Tuesday, August 31, 2010

substantiation case

Myrtis Stewart v. Commissioner, TC Memo 2010-184 , Code Sec(s) 162; 166; 167; 212; 274; 6662; 7491.

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MYRTIS STEWART, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent .
Case Information: Code Sec(s): 162; 166; 167; 212; 274; 6662; 7491
Docket: Docket No. 10376-08.
Date Issued: 08/16/2010
Judge: Opinion by VASQUEZ


HEADNOTE
XX.

Reference(s): Code Sec. 162 ; Code Sec. 166 ; Code Sec. 167 ; Code Sec. 212 ; Code Sec. 274 ; Code Sec. 6662 ; Code Sec. 7491

Syllabus
Official Tax Court Syllabus
Counsel
Myrtis Stewart, pro se.
Shawna A. Early and Robert A. Baxer, for respondent.

Opinion by VASQUEZ

MEMORANDUM FINDINGS OF FACT AND OPINION
For 2004 and 2005 respondent determined deficiencies in petitioner's Federal income taxes and section 6662(a) 1 accuracy-related penalties as follows:

Penalty
Sec. 6662(a)

Deficiency
Year
2004 $9,240 $1,848.00 2005 12,447 2,489.40

The issues for decision are whether petitioner is: (1) Entitled to deductions for losses of $25,000 for rental expenses claimed on Schedule E, Supplemental Income and Loss, for each year; (2) entitled to deductions for theft losses of $12,093 and $23,525.75 claimed on Schedules A, Itemized Deductions, for 2004 and 2005, respectively; (3) entitled to carryover losses of $1,521.13 and $1,521 for 2004 and 2005, respectively; and (4) liable for the section 6662(a) accuracy-related penalties.

FINDINGS OF FACT
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. Petitioner resided in New York when the petition was filed.

Petitioner has worked for the Internal Revenue Service (IRS) as an international examiner, i.e., a revenue agent, for over 21 years, including 2004 and 2005. Through her work, which includes examining tax returns, she has acquired a general knowledge of the Federal income tax laws and the substantiation requirements of the Code and the regulations thereunder. She also made several business investments before or during 2004 and 2005 (discussed infra). I. 116 Highland Lake (Highland Lake property), Highland, N.Y. and 112 Hillside (Hillside property), Barryville, N.Y.

A. Background

Petitioner and Mary Anastasio (Ms. Anastasio) invested in several properties together. They acquired the Hillside property sometime before the years in issue. The Hillside property covers 4 to 5 acres of land and has a New England style double Cape Cod house with an adjoining garage. Petitioner used the Hillside property as her headquarters for the management of her real estate.

Petitioner and Ms. Anastasio purchased the Highland Lake property in or around 1995 for about $200,000 with a $25,000 downpayment. Petitioner paid $12,500 of the downpayment. According to petitioner, Ms. Anastasio acquired the Highland Lake property in her name because petitioner, 2 an African American, was not “able to purchase this property *** in this town.” The Highland Lake property is a 22-room Victorian style house with a wraparound porch, which petitioner and Ms. Anastasio renovated. They purchased it because they planned to operate a bed and breakfast out of the house. But they sometimes rented it out.

A first mortgage on the Highland Lake property of about $100,000 was held by First National Bank of Jeffersonville (FNB), and a second mortgage of about $100,000 was held by the seller of the Highland Lake property. Petitioner and Ms. Anastasio each made mortgage payments of $788.62 3 per month until Ms. Anastasio became ill in 2000 and could not work. Thereafter, petitioner paid both mortgages.

Petitioner used both properties to store her collectibles. B. Collectibles Kept at the Highland Lake and Hillside Properties

1. Stamps, Coins, and Currency Sheets Petitioner has been collecting stamps and coins for over 50 years. As a young child she started collecting stamps and Lincoln wheat pennies, Indian head pennies, and buffalo nickels. In her teen years she started buying uncirculated and proof coins from the Mint. In her twenties she started buying coins and proof coins at coin shows and from coin shops. She usually purchased stamps at trade shows or stamp shops. She recorded her purchases in books (inventory records).

Petitioner accumulated a large coin collection: she had rolls of coins, unopened bags of Mint nickels and dimes, and uncut currency sheets of various denominations, including a ($777.67 and $799.56 for the first and second mortgage, respectively); $788.62 represents their equal share of both payments. Hawaiian dollar bill. She kept the less valuable coins at her Manhattan apartment and kept the more valuable coins at her Highland Lake and Hillside properties. She stored the coins in closets in plastic containers that were on rollers like toolboxes at her Highland Lake property. At the Hillside property, petitioner stored her coins in a glass curio cabinet and in a glass display cabinet with some stamps on a wall in her library.

2. Books

Petitioner also collected books for her libraries at the Highland Lake and Hillside properties. She purchased a set of 20 books on financial rating services with yearly updates for her professional library at the Highland Lake property and entire collections of books from auctions for her library at the Hillside property.

3. Artwork Petitioner also collected art. Specifically, she owned a 2- by 3-foot painting that depicts Custer's Last Stand at the Battle of the Little Bighorn in 1876 and was signed by the artist. She kept this painting at the Hillside property.

C. Falling Out and Thefts

Petitioner and Ms. Anastasio's business relationship fragmented and eventually, in or around 2004, petitioner stopped doing business with Ms. Anastasio.

Ms. Anastasio filed for bankruptcy and allowed the Highland Lake property to go into foreclosure. Petitioner filed a notice of pendency 4 for the Highland Lake property in Ms. Anastasio's bankruptcy proceeding because Ms. Anastasio allegedly did not comply with the terms of a settlement agreement and because petitioner wanted to protect her interest in the Highland Lake property. Ms. Anastasio sold the Highland Lake property in 2001 or 2002 without petitioner's knowledge. Petitioner did not receive any proceeds from the sale.

Petitioner's collectibles allegedly were stolen from the Hillside and Highland Park properties at some point. She discovered the thefts from the Hillside and Highland Park properties in 2004 and 2005, respectively, when she went to the properties and discovered that the items were gone. Neither property had been broken into or forcibly entered. The items were purportedly stolen by an acquaintance of Ms. Anastasio to whom Ms. Anastasio had given the keys to both properties. Petitioner filed police reports in New Jersey for the thefts. 5

D. Deductions Claimed for the Highland Lake and Hillside properties

1. Legal Expenses and Bad Debt Deduction Petitioner claimed on her 2004 Schedule E a deduction for legal expenses of $768 for the Highland Lake property. She provided a copy of a settlement agreement and a complaint for another lawsuit that she filed against Ms. Anastasio as substantiation of her legal expenses. The settlement agreement provides in pertinent part that Ms. Anastasio will allow petitioner to remove “clothing, books, shoes, furniture, toys, and other collectibles” from the Highland Lake property.

Petitioner concluded that she had suffered a loss for a bad debt in 2004 and 2005 after she had exhausted all legal avenues against Ms. Anastasio. She claimed on her 2004 and 2005 Schedules E deductions for bad debts of $18,926.76 and $18,328.62, respectively, for the Highland Lake property. She reconstructed her mortgage payments from 1996 to 2000 and for each of the years 2004 and 2005 deducted as a bad debt 2 years of mortgage payments as her “basis” in the Highland Lake property.

Petitioner provided an account statement from FNB for February 2 to May 1, 1996, to substantiate her basis. The account statement shows that three mortgage payments of $777.67 were drawn from petitioner and Ms. Anastasio's joint account. 2. Theft Loss Deduction Petitioner was not compensated by insurance or otherwise for the thefts of her collectibles, and she deducted the purchase prices of the items as the amounts of her theft losses.

Petitioner claimed on her 2004 Schedule A a deduction for theft losses of $12,093 for the Hillside property. Her deduction for the theft loss relates to coins, paintings, antiques, furniture, her library, and appliances. 6

Petitioner claimed on her 2005 Schedule A a deduction for theft losses of $18,525.75 for the Highland Lake property. Her deduction for the theft loss relates to coins, paintings, antiques, furniture, her professional library, and appliances. 7 II. 229 East 29th Street (East 29th Street property), New York,

N.Y.

A. Background

Petitioner, Ms. Anastasio, and another coinvestor purchased the East 29th Street property in 2003. They paid $3,000 and assumed the $21,000 or $27,000 8 debt to which the East 29th Street property was subject. Ms. Anastasio and the other coinvestor purchased the East 29th Street property in their names because, according to petitioner, she was not allowed to purchase that property in her name. The East 29th Street property is a co-op apartment that was occupied by tenants. Petitioner, Ms. Anastasio, and the other coinvestor invested in the East 29th Street property to obtain the benefits of appreciation and tax deductions. Petitioner reported rental income received of $2,304 for 2004 and 2005.

B. Deductions Claimed for the East 29th Street Property Petitioner claimed on each of her 2004 and 2005 Schedules E deductions for management fees of $2,652.06 and property taxes of $2,114.31 for the East 29th Street property. The management fees include about $50 per month for maintenance. The property taxes include some special assessments that were billed at the end of each year. She paid $309.01 per month for the management fees, maintenance fees, and property taxes. 9 She made the payments by checks drawn from her account.

Petitioner provided carbon copies of checks of $309.01 for November 2004 and May 2005 payable to "229 E. 29th St. Owners Corp.” to substantiate some of her payments. She also provided copies of bank statements for the period November 2003 to November 2004 that show checks of $309.01 were drawn from her account.

III. Tighe Avenue (Tighe Ave. property) and Brookside Lots (Brookside property), Newburgh (Newburgh) and Harriman, N.Y.

A. Background

Petitioner purchased the Tighe Ave. and Brookside properties for investment purposes with the intent to develop them. She purchased the Tighe Ave. property in 2003 for $500 at an auction. The Tighe Ave. property is undeveloped land. She rented the Tighe Ave. property to a person who resided at the Tighe Ave. property in an “RV” trailer or mobile home. The record is unclear as to how and when petitioner acquired the Brookside property. The Brookside property consists of two undeveloped, “buildable”, and nonadjoining lots in a development. Petitioner reported rental income received of $1,000 and $1,015 for 2004 and 2005, respectively.

B. Deductions Claimed for the Tighe Ave. and Brookside Properties Petitioner claimed the following deductions for her Tighe Ave. and Brookside properties:

Auto./ Auto. Cleaning
Year Travel Ins. Maint. Supplies Mail
Rent
2004 $1,500.00 $816.00 -0- -0- -0-
$3,048
1
2005 1,526.01 916.23 $489.62 $525.36 $120.02
3,168
<1>
Petitioner explained that her $916.23 deduction for
automobile insurance was erroneously reported as an other
interest expense on Schedule E.
1. Automobile and Travel Expenses
Petitioner kept a car in Newburgh to travel to, from, or between her Tighe Ave. and Brookside properties. Her deductions for automobile insurance, automobile expenses, and travel expenses are based on her actual costs, not mileage. Her actual costs include amounts she paid for automobile insurance, travel to, from, and between her properties with her car; bus fare from her New York apartment to Newburgh, and taxi fare for travel between the Tighe Ave. or Brookside properties and the taxi stand at a Newburgh bus stop. She did not keep a mileage log for the use of her car, and other than her testimony she did not provide any written evidence to substantiate her expenditures.

2. Rent Expenses

Petitioner deducted payments of $254 per month to Uncle Bob's Storage as rent, of which she paid $52 per month for the storage of her car and $202 per month for the storage of office furniture, filing cabinets, and files. 10 She moved the office furniture, filing cabinets, and files from the Hillside property to the Newburgh area.

Petitioner provided copies of account statements for the period November 2003 to November 2004 to substantiate her rent payments. The account statements show that checks of $254 per month were drawn from her account in 2004.

3. Cleaning and Maintenance Expenses

Petitioner paid $489.62 in cash to a company to cut back and clear the Tighe Ave. property because of downed power lines caused by a storm.

4. Supplies and Mail Expenses

Petitioner deducted supplies expenses of $525.36 and mail expenses of $120.02 for 2005. The supplies expenses were paid in cash.

IV. Other Real Property

A. Background

Petitioner and a coinvestor also invested in other real property that they later sold. When the property was purchased, it had a factory located on it that contained gold-spinning machines from the 1700s to the 1800s. The gold-spinning machines made gold threads for clothing from spools of gold. Petitioner and the coinvestor agreed that petitioner could remove half of the gold-spinning machines before the sale. The coinvestor, however, locked the property, and petitioner could not remove her half of the gold-spinning machines. Petitioner filed a lawsuit against the coinvestor, and while the lawsuit was pending, the gold-spinning machines disappeared from the property.

B. Deductions Claimed for the Other Real Property Petitioner claimed on her 2005 Schedule A a theft loss deduction of $5,000 for the theft of her gold-spinning machines. She testified that her gold-spinning machines were worth a lot of money and that her basis in them was $5,000. She explained that she deducted only $5,000 because she was being conservative, and the fair market value of her gold-spinning machines was uncertain. According to petitioner, the purchase price of the gold-spinning machines was included in the purchase price of the real property, but it might have been separately listed. She filed a police report in New Jersey for the theft, but she was not compensated by insurance or otherwise for the theft.

V. Carryover Losses Petitioner reported on Schedules E carryover losses of $1,521.13 11 and $1,521.23 12 for 2004 and 2005, respectively, that would carryover to 2005 and 2006. Respondent disallowed the carryover losses in the notice of deficiency because petitioner had not provided any information to substantiate her expenses.

OPINION
Deductions are a matter of legislative grace, and taxpayers bear the burden of proving that they are entitled to any 11 $26,521.13 (claimed Schedule E losses) - $25,000 ( sec. 469(i) limitation for individuals). 12 $26,521.23 (claimed Schedule E losses) - $25,000 ( sec. 469(i) limitation for individuals). deductions claimed. 13 Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79 [69 AFTR 2d 92-694] (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435 [13 AFTR 1180] (1934). In addition, taxpayers bear the burden of substantiating the amount and purpose of the item Hradesky v. Commissioner, 65 T.C. 87, 90 claimed as a deduction. (1975), affd. per curiam 540 F.2d 821 [38 AFTR 2d 76-5935] (5th Cir. 1976). Taxpayers are also required to maintain records that are sufficient to enable the Commissioner to determine their correct tax liability. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.

When taxpayers establish that they have incurred deductible expenses but are unable to substantiate the exact amounts, we can estimate the deductible amounts, but only if the taxpayers present sufficient evidence to establish a rational basis for making the estimates. See Cohan v. Commissioner, 39 F.2d 540, 543-544 [8 AFTR 10552] (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). In estimating the amount allowable, we bear heavily upon the taxpayer whose inexactitude is of his or her own making. See Cohan v. Commissioner, supra at 544. We may not use the Cohan doctrine, however, to estimate expenses covered by section 274(d). See Sanford v. Commissioner, 50 T.C. 823, 827 (1968), affd. per curiam 412 F.2d 201 [24 AFTR 2d 69-5021] (2d Cir. 1969); sec. 13

Petitioner does not claim or show that sec. 7491(a) applies. Accordingly, she bears the burden of proof. See Rule 142(a). 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).

Generally, we find petitioner's testimony and that of her witness, Nelson Abrahante 14 (Mr. Abrahante), honest and credible. They testified credibly as to the investment purpose of many of the deductions claimed on petitioner's returns. For some of those deductions, petitioner recalled the amounts of her expenses. Where petitioner's testimony provided a sufficient basis for the Court to estimate the amounts of her expenditures, we have done so, taking account of her inexactitude where appropriate. Where the original documents were lost, but where petitioner presented credible reconstructions of her expenses, we have allowed the claimed amounts. 15

I. Section 165 and 166 Theft Loss and Bad Debt Deductions Section 165(a) provides that there shall be allowed as a deduction any loss sustained during the taxable year and not compensated by insurance or otherwise. Section 165(c) limits the loss deduction for individuals to losses incurred in a trade or business, losses incurred in a transaction entered into for profit, and certain other losses including those arising from a theft. Petitioner has the burden of proving that she sustained a loss during the taxable year.

Section 166(a) generally provides that a taxpayer may deduct a debt that become worthless during the taxable year. A bona fide debt is a debt that arises from a debtor-creditor relationship reflecting an enforceable and unconditional obligation to repay a fixed sum of money. Sec. 1.166-1(c), Income Tax Regs. The existence of a bona fide debt is a factual inquiry, and the taxpayer bears the burden of proving that a bona Dixie Dairies Corp. v. Commissioner, 74 T.C. fide debt existed. 476, 493 (1980); Litton Bus. Sys., Inc. v. Commissioner, 61 T.C. 367, 377 (1973). 15 (...continued) her lawsuits against Ms. Anastasio.

A. Highland Lake Property

As stated supra, petitioner claimed on her 2004 and 2005 Schedules E deductions for bad debts of $18,926.76 and $18,328.62, respectively, for the Highland Lake property.

Respondent asserts that to the extent petitioner has realized a gain or loss on the Highland Lake property, the gain or loss is capital and was incurred upon the disposition of the property in 2001 or 2002, not during either of the years in issue. Therefore, according to respondent, petitioner is not entitled to her deductions for bad debts.

Petitioner's testimony on this issue was less than clear. She testified that she had initiated lawsuits against Ms. Anastasio, which she later withdrew, and that ownership of the Highland Lake property was being negotiated as part of a settlement. She also testified, however, that she was occupying the Hillside property and had exchanged her interest in the Highland Lake property for Ms. Anastasio's interest in the Hillside property. But, according to petitioner, Ms. Anastasio breached their settlement agreement; and she initiated another lawsuit against Ms. Anastasio, which she also withdrew. She testified further that Ms. Anastasio sold the Highland Lake property without her knowledge in either 2001 or 2002, and she did not receive any of the proceeds. She explained that she deducted 2 years of mortgage payments as her basis in the Highland Lake property as a bad debt in 2004 and 2005 after she exhausted her legal remedies and concluded that she had sustained a loss.

Petitioner has not established that a debt owed to her by Ms. Anastasio became worthless during either year in issue or that she otherwise sustained a loss during either year with respect to the Highland Lake property. Petitioner's testimony on this issue and her records are confused, uncertain, and ambiguous. She has not substantiated a basis in the Highland Lake property or in a purported debt owed to her by Ms. Anastasio. See secs. 165(b), 166(b); Whitaker v. Commissioner, T.C. Memo. 1988-418 [¶88,418 PH Memo TC]. Consequently, respondent's disallowance of the bad debt deductions claimed in respect of the Highland Lake property is sustained.

B. Antiques, Artwork, Coins and Currency Sheets, Libraries,

Gold-Spinning Machines, Furniture, and Appliances As stated supra, petitioner claimed deductions for theft losses of $12,093 and $23,525.75 16 for 2004 and 2005, respectively. She deducted her bases and not the fair market values of her artwork, coins and currency sheets, libraries, gold-spinning machines, furniture, and appliances as the amount of her theft losses.

Petitioner has not substantiated the items' fair market values immediately before the alleged theft. See secs. 1.165- 7(b)(1), 1.165-8(c), Income Tax Regs. (in the case of property held for personal use the amount of the theft loss is the lesser of the property's fair market value immediately before the theft or its adjusted basis). She also has not substantiated the See Hubert Enters., Inc. v. Commissioner, T.C. items' bases. Memo. 2008-46 (the basis of property, under section 1012, is generally defined as cost and that cost is adjusted pursuant to section 1016); see also Kikalos v. Commissioner, T.C. Memo. 1998-92 [1998 RIA TC Memo ¶98,092] (it is settled that the deductible amount of a theft loss may not exceed basis), revd. on other grounds 190 F.3d 791 [84 AFTR 2d 99-5933] (7th Cir. 1999). Neither the items' fair market values nor their bases can be determined from the record with any degree of certainty. Therefore, we cannot apply the Cohan rule to determine a reasonable allowance for the theft losses. Consequently, petitioner is not entitled to her claimed theft losses, and respondent's determinations in that respect are sustained.

II. Section 212 Expenses Section 212 allows an individual to deduct all of the ordinary and necessary expenses paid or incurred: (1) For the production of income; (2) for management, conservation, or maintenance of property held for the production of income; or

(3) in connection with the determination, collection, or refund of a tax.

A. Legal Expenses

We apply the origin of the claim test to determine whether a taxpayer's legal expenses are personal, for the production of income, or capital. The ascertainment of a claim's origin and character is a factual determination that must be made on the basis of the facts and circumstances of the litigation. United States v. Gilmore, 372 U.S. 39, 47-49 [11 AFTR 2d 758] (1963). The most important factor to consider is the circumstances out of which the litigation arose. Boagni v. Commissioner, 59 T.C. 708 (1973).

Petitioner testified that she initiated the lawsuit against Ms. Anastasio because Ms. Anastasio breached a settlement agreement allowing petitioner to remove “clothing, books, shoes, furniture, toys, and other collectibles” from the Highland Lake property.

Petitioner has not established that her claim against Ms. Anastasio, out of which her legal expenses arose, has its origin in a profit-seeking activity as distinct from a personal one. Petitioner, therefore, is not entitled to her claimed deductions for legal expenses, and respondent's determination, in that respect, is sustained.

B. Management Fees and Property Taxes

Petitioner credibly testified about the amounts of and the purposes for her deductions for management fees and property taxes for 2004 and 2005 for the 229 East 29th Street property. She also provided additional substantiation for some of her 2004 payments with copies of her account statements and carbon copies of checks. Petitioner is entitled to her claimed deductions for management fees of $2,652.06 and property taxes of $2,114.31 for 2004 and 2005.

C. Cleaning and Maintenance Expenses

Petitioner credibly testified that she paid $489.62 in 2005 to a company to cut back and clear the Tighe Ave. property because of downed power lines caused by a storm. Petitioner is entitled to her claimed deduction for cleaning and maintenance expenses of $489.62 for 2005.

D. Supplies and Mail Expenses

Petitioner credibly testified that she paid $525.36 for supplies expenses and $120.02 for mail expenses in 2005 for the Tighe Ave and Brookside properties. Petitioner is entitled to her claimed deductions for supplies and mail expenses.

E. Rent Expenses

Petitioner credibly testified that she paid about $202 per month in 2004 and 2005 for the cost of storing office furniture, filing cabinets, and files (we discuss the storage of her car infra). She also provided additional substantiation for some of her 2004 payments with copies of her account statements. Petitioner is entitled to deductions of $202 per month for rent expenses for 2004 and 2005. 17

III. Section 212 Expenses Subject to Section 274

In addition to satisfying the criteria for deductibility under section 212, certain expenses must also satisfy the strict substantiation requirements of section 274(d). Section 274(d) and , section 1.274-5T(a), (b)(2), and (6), Temporary Income Tax Regs., 50 Fed. Reg. 46014, 46016 (Nov. 6, 1985), provide that no deduction or credit shall be allowed for travel or automobile expenses unless the taxpayer substantiates his or her expenses with adequate records or other corroborating evidence.

A. Travel Expenses
For travel away from home expenses, section 274(d) and the regulations thereunder require the taxpayer to substantiate: (1) The amount of each expenditure; (2) the time of the travel;

(3) the place of the travel; and (4) the business purpose of the travel. Sec. 1.274-5T (b)(2), Temporary Income Tax Regs., supra.

As stated supra, petitioner's travel expenses include her actual costs of travel by taxi between her properties and a taxi stand and travel by bus to Newburgh. It is unclear from the record whether petitioner's travel to Newburgh was travel away 17

See supra note 10. from home—that is, overnight trips in which the exigencies of her investment activity required her to sleep or rest before returning home. See United States v. Correll, 389 U.S. 299 [20 AFTR 2d 5845] (1967); Lackey v. Commissioner, T.C. Memo. 1977-213 [¶77,213 PH Memo TC]; see also I.T. 3395, 1940-2 C.B. 64. To the extent, however, that petitioner's travel was travel away from home, she has not complied with the substantiation requirements of section 274(d). Petitioner is not entitled to deduct her travel expenses under section 212, and respondent's determination, in that respect, is sustained. See Lackey v. Commissioner, supra.

B. Automobile Expenses

For automobile expenses, section 274(d) and the regulations thereunder require the taxpayer to substantiate: (1) The amount of each expenditure or use; (2) the time of the expenditure or use; and (3) the business or investment purpose of the expense or use. See sec. 1.274-5T(b)(6)(i)(B), Temporary Income Tax Regs., supra.

As stated supra, petitioner's automobile expenses include her actual costs for automobile insurance, travel with her car to, from, or between her properties, and $52 per month for the storage cost of her car.

Other than the $52 per month petitioner paid for the storage of her car, she did not substantiate the amounts of her expenditures. She also did not substantiate the amounts or the times of the automobile's use. Consequently, petitioner is not entitled to her deductions for automobile expenses or the deductions claimed for storage costs attributable to her car. The Cohan rule is not applicable, see Sanford v. Commissioner, 50 T.C. at 827, and respondent's determinations, in that respect, are sustained.

IV. Carryover Losses As stated supra, petitioner reported on Schedules E losses of $1,521.13 and $1,521.23 for 2004 and 2005, respectively, that would carry over to 2005 and 2006.

The section 469 passive activity loss rules generally disallow the current deduction of losses and credits from activities in which the taxpayer does not materially participate. Rental activity is generally treated as a per se passive activity regardless of whether the taxpayer materially participates. Sec. 469(c)(2). Section 469(i)(1), however, permits a passive activity loss up to $25,000 attributable to a rental real estate activity in which an individual actively participates (subject to certain phaseouts not applicable here). Amounts disallowed may be carried forward to subsequent years. Sec. 469(b); sec. 1.469-1(f)(4), Income Tax Regs.

Petitioner reported on Schedules E rental income totaling $3,304 and $3,319 for 2004 and 2005, respectively. We have allowed petitioner Schedule E deductions of $7,190.37 18 and $8,325.37 19 for 2004 and 2005, respectively, which result in losses of only $3,886.37 20 and $5,006.37 21 for 2004 and 2005, respectively. Petitioner, therefore, does not have any carryover loss for either year.

V. Section 6662(a) Accuracy-Related Penalties Section 7491(c) provides that the Commissioner will bear the burden of production with respect to the liability of any individual for additions to tax and penalties. The Commissioner's burden of production under section 7491(c) is to produce evidence that it is appropriate to impose the relevant penalty, addition to tax, or additional amount. Higbee v. Commissioner, 116 T.C. 438, 446 (2001); see also Swain v. Commissioner, 118 T.C. 358, 363 (2002). Once the Commissioner satisfies this burden of production, the taxpayer must persuade the Court that the Commissioner's determination is in error by 18 $2,652.06 (management fees) + $2,114.31 (property tax) + $2,424 (rent expense). 19 $2,652.06 (management fees) + $489.62 (cleaning and maintenance expense) + $525.36 (supplies expense) + $120.02 (mail expense) + $2,114.31 (property tax) + $2,424 (rent expense). 20 $3,304 (total rental income) - $7,190.37 (total rental expenses). 21 $3,319 (total rental income) - $8,325.37 (total rental expenses). supplying sufficient evidence of an applicable exception. Higbee v. Commissioner, supra at 446.

Pursuant to section 6662(a) and (b)(1) and (2), a taxpayer may be liable for a penalty of 20 percent on the portion of an underpayment of tax due to negligence or disregard of rules or regulations or a substantial understatement of income tax. 22 The term “negligence” includes any failure to make a reasonable attempt to comply with the Code and any failure to keep adequate books and records or to substantiate items properly. Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.

Petitioner failed to provide respondent with any records and was unable to substantiate her deductions at the administrative level. Accordingly, respondent has met his burden of production. See sec. 1.6662-3(b)(1), Income Tax Regs.; see also Smith v. Commissioner, T.C. Memo. 1998-33 [1998 RIA TC Memo ¶98,033].

The accuracy-related penalty, however, 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). The decision as to whether the taxpayer acted with reasonable cause and in good faith depends upon all the pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. The most important factor is the extent of the taxpayer's effort to assess his or her proper tax liability. Id. Petitioner argues she has shown reasonable cause or good faith on account of her medical illness and/or lost or stolen records.

Although we sympathize with petitioner's circumstances (i.e., her alleged illnesses), we are reluctant to rely on her self-serving and uncorroborated testimony about her illness. Moreover, she continued to work for the IRS and to participate in her investment activity during the years in issue. Consequently, petitioner's illness does not support a reasonable cause or good faith defense.

In certain circumstances, however, the loss or theft of a taxpayer's records may support a reasonable cause or good faith defense to an accuracy-related penalty. See Allemeier v. Commissioner, T.C. Memo. 2005-207 [TC Memo 2005-207]; Brown v. Commissioner, T.C. Memo. 1997-418 [1997 RIA TC Memo ¶97,418]; Burkart v. Commissioner, T.C. Memo. 1984-429 [¶84,429 PH Memo TC]; Cavell v. Commissioner, T.C. Memo. 1980-516 [¶80,516 PH Memo TC].

As stated supra, petitioner claimed deductions for bad debts and legal expenses for the Highland Lake property that she was not able to substantiate. Petitioner credibly testified that she maintained records, but that Ms. Anastasio took some of the records, some records were submitted to other courts in her lawsuits against Ms. Anastasio, and in either case, petitioner was unable to retrieve the records. She also attempted to reconstruct her records for the Highland Lake property. We find that petitioner has a reasonable cause or good faith defense for the portions of the underpayments attributable to her claimed deductions for bad debts and legal expenses attributable to the See Irving v. Commissioner, T.C. Memo. Highland Lake property. 2006-169; Lyons v. Commissioner, T.C. Memo. 1991-84 [¶91,084 PH Memo TC]; Haley v. Commissioner, T.C. Memo. 1977-348 [¶77,348 PH Memo TC].

Petitioner's claimed deductions for theft losses related to coins and uncut currency sheets, paintings, antiques, furniture, her libraries, appliances, and the gold-spinning machines. She credibly testified that she maintained records of her purchases of her coins and uncut currency sheets and that her inventory records were stolen with her coin collections and uncut currency sheets. It is unclear from the evidence, however, whether she maintained records of her purchases for the other stolen items. The evidence also provides no mechanism for allocating the amounts of her theft losses among the stolen items. 23 In addition, she did not attempt to reconstruct the records of her purchases for any of the stolen items. Consequently, petitioner does not have a reasonable cause or good faith defense for the portions of the underpayments attributable to her claimed deductions for theft losses. See Kolbeck v. Commissioner, T.C. Memo. 2005-253 [TC Memo 2005-253]; Cherry v. Commissioner, T.C. Memo. 1998-360 [1998 RIA TC Memo ¶98,360]; Smith v. Commissioner, supra; Cook v. Commissioner, T.C. Memo. 1991-590 [1991 TC Memo ¶91,590].

Similarly, there is no evidence that petitioner maintained records during the years in issue sufficient to meet the strict substantiation requirements of section 274(d) for travel and automobile expenses. Moreover, even if such records existed, there is no evidence that those records were lost or stolen. And except for the amounts of her parking expenses, she did not attempt to reconstruct those records. Consequently, petitioner does not have a reasonable cause or good faith defense for the portions of the underpayments attributable to her claimed deductions for travel and automobile expenses. See Makspringer v. Commissioner, T.C. Memo. 1994-468 [1994 RIA TC Memo ¶94,468]; Robbins v. Commissioner, T.C. Memo. 1981-449 [¶81,449 PH Memo TC].

In reaching all of our holdings herein, we have considered all arguments made by the parties, and to the extent not mentioned above, we find them to be irrelevant or without merit.

To reflect the foregoing, Decision will be entered under Rule 155.


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1

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.
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2

Petitioner has purchased several properties in her name or in a coinvestor's name.
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The mortgage payments amounted to $1,577.23 per month
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A notice of pendency informs others about a lawsuit affecting the title to or an interest in property. See, e.g., Debral Realty, Inc. v. DiChiara, 420 N.E.2d 343 (Mass. 1981).
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Petitioner testified that she filed police reports in New Jersey because the New York police would not allow her to file police reports since the alleged perpetrators resided in New Jersey.
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Petitioner's testimony about the items stolen in each theft loss was less than clear.
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Petitioner did not describe the antiques, furniture, appliances, and paintings.
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Petitioner could not recall the exact amount of the debt.
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Ms. Anastasio and/or the other coinvestor gave petitioner their portions of the expenses, and petitioner paid the payments in whole. The $309.01 per month did not include amounts paid for additional amounts owed at the end of each year, including amounts paid for special assessments.
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Petitioner's rent expense increased by $120 in 2005. It is unclear from the record how much, if any, of the $120 is attributable to the storage of her car.
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Mr. Abrahante is a coinvestor and a former coworker of petitioner.
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It is well established that the Court may permit a taxpayer to substantiate deductions through secondary evidence where the underlying documents have been unintentionally lost or destroyed. Boyd v. Commissioner, 122 T.C. 305, 320-321 (2004); Malinowski v. Commissioner, 71 T.C. 1120, 1125 (1979); Furnish v. Commissioner, T.C. Memo. 2001-286 [TC Memo 2001-286]; Joseph v. Commissioner, T.C. Memo. 1997-447 [1997 RIA TC Memo ¶97,447]; Watson v. Commissioner, T.C. Memo. 1988-29 [¶88,029 PH Memo TC]. Moreover, even though Congress imposed heightened substantiation requirements for certain deductions by enacting sec. 274, the regulations thereunder allow a taxpayer to substantiate a deduction by reasonable reconstruction of his or her expenditures when records are lost through no fault of the taxpayer. Sec. 1.274-5T(c)(5), Temporary Income Tax Regs., 50 Fed. Reg. 46022 (Nov. 6, 1985).

Petitioner testified that Ms. Anastasio took some of her records and that other records were submitted to other courts in
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As stated supra, $18,525.75 is attributable to the theft of her coins, paintings, antiques, furniture, her professional library, and appliances, while $5,000 is attributable to the theft of her gold-spinning machines.
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Because we find that petitioner was negligent, we need not discuss whether she substantially understated her Federal income taxes. See sec. 6662(b); Ochsner v. Commissioner, T.C. Memo. 2010-122 [TC Memo 2010-122]; Fields v. Commissioner, T.C. Memo. 2008-207 [TC Memo 2008-207].
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23

On her 2004 Schedule A, petitioner only wrote “Orange Co. The”, and on her 2005 Form 4684, Casualties and Thefts, petitioner only wrote “Su-Berryvil Prop.”
© 2010 Thomson Reuters/RIA. All rights reserved.

Friday, August 27, 2010

reasonable cause and substantial authority

NPR INVESTMENTS, LLC v. U.S., Cite as 106 AFTR 2d 2010-XXXX, 08/10/2010
Code Sec(s):
Court Name: IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF TEXAS TEXARKANA DIVISION,
Docket No.: CV 5:05-CV-219-TJW,
Date Decided: 08/10/2010.
Disposition:
B. The Accuracy Related Penalties
There are two accuracy-related penalties asserted by the Government that are still in dispute in this case: 9 a 20% penalty for substantial understatement of income tax under Section 6662(b)(2) and (d) and a 20% penalty for negligence or disregard of rules and regulations under Section 6662(b)(1). The Court now addresses the applicability of the penalties.
1. Substantial Understatement of Income Tax
In the August 15, 2005 FPAA, the IRS imposed a penalty for substantial understatement of income tax. The Court now turns to this penalty.
a. Legal Principles
Section 6662(b) imposes a 20% penalty to “[a]ny substantial understatement of income tax.” 26 U.S.C. § 6662(a), (b)(2). “For purposes of this section, there is a substantial understatement of income tax for any taxable year if the amount of the understatement for the taxable year exceeds the greater of (i) 10 percent of the tax required to be shown on the return for the taxable year, or (ii) $5,000.” 26 U.S.C. § 6662(d)(1)(A). The amount of the substantial understatement used to compute the penalty does not include any item for which there was substantial supporting authority. 26 U.S.C. § 6662(d)(2)(B)(i); Treas. Reg. § 16662-4(a).
“The substantial authority standard is an objective standard involving an analysis of the law and application of the law to relevant facts. The substantial authority standard is less stringent than the more likely than not standard (the standard that is met when there is a greater than 50-percent likelihood of the position being upheld), but more stringent than the reasonable basis standard.” Treas. Reg. § 1.6662-4(d)(2). For substantial authority to exist, “the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment.” Treas. Reg. § 1.6662-4(d)(3)(i). Opinions rendered by tax professionals are not authority. Treas. Reg. § 1.6662-4(d)(3)(iii). The authorities underlying such opinions, if applicable to the facts of a particular case, may give rise to substantial authority for the tax treatment of an item.Id. In addition, in a case involving a tax shelter, the “substantial authority” exception does not apply unless the “taxpayer reasonably believed that the tax treatment of such item by the taxpayer was more likely than not the proper treatment.” 26 U.S.C. § 6662(d)(2)(C)(i)(II). 10 A “tax shelter” includes, among other things, a partnership or an investment plan “if a significant purpose of such ... is the avoidance or evasion of Federal income tax.” 26 U.S.C. § 6662(d)(2)(C)(iii).
c. Analysis
This Court may assume, arguendo, that the NPR partnership was a tax shelter within the definition. The record, however, supports a finding that substantial authority existed. The Taxpayers obtained comprehensive opinions of counsel before they filed their returns. The Sidley Austin opinions relied on the relevant authority at the time. Cohen went over the opinions with the Taxpayers and confirmed that they were reasonable. Further, Mr. Stuart Smith (“Smith”) provided expert opinion and testimony that substantial authority supported the tax treatment at issue in this case. Smith's experience includes over 40 years as a tax lawyer, both as Tax Assistant to the Solicitor General in the Department of Justice and now in private practice. (Tr. II at 60–61.) After examining the material issues identified in the opinions, Smith concluded that the opinions provided “objectively reasonable tax advice” because they “discussed all of the authorities in an even-handed balanced way, taking into account all possible challenges in a thorough and complete manner.” (Tr. II at 77.) He further concluded that the opinions were the “quality and character upon which a taxpayer could rely in good faith.” (Id.) The Court agrees with Smith's opinions and concludes that the Sidley Austin opinions provided “substantial authority” for the Taxpayers' treatment of their basis in their respective partnerships. The record also supports a finding that the Taxpayers reasonably believed that the tax treatment applied to the transactions was “more likely than not” the proper treatment. Although they are experienced attorneys, the Taxpayers are not tax lawyers. Based on all of the record evidence, the Court finds that the Taxpayers were not aware of any financial agreements between Cohen and DGI when they decided to enter the transactions and when they filed their returns. (Tr. II at 8–9.) The Taxpayers believed that Cohen was properly discharging his duties as their fiduciary. The Taxpayers sought advice from Cohen before deciding to enter these transactions and relied heavily upon his advice. The Taxpayers sought to make a profit from the investment plan when they entered the pertinent transactions, even if NPR did not. Accordingly, the Court finds that the substantial understatement penalty does not apply.
2. Negligence
In the August 15, 2005 FPAA, the IRS also imposed a penalty for negligence. The Court now turns to this penalty.
a. Legal Principles
The 20% negligence penalty applies to the extent that an understatement of the tax was attributable to the taxpayer's “negligence or disregard of rules or regulations.” 26 U.S.C. § 6662(b)(1). “For purposes of this section, the term “negligence” includes any failure to make a reasonable attempt to comply with the provisions of this title, and the term “disregard” includes any careless, reckless, or intentional disregard” of the tax laws. 26 U.S.C. § 6662(c). Negligence includes the “failure to make a reasonable attempt to comply with the provisions of the internal revenue laws or to exercise ordinary and reasonable care in the preparation of a tax return.” Treas. Reg. § 1.6662-3(b)(1). “Negligence is strongly indicated where ... [a] taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion on a return which would seem to a reasonable and prudent person to be “too good to be true” under the circumstances.” Treas. Reg. § 1.6662-3(b)(1)(ii). Disregard for the “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.” Treas. Reg. § 1.6662-3(b)(2). The Fifth Circuit defines negligence as “any failure to reasonably attempt to comply with the tax code, including the lack of due care or the failure to do what a reasonable or ordinarily prudent person would do under the circumstances.” Heasley v. Comm'r, 902 F.2d 380, 383 [66 AFTR 2d 90-5068] (5th Cir. 1990).
A taxpayer is not negligent where there is a reasonable basis for the position taken. Treas. Reg. § 1.6662-3(b)(1). “Reasonable basis is a relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper. The reasonable basis standard is not satisfied by a return position that is merely arguable or that is merely a colorable claim.” Treas. Reg. § 1.6662-3(b)(3). Reasonable basis requires reliance on legal authorities and not on opinions rendered by tax professionals. Id.; Treas. Reg. § 1.6662-4(d)(3)(iii). The Court may, however, examine the authorities relied upon in a tax opinion to determine if a reasonable basis exists. See Treas. Reg. § 1.6662-4(d)(3)(iii). “If a return position is reasonably based on one or more of the authorities set forth in [the substantial authority section] ... the return position will generally satisfy the reasonable basis standard even though it may not satisfy the substantial authority standard as defined in § 1.6662-4(d)(2).” Treas. Reg. § 1.6662-3(b)(3).
c. Analysis
The reasonable basis standard is less stringent than the substantial authority standard; if the substantial authority defense is applicable to the substantial understatement penalty, the reasonable cause defense will also be applicable.See Treas. Reg. § 1.6662-4(d)(2); Treas. Reg. § 1.6662-3(b)(3). As discussed above, the Court finds that there was “substantial authority” to rely on the Sidley Austin opinions. Id. Therefore, the “reasonable basis” standard has also been met. Accordingly, a penalty for negligence is not applicable in this case.
C. Reasonable Cause and Good Faith Defense
Finally, the Court turns to the reasonable cause and good faith issues. Notwithstanding the specific requirements of the penalties discussed above, a taxpayer may defeat the imposition of any of those penalties if he demonstrates reasonable cause.
1. Legal Principles
Section 6664(c)(1) provides an absolute defense to any accuracy-related penalty. A taxpayer that would otherwise be subject to a twenty-percent accuracy-related penalty under § 6662(b) is not liable if the taxpayer can demonstrate that the underpayment was made with reasonable cause and the taxpayer acted in good faith. 26 U.S.C. 6664(c)(1); Treas. Reg. § 1.6664-4(a). The plaintiffs bear the burden of production and proof on their reasonable cause defenses. Klamath Strategic Investment Fund v. U.S., 568 F.3d 537, 548 [103 AFTR 2d 2009-2220] (5th Cir. 2009); see Montgomery v. Commissioner, 127 T.C. 43, 66 (2006). Although each instance requires a case-by-case determination of all pertinent facts and circumstances, generally the most important factor in assessing the applicability of the exception is the amount of effort the taxpayer spent to determine the proper tax liability in light of all the circumstances. Treas. Reg. § 1.6664-4(b). When considering the taxpayer's effort to determine the proper tax liability, the taxpayer's reliance on the advice of a professional tax adviser may not be sufficient to demonstrate reasonable cause and good faith. Treas. Reg. § 1.6664-4(b)(1). Rather, the validity of the reliance turns on “the quality and objectivity of the professional advice which they obtained.” Klamath, 568 F.3d at 548, citing Swayze v. U.S., 785 F.2d 715, 719 [57 AFTR 2d 86-1050] (9th Cir. 1986). “Reliance on ... professional advice, or other facts, however, constitutes reasonable cause and good faith if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith.” Treas. Reg. § 1.6664-4(b)(1). To determine if reliance on a tax professional's advice was reasonable and in good faith, all facts and circumstances must be taken into account. Treas. Reg. § 1.6664-4(c). “For example, the taxpayer's education, sophistication and business experience will be relevant in determining whether the taxpayer's reliance on tax advice was reasonable and made in good faith.” Id. “Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of all the facts and circumstances, including the experience, knowledge, and education of the taxpayer.” Treas. Reg. § 1.6664-4(b)(1). A taxpayer is not required to challenge the advisor's conclusions, seek a second opinion, or check the advice himself. U.S. v. Boyle, 469 U.S. 241, 250–51 [55 AFTR 2d 85-1535] (1985). “To require the taxpayer to challenge the attorney, to seek a “second opinion,” or to try to monitor counsel on the provisions of the Code himself would nullify the very purpose of seeking the advice of a presumed expert in the first place.” Id. at 251.
In order to establish reasonable reliance in good faith on the advice of a tax professional, a taxpayer must establish that all facts and circumstances were considered, and no unreasonable assumptions were made. Treas. Reg. § 1.6664-4(c)(1)(i)–(ii). For the advice to be based on “[a]ll the facts and circumstances,” it must include all pertinent facts and circumstances, including “the taxpayer's purposes (and the relative weight of such purposes) for entering into a transaction and for structuring a transaction in a particular manner.” Treas. Reg. § 1.6664-4(c)(1)(i). Additionally, “[t]he advice must not be based on unreasonable factual or legal assumptions (including assumptions as to future events) and must not unreasonably rely on the representations, statements, findings, or agreements of the taxpayer or any other person.” Treas. Reg. § 1.6664-4(c)(1)(ii). “The fact that these requirements are satisfied, however, will not necessarily establish that the taxpayer reasonably relied on the advice (including the opinion of a tax advisor) in good faith.” Treas. Reg. § 1.6664-4(c)(1).
.

In short, the Taxpayers acted reasonably and in good faith in relying on their tax advisors' advice with respect to their investments in the underlying transactions. As aptly stated by Mr. Nix at trial, “at every step, we followed the advice of people we relied on, people who were supposed to have known what they were doing and did know what they were doing. And what else could we have done except follow their advice?” (Tr. II at 32–33.) The Court finds that the Taxpayers have proven, by a preponderance of the evidence, their good faith in relying on the advice of qualified tax accountants and tax lawyers. Accordingly, the criteria under the reasonable cause exception of 26 U.S.C. § 6664(c) is satisfied, and the Taxpayers are not liable for accuracy-related penalties.

Monday, August 23, 2010

LEEDS LP v. U.S., Cite as 106 AFTR 2d 2010-XXXX, 08/05/2010
________________________________________
LEEDS LP, Plaintiff, v. UNITED STATES OF AMERICA, Defendant.
Case Information:
Code Sec(s):
Court Name: UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF CALIFORNIA,
Docket No.: Case No. 08cv100 BTM (BLM),
Date Decided: 08/05/2010.
Disposition:
HEADNOTE
.
Reference(s):
OPINION
UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF CALIFORNIA,
ORDER RE CROSS-MOTIONS FOR SUMMARY JUDGMENT AND MOTION TO AMEND COMPLAINT
Judge: Honorable Barry Ted Moskowitz United States District Judge
Plaintiff and Defendant have each filed motions for summary judgment on a variety of claims [Docs. 58, 59]. Also pending is Plaintiff's motion to file a Second Amended Complaint [Doc. 74]. For the following reasons, the Court GRANTS the United States's motion for summary judgment and DENIES Plaintiff's motion for summary judgment. The Court DENIES Plaintiff's motion to file a Second Amended Complaint as moot.
I. BACKGROUND
This is a quiet-title suit challenging tax liens placed by the United States on real property at 3207 McCall Street, San Diego, CA 92106 (the “McCall Property”). The Internal Revenue Service (“IRS”) placed liens on the property because Don and Susanne Ballantyne, who owe the IRS substantial income taxes, are allegedly its true owners. Plaintiff contends that it is the only owner and that the Ballantynes have no interest in it. This is the core dispute in this case.
1. The IRS Files Tax Liens Against Don and Susanne Ballantyne
Don and Susanne Ballantyne owe income taxes to the IRS. Although they owe income taxes for several tax years, the tax years for which they owe the most money are 1985 and 1986. They filed a petition with the United States Tax Court challenging notices of income tax deficiency sent by the IRS for those two years. The court held a trial in May 1995, and on October 10, 1996, the court filed an opinion stating the Ballantynes owed deficiencies of $388,937.00 for 1985, and $931,970.00 for 1986. On appeal, the Ninth Circuit affirmed the judgment of the Tax Court.
After trial, on June 30, 1997 the IRS made assessments against the Ballantynes for those two years in the amounts of $388,937.00 (1985) and $931,970 (1986). Notice and demand for payment was made on the same day. 1 The IRS has made other assessments against the Ballantynes: one on January 2, 1995 for $25,164.00, plus interest (1990 tax year) and the other on November 16, 1998 for $11,515.00, plus interest (1997 tax year).
On November 14, 1997, the IRS recorded with the San Diego County Recorder's office a Notice of Federal Tax Lien in the amount of $5,539,789.51 against the Ballantynes for tax years 1985 ($1,743,607.49) and 1986 ($3,796,182.02). Several years later, on July 17, 2006, the IRS recorded another Notice of Federal Tax Lien against the McCall Property in the amount of $5,212,494.62, identifying Plaintiff Leeds as the nominee/alter ego of Susanne C. Ballantyne. Plaintiff has now filed this quiet-title action to remove the lien.
2. History of the McCall Property and Its Owners
Susanne Ballantyne's parents built the McCall Property around 1929 and they raised her there. The Property was owned by the Susan T. Cramer Trust (“STC Trust”), named after Ms. Ballantyne's mother. After her parents died, Ms. Ballantyne and her brother became the co-beneficiaries of the STC Trust. Her brother took his apportioned distribution of the STC Trust in 1979, leaving Ms. Ballantyne as its only trustee and beneficiary. The STC Trust still owned the McCall Property at that time.
In 1987, Susanne Ballantyne formed an intervivos trust, of which she was the sole settlor, trustee and beneficiary, called the Susanne C. Ballantyne Trust, and she placed the entire corpus of her mother's trust, including the McCall Property, into it. Then, on June 21, 1995, the STC Trust transferred legal title to the McCall Property to Leeds LP (the Plaintiff here) in exchange for a 99% limited partnership interest in Leeds. The STC Trust later transferred its 99% interest in Leeds to the Susanne C. Ballantyne Trust in July 1995. Leeds still holds legal title to the McCall Property.
Leeds was created in May 1995 by its 1% general partner, B&B Business Services, Inc. Soon thereafter, in June 1995 B&B withdrew as the general partner, and was replaced by Rhodes Investment Corporation. Rhodes is still the 1% general partner of Leeds. Rhodes itself was owned by the Susanne C. Ballantyne Trust; the trust was Rhodes's sole shareholder. And Susanne Ballantyne was Rhodes's president, secretary-treasurer, and director. Clark L. Ballantyne, her son, later took over her roles in Rhodes on November 26, 1997, a month after the Susanne C. Ballantyne Trust sold its interest in Rhodes to the Children's Trusts (defined infra).
To summarize the McCall Property's history up until this point, it was originally owned by Susanne Ballantyne's mother's trust, the STC Trust. The STC Trust was later placed in the Susanne C. Ballantyne Trust. The STC Trust then sold the property to Leeds, whose general partner was Rhodes. And Rhodes was owned by the Susanne C. Ballantyne Trust, and operated by Susanne Ballantyne herself. So, in effect, Susanne Ballantyne indirectly owned entities on both sides of the transaction: she indirectly owned the STC Trust, which sold the property, and also indirectly owned Leeds LP, which bought the property.
This complicated history continues. In January 1996, a limited partnership called Hemet C bought a 1% limited partnership interest in Leeds. About a year later, the Susanne C. Ballantine Trust transferred the remaining 98% limited partnership interest in Leeds to Hemet C. So, as of February 1997, Hemet C owned about 99% of Leeds as the limited partner, and Rhodes about 1% as general partner.
But who owns Hemet C? Hemet C is a limited partnership. Its 99% limited partners are trusts named after Don and Susanne Ballantyne's children, the Clark Lindsay Ballantyne Trust and the Laura Ballantyne Trust (collectively “Children's Trusts”). They each hold a 49.5% interest in Hemet C. A company called Snow Valley Holdings, Inc. holds Hemet C's remaining 1% as the general partner.
Snow Valley, Hemet C's general partner, is a corporation whose shares are owned by the Children's Trusts. So, the Children's Trusts are the 99% limited partners in Hemet C, and also own its 1% general partner. At the time Snow Valley became the general partner of Hemet C in December 1995, Don and Susanne Ballantyne were among its officers and directors. Don Ballantyne was a vice president and director, and Susanne Ballantyne was the secretary-treasurer and a director. They resigned their positions in November 1997.
In summary, when Leeds purchased the McCall Property from the STC Trust, Leeds's 1% general partner was Rhodes (owned by the Susanne C. Ballantyne Trust) and its 99% limited partner was the Susanne C. Ballantyne Trust. Although Rhodes retained its 1% general partnership interest, Hemet C purchased the 99% limited partnership from the Susanne C. Ballantyne Trust. And Hemet C itself is owned by the Children's Trusts (limited partners) and Snow Valley (general partner), which at the time counted Don and Susanne Ballantyne among its officers and directors.
II. LEGAL STANDARD
Summary judgment is appropriate under Rule 56 of the Federal Rules of Civil Procedure if the moving party demonstrates the absence of a genuine issue of material fact and entitlement to judgment as a matter of law. Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986). A fact is material when, under the governing substantive law, it could affect the outcome of the case. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986); Freeman v. Arpaio, 125 F.3d 732, 735 (9th Cir. 1997). A dispute is genuine if a reasonable jury could return a verdict for the nonmoving party.Anderson , 477 U.S. at 248.
A party seeking summary judgment always bears the initial burden of establishing the absence of a genuine issue of material fact. Celotex, 477 U.S. at 323. The moving party can satisfy this burden in two ways: (1) by presenting evidence that negates an essential element of the nonmoving party's case; or (2) by demonstrating that the nonmoving party failed to establish an essential element of the nonmoving party's case on which the nonmoving party bears the burden of proving at trial.Id. at 322–23. “Disputes over irrelevant or unnecessary facts will not preclude a grant of summary judgment.” T.W. Elec. Serv., Inc. v. Pacific Elec. Contractors Ass'n, 809 F.2d 626, 630 (9th Cir. 1987).
Once the moving party establishes the absence of genuine issues of material fact, the burden shifts to the nonmoving party to set forth facts showing that a genuine issue of disputed fact remains. Celotex, 477 U.S. at 314. The nonmoving party cannot oppose a properly supported summary judgment motion by “rest[ing] on mere allegations or denials of his pleadings.” Anderson, 477 U.S. at 256. When ruling on a summary judgment motion, the court must view all inferences drawn from the underlying facts in the light most favorable to the nonmoving party. Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986).
III. DISCUSSION
1. The Basis of the United States's Claimed Interest in the Property
In this quiet-title action, the Court must resolve the parties' competing claims against the McCall Property. Plaintiff Leeds believes that the lien imposed by the IRS is improper because the IRS seeks assets of the Ballantynes, and the Ballantynes have no interest in Leeds or the McCall Property. The United States claims that Leeds is merely the nominee of the Ballantynes, and that they are its true owners.
“A nominee is one who holds bare legal title to property for the benefit of another.” Scoville v. United States, 250 F.3d 1198, 1202 [87 AFTR 2d 2001-2347] (8th Cir. 2001) (citingBlack's Law Dictionary (7th ed. 1999)). “Property held by a nominee is subject to a tax lien attaching to the property of the true owner.” United States v. Beretta, 2008 WL 4862509 [102 AFTR 2d 2008-6955], at 7 (N.D. Cal. 2008) (citingG.M. Leasing Corp. v. United States , 429 U.S. 338, 351 [39 AFTR 2d 77-475] (1977)); see also 26 U.S.C. § 6321 (If a person fails to pay federal tax after a demand, a lien automatically attaches to “all property and rights to property, whether real or personal, belonging to such person.”). Nominee claims require two levels of analysis, one applying state law and the other applying federal law. A court must “look initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach, then to federal law to determine whether the taxpayer's state-delineated rights qualify as “property” or “rights to property” within the compass of the federal tax lien legislation.” United States v. Craft, 535 U.S. 274, 278 [89 AFTR 2d 2002-2005] (2002) (internal quotation marks and citations omitted).
In the first step, a court must determine whether a purported true owner of the property has a state-law interest in the property. United States v. Overman, 424 F.2d 1142, 1144 [25 AFTR 2d 70-1024] (9th Cir. 1970). The purported owner must have an interest in the property on or after the date of the assessment.See 26 U.S.C. § 6322; Rice Inv. Co. v. United States, 625 F.2d 565, 568 [46 AFTR 2d 80-5682] (5th Cir. 1980) (citingGlass City Bank v. United States , 326 U.S. 265 [34 AFTR 1] (1945)). Plaintiff challenges primarily this first step, arguing that the Ballantynes have no state-law property interest in the McCall Property. Plaintiff addresses several forms of state-law ownership, arguing that each is inapplicable or otherwise foreclosed to the United States. The Court addresses each of them below.
2. State-Law Property Rights
A. Nominee Ownership
Plaintiff first claims that California does not recognize a nominee theory of ownership. Although the parties agree that federal law recognizes a nominee theory of ownership, they dispute whether California law recognizes it. The Court holds that it does.
Several California courts have discussed or mentioned nominee ownership. Lewis v. Hankins, 214 Cal. App. 3d 195, 201–02 (1989) (affirming trial court judgment which allowed creditor to levy and sell real property owned by debtor's nominees because debtor was beneficial owner);Parkmerced Co. v. City and County of San Francisco , 140 Cal. App. 3d 1091, 1095 (1983) (noting that one general partner held real property as nominee for partnership);Baldassari v. United States , 79 Cal. App. 3d 267, 272 (1978) (“The validity of the tax liens depends upon whether plaintiffs are the bona fide owners of the properties or are only nominees.”); Baumann v. Harrison, 46 Cal. App. 2d 84, 91 (1941) (stating that “appellant took title as the nominee of [another party] but did not assume or agree to pay the indebtedness secured by the deed of trust”);see also McColcan v. Walter Magee, Inc. , 172 Cal. 182, 186 (1916) (alluding to nominee ownership and stating “one cannot by any disposition of his own property put the same or the income thereof beyond the reach of his creditors, so long as he himself retains the right to receive and use it”). And federal courts have said that California recognizes nominee ownership. United States v. Dubey, 1998 WL 835000 [82 AFTR 2d 98-7050], at 98–7055 (E.D. Cal. Oct. 21, 1998) (“Under the “nominee” doctrine in California, “a person cannot place his property ... beyond the reach of his creditors so long as he himself retains the right to ... use it.””) (quoting In re Camm's Estate, 76 Cal. App. 2d 104 (1946));see Cal Fruit Int'l, Inc. v. Spaich , 2006 WL 2711664 [98 AFTR 2d 2006-6806], at 4 (E.D. Cal. September 21, 2006).
Although California law recognizes the theory of nominee ownership, it appears that no California court has ever identified the factors involved in a nominee analysis.Cal Fruit , 2006 WL 2711664 [98 AFTR 2d 2006-6806], at 4 (“There appear to be no reported California decisions which address the issue of what factors are relevant in determining whether an individual is a nominee of a taxpayer.”) In the absence of state-law guidelines, federal courts in California have used the guidelines of federal common law. E.g., United States v. Beretta, 2008 WL 4862509 [102 AFTR 2d 2008-6955], at 7 (N.D. Cal. Nov. 11, 2008);United States v. Lang , 2008 WL 2899819 [102 AFTR 2d 2008-5367], at 5 (S.D. Cal. July 25, 2008); Sequoia Prop. & Equip. Ltd. P'ship v. United States, 2002 WL 31409620 [90 AFTR 2d 2002-6728], at 12 (E.D. Cal. Sept. 19, 2002). Federal courts in other states use the same approach. E.g., Scoville v. United States, 250 F.3d 1198, 1202 [87 AFTR 2d 2001-2347] (8th Cir. 2001) (“A nominee is one who holds bare legal title to property for the benefit of another. Under Missouri law, one who holds such title has no actual interest in the property, which remains with the beneficial owner. No Missouri court has delineated a precise test for determining whether a property holder is a nominee. Missouri courts have, however, provided a test for determining whether a conveyance is fraudulent. In such instances, Missouri courts look to “badges of fraud”.... These elements parallel those we have looked to in determining whether a property holder is in fact merely a nominee.... We think that faced with a similar situation, a Missouri court would likely apply this body of law.”).
But at this stage, it does not matter what the specific factors of nominee ownership are. Plaintiff does not argue that the United States has failed to produce evidence showing nominee ownership. Instead, it only argues that nominee ownership does not exist under California law. And because the Court holds that it does, that ends the inquiry. The Court need not analyze whether there is a genuine dispute regarding the nominee factors.
Plaintiff argues that because the nominee doctrine is not fleshed out in California, the Court should not borrow from federal common law for its analysis. Instead, the Court should apply an analogous California doctrine, the law of resulting trusts, which has been fleshed out. In support of this argument, Plaintiff cites two cases from other circuits. The first isSpotts v. United States , 429 F.3d 248, 253 [96 AFTR 2d 2005-7101] (6th Cir. 2002), also a federal tax-lien case. The district court, in applying the nominee theory, did not look to Kentucky nominee law because its nominee law is unclear. See id. at 252–53. Instead, it looked to the law of other courts.Id. at 253. The Sixth Circuit reversed, holding that even though Kentucky nominee law was unclear, the district court should have applied an analogous Kentucky state-law doctrine, that of constructive trust. See id. at 253. The second case, Holman v. United States, 505 F.3d 1060 [100 AFTR 2d 2007-6217] (10th Cir. 2007), has a very similar holding. The district court had borrowed another jurisdiction's law regarding nominee ownership, and the Tenth Circuit remanded the case, requiring the IRS to “identify the theory or theories under which it asserts that Mr. Holman has a beneficial interest in the Centerville property under Utah law.” Id. at 1068.
These two cases are not binding precedent on this Court. And as the Court has already explained, California law does recognize the nominee theory of ownership. It even gives some general guidance on how to apply it. See Baumann, 46 Cal. App. 2d at 91–92 (taking title to property but not assuming debts, control and possession of the property, and receiving rents from property contributed to nominee status);Lewis , 214 Cal. App. 3d at 201 (analysis focuses on who is the beneficial owner). The Court can supplement these general guidelines with federal common law as many other courts in this circuit have done. E.g., Lang, 2008 WL 2899819 [102 AFTR 2d 2008-5367], at 5 (S.D. Cal. July 25, 2008).
Plaintiff's motion for summary judgment on the issue of whether the United States can use a nominee theory of ownership is denied.
B. Resulting Trust
Plaintiff also claims that the United States cannot use the theory of resulting trust. “A resulting trust arises from a transfer of property under circumstances showing that the transferee was not intended to take the beneficial interest.” 11 Witkin, Summary of Cal. Law, Trusts § 297 (9th ed. 1990). It “is based on the manifestation of the person creating it.” Majewsky v. Empire Constr. Co., Ltd., 2 Cal. 3d 478, 485 (1970). “The trust arises because it is the natural presumption in such a case that it was their intention that the ostensible purchaser should acquire and hold the property for the one with whose means it was acquired.”Id.
Plaintiff Leeds assumes (for the purposes of summary judgment only) that when it purchased the McCall Property from the STC Trust in 1995, a resulting trust was created, with Leeds as the trustee and Susanne Ballantyne as the beneficiary. But Plaintiff argues that Susanne Ballantyne sold or repudiated her interest in the resulting trust when Hemet C purchased 99% of Leeds. (Rhodes, a corporation owned by the Susanne C. Ballantyne Trust, retained the remaining 1% of Leeds as general partner.)
Resulting trusts can be repudiated. In re Estate of Yool, 151 Cal. App. 4th 867, 875 (2007) (repudiation occurs when demand “has been made upon the trustee and the trustee refuses to account or convey”). Plaintiff claims that Susanne Ballantyne repudiated her interest in the resulting trust when Hemet C purchased most of Leeds. But it is generally the trustee that must repudiate the trust. 2 See, e.g., Yool, 151 Cal. App. 4th at 875. And in this case, the trustee of any resulting trust would be Plaintiff. Yet Plaintiff has failed to produce any evidence showing that it repudiated a resulting trust. A mere change in Plaintiff's ownership, especially when the new owner is a partnership largely owned by the Ballantyne's Children's Trusts and controlled by a corporation which counts the Ballantynes among its officers and directors, does not qualify as repudiation. Plaintiff itself, even with new owners, could still hold the McCall Property in trust for the benefit of the Ballantynes.
Moreover, Plaintiff's general partner, Rhodes, was never replaced. Hemet C only bought the limited partnership interest, leaving Rhodes as Plaintiff's general partner. And the Ballantynes owned and controlled Rhodes until 1997. Given the Ballantynes' continued interest and control of Plaintiff through Rhodes and the lack of any act of repudiation, the Court denies summary judgment for Plaintiff on the repudiation issue.
Plaintiff also argues that Susanne Ballantyne sold her interest in the resulting trust when Hemet C purchased all of the Susanne C. Ballantyne Trust's interest in Plaintiff. This argument also lacks merit. Plaintiff has not produced any documents referencing the sale of a resulting trust. And although the Susanne C. Ballantyne Trust sold its interest in Plaintiff, Susanne C. Ballantyne herself may still be the beneficiary of a resulting trust. She sold her ownership stake in Plaintiff, not in the resulting trust. Moreover, as discussed above, the Ballantynes still owned Plaintiff's general partner, even after the sale.
But even if there was a repudiation, taxpayers cannot simply disclaim interests in property to avoid tax liens. See Drye v. United States, 528 U.S. 49, 60–62 [84 AFTR 2d 99-7160] (1999) (holding that debtor's disclaiming of inheritance according to state law, which generally prohibits creditors from reaching the inheritance under state law, did not defeat federal tax liens);United States v. Mitchell , 403 U.S. 190, 204 [27 AFTR 2d 71-1457] (1971) (holding wife's renouncement of interest in community property under state law could not avoid attachment of federal tax lien to property). Plaintiff's interest in the Fourth Avenue Property would therefore survive any purported repudiation.
Lastly, Plaintiff is wrong that the four-year statute of limitations for a resulting trust claim has run. Plaintiff argues that a party must sue within four years of repudiation, and since the purported repudiation happened over four years before the United States filed suit, the resulting trust claim has expired. But “[t]he mere lapse of time, without repudiation, does not affect the beneficiary's rights” under a resulting trust. Yool, 151 Cal. App. 4th at 876. Here, there has been no repudiation, so Plaintiff has not shown anything beyond a “mere lapse of time.” Id. And even if the statute of limitations has run, state-law statutes of limitations are “inapplicable to bar the claims of the United States.” Bresson v. Commissioner of Internal Revenue, 213 F.3d 1173, 1175 [85 AFTR 2d 2000-1901] (9th Cir. 2000).
For these reasons, the Ballantynes may have had an interest in the McCall Property on the date of the assessment, and there is a genuine dispute regarding the existence of a resulting trust. But there is no genuine dispute regarding repudiation, and the Court grants the United States motion for summary adjudication on the repudiation issue.
C. The United States May Use a Fraudulent Transfer Theory of Ownership
Plaintiff believes that the United States cannot use a fraudulent transfer theory to assert an interest in the McCall Property. Plaintiff gives two reasons: (1) the 1997 Notice of Federal Tax Lien did not mention fraudulent transfer, and (2) the United States has not pled a fraudulent transfer claim in its Answer or as a counterclaim. 3
Plaintiff cites no case law in support of its arguments. The United States did not have to specifically plead, or give notice of, a fraudulent transfer claim. The United States has given notice that it proceeds under a nominee theory. The United States can impose a lien on property if the owner of the property is the nominee of the taxpayer. See 26 U.S.C. §§ 6321;see G.M. Leasing Corp. v. United States , 429 U.S. 338, 350–51 [39 AFTR 2d 77-475] (1977) (holding that § 6321 allows the government to impose a lien on property in the hands of a third party straw man). And although the nominee theory requires showing some type of interest in property based on a state-law theory, there is no authority supporting Plaintiff's belief that each state-law theory must be specifically pled. Cf. In re Krause, 386 B.R. 785, 833–34 [101 AFTR 2d 2008-1943] (Bankr. D. Kan. 2008), aff'd, 2009 WL 5064348 [105 AFTR 2d 2010-731] (D. Kan. Dec. 16, 2009) (distinguishing between bringing direct fraudulent conveyance action as a stand alone action, and using fraudulent conveyance law as the basis for finding a state-law interest under a nominee claim). In the absence of support for Plaintiff's argument, the Court holds that the United States has adequately pled its nominee claim and may use a fraudulent transfer theory, either under California common law or statutory law, to show that the Ballantynes have an interest in the Fourth Avenue Property and Plaintiff is merely their nominee.
D. The United States May Use an Alter-Ego Theory of Ownership
In its reply brief, Plaintiff argues that the United States cannot use an alter-ego theory of ownership for two reasons. 4 First, Plaintiff argues that an alter-ego claim has not been pled. The Court rejects this argument for the same reason it rejected Plaintiff's fraudulent-transfer arguments. The United States only had to plead a nominee claim, not the several theories of state-law property rights that might support such a claim.
Second, Plaintiff argues that the United States has said it will not assert an alter-ego claim, and should be precluded from doing so. The United States, in its proposed pretrial order, said that it “is not asserting claims under the theory of alter ego or under the California Fraudulent Conveyance Act.” But the United States has consistently maintained it is asserting a nominee claim, which can use a variety of state-law claims as support. See, e.g., Dalton v. Comm'r of Internal Revenue, 2008 WL 2651424 [TC Memo 2008-165], at 8 (U.S. Tax Ct. 2008) (In actions involving nominee claims, “various theories have been used to support the existence of an interest under State law, depending upon the jurisdiction and particular facts involved. Examples include resulting trust doctrines, constructive trust principles, fraudulent conveyance standards, and concepts drawn from State jurisprudence on piercing the corporate veil.”). Although the United States said it was not asserting alter-ego or California Fraudulent Conveyance Act claims, it may still use alter ego and fraudulent-transfer theories to show a property interest under state law. There is a distinction between asserting an alter-ego or fraudulent-transfer claim directly, and using those theories to support a nominee claim. The United States therefore is not precluded from using the alter-ego theory to support its nominee claim.
E. The Constructive Trust Theory of Ownership
Plaintiff argues for the first time in its reply brief that the United States may not use a theory of constructive trust in support of its nominee claim. The Court will not grant summary judgment on the constructive-trust theory until the United States has had an opportunity to respond. El Pollo Loco, Inc. v. Hashim, 316 F.3d 1032, 1040–41 (9th Cir. 2003) (court may not grant summary judgment on claims only raised in reply unless opposing party has opportunity to respond).
Under California law, a constructive trust is an equitable remedy, not a substantive claim. Batt v. City and County of San Francisco, 155 Cal. App. 4th 65, 82 (2007) (“A constructive trust is not an independent cause of action but merely a type of remedy, and an equitable remedy at that.”) (internal quotations marks and citations omitted); 11 Witkin,Summary of Cal. Law , Trusts § 305 (9th ed. 1990). In order to establish a constructive trust, the purported beneficiary of the trust must have a substantive right to receive the property. United States v. Pegg, 782 F.2d 1498, 1500 (9th Cir. 1986) (“Because a constructive trust is a specific remedy, the plaintiff must have some interest that can be returned to it.”) Whether or not the Ballantynes are beneficiaries, and whether Plaintiff is the trustee, of a constructive trust is not properly before the Court on this motion and may be argued after the trial.
3. The United State May Address Adequacy of Consideration and the Ballantynes' Intent
Plaintiff argues that the United States cannot rely on lack of consideration or intent in proving its nominee claim. The Court rejects this argument, as it is entirely without merit. Plaintiff cites no relevant case law supporting its argument. If adequacy of consideration and intent are relevant to establishing the Ballantynes' alleged state-law interest in the McCall Property, or if they are relevant to the nominee factors, the United States may address them.
Regarding other factors that are part of the nominee analysis, it appears that the parties recognize that different factors are appropriate depending on the facts of each case, and that there is no fixed number of nominee factors. When this case goes to trial, the parties can make arguments about the relevant nominee factors.
4. There Is a Genuine Dispute of Material Fact About Whether Plaintiff Was a Subsequent Purchaser
Under 26 U.S.C. § 6323, tax liens are not effective against third-party purchasers of property until the IRS has filed notice of the lien. Gorospe v. Comm'r of Internal Revenue, 451 F.3d 966, 967 [97 AFTR 2d 2006-2305] (9th Cir. 2006); 26 U.S.C. § 6323(a). Purchasers must have paid “adequate and full consideration” for the property, and must not have “actual notice” of the lien. 26 U.S.C. § 6323(h)(6).
Plaintiff argues that the liens are ineffective against it because they were filed after it got legal title to the McCall Property. The United States does not dispute the timing of the notice, but it argues that the statutory lien is effective against Plaintiff as the Ballantyne's nominee.
The Court agrees with the United States. If the United States establishes that Plaintiff is the Ballantyne's nominee, then Plaintiff is not entitled to the protections of 26 U.S.C. § 6323(a). See United States v. Clark, 2007 WL 3347515 [100 AFTR 2d 2007-6370], at 1 (M.D. Fla. Sept. 12, 2007) (“April E. Clark holds the subject property as a nominee of Alphonso J. Clark and thus is not entitled to the protection afforded by 26 U.S.C. § 6323.”). Moreover, Plaintiff only gets the protections of § 6323 if it meets the definition of purchaser. And a purchaser must have paid “adequate and full consideration” for the property. 26 U.S.C. § 6323(h)(6). So if the United States shows that Plaintiff did not pay full consideration for the McCall Property, this provision will not protect it. The Court holds that on the present record, there is a genuine dispute regarding whether Plaintiff is a subsequent purchaser under § 6323.
A. Rhodes And Hemet C Are Not Subsequent Purchasers
Plaintiff also argues that its two partners, Rhodes and Hemet C, are not subject to the tax lien. But § 6323 only applies to purchasers of property who paid full consideration without actual notice. Id. Rhodes and Hemet C did not buy the McCall Property; Plaintiff did. They only purchased an interest in Plaintiff, which is not covered by § 6323.See id. at 6323(h)(6). Moreover, Rhodes and Hemet C had actual notice of the assessments. Susanne Ballantyne herself controlled Rhodes at the time it purchased an interest in Plaintiff. And in January 1996, when Hemet C purchased an interest in Plaintiff, the Ballantynes held director and officer positions in Hemet C's general partner. Because the Ballantynes had actual notice of the assessments before January 1996 (they challenged the assessments in July 1994), that knowledge is imputed to Rhodes and Hemet C. Bank of N.Y. v. Fremont Gen. Corp., 523 F.3d 902, 911 (9th Cir. 2008) (“Generally, the knowledge of a corporate officer within the scope of his employment is the knowledge of the corporation.”) (quotingMeyer v. Glenmoor Homes, Inc. , 246 Cal. App. 2d 242 (1966)). Section 6323 therefore does not apply to Rhodes and Hemet C because they were not purchasers and they had actual knowledge of the assessments.
The Court grants the United States's motion for summary adjudication and finds that Rhodes and Hemet C are not subsequent purchasers under § 6323.
5. Notice of the Assessment and Demand for Payment Was Proper
Plaintiff challenges the tax assessments against the Ballantynes because of alleged procedural defects. Plaintiff, however, lacks standing to challenge the assessments. The assessment is against the Ballantynes, not Plaintiff. And a “third-party, non-delinquent taxpayer” may not attack a tax assessment based on procedural grounds. See Graham v. United States, 243 F.2d 919, 922 [51 AFTR 213] (9th Cir. 1957) (“We believe that only the taxpayer may question the assessment for taxes, and assert noncompliance by the Commissioner in sending the taxpayer a notice of deficiency by registered mail.”);Macatee, Inc. v. United States , 214 F.2d 717, 720 [45 AFTR 1818] (5th Cir. 1954) (“If there is cause for complaint for failure to give the notice required by 26 U.S.C.A. [6303], that cause belongs to the taxpayer.”). Plaintiff cites no cases contradicting the holding in Graham. But even if Plaintiff did have standing, the evidence establishes that there were no procedural defects in the assessments.
The IRS assessed taxes against the Ballantynes several times between 1995 and 1998. 5 In order for those assessments to be valid, the IRS must send notice of the assessment and demand for payment within 60 days to the taxpayer's dwelling, place of business, or last known address. 26 U.S.C. § 6303(a). There is no requirement that the taxpayer actually receive the notice, only that it is sent to the taxpayer's last-known address. United States v. Zolla, 724 F.2d 808, 810 [53 AFTR 2d 84-652] (9th Cir. 1984). Plaintiff argues that the Ballantynes have no recollection of receiving notices of the assessment or demands for payment, and that there is no evidence establishing that they received notice. Because notice and demand for payment are conditions precedent for the creation of a tax lien, see 26 U.S.C. § 6321, if notice was defective, then the liens would be invalid.
But here there was no defect. The United States has submitted and properly authenticated four Form 4340's, which show that the IRS properly sent notice and demand for payment. See Hansen v. United States, 7 F.3d 137, 138 [72 AFTR 2d 93-5922] (9th Cir. 1993) (per curiam) (“Form 4340 is probative evidence in and of itself and, in the absence of contrary evidence, shows that notices and assessments were properly made.”). The Form 4340's all state that on a particular date, the IRS sent a “statutory notice of balance due.” (See Black Decl. Exs. A–D.) Although the Ballantynes state that they have no recollection of receiving the notice of tax assessment, that is insufficient to raise a genuine issue as to whether notice was sent.Id. (declaration by taxpayers that they never received notice and demand “does not show the notice was not sent” and “fails to raise a genuine issue of material fact”). Hansen squarely rejected the same argument Plaintiff makes here.
Plaintiff relies on several Ninth Circuit cases that precedeHansen to argue that Form 4340, or some other evidence, must show the address to which the IRS sent a demand for payment. In those cases, the Ninth Circuit noted that the Form 4340 contained the taxpayer's correct address. See, e.g., United States v. Zolla, 724 F.2d 808, 810 [53 AFTR 2d 84-652] (9th Cir. 1984). The Form 4340 submitted here does not show the address to which the demands were mailed. But Hansen does not require that a Form 4340 state the address. The presumption that the IRS sent a demand arises when the Form 4340 notes that demand was sent. See United States v. Scott, 290 F. Supp. 2d 1201, 1206 [92 AFTR 2d 2003-6946] (S.D. Cal. 2003) (citing Hansen, 7 F.3d at 138) (“Where a Form 4340 indicates that notice and demand were timely given, it is sufficient in the absence of contrary evidence to establish that such notice and assessment were made.”) And here, the Form 4340's note exactly that.
The Court holds that there is not a genuine issue of fact regarding whether the IRS sent the notice and demand. The evidence establishes that notice and demand was proper under 26 U.S.C. § 6303(a). Because Plaintiffs lack standing and the notices and demands were proper, the Court grants the United States's motion for summary adjudication on the issue of proper notice and demand. Plaintiffs cannot challenge this at trial.
6. Plaintiff's Equitable Defenses
Actions to levy property subject to a tax lien generally must be brought within ten years of the original assessment. 26 U.S.C. § 6502(a)(1). Although over ten years passed without the United States levying the McCall Property, the United States argues that the statute of limitations was tolled by the Ballantyne's submission of an offer in compromise (“OIC”) to settle their tax liability. While an OIC is pending, the applicable statute of limitations is sometimes tolled.See United States v. McGee , 993 F.2d 184, 186 [71 AFTR 2d 93-1967] (9th Cir. 1993) (citing United States v. Holloway, 798 F.2d 175, 176 [58 AFTR 2d 86-5641] (6th Cir. 1986). In response, Plaintiff asserts that the United States is equitably estopped from arguing tolling of the statute of limitations. Plaintiff points to misconduct and delay in the OIC process as grounds for estoppel. The United States moves for summary adjudication on Plaintiff's estoppel claim. 6
A. Motion for Leave to File Second Amended Complaint
The First Amended Complaint does not plead equitable estoppel. Seizing on this, the United States argues that Plaintiff cannot assert equitable estoppel at trial. So Plaintiff has filed a motion for leave to file a Second Amended Complaint, which adds the estoppel claim. The Court denies Plaintiff's motion because, as set forth below, Plaintiff cannot establish estoppel.See Gompper v. VISX, Inc. , 298 F.3d 893, 898 (9th Cir. 2002) (court may deny amendment based on futility).
B. Plaintiff Cannot Prove Equitable Estoppel
The elements of equitable estoppel are “(1) [t]he party to be estopped must know the facts; (2) he must intend that his conduct shall be acted on or must so act that the party asserting the estoppel has a right to believe it is so intended; (3) the latter must be ignorant of the true facts; and (4) he must rely on the former's conduct to his injury.”Watkin v. United States Army , 875 F.2d 699, 709 (9th Cir. 1989) (citing United States v. Wharton, 514 F.2d 406, 412 (9th Cir. 1975). When a party asserts equitable estoppel against the United States, two more elements must be met: (1) “affirmative conduct going beyond mere negligence;” and (2) the “government's act will cause a serious injustice and the imposition of estoppel will not unduly harm the public interest.” Purcell v. United States, 1 F.3d 932, 932 [72 AFTR 2d 93-5821], 940 (9th Cir. 1993) (quotingS & M Inv. Co. v. Tahoe Regional Planning Agency , 911 F.2d 324, 329 (9th Cir. 1990)). The two additional elements are threshold requirements and the Court should consider them first. Purcell v. United States, 1 F.3d 932, 939 [72 AFTR 2d 93-5821] (9th Cir. 1993).
Unreasonable delay and errors in the OIC process do not establish “affirmative conduct going beyond mere negligence,” which is a necessary element of equitable estoppel. Watkin, 875 F.2d at 709. At most, Plaintiff's evidence would show that the IRS was negligent in handling Plaintiff's case, and negligence is insufficient.Id. Plaintiff also cannot show that the “imposition of estoppel will not unduly harm the public interest.” Id. In fact, permitting Plaintiff to assert equitable estoppel might frustrate the legitimate attempts of the IRS to collect on taxes owed by the Ballantynes.
Not only can Plaintiff not meet the special requirements for estoppel claims against the government, Plaintiff cannot meet the traditional elements of estoppel, which deal with detrimental reliance on misrepresentations of fact. There must be some “affirmative misrepresentation or affirmative concealment of a material fact by the government.” United States v. Ruby Co., 588 F.2d 697, 703–04 (9th Cir. 1978). Here, there is simply no misrepresentation or concealment that Plaintiff relied on to its detriment.
In fact, the Ninth Circuit has already rejected a very similar claim by a taxpayer in United States v. McGee, 993 F.2d 184 [71 AFTR 2d 93-1967](9th Cir. 1993) Although the taxpayer in that case did not raise equitable estoppel specifically, he argued that because the IRS had abandoned his OIC, tolling should have stopped. The Ninth Circuit disagreed, holding that tolling only stops when the OIC is “terminated, withdrawn or formally rejected by the government.” Id. at 186. The Ninth Circuit emphasized that the taxpayer “was also not left unprotected; he could have withdrawn his offer at any time” and restarted the statute of limitations clock. Id. McGee stands for the proposition that if consideration of the OIC takes too long, the taxpayer has a simple remedy: withdraw the OIC. The Ballantynes chose instead to see the OIC process to its conclusion, and even appealed the IRS's rejection of their OIC. If they wanted to restart the clock, they could have.
Therefore, the Court enters summary adjudication against Plaintiff on its equitable estoppel claim.
7. The Statutes of Limitations on the Tax Assessments Has Not Expired
Plaintiff wants to argue at trial that the statute of limitations on collection of the Ballantynes' tax liabilities has expired. The United States moves for summary judgment on this issue, arguing that the evidence proves the statute of limitations has not run.
The statute of limitations on collecting tax liabilities is ten years, starting on the day of the assessment. 26 U.S.C. § 6502. Here, the tax assessments were made in January 1995, June 1997, and November 1998. The parties agree the statute of limitations on all three assessments would have already expired absent tolling.
The statute of limitations on tax collection can be tolled. When an OIC is pending, the statute of limitations is tolled until the OIC is “terminated, withdrawn, or formally rejected by the government.” United States v. McGee, 993 F.2d 184, 186 [71 AFTR 2d 93-1967] (9th Cir. 1993) (citing United States v. Holloway, 798 F.2d 175, 176 [58 AFTR 2d 86-5641] (6th Cir. 1986). But due to changes in the law, tolling during the pendency of an OIC did not apply from December 21, 2000 through March 8, 2002. See Staso v. United States, 538 F. Supp. 2d 1335, 1347 [101 AFTR 2d 2008-1100] (D. Kan. 2008) (discussing changes to law regarding tolling during OIC process).
Here, the Ballantynes submitted an OIC with respect to the assessments made in 1995, 1997, and 1998. The IRS accepted the OIC for processing on October 24, 2000, which begins the tolling period. See United States v. Bourger, 2008 WL 4424810 [102 AFTR 2d 2008-6343], at 3 (D.N.J. Sept. 24, 2008) (“An offer to compromise becomes pending when it is accepted for processing.”) (quoting I.R.S. Revenue Procedure 2003–71 (2003). On October 23, 2007, the IRS Appeals Office finally rejected the Ballantyne's amended OIC, which terminated the OIC process. Although the OIC was pending during this entire time, there was no tolling from December 21, 2000 through March 8, 2002. Staso, 538 F. Supp. 2d at 1347. So to find the total number of days tolled, the Court starts with the total number of days the OIC was pending and subtracts the days that tolling did not apply: 2555 minus 443 equals 2,112 days. The Court adds 2,112 days, plus the normal 10-year limitations period, to the original expiration dates of the three assessments: January 2, 1995 assessment expires on or about October 15, 2010; June 30, 1997 assessment expires on or about April 12, 2013; November 16, 1998 assessment expires on or about August 28, 2014.
None of the statutes of limitation for the three tax assessments have expired. Plaintiff does not dispute these dates, but instead argues that the United States is equitably estopped from asserting tolling. The Court has already rejected that argument. Plaintiff also argues that tolling is only available if the OIC is considered in due course. But Plaintiff relies on a case in which the specific tolling agreement between the IRS and the taxpayer required the IRS to review the OIC in “due course.” United States v. Cooper-Smith, 310 F. Supp. 479, 482 [25 AFTR 2d 70-1063] (E.D.N.Y. 1970). Here, there is no similar language in the Ballantynes' OIC.
Plaintiff has failed to show a disputed fact and the Court enters summary adjudication against Plaintiff on the statute of limitations issue.
8. Plaintiff Cannot Limit the Value of the Tax Lien
Plaintiff argues that if it loses this quiet title action, the Court should limit the value of the tax lien against the McCall Property to the property's value on the date Plaintiff got title. Plaintiff first raised this argument in its Addendum to the Pretrial Order. It has not been pled.
Moreover, Plaintiff gives no support for its argument. It only cites California's Uniform Fraudulent Transfer Act, which states that if a creditor succeeds in a fraudulent transfer action, it may get a judgment against transferees “equal to the value of the asset at the time of the transfer, subject to adjustment as the equities may require.” Cal. Civ. Code § 3439.08(c). First, this provision only addresses claims made under California's fraudulent transfer law, not nominee claims, which is what the United States asserts here. Second, the provision only applies when the creditor seeks a monetary judgment against a transferee of the avoided transfer. See id. It does not apply when the creditor seeks to attach the property or only seeks to avoid the transfer and obtain relief directly from the debtor. See id.
The Court enters summary adjudication in favor of the United States on the issue of limiting the value of the tax lien.
IV. CONCLUSION
The Court GRANTS the United States's motion for summary judgment [Doc. 58]. The Court grants summary adjudication in favor of the United States on the following claims and issues: equitable estoppel, statute of limitations, proper notice and demand, Rhodes' and Hemet C's status as subsequent purchasers, repudiation of a resulting trust, and limiting the value of the tax lien. The Court, however, holds that there is a genuine dispute of material fact regarding Plaintiff's status as a subsequent purchaser.
The Court DENIES Plaintiff's motion for summary judgment in its entirety [Doc. 59]. The Court DENIES as moot Plaintiff's motion for leave to file a Second Amended Complaint [Doc. 74].
IT IS SO ORDERED.
DATED: August 5, 2010
Honorable Barry Ted Moskowitz
United States District Judge
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1
There is a dispute regarding whether notices and demands regarding the assessments were proper. The Court finds they were proper, as discussed in detail infra.
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2
The Court is unable to find any cases where the beneficiary has repudiated a trust. That is presumably because the resulting trust is generally used to protect the beneficiary's interest in the property.See 11 Witkin, Summary of Cal. Law, Trusts § 297 (9th ed. 1990)
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3
Plaintiff originally had a third argument, claiming that the United States's fraudulent transfer claim had been extinguished. Plaintiff has withdrawn this argument based on Bresson v. Commisioner of Internal Revenue, 213 F.3d 1173 [85 AFTR 2d 2000-1901] (9th Cir. 2000), which held that the extinguishment provisions of the California Uniform Fraudulent Transfer Act are inapplicable to actions by the IRS to collect income taxes.
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4
Normally, courts should only address arguments first raised in a reply if the opposing party has had the chance to respond to them. El Pollo Loco, Inc. v. Hashim, 316 F.3d 1032, 1040–41 (9th Cir. 2003). Nevertheless, since the Court rejects Plaintiff's arguments, the Court finds it unnecessary to have the United States respond.
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5
Plaintiff objects to evidence regarding the tax assessments as irrelevant, hearsay, and lacking foundation. The Court overrules the objections. The evidence regarding the assessments are public records attached to a declaration by John Black, an IRS Revenue Officer who is assigned to the Ballantynes case and who reviewed their IRS file. They are obviously relevant to the question of whether the assessments were made, Mr. Black's declaration establishes a proper foundation, and they fall within the public records hearsay exception. Fed. R. Evid. 803(8); see Hughes v. United States, 953 F.2d 531, 539–40 [69 AFTR 2d 92-472] (9th Cir. 1991).
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6
The United States also moved for summary adjudication on Plaintiff's purported laches defense, but Plaintiff states that it is not asserting a laches defense.
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