare a fiscal note and fiscal note summary. <sup><a href="http://www.blogger.com/null" name="SRC 3"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 3"><strong><span style="color: #145da4; font-size: xx-small;">3</span></strong></a></a></sup> Opponents of the proposed initiatives maintain that
section <a href="http://www.blogger.com/null" name="SLCSM:7352.7-1"></a>116.175's statutory directives conflict with
<a href="http://www.blogger.com/null" name="SLCSM:7352.8-1"></a>Mo. Const. art. IV, sec. 13, which provides that
“[n]o duty shall be imposed on [the state auditor] by law which is not related
to the supervising and auditing of the receipt and expenditure of public funds.”
Each appeal also challenges the fairness and sufficiency of the secretary of
state's summary statements and the auditor's fiscal notes and fiscal note
summaries for the proposed initiatives.
This Court finds that section <a href="http://www.blogger.com/null" name="SLCSM:7352.9-1"></a>116.175 is
constitutional and finds that the auditor's fiscal notes and fiscal note
summaries for the proposed initiatives were fair and sufficient. This Court
further finds that the secretary of state's summary statements for the
initiatives were fair and sufficient. This Court finds no bar to including the
secretary of state's summary statements and auditor's fiscal note summaries in
the official ballot titles for the proposed initiatives. No issues presented in
these appeals and cross-appeals indicate any impediment to placing the proposed
initiatives on the ballot. <sup><a href="http://www.blogger.com/null" name="SRC 4"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 4"><strong><span style="color: #145da4; font-size: xx-small;">4</span></strong></a></a></sup>
For the reasons explained below, the trial court's judgment in the tobacco
initiative case is affirmed; the judgment in the minimum wage case is affirmed
in part and reversed in part; and the judgment in the payday loan initiative
cases is affirmed in part and reversed in part.
<h4>
I. Background </h4>
<h4>
A. Constitutional Protections For Citizen Initiatives </h4>
Before discussing the merits of these appeals, this Court notes the
protections afforded to the citizen initiative petition process provided in
Missouri's constitution. This Court previously has stated:
<blockquote>
Nothing in our constitution so closely models participatory
democracy in its pure form. Through the initiative process, those who have no
access to or influence with elected representatives may take their cause
directly to the people. The people, from whom all constitutional authority is
derived, have reserved the “power to propose and enact or reject laws and
amendments to the Constitution.” [ <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mo49_caiii&permaId=iSLCODAM%3A97436.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">Mo.
Const., art. III, sec. 49</span></strong></a>].</blockquote>
Missourians to Protect the Initiative Process v. Blunt, <a href="http://www.blogger.com/null" name="SLCSM:7352.11-1"></a>799 S.W.2d 824, 827 (Mo. banc 1990) .
To avoid encroachment on the people's constitutional authority, courts will
not sit in judgment on the wisdom or folly of the initiative proposal presented,
nor will this Court issue an advisory opinion as to whether a particular
proposal, if adopted, would violate a superseding law of this state or the
United States Constitution. <i>Id.</i> However, “[w]hen courts are called upon
to intervene in the initiative process, they must act with restraint,
trepidation and a healthy suspicion of the partisan who would use the judiciary
to prevent the initiative process from taking its course.” <i>Id.</i>
“Before the people vote on an initiative, courts may consider only those
threshold issues that affect the integrity of the election itself, and that are
so clear as to constitute a matter of form.” United Gamefowl Breeders Ass'n of
Missouri v. Nixon, <a href="http://www.blogger.com/null" name="SLCSM:7352.12-1"></a>19 S.W.3d 137, 139 (Mo. banc
2000) . As such, when initiative petitions are challenged, this Court's primary
duty is to determine “whether the constitutional requirements and limits of
power, as expressed in the provisions relating to the procedure and form of
initiative petitions, have been regarded.” Blunt, <a href="http://www.blogger.com/null" name="SLCSM:7352.13-1"></a>799 S.W.2d at 827 .
<h4>
B. Procedures for Initiative Petitions </h4>
The constitutional requirements for an initiative petition include:
<blockquote>
[T]he initiative petition must (1) be signed by 8% of the voters in
each of two-thirds of the congressional districts in the state, (2) be filed
with the Secretary of State no less than four months before an election, (3)
contain a proper enacting clause, and (4) contain no more than one amended and
revised constitutional article, or one new article which contains not more than
one subject and matters properly connected therewith. [ <a href="http://www.blogger.com/null" name="SLCSM:7352.14-1"></a>Mo. Const., art. III, sec. 50].</blockquote>
<i>Id.</i>
Before an initiative petition appears on the ballot, the requirements of
chapter 116 must be met. Section <a href="http://www.blogger.com/null" name="SLCSM:7352.15-1"></a>116.120.1 provides
that the secretary of state shall examine any submitted petition to determine
that it complies with the Missouri Constitution and chapter 116. Section <a href="http://www.blogger.com/null" name="SLCSM:7352.16-1"></a>116.332.1 provides that, after receiving a proposed
initiative petition, the secretary of state refers a copy of the petition to the
attorney general for approval of the sufficiency of the petition as to its form.
Section <a href="http://www.blogger.com/null" name="SLCSM:7352.17-1"></a>116.332.1 also provides that a copy of the
petition must be sent to the state auditor for “purposes of preparing a fiscal
note and fiscal note summary.” <i>See also</i> sec. <a href="http://www.blogger.com/null" name="SLCSM:7352.18-1"></a>116.175 (instructing that the auditor “shall assess the
fiscal impact of the proposed measure”). <sup><a href="http://www.blogger.com/null" name="SRC 5"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 5"><strong><span style="color: #145da4; font-size: xx-small;">5</span></strong></a></a></sup>
The secretary of state reviews the attorney general's comments regarding the
form of the petition and then makes a final decision to approve or reject the
proposed petition. Sec. <a href="http://www.blogger.com/null" name="SLCSM:7352.20-1"></a>116.332.3. Once a petition
is approved as to its content and form, section <a href="http://www.blogger.com/null" name="SLCSM:7352.21-1"></a>116.334.1 instructs that the secretary of state prepare
a “concise” summary statement of the proposed measure. Section <a href="http://www.blogger.com/null" name="SLCSM:7352.22-1"></a>116.334.1 provides that the summary statement cannot
exceed 100 words, must be written in the form of a question, and cannot use
language that is “intentionally argumentative” or that is “likely to create
prejudice either for or against the proposed measure.” The secretary of state's
summary statement requires approval by the attorney general. Sec. <a href="http://www.blogger.com/null" name="SLCSM:7352.23-1"></a>116.334.1. Pursuant to section <a href="http://www.blogger.com/null" name="SLCSM:7352.24-1"></a>116.180, after the secretary of state receives the
attorney general's approval for the summary and receives the approved fiscal
note and fiscal note summary, the secretary of state certifies the official
ballot title. The official ballot title consists of the secretary of state's
summary statement and the fiscal note summary, and it is provided to the person
circulating the petition for signatures and must be affixed to each page of the
petition prior to its circulation for signatures. Sec. <a href="http://www.blogger.com/null" name="SLCSM:7352.25-1"></a>116.180. The petitioner then begins to circulate the
proposed measure to gather the signatures necessary to submit it to the
secretary of state for placement on the ballot. <sup><a href="http://www.blogger.com/null" name="SRC 6"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 6"><strong><span style="color: #145da4; font-size: xx-small;">6</span></strong></a></a></sup>
Any citizen may challenge the official ballot title or fiscal note for a
proposed initiative. Sec. <a href="http://www.blogger.com/null" name="SLCSM:7352.30-1"></a>116.190. <sup><a href="http://www.blogger.com/null" name="SRC 7"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 7"><strong><span style="color: #145da4; font-size: xx-small;">7</span></strong></a></a></sup> The appeals at issue in this
consolidated opinion reflect such challenges.
<h4>
II. Common Issues Presented </h4>
Opponents to each of the initiatives addressed in this opinion raised
arguments that section <a href="http://www.blogger.com/null" name="SLCSM:7352.32-1"></a>116.175 is unconstitutional
under <a href="http://www.blogger.com/null" name="SLCSM:7352.33-1"></a>Mo. Const. art. IV, sec. 13. Each case also
presented a challenge related to the fairness and sufficiency of the secretary
of state's summary statement and the auditor's fiscal note and fiscal note
summary prepared for the initiatives. These common issues presented are
addressed first.
<h4>
A. Standard of Review </h4>
In a court-tried case, this Court will sustain the circuit court's judgment
unless there is no substantial evidence to support it, it is against the weight
of the evidence, or it erroneously declares or applies the law. United Gamefowl
Breeders, <a href="http://www.blogger.com/null" name="SLCSM:7352.34-1"></a>19 S.W.3d at 141 ; Murphy v. Carron, <a href="http://www.blogger.com/null" name="SLCSM:7352.35-1"></a>536 S.W.2d 30, 32 (Mo. banc 1976) . This Court will
construe liberally constitutional and statutory provisions governing the ballot
initiative process to ensure the preservation of the people's power. Blunt, <a href="http://www.blogger.com/null" name="SLCSM:7352.36-1"></a>799 S.W.2d at 827 . “Statutes that place impediments on
the initiative power that are inconsistent with the reservation found in the
language of the constitution will be declared unconstitutional.” <i>Id.</i>
<h4>
B. Auditor's Constitutional Authority to Prepare Fiscal Notes and Fiscal
Note Summaries </h4>
The issue of the auditor's authority to prepare fiscal notes and fiscal note
summaries was raised in all six cases before this Court. <sup><a href="http://www.blogger.com/null" name="SRC 8"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 8"><strong><span style="color: #145da4; font-size: xx-small;">8</span></strong></a></a></sup> Specifically, the question concerns the constitutional
validity of section <a href="http://www.blogger.com/null" name="SLCSM:7352.48-1"></a>116.175, wherein the legislature
delegated to the auditor the duty to prepare fiscal notes and fiscal note
summaries, and whether the delegation of authority in that statute violates <a href="http://www.blogger.com/null" name="SLCSM:7352.49-1"></a>Mo. Const. art. IV, sec. 13.
<h4>
1. Standard of review </h4>
This Court reviews the constitutional validity of a statute <i>de novo.</i>
Gurley v. Missouri Bd. of Private Investigator Examiners, <a href="http://www.blogger.com/null" name="SLCSM:7352.50-1"></a>361 S.W.3d 406, 411 (Mo. banc 2012) . “A statute is
presumed valid and will not be held unconstitutional unless it clearly
contravenes a constitutional provision.” In re Brasch, <a href="http://www.blogger.com/null" name="SLCSM:7352.51-1"></a>332 S.W.3d 115, 119 (Mo. banc 2011) . This Court
“resolve[s] all doubt in favor of the [statute's] validity” and in doing so
should make every reasonable intendment to sustain its constitutionality. Ocello
v. Koster, <a href="http://www.blogger.com/null" name="SLCSM:7352.52-1"></a>354 S.W.3d 187, 197 (Mo. banc 2011)
(quoting Westin Crown Plaza Hotel Co. v. King, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSM&linkType=docloc&locId=mo_65166_02%2F15%2F1984&permaId=iSLACSM%3A14189.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">664
S.W.2d 2, 5</span></strong></a> (Mo. banc 1984) ). “The person challenging the statute's
validity bears the burden of proving the act clearly and undoubtedly violates
the constitution.” Kansas City Premier Apartments, Inc. v. Missouri Real Estate
Comm'n, <a href="http://www.blogger.com/null" name="SLCSM:7352.54-1"></a>344 S.W.3d 160, 167 (Mo. banc 2011) (quoting
Brasch, <a href="http://www.blogger.com/null" name="SLCSM:7352.55-1"></a>332 S.W.3d at 119 ).
Generally, “constitutional provisions are subject to the same rules of
construction as other laws, except that constitutional provisions are given a
broader construction due to their more permanent character.” StopAquila.org v.
City of Peculiar, <a href="http://www.blogger.com/null" name="SLCSM:7352.56-1"></a>208 S.W.3d 895, 899 (Mo. banc
2006) . This broad reading does not permit this Court to ascribe to the
provision “a meaning that is contrary to that clearly intended by the drafters.”
Farmer v. Kinder, <a href="http://www.blogger.com/null" name="SLCSM:7352.57-1"></a>89 S.W.3d 447, 452 (Mo. banc 2002)
. “Of particular importance is the principle that in determining meaning of a
constitutional provision due regard will be given to [its] primary objects and
all related provisions should be construed as a whole and where necessary to
bring conflicts, if any, into harmony.” State, at Information of Martin v. City
of Independence, <a href="http://www.blogger.com/null" name="SLCSM:7352.58-1"></a>518 S.W.2d 63, 66 (Mo. 1974) .
<h4>
2. The auditor's authority </h4>
<a href="http://www.blogger.com/null" name="SLCSM:7352.59-1"></a>Mo. Const. art. IV, sec. 13 provides:
<blockquote>
The state auditor shall have the same qualifications as the
governor. He [or she] shall establish appropriate systems of accounting for all
public officials of the state, post-audit the accounts of all state agencies and
audit the treasury at least once annually. He [or she] shall make all other
audits and investigations required by law, and shall make an annual report to
the governor and general assembly. He [or she] shall establish appropriate
systems of accounting for the political subdivisions of the state, supervise
their budgeting systems, and audit their accounts as provided by law. No duty
shall be imposed on him [or her] by law which is not related to the supervising
and auditing of the receipt and expenditure of public funds.</blockquote>
The auditor's authority to prepare fiscal notes and fiscal note summaries was
delegated by the legislature after this Court's decision in Thompson v.
Committee on Legislative Research, <a href="http://www.blogger.com/null" name="SLCSM:7352.60-1"></a>932 S.W.2d 392
(Mo. banc 1996) . In <i>Thompson,</i> this Court held <a href="http://www.blogger.com/null" name="SLCSM:7352.61-1"></a>section 116.170.2, RSMo 1994, violated the constitution
when the legislature delegated the authority to prepare fiscal notes and fiscal
note summaries to the joint committee on legislative research because the
legislature had no power to adopt a statute that increased the duties of the
committee beyond those expressly authorized by <a href="http://www.blogger.com/null" name="SLCSM:7352.62-1"></a>Mo.
Const. art. III, sec. 35. <i>Id.</i> at 395.
After <i>Thompson,</i> the legislature promulgated section <a href="http://www.blogger.com/null" name="SLCSM:7352.63-1"></a>116.175, which sets forth the procedure for the
auditor's preparation of the fiscal note and fiscal note summary for any
petition sample sheet, joint resolution, or bill. Section <a href="http://www.blogger.com/null" name="SLCSM:7352.64-1"></a>116.175.1 states the auditor “shall assess the fiscal
impact of the proposed measure” and “may consult with the state departments,
local government entities, the general assembly and others with knowledge
pertinent to the cost of the proposal.” Proponents and opponents of any proposed
measure are permitted to submit their own fiscal impact statement to the
auditor. <i>Id.</i> Section <a href="http://www.blogger.com/null" name="SLCSM:7352.65-1"></a>116.175 .2 directs the
auditor to prepare the fiscal note and fiscal note summary within 20 days of
receipt of the petition sample sheet. The auditor's fiscal note and fiscal note
summary “shall state the measure's estimated cost or savings, if any, to state
or local governmental entities.” Sec. <a href="http://www.blogger.com/null" name="SLCSM:7352.66-1"></a>116.175.3.
Further, “[t]he fiscal note summary shall contain no more than fifty words,
excluding articles, which shall summarize the fiscal note in language neither
argumentative nor likely to create prejudice either for or against the proposed
measure.” <i>Id.</i>
<h4>
3. The auditor's preparation of fiscal notes and fiscal note summaries is an
“investigation” </h4>
A general discussion of the auditor's protocol for preparing fiscal notes and
fiscal note summaries will suffice to resolve the constitutional issue
presented. First, the parties dispute the definition of “investigation”
contained in <a href="http://www.blogger.com/null" name="SLCSM:7352.67-1"></a>Mo. Const. art. IV, sec. 13 and whether
the auditor's preparation of the fiscal notes and fiscal note summaries is an
“investigation.” The constitutional provision does not define “investigation.”
“[W]hen words are not used in a technical sense, they 'must be given their
plain or ordinary meaning unless such construction will defeat the manifest
intent of the constitutional provision.'” Mo. Prosecuting Attorneys v. Barton
County, <a href="http://www.blogger.com/null" name="SLCSM:7352.68-1"></a>311 S.W.3d 737, 742 (Mo. banc 2010) (quoting
Rathjen v. Reorganized Sch. Dist. R-II of Shelby County, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSM&linkType=docloc&locId=mo_44787_11%2F14%2F1955&permaId=iSLACSM%3A14568.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">365
Mo. 518</span></strong></a>, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSM&linkType=docloc&locId=mo_44787_11%2F14%2F1955&permaId=iSLACSM%3A14568.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">284
S.W.2d 516, 523</span></strong></a> (Mo. banc 1955) ). If a word used is not defined, the Court
determines the plain and ordinary meaning of the word as found in the
dictionary. In re Finnegan, <a href="http://www.blogger.com/null" name="SLCSM:7352.71-1"></a>327 S.W.3d 524, 526 (Mo.
banc 2010) .
“Investigation” is defined as “detailed examination ... study ... research
... official probe.” Webster's Third New Int'l Dictionary Unabridged 1189
(2002). Similarly, “investigate” is defined as “to observe or study closely ...
to conduct an official inquiry.” <i>Id.</i>
What the auditor does in preparing a fiscal note and fiscal note summary is
certainly an official inquiry performed pursuant to statutory directive. In
preparing the fiscal note, the auditor sends copies of the proposed ballot
initiative to various state and local governmental entities requesting the
entities review the same and provide information regarding the estimated costs
or savings, if any, for the proposed ballot initiative. <i>See</i> sec. <a href="http://www.blogger.com/null" name="SLCSM:7352.72-1"></a>116.175.1 (stating that the auditor “may consult with
the state departments, local government entities, the general assembly and
others with knowledge pertinent to the cost of the proposal”). The auditor
chooses local governmental entities based on geography, population, and form of
government to ensure a good cross-section of local governments that might be
affected by the proposal are represented. Proponents, opponents, and members of
the public may submit fiscal impact submissions also; however, the auditor has
no duty to notify members of the public when he receives an initiative petition
from the secretary of state.
The auditor does not analyze or evaluate the correctness of the returned
fiscal impact submissions. Rather, he or she examines the submissions to
determine whether they appear complete, are relevant, have an identifiable
source, and are reasonable. The auditor studies each submission regarding
completeness, determining whether the entity's response conveys a complete
representation of what the entity intended to send and if it reasonably is
related to the proposal. He also reviews the submission to ensure there are no
missing pages or breaks in the continuity of information. With respect to
reasonableness, the auditor examines the submission to establish whether it
addresses or diverges from the particular issue. The auditor's determination of
reasonableness is based on the auditor's experience in state government and
overall knowledge and understanding of business and economic issues. If the
auditor concludes a submission is unreasonable, he or she determines what weight
the submission will be given when preparing the fiscal note summary. If the
auditor has any questions regarding the submission of an entity or needs to
clarify an incomplete submission, he or she may conduct a follow-up inquiry.
<sup><a href="http://www.blogger.com/null" name="SRC 9"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 9"><strong><span style="color: #145da4; font-size: xx-small;">9</span></strong></a></a></sup>
The auditor then drafts the fiscal note and fiscal note summary based solely
on the responses he or she receives. The responses submitted are listed verbatim
in the fiscal note with only minor editing. The fiscal note summary is a
compilation of the various proposals and is intended to advise the voters about
the potential cost or savings, if any, from the adoption of the initiative.
<sup><a href="http://www.blogger.com/null" name="SRC 10"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 10"><strong><span style="color: #145da4; font-size: xx-small;">10</span></strong></a></a></sup> Hence, the auditor's actions
throughout the process of preparing the fiscal notes and fiscal note summaries
fall under the plain meaning of “investigate” and “investigation.”
In <i>Allred,</i> the opponents to the proposed minimum wage initiative
assert that section <a href="http://www.blogger.com/null" name="SLCSM:7352.74-1"></a>116.175 does not require the
auditor to “investigate” the fiscal impact of a proposed initiative but rather
to “assess” it. They contend that, because section <a href="http://www.blogger.com/null" name="SLCSM:7352.75-1"></a>116.175 does not direct the auditor to “investigate”
the fiscal impact, the act of “assessing” the impact is an impermissible
delegation of the auditor's duty by the legislature.
“Assess” is defined as “to make an official valuation or estimate of” some
item. Webster's Third New Int'l Dictionary Unabridged 131 (2002). Undoubtedly,
to assess the fiscal impact of a proposed initiative, the auditor must inquire
about it, solicit comments, and then review and examine those comments. A
systemic, official inquiry such as the auditor undertakes that results in an
estimate of the potential fiscal impact of a proposed initiative is an
assessment, which is the dictionary definition of “investigation.” As such,
there is no qualitative difference between “investigating” and “assessing” the
fiscal impact of a proposed measure.
The parties in these cases also diverge with respect to the extent and
intensity of the investigation the auditor must conduct in order to meet his or
her constitutional duty under <a href="http://www.blogger.com/null" name="SLCSM:7352.76-1"></a>Mo. Const. art. IV,
sec. 13. Specifically, Allred argues section <a href="http://www.blogger.com/null" name="SLCSM:7352.77-1"></a>116.175
does not direct the auditor to perform what the Missouri Constitution requires,
which is a “true” investigation regarding the fiscal impact of an initiative
petition. Instead, Allred believes the statute asks the auditor to oversee a
less rigorous, almost clerical compilation or assembly of predictions by various
third parties about what might happen to future costs and revenues. The auditor
concedes he conducts no independent research or analysis regarding the fiscal
impact of a proposed initiative.
The extent and intensity of an investigation and resulting fiscal note in a
particular case presents a question of statutory compliance under section <a href="http://www.blogger.com/null" name="SLCSM:7352.78-1"></a>116.175 but is irrelevant to whether the statute
unconstitutionally delegated authority to the auditor. The auditor is not
required to compel and second-guess reasonable submissions from entities but is
able to rely on the responses submitted. Nor should the auditor wade into the
policy debates surrounding initiative petitions, which an independent
investigation would entail. In each of these cases, proponents and opponents
argued zealously for their position with respect to the initiative at issue. It
is not the auditor's role to choose a winner among these opposing viewpoints by
independently researching the issue himself, double-checking economic theories
and assumptions, and adopting one side's view over another's in the resulting
fiscal note.
<h4>
4. Investigation is “related to” the “supervising” of the “receipt and
expenditure of public funds” </h4>
Finding that the auditor's procedure for the preparation of fiscal notes and
fiscal note summaries is an “investigation” under <a href="http://www.blogger.com/null" name="SLCSM:7352.79-1"></a>Mo. Const. art. IV, sec. 13 does not end this Court's
inquiry. The parties also disagree as to whether the auditor's investigation is
“related to the supervising ... of the receipt and expenditure of public funds.”
The auditor believes his duty to prepare the fiscal notes and fiscal note
summaries falls within this language because investigations related to the
receipt and expenditure of public funds naturally are related to and associated
with determining the fiscal impact of a proposed initiative. The initiative
opponents disagree with the auditor's position. They argue the inclusion of the
phrase “related to” serves to restrict the auditor's authority and cite this
Court's holding in Farmer, <a href="http://www.blogger.com/null" name="SLCSM:7352.80-1"></a>89 S.W.3d 447 , for
support.
In <i>Farmer,</i> this Court resolved the constitutional validity of <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mo447.575&permaId=iSLCODAM%3A100441.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">section
447.575, RSMo</span></strong></a> 2000, which delegated a duty to the state treasurer to collect
unclaimed property under the Uniform Disposition of Unclaimed Property Act
(UDUPA). Farmer, <a href="http://www.blogger.com/null" name="SLCSM:7352.82-1"></a>89 S.W.3d at 449 . Section <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mo447.575&permaId=iSLCODAM%3A100441.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">447.575</span></strong></a>
authorized the treasurer to bring suit against persons who refused to deliver
unclaimed property to the State as required under UDUPA. Farmer, <a href="http://www.blogger.com/null" name="SLCSM:7352.84-1"></a>89 S.W.3d at 452 . The respondents argued <a href="http://www.blogger.com/null" name="SLCSM:7352.85-1"></a>Mo. Const. art. IV, sec. 15 prohibited the treasurer
from exercising the collection power in section <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mo447.575&permaId=iSLCODAM%3A100441.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">447.575</span></strong></a>.
Farmer, <a href="http://www.blogger.com/null" name="SLCSM:7352.87-1"></a>89 S.W.3d at 452 .
In finding section <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mo447.575&permaId=iSLCODAM%3A100441.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">447.575</span></strong></a>
unconstitutional, this Court construed the language, “No duty shall be imposed
on the state treasurer by law which is not related to the receipt, investment,
custody and disbursement of state funds and funds received from the United
States government” contained in <a href="http://www.blogger.com/null" name="SLCSM:7352.89-1"></a>Mo. Const. art. IV,
sec. 15. Farmer, <a href="http://www.blogger.com/null" name="SLCSM:7352.90-1"></a>89 S.W.3d at 452 . The treasurer
argued this provision should be construed broadly to find the act of receiving
or collecting abandoned property was related to the receipt, investment,
custody, and disbursement of state funds. <i>Id.</i> This Court disagreed,
stating:
<blockquote>
[T]his Court finds that [ <a href="http://www.blogger.com/null" name="SLCSM:7352.91-1"></a>Mo. Const.
art. IV, sec. 15] does not expressly or implicitly grant the treasurer authority
to enforce delivery of property but, to the contrary, specifically denies [the
treasurer] that power. The treasurer would have us construe section 15 as if it
were a broad grant of power to undertake actions not limited to those related to
receipt, investment, custody and disbursement of state funds and funds received
from the United States government. But, the words used to describe the
treasurer's powers do not broaden or expand the treasurer's authority, but
rather are words of restriction. The constitution enumerates very specific
powers that the treasurer may exercise and, then, specifically provides that no
duty not related to those specifically enumerated powers may be exercised by
her.</blockquote>
<i>Id.</i> at 453.
Further, this Court relied upon other limiting provisions in the
constitution, including <a href="http://www.blogger.com/null" name="SLCSM:7352.92-1"></a>Mo. Const. art. IV, sec. 13,
applicable to the auditor, and <a href="http://www.blogger.com/null" name="SLCSM:7352.93-1"></a>Mo. Const. art. IV,
sec. 14, which applies to the secretary of state. Farmer, <a href="http://www.blogger.com/null" name="SLCSM:7352.94-1"></a>89 S.W.3d at 453 . This Court explained:
<blockquote>
There were no similar limitations in the 1875 Constitution, and this
Court has previously recognized that it was to correct this situation that these
limiting provisions were added to the 1945 constitution, for:</blockquote>
the
background of the 1945 provision lies in the prior history of a building up of
the power and patronage of elected officials by giving to them new functions and
duties. One purpose of the new constitution was to limit and define the scope
and duties of all executive officials, agencies, and departments, including
elected officials.
<br />
<blockquote>
Indeed, the 1944 debates over the 1945 constitution themselves show
that the delegates to the constitutional convention drafted it with an eye
towards their concern that power had been too widely distributed among a variety
of elected officials under the 1875 constitution and that a focusing of more
executive power in the office of the governor and his or her appointees might
lead to more effective government. One way the 1945 constitution sought to
accomplish this goal was by precluding the expansion of the state treasurer's
role beyond that of custodian of state funds and by similarly limiting the power
of the state auditor and secretary of state.</blockquote>
<i>Id.</i> at 453-454 (internal citations omitted).
The initiative opponents argue this Court's analysis in <i>Farmer</i> is
controlling and resolves the issue of the auditor's authority, especially when
construing the phrase “related to” in a narrow fashion. The auditor avers
<i>Farmer</i> is distinguishable; however, the auditor concedes the last
sentence <a href="http://www.blogger.com/null" name="SLCSM:7352.95-1"></a>of Mo. Const. art. IV, sec. 13 should not
be construed as anything other than a limitation on the legislature's authority
to impose duties upon him.
While <i>Farmer</i> found the treasurer was seeking to expand her powers
beyond those enumerated in <a href="http://www.blogger.com/null" name="SLCSM:7352.96-1"></a>Mo. Const. art. IV, sec.
14, the provision at issue here is distinguishable because it explicitly grants
the auditor authority to conduct “investigations as required by law.” As such,
the auditor is not seeking to expand his power but rather is exercising a power
he expressly possesses. Moreover, in <i>Farmer,</i> other state officials had
the power to collect funds. Here, no other official has the express power to
draft a fiscal note or fiscal note summary.
Although <i>Farmer</i> is distinguishable, this Court is mindful that the
language “related to” was construed narrowly to avoid expanding the powers of
executive officials. Like “investigation,” “related to” has not been defined in
this provision. “Related” is defined as “having a relationship; connected by
reason of an established or discoverable relation ....” Webster's Third New
Int'l Dictionary Unabridged 1916 (2002). By including the phrase “related to,”
the drafters of the constitution imposed a limitation on the scope of
“investigation” by the auditor and any other duties to only those “related to”
“the supervising ... the receipt and expenditure of public funds.” There is a
relationship between the auditor's preparation of the fiscal notes and fiscal
note summaries and the “supervising ... of the receipt and expenditure of public
funds.” Initiative proposals may have a clear impact on the expenditure and
receipt of public funds, especially when they seek tax increases resulting in a
direct impact on state revenues. As such, it is appropriate for the auditor to
advise Missouri citizens about the expected fiscal impact of a proposed
initiative measure as part of his power “related to ... supervising the receipt
and expenditure of public funds.”
The initiative opponents also draw a sharp distinction between acts by the
auditor that look forward instead of backward as set forth in <a href="http://www.blogger.com/null" name="SLCSM:7352.97-1"></a>Mo. Const. art. IV, sec. 13. They argue the auditor's
preparation of the fiscal notes and fiscal note summaries is nothing more than
an exercise in predicting future, hypothetical budget impacts because there are
no state funds yet at issue with an initiative petition so there can be no
receipt or expenditure of funds to be supervised or audited. This is in contrast
to the auditor's power to conduct audits, which by their nature are a
retrospective review of the expenditure of public funds.
No language in <a href="http://www.blogger.com/null" name="SLCSM:7352.98-1"></a>Mo. Const. art. IV, sec. 13
creates this distinction. A plain reading of the powers enumerated in this
provision permits the auditor to engage in a review of past, present, and future
receipts and expenditures of public funds. For example, the auditor's power to
conduct post-audits of state agencies necessarily requires the examination of
the past receipt and expenditure of public funds. Further, the auditor's power
to conduct investigations as required by law is silent with respect to time
restrictions. Finally, supervising the budgeting systems of political
subdivisions of the state contemplate contemporaneous action related to the
supervising of the receipt and expenditure of public funds.
For these reasons, this Court concludes that <a href="http://www.blogger.com/null" name="SLCSM:7352.99-1"></a>Mo.
Const. art. IV, sec. 13 permits the auditor to prepare the fiscal note and
fiscal note summary as part of an investigation that is related to the
supervision of the receipt and expenditure of public funds. Therefore, section
<a href="http://www.blogger.com/null" name="SLCSM:7352.100-1"></a>116.175 is constitutional and does not
impermissibly delegate duties to the auditor beyond those prescribed in <a href="http://www.blogger.com/null" name="SLCSM:7352.101-1"></a>Mo. Const. art. IV, sec. 13.
In <i>Brown,</i> the trial court's judgment is affirmed on this issue, as it
rightly determined that section <a href="http://www.blogger.com/null" name="SLCSM:7352.102-1"></a>116.175 is
constitutional. In <i>Allred,</i> the trial court's judgment is reversed on this
issue, as it erred in finding that section <a href="http://www.blogger.com/null" name="SLCSM:7352.103-1"></a>116.175
violated <a href="http://www.blogger.com/null" name="SLCSM:7352.104-1"></a>Mo. Const. art. IV, sec. 13. In the payday
loan initiative cases, the trial court did not err in determining this issue, as
it rejected the initiative opponents' claims that section <a href="http://www.blogger.com/null" name="SLCSM:7352.105-1"></a>116.175 is unconstitutional. The judgment entered for
the payday loan cases is affirmed insofar as it correctly determined this
constitutional issue.
<h4>
C. Sufficiency and Fairness </h4>
Each appeal consolidated in this opinion also presents a challenge regarding
the fairness and sufficiency of the secretary of state's summary statement and
the auditor's fiscal note and fiscal note summary for the proposed initiative.
Before detailing the claims related to each proposed initiative, it is helpful
to understand the standards applicable for assessing the fairness and
sufficiency of initiative summary statements and fiscal notes and fiscal note
summaries.
<i>De novo</i> review of the trial court's legal conclusions about the
propriety of the secretary of state's summary statement and the auditor's fiscal
note and fiscal note summary is the appropriate standard of review when there is
no underlying factual dispute that would require deference to the trial court's
factual findings. <i>See</i> Missouri Mun. League v. Carnahan, <a href="http://www.blogger.com/null" name="SLCSM:7352.106-1"></a>303 S.W.3d 573, 579-80 (Mo. App. 2010) .
Secretary of state summary statements and auditor fiscal notes and fiscal
note summaries are required by section <a href="http://www.blogger.com/null" name="SLCSM:7352.107-1"></a>116.190.3 to
be sufficient and fair, as that statute requires:
<blockquote>
The petition [challenging a proposed initiative's official ballot
title] shall state the reason or reasons why the summary statement portion of
the official ballot title is insufficient or unfair and shall request a
different summary statement portion of the official ballot title. Alternatively,
the petition shall state the reasons why the fiscal note or the fiscal note
summary portion of the official ballot title is insufficient or unfair and shall
request a different fiscal note or fiscal note summary portion of the official
ballot title.</blockquote>
In this context, “insufficient” and “unfair” require definition and are given
a statutory interpretation that applies their common meaning. <i>See</i>
Buechner v. Bond, <a href="http://www.blogger.com/null" name="SLCSM:7352.108-1"></a>650 S.W.2d 611, 613 (Mo. banc
1983) . When reviewing whether the secretary of state and the auditor have
complied with the fairness and sufficiency requirements under section <a href="http://www.blogger.com/null" name="SLCSM:7352.109-1"></a>116.190, this Court considers that “insufficient means
inadequate; especially lacking adequate power, capacity, or competence” and
“unfair means to be marked by injustice, partiality, or deception.” <i>See</i>
State ex rel. Humane Soc'y of Missouri v. Beetem, <a href="http://www.blogger.com/null" name="SLCSM:7352.110-1"></a>317 S.W.3d 669, 673 (Mo. App. 2010) (internal
quotations omitted).
The secretary of state's summary statement must be “concise” and cannot be
“intentionally argumentative” or “likely to create prejudice.” Sec. <a href="http://www.blogger.com/null" name="SLCSM:7352.111-1"></a>116.334.1. To create such a summary statement that is
not insufficient or unfair, the summary statement must be adequate and state the
consequences of the initiative without bias, prejudice, deception, or
favoritism. <i>See</i> State ex rel. Humane Soc'y of Missouri, <a href="http://www.blogger.com/null" name="SLCSM:7352.112-1"></a>317 S.W.3d at 673 (internal quotations omitted). The
language used should “fairly and impartially summariz[e] the purposes of the
measure so that voters will not be deceived or misled.” Missouri Mun. League v.
Carnahan, <a href="http://www.blogger.com/null" name="SLCSM:7352.113-1"></a>364 S.W.3d 548, 552 (Mo. App. 2011)
(internal quotations omitted). It should accurately reflect the legal and
probable effects of the proposed initiative. Missouri Mun. League, <a href="http://www.blogger.com/null" name="SLCSM:7352.114-1"></a>303 S.W.3d at 584 . Sometimes it is necessary for the
secretary of state's summary statement to provide a context reference that will
enable voters to understand the effect of the proposed change. <i>See</i>
Missouri Mun. League, <a href="http://www.blogger.com/null" name="SLCSM:7352.115-1"></a>364 S.W.3d at 553 .
Section <a href="http://www.blogger.com/null" name="SLCSM:7352.116-1"></a>116.175.3 instructs the auditor to
prepare a fiscal note and fiscal note summary for a proposed initiative that
“state[s] the measure's estimated cost or savings, if any, to state or local
governmental entities.” In the context of requiring a fair and sufficient fiscal
note by the state auditor, “the words insufficient and unfair ... mean to
inadequately and with bias, prejudice, deception and/or favoritism state the
fiscal consequences of the proposed proposition.” Hancock v. Secretary of State,
<a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSM&linkType=docloc&locId=mo_wd50120_10%2F21%2F1994&permaId=iSLACSM%3A14853.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">885
S.W.2d 42, 49</span></strong></a> (Mo. App. 1994) . Similarly, in examining the fairness and
sufficiency of the fiscal note summary, the summary's words are considered
sufficient and fair where they adequately and without bias, prejudice, or
favoritism synopsize the fiscal note. <i>See id.</i> “[A] fiscal note summary is
not judged on whether it is the 'best' language, only [on] whether it is fair.”
Missouri Mun. League, <a href="http://www.blogger.com/null" name="SLCSM:7352.118-1"></a>303 S.W.3d at 583 .
Requiring fairness and sufficiency of an initiative's summary statement,
fiscal note, and fiscal note summary reflects that there are “procedural
safeguards [in the initiative process that] are designed either, (1) to promote
an informed understanding by the people of the probable effects of the proposed
amendment, or (2) to prevent a self-serving faction from imposing its will upon
the people without their full realization of the effects of the amendment.”
Buchanan v. Kirkpatrick, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLACSM&linkType=docloc&locId=mo_62564_04%2F03%2F1981&permaId=iSLACSM%3A14271.1&tagName=CSPAR&endParm=y"><strong><span style="color: #145da4;">615
S.W.2d 6, 11-12</span></strong></a> (Mo. banc 1981) . Initiative process “safeguards ... assure
that the desirability of the proposed amendment may be best judged by the people
in the voting booth.” <i>Id.</i> at 12.
<h4>
III. Assessing the Challenged Initiatives </h4>
<h4>
A. The Tobacco Tax Initiative </h4>
After the official ballot title for the tobacco tax initiative was certified,
tobacco tax initiative opponent Ralph Brown brought a lawsuit challenging the
fairness and sufficiency of the secretary of state's summary statement and the
auditor's fiscal note and fiscal note summary that were prepared for the
proposed initiative. <sup><a href="http://www.blogger.com/null" name="SRC 11"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 11"><strong><span style="color: #145da4; font-size: xx-small;">11</span></strong></a></a></sup> The
trial court entered a judgment denying Brown's claims contesting the fairness
and sufficiency of the secretary of state's summary statement and the auditor's
fiscal note and fiscal note summary.
<h4>
1. The tobacco tax initiative summary statement was fair and sufficient
</h4>
The tobacco tax initiative proposes additional taxes on certain tobacco
products in an effort to fund a health and education trust fund to educate about
tobacco use prevention and quitting tobacco use. Fund proceeds also are proposed
to be available for elementary, secondary, and higher education funding. The
proposed initiative additionally seeks to amend chapter 196 as it relates to the
administration of the tobacco manufacturer escrow fund, as the tobacco tax
initiative proponents believe that the current escrow scheme provides a refund
“loophole” to nonparticipating tobacco manufacturers. The secretary of state
prepared this summary statement for the proposed tobacco tax initiative:
Shall Missouri law be amended to:
<ul>
<li>create the Health and Education Trust Fund with proceeds of a tax of $0.0365
per cigarette and 25 [percent] of the manufacturer's invoice price for
roll-your-own tobacco and 15 [percent] for other tobacco products;
<li>use Fund proceeds to reduce and prevent tobacco use and for elementary,
secondary, college, and university public school funding; and
<li>increase the amount that certain tobacco product manufacturers must maintain
in their escrow accounts, to pay judgments or settlements, before any funds in
escrow can be refunded to the tobacco product manufacturer and create bonding
requirements for these manufacturers. </li>
</li>
</li>
</ul>
Brown argues that this summary statement is unfair and insufficient because
its second paragraph language is overly limiting in stating that the initiative
would amend the law to “use [the trust fund] proceeds to reduce and prevent
tobacco use and for elementary, secondary, college, and university public school
funding.” Brown contends that this language provides voters incorrect advice
because it identifies only two uses for the trust fund—(1) reducing and
preventing tobacco use and (2) for education—whereas the fund may be used for
many more purposes. He asserts that the summary statement should have reflected
the proposed initiative's other possible funding, including payment of
administrative costs, replacement revenues for lost tobacco tax revenues that
would result from decreased tobacco purchases, tobacco settlement agreement
funding, and loan forgiveness for rural medical professionals. Brown maintains
that the summary statement would have been more accurate had it used broader
language as to the possible trust fund uses. He suggests the summary should have
used a phrase like “including” or “among others.” He further contends that the
summary statement's language suggesting use limitations for the trust fund were
exacerbated by the auditor's fiscal note summary, which included a statement
that the fund's “revenue will fund only programs and services allowed by the
proposal.” Brown urges this Court to find that the summary statement's failure
to incorporate broader fund-use categories indicates that it did not advise
potential initiative signers or voters of the initiative's probable effects.
Brown also argues that the third paragraph of the summary statement is unfair
because it mischaracterizes the initiative and is inaccurate. He asserts that
the summary language stating that the proposed initiative will “increase the
amount that certain tobacco product manufacturers must maintain in their escrow
accounts” is “absolutely wrong.” The required escrow amount is specified in <a href="http://www.blogger.com/null" name="SLCSM:7352.120-1"></a>section 196.1003(b)(1), RSMo Supp. 2011, and Brown
argues that the statutory requirement is not altered by the proposed tobacco tax
initiative. Instead, he argues that the proposal would alter how much can be
refunded to certain manufacturers from escrow pursuant to section <a href="http://www.blogger.com/null" name="SLCSM:7352.121-1"></a>196.1003 (b)(2)(B). He notes that the summary
statement references escrow refunds, but he contends that the language
incorrectly suggests a change to section <a href="http://www.blogger.com/null" name="SLCSM:7352.122-1"></a>196.1003
(b)(1). Brown further contends that the third paragraph of the summary is
incorrect because it is unclear by its use of the phrase “these manufacturers.”
He argues that the summary language suggests that a bonding requirement is
created for only manufacturers who are entitled to an escrow refund, whereas the
requirement also is created for manufacturers who will not be entitled to a
refund. He also argues that the summary's use of “these manufacturers” wrongly
suggests that a bonding requirement is imposed on all manufacturers who are
entitled to a refund.
This Court finds that the trial court rightly rejected Brown's arguments
challenging the insufficiency and unfairness of the secretary of state's summary
statement. As was the trial court, this Court is mindful of the 100-word limit
imposed on the summary statement by section <a href="http://www.blogger.com/null" name="SLCSM:7352.123-1"></a>116.334. Especially considering that limitation, the
degree of specificity that Brown contends was necessary to create a fair and
sufficient summary statement is not required. The summary statement “need not
set out the details of the proposal” to be fair and sufficient. <i>Cf.</i>
United Gamefowl Breeders, <a href="http://www.blogger.com/null" name="SLCSM:7352.124-1"></a>19 S.W.3d at 141 . The
test is not whether increased specificity and accuracy would be preferable or
provide the best summary. Missourians Against Human Cloning v. Carnahan, <a href="http://www.blogger.com/null" name="SLCSM:7352.125-1"></a>190 S.W.3d 451, 457 (Mo. App. 2006) . Rather, “[t]he
important test is whether the language fairly and impartially summarizes the
purposes of the initiative.” <i>Id.</i> (internal quotations omitted). The
secretary of state's summary statement for the tobacco tax initiative complied
with this requirement.
Importantly, the secretary of state's summary statement provided sufficient
information to make clear the purpose of the proposed tobacco tax initiative and
give notice to those interested in or affected by the proposal. <i>Cf.</i>
United Gamefowl Breeders, <a href="http://www.blogger.com/null" name="SLCSM:7352.126-1"></a>19 S.W.3d at 140 (stating
in a clear title challenge case that “[t]he test is whether the ballot title
makes the subject evident with sufficient clearness to give notice of the
purpose to those interested or affected by the proposal.”). The summary
statement complied with the requirement that it “accurately [reflect] the legal
and probable effects of the [proposed] initiative.” <i>See</i> Missouri Mun.
League, <a href="http://www.blogger.com/null" name="SLCSM:7352.127-1"></a>303 S.W.3d at 584 .
This Court accepts the secretary of state's assertions that her summary
statement was an accurate explanation of the proposed initiative's modifications
to the escrow and bonding requirements for tobacco product manufacturers.
Further clarifying the bonding requirement language might make the summary more
accurate, but it was not legally necessary to make the summary fair and
sufficient. This Court agrees with the trial court that the language utilized in
the third bullet point of the summary statement did not render the summary
statement unfair or insufficient.
For these reasons, the trial court did not err in upholding the secretary of
state's summary statement for the tobacco tax initiative, and its judgment on
this issue is affirmed.
<h4>
2. The tobacco tax initiative fiscal note summary was fair and sufficient
</h4>
Brown also argues that the fiscal note summary the auditor prepared for the
tobacco tax initiative was unfair and insufficient. The fiscal note summary for
the proposed measure states: <sup><a href="http://www.blogger.com/null" name="SRC 12"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 12"><strong><span style="color: #145da4; font-size: xx-small;">12</span></strong></a></a></sup>
<blockquote>
Estimated additional revenue to state government is $283 million to
$423 million annually with limited estimated implementation costs or savings.
The revenue will fund only programs and services allowed by the proposal. The
fiscal impact to local governmental entities is unknown. Escrow fund changes may
result in an unknown increase in future state revenue.</blockquote>
Brown's appeal asserts that this fiscal note summary is unfair and
insufficient because it wrongly reiterates the secretary of state's summary
statement's suggestions about the reach of the initiative. He contends that the
fiscal note summary should not have included a suggestion that the tobacco tax
initiative will create “revenue [that] will fund only programs and services
allowed by the proposal.” He argues that this language provides improper
commentary about the proposed initiative, and he asserts that the auditor's
fiscal note summary is limited by section <a href="http://www.blogger.com/null" name="SLCSM:7352.128-1"></a>116.175
to using language that only relates to the proposed measure's “estimated cost of
savings.” Brown maintains that the language at issue demonstrates that the
auditor overlapped the secretary of state's summary statement duties by making
an improper “comment” about the proposed initiative.
In rejecting this language argument, the trial court found that the
challenged fiscal note summary language was not inaccurate or unfairly
prejudicial. Its judgment highlighted the auditor's duty to assess the proposed
initiative's fiscal impact and suggested that the challenged language reflected
the auditor's fiscal impact assessment of the proposal.
Brown fails to persuade that the trial court erred in reaching these
conclusions. This Court agrees with the auditor's arguments that the fiscal note
summary language at issue reflected a fiscal impact assessment of the proposed
measure and was in line with the auditor's duties to inform the public of the
fiscal consequences of a proposed initiative. <i>See</i> Missouri Mun. League,
<a href="http://www.blogger.com/null" name="SLCSM:7352.129-1"></a>303 S.W.3d at 582 (stating the purpose of the
auditor's duty to prepare fiscal notes is to “inform the public of the fiscal
consequences of the proposed measure”).
The trial court did not err in upholding the auditor's fiscal note summary
statement for the tobacco tax initiative, and its judgment is affirmed on this
issue.
<h4>
3. The trial court did not err in rejecting Brown's res judicata claims
</h4>
Also at issue in the Brown appeal is whether the trial court erred in
refusing to accept Brown's <i>res judicata</i> arguments asserting that the
issue of the constitutional validity of section <a href="http://www.blogger.com/null" name="SLCSM:7352.130-1"></a>116.175 previously was decided against the auditor's
position and not appealed by the auditor.
Brown's assertions of <i>res judicata</i> stemmed from his having brought
four prior cases that alleged that section <a href="http://www.blogger.com/null" name="SLCSM:7352.131-1"></a>116.175
is unconstitutional. These cases were assigned to the same trial judge, who
entered four separate final judgments finding that section <a href="http://www.blogger.com/null" name="SLCSM:7352.132-1"></a>116.175 violated <a href="http://www.blogger.com/null" name="SLCSM:7352.133-1"></a>Mo.
Const. art. IV, sec. 13. The auditor appealed one of the four judgments to this
Court. Brown v. Carnahan and Schweich, No. SC92492 . The other three trial court
judgments are final and have not been appealed.
In the interim, Brown filed another declaratory judgment and petition for
injunctive relief attacking the auditor's constitutional authority before a
different trial court judge, which is the subject of this appeal. After a
hearing on a motion for judgment on the pleadings, Brown filed “Supplemental
Suggestions Concerning Res Judicata and Count IV — the Unconstitutionality of
Section <a href="http://www.blogger.com/null" name="SLCSM:7352.134-1"></a>116.175,” in which he injected this issue
of <i>res judicata</i> for the first time, claiming the trial court's judgments
in the three unappealed cases were binding and conclusive as to the issue of the
auditor's constitutional authority to prepare the fiscal notes and fiscal note
summaries. <sup><a href="http://www.blogger.com/null" name="SRC 13"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 13"><strong><span style="color: #145da4; font-size: xx-small;">13</span></strong></a></a></sup>
The trial court rejected Brown's constitutional challenge to the validity of
section <a href="http://www.blogger.com/null" name="SLCSM:7352.135-1"></a>116.175 and found Brown waived his <i>res
judicata</i> argument because the claim was untimely. The trial court went on to
find that even had Brown raised the issue timely, it would not apply because the
initiative petitions involved were different and the parties to the lawsuits
were different.
On appeal, Brown argues the trial court erred as a matter of law by denying
his request for a declaratory judgment that section <a href="http://www.blogger.com/null" name="SLCSM:7352.136-1"></a>116.175 violates the Missouri Constitution because
claim preclusion required entry of judgment in his favor. Brown asserts the same
issue was litigated previously between the same parties, a final judgment was
entered by another court, and that judgment was not appealed. Moreover, Brown
argues he did not waive his right to raise claim preclusion because he could not
have included it in his pleadings because of the timing of the judgments.
Accordingly, Brown believes this Court is foreclosed from adjudicating the
auditor's appeal in this case.
While Brown characterizes his argument in terms of <i>res judicata,</i> what
he ultimately raised below was an offensive collateral estoppel claim.
Collateral estoppel, or issue preclusion, is used to preclude the relitigation
of an issue that already has been decided in a different cause of action. Sexton
v. Jenkins & Associates, Inc., <a href="http://www.blogger.com/null" name="SLCSM:7352.137-1"></a>152 S.W.3d 270,
273 (Mo. banc 2004) . “The doctrine requires that the issue was fully and fairly
litigated, that the issue was essential to the earlier judgment, and that the
earlier judgment be final and binding on the party against whom it is asserted.”
Id. This doctrine may be employed offensively or defensively. James v. Paul, <a href="http://www.blogger.com/null" name="SLCSM:7352.138-1"></a>49 S.W.3d 678, 685 (Mo. banc 2001) “[O]ffensive
collateral estoppel normally involves the attempt by a plaintiff to rely on a
prior adjudication of an issue to prevent the defendant from challenging a fact
necessary to the plaintiff's case and on which the plaintiff carries the burden
of proof.” <i>Id.</i> Generally, an offensive use of collateral estoppel is less
favored than a defensive use. <i>Id.</i>
Facts that give rise to an issue preclusion claim, by their very nature, are
known to the party from the inception of the lawsuit. Accordingly, a party
“should not be able to hold preclusion in reserve as a 'stealth defense' long
after the time for raising substantive defenses has passed.” Heins Implement Co.
v. Missouri Highway & Transp. Comm'n, <a href="http://www.blogger.com/null" name="SLCSM:7352.139-1"></a>859
S.W.2d 681, 685 (Mo. banc 1993) (discussing untimely assertion of <i>res
judicata</i> defense). Hence, to invoke offensive collateral estoppel, it must
be pleaded timely in the plaintiff's petition. Consumer Fin. Corp. v. Reams, <a href="http://www.blogger.com/null" name="SLCSM:7352.140-1"></a>158 S.W.3d 792, 797 (Mo. App. 2005) .
Brown concedes he did not raise <i>res judicata,</i> issue preclusion, or
offensive collateral estoppel in any of his pleadings, in his motion for
judgment on the pleadings, or at the hearing prior to the matter being submitted
for a ruling. However, Brown argues he has not waived his right to raise
preclusion because he could not have included it in his pleadings because of the
timing. None of the previous judgments was final before the auditor indicated he
wished to appeal, and as such, Brown believes he would have compromised his
legal position had he raised preclusion earlier in the instant appeal. This
argument is unavailing given this Court's disfavor of allowing a party to employ
offensive collateral estoppel and the facts that the auditor's appeal was filed
and the unappealed judgments were final before briefing and the hearing by the
trial court in this case.
Brown's <i>res judicata</i> argument fails, and the trial court's judgment in
<i>Brown</i> is affirmed.
<h4>
B. The Minimum Wage Initiative </h4>
Victor Allred brought the suit that challenges the secretary of state's
summary statement and the auditor's fiscal note and fiscal note summary for the
proposed minimum wage initiative. He alleges that the summary statement, fiscal
note, and fiscal note summary are insufficient, misleading, biased, and unfair.
<sup><a href="http://www.blogger.com/null" name="SRC 14"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 14"><strong><span style="color: #145da4; font-size: xx-small;">14</span></strong></a></a></sup> The trial court found that
the secretary of state's summary statement was fair and sufficient, and it
upheld fairness and sufficiency of the auditor's fiscal note and fiscal note
summary. <sup><a href="http://www.blogger.com/null" name="SRC 15"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 15"><strong><span style="color: #145da4; font-size: xx-small;">15</span></strong></a></a></sup> Allred
cross-appeals to challenge the trial court's fairness and sufficiency findings.
<sup><a href="http://www.blogger.com/null" name="SRC 16"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 16"><strong><span style="color: #145da4; font-size: xx-small;">16</span></strong></a></a></sup>
<h4>
1. The minimum wage initiative summary statement was fair and sufficient
</h4>
Under the proposed minimum wage initiative, the state's minimum wage would be
increased to $8.25 per hour and the minimum wage for tipped-employees would be
60 percent of the minimum wage. The proposed initiative also includes that, if
the federal minimum wage is increased above the state minimum wage, the higher
federal minimum wage rate would be in effect under the law. The secretary of
state's summary statement for the proposed minimum wage initiative states:
Shall Missouri law be amended to:
<ul>
<li>increase the state minimum wage to $8.25 per hour, or to the federal minimum
wage if that is higher, and adjust the state wage annually based upon changes in
the Consumer Price Index;
<li>increase the minimum wage for employees who receive tips to 60 [percent] of
the state minimum wage; and
<li>modify certain other provisions of the minimum wage law including the retail
or service business exemption and penalties for paying employees less than the
minimum wage? </li>
</li>
</li>
</ul>
Allred first argues that this summary statement must be revised because it
wrongly suggests that Missouri law will be “amended” by the proposed minimum
wage initiative to adjust the state minimum wage based on changes to the
consumer price index (CPI). He argues that this is inaccurate because the CPI
can be applied under existing law to adjust the minimum wage. The secretary of
state, however, asserts that the reference to the CPI adjustment in the summary
statement is necessary context to understand the proposed initiative's potential
effects, as the CPI is not actually applied under Missouri's current minimum
wage scheme. The trial court agreed with the secretary of state, finding that
the reference to the CPI was not used to repeat the existing law “but to show
that the state minimum wage, regardless of its source, [now would be] subject to
the [CPI].”
References to current law to provide context to a summary statement do not
render the summary statement unfair or prejudicial. Missouri Mun. League, <a href="http://www.blogger.com/null" name="SLCSM:7352.142-1"></a>364 S.W.3d at 553 (“The mere fact that a proposal
references something currently in the Constitution does not make it
automatically unfair or prejudicial; indeed, such a rule would be absurd in that
at least in some instances context demands a reference to what is currently
present to understand the effect of the proposed change.”). As such, Allred
fails to persuade that the trial court erred in finding that the CPI reference
was fair and sufficient in the summary statement for the minimum wage
initiative.
Allred further argues that the secretary of state's summary statement cannot
be upheld because it is not accurate in suggesting that the minimum wage is less
for tipped-workers than for non-tipped workers. He argues that both types of
workers currently are entitled to the same minimum wage when both
employer-provided compensation and tip compensation is considered. He contends
that the summary statement language is misleading about this fact. He maintains
that the summary should explain that the proposed initiative will “increase the
minimum <i>employer-paid</i> wage for tipped employees to 60 [percent] of the
state minimum wage.”
In contrast, the secretary of state asserts that her summary statement was
fair and sufficient considering the limited word count available to explain the
complex issues of how the proposed minimum wage initiative would impact wages of
tipped workers. The trial court agreed with the secretary of state's assertions,
finding that the summary statement reference to tipped-worker wages was accurate
and fairly summarized the proposed initiative. The trial court declared that
Allred's arguments suggested a need for a “level of detail [that] could not and
need not be provided” to render a summary fair and sufficient. This Court finds
no error in the trial court's reasoning on this issue. As noted in discussing
the tobacco tax initiative, the secretary of state's summary statement “need not
set out the details of the proposal” to be fair and sufficient. <i>Cf.</i>
United Gamefowl Breeders, <a href="http://www.blogger.com/null" name="SLCSM:7352.143-1"></a>19 S.W.3d at 141 .
Finally, Allred argues that the summary statement is unfair and insufficient
because it fails to explain adequately and accurately how the proposed minimum
wage initiative would result in state minimum wage adjustments based on changes
to the federal minimum wage. He contends that the summary statement fails to
explain to voters that the proposed initiative would create a new
“super-escalator” scheme whereby Missouri's state minimum wage would be
increased to meet the federal minimum wage if the federal minimum wage is higher
and then still be subject to increases based on the application of the CPI. He
argues that voters are not informed fully by the summary statement that it is
likely under the proposed measure that the state's minimum wage will increase
annually.
The secretary of state responds that her summary statement accurately states
the effects of the proposed initiative within the 100-word limit imposed for the
summary statement. She argues that setting out a separate explanation of the
“super-escalator” provision was not necessary to render the summary statement
fair and sufficient. This Court agrees, as the summary statement “need not set
out the details of the proposal” to be fair and sufficient. <i>Cf.</i> United
Gamefowl Breeders, <a href="http://www.blogger.com/null" name="SLCSM:7352.144-1"></a>19 S.W.3d at 141 . As noted
above, the test is not whether increased specificity would be have been
preferable but instead is whether the language used was fair and impartial in
summarizing the initiative's purposes. <i>See</i> Missourians Against Human
Cloning, <a href="http://www.blogger.com/null" name="SLCSM:7352.145-1"></a>190 S.W.3d at 457 .
For these reasons, this Court finds that the trial court did not err in
upholding the secretary of state's summary statement for the minimum wage
initiative. The trial court's judgment is affirmed on this issue.
<h4>
2. The minimum wage initiative fiscal note and fiscal note summary were fair
and sufficient </h4>
Allred's appeal also contests the fairness and sufficiency of the auditor's
fiscal note and fiscal note summary for the minimum wage initiative. The fiscal
note summary at issue states:
<blockquote>
Increased state and local government wage and benefit costs
resulting from this proposal will exceed $1 million annually. State government
income and sales tax revenue could increase by an estimated $14.4 million
annually; however, business employment decisions will impact any potential
change in revenue. Local government revenue will change by an unknown
amount.</blockquote>
Allred argues that this fiscal note summary and the underlying fiscal note
are insufficient and unfair because they fail to give a real assessment or
estimate of the direct costs that state and local governmental entities will
bear if the minimum wage initiative is passed. He criticizes at length the
auditor's process for creating the fiscal note and fiscal note summary. <sup><a href="http://www.blogger.com/null" name="SRC 17"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 17"><strong><span style="color: #145da4; font-size: xx-small;">17</span></strong></a></a></sup> He particularly complains that the
auditor accepted the initiative proponent's fiscal impact assessment report even
though it was filed after the statutory time deadline. Allred calls the
auditor's work creating the fiscal note summary “mere guesswork,” which he
argues cannot produce a fair and sufficient summary of the costs of the proposed
measure. He further argues that the fiscal note summary is insufficient because
it misstates likely indirect impacts of the proposed initiative. Allred contends
that the fiscal note summary should have provided more information about the
initiative's potential impacts on businesses' spending and investments.
In rejecting Allred's arguments about the unfairness and insufficiency of the
fiscal note and fiscal note summary, the trial court highlighted that the
auditor's process for creating the fiscal note and fiscal note summary has been
upheld repeatedly by the court of appeals. <sup><a href="http://www.blogger.com/null" name="SRC 18"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 18"><strong><span style="color: #145da4; font-size: xx-small;">18</span></strong></a></a></sup> Particularly, the trial court highlighted that the
auditor incorporated the fiscal impact submissions essentially verbatim when
creating the fiscal note. It also noted that the fiscal note summary at issue
for the minimum wage initiative reflected statements that were included verbatim
in the fiscal note. The trial court stressed that much of the fiscal note and
fiscal note summary creation process was left to the auditor's discretion and
should not be subjected to “partisan wrang[ling]” in litigation.
Despite Allred's assertions, this Court agrees with the trial court that the
fiscal note and fiscal note summary for the minimum wage initiative are fair and
sufficient. The fiscal note summary meets its purpose of informing the public
about the proposed initiative's potential fiscal consequences. <i>See</i> sec.
<a href="http://www.blogger.com/null" name="SLCSM:7352.146-1"></a>116.175.1. And it does so without using language
that is likely to cause bias, prejudice, deception, or favoritism for or against
the proposal. <i>See</i> Missouri Mun. League, <a href="http://www.blogger.com/null" name="SLCSM:7352.147-1"></a>364
S.W.3d at 557 . The fiscal note is required to be sufficient and fair, and it
can be considered meaningful, sufficient, and fair even if it does not use the
“best” language, set out all details of the proposed measure, or inform voters
of an express amount of potential costs of the initiative. <i>See id.</i>
This Court finds no error in the trial court's holding that the minimum wage
initiative's fiscal note and fiscal note summary were fair and sufficient and
affirms the trial court's judgment on this issue.
<h4>
C. The Payday Loan Initiative </h4>
The Northcott, Francis, Prenzler, and Reuter appeals <sup><a href="http://www.blogger.com/null" name="SRC 19"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 19"><strong><span style="color: #145da4; font-size: xx-small;">19</span></strong></a></a></sup> raise issues regarding the fairness and sufficiency
of the secretary of state's summary statement and the auditor's fiscal note and
fiscal note summary that were prepared for the proposed payday loan initiative.
The trial court agreed with the initiative's opponents that the secretary of
state's summary statement and the auditor's fiscal note and fiscal note summary
were insufficient and unfair and likely would deceive petition signers and
voters. The judgment was appealed in each of the four suits.
<h4>
1. The payday loan initiative summary statement was fair and sufficient
</h4>
The proposed payday loan initiative would limit the annual percentage rate
for payday, title, installment, and other high-cost consumer credit and small
loans to 36 percent per year. <sup><a href="http://www.blogger.com/null" name="SRC 20"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 20"><strong><span style="color: #145da4; font-size: xx-small;">20</span></strong></a></a></sup> The proposed initiative's language includes that it
is aimed at “[p]reserving fair lending by prohibiting lenders from structuring
other transactions to avoid the rate limit through subterfuge.” The secretary of
state prepared this summary statement for the proposed payday loan initiative:
<blockquote>
Shall Missouri law be amended to limit the annual rate of interests,
fees, and finance charges for payday, title, installment, and consumer credit
loans and prohibit such lenders from using other transactions to avoid the rate
limit?</blockquote>
The trial court found that the summary statement's suggestion that the
initiative would “limit the annual rate of interest” was not specific enough to
render the summary statement fair and sufficient. Noting federal truth in
lending provisions, the trial court found that the summary statement should have
provided the specific 36-percent interest rate limit proposed by the initiative.
It concluded that the omission of the 36-percent rate limit made the statement
“misleading and likely to deceive petition signers and voters.” It opined: “as a
matter of both law and fact, the initiative's impact—i.e. its 'probable
effect'—on businesses, consumers, and governmental entities, is not tied to the
mere <i>existence</i> of a 'limit,' but rather, it depends on <i>what</i> that
'limit' is.” Citing Cures Without Cloning v. Pund, <a href="http://www.blogger.com/null" name="SLCSM:7352.149-1"></a>259 S.W.3d 76 (Mo. App. 2008) , the court found that
it “must rewrite” the summary statement “to correct [the statement's]
insufficiency and unfairness,” and it decided it would “add in the essential
[36-percent] limitation.”<sup><span style="font-size: x-small;"><strong> </strong></span><a href="http://www.blogger.com/null" name="SRC 21"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 21"><strong><span style="color: #145da4; font-size: xx-small;">21</span></strong></a></a></sup>
The court amended the summary statement to provide:
<blockquote>
Shall Missouri law be amended to allow annual rates up to a limit of
36 [percent] including interests, fees, and finance charges for payday, title,
installment, and consumer credit loans and prohibit such lenders from using
other transactions to avoid the rate limit?</blockquote>
The appeals from this judgment allege that the trial court erred in finding
that the secretary of state's summary statement language was insufficient or
unfair. The appellants assert that the original summary statement was not
deceiving or misleading, was not required to include specificity about the rate
cap to be fair and sufficient, and should not have been rewritten by the trial
court.
This Court finds that the trial court's judgment on this issue was in error,
as the summary statement prepared by the secretary of state was fair and
sufficient as it originally was prepared. Section <a href="http://www.blogger.com/null" name="SLCSM:7352.151-1"></a>116.334 imposes the requirement that the secretary of
state's summary statement be prepared to be “neither intentionally argumentative
nor likely to create prejudice either for or against the proposed measure.” It
is not the role of the courts to reject the secretary of state's summary
statement when it “fairly and impartially summarizes the purpose of the
initiative so that the voters will not be misled.” <i>See</i> Missouri Mun.
League, <a href="http://www.blogger.com/null" name="SLCSM:7352.152-1"></a>364 S.W.3d at 553 (internal quotations
omitted).
Here, the secretary of state prepared a summary statement that was accurate
as to the purpose of the initiative—to limit the permissible interest rate for
certain types of loans—and there was no requirement to articulate specifically
the proposed 36-percent rate limit. That the court might believe that the
additional information about the rate limit would render a better summary is not
the test. <i>See</i> Bergman v. Mills, <a href="http://www.blogger.com/null" name="SLCSM:7352.153-1"></a>988 S.W.2d
84, 92 (Mo. App. 1999) (rejecting claims by an initiative's opponents who
alleged that the secretary of state's summary statement for the initiative was
vague, ambiguous, and insufficient; finding that “even if the language proposed
by [the opponents] is more specific, and even if that level of specificity might
be preferable, whether the summary statement prepared by the Secretary of State
is the best language for describing the referendum is not the test”).
Because the secretary of state's summary statement language was fair and
sufficient in summarizing the purpose of the initiative and was not written in a
way that would mislead voters, the trial court erred in rejecting her summary
statement. There was no reason for the trial court to declare that the secretary
of state's summary statement could not be used and to rewrite her summary. The
judgment in the payday loan initiative cases is reversed on this issue.
<h4>
2. The payday loan initiative fiscal note and fiscal note summary were fair
and sufficient </h4>
The payday loan initiative proponents also appeal the trial court's finding
that the auditor's fiscal note and fiscal note summary for the proposed payday
loan initiative were unfair and insufficient. According to the auditor's
standard practices, the fiscal note created for the proposed initiative was
essentially a verbatim reflection of the fiscal impact submissions that the
auditor received regarding the measure. <sup><a href="http://www.blogger.com/null" name="SRC 22"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 22"><strong><span style="color: #145da4; font-size: xx-small;">22</span></strong></a></a></sup> The auditor's fiscal note summary for the proposed
payday loan initiative provided:
<blockquote>
State governmental entities could have annual lost revenue estimated
at $2.5 to $3.5 million that could be partially offset by expenditure reductions
for monitoring industry compliance. Local governmental entities could have
unknown total lost revenue related to business license or other business
operating fees if the proposal results in business closures.</blockquote>
In exploring the fairness and sufficiency of this fiscal note summary at
trial, testimony was received from two economics experts. One economics
professor testified about the negative fiscal impact that the proposed
initiative would have on title loan and payday loan lenders. He also testified
regarding the proposed payday loan initiative's likely fiscal impacts related to
increased unemployment compensation payouts and lost licensing-fee revenues. The
evidence showed that the auditor's office believed that the assumptions were
correct that the proposed initiative would cause businesses to close.
The auditor staffer who prepared the fiscal note and fiscal note summary
testified that the $2.5- to $3.5-million lost revenue estimate referenced in the
fiscal note summary was derived from the figures submitted in the economic
professor's fiscal impact submission. He testified, however, that he did not
include the professor's prediction regarding lost unemployment benefits because
those are not funded through a government fund. Testimony at trial also focused
on the initiative's impact on local government tax receipts, and the auditor
admitted that no “local impact” assessment was included in the fiscal note or
fiscal note summary.
Testimony at trial further explored a reference to “510 lenders” that had
been included in the fiscal note because it was included in the professor's
report via an email from the division of finance. <sup><a href="http://www.blogger.com/null" name="SRC 23"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 23"><strong><span style="color: #145da4; font-size: xx-small;">23</span></strong></a></a></sup> The auditor's office did not follow up to determine
why the department of insurance's “no cost or savings to the department”
response to the auditor's direct inquiry regarding the fiscal impact of the
initiative was contrary to the division of finance's email in the professor's
report. The auditor's staffer who prepared the fiscal note testified that he
considered the division of finance's comments about the impact on “510 lenders”
to have been evaluated and modified in the official fiscal impact report that
the auditor received from the department of insurance. The auditor's office did
not undertake an independent analysis to determine the fiscal impact of the
initiative on “510 lenders,” and the professor's analysis of the fiscal impact
did not address the fiscal impact on “510 lenders.” Accordingly, the fiscal note
and fiscal note summary did not reflect a potential fiscal impact that the
payday loan initiative would have on “510 lenders.” The auditor's staffer
testified that he speculated that the department of insurance had reasoned that
any lost revenues impact of the payday loan initiative would be offset by the
department spending smaller amounts to regulate the lending entities at issue.
An economist testified at trial that he had been retained by opponents'
counsel to provide information at trial about the proposed initiative's impact
to “510 lenders.” He testified that the proposed initiative would result in “510
lenders” losing around 60 percent in revenues and would likely lead to the
disappearance of Missouri's “510 lenders.” He opined that the impact on those
lenders would lead to declines in state sales tax revenues and personal and
business income tax revenues, and he also projected it would lead to increased
unemployment compensation payments for laid-off employees of “510 lenders.” The
economist admitted, however, that his trial testimony evidenced fiscal impact
information on “510 lenders” that was not provided to the auditor during the
time the auditor was preparing the fiscal note and fiscal note summary.
After hearing the evidence, the trial court concluded that the “undisputed
facts” showed that the payday loan initiative's fiscal note and fiscal note
summary were “defective.” It criticized that the auditor's fiscal note summary
did not reflect the fiscal impact that the payday loan initiative would have on
lenders classified as “510 lenders.” It noted that the initiative opponents'
experts had provided evidence that “510 lenders” would be impacted negatively by
the initiative, which would cause businesses to close and the state to lose
revenues. The trial court believed it would deceive voters not to reflect
information about “510 lenders” in the fiscal note and fiscal note summary.
<sup><a href="http://www.blogger.com/null" name="SRC 24"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 24"><strong><span style="color: #145da4; font-size: xx-small;">24</span></strong></a></a></sup>
The appeals from this judgment argue that the trial court erred in concluding
that the fiscal note and fiscal note summary were insufficient and unfair. They
assert that there was substantial and competent evidence to support the
auditor's fiscal note because it fully, completely, and accurately listed and
summarized all the fiscal comments the auditor received during the statutory
period under section <a href="http://www.blogger.com/null" name="SLCSM:7352.155-1"></a>116.175. They criticize that
the trial court's judgment focused on “510 lender” evidence—particularly from
the economist—that was unavailable to the auditor when the fiscal note and
fiscal note summary were prepared. They assert that the opponents to the
initiative failed to provide evidence identifying that any lender that would be
affected by the proposal was not already considered in the auditor's fiscal note
and fiscal note summary.
This Court agrees that the trial court erred in rejecting the auditor's
fiscal note and fiscal note summary for the proposed payday loan initiative.
Contrary to the arguments of the initiative opponents, the fiscal note and
fiscal note summary complied with the auditor's obligations to create a fair and
sufficient summary and inform the public of the fiscal consequences of the
proposed measure without bias, prejudice, deception, or favoritism. <i>See</i>
Missouri Mun. League, <a href="http://www.blogger.com/null" name="SLCSM:7352.156-1"></a>364 S.W.3d at 557 . The
auditor did nothing out of his ordinary practice when incorporating verbatim the
fiscal impact submissions that were returned to him, and the initiative
opponents are unpersuasive in suggesting that the auditor should have undertaken
additional examinations of the fiscal impacts that the initiative would have
specifically on “510 lenders.” While it might have been more informative to have
had additional information related to the likely fiscal impact of the initiative
on “510 lenders,” nothing required the auditor to look beyond the information he
was provided in assessing the fiscal impact on those lenders. As noted earlier
in this opinion: “The auditor is not required to compel and second-guess
reasonable submissions from entities but is able to rely on the responses
submitted. ... [And] [i]t is not the auditor's role to choose a winner ... by
independently researching the issue himself, double-checking economic theories
and assumptions, and adopting one side's view over another's in the resulting
fiscal note.” Further, courts must remain mindful that the word limitations of
the fiscal note summary necessarily result in exclusion of specific fiscal
impact details that might improve the summary but that are not required for it
to be upheld as sufficient and fair.
This Court reverses the trial court's judgment in the payday loan initiative
cases with respect to its finding that the fiscal note and fiscal note summary
were unfair and insufficient. Further, there was no bar to incorporating the
auditor's fiscal note summary in the ballot title.
<h4>
3. The trial court's ripeness holdings are affirmed </h4>
In <i>Francis,</i> plaintiffs Francis and Hoover additionally argued that the
trial court should declare that the payday loan initiative is disqualified as a
violation of the uniform lender interest rate requirements <a href="http://www.blogger.com/null" name="SLCSM:7352.157-1"></a>of Mo. Const. art. III, sec. 44. They also asserted
that the initiative was invalid because it was void for vagueness and violative
of due process. The trial court dismissed these claims as unripe. In
<i>Francis,</i> the opponents of the initiative cross-appeal the trial court's
judgment to assert that the trial court erred in finding that these additional
constitutional claims were unripe. They argue that an exception to the ripeness
doctrine applies. They also contend that the trial court erred in dismissing
their constitutional claims as unripe because it would force taxpayers to bear
the burden and expense of holding an election on a facially unconstitutional
initiative.
This Court affirms the trial court's judgment on these issues without further
discussion, as an opinion on this matter would not have precedential value. Rule
<a href="http://www.blogger.com/null" name="SLCSM:7352.158-1"></a>84.16 (b).
<h4>
4. The intervention challenge is moot </h4>
Also at issue in the payday loan initiative cases is whether two proponents
and financial backers of the proposed payday loan initiative should be allowed
to intervene in the case. George Dennis Shull and Jerry Stockman (“Intervenors”)
are citizens, residents, legal voters, and taxpayers of the State of Missouri
who supported all four of the payday loan initiative petitions. Intervenors have
donated money and volunteered their time in working to ensure the initiative
petitions are placed on the ballot.
When these ballot title challenges were filed, Intervenors sought to
intervene as a matter of right or, alternatively, through permissive
intervention. Initially, Intervenors sought to intervene in the Prentzler suit.
In October 2011, the trial court granted Intervenors' motion for permissive
intervention in the Prentzler suit and likewise in the Reuter suit in December
2011. In November 2011, Intervenors filed another motion to intervene as a
matter of right in the Northcott and Francis suits. Intervenors also requested
that the trial court change its ruling in the Prentzler and Reuter suits from a
finding that they could intervene permissively to a determination that they
could intervene as a matter of right. Intervenors filed suggestions in support
of their motions, along with affidavits and supporting documents.
After hearing arguments about the issue and accepting all of the factual
allegations set forth in the affidavits as true, the trial court entered a final
judgment regarding intervention in each of the four lawsuits. The trial court
found Intervenors sought to defend the ballot title and fiscal note in the exact
form as they were issued and approved by the secretary of state and the auditor.
Therefore, the trial court held Intervenors failed to show how their interests
would not be protected by those officials. The trial court denied Intervenors'
motion to intervene in the Northcott and Francis suits and dismissed them as
parties from the Reuter and Prentzler suits. Intervenors were permitted to
participate as amicus curiae and file briefs consistent with that status. The
trial court certified the judgment as final for purposes of appeal.
Intervenors appealed, asserting the trial court erred in denying their
motions to intervene as a matter of right because they were entitled to
intervene pursuant to Rule <a href="http://www.blogger.com/null" name="SLCSM:7352.159-1"></a>52.12 (a). The court of
appeals affirmed the trial court's judgment, finding Intervenors failed to
establish, as mere supporters and signatories of an initiative petition, that
they had a sufficient interest in the underlying section <a href="http://www.blogger.com/null" name="SLCSM:7352.160-1"></a>116.190 actions. Prentzler v. Carnahan, <a href="http://www.blogger.com/null" name="SLCSM:7352.161-1"></a>366 S.W.3d 557, 561 (Mo. App. 2012) . The court of
appeals explained, “Given that the limited purpose of ballot initiative
challenges is to ensure the fairness and sufficiency of ballot titles and fiscal
notes, [Intervenors] proposed interests in having their signatures count and
qualifying the initiative for the ballot are not at issue in the underlying
litigation.” <i>Id.</i> at 562. Therefore, Intervenors had no direct or
immediate interest in the underlying matter of the litigation and could not
demonstrate how the outcome of the cases would cause them to incur any legal
liability or directly affect their legal rights as supporters of the initiative.
<i>Id.</i> at 564. Further, the court of appeals found Intervenors were not
assured the right to have their signatures counted, outlining several scenarios
wherein Intervenors' signatures could be invalidated or disregarded. Because
Intervenors had no control over whether their signatures would be counted for
purposes of qualifying the initiative petition, their claimed interest was
deemed too remote or attenuated for purposes of intervention as a matter of
right. <i>Id.</i> at 562-63. The court also dismissed Intervenors' argument that
the secretary of state and the auditor could not represent their interests
adequately, finding the argument inconsequential because of their failure to
establish they had a sufficient interest in the litigation. <i>Id.</i> at 564.
Intervenors did not seeking rehearing or transfer of the court of appeals'
decision regarding their claim to intervene as a matter of right. Instead,
Intervenors continued to participate in all four lawsuits as amicus curiae,
offering both oral argument and briefing on all of the factual and legal issues.
After the circuit court issued its final judgment, Intervenors appealed to this
Court, arguing their entitlement to permissive intervention.
In their sole point on appeal, Intervenors argue the circuit court erred in
overruling their motions for permissive intervention because the uncontroverted
facts demonstrate they met the requirements for permissive intervention.
Specifically, they aver that they have unique interests that are not shared by
the secretary of state or the auditor and that they have no alternative means of
defending the initiative petition other than through intervention.
This Court's judgment renders Intervenors' argument moot because they have
received the relief they ultimately sought by way of their motions to intervene;
that is, to support the payday loan initiative and ensure it is placed on the
November 2012 ballot.
<h4>
IV. Conclusion </h4>
<h4>
A. The Tobacco Tax Initiative </h4>
In the tobacco tax initiative case, the trial court properly concluded that
the auditor's statutory duties under section <a href="http://www.blogger.com/null" name="SLCSM:7352.162-1"></a>116.175 do not render that statute unconstitutional
under <a href="http://www.blogger.com/null" name="SLCSM:7352.163-1"></a>Mo. Const. art. IV, sec. 13. It also
correctly upheld the fairness and sufficiency of the secretary of state's
summary statement and the auditor's fiscal note and fiscal note summary for the
proposed tobacco tax initiative. The trial court additionally did not err in
rejecting the plaintiff's assertions of <i>res judicata</i> as to the
constitutional issue. The trial court's judgment in the tobacco tax initiative
case is affirmed.
<h4>
B. The Minimum Wage Initiative </h4>
In the minimum wage initiative case, the trial court erred in finding that
section <a href="http://www.blogger.com/null" name="SLCSM:7352.164-1"></a>116.175 is unconstitutional, and its
decision is reversed as to that issue. The trial court, however, did not err in
upholding the fairness and sufficiency of the secretary of state's summary
statement or the auditor's fiscal note and fiscal note summary for the proposed
minimum wage initiative. The trial court's judgment entered in the minimum wage
initiative case is affirmed in part and reversed in part.
<h4>
C. The Payday Loan Initiative </h4>
In the payday loan initiative cases, the trial court erred in finding the
secretary of state's initiative summary statement unfair and insufficient. It
also erred in finding the auditor's fiscal note and fiscal note summary unfair
and insufficient. The trial court's judgment is reversed as to these issues.
This Court affirms, however, the trial court's judgment as to its other
challenged holdings regarding certain constitutional arguments that were raised
by the plaintiffs in the payday loan initiative cases. The intervention
challenge raised in this case is moot. The trial court's judgment in the payday
loan initiative cases is affirmed in part and reversed in part.
Teitelman, C.J., Russell, Breckenridge, Stith, Price, and Draper, JJ.,
concur; Fischer, J., concurs in result and concurs in separate opinion filed.
<h3>
Concurring Opinion </h3>
Zel M. Fischer, Judge
<h3>
CONCURRING OPINION </h3>
I concur with the principal opinion and would allow the ballot initiatives to
be placed on the ballot. In my view, the secretary of state's summary and the
auditor's fiscal note and fiscal note summaries are fair and sufficient as these
terms have been defined by prior case decisions. “Fair” and “sufficient” have
been defined in a manner that gives discretion to these elected officials, and
elections have consequences.
“When courts are called upon to intervene in the initiative process, they
must act with restraint, trepidation, and a healthy suspicion of the partisan
who would use the judiciary to prevent the initiative process from taking its
course.” Missourians to Protect the Initiative Process v. Blunt, <a href="http://www.blogger.com/null" name="SLCSM:7352.165-1"></a>799 S.W.2d 824, 827 (Mo. banc 1990) . “Judicial
intervention is not an appropriate substitute for the give and take of the
political process.” State ex rel. Humane Soc'y of Mo. v. Beetem, <a href="http://www.blogger.com/null" name="SLCSM:7352.166-1"></a>317 S.W.3d 669, 674 (Mo. App. 2010) .
I agree with the auditor that the fiscal impact of proposed statutory and
constitutional provisions is an important consideration for voters in deciding
to vote for or against a proposed measure. However, in my view, section <a href="http://www.blogger.com/null" name="SLCSM:7352.167-1"></a>116.175<sup><span style="font-size: x-small;"><strong> </strong></span><a href="http://www.blogger.com/null" name="SRC 1"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 1"><strong><span style="color: #145da4; font-size: xx-small;">1</span></strong></a></a></sup> is an unconstitutional expansion of the auditor's
duties in contravention of the express limitations placed on the auditor by <a href="http://www.blogger.com/null" name="SLCSM:7352.169-1"></a>article IV, section 13, of the Missouri Constitution.
This view is based on the plain language of <a href="http://www.blogger.com/null" name="SLCSM:7352.170-1"></a>article
IV, section 13, and the historical context in which it was adopted.
Additionally, fiscal note summaries are not required or, for that matter, even
implied by <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mo49_caiii&permaId=iSLCODAM%3A97436.1&tagName=SEC&endParm=y"><span style="color: #145da4;"><strong>article
III, sections 49</strong></span></a><sup><span style="font-size: x-small;"><strong> </strong></span><a href="http://www.blogger.com/null" name="SRC 2"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 2"><strong><span style="color: #145da4; font-size: xx-small;">2</span></strong></a></a></sup> and
50<sup><span style="font-size: x-small;"><strong> </strong></span><a href="http://www.blogger.com/null" name="SRC 3"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 3"><strong><span style="color: #145da4; font-size: xx-small;">3</span></strong></a></a></sup> of the Missouri
Constitution. Therefore, I would not include the auditor's fiscal note summaries
on the ballot titles with the proposed initiatives.
<h3>
Standard of Review </h3>
This Court reviews the constitutional validity of a statute <i>de novo.</i>
Gurley v. Mo. Bd. of Private Investigator Exam'rs, <a href="http://www.blogger.com/null" name="SLCSM:7352.174-1"></a>361 S.W.3d 406, 411 (Mo. banc 2012) . “A statute is
presumed valid and will not be held unconstitutional unless it clearly
contravenes a constitutional provision.” In re Brasch, <a href="http://www.blogger.com/null" name="SLCSM:7352.175-1"></a>332 S.W.3d 115, 119 (Mo. banc 2011) . “The person
challenging the statute's validity bears the burden of proving the act clearly
and undoubtedly violates the constitution.” Kansas City Premier Apartments, Inc.
v. Mo. Real Estate Comm'n, <a href="http://www.blogger.com/null" name="SLCSM:7352.176-1"></a>344 S.W.3d 160, 167 (Mo.
banc 2011) (quoting Brasch, <a href="http://www.blogger.com/null" name="SLCSM:7352.177-1"></a>332 S.W.3d at 119 ).
“But, if all or part of a statute does conflict with a constitutional provision
or provisions, this Court must hold the conflicting portions invalid.” Farmer v.
Kinder, <a href="http://www.blogger.com/null" name="SLCSM:7352.178-1"></a>89 S.W.3d 447, 452 (Mo. banc 2002) .
“While a court will read a constitutional provision broadly, it cannot
ascribe to it a meaning that is contrary to that clearly intended by the
drafters.” <i>Id.</i> “Rather, a court must undertake to ascribe to the words of
a constitutional provision the meaning that the people understood them to have
when the provision was adopted.” <i>Id.</i> “The meaning conveyed to the voters
is presumptively the ordinary and usual meaning given the words of the
provision.” <i>Id.</i> “Of particular importance is the principle that in
determining [the] meaning of a constitutional provision due regard will be given
to [its] primary objects and all related provisions should be construed as a
whole and where necessary to bring conflicts, if any, into harmony.” State, at
Info. of Martin v. City of Independence, <a href="http://www.blogger.com/null" name="SLCSM:7352.179-1"></a>518 S.W.2d
63, 66 (Mo. 1974) . “A court may not add words by implication when the plain
language is clear and unambiguous.” Wright-Jones v. Nasheed, _______ S.W.3d
_______ , 2012 WL 2384429 at *3 (Mo. banc June 19, 2012) .
<h3>
Analysis </h3>
<a href="http://www.blogger.com/null" name="SLCSM:7352.180-1"></a>Article IV, section 13, of the Missouri
Constitution provides:
<blockquote>
The state auditor shall have the same qualifications as the
governor. He [or she] shall establish appropriate systems of accounting for all
public officials of the state, post-audit the accounts of all state agencies and
audit the treasury at least once annually. He [or she] shall make all other
audits and investigations required by law, and shall make an annual report to
the governor and general assembly. He [or she] shall establish appropriate
systems of accounting for the political subdivisions of the state, supervise
their budgeting systems, and audit their accounts as provided by law.
<em><strong>No duty shall be imposed on him [or her] by law which is not related
to the supervising and auditing of the receipt and expenditure of public
funds.</strong></em><strong></strong></blockquote>
(Emphasis added). This limiting provision reaffirms that the people, in
adopting the 1945 Constitution, placed express limitations of authority on
certain statewide elected officials, including the auditor, because, under the
1875 Constitution, the legislature had expanded government by giving elected
officials new functions and duties to build up their power by patronage. This
Court has previously addressed the purpose of these limiting provisions included
in the 1945 Missouri Constitution.
<blockquote>
Just as <a href="http://www.blogger.com/null" name="SLCSM:7352.181-1"></a>article IV, section 15 sets
limits on the power of the treasurer, so <a href="http://www.blogger.com/null" name="SLCSM:7352.182-1"></a>article
IV, section 13 provides: “[N]o duty shall be imposed on [the state auditor] by
law which is not related to the supervising and auditing of the receipt and
expenditure of public funds.” <a href="http://www.blogger.com/null" name="SLCSM:7352.183-1"></a>Article IV, section
14 similarly provides “no duty shall be imposed on [the secretary of state] by
law which is not related to his duties as prescribed in this constitution.”
There were no similar limitations in the 1875 Constitution, and this Court has
previously recognized that it was to correct this situation that these limiting
provisions were added to the 1945 constitution, for:</blockquote>
the background
of the 1945 provision lies in the prior history of a building up of the power
and patronage of elected officials by giving to them new functions and duties.
One purpose of the new constitution was to limit and define the scope and duties
of all executive officials (see § 12, Art. 4,) agencies, and departments,
including elected officials.
<br />
<blockquote>
Petition of Board of Public Buildings, <a href="http://www.blogger.com/null" name="SLCSM:7352.184-1"></a>363 S.W.2d 598, 608 (Mo. banc 1962) .</blockquote>
<blockquote>
Indeed, the 1944 debates over the 1945 constitution themselves show
that the delegates to the constitutional convention drafted it with an eye
towards their concern that power had been too widely distributed among a variety
of elected officials under the 1875 constitution and that a focusing of more
executive power in the office of the governor and his or her appointees might
lead to more effective government. One way the 1945 constitution sought to
accomplish this goal was by precluding the expansion of the state treasurer's
role beyond that of custodian of state funds and by similarly limiting the power
of the state auditor and secretary of state. <i>See</i> Debates, Missouri
Constitutional Convention 1945, vol. 13, 4127—4135; vol. 14,
4171—4173.</blockquote>
Farmer v. Kinder, <a href="http://www.blogger.com/null" name="SLCSM:7352.185-1"></a>89 S.W.3d 447, 453-54 (Mo.
banc 2002) .
As the principal opinion correctly points out, the auditor's authority to
prepare fiscal notes and fiscal note summaries for “proposed measures” was
enacted by the legislature after this Court's decision in Thompson v. Comm. on
Legislative Research, <a href="http://www.blogger.com/null" name="SLCSM:7352.186-1"></a>932 S.W.2d 392, 395 (Mo. banc
1996) , held that “ <a href="http://www.blogger.com/null" name="SLCSM:7352.187-1"></a>section 116.170.2, RSMo 1994
violated the constitution” because “the legislature had no power to adopt a
statute” that “increased the duties of the committee beyond those expressly
authorized by” the Missouri Constitution. Slip op. at 11-12. In my view, the
same analysis would apply to the auditor, and the legislature had no power to
enact a statute that increased the duties of the auditor beyond those expressly
authorized by the Missouri Constitution.
The principal opinion seeks to define the auditor's process in preparing the
fiscal note and fiscal note summary as an “investigation” under <a href="http://www.blogger.com/null" name="SLCSM:7352.188-1"></a>article IV, section 13, and that “[t]here is a
relationship between the auditor's preparation of the fiscal notes and fiscal
note summaries and the 'supervising ...of the receipt and expenditure of public
funds.'” Slip. op. at 16-20. I disagree with this expansive interpretation
because the solicitation and recitation of potential costs and benefits of
petition initiatives that are merely hypothetical in nature at the time they are
submitted to the auditor for the preparation of fiscal notes and fiscal note
summaries do not “relate” to “supervis[ion] ...of the <i>receipt and
expenditure</i> of public funds.”
To “supervise” means “to look over in order to read ...to coordinate, direct,
and inspect continuously and at first hand the accomplishment of: oversee with
the powers of direction and decision the implementation of one's own or
another's intentions[.]” Webster's Third New Int'l Dictionary Unabridged 2296
(1976). “Receive” means “to take possession or delivery of ...to take in: act as
a receptacle or container for ....” <i>Id.</i> at 1894. “Receipt” means “the act
or process of receiving ....” <i>Id.</i> “Expend” means “to pay out or
distribute ...to consume by use: use up ....” <i>Id.</i> at 799. “Expenditure”
means “the act or process of expending ....” <i>Id.</i> at 800. The statutory
requirement directing the auditor's office to solicit information to provide a
fiscal note and fiscal note summary pursuant to <a href="http://www.blogger.com/null" name="SLCSM:7352.189-1"></a>§
116.175, RSMo Supp. 2011, does not relate to the “act or process,” “with powers
of direction and decision,” either the auditor's taking “possession or delivery
of” or “pay[ing] out or distribut[ing]” public funds.
In the case of <i>Brown v. Carnahan, et al.,</i> the circuit court below
reasoned:
<blockquote>
It is undisputed that the preparation of the fiscal note and fiscal
note summary involves estimating costs and savings for a proposed measure, not a
review of monies received and spent. Estimating by its very nature is
forecasting what might happen, not what has happened. The plain language of the
constitution contemplates that whatever duty the state auditor is given, it must
be related to the receipt and expenditure of public funds. Estimated costs or
savings have neither been expended nor realized. One can neither supervise nor
audit funds which have not been received or expended because at that point,
there is nothing to look at. The State Auditor argues that being “related to”
infers some sort of logical connection between the preparation of the fiscal
note and the supervising and auditing of the receipt and expenditure of public
funds.</blockquote>
<blockquote>
This Court declines to find such logical connection simply because
the discussion relates to public funds. The delegation to the State Auditor of
the duty to prepare a fiscal note and summary provided by <a href="http://www.blogger.com/null" name="SLCSM:7352.190-1"></a>§ 116.175, RSMo, violates the limitations of <a href="http://www.blogger.com/null" name="SLCSM:7352.191-1"></a>Article IV, § 13 of the Missouri Constitution and
those provisions are found to be unconstitutional.</blockquote>
The mere fact that the auditor's preparation of a fiscal note and fiscal note
summary is tangentially related to “public funds” does not escape the limiting
provision of <a href="http://www.blogger.com/null" name="SLCSM:7352.192-1"></a>article IV, section 13, requiring that
such a duty be “related to the supervising ...of the receipt and expenditure of
public funds.” While the principal opinion rationalizes that the auditor's power
to conduct investigations as required by law is silent with respect to time
restrictions, the plain and ordinary meaning of the words of the limiting
provision in <a href="http://www.blogger.com/null" name="SLCSM:7352.193-1"></a>article IV, section 13, indicate a
requirement that the auditor's duties relate to the “act or process of”
receiving or expending public funds. Such an “act or process” is expressly a
concurrent one. The preparation of a fiscal note and fiscal note summary, for
inclusion in a ballot initiative petition, does not relate to the “act or
process” of receiving or expending public funds. The limiting provisions were
added in 1945 specifically to the offices of the treasurer, the auditor, and the
secretary of state to eliminate precisely this kind of additional legislative
directive from the General Assembly to an office of the executive branch.
Farmer, <a href="http://www.blogger.com/null" name="SLCSM:7352.194-1"></a>89 S.W.3d at 454 . “The language of this
clause is susceptible to a clear and unambiguous interpretation based only on
the plain and ordinary meaning of the words.” Wright-Jones, 2012 WL 2384429 at
*3 . “A court may not add words by implication when the plain language is clear
and unambiguous.” <i>Id.</i>
The initiative referendum is a powerful tool of direct democracy. “In fact,
the initiative allows the public to bypass their elected representatives and
reserves direct lawmaking power with the voters of the state.”<sup><span style="font-size: x-small;"><strong> </strong></span><a href="http://www.blogger.com/null" name="SRC 4"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 4"><strong><span style="color: #145da4; font-size: xx-small;">4</span></strong></a></a></sup> “The initiative is a tool for everyday,
ordinary citizens to 'override legislatures held in [the] thrall of wealthy
patrons.”<sup><span style="font-size: x-small;"><strong> </strong></span><a href="http://www.blogger.com/null" name="SRC 5"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 5"><strong><span style="color: #145da4; font-size: xx-small;">5</span></strong></a></a></sup> Initiative and
referendum make it possible for the people, by direct vote, to repeal “bad laws”
or enact beneficial measures that their representatives refuse to consider.
<sup><a href="http://www.blogger.com/null" name="SRC 6"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#FN 6"><strong><span style="color: #145da4; font-size: xx-small;">6</span></strong></a></a></sup>
Nothing in <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mo49_caiii&permaId=iSLCODAM%3A97436.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">article
III, sections 49</span></strong></a> and 50, requires the inclusion of a fiscal note or fiscal
note summary in an initiative petition proposing laws or amendments to the
constitution. Furthermore, the initiative process is a form of direct democracy
that presumes the supporters for or against the ballot measure, who will
rigorously campaign to support or defeat it, are left with the responsibility to
advise the voters of its potential fiscal impact.
<h3>
Conclusion </h3>
Because I would find that § <a href="http://www.blogger.com/null" name="SLCSM:7352.196-1"></a>116.175 imposes
duties on the state auditor that are not related to “supervising ...the receipt
and expenditure of public funds,” in contravention of <a href="http://www.blogger.com/null" name="SLCSM:7352.197-1"></a>article IV, section 13, I would not include the
auditor's fiscal note summaries in the official ballot titles for the proposed
initiatives at issue in this case. However, I would allow the initiative
petitions to be placed on the ballot without fiscal note summaries. In all other
respects, I concur with the principal opinion.
<blockquote>
<blockquote>
_______ </blockquote>
</blockquote>
<blockquote>
<blockquote>
Zel M. Fischer, Judge</blockquote>
</blockquote>
<br /><sup><a href="http://www.blogger.com/null" name="FN 1"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 1"><strong><span style="color: #145da4; font-size: xx-small;">1</span></strong></a></a></sup>
<br />
<br />
The tobacco tax initiative, which is challenged in the Brown appeal,
proposes additional taxes on cigarettes, roll-your-own tobacco, and other
tobacco products to create proceeds for a health and education trust fund.
<br />
<br />
The proposed minimum wage initiative, which is challenged in the Allred
appeal, seeks to increase the state's minimum wage to $8.25 per hour and the
minimum wage for tipped-employees to 60 percent of the minimum wage. The
initiative also proposes that, if the federal minimum wage is increased above
the state minimum wage, then the higher federal minimum wage rate will be in
effect under the law.
<br />
<br />
The proposed payday loan initiative seeks to limit the interest rate
charged on payday, title, installment, and other high-cost consumer credit and
small loans. The initiative would enact an interest rate cap of 36 percent per
year for such loans. The Northcott, Francis, Prenzler, and Reuter cases each
separately challenge the proposed payday loan initiative. <br /><sup><a href="http://www.blogger.com/null" name="FN 2"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 2"><strong><span style="color: #145da4; font-size: xx-small;">2</span></strong></a></a></sup>
<br />
<br />
All references to section <a href="http://www.blogger.com/null" name="SLCSM:7352.3-1"></a>116.175 are to
RSMo Supp. 2011. All other statutory references are to RSMo 2000, unless
otherwise indicated. <br /><sup><a href="http://www.blogger.com/null" name="FN 3"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 3"><strong><span style="color: #145da4; font-size: xx-small;">3</span></strong></a></a></sup>
<br />
<br />
Jurisdiction over these appeals is vested in this Court pursuant to <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mo10_cav&permaId=iSLCODAM%3A97460.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">Mo.
Const. art. V, sec. 10</span></strong></a>, as this Court ordered transfer of the appeals when
they were pending in the court of appeals. Further, <a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mo3_cav&permaId=iSLCODAM%3A97458.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">Mo.
Const. art. V, sec. 3</span></strong></a>, provides this Court exclusive jurisdiction over the
challenges presented in these appeals to the constitutional validity of section
<a href="http://www.blogger.com/null" name="SLCSM:7352.6-1"></a>116.175. <br /><sup><a href="http://www.blogger.com/null" name="FN 4"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 4"><strong><span style="color: #145da4; font-size: xx-small;">4</span></strong></a></a></sup>
<br />
<br />
These appeals do not address whether the challenged initiatives have
the requisite signatures for placement on the ballot. The secretary of state is
tasked with making that determination. <br /><sup><a href="http://www.blogger.com/null" name="FN 5"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 5"><strong><span style="color: #145da4; font-size: xx-small;">5</span></strong></a></a></sup>
<br />
<br />
The auditor's protocol for preparing fiscal notes and fiscal note
summaries is discussed in detail below. The auditor's fiscal note and fiscal
note summary are reviewed by the attorney general pursuant to section <a href="http://www.blogger.com/null" name="SLCSM:7352.19-1"></a>116.175.4. <br /><sup><a href="http://www.blogger.com/null" name="FN 6"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 6"><strong><span style="color: #145da4; font-size: xx-small;">6</span></strong></a></a></sup>
<br />
<br />
Further, since 2003, <a href="http://www.blogger.com/null" name="SLCSM:7352.26-1"></a>section 116.025, RSMo
Supp. 2011, has provided that, when statewide ballot measures are submitted to
the secretary of state, the secretary of state prepares and transmits to the
attorney general “fair ballot language statements” for the proposed measure. The
section <a href="http://www.blogger.com/null" name="SLCSM:7352.27-1"></a>116.025 statement, which is posted in
polling places next to the sample ballot, must “fairly and accurately explain
what a vote for and what a vote against the measure represent” and must include
“whether the measure will increase, decrease, or have no impact on taxes.” The
attorney general is tasked with approving the section <a href="http://www.blogger.com/null" name="SLCSM:7352.28-1"></a>116.205 statement prepared by the secretary of state,
and the statements can be challenged in accordance with <a href="http://www.blogger.com/null" name="SLCSM:7352.29-1"></a>section 116.190, RSMo Supp. 2011. <br /><sup><a href="http://www.blogger.com/null" name="FN 7"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 7"><strong><span style="color: #145da4; font-size: xx-small;">7</span></strong></a></a></sup>
<br />
<br />
All references to section <a href="http://www.blogger.com/null" name="SLCSM:7352.31-1"></a>116.190 are to
RSMo Supp. 2011. <br /><sup><a href="http://www.blogger.com/null" name="FN 8"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 8"><strong><span style="color: #145da4; font-size: xx-small;">8</span></strong></a></a></sup>
<br />
<br />
The Brown suit sought a declaratory judgment that section <a href="http://www.blogger.com/null" name="SLCSM:7352.37-1"></a>116.175 is unconstitutional because it provides the
auditor greater authority than is authorized by <a href="http://www.blogger.com/null" name="SLCSM:7352.38-1"></a>Mo.
Const. art. IV, sec. 13. The trial court found in <i>Brown</i> that the
auditor's duty to prepare fiscal notes under section <a href="http://www.blogger.com/null" name="SLCSM:7352.39-1"></a>116.175 is consistent with the auditor's authority
provided by <a href="http://www.blogger.com/null" name="SLCSM:7352.40-1"></a>Mo. Const. art. IV, sec. 13. It opined
that the auditor is the “proper elected official to perform the responsibility
of advising the people of Missouri on the expected fiscal impact” of the
proposed tobacco tax initiative. It noted that the proposed tobacco tax
initiative directly would impact state revenues. It also determined that the
proposed initiative's fund disbursement directives are related to the auditor's
task of “supervising the receipt and expenditure of public funds.”
<br />
<br />
The Allred case also alleged that section <a href="http://www.blogger.com/null" name="SLCSM:7352.41-1"></a>116.175 was unconstitutional because it granted the
state auditor authority beyond that provided by <a href="http://www.blogger.com/null" name="SLCSM:7352.42-1"></a>Mo.
Const. art. IV, sec. 13. The trial court's judgment in Allred declared that
section <a href="http://www.blogger.com/null" name="SLCSM:7352.43-1"></a>116.175 violates <a href="http://www.blogger.com/null" name="SLCSM:7352.44-1"></a>Mo. Const. art. IV, sec. 13 because the statute expands
the auditor's tasks beyond the constitutional limitations established for the
auditor's duties. The trial court held that estimating the fiscal impact of a
proposed initiative was “forecasting what might happen” and did not “relate to”
<a href="http://www.blogger.com/null" name="SLCSM:7352.45-1"></a>Mo. Const. art. IV, sec. 13's limitation that the
auditor's duties pertain to the “supervising and auditing of the receipt and
expenditure of public funds.” The trial court also found that the auditor's
fiscal note and fiscal note summary preparations were not a “true
'investigation'” because the auditor pasted voluntary responses without making
follow-up inquiries regarding the submissions used in the fiscal note. The trial
court vacated the fiscal note and fiscal note summary for the minimum wage
initiative. The judgment indicated that the fiscal note summary should be
removed from the official ballot title for the minimum wage initiative.
<br />
<br />
The Northcott and Francis suits challenging the proposed payday loan
initiative also raised claims challenging the constitutional validity of section
<a href="http://www.blogger.com/null" name="SLCSM:7352.46-1"></a>116.175, arguing that the auditor has no
constitutional authority to engage in the fiscal note duties directed by the
statute. The trial court declined to declare section <a href="http://www.blogger.com/null" name="SLCSM:7352.47-1"></a>116.175 unconstitutional as was urged by the opponents
to the proposed initiative. <br /><sup><a href="http://www.blogger.com/null" name="FN 9"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 9"><strong><span style="color: #145da4; font-size: xx-small;">9</span></strong></a></a></sup>
<br />
<br />
Although section <a href="http://www.blogger.com/null" name="SLCSM:7352.73-1"></a>116.175 imposes a 10-day
deadline for submissions, the current auditor's practice is to consider
information received beyond the deadline if there is time available to analyze
the submission, as he believes that more information yields a better fiscal note
and fiscal note summary. <br /><sup><a href="http://www.blogger.com/null" name="FN 10"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 10"><strong><span style="color: #145da4; font-size: xx-small;">10</span></strong></a></a></sup>
<br />
<br />
The current auditor's practice is to draft the fiscal note summary to
“summarize” points he thinks “are important for the public.” <br /><sup><a href="http://www.blogger.com/null" name="FN 11"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 11"><strong><span style="color: #145da4; font-size: xx-small;">11</span></strong></a></a></sup>
<br />
<br />
Although the underlying judgment in this case applies collectively to
six nearly identical tobacco tax initiatives, this Court has been informed that
only one of the versions of the proposed initiatives actually was returned to
the secretary of state with signatures. Accordingly, the six petitions are
referenced collectively as a singular initiative.
<br />
<br />
Missourians for Health and Education, the group that filed the proposed
initiative, and two of its directors, moved to intervene in the litigation.
Intervention was granted over Brown's objections. <br /><sup><a href="http://www.blogger.com/null" name="FN 12"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 12"><strong><span style="color: #145da4; font-size: xx-small;">12</span></strong></a></a></sup>
<br />
<br />
The auditor's staff member who prepared the fiscal notes and fiscal
note summaries for the proposed tobacco tax initiatives testified at trial about
the protocols applied in preparing the fiscal note and fiscal note summary for
the proposed tobacco tax initiative. He explained that fiscal impact inquiries
were made with 24 state agencies and 17 local government and public agencies,
and 26 fiscal impact submissions were returned. The submissions were reviewed
for reasonableness and completeness, and none was found to be unreasonable. The
fiscal note for the proposed tobacco tax initiative was prepared by largely
using the fiscal impact submissions “verbatim.”
<br />
<br />
Testimony at trial explained that the auditor's position is that there is
no need for the auditor's office to perform an independent analysis or “second
guess” agency fiscal impact submissions when preparing fiscal notes and fiscal
note summaries. In the tobacco initiative case, however, the auditor's staffer
admitted that he had consulted a Wikipedia page about the tobacco settlement
when he was preparing the fiscal note for the proposed tobacco tax initiative.
<br /><sup><a href="http://www.blogger.com/null" name="FN 13"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 13"><strong><span style="color: #145da4; font-size: xx-small;">13</span></strong></a></a></sup>
<br />
<br />
This motion and the auditor's responsive motion alleging Brown's
supplemental suggestions were untimely were not included in the legal file filed
with this Court. <br /><sup><a href="http://www.blogger.com/null" name="FN 14"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 14"><strong><span style="color: #145da4; font-size: xx-small;">14</span></strong></a></a></sup>
<br />
<br />
Missouri Jobs with Justice, a group seeking changes in Missouri's
required minimum wage rate, filed two proposed minimum wage initiatives with the
secretary of state, though it later withdrew its second proposed minimum wage
initiative. Because only one version of the initiative is on file, this opinion
references a singular minimum wage initiative. Missouri Jobs with Justice was
granted intervention in <i>Allred</i> following an interlocutory appeal.
<br /><sup><a href="http://www.blogger.com/null" name="FN 15"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 15"><strong><span style="color: #145da4; font-size: xx-small;">15</span></strong></a></a></sup>
<br />
<br />
The trial court vacated the fiscal note summaries prepared for the
minimum wage initiatives and indicated they should be removed from the official
ballot title. <br /><sup><a href="http://www.blogger.com/null" name="FN 16"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 16"><strong><span style="color: #145da4; font-size: xx-small;">16</span></strong></a></a></sup>
<br />
<br />
The appeal in <i>Allred</i> was filed by the auditor to challenge the
judgment finding section <a href="http://www.blogger.com/null" name="SLCSM:7352.141-1"></a>116.175 unconstitutional.
<br /><sup><a href="http://www.blogger.com/null" name="FN 17"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 17"><strong><span style="color: #145da4; font-size: xx-small;">17</span></strong></a></a></sup>
<br />
<br />
When creating the fiscal note and fiscal note summary for the minimum
wage initiative, the auditor received fiscal impact assessments from 21 state
government entities and seven local government entities. A fiscal impact report
also was filed on behalf of the initiative proponent (Missouri Jobs with
Justice), but no opponent of the proposed initiative made a fiscal impact
submission to the auditor.
<br />
<br />
The fiscal impact submissions of governmental entities were reviewed for
completeness and reasonableness, as were the numbers and calculations submitted
in the Missouri Jobs with Justice fiscal impact submission. Consistent with the
auditor's office normal procedures, the fiscal note for the minimum wage
initiative was prepared using the submissions essentially “verbatim.”
<br /><sup><a href="http://www.blogger.com/null" name="FN 18"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 18"><strong><span style="color: #145da4; font-size: xx-small;">18</span></strong></a></a></sup>
<br />
<br />
At trial, the court heard testimony regarding the auditor's process for
preparing the fiscal note and fiscal note summary for the proposed minimum wage
initiative. Two expert witnesses also testified. Allred presented the testimony
of a labor economist, Dr. David Macpherson, who is opposed to the minimum wage.
Dr. Macpherson suggested that the auditor's methods led to an inaccurate fiscal
impact assessment. Missouri Jobs with Justice presented the testimony of an
economics professor, Dr. Michael Kelsay, who opined that the contents of the
auditor's fiscal note submissions and the fiscal note's included assumptions
that were conservative and reasonable. <br /><sup><a href="http://www.blogger.com/null" name="FN 19"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 19"><strong><span style="color: #145da4; font-size: xx-small;">19</span></strong></a></a></sup>
<br />
<br />
The four lawsuits were tried in a single hearing on a single record.
Although they were not consolidated by the trial court or this Court, they are
addressed collectively in this opinion. <br /><sup><a href="http://www.blogger.com/null" name="FN 20"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 20"><strong><span style="color: #145da4; font-size: xx-small;">20</span></strong></a></a></sup>
<br />
<br />
The 36-percent rate cap reflects the rate limitation that is currently
in place for military families under 10 U.S.C. section 987. The initiative would
amend chapters 367 and 408, and its proposed new language for section <a href="http://www.blogger.com/null" name="SLCSM:7352.148-1"></a>408.100.1 provides in part:
<br />
<blockquote>
It is the intent of the people of Missouri to prevent lenders, such
as those who make what are commonly known as payday loans, car title loans, and
installment loans, which have typically carried triple-digit interest rates as
high as [300] percent annually or higher, from charging excessive fees and
interest rates that can lead families into a cycle of
debt.</blockquote>
<br /><sup><a href="http://www.blogger.com/null" name="FN 21"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 21"><strong><span style="color: #145da4; font-size: xx-small;">21</span></strong></a></a></sup>
<br />
<br />
In <i>Cures Without Cloning,</i> the court of appeals discussed the
authority a court has to rewrite a summary statement that it finds is
insufficient or unfair. <a href="http://www.blogger.com/null" name="SLCSM:7352.150-1"></a>259 S.W.3d at 82-83.
<br /><sup><a href="http://www.blogger.com/null" name="FN 22"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 22"><strong><span style="color: #145da4; font-size: xx-small;">22</span></strong></a></a></sup>
<br />
<br />
Included in the fiscal impact submissions returned to the auditor
during his preparation of the payday loan initiative fiscal note, the department
of insurance, financial institutions and professional registration reported that
it anticipated no costs or savings to that department associated with the
proposed initiative. The department of revenue also indicated it believed that
that the initiative would have no impact on that department.
<br />
<br />
When gathering information for preparing the fiscal note, the auditor
also received a proposed fiscal impact statement from an economics professor who
is an opponent of the proposed measure. The professor's opinion was that the
proposed initiative would cause payday and title loan lenders to go out of
business, resulting in a loss to state and local government revenues, increased
costs in unemployment insurance, and lost licensing-fee revenues.
<br />
<br />
Based on the information received, the auditor's office prepared a
14-page fiscal note, which included the information received regarding the
initiative “verbatim.” <br /><sup><a href="http://www.blogger.com/null" name="FN 23"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 23"><strong><span style="color: #145da4; font-size: xx-small;">23</span></strong></a></a></sup>
<br />
<br />
Although the department of insurance, financial institutions and
professional registration had not indicated a negative impact from the
initiative in its response to the auditor's inquiry, a contrary email message
from its division of finance was attached in the professor's fiscal impact
report. The division of finance email indicated that the proposed initiative
would put payday and title loan lenders out of business and would put about half
of “510 lenders” out of business. “510 lenders” are lenders who largely are
involved in financing consumer purchases. <br /><sup><a href="http://www.blogger.com/null" name="FN 24"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 24"><strong><span style="color: #145da4; font-size: xx-small;">24</span></strong></a></a></sup>
<br />
<br />
Pursuant to section <a href="http://www.blogger.com/null" name="SLCSM:7352.154-1"></a>116.190.4, the trial
court remanded the fiscal note and fiscal note summary to the state auditor for
preparation of a new fiscal note and fiscal note summary. Pending the appeals
addressed in this consolidated opinion, no new fiscal note or official ballot
title has yet been prepared for any of the initiatives at issue in these cases.
<br /><sup><a href="http://www.blogger.com/null" name="FN 1"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 1"><strong><span style="color: #145da4; font-size: xx-small;">1</span></strong></a></a></sup>
<br />
<br />
All references to § <a href="http://www.blogger.com/null" name="SLCSM:7352.168-1"></a>116.175 are to RSMo
Supp. 2011. <br /><sup><a href="http://www.blogger.com/null" name="FN 2"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 2"><strong><span style="color: #145da4; font-size: xx-small;">2</span></strong></a></a></sup>
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<br />
<a href="http://checkpoint.riag.com/app/find?begParm=y&app.version=9.7&dbName=SLCODAM&linkType=docloc&locId=mo49_caiii&permaId=iSLCODAM%3A97436.1&tagName=SEC&endParm=y"><strong><span style="color: #145da4;">Mo.
Const. art. III, sec. 49</span></strong></a>, provides:
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<blockquote>
The people reserve power to propose and enact or reject laws and
amendments to the constitution by the initiative, independent of the general
assembly, and also reserve power to approve or reject by referendum any act of
the general assembly, except as hereinafter provided.</blockquote>
<br /><sup><a href="http://www.blogger.com/null" name="FN 3"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 3"><strong><span style="color: #145da4; font-size: xx-small;">3</span></strong></a></a></sup>
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<a href="http://www.blogger.com/null" name="SLCSM:7352.173-1"></a>Mo. Const. art. III, sec. 50, provides:
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<blockquote>
Initiative petitions proposing amendments to the constitution shall
be signed by eight percent of the legal voters in each of two-thirds of the
congressional districts in the state, and petitions proposing laws shall be
signed by five percent of such voters. Every such petition shall be filed with
the secretary of state not less than six months before the election and shall
contain an enacting clause and the full text of the measure. Petitions for
constitutional amendments shall not contain more than one amended and revised
article of this constitution, or one new article which shall not contain more
than one subject and matters properly connected therewith, and the enacting
clause thereof shall be “Be it resolved by the people of the state of Missouri
that the Constitution be amended:”. Petitions for laws shall contain not more
than one subject which shall be expressed clearly in the title, and the enacting
clause thereof shall be “Be it enacted by the people of the state of
Missouri:”.</blockquote>
<br /><sup><a href="http://www.blogger.com/null" name="FN 4"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 4"><strong><span style="color: #145da4; font-size: xx-small;">4</span></strong></a></a></sup>
<br />
<br />
Heather A. Paraino, <i>Missouri's Silenced Citizen Legislators: How the
Initiative Denied to Citizens in Fourth-Class Missouri Municipalities,</i> 44
St. Louis U. L.J. 1081, 1083-84 (1997). <br /><sup><a href="http://www.blogger.com/null" name="FN 5"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 5"><strong><span style="color: #145da4; font-size: xx-small;">5</span></strong></a></a></sup>
<br />
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<i>Id.</i> at 1087. <br /><sup><a href="http://www.blogger.com/null" name="FN 6"><a href="file:///C:/Users/Peter/Downloads/RALPH_BROWN__Appellant__v__MISSOURI_SECRETARY_OF_STATE_ROBIN_CARNAHAN__Respondent__MISSOURI_STATE_AU.htm#SRC 6"><strong><span style="color: #145da4; font-size: xx-small;">6</span></strong></a></a></sup>
<br />
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David L. Callies, Nancy C. Neuffer, and Carlito P. Caliboso, <i>Ballot
Box Zoning: Initiative, Referendum and the Law,</i> 39 Wash. U. J. Urb. &
Contemp. L. 53, 58 (1991).Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-7896060186837634992012-08-10T06:25:00.000-04:002012-08-10T06:25:11.577-04:00Pickering HoodSTACEY PICKERING, IN HIS CAPACITY AS AUDITOR FOR THE STATE OF MISSISSIPPI v. JIM HOOD, ATTORNEY GENERAL, EX REL STATE OF MISSISSIPPI<br />
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Case Information: <br />
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Docket/Court: 2010-CA-00881-SCT, Supreme Court of Mississippi <br />
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Date Issued: 05/24/2012 DATE OF JUDGMENT: 04/28/2010<br />
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Tax Type(s): General Administrative Provisions, Corporate Income Tax <br />
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Case Information: COURT FROM WHICH APPEALED: HINDS COUNTY CHANCERY COURT NATURE OF THE CASE: CIVIL - OTHER <br />
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Disposition: DISPOSITION: ON DIRECT APPEAL: REVERSED AND REMANDED. ON CROSS-APPEAL: REVERSED AND REMANDED - 05/24/2012 <br />
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ATTORNEYS FOR APPELLANT: ARTHUR F. JERNIGAN, JR., SAMUEL E. L. ANDERSON <br />
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ATTORNEYS FOR APPELLEE: OFFICE OF THE ATTORNEY GENERAL, BY: HAROLD EDWARD PIZZETTA, III, GEOFFREY C. MORGAN, JUSTIN L. MATHENY, BRENT HAZZARD, JAMES T. SOUTHWICK, HARRY P. SUSMAN, DAVID A. BARRETT, <br />
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OPINION <br />
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TRIAL JUDGE: HON. DENISE OWENS <br />
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EN BANC. <br />
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DICKINSON, PRESIDING JUSTICE, FOR THE COURT: <br />
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A corporation settled a lawsuit by agreeing to pay the State of Mississippi $50 million, $10 million of which it disbursed directly to outside counsel retained by Attorney General Hood to pursue the litigation. The chancery court held that the payment was proper. But because the law requires that outside counsel retained by the Attorney General to pursue litigation in “the state or federal courts” be paid from his contingent fund or from other funds the Legislature appropriates to his office, 1 and because the Mississippi Constitution requires obligations and liabilities to the State to be paid “into the proper treasury,” 2 we reverse. <br />
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BACKGROUND FACTS AND PROCEEDINGS <br />
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To pursue claims against Microsoft for alleged violations of the Mississippi antitrust and consumer protection laws, Mississippi Attorney General Jim Hood signed a contingency-fee contract (“Retention Agreement”) with Hazzard Law, LLC, which, in turn, associated other law firms to assist with the litigation. Hazzard Law, LLC, and its associated counsel are referred to collectively herein as “Retained Counsel.” The chancery court dismissed the antitrust claims, but allowed the consumer-protection claims to proceed. <br />
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Microsoft and the Attorney General, acting on behalf of the State of Mississippi, signed a settlement agreement that required Microsoft to provide up to $60 million in vouchers for Mississippi residents, and to pay the State of Mississippi $50 million in cash. However, the settlement agreement provided that $10 million of the cash money was to be distributed to the trust account of one of the outside lawyers in Houston, Texas. <br />
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State Auditor Stacey Pickering wrote Hazzard, stating that payment of settlement funds directly to outside counsel violated Mississippi law. And because the same issue was pending in the Circuit Court of Hinds County in another case, 3 Auditor Pickering reserved all objections to the settlement until after the circuit court — and, if appealed, the Mississippi Supreme Court — resolved the issue. <br />
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Hazzard responded to the Auditor's letter by filing a petition in chancery court, seeking approval of the attorney-fee payment. Pickering filed — and the chancellor granted — a Motion to Intervene, based on Mississippi Code Section 7-7-211(g), which requires the State Auditor to investigate and recover any public funds improperly withheld, misappropriated, or illegally spent. The Auditor also filed a motion to have the $10 million held in trust disbursed to the State. <br />
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The chancellor ruled in favor of Hazzard and ordered the settlement funds distributed directly to Hazzard and other retained counsel. Pickering appealed to this Court, and the Attorney General cross-appealed, claiming the Auditor's intervention was untimely. <br />
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ANALYSIS <br />
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Because the issues in this case so closely mirror those in Pickering v. Langston, a case we also hand down today, much of our analysis will be the same. And as we did in that case, we wish to make clear in this case that our opinion should not be read as calling into question either Retained Counsel's right to be paid or the validity of the Retention Agreement. Indeed, the Auditor has made no such challenge, nor has he argued that the Attorney General was prohibited, either from depositing the funds into his contingent fund and paying Retained Counsel, or from paying the attorney fees from funds appropriated to his office by the Legislature. We address today only the narrow question of whether Mississippi law allows public-settlement funds due to the State of Mississippi to be paid directly to outside counsel. <br />
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Section 7-5-7 requires the Attorney General to pay private attorneys he retains from his contingent fund or from other funds appropriated to his office by the Legislature.<br />
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By enacting Section 7-5-7, the Legislature limited to two, the sources from which the Attorney General may pay private attorneys he engages to pursue litigation on behalf of the State of Mississippi, in Mississippi courts: <br />
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The compensation of appointees and employees made hereunder shall be paid out of the attorney general's contingent fund, or out of any other funds appropriated to the attorney general's office. 4<br />
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The statute's mandatory term “shall” is not a suggestion — it is a mandate. 5 No one asserts that the $10 million came from “other funds appropriated to the attorney general's office.” And we hold that the Attorney General's contingent fund does not include Microsoft's checking account (the source of the $10 million), nor does it include the private attorney's trust account to which Microsoft transferred the funds. <br />
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Section 7-5-7's restrictions were in place when the Attorney General and outside counsel signed the contract. They cannot now claim they are not subject to it. <br />
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The Attorney General advances several arguments in support of Microsoft's direct payment of the $10 million to the private attorney's bank account. We will address each of them. <br />
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A. The Mississippi Consumer Protection Act <br />
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The Attorney General argues that Microsoft's direct payment of contingency fees and expenses was authorized by Section 75-24-19(1)(b) of the Mississippi Consumer Protection Act (“MCPA”), which allows the Attorney General to recover “investigative costs and a reasonable attorney's fee.” 6 But the statute says nothing about the method of payment, and the provisions of that statute come into play only “if the court finds from clear and convincing evidence, that a person knowingly and willfully used any unfair or deceptive trade practice, method or act prohibited by Section 75-24-5.” 7 <br />
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This case was settled with no trial and no such finding. In fact, in her order approving the settlement and final judgment, the chancellor dismissed the case “on the merits, with prejudice in favor of Microsoft.” (Emphasis added.) And the settlement agreement, itself, provided: <br />
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No Admission. By entering into this Settlement Agreement, Microsoft does not admit any liability or wrongdoing or the truth of any of the claims or allegations in the Mississippi Action.... Plaintiff agrees not to represent, publicly or otherwise, that the settlement in any way embodies, reflects, implies or can be used to infer any culpability by Microsoft ....<br />
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(Emphasis added.) <br />
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And even if the MCPA did allow an award of attorney fees in this case, none was awarded. The settlement agreement specifically provided for Microsoft to pay $50 million to the State of Mississippi (although $10 million of that amount was to be distributed to a Texas law firm); and it further provided that “Microsoft played no part in negotiating the fees and expenses to be paid to plaintiff's counsel ....” <br />
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While Section 75-24-19(1)(b) of the MCPA does allow the Attorney General to recover “investigative costs and a reasonable attorney's fee,” the costs and fees awarded by the court are separate and apart from the primary claim. Based on the clear language of the statute, the chancellor's order, and the settlement agreement, we find this argument has no merit. <br />
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B. The Attorney General's Authority <br />
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The Attorney General next states that he has “authority to retain contingent fee lawyers, and honor his contracts with them.” In support, he provides two arguments, and we address them both. <br />
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1. The Attorney General's common-law authority to enter into and honor contingency-fee agreements is subject to statutory law.<br />
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We agree with the Attorney General that he has common-law “authority to negotiate and enter into contingency fee agreements with retained counsel for civil litigation on behalf of the State.” 8 We said as much in Pursue Energy Corp. v. Mississippi Tax Commission, 9 in which a former attorney general faced the question of how to pay outside counsel. <br />
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In Pursue Energy, then-Attorney General Mike Moore hired outside counsel to help the State Tax Commission assess and collect taxes from various entities, including Pursue Energy Corporation, 10 which challenged the retention agreement, arguing that it created a conflict of interest because it provided for the outside counsel to collect tax revenue on a contingent basis. 11 <br />
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Attorney General Moore — speaking on behalf of all parties to the contingent-fee contract — clarified by affidavit the terms of the retention agreement, stating that <br />
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it was understood by all that [the attorney]would not be paid out of any tax moneys recovered. Instead, it was contemplated that if recovery was had, the Attorney General would apply to the Legislature for an appropriation to pay the firm an amount to be measured by the terms of the retention agreement.” 12<br />
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In other words, the full amount recovered would be paid over to the State, and the attorneys would be paid by separate funds appropriated by the Legislature. Nevertheless, Pursue Energy argued the retention agreement was invalid. <br />
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For several reasons, we rejected Pursue Energy's argument, first stating that Section 7-5-7 “places no restrictions upon the type of fee the Attorney General can negotiate ....” 13 Next, we stated that the agreement did not create a conflict of interest, because there was “[n]o ... divergence of interest.” Finally — and more on point to the issue in this case — we stated: <br />
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Even more compelling is the freedom provided the Legislature in the instant case who could independently determine the fee payable to [the attorney] for the service, even to the extent that it could refuse to pay. 14<br />
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And in holding that the contingent-fee agreement was not illegal, we said: <br />
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Sections 7-5-5 and 7-5-7 ... governing the compensation of special counsel and investigators to the attorney general, permit payment on a fee, contract, or salary basis so long as payment is from the Attorney General's contingent fund or from other funds appropriated to the Attorney General's office. 15<br />
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So while we agree that the Attorney General does have authority to enter into contingency-fee agreements with outside counsel, those agreements — when made — are subject to Mississippi law and, in particular, Section 7-5-7. <br />
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Contracts with lawyers hold no special privilege. They are — as are all other contracts — subject to, and restricted by, applicable law. For instance, attorneys who enter into contingent-fee contracts in workers compensation cases are restricted by statute to an attorney fee of twenty-five percent, regardless of any contract provision to the contrary. And the statutory limitation does not render the contract void; it simply limits the amount the attorney legally may be paid. <br />
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2.Both Sections 7-5-5 and 7-5-7 restrict the sources from which the Attorney General may pay outside counsel.<br />
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The Attorney General next turns to Mississippi statutory law, and makes four arguments. His first three arguments address the plain meaning and application of Sections 7-5-5 and 7-5-7, and his final argument addresses his contingent fund. <br />
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a. The Plain Meaning of Sections 7-5-5 and 7-5-7 <br />
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Section 7-5-5. The Attorney General argues that Section 7-5-5Attorney General argues that Section 7-5-5 empowers him to retain special assistant attorneys general on a fee or contract basis, and that he is the sole judge of compensation for such assistants. And so long as his determination of compensation complies with Mississippi law, we agree. <br />
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Section 7-5-5 empowers the Attorney General to employ three assistants to “devote their time and attention primarily to defending and aiding in the defense in all courts of any suit, filed or threatened, against the State,” and “[w]hen circumstances permit, such assistants (the ones hired primarily to defend) may perform any of the attorney general's powers and duties,” and <br />
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[t]o further prosecute and insure such purposes, the attorney general is ... authorized ... to employ such additional counsel as special assistant attorneys general ... on a fee or contract basis; and the attorney general shall be the sole judge of the compensation in such cases. 16<br />
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So Section 7-5-5 establishes the Attorney General's authority to employ assistants who “devote their time and attention primarily to defending and aiding in the defense” of the State of Mississippi. But the employment of outside counsel for a single case — which occurred in this case — is covered by the next section, Section 7-5-7. And if we assigned to Section 7-5-5 the interpretation suggested by the Attorney General, Section 7-5-7 would be meaningless. <br />
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Section 7-5-7. This section addresses the Attorney General's authority to employ attorneys “to assist the attorney general in the preparation for, prosecution, or defense of any litigation ....” 17 It provides: <br />
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The attorney general is hereby authorized and empowered to appoint and employ special counsel, on a fee or salary basis, to assist the attorney general in the preparation for, prosecution, or defense of any litigation in the state or federal courts or before any federal commission or agency in which the state is a party or has an interest. The attorney general may designate such special counsel as special assistant attorney general, and may pay such special counsel reasonable compensation to be agreed upon by the attorney general and such special counsel, in no event to exceed recognized bar rates for similar services....<br />
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vThe compensation of appointees and employees made hereunder shall be paid out of the attorney general's contingent fund, or out of any other funds appropriated to the attorney general's office.<br />
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(Emphasis added.) In Pursue Energy, this Court addressed this very issue by stating: <br />
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Sections 7-5-5 and 7-5-7 ... governing the compensation of special counsel and investigators to the attorney general, permit payment on a fee, contract, or salary basis so long as payment is from the Attorney General's contingent fund or from other funds appropriated to the Attorney General's office. 18<br />
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The Pursue Court's statement could not have been more clear: the restriction on sources from which the Attorney General is authorized to pay special counsel — whether employed under Section 7-5-5 or Section 7-5-7 — applies, regardless of the fee arrangement. <br />
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b. The “Contingent Fund” Contemplated by Mississippi Code Section 7-5-7 does not include Microsoft's bank account or a private attorney's trust account.<br />
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Next, the Attorney General argues that his “contingent fund” is not limited to funds appropriated by the Legislature. Without addressing what the Attorney General's contingent fund does include, we are persuaded it includes neither Microsoft's checking account nor a private lawyer's trust account. <br />
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C. Deference to the Attorney General's Interpretation <br />
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The Attorney General next argues that, even if Sections 7-5-5 and 7-5-7 “allow room for a different interpretation” than his, this Court should defer to him. As stated earlier, we do not find these sections to be ambiguous, so this argument has no merit. <br />
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D. The Auditor's Right to Seize Microsoft's Payment to Retained Counsel <br />
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The Attorney General next advances several arguments in support of his assertion that the Mississippi Auditor should not be allowed to seize the Microsoft payment of attorney fees. <br />
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Public Funds <br />
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First, he argues that the $10 million was not public funds. But the settlement agreement clearly sets forth that, by sending the $10 million to the attorneys, Microsoft was making a payment to the State of Mississippi. The only distinction between the $10 million and the remaining $40 million was where the money was sent. Money paid to the State of Mississippi in settlement of a lawsuit is public money. This argument has no merit. <br />
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Attorney Lien <br />
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The next argument is that the attorney fee is subject to an attorney's lien. Citing several cases, the Attorney General argues that attorneys have a paramount lien on funds they hold for the payment of attorney fees. In Collins v. Schneider, this Court stated that “an attorney has a lien on the funds of his client for the services rendered in the proceeding by which the money was collected.” 19 But a lien is of no value, except to secure payment to which the attorney is lawfully entitled. As stated earlier, for example, an attorney prosecuting a workers' compensation case certainly would have no lien on funds that exceeded the twenty-five percent allowed by Mississippi statute for attorney fees. 20 In this case, no payment is due outside counsel until the parties comply with Mississippi law — and, specifically, Section 7-5-7. <br />
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The common-law concept of attorney's liens is subject to modification by the Legislature. And our Legislature has carved out a special payment requirement for private lawyers who work for the Attorney General; they may be paid only from the Attorney General's contingent fund, or from funds appropriated by the Legislature. 21 The statute's mandatory language includes no other options for payment by way of an attorney's lien. This argument has no merit. <br />
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Waiver <br />
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The Attorney General argues that the Auditor waived the State's claim by his seven-month delay in intervening in the trial-court proceedings. In addressing a similar issue in a case in which the Secretary of Health and Human Services sought recovery of federal funds improperly paid to a health-care provider who had been informed that its payments were proper, the United States Supreme Court stated: <br />
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When the Government is unable to enforce the law because the conduct of its agents has given rise to an estoppel, the interest of the citizenry as a whole in obedience to the rule of law is undermined. It is for this reason that it is well settled that the Government may not be estopped on the same terms as any other litigant. 22<br />
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The Court went on to state that “[t]he question is whether the Government has entirely forfeited its right to the money,” and that <br />
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Men must turn square corners when they deal with the Government .... This observation has its greatest force when a private party seeks to spend the Government's money. Protection of the public first requires that those who seek public funds act with scrupulous regard for the requirements of the law. 23<br />
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The Attorney General cites cases 24 not applicable to the state government. In this case, the Auditor protested the attorney-fee arrangement by sending a letter to one of the attorneys employed by the Attorney General. In that letter, the Auditor stated: <br />
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It is the formal position of the Office of the State Auditor that the diversion of $10 million from the State's settlement proceeds to outside counsel without prior legislative approval is a violation of Miss. Code. Ann. § 7-5-7 and Mississippi Supreme Court precedent.<br />
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This auditor sent this letter seven days following the chancery court order approving the settlement. This eliminates any argument that the Auditor “entirely forfeited” the State's claim. This issue has no merit. <br />
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The Auditor's Remedy <br />
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The Attorney General next argues that the Auditor has no remedy because “the relief sought is unsupported by general Mississippi contract law and would violate the constitutional prohibition on impairment of contracts.” <br />
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1. No void contract provisions <br />
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The Attorney General argues that — because no contract provision is illegal or void — the contract must be upheld. The contract, itself, establishes that Microsoft paid $50 million to the State of Mississippi. The fact that $10 million of the State's money was (according to the settlement agreement) “distributed” to the attorneys rather than the State does not change the material provisions of the agreement. In fact, the Attorney General and Microsoft specifically agreed in the settlement agreement that “Microsoft played no part in negotiating the fees and expenses to be paid to plaintiff's counsel and takes no position as to whether those fees and expenses are reasonable or appropriate.” This argument has no merit. <br />
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2. Constitutional and contract law <br />
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The Attorney General's final argument is that <br />
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neither the Auditor nor the Legislature are authorized to breach the contingency fee contract. To the extent the Auditor intends that retained counsel be paid less than what was contracted after “running it by” the Legislature and a Governor's veto, that would trample on retained counsel's constitutional property rights.<br />
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We fail to see how “retained counsel's constitutional property rights” are at issue. The settlement agreement does not establish that retained counsel are entitled to anything. As stated above, the settlement agreement specifically provides that “Microsoft played no part in negotiating the fees and expenses to be paid to plaintiff's counsel and takes no position as to whether those fees and expenses are reasonable or appropriate.” <br />
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The settlement agreement says nothing about the purpose of the $10 million — only where it was to be sent. The Attorney General agreed in the settlement agreement that the $10 million was being paid to “the State of Mississippi.” The fact that $10 million of the State's money was “distributed” to a particular bank account in Houston, Texas, does not create or vest “constitutional property rights” in anyone. This argument is without merit. <br />
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The remainder of the Attorney General's brief is dedicated to his cross-claim, arguing that the Auditor waived the State's claim. As stated above, this argument has no merit. <br />
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Section 100 of the Mississippi Constitution <br />
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Even if the Legislature had not carved out the statutory exception to the common-law attorney's lien , Section 100 of the Mississippi Constitution does not permit the Legislature to forgive, or even diminish, liquidated obligations to the State; nor does it permit Microsoft — or any other defendant — to satisfy obligations owed to the State by remitting settlement payments to private lawyers. Section 100 states: <br />
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No obligation or liability of any ... corporation held or owned by this state ... shall ever be remitted, released or postponed, or in any way diminished by the Legislature, nor shall such liability or obligation be extinguished except by payment thereof into the proper treasury; nor shall such liability or obligation be exchanged or transferred except upon payment of its face value; but this shall not be construed to prevent the Legislature from providing by general law for the compromise of doubtful claims. 25<br />
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The Legislature constitutionally may permit the Attorney General to compromise doubtful claims. But once the claim is settled, and the amount due is determined and agreed through compromise, the claim and debt become liquidated, and full payment of the amount due must be made into the proper State treasury. Section 100 clearly provides that, in order to extinguish the debt, payment of the amount due must be made into the proper treasury. The issue here is not whether the debt was diminished, but rather whether the amount due was paid into the proper state treasury. <br />
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CONCLUSION <br />
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The settlement agreement provided that the $10 million at issue in this case was to be paid “to the State of Mississippi.” That is where it must be paid — and distributed. The plain language of Section 7-5-7 mandates that outside counsel retained by the Attorney General be paid only from the Attorney General's “contingent fund,” or from funds appropriated to the Attorney General by the Legislature. This Court so held in Pursue Energy. 26 And our Constitution required the $10 million in State funds to be paid into a proper treasury. Because that was not done here, and because the parties did not comply with Section 7-5-7, we reverse the chancellor and remand this matter for further action consistent with this opinion. <br />
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ON DIRECT APPEAL: REVERSED AND REMANDED. ON CROSS-APPEAL: REVERSED AND REMANDED. <br />
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WALLER, C.J., CARLSON, P.J., RANDOLPH, LAMAR AND PIERCE, JJ. CONCUR. PIERCE, J., SPECIALLY CONCURS WITH SEPARATE WRITTEN OPINION JOINED BY WALLER, C.J., DICKINSON, P.J., RANDOLPH AND LAMAR, JJ. KING, J., CONCURS IN PART AND DISSENTS IN PART WITH SEPARATE WRITTEN OPINION JOINED BY KITCHENS AND CHANDLER, JJ. <br />
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Concurring Opinion <br />
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PIERCE, JUSTICE, SPECIALLY CONCURRING: <br />
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For the reasons stated in my separate opinion in Pickering v. Langston, 2010-CA-00362-SCT , I specially concur in this companion case. <br />
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WALLER, C.J., DICKINSON, P.J., RANDOLPH AND LAMAR, JJ., JOIN THIS OPINION. <br />
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KING, JUSTICE, CONCURRING IN PART AND DISSENTING IN PART: <br />
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I join the majority in holding that the funds in question are state funds. However, for the reasons stated in my separate opinion in Pickering v. Langston, 2010-CA-00362-SCT , a companion case, which is also being released today, I dissent from that portion of the majority opinion holding that the law relating to an attorney's fee lien was altered by Mississippi Code Section 7-5-7 (Rev. 2002). <br />
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Additionally, I would make clear that the Legislature is not unilaterally empowered to alter the compensation established by a valid contract. Beyond dispute, if there exists a valid contract, the Legislature may not refuse payment on the contract without possibly subjecting the State to legal action. <br />
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KITCHENS AND CHANDLER, JJ., JOIN THIS OPINION. <br />
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1<br />
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Miss. Code Ann. § 7-5-7 (Rev. 2002). <br />
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2<br />
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Miss. Const. art 4 § 100 (1890). <br />
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3<br />
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Pickering v. The Langston Law Firm, No. 251-07-1258CIV . <br />
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4<br />
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Miss. Code Ann. § 7-5-7 (Rev. 2002) (emphasis added). <br />
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5<br />
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Franklin v. Franklin, 858 So. 2d 110, 115 (Miss. 2003) . <br />
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6<br />
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Miss. Code Ann. § 75-24-19(1)(b) (Rev. 2009). <br />
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7<br />
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Id. <br />
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8<br />
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We note here the obvious, that is, that any such contingency-fee contract would be — as are all contracts governed by Mississippi law — subject to Mississippi constitutional and statutory provisions and limitations. <br />
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9<br />
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Pursue Energy Corp. v. Miss. State Tax Comm'n, 816 So. 2d 385 (Miss. 2002) . <br />
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10<br />
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Id. at 386-87. <br />
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11<br />
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Id. at 387. <br />
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12<br />
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Id. (emphasis added). <br />
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13<br />
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Id. at 391. <br />
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14<br />
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Id. at 392. <br />
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15<br />
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Id. at 390 (emphasis added). <br />
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16<br />
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Miss. Code Ann. § 7-5-5 (emphasis added). <br />
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17<br />
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Miss. Code Ann. § 7-5-7. <br />
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18<br />
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Pursue Energy, 816 So. 2d at 390 (emphasis added). <br />
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19<br />
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Collins v. Schneider, 192 So. 20, 22 (Miss. 1939) . <br />
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20<br />
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See Miss. Code Ann. § 71-3-63(3) (Rev. 2011). <br />
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21<br />
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Miss. Code Ann. § 7-5-7. <br />
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22<br />
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Heckler v. Cmty. Health Servs. of Crawford County, Inc., 467 U.S. 51, 104 S. Ct. 2218, 2224 (1984) . <br />
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23<br />
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Id., 104 S. Ct at 2225-26; see also State v. Ex. Rel. Rice, 4 So. 2d 270, 277 (Miss. 1940) (“[T]he state cannot abdicate its duty as trustee of property in which the whole people are interested, any more than it can surrender its police powers in the administration of government and in the preservation of peace and order.”). <br />
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24<br />
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Setinel Indus. Contracting Corp. v. Kimmins Indus. Serv. Corp., 743 So. 2d 954, 964 (Miss. 1999) ; Eastline Corp. v. Marion Apartments, Ltd., 524 So. 2d 582, 584 (Miss. 1988) . <br />
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25<br />
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Miss. Const. art. 4, § 100. <br />
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26<br />
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Pursue Energy, 816 So. 2d at 390 . <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-20294560861852502582012-08-10T06:16:00.001-04:002012-08-10T06:16:56.402-04:00Pickering LangstonSTACEY PICKERING, IN HIS CAPACITY AS AUDITOR FOR THE STATE OF MISSISSIPPI v. LANGSTON LAW FIRM, P.A.; JOSEPH C. LANGSTON; STATE OF MISSISSIPPI; LUNDY & DAVIS; AND AYLSTOCK, WITKIN, KREIS & OVERHOLTZ<br />
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Case Information: <br />
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Docket/Court: 2010-CA-00362-SCT, Supreme Court of Mississippi <br />
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Date Issued: 05/24/2012 DATE OF JUDGMENT: 02/24/2010<br />
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Tax Type(s): General Administrative Provisions, Corporate Income Tax <br />
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Cite: 88 So 3d 1269 <br />
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Case Information: COURT FROM WHICH APPEALED: HINDS COUNTY CIRCUIT COURT NATURE OF THE CASE: CIVIL - STATE BOARDS AND AGENCIES <br />
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Disposition: DISPOSITION: REVERSED AND REMANDED <br />
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Headnote<br />
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1. STATUTES — CONSTRUCTION AND OPERATION — GENERAL RULES OF CONSTRUCTION — Construction as mandatory or directory. Where a statute includes the mandatory term "shall,' the court does not view its restriction as a suggestion; it is a mandate. <br />
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2. APPEAL AND ERROR — REVIEW — TRIAL DE NOVO — Trial de novo — Cases triable in appellate court — In general. For questions of law and statutory interpretation, the appellate court employs a de novo standard of review. <br />
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3. ATTORNEY GENERAL — Compensation. The $14 million received by private law firm that had been hired by Attorney General to collect delinquent taxes from corporation, which sum the State Auditor sought to recover for State as public funds, was part of corporation's negotiation and payment of its tax liability, even if Attorney General believed that the $14 million sum was negotiated after settlement with corporation, where settlement agreement stated that the $14 million was part of corporation's $118.2 million payment of its tax liability, and settlement agreement contained a merger clause. . <br />
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4. CONTRACTS — CONSTRUCTION AND OPERATION — GENERAL RULES OF CONSTRUCTION — Oral agreements collateral to written contracts. The provisions of a written agreement ordinarily will prevail over prior conflicting verbal understandings. <br />
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5. APPEAL AND ERROR — BRIEFS — Form and requisites in general. Appellate court will not review an issue that is totally unsupported by any authority. <br />
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6. ATTORNEY AND CLIENT — LIEN — Nature of attorney's lien. An "attorney's lien' is the right of an attorney to hold or retain a client's money or property. <br />
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7. ATTORNEY AND CLIENT — LIEN — Statutory provisions. The provisions of the common law, including the concept of attorney's liens, are subject to modification by the Legislature. <br />
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8. COMMON LAW — Adoption and repeal — In general. The provisions of the common law, including the concept of attorney's liens, are subject to modification by the Legislature. <br />
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9. ATTORNEY GENERAL — Compensation. The Legislature has carved out a special statutory payment requirement for private lawyers who work for the Attorney General, under which they may be paid only from the Attorney General's contingent fund, or from funds appropriated by the Legislature. . <br />
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10. ATTORNEY GENERAL — Compensation. Under statute addressing Attorney General's payment of private lawyers who work for the Attorney General, law firm hired by Attorney General to collect delinquent taxes from corporation could not be paid directly from taxes collected through settlement with corporation. . <br />
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11. ATTORNEY GENERAL — Compensation. Statute addressing Attorney General's payment of private lawyers who work for the Attorney General does not allow direct payment of attorney fees from taxes collected through litigation, nor does it allow for payment by assertion of, and execution upon, an attorney's lien on public funds. . <br />
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12. ATTORNEY AND CLIENT — COMPENSATION — Contracts for compensation — In general. Fee contracts with lawyers hold no special privilege, and they are, as are all other contracts, subject to, and restricted by, applicable law. <br />
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13. TAXATION — PROPERTY TAXES — COLLECTION AND ENFORCEMENT AGAINST PERSONS OR PERSONAL PROPERTY — IN GENERAL — Authority to compromise or remit. State Constitution does not permit the Legislature to forgive, or even diminish, a tax obligation to the State, unless it is a doubtful claim. . <br />
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14. TAXATION — INCOME TAXES — COLLECTION AND ENFORCEMENT — In general. State Constitution does not permit the Legislature to forgive, or even diminish, a tax obligation to the State, unless it is a doubtful claim. . <br />
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15. TAXATION — PROPERTY TAXES — PAYMENT AND REFUNDING OR RECOVERY OF TAX PAID — Officers to whom payment may be made. State constitutional provision restricting release of obligations or liabilities owed to State does not permit a taxpayer to satisfy its tax obligation to the State by remitting tax payments to private lawyers hired by the Attorney General to collect the taxes. . <br />
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16. TAXATION — INCOME TAXES — PAYMENT — In general. State constitutional provision restricting release of obligations or liabilities owed to State does not permit a taxpayer to satisfy its tax obligation to the State by remitting tax payments to private lawyers hired by the Attorney General to collect the taxes. . <br />
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17. STATES — PROPERTY, CONTRACTS, AND LIABILITIES — Rights and remedies of state on contracts in general, and debts due state. Under state constitutional provision restricting release of obligations or liabilities owed to State, the Legislature may permit the Attorney General to compromise doubtful claims, but once the claim is settled, and the amount due is determined and agreed through compromise, the claim and debt become liquidated, and full payment of the amount due must be made into the proper State treasury. . <br />
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18. STATES — PROPERTY, CONTRACTS, AND LIABILITIES — Rights and remedies of state on contracts in general, and debts due state. Under state constitutional provision generally restricting release of obligations or liabilities owed to State but allowing doubtful claims to be released, an unliquidated debt becomes liquidated when it is reduced to judgment, or when the parties agree on its amount. . <br />
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19. TAXATION — PROPERTY TAXES — PAYMENT AND REFUNDING OR RECOVERY OF TAX PAID — Amount of payment. Corporation's tax obligation to State was liquidated, and thus, under state constitutional provision restricting release of obligations or liabilities owed to State, full payment of amount due had to be made into the proper State treasury; while corporation initially had disputed State's claim for delinquent taxes, rendering it an unliquidated debt, corporation and State signed a settlement agreement that was quite specific in setting forth the amount due to State from corporation. . <br />
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20. TAXATION — INCOME TAXES — PAYMENT — In general. Corporation's tax obligation to State was liquidated, and thus, under state constitutional provision restricting release of obligations or liabilities owed to State, full payment of amount due had to be made into the proper State treasury; while corporation initially had disputed State's claim for delinquent taxes, rendering it an unliquidated debt, corporation and State signed a settlement agreement that was quite specific in setting forth the amount due to State from corporation. . <br />
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21. STATES — PROPERTY, CONTRACTS, AND LIABILITIES — Rights and remedies of state on contracts in general, and debts due state. State's "proper treasuries,' into which the state Constitution requires liquidated claims of the State to be paid, are limited to State depositories. . <br />
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22. STATES — FISCAL MANAGEMENT, PUBLIC DEBT, AND SECURITIES — Collection and custody of funds. The right of the legislature to control the public treasury, to determine the sources from which the public revenues shall be derived and the objects upon which they shall be expended, and to dictate the time, the manner, and the means both of their collection and disbursement, is firmly and inexpugnably established. <br />
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23. STATES — FISCAL MANAGEMENT, PUBLIC DEBT, AND SECURITIES — Disbursements in general. The right of the legislature to control the public treasury, to determine the sources from which the public revenues shall be derived and the objects upon which they shall be expended, and to dictate the time, the manner, and the means both of their collection and disbursement, is firmly and inexpugnably established. <br />
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24. STATES — PROPERTY, CONTRACTS, AND LIABILITIES — Rights and remedies of state on contracts in general, and debts due state. State's proper treasuries, into which the state Constitution requires liquidated claims of the State to be paid, are whatever the Legislature says they are. . <br />
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25. STATES — PROPERTY, CONTRACTS, AND LIABILITIES — Rights and remedies of state on contracts in general, and debts due state. In absence of a statute authorizing special counsel's retention of attorney fees before paying the balance of the debt to the State, the private bank account of special counsel hired by the Attorney General cannot be a proper treasury into which the state Constitution requires a liquidated claim of the State to be paid. . <br />
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26. ATTORNEY GENERAL — Compensation. The $14 million received by private law firm that had been hired by Attorney General to collect delinquent taxes from corporation, which sum the State Auditor sought to recover for State, constituted public funds, though the money had not yet been filtered through the State treasury, because it was a payment of taxes; settlement agreement with corporation stated that the $14 million was part of corporation's $118.2 million payment of its tax liability. . <br />
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27. ATTORNEY GENERAL — Compensation. The statutory restriction on sources from which the Attorney General is authorized to pay special counsel applies regardless of the fee arrangement. . <br />
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28. CONSTITUTIONAL LAW — CONSTRUCTION AND OPERATION OF CONSTITUTIONAL PROVISIONS — CONSTITUTIONALITY OF STATUTORY PROVISIONS — Statutory abrogation of constitutional right. A statute cannot trump the Mississippi Constitution. <br />
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29. ESTOPPEL — EQUITABLE ESTOPPEL — NATURE AND ESSENTIALS IN GENERAL — Waiver distinguished — Nature and elements of waiver. Waiver presupposes full knowledge of a right existing, and an intentional surrender or relinquishment of that right; it contemplates something done designedly or knowingly, which modifies or changes existing rights or varies or changes the terms and conditions of a contract. <br />
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30. ESTOPPEL — EQUITABLE ESTOPPEL — NATURE AND ESSENTIALS IN GENERAL — Waiver distinguished — Nature and elements of waiver. "Waiver' is the voluntary surrender of a right. <br />
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31. ESTOPPEL — EQUITABLE ESTOPPEL — NATURE AND ESSENTIALS IN GENERAL — Waiver distinguished — Nature and elements of waiver. To establish a waiver, there must be shown an act or omission on the part of the one charged with the waiver fairly evidencing an intention permanently to surrender the right alleged to have been waived. <br />
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32. ESTOPPEL — EQUITABLE ESTOPPEL — NATURE AND ESSENTIALS IN GENERAL — Waiver distinguished — Implied waiver and conduct constituting waiver. To establish a waiver, there must be shown an act or omission on the part of the one charged with the waiver fairly evidencing an intention permanently to surrender the right alleged to have been waived. <br />
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33. ESTOPPEL — EQUITABLE ESTOPPEL — NATURE AND ESSENTIALS IN GENERAL — Waiver distinguished — Nature and elements of waiver. State Auditor's 30–month delay before seeking recovery, as misappropriated public funds, of the $14 million received by private law firm that had been hired by Attorney General to collect delinquent taxes from corporation, which sum was part of corporation's negotiation and payment of its tax liability, did not constitute waiver; Auditor began to investigate almost immediately, and actively pursued the case. . <br />
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34. STATES — PROPERTY, CONTRACTS, AND LIABILITIES — Rights and remedies of state on contracts in general, and debts due state. State Auditor's 30–month delay before seeking recovery, as misappropriated public funds, of the $14 million received by private law firm that had been hired by Attorney General to collect delinquent taxes from corporation, which sum was part of corporation's negotiation and payment of its tax liability, did not constitute waiver; Auditor began to investigate almost immediately, and actively pursued the case. . <br />
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ATTORNEYS FOR APPELLANT: ARTHUR F. JERNIGAN, JR., CRAIG M. GENO, SAMUEL E. L. ANDERSON <br />
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ATTORNEYS FOR APPELLEES: FRED KRUTZ, C. YORK CRAIG, III, OFFICE OF THE ATTORNEY GENERAL, BY: JIM HOOD, GEOFFREY C. MORGAN, HAROLD EDWARD PIZZETTA, III, JUSTIN L. MATHENY <br />
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OPINION <br />
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TRIAL JUDGE: HON. WINSTON L. KIDD <br />
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EN BANC. <br />
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DICKINSON, PRESIDING JUSTICE, FOR THE COURT: <br />
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A corporation settled its delinquent tax liability to the State of Mississippi by paying $100 million to the State, $4.2 million to a private charity, and $14 million to a private law firm hired by the Attorney General to pursue the claim. Mississippi's Auditor demanded that, because the $18.2 million paid to the private charity and the law firm constituted public funds, it must be turned over to the State. The charity complied; but the law firm refused, claiming the payment of its fees was not made with public funds and, in any case, the Auditor had waived the State's claim. The Auditor filed suit and the trial court granted summary judgment to the law firm. We reverse. <br />
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When the Attorney General pays special assistants, Mississippi statutory law requires that they be paid from the Attorney General's contingent fund or from other funds appropriated to the Attorney General's office by the Legislature. 1 Also, our constitution requires obligations and liabilities to the State (for instance, a tax liability) to be paid “into the proper treasury.” 2 Neither of these requirements was met in this case. <br />
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BACKGROUND FACTS AND PROCEEDINGS <br />
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After several years of aggressive acquisitions and market growth, WorldCom — a Mississippi corporation located primarily in Clinton, Mississippi — became the second-largest provider of long-distance telephone service in America; but a series of accounting and securities scandals culminated in WorldCom's July 21, 2002, petition for Chapter 11 bankruptcy protection. When WorldCom's reorganization plan became effective, it merged into MCI Communications, Inc. (“MCI”). <br />
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The State of Mississippi — through its Attorney General, Jim Hood — filed a proof of claim in the bankruptcy, alleging WorldCom owed the State of Mississippi more than $1 billion for delinquent taxes, interest, and penalties. To assist in collecting the taxes, he signed a contingent-fee contract (“Retention Agreement”) with the Langston Law Firm, a Mississippi law firm. <br />
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The Langston Law Firm entered into a separate contract to divide attorney fees with the law firm of Lundy & Davis, LLP, which likewise agreed to split its fees with the law firm of Aylstock, Witkin, Kreis & Overholtz. These three law firms, together with the Langston Law Firm's then-principals — Joseph C. Langston and Timothy R. Balducci — are the appellees, and we refer to them herein collectively as “Langston,” “the Langston Firm,” or “Retained Counsel.” ¶6. Settlement discussions resulted in a written settlement agreement (“Settlement Agreement”) dated May 6, 2005, signed by MCI, Inc., on behalf of itself and the reorganized debtors, and by the State of Mississippi through Attorney General Hood. According to the terms, MCI settled its tax liability in exchange for some real property and payment “to or on behalf of the State,” the total sum of $118.2 million, divided as follows: The State received $100 million, Langston received $14 million, and the Children's Justice Center of Mississippi (“Justice Center”) received $4.2 million. <br />
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State Representative Joey Fillingane — on behalf of the Mississippi Legislative Conservative Coalition, representing twenty-four members of the Mississippi House of Representatives — formally requested then-Auditor Phil Bryant to conduct a performance review and audit of the settlement. Auditor Bryant conducted the audit and issued three draft reports before issuing his final findings. The first draft, issued in September 2005, included four recommendations, two of which were that <br />
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[t]he Mississippi Legislature should clarify the Attorney General's authority for the contengency fees for private attorneys retained by the Attorney General, ... [and] [t]he State Legislature should clearly determine the status of all fees received by private attorneys retained by the State Attorney General to act on the State's behalf, even if those fees were not paid directly by the State of Mississippi.<br />
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The second draft audit, issued in October 2005, included four recommendations, two of which were that <br />
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[t]he Mississippi Legislature should clarify the conditions under which the Attorney General has the authority to determine the contengency fees for private attorneys retained by the Attorney General, ... [and] [t]he State Legislature or the Courts should clearly determine the status of all fees received by private attorneys retained by the State Attorney General to act on the State's behalf, even if those fees were not paid directly by the State of Mississippi.<br />
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In his third draft, issued in September 2006, the Auditor made the following finding as to the $14 million: <br />
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The $14 million paid in attorney's fee is ... part of the settlement “as payment of tax and interest to or on behalf of the State of Mississippi.” Initially, such payment should have been deposited into the State General Fund with all other MCI settlement funds. Then, there would have been the opportunity through the legislative process, to set aside funds in an amount the Legislature found to be appropriate to pay outside counsel hired by the Attorney General to represent the people of the State of Mississippi. In such cases where the Attorney General has a contract with a private law firm, it is the Legislature's prerogative to always determine proper payment and appropriate that amount to the Attorney General's Contingency Fund. These funds may then be audited as part of the financial statement of the State. ( § 7-5-7).<br />
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The draft went on to recommend that <br />
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[b]ecause the legislative process was bypassed in the appropriation of these funds, any portions of the settlement not authorized by the Legislature should be returned to the General Fund. The State Auditor's office with the assistance of the Mississippi Attorney General should recover these public funds on behalf of the taxpayers of the State.<br />
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In his October 2006 official audit, Auditor Bryant stated that the Attorney General had lacked authority to enter into the settlement agreement because “he may only pay private attorneys out of contingency funds in his budget or from other funds appropriated to the office of the Attorney General by the Legislature.” <br />
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In his official Findings, the Auditor stated that the $14 million in attorney fees was part of the settlement “as payment of tax and interest to or on behalf of the State of Mississippi,” which should have been deposited into the State General Fund ....” Based on this finding, the Auditor recommended that “[t]he State Auditor's office with the assistance of the Mississippi Attorney General should recover these public funds on behalf of the taxpayers of the State.” <br />
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In November 2006, the Auditor formally demanded that Langston and the Justice Center turn over to the State the $18.2 million they received from the MCI settlement proceeds. The Justice Center complied, but Langston refused, claiming the $14 million it was paid was not public funds. He did, however, offer a compromise, to which the Auditor responded that he would delay action “until a thorough review” of Langston's offer of compromise could be completed. <br />
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On September 10, 2007, the Auditor posted a letter to the Attorney General, attaching a draft complaint, and demanding that he file suit to recover the $14 million. Eleven days later, Langston filed an adversary proceeding (a lawsuit in a bankruptcy court, related to a particular bankruptcy proceeding) in the MCI bankruptcy, seeking a declaratory judgment that the $14 million attorney-fee payment was proper under Mississippi law, and that the Auditor had waived, or was estopped from, challenging the settlement agreement. <br />
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On December 20, 2007, Auditor Bryant — both in his capacity as Auditor, and on behalf of the State of Mississippi — sued the Langston Firm in Hinds County Circuit Court, seeking recovery of the $14 million. The next day, two things happened in the bankruptcy court: The Auditor asked the bankruptcy court to abstain and to allow the matter to be settled in Mississippi state court; and the Langston Firm filed a motion for summary judgment. <br />
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In January 2008, Stacey Pickering became Mississippi's Auditor, and was substituted for former Auditor Bryant in both the Mississippi litigation and in the bankruptcy proceedings. <br />
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The bankruptcy court ruled against Langston, holding that the Auditor's claim was not a collateral attack on the settlement agreement, and that the issues related to the Auditor's claim “were not before the [bankruptcy] Court in connection with approving the settlement of the Debtors' tax obligations to the State, nor could they have been raised.” 3 The court further stated that the Auditor would have lacked standing to pursue the matter in the bankruptcy court, and that the issues raised by the Auditor were unique to Mississippi nondebtor parties and unrelated to the Debtors' settlement with the State. The Langston Firm appealed the bankruptcy judge's order, but the United States District Court affirmed the bankruptcy judge, stating in its order that “any decision on the merits of the claim is left to the Mississippi state court.” 4 <br />
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Meanwhile, back in the Mississippi litigation — after the suit had been removed to federal court and then remanded — all parties filed motions for summary judgment. The trial court denied the Auditor's motion and granted summary judgment to the Langston Firm and the State of Mississippi, holding that “the subject funds are not public funds since the Langston Law Firm received absolutely no funds from the State;” and that — since “no one lodged any objection to the settlement” in MCI's bankruptcy proceedings — “the State Auditor has waived its right to lodge any objections” to the settlement agreement. The Auditor timely filed this appeal. <br />
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ANALYSIS <br />
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I. Preliminary Matters <br />
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A. Langston's Right to Compensation <br />
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We wish to make clear at the outset that our opinion should not be read as addressing — one way or the other — the reasonableness of the amount of attorney fees involved, Retained Counsel's right to be paid, or the validity of the Retention Agreement. Indeed, the Auditor has made no such challenges, nor has he argued that the Attorney General was prohibited, either from depositing the funds into his contingent fund and paying Retained Counsel, or from paying the attorney fees from funds appropriated to his office by the Legislature. We address today only the narrow question of whether Mississippi law allows public settlement funds due to the State of Mississippi to be paid directly to outside counsel. <br />
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B. The Issues Before Us <br />
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The Legislature has limited the Attorney General to two sources from which he may pay the private attorneys he appoints to assist with litigation filed in the State of Mississippi. In addressing the payment of such outside counsel, Mississippi law states: <br />
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The compensation of appointees and employees made hereunder shall be paid out of the attorney general's contingent fund, or out of any other funds appropriated to the attorney general's office. 5<br />
<br />
Because the statute includes the mandatory term “shall,” we do not view its restriction as a suggestion — it is a mandate. 6 The statutory restriction was in place when the Attorney General and Langston signed the contract, and they cannot now claim they are not subject to it. <br />
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Indeed, rather than attack the statute's mandate, the Langston Firm argues that the statute does not apply, because it was not paid with public funds. The Attorney General makes the same argument, but then goes further, arguing that he has authority — without legislative appropriation — to pay private attorneys with public funds. And both Langston and the Attorney General argue that the Auditor waived the State's claim to the $14 million. <br />
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While the parties have advanced numerous arguments, and still more numerous sub-issues, this case requires us to address only three questions: (1) Was the $14 million public funds? If so, (2) did the Attorney General have authority to allow MCI to use those public funds to pay private lawyers without legislative approval or compliance with Section 7-5-7? If not, (3) did the Auditor waive the State's claim to the $14 million? For these questions of law and statutory interpretation, we employ a de novo standard of review. 7 We also consider whether the settlement violated Section 100 of Article Four of the Mississippi Constitution. <br />
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C. Timing of the Settlement <br />
<br />
Before addressing the first question, we think it important to analyze the timing of the settlement. Both the Attorney General and the Langston Firm base almost all their arguments on the premise that the $14 million attorney fee was negotiated and paidafter MCI had settled the State's tax claim. They argued as much in their briefs and here in oral argument. And Attorney General Hood stated in an affidavit that the “settlement with the State was complete prior to the attorneys fees being finally negotiated between Joey Langston, Billy Quin, and MCI.” (Emphasis added.) <br />
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We neither take lightly nor casually dismiss the representations of officers of this Court — whether made in briefs or sworn affidavits. But for several reasons, we must reject the representation that MCI's settlement with the State was complete before MCI negotiated with Langston and agreed to pay the $14 million in attorney fees, and to make a $4.2 million charitable contribution to the Justice Center. <br />
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1. Payment of Tax <br />
<br />
First, the Settlement Agreement clearly states that — “in full and complete satisfaction” of its tax debt to the State — MCI agreed to pay $100 million to the State, $14 million to Langston, and $4.2 million to the Justice Center. And there was only one Settlement Agreement — signed by the Attorney General on behalf of the State of Mississippi. Thus, the Settlement Agreement's own wording belies any claim that the tax-claim settlement was consummated before the attorney-fee negotiation. <br />
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2. Langston's Representations <br />
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Langston insists that the $14 million it received was not part of MCI's tax payment. And Attorney General Hood argues the $14 million was not even part of the settlement with the State, because it was negotiated after the settlement with the State was complete. But in pleadings filed in the trial court, Langston makes the following statement to the contrary: “Langston admits that MCI agreed to a settlement of its tax liability on May 6, 2005, by virtue of the Settlement Agreement and Release which was signed by counsel for MCI and Attorney General Jim Hood.” And it is undisputed that, in that Settlement Agreement, the $14 million clearly was part of the settlement of MCI's tax payment. <br />
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3. Merger Clause <br />
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The Settlement Agreement includes a merger clause that states: <br />
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This agreement constitutes a single, integrated written contract that expresses the entire agreement of the Parties with respect to the matters contained herein and supersedes all negotiations, prior discussions, and preliminary agreements, either oral or written. The parties disclaim reliance on any and all prior agreements, representations, negotiations, and understandings, oral or written, express or implied.<br />
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In arguing that the State's claim was settled before the attorney-fee negotiations took place, Attorney General Hood stated in his affidavit that <br />
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[neither I nor any of the other parties that participated in the MCI settlement considered the payment for attorney fees to be part of the State's recovery. The settlement with the State was complete prior to the attorneys fees being finally negotiated between Joey Langston, Billy Quinn, and MCI.<br />
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While the Attorney General's representations may very well reflect what he believed to have happened, he signed a Settlement Agreement that says otherwise. And the provisions of a written agreement ordinarily will prevail over prior conflicting verbal understandings.8 This is particularly so where, as here, the written agreement includes a merger clause that states the $14 million was part of MCI's payment of its tax liability. The Settlement Agreement makes no mention of separate negotiations for attorney fees after MCI settled its tax liability. <br />
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4. No Fine or Penalty 8 <br />
<br />
The Settlement Agreement clearly provides that “no part of the Settlement Payment [which includes the $14 million] is a fine or penalty.” So if, as the Attorney General and Langston suggest, the $14 million was not part of MCI's payment of its tax liability — and it was not a fine or penalty — we struggle to understand what it could have been. We reject the notion that MCI gratuitously paid Langston $14 million it could have kept. The Settlement Agreement's provisions and the facts clearly indicate that the $14 million was a part of MCI's negotiation and payment of its tax liability. <br />
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II. Public Funds <br />
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In its brief, the Langston Firm, claiming the summary judgment was “proper because the Attorney Fees are not 'public funds' as a matter of Mississippi law,” makes six arguments. We shall address them all. <br />
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A. Attorney Lien <br />
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Langston argues that the $14 million was not public funds because the attorneys hold a “superior lien” on the $14 million. As authority, Langston cites Collins v. Schneider, in which this Court stated that “an attorney has a lien on the funds of his client for the services rendered in the proceeding by which the money was collected.” 9 The Attorney General cites Halsell v. Turner 10 for the same proposition. For several reasons, we find no merit in this argument. <br />
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The Client's Funds? <br />
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First, both Collins and Halsell specifically limit the application of an attorney lien to funds belonging to the client (who, in this case, is the State of Mississippi). So it is surprising that Langston and the Attorney General make this argument, because both go to great lengths to convince us that the $14 million was never the client's — the State of Mississippi's — money. Indeed, the Attorney General stated by affidavit that “[none] of the parties involved considered the payment of the attorneys' fees to be part of the State's recovery.” <br />
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The Attorney General further stated that the State's tax claim was settled “prior to the negotiation of fees between [Langston] and [MCI],” and that “[none] of said attorneys' fees were deposited into or transferred out of the State Treasury or any other State-held account.” Likewise, Langston argues that the $14 million was “not 'received, collected by, or available for the support of or expenditure' 11 by the state,” but instead “always belonged to Retained Counsel.” <br />
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In summary, Langston and the Attorney General both argue on the one hand that the $14 million never belonged to the client (the State of Mississippi); but then argue on the other hand that Langston holds an attorney lien on the funds, citing as authority cases that recognize an attorney's lien on funds that do belong to the client (the State of Mississippi). These arguments are irreconcilable. Neither Langston nor the Attorney General cites any authority for the proposition that an attorney's lien may be applied to funds not belonging to the client, nor do they argue in the alternative that an attorney's lien would apply if the disputed funds were public funds. And this Court has held in numerous cases that we will not review an issue that is totally unsupported by any authority. 12 <br />
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Held in trust? <br />
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Furthermore, even though we find today that the $14 million was public funds, we nevertheless reject Langston's assertion that “the lawyers have a lien against [the $14 million],” allowing them to withhold it from the State. It is true that, under certain circumstances, an attorney's lien is “[t]he right of an attorney to hold or retain a client's money or property ....” 13 But it is also true that — if Langston is truly asserting an attorney's lien, as he claims — the $14 million would be in his trust account, which it is not. <br />
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The Mississippi Rules of Professional Conduct state: “A lawyer shall hold clients' and third persons' property separate from the lawyer's own property,” and the “[f]unds shall be kept in a separate trust account ....” 14 Langston does not even pretend that he is asserting a lien on the $14 million in client funds he holds in trust. Instead, Langston quite forthrightly tells us that the money has been disbursed — partly to itself, partly to another law firm, and partly (“millions”) to the state and federal government in taxes. So by Langston's own admission, even if an attorney lien were proper in this case, there are no funds in trust on which to assert it. <br />
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Section 7-5-7 <br />
<br />
Also, even if Langston did hold the $14 million in trust, it could not assert an attorney's lien on it, nor could it collect fees from it. The provisions of the common law — and this includes the concept of attorney's liens — are subject to modification by the Legislature. And our Legislature has carved out a special, statutory, payment requirement for private lawyers who work for the Attorney General; they may be paid only from the Attorney General's contingent fund, or from funds appropriated by the Legislature. 15 Specifically, the statute provides, in relevant part: <br />
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The attorney general is hereby authorized and empowered to appoint and employ special counsel, on a fee or salary basis, to assist the attorney general in the preparation for, prosecution, or defense of any litigation in the state or federal courts ... in which the state is a party or has an interest.<br />
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The attorney general may designate such special counsel as special assistant attorney general, and may pay such special counsel reasonable compensation to be agreed upon by the attorney general and such special counsel, in no event to exceed recognized bar rates for similar services.<br />
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The compensation of appointees and employees made hereunder shall be paid out of the attorney general's contingent fund, or out of any other funds appropriated to the attorney general's office. 16<br />
<br />
This statute clearly limits to two, the sources from which the Attorney General was authorized to pay Langston's attorney fees: the “attorney general's contingent fund,” or “other funds appropriated” to his office. The statute does not allow direct payment of attorney fees from taxes collected through litigation. And the statute's mandatory language includes no option for payment by assertion of, and execution upon, an attorney's lien on public funds. <br />
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We wish to make it clear that we do not call into question the right of the Attorney General to enter into contingency-fee contracts with outside counsel. But contracts with lawyers hold no special privilege. They are — as are all other contracts — subject to, and restricted by, applicable law. For instance, attorneys who enter into contingent-fee contracts in workers' compensation cases are restricted by statute to an attorney fee of twenty-five percent, regardless of any contract provision to the contrary. And while a contract with a larger percentage would not be void, it would be subject to the statutory restriction. <br />
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Section 27-75-15 <br />
<br />
By contrast, where lawsuits must be filed in other states to collect taxes due to Mississippi, the Legislature has made a special provision for the payment of attorney fees to counsel from those states. Section 27-75-15 allows the Attorney General to <br />
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employ attorneys residing in a sister state, district or territory, where suits are instituted to recover taxes due the State of Mississippi .... [S]uch attorney fees may, within the discretion of the designated officers, be set on ... a contingent fee basis. The ... contingent fee shall be deducted from and paid out of the proceeds of the particular claim, subject, however, to the approval of the governor as to the employment and amount of such fee in either instance. 17<br />
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This statute is instructive for two reasons. First, its safeguard requirement is the Governor's approval of the fees, rather than Section 7-5-7's requirement of appropriation by the Legislature. We find it illogical that the Legislature would require the Attorney General to obtain the Governor's approval of fees to be paid to counsel in another state, but allow him to pay Langston with no one's approval. <br />
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Second, the statute limits the class of outside attorneys the Attorney General may pay “out of the proceeds” of a particular claim. By granting the Attorney General the limited and specific authority to use proceeds to pay “attorneys residing in a sister state,” the statute excludes all other classifications, including attorneys residing in this state, who pursue claims filed in Mississippi. Stated differently, had the Legislature wanted to grant the Attorney General the authority to use the proceeds of a particular claim to pay attorneys who reside in Mississippi, it easily could have excluded from the statute its limitations to out-of-state attorneys filing claims in other states. <br />
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The Attorney General contracted with Langston, a Mississippi law firm, to pursue the State of Mississippi's claim in the courts of Mississippi. So Section 27-75-15 does not apply, and Langston's attorney fees may not be paid lawfully from funds held in trust, nor may they be paid directly “out of the proceeds” of the settlement by the defendant in the litigation. This restriction does not apply to other clients' private lawyers, who lawfully may assert a lien on — and ultimately collect their fees from — client funds, wherever they may be found. <br />
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Article Four, Section 100 of the Mississippi Constitution <br />
<br />
Finally, even if the Legislature had not carved out the statutory exception to the common-law attorney's lien, Article Four, Section 100 of the Mississippi Constitution does not permit the Legislature to forgive, or even diminish, a tax obligation to the State, unless it is a doubtful claim. Nor does it permit MCI — or any other taxpayer — to satisfy its tax obligation to the State by remitting tax payments to private lawyers. Section 100 states: <br />
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No obligation or liability of any ... corporation held or owned by this state ... shall ever be remitted, released or postponed, or in any way diminished by the Legislature,nor shall such liability or obligation be extinguished except by payment thereof into the proper treasury ; nor shall such liability or obligation be exchanged or transferred except upon payment of its face value; but this shall not be construed to prevent the Legislature from providing by general law for the compromise of doubtful claims. 18<br />
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The Legislature may constitutionally permit the Attorney General to compromise doubtful claims. But once the claim is settled, and the amount due is determined and agreed through compromise, the claim and debt become liquidated, and full payment of the amount due must be made into the proper State treasury. Section 100 clearly requires that, for MCI to extinguish its tax debt, it must pay the full amount due into the proper treasury. Justice King, in his dissent, misreads our concern. The issue here is not whether the Legislature diminished the debt, but rather that less than the full amount due was paid into the proper state treasury. <br />
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In briefing this issue, the Attorney General raised several arguments. We shall address each of them. <br />
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1. Section 100 applies to unliquidated tax liabilities that become liquidated through judgment or settlement. <br />
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The Attorney General — while conceding that Section 100 generally applies to tax obligations — argues it does not apply here because MCI's tax obligation “was controverted, uncertain, and therefore unliquidated.” He further states that “this Court repeatedly has held that only liquidated amounts of taxes fall within the purview of Section 100,” citing only two cases for the proposition, neither of which involve the issue before us. <br />
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In the first case — Pan American Petroleum Corp. v. Gully — the question presented was whether, in light of Section 100, a judgment “which was for a sum less than sued for, could not be pleaded as res judicata.” 19 Holding that the judgment was indeed res judicata, this Court stated that Section 100 “was not intended to prevent the entry of a judgment for a less amount than the amount sued for where the claim was unliquidated and not capable of ascertainment by calculation, or some equally certain manner.” But Gully never addressed whether Section 100 required the judgment, when paid, to be paid into a “proper treasury.” <br />
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The second case — Robertson v. Weston Lumber Co. — likewise gives no support for the Attorney General's argument. In fact, we note the following language from Robertson — cited with approval in Gully — that announces a principle quite important to this case: <br />
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But where the amount due the state is in its very nature uncertain, it is competent for the state or the officer having power to represent it, acting in good faith, to consent to a judgment liquidating the amount due.” 20<br />
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Thus, according to both Gully and Robertson, an unliquidated debt becomes liquidated when it is reduced to judgment, or when the parties agree on its amount. <br />
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The issue in Robertson was whether Section 100 prevented the State from compromising and settling a dispute over timber unlawfully cut from land the State held in trust. The Robertson Court did not address the issue before us today, that is, whether the payment of the debt — once it becomes liquidated — must be made into a “proper treasury” as required by Section 100. <br />
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MCI disputed the State's tax claim, rendering it an unliquidated debt. But when MCI and the State settled, they signed a settlement agreement that was quite specific in setting forth the amount due the State from MCI. From that point on, there has been no dispute over the amount of MCI's liquidated obligation to the State, so the Attorney General's argument that Section 100 does not apply is without merit. <br />
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2. A private lawyer's trust account is not a “proper treasury” unless specifically authorized by the Legislature. <br />
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The Attorney General argues that, even if Section 100 applies, it was not violated, because the $14 million attorney-fee payment was paid into the “proper treasury.” He further argues that (1) “'proper treasury' simply means that the funds were remitted to a proper recipient;” (2) “the historic practice ... has been to permit the deduction of contingent fees from recoveries before payment of the balance over to the State;” and (3) to suggest otherwise “would be inconsistent with the holdings of all the modern American courts around the country ....” <br />
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A. “Proper treasury” does not simply mean “proper recipient.” <br />
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The Attorney General asserts that “proper treasury” as used by Section 100 “simply means that the funds were remitted to a proper recipient.” He cites no cases from this Court so holding, but suggests his interpretation of the phrase “is consistent” with Adams v. Fragiacomo, 21 which says no more than that Section 100's phrase “proper treasury” makes it difficult to apply Section 100 to nonmonetary obligations. <br />
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The only other authority the Attorney General offers in support of his interpretation of “proper treasury” is the following definition of the word “proper” from the 1910 edition of Black's Law Dictionary: “that which is fit, suitable, adapted, and correct.” But in that same dictionary, under the Ts, is found the following definition of “treasury”: <br />
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A place or building in which stores of wealth are reposited; particularly, a place where the public revenues are deposited and kept, and where money is disbursed to defray the expenses of government. Webster. That department of government which is charged with the receipt, custody, and disbursement (pursuant to appropriations) of the public revenues or funds. 22<br />
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The Auditor correctly argues that the State's “proper treasuries” are limited to State depositories, and the dictionary the Attorney General urges us to consult supports that interpretation. <br />
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B. The Legislature may designate the “proper treasury.” <br />
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The Attorney General next argues that direct payment of attorney fees cannot violate Section 100, because the Legislature at various times specifically has authorized the retention of contingent fees from tax proceeds. For example, the Attorney General cites an 1892 law authorizing the “state revenue agent” to “retain, as full compensation for his services and expenses, twenty per centum on all amounts collected and paid over by him ....” 23 <br />
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The Attorney General argues that it cannot be unconstitutional to permit the retention of a contingent fee prior to paying the balance into the treasury, because, otherwise, Section 4199 — passed two years after the ratification of the 1890 Constitution — would have been unconstitutional. But it is axiomatic and “obvious” that the Legislature holds the State's purse strings: 24 <br />
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The right of the legislature to control the public treasury, to determine the sources from which the public revenues shall be derived and the objects upon which they shall be expended, to dictate the time, the manner, and the means both of their collection and disbursement is firmly and inexpugnably established in our political system. 25<br />
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The Legislature determines where public funds come from and where they may go. It follows that the “proper treasury,” as that term is used in Section 100, is whatever the Legislature says it is. So, under Section 4199 of the 1892 Mississippi law, the Legislature determined where the tax revenues should go. <br />
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Section 4199 is notable for another reason. The fact that the Legislature found it necessary specifically to permit the revenue agent to retain a twenty-percent fee raises the presumption that such an arrangement would not have been permissible without the statute. And no such statute authorized the Attorney General to approve MCI's direct payment of $14 million in public funds to a private law firm. <br />
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The Attorney General argues that Section 4199 was necessary only because the Office of the State Revenue Agent was not a constitutional office. We agree, but note that “special assistant attorney general” also is a creature of statute, not a constitutional office. In the absence of a statute like Section 4199 authorizing special counsel's retention of fees before paying the balance of the debt to the State, special counsel's private bank account cannot be a “proper treasury” within the meaning of Section 100. <br />
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The Attorney General's final argument on this point is that “this Court recognized [in Robertson v. Miller 26] that '[t]he twenty per cent commission for the fees due the state revenue agent for making such collections were deducted by him before said taxes were paid into the proper treasury.'” 27 But the language quoted by the Attorney General was not the holding of this Court; rather it was an excerpt from the facts to which the parties had stipulated in the court below. <br />
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C. Other jurisdictions do not support the Attorney General's argument. <br />
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The Attorney General claims: “[A]ny suggestion that the funds at issue in this case were not paid to the 'proper treasury' would be inconsistent with the holdings of all the modern American courts around the country that have decided the same issues presented in this case.” 28 The Attorney General provides no citation of authority discussing a constitutional provision like Section 100 or the construction of the term “proper treasury.” Instead, he relies on the assumption that other states prohibit state funds from being deposited into an “improper treasury,” repeating the same arguments and citing the same cases we have discussed elsewhere in this opinion. Suffice it to say here that the Attorney General has supplied no authority for his argument that other states having constitutional provisions analogous to Section 100 have permitted private attorneys to keep state funds without specific authorization or appropriation. This argument is without merit. <br />
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One final word about Collins and Halsell. We find no fault in our previous holdings in those cases, and do not now retreat from them. But both Langston's argument and the oldings from those cases presuppose that the attorney holding the funds and asserting the lien is legally entitled to be paid the fees out of those funds. Langston was not, and is not. <br />
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B. Section 7-7-1 <br />
<br />
Langston next points to the language of Section 7-7-1, which states that “public funds” are “all funds which are ... available for the support of or expenditure by any state department, institution or agency, whether such funds be derived from taxes or from fees collected ... or from some other source ....” 29 In essence, The Langston Firm argues that the $14 million was not “received, collected by, or available” for the State's use, because the attorney fees were paid pursuant to a separate negotiation, and the funds were never transferred to the State. <br />
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<br />
The Langston Firm grounds the argument on two points, first stating that <br />
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<br />
[t]he Auditor's contention that [MCI] paid $118.2 million to settle its income tax debt is contrary to the plain language of the Settlement Agreement .... [T]he Auditor conveniently ignores Paragraph 8(ii) of the Settlement Agreement [which] clearly states that, as a part of the settlement, [MCI] agreed to pay the attorney fees of Retained Counsel.<br />
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Second, the Langston Firm tells us: “After settling the State's income tax claims, and in lieu of payment under the Retention Agreement, the Attorney General instructed The Langston Firm to negotiate Retained Counsel's fee directly with [MCI].” This entire argument is based on the false notion (as discussed above) that MCI first settled its tax liability with the State, and then engaged in an entirely separate negotiation and agreement concerning the Langston Firm's attorney fees. <br />
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We are skeptical of the notion that MCI — or, for that matter, any defendant — would settle with the plaintiff and then — instead of packing up and going home — charitably agree to negotiate, and then (with no legal obligation to do so) pay the plaintiff's attorney fees. But we need not speculate, because the Settlement Agreement provides conclusive evidence it did not happen here. <br />
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What did happen here is not complex. The State — claiming MCI owed more than a billion dollars in taxes, penalty, and interest — filed suit to collect. MCI agreed to pay $118.2 million as “payment of tax and interest.” But MCI did not pay all of its “taxes, penalty, and interest” directly to the State treasury, allowing the State, in compliance with statutory requirements, to pay its own attorney-fee bill from Langston. Instead, the Attorney General allowed MCI to use part of the State's tax revenue to pay Langston. <br />
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The fact that $14 million of MCI's taxes has not yet been filtered through the State treasury does not make it any less a payment of taxes. We find the $14 million was — and is — part of MCI's payment of its tax liability to the State; and we further find that the $14 million was — and is — “available for the support of or expenditure by any state department,” as referenced in Section 7-7-1. <br />
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C. Section 7-5-7 <br />
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The Langston Firm next argues that “[i]f public funds are not used to compensate outside counsel,” Section 7-5-7 is inapplicable and “never comes into play.” We agree. But the question of whether the $14 million was public funds is not answered by a statute that applies if it was public funds. This argument has no merit. <br />
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D. The Law in Other States <br />
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The Langston Firm argues its position is supported by “the overwhelming weight of legal authority on the topic,” specifically citing several cases from other states and an article from a legal encyclopedia that states: <br />
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A statute that allows the attorney general to hire assistants and to pay them from appropriations does not prohibit the attorney general in the exercise of his or her common-law power from entering into contingency fee arrangements or agreements that otherwise provide for civil defendants sued by the state to pay attorney fees directly to the state's outside counsel. 30<br />
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But further review reveals that, as its authority, the article cites State ex rel Nixon v. American Tobacco Co., Inc., a Missouri case interpreting a Missouri statute that is different from Mississippi's in one crucial respect. The Missouri statute provides that “compensation and expenses of said assistants and employees may be paid out of any state or federal funds appropriated to said department for such purposes.” 31 By contrast, Mississippi's statute says such compensation “shall be paid out of the attorney general's contingent fund, or out of any other funds appropriated to the attorney general's office.” 32 The Missouri statute's permissive term “may,” is of no assistance in applying Mississippi's statute, which includes the mandatory term “shall.” <br />
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Both the Langston Firm and the Attorney General cite People v. Philip Morris, in which the Illinois Supreme Court held that “tobacco settlement funds, which have never been in the state's hands, are not 'state funds' until after ... attorney fees are paid and the funds go into the state treasury.” 33 But Illinois has a provision of law entitled “The Attorneys Lien Act” under which the Illinois legislature provided that <br />
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<br />
<br />
attorneys at law shall have a lien upon all claims ... which may be placed in their hands by their clients for suit or collection ... for the amount of any fee which may have been agreed upon by and between such attorneys and their clients .... 34<br />
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Mississippi has no such act, but instead has a statute that limits the sources from which private attorneys employed by the Attorney General may be paid 35 and a constitutional provision that requires all funds due to the State to be paid into the State treasury. These differences in Illinois law and Mississippi law render People v. Philip Morris inapposite to the case before us today. <br />
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The other cases cited by Langston are likewise distinguishable. The Minnesota Court of Appeals held that fees paid directly to “special attorneys” were not public funds, but only after concluding that the Minnesota statute controlling such attorneys did not specify how those fees were to be paid. 36 Again, Section 7-5-7 distinguishes Mississippi law. <br />
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The Maryland Supreme Court also has found that contingent-fee payments do not constitute public funds, but (in part) because the applicable Maryland statute — unlike Mississippi's — places no restrictions on the source of such payments. 37 <br />
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The only other authority cited by Langston on this point is a footnote in State v. Hagerty, 38 in which the issue before the North Dakota Supreme Court was whether the North Dakota Attorney General would be allowed to employ private counsel on a contingent-fee basis. The court held that contingent-fee contracts would be allowed, “unless such agreements are specifically prohibited by statute.” 39 <br />
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<br />
In the footnote, the court stated that certain statutory language (“compensation must be paid out of the funds appropriated therefor”) prevented payment of attorney fees from funds appropriated for a different purpose. 40 The North Dakota court did not address the issues before us today. <br />
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E. In Re Hood <br />
<br />
The Langston Firm cites this Court's holding in In Re Hood, 41 but then says that “[f]or purposes of this appeal, the holding in In Re Hood is neither remarkable nor relevant.” We agree. <br />
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F. Pursue Energy <br />
<br />
Next, Langston argues that this Court's holding in Pursue Energy Corp. v. Mississippi State Tax Commission 42 “supports Retained Counsel's position, not that of the Auditor.” We find no support in Pursue Energy for Langston's position. In fact, we find that former Attorney General Mike Moore's method of paying attorney fees to private counsel in Pursue Energy placed Attorney General Hood and Langston on clear notice that — while the Attorney General had authority to hire Langston on a contingent-fee basis — payment of the contingent fee would be subject to legislative appropriation. <br />
<br />
<br />
<br />
In Pursue Energy, then-Attorney General Moore hired outside counsel to help the State Tax Commission assess and collect taxes from various entities, including Pursue Energy Corporation. 43 Pursue Energy challenged the retention agreement, arguing that it created a conflict of interest because it provided for the outside counsel to collect tax revenue on a contingent basis. 44 <br />
<br />
<br />
<br />
Attorney General Moore — speaking on behalf of all parties to the contingent-fee contract — clarified by affidavit the terms of the retention agreement, stating that <br />
<br />
<br />
<br />
it was understood by all that [the attorney]would not be paid out of any tax moneys recovered. Instead, it was contemplated that if recovery was had, the Attorney General would apply to the Legislature for an appropriation to pay the firm an amount to be measured by the terms of the retention agreement. 45<br />
<br />
In other words, the full amount recovered would be paid over to the State, and the attorneys would be paid by separate funds appropriated by the Legislature. Nevertheless, Pursue Energy argued the retention agreement was invalid. <br />
<br />
<br />
<br />
For several reasons, we rejected Pursue Energy's argument. First, we stated that Section 7-5-7 “places no restrictions upon the type of fee the Attorney General can negotiate ....” 46 Next, we stated that the agreement did not create a conflict of interest because “[n]o ... divergence of interest exists in the case sub judice.” Finally — and more on point to the issue in this case — we stated: <br />
<br />
<br />
<br />
Even more compelling is the freedom provided the Legislature in the instant case who could independently determine the fee payable to [the attorney] for the service, even to the extent that it could refuse to pay. 47<br />
<br />
In an attempt to characterize Pursue Energy as supportive of its arguments, the Langston Firm states: <br />
<br />
<br />
<br />
This Court's holding in Pursue Energy makes clear that the Legislature's right to appropriate a contingency fee would not have been available in the absence of the subsequent modification of the retention agreement. Otherwise, the modification would not have been necessary.<br />
<br />
As its only support for this statement, the Langston Firm cites the excerpt from Attorney General Moore's affidavit filed in Pursue Energy, quoted above. We fail to see how this language provides any support for Langston's arguments. <br />
<br />
<br />
<br />
First, the language — although indeed found in the Pursue Energy opinion — is not this Court's language, but rather was a quote from Attorney General Moore's affidavit. So it is of no value in drawing any conclusion as to what would have happened, had there been no modification. <br />
<br />
<br />
<br />
Second, we disagree with the Langston Firm as to the significance of the language. Outside counsel in Pursue Energy were to be paid by legislative appropriation, in compliance with Section 7-5-7. And in holding that the contingent-fee agreement was not illegal, we said: <br />
<br />
<br />
<br />
Sections 7-5-5 and 7-5-7 ... governing the compensation of special counsel and investigators to the attorney general, permit payment on a fee, contract, or salary basis so long as payment is from the Attorney General's contingent fund or from other funds appropriated to the Attorney General's office. 48<br />
<br />
Finally, we note that much of the discussion about contingent-fee agreements has little relevance in this case because Langston did not receive a contingent fee. While there was a contingency-fee agreement, both Langston and the Attorney General tell us its terms were not followed, and the fees were negotiated between Langston and MCI, with the State taking no part. So for all these reasons, Pursue Energy provides no support for the Langston Firm's arguments. Instead, it clearly sets forth the law we follow today. <br />
<br />
<br />
<br />
III. Section 7-5-5 <br />
<br />
The Attorney General argues that, even if the $14 million was public funds, MCI's direct payment to Langston was proper, because Section 7-5-5 does not restrict his authority to enter into contingent-fee agreements; it empowers him to retain special assistant attorneys general on a fee or contract basis, and it establishes the Attorney General as the sole judge of compensation for such assistants. We find several problems with this argument. <br />
<br />
<br />
<br />
Contingent Fee? <br />
<br />
First, while we agree that the Attorney General may enter into contingent-fee agreements with private counsel, the $14 million paid to Langston in this case was not a contingent fee, but rather was a negotiated fee. And, according to the Attorney General's own representations to this Court, he was not “the sole judge” of the compensation. Indeed, the Attorney General tells us he had no involvement in deciding the fee. <br />
<br />
<br />
<br />
Although the Attorney General and Langston did sign a contingent-fee agreement, Langston was instructed to negotiate attorney fees with MCI. In fact, in a letter responding to the Auditor's findings, the Attorney General — referring to the attorney-fee negotiation — stated: “I told the attorneys that this was a matter between them and [MCI] ....” <br />
<br />
<br />
<br />
So as it turned out, the Attorney General was not the sole judge of Langston's compensation — MCI was. And since Langston was not paid on a contingent-fee basis, but rather was paid a negotiated fee by MCI, neither the Attorney General's authority to enter into contingent-fee agreements, nor his authority to judge the compensation, is at issue in this case. <br />
<br />
<br />
<br />
“Primarily To Defending” <br />
<br />
We also note that Section 7-5-5 empowers the Attorney General to employ three assistants to “devote their time and attention primarily to defending and aiding in the defense in all courts of any suit, filed or threatened, against the State,” and “[w]hen circumstances permit, such assistants [the ones hired primarily to defend] may perform any of the attorney general's powers and duties,” and <br />
<br />
<br />
<br />
[t]o further prosecute and insure such purposes, the attorney general is ... authorized ... to employ such additional counsel as special assistant attorneys general ... on a fee or contract basis; and the attorney general shall be the sole judge of the compensation in such cases. 49<br />
<br />
This section addresses the Attorney General's authority to employ assistants who “devote their time and attention primarily to defending and aiding in the defense” of the State of Mississippi. If the Attorney General's Retention Agreement with Langston included the duty “primarily to defending” or “aid[ing] in the defense of” the State, we are unable to discern it. The next section, Section 7-5-7 (discussed below), addresses the Attorney General's authority to employ assistants “to assist the attorney general in the preparation for, prosecution, or defense of any litigation ....” 50 <br />
<br />
<br />
<br />
Pursue Energy: Section 7-5-5 Subject To Legislative Appropriation <br />
<br />
In Pursue Energy, this Court addressed this very issue by stating: <br />
<br />
<br />
<br />
Sections 7-5-5 and 7-5-7 ... governing the compensation of special counsel and investigators to the attorney general, permit payment on a fee, contract, or salary basis so long as payment is from the Attorney General's contingent fund or from other funds appropriated to the Attorney General's office. 51<br />
<br />
The Pursue Energy Court's statement could not have been more clear. The restriction on sources from which the Attorney General is authorized to pay special counsel — whether employed under Section 7-5-5 or Section 7-5-7 — applies, regardless of the fee arrangement. <br />
<br />
<br />
<br />
Section 100 of the Mississippi Constitution <br />
<br />
Even if Section 7-5-5 did apply exactly as the Attorney General claims, a statute cannot trump the Mississippi Constitution. We find no exception to Section 100's requirement that all obligations and liabilities due the State must be paid into “the proper treasury,” 52 nor does any statute provide an additional fund from which the attorneys might be paid. The Legislature constitutionally may permit the Attorney General to compromise doubtful claims. But, once the claim is settled, and the amount due is determined and agreed through compromise, the claim and debt become liquidated, and full payment of the amount due must be made into the proper State treasury. Section 100 clearly provides that, in order to extinguish the debt, payment of the full amount due must be made into the proper treasury. Justice King, in his dissent, misreads our concern. The issue here is not whether the Legislature diminished the debt, but rather that less than the full amount due was paid into a proper state treasury. <br />
<br />
<br />
<br />
IV. Waiver <br />
<br />
The next issue we must address is whether the Auditor waived the State's claim to the $14 million. Langston claims that, even if the $14 was public funds subject to Section 7-57' s restrictions, the Auditor waived his right to pursue the claim. <br />
<br />
<br />
<br />
The state-court action that resulted in this appeal unfolded parallel to a bankruptcy-court action in New York, in which the Langston Firm requested a declaratory judgment that the State Auditor had waived (or was estopped from asserting) his right to challenge the settlement. The bankruptcy court held that the Auditor's attempt to recoup the payment was not a challenge to the settlement agreement, that the Auditor couldn't have challenged the agreement anyway, because the State already was represented in the proceeding by the Attorney General, and that the Auditor's claims were strictly Mississippi state-law claims. And, after the Langston Firm removed this case to federal court, the district judge remanded for the same reason. <br />
<br />
<br />
<br />
So, whatever law governs waiver and estoppel of creditor claims in a bankruptcy case, that law is inapposite here. The State Auditor is not challenging the settlement itself, but the Langston Firm's receipt of money in violation of Section 7-5-7. The Auditor is asserting his authority under Section 7-7-211(g) to recover misappropriated public funds; he is not asserting a right as a creditor in a bankruptcy proceeding. The bankruptcy cases cited by Langston are irrelevant to the issue of whether the Auditor waived his right to proceed under Section 7-7-211(g). <br />
<br />
<br />
<br />
Turning then to the waiver claim, our law is well-settled: <br />
<br />
<br />
<br />
Waiver presupposes full knowledge of a right existing, and an intentional surrender or relinquishment of that right. It contemplates something done designedly or knowingly, which modifies or changes existing rights or varies or changes the terms and conditions of a contract. It is the voluntary surrender of a right. To establish a waiver, there must be shown an act or omission on the part of the one charged with the waiver fairly evidencing an intention permanently to surrender the right alleged to have been waived. 53<br />
<br />
Here, the only conduct alleged to constitute waiver was the State Auditor's decision to wait thirty months before seeking recovery of the $14 million fee payment. But the Attorney General notes that the State Auditor launched an investigation into the settlement less than two months after the State memorialized the Settlement Agreement with MCI. The Auditor released an initial audit draft report in October 2005, a second draft report in November 2005, and a third in September 2006 — the latter being the first to question the legality of the fee payment. The third report was finalized in October 2006, and the Auditor demanded the Langston Firm repay the fee payment. The Langston Firm refused the demand in April 2007 and sued the Auditor in New York Bankruptcy Court in September 2007. The Auditor filed this state-court suit in December 2007. <br />
<br />
<br />
<br />
It is difficult to imagine how this undisputed course of conduct could constitute an “omission ... fairly evidencing an intention permanently to surrender the right ....” The Auditor began to investigate almost immediately, and he has actively pursued the case to this point. Because neither Langston nor the circuit court cited any authority for the proposition that waiver can be implied in this situation, we reverse the circuit court and hold that the State Auditor did not waive his right to proceed under Section 7-7-211(g). <br />
<br />
<br />
<br />
CONCLUSION <br />
<br />
The plain language of Section 7-5-7 mandates that outside counsel retained by the Attorney General be paid only from the Attorney General's “contingent fund,” or from funds appropriated to the Attorney General by the Legislature. This Court so held in Pursue Energy. 54 But the parties bypassed the State treasury by agreeing that MCI would send part of its tax payment directly to the lawyers to pay attorney fees. <br />
<br />
<br />
<br />
Because the $14 million Langston received was part of MCI's payment of its tax obligations, that money constitutes “public funds” for the purposes of the Auditor's statutory authority to recover misappropriated public funds. Article Four, Section 100, of the Mississippi Constitution requires that those funds be deposited in the proper public treasury. <br />
<br />
<br />
<br />
And neither the Attorney General nor the Langston Firm provided sufficient evidence to establish that the Auditor waived the State's claim to the funds. We therefore reverse the circuit court's judgment and remand this matter for disposition consistent with this opinion. <br />
<br />
<br />
<br />
REVERSED AND REMANDED. <br />
<br />
<br />
<br />
WALLER, C.J., RANDOLPH, LAMAR AND PIERCE, JJ., CONCUR. PIERCE, J., SPECIALLY CONCURS WITH SEPARATE WRITTEN OPINION <br />
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<br />
JOINED BY WALLER, C.J., DICKINSON, P.J., RANDOLPH AND LAMAR, JJ. KING, J., CONCURS IN PART AND DISSENTS IN PART WITH SEPARATE WRITTEN OPINION JOINED BY KITCHENS AND CHANDLER, JJ. CARLSON, P.J., NOT PARTICIPATING. <br />
<br />
<br />
<br />
Concurring Opinion <br />
<br />
PIERCE, JUSTICE, SPECIALLY CONCURRING: <br />
<br />
<br />
<br />
No one disputes the authority of the Attorney General to enter into a contingency-fee contract with outside counsel to assist in the prosecution of the claim, which is the subject of this lawsuit. No one has challenged the reasonableness of the amount of attorney fees involved, nor the right of Retained Counsel to be paid. Further, no one has challenged the right of the Attorney General to deposit settlement funds into his contingent fund and pay Retained Counsel therefrom. The only question currently before this Court is whether fees paid to outside counsel were public funds. I agree with the majority that said funds were indeed public funds. <br />
<br />
<br />
<br />
I also agree with the majority that Retained Counsel can be paid only from funds appropriated to the Attorney General's office by the Legislature or through the Attorney General's contingent fund. It must be so, because a reading of the law can lead only to that conclusion. Furthermore, any public funds must be subject to audit. The auditor must be able to verify payment and determine, for example, if costs associated with litigation appear reasonable. <br />
<br />
<br />
<br />
Had the Attorney General paid outside counsel using his contingent fund, we would not be here. The Attorney General did not. And that is why we are here. <br />
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<br />
WALLER, C.J., DICKINSON, P.J., RANDOLPH AND LAMAR, JJ., JOIN THIS OPINION. <br />
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<br />
KING, JUSTICE, CONCURRING IN PART AND DISSENTING IN PART: <br />
<br />
<br />
<br />
With appropriate respect for the Majority, I concur in part and dissent in part. I join the Majority in holding that all of the funds in question were paid in settlement of MCI's tax liability to the State of Mississippi, and therefore are indeed public funds. The term “public funds” is defined as “all funds which are received, collected by, or available for the support of or expenditure by any state department, institution or agency, whether such funds be derived from taxes or from fees collected by such state department, institution or agency or from some other source.” Miss. Code Ann. § 7-7-1 (Rev. 2002). <br />
<br />
<br />
<br />
MCI was alleged to have an unpaid tax liability to the State of Mississippi of $1billion. In an effort to obtain payment of that tax liability, Mississippi Attorney General Jim Hood, under the authority granted to him in Mississippi Code Section 7-5-7 (Rev. 2002), executed a written retention agreement with the Langston Law Firm to recover those unpaid taxes. That retention agreement in all respects met the legal requirements for a valid contract and is, therefore, entitled to be honored. <br />
<br />
<br />
<br />
A valid contract must have: (1) two or more contracting parties, (2) consideration, (3) an agreement that is sufficiently definite, (4) parties with the legal capacity to make a contract, (5) mutual assent, and (6) no legal prohibition precluding contract formation. Rotenberry v. Hooker, 864 So. 2d 266, 270 (Miss. 2003) . Beyond question, those six requirements were met. The retention agreement clearly indicates that Attorney General Hood and the Langston Law Firm agreed that the Langston Law Firm would represent the State in an effort to recover delinquent taxes from WorldCom in exchange for compensation, specifically outlined in a fee schedule, attached to the agreement. The agreement between Attorney General Hood and the Langston Law Firm was a valid and enforceable contract. <br />
<br />
<br />
<br />
In fulfillment of its obligations under that contract, the Langston Law Firm negotiated a written settlement between MCI (previously WorldCom) and the State of Mississippi, acting through Attorney General Hood. In 2005, the settlement agreement was approved in its entirety and entered as a court judgment by the United States Bankruptcy Court, Southern District of New York. <br />
<br />
<br />
<br />
Under the terms of that agreement, as reduced to a court judgment, MCI resolved its tax liability by transferring to the State of Mississippi real property, with the estimated value of $7 million, and paying in cash the total sum of $118.2 million, divided as follows: the State received $100 million, the Langston Law Firm received $14 million and the Children's Justice Center of Mississippi received $4.2 million. The agreement specified that the amounts were paid “to or on behalf of the State.” Based on the language within the agreement, the total $118.2 was to be paid in settlement of MCI's tax liability, and as such, was public funds. Having completed its contractual obligation, the Langston Law Firm is entitled to be compensated for professional services rendered under the contract. <br />
<br />
<br />
<br />
The Majority holds that there are only two ways for the Langston Law Firm to receive payment for its professional services. The Majority states that either there must be a specific legislative appropriation for that purpose or the Attorney General must write a check to the Langston Law Firm from his contingency account. The Majority has relied on Section 7-5-7 in reaching this conclusion. I believe that the Majority's reading of 7-5-7 is overly broad and that it engrafts upon the statute that which is not set forth in it. Absent engrafting upon it, my reading does not lead me to the same conclusion as the Majority in reading Section 7-5-7. 55 <br />
<br />
<br />
<br />
The settlement amount was recovered on behalf on the State of Mississippi as a result of an attorney-client relationship. Therefore, the Langston Law Firm had the right to assert an attorney's lien and retain, from funds within its possession, an appropriate amount of money as compensation for its professional services. This Court consistently has held that a Mississippi attorney may impose a lien entitling the attorney to recover his fee and expenses from the proceeds of the judgment of a case. Tyson v. Moore, 613 So. 2d 817, 827 (Miss. 1992) . A lien is defined to be “a right by the possessor of property to hold it for the satisfaction of some demand.” Stewart v. Flowers, 44 Miss. 513, 514 (1870) . An attorney's lien attaches once that fund is created or once the property itself is finally adjudicated as being the property of the client. Id. The lien applies so long as the attorney has the funds in his possession, and is paramount to any other claim. Collins v. Schneider, 192 So. 20, 22 (Miss. 1939) . Once the money from a judgment has come into the attorney's possession, the attorney “may retain it to the amount of his bill.” Stewart, 44 Miss. at 514 . <br />
<br />
<br />
<br />
The Majority opinion suggests that the common-law concept of attorney's lien was modified by the Legislature in Mississippi Code Section 7-5-7. There is no language within the statute which alters the right to claim an attorney's lien or which can be read to suggest that the Langston Law Firm was not entitled to assert an attorney's lien against the settlement proceeds which it obtained by its professional services. The statute makes absolutely no reference, or modification, to an attorney's lien, the attorney's right to be paid for professional services, or its superior priority. Because there was a valid employment contract, the Langston Law Firm was entitled to payment of its contractual fee from the settlement. As soon as the settlement agreement was finalized, and judgment entered by the United States Bankruptcy Court, $14 million was paid by MCI, on behalf of the State, directly to the Langston Law Firm. Once the money was in its possession, the Langston Law Firm was entitled to retain any earned and undisputed fee. <br />
<br />
<br />
<br />
The Majority suggests that the Langston Law Firm could not assert a lien because it did not hold the funds in a separate trust account pursuant to Mississippi Rule of Professional Conduct 1.15(a). 56 The rule also specifically states that a lawyer may disburse any portion of a client's property that is not in dispute. See M.R.P.C. 1.15(c). 57 When the Langston Law Firm received the $14 million, there was no dispute as to the amount owed to the Langston Law Firm for professional services, and thus, the disbursement was permissible. Therefore, the Langston Law Firm was entitled to retain the money received from MCI as earned and undisputed fees for its professional services. <br />
<br />
<br />
<br />
Because Section 7-5-7 does not alter the law related to an attorney's fee lien, I disagree with the Majority's holding that Article Four, Section 100 of the Mississippi Constitution prohibits the payment made directly to the Langston Law Firm. I disagree with the Majority's interpretation and application. Section 100 states: <br />
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<br />
<br />
No obligation or liability of any person, association, or corporation held or owned by this state, or levee board, or any county, city, or town thereof, shall ever be remitted, released or postponed, or in any way diminished by the legislature, nor shall such liability or obligation be extinguished except by payment thereof into the proper treasury; nor shall such liability or obligation be exchanged or transferred except upon payment of its face value; but this shall not be construed to prevent the legislature from providing by general law for the compromise of doubtful claims.<br />
<br />
Miss. Const. art. 4, § 100 (1890). <br />
<br />
<br />
<br />
Section 100 specifically prohibits the Legislature from diminishing a tax obligation owed to the State. In the case before us, the action is not a legislative action, but is instead a court judgment. See In re Worldcom, Inc., Case No. 02-13533 (Bankr. S.D. N.Y., May 13, 2005) . Additionally, the payment by MCI did not serve to reduce the tax liability of MCI. The agreed tax liability was the same, $118.2 million plus the value of the real estate. Rather than diminish its tax liability, the payment transmitted a portion of the settlement proceeds to the State's attorneys for the benefit of the State. <br />
<br />
<br />
<br />
Beyond question, the better approach would have been to submit all of the settlement proceeds to the Attorney General, have him to deposit those settlement proceeds into his contingency account, and then write a check to Langston Law Firm for the fees earned for professional services. However that did not happen. To now require: (1) the Langston Law Firm to write a check to the Attorney General for $14 million, (2) the Attorney General to deposit that $14 million check into his contingency fund account, and (3) the Attorney General to write a $14 million check to the Langston Law Firm from his contingency account would, at best, be an inefficient and totally symbolic gesture. <br />
<br />
<br />
<br />
While disagreeing with the trial court's reasoning, I agree with its result and would therefore, affirm its actions. This Court consistently has held that when a trial court reaches the right result, but for the wrong reason, it should be affirmed. See Denham v. Holmes, 60 So. 3d 773, 789 (¶59) (Miss. 2011) . <br />
<br />
<br />
<br />
KITCHENS AND CHANDLER, JJ., JOIN THIS OPINION. <br />
<br />
1<br />
<br />
<br />
<br />
<br />
<br />
Miss. Code Ann. § 7-5-7 (Rev. 2002). <br />
<br />
2<br />
<br />
<br />
<br />
Miss. Const. art. 4, § 100 (1890). <br />
<br />
3<br />
<br />
<br />
<br />
Langston Law Firm v. Mississippi, 410 B.R. 150, 153 (S.D.N.Y. 2008) . <br />
<br />
4<br />
<br />
<br />
<br />
Id. at 157. <br />
<br />
5<br />
<br />
<br />
<br />
Miss. Code Ann. § 7-5-7 (Rev. 2002). <br />
<br />
6<br />
<br />
<br />
<br />
Franklin v. Franklin, 858 So. 2d 110, 115 (Miss. 2003) . <br />
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7<br />
<br />
<br />
<br />
Arceo v. Tolliver, 19 So. 3d 67, 70 (Miss. 2009) (citing Powe v. Byrd, 892 So. 2d 223, 227 (Miss. 2004) ) (questions of law); Sheppard v. Miss. State Highway Patrol, 693 So. 2d 1326, 1328 (Miss. 1997) (statutory interpretation). <br />
<br />
8<br />
<br />
<br />
<br />
See, e.g., B.C. Rogers Poultry, Inc. v. Wedgeport, 911 So. 2d 483, 490 (Miss. 2005) (“the parol evidence rule ... precludes the enforcement of inconsistent or prior agreements in a finalized contract”). <br />
<br />
9<br />
<br />
<br />
<br />
Collins v. Schneider, 192 So. 20, 22 (Miss. 1939) . <br />
<br />
10<br />
<br />
<br />
<br />
Halsell v. Turner, 36 So. 531 (Miss. 1904) (holding attorney has a lien on client funds in attorney's possession). <br />
<br />
11<br />
<br />
<br />
<br />
Quoting the definition of “public funds” from Section 7-7-1. <br />
<br />
12<br />
<br />
<br />
<br />
See, e.g., Robinson Prop. Group, Ltd. P'ship v. McCalman, 51 So. 3d 946, 953 (Miss. 2011) (citing Read v. So. Pine Elec. Power Ass'n, 515 So. 2d 916, 921 (Miss. 1987) ; Burk v. State, 506 So. 2d 993 (Miss. 1987) ; Simpson v. State, 497 So. 2d 424 (Miss. 1986) ; Bonderer v. Robinson, 502 So. 2d 314 (Miss. 1986) ). <br />
<br />
13<br />
<br />
<br />
<br />
Black's Law Dictionary 767 (abr. 8th ed. 2004). <br />
<br />
14<br />
<br />
<br />
<br />
Miss. R. Prof'l Conduct 1.15. <br />
<br />
15<br />
<br />
<br />
<br />
Miss. Code Ann. § 7-5-7 (Rev. 2002). <br />
<br />
16<br />
<br />
<br />
<br />
Id. (emphasis added). <br />
<br />
17<br />
<br />
<br />
<br />
Miss. Code Ann. § 27-75-15 (Rev. 2010) (emphasis added). <br />
<br />
18<br />
<br />
<br />
<br />
Miss. Const. art. 4, § 100 (emphasis added). <br />
<br />
19<br />
<br />
<br />
<br />
Pan Am. Petroleum Corp. v. Gully, 175 So. 185, 189 (Miss. 1937) . <br />
<br />
20<br />
<br />
<br />
<br />
Robertson v. Weston Lumber Co., 124 Miss. 606, 87 So. 120, 124 (1921) . <br />
<br />
21<br />
<br />
<br />
<br />
Adams v. Fragiacomo, 15 So. 798, 800 (Miss. 1893) . <br />
<br />
22<br />
<br />
<br />
<br />
Black's Law Dictionary (1910). <br />
<br />
23<br />
<br />
<br />
<br />
1892 Miss. Laws ch.126, § 4199, 922. <br />
<br />
24<br />
<br />
<br />
<br />
Hood ex rel. State Tobacco Litigation, 958 So. 2d 790, 812 (Miss. 2007). <br />
<br />
25<br />
<br />
<br />
<br />
Id. (quoting City of Belmont v. Miss. State Tax Comm'n, 860 So. 2d 289, 306-07 (Miss. 2003) (citing Colbert v. State, 39 So. 65, 66 (Miss. 1905) )). <br />
<br />
26<br />
<br />
<br />
<br />
Robertson v. Miller, 109 So. 900 (Miss. 1926) . <br />
<br />
27<br />
<br />
<br />
<br />
Emphasis added by the Attorney General. <br />
<br />
28<br />
<br />
<br />
<br />
(Emphasis added.) <br />
<br />
29<br />
<br />
<br />
<br />
Miss. Code Ann. § 7-7-1 (Rev. 2002). <br />
<br />
30<br />
<br />
<br />
<br />
7 Am. Jur. 2d Attorney General § 5 (2007) (citing State ex rel Nixon v. American Tobacco Co., Inc., 34 S.W.3d 122 (Mo. 2000) ). <br />
<br />
31<br />
<br />
<br />
<br />
Mo. Ann. Stat. § 27.020(3) (West 2000) (emphasis added). <br />
<br />
32<br />
<br />
<br />
<br />
Miss. Code Ann. § 7-5-7 (emphasis added). <br />
<br />
33<br />
<br />
<br />
<br />
People v. Philip Morris, 759 N.E.2d 906, 914 (Ill. 2001) . <br />
<br />
34<br />
<br />
<br />
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770 Ill. Comp. Stat. Ann. 5-1 (West 1998). <br />
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35<br />
<br />
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Miss. Code Ann. § 7-5-7. <br />
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36<br />
<br />
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<br />
Conant v. Robins, Kaplan, Miller & Ciresi, L.L.P., 603 N.W.2d 143, 148 (Minn. Ct. App. 1999) . <br />
<br />
37<br />
<br />
<br />
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Philip Morris Inc. v. Glendening, 709 A.2d 1230, 1240 (Md. 1998) . <br />
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38<br />
<br />
<br />
<br />
State v. Hagerty, 580 N.W. 2d 139 (N.D. 1998) . <br />
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39<br />
<br />
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Id. at 148. <br />
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40<br />
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Id. at 146 n.1 (citing N.D. Cent. Code § 54-12-08). <br />
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41<br />
<br />
<br />
<br />
In Re Hood, 958 So. 2d 790 (Miss. 2007) . <br />
<br />
42<br />
<br />
<br />
<br />
Pursue Energy Corp. v. Miss. State Tax Comm'n, 816 So. 2d 385 (Miss. 2002) . <br />
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43<br />
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Id. at 386-87. <br />
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44<br />
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Id. at 387. <br />
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45<br />
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<br />
Id. (emphasis added). <br />
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46<br />
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Id. at 391. <br />
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47<br />
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Id. at 392. <br />
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48<br />
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Id. at 390 (emphasis added). <br />
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49<br />
<br />
<br />
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Miss. Code Ann. § 7-5-5 (emphasis added). <br />
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50<br />
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Miss. Code Ann. § 7-5-7. <br />
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51<br />
<br />
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Pursue Energy, 816 So. 2d at 390 (emphasis added). <br />
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52<br />
<br />
<br />
<br />
Miss. Const. art. 4, § 100. <br />
<br />
53<br />
<br />
<br />
<br />
Titan Indem. Co. v. Hood, 895 So. 2d 138, 150-51 (Miss. 2004) (emphasis added). <br />
<br />
54<br />
<br />
<br />
<br />
Pursue Energy, 816 So. 2d at 390 . <br />
<br />
55<br />
<br />
<br />
<br />
Mississippi Code Section 7-5-7 states: <br />
<br />
The governor may engage counsel to assist the attorney general in cases to which the state is a party when, in his opinion, the interest of the state requires it, subject to the action of the legislature in providing compensation for such services. <br />
<br />
<br />
<br />
The attorney general is hereby authorized and empowered to appoint and employ special counsel, on a fee or salary basis, to assist the attorney general in the preparation for, prosecution, or defense of any litigation in the state or federal courts or before any federal commission or agency in which the state is a party or has an interest. <br />
<br />
<br />
<br />
The attorney general may designate such special counsel as special assistant attorney general, and may pay such special counsel reasonable compensation to be agreed upon by the attorney general and such special counsel, in no event to exceed recognized bar rates for similar services. <br />
<br />
<br />
<br />
The attorney general may also employ special investigators on a per diem or salary basis, to be agreed upon at the time of employment, for the purpose of interviewing witnesses, ascertaining facts, or rendering any other services that may be needed by the attorney general in the preparation for and prosecution of suits by or against the state of Mississippi, or in suits in which the attorney general is participating on account of same being of statewide interest. <br />
<br />
<br />
<br />
The attorney general may pay travel and other expenses of employees and appointees made hereunder in the same manner and amount as authorized by law for the payment of travel and expenses of state employees and officials. <br />
<br />
<br />
<br />
The compensation of appointees and employees made hereunder shall be paid out of the attorney general's contingent fund, or out of any other funds appropriated to the attorney general's office. <br />
<br />
56<br />
<br />
<br />
<br />
<br />
<br />
Mississippi Rule of Professional Conduct 1.15(a) states: <br />
<br />
A lawyer shall hold clients' and third persons' property separate from the lawyer's own property. Funds shall be kept in a separate trust account maintained in the state where the lawyer's office is situated, or elsewhere with the consent of the client or third person. Other property shall be identified as such and appropriately safeguarded. Complete records of such trust account funds and other property shall be kept and preserved by the lawyer for a period of seven years after termination of the representation. <br />
<br />
57<br />
<br />
<br />
<br />
<br />
<br />
Mississippi Rule of Professional Conduct 1.15(c) states: <br />
<br />
When a lawyer is in possession of property in which both the lawyer and another person claim an interest, the property shall be kept separate by the lawyer until completion of an accounting and severance of their respective interests. If a dispute arises concerning their respective interests, the lawyer shall disburse the portion not in dispute, and keep separate the portion in dispute until the dispute is resolved. <br />
<br />
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<br />
<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-79756909546957370382012-08-09T21:24:00.001-04:002012-08-09T21:24:33.442-04:00DependencyPrincess G. McLeod v. Commissioner, TC Summary Opinion 2012-75 <br />
<br />
<br />
<br />
<br />
PRINCESS G. MCLEOD, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent . <br />
<br />
Case Information: Code Sec(s): <br />
<br />
Docket: Docket No. 11692-10S. <br />
<br />
Date Issued: 07/30/2012 <br />
<br />
Reference(s): Code Sec. 152 ; Code Sec. 24 ; Code Sec. 2 ; Code Sec. 32 <br />
<br />
<br />
<br />
<br />
<br />
Syllabus <br />
<br />
Official Tax Court Syllabus<br />
<br />
Counsel <br />
<br />
Caroline Delisle Ciraolo and Brandon N. Mourges, for petitioner.<br />
<br />
Michael A. Raiken and Nancy M. Gilmore, for respondent.<br />
<br />
<br />
<br />
SUMMARY OPINION<br />
<br />
PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.<br />
<br />
<br />
<br />
DEAN, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect when the petition was filed. Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code (Code) in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. <br />
<br />
<br />
<br />
Respondent determined a deficiency of $4,824 in petitioner's Federal income tax for 2008. The issues for decision are whether petitioner is entitled to: (1) a dependency exemption deduction; (2) head of household filing status; (3) the child tax credit (CTC); (4) the additional CTC; and (5) the earned income credit (EIC). <br />
<br />
<br />
<br />
Background<br />
<br />
Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by reference. Petitioner resided in Maryland when the petition was filed. <br />
<br />
<br />
<br />
During 2008 petitioner and her then boyfriend Wayne Smith 1 lived together at<br />
<br />
<br />
<br />
Mr. Smith's sister's house. On a Friday in May 2008 Kendra Sumpter left her biological daughter K.S. 2 with Mr. Smith for the weekend. At the time Mr. Smith believed K.S. was his biological daughter. <br />
<br />
<br />
<br />
Several days passed, and K.S. continued to stay with Mr. Smith and petitioner at Mr. Smith's sister's house. When after several weeks Ms. Sumpter did not return for K.S., petitioner and Mr. Smith began to look for new living arrangements for the three of them. <br />
<br />
<br />
<br />
Petitioner and Mr. Smith found suitable accommodations—a two-bedroom, two-bathroom apartment with rent of $800 a month. When Ms. Sumpter left K.S. with Mr. Smith and petitioner, she did not leave her with anything but the clothes on her back. Petitioner and Mr. Smith busied themselves with taking care of K.S. and providing a home for the three of them. 3 They purchased clothing, food, bedding, and school supplies for K.S.; they also paid for medical care and enrolled her in school. <br />
<br />
<br />
<br />
Mr. Smith was unemployed in 2008 and received Social Security benefits of $304 a month and Supplemental Security Income of $353 a month. Petitioner was employed and received wage income of $15,271 for 2008. Mr. Smith also received for a period near the end of 2008 cash assistance of $200 a month, food stamps of $130 a month, and medical assistance from the State of Maryland. <br />
<br />
<br />
<br />
Ms. Sumpter did not return for K.S. until July 2008. She was accompanied by two men and attempted to forcibly remove K.S. from petitioner and Mr. Smith's apartment. <br />
<br />
<br />
<br />
This is when the Maryland courts entered the tableau. Mr. Smith filed for a protective order against Ms. Sumpter. In July 2008 Mr. Smith filed for custody of K.S. Petitioner was a witness in the custody proceedings and testified that she and Mr. Smith contributed financially to the care of K.S. In January 2009 the Circuit Court for Baltimore City (circuit court) granted Mr. Smith temporary sole physical custody and temporary sole legal custody of K.S., ordered Ms. Sumpter to pay child support, and ordered Mr. Smith and Ms. Sumpter to appear with K.S. for a DNA test on February 12, 2009. The DNA test results excluded Mr. Smith from being K.S.'s biological father. In April 2009 the circuit court issued an order vacating its January 2009 temporary custody order, and K.S. was returned to the custody of Ms. Sumpter. <br />
<br />
<br />
<br />
Petitioner timely filed a Form 1040, U.S. Individual Income Tax Return, for 2008. At the time she filed her return, Mr. Smith still believed he was K.S.'s biological father. Petitioner reported her filing status as head of household. She claimed a dependency exemption deduction for K.S. and reported that K.S. was her niece. She also claimed the CTC, the additional CTC, and the EIC. <br />
<br />
<br />
<br />
Respondent issued petitioner a notice of deficiency for 2008 in which he changed petitioner's filing status to single and disallowed the dependency exemption deduction, the CTC, the additional CTC, and the EIC. <br />
<br />
<br />
<br />
Discussion<br />
<br />
Generally, the Commissioner's determinations are presumed correct, and the taxpayer bears the burden of proving that those determinations are erroneous. Rule 142(a); see INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 [69 AFTR 2d 92-694] (1992); Welch v. Helvering, 290 U.S. 111, 115 [12 AFTR 1456] (1933). Deductions and credits are a matter of legislative grace, and the taxpayer bears the burden of proving that he or she is entitled to any deduction or credit claimed. Rule 142(a);Deputy v. du Pont, 308 U.S. 488, 493 [23 AFTR 808] (1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 [13 AFTR 1180] (1934). <br />
<br />
<br />
<br />
In some cases the burden of proof with respect to relevant factual issues may shift to the Commissioner under section 7491(a). The issues for decision in this case are legal issues; therefore, the Court need not decide who bears the burden of proof. <br />
<br />
<br />
<br />
I. Dependency Exemption Deduction The dependency exemption deduction is the threshold issue here because the Court's decision concerning this issue affects petitioner's filing status and entitlement to the credits claimed for 2008. <br />
<br />
<br />
<br />
The Code allows a deduction for the exemption amount for each individual who is a dependent (as defined in section 152) of the taxpayer for the taxable year. Sec. 151(c). Section 152(a) defines “dependent” as a qualifying child or a qualifying relative. <br />
<br />
<br />
<br />
A. Qualifying Child<br />
<br />
<br />
<br />
Section 152(c)(1) provides that a qualifying child is an individual who bears a defined relationship to the taxpayer, who has the same principal place of abode as the taxpayer for more than one-half of such taxable year, who meets certain age requirements, and who has not provided over one-half of such individual's own support for the calendar year in which the taxable year of the taxpayer begins. <br />
<br />
<br />
<br />
An individual bears a relationship to the taxpayer if, among other possibilities, the individual is the taxpayer's child. Sec. 152(c)(2)(A). The term “child” includes an individual who is an eligible foster child of the taxpayer. Sec. 152(f)(1)(A)(ii). The term “eligible foster child” for the purposes of subparagraph (A)(ii) means an individual who is placedwith the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction. Sec. 152(f)(1)(C). <br />
<br />
<br />
<br />
Petitioner argues that K.S. qualifies as an eligible foster child for 2008 because she was “placed with” petitioner by an order of a court of competent jurisdiction—the circuit court—and because she meets the “spirit of the law”. <br />
<br />
<br />
<br />
Petitioner and Mr. Smith were not married at the time he was given custody of K.S. Petitioner's name does not appear on any of the custody documents. The complaint for child support and medical insurance, the temporary custody order, the consent judgment for child support, the earnings withholding order, the health insurance withholding order, and the order dismissing the countercomplaint for custody all list Mr. Smith as the sole plaintiff and Ms. Sumpter as the sole defendant. The circuit court awarded sole temporary physical custody and sole legal custody to Mr. Smith. At any time during 2008, had Mr. Smith taken K.S. to live elsewhere, petitioner would have had no legal rights to custody of or visitation with K.S. K.S. was never “placed with the taxpayer” by a court of competent jurisdiction as required for petitioner to be allowed to claim her as an eligible foster child. <br />
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Petitioner also relies on the definition of “foster child” in section 1.152- 2(c)(4), Income Tax Regs., which states: <br />
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<br />
For purposes of determining the existence of any of the relationships<br />
<br />
specified in section 152(a) or (b)(1), a foster child of an individual<br />
<br />
(if such foster child satisfies the requirements set forth in paragraph<br />
<br />
(b) of § 1.152-1 with respect to such individual) shall, for taxable<br />
<br />
years beginning after December 31, 1969, be treated as a child of<br />
<br />
such individual by blood. For purposes of this subparagraph, a foster<br />
<br />
child is a child who is in the care of a person or persons (other than<br />
<br />
the parents or adopted parents of the child) who care for the child as<br />
<br />
their own child. Status as a foster child is not dependent upon or<br />
<br />
affected by the circumstances under which the child became a<br />
<br />
member of the household.<br />
<br />
The pertinent phrase here is "if such foster child satisfies the requirements <br />
<br />
set forth<br />
<br />
in paragraph (b) of § 1.152-1 with respect to such individual". Under <br />
<br />
section 1.152-<br />
<br />
1(b), Income Tax Regs., to meet the relationship test an individual must live <br />
<br />
with the<br />
<br />
taxpayer and be a member of the taxpayer's household during theentire taxable<br />
<br />
year. There are also special circumstances not pertinent here where a <br />
<br />
taxpayer and<br />
<br />
the dependent will be considered as occupying the same household for the <br />
<br />
entire<br />
<br />
taxable year notwithstanding certain temporary absences. Id.<br />
<br />
K.S. began residing with Mr. Smith and petitioner in May 2008. She lived with Ms. Sumpter for the first four months of 2008. Mr. Smith saw K.S. at irregular intervals and at the whim of Ms. Sumpter during the first four months of 2008. There was no custody agreement in place at that time dictating where and with whom K.S. was to reside. K.S. was not temporarily absent from and therefore not a member of petitioner's household for the entire taxable year, making the rest of the definition of a foster child in section 1.152-2(c)(4), Income Tax Regs., inapplicable to petitioner's argument. <br />
<br />
<br />
<br />
K.S. is not related to petitioner as an eligible foster child, and, therefore, is not petitioner's qualifying child. <br />
<br />
<br />
<br />
B. Qualifying Relative<br />
<br />
<br />
<br />
Although K.S. is not petitioner's qualifying child, the Court must also decide whether K.S. is petitioner's dependent as a qualifying relative. <br />
<br />
<br />
<br />
Section 152(d) defines a “qualifying relative”. A qualifying relative must either satisfy one of the family relationships enumerated in the statute, sec. 152(d)(2)(A)-(G), 4 or be an individual who “for the taxable year of the taxpayer” has the same principal place of abode as the taxpayer and is a member of the taxpayer's household, sec. 152(d)(2)(H). <br />
<br />
<br />
<br />
The regulations issued under section 152 clarify that the individual must live with the taxpayer for the entire taxable year to meet the definition of a qualifying relative. Sec. 1.152-1(b), Income Tax Regs.; 5 see also Von Tersch v. Commissioner, 47 T.C. 415, 422 (1967); Trowbridge v. Commissioner, 30 T.C. 879, 880 (1958), aff'd, 268 F.2d 208 [4 AFTR 2d 5048] (9th Cir. 1959); Golden v. Commissioner, T.C. Memo. 1997-355 [1997 RIA TC Memo ¶97,355]; Douglas v. Commissioner, T.C. Memo. 1994-519 [1994 RIA TC Memo ¶94,519], aff'd without published opinion 86 F.3d 1161 [77 AFTR 2d 96-2338] (9th Cir. 1996). , Although petitioner testified and submitted other evidence to prove that she provided more than one-half of K.S.'s support during 2008, the relative amount of that support is of no legal consequence. K.S. lived with petitioner only from May 2008 through December 2008. Because K.S. lived with petitioner for only eight months in 2008, she is not petitioner's qualifying relative. <br />
<br />
<br />
<br />
The Court concludes that K.S. is neither petitioner's qualifying child nor her qualifying relative. Therefore, K.S. is not petitioner's dependent. Although the Court recognizes petitioner's generosity in caring for K.S. as her own child, petitioner is not entitled to a dependency exemption deduction for K.S. for 2008. <br />
<br />
<br />
<br />
II. Head of Household Filing Status Pertinent here, section 2(b)(1)(A) defines “head of a household” as an unmarried individual who maintains as his or her home a household that constitutes for more than one-half of the taxable year the principal place of abode of either a qualifying child or any other dependent of the taxpayer, if the taxpayer is entitled to a deduction for the dependent under section 151. <br />
<br />
<br />
<br />
The Court finds above that K.S. is not petitioner's qualifying child or qualifying relative. Therefore, petitioner did not have any dependents, and her correct filing status for 2008 was single. <br />
<br />
<br />
<br />
III. CTC and Additional CTC<br />
<br />
<br />
<br />
Subject to limitations based on adjusted gross income, section 24(a) provides a credit with respect to each qualifying child of a taxpayer. A portion of the credit is refundable. Sec. 24(d). The refundable portion of the credit is commonly referred to as the additional child tax credit. Section 24(c)(1) defines the term “qualifying child” as a “qualifying child of the taxpayer (as defined in section 152(c)) who has not attained age 17.”<br />
<br />
<br />
<br />
Petitioner has no qualifying child within the meaning of section 152(c). Therefore, petitioner is not entitled to the CTC or the additional CTC. IV. EIC<br />
<br />
<br />
<br />
Section 32(a)(1) allows an “eligible individual” the EIC against that individual's income tax liability. Section 32(a)(2) provides limitations on the amount of the allowable credit based on certain percentages and amounts (as determined by section 32(b)). Generally, the limitation amount is based on the amount of the taxpayer's earned income and whether the taxpayer has no qualifying children, one qualifying child, or two or more qualifying children, as defined in section 152(c). Sec. 32(a), (b), and (c). <br />
<br />
<br />
<br />
K.S. is not petitioner's qualifying child. Therefore, petitioner is not entitled to the EIC in relation to her under section 32(a)(1). <br />
<br />
<br />
<br />
Individuals without qualifying children, however, may be eligible for the EIC if their earned income is no greater than the phaseout amount the Code permits. Sec. 32(a)(1), (b)(2), (j)(1); see Rowe v. Commissioner, 128 T.C. 13, 15 (2007). Earned income for purposes of the EIC includes wages and net earnings from self- employment. Sec. 32(c)(2); sec. 1.32-2(c)(2), Income Tax Regs. <br />
<br />
<br />
<br />
Rev. Proc. 2007-66, sec. 3.07, 2007-2 C.B. 970, 973, lists the amounts used to determine the EIC for 2008 under section 32(b). The revenue procedure lists the completed phaseout amount as $12,880 for an individual with no qualifying children. Id. The “completed phaseout amount” is the amount of adjusted gross income (or, if greater, earned income) at or above which no credit is allowed. Id. Petitioner's adjusted gross income and earned income both exceeded the phaseout amount of $12,880 for 2008. Accordingly, she is ineligible to claim the EIC under section 32(c)(1)(A)(ii) as an individual without a qualifying child for 2008. <br />
<br />
<br />
<br />
V. Conclusion While the Court commends petitioner for caring for K.S., she does not meet the legal requirements for claiming K.S. as a dependent. Therefore, respondent's determinations to deny petitioner a dependency exemption deduction for K.S., to change petitioner's filing status from head of household to single, to deny petitioner the CTC and additional CTC, and to deny petitioner the EIC for 2008 are sustained. <br />
<br />
<br />
<br />
We have considered all of petitioners' arguments, and, to the extent not addressed herein, we conclude that they are moot, irrelevant, or without merit. <br />
<br />
<br />
<br />
To reflect the foregoing, Decision will be entered for respondent. <br />
<br />
2<br />
<br />
<br />
<br />
<br />
<br />
The Court redacts the names of minor children. See Rule 27(3). <br />
<br />
4<br />
<br />
<br />
<br />
The only one of these family relationships that K.S. could bear to petitioner is her child. The Court has already found that K.S. is not petitioner's eligible foster child and, therefore, not her child. <br />
<br />
5<br />
<br />
<br />
<br />
Sec. 1.152-1(b), Income Tax Regs., references sec. 152(a)(9). Although sec. 1.152-1(b), Income Tax Regs., has not been amended to reflect changes in sec. 152 that were enacted by the Working Families Tax Relief Act of 2004, Pub. L. No. 108-311, sec. 201, 118 Stat. at 1169, the Court notes that the language of former sec. 152(a)(9) has been carried over unchanged in current sec. 152(d)(2)(H). The Court concludes that the regulatory interpretation that “for the taxable year of the taxpayer” (as used in sec. 152(d)(2)(H)) means for the entire taxable year remains in force. <br />
<br />
<br />
<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-87648638430685608302012-08-09T21:19:00.002-04:002012-08-09T21:19:52.558-04:00Gambling lossesFortunato Gonzalez, et ux. v. Commissioner, TC Summary Opinion 2012-78 , Code Sec(s) 61; 165. <br />
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<br />
FORTUNATO GONZALEZ AND MARIA C. GONZALEZ, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent . <br />
<br />
Case Information: Code Sec(s): 61; 165 <br />
<br />
Docket: Docket No. 12759-11S. <br />
<br />
Date Issued: 08/6/2012 <br />
<br />
Judge: Opinion by Panuthos, CSTJ <br />
<br />
Reference(s): Code Sec. 61 ; Code Sec. 165 <br />
<br />
<br />
<br />
<br />
<br />
HEADNOTE <br />
<br />
1. <br />
<br />
<br />
<br />
Reference(s): Code Sec. 61 ; Code Sec. 165 <br />
<br />
<br />
<br />
Syllabus <br />
<br />
Official Tax Court Syllabus<br />
<br />
<br />
<br />
Counsel <br />
<br />
Fortunato Gonzalez and Maria C. Gonzalez, pro sese.<br />
<br />
Thomas Rohall, for respondent.<br />
<br />
<br />
<br />
PANUTHOS, Chief Special Trial Judge<br />
<br />
<br />
<br />
PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.<br />
<br />
<br />
<br />
This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect when the petition was filed. Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case. All section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. <br />
<br />
<br />
<br />
Respondent determined a deficiency of $4,944 with respect to petitioners' Federal income tax for 2009. After concessions, 1 the issue for decision is whether and to what extent petitioners incurred deductible gambling losses. <br />
<br />
<br />
<br />
Background<br />
<br />
Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time the petition was filed, petitioners resided in San Francisco, California. <br />
<br />
<br />
<br />
Fortunato Gonzalez (petitioner) was employed as president of Gonzalez Concrete Co. Petitioners were recreational gamblers. Petitioners played slot machines regularly on weekends at Cache Creek Casino Resort (casino). Petitioners did not maintain formal records of their gambling activities in 2009. Petitioners did not use a casino members club card because they did not trust it for 1 <br />
<br />
<br />
<br />
Petitioners concede receiving unemployment compensation of $908 from the California Employment Development Department. Petitioners also agree that they received other income of $4,058 from Health Net Class Settlement. Finally, petitioners concede receiving gambling winnings of $20,700 from Cache Creek Casino Resort. Petitioners agree that these items are includable as income for 2009. accurate readings. While petitioners did not maintain a diary, a log, or a regular record of their gambling activity, they did retain copies of canceled checks, totaling $29,700, which were negotiated near weekends or holidays. Petitioners cashed these checks to have funds available for gambling activities. <br />
<br />
<br />
<br />
Petitioners received four Forms W-2G, Certain Gambling Winnings, representing winnings of $2,000, $10,000, $2,700, and $6,000, at the casino. <br />
<br />
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Petitioners timely filed a 2009 Form 1040, U.S. Individual Income Tax Return, reporting $34,359 of income earned from wages and $724 from rental activity. Petitioners' return was selected for examination. The Internal Revenue Service (IRS) determined that Forms W-2G provided by the casino reflected gambling income which petitioners failed to report on their 2009 Federal income tax return. <br />
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Discussion<br />
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I. Burden of Proof In general, the Commissioner's determination set forth in a notice of deficiency is presumed correct, and the taxpayer bears the burden of showing that the determination is in error. Rule 142(a);Welch v. Helvering, 290 U.S. 111, 115 [12 AFTR 1456] (1933). The burden of proof with respect to a factual issue may be placed on the Commissioner under section 7491(a) if the taxpayer introduces credible evidence regarding that issue and establishes that the taxpayer complied with the requirements to substantiate items, maintain records, and fully cooperate with the Commissioner's reasonable requests. Sec. 7491(a)(2)(A) and (B). <br />
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Section 7491 does not require the burden of proof to be placed on respondent. Petitioners have neither asserted that the burden of proof should be placed on respondent nor established that they complied with the requirements of section 7491(a). Accordingly, petitioners bear the burden of proof. See 7491(a)(2)(A) and (B). <br />
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II. Gambling Losses Gross income includes all income from whatever source derived, including gambling. See sec. 61; McClanahan v. United States, 292 F.2d 630, 631-632 [8 AFTR 2d 5077] (5th Cir. 1961). In the case of a taxpayer not engaged in the trade or business of gambling, gambling losses are allowable as an itemized deduction, but only to the extent of gains from gambling transactions. Sec. 165(d);McClanahan, 292 F.2d at 632. In order to establish entitlement to a deduction for gambling losses the taxpayer must prove the losses sustained during the taxable year. Mack v. Commissioner, 429 F.2d 182 [26 AFTR 2d 70-5265] (6th Cir. 1970), aff'g T.C. Memo. 1969-26 [¶69,026 PH Memo TC]. <br />
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As a general matter, when gambling winnings of $1,200 or more from a bingo game or slot machine play are paid, the payor is required to inform the IRS of the payments. See Park v. Commissioner, 136 T.C. 569, 574 (2011); sec. 7.6041-1(a), Temporary Income Tax Regs., 42 Fed. Reg. 33286 (June 30, 1977). Petitioners received gambling winnings totaling $20,700, as indicated from the four separate Forms W-2G issued by the casino. Petitioners credibly testified that these winnings were used for further gambling activities during their weekend trips. <br />
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Petitioners attempted to substantiate gambling losses, relying on (1) their general testimony that they lost more money than they won, (2) checks that were cashed regularly so that funds would be available at the casino, and (3) the theory that all gamblers lose money. <br />
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As a general rule, if the trial record provides sufficient evidence that a taxpayer has incurred a deductible expense, but the taxpayer is unable to substantiate adequately the precise amount of the deduction to which he or she is otherwise entitled, the Court may estimate the amount of the deductible expense, bearing heavily against the taxpayer whose inexactitude is of his or her own making and allow the deduction to that extent. Cohan v. Commissioner, 39 F.2d 540, 543 [8 AFTR 10552]- 544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). The Court must have some basis upon which an estimate may be made. Jones v. Commissioner, T.C. Memo. 2011-77 [TC Memo 2011-77] (citing Vanicek v. Commissioner, 85 T.C. at 742-743). <br />
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In Szkircsak v. Commissioner, T.C. Memo. 1980-129 [¶80,129 PH Memo TC], we found that the taxpayer's forthright and candid testimony was corroborated by the fact that many checks were cashed immediately before and during gambling trips. Also, loans and additional cashed checks suggested that the gambling trips met with little success. In Doffin v. Commissioner T.C. Memo. 1991-114 [¶91,114 PH Memo TC], the Court looked to evidence , which indicated that the taxpayer had few assets, little income apart from gambling, and no significant accessions to wealth during the year at issue. In both cases, the Court employed the Cohan rule to estimate the gambling losses. <br />
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Petitioners wrote checks to cash at least once a month for most of the year in issue, and most of the checks were negotiated near weekends and holidays. We are satisfied that at least some of these funds and some of the winnings were used to engage in gambling activities. Taking into account the credible testimony of petitioners, the fact that gambling winnings were used to engage in additional gambling activity, the cashing of checks on the weekends, and the fact that petitioners' disposable income from other sources was otherwise limited, and using our best judgment to reasonably estimate the amount of gambling losses, we allow petitioners a gambling loss of $15,000. Accordingly, petitioners may deduct $15,000 of gambling losses against the $20,700 of gambling winnings. <br />
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To reflect the foregoing, <br />
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Decision will be entered under Rule 155. <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-29897303602687852572012-08-09T21:17:00.001-04:002012-08-09T21:17:43.445-04:00PromotionKENNETH MICHAEL FRANCIS AND SEDEF TARLAN FRANCIS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent . <br />
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Case Information: Code Sec(s): <br />
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Docket: Docket No. 19986-10S. <br />
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Date Issued: 08/8/2012 <br />
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Reference(s): Code Sec. 61 ; Code Sec. 451 ; Code Sec. 6662 ; Code Sec. 7491 <br />
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Syllabus <br />
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Official Tax Court Syllabus<br />
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Counsel <br />
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Kenneth Michael Francis, pro se.<br />
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Mistala G. Merchant and Maggie Stehn (student), for respondent.<br />
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SUMMARY OPINION<br />
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PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.<br />
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ARMEN, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect when the petition was filed. 1 Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case. <br />
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Respondent determined a deficiency in petitioners' 2008 joint Federal income tax of $6,491 and an accuracy-related penalty under section 6662(a) of $1,287. 2 After a concession by petitioners, 3 the issues for decision are: (1) Whether petitioners must include an award of backpay in their gross income for 2008; and (2) whether they are liable for the accuracy-related penalty under section 6662(a). <br />
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Background<br />
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Some of the facts have been stipulated, and they are so found. We incorporate by reference the parties' stipulation of facts and accompanying exhibits. Petitioners resided in the State of California when the petition was filed. <br />
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In 2005 Kenneth Michael Francis (petitioner) was granted an award of backpay by the U.S. Air Force Board for the Correction of Military Records (BCMR). The BCMR held, inter alia, that petitioner was wrongfully denied a promotion to the rank of lieutenant colonel in the U.S. Air Force (promotion denial). <br />
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In December 2008 petitioners received a payment of $24,566 (promotion backpay) from the Defense Finance and Accounting Service (DFAS). 4 The promotion backpay represented the difference between the military pay and allowances petitioner received as an Air Force major and the military pay and allowances he would have received as an Air Force lieutenant colonel while he served on active duty from October 1998 to April 2002. <br />
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In February 2009 petitioner self-prepared and filed petitioners' 2008 joint Federal income tax return (joint return). Petitioners, however, did not report the promotion backpay on their joint return. <br />
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DFAS mailed petitioner a letter dated September 6, 2008 (DFAS letter), that states: “The following are enclosed for your use and information *** Treasury Department Form W-2, Wage and Tax Statement, indicating taxable income that must be reported on your next tax return”. Attached to the DFAS letter was a Form W-2, Wage and Tax Statement, for 2008 reporting the promotion backpay as wages. At trial petitioner testified that petitioners did not receive the DFAS letter and Form W-2 until approximately April 2009 because DFAS had mailed the letter to his mother's address in Illinois (Illinois address). Petitioners were aware, however, that DFAS typically sent tax correspondence to the Illinois address and that the Illinois address was petitioner's “permanent home of record” on file with DFAS. <br />
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In or around April 2009 petitioner began treatment for melanoma and remained in treatment for approximately a year thereafter. Petitioners never filed an amended joint return for 2008 including the promotion backpay in their gross income or otherwise reported the promotion backpay on any other tax return. <br />
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Discussion<br />
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I. Burden of Proof In general, the Commissioner's determinations set forth in a notice of deficiency are presumed to be correct, and the taxpayer bears the burden of proving that those determinations are in error. Rule 142(a);Welch v. Helvering, 290 U.S. 111, 115 [12 AFTR 1456] (1933). Pursuant to section 7491(a), the burden of proof as to factual matters shifts to the Commissioner under certain circumstances. Petitioners have neither alleged that section 7491(a) applies, nor have they established their compliance with its requirements. Accordingly, petitioners bear the burden of proof. See Rule 142(a); Welch v. Helvering, 290 U.S. at 115; cf. sec. 6201(d). 5 <br />
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II. Unreported Income Section 61(a)(1) provides the general rule that gross income includes income from whatever source derived, including compensation for services. Section 451(a) generally provides that taxpayers, such as petitioners, who use the cash receipts and disbursements method of accounting, must include any item of gross income in their gross income for the taxable year in which the item is actually or constructively received. See sec. 1.451-1(a), Income Tax Regs. <br />
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Petitioners generally argue that the promotion backpay received in 2008 should be included in their gross income for the years 1998 through 2002 because the promotion backpay is attributable to the services petitioner provided in those years. Petitioners further contend that the promotion backpay should have been allocated to the years 1998 through 2002 because their taxable income was subject to a lower tax bracket during those years when compared to 2008. In this regard, petitioners believe that by reporting the promotion backpay as taxable wages for 2008 on Form W-2, DFAS has placed an artificial tax burden on them that is contrary to the purpose of the BCMR decision, i.e., to place petitioner in the same position that he would be in if the promotion denial had never occurred. 6 <br />
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The parties do not dispute that DFAS paid, and petitioners actually received, the promotion backpay in 2008. Petitioners have failed to show, and the record does not suggest, that the promotion backpay was constructively received by petitioners in any prior year. Therefore, the promotion backpay is properly includible in petitioners' gross income for 2008. See sec. 451(a); Prewitt v. Commissioner, T.C. Memo. 1995-24 [1995 RIA TC Memo ¶95,024]; sec. 1.451-1(a), Income Tax Regs. <br />
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Petitioners' argument that they should be entitled to retroactively allocate the promotion backpay to their gross income for the years 1998 through 2002 because their tax bracket for that period was lower than their tax bracket for 2008 has been rejected by this Court in the past. See Prewitt v. Commissioner, T.C. Memo. 1995- 24 [1995 RIA TC Memo ¶95,024]. We acknowledge that the purpose of the BCMR decision was to place petitioner in the same situation he would have been in if the promotion denial had never occurred. Although not clear from the record, it may very well be that petitioners would have paid less tax with respect to the promotion backpay if the promotion denial had never occurred. Under the circumstances we can appreciate petitioners' dismay. Nevertheless, we are constrained to apply the law as written by Congress to the facts as they occurred and not as they might have occurred. See Commissioner v. Nat'l Alfalfa Dehydrating & Milling Co. 417 U.S. 134, 148-149 [33 AFTR 2d 74-1347] , (1974). We cannot reallocate the promotion backpay petitioner received in 2008 to prior years simply because doing so might provide favorable tax treatment for petitioners. Therefore, we sustain respondent's deficiency determination. <br />
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III. Accuracy-Related Penalty Respondent determined that petitioners are liable for the accuracy-related penalty under section 6662(a) for a substantial understatement of income tax for the taxable year 2008. <br />
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Section 6662(a) and (b)(2) imposes a penalty equal to 20% of the amount of any underpayment that is due to a substantial understatement of income tax. An individual substantially understates his or her income tax when the reported tax is understated by the greater of 10% of the tax required to be shown on the return or $5,000. Sec. 6662(d)(1)(A). <br />
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With respect to a taxpayer's liability for any penalty, section 7491(c) places on the Commissioner the burden of production, thereby requiring the Commissioner to come forward with sufficient evidence indicating that it is appropriate to impose the penalty. Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). Once the Commissioner meets his burden of production, the taxpayer must come forward with persuasive evidence that the Commissioner's determination is incorrect. See Rule 142(a); Welch v. Helvering, 290 U.S. at 115. <br />
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Respondent has satisfied his burden of production because the record shows that petitioners understated their income tax for 2008 by $6,491, which constitutes a substantial understatement within the meaning of section 6662(d)(1)(A). See Higbee v. Commissioner, 116 T.C. at 446. <br />
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The accuracy-related penalty does not apply to any portion of an underpayment, however, if the taxpayer proves that the taxpayer had reasonable cause for that portion of the underpayment and that the taxpayer acted in good faith with respect to such portion. Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. Petitioners bear the burden of proving that the accuracy-related penalty should not be imposed. See sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at 446. <br />
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The decision as to whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account the pertinent facts and circumstances. See Neely v. Commissioner, 85 T.C. 934, 947-950 (1985). Most important in this decision “is the extent of the taxpayer's effort to assess the taxpayer's proper tax liability.” Sec. 1.6664-4(b)(1), Income Tax Regs. A taxpayer must take reasonable steps to determine and apply the law. Niedringhaus v. Commissioner, 99 T.C. 202, 222 (1992); Campbell v. Commissioner, T.C. Memo. 2001-118 [TC Memo 2001-118]. <br />
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Petitioners contend that they should not be liable for the accuracy-related penalty with respect to the portion of the underpayment attributable to the promotion backpay. 7 Although petitioners admit that they received the promotion backpay in December 2008, they did not report the promotion backpay on their joint return because they believed that the payment was nontaxable. Petitioners, however, presented no evidence that they consulted a tax professional or took any other reasonable steps to ascertain the proper tax treatment of the promotion backpay they received. <br />
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Moreover, although petitioners allege that they did not receive the DFAS letter or the Form W-2 until April 2009, they still did not file an amended joint return or contact a tax professional thereafter. 8 Petitioners admitted at trial that they should have filed an amended return once they received the DFAS letter and Form W-2. Petitioners, however, point to petitioner's yearlong treatment for melanoma beginning in April 2009 as reasonable cause for not filing an amended joint return. Petitioners provided no explanation as to why they did not file an amended joint return once petitioner's treatment for melanoma ended or why petitioner Sedef Tarlan Francis could not have prepared an amended return for petitioner to sign. <br />
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Although the record might support a finding of good faith on petitioners' part, the standard we are obliged to apply also requires the existence of reasonable cause. See sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. Thus, petitioners might have had a good faith belief that the promotion backpay was nontaxable. However, they have failed to prove that they acted with reasonable cause under the relevant facts and circumstances. Therefore, we sustain respondent's determination with respect to the accuracy-related penalty. <br />
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Conclusion<br />
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We have considered all of the arguments advanced bypetitioners, and, to the extent not expressly addressed, we conclude that those arguments do not support a result contrary to our decision herein. <br />
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To give effect to our disposition of the disputed issues as well as petitioners' concession, <br />
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Decision will be entered for respondent. <br />
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Unless otherwise indicated, all subsequent section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. <br />
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2<br />
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All dollar amounts are rounded to the nearest dollar. <br />
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3<br />
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Petitioners concede that they received but failed to report a taxable retirement distribution of $290 on their 2008 joint Federal income tax return. <br />
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5<br />
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We note that petitioners do not allege that sec. 6201(d) applies and do not dispute that they received all $24,566 of the promotion backpay in December 2008 reported on the 2008 Form W-2, Wage and Tax Statement, issued by DFAS. <br />
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7<br />
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As for the portion of the underpayment attributable to the unreported retirement distribution, petitioners make no argument regarding the penalty and are therefore deemed to have conceded that matter. <br />
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8<br />
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Petitioner was aware that DFAS frequently sent tax correspondence to his mother's address in Illinois. Petitioner, however, presented no evidence that he inquired whether his mother received the DFAS letter or Form W-2 before he filed petitioners' joint return in February 2009.Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-55560779795312142012012-08-09T21:09:00.001-04:002012-08-09T21:09:00.604-04:00Horse case lawyerLogene L. Foster, et ux. v. Commissioner, TC Memo 2012-207 , Code Sec(s) 183; 162. <br />
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LOGENE L. FOSTER AND AGNES M. FOSTER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent. <br />
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Case Information: <br />
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Code Sec(s): 183; 162 <br />
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[pg. 1512] Docket: Dkt. No. 3576-10. <br />
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Date Issued: 07/23/2012. <br />
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Judge: Opinion by Cohen, J. <br />
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Tax Year(s): Years 2004, 2005, 2006. <br />
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Disposition: Decision for Taxpayers in part and for Commissioner in part. <br />
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HEADNOTE <br />
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1. Activities not-for-profit—deductions and losses—horse breeding activity— profit motive—proof. Attorney/law firm owner and wife/bookkeeper were denied loss deductions relating to horse breeding activity: overall evidence showed that taxpayers didn't engage in activity for profit under Code Sec. 183 . Evidence included that other than income and expense statements and general business plan, taxpayers kept almost no business records for activity; supposed business plan didn't include budgets, economic forecasts or other analyses demonstrating financial management or planning for activity; supposed cost control measures weren't shown to have actually reduced expenses; and although taxpayers made some changes to activity, by among other things adding thoroughbred racing, those changes weren't shown to have been done for profitability vs. noneconomic purposes. It was also telling that taxpayers realized no profits in more than 25 years and used their losses to offset substantial in[pg. 1513] come from husband's law practice. Countervailing facts that some losses were attributable to circumstances beyond taxpayers' control and that they sought out expert advice weren't controlling. <br />
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Reference(s): ¶ 1835.01(38) Code Sec. 183; Code Sec. 162 <br />
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2. Business deductions—substantiation—rental payments—closely owned corps.—tax avoidance transactions; economic substance—burden of proof—increased deficiencies. Attorney/law firm owner and wife/bookkeeper were denied business deductions for firm's supposed payments to 1 of 3 sons who worked as horse trainer and in respect to whom there was no evidence of what hours he worked for firm, what his duties for firm entailed, or on what basis he was paid. However, deductions for firm's rent payments to S corp., to which taxpayers had transferred law firm's building and which was owned by taxpayers' other 2 sons, who themselves were attorneys, were allowed. IRS, which raised issue of these deductions only for 1st time in amendment to answer and thus bore burden of proof on same, failed to prove its theory that rent payments related to tax avoidance transaction involving building's transfer. Rather, evidence that sons joined taxpayers in personally guaranteeing loan for building's initial purchase, that taxpayers had non-tax business reason for subsequently transferring building, that sons or their S corp. made most of building's mortgage payments, and that sons took out additional loan for building improvements indicated that transaction had economic substance. <br />
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Reference(s): ¶ 1625.019(5) ; ¶ 1625.306(5) ; ¶ 79,007.01(10) Code Sec. 162 <br />
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3. Accuracy-related negligence or substantial understatement penalties—burden of proof and production—reasonable cause. Accuracy-related penalties for negligence or substantial understatement were upheld against attorney/law firm owner and wife/bookkeeper to extent of underpayments attributable to their improper claims for hobby loss deductions and unjustified decision to treat unproven firm payments to sons as reduction to firm income: IRS was deemed to have met its burden of production on penalties' applicability when considering substantial amounts of taxpayers' claims; and they had no reasonable cause or good faith for same where they relied solely on IRS's concession of prior year loss for claiming hobby losses in subject years and sought out no professional advice to support their income reduction/omission position. Although taxpayers claimed to have talked to accountant or “few people” regarding hobby loss and used paid preparer for their returns, there was no indication of what information was provided to those professionals or whether they were competent. <br />
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Reference(s): ¶ 66,625.01(10) ; ¶ 74,915.03(5) Code Sec. 6662; Code Sec. 7491 <br />
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Syllabus <br />
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Official Tax Court Syllabus<br />
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Counsel <br />
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Kenneth Alan Love, for petitioners. <br />
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Benjamin J. Peeler and Lewis A. Booth, for respondent. <br />
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COHEN, Judge <br />
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MEMORANDUM FINDINGS OF FACT AND OPINION <br />
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Respondent determined deficiencies in the Federal income tax of Logene L. Foster (petitioner) and Agnes M. Foster and penalties as follows: <br />
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Penalty <br />
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Year Deficiency Sec. 6662(a) <br />
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2004 $32,061 $6,412.20 <br />
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2005 24,865 4,973.00 <br />
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2006 22,383 4,476.60 <br />
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By amended answer, respondent asserts increased deficiencies as follows: [pg. 1514] <br />
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Penalty <br />
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Year Deficiency Sec. 6662(a) <br />
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2004 $53,240 $10,648.00 <br />
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2005 43,772 8,754.40 <br />
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2006 41,123 8,224.60 <br />
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------------------------------------------------------------------------------The issues for decision are: (1) whether petitioners engaged in a horse racing, training, and breeding activity (horse activity) with the objective of making a profit within the meaning of section 183; (2) whether petitioners are entitled to certain deductions pursuant to section 162 with respect to petitioner's law firm; and (3) whether petitioners are liable for accuracy-related penalties under section 6662(a). Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. <br />
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FINDINGS OF FACT <br />
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Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. Petitioners resided in Texas at the time the petition was filed. <br />
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Petitioner is a lawyer who has profitably headed his own firm, the Foster Law Firm, for more than three decades. Since 1984 petitioners also have operated a horse racing, training, and breeding activity, first as L&A Quarter Horses and later as L&A Racing (L&A). Petitioner Agnes Foster keeps the books for the law firm and the horse activity. Two of petitioners' sons, Lynn Foster and Lonnie Foster, are lawyers and work at petitioner's law firm. Another son, Lawrence Foster, is a professional horse trainer. <br />
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Petitioners' Horse Activity <br />
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When petitioner was growing up his family had horses, and from a young age he rode and trained horses. In 1984 one of petitioners' friends, who owned and raced quarter horses, convinced petitioners to buy a quarter horse from him to race. Shortly thereafter, petitioners sought business and tax advice from a certified public accountant with respect to pursuing their horse activity. <br />
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In 1984 petitioners also bought a home with approximately 12 acres of land and a barn for $375,000 to accommodate their horse activity. They made a number of improvements to the property, including building stalls in the barn, adding fences, building an exercise track and a round pen for breaking and training horses, and installing a horse walker. Many of the improvements to their property to accommodate the horses were made by petitioners and their three sons. A 2010 appraisal, which included the residential portion of the property, indicated that this property had appreciated in value to $550,000. <br />
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Petitioners and their three sons attended races in which their horses ran, helped when their mares foaled; mucked stalls; and fed, galloped, walked, and bred the horses. Petitioners themselves spent more than 20 hours during the week and on weekends working with and caring for the horses. Two of their sons, Lonnie and Lawrence, learned to break and train horses and obtained their trainer's licenses. Petitioners eventually primarily employed Lawrence to care for and train their horses. <br />
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Through the years petitioners continued to buy and race quarter horses and consult with professional trainers and veterinarians regarding their horses. They bought some broodmares and began breeding horses, both for their own racing activity and to sell. Petitioners eventually began racing thoroughbred horses in addition to quarter horses. <br />
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Petitioners maintained a separate checking account for L&A and during the years in issue used QuickBooks software to track income and expenses. Beyond that, however, petitioners maintained few business records. Their business plan consisted of little more than generalized goals for the horse activity and a narrative account of significant events that occurred in the operation. [pg. 1515] <br />
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To reduce expenses, petitioners sometimes fed the horses mule feed instead of horse feed; performed some of their own veterinary work such as worming; had Lawrence, rather than a farrier, shoe the horses; and sold horses when the horses were no longer able to race. However, there were no records that substantiated the cost-reducing effects these measures had on the horse operation. <br />
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Petitioners experienced some setbacks with their horse activity. Some of their horses became ill, were injured, or died. Also, the State of Texas failed to pass much-hoped-for legislation allowing video gambling at the State's horseracing tracks, causing Texas horseracing purses to be less than those of surrounding States. <br />
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In 1996 petitioners' returns were audited by the Internal Revenue Service (IRS) in relation to the horse activity for 1992, 1993, and 1994. The IRS contended that petitioners were not engaged in the horse activity for profit within the meaning of section 183. Petitioners requested review by the IRS Office of Appeals, and the IRS eventually conceded the section 183 issue. <br />
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<br />
<br />
By 2004 petitioners were considering ending the horse activity. The activity had sustained substantial losses every year of its operation and Lawrence, who by this time was training only for petitioners, was thinking about starting a hauling business. However, petitioners decided to try pinhooking horses because they knew of some people “who had done real good” with pinhooking. Pinhooking involves buying a young horse and training it to the point it can begin racing, then selling the horse to someone else who will actually race it. They began pinhooking around 2005 but also continued with their previously unprofitable activities of racing and breeding. <br />
<br />
<br />
<br />
Although petitioners have reported losses for the horse activity every year from 1984 through 2009, they do not know the total amount of their losses because they did not retain records of losses for years before 2002. However, considering only years 2002 through 2009, petitioners' losses have been substantial: <br />
<br />
<br />
<br />
------------------------------------------------------------------------------<br />
<br />
Year Net loss from <br />
<br />
horse activity <br />
<br />
------------------------------------------------------------------------------<br />
<br />
<br />
<br />
2002 ($166,447) <br />
<br />
<br />
<br />
2003 (118,486) <br />
<br />
<br />
<br />
2004 (88,221) <br />
<br />
<br />
<br />
2005 (79,108) <br />
<br />
<br />
<br />
2006 (71,987) <br />
<br />
<br />
<br />
2007 (76,213) <br />
<br />
<br />
<br />
2008 (54,204) <br />
<br />
<br />
<br />
2009 (69,078) <br />
<br />
----------<br />
<br />
Total (723,744) <br />
<br />
------------------------------------------------------------------------------Petitioner's Law Firm In contrast to the horse activity, petitioner's law firm has been profitable through the years. Until 2003 petitioners owned the building in which the law firm is located. In 2003 petitioners sold the building to the Foster Law Firm, P.C., an S corporation owned by petitioners' sons, Lynn and Lonnie, both of whom are lawyers who work as independent contractors for petitioner's law firm. Petitioner did not want to deal with tenants and maintenance of the building any longer, and his sons viewed the sale as a natural step in their father's transition to eventual retirement from practicing law. Lynn and Lonnie obtained bank financing for the purchase, and the bank required that they and petitioners personally guarantee the loan. <br />
<br />
<br />
<br />
The law firm remained in the same building after the sale, and petitioners claimed deductions reported on the law firm's Schedules C, Profit or Loss From Business, for rent payments to their sons' S corporation in the following amounts for the years in issue: $30,000 for 2004, [pg. 1516] $24,500 for 2005, and $28,600 for 2006. Additionally, the law firm made payments of $3,155 (rounded to the nearest whole number) to the building's mortgage lender in 2005 which petitioners treated as lease payments, bringing the total payment amount for 2005 to $27,655. Petitioner's law firm and the S corporation had no written rent or lease agreement during the years in issue. <br />
<br />
<br />
<br />
Petitioners also made payments from the law firm to their three sons during the years in issue. Payments of $98,074.52, $89,900.64, and $88,361.15 were made to Lonnie for contract legal services for 2004, 2005, and 2006, respectively. Lynn was paid $106,475.92, $108,591.84, and $102,931.08 for contract legal services for 2004, 2005, and 2006, respectively. Lawrence was paid $26,000, $25,500, and $22,000 for 2004, 2005, and 2006, respectively, for performing various tasks at the law firm. Petitioners did not claim deductions for these payments on their tax returns. <br />
<br />
<br />
<br />
In addition to their substantial income from the law firm, petitioners receive other income, such as Social Security benefits and distributions from a Keogh account. The following table shows petitioners' total income reported for 2002 through 2006: <br />
<br />
<br />
<br />
------------------------------------------------------------------------------<br />
<br />
Law firm <br />
<br />
Year income Other income Total income <br />
<br />
------------------------------------------------------------------------------<br />
<br />
<br />
<br />
2002 $261,225 $23,364 $284,589 <br />
<br />
<br />
<br />
2003 213,587 23,902 237,489 <br />
<br />
<br />
<br />
2004 203,502 84,761 288,263 <br />
<br />
<br />
<br />
2005 161,340 60,173 221,513 <br />
<br />
<br />
<br />
2006 178,634 67,042 245,676 <br />
<br />
------------------------------------------------------------------------------The IRS commenced an examination of petitioners' joint tax returns for 2004, 2005, and 2006. On November 12, 2009, respondent sent petitioners a notice of deficiency disallowing the loss deductions with respect to their horse activity. Petitioners filed a petition for redetermination with this Court on February 12, 2010. <br />
<br />
<br />
<br />
In an amended answer to the petition filed on January 11, 2011, respondent asserted increased deficiencies and penalties based on allegations that the law firm's rent payments to petitioners' sons' S corporation should be disallowed and that petitioners underreported the income of the law firm on their Schedules C for the years in issue. Respondent alleged, and petitioners have conceded, that the amounts of unreported income for the law firm were $233,889 for 2004, $229,000 for 2005, and $217,898 for 2006. As an offset, however, the parties have agreed that petitioners are entitled to additional deductions with respect to the law firm for amounts paid to Lynn and Lonnie for contract legal services for the years in issue. <br />
<br />
<br />
<br />
OPINION <br />
<br />
Horse Activity <br />
<br />
Respondent determined that petitioners' horse activity was not an activity engaged in for profit within the meaning of section 183 and disallowed loss deductions they claimed on Schedule F, Profit or Loss From Farming, for the years in issue. Petitioners counter that they engaged in the horse activity with an intent to realize a profit. <br />
<br />
<br />
<br />
Under section 183(a), if an activity is not engaged in for profit, no deduction attributable to that activity is allowed except to the extent provided by section 183(b). In relevant part, section 183(b) allows those deductions that would have been allowable had the activity been engaged in for profit only to the extent of gross income derived from the activity (reduced by deductions attributable to the activity that are allowable without regard to whether the activity was engaged in for profit). <br />
<br />
<br />
<br />
Section 183(c) defines an activity not engaged in for profit as “any activity other than one with respect to which deductions are allowable for the taxable year under section 162 or under paragraph (1) or (2) of section 212.” For expenses to be deductible under section 162, Trade or Busi[pg. 1517] ness Expenses, or section 212, Expenses for Production of Income, and not subject to the limitations of section 183, taxpayers must show that they engaged in the activity with the primary objective of making a profit. Westbrook v. Commissioner, 68 F.3d 868, 875 [76 AFTR 2d 95-7397] (5th Cir. 1995), aff'g T.C. Memo. 1993-634 [1993 RIA TC Memo ¶93,634]. <br />
<br />
<br />
<br />
Under section 183(d), in the case of an activity consisting in major part of the breeding, training, showing, or racing of horses, if the gross income derived from the activity exceeds the deductions for any two of seven consecutive taxable years, then the activity shall be presumed to be engaged in for profit, unless the Commissioner establishes to the contrary. See Golanty v. Commissioner, 72 T.C. 411, 425 (1979), aff'd without published opinion , 647 F.2d 170 (9th Cir. 1981). Petitioners have reported losses for L&A for every year from 1984 through 2009; therefore, the presumption does not apply in this case. <br />
<br />
<br />
<br />
The expectation of a profit need not be reasonable, but the taxpayer must conduct the activity with the actual and honest objective of making a profit. Keanini v. Commissioner, 94 T.C. 41, 46 (1990). Greater weight is given to objective facts than to a taxpayer's self-serving statement of intent. King v. Commissioner , 116 T.C. 198, 205 (2001); sec. 1.183-2(a) and (b), Income Tax Regs. Evidence from years subsequent to the years in issue is relevant to the extent it creates inferences regarding a taxpayer's requisite profit objective in earlier years. See Hoyle v. Commissioner, T.C. Memo. 1994-592 [1994 RIA TC Memo ¶94,592]; Smith v. Commissioner, T.C. Memo. 1993-140. <br />
<br />
<br />
<br />
Generally, taxpayers bear the burden of proving that the requisite profit objective exists. Rule 142(a); Westbrook v. Commissioner, 68 F.3d at 876. The burden of proof may shift to the Commissioner if the taxpayers establish that they complied with the requirements of section 7491(a)(2)(A) and (B) to substantiate items, to maintain required records, and to cooperate fully with the Commissioner's reasonable requests. However, we decide this issue on the preponderance of the evidence and, therefore, the burden of proof is not relevant. See Estate of Black v. Commissioner, 133 T.C. 340, 359 (2009); Knudsen v. Commissioner, 131 T.C. 185, 189 (2008). <br />
<br />
<br />
<br />
Section 1.183-2(b), Income Tax Regs., provides a nonexclusive list of factors to be weighed when considering whether a taxpayer is engaged in an activity for profit. These factors are: (1) the manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that the assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, that are earned from the activity; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved in the activity. All facts and circumstances are to be taken into account, and no single factor or mathematical preponderance of factors is determinative. Westbrook v. Commissioner, 68 F.3d at 876. We address the most relevant factors in determining petitioners' intent objectively. <br />
<br />
<br />
<br />
Carrying on the activity in a businesslike manner, such as by maintaining complete and accurate books and records, conducting the activity in a manner similar to other activities of the same nature which are profitable, and making changes in operations to adopt new techniques or abandon unprofitable methods are factors that may indicate a profit objective. Sec. 1.183-2(b)(1), Income Tax Regs. Businesslike conduct is characterized by careful and thorough investigation of the profitability of a proposed venture, monitoring of a venture in progress, and attention to problems that arise over time. See Ronnen v. Commissioner, 90 T.C. 74, 93 (1988); Taube v. Commissioner, 88 T.C. 464, 481-482 (1987). <br />
<br />
<br />
<br />
Petitioners contend that they maintained complete and accurate books and records. However, other than income and expense [pg. 1518] statements prepared with QuickBooks software and a “business plan” that included only generalized goals for the operation and a year-by-year narrative account of notable events occurring in the horse activity, petitioners produced virtually no business records. The business plan created by petitioners does not include budgets, economic forecasts or other analyses demonstrating financial management or planning of the activity and appears intended only to comply with regulations under section 183 in anticipation of tax benefits. Petitioners also did not retain any business records for years before 2002 and, consequently, are unable to determine with any accuracy the total losses they have incurred in the horse activity since its beginning in 1984. <br />
<br />
<br />
<br />
The absence of accurate books and records does not conclusively establish the lack of a profit objective, see De Boer v. Commissioner, T.C. Memo. 1996-174 [1996 RIA TC Memo ¶96,174], but there was scant evidence that petitioners used the few records that they did maintain for the important purposes of “cutting expenses, increasing profits, and evaluating the overall performance of the operation”,see Golanty v. Commissioner, 72 T.C. at 430. They appear to have maintained income and expense statements in order to memorialize transactions for tax reporting purposes, rather than to analyze expenses or determine profitability. See Keating v. Commissioner, T.C. Memo. 2007-309 [TC Memo 2007-309], aff'd, 544 F.3d 900 [102 AFTR 2d 2008-6638] (8th Cir. 2008); Dodge v. Commissioner, T.C. Memo. 1998-89 [1998 RIA TC Memo ¶98,089], aff'd without published opinion 188 F.3d 507 [84 AFTR 2d 99-6001] (6th Cir. 1999). , This conclusion is supported by petitioner's testimony that he “really wasn't keeping up [with] the losses particularly.” <br />
<br />
<br />
<br />
Petitioners' recordkeeping fell short of being businesslike in other respects that this Court has deemed important in determining whether taxpayers have the requisite profit objective. They did not produce separate records for each of their horses to demonstrate that they tracked breeding results and racing performance. See Dodge v. Commissioner, T.C. Memo. 1998-89 [1998 RIA TC Memo ¶98,089]. They also did not produce any records that showed that they reviewed each of their specific horse-related activities of quarter horse racing, thoroughbred racing, breeding, and pinhooking to assess which were more profitable. See Ballich v. Commissioner, T.C. Memo. 1978-497 [¶78,497 PH Memo TC]. <br />
<br />
<br />
<br />
Perhaps the most important indication of whether an activity is being performed in a businesslike manner is whether the taxpayer implements methods for controlling losses, including efforts to reduce expenses and generate income. See Dodge v. Commissioner, T.C. Memo. 1998-89 [1998 RIA TC Memo ¶98,089]. Petitioners argue that they worked to reduce their expenses, including at times feeding the horses mule feed instead of horse feed; doing some of their own veterinary work; and having their trainer son Lawrence, rather than a farrier, shoe the horses. However, they provided no evidence regarding how much they reduced their expenses, if any, by implementing these measures. See Dennis v. Commissioner, T.C. Memo. 2010-216 [TC Memo 2010-216] (the taxpayer demonstrated a profit objective with respect to reducing expenses where he provided calculations showing the cost-reducing effects of performing certain veterinary and horse care services himself). <br />
<br />
<br />
<br />
Petitioners' failure to produce any significant income was a key factor in their failure to earn a profit. See Dodge v. Commissioner, T.C. Memo. 1998-89 [1998 RIA TC Memo ¶98,089]. Petitioners contend that they made changes in their operations over the years in an effort to increase their income. Those changes involved adding quarter horse breeding, thoroughbred racing, and pinhooking to their initial activity of quarter horse racing. There was little in the record, however, that established that these changes were implemented for the purpose of making the activity profitable rather than for other noneconomic reasons, and petitioners did not produce any evidence demonstrating that they made a careful and thorough investigation of the potential profitability of any of these changes before making them. See Taube v. Commissioner, 88 T.C. at 481. <br />
<br />
<br />
<br />
Furthermore, specific activities that had proven unprofitable were not expeditiously [pg. 1519] abandoned. See Wesinger v. Commissioner, T.C. Memo. 1999-372 [1999 RIA TC Memo ¶99,372] (the lack of a profit objective was indicated where the taxpayer failed to expeditiously abandon a business technique that had not been profitable). As of 2004, the first year in issue here, petitioners considered abandoning the horse activity altogether but instead continued with a new speculative venture. After petitioners began pinhooking, they still were racing and breeding horses, activities in which they had incurred substantial losses. In fact, during 2006 their racing expenses increased dramatically from immediately prior years. On balance, we are not persuaded that petitioners carried on their horse activity in a businesslike manner. This factor negates a profit objective. <br />
<br />
<br />
<br />
The taxpayers' expertise, research, and study of an activity, as well as their consultation with experts, may be indicative of a profit motive. See sec. 1.183- 2(b)(2), Income Tax Regs. Petitioners had extensive knowledge about horses and the horse industry, partly because of petitioner's years of breaking and training horses, but also from their continued study of bloodlines and breeding, training, and racing techniques. Furthermore, during the course of the horse activity, petitioners consulted with persons who were knowledgeable about horse racing, training, and breeding, including professional trainers and veterinarians. See Givens v. Commissioner, T.C. Memo. 1989-529 [¶89,529 PH Memo TC] (a profit objective was indicated where the taxpayer sought and acquired advice in all aspects of Tennessee walking horse breeding from experienced owners, trainers, and a veterinarian). Petitioners also sought business and tax advice from an accountant when they began their horse activity. In the face of mounting losses, it would have been prudent to seek further business advice; however, on balance we believe this factor slightly favors petitioners. <br />
<br />
<br />
<br />
The taxpayers' devotion of much of their personal time and effort to carrying on an activity may indicate a profit motive, particularly if the activity does not involve substantial personal or recreational aspects. Sec. 1.183-2(b)(3), Income Tax Regs. Although both petitioners also were involved in working at the law firm, they spent more than 20 hours during the week and on weekends working in their horse activity, often performing manual and menial tasks such as feeding and walking the horses and mucking stalls. See Givens v. Commissioner, T.C. Memo. 1989-529 [¶89,529 PH Memo TC] (the taxpayer demonstrated the requisite profit objective where he spent two to four hours daily and more time on weekends doing chores and maintenance in his horse activity). This factor favors petitioners. <br />
<br />
<br />
<br />
An expectation that assets used in the activity will appreciate may indicate a profit motive even if the taxpayers derive no profit from current operations. Sec. 1.183-2(b)(4), Income Tax Regs. Petitioners argue that they expected the horses that they owned to appreciate because of successful racing and breeding. Petitioners provided no records for 2004, but computer printouts provided for 2005 and 2006 indicate that during those years petitioners sold a number of horses for more than they had paid for them. The printouts, however, were not substantiated with receipts, bills of sale, or other records. Petitioners also contend that they expected the 12-acre property on which they conducted their horse activity to appreciate, and the 2010 appraisal indicated that the property had increased in value from $375,000 at the time of purchase to $550,000. <br />
<br />
<br />
<br />
However, a profit objective may be inferred from such expected appreciation of the activity's assets only where the appreciation exceeds operating expenses and is sufficient to recoup the accumulated losses of prior years. See Golanty v. Commissioner, 72 T.C. at 427-428; Hillman v. Commissioner T.C. Memo. 1999-, 255. The appreciation of petitioners' horse activity assets does not begin to approach the amounts of losses petitioners have reported since the beginning of their horse activity. Furthermore, the 12-acre property also is petitioners' principal residence, and much of its appreciation likely is attributable to the residential portion of the property rather than the portion used in the horse activity. This factor is neutral. [pg. 1520] <br />
<br />
<br />
<br />
A history of continued losses with respect to the activity may indicate the lack of a profit motive. See sec. 1.183-2(b)(6), Income Tax Regs. While a series of losses during the initial or startup stage of an activity may not necessarily indicate a lack of a profit motive, a record of large losses over many years is persuasive evidence that a taxpayer did not have such a motive. Golanty v. Commissioner, 72 T.C. at 426; Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965), aff'd, 379 F.2d 252 [19 AFTR 2d 1566] (2d Cir. 1967). An activity's cumulative losses should not be of such a magnitude that an overall profit on the entire operation, including recoupment of past losses, could not possibly be achieved. Bessenyey v. Commissioner, 45 T.C. at 274. If losses are sustained because of unforeseen or fortuitous circumstances beyond the control of the taxpayer, such losses would not be an indication of the lack of a profit motive. See sec. 1.183-2(b)(6), Income Tax Regs. <br />
<br />
<br />
<br />
Petitioners have realized no profits whatsoever in more than 25 years of engaging in their horse activity. They argue, however, that their losses are not an indication that they lack a profit objective because the losses have been caused by factors beyond their control. Those factors include injury, illness, and death of a number of their horses and the failure of legislation that would have allowed video lottery terminals (slot machines) at horseracing tracks in the State of Texas. We acknowledge that horseracing, breeding, and training are highly speculative activities, but these events hardly account for an unbroken string of more than 25 years of losses. Furthermore, petitioners did not show that their horse activity would have been profitable if events beyond their control had not occurred. See Burger v. Commissioner, 809 F.2d 355, 360 [59 AFTR 2d 87-431] n.8 (7th Cir. 1987), aff'g T.C. Memo. 1985-523 [¶85,523 PH Memo TC]. <br />
<br />
<br />
<br />
Petitioners further contend that they could potentially earn a substantial profit with one outstanding horse. The possibility of a speculative profit in a taxpayer's horse activity, however, is insufficient to outweigh the absence of profits for a sustained period of years. See Chandler v. Commissioner, T.C. Memo. 2010-92 [TC Memo 2010-92] (the possibility of a speculative profit did not outweigh more than 20 years of losses reported for the taxpayer's horse activity); McKeever v. Commissioner, T.C. Memo. 2000-288 [TC Memo 2000-288] (11 consecutive years of horse activity losses failed to indicate that the taxpayer had a profit objective even though there was the possibility of a speculative profit). This factor strongly favors respondent. <br />
<br />
<br />
<br />
Substantial income from sources other than the activity may indicate that the activity is not engaged in for profit. See sec. 1.183-2(b)(8), Income Tax Regs. This is particularly true if the losses from the activity generate substantial tax benefits. Golanty v. Commissioner, 72 T.C. at 429. A taxpayer with substantial income unrelated to the activity can more readily afford a hobby. See Wesley v. Commissioner, T.C. Memo. 2007-78 [TC Memo 2007-78]. Petitioners' substantial income from the law firm and other sources has allowed them to continue their horse activity in spite of more than 25 years of losses, and the activity also has generated generous tax savings in the form of net losses that offset that income. This factor favors respondent. <br />
<br />
<br />
<br />
Finally, the presence of personal motives and recreational elements in carrying on an activity may indicate that the activity is not engaged in for profit. Sec. 1.183-2(b)(9), Income Tax Regs. Petitioners contend that the horse activity, particularly mucking stalls, was hard work rather than pleasure. We do not believe, however, that petitioners and their sons would have continued the losing horse activity for more than 25 years unless they received satisfaction from the work. It is more likely that such satisfaction, rather than a profit objective, accounts for their persistence. This factor does not favor petitioners but is neutral. <br />
<br />
<br />
<br />
After weighing all the facts and circumstances in the light of the relevant factors, we conclude that petitioners did not engage in their horse activity for the years in issue with the requisite profit objective. The many years of losses without a meaningful plan for recouping them are most persuasive. Accordingly, we sustain respondent's disallowance of the loss deductions relating to the horse activity under section 183. [pg. 1521] <br />
<br />
<br />
<br />
Law Firm Deductions Under Section 162 <br />
<br />
If the Commissioner raises new matters or asserts increased deficiencies in his answer to the taxpayers' petition, the Commissioner bears the burden of proof on those issues. See Rule 142(a); Truesdell v. Commissioner, 89 T.C. 1280, 1292-1293 (1987). Respondent first raised the issues of the law firm's unreported income and the disallowance of petitioners' claimed deductions for the law firm's rent payments in his amended answer; therefore, respondent has the burden of proof on these issues. <br />
<br />
<br />
<br />
Payments to Petitioners' Sons Inasmuch as petitioners have conceded that they underreported the law firm's gross income for the years in issue, respondent has carried the burden of proof with respect to such income. Petitioners assert that the amounts of unreported income consisted of payments for services provided by their sons that petitioners subtracted from the law firm's gross income before reporting that income on their tax returns. Petitioners now argue that the unreported income should be offset by deductions for those payments not claimed on their tax returns. Respondent, however, seeks the increased deficiency only with respect to payments made to Lawrence; respondent does not dispute the deductibility of payments made to Lynn and Lonnie for contract legal services. <br />
<br />
<br />
<br />
Section 162(a) allows a deduction for ordinary and necessary expenses paid or incurred by a taxpayer in carrying on any trade or business. In general, payments made or incurred by a trade or business for personal services rendered are ordinary and necessary business expenses and may be deducted under section 162(a). The burden of showing entitlement to a claimed deduction is on the taxpayer. See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 [69 AFTR 2d 92-694] (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 [13 AFTR 1180] (1934). Taxpayers must maintain records sufficient to substantiate the amounts and purposes of deductions claimed. See sec. 6001; Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), aff'd per curiam, 540 F.2d 821 [38 AFTR 2d 76-5935] (5th Cir. 1976). <br />
<br />
<br />
<br />
Petitioners have produced no records substantiating the work that Lawrence performed at the law firm. I the event a taxpayer establishes that he or she n incurred a deductible expense but is unable to substantiate the precise amount, the Court may approximate the amount of the expense. Cohan v. Commissioner, 39 F.2d 540, 543-544 [8 AFTR 10552] (2d Cir. 1930). The Court, however, must have sufficient evidence upon which to make a reasonable estimate to apply the Cohan rule. Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). Petitioners' evidence regarding the duties Lawrence performed for the law firm consisted only of generalized testimony that he transported boxes of documents for petitioner and drove petitioner to work. Petitioners provided no details establishing Lawrence's duties, how many hours he worked, or on what basis he was paid during the years at issue. Therefore, we have no reasonable basis for applying the Cohan rule, and we conclude that petitioners are not entitled to any deductions for payments made from the law firm to their son Lawrence. <br />
<br />
<br />
<br />
Rent Payments The S corporation bought the office building in which the law firm is located from petitioners in 2003. Subsequently, the law firm made rent payments to the S corporation of $30,000 for 2004, $27,655 for 2005 (which included building mortgage payments made by petitioners and treated as rent payments), and $28,600 for 2006. Petitioners claimed deductions for these payments on their Schedules C for the law firm for the years in issue. <br />
<br />
<br />
<br />
Respondent contends that the sale of the building was a tax-motivated transaction by which petitioners transferred an asset to their sons at less than fair market value, increased the depreciable basis of a building that had previously been fully depreciated, avoided recapture of depreciation, and allegedly entered into an oral lease but did not comply with the terms of the lease they describe. According to respondent, these factors indicate that the sale had no economic substance and thus petitioners' [pg. 1522] deductions for rent payments should be disallowed by the Court. Petitioners assert nontax reasons for the sale of the building and actual transfer of ownership. <br />
<br />
<br />
<br />
Respondent further argues that “[i]n substance the petitioners have achieved a significant increase in the deductions against the Schedule C income of the [law firm], while passing a significant family owned asset to the next generation with *** little or no tax consequence to the petitioners' sons.” <br />
<br />
<br />
<br />
A transaction may be disregarded as lacking in economic substance where there is no legitimate business purpose and the transaction is motivated only by a desire to minimize taxes. See W.H. Armston Co. v. Commissioner, 188 F.2d 531, 533 [40 AFTR 460] (5th Cir. 1951), aff'g 12 T.C. 539 (1949). Where there is a legitimate business purpose, however, the transaction will be recognized as having economic substance even though a tax-saving purpose is also present. See L.W. Tilden, Inc. v. Commissioner, 192 F.2d 704, 708-709 [41 AFTR 400] (5th Cir. 1951), rev'g a Memorandum Opinion of this Court dated March 16, 1950, 9 T.C.M. (CCH) 219 (1950). <br />
<br />
<br />
<br />
Respondent relies on W.H. Armston Co. In that case a closely held corporation, a construction company whose majority owners were husband-and-wife stockholders, sold some heavy equipment to the stockholder wife who then leased the equipment back to the corporation. The Court of Appeals for the Fifth Circuit determined that the purported sale had no legitimate business purpose other than as a device for minimizing the corporation's tax liability as a result of deductions for the lease payments. The court consequently held that the lease payments made to the wife were constructive dividends that were not deductible as ordinary and necessary business expenses by the corporation. In holding that the purported sale should be disregarded for tax purposes, the court noted that the wife was primarily a housewife with no independent income of her own who relied on the advice of her husband in anything she did relating to the corporation. <br />
<br />
<br />
<br />
Here, unlike the stockholder wife in W.H. Armston Co., petitioners' sons, Lynn and Lonnie, have income of their own and were required to join petitioners in personally guaranteeing the loan used to purchase the building. Except for building payments of $3,155 made by petitioners that were treated as rent payments, the S corporation or petitioners' sons made the building's mortgage payments, and their sons also took out an additional loan to have improvements made to the building. Furthermore, the testimony at trial established that there was a legitimate business purpose for the sale of the building: Petitioner was tired of having to deal with tenants and maintenance of the building, and petitioners' sons, who were lawyers that worked at their father's law firm, viewed purchasing the building as a natural step in their father's transition to eventual retirement from his law practice. <br />
<br />
<br />
<br />
Whether the sale of the building was at a less-than-arm's-length price, whether some of the deductions that petitioners have claimed in relation to the building were properly deductible on the Schedules C of the law firm, and whether a fair market rent was being charged are issues that might bear more scrutiny. However, respondent has asserted only that the rent payments are not allowable because the transaction was purely tax motivated. Respondent has not persuaded us that the transaction lacked economic substance. Thus the rent deductions for payments actually made are not disallowed. <br />
<br />
<br />
<br />
Section 6662(a) Accuracy-Related Penalties <br />
<br />
Section 6662(a) and (b)(1) and (2) imposes a 20% accuracy-related penalty on any underpayment of Federal income tax attributable to a taxpayer's negligence or disregard of rules or regulations or substantial understatement of income tax. Section 6662(c) defines negligence as including any failure to make a reasonable attempt to comply with the provisions of the Code and defines disregard as any careless, reckless, or intentional disregard. Disregard of rules or regulations is careless if the taxpayer does not exercise reasonable diligence to determine the correctness of a tax return position that is contrary to the rule or regulation. Sec. 1.6662-3(b)(2), Income Tax Regs. An understatement of income tax is substantial if it exceeds the [pg. 1523] greater of 10% of the tax required to be shown on the return or $5,000. Sec. 6662(d)(1)(A). <br />
<br />
<br />
<br />
Under section 7491(c), the Commissioner bears the burden of production with regard to penalties and must come forward with sufficient evidence indicating that it is appropriate to impose penalties. Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Considering the substantial amounts of unreported income and the erroneous loss deductions that petitioners claimed for the years in issue, respondent has satisfied the burden of producing evidence that the penalties are appropriate. <br />
<br />
<br />
<br />
Once the Commissioner has met the burden of production the taxpayer must come forward with persuasive evidence that the penalties are inappropriate because he or she acted with reasonable cause and in good faith. Sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at 447-448. The decision as to whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all of the pertinent facts and circumstances. See sec. 1.6664-4(b)(1), Income Tax Regs. <br />
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Petitioners have not shown reasonable cause for claiming the erroneous loss deductions for their horse activity or underreporting the law firm's income with respect to amounts paid to their son Lawrence. As to the horse activity, petitioners rely solely on the fact that the IRS conceded the section 183 issue during their first audit for tax years 1992 through 1994. <br />
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A failure by the Commissioner to disallow similar deductions in a prior year's audit of a taxpayer's return may be a factor to be considered with respect to the imposition of the accuracy-related penalty. See Stewart v. Commissioner, T.C. Memo. 2002-199 [TC Memo 2002-199]; Sheehy v. Commissioner, T.C. Memo. 1996-334 [1996 RIA TC Memo ¶96,334]. However, petitioners' first audit was conducted more than 10 years earlier when the horse activity arguably was still within its startup phase during which losses could be expected. In subsequent years, petitioners continued to sustain significant losses, but did not seek competent advice regarding whether they should have continued to treat their horse activity as being engaged in for profit. Petitioner's testimony indicated only that they talked with a certified public accountant and “a few people” at a time undisclosed in the record. Petitioners gave no details regarding what information they provided to the accountant or what the accountant's advice was. The accountant did not testify. As to petitioners' underreporting of the law firm's income with respect to amounts paid to their son Lawrence, they produced no evidence proving that they sought or relied upon competent advice in relation to the unjustified practice of omitting from gross receipts income distributed to their sons. <br />
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Petitioners' tax returns for the years in issue were prepared by a bookkeeping and tax service, not a certified public accountant, and petitioners gave no details about the information they provided to their tax return preparer or whether their tax return preparer was competent to prepare their tax returns. Therefore, we sustain the penalties on the recomputed and increased deficiencies with respect to the disallowed horse activity losses and the unreported law firm income related to payments made to petitioners' son Lawrence. <br />
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In reaching our conclusions, we have considered all arguments made by the parties and, to the extent not mentioned above, we conclude they are moot, irrelevant, or without merit. <br />
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To reflect the foregoing, <br />
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Decision will be entered under Rule 155. <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-74826650055338882352012-08-09T21:06:00.001-04:002012-08-09T21:06:37.150-04:00Partnership economic interestStephan F. Brennan, et ux., et al. v. Commissioner, TC Memo 2012-209 , Code Sec(s) 702; 704; 761. <br />
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STEPHAN F. BRENNAN AND BETH A. BRENNAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent MELVIN W. ASHLAND AND BROOKE C. ASHLAND, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent. <br />
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Case Information: Code Sec(s): 702; 704; 761 <br />
<br />
[pg. 1527] Docket: Dkt. Nos. 25117-08, 25306-08. 1 <br />
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Date Issued: 07/23/2012. <br />
<br />
Judge: Opinion by Kroupa, J. <br />
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Prior History: Earlier proceeding at (2012) TC Memo 2012-187, RIA TC Memo ¶2012-187 (opinion by Kroupa, J.). <br />
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Tax Year(s): Years 1997, 1998, 1999, 2000, 2002, 2003, 2004, 2005. <br />
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Disposition: Decision for Commissioner. <br />
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HEADNOTE <br />
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1. Partnership income—partner's distributive share—liquidation of partnership interest. Members/partners in investment LLC/partnership were required to recognize their distributive shares, of capital gain income from sale of partnership's institutional accounts/customer lists, as set forth in partnership restructuring agreement [pg. 1528] plus other partnership items in accord with Code Sec. 702(a) . Argument that one partner didn't realize any income from sale, because his partner status terminated in accord with restructuring agreement in year before sale payments were made, was belied by facts that partner was entitled to receive proceeds in liquidation of his partnership interest after sale, that he remained partner for tax purposes until that interest was completely liquidated, and that partnership didn't distribute proceeds or make other distribution in complete liquidation before end of last year at issue. <br />
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Reference(s): ¶ 7025.01(5) Code Sec. 702; Code Sec. 704; Code Sec. 761 <br />
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2. Failure to timely file returns penalties—burden of proof and production— reasonable cause; willful neglect. Failure to timely file returns penalties were upheld against members/partners in investment LLC/partnership for year for which they didn't file on time: IRS met its burden of production on penalties' applicability with proof of taxpayers' delinquency; and they didn't show such was due to reasonable cause and not willful neglect. <br />
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Reference(s): ¶ 66,515.14(5) ; ¶ 74,915.03(15) Code Sec. 6651; Code Sec. 7491 <br />
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3. Accuracy-related substantial understatement penalties—burden of proof and production—reasonable cause; good faith. Accuracy-related substantial understatement penalties were upheld against members/partners in investment LLC/partnership for years for which they failed to properly account for their distributive shares of partnership income: IRS met its burden of production on penalties' applicability to extent Rule 155 computations showed taxpayers had understatements for each year that were substantial within meaning of Code Sec. 6662(d) ; and taxpayers didn't offer any reasonable cause or good faith for same. <br />
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Reference(s): ¶ 66,625.01(10) ; ¶ 74,915.03(5) Code Sec. 6662; Code Sec. 7491 <br />
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Syllabus <br />
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Official Tax Court Syllabus<br />
<br />
Counsel <br />
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William Edward Taggart, Jr., for petitioners in Docket No. 25117-08. <br />
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Arthur V. Pearson and Jason J. Galek, for petitioners in Docket No. 25306-08. <br />
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Lori Katrine H. Shelton, Elizabeth Wickstrom, and Matthew Williams, for respondent. <br />
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KROUPA, Judge <br />
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Respondent determined the following deficiencies, accuracy-related penalties under section 6662(a) 2 and additions to tax under section 6651(a): <br />
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Petitioners Stephan Brennan and Beth Brennan <br />
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Addition to tax <br />
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Year Deficiency Sec. 6651(a)(1) <br />
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2002 $1,783,909 $438,655 <br />
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2003 91,652 ---<br />
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2004 68,296 ---<br />
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Petitioners Melvin Ashland and Brooke Ashland <br />
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Penalty and addition to tax <br />
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Year Deficiency Sec. 6662(a) Sec. 6651(a)(1) <br />
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1997 $248,896 $49,779 ---<br />
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1998 380,718 76,144 ---<br />
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1999 407,185 81,437 ---<br />
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2000 135,079 27,016 $3,183 <br />
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2002 439,876 87,975 ---<br />
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2004 135,011 27,002 ---<br />
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2005 123,095 24,619 ---<br />
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There are three issues for decision. 3 The first issue is to what extent (if any) the Brennans and the Ashlands must recognize capital gains income for 2003 and 2004 from the sale of certain assets by Cutler & Company LLC 4 (Cutler), a partnership for Federal tax purposes. We hold that they each must recognize their distributive shares of the capital gains income for 2003 and 2004. The second issue is whether the Ashlands are liable for an addition to tax under section 6651(a)(1) for late filing of a Federal tax return for 2000. We hold they are liable. The final issue is whether the Ashlands are liable for the accuracy-related penalty under section 6662(a) for each year at issue. We hold they are liable. <br />
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FINDINGS OF FACT <br />
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Some of the facts have been stipulated and are so found. The stipulation of facts, the first, second and third supplemental stipulation of facts and the accompanying exhibits are incorporated by this reference. <br />
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The Ashlands resided in Oregon and the Brennans resided in Nevada when each filed a petition. <br />
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I. Background <br />
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Ms. Ashland and Mr. Brennan were members of Cutler. Cutler managed asset portfolios for wealthy individuals and institutional investors, charging management fees for its services. Cutler decided to restructure its business in 2002 after turmoil resulted among its members. To that end, Cutler, Ms. Ashland and Mr. Brennan, among others, entered into an Agreement Regarding Restructuring of Cutler & Co. (restructuring agreement) in June 2002. Cutler agreed to sell certain institutional accounts, i.e., a customer list, under the restructuring agreement. <br />
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Cutler was to use the sale proceeds first to satisfy certain Cutler liabilities and obligations. Any remaining proceeds (net IA sale proceeds) were to be distributed to the members, including Ms. Ashland and Mr. Brennan, who were each to receive 44.985% of the net IA sale proceeds under the restructuring agreement. Mr. Brennan was to hold an economic interest in Cutler rather than a membership interest upon the sale of the institutional accounts. The economic interest conferred on Mr. Brennan the right to share in the income, gains, losses, deductions, credits or similar Cutler items and was to serve as collateral for Cutler's obligation with respect to the net IA sale proceeds. Ms. Ashland was to remain a Cutler member after the sale of the institutional accounts. <br />
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Cutler sold the institutional accounts to Fox Asset Management LLC (Fox) on October 31, 2002 (IA sale). Fox made certain payments to Cutler for the institutional accounts in 2003 and 2004, with the last payment being made in April 2004. Cutler did not distribute cash or any property to Mr. Brennan in 2003 or 2004. <br />
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Cutler filed for bankruptcy in April 2004. Ms. Ashland was the last remaining Cutler member as of September 2004. [pg. 1530] <br />
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II. Tax Returns <br />
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Cutler filed Forms 1065, U.S. Return of Partnership Income, for 2003 and 2004. Cutler reported $1,228,244 and $947,675 of long-term capital gains income from the IA sale for 2003 and 2004, respectively. <br />
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The Ashlands filed joint Federal income tax returns for 2003 and 2004. The Ashlands reported a portion of the capital gains income Cutler reported from the IA sale for 2003. They did not report any capital gains income for 2004. <br />
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The Brennans filed joint Federal income tax returns for 2003 and 2004. The Brennans did not report any of the capital gains income for 2003 or 2004 that Cutler reported from the IA sale. <br />
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III. Deficiency Litigation <br />
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Respondent issued the Ashlands and the Brennans separate deficiency notices determining that both failed to report capital gains income from the IA sale for 2003 and 2004. Respondent took inconsistent positions in the deficiency notices with respect to the capital gains income reported on Cutler's Forms 1065 for 2003 and 2004 to avoid being in a “whipsaw” 5 position. More specifically, respondent determined that the Ashlands were required to report all of the capital gains income from the IA sale for 2003 and 2004 while also determining that the Brennans were required to report a portion of the same capital gains income for those years. The Ashlands and the Brennans each filed petitions with this Court for redetermination. <br />
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OPINION <br />
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We are asked to decide to what extent (if any) the Brennans and the Ashlands must recognize capital gains income from the IA sale for 2003 and 2004. We also must decide whether the Ashlands are liable for a late-filing addition to tax under section 6651(a) for 2000 and whether the Ashlands are liable for an accuracy-related penalty under section 6662(a) for each year at issue. 6 We address each issue in turn. <br />
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I. Capital Gains Income <br />
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We first turn to whether the Brennans must recognize capital gains income from the IA sale for 2003 and 2004. Cutler was a partnership for tax purposes when the relevant capital gains income was realized from the IA sale. A partnership is not subject to Federal income tax under subchapter K. Secs. 701, 6031. The partners, rather, are liable for tax in their separate or individual capacities. Sec. 701. Each partner is required to take into account his or her distributive share of the partnership's income, gain, loss, deductions and credits. Sec. 702(a). Moreover, a partner must take into account his or her distributive share regardless of whether any actual distribution of cash or other property is made. United States v. Basye, 410 U.S. 441 [31 AFTR 2d 73-802] (1973); sec. 1.702-1(a), Income Tax Regs. A partner's distributive share is determined by the governing partnership agreement. Sec. 704(a). 7 A partner's distributive share is includible in the partner's income in the taxable year of the partnership ending within or with the taxable year of the partner. Sec. 706(a). A partnership's taxable year shall close with respect to a partner who sells or exchanges his entire interest in a partnership and with respect to a partner whose entire interest is liquidated. Sec. 1.706-1(c)(2)(i), Income Tax Regs. <br />
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The Brennans argue that Mr. Brennan's status as a partner of Cutler for tax purposes terminated in 2002 and therefore Mr. Brennan did not realize any capital gains income from the IA sale in 2003 or 2004. Respondent counters that Mr. Brennan was a Cutler partner for tax purposes for 2003 and 2004 and therefore must take into account his distributive share of the capital gains income from the IA sale. We agree with respondent. [pg. 1531] <br />
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A partner that retires 8 or otherwise withdraws from a partnership remains a partner for tax purposes until his or her interest in the partnership has been completely liquidated. Scott v. Commissioner, T.C. Memo. 1997-507 [1997 RIA TC Memo ¶97,507], aff'd without published opinion, 182 F.3d 915 [84 AFTR 2d 99-5029] (5th Cir. 1999); sec. 1.736-1(a)(1)(ii), Income Tax Regs. A retiring partner's interest in a partnership is completely liquidated when the entire partnership interest is terminated through a distribution or series of distributions to the partner by the partnership. Secs. 736(b), 761(d); sec. 1.761-1(d), Income Tax Regs. The partnership interest liquidates upon the final distribution to the partner where the interest is to be liquidated through a series of distributions. Sec. 1.761-1(d), Income Tax Regs. <br />
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Here, Mr. Brennan was entitled to receive 44.985% of the net IA sale proceeds in complete liquidation of his partnership interest 9 in Cutler after the IA sale. Cutler received proceeds from the IA sale in 2003 and 2004, yet never distributed any amount of the net IA sale proceeds to Mr. Brennan. Nor did Cutler make any other distribution of cash or property in complete liquidation of Mr. Brennan's partnership interest in Cutler before the end of 2004. Accordingly, Mr. Brennan remained a Cutler partner for tax purposes for 2003 and 2004. Consequently, Mr. Brennan must take into account his distributive shares of the capital gains income from the IA sale for 2003 and 2004 as set forth in the restructuring agreement, along with various other partnership items as required under section 702(a). <br />
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We now address what portion of the capital gains income from the IA sale for 2003 and 2004 the Ashlands must recognize. The Ashlands do not dispute that Ms. Ashland was a Cutler partner for tax purposes during 2003 or 2004. Therefore, Ms. Ashland must take into account her distributive shares of the capital gains income from the IA sale for 2003 and 2004 as set forth in the restructuring agreement, along with various other partnership items as required under section 702(a). <br />
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II. Addition to Tax <br />
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We next turn to whether the Ashlands are liable for the late-filing addition to tax under section 6651(a)(1) for 2000. The late-filing addition to tax is imposed for failure to file a tax return on or before the specified filing date unless it is shown that such failure is due to reasonable cause and not due to willful neglect. Sec. 6651(a)(1); United States v. Boyle, 469 U.S. 241, 245 [55 AFTR 2d 85-1535] (1985). The Commissioner has the burden of production with respect to additions to tax. Sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2001). To meet this burden, the Commissioner must produce sufficient evidence establishing that it is appropriate to impose the additions to tax. See Higbee v. Commissioner, 116 T.C. at 446-447. If the Commissioner meets his burden, then the taxpayer bears the burden of proving that the late filing or nonfiling was due to reasonable cause and not willful neglect. Id. at 446. <br />
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Respondent satisfied his burden of production by showing that the Ashlands did not timely file their income tax return for 2000. In contrast, the Ashlands have not demonstrated nor argued that they timely filed a joint income tax return for 2000. Moreover, the Ashlands have not established nor argued that their failure to file is due to reasonable cause and not due to willful neglect. Accordingly, we sustain respondent's determination that the Ashlands are liable for the late-filing addition to tax for 2000. <br />
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III. Accuracy-Related Penalties <br />
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We last address respondent's determination that the Ashlands are liable for an accuracy-related penalty under section 6662(a) for each year at issue. The Commissioner has the burden of production, and the taxpayer has the burden as to reasonable cause. Sec. 7491(c); Rule 142(a); [pg. 1532] see Higbee v. Commissioner, 116 T.C. at 446-447. <br />
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A taxpayer is liable for an accuracy-related penalty on any part of an underpayment attributable to, among other things, a substantial understatement of income tax. Sec. 6662(b)(2). There is a substantial understatement of income tax if the amount of the understatement exceeds the greater of either 10% of the tax required to be shown on the return or $5,000. Sec. 6662(a), (b)(2), (d)(1)(A); sec. 1.6662-4(a), Income Tax Regs.; see Jarman v. Commissioner, T.C. Memo. 2010-285 [TC Memo 2010-285]. We find that respondent has met his burden of production if Rule 155 computations show the Ashlands have a substantial understatement of income tax for each year at issue. See Higbee v. Commissioner, 116 T.C. at 446; Jarman v. Commissioner, T.C. Memo. 2010-285 [TC Memo 2010-285]. A taxpayer is not liable for an accuracy-related penalty, however, if the taxpayer acted with reasonable cause and in good faith with respect to any portion of the underpayment. Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. The Ashlands failed to establish or even argue that the reasonable cause exception applies to any of their underpayments. Moreover, the record does not establish that the Ashlands acted with reasonable cause and in good faith with respect to any portion of the underpayment for any of the years at issue. Accordingly, we sustain respondent's determination that the Ashlands are liable for the accuracy-related penalty for each year at issue. <br />
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We have considered all arguments made in reaching our decision and, to the extent not mentioned, we conclude that they are moot, irrelevant or without merit. <br />
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To reflect the foregoing, and due to the parties' concessions, <br />
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Decisions will be entered under Rule 155. <br />
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1<br />
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These cases have been consolidated for trial, briefing and opinion. Joseph Furey and Katherine Furey were petitioners in a consolidated case at Docket No. 25772-08. The Fureys have since entered into a stipulated decision with respondent, and their case has been severed from these consolidated cases. <br />
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2<br />
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All section references are to the Internal Revenue Code for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. All monetary amounts are rounded to the nearest dollar. <br />
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3<br />
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Respondent has conceded on brief his determination that Mr. Brennan failed to report a “guaranteed payment” of $4,300,616 (or any other amount) for 2002. The Brennans have conceded that for 2002 they failed to report certain dividend income and a certain retirement distribution. These concessions resolve the Brennans' deficiency for 2002. The Brennans have also conceded the addition to tax under sec. 6651(a)(1) that respondent determined for 2002. Additionally, the Brennans have conceded that they failed to report certain dividend income for 2003 and 2004 and certain gambling income for 2004. <br />
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The Ashlands have conceded that they were not entitled to a $4,785,616 flow-through loss deduction from Airport Plaza Partnership for 2002 from purported “guaranteed payments” Airport Plaza made. In addition, our decision in Brennan v. Commissioner, T.C. Memo. 2012-187 [TC Memo 2012-187], bars the Ashlands from claiming that Cutler made certain “guaranteed payments” in 2002 entitling them to a $4,785,616 flow-through loss deduction from Cutler. The flow-through loss deduction concession with respect to Airport Plaza and our decision resolve the Ashlands' deficiency for 2002. <br />
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The Ashlands' deficiencies for 1997, 1998, 1999, 2000, 2004 and 2005 are based on the disallowance of net operating loss carrybacks and carryforwards stemming from the claimed flow-through loss deduction from Airport Plaza for 2002. Accordingly, these deficiencies too are resolved by the Ashlands' concession and our decision in Brennan. <br />
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All other issues either have been conceded or need not be decided because they follow from our holdings or are computational. <br />
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4<br />
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Cutler changed its name to Table Rock Asset Management in 2003. We refer to Table Rock Asset Management as Cutler for convenience and clarity. <br />
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5<br />
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The term “whipsaw” refers to a situation when different taxpayers treat the same transaction involving the same items inconsistently, thus creating the possibility that income could go untaxed or two unrelated parties could deduct the same expenses on their separate returns. <br />
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6<br />
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The taxpayer generally bears the burden of proving the Commissioner's determinations are erroneous. Rule 142(a). The burden of proof may shift to the Commissioner if the taxpayer satisfies certain conditions. Sec. 7491(a). We resolve the issues here on a preponderance of the evidence, not on an allocation of the burden of proof. Therefore, we need not consider whether sec. 7491(a) would apply. See Estate of Black v. Commissioner, 133 T.C. 340, 359 (2009). <br />
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7<br />
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The partnership agreement includes all understandings and agreements among the partners, or between one or more partners and the partnership, concerning affairs of the partnership and responsibilities of partners, whether oral or written, and whether or not embodied in a document referred to by the partners as the partnership agreement. Sec. 1.704-1(b)(2)(ii)(h), Income Tax Regs. Therefore, the allocation of the capital gains income from the IA sale to Mr. Brennan and Ms. Ashland set forth in the restructuring agreement overrides any different allocation set forth in a prior Cutler partnership agreement or other document. <br />
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8<br />
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A partner retires when he or she ceases to be a partner under local law. Sec. 1.736-1(a)(1)(ii), Income Tax Regs. <br />
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9<br />
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Because Cutler is a partnership for tax purposes and for convenience and clarity, we refer to Mr. Brennan's membership interest in Cutler as a partnership interest. <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-70460349132301440792012-08-09T21:04:00.002-04:002012-08-09T21:04:34.907-04:00Debt dischargeBernard R. Shepherd, et ux. v. Commissioner, TC Memo 2012-212 , Code Sec(s) 108; 61. <br />
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BERNARD R. SHEPHERD AND DESIREE SHEPHERD, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent. <br />
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Case Information: Code Sec(s): 108; 61 <br />
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[pg. 1539] Docket: Dkt. No. 26910-10. <br />
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Date Issued: 07/24/2012. <br />
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Judge: Opinion by Ruwe, J. <br />
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Tax Year(s): Year 2008. <br />
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Disposition: Decision for Commissioner. <br />
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HEADNOTE <br />
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1. Income exclusions—discharge of indebtedness—insolvency—computations—asset valuation—proof. Pro se married couple didn't qualify for Code Sec. 108 income exclusion for DOI income from settled/discharged credit card debt: taxpayers didn't prove they were insolvent within meaning of Code Sec. 108(a)(1)(B) and Code Sec. 108(d)(3) , in that they didn't put forth credible evidence of some of their assets/real properties' FMVs immediately before discharge. Although taxpayers did submit some evidence, including testimony about comparable sales and property tax bills or bank loan valuations, such wasn't sufficient to establish FMV for federal tax purposes, particularly where tax bill and loan documents didn't describe properties or explain methodology used, and testimony about comparable sales was uncorroborated and based on noncontemporaneous sales. <br />
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Reference(s): ¶ 1085.05(10) Code Sec. 108; Code Sec. 61 <br />
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Syllabus <br />
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Official Tax Court Syllabus<br />
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Counsel <br />
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Bernard R. Shepherd and Desiree Shepherd, pro sese. <br />
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Kristina L. Rico, for respondent. <br />
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RUWE, Judge <br />
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MEMORANDUM FINDINGS OF FACT AND OPINION <br />
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Respondent determined a $1,613 deficiency in petitioners' 2008 Federal income tax. The issue for decision is whether petitioners are entitled to exclude from gross income under section 108(a)(1)(B) 1 discharge of indebtedness income of $4,412. <br />
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FINDINGS OF FACT <br />
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Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. <br />
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At the time the petition was filed, petitioners resided in New Jersey. <br />
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In November 2007 petitioners' credit card company, Capital One Bank (USA) N.A. (Capital One), referred petitioners' delinquent account to an outside collection agency. The principal loan balance due on petitioners' Capital One account at the time of the referral was $9,962.06. Petitioners entered into a settlement agreement with the outside collection agency, agreeing to settle their Capital One loan balance for $5,550. Petitioners made payments totaling $5,550 from March 28 to July 30, 2008. The outside collection agency then notified Capital One that petitioners had paid the full amount required by the settlement agreement. Capital One coded petitioners' account as “Settled in Full” and discharged the remaining liability on September 3, 2008. <br />
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In January 2009 Capital One issued to Mr. Shepherd a Form 1099-C, Cancellation of Debt, showing that $4,412 of indebtedness had been canceled on September 3, 2008. Petitioners did not report the $4,412 as income on their 2008 joint Federal income tax return. <br />
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The parties did not dispute the fair market values of the following of petitioners' assets immediately before petitioners' discharge: [pg. 1540] <br />
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<br />
<br />
------------------------------------------------------------------------------<br />
<br />
Asset Fair Market Value <br />
<br />
------------------------------------------------------------------------------<br />
<br />
<br />
<br />
Cash $300.00 <br />
<br />
<br />
<br />
Cars 12,550.00 <br />
<br />
<br />
<br />
Computers 100.00 <br />
<br />
<br />
<br />
Household goods 2,100.00 <br />
<br />
<br />
<br />
Tools 50.00 <br />
<br />
<br />
<br />
Jewelry 4,000.00 <br />
<br />
<br />
<br />
Clothing 350.00 <br />
<br />
<br />
<br />
Books 25.00 <br />
<br />
<br />
<br />
Life insurance 1,108.24 <br />
<br />
<br />
<br />
Investments 10,223.79 <br />
<br />
<br />
<br />
Boat 300.00 <br />
<br />
---------<br />
<br />
Total 31,107.03 <br />
<br />
------------------------------------------------------------------------------<br />
<br />
Likewise, the parties did not dispute the amounts of the following of petitioners' liabilities: <br />
<br />
<br />
<br />
------------------------------------------------------------------------------<br />
<br />
Liability Amount <br />
<br />
------------------------------------------------------------------------------<br />
<br />
<br />
<br />
Principal residence mortgage $555,015.31 <br />
<br />
<br />
<br />
Beach house mortgage 177,535.00 <br />
<br />
<br />
<br />
Real estate taxes 14,091.24 <br />
<br />
<br />
<br />
Credit card debt 25,659.43 <br />
<br />
<br />
<br />
Car debt 8,519.98 <br />
<br />
<br />
<br />
Utilities 1,563.84 <br />
<br />
<br />
<br />
Loan from New Jersey Public <br />
<br />
Employees Retirement System 15,532.75 <br />
<br />
<br />
<br />
Miscellaneous bills 936.91 <br />
<br />
----------<br />
<br />
Total 798,854.46 <br />
<br />
------------------------------------------------------------------------------<br />
<br />
The parties disagree about the values of three assets which are not included in the above lists. During 2008 petitioners owned a house in Mullica Hill, New Jersey (principal residence), and a house in Brigantine, New Jersey (beach house). Petitioners continued to own these houses at the time of trial in 2012. The parties disagree about the values of these two houses. They also disagree about the value of Mr. Shepherd's pension in the New Jersey Public Employees Retirement System (PERS). <br />
<br />
<br />
<br />
OPINION <br />
<br />
The Commissioner's determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving that the determinations are in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 [12 AFTR 1456] (1933). “Income from discharge of indebtedness” is included within the broad definition of income. Sec. 61(a)(12). Section 108 provides certain exceptions to section 61(a)(12). Section 108(a)(1)(B) excludes discharge of indebtedness income from gross income if the discharge occurs when the taxpayer is insolvent. The amount of income excluded under section 108(a)(1)(B) “shall not exceed the amount by which the taxpayer is insolvent.” Sec. 108(a)(3). The term “insolvent” means “the excess of liabilities over the fair market value of assets.” Sec. 108(d)(3). Whether a taxpayer is insolvent, and the amount by which the taxpayer is insolvent, is “determined on the basis of the taxpayer's assets and liabilities immediately before the discharge.” Id. <br />
<br />
<br />
<br />
Respondent acknowledges that petitioners correctly listed the fair market values of most of their assets and liabilities. Petitioners and respondent dispute whether petitioners met their burden of proving the fair market values of the beach house and the principal residence, which were petitioners' largest assets. Additionally, petitioners and respondent dispute whether Mr. Shepherd's pension is an asset for purposes of determining whether petitioners are insolvent under section 108(d)(3). [pg. 1541] <br />
<br />
<br />
<br />
Burden of Proof Regarding the Fair Market Values of the Beach House and the Principal Residence <br />
<br />
“The burden of proving insolvency under section 108(a)(1)(B) is on petitioners.” Bressi v. Commissioner, T.C. Memo. 1991-651 [1991 TC Memo ¶91,651], 1991 Tax Ct. Memo LEXIS 693, at *18 (citing Rule 142(a) and Welch v. Helvering, 290 U.S. 111, 115 [12 AFTR 1456] (1933)), aff'd without published opinion 989 F.2d 486 (3d Cir. 1993). Therefore, , petitioners have the burden of proving the fair market value of all their assets immediately before the discharge. 2 See sec. 108(d)(3). <br />
<br />
<br />
<br />
Beach House <br />
<br />
<br />
<br />
Respondent argues that petitioners have not met their burden of proving the fair market value of their beach house immediately before the discharge. Petitioners contend they offered sufficient evidence to prove that the fair market value of the beach house was approximately $340,000. 3 <br />
<br />
<br />
<br />
To support the fair market value of their beach house petitioners offered into evidence a “Civil Action Stipulation of Settlement” (settlement) between petitioners and the City of Brigantine. The settlement provides that the value of the beach house for local property tax purposes is $380,000 for the 2010 tax year. Petitioners signed the settlement on May 16, 2011. <br />
<br />
<br />
<br />
“This Court has held previously that a value placed upon property for the purpose of local taxation, unsupported by other evidence, cannot be accepted as determinative of fair market value for Federal income tax purposes in the absence of evidence of the method used in arriving at that valuation.” Pierce v. Commissioner, 61 T.C. 424, 431 n.6 (1974); see Gilmartin v. Commissioner T.C. Memo. 1973-247, 1973 Tax Ct. Memo LEXIS 40, at *20-21; Bishop v. Commissioner, T.C. Memo. 1962-146 [¶62,146 PH Memo TC], 1962 Tax Ct. Memo LEXIS 163, at *61. The settlement does not describe the beach house nor the method used to determine the value of the beach house. Additionally, the settlement shows the beach house's valuation for tax purposes for 2010, whereas petitioners' debt was discharged on September 3, 2008. As a result, we find that the settlement is not convincing evidence of the fair market value of the beach house immediately before petitioners' discharge. <br />
<br />
<br />
<br />
At trial Mr. Shepherd testified that in his opinion the value of the beach house immediately before the discharge was approximately $340,000. Mr. Shepherd's valuation testimony was allegedly based on comparable sales that he assembled for the purpose of a property tax appeal. Apparently, this was for the 2010 tax year, which was at least two years after the discharge on September 3, 2008. While comparable sales can be persuasive evidence of fair market value,see First Nat'l Bank of Kenosha v. United States, 763 F.2d 891, 896 [56 AFTR 2d 85-6492] (7th Cir. 1985), petitioners neither offered into evidence nor described in detail the comparable sales or their dates. In order to corroborate Mr. Shepherd's testimony, the Court would need to review the comparable sales to determine whether a proper valuation methodology was used and that the comparable sales occurred in close proximity to the date of discharge. As a result, we find that Mr. Shepherd's testimony is not convincing evidence of the fair market value of the beach house immediately before petitioners' discharge. <br />
<br />
<br />
<br />
Accordingly, we find that petitioners did not meet their burden of proving the fair market value of the beach house immediately before the discharge. <br />
<br />
<br />
<br />
Principal Residence <br />
<br />
<br />
<br />
Respondent argues that petitioners have not met their burden of proving the fair market value of the principal residence immediately before the discharge. Petitioners contend they offered sufficient evidence to prove that the fair market value of the principal residence was $380,000 immedi[pg. 1542] ately before the discharge. 4 Petitioners offered the following evidence to support their valuation: (1) a letter dated March 29, 2011, from Chase Home Finance LLC (Chase) showing the value of the principal residence; and (2) a “2008 Final/2009 Preliminary Tax Bill” (tax bill). <br />
<br />
<br />
<br />
Petitioners applied for a loan modification for the principal residence through the Federal Home Affordable Modification Program (HAMP). As part of Chase's review to determine whether petitioners' loan qualified for a HAMP modification, Chase had to value petitioners' principal residence. In a letter Chase informed petitioners that an “exterior broker price opinion/ appraisal” 5 was used to value the property as of March 2011 at $380,000. <br />
<br />
<br />
<br />
Section 108(d)(3) requires that the fair market value of a taxpayer's assets be determined “immediately before the discharge.” Chase determined the fair market value of the principal residence as of March 2011, almost three years after the date of petitioners' discharge. 6 Furthermore, the letter from Chase does not describe the property nor explain, even briefly, the methodology used to determine its value. We find that Chase's valuation of the principal residence as of March 2011 is not convincing evidence of the fair market value of the principal residence immediately before petitioners' discharge. <br />
<br />
<br />
<br />
Petitioners offered into evidence a tax bill they received for their principal residence. The tax bill shows a net taxable value of $337,700 for petitioners' principal residence. The tax bill does not describe the property in detail nor the methodology used in determining the tax value. As we noted earlier, a value placed upon property for local taxation purposes is not determinative of fair market value of the property for Federal income tax purposes in the absence of evidence of the method used in arriving at that valuation. See Pierce v. Commissioner, 61 T.C. at 431 n.6; Gilmartin v. Commissioner , 1973 Tax Ct. Memo LEXIS 40, at *20-21; Bishop v. Commissioner, 1962 Tax Ct. Memo LEXIS 163, at *61. <br />
<br />
<br />
<br />
Furthermore, in New Jersey the assessed value of property is generally not equivalent to the fair market value of the property. See City of Passaic v. Passaic Cnty. Bd. of Taxation, 113 A.2d 753, 756 (1955) (”There has been general agreement for over a century that individual property valuations and assessments have been and are marred by the grossest inequities.”). In fact, the statutory framework for property assessments in New Jersey specifically contemplates that the assessed value of a property for tax purposes will not be equivalent to the fair market value of the property. See N.J. Stat. Ann. sec. 54:3-17 (West 2002) (each county tax administrator must annually determine the “ratio or percentage of true value at which the real property of each taxing district is in fact assessed”); id. sec. 54:1-35.3 (The director of the division of taxation must determine the “ratio of aggregate assessed to aggregate true valuation of real estate of each taxing district.”). <br />
<br />
<br />
<br />
We find that the tax bill is not convincing evidence of the fair market value of the principal residence. We further find that petitioners have not met their burden of proving the fair market values of the principal residence and the beach house immediately before the discharge. Accordingly, petitioners have failed to establish that they were insolvent as defined in section 108(d)(3). <br />
<br />
<br />
<br />
Mr. Shepherd's Pension <br />
<br />
<br />
<br />
We have previously found that petitioners were not insolvent as defined in section 108(d)(3) because they failed to meet their burden of proving the fair market values of the beach house and the principal residence. Nevertheless, we will discuss whether Mr. Shepherd's pension is an asset because the parties have discussed this issue extensively. <br />
<br />
<br />
<br />
Petitioners contend that Mr. Shepherd's pension is not an asset for purposes of determining insolvency under section 108(d)(3). Respondent disagrees. [pg. 1543] <br />
<br />
<br />
<br />
Mr. Shepherd is employed by Gloucester township and is a contributing member of PERS. On March 21, 2007, Mr. Shepherd obtained a $21,973.30 loan from PERS against his pension. Mr. Shepherd testified that this amount was the maximum he could borrow from PERS. On May 1, 2007, Mr. Shepherd made his first of 58 monthly loan repayments of $378.85 to PERS. Mr. Shepherd continued making contributions to his pension after he received the loan. <br />
<br />
<br />
<br />
Petitioners classified Mr. Shepherd's loan from PERS as a liability under section 108(d)(3). We note that it is wholly inconsistent to show a loan as a liability if the loan is fully secured by collateral and the collateral is not listed as an asset. By including the loan and not the underlying collateral, petitioners are presenting themselves as more insolvent than the reality of the matter. For consistency purposes, petitioners must either remove the loan as a liability or include the collateral that secures the loan as an asset. <br />
<br />
<br />
<br />
The term “insolvent” means “the excess of liabilities over the fair market value of assets.” Sec. 108(d)(3). This Court has held that the word “assets” as used in the definition of the term “insolvent” for section 108(d)(3) includes “assets exempt from the claims of creditors under applicable State law.” Carlson v. Commissioner, 116 T.C. 87, 105 (2001). We reasoned that if a debtor's assets, including assets exempt from the claims of creditors under State law, exceed liabilities, then the debtor has the ability to pay a tax on income from the discharge of indebtedness. Id. at 104. Mr. Shepherd's pension is exempt from claims of creditors under New Jersey State law. See N.J. Stat. Ann. sec. 25:2-1 (West 1997 & Supp. 2012). Under the Court's holding in Carlson, Mr. Shepherd's pension will not escape classification as an asset under section 108(d)(3) solely because of its exemption from claims of creditors. <br />
<br />
<br />
<br />
Mr. Shepherd had the ability to withdraw some portion of his pension on the date of petitioners' discharge. A member of PERS “may borrow from the retirement system, an amount equal to not more than 50% of the amount of his accumulated deductions”. N.J. Stat. Ann. sec. 43:15A-34 (West 1991 & Supp. 2012). A member of PERS may have more than one loan outstanding at any time. See id. Mr. Shepherd continued making contributions to his pension with PERS every pay period from the date he received the loan from PERS to the date of petitioners' discharge. Additionally, during this period Mr. Shepherd made monthly loan repayments of $378.85 to PERS. In other words, Mr. Shepherd's loan balance with PERS decreased from the date he obtained the loan to the date of petitioners' discharge while his accumulated contributions to his pension increased over that period. Therefore, we note that Mr. Shepherd's outstanding loan balance on the date of petitioners' discharge must have been less than 50% of his accumulated contributions to his pension. As a result, Mr. Shepherd had the right to immediately withdraw some portion of his accumulated contributions as a loan from his pension with PERS immediately before petitioners' discharge of indebtedness. We find that the portion of Mr. Shepherd's pension that could have been withdrawn as a loan from PERS is an asset for purposes of insolvency under section 108(d)(3). 7 <br />
<br />
<br />
<br />
Petitioners did not provide any evidence of Mr. Shepherd's accumulated contributions to the pension immediately before the discharge. Therefore, we are unable to determine what portion of Mr. Shepherd's pension could have been withdrawn as a loan. Accordingly, we find that petitioners have not met their burden of proving the fair market value of the portion of Mr. Shepherd's pension that constitutes an asset. <br />
<br />
<br />
<br />
Conclusion <br />
<br />
Section 108(d)(3) requires that a taxpayer establish the fair market value for all of his assets and liabilities in order to make a determination of insolvency. If we were to accept petitioners' valuation of their houses and exclude from liabilities the loan from PERS, petitioners would be [pg. 1544] approximately $32,000 insolvent. However, petitioners have not met their burden of proving the fair market values of the beach house, the principal residence, and Mr. Shepherd's pension. Since petitioners have not established they were insolvent as defined in section 108(d)(3), petitioners are not entitled to exclude their discharge of indebtedness income from gross income under section 108(a)(1)(B). <br />
<br />
<br />
<br />
In reaching our decision, we have considered all arguments made by the parties, and to the extent not mentioned or addressed, they are irrelevant or without merit. <br />
<br />
<br />
<br />
To reflect the foregoing, <br />
<br />
<br />
<br />
Decision will be entered for respondent. <br />
<br />
1<br />
<br />
<br />
<br />
<br />
<br />
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. <br />
<br />
2<br />
<br />
<br />
<br />
In some cases the burden of proof with respect to relevant factual issues may shift to the Commissioner under sec. 7491(a). However, petitioners have not argued that the burden of proof should shift to respondent, nor have they produced credible evidence as required by sec. 7491(a)(1). Therefore, we hold that the burden of proof does not shift to respondent. <br />
<br />
3<br />
<br />
<br />
<br />
At trial Mr. Shepherd testified that petitioners purchased the beach house in 1996 for $118,000. Petitioners offered into evidence a Wells Fargo monthly mortgage statement for the beach house loan showing the unpaid principal balance of $177,539.03 on December 18, 2008. <br />
<br />
4<br />
<br />
<br />
<br />
At trial Mr. Shepherd testified that petitioners obtained a $580,000 mortgage on the principal residence in 2005. Mr. Shepherd further testified that in 2005 the approximate appraised value of the principal residence was $750,000. Petitioners offered into evidence a Chase monthly mortgage statement showing the unpaid principal balance on the principal residence loan was $555,015.31 on August 15, 2008. <br />
<br />
5<br />
<br />
<br />
<br />
The letter from Chase does not explain what “exterior broker price opinion/appraisal” means. <br />
<br />
6<br />
<br />
<br />
<br />
We take judicial notice of the large downturn in national residential real estate values that occurred after September 2008. <br />
<br />
7<br />
<br />
<br />
<br />
Therefore, it is unnecessary for us to decide whether Mr. Shepherd's entire pension constitutes an asset under sec. 108(d)(3). <br />
<br />
<br />
<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-24714333885112320072012-08-09T19:44:00.001-04:002012-08-09T19:44:39.797-04:00Derivium loanGregory Raifman, et ux. v. Commissioner, TC Memo 2012-228 , Code Sec(s) 165; 6320; 6330. <br />
<br />
<br />
<br />
<br />
GREGORY RAIFMAN AND SUSAN RAIFMAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent . <br />
<br />
Case Information: Code Sec(s): 165; 6320; 6330 <br />
<br />
Docket: Docket No. 12144-11L. <br />
<br />
Date Issued: 08/7/2012 <br />
<br />
<br />
<br />
<br />
<br />
HEADNOTE <br />
<br />
XX. <br />
<br />
<br />
<br />
Reference(s): Code Sec. 165; Code Sec. 6320; Code Sec. 6330 <br />
<br />
<br />
<br />
Syllabus <br />
<br />
Official Tax Court Syllabus<br />
<br />
Counsel <br />
<br />
Brian G. Isaacson and Emily J. Kingston, for petitioners. <br />
<br />
Daniel J. Parent, for respondent. <br />
<br />
<br />
<br />
MEMORANDUM OPINION <br />
<br />
WELLS, Judge: This case is before the Court on respondent's motion for summary judgment pursuant to Rule 121. 1 Petitioners ask us to review the [*2] determination of respondent's Appeals Office to proceed with collection actions with respect to petitioners' 2003 tax liability. The parties agree that the only disputed issue is whether petitioners are entitled to a deduction for a theft loss for their 2006 tax year that can be carried back to eliminate their 2003 tax liability. <br />
<br />
<br />
<br />
Background <br />
<br />
The facts set forth below are based upon examination of the pleadings, moving papers, responses, and attachments, and they are not in dispute. Petitioners resided in California at the time they filed their petition. <br />
<br />
<br />
<br />
During 2003, petitioners' financial adviser, Joe Ramos of Private Consulting Group, provided them with information about Derivium Capital, LLC (Derivium), a South Carolina entity owned and controlled by Charles Cathcart and Yuri Debevc. Derivium 2 offered a program called the "90% Stock Loan”, which Derivium marketed to high-net-worth individuals with large equity investments. 3 As explained in Derivium's marketing materials, the 90% Stock Loan permitted [*3] investors to receive cash in the amount of 90% of the value of any stock the investors transferred to Derivium. Derivium would then “establish hedging transactions to protect the value” of the stock. The principal and interest on the 90% Stock Loan would not be due until maturity, after a term of at least three years. Derivium characterized the 90% Stock Loan as a nonrecourse loan and claimed that it offered investors the opportunity to generate liquidity without triggering a taxable event and to hedge against a market downturn while retaining the benefits of any market gains. <br />
<br />
<br />
<br />
On August 5, 2003, petitioners signed a Master Loan Agreement and blank schedule A-1 with WITCO, Ltd. (WITCO), an entity that Derivium told petitioners was a foreign lender. WITCO was owned and controlled by Mr. Cathcart and Mr. Debevc. The Master Loan Agreement stated: <br />
<br />
<br />
<br />
The Client understands that by transferring custody of the Collateral to WITCO as agent for the Lender under terms of this Agreement and Schedule(s) A, the Client grants to the Lender and its agent, WITCO, the right and power, without the requirement of notice to or consent of the Client, to assign, transfer, pledge, repledge, hypothecate, rehypothecate, lend, encumber, short sell, and/or sell outright some or all of the Collateral during the Loan Term (as defined in Schedule(s) A). *** *** WITCO and the Lender unconditionally agree to return to the Client, at the end of the Loan Term, the same Collateral received for such Loan, as such Collateral is listed and described in the associated Schedule A, so long as [*4] the Client has then satisfied in full all outstanding Loan obligations to the Lender, including the payment of interest accrued on the Loan. If the Collateral is stock, the Collateral to be returned to the Client as per this paragraph shall reflect any and all stock splits, conversions, exchanges, mergers, or other dividends and distributions, except dividends paid on the Collateral that are to be credited toward interest due under the Loan to the Client, as provided in Schedule A. During early September 2003, petitioners signed another schedule A-1 that listed information about the collateral, loan amount, and loan term. The schedule A-1 defined the “Loan Term” as three years from the date the loan proceeds are distributed. Additionally, it stated that the estimated value of the collateral was $2,537,600, that the loan amount would be 90% of that value, and that the interest rate would be 11.25%, compounded annually and due at maturity. Petitioners renewed the loan on the maturity date, but if the value of the collateral on that date did not equal or exceed 90% of the payoff amount, petitioners would have to pay additional interest at the time of renewal. <br />
<br />
<br />
<br />
On August 19, 2003, petitioners authorized the transfer of 320,000 shares of ValueClick stock from their account to WITCO's account. WITCO received the shares of ValueClick stock in two installments: 159,000 and 161,000 shares on August 28 and September 22, 2003, respectively. On August 28 and 29, 2003, WITCO sold 159,000 shares of ValueClick stock. The transfer and sale of petitioners' shares of ValueClick stock was conducted through WITCO's account [*5] at Wachovia Securities, LLC (Wachovia). On a date not disclosed in the record but before September 22, 2003, WITCO distributed $1,260,410.52 to petitioners. On September 22, 2003, WITCO sold 161,000 shares of ValueClick stock. On September 29, 2003, WITCO distributed $1,362,804.48 to petitioners. <br />
<br />
<br />
<br />
During 2004, petitioners entered into two more 90% Stock Loan transactions with entities related to Derivium. On July 6, 2004, through their wholly owned entity Helicon Investments, Ltd. (Helicon), petitioners signed a Master Loan Agreement with Optech, Ltd. (Optech). The terms of that Master Loan Agreement were identical to the terms of the WITCO Master Loan Agreement in all material respects. The estimated value of the collateral was $3,540,000, the anticipated loan amount was 86% of the value of the collateral, 4 the loan term was three years, and the interest rate for the loan was 11.75%, compounded annually and due at maturity. On or about July 9, 2004, Helicon transferred 300,000 shares of ValueClick stock to Optech's Wachovia account. In a series of sales on July 9, 12, 13, 14, 15, and 16, 2004, Optech sold 300,000 shares of ValueClick stock. On July 23, 2004, Optech transferred $2,810,475.60 into Helicon's bank account. [*6] During November 2004, petitioners, through their wholly owned entity Gekko Holdings, LLC (Gekko), entered into another Master Loan Agreement with Optech. The terms of that Master Loan Agreement are not disclosed in the record, 5 but the parties agree that they were identical in all material respects to the terms of the other two 90% Stock Loan transactions. On November 19, 2004, petitioners authorized the transfer of 200,000 shares of ValueClick stock from Gekko to Optech. Those shares were transferred to Optech's Wachovia account on November 23, 2004. On November 24, 26, 29, and 30, 2004, Optech sold 200,000 shares of ValueClick stock. On November 30, 2004, Optech provided Gekko with an “Activity Confirmation” statement reporting that the total value of Gekko's collateral was $2,400,299.83 and the amount of the 90% Stock Loan was $2,160,269.85. The statement noted that the loan term was three years and that the interest rate on the loan was 11.75%. On December 2, 2004, Optech transferred $2,160,266.92 in cash to Gekko. <br />
<br />
<br />
<br />
During the terms of the loans, Optech sent petitioners quarterly and yearly account statements reporting the balance of the loans, the accrued interest, and the current value of the underlying collateral. Petitioners were not obligated to make [*7] payments during the term of the loans, and they did not make any payments with respect to either the principal of or the interest on the loans. During the term of each of the loans, the share price of ValueClick stock increased so that the value of petitioners' underlying collateral greatly exceeded the amount of the principal and interest on each loan. <br />
<br />
<br />
<br />
On August 10, 2006, petitioners completed an Optech form electing to renew or refinance their September 29, 2003, loan for another term of three years. 6 Petitioners received no response from Optech. On October 17, 2006, Carin Levine, the general counsel for petitioners' investment adviser Private Consulting Group, sent Optech a letter demanding the return of 320,000 shares of ValueClick stock that had been pledged as collateral for petitioners' September 29, 2003, loan. Petitioners again received no response from Optech. On November 21, 2006, Ms. Levine initiated arbitration proceedings against Optech on behalf of petitioners. <br />
<br />
<br />
<br />
After September 29, 2006 and before the end of the calendar year, petitioners initiated an investigation of Optech, WITCO, Derivium, and Messrs. Cathcart and Debevc. Petitioners discovered that Derivium had been sued by a number of other borrowers and that it had filed for bankruptcy during 2005. [*8] Additionally, during the course of their 2006 investigation, petitioners learned that the California Corporations Commission had filed suit against Derivium to enjoin it from engaging in the 90% Stock Loan program. After learning these facts during late 2006, petitioners reported to the Federal Bureau of Investigation that Derivium had stolen their ValueClick stock. <br />
<br />
<br />
<br />
Petitioners did not report the Derivium transactions or the funds received from Derivium on their 2003 or 2004 return. Petitioners filed an amended tax return for their 2006 tax year, claiming a theft loss of $7,593,956 from “the illegal sale of 820,000 shares of ValueClick stock sold without their knowledge or permission”. That amount was equal to their basis in the shares of ValueClick stock, the fair market value of which, at the time the alleged theft was allegedly discovered during late 2006, petitioners reported to be $17,716,000. Because their claimed theft loss was so large, petitioners also filed an amended tax return for their 2003 tax year, claiming a theft loss carryback of $5,386,786. <br />
<br />
<br />
<br />
During September 2007, petitioners filed an arbitration demand against their financial advisers, Joe Ramos and Private Consulting Group, for breach of contract, breach of fiduciary duty, professional negligence, and constructive fraud in connection with the 90% Stock Loan. However, petitioners recovered from their financial advisers only what they characterized as a “paltry sum”, the amount [*9] of which is not disclosed in the record. Petitioners also attempted to recover from Wachovia and one of Wachovia's financial advisers. On July 19, 2010, petitioners filed a Financial Industry Regulatory Authority arbitration claim against Wachovia, asserting: (1) fraud, concealment, and conspiracy to commit fraud; (2) breach of fiduciary duty; (3) breach of contract; (4) aiding and abetting fraud and breach of fiduciary duty; (5) violation of the California Securities Act; (6) violation of National Association of Securities Dealers and New York Stock Exchange rules; and (7) conversion. See Wachovia Sec., LLC v. Raifman, No. C 10-04573 SBA, 2010 WL 4502360 (N.D. Cal. Nov. 1, 2010). Petitioners were unsuccessful in that claim. See id. <br />
<br />
<br />
<br />
Respondent examined petitioners' 2003 tax return and disallowed certain business expense deductions related to a horse breeding business. Petitioners entered a closing agreement with respondent during February 2009 with respect to their 2003 tax liability. Additionally, petitioners consented to the assessment and collection of their 2003 tax liability. 7 [*10] On August 3, 2009, respondent issued petitioners a notice of intent to levy with respect to their 2003 tax liability. On August 12, 2009, petitioners submitted a Form 12153, Request for a Collection Due Process (Levy) Hearing. On October 1, 2009, respondent mailed to petitioners a Notice of Federal Tax Lien Filing and Your Right to a Hearing Under IRC 6320. On October 30, 2009, petitioners submitted a Form 12153, Request for a Collection Due Process (Lien) Hearing. The explanation on the Form 12153 with respect to the levy action stated that the "2003 liability will be eliminated by a carryback”, and the explanation on the Form 12153 with respect to the lien stated: “The 2003 tax liability will be extinguished by an NOL”. <br />
<br />
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On October 22, 2010, petitioners received a letter from Theresa Amper with respondent's Appeals Office. Before the hearing, petitioners' counsel Emily J. Kingston provided Ms. Amper with copies of petitioners' amended 2003 and 2006 tax returns showing the claimed theft loss. On November 16, 2010, Ms. Amper conducted the hearing with Ms. Kingston and determined that the matter should be assigned to another settlement officer to determine whether to allow the theft loss [*11] deduction claimed on petitioners' amended 2006 return and the corresponding carryback on their amended 2003 return. <br />
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After that settlement officer returned the matter to Ms. Amper, she conducted another hearing with Ms. Kingston on February 11, 2011. During the hearing, Ms. Kingston contended that Ms. Amper should suspend the collection actions while respondent considered the theft loss deduction claimed on petitioners' amended 2006 return. However, Ms. Amper declined to consider the theft loss carryback and determined that it was appropriate to sustain the lien and levy; and on April 19, 2011, respondent's Appeals Office mailed petitioners a Notice of Determination Concerning Collection Action(s) Under Section 6320 and a Notice of Determination Concerning Collection Action(s) Under Section 6330. <br />
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Respondent concedes that petitioners' carryback with respect to their claimed theft loss during 2006 was within the scope of the Appeals hearing and should have been considered by Ms. Amper. However, respondent's motion indicates that respondent does not intend to seek remand of petitioners' case to the Appeals Office for consideration of the issue. <br />
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Discussion <br />
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Rule 121(a) provides that either party may move for summary judgment upon all or any part of the legal issues in controversy. Full or partial summary [*12] judgment may be granted only if no genuine issue exists as to any material fact and the issues presented by the motion may be decided as a matter of law. See Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 [73 AFTR 2d 94-1198] (7th Cir. 1994). The moving party bears the burden of proving that there is no genuine issue of material fact, and factual inferences are viewed in the light most favorable to the nonmoving party. Sundstrand Corp. v. Commissioner, 98 T.C. at 520. However, the party opposing summary judgment must set forth specific facts that show a genuine issue of material fact exists and may not rely merely on allegations or denials in the pleadings. Rule 121(d). <br />
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Section 6321(a) provides that if any person liable to pay any tax neglects or refuses to pay after demand, the Commissioner may collect such tax by placing a lien on the person's property or rights to property. Section 6331(a) provides that, if any person liable to pay any tax neglects or refuses to do so within 10 days after notice and demand, the Commissioner may collect such tax by levy upon property belonging to such person. However, the Commissioner is required to give written notice of his intent to file a lien or to levy and must inform the taxpayer of the right to request a hearing before the Commissioner's Appeals Office. Secs. 6320(a), 6330(a). A hearing under section 6320 is conducted in accordance with the procedural requirements of section 6330. Sec. 6320(c). At the hearing, the [*13] taxpayer may raise any relevant issues including appropriate spousal defenses, challenges to the appropriateness of collection actions, and collection alternatives. Sec. 6330(c)(2)(A). Further, a taxpayer may dispute the underlying tax liability for any tax period if the taxpayer did not receive a notice of deficiency or otherwise have an opportunity to dispute the tax liability. Sec. 6330(c)(2)(B). Following a hearing, the Appeals Office must make a determination whether the proposed lien or levy action may proceed. In addition to considering issues raised by the taxpayer under section 6330(c)(2), the Appeals Office must also verify that the requirements of any applicable law or administrative procedure have been met, and whether the proposed collection action appropriately balances the need for efficient collection of taxes with the taxpayer's concerns regarding the intrusiveness of the proposed collection action. Sec. 6330(c)(1), (3). <br />
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Where the validity of the underlying tax liability is properly in issue, the Court will review the determination of the Appeals Office de novo. Sego v. Commissioner, 114 T.C. 604, 610 (2000); Goza v. Commissioner, 114 T.C. 176, 181-182 (2000). However, where the validity of the underlying tax is not properly in issue, the Court will review the determination for abuse of discretion.Sego v. Commissioner, 114 T.C. at 610; Goza v. Commissioner, 114 T.C. at 181-182. The underlying tax liability is the amount unpaid after the application of all credits to [*14] which the taxpayer is entitled, including credits stemming from overpayments in other years. Landry v. Commissioner, 116 T.C. 60, 62 (2001). Our jurisdiction under section 6330(d)(1)(A) encompasses the consideration of facts and issues related to tax years other than the years covered in the notice of determination where the facts and issues from those other years are relevant in evaluating a claim that an alleged unpaid tax has been paid. Freije v. Commissioner, 125 T.C. 14, 27 (2005). <br />
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In the instant case, we have jurisdiction to consider petitioners' claimed theft loss deduction on their amended 2006 return because the carryback of that loss would reduce or eliminate the amount of unpaid tax with respect to petitioners' 2003 tax year. See id. Although petitioners have had the opportunity to dispute their underlying liability with respect to the theft loss stemming from the 2003 90% Stock Loan, they have not had the opportunity to dispute their underlying liability with respect to the theft loss stemming from the 2004 90% Stock Loans. Because most of the theft loss deduction claimed on their amended 2006 return stems from the 2004 transactions, respondent concedes that petitioners are entitled to dispute their underlying liability in the instant case. Accordingly, we review the determination of the Appeals Office de novo. [*15] We have decided a number of other cases involving the 90% Stock Loan marketed by Derivium and its affiliates. InCalloway v. Commissioner, 135 T.C. 26 (2010), we rejected the taxpayer's argument that the 90% Stock Loan was a loan and instead held that it was a sale. To reach that conclusion, we analyzed the substance of the transaction under the factors set forth inGrodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, 1237-1238 (1981). Calloway v. Commissioner, 135 T.C. at 34-37. Those factors include: (1) whether legal title passes; (2) how the parties treat the transaction; (3) whether an equity interest was acquired in the property; (4) whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments; (5) whether the right of possession is vested in the purchaser; (6) which party pays the property taxes; (7) which party bears the risk of loss or damage to the property; and (8) which party receives the profits from the operation and sale of the property. Id. at 34; see also Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. at 1237-1238. In Calloway, as in the instant case, Derivium did not hold the stock as collateral, but instead immediately sold it and gave the taxpayer 90% of the proceeds. Calloway v. Commissioner, 135 T.C. at 38-39. On the basis of the Grodt & McKay factors, we concluded that the taxpayer transferred all of the rights and privileges of ownership to Derivium and held that [*16] the transfer of stock was a sale, not a loan. Id. Since deciding Calloway, we have reached the same conclusion in a number of similar cases. See Landow v. Commissioner, T.C. Memo. 2011-177 [TC Memo 2011-177]; Sollberger v. Commissioner, T.C. Memo. 2011-78 [TC Memo 2011-78]; Kurata v. Commissioner, T.C. Memo. 2011-64 [TC Memo 2011-64]; Shao v. Commissioner, T.C. Memo. 2010-189 [TC Memo 2010-189]. In Calloway we noted: “The only right petitioner retained regarding shares of IBM stock was an option, exercisable three years later, in 2004, to require Derivium to acquire 990 shares of IBM stock and deliver them to him in 2004.” Calloway v. Commissioner, 135 T.C. at 38. <br />
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Petitioners contend that the 90% Stock Loan was neither a loan nor a sale but rather a theft. Section 165(a) allows a taxpayer to deduct any loss sustained during the taxable year that is not compensated for by insurance or otherwise. Section 165(c) limits the deduction for individuals to losses incurred in a trade or business, losses incurred in a transaction engaged in for profit, and casualty and theft losses. Under section 165(e), “any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss.” A taxpayer is not entitled to deduct a loss if he has a claim for reimbursement and there is a reasonable prospect of recovery. ,Sec. 1.165-1(d)(2)(i), (3), Income Tax Regs. A reasonable prospect of recovery exists when the taxpayer has a bona fide claim for recoupment from third parties or otherwise and there is a substantial [*17] possibility that such claims will be decided in the taxpayer's favor. Ramsay Scarlett & Co. v. Commissioner, 61 T.C. 795, 811, (1974), aff'd, 521 F.2d 786 [36 AFTR 2d 75-5539] (4th Cir. 1975). The amount of a casualty or theft loss is generally limited to the lesser of the property's reduction in fair market value or the property's adjusted tax basis. Secs. 1.165-7(b)(1), 1.165-8(c), Income Tax Regs. Taxpayers bear the burden of proving both the occurrence of a theft within the meaning of section 165 and the amount of the loss. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 [12 AFTR 1456] (1933). <br />
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For tax purposes, whether a theft loss has been sustained depends upon the law of the jurisdiction in which the loss occurred. Bellis v. Commissioner, 540 F.2d 448, 449 [38 AFTR 2d 76-5546] (9th Cir. 1976), aff'g 61 T.C. 354 (1973); Edwards v. Bromberg, 232 F.2d 107, 111 [49 AFTR 856] (5th Cir. 1956); Monteleone v. Commissioner, 34 T.C. 688, 692 (1960). The exact nature of a theft, whether it be larceny, embezzlement, obtaining money by false pretenses, or other wrongful misappropriation of property of another, is of little importance provided that it constitutes a theft. Bromberg, 232 F.2d at 111; see also sec. 1.165-8(d), Income Tax Regs. <br />
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Because the alleged theft took place in California, we will apply California law. In California, all larcenous crimes have been consolidated into the single crime of theft, People v. Davis, 965 P.2d 1165, 1167 (Cal. 1998), defined in Cal. [*18] Penal Code sec. 484(a) (West 2010) as follows: “Every person who shall feloniously steal, take, carry, lead, or drive away the personal property of another, *** or who shall knowingly and designedly, by any false or fraudulent representation or pretense, defraud any other person of money, labor or real or personal property *** is guilty of theft.” That statute encompasses at least two varieties of theft involving fraud. See People v. Ashley, 267 P.2d 271, 279 (Cal. 1954) (distinguishing theft by false pretenses and theft by trick or device). We need not concern ourselves with the technical distinctions between those larcenous offenses. Because petitioners contend that the theft involved fraud, for present purposes it is sufficient to observe that the following elements are essential under California law: (1) the perpetrator made a false pretense or representation which materially influenced the owner to part with his property; (2) the perpetrator did so knowingly with the intent to defraud the property owner; and (3) the owner was actually defrauded. Id. at 279, 282; People v. Traster, 4 Cal. Rptr. 3d 680, 686-687 (Ct. App. 2003); People v. Sanders, 79 Cal. Rptr. 2d 806, 810-811 (Ct. App. 1998). <br />
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Petitioners attempt to distinguish the facts of their case from those of Calloway and the other prior Derivium cases by arguing that, under the terms of the Master Loan Agreements they signed, Derivium had the right to sell their stock [*19] only during the “Loan Term”. Because the schedules A-1defined the “Loan Term” as beginning on the date the loan proceeds were distributed and because Derivium sold their shares of ValueClick stock before the loan proceeds were distributed, petitioners contend that the sale of their ValueClick stock was a theft. Petitioners contend that the amount of their theft loss is the adjusted basis in their shares of ValueClick stock, which is the amount they claimed on their amended 2006 return. <br />
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We are not convinced by petitioners' “Loan Term” argument. The loan agreements in the prior Derivium cases we have considered are nearly identical to the loan agreements in the instant case. For instance, inCalloway the loan agreement gave Derivium the right to sell the stock “during the period covered by the loan”, and the Schedule A-1 stated that the loan term was measured “starting from the date on which final loan proceeds are delivered on the loan transaction.” Calloway v. Commissioner, 135 T.C. at 29. Similarly, the loan agreements in Kurata and Landow also permitted Derivium to sell the stock only “during the period covered by the loan.” See Landow v. Commissioner, T.C. Memo. 2011-177 [TC Memo 2011-177]; Kurata v. Commissioner, T.C. Memo. 2011-64 [TC Memo 2011-64]. We conclude that there is no meaningful distinction between the phrases “during the period covered by the loan” and “during the Loan Term”. In Calloway, Kurata, and Landow, despite the [*20] ostensible limitations on the period during which Derivium was authorized to sell the taxpayers' stock, Derivium nonetheless sold the stock before it distributed the loan proceeds. In Landow, we rejected the taxpayers' argument that the Derivium transaction constituted a theft that resulted in an involuntary conversion under section 1033(a). We similarly reject petitioners' “Loan Term” argument. <br />
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However, the instant case is distinguishable from the prior Derivium cases we have considered for a different reason. In none of the prior Derivium cases we have considered did the taxpayers attempt to exercise their rights to a return of their collateral after the maturity dates. Rather, in the prior Derivium cases we have considered: (1) the value of the supposed collateral had declined so that the taxpayers either (a) walked away from the loan, see Calloway v. Commissioner, 135 T.C. at 32; Kurata v. Commissioner, T.C. Memo. 2011-64 [TC Memo 2011-64], or (b) renewed the loan and payed a fee to do so, see Shao v. Commissioner, T.C. Memo. 2010-189 [TC Memo 2010-189]; or (2) the loan had not yet reached maturity,see Landow v. Commissioner, T.C. Memo. 2011-177 [TC Memo 2011-177]; Sollberger v. Commissioner, T.C. Memo. 2011-78 [TC Memo 2011-78]. In contrast, after initially trying to renew the loan, petitioners requested the return of their shares of ValueClick stock, the value of which would have exceeded the amount of interest and principal due on their loan. Pursuant to the terms of the Master [*21] Loan Agreement, Derivium was obligated to return petitioners' collateral to them at the end of the Loan Term, after deducting the amount of interest and principal petitioners owed. However, petitioners' stock was not returned, which, as noted above, led to their investigation of Optech, WITCO, Derivium, and Messrs. Cathcart and Debevc. <br />
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As we stated in Calloway, Derivium's 90% Stock Loan transactions, such as those in issue in the instant case, can be characterized as sales of stock and the simultaneous purchase of options, 8 exercisable on the maturity dates, to purchase equivalent shares of stock. See Calloway v. Commissioner, 135 T.C. at 38. Each option's strike price is equal to the principal on the loan plus the interest due. The affidavit signed by Mr. Raifman in support of petitioners' opposition to respondent's motion for summary judgment states that petitioners believed that Derivium would engage in a hedging strategy to ensure that it would be solvent , *** [*22] and able to fulfill its obligations under the Master Loan Agreements to deliver to petitioners, on the dates of maturity, all of their shares of ValueClick stock if petitioners sought to exercise their options. Instead, it appears that Derivium engaged in no hedging strategy at all and that it had initially used funds from other borrowers to return collateral to some borrowers in a contrivance resembling a Ponzi scheme. See Shao v. Commissioner, T.C. Memo. 2010-189 [TC Memo 2010-189] (recounting Derivium's history). When it sold its clients' stock, Derivium apparently funneled to various offshore businesses the 10% of funds not returned to the clients. See Grayson Consulting, Inc. v. Wachovia Sec., LLC (In re Derivium Capital, LLC) , 437 B.R. 798, 802 (Bankr. D.S.C. 2010). As a result of the true nature of Derivium's hedging strategy (or lack thereof) and because of additional legal troubles with the State of California and the Internal Revenue Service, Derivium was soon insolvent and filed for bankruptcy protection. See Shao v. Commissioner, T.C. Memo. 2010-189 [TC Memo 2010-189]. When petitioners attempted to exercise their first option during 2006, Derivium failed to respond to any of petitioners' letters. <br />
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From the beginning, according to Mr. Raifman's affidavit, Derivium misrepresented the nature of the transaction into which petitioners entered. As far as we can tell, Derivium never engaged in a plausible hedging strategy. Instead, [*23] its alleged actions appear to be tantamount to a massive bet that the price of all of its clients' stocks would fall, “hedged” only by a Ponzi scheme. Mr. Raifman also states in his affidavit that petitioners relied on Derivium's misrepresentations when they chose to enter into the 90% Stock Loan program and that they were defrauded. Indeed, it appears that the failure of Derivium to honor petitioners' options to repurchase their ValueClick stock cost petitioners millions of dollars. On the basis of the statements in Mr. Raifman's affidavit, 9 we conclude that the instant case is distinguishable fromLandow and the other prior Derivium cases. Accordingly, we conclude that there remains a dispute over genuine issues of material fact concerning the existence of a theft loss under California law. <br />
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Additional genuine issues of material fact appear to us to remain in dispute with respect to petitioners' claim of a theft loss. At trial, we expect that petitioners will need to introduce, inter alia, evidence proving the amount of their loss, which will likely require valuation of the options to repurchase the ValueClick stock. Additionally, we expect that petitioners will need to introduce evidence showing that, at the time they claimed the theft loss deduction for 2006, they had no [*24] reasonable prospect of recovery, including no possibility of recovery on their claims against their investment advisers or Wachovia. <br />
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On the basis of the foregoing, we will grant respondent's motion for summary judgment insofar as we conclude that petitioners' transfers of stock to Derivium under the 90% Stock Loan were sales and not loans, but we will deny respondent's motion for summary judgment insofar as we conclude that genuine issues of material fact remain as to whether petitioners may be entitled to a deduction for a theft loss in the amount of the value of the options they purchased from Derivium that may be carried back from petitioners' 2006 tax year to petitioners' 2003 tax year. 10 [*25] In reaching these holdings, we have considered all the parties' arguments, and, to the extent not addressed herein, we conclude that they are moot, irrelevant, or without merit. <br />
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To reflect the foregoing, <br />
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An appropriate order will be issued. <br />
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1<br />
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Unless otherwise indicated, section references are to the Internal Revenue Code of 1986, as amended, and Rule references are to the Tax Court Rules of Practice and Procedure. <br />
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2<br />
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As noted below, petitioners signed agreements with two entities related to Derivium. For convenience, unless we indicate that we are discussing the specific terms of those agreements, we will refer to all of the entities involved in the 90% Stock Loan program as Derivium. <br />
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3<br />
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Although we refer to the Derivium program as the “90% Stock Loan” and sometimes use terms such as “loan”, “collateral”, “loan term”, “maturity”, etc., we use those terms for convenience only. We do not intend our use of those terms to imply that the transaction constituted a loan for tax purposes. <br />
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4<br />
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It is unclear from the record why the anticipated loan amount was only 86% of the value of the collateral instead of 90%. <br />
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5<br />
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The record contains two copies of the July 6, 2004, Master Loan Agreement. It appears that respondent mistakenly produced two copies of that agreement instead of a copy of the November 2004 agreement. <br />
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6<br />
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The September 29, 2003, loan was made by WITCO; it is unclear from the record how Optech came to hold the loan. <br />
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7<br />
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As part of his examination, respondent also determined that the 2003 90% Equity Loan should have been treated as a sale of 320,000 shares of ValueClick stock and that petitioners owed tax on the capital gain from the sale. Although petitioners therefore have had a prior opportunity to dispute the characterization of their 2003 transaction with Derivium, because most of the purported theft loss stems from the 2004 transactions respondent does not contend that petitioners are precluded, on the basis of their waiver with respect to their 2003 tax liability, from disputing the characterization of the underlying transaction. <br />
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8<br />
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In New Phoenix Sunrise Corp. v. Commissioner 132 T.C. 161, 166 (2009), aff'd, 408 Fed. Appx. 908 [106 AFTR 2d 2010-7116] (6th Cir. 2010), we defined an “option” as follows: <br />
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An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an asset at a predetermined price (the strike price). In exchange for selling an option, the seller receives from the purchaser a premium which reflects the value of the option. The risk to a purchaser of an option is limited to the premium. The risk to the seller of an option can be unlimited; it is the difference between the strike price and the market price of the asset at expiration less the premium. <br />
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9<br />
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We are required, for purposes of deciding respondent's motion for summary judgment, to view these factual statements in the light most favorable to petitioners, as the nonmoving party. See Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994) <br />
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10<br />
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We are puzzled by respondent's choice not to seek remand of petitioners' case to the Appeals Office, despite respondent's concession that the Appeals Office erred by failing to consider whether petitioners' carryback with respect to their claimed theft loss during 2006 was within the scope of the Appeals hearing. Accordingly, we will order respondent to wait until he has concluded the examination of petitioners' amended 2006 return before proceeding with the instant case in this Court. In that regard, we will also order the parties to submit a status report advising the Court when the examination of petitioners' 2006 return has been concluded. <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-71322050129926350762012-08-09T19:39:00.001-04:002012-08-09T19:39:52.969-04:00Passive TruckingJoseph Veriha, et ux. v. Commissioner, 139 T.C. No. 3, Code Sec(s) 469. <br />
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JOSEPH VERIHA AND CHRISTINA F. VERIHA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.<br />
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Case Information: Code Sec(s): 469 <br />
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Docket: Dkt. No. 7099-10. <br />
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Date Issued: 08/8/2012 . <br />
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Judge: Opinion by Wells, J. <br />
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Tax Year(s): <br />
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Disposition: <br />
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HEADNOTE <br />
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1. <br />
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Reference(s): Code Sec. 469 <br />
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Syllabus <br />
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Official Tax Court Syllabus<br />
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During 2005, P-H was the sole owner of JVT, a C corporation in the trucking business, and he actively participated in JVT's business. JVT leased the tractors and trailers used in its business from TRI, an S corporation in which P-H owned 99% of the shares of stock, and JRV, a single-member LLC in which P-H was the only member. The lease of each tractor and each trailer was governed by a separate contract. During 2005, TRI generated net income and JRV generated a net loss. On their 2005 joint return Ps treated the net income from TRI as passive income and treated the net loss from JRV as a passive loss. R determined that, pursuant to sec. 1.469-2(f)(6), Income Tax Regs. (sometimes referred to as the “self-rental rule or the recharacterization rule”), each tractor and each trailer should be considered a separate “item of property” and that the income P-H received from TRI should be recharacterized as nonpassive income. Ps contend that the entire collection of tractors and trailers is one “item of property”. <br />
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Held: For purposes of sec. 1.469-2(f)(6), Income Tax Regs., each individual tractor or trailer was an “item of property” and the income P-H received from TRI was subject to recharacterization. <br />
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Counsel <br />
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Amy L. Barnes and Robert Edward Dallman, for petitioners. <br />
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Laurie B. Downs, for respondent. <br />
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WELLS, Judge <br />
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OPINION <br />
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Respondent determined a deficiency in petitioners' 2005 Federal income tax of $258,785 and an accuracy-related penalty pursuant to section 6662(a) of $51,757. 1 Respondent concedes that petitioners are not liable for the penalty. The issue we must decide is whether the income petitioner Joseph Veriha received from an S corporation in which he owned 99% of the stock should be recharacterized as nonpassive income pursuant to section 1.469-2(f)(6), Income Tax Regs. (sometimes referred to as the “self-rental rule or the recharacterization rule”). <br />
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Background <br />
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The parties submitted the instant case fully stipulated, without trial, pursuant to Rule 122. The parties' stipulations of fact are hereby incorporated by reference and are found accordingly. Petitioners are husband and wife who resided in Wisconsin at the time they filed their petition. <br />
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Mr. Veriha is the sole owner of John Veriha Trucking, Inc. (JVT), a corporation with its principal place of business in Wisconsin. JVT was a C corporation during 2005 but has since elected S corporation status. Petitioners were both employed by JVT during 2005, and Mr. Veriha materially participated in JVT's business. JVT is a trucking company that leases its trucking equipment from two different entities, Transportation Resources, Inc. (TRI), and JRV Leasing, LLC (JRV). The trucking equipment JVT leases consists of two parts: a motorized vehicle (tractor) and a towed storage trailer (trailer). TRI is an S corporation in which Mr. Veriha owns 99% of the stock; his father owns the remaining 1%. TRI is an equipment leasing company with its principal place of business in Wisconsin. TRI owns only the tractors and trailers that it leases to JVT. During 2005, TRI and JVT entered into 125 separate lease agreements, one for each tractor or trailer leased. TRI's only source of income during 2005 was the leasing agreements with JVT. JRV is a single-member limited liability company, and Mr. Veriha is its sole member. JRV is an equipment leasing company that owns only the tractors and trailers that it leases to JVT. During 2005, JRV and JVT entered into 66 separate lease agreements, one for each tractor or trailer leased. JRV's only source of income during 2005 was the leasing agreements with JVT. <br />
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Each tractor was leased to JVT as one unit, and each trailer was leased to JVT as one unit. The monthly rate for leasing each tractor was determined by the tractor's age, and the monthly rate for leasing each trailer was determined by the type of trailer. During 2005, the tractors and trailers owned by TRI and JRV were all parked in the same lot and were intermingled. All the tractors were painted the same yellow color, and all received the same scheduled maintenance. JVT paid the expenses for all of the tractors and trailers and insured all the tractors and trailers under the same blanket insurance policy. In determining which tractor or trailer to use on a route, JVT made no distinction between those TRI owned and those JRV owned. Similarly, when it assigned drivers, JVT did not make any distinction on the basis of the ownership of the tractor or trailer. <br />
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During 2005, TRI generated net income, which it reported to Mr. Veriha on a Schedule K-1, Partner's Share of Income, Deductions, Credits, etc. Petitioners treated that net income as passive income on their return. <br />
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During 2005, JRV generated a net loss, which petitioners reported on their Schedule C, Profit or Loss From Business. Petitioners treated that loss as a passive loss on their return. <br />
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Respondent issued a notice of deficiency to petitioners in which respondent determined that petitioners' income from TRI should be recharacterized as nonpassive income pursuant to section 1.469-2(f)(6), Income Tax Regs. Petitioners timely filed their petition in this Court. <br />
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Discussion <br />
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Section 469(a) disallows the passive activity loss of an individual taxpayer. Passive activity losses are suspended until the taxpayer either has offsetting passive income or disposes of the taxpayer's entire interest in the passive activity., Sec. 469(b), (g). Congress enacted the passive activity rules in response to concern about the widespread use of tax shelters in which taxpayers were avoiding tax on unrelated income. See Schaefer v. Commissioner, 105 T.C. 227, 230 (1995). <br />
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The Code defines “passive activity” as an activity involving the conduct of a trade or business in which the taxpayer does not materially participate. Sec. 469(c)(1). However, the term “passive activity” generally includes any rental activity, regardless of material participation. Sec. 469(c)(2), (4). Section 469 does not define “activity”. See Schwalbach v. Commissioner, 111 T.C. 215, 223 (1998). However, the Secretary has prescribed regulations pursuant to section 469(l) that specify what constitutes an “activity”. Section 1.469-4(c), Income Tax Regs., sets forth rules for grouping activities together to determine what constitutes a single “activity”. That regulation provides: “One or more trade or business activities or rental activities may be treated as a single activity if the activities constitute an appropriate economic unit for the measurement of gain or loss for purposes of section 469.” Sec. 1.469-4(c)(1), Income Tax Regs. Whether activities constitute an “appropriate economic unit” depends on the facts and circumstances. Sec. 1.469-4(c)(2), Income Tax Regs. <br />
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Section 469(d)(1) defines “passive activity loss” as “the amount (if any) by which--(A) the aggregate losses from all passive activities for the taxable year, exceed (B) the aggregate income from all passive activities for such year.” A passive activity loss is computed by first netting items of income and loss within each passive activity and then subtracting aggregate income from all passive activities from aggregate losses from all passive activities. See id.; sec. 1.469-2T, Temporary Income Tax Regs., 53 Fed. Reg. 5686 (Feb. 25, 1988). <br />
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In carrying out the provisions of section 469, section 469(l)(2) authorizes the Secretary to promulgate regulations “which provide that certain items of gross income will not be taken into account in determining income or loss from any activity (and the treatment of expenses allocable to such income)”. While the general rule of section 469(c)(2) characterizes all rental activity as passive, section 1.469-2(f)(6), Income Tax Regs., requires net rental income received by the taxpayer for use of an item of the taxpayer's property in a business in which the taxpayer materially participates to be treated as income not from a passive activity, and provides: (f)(6) Property rented to a nonpassive activity.--An amount of the taxpayer's gross rental activity income for the taxable year from an item of property equal to the net rental activity income for the year from that item of property is treated as not from a passive activity if the property-- <br />
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(i) Is rented for use in a trade or business activity *** in which the taxpayer materially participates *** . A taxpayer's activities include activities conducted through C corporations that are subject to section 469. Sec. 1.469-4(a), Income Tax Regs. <br />
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Section 1.469-2(f)(6), Income Tax Regs., explicitly recharacterizes as nonpassive net rental activity income from an “item of property” rather than net income from the entire rental “activity”. Section 469 and the regulations thereunder distinguish between net income from an “item of property” and net income from the entire “activity”, which might include rental income from multiple items of property. Even when items of property are grouped together in one activity, section 1.469-2(f)(6), Income Tax Regs., still applies to recharacterize rental income from an item of property as nonpassive income. Carlos v. Commissioner, 123 T.C. 275, 282 (2004). <br />
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The parties disagree about the definition of the phrase “item of property”. In the notice of deficiency, respondent determined that the income from TRI should be recharacterized as nonpassive income. The notice of deficiency does not explain the rationale for that recharacterization, and petitioners contend that the notice of deficiency determined that each fleet of tractors and trailers TRI and JRV owned was a separate “item of property” and that the income from TRI should be recharacterized pursuant to section 1.469-2(f)(6), Income Tax Regs. However, on brief respondent contends that the notice of deficiency determined that each individual tractor or trailer is an “item of property” but that respondent elected not to challenge the offsetting of income and losses with respect to each tractor or trailer within TRI or JRV. In contrast, petitioners contend that the entire collection of tractors and trailers, i.e., all the tractors and trailers whether owned by TRI or JRV, constitutes a single “item of property”. <br />
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Because neither the Code nor the regulations define the phrase “item of property”, we follow the established rule of construction that an undefined term is given its ordinary meaning. See FDIC v. Meyer, 510 U.S. 471, 476 (1994); Gates v. Commissioner, 135 T.C. 1, 6 (2010). When seeking to ascertain the ordinary meaning of a term, a court may look for assistance to sources such as dictionaries. Muscarello v. United States, 524 U.S. 125, 127-132 (1998); Gates v. Commissioner, 135 T.C. at 6. <br />
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Webster's Third New International Dictionary 1203 (2002) provides the following definitions of the term “item”: “an individual thing (as an article of household goods, an article of apparel, an object in an art collection, a book in a library) singled out from an aggregate of the individual things *** item applies chiefly to each thing in a list of things or in a group of things that lend themselves to listing (an item in a laundry list) (each item of income) (an item in an inventory).” Webster's Ninth New Collegiate Dictionary 643 (1990) similarly defines “item” as “a separate particular in an enumeration, account, or series”. The American Heritage Dictionary of the English Language 930 (2000) defines “item” as “[a] single article or unit in a collection, enumeration, or series.” Black's Law Dictionary 908 (2009) defines “item” as “[a] piece of a whole”. In all of the foregoing dictionary definitions “item” is defined as a separate thing that is part of a larger collection. Those definitions support respondent's contention that each separate tractor or trailer is an “item of property”. Indeed, the articulation of petitioners' argument requires the use of a term such as “collection”, “group”, or “whole”, all of which serve to distinguish the collection of tractors and trailers from any single tractor or trailer, i.e., any single “item of property”. Accordingly, we conclude that each individual tractor or trailer is an “item of property” within the meaning of section 1.469-2(f)(6), Income Tax Regs. <br />
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However, as one court has noted, the definition of the term “item” is context specific: [T]he dictionary definition *** is of little value because “items” is a relative term whose contours are constructed by context. Only when measured by the remaining particulars in a given classification can one discern whether a designation is an item. Thus, we are left *** with determining the meaning of “items” as used in the statute without an accompanying list of associated particulars. That being so, reasonable persons could differ on the degree of specificity inherent in the term. United States v. Zheng, 768 F.2d 518, 523 (3d Cir. 1985). Although we conclude that each tractor and each trailer is a separate item of property, we can conceive of cases in which the result would be different. For example, if JVT had always used each tractor with one particular trailer and if the lease agreements between JVT and TRI and JRV were for particular tractor-trailer pairs, then each tractor-trailer combination might be considered an “item of property”. <br />
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Petitioners contend that accepting respondent's argument that each tractor and each trailer is an “item of property” would compel absurd results such as, for example, that a business renting tools would have to recharacterize income with respect to each individual tool. However, that would not necessarily be the case; rather, it would be the case only if the context suggested that each tool should be considered an “item of property”. If, for instance, the business leased tool sets and only tool sets, then each set might be considered an “item of property”. If, on the other hand, as in the instant case, the lease of each tool were governed by a separate lease agreement with a separate price, then we would not consider absurd the result that the business would have to recharacterize income on that basis. <br />
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Petitioners contend that respondent's position is at odds with that taken by the Commissioner in Shaw v. Commissioner, T.C. Memo. 2002-35 [TC Memo 2002-35], in which the Commissioner reclassified as nonpassive the net rental income from various properties, including “over the road trailers”. In Shaw, for purposes of section 1.469-2(f)(6), Income Tax Regs., the Commissioner treated all of the over the road trailers as one item of property. We are not persuaded by petitioners' contention. We have repeatedly held that, even with respect to the same taxpayer, the Commissioner is not bound in any given year to allow the same treatment as in prior years. See, e.g., Pekar v. Commissioner, 113 T.C. 158, 166 (1999); Murphy v. Commissioner, 92 T.C. 12, 15 (1989); Lee v. Commissioner, T.C. Memo. 2006-70 [TC Memo 2006-70]. As we stated in Murphy v. Commissioner, 92 T.C. at 15: “The erroneous past actions of respondent cannot be relied upon to allow *** [the treatment of an item] not permitted by statute.” Certainly, the same would be true as to different taxpayers. Accordingly, we conclude that respondent is not bound to treat petitioners' tractors and trailers as one item of property even though the Commissioner may have treated the over the road trailers in Shaw as one item of property. Moreover, it is not even clear that, in Shaw, the Commissioner actually treated all of the over the road trailers as one item of property. Indeed, the Commissioner's treatment of the trailers inShaw is consistent with respondent's position in his brief that, although respondent considers each individual tractor or trailer a separate item of property, respondent is electing not to challenge petitioners' offset of the income and losses from each item of property within TRI and JRV. <br />
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Petitioners further contend that, within the trucking industry, the phrase “item of property” typically refers to an entire fleet of trucks. However, petitioners cite no authority for that proposition, and we find it implausible. Indeed, even within the context of the instant case, Mr. Veriha's decision to hold the entire fleet of tractors and trailers under the title of two different entities is inconsistent with the proposition that the entire fleet is viewed as a single “item of property”. Moreover, that proposition is also inconsistent with the fact that JVT entered into a separate lease agreement with TRI or JRV for each tractor and each trailer it leased. Indeed, those separate lease agreements strongly suggest that JVT, TRI, and JRV viewed each of the tractors or trailers as a separate “item of property”. <br />
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As we stated in Shaw v. Commissioner, T.C. Memo. 2002-35 [TC Memo 2002-35], a taxpayer “must accept the tax consequences of his business decisions and the manner in which he chose to structure his business transactions.” Or, as the Supreme Court has stated: “[W]hile a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not, and may not enjoy the benefit of some other route he might have chosen to follow but did not.” Commissioner v. Nat'l Alfalfa Dehydrating & Milling Co. 417 U.S. 134, 149 [33 AFTR 2d 74-1347] (1974) (internal citations omitted). , On the basis of the foregoing, we conclude that each individual tractor and each trailer was a separate “item of property” within the meaning of section 1.469- 2(f)(6), Income Tax Regs. However, because respondent has not contested petitioners' netting of gains and losses within TRI, only TRI's net income is recharacterized as nonpassive income. 2 <br />
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(continued...) <br />
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In reaching these holdings, we have considered all the parties' arguments, and, to the extent not addressed herein, we conclude that they are moot, irrelevant, or without merit. <br />
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To reflect the foregoing, <br />
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Decision will be entered under Rule 155. <br />
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1<br />
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Unless otherwise indicated, section references are to the Internal Revenue Code of 1986 (Code), as amended, and Rule references are to the Tax Court Rules of Practice and Procedure. <br />
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2<br />
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We note that this result is necessarily more favorable to petitioners than the result would have been had respondent contended that it was necessary for the income from each tractor or trailer within TRI and JRV to be recharacterized as nonpassive. <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-68666979658995228732012-08-08T19:54:00.001-04:002012-08-08T19:54:42.787-04:00Marriott CaseMARRIOTT INTERNATIONAL RESORTS, LP,. ET AL. v. U.S., Cite as 102 AFTR 2d 2008-6039 (83 Fed. Cl. 291), 08/28/2008 , Code Sec(s) 752 <br />
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MARRIOTT INTERNATIONAL RESORTS, L.P., ET AL., PLAINTIFFS v. UNITED STATES, DEFENDANT.<br />
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Case Information: <br />
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Code Sec(s): 752 <br />
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[pg. 2008-6039] Court Name: U.S. Court of Federal Claims, <br />
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Docket No.: Nos. 01-256T & 01-257T (consolidated), <br />
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Date Decided: 08/28/2008. <br />
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Prior History: Earlier proceedings at (2006, CA Fed Cir) 97 AFTR 2d 2006-853, 437 F3d 1302, reversing and remanding (2004, Ct Fed Cl) 94 AFTR 2d 2004-5312, which was amended in part by (2004, Ct Fed Cl) 94 AFTR 2d 2004-6963 and from which petition to appeal was granted by (2005, CA9) 95 AFTR 2d 2005-1003. <br />
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Tax Year(s): Year 1994. <br />
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Disposition: Decision for Govt. <br />
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Cites: 83 Fed. Cl. 291, 2008-2 USTC P 50540. <br />
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HEADNOTE <br />
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1. Partnership transactions—gains and losses—basis—treatment of certain liabilities—liabilities defined—contingent obligations—obligation to close short sale—Court of Federal Claims. In case involving partnership claim for more than $71 million loss on '94 sale of mortgage notes, as effected through series of transactions involving borrowed Treas. notes and short sales, CFC ruled that obligation to close short sale was Code Sec. 752 “liability” for which basis adjustment was required. Analyzing then applicable law, including Federal Reserve Board-promulgated “Regulation T,” CFC noted that although transactions here pre-dated Reg § 1.752 and Rev. Rul. 95-26,1995-1 CB 131 's short sales rule, and although taxpayers weren't given explicit notice that obligation to close short sale might give rise to Code Sec. 752 liability, taxpayers did have indirect notice of same via long-standing constraints regarding shorts sales and well-established symmetry principles. Taxpayers' contrary position if allowed would result in asymmetry distorting tax laws regarding basis. CFC concluded that where there had been basis increase for contribution of short sale proceeds, there must also be basis reduction for contribution of obligation to replace notes that had been sold short. <br />
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Reference(s): ¶ 7525.01(5) Code Sec. 752 <br />
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OPINION <br />
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Harold J. Heltzer, Crowell & Moring LLP, Washington, D.C., for plaintiff. With him on the briefs were Robert L. Willmore and Alex E. Sadler, Crowell & Moring LLP, Washington, D.C. <br />
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G. Robson Stewart, Court of Federal Claims Section, Tax Division, United States Department of Justice, Washington, D.C., for defendant. With him on the brief were Nathan J. Hochman, Assistant Attorney General, John A. Dicicco, Deputy Assistant Attorney General, David Gustafson, Chief, and Mary M. Abate, Assistant Chief, Court of Federal Claims Section, Tax Division, United States Department of Justice, Washington, D.C. <br />
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In the United States Court of Federal Claims, <br />
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OPINION AND ORDER<br />
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Judge: LETTOW, Judge. <br />
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Cross-motions for summary judgment in a tax case; recognition of basis upon contribution of assets and liabilities to a partnership; 26 U.S.C. §§ 722, 752; contingent liabilities; short sales; Federal Reserve Board's Regulation T <br />
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Pending before the court are cross-motions for summary judgment, filed by the parties in this partnership-taxation case. 1 At issue is a claimed tax loss of $71,189,461 on the sale of Mortgage Notes, as manifested on a partnership tax return. This loss was the planned result of a series of transactions entered into by Marriott-affiliated entities with the intention of recognizing a tax loss based upon the premise that the obligation to close a short sale 2 is not considered a liability for partnership-tax-basis purposes. 3 The Internal Revenue Service (“IRS” or “the Service”) took issue with this premise and disallowed the claimed loss. Following extensive prior proceedings related to discovery and privilege, 4 the motions now at issue were filed and have been fully briefed. A hearing on the cross-motions was held on May 19, 2008, and supplemental briefs were filed on June 6, 2008. The competing motions accordingly are ready for disposition. [pg. 2008-6041] <br />
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FACTS 5<br />
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The parties provided the court with charts that set out the competing federal income tax consequences of Marriott's transactions. See Joint Status Report (Oct. 16, 2006), Ex. A (“Joint Submission”). Subsequently, the government provided a summary setting out specific dates and dollar amounts for aspects of the transactions. See Exhibit submitted in conjunction with the hearing held on May 19, 2008 (“Gov't's Summary”). These submissions, together with the parties' proposed findings of uncontroverted facts and responses, supply a baseline of agreed facts underpinning the cross-motions for summary judgment. <br />
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A. The Transactions<br />
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Plaintiff, Marriott International Resorts (“Marriott Resorts”) is a Delaware limited partnership with its principal place of business located in Montgomery County, Maryland. Compl. ¶¶ 1, 4. 6 For a tax period ending October 28, 1994, Marriott International JBS Corporation (“JBS”) and Marriott Ownership Resorts, Inc. (“MORI”) were Marriott Resorts' general partner and limited partner, respectively. Compl. ¶¶ 1, 15. For a tax period ending December 30, 1994, JBS and Marriott International Capital Corporation (“MICC”) were Marriott Resorts' general partner and limited partner, respectively. Defendant's Proposed Findings of Uncontroverted Facts (“DPFUF”) ¶ 3. JBS, MORI, and MICC were, at all times relevant to this case, controlled subsidiaries of Marriott International, Inc (“Marriott International”) 7 and Marriott Resorts was wholly owned initially by MORI and JBS and subsequently by MICC and JBS. Plaintiffs' Response to Defendant's Proposed Findings of Uncontroverted Facts (“PRDPFUF”) at 6, 9–10. <br />
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During the periods at issue, MORI engaged in the business of selling timeshare interests in resort properties. Compl. ¶ 9. As part of this business, MORI offered buyers the opportunity to finance their purchases by having the buyer execute a promissory note, secured by a mortgage on the timeshare unit (“Mortgage Notes”). Compl. ¶ 9. The Mortgage Notes issued by MORI to the purchasers of its time-share units bore interest at a fixed interest rate. See Heltzer Decl., Ex. 1 (Pls.' Resp. to Def.'s First Set of Interrogs. (Oct. 8, 2002) (“Pls.' Interrog. Resp.”)) at 3; Ex. 2 (Mem. to Growth Committee regarding “Hedging MORI Note Exposure” (Apr. 22, 1994)) at MAR-008867. On November 22, 1993, MORI and another Marriott entity, MTMG Corporation, entered into an agreement with Teachers Insurance and Annuity Association of America (“TIAA”), an unrelated third party, in which the Marriott entities agreed to sell and TIAA agreed to buy up to $175,000,000 of Mortgage Notes. Def.'s Mot. for Summary Judgment (“Def.'s Mot.”), Attached Decl. of G. Robson Stewart (Feb. 1, 2008) (“First Stewart Decl.”), Ex. 1 (MTMG Corp. Purchase Agreement, (Nov. 22, 1993)) at 1–2. 8 <br />
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On January 3, 1994, Philip Hamon of the investment banking firm CS First Boston, sent by facsimile to Lester Pulse, Senior Vice President of Marriott International, a document which described a series of transactions that might enable Marriott to recognize a loss for Federal income tax purposes based upon the premise that a short-sale obligation would not be considered a liability for partnership tax-basis purposes. First Stewart Decl., Ex. 3 (Facsimile from Hamon to Pulse (Jan. 3, 1994)). The transactions described in the CS First Boston tax document consisted of the following steps: <br />
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Marriott International sells short two-year Treasury notes and invests the proceeds in five-year Treasury notes. <br />
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Marriott International, as a limited partner, and a third party, as the general partner, form a partnership. <br />
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Marriott International contributes the five-year Treasury notes, subject to the short-sale obligations, to the partnership and the general partner contributes some cash. <br />
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The partnership obtains additional assets and subsequently sells the five-year Treasury notes and closes the short sale obligation on the two-year Treasury notes. <br />
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Marriott International transfers its partnership interest to another Marriott subsidiary. <br />
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No gain or loss is recognized on the transfer, but the partnership-interest transfer results in a technical termination of the partnership which causes a deemed distribution of the assets to each partner and a re-contribution of the assets to a new partnership. <br />
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The tax basis of the assets takes on the “outside” tax basis of Marriott International's interest, i.e., the value of the five-year Treasury notes Marriott International contributed to the first partnership, which value is not reduced by the short-sale obligation. 9 <br />
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The remaining additional assets later are depreciated or are sold, and Marriott International recognizes the resulting tax losses. <br />
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First Stewart Decl., Ex. 3 (Facsimile from Hamon to Pulse); see also First Stewart Decl., Ex. 4 (Letter from Hamon to Michael Dearing (June 24, 1994) (“Intent Letter”)), Ex. 5 (Letter from Hamon to Dearing (June 24, 1994) (“Agreement Letter”)). <br />
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Thereafter, on or about April 25, 1994, MORI established a short position in five-year Treasury securities with a face amount of $65,000,000 (“First Short Sale”). Compl. ¶ 13. The First Short Sale was executed through CS First Boston. First Stewart Decl., Ex. 6 (Letter from Brit Bartter, CS First Boston, to Dearing (July 8, 1994)) at 1. MORI received cash proceeds in the amount of $63,703,816 that were invested in repurchase obligations (“Repos”) yielding a fixed return. Compl. ¶ 13; Gov't's Summary. 10 <br />
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On May 9, 1994, JBS was incorporated in the State of Delaware. 11 On May 10, 1994, MORI and JBS entered into a partnership agreement and created Marriott Resorts with the filing of a Certificate of Limited Partnership. First Stewart Decl., Ex. 8 (Marriott Resorts Limited Partnership Agreement). 12 JBS was the general partner of Marriott Resorts holding a 1% interest, and MORI was a limited partner of Marriott Resorts holding a 99% interest. Compl. ¶ 22. Contemporaneously, MORI contributed to Marriott Resorts (i) the Repos, and (ii) Mortgage Notes with a face amount of approximately $65,200,000, and Marriott Resorts also assumed MORI's obligations to close the First Short Sale. Compl. ¶¶ 16–17; First Stewart Decl., Ex. 8 (Marriott Resorts Limited Partnership Agreement) ¶ 10. JBS also contributed $1,000,000 to Marriott Resorts. Compl. ¶ 18; Gov't's Summary; First Stewart Decl., Ex. 8 (Marriott Resorts Limited Partnership Agreement) ¶ 9. <br />
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On or about August 15, 1994, MORI established a short position in five-year Treasury securities with a face amount of $10,000,000 (“the Second Short Sale”). Compl. ¶ 14. The Second Short Sale was also executed through CS First Boston. First Stewart Decl., Ex. 10 (Facsimile from Timothy Lu, CS First Boston, to Dearing (Oct. 12, 1994)) at 2. MORI received cash proceeds in the amount of $9,463,451 that were invested through CS First Boston in Repos. Compl. ¶ 14; Gov't's Summary. On August 16, 1994, MORI contributed to Marriott Resorts (i) the Repos and (ii) Mortgage Notes with a face amount of approximately $11,900,000, and Marriott Resorts also assumed the obligation to close the Second Short Sale. Compl. ¶¶ 19–20; Gov't's Summary. On October 1, 1994, MORI contributed additional Mortgage Notes with a face amount of approximately $6,200,000. Compl. ¶ 21. <br />
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On September 29, 1994, Marriott Resorts closed the First Short Sale with CS First Boston by using the funds invested in the Repos to purchase replacement Treasury notes with a face amount of $65,000,000 at a cost of $62,667,034. First Stewart Decl., Ex. 9 (Facsimile from Lu to Dearing (Sept. 29, 1994)) at 2; Gov't's Summary. On October 17, 1994, Marriott Resorts closed the Second Short Sale with CS First Boston by purchasing replacement Treasury notes with a face amount of $10,000,000 at a cost of $9,279,811. Compl. ¶ 23; First Stewart Decl., Ex. 10 (Facsimile from [pg. 2008-6043] Lu to Dearing) at 2, 5. 13 The short sales were closed by liquidating the Repos and using those funds to buy back the Treasury securities, which then were returned to CS First Boston. Joint Submission at 5; Gov't's Summary. In connection with the transactions related to the short sales and Repos, Marriott paid CS First Boston a “structuring fee” of $200,000 and expenses of $22,540.22, for a total transaction cost of $222,540.22. First Stewart Decl., Ex. 6 (Letter from Bartter to Dearing (July 8, 1994)) at 2, Ex. 9 (Facsimile from Lu to Dearing (Sept. 29, 1994)) at 2, Ex. 11 (Marriott Resorts' partnership return (Form 1065) for the taxable year ended Oct. 28, 1994) at 3. In addition, the trading price of the transactions included a bid-ask spread of $50,000. First Stewart Decl., Ex. 9 (Facsimile from Lu to Dearing) at 2. <br />
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On October 28, 1994, MORI transferred its entire partnership interest in Marriott Resorts to MICC. Joint Submission at 6; Compl. ¶ 24. The transfer of MORI's interest in Marriott Resorts to MICC triggered a technical termination of Marriott Resorts under I.R.C. § 708(b)(1)(B). Joint Submission at 7; Compl. ¶ 25. Under I.R.C. § 708(b)(1), the termination resulted in a deemed distribution of Marriott Resorts's assets to its partners (JBS and MICC) followed by the creation of a new partnership by JBS and MICC, and contribution of the assets previously held by Marriott Resorts to the new partnership, which also was named Marriott Resorts. Compl. ¶ 26. The actual assets held by Marriott Resorts prior to, and after, the termination consisted of the Mortgage Notes, $1 million cash, and a receivable with a face amount of $3,303,164. Compl. ¶¶ 26, 28. <br />
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Prior to the termination, MICC had a purported basis of $159,444,635 in its interest in Marriott Resorts (i.e., not reduced by the obligation to close the short sales by purchasing replacement Treasury securities), attributable to the bases of the Mortgage Notes, the Repos, and minor adjustments due to Marriott Resorts' operations (i.e., interest and investment income). Compl. ¶ 27. After the termination, JBS's and MICC's partnership bases were allocated to the new Marriott Resorts' assets (the Mortgage Notes, cash, and the receivable). Compl. ¶ 29. Thus, the new Marriott Resorts was assigned a purported basis in the Mortgage Notes of $155,141,472. Compl. ¶ 29. <br />
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On or about November 14, 1994, Marriott Resorts conveyed the Mortgage Notes to a grantor trust and received a certificate representing all of the interest in the trust other than the residual interest. Compl. ¶¶ 30–31. On the same date, Marriott Resorts sold to TIAA the certificate for $81,974,204 less transaction fees of $522,093, for a net amount realized of $81,452,111. Compl. ¶ 31. The purported basis of the certificate of interest in the timeshare mortgages sold to TIAA was $150,894,679 (i.e., not reduced by the obligation to close the short sales by purchasing replacement Treasuries), and on its partnership return (Form 1065) for the period ended December 30, 1994, Marriott Resorts reported a loss on the sale of the interest in the timeshare mortgages of $71,189,461. First Stewart Decl., Ex. 12 (Marriott Resorts' Form 1065 for the taxable year ended Dec. 30, 1994); Gov't's Summary. 14 <br />
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B. Disallowance by the IRS<br />
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On February 2, 2001, the IRS issued an FPAA with respect to Marriott Resorts' taxable year ended October 28, 1994. Compl. ¶ 35 and Ex. A (FPAA). In the FPAA, for Marriott Resorts' October 28, 1994, taxable year, the IRS reduced the partnership basis by $75,000,000 to reflect the obligation to complete the short sale by returning the Treasury notes to CS First Boston. Compl. Ex. A. <br />
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Also on February 2, 2001, the IRS issued an FPAA with respect to Marriott Resorts's taxable year ended December 30, 1994. Compl. in No. 01-257T ¶ 35 and Ex. A (FPAA). In the FPAA for Marriott Resorts' December 30, 1994 taxable year, the IRS determined that Marriott Resorts realized a gain on the sale of the Mortgage Notes of $1,757,378, not the loss reported on the Marriott Resorts' Form 1065 of $71,189,461. This determination was based on the reduction in the partnership basis of $75,000,000 which reflected the obligation to return Treasury notes to CS First Boston. Compl. in No. 01-257T Ex. A. <br />
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JURISDICTION<br />
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Marriott Resorts and JBS filed their complaints in this court pursuant to 28 U.S.C. § 1508 and I.R.C. § 6226. In accord with I.R.C. § 6226(e)(1), Marriott Resorts and JBS deposited funds with the Secretary of the Treasury in amounts that at least equaled the tax liability including interest that would arise if the treatment of the partnership items on Marriott Resorts' return was made consistently with the FPAAs. Compl. ¶ 7; Compl. in No. 01-257T ¶ 7. <br />
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STANDARD FOR DECISION<br />
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Summary judgment is appropriate only if “there is no genuine issue as to any material fact and ... the moving party is entitled to a judgment as a matter of law.” Rule 56(c) of the Rules of the Court of Federal Claims; see Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247–49 (1986). The moving party carries the burden of establishing that no genuine issue of material fact exists. Celotex Corp. v. Catrett, 477 U.S. 317, 322–23 (1986). A “genuine” dispute is one that “may reasonably be resolved in favor of either party.” Anderson, 477 U.S. at 250. A material fact is one that “might affect the outcome of the suit under the governing law.” Id. at 248. In considering the existence of a genuine issue of material fact, a court must draw all inferences in the light most favorable to the non-moving party. Matsushita Elec. Indus. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986). If no rational trier of fact could find for the non-moving party, a genuine issue of material fact does not exist and the motion for summary judgment may be granted. Id. <br />
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With respect to cross-motions for summary judgment, each motion is evaluated on its own merits and reasonable inferences are resolved against the party whose motion is being considered. Mingus Constructors, Inc. v. United States, 812 F.2d 1387, 1391 (Fed. Cir. 1987). To the extent there is a genuine issue of material fact, both motions must be denied. Id. <br />
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ANALYSIS<br />
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[1] This case turns on I.R.C. § 752, which governs the change in basis that occurs when a partner's liabilities are either increased or decreased. 15 The government asserts that under I.R.C. § 752, “[Marriott Resorts] must include in its partnership basis the short sale obligations it “assumed” from [MORI], because [(1)] the short sale obligations to replace the borrowed Treasury Notes are legal liabilities secured by the proceeds from the Treasury short sale, and [(2)] the proceeds from the short sales quantify the amount of liability for purposes of § 752, irrespective of the term of the underlying securities.” Def.'s Supp. Br. at 2. In opposition, Marriott contends that the obligation to close a short sale is not a “liability” under I.R.C. § 752 for the purposes of calculating partnership basis. Pls.' Cross-Mot. at 1. <br />
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A. Short Sales<br />
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In a short sale, the seller trades securities that he does not own, “seek[ing] to profit by trading stocks which he expects to decline in value.” Zlotnick v. TIE Commc'ns, 836 F.2d 818, 820 (3d Cir. 1988); see also Provost v. United States, 269 U.S. 443, 450–53 [5 AFTR 5681] (1926). 16 In Zlotnick, the Third Circuit provided a useful description of short sales: <br />
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Short selling is accomplished by selling stock which the investor does not yet own; normally this is done by borrowing shares from a broker at an agreed upon fee or rate of interest. At this point the investor's commitment to the buyer of the stock is complete; the buyer has his shares and the short seller his purchase price. The short seller is obligated, however, to buy an equivalent number of shares in order to return the borrowed shares. In theory, the short seller makes this covering purchase using the funds he received from selling the borrowed stock. Herein lies the short seller's potential for profit: if the price of the stock declines after the short sale, he does not need all the funds to make his covering purchase; the short seller then pockets the difference. On the other hand, there is no limit to the short seller's potential loss: if the price of the stock rises, so too does the short seller's loss, and since there is no cap to a stock's price, there is no limitation on the short seller's risk. There is no time limit on this obligation to cover.<br />
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[pg. 2008-6045] <br />
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“Selling short,” therefore, actually involves two separate transactions: the short sale itself and the subsequent covering purchase.<br />
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836 F.2d at 820; see also James W. Christian, Robert Shapiro, & John-Paul Whalen, Naked Short Selling: How Exposed are Investors?, 43 Hous. L. Rev. 1033, 1041–42 (2006) (describing short sales). <br />
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Short sales are federally regulated. See Levitin v. PaineWebber, Inc., 159 F.3d 698, 705 (2d Cir. 1998). The Securities and Exchange Act of 1934 (the “Act”) provides the general authority for the imposition of rules with respect to the extensions of credit by brokers and dealers to customers for purchasing and carrying securities. 15 U.S.C. § 78g(a). The Act directs the Board of Governors of the Federal Reserve System to prescribe rules and regulations with respect to the amount of credit that may be initially extended and maintained by a broker or dealer on any security. Id. Section 10(a) of the Act gives the Federal Reserve Board authority to regulate short sales and the withdrawals by a customer of funds or securities, 15 U.S.C. § 78j(a); the Federal Reserve Board promulgated Regulation T in 1938. Levitin, 159 F.3d at 705. <br />
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The purpose of Regulation T is “to regulate extensions of credit by and to brokers and dealers; it also covers related transactions within the Board's authority under the Act. It imposes, among other obligations, initial margin requirements and payment rules on securities Citations to Regulation T in this opinion are to the version in effect in 1994 because that 17 was the date of the transactions at issue transactions.” 12 C.F.R. § 220.1(a) (1994). 17 The margin requirements are designed to protect brokerage houses by guaranteeing that their loans to short sellers are repaid. See Cromer Fin. Ltd. v. Berger, 137 F. Supp. 2d 452, 472 (S.D.N.Y. 2001). Regulation T governs all short sales executed by United States broker-dealers. 12 C.F.R. §§ 220.1(a), 220.18(c)–(d) (1994). <br />
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Under Regulation T, a creditor is “any broker or dealer,” and a customer is any person “to or for whom a creditor extends, arranges, or maintains any credit.” 12 C.F.R. §§ 220.2(b), (c) (1994). Thus, CS First Boston is a creditor and MORI is a customer for purposes of Regulation T. As a creditor, CS First Boston was required to maintain a record for MORI's account showing the full details of all transactions. 12 C.F.R. § 220.3(a) (1994). MORI's short sale transactions were required to be maintained in a margin account. 12 C.F.R. §§ 220.1(b)(1), 220.4(a)(1) (1994). MORI was required to post initial margin for the short sales of Treasury notes equal to 100 percent of the market value of the notes — the short sale proceeds — plus any additional margin that may have been required by CS First Boston. 12 C.F.R. §§ 220.5(b)(1), 220.12(d) (1994). 18 Only items in MORI's margin account in which the short sales were conducted could be considered by CS First Boston to determine whether MORI had posted the required margin collateral. 12 C.F.R. § 220.3(b) (1994). Moreover, MORI was prohibited from withdrawing any funds or securities from its CS First Boston margin account if doing so would create or increase any margin deficiency. 12 C.F.R. § 220.4(e)(1)(ii) (1994); see United States v. Russo, 74 F.3d 1383, 1388 (2d Cir. 1996) (“[A]ny proceeds from the [short] sale are frozen under [Regulation T] until the seller covers the short sale.”); see also Federal Reserve Staff Opinion, Nov. 21, 1979, F.R.R.S. 5-693 (stating that even when the short seller covers some of his short sales, the broker may only release the frozen funds to the extent that the customer's account balance exceeds the margin requirements established by Regulation T). <br />
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Regulation T thus forms a linkage that binds the two steps of the short-sale transaction together. The practical effect of Regulation T on short sales was explained by the Second Circuit in Levitin: <br />
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[A] broker who lends a customer stock for a short sale does not typically pay the proceeds of the sale to the customer to be spent when and how she wants, waiting for the customer to cover when and if it suits her. If a broker did that, the price might increase and the customer become insolvent or disappear, leaving the broker out the entire value of the stock — the price at the time of the sale plus its increase. Brokers therefore demand collateral, usually by taking an amount from the customer's account equal to the security required. The proceeds from the sale will, of course, usually be available as security, but if those proceeds and the balance in the customer's account are not sufficient to satisfy the security requirement, the customer will have to post additional collateral.... The collateral posted must satisfy federal margin requirements associated with short trades.<br />
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159 F.3d at 700. <br />
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In its reply brief, the government has argued that because Regulation T requires collateral be maintained with the broker-dealer while the short sale is outstanding, it is relevant to the issue at hand. See Def.'s Reply at 2, 4–5, 17–18. The government contends that “short sale obligations are binding, secured liabilities because the short sale proceeds are “frozen” as collateral until the short sales are closed,” “the short sale obligations are [thus] fixed and determinable for partnership basis purposes on the date the obligations become partnership obligations, and the amount of the obligations equals the amount of the proceeds from the short sales that were contributed to [Marriott Resorts].” Def.'s Reply at 2 (citing Rev. Rul. 95–45, 1995-1 C.B. 53). Accordingly, “[b]ecause [Marriott Resorts] increased its tax basis by the amount of the short sale proceeds, the corresponding short sale obligation is similar to a conventional purchase-money financing that would be included in partnership liabilities under [I.R.C.] § 752.... Unlike short sales, a liability that is truly contingent does not immediately create or increase the borrower's tax basis in any property precisely because the obligation is contingent.” Def.'s Reply at 18. <br />
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Marriott replies that “[t]he existence of collateral ... does not change the fundamental reality that the ultimate cost of closing the short sale simply cannot be determined until the replacement securities have been purchased by the short seller,” and the obligation thus is not “fixed” in amount. Pls.' Reply at 6. Rather, Marriott asserts that the margin requirements fluctuate with the value of the short security subject to a “maintenance margin,” which is not specifically addressed in Regulation T but rather is established by the applicable Exchange rule, typically New York Stock Exchange Rule 431 (“NYSE Rule 431”). Pls.' Supp. Br. at 3 (citing Charles F. Rechlin, Securities Credit Regulation in 22 West's Securities Law Series §§3:32 & 3:33 (2d ed. 2007); Steven Lofchie, Lofchie's Guide to Broker-Dealer Regulation 564–65, 569, 589, 596 (2005)). Marriott contends that until the short seller purchases the securities he must deliver to the broker-dealer to close the short sale, “the cost of closing the short sale is contingent and undetermined, and the obligation thus cannot constitute a “liability” for purposes of Section 752,” with the consequence that the partnership basis is not adjusted on account of the obligation. Pls.' Supp. Br. at 3. <br />
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The government responds that Marriott's argument that a short sale obligation is a contingent liability “is impossible to square with Regulation T's requirement that the full market value of the short sale liability be posted as collateral for the binding obligation to replace the shorted securities.” Def.'s Supp. Br. at 5. <br />
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B. “Inside” Basis and “Outside” Basis for Partnerships and Partners<br />
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A partnership's basis in its assets is referred to as its “inside basis,” and a partner's basis in his or her partnership interest is called his or her “outside basis.” Kligfeld Holdings v. Commissioner, 128 T.C. 192, 195–96 (2007). Generally, I.R.C. § 723 provides the rule for calculating “inside basis”: <br />
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The basis of property contributed to a partnership by a partner shall be the adjusted basis of such property to the contributing partner at the time of the contribution increased by the amount (if any) of gain recognized under [S]ection 721(b) to the contributing partner at such time.<br />
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I.R.C. § 723. A partner's basis in the interest it owns in the partnership itself, or “outside basis,” is governed by I.R.C. § 705 which provides that such basis is calculated by applying I.R.C. § 722 for “contributions to a partnership” or I.R.C. § 742 for “transfers of a partnership interest.” 19 Section 722 provides: <br />
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The basis of an interest in a partnership acquired by a contribution of property, including money, to the partnership shall be the amount of such money and the adjusted basis of such property to the contributing partner at the time of the contribution increased by the amount (if any) of gain recognized under [S]ection 721(b) to the contributing partner at such time.<br />
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I.R.C. § 722. Apart from Section 721(b), a partnership and its partners do not recognize a gain or loss if the partner contributes property to the partnership in exchange for a partnership interest. I.R.C. § 721(a). <br />
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C. Applicability of Section 752<br />
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1. Statutory language.<br />
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Section 752 of the I.R.C. specifies the adjustments that are made in a partner's basis in his or her partnership interest to reflect his or her share of the partnership's liabilities. In relevant part, Section 752 provides that: “[a]ny increase in a partner's share of the liabilities of a partnership, or any increase in a partner's individ- [pg. 2008-6047] ual liabilities by reason of the assumption by such partner of partnership liabilities, shall be considered as a contribution of money by such partner to the partnership.” I.R.C. § 752(a). Conversely, “[a]ny decrease in a partner's share of the liabilities of a partnership, or any decrease in a partner's individual liabilities by reason of the assumption by the partnership of such individual liabilities, shall be considered as a distribution of money to the partner by the partnership.” I.R.C. § 752(b). The legislative history does not address the meaning of the term “liability,” but rather merely explains that Section 752 was intended to deal with the effect of a partner's assumption of partnership liabilities and the partnership's assumption of a partner's liabilities. See S. Rep. No. 83-1622, at 405 (1954), as reprinted in 1954 U.S.C.C.A.N. 4621, 5047; accord H.R. Rep. No. 83-1337, at S236–237 (1954), as reprinted in 1954 U.S.C.C.A.N. 4017, 4376–77. <br />
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In 1994, at the time the transactions at issue in this case occurred, there was no regulatory definition of “liability” for purposes of Section 752. A revenue ruling and judicial precedents delineated the statutory framework as it existed during Marriott Resorts' short sale transactions. A subsequently issued chain of revenue rulings, Treasury Regulations, and judicial precedents significantly changed that framework after the transactions at issue here were completed. <br />
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2. The Helmer, Long and La Rue decisions.<br />
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The first significant interpretation of Section 752 came in Helmer v. Commissioner, 34 T.C.M. (CCH) 727 [¶75,160 PH Memo TC] (1975). In Helmer, a partnership received payments in accord with an agreement that gave a third-party corporation the option to buy certain real estate in which the partnership held a two-thirds interest. Id. at 728. During the term of the option agreement, the partnership retained the right to possess and enjoy profits from the property in question, and there was no provision in the option agreement for repayment of the amounts paid under the option agreement should the agreement terminate. Id. at 729. The taxpayers received payments directly from the third party pursuant to the option agreement during the years in issue, and listed these amounts as distributions to the taxpayers on the partnership's books and tax returns. The taxpayers received partnership distributions during the years in issue, and had the partnership pay personal expenses, in excess of their adjusted bases in the partnership. Id. <br />
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The Tax Court held in Helmer that the option agreement and receipt of the option payments “created no liability on the part of the partnership to repay the funds paid nor to perform any services in the future ... [N]o liability arose under [S]ection 752 and the partners' bases cannot be increased by such amounts.” 34 T.C.M. (CCH) at 731 [¶75,161 PH Memo TC]. The court noted that there were no provisions in the option agreement for repayment of, or restrictions on, the option payments. Id. Further, the court emphasized that income attributable to the option payments was subject to deferral at the partnership level due only to the inability of the partnership to determine the character of the gain, not because the partnership was subject to a liability to repay the funds paid or to perform any services in the future. Id. <br />
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A few years after Helmer, the Tax Court again considered the reach of Section 752 in Long v. Commissioner , 71 T.C. 1 (1978), aff'd in part and rev'd in part on other grounds, 660 F.2d 416 [48 AFTR 2d 81-5912] (10th Cir. 1981). Long addressed an estate's recognition of taxable gain on the liquidation of the decedent's partnership interest. 71 T.C. at 5. The partnership was a construction company that had pending against it claims in litigation, and the question presented was whether those claims could be considered liabilities includable in the estate's outside basis under Section 752. Id. at 6–7. The Tax Court in Long held that the claims were not sufficiently definite to be treated as liabilities that could be included in the decedent's outside basis because they had been in contested litigation at the time of decedent's death. Id. at 7–8 (“Although they may be considered “liabilities” in the generic sense of the term, contingent or contested liabilities ... are not “liabilities” for partnership basis purposes at least until they have become fixed or liquidated.... Those liabilities should be taken into account only when they are fixed or paid.”). <br />
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This emerging line of precedent was extended ten years later by the Tax Court's decision in La Rue v. Commissioner, 90 T.C. 465 (1988). That case concerned reserves reflecting “back office” errors of a brokerage partnership. The reserves were established to cover the brokerage's potential failure to execute trade orders by customers. To correct such errors, the brokerage had to purchase securities and deliver them to customers. Id. at 468. “Gain or loss was incurred on these transactions measured by the difference between the customer's contract price and what the broker had to pay to obtain the securities.” Id. “The precise amount of gain or loss was not determinable until the securities in question were actually bought or sold.” Id. at 475. The question was whether the partnership's reserves for the “back office” errors was a liability within the meaning of Section 752 that increased the partners' outside basis. 90 T.C. at 477–78. The IRS argued that the reserves were not liabilities for purposes of Section 752. The Tax Court concurred. Citing its opinion in Long, the court held that the “all-events” test determines when a liability is includable in basis under Section 752. Id. at 478. As that test would have it, a liability can only be included in basis “for the taxable year in which all the events have occurred which determine the fact of liability and the amount thereof can be determined with reasonable accuracy.” Id. The court concluded that the amount of liabilities was not determinable “until the securities are actually purchased ... and the transaction closed.” Id. at 479. <br />
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Notably, the Tax Court in Helmer, Long, and La Rue determined in each case that the obligations at issue were not sufficiently free from contingencies to be deemed liabilities that would give rise to a change in a partner's outside basis under Section 752. However, the IRS soon indicated that there were circumstances in which some degree of contingency would not prevent recognition of a liability that changed a partner's basis under Section 752. <br />
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3. Revenue Rulings and Treasury Regulations.<br />
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Six months after La Rue was decided by the Tax Court, on September 19, 1988, the IRS issued Revenue Ruling 88-77, 1988-2 C.B. 128, 1988 WL 546796, which defined liability under Section 752. The ruling states: <br />
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For purposes of section 752 of the Code, the terms “liabilities of a partnership” and “partnership liabilities” include an obligation only if and to the extent that incurring the liability creates or increases the basis to the partnership of any of the partnership's assets (including cash attributable to borrowings), gives rise to any immediate deduction to the partnership, or, under section 705(a)(2)(B), currently decreases a partner's basis in the partner's partnership interest.<br />
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Rev. Rul. 88-77. <br />
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A few months after issuing Revenue Ruling 88-77, the Commissioner issued a temporary regulation containing a similar definition of “liability” under Section 752: <br />
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[U]nder section 752, an obligation is a liability of the obligor for purposes of [S]ection 752 and the regulations thereunder to the extent, but only to the extent, that incurring or holding such obligation gives rise to — <br />
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((1)) The creation of, or an increase in, the basis of any property owned by the obligor (including cash attributable to borrowings); <br />
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((2)) A deduction that is taken into account in computing the taxable income of the obligor; or <br />
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((3)) An expenditure that is not deductible in computing the obligor's taxable income and is not properly chargeable to capital. <br />
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Temp. Treas. Reg. § 1.752-1T(g), 1989-1 C.B. 180, 192, 53 Fed. Reg. 53,140, 53,150–51 (Dec. 30, 1988). However, the final regulations adopted in 1991 omitted any definition of “liability.” See 1992-1 C.B. 218, 56 Fed. Reg. 66,348 (Dec. 23, 1991). According to the IRS, “[t]his change was made only for the purpose of simplification and not to change the substance of the regulation.” IRS Field Service Advisory, 1997 WL 33313960 (Nov. 21, 1997). <br />
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Thereafter, in 1995, the Commissioner issued Revenue Ruling 95-26, which addressed whether a partnership's short sale of securities creates a liability within the meaning of Section 752. Rev. Rul. 95-26, 1995-1 C.B. 131. The revenue ruling concludes that a liability under Section 752 includes an obligation to the extent that incurring the liability creates or increases the basis to the partnership of any of the partnership's assets, including cash attributable to borrowings. The Commissioner reasoned that a short sale creates such a liability inasmuch as (1) the partnership's basis in its assets is increased by the amount of cash received on the sale of the borrowed securities, and (2) a short sale creates an obligation to return the borrowed securities. See Rev. Rul. 95-26, 1995-1 C.B. at 132. In this respect, the Commissioner relied on Revenue Ruling 88-77. Id. Accordingly, for those partners directly affected by Revenue Ruling 95-26, the Commissioner concluded that the partners' bases in their partnership interests were increased under Section 722 to reflect their shares of the partnership's liability under Section 752. 20 <br />
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4. Treasury Regulation § 1.752.<br />
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On May 26, 2005, the IRS published regulations dealing with the assumption of some fixed and contingent obligations in connection with the issuance of a partnership interest. Treas. [pg. 2008-6049] Reg. § 1.752-1(a)(4)(I) (effective May 26, 2005); see Prop. Treas. Reg. § 1.752-1(a)(1)(ii), 68 Fed. Reg. 37,434, 37,436 (proposed June 24, 2003). These final regulations include a new definition of liability, expanding the definition to include “any fixed or contingent obligation to make payment without regard to whether the obligation is otherwise taken into account for purposes of the Internal Revenue Code.” Treas. Reg. § 1.752-1(a)(4)(ii); see also Treas. Reg. § 1.752-6(a); Treas. Reg. § 1.752-7(b)(3). The Treasury Department made this new regulation and the attendant definition of “liability” retroactive, applying it to all assumptions of “liabilities” (as newly defined) by partnerships occurring on or after June 24, 2003 (i.e., the date the regulation was proposed). See Treas. Reg. 1.752-1(a)(4)(iv). In addition, the new regulation also reached back in part to transactions occurring during the period between October 18, 1999 and June 24, 2003, by requiring a partner to reduce his basis in his partnership interest by the amount of any contingent obligation assumed by the partnership between October 18, 1999 and June 24, 2003. See Treas. Reg. § 1.752.6(a), (d). However, unlike the statute, the new regulation “would not allow the partner to increase his [or her] basis for the share of the new partnership liability.” Klamath Strategic Inv. Fund, LLC v. United States, 440 F. Supp. 2d 608, 620 [98 AFTR 2d 2006-5495] & n.9 (E.D. Tex. 2006). <br />
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By promulgating the regulation, the government intended to change the law governing liabilities under Section 752. The regulation itself indicates that it modifies settled law regarding “liabilities” for Section 752: “The definition of a liability contained in these proposed regulations does not follow Helmer v. Commissioner, TC Memo 1975-160 [¶75,160 PH Memo TC]. (The Tax Court ... in Helmer held that a partnership's issuance of an option to acquire property did not create a partnership liability for purposes of Section 752.).” See Notice of Proposed Rulemaking, 68 Fed. Reg. 37,434, 37,436 (June 24, 2003). <br />
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5. Marriott's transactions predate regulations.<br />
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Generally, retroactive regulations are prohibited, except under limited circumstances. See I.R.C. § 7805(b)(1)(A), (b)(3) (allowing treasury regulations to operate retroactively to “prevent abuse”), or (b)(6) (permitting retroactivity if authorized by Congress). 21 However, because Marriott's transactions occurred in 1994 and thus predate even the retroactive portions of Treasury Regulation § 1.752, the new regulatory definition of “liability” put forth in that regulation does not apply to the case at hand. Rather, the pertinent analysis focuses on the law as it stood in 1994 at the time of Marriott's transactions, prior to Revenue Ruling 95-26 and Treasury Regulation § 1.752. <br />
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D. Treatment of Short Sales As Of 1994 Under Section 752<br />
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None of the precedents extant at the time of Marriott's transactions addressed short sales and the effect of Regulation T. See La Rue, 90 T.C. 465; Long, 71 T.C. 1; Helmer, 34 T.C.M. (CCH) 727 [¶75,160 PH Memo TC]; Rev. Rul. 88-77. The short-sale concept was introduced into an analysis of Section 752 in Revenue Ruling 95-26, which was issued a year after the transactions at issue. <br />
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The courts that have addressed the issue of whether short sales involve contingent obligations have tended to hold that the obligation to close such sales is a liability under Section 752. See, e.g., Kornman Assocs., Inc. v. United States , 527 F.3d 443, 452 [101 AFTR 2d 2008-2132] (5th Cir. 2008). However, because of timing, Kornman is not a precedent squarely applicable to Marriott's transactions. The transactions here preceded the Revenue Ruling 95-26 while the transactions at issue in Kornman occurred in 1999, five years after the Revenue Ruling was issued. See Kornman, 527 F.3d at 447. The Fifth Circuit in Kornman was able to state that the taxpayer there had adequate notice of the IRS's position: <br />
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We do not believe that the Appellants were unfairly surprised or prejudiced by the IRS's challenge to this tax shelter because they were on notice as early as 1988, and certainly by 1995, that the IRS considered the obligation to close a short sale to be a liability under section 752. Revenue Ruling 95-26 is distinguishable from the earlier cases and revenue rulings cited by the Appellants, and it is fully consistent with regulations promulgated by the IRS after 1995.<br />
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Id. at 462. The same observation could not be made in this instance. Marriott was not put on explicit notice. Its transaction in 1994 preceded Revenue Ruling 95-26 which addressed short sales. The earlier revenue ruling issued in 1988, Revenue Ruling 88-77, neither expressly men- tioned short sales nor cited the Federal Reserve Board's Regulation T. <br />
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Nonetheless, in 1994 Marriott had indirect notice that the obligation to close a short sale might well give rise to a liability under Section 752. Revenue Ruling 88-77 emphasized that the IRS considered that symmetry had a bearing on the interpretation of Section 752. As the Fifth Circuit pointed out in Kornman, “Revenue Ruling 88-77 ... defined liability under section 752 to “include an obligation only if and to the extent that incurring the liability creates or increases the basis to the partnership of any of the partnership's assets (including cash attributable to borrowings).”” 527 F.3d at 458 (quoting Rev. Rul. 88-77). Here, as in Kornman, the cash received in the short sale was an asset of the partnership and the basis of the partnership's assets was increased by those receipts. Symmetrical treatment would call for recognition of the corresponding obligation to replace the borrowed Treasury notes. <br />
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This case has a relatively close parallel to a second precedent, Salina P'ship v. Commissioner, 80 T.C.M. (CCH) 686, 2000 [TC Memo 2000-352] WL 1700928 (2000), which involved, among other things, a short sale of Treasury bills in 1992. The timing of the transaction in Salina thus was pragmatically the same as those carried out by the Marriott entities. At issue in Salina was “whether Salina's obligation to close out its short sale transaction by returning the Treasury bills that it borrowed from ABN and Goldman Sachs represent[ed] a liability within the meaning of section 752.” 80 T.C.M. (CCH) at 697. The Tax Court began its analysis by noting the absence of a statutory definition of liabilities and then turned to Revenue Ruling 88-77 and the definition of liabilities set out in Temp. Treas. Reg. § 1.752-1T(g) issued late in 1988. Id. at 697–98. After taking account of the interpretation of Revenue Ruling 88-77 that had been set out in Revenue Ruling 95-26, the Tax Court focused on the difference that would exist between the partnership's inside basis and the partners' outside basis if the taxpayer's position were to prevail. See 80 T.C.M. (CCH) at 698. The taxpayer had argued that the differential was dictated by I.R.C. § 1233 and Treas. Reg. § 1.1233-(1)(a), which require a short sale to be treated as an “open transaction” for income tax purposes. Id. For such transactions, income recognition is deferred until the transaction is closed with the return of the borrowed securities. The Tax Court refused to apply Section 1233 by analogy, however, viewing Sections 1233 and 752 as serving different purposes. 80 T.C.M. (CCH) at 698. It considered that Section 1233 was intended to clarify and simplify the recognition of gain or loss on the two steps of a short sale transaction, while the basis adjustment provisions of I.R.C. §§ 705 and 752 were “intended to avoid distortions in the tax reporting of partnership items by promoting parity between a partnership's aggregate inside basis in its assets and its partners' outside bases in their partnership interests.” Id. Because Salina “had a legally enforceable financial obligation to return the borrowed Treasury bills” and had “reported the obligation as a liability on its opening balance sheet,” the Tax Court sustained the IRS' adjustments in Salina's partners' “outside bases” to reflect their shares of the liability arising with the obligation to return the borrowed Treasury bills. Id. at 700. <br />
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The decision in Salina is persuasive insofar as it refuses to apply the “open transaction” principles reflected in I.R.C. § 1233 to the definition of liability in I.R.C. § 752. The concepts do not fit conformably. The partnership basis rules embodied in Sections 705, 722, and 752 contemplate adjustments to basis at the time the transaction occurs and do not leave basis open to be resolved definitively when a stepped transaction is closed. Hr'g Tr. 35:21-25 (May 19, 2008) (“Under [Section] 722, ... [you make the basis calculation] at the time of the contribution. That's when [the] partnership interest came into being.”); see also Hr'g Tr. 30:12–16 (“[Section 722] specifies that the partnership basis has to be calculated at the time of the contribution of the asset to the partnership.”). Moreover, the intention that symmetry will apply with the partnership basis rules is a strong consideration. Otherwise, manipulation of basis could readily generate distortion of gain or loss. These precepts supplied the analytical foundation for Rev. Rul. 88-77 and provided indirect notice to Marriott that the short sales in 1994 might well not produce the tax consequences it sought. <br />
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The government urges the court to adopt the broad rationale that any short sale of borrowed securities, ranging from a traded speculative common stock to a short-term Treasury bill, generates an obligation to return securities that is cognizable as a liability under Section 752. Def.'s Mot. at 26–29; Def.'s Supp. Br. at 6–7. 22 The court considers that it is not neces- [pg. 2008-6051] sary to go that far to resolve the dispute in this case. Rather, where Treasury bills or notes are involved, the risks in closing the short sale transaction are relatively circumscribed and the resulting liability should be recognized for basis-adjustment purposes under Section 752. 23 Other unusual circumstances may exist where a basis adjustment may not be appropriate, notwithstanding the symmetrical considerations that underpin basis adjustments generally under Sections 705, 722, and 752. <br />
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The court thus concludes that the IRS properly adjusted the outside basis of the Marriott partners to reflect the Marriott partnership's obligation to return the borrowed Treasury notes. Constraints on short sales established by the Federal Reserve Board's Regulation T were always implicitly present in Section 752 from the date of that Section's adoption in 1954. Marriott's argument about the short sales “treats [their] contingent assets and ... contingent liabilities asymmetrically.” See Robert Bird & Alan Tucker, Tax Sham or Prudent Investment: Deconstructing the Government's Pyrrhic Victory in Salina Partnership v. Commissioner, 22 Va. Tax Rev. 231, 254 (2002). Regulation T seeks to prevent just such treatment, albeit for the purpose of preventing a loss to a broker dealer stemming from a short seller who would borrow securities, sell them short, and then abscond with or otherwise impair the proceeds before completing the purchase and return of the securities. Here, when MORI contributed the obligation to close the short sales to Marriott Resorts, it treated the contribution as a contingent obligation that did not require a decrease in its outside basis in Marriott Resorts under Section 752. Pls.' Cross-Mot. at 7–8. However, when MORI contributed the $73 million in Repos to Marriott Resorts, it treated the transaction as a contribution of a fixed asset, entitling it to increase its outside basis in Marriott Resorts. Id. This asymmetry distorted the tax laws pertaining to outside basis. As the Fifth Circuit commented in Kornman: “If the obligation to replace the borrowed securities was a “contingent liability” that did not increase the amount realized on the sale, then the proceeds from the short sale should also be treated as a “contingent asset” that has no effect on the outside basis calculation under [S]ection 722.” Kornman , 527 F.3d at 460. The initial short sale, which generates the cash proceeds, and the subsequent covering transaction are “inextricably intertwined,” because under Regulation T the proceeds are chained to the obligation to close the short sale. Thus, the proceeds of the first step in the short sale transactions are also subject to the uncertainties of closing the short sale. Id. (citing Zlotnick, 836 F.2d at 820). In short, if contribution of the proceeds of the short sale increased the partners' outside basis, the contribution of the obligation to return the Treasury notes that had been sold short required a decrease in the partners' outside basis. <br />
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CONCLUSION<br />
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For the reasons stated, the government's motion for summary judgment is GRANTED and Marriott's cross-motion for summary judgment is DENIED. In accord with IRC § 6226(h), this disposition shall be considered as a decision of the court that the notice of final partnership administrative adjustment issued by the IRS was correct. The clerk shall enter judgment for the defendant. <br />
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No costs. <br />
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IT IS SO ORDERED. <br />
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Charles F. Lettow <br />
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Judge <br />
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1<br />
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This case arises under the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, 96 Stat. 324, 648–671 (“TEFRA”) (codified in scattered sections of the Internal Revenue Code (“I.R.C.”), including especially 26 U.S.C. (“I.R.C.”) §§ 6221–6234). A TEFRA partnership proceeding provides a means to determine the appropriateness of the partnership's reporting of “partnership items” on its annual information return. See McGann v. United States, 81 Fed. Cl. 642, 643–44 [101 AFTR 2d 2008-1992] (2008). Partnerships are pass-through entities for tax purposes, I.R.C. §§ 701, 702, and when the IRS disagrees with a partnership's reporting of any partnership item, it must issue a Final Partnership Administrative Adjustment (“FPAA”) before making any assessments against the partners attributable to such an item. See ,I.R.C. §§ 6223(a)(2), (d)(2), 6225(a). The timely mailing of the FPAA suspends the running of the limitations period for assessing any income taxes that are attributable to any partnership item or affected item. I.R.C. § 6229(d). <br />
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2<br />
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A short sale has been defined as “consisting of two transactions: (1) the taxpayer's sale of property (typically, securities) borrowed from another person (typically, a broker), and (2) the subsequent closing out of the short position by the taxpayer's delivery of securities to the person who loaned the securities that were sold.” Salina P'ship v. Commissioner, 80 T.C.M. (CCH) 686, 690 [TC Memo 2000-352] n.5 (2000) (citing 2 Boris Bittker & Lawrence Lokken, Federal Taxation of Income, Estates and Gifts ¶ 54.3.1, at 54–21 (2d ed. 1990)). <br />
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3<br />
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Generally, “basis” is a concept that is fundamental to the reporting of gain or loss on a transaction for tax purposes. Gain or loss is typically calculated by subtracting “basis” from the “amount realized.” I.R.C. § 1001(a). The “basis” of property is usually the cost of the property or the value when received, although there are a number of specific exceptions to this general rule. See I.R.C. §§ 1011–1016. <br />
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4<br />
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See Marriott Int'l Resorts, L.P. v. United States, 437 F.3d 1302, 1308 [97 AFTR 2d 2006-853] (Fed. Cir. 2006) (holding that the Commissioner of the IRS by formal explicit action could delegate authority to invoke the deliberative process privilege on the Service's behalf to an Assistant Chief Counsel). After this decision, the government submitted for the court's inspection in camera over 4,000 pages of agency records as to which the deliberative-process privilege was claimed. <br />
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5<br />
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The recitations that follow do not constitute findings of fact by the court. Instead, the recitals are taken from the parties' filings and are undisputed or alleged and assumed to be true for purposes of the pending motions, except where a factual controversy is explicitly noted. <br />
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6<br />
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References to “Compl. ¶ ___” are to the complaint filed in No. 01-256T. References to “Compl. in No. 01-257T ¶ ___” are to the complaint in No. 01-257T. <br />
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7<br />
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In October of 1993, Marriott International was spun off from its former parent, Marriott Corporation. Pls.' Opp'n to Def.'s Mot. for Summary Judgment and Pls.' Cross-Mot. for Partial Summary Judgment (“Pls.' Cross-Mot.”), Attached Decl. of Harold J. Heltzer (Mar. 25, 2008) (“Heltzer Decl.”), Ex. 6 (Dep. of M. Lester Pulse, Jr. (Dec. 11, 2002)) at 87; Ex. 7 (Dep. of Michael E. Dearing (Dec. 12, 2002)) at 24. <br />
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8<br />
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MORI's sale of the Mortgage Notes to TIAA in 1994 was priced to provide TIAA with a yield of 240 basis points (a 2.4% spread) above the average yields on U.S. Treasury securities adjusted to a constant maturity of four years. Heltzer Decl., Ex. 2 (Mem. to Growth Committee) at MAR-008866; Ex. 3 (Mem. to Corp. Growth Comm. entitled “MORI Note Sale to TIAA Closed” (Dec. 7, 1994)) at MAR-008673. Because the interest rate on the Mortgage Notes was fixed, and the yield TIAA received at the time of its purchase of the Mortgage Notes changed with the prevailing interest rate, MORI was exposed to interest-rate risk on the sale of the Mortgage Notes to TIAA. Heltzer Decl., Ex. 1 (Pls.' Interrog. Resp.) at 2–5; Ex. 2 (Mem. to Growth Committee) at MAR-008866-67. <br />
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The Mortgage Notes were sold by MORI to TIAA in the form of interests in securitized portfolios, referred to as “pass-through certificates.” First Stewart Decl., Ex. 1 (MTMG Corp. Purchase Agreement) at 1. The securitization of the Mortgage Notes involved the use of a bankruptcy-remote special purpose entity, with Marriott Resorts functioning in that role. Heltzer Decl., Ex. 1 (Pls.' Interrog. Resp.) at 3–5. The use of such an entity allowed the securitized Mortgage Notes to receive a higher credit rating, and thus be sold at a higher price. Heltzer Decl., Ex. 1 (Pls.' Interrog. Resp.) at 3–5; Ex 6 (Dep. of M. Lester Pulse, Jr., (Dec. 11, 2002)) at 35–36; Ex. 7 (Dep. of Michael E. Dearing (Dec. 12, 2002)) at 101–02. <br />
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9<br />
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The distinction between a partner's “outside” basis in its partnership interest and the partnership's “inside basis” is addressed infra, at 12–13. <br />
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10<br />
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The Repos were repurchase transactions in 30-day Eurodollar equivalent investments adjusted to the prevailing 30-day LIBOR rate. First Stewart Decl., Ex. 4 (Intent Letter). <br />
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11<br />
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Although the Complaint recites the date of incorporation as May 6, 1994, documentary evidence shows that incorporation actually occurred on May 9, 1994. See First Stewart Decl., Ex. 7 (Certificate of Incorporation of Marriott International JBS Corporation). <br />
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12<br />
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The Complaint states this date as May 6, 1994, but documentary evidence indicates that it occurred on May 10, 1994. See First Stewart Decl., Ex. 8 (Marriott Resorts Limited Partnership Agreement) at MAR-009198. <br />
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13<br />
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The net gain on the short sales reported by Marriott Resorts after trading and transaction 13 costs was $819,532. <br />
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14<br />
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In its Complaint, Marriott states that the loss on the sale of the interest in the timeshare mortgages was $69,442,568 ($81,452,111 minus $150,894,679). Compl. ¶ 33. Plaintiffs' position is that the loss alleged in the Complaint is correct. PRDPFUF at 11 n.1. Both parties agree that the difference is immaterial to the resolution of the pending motions. Def.'s Mot. at 12 n.15; PRDPFUF at 11 n.1. <br />
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15<br />
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In full, Section 752 provides: <br />
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§ 752. Treatment of certain liabilities <br />
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((a)) Increase in partner's liabilities.–Any increase in a partner's share of the liabilities of a partnership, or any increase in a partner's individual liabilities by reason of the assumption by such partner of partnership liabilities, shall be considered as a contribution of money by such partner to the partnership. <br />
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((b)) Decrease in partner's liabilities.–Any decrease in a partner's share of the liabilities of a partnership, or any decrease in a partner's individual liabilities by reason of the assumption by the partnership of such individual liabilities, shall be considered as a distribution of money to the partner by the partnership. <br />
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((c)) Liability to which property is subject.–For purposes of this section, a liability to which property is subject shall, to the extent of the fair market value of such property, be considered as a liability of the owner of the property. <br />
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((d)) Sale of exchange of an interest.–In the case of a sale or exchange of an interest in a partnership, liabilities shall be treated in the same manner as liabilities in connection with the sale or exchange of property not associated with partnerships. <br />
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I.R.C. § 752. Section 752 has remained unchanged since its enactment as part of the Internal Revenue Code of 1954. <br />
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In 1984, Section 752 was affected by enactment of a collateral statute that overruled the decision rendered in Raphan v. United States, 3 Cl. Ct. 457 [52 AFTR 2d 83-5987] (1983), which had interpreted Section 752. See Pub. L. No. 98-369, Div. A, Title I, § 79, 98 Stat. 597 (July 18, 1984), set out at I.R.C. § 752 note. Raphan held that a guarantee by a general partner of an otherwise nonrecourse debt of the partnership did not require the partner to be treated as personally liable for that debt. 3 Cl. Ct. at 465–66. <br />
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16<br />
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Although the decision in Zlotnick addresses the short sale of stocks, the same basic principles apply to a short sale of Treasury notes or other securities. See Kornman v. Assocs., Inc. v. United States, 527 F.3d 443, 450–51 [101 AFTR 2d 2008-2132] (5th Cir. 2008). <br />
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17<br />
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Citations to Regulation T in this opinion are to the version in effect in 1994 because that was the date of the transactions at issue. <br />
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18<br />
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Under Regulation T, a United States Treasury Notes is considered an “exempt” security because it is a government security. 12 C.F.R. § 220.2 (r) (1994); 15 U.S.C. §§ 78c(a)(12), (42). By contrast, a “nonexempt” security requires a higher initial posted margin, equal to 150 percent of the market value of the security. 12 C.F.R. § 220.12(c) (1994). <br />
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19<br />
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Section 705 states that once the outside basis is determined under Sections 722 or 742, the basis is increased by the partner's respective share of income items. I.R.C. § 705(a)(1). The basis calculation continues by decreasing basis by (1) “distributions” that are set forth in Section 733, i.e., money or property that the partnership transfers to its partners, (2) “losses of the partnership,” and (3) certain expenditures of the partnership which are “not deductible in computing taxable income and not properly chargeable to a capital account.” I.R.C. § 705(a)(2). <br />
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20<br />
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Revenue Ruling 95-45 held that a corporation's assumption of its shareholders' “obligation to deliver replacement securities to close out a short-sale constitutes the assumption of a liability for purposes of [S]ections 357 and 358 of the Code.” Rev. Rul. 95-45, 1995-1 C.B. 53, 1995 WL 335770 (June 6, 1995). Further, “the amount of the short-sale liability is the amount of basis to which the short sale gave rise.” Id. In other words, “[t]he amount of the liability assumed equals the proceeds of the original short sale.” Id.; see also IRS Field Service Advisory, 1997 WL 33313960 (Nov. 21, 1997) (stating that the liability-basis principles contained in Revenue ruling 95-45 are applicable to partnerships). <br />
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21<br />
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Courts have struggled with the question whether the retroactivity provisions of Treasury Regulation § 1.752 are valid and enforceable. Compare Cemco Investors, LLC v. United States , 515 F.3d 749, 752 [101 AFTR 2d 2008-768] (7th Cir. 2008) (applying Treas. Reg. § 1.752 retroactively), with Klamath Strategic Inv. Fund, LLC v. United States, 440 F. Supp. 2d. 608, 619–25 (E.D. Tex. 2006) (declining to apply Treas. Reg. § 1.752 retroactively). See generally Jade Trading LLC v. United States, 80 Fed. Cl. 11, 44–45 [100 AFTR 2d 2007-7123] & n.64 (2007) (opining that a “sold call option” contributed to a partnership “would not be considered a liability for purposes of section 752” as it was interpreted prior to the regulations issued by the Department of Treasury in 2005, but noting that under those regulations the option would be treated as a liability). <br />
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22<br />
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As the government's counsel explained at the hearing: <br />
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“[E]ach individual asset would and the type of transaction would need to be looked at individually. We thought about that kind of a situation, if you're talking about a stock, as opposed to a Treasury note. But, that would make a difference with respect to the contingent nature of the obligation. I don't really think it will, because ... the unique aspect of the short sale is that [the] obligation to return the property exists until the short sale is done.<br />
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Hr'g Tr. 40:7–16 (May 19, 2008). <br />
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23<br />
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In this instance, Marriott's contingency in closing the short sales of Treasury notes was constrained both by the Federal Reserve Board's Regulation T and by the nature of the securities involved. The only risk involved was interest-rate risk, not credit risk. Even the interest-rate risk with the Treasury notes Marriott borrowed was relatively small because the notes had a maturity of less than five years. <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-84742892408523885912012-08-07T07:48:00.001-04:002012-08-08T07:17:58.788-04:00Right to remain silentBetty Loren-Maltese v. Commissioner, TC Memo 2012-214 , Code Sec(s) 6501; 7454; 6663. <br />
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BETTY LOREN-MALTESE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent . <br />
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Case Information: Code Sec(s): 6501; 7454; 6663 <br />
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Docket: Docket No. 1069-05. <br />
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Date Issued: 07/30/2012 <br />
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HEADNOTE <br />
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XX. <br />
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Reference(s): Code Sec. 6501; Code Sec. 7454; Code Sec. 6663 <br />
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Syllabus <br />
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Official Tax Court Syllabus<br />
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Counsel <br />
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John James Morrison, for petitioner. <br />
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Sean R. Gannon and Katie Chapman, for respondent. <br />
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MEMORANDUM FINDINGS OF FACT AND OPINION <br />
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HOLMES, Judge: Betty Loren-Maltese is a locally well-known Illinois public servant who until recently was serving time in federal prison for her role in an insurance scheme to defraud the Town of Cicero of more than $10 million.See United States v. Spano, 421 F.3d 599, 602 (7th Cir. 2005). The government also indicted her on charges of criminal-tax fraud, but the criminal-tax trial led to a hung jury and the charges were dismissed. The Commissioner claims that Ms. Loren- Maltese fraudulently underreported income on her 1994 income tax return by omitting two very substantial conversions of campaign funds to personal use. This, he argues, justifies imposing on her a civil-fraud penalty and eliminates the bar of the statute of limitations. Ms. Loren-Maltese was mostly silent during her trial in our Court, relying on her attorney's advice to take shelter under the Fifth Amendment. <br />
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OPINION <br />
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It's the facts that make this case interesting, but there are three issues of law that color its background: the general rules of tax fraud, the proper tax treatment of money taken by a politician from her campaign fund for personal use, and the effect of taking the Fifth Amendment in civil litigation. We'll quickly review them. <br />
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Tax fraud is important in this case because fraud stops the clock on the statute of limitations, and so much time has passed that proving fraud is the only way the Commissioner can win. See ,sec. 6501(a), (c). 1 The question is: Can theCommissioner prove, by clear and convincing evidence, that Ms. Loren-Maltese intentionally evaded a tax that she believed was due? To do so, the Commissioner must establish that (1) an underpayment exists; and (2) some portion of the underpayment was due to fraud. See sec. 7454(a); Rule 142(b); Duncan & Assocs. v. Commissioner, T.C. Memo. 2003-158 [TC Memo 2003-158], 2003 WL 21233527, at *4. Fraud requires a state of mind—it is commonly defined as an “intentional wrongdoing” on the part of the taxpayer with “the specific purpose to evade a tax believed to be owing.” McGee v. Commissioner, 61 T.C. 249, 256 (1973), aff'd, 519 F.2d 1121 [36 AFTR 2d 75-5888] (5th Cir. 1975). <br />
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Because it's rare to have direct proof of someone's state of mind, we usually have to rely on circumstantial evidence. Petzoldt v. Commissioner, 92 T.C. 661, 699 (1989). We consider the entire record. Beaver v. Commissioner, 55 T.C. 85, 92 (1970). We may infer fraud from any conduct calculated to mislead or conceal. Id. at 93; Acker v. Commissioner, 26 T.C. 107, 112 (1956). And we look for “badges of fraud”—including the ones the Commissioner argues are present in this case: inadequate records; implausible or inconsistent explanations of behavior; concealing assets; engaging in illegal activities; and attempting to conceal activities. Bradford v. Commissioner, 796 F.2d 303, 307 [58 AFTR 2d 86-5532]-08 (9th Cir. 1986), aff'g T.C. Memo. 1984-601 [¶84,601 PH Memo TC]. We also look at the taxpayer's background, including her sophistication, experience, and education. Niedringhaus v. Commissioner 99 T.C. 202, 211 , (1992). <br />
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The second legal issue in this case is the use of campaign funds. Ms. Loren- Maltese controlled two of these: the Republican Committeeman Fund for the Town Republican Organization of Cicero (Organization Fund), and the Betty Loren- Maltese Committeeman Fund (Committeeman Fund). Cicero's town attorney, Burt Odelson, told Ms. Loren-Maltese before she filed her 1994 return that the Illinois state election code didn't require her to file financial reports or publicly disclose contributions or expenditures for the Committeeman Fund. The Organization Fund, however, was required to file publicly disclosed financial reports that gave detailed lists of contributions and expenditures. 2 He also correctly explained the tax consequences of taking money from the funds—Ms. Loren-Maltese could supplement her salary by taking money from either the Organization Fund or the Committeeman Fund to buy something for herself or to make an investment for her own personal benefit, but the money would be personal income to her and she'd owe tax on it in the year that she took it. See United States v. Scott, 660 F.2d 1145, 1151 [49 AFTR 2d 82-1279] (7th Cir. 1981); Stratton v. Commissioner, 54 T.C. 255, 282 (1970). She could also buy things or make investments as a fund's agent, and, if she used what she bought for the fund's intended political purpose would not have to include that money in her income,. See Stratton, 54 T.C. at 282; Rev. Rul. 71-449, 1971-2 C.B. 77. <br />
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The third and final legal issue in this case is the consequence of Ms. Loren- Maltese's taking the Fifth Amendment. Like the other legal issues, the law here is well settled, and Ms. Loren-Maltese's steadfast invocation of her right not to incriminate herself makes the Commissioner's job at least a bit easier. The parties took pains to argue about whether Ms. Loren-Maltese's invocation of the Fifth was justified—but that doesn't matter much here because even a valid invocation of the Fifth Amendment allows us to draw a negative inference from her refusal to answer a question if the Commissioner produces some additional supporting evidence. See Baxter v. Palmigiano, 425 U.S. 308, 318 (1976). <br />
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We can also draw inferences from her silence if, under the circumstances, it would've been natural for her to object. See United States v. Hale, 422 U.S. 171, 176 (1975). This later principle is not constitutional, just an acknowledgment of human nature. The original Cicero made the point 2,000 years ago in his oration exposing the plot of Lucius Catilina and his friends to plunder their government's treasury. 3 He observed that people have a natural tendency to defend their reputation, and that silence in the face of accusations suggests that there might be some merit to the charges. The Latin is more succinct: Cum tacent, clamant. M. Tullius Cicero, First Oration Against Lucius Catilina: Delivered in the Senate 21. <br />
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FINDINGS OF FACT <br />
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The silence that shouts out here arose from Cicero, Illinois, a suburb of Chicago that sits on its western hip like a well-holstered gun, and that has a colorful history that reaches back into the 1920s when Al Capone took refuge there. (Capone, though best known for his failure to file accurate tax returns, was also apparently well known for superintending a large number of saloons and other illegal enterprises in Cicero during Prohibition.) Some of this past is not dead, and is not even past—as Ms. Loren-Maltese remarked at trial: “There's always investigations in Cicero.” <br />
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With a population of around 80,000, Cicero is one of the largest municipalities in Illinois. It also has the unusual distinction of being its own township. Cicero, Ill., Code of Ordinances pt. I (2001). This makes Cicero more autonomous than most municipalities: It runs its own elections, administers its own finances (although Cook County may review some township functions, such as property-tax assessments), and provides services for its citizens that are ordinarily provided by counties in Illinois. See, e.g., 60 Ill. Comp. Stat. Ann. 1/85-10 (West 2006 & Supp. 2012) (powers generally); 60 Ill. Comp. Stat. Ann. 1/85-13 (health and safety authority); 60 Ill. Comp. Stat. Ann. 1/235-5 (taxation authority). Cicero also has its own police department, fire department, housing department, liquor commission, etc. At the time of the events leading to this case, Cicero was divided into 80 voting precincts, each of which had at least one precinct captain for each party. The precinct captain, who is appointed by the committeeman or another elected official, marshals support for party nominees. The Town is governed by a board of trustees and by the town president, both of which hold considerable power in the Town's day-to-day affairs. <br />
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Ms. Loren-Maltese was the President of Cicero and the Republican Committeeman of Cicero Township in 1994. She is also the widow of Frank Maltese, a “prominent Cicero politician who confessed to being a mob bookmaker and pleaded guilty to a federal gambling charge.” Hanania v. Loren-Maltese, 212 F.3d 353, 354-55 (7th Cir. 2000) (citing United States v. Maltese, No. 90 CR 87-19, 1993 WL 222350 (N.D. Ill. June 22, 1993)). Like his wife, Mr. Maltese was sentenced to prison, but he died of natural causes before he began serving his sentence. <br />
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Ms. Loren-Maltese's political roots in Cicero are deep, and sprouted from her job as editor of The Cicero Observer, a Republican newsletter about the Town's politics. She was also an important supporter and precinct captain for former Town President Henry Klosak. She served as his presidential aide and, since 1980, held several appointments in Town government with a portfolio of subjects from Section 8 housing to traffic violations and even deputy court-clerking duties. Mr. Maltese then appointed her to be the town's deputy liquor commissioner when the previous one resigned during an FBI investigation into his practice of taking bribes and skimming money off liquor-license renewal fees. See United States v. Maltese, 1993 WL 222350, at *2. <br />
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Ms. Loren-Maltese had more effective power than most deputy liquor commissioners, because the incumbent liquor commissioner was serving at the same time as president of Cicero, and most of his liquor-commissioner-related duties fell to her. The Town had problems on this front—when Ms. Loren-Maltese took over the job, there weren't any records, and she had to go up and down the streets of the Town to find out who was selling liquor and who had a license. She also held hearings in cases arising from violations of the liquor laws and license revocations, and she even worked on a revision of the Town's liquor ordinance. <br />
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On January 12, 1993, Mr. Maltese (who himself had an active public life as simultaneously town assessor, head of the public-works department, and member of the Town's board of trustees) succeeded in securing his wife's appointment as interim president after Mr. Klosak died in office. She then won election in her own right in April 1993. Ms. Loren-Maltese claims she was a “political neophyte,” yet she managed to be reelected for three additional four-year terms in some hotly contested elections and remained president until convicted in September 2002. She was also not above being a bit aggressive in dealing with political rivals. See Cruz v. Town of Cicero, Ill., 275 F.3d 579, 588-89 (7th Cir. 2001) (holding that a reasonable jury could conclude that Ms. Loren-Maltese was motivated by improper animus when she rejected a developer's condominium-conversion application in retribution for his repaying her “million-dollar favor” of approving a favorable lease with merely a bouquet of flowers.) When Ms. Loren-Maltese became president, she was also appointed the Republican committeeman of Cicero Township and was later elected to a full term in that job too. Committeeman is a political position—the Republican committeeman of Cicero Township heads the Town Republican Organization of Cicero. In that position, she promoted Republican candidates for office and oversaw scores of precinct captains. The job also gave her control over the Organization Fund. <br />
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Her tenure in office was not tranquil. In October 1996 the Chicago Sun- Times ran an article that named her as a target of a government investigation. In June 2001 a federal grand jury indicted her and several coconspirators for conspiracy to defraud the Town through a pattern of racketeering via multiple acts of bribery, money laundering, mail and wire fraud, official misconduct, and interstate transportation of stolen property. Her criminal trial lasted about three months, culminating in a conviction on August 23, 2002, on all but one count of the indictment (the criminal tax charge later tried separately). This put an end to her political career, and she was sentenced to eight years in prison. The government then tried her separately on the criminal-tax charges, but the jury hung, and the government decided not to try her again. See Gov't Motion to Dismiss Count 13 of the Above-Captioned Indictment, United States v. Spano, No. 1:01-cr-348 (N.D. Ill. Jan. 31, 2003), ECF No. 494. Ms. Loren-Maltese and the other conspirators appealed their convictions and sentences to the Seventh Circuit, which upheld the convictions but remanded for resentencing. See United States v. Spano, 421 F.3d 599 (7th Cir. 2005). The trial court then upheld the original sentence, and she remained imprisoned until 2010. <br />
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Even though the criminal tax-fraud indictment was dismissed, the Commissioner was not through with Ms. Loren-Maltese. He issued a notice of deficiency alleging civil tax-fraud for tax year 1994. Ms. Loren-Maltese filed a 4 petition in our court while involuntarily living in a federal prison in California, and we held a short trial in Chicago whose record was supplemented by the parties' stipulated admission—“as testimony and exhibits in this proceeding”—of slightly fewer than 10,000 pages of transcript and numerous exhibits from her criminal trials. 5 <br />
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The Commissioner boiled down this sea of information into a very detailed analysis of two transactions: Ms. Loren-Maltese's purchase of a 1993 classic black Cadillac Allante convertible, and her investment in a luxury golf course and clubhouse. The Commissioner contends that her withdrawal of more than $350,000 from the Committeeman Fund to finance the car and investment created taxable income and that she fraudulently tried to evade the tax due on that income. <br />
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A. The Car In September 1994, Ms. Loren-Maltese visited a local dealer and bought a classic black limited-edition 1993 Cadillac Allante convertible for $53,512.40. She paid with a check, and the check was drawn on the Committeeman Fund. All the documents prepared by the dealer, which we find Ms. Loren-Maltese reviewed, show the owner as Betty Loren-Maltese (and not in any representative capacity for the Town of Cicero or the Republican Party)—including the Bill of Sale/Purchase Agreement, the Certificate of Origin, and the title and license-plate registration. Ms. Loren-Maltese even transferred the license plate from her other personal car to the Cadillac. She added the Cadillac to her personal automobile-insurance policy, and designated its use as “pleasure use” (even though her insurance agent, Eric Sundstrom, explained that if the Allante were owned by the Town it would need a separate commercial policy). Ms. Loren-Maltese gave the dealership her personal information such as her address and driver's-license number. 6 The name on the title creates a prima facie presumption under Illinois law that she is the owner. See United States v. Ellis, 739 F.2d 1250, 1254 (7th Cir. 1984). <br />
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Paper formalities aren't conclusive, though. See Stratton, 54 T.C. at 269, 282. "[T]axation is not so much concerned with the refinements of title as it is with actual command over the property taxed.” Corliss v. Bowers, 281 U.S. 376, 378 [8 AFTR 10910] (1930); Friedman v. Commissioner T.C. Memo. 1968-145 [¶68,145 PH Memo TC], aff'd, 421 F.2d 658 [25 AFTR 2d 70-535] (6th , Cir. 1970). On this issue, the Commissioner points not just to the paper trail but to Ms. Loren-Maltese's silence at trial. She invoked the Fifth on virtually every question about the car, including its purchase and her use of it, and how she reported (or rather didn't report) on her 1994 tax return her use of Committeeman Fund money to buy it. <br />
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Ms. Loren-Maltese, whose coiffure is legendary in Chicagoland, broke her Fifth Amendment silence on this subject only once—to tell us that though the car was a convertible, she didn't go “cruising around” Town with the top down because she “wouldn't want to mess up [her] hair.” On this narrow issue, we find her entirely credible, but the evidence that her use of the Cadillac was personal rather than political is overwhelming. Though she was a good-humored, engaging, and credible witness when actually answering questions, her silence on substantive questions severely injured her case—not only because we specifically warned her that claiming the Fifth Amendment would allow us to draw a negative inference, but because the Commissioner's voluminous evidence against her strongly supported that inference. <br />
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Ms. Loren-Maltese used money from her personal bank account 7 to pay the insurance premiums as well as for the annual license-plate registration renewals, gas, repairs, and maintenance for the car. Ms. Loren-Maltese, who has also been a licensed real-estate agent since the 1970s, even deducted gas and mileage for the car on her 1994 income tax return as a “real estate sales” business expense—which we find was clearly not a political purpose. <br />
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Shortly after she bought the car, Ms. Loren-Maltese called her secretary, Lauren Racanelli, down from her office to “see her new car” (while she was on her way to her summer home in Lakes of the Four Seasons in Crown Point, Indiana). Both Ms. Racanelli and Commander Clarence Gross (of the Cicero Police Department), and even her own administrative assistant, never saw the Cadillac at any political or campaign function, and there were numerous such events during Ms. Loren-Maltese's presidency. <br />
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Ms. Loren-Maltese refused to testify to the whereabouts of the Allante, but the evidence leads us to find that in 1994 the car wasn't even normally in Cicero, but rather garaged at her summer home in Indiana, and that this continued to be the case until 1998. Ms. Racanelli only saw the car twice: the first time when Ms. Loren-Maltese called her down from her office to see the new car before driving it to Indiana, and the second time at the garage next to the town hall about a month later. Commander Gross, the policeman who had the chore of supervising the garage, saw the Allante in Ms. Loren-Maltese's personal parking spot only “several” times in the six months after she first bought it, and then didn't see the car at all after that until 1998 (when it had a vehicle decal from the gated community in Indiana where she had her summer home). <br />
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These facts, together with Ms. Loren-Maltese's silence at trial, lead us to find that she personally converted $53,512.40 from the Committeeman Fund to buy a car for her personal use, failed to include that amount as income on her return, and that then caused an understatement of her tax liability. An understatement alone is not enough to show fraud. The Commissioner must provide some evidence to support an inference of fraudulent intent. There is plenty to suggest that not only did Ms. Loren-Maltese understand that she was using campaign funds for personal use, but that she willfully did so with the intent to evade tax she knew would have been due. She was well-advised by the town attorney on the details and importance of titling and tracing funds. She used this knowledge to hide her use of campaign funds—transferring money from the Organization Fund (which had a reporting requirement) to the Committeeman Fund (which until the end of 1995 did not). Moreover, once the political winds shifted, Ms. Loren-Maltese asked Commander Gross to garage the car at his home from 1998 until 2000 or 2001—after the Chicago Sun-Times named her as the target of a federal investigation, and after she learned that Charles Schneider (one of her alleged co-conspirators) had been served with a grand-jury subpoena. <br />
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We therefore find that the Commissioner has shown by clear and convincing evidence that Ms. Loren-Maltese's understatement of income was due to fraud. B. The Golf Course Once the Commissioner has established fraud for one portion of the understatement, the burden shifts to the taxpayer to show by a preponderance of the evidence that other parts of the understatement aren't also due to fraud. Sec. 6663(b); Bussell v. Commissioner, T.C. Memo. 2005-77 [TC Memo 2005-77], 2005 WL 775755, at *13, aff'd, 262 Fed. Appx. 770 [101 AFTR 2d 2008-313] (9th Cir. 2007). <br />
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The other part of the asserted understatement in this case comes from Ms. Loren-Maltese's investment in the Four Seasons, a historic resort and golf course located on Miscauno Island, Wisconsin. In 1993, however, it badly needed substantial renovation to regain its old glory—and the money for the work came from Specialty Risk Consultants, 8 Plaza Partners 9 (which owned the Four Seasons), Miscauno Management (which managed the resort), and also from loans by Ms. Loren-Maltese and others. <br />
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Plaza Partners bought the Four Seasons Golf Course from Miscauno Management on December 2, 1993. Ms. Loren-Maltese went with Gregory Ross, John LaGiglio, and Michael Spano, Sr. to see if it would be a good investment. 10 Between July and September of 1994 Ms. Loren-Maltese gave Mr. LaGiglio three checks totaling $300,000 that she drew on the Committeeman Fund's account. All these checks were for investment in the Four Seasons. <br />
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The investment was memorialized in a promissory note dated January 11, 1994; a nominee agreement executed by Ms. Loren-Maltese dated November 1, 1994; and a mortgage on the Four Seasons dated November 28, 1994. All these documents identify Ms. Loren-Maltese in her personal capacity only—there is no mention of her in any representative capacity, much less as an officer or agent of the Committeeman Fund. This is striking when one notices that the other investors (such as Specialty Risk Consultants) were identified in their respective promissory notes as holding interests as partnerships. The documents also show that the deal was meticulously researched and carefully drafted. The investors even commissioned research into a complicated question of Wisconsin law of whether multiple parties who share a mortgage can have equal priority in the event of a default. The lawyers who did the research carefully noted the names of the parties involved, their legal capacities, and the amounts of their investments. <br />
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These notes and other documents show that Ms. Loren-Maltese gave Mr. LaGiglio a check for $100,000 that was drawn on the Committeeman Fund in July 1994 and that she personally signed that check. Mr. LaGiglio deposited it into Plaza Partners' account the next day. On July 20, 1994, Ms. Loren-Maltese withdrew $250,000 from the Organization Fund account and deposited it in the Committeeman Fund account, and later that day Ms. Loren-Maltese gave Mr. LaGiglio a check drawn on the Committeeman Fund for $100,000 which he deposited in the Plaza Partners account. Two months later, Ms. Loren-Maltese gave Mr. LaGiglio another check for $100,000 drawn on the Committeeman Fund, which he deposited into Miscauno Management. This leads us to find that Ms. Loren- Maltese financed this investment with campaign money, but when payments were made in partial satisfaction of the resulting debt they were made to Ms. Loren- Maltese personally. This was again in contrast to other checks in the record, for instance those written by Specialty Risk Consultants 11 to Ms. Loren-Maltese as political contributions, which were written to her as “Betty Loren-Maltese, Committeeman,” “The Committee to Elect Betty Loren-Maltese,” or written directly to the Committeeman Fund, but werenot written to Ms. Loren-Maltese personally. <br />
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There is one important quibble. Although Ms. Loren-Maltese's promissory note is for $500,000, which is the amount the Government argued during the criminal investigation was her total investment in the property. After her two criminal trials, however, the Commissioner limits his argument to the $300,000 that he can trace to withdrawals in 1994 from the Funds that Ms. Loren-Maltese controlled. <br />
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Ms. Loren-Maltese fails to carry her burden to establish by a preponderance of the evidence that the understatement of income arising from the Four Seasons investment wasn't done with fraudulent intent. Ms. Loren-Maltese argues that the repayments support her contention that this was an investment on behalf of the Committeeman Fund. But we find that the timing of the partial repayments 12 is actually more consistent with trying to conceal fraud. The terms of the promissory note required monthly payments much earlier than when the first one was made, with interest and a late fee. 13 But the checks were issued only after a grand-jury subpoena for information and documents relating to investments made in the Four Seasons was served on Mr. Schneider and Specialty Risk Consultants in September 1995. <br />
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Ms. Loren-Maltese's claim is also inconsistent with her treatment of the investment on her Form D-2s. 14 The chicanery with these financial reports (which overstate the amount of money available to the Committeeman Fund) also suggests fraud: <br />
<br />
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Actual amount<br />
<br />
Amount reported available<br />
<br />
on Form D-2 as of Committeeman<br />
<br />
first date of Fund Bank<br />
<br />
D-2 period reporting period statements <br />
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Difference<br />
<br />
11/8 - 12/31/1995 $787,669.00 $474,063.18 <br />
<br />
$313,605.82<br />
<br />
813,316.00 15<br />
<br />
1/1 - 6/30/1996 449,570.18 <br />
<br />
363,745.82<br />
<br />
157/1 - 12/31/1996 968,301.00 766,081.49 202,219.51 1/1 - 6/30/1997 978,275.35 900,025.14 78,250.21 7/1 - 12/31/1997 557,941.49 483,229.06 74,712.43 <br />
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Ms. Loren-Maltese argued at length during her second criminal trial that the difference between the reported assets and the actual account balances of the Committeeman Fund represented the amount of the loan balance on the Four Seasons investment. This explanation makes no sense: The Committeeman Fund's share of the loan was supposedly $300,000, and at the beginning of January 1996 no payments had yet been made, but the difference between the Fund's reported assets and cash-on-hand was still more than $50,000 greater than the amount of the loan. And the difference continued to fluctuate evenafter Ms. Loren-Maltese reimbursed the Fund in 1996. Ms. Loren-Maltese nevertheless argues that the reported assets and the cash-on-hand between the end-of-year 1996 and midyear 1997 reports is due to the $150,000 and the $75,000 repayments. Again, neither the facts nor simple arithmetic supports her argument. By the beginning of the third reporting period she had received a repayment of $150,000 which she deposited in the Committeeman Fund, and by the beginning of the fourth reporting period she received two payments for $75,000 and $46,925.32. Something is clearly missing. <br />
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We draw a negative inference from her taking the Fifth Amendment when asked at trial about whether she knowingly falsified the Forms D-2 to disguise her investment in the Four Seasons. The omissions and inconsistencies in these forms, along with her less-than-credible explanations, flash another badge of fraud, that of implausible explanations. <br />
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Her contention that she complied with state reporting requirements and treated the promissory note as an investment is not credible. In 1998 the Form D-2 changed to include an investment schedule, and Ms. Loren-Maltese reported the loan amount's face value as only $75,000 on that schedule. She also reported only some of the repayments on the promissory note. She reported interest received on October 18, 1996, of only $46,925.32. But she failed to report the $75,000 payment she received that same day, as well as the $150,000 payment on January 5, 1996—even though she claims that these payments reduced the loan balance. This is exceptionally suspicious imprecision—especially given the meticulous attention to detail on other expenditures and receipts on the Forms D-2, which include the exact values of keychains, McDonald's meals, and similarly modest expenses. <br />
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We therefore find that Ms. Loren-Maltese's treatment of the promissory note from start (the name on the promissory note, mortgage, and nominee agreement) to finish (her treatment on the disclosure on the Forms D-2) is inconsistent with the withdrawal of $300,000 from the Committeeman Fund to invest in the luxury golf course as the Committeeman Fund's own investment. Her attempts to recharacterize this as an investment on behalf of the Fund, rather than a conversion of the Fund's assets to her personal use—an attempt we find she made only after Specialty Risk Consultants received a subpoena—are too little too late, and fail to refute the Commissioner's argument that any understatement of tax flowing from her failure to include the amount of her investment in the Four Seasons as income on her 1994 return was due to fraud. <br />
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The Commissioner also reminds us that a taxpayer's level of education and business experience is a factor in figuring out whether a person is acting with fraudulent intent. Niedringhaus, 99 T.C. at 211. Ms. Loren-Maltese is a capable politician who managed the business affairs of the Town. She understood contracts and the importance of title from her experience as a real-estate agent. She understood what a nominee was from her experience as deputy liquor commissioner. She hired attorneys to create the Committeeman Fund and to document the Four Seasons investment. She participated in a complex scheme to defraud the Town of Cicero of over $10 million, which not only indicates an astute understanding of business affairs, but also a willingness to defraud. <br />
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Finally, the record has ample evidence that Ms. Loren-Maltese tried to conceal her activities. She used the Committeeman Fund to hide her expenditures—and concealing assets is powerful evidence of fraud. Friedman v. Commissioner, T.C. Memo. 1968-145 [¶68,145 PH Memo TC], aff'd, 421 F.2d 658 [25 AFTR 2d 70-535] (6th Cir. 1970). She falsified campaign-finance disclosures (the Forms D-2). She even tried to hide the car itself once she understood she was under federal investigation. <br />
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Thus, we find that both items that the government argues Ms. Loren-Maltese should have included in her income, should have been included in her income. Ms. Loren-Maltese's failure to do so was due to fraud, so the statute of limitations is no bar to assessing this old deficiency. This means that <br />
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Decision will be entered for respondent. <br />
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1<br />
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Unless we say otherwise, all section references are to the Internal Revenue Code for the year at issue, and the Rule references are to the Tax Court Rules of Practice and Procedure. <br />
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2<br />
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In 1994 Illinois law allowed public officials, who like Ms. Loren-Maltese, were also political-party officials, to raise money from donors—in their capacity as party officials—in amounts that they could keep secret. This was because political-party officials were not considered public officeholders under Illinois law, which required only political committees for public officeholders to disclose committee contributions and expenditures. See 10 Ill. Comp. Stat. Ann. 5/9-1.3, 5/9-1.7, 5/9-10 (West 2010). Illinois sewed up this loophole in 1995 by redefining members of political-party committees as public officeholders. 1995 Ill. Legis. Serv. P.A. 89-405 (H.B. 1498), sec. 10 (West). This made Ms. Loren-Maltese's Committeemen Fund subject to the same public financial-disclosure requirements as any other political fund beginning November 8, 1995. See 10 Ill. Comp. Stat. Ann. 5/9-1.3, 5/9-1.7. <br />
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3<br />
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And, allegedly, to murder the Senate, overthrow the Republic, and set their city on fire. See Z. Yavetz, “The Failure of Catiline's Conspiracy”, 12 Historia: Zeitschrift f Alte Geschichte 485, 485 n.1 (1963). <br />
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4<br />
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Our decisions are appealable to the circuit where the taxpayer resides when she files her petition unless the parties stipulate differently., Sec. 7482(b)(1)(A), (2). Ms. Loren-Maltese was a longtime resident of Cicero until she was incarcerated. Unless incarceration results in a change of residency, which we doubt but need not resolve here, our decision would be appealable to the Seventh Circuit unless the parties stipulate differently. <br />
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5<br />
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We therefore accept as testimony for purposes of this trial all of the testimony that took place in the criminal trials, and we (like the parties) used the documentary evidence extensively. See, e.g., Hoover v. Commissioner, T.C. Memo. 2006-82 [TC Memo 2006-82], 2006 WL 1073427, at *1; Vardine v. Commissioner, T.C. Memo. 1969-57 [¶69,057 PH Memo TC]. <br />
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6<br />
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The exhibits included the title to a Jeep which the Town of Cicero bought that same year. We observed that all the documents related to the Jeep identify the Town as purchaser and Ms. Loren-Maltese as the Town's duly authorized agent. We find that this shows that Ms. Loren-Maltese knew how to distinguish personal from government car ownership. <br />
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7<br />
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With the exception of two payments made in years not at issue made with funds from the Committeeman Fund--one for 1995 and one for 1997. <br />
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8<br />
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The money from the Specialty Risk Consultant bank account came from payments the Town received to administer insurance claims of its employees. United States v. Spano, 421 F.3d 599, 602 (7th Cir. 2005). <br />
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9<br />
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Plaza Partners was created on October 17, 1992, to serve as a nominee for Messrs. John LaGiglio and Frank Taylor (who were also convicted for their role in operating Specialty Risk Consultants, which was the insurance administrator for Cicero, and the key organization in defrauding the Town of more than $10 million). Both men needed nominees to disguise their interest in various investments, as they had trouble with the IRS, so they put their partnership interests in their wives' names. See Spano, 421 F.3d at 604; Plea Agreement at 7, United States v. Taylor, No. 1:01-cr-348-10 (N.D. Ill. Apr. 24, 2002), ECF No. 161. <br />
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10<br />
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Mr. Ross was a former special agent with the IRS, and a co-conspirator turned government witness. See Plea Agreement, United States v. Ross, No. 1:01- cr-348-8 (N.D. Ill. May 13, 2002), ECF No. 195; Plea Agreement, United States v. Ross, No. 1:00-cr-734 (N.D. Ill. Apr. 19, 2002), ECF No. 35; Plea Agreement, United States v. Ross, No. 1:01-cr-30-5 (N.D. Ill. Feb. 14, 2002), ECF No. 145. He, Mr. LaGiglio, and Mr. Spano were also convicted for their participation in the insurance-fraud scheme that ensnared Ms. Loren-Maltese. <br />
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11<br />
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At some point after the promissory note was signed, ownership of the Four Seasons was transferred to Specialty Risk Consultants. <br />
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12<br />
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A total of $271,925.32 was repaid in three checks issued by Specialty Risk Consultants: $150,000 on January 5, 1996, and two checks for $75,000 and $46,925.32 on October 18, 1996. The checks were payable to Betty Loren-Maltese, and she later (on February 5 and October 21, 1996, respectively) signed them over to the Committeeman Fund. <br />
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13<br />
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The first payment, of interest from October 1, 1994, through March 31, 1995, was due on April 1, 1995, and monthly installments of interest and principal should have begun on May 1, 1995, and continued until October 1, 1995. The promissory note provided for a 5% late fee for any payment not received by five business days after its due date. <br />
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14<br />
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<br />
Form D-2, Report of Campaign Contributions and Expenditures, is the name of the form political committees use in Illinois to report their assets, contributions, and expenses. “A Guide to Campaign Disclosure”, Illinois State Board of Elections, 14 (Mar. 2012), http://www.elections.il.gov/downloads/ campaigndisclosure/pdf/campdiscguide.pdf. <br />
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15<br />
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Ms. Loren-Maltese filed two Forms D-2 that allegedly detail the amount of the Committeeman Fund's assets on January 1, 1996: one, a pre-election report for the period of January 1, 1996, through February 18, 1996, filed on March 1, 1996, and claiming assets of $777,162, and another, a semi-annual report for the period January 1, 1996, through June 30, 1996, filed on October 17, 1996, claiming assets of $813,316. This unexplained $36,000 discrepancy underscores how unbelievable the Committeeman Fund's Forms D-2 are. <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-908680834165717372012-08-07T07:04:00.001-04:002012-08-07T07:04:54.550-04:00ProtesterMichael C. Worsham v. Commissioner, TC Memo 2012-219 , Code Sec(s) 61; 6651; 6654; 6673; 7491. <br />
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MICHAEL CRAIG WORSHAM, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent . <br />
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Case Information: Code Sec(s): 61; 6651; 6654; 6673; 7491 <br />
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Docket: Docket No. 31151-09. <br />
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Date Issued: 07/31/2012 <br />
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HEADNOTE <br />
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XX. <br />
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Reference(s): Code Sec. 61; Code Sec. 6651; Code Sec. 6654; Code Sec. 6673; Code Sec. 7491 <br />
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<br />
Syllabus <br />
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Official Tax Court Syllabus<br />
<br />
Counsel <br />
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Michael Craig Worsham, pro se. <br />
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Marissa R. Lenius, Elizabeth S. Henn, Peter N. Scharff, and Tyler N. Orlowski, for respondent. <br />
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MEMORANDUM FINDINGS OF FACT AND OPINION <br />
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GOEKE, Judge: By statutory notice of deficiency, respondent determined a $6,357 1 deficiency in petitioner's 2006 Federal income tax. Petitioner failed to file a 2006 Federal tax return. Respondent also determined a $1,430 addition to tax under section 6651(a)(1), 2 an $858 addition to tax under section 6651(a)(2), and a $301 addition to tax under section 6654(a). In an amendment to the answer to the petition, respondent asserted that the deficiency in tax was actually $67,298. In his amendment to answer respondent also asserted a $48,791 fraudulent failure to file addition to tax under section 6651(f), 3 as well as an increase of the section 6651(a)(2) addition to $16,825 and of the section 6654(a) addition to $3,185. The parties later stipulated certain amounts paid to petitioner during 2006, 4 as well as certain deductions. Finally, respondent filed a motion to impose sanctions against petitioner pursuant to section 6673(a)(1). The issues for our consideration are: <br />
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(1) whether petitioner failed to report taxable income of $193,026 for 2006. We hold that he did; <br />
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(2) whether petitioner is liable for the section 6651(f) fraudulent failure to file addition to tax for 2006. We hold that he is; <br />
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(3) whether petitioner is liable for the section 6651(a)(2) addition to tax resulting from his failure to pay the tax shown on a substitute for return (SFR) prepared by respondent. We hold that he is; <br />
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(4) whether petitioner is liable for additions to tax for failure to pay estimated taxes under section 6654 for 2006. We hold that he is; and <br />
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(5) whether to impose sanctions under section 6673 on petitioner for presenting frivolous or groundless arguments before the Court. We shall not. <br />
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FINDINGS OF FACT <br />
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At the time the petition was filed, petitioner resided in Maryland. Petitioner has a bachelor of science in chemistry, a master of science in civil engineering and a juris doctor from the University of Baltimore School of Law. He moved to Maryland in 1993 to work for the U.S. Army Environmental Center at Aberdeen Proving Ground. Over the next several years he attended law school at night, was sworn in as a member of the Maryland bar in 1998, and left the army in 2001 to start a solo law practice from his home. Petitioner's practice was not in the area of tax, and he did not take any tax courses in law school. <br />
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Petitioner filed a Federal tax return every year from 1989 (when he had just begun graduate school to earn his master of science in civil engineering) through 2004. On his 2004 Federal tax return petitioner reported $26,294 of adjusted gross income, $8,359 of taxable income, and $7,712 of self-employment income. 5 Petitioner's practice of law became more profitable during 2005. An accountant suggested petitioner incorporate his business for tax reasons, which he did, incorporating it under the name Michael C. Worsham, P.C. (Worsham, P.C.). During 2006 Worsham, P.C., had a corporate charter in effect in the State of Maryland, elected to be treated as an S corporation, and was wholly owned by petitioner. <br />
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Petitioner testified that during 2006 “without looking for it” he discovered information which led him to conclude that he was not required to file Federal tax returns or pay Federal income taxes. As a result, petitioner has not filed a personal Federal tax return for any year since 2004. 6 However, petitioner did make a $2,000 estimated tax payment to the U.S. Treasury for the 2005 tax year and also made a payment to the U.S. Treasury of $45,000 in April 2006, in connection with the filing of a Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, for 2005. The $45,000 payment was credited to petitioner's 2005 income tax account. 7 Petitioner did not make any payments with respect to his 2006 tax. <br />
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In payment for legal services petitioner performed, deposits totaling $192,410 were made to Worsham, P.C.'s business checking account during 2006. The parties stipulated that Worsham, P.C., incurred deductible expenses of $163,772 during 2006, including $118,000 in wages paid to petitioner. During 2006 petitioner also deposited $57,015 in settlement proceeds into a personal checking account. The proceeds were the result of personal lawsuits brought by petitioner in his own name. Finally, during 2006 petitioner made mortgage interest payments of $6,737, real property tax payments totaling $2,761, and charitable contributions of $840. <br />
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Before April 15, 2007, petitioner received three Forms 1099-MISC, Miscellaneous Income, reporting taxable payments of $20,000, $6,200, and $8,000 paid during 2006 to petitioner, Worsham, P.C., and the “Michael C. Worsham Trust Account”, 8 respectively. Each of these payments was the result of either compensation for legal services or settlement of a personal lawsuit (brought in his own name) and was not part of the amounts earned by petitioner or Worsham, P.C., previously discussed. Before April 15, 2007, petitioner also received a Form 1099- INT, Interest Income, prepared by Aberdeen Proving Ground Federal Credit Union reporting $961 of interest paid to petitioner on a personal account. <br />
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Using the information on the Forms 1099-MISC and Form 1099-INT (and not accounting for any deductions other than the standard deduction and one personal exemption as petitioner had not yet supplied information regarding home mortgage interest paid, property taxes paid, and charitable contributions made), respondent prepared an SFR for petitioner for 2006. This SFR showed tax due of $6,357. Respondent then issued a notice of deficiency to petitioner on September 28, 2009, determining a $6,357 deficiency in tax and the additions to tax described earlier. <br />
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After the petition was filed, respondent issued a subpoena duces tecum to each of petitioner's banks for statements of account for 2006. Respondent then performed bank deposits analyses for a Worsham, P.C. account at M&T Bank and petitioner's personal account at Aberdeen Proving Ground Federal Credit Union. As a result of the bank deposits analyses, respondent determined that petitioner's unreported income was substantially in excess of the amount determined in the notice of deficiency. We permitted respondent to amend the answer to assert an increased deficiency and to assert that petitioner is liable for the section 6651(f) fraudulent failure to file addition to tax. <br />
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After learning of the subpoenas duces tecum issued to his banks, petitioner filed a motion to dismiss seeking to have his case dismissed without prejudice. Petitioner mailed a letter to M&T Bank in which he stated: “Because I am dismissing this case, the Subpoena issued by the IRS to M&T Bank should no longer be valid, and M&T Bank should not be required to respond by producing copies of my account records.” Shortly after he mailed this letter to M&T Bank, we denied petitioner's motion to dismiss. <br />
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OPINION <br />
<br />
I. Burden of Proof Generally, taxpayers bear the burden of proving, by a preponderance of the evidence, that the determinations of the Commissioner in a notice of deficiency are incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 [12 AFTR 1456] (1933). Petitioner has not argued that the burden of proof with respect to the deficiency determined in the notice of deficiency should shift to respondent. However, respondent concedes that he bears the burden of proof with respect to the increased deficiency asserted in the amendment to answer. See Rule 142(a). Respondent also bears the burden of proving, by clear and convincing evidence, that the section 6651(f) fraudulent failure to file addition to tax applies. See sec. 7454(a). With respect to the additions to tax under sections 6651(a)(1) and (2) and 6654(a) determined in the notice of deficiency, respondent bears the burden of production. See sec. 7491(c). With respect to the additions to tax applicable to the increased deficiency asserted in the amendment to answer, respondent concedes he bears the burden of both production and proof. See sec. 7491(c); Rule 142(a). As discussed infra, we find that respondent has met any burden of proof (or production as the case may be) he bears with respect to each issue. <br />
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II. Whether Petitioner Failed To Report Taxable Income of $193,026 for 2006 <br />
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Section 1 imposes a Federal income tax on the taxable income of individuals. Taxable income is defined as gross income minus any allowed deductions. Sec. 63. Gross income is defined as all income from whatever source derived. Sec. 61(a). Section 61(a) specifically includes in the definition of income wages and compensation for services, including fees, and interest. Settlement proceeds are included in the broad definition of income under section 61(a) unless they are damages received on account of personal injuries or sickness. Sec. 104(a)(2); Commissioner v. Schleier, 515 U.S. 323, 328-329 [75 AFTR 2d 95-2675] (1995). <br />
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During 2006 petitioner received significant wages, compensation for legal services, settlement proceeds from personal lawsuits, and interest but chose to neither report these amounts nor pay any Federal income tax on them. Petitioner does not dispute that he received the amounts in question; indeed, he stipulated their receipt. Rather, petitioner makes a series of arguments that he owed no Federal taxes on his earnings during 2006. <br />
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In his posttrial brief petitioner argues that: (1) “there is no constitutional basis for federal taxes on the ordinary labor of a working American like Petitioner”; (2) “there is no federal statute that *** establishes federal tax liability for money earned from the ordinary labor of Americans”; and (3) respondent has failed to account for the basis value of a person's labor which “would be valued at near or the same as the value of the gross receipts which that same labor generated”. Petitioner has previously raised other issues, including: (1) “Respondent mislead [sic] Petitioner and others into believing that a Form 1040 [U.S. Individual Income Tax Return] was the only acceptable return” and that petitioner should not be liable for additions to tax because “Petitioner has not been given any or reasonable notice of a return or form to be filed other than Form 1040”; (2) “Whether *** the Fifth Amendment may apply to Petitioner and the demands made upon Petitioner by Respondent”; (3) issues relating to internal revenue districts; (4) whether certain withholding actions taken by respondent were unlawful without an assessment and proper notice; (5) whether the Tax Court has jurisdiction to determine constitutional issues related to income tax determination and the statutory basis for the same; 9 (6) “whether a [Tax Court] Judge can preside over and rule in a case where constitutional issues are inexorably linked to and required for resolution of that case, given the conflict between the Court's limited constitutional jurisdiction and that Judge's sworn requirement as” a member of a State bar association to support and defend the Constitution; and (7) that Form 1040 violates the Paperwork Reduction Act, 44 U.S.C. §§ 3501-3520. , 1207 (3d Cir. 1977); Hawkins v. Commissioner, T.C. Memo. 2003-181 [TC Memo 2003-181] (”Petitioners contend that only a court established under Article III of the Constitution, rather than a legislative court established under Article I of the Constitution, can adjudicate the [constitutional] issues they have raised. Petitioners' arguments have no merit.” (Fn. ref. omitted.);Broughton v. Commissioner T.C. , Memo. 1979-77 (”in many cases involving various claims we have ruled *** that the income tax is a constitutional tax, that the provisions for a determination of deficiency by respondent are constitutional, [and] that this Court is a constitutional court”). <br />
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We decline the invitation to address in detail petitioner's numerous arguments. Courts confronting frivolous “tax protester” 10 arguments regarding the <br />
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Federal income tax often quote Crain v. Commissioner, 737 F.2d 1417, 1417 [54 AFTR 2d 84-5698] (5th Cir. 1984), which stated: “We perceive no need to refute these arguments with somber reasoning and copious citation of precedent”. Addressing frivolous tax-protester arguments: (1) wastes the limited resources of the Court; (2) delays the assessment of tax; and (3) risks dignifying such arguments or suggesting that they have some colorable merit. Wnuck v. Commissioner, 136 T.C. 498, 510-513 (2011). We have also recognized that tax-protester arguments: (1) are unlimited; <br />
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(2) may have little actual importance to those making them; (3) have already been answered; and (4) are patently frivolous. Id. at 501-505. Finally, we have noted that litigants who press frivolous tax-protester arguments often fail to hear their refutation. Id. at 504-505. <br />
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Petitioner repeatedly claims his arguments are not frivolous, but we disagree. Regarding petitioner's constitutional arguments, courts have previously stated that “The constitutionality of our income tax system—including the role played within that system by the Internal Revenue Service and the Tax Court—has long been “Persons who make frivolous anti-tax arguments have sometimes been called `tax protesters'.” Wnuck v. Commissioner, 136 T.C. 498, 502 n. 2 (2011). established.” Crain v. Commissioner, 737 F.2d at 1417 [54 AFTR 2d 84-5698]-1418; see also Powers v. Commissioner, T.C. Memo. 2009-229 [TC Memo 2009-229]; DiCarlo v. Commissioner, T.C. Memo. 1992-280 [1992 RIA TC Memo ¶92,280]. We therefore hold these constitutional arguments are frivolous. <br />
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Petitioner's argument that no Federal statute imposes a tax on a person's ordinary labor relies on selective and misguided readings of multiple statutes. Petitioner's argument that he had a basis in his labor is also frivolous. Courts have clearly held that the statutory law does impose a tax on payments for a person's ordinary labor and that taxpayers have no basis in their labor supplied. Howard v. Commissioner, T.C. Memo. 2000-222 [TC Memo 2000-222] (taxpayer claimed that payments for his labor were not income and that he had a basis in his labor equal to the amount of the payment received for it; we stated that “All of these arguments have been consistently rejected by the courts and can be accurately characterized as timeworn protester type rhetoric.”); see also Rowlee v. Commissioner, 80 T.C. 1111, 1113, 1119-1121 (1983); Hyslep v. Commissioner, T.C. Memo. 1988-289 [¶88,289 PH Memo TC]; Cornell v. Commissioner, T.C. Memo. 1983-370 [¶83,370 PH Memo TC]. We therefore find these arguments are frivolous. <br />
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The arguments not already addressed were not argued in petitioner's posttrial brief and were either not well developed or not developed at all. We will not address them other than to say: “The short answer to all of petitioner's arguments is that he is not exempt from Federal income tax.” Martin v. Commissioner, T.C. Memo. 1990-560 [¶90,560 PH Memo TC] (citing Abrams v. Commissioner, 82 T.C. 403, 406-407 (1984)). <br />
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One final argument by petitioner relating to the deficiency 11 that we will fully address relates to the cases respondent cites in his opening brief. Petitioner claims that Tax Court opinions filed before September 25, 2005, are not available through searches on the Tax Court's Web site, and respondent has cited several such older cases in his brief without providing petitioner with copies of those cases. Petitioner argues that “in fairness *** [we] should not consider arguments based on these older cases that are not available to Petitioner in a publicly accessible database.” In support of this argument, petitioner cites rule 32.1(b) of the Federal Rules of Appellate Procedure, which provides that “If a party cites a federal judicial opinion *** that is not available in a publicly accessible electronic database, the party must file and serve a copy of that opinion *** with the brief or other paper in which it is cited.” <br />
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We disagree with petitioner. Rule 1(a)(1) of the Federal Rules of Appellate Procedure provides that “These rules govern procedure in the United States courts of appeals.” The Tax Court is not an appellate court, and the Federal Rules of Appellate Procedure therefore do not apply to cases disputed herein. In addition, the Tax Court Rules of Practice and Procedure contain no similar rule regarding cases not available on a public database. <br />
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Having found all of petitioner's arguments to be frivolous or inapplicable, we find that respondent has proved that petitioner failed to report taxable income of $193,026 for 2006 and is liable for the Federal tax he failed to pay on that income. <br />
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III. Whether Petitioner Is Liable for the Section 6651(f) Fraudulent Failure To File Addition to Tax for 2006 <br />
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Section 6651(f) imposes an addition to tax of up to 75% 12 in the case of any fraudulent failure to file a tax return. Respondent has the burden of proving fraud by clear and convincing evidence. See sec. 7454(a); Rule 142(b). To satisfy the burden of proof, respondent must show: (1) an underpayment of tax exists; and (2) petitioner intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Clayton v. Commissioner, 102 T.C. 632, 646 (1994); see also Sadler v. Commissioner, 113 T.C. 99, 102 (1999); Parks v. Commissioner, 94 T.C. 654, 660-661 (1990). <br />
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A. Underpayment of Tax The clear and convincing standard applies not merely to whether an underpayment is attributable to fraud, but also to whether an underpayment exists. Parks v. Commissioner, 94 T.C. at 660-661; Di Rocco v. Commissioner, T.C. Memo. 2009-300 [TC Memo 2009-300]. Considering the facts and law discussed hereinabove, we find that respondent has proven by clear and convincing evidence that an underpayment of tax exists for 2006. <br />
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B. Fraudulent Intent The Commissioner must prove by clear and convincing evidence that a portion of the underpayment for each taxable year in issue was due to fraud. See Prof'l Servs. v. Commissioner, 79 T.C. 888, 930 (1982). The existence of fraud is a question of fact to be resolved upon consideration of the entire record. King's Court Mobile Home Park, Inc. v. Commissioner 98 T.C. 511, 516 (1992). The , taxpayer's entire course of conduct may establish the requisite fraudulent intent. Stone v. Commissioner, 56 T.C. 213, 223-224 (1971). Because direct proof of a taxpayer's intent is rarely available, fraud may be proved by circumstantial evidence and reasonably inferred from the facts. Spies v. United States, 317 U.S. 492, 499 [30 AFTR 378] (1943); Niedringhaus v. Commissioner , 99 T.C. 202, 210 (1992); Rowlee v. Commissioner, 80 T.C. at 1123. <br />
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Petitioner has argued that although he failed to file his 2006 tax return, his failure to file was not fraudulent because he had a good-faith belief that he was not required to pay Federal tax on the amounts he earned. Petitioner's argument is similar to the argument made by the taxpayer inRowlee v. Commissioner, 80 T.C. at 1123-1124. In that case we found that the taxpayer's failure to file was fraudulent, stating: <br />
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Failure to file tax returns, without more, is not proof of fraud; such omission may be consistent with a state of mind other than the intention and expectation of defeating the payment of taxes. *** <br />
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Failure to file, however, may be considered in connection with other facts in determining whether any deficiency or underpayment of tax is due to fraud. *** Here, there is no question that *** [taxpayer's] purpose was to avoid, and not merely to postpone, the payment of taxes that he claims he was not obligated to pay. On the basis of the entire record, the failure to file must be viewed as conduct intended to conceal *** [taxpayer's] noncompliance with the law. The burden on respondent to both locate and assess a delinquent taxpayer is, in a sense, greater than the verification of items reported on a return that has been filed but may be false. And, as stated in Helvering v. Mitchell, *** [303 U.S. 391, 401 [20 AFTR 796] (1938)], it is that necessity for which the Government is to be compensated by the addition to tax. [Taxpayer] contends that he could not have intended to conceal his conduct because of his attempts to confront various agents of respondent. But those attempts *** occurred long after the time for filing his returns had passed. *** [Taxpayer] cannot disregard the laws that have been passed by Congress and upheld by the courts; fail to perform an affirmative duty imposed upon him by those laws; proclaim, only when he has been discovered, that those laws are inconsistent with his or another's philosophy; and then expect to avoid the consequences of his avowedly freely exercised disobedience. [Citations and fn. refs. omitted.] Certain indicia, commonly known as badges of fraud, constitute circumstantial evidence which may give rise to a finding of fraudulent intent. Bradford v. Commissioner, 796 F.2d 303, 307 [58 AFTR 2d 86-5532] (9th Cir. 1986), aff'g T.C. Memo. 1984-601 [¶84,601 PH Memo TC]. “Although no single factor is necessarily sufficient to establish fraud, the existence of several indicia is persuasive circumstantial evidence of fraud.” Petzoldt v. Commissioner, 92 T.C. 661, 700 (1989). As discussed below, several badges of fraud are applicable in this case. <br />
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Failure to file a tax return is a badge of fraud and “An extended pattern of failing to file income tax returns *** may be persuasive circumstantial evidence of fraud.” DeVries v. Commissioner, T.C. Memo. 2011-185 [TC Memo 2011-185] (citing Marsellus v. Commissioner, 544 F.2d 883, 885 [39 AFTR 2d 77-595] (5th Cir. 1977), aff'g T.C. Memo. 1975-368 [¶75,368 PH Memo TC])); see also Bradford v. Commissioner, 796 F.2d at 307. In addition, when failure to file is viewed in the light of the previous filing of tax returns for prior years, the nonfiling “weighs heavily against” the taxpayer because it demonstrates the taxpayer's awareness of the filing requirement. Castillo v. Commissioner, 84 T.C. 405, 409 (1985). Petitioner filed a Federal tax return every year from 1989 through 2004 but has not filed a tax return since. We find that petitioner's pattern of failing to file tax returns after 2004 is persuasive evidence of fraud, especially when viewed in the light of his prior tax return filings and failure to make estimated tax payments. See Niedringhaus v. Commissioner 99 T.C. at 213 (”We find that petitioner's , failure to file returns, combined with his failure to make estimated tax payments, was a deliberate attempt to conceal his correct tax liability and to frustrate its collection.”) (citing Miller v. Commissioner, 94 T.C. 316, 337 (1990)). <br />
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Petitioner argues that he stopped filing tax returns only upon discovering information in 2006 which led him to conclude that he was not required to file tax returns or pay taxes. We believe it more likely that petitioner stopped filing tax returns because of his larger tax burden resulting from the increasing profitability of his law practice. <br />
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Petitioner also argues that the years 1993 through 2001 are irrelevant because he was required to file returns and pay Federal income tax for those years as a Federal employee in the army. We have previously noted that the theory that only Federal employees are subject to Federal income tax “is a common, frivolous, tax-protester argument” of no merit. Hamilton v. Commissioner , T.C. Memo. 2009-271 [TC Memo 2009-271] (fn. ref. omitted). <br />
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While tax-protester arguments may not be evidence of fraud by themselves, they may be indicative of fraud if made in conjunction with affirmative acts designed to evade Federal income tax. DeVries v. Commissioner, T.C. Memo. 2011-185 [TC Memo 2011-185] (citing Kotmair v. Commissioner 86 T.C. 1253, 1260-1261 (1986)). In , the instant case petitioner has raised a multitude of frivolous, tax-protester arguments in conjunction with the failure to file a tax return or make estimated tax payments. Petitioner has also engaged in affirmative acts (relating to the subpoenas duces tecum) designed to evade Federal income taxes, as described infra. We therefore find petitioner's tax-protester arguments are indicative of fraud. <br />
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A taxpayer's education, training, business experience, and knowledge of income tax laws are relevant in deciding whether a taxpayer committed fraud. Drobny v. Commissioner, 86 T.C. 1326, 1349 (1986); Harker v. Commissioner, T.C. Memo. 1994-583 [1994 RIA TC Memo ¶94,583], aff'd, 82 F.3d 806 [77 AFTR 2d 96-2081] (8th Cir. 1996). Petitioner is a highly intelligent individual with graduate degrees in both engineering and law. He is an accomplished businessman and attorney, having formed his own successful law practice which he incorporated as an S corporation for tax reasons after an accountant suggested doing so. Although he does not practice in the area of tax, nor did he take any tax courses in law school, petitioner has the intelligence and ability to recognize the frivolous, incorrect, and completely discredited nature of the arguments he has made in support of his failure to pay Federal taxes or file a Federal tax return. We find these facts are further evidence of fraud. <br />
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In addition to the previously described facts, we also note that after learning of the subpoenas duces tecum issued to his banks petitioner filed a motion to dismiss, seeking to have his case dismissed without prejudice. After filing the motion to dismiss, petitioner mailed a letter to one bank in which he stated: “Because I am dismissing this case, the Subpoena issued by the IRS to M&T Bank should no longer be valid, and M&T Bank should not be required to respond by producing copies of my account records.” Essentially, once petitioner knew respondent was about to discover the true amount of income he received during 2006 he sought to avoid the consequences by paying only the smaller deficiency and additions to tax originally determined by respondent. We believe these facts are evidence that petitioner was more concerned with trying to conceal the true amount of income he received than with presenting good-faith (but misguided) arguments regarding his Federal tax liability and duty to file a Federal tax return. <br />
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Considering the evidence, we find respondent has proved by clear and convincing evidence that the underpayment for 2006 was due to fraud. As we have previously found, respondent has proved that an underpayment of tax existed for 2006. Petitioner is therefore subject to the section 6651(f) fraudulent failure to file addition to tax for 2006. <br />
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IV. Whether Petitioner Is Liable for the Section 6651(a)(2) Addition to Tax for 2006 <br />
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Section 6651(a)(2) imposes an addition to tax for any failure to pay the tax shown on a return on or before the date prescribed for payment. The addition is equal to 0.5% of the amount shown as tax on the return for each month, or fraction thereof, during which the failure to pay continues, up to a maximum of 25%. Sec. 6651(a)(2). The addition will not apply if it is shown that the failure to pay timely was due to reasonable cause and not due to willful neglect. Id. A failure to pay is due to reasonable cause if the taxpayer “exercised ordinary 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.; see also Ruggeri v. Commissioner, T.C. Memo. 2008-300 [TC Memo 2008-300]. Willful neglect contemplates “a conscious, intentional failure or reckless indifference.” United States v. Boyle, 469 U.S. 241, 245 [55 AFTR 2d 85-1535] (1985). <br />
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Under section 6020(b)(1), when a taxpayer fails to make any return required by law, the Commissioner “shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise.” Under section 6651(g)(2), any return so prepared by the Commissioner shall be treated as the taxpayer's return for purposes of section 6651(a)(2). Respondent prepared such a return in this case which showed that petitioner owed $6,357 in tax before the addition of interest and additions to tax. 13 <br />
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Petitioner has not paid any portion of the amount reported due on the return respondent prepared. Petitioner did not demonstrate reasonable cause for failing to pay. Rather, petitioner intentionally chose not to file and pay tax for 2006, making a variety of frivolous tax-protester arguments. Frivolous positions do not constitute reasonable cause for failure to timely pay tax due. McGowan v. Commissioner, T.C. Memo. 2006-154 [TC Memo 2006-154] (”Misguided interpretations of the Constitution or other typical tax protester arguments are not reasonable cause.”). As a result, we find that petitioner failed to timely pay the tax shown due on the section 6020 return without reasonable cause and is liable for the addition to tax under section 6651(a)(2). <br />
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V. Whether Petitioner Is Liable for the Addition to Tax for Failure To Pay Estimated Tax Under Section 6654 for 2006 <br />
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Respondent determined an addition to his calculation of tax liability for 2006 for failure to pay estimated tax. Section 6654(d)(1)(B) provides that a taxpayer's required annual payment is limited to the lesser of 90% of the tax shown on the return for the taxable year (or, if no return is filed, 90% of the tax for such year), or 100% of the tax shown on the return of the individual for the preceding taxable year. 14 Petitioner did not address this issue but has argued that he had no tax liability for 2006. We have already found that petitioner was liable for tax for 2006. Therefore, petitioner is liable for the section 6654 addition to tax. The amount of the addition shall be determined by the parties in their Rule 155 calculations in accordance with the other holdings herein. <br />
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VI. Section 6673 Sanctions Respondent filed a motion requesting that the Court impose sanctions against petitioner pursuant to section 6673(a)(1). Section 6673(a)(1) authorizes the Court to require a taxpayer to pay a penalty to the United States in an amount not to exceed $25,000 whenever it appears to the Court that the taxpayer instituted or maintained the proceeding primarily for delay or that the taxpayer's position in the proceeding is frivolous or groundless. <br />
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Petitioner has taken a multitude of frivolous and groundless positions characteristic of tax protesters. However, considering the facts of this case, 15 we decline to impose sanctions against petitioner, although we strongly warn petitioner that making such arguments before this Court in the future will likely result in the imposition of sanctions against him. <br />
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VII. Conclusion We find petitioner failed to report taxable income of $193,026 for 2006 and is liable for the related deficiency. Further, we find petitioner liable for an addition to tax under section 6651(f), as well as additions to tax under sections 6651(a)(2) and 6654. However, we choose not to impose sanctions against petitioner under section 6673. <br />
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In reaching our holdings herein, we have considered all arguments made, and, to the extent not mentioned above, we conclude they are moot, irrelevant, or without merit. <br />
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To reflect the foregoing, <br />
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An appropriate order and decision will be entered under Rule 155. <br />
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1<br />
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All dollar amounts are rounded to the nearest dollar. <br />
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2<br />
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Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for 2006, and all Rule references are to the Tax Court Rules of Practice and Procedure. <br />
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3<br />
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Because of the sec. 6651(f) fraudulent failure to file addition to tax he now seeks against petitioner, respondent is seeking imposition of the sec. 6651(a)(1) addition to tax only as an alternative should we not hold petitioner liable for the fraudulent failure to file addition. <br />
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4<br />
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Petitioner disputes that these amounts constituted taxable income paid to him. <br />
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5<br />
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In the five tax years from 2000 to 2004 the highest amount of Federal tax petitioner paid in any one year was $6,185 for 2000. <br />
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6<br />
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Petitioner also did not file a Federal tax return on behalf of Worsham, P.C., for tax year 2005 or 2006. <br />
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7<br />
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Petitioner testified that for 2005 he paid more in tax than he actually owed. <br />
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8<br />
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No information was provided about this trust or trust account. <br />
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9<br />
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For jurisdictional purposes we note that the Tax Court is a constitutional court with the power to address constitutional issues raised before it. See Cupp v. Commissioner, 65 T.C. 68, 84 (1975), aff'd without published opinion, 559 F.2d 1207 (3d Cir. 1977); Hawkins v. Commissioner, T.C. Memo. 2003-181 (“Petitioners contend that only a court established under Article III of the Constitution, rather than a legislative court established under Article I of the Constitution, can adjudicate the [constitutional] issues they have raised. Petitioners' arguments have no merit.” (Fn. ref. omitted.); Broughton v. Commissioner, T.C. Memo. 1979-77 (“in many cases involving various claims we have ruled *** that the income tax is a constitutional tax, that the provisions for a determination of deficiency by respondent are constitutional, [and] that this Court is a constitutional court”). <br />
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10<br />
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“Persons who make frivolous anti-tax arguments have sometimes been called 'tax protesters'.” Wnuck v. Commissioner, 136 T.C. 498, 502 n. 2 (2011). <br />
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11<br />
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This argument, as well as our response, is also applicable to the other issues considered in this opinion. <br />
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12<br />
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In this case the addition to tax is 75% of the underpayment of tax. <br />
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13<br />
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Respondent concedes that the sec. 6651(a)(2) addition to tax is not applicable to the increase in the deficiency later asserted because that increase was never shown on a tax return prepared by or for petitioner. <br />
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14<br />
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Petitioner did not file a 2005 Federal tax return. <br />
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15<br />
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We note that this is the first time petitioner has made such frivolous arguments before this Court. <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-3239229695361325582012-08-07T06:32:00.002-04:002012-08-07T06:32:34.650-04:00US AttorneyRobert L. Bernard, et ux. v. Commissioner, TC Memo 2012-221 , Code Sec(s) 61; 72; 408; 6662; 7491. <br />
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ROBERT L. BERNARD AND DIOLINDA B. ABILHEIRA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent. <br />
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Case Information: Code Sec(s): 61; 72; 408; 6662; 7491 <br />
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Docket: Dkt. No. 5787-10. <br />
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Date Issued: 08/01/2012. <br />
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Judge: Opinion by Cohen, J. <br />
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Tax Year(s): <br />
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Disposition: <br />
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HEADNOTE <br />
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1. <br />
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Reference(s): Code Sec. 61; Code Sec. 72; Code Sec. 408; Code Sec. 6662; Code Sec. 7491 <br />
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Syllabus <br />
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Official Tax Court Syllabus<br />
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Counsel <br />
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Robert L. Bernard and Diolinda B. Abilheira, pro sese. <br />
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Randall G. Durfee, Ashley V. Targac, and Paul C. Feinberg, for respondent. <br />
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COHEN, Judge <br />
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MEMORANDUM FINDINGS OF FACT AND OPINION <br />
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Respondent determined a deficiency of $44,643 and a section 6662 penalty of $8,179 in relation to petitioners' Federal income tax for 2007. After concessions, the issues for decision are whether distributions petitioners received from various individual retirement accounts (IRAs) are [*2] taxable as ordinary income and whether petitioners are liable for the section 6662 penalty. All section references are to the Internal Revenue Code (Code) for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. <br />
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FINDINGS OF FACT <br />
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Petitioners resided in Texas when they filed their petition. Robert L. Bernard <br />
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(petitioner) is a former assistant U.S. attorney. Beginning in 1995, he suffered from various health ailments, including cardiac disorders, depression, and memory loss. He retired in 2000 because of disability. Petitioner prepared his own income tax returns before petitioners were married and prepared their joint returns after they were married in 1967. <br />
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Petitioner Diolinda Abilheira is a registered nurse. She received a bachelor's degree from Boston College and a master's degree from Boston University, and she did graduate work at Case Western Reserve University in Cleveland. She participated in a Teachers Insurance and Annuity Association-College Retirement Equities Fund program while working as an assistant professor at the University of Rhode Island. During 2007 she received $18,744 from this IRA. She also received $67,000 that year from a Pennsylvania M Fund account, another IRA held in her name. [*3] During 2007 petitioners received income from interest, royalties, dividends, Social Security benefits, and other IRA distributions in addition to the income described in the preceding paragraph. They filed a joint Form 1040, U.S. Individual Income Tax Return, that petitioner prepared using TurboTax software. <br />
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The adjusted gross income reported on petitioners' return was $143,267. They underreported interest income by $783, rents and royalties by $670, Social Security benefits by $3,215, and dividends by $20,220. The tax reported on the return was $9,292. <br />
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During 2007 petitioners received a total of $142,552 from their various IRAs. They did not report any of the distributions as IRA distributions on the appropriate line on Form 1040. They did not attach a Form 8606, Nondeductible IRAs, to their return or otherwise indicate that they were claiming that any of their distributions were nontaxable based on previous nondeductible contributions. As of the time of trial in October 2011, petitioners had not calculated the amounts of any nondeductible contributions they made to their IRAs, and neither the amounts of any such contributions nor the amounts reported on prior years' tax returns can be determined from evidence in the record. <br />
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Instead of correctly reporting the IRA distributions on their tax return, petitioners mischaracterized $99,334.82 of the distributions as proceeds of sale, [*4] claimed a combined basis of $49,054, and reported $50,280.82 as long-term capital gains. They agreed that they failed to report six additional IRA distributions totaling $26,637. <br />
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When the 2007 return was prepared, petitioner had misfiled or misplaced the information returns reporting their income. Petitioners had received notice that the Internal Revenue Service was challenging their treatment of IRA distributions on tax returns for earlier years. Petitioners obtained an extension of time to file the 2007 return because petitioner was suffering from depression, confusion, and memory loss. Petitioner was hospitalized in May 2008 during the period of extension for filing the 2007 return. <br />
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The notice of deficiency sent to petitioners for 2007 was based on information returns filed by third parties. Those information returns reported $142,552 as taxable amounts from retirement accounts. During the course of this case, respondent acknowledged that a portion of the distributions had been included in income as long-term capital gains and has conceded that petitioners would be entitled to decrease their long-term capital gain income by the $50,280.82 reported on their return if respondent's adjustment to retirement distribution income is sustained. <br />
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[*5] OPINION <br />
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Procedural Matters <br />
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In the petition, petitioners asserted that they "demand regular tax case procedures that are appealable to Court of Appeals." The case was set for trial on January 24, 2011, but was continued on petitioners' motion so that the parties could determine the amounts of nondeductible contributions to the IRAs. The case was continued to March 23, 2011, but was thereafter continued again on petitioners' motion so that they could take a trip out of the country. <br />
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By notice served May 9, 2011, the case was set for trial on October 17, 2011. When the case was called, petitioner moved that the trial be conducted under the small tax case procedures of section 7463, even though doing so would give up the parties' rights to appeal. See sec. 7463(b). Respondent objected because the amount in dispute for 2007, including the deficiency and the penalty, exceeded $50,000. See ,sec. 7463(a), (e). The motion was denied. <br />
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Petitioners continue to argue that this case qualifies for section 7463 status because the deficiency (ignoring the penalty) is less than $50,000 and their computations show that they do not owe taxes on certain of the distributions, thus bringing the total in dispute to less than $50,000. Petitioner, although trained as a lawyer, stated that they would give up their right to appeal in order to avoid having [*6] rules of evidence strictly applied. They apparently assume--erroneously--that relaxed rules of procedure and evidence under Rule 174(b) relieve them of the necessity of timely and appropriate evidence and arguments based on applicable law. Rule 174(b), however, refers to consistency with "orderly procedure" and requires evidence that has "probative value". In any event, this case is governed by procedures and rules applicable to cases not eligible for an election under section 7463. See id. <br />
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Petitioners were directed to file an opening brief addressing the legal arguments in respondent's pretrial memorandum, which specifically described (1) the requirements that taxpayers identify and substantiate nondeductible contributions to IRAs that reduce the amounts of taxable distributions and (2) the treatment of IRA distributions as ordinary income and not capital gains. Petitioners' opening brief filed January 3, 2012, did not address those legal arguments but made factual assertions and attached documents allegedly relating to characterization of contributions and unrelated errors by respondent, none of which were part of the evidentiary record. Petitioners' legal arguments were directed at the section 6662 penalty and did not address the statutory treatment of IRA distributions. [*7] Respondent's answering brief was filed February 16, 2012. Among other things, respondent argued that petitioners had failed to produce any evidence corroborating their blanket assertions that the distributions were a return of capital and not taxable. <br />
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Petitioners' reply brief was filed April 4, 2012. On May 16, 2012, approximately 16 months after the first continuance, 7 months after the trial, 3 months after respondent's brief was filed, and 1-1/2 months after their reply brief was filed, petitioners filed a motion to incorporate into the record the exhibits to their briefs that had not been produced at trial. Respondent objects on grounds of relevance, in that the tendered records do not support petitioners' claims, and timeliness, and contends that consideration of the records after cross-examination and briefing would be prejudicial. We agree with respondent on both grounds, and petitioners' motion to incorporate these exhibits into the trial record will be denied. <br />
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Petitioners assert a variety of alleged missteps and misconduct by respondent's counsel, ranging from changing calculations to wrongful disclosure of an unrelated taxpayer's return information. None of the assertions, even if true, would affect petitioners' deficiency. Petitioners' attacks on the Court in relation to its Rules of Practice and Procedure and the rulings in this and other cases lack merit and will not be addressed in this opinion. Adverse rulings are not grounds [*8] for disqualification or recusal. See United States v. Conforte, 624 F.2d 869, 882 [45 AFTR 2d 80-1630] (9th Cir. 1980); United States v. Carroll, 567 F.2d 955, 958 [41 AFTR 2d 78-442] (10th Cir. 1977); United States v. Haldeman, 559 F.2d 31, 136 (D.C. Cir. 1976); United States v. Ming, 466 F.2d 1000, 1003-1004 [29 AFTR 2d 72-1240] (7th Cir. 1972). Because we have declined petitioners' attempts to have this case treated as a small tax case, petitioners have the right to challenge those rulings on appeal. IRA Distributions Taxation of distributions from retirement accounts is governed specifically by statute and regulation. Section 61(a) defines gross income as "all income from whatever source derived, including (but not limited to) *** (9) [a]nnuities; *** [and] (11) [p]ensions". Section 408(d)(1) provides a series of rules relating to IRAs, specifically that: "Except as otherwise provided in this subsection, any amount paid or distributed out of an individual retirement plan shall be included in gross income by the payee or distributee, as the case may be, in the manner provided under section 72." This provision is explained further in section 1.408-4(a), Income Tax Regs. See also Arnold v. Commissioner, 111 T.C. 250, 253 (1998); Gallagher v. Commissioner, T.C. Memo. 2001-34 [TC Memo 2001-34]; Martin v. Commissioner, T.C. Memo. 1992-331 [1992 RIA TC Memo ¶92,331], aff'd without published opinion 987 F.2d 770 (5th Cir. 1993); Costanza v. , Commissioner, T.C. Memo. 1985-317 [¶85,317 PH Memo TC]. [*9] Petitioners claim that because capital gains within their IRAs increased the value of those accounts, they are entitled to report the distributions received as capital gains. They also contend that capital gains within the accounts "increased the cost basis of petitioners' shares." They have cited no authority to support this position, and there is none. Gains within IRAs are not taxed, but accumulated income included in distributions is taxed in accordance with the provisions of section 408(d). See, e.g., sec. 408(e). The deferred taxation of income at ordinary rates is the offset for the benefits of qualified plans. <br />
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Petitioners also claim that the distributions during 2007 were a return of their investments made through nondeductible contributions. However, the evidence, even considering the records not produced until after trial, does not support their generalized assertions. For example, petitioners claim that nondeductible contributions to petitioner's Thrift Savings Plan (TSP) account were among the amounts distributed from a rollover IRA and are therefore not taxable. Petitioner's contributions to his TSP account, however, appear to have been made with pretax dollars. The materials attached to petitioners' opening brief and the authorities cited in respondent's brief indicate that such pretax contributions and any increase in value of the TSP account are taxable when received as distributions unless there is a qualified rollover to a retirement plan such as an IRA. See secs. 401, 402, [*10] 7701(j). Where pretax TSP funds are rolled over to an IRA, as petitioner's were, later distributions from the IRA are fully taxable as ordinary income under sections 72 and 408. <br />
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Moreover, petitioners have not shown that any nondeductible contributions were not used in prior years to reduce taxable distributions from their IRAs. They ignore relevant authorities cited by respondent and have not cited any provision of section 72 on which they rely to reduce the taxable amounts of the distributions that they received in 2007. Thus all of the distributions are included in their gross income and taxed as ordinary income. The amounts previously reported as capital gains will be eliminated in the Rule 155 computation in accordance with respondent's concession. Section 6662 Penalty Respondent has the burden of producing evidence that the section 6662(a) penalty applies. See sec. 7491(c). Section 6662(a) and (b)(1) and (2) imposes a 20% accuracy-related penalty on any underpayment of Federal income tax attributable to a taxpayer's negligence or disregard of rules or regulations or substantial understatement of income tax. Section 6662(c) defines negligence as including any failure to make a reasonable attempt to comply with the provisions of the Code and defines disregard as any careless, reckless, or intentional disregard. [*11] Disregard of rules or regulations is careless if the taxpayer does not exercise reasonable diligence to determine the correctness of a return position that is contrary to the rule or regulation. Sec. 1.6662-3(b)(2), Income Tax Regs. A substantial understatement of income tax exists if the understatement exceeds the greater of 10% of the tax required to be shown on the return or $5,000. Sec. 6662(d)(1)(A). <br />
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The stipulated omission of significant income in this case and the resulting understatement in excess of 10% of the tax required to be shown on the return satisfy respondent's burden of showing that the section 6662 penalty is appropriate, and petitioners must show that the penalty should not be imposed. See Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). The accuracy-related penalty under section 6662(a) is not imposed with respect to any portion of the underpayment as to which the taxpayer acted with reasonable cause and in good faith. Sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at 448. <br />
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Petitioners rely on petitioner's health problems, which started in 1995, as an excuse for the numerous errors on their tax return for 2007. They assert that the determination of the penalty in this case was done arbitrarily by computer, without regard to petitioner's poor health, and that penalties have not been imposed against other taxpayers, such as the Secretary of the Treasury, who relied on TurboTax to [*12] prepare their tax returns. They confuse authorities describing a serious medical condition as an excuse for late filing of a return with those describing reasonable cause sufficient to avoid a penalty under section 6662(a). <br />
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To the extent that the omission of numerous items of income and mischaracterization of others in this case led to a substantial understatement of income tax, petitioners have not shown that they had reasonable cause. The treatment of a portion of the distribution as capital gains was contrary to law. Petitioners did not rely on relevant authorities or competent tax advisers or otherwise make reasonable efforts to assess their proper tax liability. See Bunney v. Commissioner, 114 T.C. 259, 266-267 (2000); sec. 1.6664-4(b)(1), Income Tax Regs. <br />
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Although they cite petitioner's poor health, confusion, and memory loss as excuses for the errors on their return, we view petitioners' failure to seek competent help in preparing the return as negligence. Petitioner admits that he did not maintain organized files for the information returns that were received and thus did not have all of the information at hand when he prepared the return. The length and severity of the health problems suggest that a reasonable person in petitioner's position would have sought help rather than adopt his disability as an excuse for [*13] inaccurate reporting. He did not exercise reasonable diligence in determining petitioners' joint tax liability. <br />
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Petitioner Abilheira, who was obviously aware of petitioner's condition, testified that she did not notice that over $85,000 in distributions that she received was omitted from the joint return because she "didn't pay that much attention to it." There is no indication that she had any disabling health condition. She is well educated and was negligent in not taking steps to assure that the tax return was correct. <br />
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We have considered the other arguments of the parties. They are irrelevant, lack merit, or are unnecessary to the result reached. To reflect respondent's concessions and the foregoing, <br />
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Decision will be entered under Rule 155. <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-50658442783859192602012-08-07T06:24:00.001-04:002012-08-07T06:24:49.227-04:00Construction hobbyLeon S. Verrett III, et ux. v. Commissioner, TC Memo 2012-223 , Code Sec(s) 183; 6662; 7491. <br />
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LEON SOLOMON VERRETT III AND CHARLOTTE I. VERRETT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent . <br />
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Case Information: Code Sec(s): 183; 6662; 7491 <br />
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Docket: Docket No. 21079-10. <br />
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Date Issued: 08/2/2012 <br />
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HEADNOTE <br />
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XX. <br />
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Reference(s): Code Sec. 183; Code Sec. 6662; Code Sec. 7491 <br />
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Syllabus <br />
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Official Tax Court Syllabus<br />
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Counsel <br />
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Leon Solomon Verrett III and Charlotte I. Verrett, pro sese. <br />
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Olivia J. Hyatt, for respondent. <br />
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MEMORANDUM FINDINGS OF FACT AND OPINION <br />
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KROUPA, Judge: Respondent determined deficiencies in petitioners' Federal income tax of $6,636, $8,518 and $5,354 for 2006, 2007 and 2008, respectively (years at issue). 1 Respondent disallowed, among other things, petitioners' claimed deductions for expenses arising from a construction activity [*2] (construction activity) Leon Solomon Verrett III (petitioner) conducted. Respondent also determined petitioners liable for the accuracy-related penalty under section 6662(a) for the years at issue. 2 <br />
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After concessions by petitioners, 3 only two issues for decision remain. The primary issue is whether petitioner's construction activity was for profit during the years at issue. We hold that it was not. We are also asked to decide whether petitioners are liable for the accuracy-related penalty under section 6662(a) for the years at issue. We hold that they are. <br />
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FINDINGS OF FACT <br />
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The parties have stipulated some facts. We incorporate the stipulation of facts and the accompanying exhibits by this reference. Petitioners resided in North Carolina when they filed the petition. <br />
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Mrs. Verrett is a doctor and earned wage income of $125,000, $119,629 and $122,537 for the years at issue. Petitioner performed construction services under the moniker “Leon's Not So Odd Jobs” beginning in 1994. The construction [*3] activity has not generated a profit for any of the 17 years it has operated. Petitioner was employed as a purchasing manager before starting the construction activity. <br />
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Petitioner managed his construction activity from a home office. The construction activity had a listing in the local telephone directory. The construction activity did not have a business plan, a dedicated bank account or an Internet presence. Petitioner did not use computer software to track finances although he had done so as a purchasing manager. <br />
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Petitioner was not licensed as a general contractor. The construction activity consequently generated limited income without the license because petitioner could not lawfully undertake larger construction jobs. Petitioner owned a tractor, four trailers, various power tools and other machinery that he used in his construction activity. <br />
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Petitioner charged lower rates than did other local contractors. Petitioner did not follow the industry practice of applying a 20% overhead charge to the cost of materials. Rather, petitioner directed his clients to purchase the materials from a home improvement store. <br />
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Most of petitioner's construction services during the years at issue involved uncompensated projects for his family and his church. Petitioner renovated his [*4] own home and restored his mother-in-law's home after it suffered water damage. Petitioner was the volunteer director of a $1.6 million construction project at his church. Petitioner used the same tools and equipment for these endeavors that he used when providing paid construction services. <br />
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Petitioners claimed construction activity income of $3,400, $4,000 and $13,395 and expenses of $31,757, $36,152 and $30,174 for the years at issue. Respondent issued petitioners the deficiency notice for the years at issue. Petitioners timely filed a petition. <br />
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OPINION <br />
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We are asked to decide whether petitioner conducted his construction activity for profit within the meaning of section 183 when it failed to generate a profit during any of the years at issue or any of the other 14 years he conducted the activity. We are also asked to decide whether petitioners are liable for the accuracy-related penalty. We address each of these issues in turn. <br />
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I. Section 183 Analysis Whether a taxpayer may deduct expenses related to an activity depends on whether it is carried on for profit. Secs. 162, 212. A taxpayer generally may not deduct losses attributable to an activity unless that activity is engaged in for profit. Sec. 183(a). An activity is engaged in for profit if the taxpayer has an actual, [*5] honest profit objective, even if it is unreasonable or unrealistic. Sec. 1.183-2(a), Income Tax Regs. <br />
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Petitioner bears the burden of proving by a preponderance of the evidence that he was engaged in the construction activity for profit. See Rule 142(a). The decision in this case is appealable to the United States Court of Appeals for the Fourth Circuit, absent stipulation to the contrary, so we apply that law. See Golsen v. Commissioner, 54 T.C. 742 (1970), aff'd, 445 F.2d 985 [27 AFTR 2d 71-1583] (10th Cir. 1971). We examine whether the taxpayer engaged in the activity with the actual and honest objective of making a profit. See Hendricks v. Commissioner, T.C. Memo. 1993-396 [1993 RIA TC Memo ¶93,396], aff'd, 32 F.3d 94 [74 AFTR 2d 94-5841] (4th Cir. 1994). <br />
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This Court considers whether an activity is engaged in for profit on a case-by-case basis, taking into account all the facts and circumstances involved. See Golanty v. Commissioner, 72 T.C. 411, 426 (1979), aff'd without published opinion, 647 F.2d 170 (9th Cir. 1981). The taxpayer's expectation of profit need not be reasonable but it must be bona fide. See Keanini v. Commissioner 94 T.C. , 41, 46 (1990); Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), aff'd without opinion, 702 F.2d 1205 (D.C. Cir. 1983); Golanty v. Commissioner, 72 T.C. at 425-426; sec. 1.183-2(a), Income Tax Regs. Greater weight is given to objective facts rather than to the taxpayer's statement of intent. See Indep. Elec. Supply, [*6] Inc. v. Commissioner, 781 F.2d 724, 726-727 [57 AFTR 2d 86-665] (9th Cir. 1986), aff'g Lahr v. Commissioner, T.C. Memo. 1984-472 [¶84,472 PH Memo TC]; Engdahl v. Commissioner 72 T.C. 659, 666 , (1979); sec. 1.183-2(a) and (b), Income Tax Regs. <br />
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We structure our analysis of whether an activity is engaged in for profit around nine nonexclusive factors. Sec. 1.183-2(b), Income Tax Regs. The nine factors are: (1) the manner in which the taxpayer carried on the activity, (2) the expertise of the taxpayer or his or her advisers, (3) the time and effort expended by the taxpayer in carrying on the activity, (4) the expectation that the assets used in the activity may appreciate in value, (5) the success of the taxpayer in carrying on other similar or dissimilar activities, (6) the taxpayer's history of income or loss with respect to the activity, (7) the amount of occasional profits, if any, which are earned, (8) the financial status of the taxpayer, and (9) whether elements of personal pleasure or recreation are involved. Id. <br />
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No factor or set of factors is controlling, nor is the existence of a majority of factors favoring or disfavoring a profit objective controlling. Keating v. Commissioner, 544 F.3d 900, 904 [102 AFTR 2d 2008-6638] (8th Cir. 2008), aff'g T.C. Memo. 2007-309 [TC Memo 2007-309]; Hendricks v. Commissioner, 32 F.3d at 98; Golanty v. Commissioner, 72 T.C. at 426-427; sec. 1.183-2(b), Income Tax Regs. Moreover, certain factors may be given more weight than others because they are more meaningfully applied to the [*7] facts. See Vitale v. Commissioner, T.C. Memo. 1999-131 [1999 RIA TC Memo ¶99,131], aff'd without published opinion, 217 F.3d 843 [86 AFTR 2d 2000-5059] (4th Cir. 2000). All nine factors do not necessarily apply in every case. See Green v. Commissioner, T.C. Memo. 1989-436 [¶89,436 PH Memo TC]; see also Akelis v. Commissioner, T.C. Memo. 1989-182 [¶89,182 PH Memo TC]. <br />
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A. Manner in Which the Taxpayer Conducts the Activity We begin with the first factor by considering whether petitioner carried on the construction activity in a businesslike manner. See sec. 1.183-2(b)(1), Income Tax Regs. An activity is operated in a businesslike manner when, among other things, the organizer had a business plan, advertised the services, maintained complete records and instituted changes in an effort to earn a profit. See Engdahl v. Commissioner, 72 T.C. at 666-667; Rinehart v. Commissioner, T.C. Memo. 2002-9 [TC Memo 2002-9]; sec. 1.183-2(b)(1), Income Tax Regs. <br />
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Petitioner did not develop a business plan nor maintain a dedicated bank account for the construction activity. See Keating v. Commissioner, T.C. Memo. 2007-309 [TC Memo 2007-309]. His marketing efforts were limited to placing a listing in the telephone directory. The construction activity did not have a Web site. Petitioner did not maintain complete and accurate records. <br />
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Petitioner also charged a significantly lower rate than did competing services. He acknowledged that he needed to increase his prices to make a profit. [*8] Further, he rejected the industry practice of charging 20% overhead on materials. Most of the construction activity was devoted to charitable and unpaid personal projects. This is inconsistent with a venture motivated by profit. <br />
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Finally, petitioner understood that the construction activity's income would be limited unless he became a licensed general contractor. He never did so. He suggests that the costs associated with the license were prohibitive. There is no indication, however, that petitioner attempted to finance his costs for the license. His claimed inability to afford the license is inconsistent with his accumulation of substantial tools and machinery. <br />
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We find that petitioner did not conduct the construction activity in a businesslike manner. This factor weighs in favor of respondent. <br />
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B. The Expertise of the Taxpayers or Advisers The second factor is whether petitioner developed his own expertise and sought guidance from industry experts. See sec. 1.183-2(b)(2), Income Tax Regs. Petitioner acknowledged his practices made the construction activity consistently unprofitable. He testified that he came from a family of construction workers, yet nothing in the record established his relatives were experts or that he consulted with them. We find that petitioner did not demonstrate any business expertise or consult with any experts. This factor weighs against petitioner. [*9] <br />
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C. The Taxpayer's Time and Effort <br />
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The third factor focuses on the time and effort the taxpayer expended in carrying on the activity. Sec. 1.183- 2(b)(3), Income Tax Regs. Petitioner spent significant time on his construction activity during the years at issue. Respondent emphasizes, however, and we agree, that petitioner devoted most of his time to projects for his church or his family. The construction activity therefore had a substantial personal aspect. See id. We note that during the years at issue petitioner's paid projects generated only $20,795 of income while the construction activity resulted in net losses of $63,835. Accordingly, we find this factor favors respondent. <br />
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D. Expectation That Property Used in the Activity May Appreciate Fourth, we weigh petitioner's expectation that the assets used in the construction activity may appreciate. See sec. 1.183-2(b)(4), Income Tax Regs. The construction activity did not have any appreciating assets. Rather, all of the assets were depreciable. This factor favors respondent. <br />
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E. Taxpayer's Success in Other Similar Activities A taxpayer's previous success in similar activities may show that the taxpayer has a profit objective even though the current activity is presently unprofitable. See sec. 1.183-2(b)(5), Income Tax Regs. A taxpayer's success in [10*] other, unrelated activities also may indicate a profit objective. See Daugherty v. Commissioner, T.C. Memo. 1983-188 [¶83,188 PH Memo TC]. Petitioner was a skilled tradesman. Petitioner did not have any experience, however, operating a construction company. Nor did petitioner apply transferable skills from his past professional experience to the construction activity. We find that petitioner did not have previous experience operating a similar venture. This factor also favors respondent. <br />
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F. History of Income or Losses The sixth factor is the taxpayer's history of income or losses with respect to the activity. See sec. 1.183-2(b)(6), Income Tax Regs. Petitioner acknowledges that the construction activity was never profitable. Neither petitioner's pricing nor his decision to disregard the general contractor's license constitute an unforeseen circumstance outside of his control. See id. Nor can the years at issue be reasonably characterized as the construction activity's startup stage. See id. This factor weighs against petitioner. <br />
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G. Amount of Occasional Profits The seventh factor is whether the activity generated any occasional profits. See sec. 1.183-2(b)(7), Income Tax Regs. The construction activity never generated any profits. This factor also weighs against petitioner. [*11] <br />
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H. Financial Status of the Taxpayer <br />
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Respondent argues that the eighth factor, the financial status of the taxpayer, negates petitioner's profit motive. See sec. 1.183-2(b)(8), Income Tax Regs. He asserts that the construction activity losses benefited the couple by offsetting Mrs. Verrett's substantial wage income from her medical practice. We agree. This factor favors respondent. <br />
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I. Elements of Personal Pleasure The last factor looks to elements of personal pleasure or recreation. See sec. 1.183-2(b)(9), Income Tax Regs. Petitioner enjoyed the activity and derived personal satisfaction from helping his church, the community and his family. We note, however, that petitioner's enjoyment of the construction activity is not sufficient to cause the activity to be classified as a hobby if other factors indicate that he engaged in it for profit. See id. This factor favors respondent. <br />
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J. Sum of the Factors After considering all the facts and circumstances, we find that petitioner has not shown that he engaged in the construction activity for profit. We recognize that petitioner was an able craftsman. His desire to be a contributing member of his community is admirable. Petitioner's decisions regarding pricing, the general contractor's license and unpaid projects, however, show that he was not primarily [*12] motivated by profit. It is significant that the construction activity has never generated a profit. A for-profit enterprise would not repeatedly and consistently generate losses without changing its practices. Nor can we ignore that the losses offset Mrs. Verrett's wage income. We conclude that, during the years at issue, petitioner did not engage in the construction activity with the dominant objective and intent of realizing a profit, and petitioners are not entitled to the expense deductions claimed to the extent they exceed the gross income from the construction activity. <br />
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II. Accuracy-Related Penalty We now turn to respondent's determination that petitioners are liable for an accuracy-related penalty under section 6662(a) for each year at issue. A taxpayer is liable for an accuracy-related penalty on any part of an underpayment attributable to, among other things, negligence or a substantial understatement of income tax. Sec. 6662(b)(1) and (2). The Commissioner has the burden of production and must come forward with sufficient evidence that it is appropriate to impose a penalty. Sec. 7491(c); see Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). The taxpayer bears the burden of proof as to any defense to the accuracy-related penalty. Sec. 7491(c); Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446. [*13] Negligence is defined as any failure to make a reasonable attempt to comply with the provisions of the Code or to exercise ordinary and reasonable care in the preparation of a tax return. Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. A taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion on a return that would seem to a reasonable and prudent person to be “too good to be true” under the circumstances. Sec. 1.6662-3(b)(1)(ii), Income Tax Regs. There is a substantial understatement of income tax if the amount of the understatement exceeds the greater of either 10% of the tax required to be shown on the return or $5,000. Sec. 6662(a), (b)(2), (d)(1)(A); sec. 1.6662-4(a), Income Tax Regs. <br />
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Petitioners conceded almost all of the adjustments set forth in the deficiency notice. The record does not support the conclusion that the construction activity was for profit. There is nothing in the record to show that petitioners made a reasonable attempt to comply with the Code. Further, petitioners' concessions and the Court's decision result in a substantial understatement of income tax for each of the years at issue. See Higbee v. Commissioner, 116 T.C. at 446; Jarman v. Commissioner, T.C. Memo. 2010-285 [TC Memo 2010-285]. Respondent has met his burden of production. [*14] A taxpayer is not liable for an accuracy-related penalty, however, if the taxpayer acted with reasonable cause and in good faith with respect to any portion of the underpayment. Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. The determination of whether a taxpayer acted with reasonable cause and in good faith depends on the pertinent facts and circumstances, including the taxpayer's efforts to assess his or her proper tax liability, the knowledge, experience and education of the taxpayer, and the reliance on the advice of a professional. Sec. 1.6664-4(b)(1), Income Tax Regs. <br />
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Petitioners have not demonstrated that they acted with reasonable cause. Petitioners have not provided any evidence that the conceded deductions were made in good faith or with reasonable cause. Nor have petitioners shown reasonable cause for claiming deductions for the construction activity losses. <br />
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We find under the relevant facts and circumstances that petitioners did not act with reasonable cause and in good faith with respect to the years at issue. We therefore hold petitioners liable for the accuracy-related penalty under section 6662(a) for the years at issue. [*15] We have considered all arguments made in reaching our decision and, to the extent not mentioned, we conclude that they are moot, irrelevant, or without merit. <br />
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To reflect the foregoing, Decision will be entered for respondent. <br />
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Dollar amounts are rounded to the nearest dollar. <br />
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All section references are to the Internal Revenue Code (Code) in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. <br />
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Petitioners concede all adjustments to their income tax for the years at issue, except with respect to deductions from the construction activity claimed on Schedule C, Profit or Loss From Business. <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-21731284013082223752012-08-06T21:43:00.002-04:002012-08-06T21:43:36.502-04:00Medical MarijuanaMartin Olive v. Commissioner, 139 T.C. No. 2, Code Sec(s) 162; 280E; 6662; 7491. <br />
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MARTIN OLIVE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent .<br />
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Case Information: Code Sec(s): 162; 280E; 6662; 7491 <br />
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Docket: Docket No. 14406-08. <br />
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Date Issued: 08/2/2012 <br />
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HEADNOTE <br />
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XX. <br />
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Reference(s): Code Sec. 162; Code Sec. 280E; Code Sec. 6662; Code Sec. 7491 <br />
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Syllabus <br />
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Official Tax Court Syllabus<br />
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Counsel <br />
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Henry G. Wykowski and Chris Wood (student), for petitioner. <br />
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Daniel J. Parent, for respondent. <br />
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KROUPA, Judge: This case stems from the operation of petitioner's sole proprietorship, the Vapor Room Herbal Center (Vapor Room). The Vapor Room's principal business is the retail sale of marijuana (medical marijuana) pursuant to the California Compassionate Use Act of 1996 (CCUA), codified at Cal. Health & Safety Code sec. 11362.5 (West 2007). 1 The Vapor Room provides minimal activities and services as part of its principal business of selling medical marijuana. <br />
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Respondent determined deficiencies of $367,531 and $1,146,633 in petitioner's Federal income tax for 2004 and 2005, respectively, after determining that petitioner failed to substantiate any costs of goods sold (COGS) or expenses reported for the Vapor Room. Respondent also determined for the respective years that petitioner was liable for section 6662(a) accuracy-related penalties of $73,506 and $229,327 due to substantial understatements of income tax or, alternatively, negligence or disregard of rules and regulations. Respondent, in an amendment to answer, increased the deficiencies to $692,501 for 2004 and $1,199,814 for 2005 to reflect unreported gross receipts that respondent discovered after he issued the deficiency notice. Respondent correspondingly increased the accuracy-related penalties to $138,500 and $239,963. <br />
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We decide as to the Vapor Room for 2004 and 2005: 1. whether petitioner underreported gross receipts in amounts respondent alleges in an amendment to answer. We hold he did; 2. whether petitioner may deduct COGS in amounts greater than those respondent allows. 2 We hold he may to the extent stated; 3. whether petitioner may deduct his claimed expenses. We hold he may not; and 4. whether petitioner is liable for the accuracy-related penalties. We hold he is to the extent stated. , <br />
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FINDINGS OF FACT <br />
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I. Preliminaries The parties submitted stipulated facts and exhibits. We incorporate the stipulated facts and exhibits by this reference. Petitioner is a high school graduate who resided in California when he filed the petition. He filed Federal income tax returns for 2004 and 2005 and included in each return a Schedule C, Profit or Loss From Business (Sole Proprietorship), reporting the Vapor Room's gross receipts, COGS and expenses for the corresponding year. He reported that the Vapor Room's “principal business” is “Retail Sales” and that its product is “Herbal.” <br />
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II. CCUA <br />
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The State of California's voters approved the CCUA as a ballot initiative in 1996. The CCUA is intended to ensure that “seriously ill Californians” (recipients) can obtain and use marijuana if physicians recommend marijuana as beneficial to recipients' health. Numerous medical marijuana dispensaries were formed in California to dispense medical marijuana to recipients. 3 Medical marijuana, however, is a controlled substance under Federal law. <br />
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III. Petitioner Forms the Vapor Room Petitioner, while pursuing a college degree in arts and education, became involved in the medical marijuana industry by volunteering at a medical marijuana dispensary in San Francisco, California. The dispensary had a single business, the dispensing of medical marijuana. Petitioner learned that an approximately 1,250-square-foot room in his low-income neighborhood of San Francisco was available to rent at a minimal cost and he decided to abandon his college studies during his second year and establish a medical marijuana dispensary in the room. He sought the help of local friends and marijuana suppliers and, on January 25, 2004, began operating an unlicensed medical marijuana dispensary as a sole proprietorship. 4 He named his dispensary the Vapor Room. 5 He established the <br />
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Vapor Room so that its patrons, almost all of whom were recipients (including some with terminal diseases such as cancer or HIV/AIDs) could socialize and purchase and consume medical marijuana there. 6 <br />
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Petitioner designed the Vapor Room with a comfortable lounge-like, community center atmosphere, placing couches, chairs and tables throughout the premises. He placed vaporizers, games, books and art supplies on the premises for patrons to use at their desire. He set up a jewelry-store-like glass counter with a cash register on top and jars of the Vapor Room's medical marijuana inventory displayed underneath and behind the counter. <br />
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IV. Operation of the Vapor Room The Vapor Room was generally open for business (except on some holidays) on weekdays from 11 a.m. to 8:30 p.m., and on weekends from noon to 8 p.m. The Vapor Room sold nothing but medical marijuana (in three different forms) and its patrons went to the Vapor Room primarily to consume marijuana, knowing that it was readily available there. 7 Patrons also frequented the Vapor Room to socialize with each other incident to consuming marijuana. Petitioner required that each patron possess either a doctor's recommendation to use medical marijuana or a similar certificate the San Francisco government issued. This documentation contained the person's picture and identification number, but not his or her name. Patrons came to know at least the first name of the other patrons who regularly frequented the Vapor Room. <br />
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The Vapor Room's staff members (collectively, staff members) were petitioner and a few other individuals (four working as employees and an undisclosed number working as volunteers) and all staff members qualified under the CCUA to receive and consume medical marijuana. Neither the staff members nor the other patrons paid petitioner a stated fee to frequent the Vapor Room. Nor did petitioner require that any patron purchase medical marijuana from him to frequent the Vapor Room or to take part in its activities or services. Patrons had access to all of the activities and services that the Vapor Room provided and marijuana was routinely passed throughout the room for consumption without cost to patrons who wanted to partake. <br />
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The Vapor Room's sole source of revenue was its sale of medical marijuana and patrons did not specifically pay for anything else connected with or offered by the Vapor Room. Petitioner purchased for cash (or sometimes received for free) the Vapor Room's medical marijuana inventory from suppliers, each of whom was eligible under the CCUA to receive and consume marijuana. Petitioner typically purchased high-quality marijuana to dispense to the patrons and he allowed them to consume the marijuana virtually anywhere on the premises. Petitioner sold to the patrons for cash 93.5% of the marijuana that he received and he gave the rest to patrons (including himself and the other staff members) for free. One to three staff members monitored the counter in the Vapor Room and they explained to patrons the attributes and effects of the different types of medical marijuana in the Vapor Room's inventory. Petitioner set each patron's cost for the medical marijuana according to the quantity desired, the quality of the marijuana and the amount petitioner decided the patron should pay. Petitioner sometimes gave patrons medical marijuana for free. Petitioner and the other staff members occasionally sampled the medical marijuana inventory for free and they would regularly “hang out” at the Vapor Room after business hours and consume marijuana. Staff members and other patrons sometimes consumed medical marijuana together. 8 <br />
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Petitioner provided regular activities at the Vapor Room, such as yoga classes, chess and other board games and movies (with complimentary popcorn and drinks). Patrons sometimes consumed medical marijuana while participating in these activities. The Vapor Room regularly offered chair massages with a therapist. Patrons sometimes consumed medical marijuana before or after a massage. Patrons, while at the Vapor Room, regularly drank complimentary tea or water and they occasionally ate complimentary snacks or light food such as pizza and sandwiches. <br />
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Staff members explained to patrons the promoted benefits of vaporizing marijuana (as opposed to smoking it). The staff members also helped patrons understand how to operate a vaporizer and the staff members helped patrons operate a vaporizer upon request. Petitioner did not require that a patron buy medical marijuana from the Vapor Room as a condition of using one of the Vapor Room's vaporizers and patrons sometimes consumed in a vaporizer (or elsewhere in the room) marijuana they obtained elsewhere. Staff members sometimes delivered medical marijuana to terminally ill patrons at locations other than the Vapor Room and joined those patrons in consuming marijuana at those other locations. The Vapor Room's staff members lived near the Vapor Room. <br />
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Patrons discussed with other patrons (sometimes one-on-one) their illnesses and their lives in general and they counseled one another on various personal, legal or political matters related to medical marijuana. Staff members (or other persons the Vapor Room retained) educated patrons or members of the public on medical marijuana and about using medical marijuana responsibly. The Vapor Room had a program through which patrons wrote letters to individuals who were incarcerated for distributing medical marijuana. <br />
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V. Vapor Room's Gross Receipts, COGS and Reported Income <br />
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A. Reported Income Petitioner's tax returns for 2004 and 2005 reported that the Vapor Room's net income was $64,670 and $33,778, respectively. 9 The net income was calculated as follows: 2005 <br />
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2004 <br />
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Gross receipts $1,068,830 $3,131,605 <br />
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COGS 993,377 2,812,478 <br />
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Gross income 75,453 319,127 <br />
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Expenses: <br />
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Advertising -0- 660<br />
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Bank fees -0- 790<br />
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Deductible meals and entertainment -0- 3,072<br />
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Depreciation -0- 11,506<br />
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Internet services and fee 1,605 -0- <br />
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Legal and professional services -0- 46,900 <br />
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Office -0- 13,337 <br />
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Payroll fees -0- 1,353 <br />
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Postage and delivery -0- <br />
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Printing and reproduction -0- 1,952 <br />
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Rent 4,000 14,300 <br />
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Repairs and maintenance 730 3,505 <br />
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Security services 750 412 <br />
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Supplies 2,922 -0- <br />
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Taxes and licenses -0- 8,750 <br />
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Telephone -0- 965 <br />
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Travel 776 Utilities -0- 3,426 <br />
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175,934 <br />
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Wages -0- <br />
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Total10,783285,349 Net profit64,67033,778<br />
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1 B. Gross Receipts Staff members noted the amount of the Vapor Room's sales for each business day as shown on the cash register tape and counted the cash in the register. The total daily sales as ascertained by the cash register tape and by the daily count were recorded in a book (recording book). <br />
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Petitioner's Schedules C for 2004 and 2005 reported gross receipts of $1,068,830 and $3,131,605, respectively. The gross receipts reported on the Schedule C for 2004, however, did not include any gross receipts received before July 14, 2004. C. COGS <br />
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Petitioner's Schedules C for 2004 and 2005 reported that the Vapor Room's COGS were $993,337 and $2,812,478, respectively. These amounts were calculated as follows: <br />
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2004 2005<br />
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Purchases less cost of items<br />
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withdrawn for personal use -0- $2,796,724<br />
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Cost of labor $88,209 -0-<br />
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Materials and supplies 905,168 15,754<br />
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COGS 993,377 2,812,478<br />
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The labor amounts represent petitioner's payments to marijuana growers in return for marijuana that they grew. <br />
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D. Expenses Petitioner paid the Vapor Room's expenses by using cash from the cash register or by using a check or a debit card drawn on a bank account that petitioner opened as a sole proprietor “DBA Vapor Room.” Petitioner opened this account on July 6, 2004, and he regularly deposited funds into the account to cover the draws from the account. <br />
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Petitioner paid the Vapor Room's employees through a payroll service. Petitioner paid the employees (who were the same individuals in both 2004 and 2005) wages of $37,588 and $96,965. Petitioner reported those wages to the Internal Revenue Service for Federal employment tax purposes. None of the employees had a specific job at the Vapor Room and each employee at one time or another performed all required jobs. <br />
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Respondent concedes that petitioner paid the following ordinary and necessary business expenses during 2004 and 2005: <br />
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Expense 2004 2005<br />
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Advertising -0- $650<br />
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Bank and payroll (Paychex) fees $557 1,271<br />
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Bottled water -0- 473<br />
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Employment taxes 3,002 7,609<br />
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Garbage -0- 317<br />
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Office expense and supplies 2,992 13,337<br />
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Phone and internet 681 784<br />
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Postage -0- 13<br />
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Rent 12,000 12,300<br />
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Repairs and maintenance -0- 2,297<br />
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Security alarm monitoring 361 413<br />
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Security system/locksmith -0- 11,506<br />
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Utilities 748 1,731<br />
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Wages 37,588 96,965<br />
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Total 57,929 149,666<br />
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The items underlying the office expense and supplies for 2004 include office supplies (e.g., labels), paper cups, a step ladder, a shredder, zip bags, glass canisters, a degreaser, marijuana rolling papers and lighters. The advertising expense for 2005 relates to advertisements aimed at medical marijuana audiences. The items underlying the office expense and supplies for 2005 include paper towels, marijuana-related calendars, magazines and books, marijuana rolling papers, zip-bags, vaporizer bags, lighters, brown paper bags, containers and storage jars. <br />
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E. Petitioner's Withdrawals Petitioner regularly took cash from the cash register to use personally, including to pay for personal trips to New York, New York, to Barcelona, Spain, to Amsterdam, the Netherlands, to Venice, Italy, to Cabo San Lucas, Mexico, and to the British Virgin Islands. He coded these withdrawals in the recording books so that the Vapor Room's employees would not know the amount of money he was taking from the business. <br />
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VI. Audit Respondent began auditing petitioner's 2004 tax return in April 2006 and respondent's revenue agent met with petitioner (accompanied by his independent accountant/tax preparer William Ehardt and an attorney) on July 6, 2006. 10 The revenue agent requested the Vapor Room's bank statements and substantiation for COGS and petitioner gave the revenue agent two documents Mr. Ehardt had prepared: a document entitled “Vapor Room Profit and Loss January through December 2004” (Ehardt P&L) and a document entitled “Vapor Room General Ledger As of December 2004” (Ehardt GL). The Ehardt GL reports that the Vapor Room's first sale occurred on July 14, 2004. The Ehardt P&L and the Ehardt GL each report that the Vapor Room's total income for 2004 was $1,068,830, which corresponds to the amount of gross receipts reported on the Federal income tax return for 2004. Many (but not all) of the expenditures shown on the Ehardt P&L and the Ehardt GL were reported on the return for 2004. <br />
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The revenue agent next met with Mr. Ehardt in August 2006 (the second and last meeting that the revenue agent had with petitioner or his representatives) and was informed that petitioner had “ledgers” showing cash received for sales and cash paid for purchases, but no further documents. Petitioner did not tender any ledgers at that time. <br />
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VII. Deficiency Notice Respondent issued the deficiency notice to petitioner. The deficiency notice states that petitioner may not deduct any of the reported COGS on account of lack of substantiation. Petitioner, after the deficiency notice was issued, provided respondent's counsel with $25,776 in receipts for COGS for 2004 and $27,370 in receipts for COGS for 2005. Respondent concedes that petitioner may deduct those respective amounts as COGS for 2004 and 2005. <br />
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The deficiency notice also states that petitioner may not deduct any of the reported expenses on account of lack of substantiation. Respondent later conceded that petitioner substantiated the $57,929 and $149,666 of expenses previously mentioned but asserts that section 280E precludes any deduction of these expenses. Respondent's revenue agent had relied upon sections 280E and 6001 during the audit to disallow all of the Vapor Room's reported expenses, but the deficiency notice does not specifically say that. Respondent formalized the applicability of section 280E in a second amendment to answer. VIII. Ledgers Petitioner gave respondent five ledgers (collectively, ledgers) during this proceeding. The credible evidence in the record fails to establish when the ledgers were prepared. The ledgers, however, do not appear to be (and we do not find that they are) the same as the recording books. <br />
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The ledgers purport to show the Vapor Room's receipts and cash disbursements (not including payments through the Vapor Room's bank account) for January 25 through March 13, 2004; June 1 through October 30, 2004; November 1, 2004, through April 25, 2005; April 26 through October 8, 2005; and October 9, 2005, through February 18, 2006, respectively. Petitioner has never produced a ledger (or recording book) for the 79-day period from March 14 through May 31, 2004. <br />
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The ledgers show categories of cash received and expenditures made during each business day in a total figure for each category and they list few (and in some cases no) specifics on the components of the categories. The ledgers sometimes contain no identification for an expenditure. Petitioner cannot definitively identify some of the entries in the ledgers. <br />
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The ledgers (as respondent adjusted for 2004 to reflect the missing 79-day period) report that the Vapor Room's gross receipts for 2004 and 2005 were $1,967,956 and $3,301,898, respectively. <br />
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OPINION <br />
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I. Overview California law allows petitioner to dispense medical marijuana to the recipients through the Vapor Room. Federal law prohibits taxpayers, however, from deducting any expense of a trade or business that consists of the trafficking of a controlled substance such as marijuana. See sec. 280E. We are asked to decide whether the Vapor Room, a medical marijuana dispensary permitted by California law, may deduct any of its expenses. We also are asked to decide whether petitioner underreported the Vapor Room's gross receipts, whether petitioner overreported the Vapor Room's COGS and whether petitioner is liable for an accuracy-related penalty. <br />
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We first discuss the burden of proof and our perception of the witnesses. We then decide the referenced issues. <br />
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II. Burden of Proof Petitioner bears the burden of proving that respondent's determination of the deficiencies set forth in the deficiency notice is incorrect. See Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 [12 AFTR 1456] (1933). Section 7491(a) sometimes shifts the burden of proof to the Commissioner, but that section does not apply where a taxpayer fails to satisfy the recordkeeping and substantiation requirements. See sec. 7491(a)(2)(A) and (B). Petitioner has failed to satisfy those requirements. Respondent bears the burden of proof only with respect to the increased deficiencies pleaded in the amendment to answer. 11 See Rule 142(a)(1). <br />
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III. Witness Testimony We determine the credibility of each witness, weigh each piece of evidence, draw appropriate inferences and choose between conflicting inferences in finding the facts of a case. The mere fact that one party presents unopposed testimony on that party's behalf does not necessarily mean that we will find the elicited testimony to be credible. We will not accept the testimony of witnesses at face value to the extent we perceive the testimony to be incredible or otherwise unreliable. See Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 84 (2000), aff'd, 299 F.3d 221 [90 AFTR 2d 2002-5442] (3d Cir. 2002); see also Ruark v. Commissioner, 449 F.2d 311, 312 [28 AFTR 2d 71-5831] (9th Cir. 1971), aff'g per curiam T .C. Memo. 1969-48; Clark v. Commissioner, 266 F.2d 698, 708-709 [3 AFTR 2d 1333] (9th Cir. 1959), aff'g in part and remanding T.C. Memo. 1957-129 [¶57,129 PH Memo TC]. <br />
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Petitioner's testimony and the testimony of his other witnesses was rehearsed, insincere and unreliable. We do not rely on petitioner's testimony to support his positions in this case, except to the extent his testimony is corroborated by reliable documentary evidence. We also do not rely on the uncorroborated testimony of petitioner's other witnesses, three of whom are (or were) patrons of the Vapor Room and all of whom are closely and inextricably connected with the medical marijuana industry and with a desired furtherance of that movement. <br />
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IV. Unreported Gross Receipts We start our analysis of the substantive issues by determining the amount of the Vapor Room's gross receipts. Petitioner reported that the Vapor Room's gross receipts were $1,068,830 for 2004 and $3,131,605 for 2005. Respondent did not adjust those amounts in the deficiency notice. Petitioner later, however, gave respondent the ledgers that revealed that the Vapor Room's gross receipts were greater than the reported amounts. Respondent then computed the Vapor Room's gross receipts using the ledgers. Respondent first totaled the cash that petitioner recorded in the ledgers for each year as sales receipts ($1,513,370 and $3,301,898, respectively). Respondent then extrapolated from the ledgers' recording of the sales receipts for 2004 that the Vapor Room's total sales during the missing 79-day period were $454,586. Respondent concluded that the Vapor Room's gross receipts for 2004 and 2005 were $1,967,956 ($1,513,370 + $454,586) and $3,301,898, respectively, and asks the Court to find the same. <br />
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Petitioner does not dispute that he underreported the Vapor Room's gross receipts for 2004 and 2005 (including that he failed to report any gross receipts received before July 14, 2004). He asks the Court, however, to find that the Vapor Room's gross receipts for the respective years totaled $1,969,331 and $3,264,798 (i.e., $1,375 more and $37,100 less than the respective amounts respondent determined). He supports his proposed finding with citations to profit and loss statements that his current accountant, Marlee Taxy, C.P.A., prepared for the respective years. One statement reports without further explanation that the Vapor Room's “Sales (as per Ledger)” for 2004 were $1,948,882 (inclusive of a $450,904 adjustment to reflect the 79 missing days) and that its total income for 2004 also included a $20,448 upward adjustment for “Actual to agree with cash in Ledger” ($1,948,882 + $20,448 = $1,969,331). The other statement reports without further explanation that the Vapor Room's “Sales (as per Ledger)” for 2005 were $3,308,328 and that its total income for 2005 also included a $43,530 downward adjustment for “Actual to agree with cash in Ledger” ($3,308,328 - $43,530 = $3,264,798). Neither petitioner nor any of his witnesses explained the calculation of the numbers in those statements. <br />
<br />
<br />
<br />
Petitioner's reporting in the ledgers of the Vapor Room's sales is reliable evidence of the amount of the Vapor Room's gross receipts for 2004 and 2005. Respondent and Ms. Taxy calculated the Vapor Room's gross receipts using those ledgers. They arrived at slightly different totals for each year. We place more weight on respondent's calculations. They were accompanied by sufficient detail. We accept respondent's computation as the more accurate calculation of the Vapor Room's gross receipts for 2004 and 2005. We hold that the Vapor Room's gross receipts for the respective years were $1,967,956 and $3,301,898. We note that petitioner in his answering brief sets forth no objection to respondent's request in his opening brief that the Court find that the ledgers (as adjusted for the missing period) stated that the Vapor Room's sales during the respective years were in the amounts that respondent calculated. <br />
<br />
<br />
<br />
V. COGS <br />
<br />
<br />
<br />
We now turn to the parties' dispute as to the Vapor Room's COGS. Petitioner argues that respondent arbitrarily determined the Vapor Room's COGS in the deficiency notice because the notice states that the Vapor Room's COGS were zero for 2004 and 2005. Petitioner argues that the burden of proof is therefore upon respondent. See Helvering v. Taylor, 293 U.S. 507, 515 [14 AFTR 1194] (1935); Palmer v. United States, 116 F.3d 1309, 1312 [80 AFTR 2d 97-5100] (9th Cir. 1997). We disagree that respondent's determination of the Vapor Room's COGS was arbitrary so as to shift the burden of proof on that issue to respondent. <br />
<br />
<br />
<br />
A cash method taxpayer like petitioner may generally deduct all ordinary and necessary expenses of the business upon payment of those expenses. See sec. 162(a). Deductions are strictly a matter of legislative grace, however, and petitioner must prove he is entitled to deduct the Vapor Room's claimed amounts of COGS (as well as the Vapor Room's claimed amounts of expenses). See Rule 142(a)(1); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 [13 AFTR 1180] (1934); Goldsmith v. Commissioner, 31 T.C. 56, 62 (1958); Hahn v. Commissioner, 30 T.C. 195, 198 (1958), aff'd, 271 F.2d 739 [4 AFTR 2d 5843] (5th Cir. 1959); see also Briggs v. Commissioner, T.C. Memo. 2000-380 [TC Memo 2000-380]; King v. Commissioner T.C. Memo. 1994-318 [1994 RIA TC Memo ¶94,318], aff'd without , published opinion, 69 F.3d 544 [76 AFTR 2d 95-7445] (9th Cir. 1995); Whatley v. Commissioner, T.C. Memo. 1992-567 [1992 RIA TC Memo ¶92,567], aff'd without published opinion 21 F.3d 1119 [73 AFTR 2d 94-1775] (9th Cir. 1994). , Petitioner is required to maintain sufficient permanent records to substantiate the Vapor Room's deductions. See sec. 6001; see also Briggs v. Commissioner, T.C. Memo. 2000-380 [TC Memo 2000-380]; ,sec. 1.6001-1(a), (d), Income Tax Regs. Respondent's determination in the notice of deficiency of the Vapor Room's COGS as zero reflects that petitioner failed to produce credible records supporting any greater deductions of COGS. Petitioner, in fact, concedes in his posttrial brief that he “freely admitted” to the revenue agent that he had no receipts for COGS. <br />
<br />
<br />
<br />
Petitioner argues nonetheless that the ledgers alone are sufficient substantiation for taxpayers operating in the medical marijuana industry because, he states, that industry “shun[s] formal `substantiation' in the form of receipts.” We disagree with petitioner that the ledgers standing alone are sufficient substantiation. The ledgers did not specifically identify the marijuana vendors or reflect any marijuana that was received or given away. The ledgers neither were independently prepared nor bore sufficient indicia of reliability or trustworthiness. The substantiation rules require a taxpayer to maintain sufficient reliable records to allow the Commissioner to verify the taxpayer's income and expenditures. See sec. 6001; sec. 1.6001-1(a), Income Tax Regs.; see also Obot v. Commissioner, T.C. Memo. 2005-195 [TC Memo 2005-195]. Neither Congress nor the Commissioner has prescribed a rule stating that a medical marijuana dispensary may meet that substantiation requirement merely by maintaining a self-prepared ledger listing the amounts and general categories of its expenditures. It is not this Court's role to prescribe the special substantiation rule that petitioner desires for medical marijuana dispensaries and we decline to do so. <br />
<br />
<br />
<br />
Petitioner seeks to strengthen the probative value of the ledgers through his and Ms. Taxy's testimony. He testified that he contemporaneously recorded in the ledgers all of the Vapor Room's purchases of marijuana and Ms. Taxy testified that she totaled the Vapor Room's COGS for the respective years at $1,651,554 and $2,713128. Respondent rebuts that petitioner has failed to substantiate that the amount of the Vapor Room's COGS exceeded $25,776 for 2004 or $27,370 for 2005. Respondent concludes that the Vapor Room's COGS are limited to the amounts petitioner was able to substantiate to respondent's satisfaction. We disagree with both parties. <br />
<br />
<br />
<br />
The Vapor Room's sales for the respective years were $1,967,956 and $3,301,898. We consider it unreasonable to conclude that the Vapor Room's COGS totaled the small amounts that respondent asks us to find. We also consider it unreasonable, however, to conclude that the Vapor Room's COGS are those amounts set forth in the ledgers. We do not believe that the COGS entries set forth in the ledgers are entirely accurate and we decline to rely upon those entries in their entirety. Petitioner consciously chose to transact the Vapor Room's business primarily in cash. He also chose not to keep supporting documentation for the Vapor Room's expenditures. He did so at his own peril. 12 The mere fact that we rely on the ledgers to determine the amounts of the Vapor Room's gross receipts is not necessarily inconsistent with our refusing to rely upon the ledgers to determine the amount of the Vapor Room's COGS (or expenses). Nor are the ledgers necessarily accurate as to COGS (and expenses) simply because petitioner recorded more sales receipts in the ledgers than he did in the Federal income tax returns he filed for the years at issue. We find the expenditure entries in the ledgers vague and incomplete in many instances. Moreover, we seriously doubt that they were recorded contemporaneously or accurately with the expenditures. 13 We also doubt that petitioner made each recorded expenditure in the amount and for the purpose (if any) stated. 14 <br />
<br />
<br />
<br />
We are left to ascertain the Vapor Room's COGS on the basis of the record. The evidence is not satisfactory for this purpose. We nevertheless must do our best with the materials at hand. “Absolute certainty in such matters is usually impossible and is not necessary; *** [we] make as close an approximation as *** [we] can, bearing heavily *** upon the taxpayer whose inexactitude is of his own making.” Cohan v. Commissioner, 39 F.2d 540, 543-544 [8 AFTR 10552] (2d Cir. 1930); accord Edelson v. Commissioner, 829 F.2d 828, 831 [60 AFTR 2d 87-5700] (9th Cir. 1987) (stating that “a court should allow the taxpayer some deductions [under theCohan rule] if the taxpayer proves he [or she] is entitled to the deduction but cannot establish the full amount claimed”), aff'g T.C. Memo. 1986-223 [¶86,223 PH Memo TC]; see also Lollis v. Commissioner 595 F.2d , 1189, 1190 (9th Cir. 1979), aff'g T.C. Memo. 1976-15 [¶76,015 PH Memo TC]; Goldsmith v. Commissioner, 31 T.C. at 62. <br />
<br />
<br />
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We are aided, in small part, by the testimony of Henry C. Levy, C.P.A. Petitioner called Mr. Levy as an expert on the medical marijuana industry and the Court recognized him as such. Having said that, we generally found Mr. Levy to be unreliable. He was unreliable in that he was not sufficiently independent of petitioner and his cause (e.g., Mr. Levy is petitioner's current bookkeeper and accountant and has approximately 100 other medical marijuana dispensaries as clients). See Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 86-87. In addition, his testimony improperly consisted mainly of legal opinions and conclusions. 15 See Gibson & Assocs., Inc. v. Commissioner, 136 T.C. 195, 229-230 (2011); Alumax, Inc. v. Commissioner 109 T.C. 133, 171 (1997), aff'd, 165 F.3d , 822 (11th Cir. 1999); see also United States v. Scholl, 166 F.3d 964, 973 [83 AFTR 2d 99-902] (9th Cir. 1999). <br />
<br />
<br />
<br />
We have broad discretion to evaluate the cogency of an expert's analysis. We may adopt only those parts of an opinion we consider to be reliable. See Helvering v. Nat'l Grocery Co., 304 U .S. 282, 294-295 (1938); Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 85-86; IT & S of Iowa, Inc. v. Commissioner, 97 T.C. 496, 508 (1991). Mr. Levy opined that the average COGS of three of his medical marijuana dispensary clients was 75.16% of their sales for 2005 and that part of his opinion comports with Dr. Gieringer's opinion that the COGS of medical marijuana dispensaries ranged from 70 to 85% of sales during the years at issue. We consider 75.16% of sales to be a reasonable measure of the Vapor Room's COGS. We therefore adopt that percentage of sales as a measure of the Vapor Room's COGS for each year at issue. <br />
<br />
<br />
<br />
This does not mean, however, that the Vapor Room's COGS equals 75.16% of its gross receipts. We are mindful that this is not the right percentage because petitioner gave some of the Vapor Room's inventory to patrons for free and the parties dispute whether the Vapor Room's cost of that portion of the medical marijuana is includable in the Vapor Room's COGS. Petitioner argues that these costs are so includable. We disagree. <br />
<br />
<br />
<br />
Petitioner did not sell the marijuana underlying these costs and he did not hold all the marijuana out for sale. These costs, therefore, hardly reflect the cost of the goods that petitioner sold. See Fuller v. Commissioner 20 T.C. 308, 316 , (1953), aff'd, 213 F.2d 102 [45 AFTR 1551] (10th Cir. 1954). Petitioner acknowledges that inventory withdrawn for personal use is not included in a COGS calculation and petitioner withdrew the referenced medical marijuana from the Vapor Room's inventory of marijuana for sale. He personally consumed some of it and gave the rest to his selected patrons for free. Petitioner's claim that he gave the marijuana to needy patrons out of compassion, even if true (which we need not decide), does not dictate a different result. 16 Inventory that is given to a qualified charitable organization may receive special treatment. The recipients of petitioner's gratuities, however, were not qualified charitable organizations. Nor does the record or caselaw support petitioner's characterization of the free medical marijuana distributions as rebates to customers. We conclude that the Vapor Room's COGS for each year at issue equals 75.16% of the Vapor Room's gross receipts for the year, as further adjusted to take into account our finding that petitioner gave away 6.5% of the Vapor Room's purchases. 17 We therefore hold that the Vapor Room's COGS for 2004 and 2005 are $1,382,973 ($1,967,956 x 75.16% x 93.5%) and $2,320,396 ($3,301,898 x 75.16% x 93.5%), respectively. <br />
<br />
<br />
<br />
VI. Expenses <br />
<br />
<br />
<br />
A. Overview We turn now to decide the parties' dispute on the deductibility of the Vapor Room's expenses. Respondent argues that petitioner failed to substantiate expenses in amounts greater than $57,929 for 2004 and $149,666 for 2005. Respondent also argues that section 280E precludes petitioner from deducting any of those amounts notwithstanding that the amounts were substantiated. Petitioner argues that he is entitled to deduct the Vapor Room's expenses in full. Petitioner asserts that the Vapor Room's expenses are as follows: 182004 2005 <br />
<br />
<br />
<br />
Expense Advertising $1,466 $5,902 Bank fees 724 1,271 Charity -0- 7,810 Donations 683 3,330 Internet services and fee 2,219 784 <br />
<br />
<br />
<br />
Legal and professional services 390 36,670 (...continued) deduction. <br />
<br />
<br />
<br />
Other 12,787 24,596 <br />
<br />
<br />
<br />
Payroll taxes 2,876 7,418 <br />
<br />
<br />
<br />
Rent 14,369 12,300 <br />
<br />
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<br />
Repairs and maintenance 1,328 11,486 <br />
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<br />
<br />
Security services 827 5,988 <br />
<br />
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<br />
State -0- 1,547 <br />
<br />
<br />
<br />
Supplies 26,649 31,401 <br />
<br />
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<br />
Taxes and licenses 195 2,500 <br />
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<br />
Travel and meals and entertainment 2,549 3,602 <br />
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<br />
Utilities 973 2,248 <br />
<br />
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<br />
Wages Paid in cash 133,071 161,751 <br />
<br />
<br />
<br />
96,965 <br />
<br />
<br />
<br />
Paid through Paychex 37,588 Total 236,502 417,569 <br />
<br />
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<br />
This column totals $238,694. Petition r does not explain how e his total differs. Petitioner asserts that section 280E, if applicable, which he argues it is not, precludes a deduction for the years at issue of only $12,636 and $20,748 of expenses. He calculates those amounts on the basis of his reading of our Opinion in Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner (CHAMP), 128 T.C. 173 (2007). We disagree with petitioner's reading of our Opinion in CHAMP and further find that the factual settings ofCHAMP and this case are distinguishable. B. Substantiation Petitioner has failed to maintain required permanent records. He also has failed to substantiate the Vapor Room's expenses with the exception of those expenses respondent concedes. We decline to attempt to estimate any of his expenses pursuant to Cohan v. Commissioner, 39 F.2d 540 [8 AFTR 10552], because, as discussed below, we hold that section 280E precludes any deduction of the Vapor Room's expenses. See also Lewis v. Commissioner, 560 F.2d 973, 977 [40 AFTR 2d 77-5817] (9th Cir. 1977) (stating that the Cohan rule may not be applied to certain expenses), rev'g on other grounds T.C. Memo. 1974-59 [¶74,059 PH Memo TC]; Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968) (same), aff'd, 412 F.2d 201 [24 AFTR 2d 69-5021] (2d Cir. 1969). We hold that petitioner may not deduct any expense other than the expenses that respondent concedes. Those conceded expenses, however, must still fall outside section 280E to be deductible. <br />
<br />
<br />
<br />
C. Section 280E We now turn to section 280E. A taxpayer may not deduct any amount for a trade or business where the “trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances *** which is prohibited by Federal law.” 19 Sec. 280E. We have previously held, and the parties agree, that medical marijuana is a controlled substance under section 280E. See CHAMP, 128 T.C. at 181; see also Gonzalez v. Raich, 545 U.S. 1 (2005); United States v. Oakland Cannabis Buyers' Coop., 532 U.S. 483 (2001). <br />
<br />
<br />
<br />
Petitioner argues that he may deduct the Vapor Room's expenses notwithstanding section 280E because, he claims, the Vapor Room's business did not consist of the illegal trafficking in a controlled substance. He argues that the illegal trafficking in controlled substances is the only activity covered by section 280E. We disagree that section 280E is that narrow and does not apply here. We therefore reject petitioner's contention that section 280E does not apply because the Vapor Room was a legitimate operation under California law. We have previously held that a California medical marijuana dispensary's dispensing of medical marijuana pursuant to the CCUA was “trafficking” within the meaning of section 280E. See CHAMP, 128 T.C. at 182-183. That holding applies here with full force. <br />
<br />
<br />
<br />
Petitioner asserts that the Vapor Room provided caregiving services in addition to dispensing medical marijuana. He invites the Court to reinterpret section 280E more narrowly than we did inCHAMP to reach only those illegal underground businesses that have a single business of drug trafficking. We decline to do so. The taxpayer in CHAMP was a legitimate (under State law) operation that had a second business (providing caregiving services) and we applied section 280E there. The dispensing of medical marijuana, while legal in California (among other States), 20 is illegal under Federal law. Congress in section 280E has set an illegality under Federal law as one trigger to preclude a taxpayer from deducting expenses incurred in a medical marijuana dispensary business. This is true even if the business is legal under State law. <br />
<br />
<br />
<br />
Petitioner argues alternatively that he may deduct all of the Vapor Room's expenses attributable to the Vapor Room's caregiving business. He asserts that he trafficked marijuana only during the short time it took for the staff members to pass the medical marijuana to the patrons in exchange for payment and that the rest of the Vapor Room's business was providing caregiving services. He compares his business to the medical marijuana dispensary inCHAMP. We found there that the taxpayer had two businesses (one the dispensing of medical marijuana and the other the providing of caregiving services). Petitioner asserts that the Vapor Room's overwhelming purpose was to provide caregiving services, that the Vapor Room's expenses are almost entirely related to the caregiving business and that the Vapor Room would continue to operate even if petitioner did not sell medical marijuana. We disagree. The record does not establish these assertions. Moreover, as previously stated, all of the testimony from petitioner and from his other witnesses was rehearsed, not impartial and not credible. We find instead that petitioner had a single business, the dispensing of medical marijuana, and that he provided all of the Vapor Room's services and activities as part of that business. <br />
<br />
<br />
<br />
The record establishes that the Vapor Room is not the same type of operation as the medical marijuana dispensary inCHAMP that we found to have two businesses. The differences between the operations are almost too numerous to list. The dispensary there was operated exclusively for charitable, educational and scientific purposes and its income was slightly less than its expenses. See CHAMP, 128 T.C. at 174, 176-177. The director there was well experienced in health services and he operated the dispensary with caregiving as the primary feature and the dispensing of medical marijuana (with instructions on how to best consume it) as a secondary feature. See id. at 174-175. Seventy-two percent of the CHAMP dispensary's employees (18 out of 25) worked exclusively in its caregiving business and the dispensary provided its caregiving services regularly, extensively and substantially independent of its providing medical marijuana. See id. at 175-176, 178, 183, 185. It rented space at a church for peer group meetings and yoga classes and the church did not allow marijuana on the church's premises. See id. at 176. It provided its low-income members with hygiene supplies and with daily lunches consisting of salads, fruit, water, soda and hot food. See id. at 175. Its members, approximately 47% of whom suffered from AIDS, paid a single membership fee for the right to receive caregiving services and medical marijuana from the taxpayer. See id. at 174-175. The names of the dispensaries are even diametrically different. The name of the dispensary there, “Californians Helping To Alleviate Medical Problems,” stresses the dispensary's caregiving mission. The name of the dispensary here, “The Vapor Room Herbal Center,” stresses the sale and consumption (through vaporization) of marijuana. <br />
<br />
<br />
<br />
Petitioner essentially reads our Opinion inCHAMP to hold that a medical marijuana dispensary that allows its customers to consume medical marijuana on its premises with similarly situated individuals is a caregiver if the dispensary also provides the customers with incidental activities, consultation or advice. Such a reading is wrong. A business that dispenses marijuana does not necessarily consist simply of the act of dispensing marijuana, just as a business that sells other goods does not necessarily consist simply of the passing of those goods. <br />
<br />
<br />
<br />
All facts and circumstances must be taken into account to ascertain the parameters of a business. Two activities can be separated or aggregated for tax purposes depending on the “degree of organizational and economic interrelationship *** , the business purpose which is (or might be) served by carrying on the various undertakings separately or together in a trade or business *** , and the similarity of *** [the] undertakings.” Sec. 1.183-1(d)(1), Income Tax Regs.;see also Tobin v. Commissioner, T.C. Memo. 1999-328 [1999 RIA TC Memo ¶99,328] (listing certain factors to consider in deciding whether a taxpayer's characterization of two or more undertakings as a single activity for purposes of section 183 is unreasonable). The Commissioner usually will accept a taxpayer's characterization of several undertakings either as a single activity or as separate activities. See sec. 1.183-1(d)(1), Income Tax Regs. The Commissioner will reject the characterization, however, if it is artificial and cannot be reasonably supported under the facts and circumstances of the case. See id. A taxpayer, to be engaged in a trade or business for purposes of section 162, must be involved in the activity with continuity and regularity and the taxpayer's primary purpose for engaging in the activity must be for income or profit.See Commissioner v. Groetzinger, 480 U.S. 23, 35 [59 AFTR 2d 87-532] (1987). <br />
<br />
<br />
<br />
The facts here persuade us that the Vapor Room's dispensing of medical marijuana and its providing of services and activities share a close and inseparable organizational and economic relationship. They are one and the same business. Petitioner formed and operated the Vapor Room to sell medical marijuana to the patrons and to advise them on what he considered to be the best marijuana to consume and the best way to consume it. Petitioner provided the additional services and activities incident to, and as part of, the Vapor Room's dispensing of medical marijuana. Petitioner and the Vapor Room's employees were already in the room helping the patrons receive and consume medical marijuana and the entire site of the Vapor Room was used for that purpose. The record does not establish that the Vapor Room paid any additional wages or rent to provide the incidental services and activities. Nor does the record establish that the Vapor Room made any other significant payment to provide the incidental activities or services. Petitioner also oversaw all aspects of the Vapor Room's operation and the Vapor Room had a single bookkeeper and a single independent accountant for its business. These facts further support our conclusion that the Vapor Room had only one trade or business. See Tobin v. Commissioner, T.C. Memo. 1999-328 [1999 RIA TC Memo ¶99,328]. <br />
<br />
<br />
<br />
That petitioner may have sometimes overcharged patrons for marijuana to subsidize the cost of the Vapor Room's limited services or activities does not change our view. Petitioner's payment of the Vapor Room's expenses to dispense medical marijuana allowed the Vapor Room to fulfill its business purpose of selling medical marijuana that in turn allowed the Vapor Room to offer its incidental services and activities in support of that purpose. Moreover, the Vapor Room's only revenue was from patrons' purchase of marijuana. The Vapor Room would not have had any revenues at all (and could not have operated) if none of the patrons had purchased marijuana from petitioner. The Vapor Room did not spawn a second business simply by occasionally providing the patrons with snacks, a massage, or a movie, or allowing the patrons to play games in the room and to talk there to each other. <br />
<br />
<br />
<br />
Petitioner also has not established that the Vapor Room's activities or services independent of the dispensing of medical marijuana were extensive. He tried to establish that they were but failed. His counsel, at trial, repeatedly asked petitioner's patrons/witnesses to describe “caregiving” services that petitioner provided at the Vapor Room. The witnesses strained to come up with any such service, other than through their rehearsed statements that fell short of establishing caregiving services of the type and extent described inCHAMP, 128 T.C. at 175-176. Petitioner's actions spoke loudly when he filed the tax returns for 2004 and 2005, reporting that the Vapor Room's principal business was the retail sale of “herbal” (which we understand to be marijuana). We perceive his claim now that the Vapor Room actually consists of two businesses as simply an after-the-fact attempt to artificially equate the Vapor Room with the medical marijuana dispensary in CHAMP so as to avoid the disallowance of all of the Vapor Room's expenses under section 280E. We conclude that section 280E applies to preclude petitioner from deducting any of the Vapor Room's claimed expenses. <br />
<br />
<br />
<br />
VII. Accuracy-Related Penalty We now turn to decide whether petitioner is liable for an accuracy-related penalty under section 6662(a). A taxpayer may be liable for a 20% penalty on any underpayment of tax attributable to negligence or disregard of rules or regulations or any substantial understatement of income tax. See sec. 6662(a) and (b)(1) and (2). “Negligence” includes any failure to make a reasonable attempt to comply with the provisions of the Code and includes “any failure by the taxpayer to keep adequate books and records or to substantiate items properly.” Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. Negligence has also been defined as a lack of due care or failure to do what a reasonable person would do under the circumstances. See Allen v. Commissioner 925 F.2d 348, 353 [67 AFTR 2d 91-543] (9th Cir. 1991), , aff'g 92 T.C. 1 (1989). “Disregard” includes any careless, reckless or intentional disregard of rules or regulations. See sec. 6662(c); sec. 1.6662-3(b)(2), Income Tax Regs. An individual's understatement of income tax is substantial if the understatement exceeds the greater of 10% of the tax required to be shown on the return or $5,000. See sec. 6662(d)(1)(A). An accuracy-related penalty does not apply, however, to any portion of an underpayment for which there was reasonable cause and where the taxpayer acted in good faith. See sec. 6664(c)(1). <br />
<br />
<br />
<br />
Respondent bears the burden of production to establish that it is appropriate to impose the accuracy-related penalty. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2001). The burden of proof is then upon petitioner (except for the increased portions of the accuracy-related penalty raised in the amendment to answer) if and once respondent meets his burden of production. See Higbee v. Commissioner, 116 T.C. at 447, 449. Respondent bears the burden of proof as to the increased portions of the accuracy-related penalty raised in the amendment to answer. See Rule 142(a)(1). <br />
<br />
<br />
<br />
Respondent argues that petitioner is liable for the accuracy-related penalty to the extent he has understated the Vapor Room's gross receipts and failed to substantiate the Vapor Room's COGS and expenses. Petitioner's sole argument in brief is that the penalty does not apply because, he states, any inaccuracy underlying an understatement was “accidental, not substantial, and/or not negligent on the part of the taxpayer.” Petitioner asserts that the Vapor Room was his first business and that he was not instructed on the proper way to keep the books and records of a business. <br />
<br />
<br />
<br />
We agree with respondent that the accuracy-related penalty applies in this case but disagree that it applies to the full amounts of the underpayments. Respondent concedes that petitioner substantiated $57,929 and $149,666 of the Vapor Room's reported expenses for 2004 and 2005, respectively. We nonetheless disallowed the deduction of those expenses under section 280E. The application of section 280E to the expenses of a medical marijuana dispensary had not yet been decided when petitioner filed his Federal income tax returns for 2004 and 2005. The accuracy-related penalty does not apply, therefore, to the portion of each underpayment that would not have resulted had petitioner been allowed to deduct his substantiated expenses. Cf. Van Camp & Bennion v. United States, 251 F.3d 862, 868 [87 AFTR 2d 2001-2408] (9th Cir. 2001) (”Where a case is one `of first impression with no clear authority to guide the decision makers as to the major and complex issues,' a negligence penalty is inappropriate” (quotingFoster v. Commissioner, 756 F.2d 1430, 1439 [55 AFTR 2d 85-1285] (9th Cir. 1985), aff'g in part and vacating as to an addition to tax for negligence 80 T.C. 34 (1983))). <br />
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<br />
<br />
The accuracy-related penalty does apply, however, to the remainder of each underpayment because those portions of the underpayments are attributable to negligence. 21 Petitioner consciously opted not to keep adequate books and records and that action was in reckless or conscious disregard of rules or regulations. See Higbee v. Commissioner, 116 T.C. at 449. He also did not record or report any of the Vapor Room's gross receipts for approximately the first six months of its business. He also initially gave respondent's revenue agent one set of documents (the Ehardt GL and the Ehardt P&L) that does not correspond with the ledgers he now relies upon. Our decision to find petitioner liable does not change even though the Vapor Room may have been petitioner's first business or he was not “instructed” on the proper way to keep books. The Code requires that taxpayers who decide to go into business for themselves maintain sufficient records to substantiate their income and expenditures. A reasonable person would have sought to comply with this requirement. We sustain respondent's determination (as supplemented through the amendment to answer but as we modify) that petitioner is liable for the penalty for each year. VIII. Epilogue We have considered all arguments that the parties made and have rejected those arguments not discussed here as without merit. <br />
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<br />
<br />
To reflect the foregoing, Decision will be entered under Rule 155. <br />
<br />
1<br />
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<br />
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Unless otherwise indicated, section references are to the applicable versions of the Internal Revenue Code (Code), Rule references are to the Tax Court Rules of Practice and Procedure and dollar amounts are rounded to the nearest dollar. <br />
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2<br />
<br />
<br />
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COGS is not a deduction within the meaning of sec. 162(a) but is subtracted from gross receipts in determining a taxpayer's gross income. See Max Sobel Wholesale Liquors v. Commissioner 69 T.C. 477 (1977), aff'd, 630 F.2d 670 [46 AFTR 2d 80-5799] (9th Cir. 1980); sec. 1.162-1(a), Income Tax Regs. We refer to COGS as a deduction for convenience. <br />
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3<br />
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Approximately 50 medical marijuana dispensaries were located in California in 2004. <br />
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4<br />
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Petitioner was oblivious to the licensing requirement for his medical marijuana dispensary. He received the requisite license from San Francisco in or about July 2004. <br />
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5<br />
<br />
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A vaporizer is an expensive apparatus that extracts from marijuana its principal active component and allows the user to inhale vapor rather than smoke. Petitioner chose the name of his business to publicize that the Vapor Room had the requisite equipment to allow patrons to vaporize marijuana there. <br />
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6<br />
<br />
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We say “almost all” because patrons also included designated caregivers of the recipients, who were entitled to receive medical marijuana for recipients. We use the term “patrons” to include only recipients. <br />
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7<br />
<br />
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The medical marijuana in the Vapor Room's inventory was in the following three forms: (1) dried marijuana, (2) food (e.g., bakery goods, butter and candy) laced with marijuana and (3) a concentrated version of the principal active component of marijuana. <br />
<br />
8<br />
<br />
<br />
<br />
Petitioner was not forthcoming with the specific prices at which he sold his marijuana or the specific amount of medical marijuana that was consumed for free. Nor does the record contain a formula for the price that petitioner charged a patron for medical marijuana or reveal whether any discount price had a set floor such as the Vapor Room's cost. Petitioner, during 2004, sold approximately 32% of the marijuana (inclusive of the portion he dispensed for free) for less than what would otherwise have been the sale price. <br />
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9<br />
<br />
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Petitioner used the cash method to compute the Vapor Room's net income. Respondent does not challenge petitioner's use of that method. We discuss it no further. <br />
<br />
1<br />
<br />
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The expenses in this column actually total $286, 85, or $1,536 more than $285,349. Petitioner apparently reported the Vapor Room's “Deductible meals and entertainment” at 100% of the reported cost and then reduced the $286,885 to $285,349 (without noting so) to take into account the 50% reduction of sec. 274(n). <br />
<br />
10<br />
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Petitioner filed his Federal income tax return for 2005 during the last week of September 2006. The audit was expanded at or about that time to include 2005. <br />
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11<br />
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Petitioner does not argue that respondent bears the burden of proving the applicability of sec. 280E. We need not decide that issue because our resolution of that issue does not rest on which party bears the burden of proof. See Estate of Morgens v. Commissioner, 133 T.C. 402, 409 (2009), aff'd, 678 F.3d 769 [109 AFTR 2d 2012-2006] (9th Cir. 2012); see also Knudsen v. Commissioner, 131 T.C. 185, 186-189 (2008). <br />
<br />
12<br />
<br />
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Petitioner asserts that he minimized the Vapor Room's use of checks because he did not want his bank to know that the Vapor Room was a medical marijuana dispensary. We find that assertion incredible, especially given that petitioner informed the bank that his business was named “Vapor Room.” <br />
<br />
13<br />
<br />
<br />
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The ledgers apparently were not available at the start of this proceeding when petitioner admitted under Rule 90 that the Vapor Room started its business in July 2004. The ledgers show sales for the Vapor Room on most (if not all) of the days from January 25 through March 13, 2004, and June 1 through October 30, 2004. <br />
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14<br />
<br />
<br />
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Petitioner informs us that California did not allow medical marijuana dispensaries to earn a profit for the years at issue. The need to report no profit may improperly cause a dispensary to understate gross receipts or to overstate expenditures. We are especially wary here, where petitioner by his own admission understated his gross receipts and took steps to disguise his cash withdrawals from his business to conceal them from his employees. We also note that petitioner in his petition challenged only respondent's disallowance of the COGS and expenses petitioner reported on the returns and stated in the petition that he had incurred the reported expenditures in the amounts stated (without mention of any greater or additional expense amounts). <br />
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15<br />
<br />
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Petitioner also called Dale Gieringer, Ph.D., and Ms. Taxy to testify as experts on the medical marijuana industry and the Court recognized them as such. We similarly consider their testimony to be unreliable for similar reasons. We adopt their opinions only to the limited extent stated. <br />
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16<br />
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Both staff members (including petitioner) and other patrons received medical marijuana for free. The record does not disclose how much of the free marijuana actually went to “needy” individuals. <br />
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17<br />
<br />
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The medical marijuana petitioner gave away might arguably still qualify as an ordinary and necessary business expense under sec. 162(a). We need not decide that issue, however, because we hold later that sec. 280E precludes any such deduction. <br />
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18<br />
<br />
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The largest claimed expense is wages paid in cash. Petitioner opted not to specifically identify the purported recipients of these “wages.” We are troubled with petitioner's claimed cash transactions and doubt that any of the claimed cash wages were ever reported as income. <br />
<br />
19<br />
<br />
<br />
<br />
The parties agree that sec. 280E disallows deductions only for the expenses of a business and not for its COGS. See also Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner (CHAMP), 128 T.C. 173, 178 n.4 (2007). <br />
<br />
20<br />
<br />
<br />
<br />
Our research reveals for information purposes that 17 States and the District of Columbia have legalized medical marijuana as of July 19, 2012. See http://medicalmarijuana.procon.org/view.resource.php?resourceID=000881 (last visited July 19, 2012). Those States are Alaska, Arizona, California, Colorado, Connecticut, Delaware, Hawaii, Maine, Michigan, Montana, Nevada, New Jersey, New Mexico, Oregon, Rhode Island, Vermont and Washington. Id. <br />
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21<br />
<br />
<br />
<br />
The underpayments also appear to be “substantial” within the statutory definition of that word. The accuracy-related penalty will also apply to the referenced portions of the underpayments if that definition is met. <br />
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<br />
<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com1tag:blogger.com,1999:blog-3318191946786047021.post-49414712004872886992012-08-04T13:56:00.001-04:002012-08-04T13:56:32.138-04:00YachtESTATE OF ROBERT S. BOWEN v. U.S., Cite as 110 AFTR 2d 2012-XXXX, 07/23/2012 <br />
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<br />
ESTATE OF ROBERT S. BOWEN Plaintiff v. UNITED STATES OF AMERICA Defendant.<br />
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Case Information: <br />
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Code Sec(s): <br />
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Court Name: IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MARYLAND, <br />
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Docket No.: CIVIL ACTION NO. MJG-11-2231, <br />
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Date Decided: 07/23/2012. <br />
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Disposition: <br />
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HEADNOTE <br />
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. <br />
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Reference(s): <br />
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OPINION <br />
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IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MARYLAND, <br />
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<br />
MEMORANDUM AND ORDER<br />
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Judge: Marvin J. Garbis United States District Judge <br />
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The Court has before it the United States' Motion for Summary Judgment [Document 8], Plaintiff's Motion for Summary Judgment [Document 15] and the materials submitted relating thereto. The Court has held a hearing and had the benefit of the arguments of counsel. <br />
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I. BACKGROUND<br />
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In 2006, Robert S. Bowen (“Bowen”) was a resident of Annapolis, Maryland who, after his retirement, engaged in various business enterprises. Bowen died in November, 2009. <br />
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The instant case relates to a yacht (“the Boat”) that Bowen bought in 2006. Bowen's Estate (“Plaintiff”) claims that Bowen paid almost $750,000 for the Boat and expended over $1,000,000 to repair defects. The Boat was sold by the Estate for $350,000 in 2010. <br />
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Plaintiff seeks a refund of federal income taxes paid by Bowen for the year 2006, contending that he did not claim certain deductions to which he was entitled in regard to the Boat. The Government contends that Bowen did not have a right to any such deductions on the 2006 federal income tax return. <br />
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II. SUMMARY JUDGMENT STANDARD<br />
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A motion for summary judgment shall be granted if the pleadings and supporting documents “show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.” Fed. R. Civ. P. 56(c)(2). <br />
<br />
<br />
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The well-established principles pertinent to such motions can be distilled to a simple statement: The Court may look at the evidence presented in regard to the motion for summary judgment through the non-movant's rose colored glasses, but must view it realistically. After so doing, the essential question is whether a reasonable fact finder could return a verdict for the non-movant or whether the movant would, at trial, be entitled to judgment as a matter of law. See, e.g., Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986); Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986); Adickes v. S.H. Kress & Co., 398 U.S. 144, 158–59 (1970); Shealy v. Winston, 929 F.2d 1009, 1012 (4th Cir. 1991). <br />
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III. DISCUSSION<br />
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As discussed herein, Plaintiff seeks a recovery based upon a variety of theories. The parties certainly disagree as to whether Mr. Bowen was engaged in a business or hobby vis-à-vis the boat and other intent issues. However, it is not necessary to determine whether Plaintiff has presented sufficient evidence to avoid summary judgment in regard to such matters. Rather, as discussed herein, even accepting Plaintiff's position on all such issues, the Government is entitled to summary judgment. <br />
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A. The Boat Transactions<br />
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In 2006, Bowen ordered 1 a 65-foot yacht to be built by a Chinese boat-building company. The Boat, for which Bowen paid some $750,000, was manufactured in 2006 and shipped by freighter from China in November 2006. The Boat arrived in North Carolina on or about December 28, 2006. The Boat was inspected in North Carolina in early January 2007. Substantial problems were found, but Bowen was able to sail the Boat to Annapolis. <br />
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<br />
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Bowen made claims against the Chinese company for manufacturing defects and against an insurer for damage occurring during shipment. Bowen eventually settled his claims against the insurer for $120,000 in 2009. Bowen was not able to obtain any recovery from the manufacturer. <br />
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From 2007 through 2009, Bowen paid substantial amounts for repairs to the Boat. In June 2010, Bowen's Estate sold the Boat for $350,000. <br />
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B. The Nature of This Tax Refund Suit<br />
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Plaintiff has properly filed this tax refund suit. Plaintiff, by Bowen while alive, met the jurisdictional prerequisite of full payment 2 of the amount shown due on his 2006 federal income tax return. Plaintiff timely filed a claim for refund on Form 1040-X (Amended Return) stating the grounds upon which the refund is claimed on or about October 13, 2010. The Estate timely filed the instant lawsuit on August 11, 2011. <br />
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A timely claim for refund is a jurisdictional prerequisite to a tax refund suit. § 1314(b). 3 Consequently, in a tax refund suit, the plaintiff's grounds for recovery are limited to those grounds set forth in the claim for refund on which the suit is based. United States v. Felt & Tarrant Mfg. Co., 283 U.S. 269, 272 [9 AFTR 1416] (1931). The statement of grounds in a claim for refund must state “in detail each ground upon which a credit or refund is claimed and facts sufficient to apprise the Commissioner of the exact basis thereof.” 26 C.F.R. § 301.6402-2(b). Thus, the claim must contain “sufficient information to allow the Commissioner to address the merits of the dispute.” Beckwith Realty, Inc. v. United States, 896 F.2d 860, 863 [65 AFTR 2d 90-757] (4th Cir. 1990). The Service should not need to “hazard a guess” as to the amount or reason that the taxpayer was seeking a refund. Id. at 862. <br />
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The claim for refund on which Plaintiff bases the instant case is little more than a “hodge-podge” with a listing of Internal Revenue Code 4 Sections that, for the most part, have no conceivable materiality. Moreover, Plaintiff adds to each identification of specific Code sections, the ineffectual mantra “or any other applicable provision of the IRC.” See IA 80 Group, Inc. v. United States, 347 F.3d 1067, 1075 [92 AFTR 2d 2003-6714] n.9 (8th Cir. 2003)(“A general objection and demand for refund would in fact encompass all conceivable grounds for a refund, but the IRS is not required to ferret out on its own the specific claims advanced by the taxpayer.”) <br />
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The Court will address each ground for recovery stated in Plaintiff's claim for refund. In so doing, the Court will determine only whether there is a basis for recovery of an overpayment of Bowen's 2006 federal income tax liability by virtue of a ground stated in the claim for refund at issue. The Court is not addressing whether there could be some basis for recovery of an overpayment of Bowen's federal income tax liability for some other year or on a ground that might have been set forth in some other claim for refund. <br />
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C. Asserted Grounds For Recovery<br />
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1. “Damaged Inventory”<br />
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The claim for refund states: <br />
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The taxpayer is deceased; and, additional information has come to light to amend the 2006 tax return as originally filed to include a deduction for a business loss.<br />
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So this return amends the 2006 original return by including a deduction [for] 2006 for a business loss for damaged inventory. The deduction was erroneously omitted from and not previously taken on the 2006 Income Tax Return as originally filed.<br />
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As discussed at the hearing on the instant motions, the claim for “damaged inventory” is a claim that the Boat constituted inventory of Bowen's boat business that became worthless at the end of the year 2006. Hence, it is claimed, Bowen would have been entitled to a 2006 deduction by virtue of marking down its inventory from the cost of the Boat to its end of year fair market value. Thus, Plaintiff claims that Bowen was entitled to a cost of goods sold deduction on his Schedule C because his end of year inventory was worthless. <br />
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The Court will assume, but by no means finds, that Plaintiff has submitted evidence sufficient to prove that Bowen was engaged in a business cognizable for income tax purposes and that the Boat could properly be considered to be inventory of that business. Nevertheless, the Government is entitled to summary judgment with regard to the “damaged inventory” loss claim. <br />
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First, and conclusively, Plaintiff manifestly has not presented evidence sufficient to prove that the value of the Boat was zero at the end of 2006. Plaintiff has presented no appraisal or other evidence sufficient to establish that the Boat had no value, 5 or what was the fair market value of the Boat as of the end of 2006. <br />
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Furthermore, the Amended Return that constitutes the claim for refund on which the suit is based includes an election that does not permit an inventory mark down deduction. The alleged boat business is reported as “Ferro Yachts” on Schedule C. Any inventory markdown deduction must be reported in connection with Part III, Cost of Goods Sold. This section calls for the reporting of, among other things, “inventory at beginning of the year” (line 35), purchases (line 36) and “inventory at end of year” (line 41). <br />
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Plaintiff left blank the line for opening inventory which, as Plaintiff argues is correct in that there was no opening inventory. Plaintiff left blank the line for closing inventory which, as Plaintiff argues, is correct if the closing inventory had no value. Plaintiff also left blank the line for purchases which is not correct. However, since there is an entry in the Other Expenses category for “Inventory Damage Loss” of $1,030,917 (an amount that includes, but is not limited to, what was actually paid for the Boat), the Court will assume that this could constitute substantial compliance with the need to report purchases. <br />
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However, Plaintiff did not leave blank the line requiring the statement of “Method(s) used to value closing inventory” (line 33). On this line, Plaintiff elected “Cost” and not “Lower of cost or market.” Therefore, the closing inventory had to be reported at cost. Accordingly, even if Plaintiff had established that the Boat had a year-end value lower than its cost, there would still be no “damaged inventory” deduction. <br />
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2. “Stock in Trade”<br />
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The claim for refund states: <br />
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Alternatively, if the expenditures may not be deducted in 2006 as a business loss for damaged inventory, then<br />
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the expenditures may be capitalized as:<br />
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stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business and written down to lower of cost or market at year end ...<br />
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To the extent that this can be comprehended, it appears to be duplicative of the “damaged inventory” ground. <br />
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Even if there could be some valid legal theory found in the foregoing verbiage, however, the theory would be based upon the contention that the Boat had a lower value than its cost as of the end of 2006. Any such claim would fail due to the absence of proof of the end of year fair market value and also the election to value inventory at cost rather than the lower of cost or market. <br />
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3. “Capitalization”<br />
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The claim for refund states: <br />
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Alternatively, if the expenditures may not be deducted in 2006 as a business loss for damaged inventory, then<br />
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the expenditures may be capitalized as:<br />
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....<br />
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property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in Internal Revenue Code Section(s) (hereafter “IRC”) 167 and or IRC 1245 or real property used in his trade or business under IRC 1250; and or depreciated under IRC 167, 168, 179 and or any other applicable provision of the Internal Revenue code as amended, and or amortized under IRC 195 and or any other applicable provision of the Internal Revenue code as amended ...<br />
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a. § 167 (Depreciation)<br />
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Section 167(a) of the Code provides: <br />
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(a) There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) - <br />
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((1)) of property used in the trade or business, or <br />
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((2)) of property held for the production of income. <br />
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The Court will assume that Plaintiff can prove that the Boat was, as of the end of 2006, property either used in Bowen's trade or business or held for the production of income. Thus, it is assumed that the Boat could be depreciable property. However, the right to a depreciation deduction does not commence until the depreciable property is placed in service. The term “placed in service,” means the time that property is first placed by the taxpayer “in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income, in a tax-exempt activity, or in a personal activity.” 26 C.F.R. § 1.167(a)-11(e)(1)(i); see also 26 C.F.R. § 1.179-4(e). <br />
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Plaintiff has not produced evidence adequate to prove that the Boat was put in service before the end of 2006. Indeed, it is undisputed that the Boat was unloaded in North Carolina from the freighter bringing it from China on or about December 28, 2006. The Boat was not even inspected in North Carolina until early January 2007 and was then sailed to Maryland where various remedial measures, continuing through 2009, were necessary. <br />
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Furthermore, even if there were, somehow, found to be proof that Bowen was entitled to some depreciation deduction for 2006, Plaintiff has not presented evidence adequate to prove the amount of depreciation that would be allowable for the year. 6 <br />
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b. § 168 (Accelerated Cost Recovery)<br />
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Code Section 168 relates to a taxpayer's ability to accelerate the rate of depreciation of certain depreciable property. Plaintiff does not explain how this provision enabled Bowen to have any depreciation deduction at all for the Boat in 2006. <br />
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c. § 1245 (Disposition Gain)<br />
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Code Section 1245 relates to the treatment of gain from dispositions of certain depreciable property. There was no disposition of the Boat in 2006. Plaintiff does not explain how there can be a basis for recovery under this provision. <br />
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d. § 1250 (Disposition of Realty)<br />
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Code Section 1250 relates to gain from dispositions of certain depreciable realty. Plaintiff does not explain how the Boat could be considered to be “realty” in 2006 or in any year and/or even if it were realty, how there could be some basis for recovery under this provision. <br />
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e. § 178 (Disposition of Depreciable Property)<br />
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Code Section 178 relates to gain from dispositions of certain depreciable property. There was no disposition of the Boat in 2006. Plaintiff does not explain how there can be any basis for recovery under this provision. <br />
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f. § 179 (Expensing Depreciable Assets)<br />
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Code Section 179 relates to an election to expense the cost of certain depreciable business assets. As discussed above, the Boat was not, in 2006, a depreciable business asset. Plaintiff does not explain how there is some basis for recovery under this provision. <br />
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g. § 195 (Start-Up Expenditures)<br />
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Code Section 195 relates to start-up expenditures and, in essence, allows a taxpayer to defer certain deductions. Plaintiff does not explain how this provision has any pertinence to the instant case or how it could benefit from deferring from 2006 to a later year any deductions to which Bowen may have been entitled. <br />
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4. §§ 172, 174, and 163<br />
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The claim for refund states, as alternative grounds for recovery: <br />
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the expenditures may be deducted under 172, 174, 163 ...<br />
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a. § 172 (Net Operating Loss)<br />
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Section 172(a) provides, in pertinent part: <br />
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There shall be allowed as a deduction for the taxable year an amount equal to the aggregate of (1) the net operating loss carryovers to such year, plus (2) the net operating loss carrybacks to such year.<br />
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Generally, a net operating loss can be carried forward from a prior year and back from a later year. The carry forward can be to each of the 20 years following the loss year and the carryback can be “to each of the 2 [or 3 7] taxable years preceding the taxable year of such loss.” § 172(b)(1)(A). <br />
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The claim for refund does not specify the taxable year or years from which a net operating loss would be carried forward or back to 2006. Literally, then, the claim would include a carry forward from any of the years 20 years before and 2 or 3 years after 2006. Even if construed as limited to carrybacks, the claim for refund does not specify which of the returns for the years 2007, 2008, and/or 2009 must be examined to determine the amount of any “carryable” net operating loss. <br />
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This alone is sufficient reason to grant summary judgment to the Government in regard to whatever is meant by Plaintiff's reference to § 172 in the claim for refund. <br />
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The Court notes the Government's apparently meritorious contention that a refund claim for a net operating loss deduction must be made on an amended tax return for the net operating loss year and not for the year to which the loss is to be carried. Plaintiff did not directly address this contention but filed, in March 2012, a Form 1040-X for 2009 claiming a net operating loss carryback from 2009 to 2006. The Government contends that this 2009 refund claim was untimely. It suffices, for present purposes, to note that the 2009 1040-X refund claim is not part of the instant case. If and when Plaintiff files a tax refund suit based on that claim, its validity shall be resolved in due course. <br />
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Finally, even if the claim for refund at issue should, somehow, be considered adequate to specify a claim for a net operating loss carryback to 2006 from some other year or years, Plaintiff has not presented evidence adequate to establish the amount of any net operating loss from any year that could be carried back to 2006. <br />
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b. § 174 (Research and Experimental Deductions)<br />
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Code Section 174 relates to research and experimental expenditures and, in essence, allows a deduction for such expenditures that might otherwise be capitalized. However, § 174(e) provides: “This section shall apply to a research or experimental expenditure only to the extent that the amount thereof is reasonable under the circumstances.” <br />
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Plaintiff has not presented evidence adequate to establish that the amount paid in 2006 for the acquisition of the Boat was a reasonable expenditure for research and experimental purposes. <br />
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c. § 163 (Interest)<br />
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Section 163 provides for a deduction for interest paid on indebtedness. Plaintiff does not, however, contend that Bowen paid any deductible interest in 2006 and does not explain how § 163 is pertinent to the instant case. <br />
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5. “Capitalization”<br />
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The refund claim states, as another alternative: <br />
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the expenditures may be capitalized as a capital asset under IRC 1221 deducted as expenses related to the production of income under IRC 212 ...<br />
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a. § 1221 Capital Asset<br />
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Section 1221 states: <br />
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((a)) In general <br />
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For purposes of this subtitle, the term “capital asset” means property held by the taxpayer (whether or not connected with his trade or business), but does not include — <br />
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((1)) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; <br />
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((2)) property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in section 167, or real property used in his trade or business; <br />
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Plaintiff does not explain how this section, applicable if the Boat were not treated as inventory or property used in Bowen's trade or business, could provide a basis for some deduction for the year 2006. <br />
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b. § 212 (General Deduction Provision)<br />
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Section 212 states: <br />
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In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year — <br />
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((1)) for the production or collection of income; <br />
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((2)) for the management, conservation, or maintenance of property held for the production of income; or <br />
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((3)) in connection with the determination, collection, or refund of any tax. <br />
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The Section does not, itself, define, increase, or decrease deductions allowable by other Code Sections. Plaintiff does not explain how this provision would provide a ground for a tax refund. <br />
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6. “Decrease in Value”<br />
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The claim for refund states as another alternative: <br />
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the decrease in value of the expenditures may be allowed as losses under IRC 165, 166 ...<br />
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a. § 165 (Casualty Loss)<br />
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Section 165 states: <br />
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There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.<br />
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As relevant hereto, § 165(h) provides a deduction for a loss from a “casualty.” To qualify as a “casualty,” a loss must be “due to sudden, unexpected, or unusual events as opposed to a gradually developed result, such as one that occurs through normal operation and deterioration.” Smith v. Comm'r, 608 F.2d 321, 322 [44 AFTR 2d 79-6040] (8th Cir. 1979). <br />
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Plaintiff contends that Bowen sustained a casualty loss because the Boat was damaged by waves while in transit from China to North Carolina. <br />
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It is true that damages caused by waves as alleged by Plaintiff would constitute damage caused by a casualty for § 165 purposes. However, Plaintiff has not presented admissible evidence adequate to prove that the Boat was damaged by waves while en route to the United States. The only “evidence” that there was casualty damage consists of out of court (hearsay) statements alleged made by boat crew members. <br />
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Moreover, even if Plaintiff were to prove that there had been a casualty, Plaintiff has not presented evidence adequate to establish the amount of damage caused by the casualty as distinct from the damage caused by defective manufacturing. <br />
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In addition, there is a timing issue. A casualty loss is deductible only after it can be ascertained with reasonable certainty whether or not reimbursement — such as from an insurer - will be received. 26 C.F.R. § 1.165-1(d). It is undisputed that, until 2009, Bowen was pursuing a claim for the damage occurring during shipment from an insurer. Hence, there can be no 2006 casualty loss deduction for such damage. See D.L. White Constr., Inc. v. Comm'r, 2010 T.C.M. 141, 2010 WL 2595080 [TC Memo 2010-141], 4 (T.C. 2010)(disallowing the loss to be deducted in 2002 when insurance proceeds were received in 2004). <br />
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Finally, a casualty loss is deductible only to the extent the loss is “not compensated for by insurance or otherwise.” There is no doubt that Bowen recovered $120,000 from an insurer in settlement of his claim for damage occurring while the Boat was en route, i.e., during the time when any casualty would have occurred. Plaintiff has not presented evidence adequate to prove that any damage from a casualty exceeded $120,000. <br />
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b. § 166 (Bad Debt)<br />
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Section 166 provides for a deduction for a debt that becomes worthless during the taxable year. Plaintiff does not explain how this provision can have any relevance to the instant case. <br />
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IV. CONCLUSION<br />
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For the foregoing reasons: <br />
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(1.) The United States' Motion for Summary Judgment [Document 8] is GRANTED. <br />
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(2.) Plaintiff's Motion for Summary Judgment [Document 15] is DENIED. <br />
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(3.) Judgment shall be entered by separate Order. <br />
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SO ORDERED, on Monday, July 23, 2012. <br />
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Marvin J. Garbis <br />
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United States District Judge <br />
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1<br />
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Through a holding company. <br />
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Flora v. United States, 362 U.S. 145 [5 AFTR 2d 1046] (1960). <br />
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All § references herein are to the Internal Revenue Code, Title 26 of the United States Code, unless otherwise stated. <br />
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References herein to “Code” are to the Internal Revenue Code, Title 26, United States Code. <br />
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The Boat, with all of its problems, was sufficiently functional to sail, on its own, from North Carolina to Maryland in early 2007. <br />
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6<br />
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Indeed, even on the most extreme assumption - that the Boat was “in service” the minute it was unloaded from the freighter - there would be some 3 days of depreciation in 2006. <br />
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7<br />
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In certain circumstances, 3 taxable years may be allowed. § 172 (b)(1)(F). <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-58380505234914797852012-08-04T13:52:00.002-04:002012-08-04T13:52:55.221-04:00Lawyer CurrencyU.S. v. CONEY, Cite as 110 AFTR 2d 2012-XXXX, 07/24/2012 <br />
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UNITED STATES OF AMERICA, Plaintiff-Appellee v. BARBARA SUSAN CONEY, also known as Barbara Susan Chenoweth Coney, Individually and in her capacity as Executrix of the Succession of Curtis John Coney, Jr., Defendant-Appellant.<br />
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Case Information: <br />
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Code Sec(s): <br />
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Court Name: IN THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT, <br />
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Docket No.: No. 11-30387, <br />
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Date Decided: 07/24/2012. <br />
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Prior History: <br />
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Disposition: <br />
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HEADNOTE <br />
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Reference(s): <br />
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OPINION <br />
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IN THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT, <br />
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Appeals from the United States District Court for the Eastern District of Louisiana <br />
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Before GARZA, DENNIS, and HIGGINSON, Circuit Judges. <br />
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Judge: EMILIO M. GARZA, Circuit Judge: <br />
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The Government filed suit against Defendant-Appellant, Barbara Coney, to reduce to judgment the tax liability owed by Barbara and her deceased husband, Curtis, for the tax years 1996–2001. The district court granted summary judgment in favor of the Government and rendered judgment in the amount of $2,687,408.59. Barbara appeals, primarily claiming that the couple's tax liability had been discharged in a prior bankruptcy proceeding. We AFFIRM. <br />
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I<br />
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Curtis was the sole shareholder of CLS, Inc. (“CLS”), a law firm that primarily represented plaintiffs seeking to recover damages arising from automobile accidents. Because CLS was a Subchapter S corporation, Curtis and Barbara were required to report the firm's income on their joint income tax returns, regardless of whether that income was actually distributed to them during the tax year. See Nail v. Martinez, 391 F.3d 678, 683 (5th Cir. 2004); Green v. Comm'r of Internal Revenue, 963 F.2d 783, 786 [70 AFTR 2d 92-5077] (5th Cir. 1992). <br />
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The present action concerns the Coneys' joint income tax liabilities for the 1996–2001 tax years. The Coneys did not enter into an installment agreement with respect to those liabilities. The couple was required to make estimated tax payments for the relevant years, see 26 U.S.C. § 6654(d), but they did not make all or part of their estimated tax payments during any of those years. Further, although the Coneys did file a joint tax return for each of the relevant years, they did not pay the balance of their tax liability when filing their returns. Similarly, throughout the relevant tax years, Curtis consistently withheld insufficient amounts of tax from his income to meet his personal income tax liability. In total, the Coneys reported $7,503,795 of income on their joint returns for the tax years 1996 to 2001. Of this total, $1,418,584 was paid to Curtis in the form of wages; the remainder was income earned by CLS that was required to be included on the Coneys' personal returns. Because the Coneys failed to tender payment of the balance of their tax liability when filing their returns, the couple's returns declared that they owed at the time of filing a total of $1,619,951 to the Internal Revenue Service (“IRS”) for the relevant years. <br />
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The IRS assessed the outstanding taxes reported on the Coneys' 1996–2001 returns, along with interest and penalties. Beginning in 1997, the IRS also began to file liens in the public record to secure the couple's tax liabilities. The Coneys retained an attorney to assist them with negotiating a second installment agreement with the IRS. 1 As part of that representation, the Coneys' attorney provided the IRS with a list of CLS's pending cases and advised the agency that the couple would use the firm's fees from those cases to pay down the balance of the couple's 1994 and 1996 tax liabilities. However, subsequent bank records show that the couple did not use a $245,000 fee that the firm received from one of the listed cases in 2001 to pay down the couple's tax liabilities. <br />
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During the relevant tax years, CLS engaged in a high volume of cash transactions. Between 1998 and 2001, CLS employees made cash withdrawals totaling $2,116,929 from the firm's operating account, nearly 30% of the firm's gross receipts during the period. Throughout the relevant tax years, Curtis used some of this cash to pay illegal kickbacks to “runners” in exchange for client referrals. In an effort to conceal the illegal kickbacks from the Government, Curtis instructed CLS's staff from 1997 to 2001 to write checks to cash, either singly or in the aggregate, in amounts less than $10,000 per day. When a depositor withdraws more than $10,000 in currency during one business day, 31 U.S.C. § 5313(a) and its implementing regulations require financial institutions to file a report with the Commissioner of Internal Revenue. See 31 C.F.R. §§ 1010.306(a)(3), 1010.311, 1010.313. Structuring cash transactions to avoid the reporting requirements is a crime. 31 U.S.C. § 5324(a)(3), (d). <br />
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Eventually, a federal grand jury was empaneled to investigate possible criminal behavior on the part of various parties involved in the litigation of personal injury cases in Louisiana. Kathy Martino, a legal assistant employed by CLS, was subpoenaed to testify to the grand jury. Curtis had previously instructed Martino to write checks to cash on the firm's account in a manner that would avoid the federal currency transaction reporting requirements. After learning that Martino had been subpoenaed to testify, Curtis and Barbara asked Martino to meet with them at their home. At the meeting, which was recorded by Martino with the assistance of federal agents, both Curtis and Barbara “sought to influence Ms. Martino's grand jury testimony by urging her to testify falsely to the grand jury.” In particular, both Coneys instructed Martino “to feign ignorance in response to any grand jury questions regarding the specific operations of [CLS], including using runners and paying them through structured transactions.” <br />
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In October 2002, the grand jury returned an indictment charging Curtis with (a) one count of conspiracy to structure financial transactions in violation of 31 U.S.C. § 5324 from 1997 to 2001, (b) ten counts involving ten separate incidents of structuring financial transactions in violation of 31 U.S.C. § 5324 from 1997 to 2001, and (c) one count of obstruction of justice for attempting to influence Martino's grand jury testimony. The grand jury also returned an indictment charging Barbara with one count of obstruction of justice for attempting to influence Martino's grand jury testimony. In 2003, Curtis and Barbara pleaded guilty to all the counts charged against them. In the factual basis supporting their pleas, the couple admitted that Curtis had specifically instructed Martino “never to write checks to cash on the law firm's operating account amounting to more than $10,000 in one day so as not to trigger the statutory reporting requirements.” The couple also admitted that Martino paid the runners at the direction and instructions of Curtis “and with the full knowledge of his wife, Barbara.” <br />
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In April 2005, the IRS notified the Coneys of its intent to levy on the couple's assets to collect their outstanding liabilities for the tax years 1996–1998. A few months later, the Coneys filed a petition for Chapter 7 bankruptcy relief. The bankruptcy court eventually entered an order granting the Coneys a discharge of their debts under 11 U.S.C. § 727. The couple did not seek a determination of whether their tax liabilities were dischargeable, and the bankruptcy court closed the bankruptcy case. <br />
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After the bankruptcy court entered the discharge order, the Government filed the instant suit to reduce the Coneys' unpaid tax assessments to judgment. Curtis died while the case was pending in the district court, so the court substituted Barbara as a party in her capacity as executrix of Curtis's estate, in addition to her status as defendant in her individual capacity. The Government moved for summary judgment, contending that the Coneys' tax liabilities were excepted from the bankruptcy court's discharge order under 11 U.S.C. § 523(a)(1)(C). Section 523(a)(1)(C) provides that “[a] discharge under section 727 ... of this title does not discharge an individual debtor from any debt ... for a tax ... with respect to which the debtor ... willfully attempted in any manner to evade or defeat such tax.” The Coneys opposed the motion, asserting that the taxes were not excepted from discharge under § 523(a)(1)(C). <br />
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The district court granted the Government's motion for summary judgment, holding that the Coneys' tax liabilities for the relevant tax years were not dischargeable. The district court concluded that the Coneys had willfully attempted to evade and defeat their tax debts by knowingly and intentionally (1) “structur[ing] the runner transactions to evade the [federal currency transaction reporting requirements], the natural and inescapable consequences of which was to conceal those substantial cash transactions from the IRS” and (2) “attempt[ing] to influence a grand jury witness to conceal the structuring scheme, which itself concealed the existence of the cash transactions from the IRS.”United States v. Coney , No. 08–1628, 2011 WL 1103631 [107 AFTR 2d 2011-1414], at 6 (E.D. La. Mar. 22, 2011). After receiving proposed orders from the parties regarding the proper calculation of interest, the district court rendered judgment for the Government in the amount of $2,687,408.59, plus post-judgment interest. This appeal followed. <br />
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II<br />
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On appeal, Barbara claims that the district court erred by concluding that she and Curtis willfully attempted in any manner to evade or defeat the payment of their taxes for the relevant years. She contends that the Government failed to establish that either of the Coneys (1) committed an affirmative act in violation of their duty to pay taxes or (2) willfully committed such an affirmative act. Alternatively, Barbara asserts that even if the Government met its burden as to Curtis under § 523(a)(1)(C), the Government did not establish that she willfully attempted to evade taxation. She also contends that even if the district court did not err in granting summary judgment for the Government, the court erred by awarding a money judgment in an improper amount. <br />
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We review a grant of summary judgment de novo, applying the same standard as the district court. Harrigill v. United States, 410 F.3d 786, 789 [95 AFTR 2d 2005-2626] (5th Cir. 2005). “Summary judgment is proper when the record, viewed in the light most favorable to the nonmoving party, demonstrates that no genuine issue of material fact exists and that the movant is entitled to judgment as a matter of law.” Id. (citing Fed. R. Civ. P. 56(c); Blow v. City of San Antonio, 236 F.3d 293, 296 (5th Cir. 2001)). <br />
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A<br />
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“When a Chapter 7 debtor obtains bankruptcy relief, the general rule is that all debts arising prior to the filing of the bankruptcy petition will be discharged.” In reBruner , 55 F.3d 195, 197 [76 AFTR 2d 95-5024] (5th Cir. 1995) (citing 11 U.S.C. § 727(b)). However, to ensure that the Bankruptcy Code's “fresh start” policy is only available to “honest but unfortunate debtor[s],” Congress has provided that certain types of liabilities are excepted from the general rule of discharge. In re Fretz, 244 F.3d 1323, 1326 [87 AFTR 2d 2001-1380]–27 (11th Cir. 2001) (quoting Grogan v. Garner, 498 U.S. 279, 286 [70 AFTR 2d 92-5639]–87 (1991)); see also Bruner, 55 F.3d at 197. We strictly construe exceptions to the general rule of discharge in favor of the debtor, In reCross , 666 F.2d 873, 879–880 (5th Cir. 1982);see also Fretz , 244 F.3d at 1327 (collecting cases), and the party arguing against dischargeability bears the burden of proving the application of an exception by a preponderance of the evidence. In re Grothues, 226 F.3d 334, 337 [86 AFTR 2d 2000-5780] (5th Cir. 2000). <br />
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11 U.S.C. § 523(a)(1)(C) is one such exception. It provides: <br />
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((a)) A discharge under section 727 ... of this title does not discharge an individual debtor from any debt— <br />
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((1)) for a tax ...— <br />
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((C)) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax[.] <br />
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11 U.S.C. § 523(a)(1)(C). <br />
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Section 523(a)(1)(C) creates two exceptions to discharge—when a debtor files a fraudulent return and when a debtor “willfully attempt[s] in any manner to evade or defeat [a] tax.” The central issue in this appeal is whether the district court properly determined that both Coneys “willfully attempted” to evade or defeat their taxes for the relevant tax years. <br />
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Although we have not previously had to explicitly address the issue, we agree with our sister circuits that the plain language of the “willfully attempted” exception “contains a conduct requirement (that the debtor “attempted in any manner to evade or defeat [a] tax”), and a mental state requirement (that the attempt was done “willfully”).”Fretz , 244 F.3d at 1327 (citing In reFegeley , 118 F.3d 979, 983 [80 AFTR 2d 97-5268] (3d Cir. 1997)). Because Barbara contends that the district court applied the wrong standard when deciding the dischargeability issue under both the conduct and the mental state prongs, we begin by determining the proper standard under each. <br />
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First, Barbara asserts that the district court misinterpreted our opinion in Bruner and applied the wrong standard when analyzing whether the Coneys' actions satisfied the conduct requirement of § 523(a)(1)(C). She claims that the conduct prong required the Government to establish that the Coneys committed “affirmative acts in contravention of their duty to pay [their] taxes.” In short, Barbara asserts that because the Coneys filed accurate tax returns, attempted to pay their taxes to the best of their abilities, and did not conceal their income or assets, the couple did not engage in conduct that constituted an attempt to evade or defeat their taxes. <br />
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We disagree with Barbara's analysis of § 523(a)(1)(C)'s conduct requirement. Her argument implicitly assumes that a willful attempt to evade or defeat taxes must consist of an attempt to evade the assessment of taxes rather than the payment or collection thereof. Although we have not previously addressed the validity of her assumption, the bulk of federal authority considering the issue has held that § 523(a)(1)(C)'s conduct requirement applies equally to attempts to evade or defeat the collection and payment of a tax. See In re Griffith, 206 F.3d 1389, 1395 [85 AFTR 2d 2000-1249]–96 (11th Cir. 2000) (en banc) (overturning In re Haas, 48 F.3d 1153 [75 AFTR 2d 95-1585] (11th Cir. 1995), in part, and holding that the conduct requirement of § 523(a)(1)(C) is satisfied where debtors engage in affirmative acts to avoid payment or collection of taxes); Dalton v. I.R.S., 77 F.3d 1297, 1301 [77 AFTR 2d 96-1487] (10th Cir. 1996) (holding that conduct requirement includes attempts to conceal assets to avoid the payment or collection of taxes). For the following reasons, we agree with the majority position. <br />
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We begin, as we must, with the plain language of § 523(a)(1)(C). See Carder v. Cont'l Airlines, Inc., 636 F.3d 172, 175 (5th Cir. 2011). The statute excepts “such taxes” from discharge that the debtor “willfully attemptedin any manner to evade or defeat.” 11 U.S.C. § 523(a)(1)(C) (emphasis added). By using the unqualified phrase “in any manner” to modify a debtor's “willful attempts” to evade or defeat his taxes, the plain language of the statute suggests that “willful attempts” under § 523(a)(1)(C) include attempts to evade or defeat the payment or collection of a tax. See Dalton, 77 F.3d at 1301 (“[T]he modifying phrase “in any manner” is sufficiently broad to include willful attempts to evade taxes by concealing assets to protect them from execution or attachment.”) (quoting In re Jones, 116 B.R. 810, 814 (Bankr. D. Kan. 1990)). The plain language of the statute offers no reason to conclude that “willful attempts” only refer to attempts to evade the assessment of tax, but not the collection or payment thereof. <br />
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This broad reading of § 523(a)(1)(C) comports with the manner in which federal courts have interpreted similar language in the Internal Revenue Code. See Spies v. United States, 317 U.S. 492, 499 [30 AFTR 378] (1943) (interpreting the predecessor of 26 U.S.C. § 7201, which criminally sanctioned “[A]ny person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof ....”); id. (“Congress did not define or limit the methods by which a willful attempt to defeat and evade might be accomplished and perhaps did not define lest its effort to do so result in some unexpected limitation. Nor would we by definition constrict the scope of the Congressional provision that it may be accomplished “in any manner.””). 2 <br />
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Further, the surrounding statutory language buttresses our interpretation of the conduct requirement because a contrary ruling would render the language creating the “willfully attempted” exception from discharge largely superfluous.See Hibbs v. Winn , 542 U.S. 88, 101 (2004) (“[W]e follow “the cardinal rule that statutory language must be read in context since a phrase gathers meaning from the words around it.””) (citation omitted);id. (“A statute should be construed so that effect is given to all its provisions, so that no part will be inoperative or superfluous, void or insignificant.”) (citation omitted). In particular, other portions of § 523(a)(1) specifically except tax debts from discharge with respect to which the debtor did not file a required return, 11 U.S.C. § 523(a)(1)(B)(I), or “made a fraudulent return.”Id. § 523(a)(1)(C). Thus, if we were to interpret the conduct requirement to only apply to attempts to evade or defeat the assessment of tax, it is not clear what purpose the relevant language would serve; it is difficult to conceive how a debtor could willfully attempt to evade the assessment of a tax other than by failing to file or filing a fraudulent tax return. Griffith, 206 F.3d at 1395;Dalton , 77 F.3d at 1301. <br />
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Moreover, construing the conduct requirement in § 523(a)(1)(C) to apply to attempts to evade or defeat the payment or collection of taxes is supported by the “basic policy animating the Code of affording relief only to an “honest but unfortunate debtor.”” See Cohen v. de la Cruz, 523 U.S. 213, 217 (1998) (describing policy of Bankruptcy Code) (citations omitted). “[A]ny statutory interpretation of “evade or defeat” which relieves the dishonest debtor who conceals assets to avoid the payment or collection of taxes, but which penalizes the same dishonesty to avoid assessment, would be an absurd result.” Dalton, 77 F.3d at 1301. <br />
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Lastly, our interpretation of the conduct requirement does not conflict with our prior holding in Bruner. Although in Bruner we distinguished the Bruners' actions from those of the debtor in Haas on the grounds that the Bruners “were involved in much more flagrant conduct aimed at avoiding even the imposition of a tax assessment against them,” Bruner, 55 F.3d at 200, we did not hold that the conduct requirement only applied to attempts to evade the assessment of tax. Indeed, in Bruner we appeared to have determined that the Bruners' tax debts were ineligible for discharge, in part, because they had engaged in conduct that could be construed as attempts to avoid payment or collection of tax. See id. (“Moreover, they apparently conducted an inordinate number of cash transactions and even created a shell entity designed to conceal their income and assets.”). <br />
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Accordingly, we hold that the conduct requirement of § 523(a)(1)(C) includes willful attempts to evade or defeat the payment or collection of taxes, in addition to their assessment. 3 <br />
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2<br />
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Second, Barbara asserts that the district court applied an improper standard when determining that the Coneys' actions satisfied § 523(a)(1)(C)'s mental state requirement—i.e., that their attempts to evade or defeat their taxes were done “willfully.” Barbara concedes that Curtis directed his employees to structure transactions to avoid federal currency reporting requirements and that they both attempted to interfere with the grand jury's investigation of Curtis's activities; however, she alleges that those actions did not satisfy § 523(a)(1)(C)'s mental state requirement because neither Coney took those actions with the specific intent to evade or defeat their taxes. In short, she asserts that § 523(a)(1)(C)'s mental state prong requires that a debtor take an action with the specific intent to “thwart” the IRS's efforts to assess, collect, or secure payment of a debtor's taxes. <br />
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We disagree. Our sister circuits have uniformly concluded that “a debtor's attempt to avoid his tax liability is considered willful under § 523(a)(1)(C) if it is done voluntarily, consciously or knowingly, and intentionally,” and have declined to require that a debtor engage in such an attempt with the specific intent to defraud the IRS. Fretz, 244 F.3d at 1330 (citing In re Tudisco, 183 F.3d 133, 137 [84 AFTR 2d 99-5265] (2d Cir. 1999); Fegeley, 118 F.3d at 984; In reBirkenstock , 87 F.3d 947, 952 [78 AFTR 2d 96-5229] (7th Cir. 1996);Dalton , 77 F.3d at 1302; In re Toti, 24 F.3d 806, 809 [73 AFTR 2d 94-2022] (6th Cir. 1994)). We implicitly adopted that position in Bruner by applying the three-part test for civil willfulness under the Internal Revenue Code to determine whether the debtors in that case “willfully attempted” to evade or defeat their taxes. See Bruner, 55 F.3d at 197, n.4; see also Fegeley, 118 F.3d at 984 (declining to interpret the willfulness language in § 523(a)(1)(C) “consistently with the criminal provisions of the Internal Revenue Code,” which require proof of fraud); Toti, 24 F.3d at 809 (holding “that the definition of “willfully attempted to evade” was consistent with the definition found in other civil tax cases, which equates “willful” with voluntary, conscious, and intentional evasions of tax liabilities”) (citations omitted). <br />
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Accordingly, all the Government has to establish in order to satisfy § 523(a)(1)(C)'s mental state requirement is that the debtor (1) had a duty to pay taxes under the law, (2) knew he had that duty, and (3) voluntarily and intentionally violated that duty. Bruner, 55 F.3d at 197;Fretz , 244 F.3d at 1330. To satisfy the third prong of this test, the Government need only establish that a debtor voluntarily and intentionally committed or attempted to commit an affirmative act or culpable omission that, under the totality of the circumstances, constituted an attempt to evade or defeat the assessment, collection, or payment of a tax; the debtor need not have made their attempt with the specific intent to defraud the IRS. See Fretz, 244 F.3d at 1330 (holding that the willfulness language in § 523(a)(1)(C) does not require fraudulent intent) (citing Fegeley, 118 F.3d at 984); Birkenstock, 87 F.3d at 952 (“This willfulness requirement prevents the application of the exception to debtors who make inadvertent mistakes, reserving nondischargeability for those whose efforts to evade tax liability are knowing and deliberate.”). <br />
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B<br />
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1<br />
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Applying these standards to Curtis, we conclude that he willfully attempted to evade or defeat his tax liabilities for the 1996–2001 tax years under § 523(a)(1)(C). <br />
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First, given the context of Curtis's interactions with the IRS, we hold that his attempts to (1) structure cash transactions to avoid federal reporting requirements and (2) obstruct the Government's investigation of his activities satisfied § 523(a)(1)(C)'s conduct requirement. Specifically, while the Coneys were incurring significant unpaid tax liabilities, attempting to negotiate payment plans with the IRS, and seeking to stave off collection proceedings by promoting the continued viability of Curtis's law firm to the IRS, Curtis was directing his employees to engage in a high volume of cash transactions and to illegally structure those transactions in a manner that would hide them from the Government. Further, Curtis appeared to have ordered the bulk of these transactions in order to acquire cash to illegally pay runners to generate cases for his firm—payments which Curtis contends he did not deduct from income on his tax returns as business expenses. <br />
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Under these circumstances, we agree with the district court that Curtis's efforts to circumvent the federal currency transaction reporting requirements defeated the IRS's ability to collect his tax liabilities and therefore constituted attempts to evade or defeat collection and payment of his taxes. As a general matter, the currency transaction reports provide the IRS with a valuable tool in pursuing the collection and payment of delinquent tax liability. The Bank Secrecy Act (“BSA”) and its implementing regulations require financial institutions to send a report to the IRS when a depositor withdraws more than $10,000 in currency during one business day. See 31 U.S.C. § 5313(a); 31 C.F.R. §§ 1010.306(a)(3), 1010.311, 1010.313. Congress enacted the BSA, in part, because it was concerned with the problem of tax evasion. Ca. Bankers Ass'n v. Schultz, 416 U.S. 21, 27 [33 AFTR 2d 74-1041]–29 (1974). Moreover, Congress has found and the Secretary of the Treasury has determined that currency transaction reports “have a high degree of usefulness in ... tax ... investigations or proceedings.” 12 U.S.C. § 1829b; 31 C.F.R. § 1010.301. <br />
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Although not every attempt to avoid the currency transaction reporting requirements may constitute an attempt to evade or defeat a tax, we conclude that Curtis's structuring activities satisfied the conduct requirement. Specifically, given the high volume of cash transactions performed at Curtis's instructions, the illegal purpose for which Curtis used much of that cash, the Coneys' significant outstanding tax liability during the years in question, and the Coneys' attempt to forestall collection of their tax debts by highlighting the prospects of Curtis's law firm, the currency transaction reports would have been particularly relevant to the IRS in this case. If the IRS had received reports notifying it of the volume of cash withdrawals from CLS's operating account that were not being deducted as business expenses, it is reasonable to conclude that the IRS would have investigated and instituted collection proceedings years earlier. At the very least, the broad scope and five-year duration of Curtis's structuring activities allowed him to shift significant assets out of the couple's possession in a manner that concealed the movement from the IRS and has prevented the agency from tracing how those assets were used, thereby further thwarting the agency's efforts to collect his tax liabilities. Similarly, Curtis's attempt to derail the grand jury investigation of his activities formed a further effort to conceal his structuring crimes and the underlying illegal runner payments; thus his obstruction of justice offense constituted an additional attempt to evade or defeat the payment or collection of his taxes. <br />
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<br />
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Accordingly, we hold that Curtis's attempts to avoid the currency transaction reporting requirements and to obstruct the Government's investigation of his activities were affirmative acts to evade or defeat the collection and payment of his tax liabilities for the relevant tax years. See Fretz, 244 F.3d at 1329 (“The conduct requirement is satisfied, however, where a debtor engages in affirmative acts to avoid payment or collection of taxes ....”) (citation omitted). <br />
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We also conclude that Curtis engaged in his attempts to evade or defeat the collection or payment of his taxes with the requisite mental state under § 523(a)(1)(C)—willfully. To satisfy § 523(a)(1)(C)'s mental state requirement, the Government had to establish that Curtis (1) had a duty to pay taxes under the law, (2) knew he had that duty, and (3) voluntarily and intentionally violated that duty.Bruner , 55 F.3d at 197; Fretz, 244 F.3d at 1330. To satisfy the third prong of this test, a debtor need only voluntarily and intentionally commit or attempt to commit an affirmative act or culpable omission that, under the totality of the circumstances, constituted an attempt to evade or defeat the assessment, collection, or payment of a tax; the debtor need not have made his attempt with the specific intent to defraud the United States. See Fretz, 244 F.3d at 1330. <br />
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Here, Curtis indisputably had a duty to pay the relevant taxes. It is also undisputed that he demonstrated his knowledge of that duty by filing tax returns for the relevant tax years that expressly acknowledged his outstanding tax liabilities. Further, Curtis pleaded guilty in criminal proceedings to committing the acts which we have determined satisfied § 523(a)(1)(C)'s conduct requirement, and he specifically acknowledged in the factual basis supporting his plea that he (a) structured transactions during the relevant tax years to avoid the federal reporting requirements and (b) attempted to interfere with the grand jury's investigation of his activities. Thus, he necessarily admitted to voluntarily and intentionally committing the affirmative acts that we have concluded were attempts to evade or defeat the collection and payment of his tax liabilities for the relevant years. See Wolfson v. Baker, 623 F.2d 1074, 1077–78 (5th Cir. 1980) (holding that in both civil and criminal cases collateral estoppel “bars relitigation of an issue actually and necessarily decided in a prior action”). It does not matter if he did not commit those acts with the specific intent to defeat the collection of his taxes. See Fretz, 244 F.3d at 1330. <br />
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2<br />
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For similar reasons, we conclude that Barbara willfully attempted to evade or defeat her tax liabilities for the 1996–2001 tax years under § 523(a)(1)(C). <br />
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First, under the totality of the circumstances, Barbara's attempt to interfere with the Government's investigation of Curtis's activities satisfied § 523(a)(1)(C)'s conduct requirement. In the factual basis supporting her guilty plea to obstruction of justice, Barbara admitted that (1) Martino paid the runners at the direction and instructions of Curtis “and with [Barbara's] full knowledge” and that (2) “on numerous occasions [both Coneys] instructed Ms. Martino to feign ignorance in response to any grand jury questions regarding the specific operations of [CLS], including using runners and paying them through structured transactions.” Accordingly, when Barbara attempted to influence Martino's grand jury testimony, Barbara necessarily knew that Martino was structuring the firm's cash withdrawals at Curtis's direction in a manner that would avoid the currency transaction reporting requirements. See Wolfson, 623 F.2d at 1077–78 (describing operation of collateral estoppel). <br />
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As stated previously, Curtis's efforts to avoid the currency transaction reporting requirements constituted an attempt to evade or defeat the collection and payment of his taxes. Barbara sought to further conceal Curtis's activities from the Government by attempting to persuade Martino to lie to the grand jury regarding the runner payments and the structuring efforts undertaken to avoid detection of those payments. As we held regarding Curtis's obstruction of justice offense, Barbara's effort to influence Martino's testimony likewise was an attempt to evade or defeat the payment or collection of her taxes under these circumstances—i.e., because the currency transaction reporting requirements would have greatly assisted the IRS with collecting the Coneys' tax liabilities. Thus, Barbara's efforts to persuade Martino to testify falsely to the grand jury constituted an affirmative act to defeat the collection and payment of her taxes, thereby satisfying § 523(a)(1)(C)'s conduct requirement. See Fretz, 244 F.3d at 1329 (“The conduct requirement is satisfied, however, where a debtor engages in affirmative acts to avoid payment or collection of taxes ....”) (citation omitted). <br />
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Second, Barbara's attempt to evade or defeat her taxes for the relevant years satisfied all three prongs of § 523(a)(1)(C)'s mental state requirement. Bruner, 55 F.3d at 197. It is undisputed that Barbara had a duty to pay the relevant taxes. However, Barbara contends that even though she signed the couple's joint tax returns for the relevant years, she did not know she had a duty to pay those taxes because she was not involved in the couple's finances and Curtis had told her that he had paid the couple's tax liabilities. We disagree. <br />
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In certain cases, a taxpayer may be unaware of his duty to pay taxes, despite the fact that he filed a tax return during the relevant tax year. For instance, in Birkenstock, the Seventh Circuit held that a wife lacked knowledge of her duty to pay certain taxes—even though she had signed joint tax returns for the years in question—because she had no reason to believe that her husband had improperly imputed certain income to a family trust. Birkenstock, 87 F.3d at 953. Here, however, the Coneys' tax returns expressly indicated the couple's outstanding tax liabilities. Thus, Barbara's signature on the returns confirms her knowledge of her duty to pay the relevant taxes. <br />
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Nevertheless, Barbara maintains that Curtis told her that he had subsequently paid some of the couple's outstanding taxes for the relevant years, thereby negating her knowledge of her duty to pay the relevant taxes. We find this argument unpersuasive. At her deposition, Barbara admitted that by 1999, she knew that the IRS was attempting to collect the couple's outstanding tax liabilities. Thus, when she attempted to influence Martino's grand jury testimony in 2002, Barbara had knowledge of her outstanding tax liabilities and her corresponding duty to pay those liabilities. <br />
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Lastly, we conclude that Barbara's actions satisfied the third prong of § 523(a)(1)(C)'s mental state requirement—i.e., she voluntarily and intentionally violated her duty to pay her taxes.Bruner , 55 F.3d at 197; Fretz, 244 F.3d at 1330. Barbara pleaded guilty to a count of obstruction of justice based on her attempt to interfere with Martino's testimony and admitted that she committed that offense with “full knowledge” of Curtis's activities. Thus, Barbara necessarily attempted to influence Martino's grand jury testimony voluntarily and intentionally. Because we have concluded that Barbara's obstruction of justice offense was an attempt to evade or defeat the collection and payment of her tax liabilities for the relevant tax years, Barbara voluntarily and intentionally violated her duty to pay her taxes. It does not matter if she did not make her attempt to evade or defeat her taxes with the specific intent to defeat the collection of her taxes.Fretz , 244 F. 3d at 1330. 4 <br />
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Accordingly, we conclude that the district court did not err when it concluded that the Coneys' tax liabilities for the tax years 1996–2001 were excepted from the bankruptcy court's discharge order under 11 U.S.C. § 523(a)(1)(C). <br />
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C<br />
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Alternatively, Barbara contends that the district court erred in awarding the Government a money judgment. She further claims that even if a money judgment was proper, the court awarded judgment in an improper amount. Because her challenges to the district court's judgment and its calculation of interest turn on questions of law, we review them de novo. See Trans-Serve, Inc. v. United States, 521 F.3d 462, 468 [101 AFTR 2d 2008-1245] (5th Cir. 2008). <br />
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Barbara's arguments are unpersuasive. First, she offers no support for her argument that the district court should have refrained from awarding a money judgment. Regardless, the district court had the authority to award a money judgment.See 26 U.S.C. § 7402. <br />
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Second, Barbara alternatively makes two challenges to the amount of the district court's judgment. On the one hand, by contending that a proper judgment would have been in the amount of $1,311,729—the amount of the couple's unpaid tax liability exclusive of interest or any penalties—Barbara implicitly argues that the judgment should not have assessed any interest on her outstanding tax liabilities. However, the Internal Revenue Code clearly requires Barbara to pay interest on her unpaid tax liabilities for the period from the date they were due to the date of payment. See 26 U.S.C. § 6601(a); 28 U.S.C. § 1961(c)(1). <br />
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On the other hand, Barbara contends that even if the district court could have awarded interest on the couple's unpaid tax liabilities, the district court improperly calculated that interest. She asserts that the district court erroneously combined the couple's tax liabilities for six different tax years into one sum. She argues that tax liabilities from different years should not be lumped into one sum because interest would accrue upon interest and “interest accrues at different rates on the liabilities over the different years.” Barbara's arguments are misguided. The Internal Revenue Code provides that postjudgment interest is compounded daily; hence, there is no prohibition on “interest accruing upon interest.” 26 U.S.C. § 6622. Moreover, combining the couple's tax liabilities from different years into one judgment does not have any effect on the calculation of interest. While it is true that the underpayment interest rate changes over time, the Government adjusts that rate quarterly and the underpayment rate is therefore the same for any given quarter regardless of when the underpayment occurred. Id. § 6621(a)(2), (b). <br />
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The Government provided the district court with detailed interest calculations, and Barbara has not pointed to any evidence that calls its calculations into question. Accordingly, we conclude that the district court did not err in awarding judgment for the Government in the amount of $2,687,408.59. <br />
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D<br />
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Barbara also claims that the district court abused its discretion by denying two motions she filed in the lower court to strike three statements in the Government's summary judgment filings. Two of the statements alleged that CLS filed fraudulent tax returns for the relevant tax years, and the other alleged that the Coneys' tax attorneys assisted the couple in filing false and inaccurate returns. Barbara contends that the district court should have stricken the disputed statements because of their scandalous and prejudicial nature and because they impermissibly expanded the pleadings by advancing a new allegation of fraud. <br />
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We review a district court's ruling on a motion to strike for abuse of discretion. Cambridge Toxicology Grp., Inc. v. Exnicios, 495 F.3d 169, 178 (5th Cir. 2007). 5 Federal Rule of Civil Procedure 12(f) provides that a district court “may strike from a pleading ... any redundant, immaterial, impertinent, or scandalous matter.” The district court denied Barbara's motions to strike as moot, determining that the disputed pleadings were “unrelated to the undisputed facts that support[ed]” its order granting summary judgment for the Government. Coney, 2011 WL 1103631 [107 AFTR 2d 2011-1414], at 2, n.5. But even though the disputed pleadings were not related to the grounds upon which the district court granted summary judgment, they were not immaterial or impertinent to the controversy itself. See Augustus v. Bd. of Pub. Instruction of Escambia Cnty., Fla., 306 F.2d 862, 868 (5th Cir. 1962) (holding “that the action of striking a pleading should be sparingly used by the courts” and that “motion[s] to strike should be granted only when the pleading to be stricken has no possible relation to the controversy”) (quoting Brown & Williamson Tobacco Corp. v. United States, 201 F.2d 819, 822 (6th Cir. 1953)). Here, the disputed statements were material and pertinent to the underlying controversy because filing a fraudulent tax return is an alternative basis for nondischargeability under 11 U.S.C. § 523(a)(1)(C). <br />
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Similarly, we reject Barbara's contention that the disputed pleadings were “scandalous.” Although the disputed pleadings might “offend[] the sensibilities” of Barbara and her attorneys, those pleadings are not scandalous because they are directly relevant to the controversy at issue and are minimally supported in the record. SeeIn re Gitto Global Corp., 422 F.3d 1, 12 (1st Cir. 2005) (holding that a pleading is not “scandalous” under Rule 12(f) merely because “the matter offends the sensibilities of the objecting party if the challenged allegations describe acts or events that are relevant to the action[;] [a]s a result, courts have permitted allegations to remain in the pleadings when they supported and were relevant to a claim for punitive damages”) (quoting Hope ex rel. Clark v. Pearson, 38 B.R. 423, 424–25 (Bankr. M.D. Ga. 1984)). Thus, the district court did not abuse its discretion by denying Barbara's two motions to strike statements contained in the Government's summary judgment filings. <br />
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III<br />
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For the foregoing reasons, we AFFIRM the judgment of the district court. <br />
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1<br />
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The Coneys, particularly Curtis, have a history of unpaid tax liabilities. From 1991 to 1995, the IRS filed three federal tax liens against Curtis—the 1995 lien was also filed against Barbara since the couple appeared to have married during the 1994 tax year—to secure significant outstanding tax liabilities for the tax years 1988, 1989, 1990, 1992, and 1994. In 1994, Curtis entered into an installment agreement with the IRS, in which he promised to pay $10,000 per month, plus 60% of his firm's case proceeds, minus expenses, until he paid off his liabilities for the tax years 1989, 1990, and 1993, which then totaled $655,468. The agreement also required Curtis to use the remaining 40% of the firm's case proceeds, minus expenses, to make estimated tax payments to the IRS for future tax years. <br />
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2<br />
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We acknowledge that unlike 26 U.S.C. § 7201 and similar tax provisions, 11 U.S.C. § 523(a)(1)(C) does not disjunctively refer to both attempts “to evade or defeat any tax or the payment thereof.” 26 U.S.C. § 7201 (emphasis added). The absence of such “payment thereof” language in § 523(a)(1)(C) originally persuaded the Eleventh Circuit in Haas to hold that the subsection did not apply to attempts to evade or defeat the collection or payment of taxes. Griffith, 206 F.3d at 1394. However, as noted above, the Eleventh Circuit has overruled that holding. Id. at 1395–96. We likewise decline to follow Haas because limiting “willful attempts” under § 523(a)(1)(C) to attempts to evade the assessment of tax would render the subsection superfluous and undermine the statute's purpose of reserving discharge for honest but unfortunate debtors. Seeinfra. Moreover, we have previously declined to interpret the Internal Revenue Code and Bankruptcy Code in the same manner when interpreting § 523(a)(1)(C), undermining any inferences that we could draw from the absence of “payment thereof” language in § 523(a)(1)(C). See Bruner, 55 F.3d at 200 (“We are not convinced that the language of the Internal Revenue Code must be interpreted the same as that of the Bankruptcy Code. Both are very complex regulatory schemes with careful balances of different and competing policies.”). <br />
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3<br />
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As in Bruner, because we hold that both Coneys willfully engaged in affirmative acts to avoid collection and payment of their taxes, we need not determine whether (1) their actions amounted to “culpable omissions,” Bruner, 55 F.3d at 200 (concluding that “[§] 523(a)(1)(C) surely encompasses both acts of commission as well as culpable omissions”), or (2) “mere nonpayment” of tax is sufficient to preclude discharge. Id. <br />
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4<br />
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Barbara also appears to contend that neither she nor Curtis could have willfully attempted to evade or defeat their taxes because they lacked the ability to pay their tax liabilities. She asserts that the district court erroneously found that the couple could have used the money they illegally paid to runners to satisfy the entirety of their tax liabilities. But whether a debtor had the ability to pay his taxes is only one “appropriate factor” we employ when deciding whether a debtor “willfully attempted” to evade or defeat their taxes. In reGrothues , 226 F.3d 334, 339 [86 AFTR 2d 2000-5780] (5th Cir. 2000) (“As to the lack of a finding that the Grothues had the ability to pay the taxes, the key § 523(a)(1)(C) determination is whether debtor's conduct is willful. Whether debtor has the ability to pay is, of course, an appropriate factor in making that determination, but it is not a litmus test.”). Here, given the Coneys' substantial income during the relevant tax years and the reasons stated above, we conclude that both Coneys willfully attempted to evade or defeat their taxes, even if the Government did not establish as a matter of law that the couple could have paid every cent of their tax liabilities if they had chosen to. <br />
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5<br />
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We assume without deciding that Barbara could file a motion to strike the Government's summary judgment filings pursuant to Rule 12(f). Cf. 5C Charles Alan Wright et al., Federal Practice & Procedure § 1380 & n.8.5 (3d ed. 2012) (“Rule 12(f) motions only may be directed towards pleadings as defined by Rule 7(a); thus motions, affidavits, briefs, and other documents outside of the pleadings are not subject to Rule 12(f).”) <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-71455447554210799332012-08-04T08:58:00.001-04:002012-08-04T08:58:45.819-04:00SE HealthCAMPBELL v. U.S., Cite as 110 AFTR 2d 2012-XXXX, 07/30/2012 <br />
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FREDERICK B. CAMPBELL, Plaintiff, v. UNITED STATES OF AMERICA, and TIMOTHY GEITHNER, Defendants.<br />
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Case Information: <br />
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Code Sec(s): <br />
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Court Name: UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK, <br />
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Docket No.: 11-Civ-5782 (BSJ), <br />
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Date Decided: 07/30/2012. <br />
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Disposition: <br />
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HEADNOTE <br />
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Reference(s): <br />
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OPINION <br />
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UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK, <br />
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OPINION & ORDER<br />
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Judge: BARBARA S. JONES UNITED STATES DISTRICT JUDGE <br />
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INTRODUCTION<br />
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Plaintiff pro se in this action, Frederick B. Campbell, seeks a declaration that §§ 106 and 162(1) of the Internal Revenue Code (“Tax Code”), 26 U.S.C. §§ 106, 162(1), are unconstitutional. For the reasons that follow, the United States Defendant's motion to dismiss is granted. <br />
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BACKGROUND<br />
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Section 106 of the Tax Code allows individuals who are employed by third-parties to exclude the cost of employer-provided health insurance benefits from their income, which reduces their income, Social Security, and Medicare tax liabilities. Section 162(1) allows individuals who are self-employed to deduct the cost of their health-insurance premiums from their income taxes, but not from their Social Security or Medicare taxes. <br />
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Plaintiff is self-employed and thus entitled to deduct the cost of his health-insurance premiums from his income taxes pursuant to § 162(1). The gravamen of Plaintiff's complaint is that it is unconstitutional for Congress to subsidize health care through §§ 106 and 162(1) of the Tax Code rather than through an appropriations law. (Am. Complaint, ¶¶ 20–23.) Defendant moves to dismiss the Complaint on the ground that Plaintiff lacks standing to sue. <br />
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LEGAL STANDARD<br />
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A Plaintiff's standing to sue is a threshold question, as it “determin[es] the power of the court to entertain the suit.” Warth v. Seldin, 422 U.S. 490, 498 (1975). To demonstrate standing, a plaintiff must show by a preponderance of the evidence that he has “suffered (1) a concrete, particularized, and actual or imminent injury-in-fact (2) that is traceable to defendant's conduct and (3) likely to be redressed by a favorable decision.” Woods v. Empire Health Choice, Inc., 574 F.3d 92, 96 (2d Cir. 2009) (citing Lujan v. Defenders of Wildlife, 504 U.S. 555, 560–61 (1992)); Luckett v. Bure, 290 F.3d 493, 497 (2d Cir. 2002). <br />
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DISCUSSION<br />
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Plaintiff here has not alleged an “injury in fact” caused by the challenged government conduct. Lujan, 504 U.S. at 560. For several reasons, the first injury that Plaintiff claims—that he pays higher taxes than individuals who are eligible for a tax exclusion under § 106 (Am. Complaint, ¶¶ 14–15)—is not cognizable. For one, Plaintiff has not alleged an “invasion of a legally protected interest” here, Lujan, 504 U.S. at 560, as Congress may enact tax laws that treat some taxpayers more favorably than others, consistent with the Constitution. See Regan v. Taxation with Representation of Wash., 461 U.S. 540, 547 [51 AFTR 2d 83-1294] (1983) (rejecting challenge to a tax law that favored some groups over others, stating, “[l]egislatures have especially broad latitude in creating classifications and distinctions in tax statutes”); see also Comm'r v. Nat'l Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 148 [33 AFTR 2d 74-1347]–49 (1974) (quoting New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 [13 AFTR 1180] (1934)) (“[T]he propriety of a deduction does not turn upon general equitable considerations, such as a demonstration of effective economic and practical equivalence. Rather, it “depends upon legislative grace.””). Moreover, the reason why Plaintiff's tax liability is calculated pursuant to § 162(1) rather than § 106 is the direct result of his decision to be self-employed; Congress has not imposed that choice on him, and so “he must live with the consequences of the federal tax code and the limitations it places upon him.” Campbell v. United States, No. 00-4746, 2001 WL 1262934 [88 AFTR 2d 2001-6762], at 4 (S.D.N.Y. Oct. 22, 2001). <br />
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Lastly, the injury is abstract. Though Plaintiff complains about his discrepant tax treatment for purposes of describing his harm, his chief complaint is that Congress has used the Tax Code—rather than an appropriations law—to distinguish between the self-employed and those who work for third-parties. But a complaint about Congress's lawmaking methods, or the constitutionality of its actions, is a generalized grievance, which Plaintiff lacks standing to pursue. See Valley Forge Christian Coll. v. Am. United for Separation of Church & State, Inc., 454 U.S. 464, 479 (1982). <br />
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The second injury that Plaintiff claims is also speculative. Plaintiff contends that allowing exclusions under § 106 will cause the government to lose revenue, which will require Congress to impose higher tax rates in general to compensate for that loss, ultimately making Plaintiff's tax liability higher than it would be otherwise. (Am. Complaint, ¶ 16.) Plaintiff cannot predict or presume to know why Congress raises or lowers taxes. And he has not alleged facts to suggest how §§ 106 and 162(1) relate to the remaining provisions of the Tax Code such that the repeal of the former would cause a net increase in revenue. Certainly, Plaintiff's vague assertions about Congress's future actions do not allege any injury to him that is “actual or imminent.” Lujan, 504 U.S. at 560; see Green Island Power Auth. v. F.E.R.C., 577 F.3d 148, 161 (2d Cir. 2009) (rejecting an alleged injury as speculative where it was based on a number of assumptions about the future conduct of a third party). <br />
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For similar reasons, the Court finds that Plaintiff's alleged harms would not be redressed by the relief that he seeks. See Lamar Advertising v. Town of Orchard Park, 356 F.3d 365, 373 (2d Cir. 2004) (quoting Lujan, 504 U.S. at 560) (“[I]t must be likely, as opposed to merely speculative, that the injury will be redressed by a favorable decision.”). The Court does not believe that a declaration that §§ 106 and 162(1) are unconstitutional would be likely to prompt Congress to subsidize healthcare costs differently; to lower taxes; or to replace §§ 106 and 162(1) with an appropriations law that accomplishes the same effects. Therefore, it is unclear to the Court how the relief that Plaintiff seeks could remedy the fact that his tax liability is higher than those employed by third-parties or prevent Congress from raising taxes in the future, for whatever reason. <br />
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CONCLUSION<br />
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For the reasons stated above, the Court finds that Plaintiff lacks standing to pursue this action. Because the Court has concluded that Plaintiff lacks standing, it dismisses as moot Plaintiff's motion for summary judgment. <br />
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The clerk of the Court is directed to terminate the motion at docket numbers 24 and 26 and to close the case. <br />
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SO ORDERED: <br />
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Barbara S. Jones <br />
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UNITED STATES DISTRICT JUDGE <br />
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Dated: New York, New York <br />
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July 30, 2012 <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0tag:blogger.com,1999:blog-3318191946786047021.post-64362361166802164062012-08-02T05:15:00.002-04:002012-08-02T05:15:36.946-04:00Michigan ITC PartnershipPhillips Stevens Building Company, LLC Petitioner, v. Michigan Department of Treasury, Respondent.<br />
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Case Information: <br />
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Docket/Court: 433192, Michigan Tax Tribunal <br />
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Date Issued: 06/27/2012 <br />
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Tax Type(s): Corporate Income Tax <br />
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OPINION <br />
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Tribunal Judge Presiding, Steven H. Lasher <br />
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ORDER GRANTING PETITIONER'S MOTION TO EXTEND TIME <br />
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ORDER GRANTING RESPONDENT'S MOTION FOR SUMMARY DISPOSITION <br />
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FINAL OPINION AND JUDGMENT <br />
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Petitioner, Phillips Stevens Building Company, LLC, is appealing Final Assessment No. S198906 issued by Respondent, Michigan Department of Treasury, on March 9, 2012. The Final Assessment established that Petitioner owes Single Business Tax (SBT) in the amount of $7,215, plus interest. Respondent audited Petitioner's SBT returns for tax years 2006 and 2007 and disallowed an Investment Tax Credit (ITC) carry forward. Respondent concluded that the sale and purchase of an intangible membership interest in Petitioner does not qualify for the ITC, as set forth in MCL 208.35a. As a result, Respondent filed a Motion for Summary Disposition, under MCR 2.116(C)(10), on May 17, 2012, arguing that no genuine issues of fact remain for the Tribunal to decide. <br />
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Petitioner filed an untimely response and corresponding Motion to Extend Time to file the response on June 12, 2012. Petitioner maintains that the transaction was actually the acquisition of its only tangible asset, a building, which qualifies for the ITC. <br />
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The Tribunal disagrees. The transaction involved resulted in the purchase and sale of a membership interest, which the Tribunal concludes is an intangible asset and therefore does not meet the statutory requirements for claiming an ITC. As such, Petitioner is not entitled to the ITC carry forward and Respondent's Final Assessment is affirmed. <br />
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RESPONDENT'S ARGUMENT <br />
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In support of its Motion, Respondent contends that it is entitled to summary disposition in its favor as there remain no genuine issues of material fact for the Tribunal to decide. Respondent states that: <br />
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In February of 2005 Petitioner's member, the Phillip D. Stevens Living Trust, sold its 43.2% membership interest in Petitioner to Debora Stevens and Gary Andrus.... Stevens and Andrus, Purchasers, contributed cash to the partnership in exchange for the membership interest. Petitioner made a federal IRC Section 754 election for the 2005 tax year. Petitioner claimed an ITC on its 2005 SBT tax return for this transaction and claimed carryforward amounts from that credit on its 2006 and 2007 returns. The Department denied the ITC because the credit is not available on an intangible asset.<br />
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Motion for Summary Disposition, p 1. Respondent contends that the “... legal question to be addressed is thus whether the purchase and sale of a membership interest in Petitioner qualifies for the ITC.” Id. at 2. Respondent argues that the statute provides a credit for the purchase of tangible assets; thus, the subject transaction does not qualify as it was a purchase of intangible assets, by definition. <br />
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Respondent rebuts Petitioner's argument that its federal 754 election alters the underlying nature of the sale and purchase at issue by stating that “... if the purchase at issue was actually the purchase of a tangible asset as petitioner argues, the 754 election would not be available.” Id. <br />
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PETITIONER'S ARGUMENT <br />
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First, Petitioner filed a Motion for Extension of Time to File Written Opposition to Respondent's Motion. Petitioner states that reasonable cause exists to justify the extension of time to file a response because Petitioner's accountant contracted pneumonia and could not communicate with Petitioner until June 11, 2012. <br />
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In response to Respondent's Motion, Petitioner maintains that the transactions involved qualified for the SBT ITC. Petitioner cites Internal Revenue Code, Section 708, which provides that if there has been a sale or exchange of 50 percent or more of the total interest in partnership capital and profits within a 12-month period, the taxable year of the partnership closes; thus a “technical” termination occurs. 1 Petitioner argues that the partnership terminated after the February 2005 sale of a 43.2% membership interest to Debora Stevens and Gary Andrus because a previous transfer occurred in January, 2005, that resulted in more than 50% of the total partnership interest being sold in 2005. Petitioner states that “... as a result of these related transactions ... Petitioner, taxed as a partnership, incurred a technical termination and is allowed to report the sale as a sale of a qualifying tangible asset at fair market value.” Response, p 2. <br />
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Petitioner also argues that “... the 2004 short-year ending February 2005 SBT Return filed by Petitioner included an ITC carry forward of $22,923 into that short year. The Respondent inappropriately disallowed said carry forward inasmuch as the limitation statute [expired] on September 15, 2009 (four years after filing date).” Id. at 3. Thus, Petitioner contends that “... Respondent cannot improperly disregard the tax termination for that short period and at the same time not allow a carry forward of the ITC....” Id. <br />
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FINDINGS OF FACT <br />
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The Tribunal has reviewed the respective briefs filed by the parties, and finds the following facts: <br />
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1. In January, 2005, the Debora J. Stevens Revocable Living Trust (“Debora”) purchased a 27.7% membership interest in Petitioner. Petitioner's Opposition to Motion for Summary Judgment, p 1. <br />
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2. In February, 2005, Debora and the Gary W. Andrus Revocable Living Trust (“Gary”) purchased a 43.2% membership interest from the Phillip D. Stevens Living Trust (“Phillip”). As a result, Debora and Gary held the entirety of Petitioner's membership interests equally. Membership Interest Purchase Agreement, p 1. <br />
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3. Pursuant to the Membership Interest Purchase Agreement, Debora and Gary agreed to purchase from Phillip all of its interests in Petitioner for $3,240,000.00 in cash, certified funds or wire transfer of immediately available funds. <br />
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4. As a result of the above transaction, under IRC Section 708, the partnership experienced a “technical” termination. <br />
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5. Petitioner made a Federal IRC Section 754 election for the 2005 tax year. <br />
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6. Petitioner claimed an ITC on its 2005 SBT tax return and claimed carryforward amounts from that credit on its 2006 and 2007 returns. <br />
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STANDARD OF REVIEW <br />
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Respondent moves for summary disposition pursuant to MCR 2.116(C)(10). In Occidental Dev LLC v Van Buren Twp, MTT Docket No. 292745 (March 4, 2004) , the Tribunal stated “[a] motion for summary disposition under MCR 2.116(C)(10) tests the factual support for a claim and must identify those issues regarding which the moving party asserts there is no genuine issue of material fact.” Under subsection (C)(10), a motion for summary disposition will be granted if the documentary evidence demonstrates that there is no genuine issue of material fact, and the moving party is entitled to judgment as a matter of law. Smith v Globe Life Insurance, 460 Mich 446, 454-455 ; 597 NW2d 28 (1999). In the event, however, it is determined that an asserted claim can be supported by evidence at trial, a motion under subsection (C)(10) will be denied. Arbelius v Poletti, 188 Mich App 14 ; 469 NW2d 436 (1991). <br />
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The Michigan Supreme Court has established that a court must consider affidavits, pleadings, depositions, admissions, and documentary evidence filed by the parties in the light most favorable to the non-moving party. Quinto v Cross & Peters Co, 451 Mich 358, 362-63 ; 547 NW2d 314 (1996) (citing MCR 2.116(G)(5)). The moving party bears the initial burden of supporting his position by presenting his documentary evidence for the court to consider. Neubacher v Globe Furniture Rentals, 205 Mich App 418 , 420; 522 NW2d 335 (1994). The burden then shifts to the opposing party to establish that a genuine issue of disputed fact exists. Id. Where the burden of proof at trial on a dispositive issue rests on a nonmoving party, the nonmoving party may not rely on mere allegations or denials in pleadings, but must go beyond the pleadings to set forth specific facts showing that a genuine issue of material fact exists. McCart v J Walter Thompson, 437 Mich 109, 115 ; 469 NW2d 284 (1991). If the opposing party fails to present documentary evidence establishing the existence of a material factual dispute, the motion is properly granted. McCormic v Auto Club Ins Ass'n, 202 Mich App 233, 237 ; 507 NW2d 741 (1992). <br />
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CONCLUSIONS OF LAW <br />
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The Tribunal finds that Petitioner has shown good cause to grant its Motion for Extension of Time to File Written Opposition to Respondent's Motion. Accordingly, Petitioner's response was considered in the rendering of this decision. <br />
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The Tribunal has considered Respondent's Motion for Summary Disposition, under the criteria for MCR 2.116(C)(10), and based on the pleadings, affidavits and other documentary evidence filed with the Tribunal, determines that granting the Motion is appropriate. The Tribunal concludes that the pleadings, affidavits and documentary evidence prove there is no genuine issue with respect to any material fact. <br />
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The issue in this appeal is whether Petitioner is allowed to carry forward the unused portion of the ITC, claimed in the 2005 tax year, to the 2006 and 2007 tax years. However, the Tribunal is first charged with determining whether Petitioner was entitled to claim the ITC in the 2005 tax year, pursuant to MCL 208.35a. This determination will then enable the Tribunal to decide whether Respondent properly issued a Final Assessment for SBT deficiency totaling $7,215, plus interest. <br />
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The relevant statute is repealed MCL 208.35a, which stated that a taxpayer could claim a credit against the tax imposed by the SBTA provided the taxpayer: <br />
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[c]alculate the cost, including fabrication and installation, paid or accrued in the taxable year of tangible assets of a type that are, or under the internal revenue code will become, eligible for depreciation, amortization, or accelerated capital cost recovery for federal income tax purposes, provided that the assets are physically located in the state for use in a business activity in this state and are not mobile tangible assets.<br />
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Petitioner supports its arguments by relying on the federal treatment of the partnership after the technical termination that occurred after the Membership Interest Purchase Agreement was executed, which resulted in more than 50% of the partnership membership interest being sold within a period of 12 consecutive months. Petitioner, in its petition, states that the February 2005 purchase resulted in an: <br />
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[a]utomatic classification change with the following deemed to have occurred simultaneously: (1) Petitioner was liquidated at the time of sale and its tax year ended automatically; (2) the husband and wife purchased the distributed assets of Petitioner from the selling member; and (3) the husband and wife recontributed the distributed assets to the Petitioner which is treated as a new entity for tax purposes.<br />
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Petition, p 2. Petitioner cites IRS Rev. Rule 99-6 (Situation 1) and IRS Regs. § 1.741-1(b) and states that “[t]he acquisition of the building (i.e., the underlying asset) would thus be fully eligible to receive favorable ITC tax treatment for SBT purposes.” Id. <br />
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The Tribunal reviewed IRS Rev. Rule 99-6 (Situation 1) and IRS Regs. § 1.741-1(b) and finds Petitioner's reliance on them flawed. The “issue” in Rev. Rul. 99-6 is the following: <br />
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What are the federal income tax consequences if one person purchases all of the ownership interests in a domestic limited liability company (LLC) that is classified as a partnership ... causing the LLC's status as a partnership to terminate under § 708(b)(1)(A) of the Internal Revenue Code?<br />
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This issue is not relevant to the facts of this case because it references a partnership termination under IRC § 708(b)(1)(A) or a termination when “... no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership.” Id. Under the relevant facts of this case, Petitioner was subject to a technical termination under IRC § 708(b)(1)(B), which states that “within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.” Id. <br />
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In its response to Respondent's Motion, Petitioner states that Michigan Revenue Administrative Bulletin (“RAB”) No. 1992-3 supports its argument that it is allowed to report the technical termination as a sale of a qualifying tangible asset at fair market value. Although RAB 1992-3 does generally apply to the ITC, it merely outlines the criteria for the taking and reporting of the capital acquisition deduction. The RAB indicates that a capital acquisition deduction is a deduction of the entire cost of certain tangible assets in the year of acquisition. For this RAB to apply, Petitioner would first have to prove that it purchased a tangible asset (i.e., the commercial real property) in 2005. <br />
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A partnership that terminates under the sale or exchange rule is deemed to contribute all its assets to a new partnership and then make a liquidating distribution of its interests in the new partnership. Treas. Reg. § 1.708-1(b)(4). Thus, Debora and Gary contributed Petitioner's property to the new partnership; the partnership property was not purchased by Petitioner due to the technical termination. Petitioner's attempt to disguise the true facts of the transaction fails as it was not a sale and purchase of Petitioner's partnership property. <br />
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Further, Petitioner's argument that its Federal 754 election supports its eligibility for the ITC fails. IRC § 754 states that “[s]uch an election shall apply with respect to ... all transfers of interests in the partnership during the taxable year with respect to which such election was filed and all subsequent taxable years.” IRC § 743 states that “[t]he basis of partnership property shall not be adjusted as the result of a transfer of an interest in a partnership by sale or exchange ....” Thus, the Federal 754 election is applicable upon the sale of an interest in the partnership and not on the contribution of property. Again, this election does not change the reality of the underlying transaction and only alters the partner's federal reporting position by allowing a step-up in basis. <br />
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Rather, as contended by Respondent, the actual transaction that occurred was the sale and purchase of Petitioner's membership interest, as evidenced by the Membership Interest Purchase Agreement. Because the ITC provides a credit for the purchase of tangible assets only, the Tribunal must determine whether the membership interest is a tangible asset. <br />
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The SBTA does not provide a definition of what constitutes a tangible asset. Pursuant to repealed MCL 208.2(2), one must examine the “... laws of the United States relating to federal income taxes.” Upon review of the Internal Revenue Code, the Tribunal finds that it does not specifically define what a tangible asset is. Although the word “tangible” is not statutorily defined, undefined statutory words and phrases are construed according to their common and approved usage, unless such a construction would be inconsistent with the Legislature's manifest intent. ADVO-Systems, Inc v Dep't of Treasury, 186 Mich App 419, 424 ; 465 NW2d 349 (1990). The Tribunal looks to The American Heritage College Dictionary defines “tangible” as, “1a. discernable by the touch; palpable. b. Possible to touch. c. Possible to be treated as fact; real or concrete.” The American Heritage College Dictionary (2002), at 1408. Further, upon examination of the legal definition of “tangible,” Black's Law Dictionary defines “tangible” as “[h]aving or possessing physical form; corporeal. 2. Capable of being touched and seen; perceptible to the touch; capable of being possessed or realized....” Black's Law Dictionary (9th ed). <br />
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The Tribunal finds that reliance on these dictionary definitions to ascertain the plain meaning of the term tangible asset is appropriate. In applying these definitions, it is apparent that the purchase of the partnership interest is an intangible asset as it is not corporeal in nature. Moreover, Respondent has proven that a genuine issue of disputed fact does not exist and Petitioner has failed to rebut that presumption. Respondent properly determined that Petitioner's subject property does not meet the requirements for an ITC. <br />
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The statute of limitations has run regarding whether Petitioner's 2005 Single Business Tax Return is deficient due to an improper ITC application. MCL 205.27a(2). As such, the Tribunal has no jurisdiction over this issue. However, the Tribunal has proper jurisdiction over whether the ITC carry forward was properly applied to Petitioner's 2006 and 2007 tax return and concludes that the carry forward is invalid. Thus, Respondent's Final Assessment is affirmed. Therefore, <br />
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IT IS ORDERED that Petitioner's Motion for Extension is GRANTED. <br />
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IT IS FURTHER ORDERED that Respondent's Motion for Summary Disposition is GRANTED. <br />
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IT IS FURTHER ORDERED that Respondent's Final Assessment No. S198906 is AFFIRMED. <br />
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This Order resolves all pending claims in this matter and closes this case. <br />
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MICHIGAN TAX TRIBUNAL<br />
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By: Steven H. Lasher<br />
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Entered: June 27, 2012 <br />
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Although Petitioner is an LLC, an LLC with at least two members is classified as a partnership for federal income tax purposes. Therefore, the Tribunal shall refer to Petitioner as a partnership in this Final Opinion and Judgment. <br />
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<br />Peter Reillyhttp://www.blogger.com/profile/01473701483727808782noreply@blogger.com0