United States v. Kayser, 2007 U.S. App. LEXIS 12529 (2nd Cir. 2007).

2007 U.S. App. LEXIS 12529

UNITED STATES OF AMERICA, Plaintiff-Appellee, v. MICHAEL KAYSER, Defendant-Appellant.

No. 06-50178

UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT

2007 U.S. App. LEXIS 12529

December 5, 2006, Argued and Submitted, Pasadena, California

May 31, 2007, Filed

PRIOR HISTORY:    [*1]  Appeal from the United States District Court for the Southern District of California. D.C. No. 05-CR-0288-JTM. Jeffrey T. Miller, District Judge, Presiding.

COUNSEL:   David J. Zugman, Burcham & Zugman, APC, San Diego, California, for the defendant-appellant.

Carol C. Lam, United States Attorney; Bruce R. Castetter, George Aguilar, Assistant United States Attorneys, San Diego, California, for the plaintiff-appellee.

JUDGES:   Before: Stephen Reinhardt, Alex Kozinski, and Sandra S. Ikuta, Circuit Judges.

OPINION BY:   Sandra S. Ikuta

OPINION:   IKUTA, Circuit Judge:

Michael Kayser appeals from his conviction for tax evasion in violation of 26 U.S.C. § 7201 for the year 2000. He alleges, among other things, that the district court erred in failing to instruct the jury in accordance with his theory of defense. We have jurisdiction under 28 U.S.C. § 1291 and we reverse and remand.

BACKGROUND

From November 1998 to May 2000, A2Z USA, Inc. (”A2Z”) employed Kayser first as a salesperson and later as a vice president for its Internet-based shopping mall. A2Z compensated Kayser as an independent contractor and paid him a commission by checks made out to his  [*2]  name. In July 1999, Kayser incorporated Aspen Ventures Inc. (”Aspen Ventures”) to receive A2Z income and take business deductions related to that income.

After failing to file timely tax returns for 1998 through 2000, Kayser ultimately filed his delinquent individual and corporate tax returns for those years in August 2001. Kayser was subsequently indicted on two counts of attempted income tax evasion (for 1999 and 2000) in violation of 26 U.S.C. § 7201. n1

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n1 Section 7201 provides:Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $ 100,000 ($ 500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.
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At trial, the government alleged that Kayser had improperly structured his individual and Aspen Ventures’  [*3]  corporate returns for 1999 and 2000 to evade the payment of taxes on his A2Z activities. For the year 1999 (count 1), the government contended that Kayser received $ 104,000 of A2Z income that should have been reported on his individual return, but Kayser improperly reported this income on Aspen Ventures’ corporate return. For the year 2000 (count 2), the government showed that Kayser failed to report his A2Z income on either his individual or Aspen Ventures’ corporate return. n2

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n2 Testimony at trial indicated that Kayser received either $ 41,765 or $ 53,445 in income from A2Z in 2000 and that this income should have been reported on Kayser’s individual return for 2000.

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However, Kayser did report $ 49,026 in deductible business expenses on Aspen Ventures’ 2000 return. These deductions were composed of automobile expenses, office expenses, utilities, travel and entertainment expenses, and rents. Kayser’s accountant testified that the deductions were calculated from receipts and records maintained by Kayser.  [*4]  As reported, the expenses generated a net operating loss of $ 49,026 on Aspen Ventures’ 2000 return, which Kayser then carried back to eliminate the corporate taxes owed by Aspen Ventures on the income it reported for 1999.

The government alleged that Kayser willfully structured his individual and corporate returns in the manner described above to evade taxes, and that as a result of this improper reporting, Kayser was able to declare virtually no tax due on the $ 145,000 or more he received from A2Z as income in 1999 and 2000.

At trial, Kayser’s primary theory of defense was that he had not willfully evaded paying taxes. During the course of the trial, Kayser raised a second theory, namely, that the A2Z income he failed to report on his individual return in 2000 should be offset by the $ 49,026 in business deductions he improperly reported on Aspen Ventures’ corporate returns in 2000 and carried back to 1999. This theory was supported by two principle pieces of evidence. First, Kayser testified that he incurred the entire $ 49,026 in business deductions in connection with the production of the individual A2Z income he received in 2000. In addition, Kayser’s accountant and the government’s  [*5]  expert both testified that an independent contractor’s legitimate and allowable business deductions could generally be used to reduce business income on an individual return.

On the last day of trial, Kayser asked the district court to approve the following jury instruction: “If the defendant had unclaimed deductions which would have offset his tax liability such that there was no tax due and owing, then there is no tax deficiency.” The government argued that this instruction was unwarranted because Kayser had introduced no evidence of previously “unclaimed” deductions. The government also argued that Kayser’s theory of defense was improper under United States v. Miller, 545 F.2d 1204 (9th Cir. 1976), which the government read as precluding Kayser from arguing that the business deductions he reported on Aspen Ventures’ returns could be used to negate his individual tax deficiency.

The district court agreed with the government and declined to give the requested instruction. The district court noted that the evidence did not support the instruction and also implicitly agreed with the government’s argument that Miller precluded the theory of defense in this case.  [*6]

Following trial, the jury found Kayser guilty of tax evasion for the year 2000, but failed to reach a unanimous verdict on the count concerning tax evasion in 1999. On appeal, Kayser argues that the district court erred by rejecting his proposed jury instruction.

DISCUSSION

Kayser contends he was entitled to a jury instruction on his theory that the government could not prove there was a tax deficiency in 2000 if Kayser had sufficient allowable business expenses to offset his unreported A2Z income for that year. Our cases hold that “[a] defendant is entitled to have the judge instruct the jury on his theory of defense, provided that it is supported by law and has some foundation in the evidence.” United States v. Fejes, 232 F.3d 696, 702 (9th Cir. 2000) (internal quotations omitted). Here, the district court declined to give Kayser’s proposed instruction on two grounds, namely, that the instruction was erroneous as a matter of law under United States v. Miller, 545 F.2d 1204 (9th Cir. 1976) and that the evidence was insufficient to support the instruction. We examine both of these determinations in turn.

A.

We first consider whether Kayser’s  [*7]  proposed instruction was erroneous as a matter of law. The elements of attempted income tax evasion under 26 U.S.C. § 7201 are: (1) willfulness; (2) the existence of a tax deficiency; and (3) an affirmative act constituting an evasion or attempted evasion of the tax. Sansone v. United States, 380 U.S. 343, 351, 85 S. Ct. 1004, 13 L. Ed. 2d 882 (1965); see also United States v. Marashi, 913 F.2d 724, 735 (9th Cir. 1990). A tax deficiency occurs when a defendant owes more federal income tax for the applicable tax year than was declared due on the defendant’s income tax return. See 9TH CIR. CRIM. JURY INSTR. 9.35 (2005).

A defendant may negate the element of tax deficiency in a tax evasion case with evidence of unreported deductions. See United States v. Marabelles, 724 F.2d 1374, 1378-79 (9th Cir. 1984); Elwert v. United States, 231 F.2d 928, 933 (9th Cir. 1956). Both Marabelles and Elwert involved small business owners who (among other things) under-reported their income for one or more years. Marabelles, 724 F.2d at 1378-79; Elwert, 231 F.2d at 933-34. At trial  [*8]  for criminal tax evasion, the defendants introduced evidence of deductions for labor costs that had not been claimed on their returns in order to disprove the element of tax deficiency. Marabelles, 724 F.2d at 1378-79; Elwert, 231 F.2d at 933-34. In rejecting the defendants’ challenges to the sufficiency of the evidence supporting their respective convictions, we held that “the burden is on the defendant to prove that he had allowable deductions that were not shown in his return, once the Government establishes unreported income and allows the deductions claimed by the defendant in [his] return and others that it can calculate without his assistance.” Marabelles, 724 F.2d at 1379 n.3; Elwert, 231 F.2d at 933.

Notwithstanding the greater sophistication of Kayser’s alleged tax evasion scheme, Marabelles andElwert are controlling in Kayser’s case. Like the defendants in those cases, Kayser failed to report income on his individual return and was entitled to demonstrate at trial that he had deductions that could offset this previously unreported income. See Marabelles, 724 F.2d at 1379 n.3;  [*9]  Elwert, 231 F.2d at 933.

The government, however, argues that United States v. Miller prohibits a defendant who reports his income and deductions in one manner from arguing for an alternative characterization at trial. See Miller, 545 F.2d at 1215 (rejecting defendant’s “return-of-capital” defense because the defendant “presented no concrete proof that the amounts were considered, intended, or recorded on the corporate records as a return of capital at the time they were made”); see also United States v. Boulware (Boulware II), 470 F.3d 931, 935 (9th Cir. 2006) (same). The government thus contends that Kayser’s decision to report the $ 49,026 in business expenses on Aspen Ventures’ returns prevents Kayser from now arguing that these expenses were actually incurred by him individually in relation to his A2Z activities as an independent contractor.

Contrary to the government’s argument, Miller does not preclude a defendant in a tax evasion case from asserting a defense that is inconsistent with information falsely reported on his challenged tax returns. Miller, 545 F.2d at 1215-16. Rather, Miller allows  [*10]  a defendant to present evidence at trial regarding the facts of the transaction at issue, notwithstanding the defendant’s improper or “scrambled” reporting of those facts. Id. In Miller, the government alleged that the defendant had diverted substantial sums from his closely held corporation and failed to report the funds as income. Id. at 1209. The diverted funds had been recorded on the corporation’s books as “repayments of loans,” which were later shown to be nonexistent or false. Id. at 1209, 1215-16.

Miller tried to convince the district court to apply certain technical tax rules to transform a taxable diversion of funds into a non-taxable return of capital. Id. at 1210-14. Miller argued that a court must automatically treat funds diverted by a shareholder from a closely held corporation as a constructive corporate distribution, pursuant to a rule established in civil tax decisions. Id. Under the facts of his case, Miller contended that such a distribution would be a non-taxable return of capital. Id. at 1211 & n.9. Therefore, the government could not prove a tax deficiency and Miller could not be  [*11]  convicted of tax evasion. Id. at 1211-12.

We rejected Miller’s theory, holding that the civil constructive distribution rules did not automatically apply in a criminal tax evasion case. Id. at 1214-15. Instead, we held that a criminal defendant wishing to raise a “return-of-capital” defense had to introduce evidence that the diverted funds were, in fact, a return of capital. Id. at 1215. For example, the defendant could demonstrate that the diverted funds were intended to be a return of capital by showing an adjustment in the corporate records indicating a reduction in his basis at the time of distribution. See id. at 1215.

Consistent with this ruling, Miller was allowed to present evidence to establish his return-of-capital defense at trial. See id. at 1215-16. However, the record did not support his defense: among other things, there was a substantial question whether Miller was even a shareholder of the corporation who could receive payments as a return of capital. Id. Based on the evidence, the district court concluded that the diverted funds constituted additional taxable salary, rather  [*12]  than a non-taxable return of capital. Id. at 1215. We held that the district court’s conclusion was not clearly erroneous. Id. at 1215-16.

Neither we nor the district court suggested that Miller was bound by the original characterization of the diverted funds, i.e., the corporation’s characterization of the diverted funds as “repayments of loans” or Miller’s failure to report the diverted funds on his tax returns. Id. at 1214-16. Rather, we concluded that “whether diverted funds constitute constructive corporate distributions depends on the factual circumstances involved in each case under consideration,” id. at 1214, and the demonstration made by the defendant at trial, id. at 1215.

The import of our holding in Miller is that a defendant remains free to present evidence that funds diverted from a corporation are a non-taxable return of capital, regardless of the manner in which he or the corporation originally reported the transaction. See id. at 1214-16; see also Boulware II, 470 F.3d at 934-35. n3 Miller is thus consistent with Marabelles and Elwert  [*13]  , which provide the controlling authority in this case. Like Miller, Marabelles and Elwert permit defendants to present evidence at trial to establish the nature of their business transactions–including their actual business deductions–even when the position they take at trial is inconsistent with their original tax reportings. Marabelles, 724 F.2d at 1379 n.3; Elwert, 231 F.2d at 933.

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n3 Boulware II does not hold otherwise. In Boulware II, the government moved in limine to preclude the defendant from introducing expert testimony that the diverted funds could be deemed a constructive dividend constituting a return of capital. 470 F.3d at 933-34. The trial court granted the government’s motion, reasoning that the evidence proffered did not go to the question of whether the funds were, in fact, “considered, intended, or recorded on the corporate records as a return of capital” at the time of the distribution. Id. at 934-35 (internal quotation marks omitted). We affirmed the district court’s ruling. Id. In so holding, we did not conclude that Boulware was bound by the manner in which he originally reported the transaction. See id. Nor did we hold that Boulware was precluded from introducing evidence to support his return-of-capital theory. See id. Rather, we held that under Miller, Boulware was required to show that the distribution was intended to be a return of capital. Id. at 933-35. Because Boulware’s proffered evidence did not go to the question whether the diverted funds ” ‘were considered, intended, or recorded on the corporate records as a return of capital at the time they were made,’ ” id. at 935 (quoting Miller, 545 F.2d at 1215), we held the district court properly concluded that Boulware failed to lay the requisite evidentiary foundation for a return-of-capital defense. Id. at 934-35.

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Following Marabelles and Elwert, we hold that if Kayser had business expenses that were allowable offsets against his individual income, he had the right to show them and explain them as part of his defense for tax evasion. Marabelles, 724 F.2d at 1379 n.3; Elwert, 231 F.2d at 933. The fact that Kayser improperly reported the deductions he now claims negate his individual deficiency, while the defendants in Marabelles and Elwert simply failed to report certain deductions, does not alter our conclusion. Kayser’s improper report of deductions on his corporate return does not change the underlying nature of these expenses, although the filing of a false return itself may constitute a separate offense. See 26 U.S.C. § 7206(1). When the Supreme Court held that a tax deficiency is a necessary element of tax evasion under section 7201, it made no exception for cases where the defendant owed no tax to the government but had improperly reported the underlying income and deductions that demonstrated this lack of a tax deficiency. See Lawn v. United States, 355 U.S. 339, 361, 78 S. Ct. 311, 2 L. Ed. 2d 321, 1958-1 C.B. 540 (1958);  [*15]  Sansone, 380 U.S. at 351, 354. Therefore, Kayser’s prior report of $ 49,026 in deductions on Aspen Ventures’ returns does not preclude him from now arguing that these deductions are offsets to his individual A2Z income, provided that he carries the burden of demonstrating the legitimacy and allowability of these deductions. See Marabelles, 724 F.2d at 1379 n.3 (”the burden is on the defendant to prove that he had allowable deductions that were not shown in his return” (emphasis added) (citing Elwert, 231 F.2d at 933)). n4

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n4 Kayser did not argue that the $ 49,026 in business deductions he reported on Aspen Ventures’ 2000 return “flowed through” Aspen Ventures to his individual return. The government’s argument that Aspen Ventures is not a flow-through entity is therefore irrelevant.

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B.

Having concluded that Kayser’s theory of defense represents a correct application of Marabelles and Elwert, we next turn to the question whether Kayser established  [*16]  an adequate foundation in the record to warrant an instruction on this theory. The legal standard is generous: “a defendant is entitled to an instruction concerning his theory of the case if the theory is legally sound and evidence in the case makes it applicable, even if the evidence is weak, insufficient, inconsistent, or of doubtful credibility.” United States v. Washington, 819 F.2d 221, 225 (9th Cir. 1987). A defendant needs to show only that “there is evidence upon which the jury could rationally sustain the defense.” United States v. Jackson, 726 F.2d 1466, 1468 (9th Cir. 1984) (per curiam); see also United States v. Johnson, 459 F.3d 990, 993 (9th Cir. 2006). Where, as here, factual disputes are raised, this standard protects the defendant’s right to have questions of evidentiary weight and credibility resolved by the jury. Jackson, 726 F.2d at 1468; see also Johnson, 459 F.3d at 993.

We review the district court’s conclusion that Kayser’s proposed instruction was not supported by sufficient evidence for an abuse of discretion. Fejes, 232 F.3d at 702.

Kayser’s theory of defense  [*17]  was that the jury should apply the $ 49,026 in deductions he initially reported on his corporate tax return in 2000 to eliminate the deficiency on his personal return for that year. Under Marabelles and Elwert, this theory required Kayser to establish two elements: First, Kayser had to show that the $ 49,026 represented legitimate business expenses actually incurred by him in an individual capacity. Second, Kayser had to demonstrate that the $ 49,026 of business expenses represented “allowable” deductions on his individual return within the meaning of the Tax Code. Marabelles, 724 F.2d at 1379 n.3 (citing Elwert, 231 F.2d at 933). We conclude that Kayser’s evidence was sufficient to warrant a jury instruction on this theory.

Through his own testimony, and the testimony of his accountant, Kayser presented evidence that he maintained records and receipts of his business expenses and that from those records, his accountant calculated the $ 49,026 of business expenses reported on Kayser’s corporate return. Kayser further testified that all of the $ 49,026 in business expenses was incurred in connection with his previously unreported individual  [*18]  A2Z income for 2000. n5 On this record, a rational jury could have concluded that Kayser actually incurred $ 49,026 in business expenses and that these expenses were legitimate.

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n5 The dissent contends that “Kayser made only very broad statements that the deductions relate to his personal income, and even then he hedged quite a bit.” Dissent at 6590. However, as the dissent acknowledges, on direct examination, Kayser specifically and unambiguously testified that “every deduction” reported on Aspen Ventures’ 2000 corporate return related directly to Kayser’s A2Z income. The prosecution made effective use of its cross-examination to raise doubts about the assertions Kayser made on direct examination. While Kayser’s stumbling answers on cross-examination may further weaken the evidence supporting his defense, under our case law, Kayser is entitled to his proposed instruction even if the evidence supporting his theory of defense “is weak, insufficient, inconsistent, or of doubtful credibility.” Washington, 819 F.2d at 225.

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We also conclude that there was sufficient evidence from which a rational jury could find that the $ 49,026 represented allowable business expenses with respect to Kayser’s personal return. The record included Aspen Ventures’ 2000 tax return, which detailed that the business deductions in the amount of $ 49,026 were composed of automobile expenses, office expenses, utilities, travel and entertainment expenses, and rents. The government did not challenge either the character, amount, or validity of the expenses. At the same time, both the government’s expert and Kayser’s accountant testified that as a general matter, business expenses of the type reported on Aspen Ventures’ 2000 return could be used to reduce business income on an individual return. This evidence, though arguably weak, was sufficient to allow a rational jury to sustain Kayser’s defense. The district court therefore abused its discretion in failing to instruct the jury on this theory. n6

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n6 In discussing the weakness of Kayser’s evidence, the dissent merges the two separate counts of Kayser’s indictment by noting that “[t]o escape conviction, . . . Kayser had to show that he had enough deductions to shelter both his 1999 and 2000 income.” Dissent at 6589 (emphasis in original). There is no dispute that Kayser did not have sufficient deductions to offset both his 1999 and 2000 income. However, Kayser may still raise a deficiency defense with respect to the second count of his indictment (relating to the 2000 tax year) when a rational jury could conclude that Kayser had sufficient allowable deductions to negate the government’s proof of deficiency with respect to that year.

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C.

We thus conclude that the requested jury instruction was supported by law and had sufficient foundation in the evidence. Because the district court erred in declining to instruct the jury on Kayser’s theory of defense, we reverse Kayser’s conviction. n7

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n7 Kayser argues that any instructional error by the district court cannot be harmless. See United States v. Escobar De Bright, 742 F.2d 1196, 1201-02 (9th Cir. 1984) (holding that an erroneous refusal to give defendant’s proposed theory of defense instruction is reversible per se). We have not revisited Escobar De Bright in light of Neder v. United States, 527 U.S. 1, 119 S. Ct. 1827, 144 L. Ed. 2d 35 (1999). Nor do we need to, because the district court’s failure to give Kayser’s proposed instruction prevented him from making a significant challenge to the deficiency element of the tax evasion count for the year 2000, and thus cannot be harmless beyond a reasonable doubt.See Chapman v. California, 386 U.S. 18, 87 S. Ct. 824, 17 L. Ed. 2d 705 (1967).

Kayser also argues that he was wrongfully prevented from introducing evidence to support his theory of defense and that the district court misapplied the Sentencing Guidelines in determining the total tax loss by refusing to reduce Kayser’s 2000 unreported income by the deductions he reported on Aspen Ventures’ 2000 return and carried back to 1999. Given our reversal and remand for a new trial, we do not reach these issues.

Finally, Kayser asserts that his indictment should be dismissed because the grand jury was improperly instructed. However, as Kayser acknowledges, our precedent has squarely rejected his position and we therefore affirm the district court’s denial of Kayser’s motion to dismiss the indictment. See United States v. Navarro-Vargas, 408 F.3d 1184 (9th Cir. 2005) (en banc); United States v. Cortez-Rivera, 454 F.3d 1038 (9th Cir. 2006).

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REVERSED and REMANDED.

DISSENT BY:   Alex Kozinski

DISSENT:   KOZINSKI, Circuit Judge, dissenting:

The majority begins its analysis by dutifully reciting a well-established rule: “A defendant may negate the element of tax deficiency in a tax evasion case with evidence of unreported deductions.” Maj. op. at 6576 (citing United States v. Marabelles, 724 F.2d 1374, 1378-79 (9th Cir. 1984); Elwert v. United States, 231 F.2d 928, 933 (9th Cir. 1956)). But it then jumps the rails by removing the word “unreported” and allowing a defendant to escape a criminal tax conviction by recharacterizing reported deductions. Id. at 12. This new rule finds no support in our caselaw and conflicts with United States v. Miller, 545 F.2d 1204 (9th Cir. 1976), and United States v. Boulware (Boulware II), 470 F.3d 931 (9th Cir. 2006). Even if this new rule were permissible, defendant did not present evidence that could support such an instruction. For both these reasons, I respectfully dissent.

1. Kayser was charged with tax evasion for failing to report income on his 2000 individual return. His proposed instruction  [*22]  would have allowed the jury to apply the $ 49,026 in deductions, which he had reported on his corporate tax return, to his personal income. As the government argued at trial, this defense is foreclosed by Miller. In Miller, we dealt with a highly analogous situation, where the taxpayer wished to recharacterize a distribution from his corporation as a return of capital, rather than as a dividend. Miller’s argument, like Kayser’s, was that what mattered was the reality of the transaction, not the way he initially papered it. We rejected this contention. Our rationale for reaching this conclusion is highly instructive:In civil tax cases the purpose is tax collection and the key issue is the establishment of the amount of tax owed by the taxpayer. In a criminal tax proceeding the concern is not over the type or the specific amount of the tax which the defendant has evaded, but whether he has willfully attempted to evade the payment or assessment of a tax. Goldberg, supra, 330 F.2d at 40; Simon, supra, 248 F.2d at 876.

The difficulty in automatically applying the constructive distribution rules to this case is that it completely  [*23]  ignores one essential element of the crime charged: the willful intent to evade taxes, and concentrates solely on the issue of the nature of the funds diverted. That latter aspect is not the important element. Where the taxpayer has sought to conceal income by filing a false return, he has violated the tax evasion statutes. It does not matter that that amount could have somehow been made non-taxable if the taxpayer had proceeded on a different course. n12 To apply the constructive distribution rules to this situation would nullify all of the taxpayer’s prior unlawful acts.

n12 At the time the funds are initially diverted, it might well be argued that they could constitute either income or a return of capital. However, once the taxpayer has assumed control of the funds and then fails to report such funds as income or to make any adjustments in the corporate books to reflect a return of capital, he has already violated the tax evasion statutes. Accord, Spies v. United States, 317 U.S. 492, 498-99, 63 S. Ct. 364, 87 L. Ed. 418, 1943 C.B. 1038 (1943); United States v. Swallow, 511 F.2d 514, 521 (10th Cir.), cert. denied, 423 U.S. 845, 96 S. Ct. 82, 46 L. Ed. 2d 66 (1975).

Miller, 545 F.2d at 1214 & n.12; see also Boulware II, 470 F.3d at 933-35 (same).

Under this rule, a defendant in a criminal tax case is bound by the way he papered the transaction at the time he earned the income in question. In Miller, the taxpayer was bound by the fact that his corporate books did not reflect the distribution as a return of capital. That he could later, as a matter of economic reality, claim that the distribution was a return of capital was of no consequence, because contemporaneously maintained records did not support that re-characterization. Miller went on to explain:

In holding that the constructive distribution rules should not automatically be applied, it is not herein asserted that diverted funds could never be a return of capital. However, to constitute the latter, there must be some demonstration on the part of the tax-payer and/or the corporation that such distributions were intended to be such a return. To hold otherwise would be to permit the taxpayer to divert such funds and if not caught, to later pay out another return of capital; or if caught, to avoid conviction by raising the defense that the sums were a return of capital and hence non-taxable.

545 F.2d at 1215 (footnote omitted); see also Boulware II, 470 F.3d at 934 (”[D]efendant must show not merely that the funds could have been a return of capital, but that the funds were in fact a return of capital at the time of the transfer.”).  [*24]

Although this rule creates some tension with Marabelles and Elwert, n1 these cases can be reconciled because Marabelles and Elwert deal with the situation where the taxpayer failed to claim deductions. In such circumstances, the deductions are unreported, so the taxpayer is not bound under Miller by any prior characterization. Unlike in Marabelles and Elwert, defendant here did not fail to report business expenses on his return; he claimed the deductions on his corporate return and carried back the losses to wipe out tax liability for the prior year. Kayser’s act of claiming the deductions on his corporate return was not merely proof of the underlying reality; it was the reality because it had a legally operative effect: Had Kayser not been audited, these deductions would have been carried back to reduce his corporate tax liability to zero for 1999; his 2000 personal tax liability would have been zero because of his failure to declare income.

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n1 This tension was pointed out by Judge Thomas’s concurring opinion in Boulware II. Judge Thomas criticized Miller because it holds that “a defendant may be criminally sanctioned for tax evasion without owing a penny in taxes to the government. Not only does this result indicate a logical fallacy, but is in flat contradiction with the tax evasion statute’s requirement of ‘the existence of a tax deficiency.’ ” 470 F.3d at 938 (Thomas, J., concurring) (quoting Marabelles, 724 F.2d at 1379). Nevertheless, Judge Thomas, like the Boulware II majority, concluded that they were bound by Miller and ruled in favor of the government.

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The IRS, however, did audit Kayser and found that he had underreported his personal income in 2000. If the deductions are shifted from his corporate to his individual return, this would affect his 1999 corporate tax liability. The same deductions cannot be used twice: He can either use them to wipe out his 2000 personal income or he can carry them back to wipe out his 1999 corporate income. Having chosen to do the latter when he filed his returns, the deductions are used up and are not available to offset his 2000 personal income. Contrary to the majority’s holding, Marabelles and Elwert are thus not on point because Kayser does not have allowable deductions that were not reported on his return. Even if the deductions in question could have been treated as personal deductions, had Kayser claimed them as such on his individual return, the district court properly concluded that Kayser is stuck with the way he reported them at the time–which was as corporate deductions. To let him now go back and treat the deductions as applicable to his personal income allows for precisely the kind of heads-I-win, tails-the-government-loses scenario that Miller sought to foreclose.  [*26]

2. Even under the majority’s new rule, the district court did not abuse its discretion in refusing to give the proposed instruction because Kayser did not present sufficient evidence to warrant the instruction. Kayser needed to establish that he had enough allowable deductions to eliminate tax liability. In other words, he needed to show that he would have and could have reported sufficient deductions to offset all income. The majority strains to find “arguably weak” evidence in the record to support both propositions, see maj. op. at 6581-83, but the evidence on both counts falls far short of providing a sufficient basis “upon which the jury could rationally sustain the defense.” United States v. Jackson, 726 F.2d 1466, 1468 (9th Cir. 1984) (per curiam); see also United States v. Streit, 962 F.2d 894, 898 (9th Cir. 1992) (same) (”The ‘merest scintilla of evidence,’ however, will not suffice.” (quoting Jackson, 726 F.2d at 1468)). n2

- - - - - - - - - - - - - - Footnotes - - - - - - - - - - - - - - -

n2 Nor did the district court prevent defendant from presenting evidence to support the proposed instruction. The majority does not reach this issue, see maj. op. at 6583-84 n.7, but it’s worth noting that the district court gave defendant ample opportunity to introduce such evidence. When defendant first raised the issue on the penultimate day of trial, the court noted that “you may have a problem given the state of the evidence if you argue that, but you may not. It just depends on how everything comes in and what the arguments are, what the objections are. And I can’t rule hypothetically on every permutation of argument that we might hear in the case. We’ll just have to defer that until the time of argument.” When defendant presented his proposed instruction the next day, the court similarly noted, “Well, I’m going to decline to give this instruction at this point; the evidence doesn’t support it.” Defendant thus cannot blame the district court for his failure to present the requisite evidence.

- - - - - - - - - - - - End Footnotes- - - - - - - - - - - - - -  [*27]

Kayser reported $ 49,026 in business expenses on his 2000 corporate return and carried back these expenses to eliminate his corporate tax liability for 1999. He was able to carry back these losses because he failed to report $ 41,765 of personal income from A2Z in 2000 and thus had no 2000 reported income against which to claim deductions. n3 Unlike Marabelles and Elwert, therefore, the deductions Kayser wanted to use to offset his unreported 2000 income at the time of trial were not unused. Rather, they were doing work in sheltering his 1999 corporate income. Had the 1999 tax year been beyond the government’s reach, perhaps Kayser could have argued that he had erred in assigning the deductions (for his 2000 expenses) to his corporate return and carrying them back to 1999. The majority’s new rule would allow that (though Miller would, in my view, prohibit it).

- - - - - - - - - - - - - - Footnotes - - - - - - - - - - - - - - -

n3 At trial, the IRS case agent testified that Kayser underreported his 2000 personal income by $ 53,445, but the government’s expert calculated the figure more conservatively at $ 41,765. See maj. op. at 6574 n.2. The district court relied on the more conservative calculation at sentencing, and the government relies on the same figure on appeal. While we also must rely on the conservative calculation here, it’s worth noting that Kayser concedes that he’d have no defense if the jury bought the higher calculation because he wouldn’t have had sufficient deductions to eliminate all tax liability.

- - - - - - - - - - - - End Footnotes- - - - - - - - - - - - - -  [*28]

But the 1999 tax year was not beyond the government’s reach. In fact, Kayser was being tried for tax evasion for both 1999 and 2000. To escape conviction, therefore, Kayser had to show that he had enough deductions to shelter both his 1999 and 2000 income. There just weren’t enough deductions to do this. On his 1999 corporate return, Kayser reported $ 104,532 in income; he paid taxes on none of it because he claimed $ 111,061 in deductions to wipe out his 1999 corporate income–including $ 49,026 in carryback losses from 2000. If he shifted $ 41,765 of these deductions to cover his unreported income for 2000, that would have left him only $ 69,296 in deductions for 1999 to offset the $ 104,532 in income reported on his corporate return. Thus, even assuming Kayser were allowed to reassign some or all of his deductions from 1999 to 2000, he would have some unsheltered income in one or both years; the majority admits as much. See maj. op. at 6583 n.6.

Which is no doubt why the record is so muddy as to whether Kayser would or could have reassigned the deductions to his personal income: Had Kayser shown unequivocally that the deductions were available in 2000, and that he would  [*29]  have claimed them that year, he would have exposed himself to a conviction for tax evasion in 1999. Kayser therefore hedged his testimony. On direct examination, Kayser indicated that “every deduction on [his] corporate return . . . related to [his] A2Z income,” and that he would “have attempted to declare some of the deductions” on his individual return. (Emphasis added.) On cross-examination, Kayser testified that the 2000 business expenses “could have been [Aspen Ventures expenses], yeah, but they were primarily due to the consulting business [apparently referring to his employment with A2Z] as well as Image Network, or Clear Blue Media is otherwise known as.” When pressed further, Kayser testified that these were Aspen Ventures expenses “if I’m understanding–I’m getting a little confused, but yes.”

Note that Kayser made only very broad statements that the deductions relate to his personal income, and even then he hedged quite a bit: He claimed he would have attempted to declare some of those deductions on his individual return. He didn’t say what portion of the $ 49,026 he would have claimed; it could have been $ 41,765 or more, or it could have been less. It’s  [*30]  even less clear when we consider his backtracking on cross-examination: He admitted that some of the expenses “could have been” attributable to Aspen Ventures, and that the expenses “were primarily due to the consulting business as well as Image Network.” Again, we don’t know which portion. As the majority notes, it is defendant’s burden to show that the claimed expenses would have reduced his income to zero for the relevant tax year (here 2000). Maj. op. at 6577 (citing Marabelles, 724 F.2d at 1379 n.3; Elwert, 231 F.2d at 933). On this record, a rational jury could not find that Kayser had shown sufficient business expenses that he would have used to offset all tax liability for 2000.

Even assuming Kayser had testified that he would have claimed all the deductions on his individual return, this wouldn’t have been enough. To wipe out his 2000 unreported income, Kayser also had to show that the deductions would have been allowable. See maj. op. at 6582 (citing Marabelles, 724 F.2d at 1379 n.3; Elwert, 231 F.2d at 933). It’s a point Kayser did not address in his testimony. The question then is whether the  [*31]  other two witnesses–the government’s expert and Kayser’s accountant–addressed the allowability of the deductions. The government’s expert certainly provided Kayser no help. On cross-examination, the expert indicated that it was “theoretically” possible that Kayser could have claimed the deductions on his individual return “if those deductions had passed the many different requirements that the IRS imposes in order to claim the deductions related to the business incurred for furthering the business.” (Emphasis added.) A theoretical possibility, however, is not evidence, not even “arguably weak” evidence, that such deductions were indeed allowable on Kayser’s individual return. The government’s expert never said that any of the expenses were actually allowable to offset Kayser’s personal income.

This brings us down to the accountant’s testimony. Kayser’s accountant (who was the government’s witness) testified on direct that “[i]f the deductions were attributable to Mr. Kayser and had he paid those personally, he could have deducted those personally . . . and the tax return for the corporation would have been nonexistent; it just would have been a zero return.” (Emphasis  [*32]  added.) On cross-examination, the accountant testified that “if in fact the corporation was not the recipient of the income and we pick that up on Michael Kayser’s personal tax return and we pick up the expenses and all of them are–all the income is reported and all expenses are allowable, I don’t–I cannot see a significant change in the tax.” (Emphasis added.) On re-direct, he indicated that if Kayser had accurately reported his individual income, Kayser would have had to file a “new tax return or amended tax return,” and “certain other parts of the tax return [would be] inapplicable or at least [would need] to be amended.”

The majority seems to think it’s sufficient that “both the government’s expert and Kayser’s accountant testified that as a general matter, business expenses of the type reported on Aspen Ventures’ 2000 return could be used to reduce business income on an individual return.” Maj. op. at 6582-83. But the majority does not examine what the witnesses actually said. Significantly, the majority points to no statement by either witness that supports its watery characterization. In fact, neither witness testified that the actual business expenses reported by  [*33]  Aspen Ventures were allowable on Kayser’s individual return. Kayser’s accountant, like the government’s expert, assumed hypothetically that the deductions were allowable and then opined what effect this would have had on Kayser’s 2000 individual return. Even then, the accountant hedged, suggesting that other parts of the return would have to be amended. Nowhere did he say that the deductions were actually allowable under the tax code; nor did he claim that Kayser’s hypothetical individual return, when adjusted properly, would have resulted in zero tax liability.

In short, Kayser did not provide sufficient proof to enable a rational jury to find that he had enough allowable deductions to reduce his 2000 personal tax liability to zero. Nor could he, given that he needed these same deductions to shelter his 1999 income. Under these circumstances, the district court did not abuse its discretion in refusing to give the instruction. See Streit, 962 F.2d at 898. Indeed, it did exactly what a district court should do when a party proposes an instruction that’s not supported by the evidence.

* * *

In reversing defendant’s conviction, the majority creates a defense against  [*34]  criminal tax liability that conflicts with established circuit precedent. And it does so unnecessarily, as defendant has fallen far short of meeting his burden to warrant the erroneous instruction. The majority thus eviscerates the evidentiary standard for proposed jury instructions by forcing a district court to give an instruction that’s only supported by generalities and hypothetical possibilities. I must part company with my colleagues in both of these precarious endeavors.

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May 31st, 2007 | 1 Comment »

Private Letter Ruling 200721013 (2007).

Internal Revenue Service Department of the Treasury

Washington, DC 20224

Number: 200721013

Third Party Communication: None Release Date: 5/25/2007 Date of Communication: Not Applicable

Index Number: 61.0000, 6041.0000

Person To Contact:

Telephone Number:

Refer Reply To: CC:ITA:B04 PLR15711106

Date: February 09, 2007

, ID No.

This responds to your letter dated November 30, 2006, requesting a ruling that Taxpayer does not have an information reporting obligation under section 6041 for amounts paid to its customers, purchasers of real property. Specifically, you request a ruling that the amounts are not reportable under section 6041 because the amounts are not taxable income to the purchasers.

FACTS

Taxpayer is a real estate broker located in State A. Taxpayer represents customers who purchase homes offered for sale on Y. Y is a database that allows real estate brokers representing sellers under a listing contract to share information about properties with real estate brokers who may represent potential purchasers or wish to cooperate with a seller’s broker in finding a purchaser for the property.

A seller is required by law to pay a commission when a seller offers a home for sale on

Y. Part of the commission is paid to the seller’s agent, a broker that lists the home for sale; and part of the commission is paid to the buyer’s agent, a broker that produces a ready, willing, and able purchaser. Taxpayer receives commissions from the seller when it acts as a buyer’s agent in connection with real estate transactions.

PLR15711106 2

Taxpayer enters into written and signed buyer’s agency agreements with each purchaser that it represents. In its buyer’s agency agreement, Taxpayer agrees to pay the purchaser Amount 1 of any commission that it receives from the seller in a completed sales transaction. Taxpayer pays the purchaser in one of two ways: (1) after closing, the cash and loan proceeds are distributed to the seller and the agents, and after Taxpayer receives its share of the commission, Taxpayer writes a check to the purchaser pursuant to the agreement; or (2) the purchaser receives a credit at closing in an amount equal to Amount 1 of the commission owed to Taxpayer. The buyer’s agency agreement permits the purchaser to use the payment towards the purchaser’s down payment, closing costs, and/or a reduction in purchase price as directed by the purchaser and allowed by law.

LAW AND ANALYSIS

Issue 1 – Payments or Credits are Not Taxable Income

Section 61 of the Internal Revenue Code (Code) provides that, except as otherwise provided, gross income means all income from whatever source derived.

Situation 2 of Rev. Rul. 200627, 200621 I.R.B. 915, involves a nonprofit corporation that provides down payment assistance towards the purchase of homes to lowincome individuals and families. The ruling holds that down payment assistance received by a home purchaser represents a rebate or an adjustment to the purchase price, and, as such, is not included in a purchaser’s gross income.

Rev. Rul. 7696, 19761 C.B. 23, as modified by Rev. Rul. 200528, 20051 C.B. 997, involves a manufacturer of automobiles that paid rebates to its retail customers who purchased or leased new automobiles. The ruling holds that a rebate is not includible in a customer’s gross income; but rather, represents an adjustment to the purchase price of the automobile.

In the present case, a payment or credit at closing from Taxpayer represents an adjustment to the purchase price of the home and generally is not includible in a purchaser’s gross income.

Issue 2 – Information Reporting Obligations

Section 6041 of the Code requires all persons engaged in a trade or business and making payment in the course of such trade or business to another person, of rent, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable gains, profits, and income of $600 or more in any taxable year, to file an information return with the Internal Revenue Service and to furnish an information statement to the payee.

PLR15711106 3

Section 1.60411(a)(2) of the Income Tax Regulations provides that the return required by section 6041(a) of the Code is made on Forms 1096 and 1099. Section 1.60411(c) provides that payments are fixed when they are paid in amounts definitely predetermined. Income is determinable whenever there is a basis of calculation by which the amount to be paid may be ascertained.

A payor generally is not required to make a return under section 6041 of the Code for payments that are not includible in the recipient’s income, nor is a payor required to make a return if the payor does not have a basis to determine the amount of a payment that is required to be included in the recipient’s income.

In the present case, Taxpayer does not have an information reporting obligation under section 6041 of the Code because, as concluded above, a payment or credit at closing represents an adjustment to the purchase price of the home and generally is not includible in a purchaser’s gross income. Nor does Taxpayer have an information reporting obligation for those amounts under any other section of the Code.

A copy of this letter must be attached to any income tax return to which it is relevant. We enclose a copy of the letter for this purpose. Also enclosed is a copy of the letter ruling showing the deletions proposed to be made to the letter when it is disclosed under section 6110 of the Code.

This ruling is directed only to the taxpayer(s) requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, we are sending a copy of this letter to your authorized representative.

Sincerely,

Donna Welch Senior Technician Reviewer, Branch 4 Office of Associate Chief Counsel (Income Tax & Accounting)

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May 25th, 2007 | No Comments »

Private Letter Ruling 200721006 (2007).

Refer Reply To:

CC: PA:APJP:B02

PLR14819806 Date: February 14, 2007

Date of Death:Date of Death:

Dear :

In a letter dated October 2, 2006, , the personal representative of the , requested an extension of time under Reg. Section 301.91003 to file an election under IRC §6166 to pay estate tax in installments. Alternatively, requested that the §6166 election be considered a procedural directive and granted on the basis of the “substantial compliance doctrine.” For the following reasons, we are unable to grant this request.

Pertinent facts:

passed away on . timely filed Form 4768 on to request an extension of time to file Form 706 on or before . filed Form 706 along with a request for election under IRC §6166 on or about . On , the Internal Revenue Service notified the Estate that the election under §6166 was denied due to it not being timely filed.

Relevant statutory and regulatory sections:

Treas. Reg. §301.91001(a) states that the regulations under §§301.91001, 301.91002 and 301.91003 provide the standards used to determine whether or not an extension of time to make a regulatory election will be granted. Sections 301.91001 and 301.91002 also provide automatic extensions of time for certain statutory elections. Section 301.91003 provides extensions of time for making regulatory elections that do not meet the requirements of §301.91002.

Treas. Reg. §301.91001(b) defines “statutory election” as an election whose due date is prescribed by statute. Alternatively “regulatory election” means “an election PLR14819806 2

whose due date is prescribed by a regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice or announcement published in the Internal Revenue Bulletin. Treas. Reg. §301.91001(b).

I.R.C. Section 6166 states that if the value of an interest in a closely held business, which is included in determining the gross estate of a decedent who was a citizen or resident of the United States, exceeds 35 percent of the adjusted gross estate, the executor may elect to pay part or all of the tax imposed in 2 or more (but not exceeding 10) equal installments. IRC §6166(a)(1). Per §6166(d), this election must be made no later than the time prescribed by section 6075(a) of the Internal Revenue Code for filing the estate tax return. Section 6075(a) states that such returns must be filed within 9 months after the date of the decedent’s death. Because the due date for an election under §6166 is prescribed by statute, the election is by definition a statutory election within the meaning of Treas. Reg. §301.91001(b). Additionally, there are no regulations that purport to prescribe the due date for a §6166 election. Treas. Reg. §20.61661(b) states the election provided under §6166(a) is made by attaching certain information to a timely filed estate tax return, however it is §6075 that prescribes what makes an estate tax return timely. The due date cannot be determined without reference to statute. Mere incorporation of a statutory due date in a regulation does not change a statutory election into a regulatory election. Therefore, Treas. Reg. §301.91003 does not apply in this instance as that section is applicable only to certain regulatory elections and not to statutory elections.

Furthermore, the “substantial compliance” doctrine does not apply in the context of making an election under §6166. The United States Tax Court, considering statutory and regulatory provisions nearly identical to the current §6166 provisions, has stated that there are no reasonable cause exceptions to the requirements for election, and a taxpayer is granted relief under the election only if he complies with the statutory requirements. See Estate of Glenard B. Boyd v. Commissioner, T.C. Memo 1983316 (1983) (ruling in the context of §2032A and its regulations). The court has also stated that where regulations provide that the election must be made on a timely filed estate tax return, the requirement of “a timely filed return is mandatory” and the provisions “leav[e] no room for a reasonable cause exception for an untimely return.” Estate of Shella B. Gardner v. Commissioner, 82 T.C. 989, 992 (1984) (ruling in the context of §2032A and its regulations).

PLR14819806 3

Conclusion

Because Treas. Reg. §301.91003 applies only to regulatory elections and not statutory elections, and an election under IRC §6166 is a statutory election, the request for extension to file is denied.

Sincerely,

Blaise G. Dusenberry Special Counsel, Administrative Provisions & Judicial Practice (Procedure & Administration)

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May 25th, 2007 | 1 Comment »

McNamee v. Dept of Treasury, 2007 U.S. App. LEXIS 12016 (2nd Cir. 2007).

2007 U.S. App. LEXIS 12016

SEAN P. McNAMEE, Plaintiff-Appellant, - v. - DEPARTMENT OF THE TREASURY, INTERNAL REVENUE SERVICE, Defendant-Appellee.

Docket No. 05-6151-cv

UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT

2007 U.S. App. LEXIS 12016

December 8, 2006, Argued

May 23, 2007, Decided

PRIOR HISTORY:    [*1]  Appeal from a judgment of the United States District Court for the District of Connecticut, Christopher F. Droney, Judge, upholding Internal Revenue Service determination that plaintiff is personally liable for the employment tax liabilities of his wholly-owned limited-liability company, which he had chosen not to have treated as a corporation. McNamee v. Dep’t of the Treasury, 2005 U.S. Dist. LEXIS 25775 (D. Conn., 2005)

DISPOSITION:   Affirmed.

COUNSEL:   SEAN P. McNAMEE, Wallingford, Connecticut, Plaintiff-Appellant, Pro se.

BRIDGET M. ROWAN, Attorney, Tax Division, Department of Justice, Washington, D.C. (Eileen J. O’Connor, Assistant Attorney General, David I. Pincus, Attorney, Tax Division, Washington, D.C., Kevin J. O’Connor, United States Attorney for the District of Connecticut, on the brief), for Defendant-Appellee.

JUDGES:   Before: KEARSE and STRAUB, Circuit Judges, and KEENAN, District Judge *.
* Honorable John F. Keenan, of the United States District Court for the Southern District of New York, sitting by designation.

OPINION BY:   KEARSE

OPINION:   KEARSE, Circuit Judge:

Plaintiff pro se Sean P. McNamee, the single-member owner of a now-defunct limited liability company (or “LLC”) formed under Connecticut law, appeals from a judgment of the United States District  [*2]  Court for the District of Connecticut, Christopher F. Droney, Judge, rejecting his challenge to a determination by the Internal Revenue Service (”IRS”) under Treasury Regulations §§ 301.7701-2 and 301.7701-3, 26 C.F.R. §§ 301.7701-2 and 301.7701-3, that, because of his failure to exercise his option to have his LLC treated as a corporation, McNamee was personally liable for the LLC’s employment tax liabilities. McNamee alleged principally that the Treasury Regulations, and hence the IRS determination, were contrary (a) to state law treating an LLC and its members as separate entities, and (b) to provisions of the Internal Revenue Code (or “Code”). The district court, concluding that the Treasury Regulations were both consistent with the Code and reasonable, ruled in favor of the government. On appeal, McNamee pursues his contentions that the regulations are invalid because they contravene state law and the federal statutory scheme. For the reasons that follow, we affirm.

I. BACKGROUND

The material facts appear to be undisputed. McNamee was the sole proprietor of an unincorporated accounting  [*3]  firm, W.F. McNamee & Company LLC (”WFM-LLC”), a Connecticut limited liability company that ceased operation in March 2002. WFM-LLC employed an average of six persons.

The Internal Revenue Code imposes two forms of employment tax obligations on an employer (hereinafter “payroll taxes”). First, the employer is required to pay unemployment taxes, see 26 U.S.C. § 3301, and to make contributions to its employees’ social-security and Medicare benefits pursuant to the Federal Insurance Contributions Act (”FICA”), see id. § 3111. Second, the employer is required to withhold from employee compensation and remit to the government (a) employee income taxes, see id. § 3402, and (b) the employees’ own mandated FICA contributions, see id. §§ 3101, 3102(b). With respect to the third and fourth quarters of 2000 and all four quarters of 2001, WFM-LLC made no payment of any of the required payroll taxes.

The Code recognizes a variety of business entities–including corporations, companies, associations, partnerships, sole proprietorships, and groups–and, based on the classifications, treats the entities in various ways for income tax purposes.  [*4]  For example, the income of a corporate entity is generally subject to a double wave of taxation, in that the corporation is taxed directly, see 26 U.S.C. § 11(a), and its individual shareholders are further taxed on dividends paid to them out of the corporation’s income, see id. § 61(a)(7). In contrast, an unincorporated sole proprietorship that is treated as such is taxed only once: the owner simply lists his business income on Schedule C of his individual tax return; the proprietorship entity is not directly taxed, see generally id. § 61(a)(2); 26 C.F.R. § 301.7701-3(b).

As discussed in greater detail in Part II below, the Code’s definitions of various types of business entities are broad, and to some extent they overlap one another. See 26 U.S.C. § 7701(a). In an attempt to eliminate ambiguity, the Treasury Regulations instruct that certain entities must be classified as corporations, see 26 C.F.R. § 301.7701-2(b), while other entities are permitted to decide for themselves whether or not to be treated as corporations, see id. § 301.7701-3.  [*5]  Thus, an entity whose classification as a corporation is not required (referred to in the Regulations as an “eligible entity”), and which has only one owner, has the option of being classified either as an “association”–which is defined in § 301.7701-2(b)(2) as a corporation–or as a “sole proprietorship” that is to be “disregarded as an entity separate from its owner,” id. § 301.7701-2(a).

An eligible entity exercises that option simply by filing IRS Form 8832, entitled “Entity Classification Election,” having checked the appropriate box on the Form. See id. § 301.7701-3(c) (the “check-the-box” regulation). In the absence of such an election, an eligible entity that has only one owner is disregarded as a separate entity. See id. § 301.7701-3(b).

WFM-LLC, McNamee’s LLC, was not required to be classified as a corporation, and McNamee elected not to have it treated as one. Thus, under the Treasury Regulations, WFM-LLC was disregarded as a separate entity and was treated as a sole proprietorship. WFM-LLC’s unpaid payroll taxes for 2000 and 2001 totaled $ 64,736.18. The IRS, having disregarded WFM-LLC as a separate entity, assessed those taxes against McNamee  [*6]  personally and placed a lien on his property.

McNamee filed a timely administrative appeal. He did not dispute WFM-LLC’s liability for the unpaid $ 64,736.18. However, pointing to sections of Connecticut law providing that members of an LLC are not personally liable for the debts of the LLC, see, e.g., Conn. Gen. Stat. Ann. § 34-133 (West 2005), he argued that the IRS did not have the authority to “unilaterally pierce the corporate veil of an LLC simple [sic] by looking at how it reports it’s [sic] income,” and that the IRS’s application of the check-the-box regulation was therefore “in direct conflict with the right of an LLC member.” (McNamee Request for a Collection Due Process Hearing.)

In a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330, dated October 23, 2003 (”IRS Determination”), the IRS Appeals Office rejected McNamee’s appeal. The unpaginated explanatory Attachment (”IRS Determination Attachment”) stated that the IRS’s review confirmed that “[WFM-LLC] was set up as a single member LLC, and that you, as the single member, did not elect association status . . . .” (IRS Determination  [*7]  Attachment, first page.) After discussing the pertinent Treasury Regulations, the IRS concluded that, “[t]herefore, the LLC has been disregarded as an entity separate from you. You, as the single member owner, are personally liable for the employment tax debt of the LLC” (id. third page). The IRS also noted that, while the administrative appeal was pending, McNamee had terminated the existence of WFM-LLC (see id. first page), and that he offered no alternative means of collecting the amount due (see id. third page).

McNamee brought the present action in the district court pursuant to, inter alia, 26 U.S.C. §§ 6320 and 6330, seeking review of the IRS’s administrative determination. He principally reiterated his contentions that the IRS had no authority to disregard the protection from liability afforded to members of an LLC by Connecticut law and thereby hold him responsible for WFM-LLC’s tax liabilities. He also contended that the regulations relied on by the IRS conflicted with provisions of the Internal Revenue Code.

McNamee moved for summary judgment in his favor. The government moved for affirmance of its  [*8]  determination that McNamee is liable for WFM-LLC’s unpaid payroll taxes. The district court summarily denied McNamee’s motion and granted the IRS’s motion, “find[ing] that the regulations at issue here were both reasonable and consistent with the purposes of the revenue statutes.” Ruling on Pending Motions, dated September 26, 2005, at 1.

Judgment was entered in favor of the government, and this appeal followed.

II. DISCUSSION

On appeal, McNamee argues principally that the check-the-box regulations “directly contradict the relevant statutory provisions of the Internal Revenue Code” (McNamee brief on appeal at 2), violate federal policy, and “ignore the limited liability laws created by local legislation,” (id. at 6). He also argues that an IRS proposal in October 2005 to amend the check-the-box regulations–and relieve the owner of a single-member LLC from any possibility of personal liability for the LLC’s payroll tax liability–shows that the current check-the-box regulation is “wrong” (id. at 7). Finding no merit in any of McNamee’s contentions, we affirm.

A. The Validity of the Treasury Regulations

1. The Standard of Review

In reviewing a challenge  [*9]  to an agency regulation interpreting a federal statute that the agency is charged with administering, the first duty of the courts is to determine “whether the statute’s plain terms ‘directly addres[s] the precise question at issue.’” Nat’l Cable & Telecomms. Ass’n v. Brand X Internet Servs., 545 U.S. 967, 986, 125 S. Ct. 2688, 162 L. Ed. 2d 820 (2005) (”National Cable”) (quoting Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 843, 81 L. Ed. 2d 694 (1984)). “If the statute is ambiguous on the point, we defer . . . to the agency’s interpretation so long as the construction is ‘a reasonable policy choice for the agency to make.’” Nat’l Cable, 545 U.S. at 986 (quoting Chevron, 467 U.S. at 845). As stated in Chevron itself,[f]irst, always, is the question whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress. If, however, the court determines Congress has not directly addressed the  [*10]  precise question at issue, the court does not simply impose its own construction on the statute, as would be necessary in the absence of an administrative interpretation. Rather, if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency’s answer is based on a permissible construction of the statute.
467 U.S. at 842-43 (footnotes omitted) (emphases added).

“If Congress has explicitly left a gap for the agency to fill, there is an express delegation of authority to the agency to elucidate a specific provision of the statute by regulation[, and s]uch legislative regulations are given controlling weight unless they are arbitrary, capricious, or manifestly contrary to the statute.” Id. at 843-44. See also interpretation claiming deference was promulgated in the exercise of that authority”).

In the Internal Revenue Code, Congress expressly delegated authority to the Secretary of the Treasury to adopt regulations to fill in gaps in the Code:§ 7805. Rules and regulations

(a) Authorization

Except where such authority is expressly given by this title  [*11]  to any person other than an officer or employee of the Treasury Department, the Secretary shall prescribe all needful rules and regulations for the enforcement of this title, including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue.

. . . .

(d) Manner of making elections prescribed by Secretary

Except to the extent otherwise provided by this title, any election under this title shall be made at such time and in such manner as the Secretary shall prescribe.
26 U.S.C. §§ 7805(a) and (d) (emphasis added); see also 26 U.S.C. § 7701(a)(11)(B) (”The term ‘Secretary’ means the Secretary of the Treasury or his delegate.”). With respect to the promulgation of regulations interpreting the Code, the Secretary of the Treasury has delegated authority to the Commissioner of Internal Revenue (”Commissioner”). See 26 C.F.R. § 301.7805-1. “Because Congress has delegated to the Commissioner the power to promulgate ‘all needful rules and regulations for the enforcement of [the Internal Revenue Code],’ 26 U.S.C. § 7805(a)  [*12]  , we must defer to his regulatory interpretations of the Code so long as they are reasonable, see National Muffler Dealers Ass’n v. United States, 440 U.S. 472, 476-477, 59 L. Ed. 2d 519 (1979).” Cottage Savings Ass’n v. Commissioner of Internal Revenue, 499 U.S. 554, 560-61, 111 S. Ct. 1503, 113 L. Ed. 2d 589 (1991).

2. The Relevant Provisions of the Code

The Internal Revenue Code sets out “[d]efinitions” of various types of business entities in the first three subsections of § 7701(a), under the headings “Person[s],” “Partnership[s],” and “Corporation[s].” As an examination of these provisions reveals, the categories are overlapping and somewhat ambiguous:

(a) When used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof–
(1) Person

The term “person” shall be construed to mean and include an individual, a trust, estate, partnership, association, company or corporation.

(2) Partnership . . .

The term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation,  [*13]  or venture is carried on, and which is not, within the meaning of this title, a trust or estate or a corporation . . . .

(3) Corporation

The term “corporation” includes associations . . . .
26 U.S.C. §§ 7701(a)(1), (2), and (3) (emphases added). Thus, each subsection tends to be illustrative, rather than definitive, and none of them specifies the characteristics of the entity that it “defin[es].”

Potential overlap among definitions is evident from the lack of even illustrative definitional entries of such terms as “company” and “association.” For example, a “company” could be deemed a “partnership” within the meaning of subsection (a)(2) if it is an “unincorporated organization”; but it is a “corporation” within the meaning of subsection (a)(3) if it is an “association.” However, the Code contains no definition of the term “association.” It does, however, define the term “shareholder” to “include[] a member in an association.” Id. § 7701(a)(8). Sole proprietorships are nowhere defined in the Code, although the existence of such a business form is recognized, see, e.g., 26 U.S.C. § 172(b)(1)(F)(iii)  [*14]  (relating to net operating loss carryovers and carrybacks).

Limited liability companies are not expressly mentioned, much less defined, in the Code. Although an LLC might be considered a company or an association, its proper characterization is not clear from the terms of the Code itself. Limited liability companies are “a relatively new business structure allowed by state statute,” having some features of corporations and some features of partnerships. IRS Publication 3402, Tax Issues for Limited Liability Companies 1 (2000), available at http://www.irs.gov/businesses/small/article/0,,id-=98277,00.html (”IRS Pub. 3402″). For example, “similar to a corporation, owners have limited personal liability for the debts and actions of the LLC.” Id.; see, e.g., Conn. Gen. Stat. Ann. § 34-133. “Other features of LLCs are more like a partnership, providing management flexibility,” IRS Pub. 3402; see, e.g., Conn. Gen. Stat. Ann. §§ 34-109 (execution of documents), 34-130 (agency), 34-140 (management), and in some cases affording “the benefit of pass-through taxation,” IRS Pub. 3402; but see Conn. Gen. Stat. Ann. § 34-113  [*15]  (”A limited liability company formed under sections 34-100 to 34-242 . . . shall be treated, for purposes of taxes imposed by the laws of the state or any political subdivision thereof, in accordance with the classification for federal tax purposes.” (emphases added)).

Under Connecticut law, a limited liability company may have a single member. See, e.g., id. §§ 34-101(10), 34-140(c). The Internal Revenue Code is unclear as to whether such a company falls within subsection (a)(2) or (a)(3) of § 7701. It hardly seems to be a subsection (a)(3) “association,” as one person does not associate with himself. Nor is a one-person operation in the same genre as the specific subsection (a)(2) entities that are included within the term “partnership”–i.e., “syndicate, group, pool, joint venture”– all of which, like the term partnership itself, denote combinations of persons rather than a single person, see, e.g., Conn. Gen. Stat. Ann. § 34-301(9) (”‘Partnership’ means an association of two or more persons . . . .”). The closest fit for a single-owner LLC would seem to be “other unincorporated organization”–an organization that  [*16]  might or might not be an entity separate from its owner.

3. The Gap-Filling Treasury Regulations

Against this ambiguous statutory background, the Treasury Regulations were intended to provide straightforward guidance as to how various types of entities, including single-owner businesses, are to be classified for tax purposes. Treasury Regulation § 301.7701-1 states “[i]n general” that[t]he Internal Revenue Code prescribes the classification of various organizations for federal tax purposes. Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.

. . . .

(4) Single owner organizations. Under §§ 301.7701-2 and 301.7701-3, certain organizations that have a single owner can choose to be recognized or disregarded as entities separate from their owners.
26 C.F.R. §§ 301.7701-1(a)(1) and (4) (emphases added). The Regulations proceed to describe the classification of business entities:

(a) Business entities. For purposes of  [*17]  this section and § 301.7701-3, a business entity is any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under § 301.7701-3) that is not properly classified as a trust under § 301.7701-4 or otherwise subject to special treatment under the Internal Revenue Code. A business entity with two or more members is classified for federal tax purposes as either a corporation or a partnership. A business entity with only one owner is classified as a corporation or is disregarded; if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner.26 C.F.R. § 301.7701-2(a) (emphasis added). Subsection (b) of this Regulation defines the term “corporation” to include a business entity that is incorporated under federal or state law, see id. § 301.7701-2(b)(1), an “association (as determined under § 301.7701-3),” id. § 301.7701-2(b)(2) (emphasis added), and various other business entities, see id. §§ 301.7701-2(b)(3), (4), (5), (6), (7), and (8).

Subsection  [*18]  (c) of Treasury Regulation 301.7701-2 states in pertinent part, with regard to “[o]ther business entities,” that “[f]or federal tax purposes,”

(1) The term partnership means a business entity that is not a corporation under paragraph (b) of this section and that has at least two members.

(2) Wholly owned entities–(i) In general. A business entity that has a single owner and is not a corporation under paragraph (b) of this section is disregarded as an entity separate from its owner.
26 C.F.R. §§ 301.7701-2(c)(1) and (2)(i). Finally, Treasury Regulation 301.7701-3(a) provides that “an eligible entity”–which it defines as a “business entity that is not classified as a corporation under § 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8)”–is given an option whether or not to be classified as a corporation. Thus,[a]n eligible entity with at least two members can elect to be classified as either an association (and thus a corporation under § 301.7701-2(b)(2)) or a partnership, and an eligible entity with a single owner can elect to be classified  [*19]  as an association or to be disregarded as an entity separate from its owner. Paragraph (b) of this section provides a default classification for an eligible entity that does not make an election. . . .

(b) Classification of eligible entities that do not file an election –(1) Domestic eligible entities. Except as provided in paragraph (b)(3) of this section, unless the entity elects otherwise, a domestic eligible entity is–

(i) A partnership if is has two or more members; or

(ii) Disregarded as an entity separate from its owner if it has a single owner.26 C.F.R. §§ 301.7701-3(a) and (b)(1) (emphases added). See also id. § 301.7701-3(b)(3) (a single-owner entity that was in existence prior to the effective date of this regulation and that claimed to be a partnership under the prior regulations will be disregarded as an entity separate from its owner).

An entity files its election to be treated as an association simply by checking the appropriate box or boxes on IRS “Form 8832, Entity Classification Election” and filing that Form. Id. § 301.7701-3(c).

These regulations became effective on January 1, 1997, replacing  [*20]  regulations, known as the “Kintner regulations,” that had been in place since 1960. The Kintner regulations had been adequate during the first several decades after their adoption. But, as explained in the 1996 proposal for their amendment, the Kintner regulations were complicated to apply, especially in light of the fact thatmany states ha[d] revised their statutes to provide that partnerships and other unincorporated organizations may possess characteristics that traditionally have been associated with corporations, thereby narrowing considerably the traditional distinctions between corporations and partnerships under local law.
Simplification of Entity Classification Rules, 61 Fed. Reg. 21989, 21989-90 (proposed May 13, 1996). “One consequence of the increased flexibility” in local laws authorizing an entity that “in all meaningful respects, is virtually indistinguishable from a corporation” was that the Kintner regulations required “taxpayers and the IRS [to] expend considerable resources on classification issues.” Id. at 21990; see, e.g., Littriello v. United States, No. 05-6494, 2007 U.S. App. LEXIS 8471, 2007 WL 1093723, at *3 (6th Cir. Apr. 13, 2007)  [*21]  (”Littriello”) (the Kintner regulations “proved less than adequate to deal with the new hybrid business entities–limited liability companies, limited liability partnerships, and the like–developed in the last years of the last century under various state laws”).

In light of the emergence of limited liability companies and their hybrid nature, and the continuing silence of the Code on the proper tax treatment of such companies in the decade since the present regulations became effective, we cannot conclude that the above Treasury Regulations, providing a flexible response to a novel business form, are arbitrary, capricious, or unreasonable. The current regulations allow the single-owner limited liability company to choose whether to be treated as an “association”–i.e., a corporation–or to be disregarded as a separate entity. If such an LLC elects to be treated as a corporation, its owner avoids the liabilities that would fall upon him if the LLC were disregarded; but he is subject to double taxation–once at the corporate level and once at the individual shareholder level. If the LLC chooses not to be treated as a corporation, either by affirmative  [*22]  election or by default, its owner will be liable for debts incurred by the LLC, but there will be no double taxation. The IRS check-the-box regulations, allowing the single-owner LLC to make the choice, are therefore eminently reasonable. Accord Littriello, 2007 U.S. App. LEXIS 8471, [WL] at *4-*6.

4. The Proposed New Regulations

McNamee’s contention that the fact that the IRS has proposed new regulations that would definitively make an LLC’s single owner not liable for the LLC’s unpaid payroll taxes means that the current regulations are “wrong” (McNamee brief on appeal at 7) is wide of the mark. To begin with, “‘[i]t goes without saying that a proposed regulation does not represent an agency’s considered interpretation of its statute and that an agency is entitled to consider alternative interpretations before settling on the view it considers most sound.’” Littriello, 2007 U.S. App. LEXIS 8471, [WL] at *7 (quoting Commodity Futures Trading Commission v. Schor, 478 U.S. 833, 845, 106 S. Ct. 3245, 92 L. Ed. 2d 675 (1986)) (emphasis ours).

Further, “if the agency adequately explains the reasons for a reversal of policy, change is not invalidating, since the  [*23]  whole point of Chevron is to leave the discretion provided by the ambiguities of a statute with the implementing agency,” and to allow the agency to “consider varying interpretations and the wisdom of its policy on a continuing basis, . . . for example, in response to changed factual circumstances.” Nat’l Cable, 545 U.S. at 981 (internal quotation marks omitted).

Here, the IRS explained that its October 2005 proposal to change the regulations was a response to[a]dministrative difficulties [that] have arisen from the interaction of the disregarded entity rules and the federal employment tax provisions. Problems have arisen for both taxpayers and the IRS with respect to reporting, payment and collection of employment taxes, particularly where state employment tax law also sets requirements for reporting, payment and collection that may be in conflict with the federal disregarded entity rules. The Treasury Department and the IRS believe that treating the disregarded entity as the employer for purposes of federal employment taxes will improve the administration of the tax laws and simplify compliance.
Disregarded Entities; Employment and Excise Taxes, 70 Fed. Reg. 60475, 60476  [*24]  (proposed Oct. 18, 2005). The proposed changes, which have not been adopted as of the filing of this opinion, provide no basis for finding the existing regulations unreasonable.

B. McNamee’s Reliance on State Law

McNamee also contends that the Treasury Regulations are invalid on the theory that they ignore the Connecticut law provisions that accord an LLC member limited liability. He states that “the treasury has consistently held that the owner of a single member LLC is the employer for Federal tax purposes,” and argues that United States v. Galletti, 541 U.S. 114, 124 S. Ct. 1548, 158 L. Ed. 2d 279 (2004), shows that the IRS exceeded its authority “in attempt[ing] to ignore the limited liability laws created by local legislation.” (McNamee brief on appeal at 6.) We are unpersuaded.

First, as discussed in Part II.A. 3. above, the IRS has not dictated that the owner of a single-member LLC always be considered the employer for federal tax purposes; rather, it has given the LLC the option to elect association status. If the LLC elects to be treated as an association, the LLC is regarded as the employer.

Second,  [*25]  Galletti did not involve either Treasury Regulations interpreting the Code or a single-member limited liability company. Galletti involved nonpayment of payroll taxes by a partnership and the government’s assertion of claims for the unpaid taxes in individual bankruptcy proceedings filed by the partnership’s general partners. The question raised was “whether, in order for the United States to avail itself of the 10-year increase in the statute of limitations for collection of a tax debt, it must assess the taxes not only against a partnership that is directly liable for the debt, but also against each individual partner who might be jointly and severally liable for the debts of the partnership.” 541 U.S. at 116. The Supreme Court noted that under state law, a partnership was regarded as an entity separate from its partners and that the liability of the partners for partnership debt was secondary, i.e., derived from the liability of the partnership. See id. at 116, 122 n. 4. The Court held that the government was not required, in order to press its claims in bankruptcy, to assess the payroll taxes against the individual partners because  [*26]  payroll taxes are imposed on the “employer,” e.g., 26 U.S.C. §§ 3402, 3403, and the employer was the partnership, rather than its partners, see 541 U.S. at 121. The Galletti Court’s identification of the partnership as the employer has no bearing on whether the sole owner of an LLC is to be considered the employer.

A partnership, as discussed above, has at least two members; and while a partnership may elect to be treated as a corporation, “partnership” and “corporation” are its only options. 26 C.F.R. § 301.7701-3(a) (”An eligible entity with at least two members can elect to be classified as either an association (and thus a corporation under § 301.7701-2(b)(2) or a partnership . . . .” (emphases added)); id. § 301.7701-2(a) (”A business entity with two or more members is classified for federal tax purposes as either a corporation or a partnership.” (emphases added)). There is no Code provision or regulation that allows a partnership to be disregarded as an entity in order for its partners to be treated as the taxable entity. Thus, it is hardly remarkable  [*27]  that the Galletti Court concluded that the employer was the partnership rather than its partners.

Further, we note that although the payroll tax sections of the Code define “employer”–in various ways–see 26 U.S.C. §§ 3306 and 3401, as discussed in Part II.A. 2. above the Code does not even mention limited liability companies. Thus, nothing in the Code provides that an LLC is always to be regarded, for purposes of federal taxation, as the employer. Under the pertinent Treasury Regulations, the single-member LLC is the employer if it elects to be treated as a corporation; but if it does not elect that treatment, it is “[d]isregarded” as a “separate” entity, 26 C.F.R. § 301.7701-3(b)(1)(ii) (emphasis added), and hence cannot be regarded as the employer.

Finally, we reject McNamee’s contention that the IRS’s attempt to collect his LLC’s unpaid payroll taxes from him is impermissible because it violates the limited-liability rights granted him by state law. As the Court of Appeals for the Sixth Circuit noted in rejecting such a claim in Littriello,

[t]he federal government has historically  [*28]  disregarded state classifications of businesses for some federal tax purposes. In Hecht v. Malley, 265 U.S. 144, 44 S. Ct. 462, 68 L. Ed. 949, 1924-1 C.B. 489, T.D. 3595 . . . (1924), for example, the United States Supreme Court held that Massachusetts trusts were “associations” within the meaning of the Internal Revenue Code despite the fact they were not so considered under state law. As courts have repeatedly observed, state laws of incorporation control various aspects of business relations; they may affect, but do not necessarily control, federal tax provisions. See, e.g., Morrissey, 296 U.S. at 357-58, 56 S. Ct. 289, 80 L. Ed. 263 . . . (explaining that common law definitions of certain corporate forms do not control interpretation of federal tax code). As a result, . . . single-member LLCs are entitled to whatever advantages state law may extend, but state law cannot abrogate [their owner’s] federal tax liability.
Littriello, 2007 U.S. App. LEXIS 8471, [WL] at *6. We agree.

Moreover, McNamee could have had the benefit of limited personal liability if he had simply elected to have his LLC treated as a corporation; he chose not to do so and thereby avoided having the LLC taxed as a separate  [*29]  entity. We know of no provision, policy, or principle that required the federal government to allow him both to escape personal liability for the taxes owed by his sole proprietorship and to have the proprietorship escape taxation as a separate entity.

CONCLUSION

We have considered all of McNamee’s contentions on this appeal and have found them to be without merit. The judgment of the district court is affirmed.

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May 23rd, 2007 | No Comments »

Private Letter Ruling 200720007 (2007).

Internal Revenue Service Department of the Treasury Washington, DC 20224

Number: 200720007

Third Party Communication: NoneRelease Date: 5/18/2007 Date of Communication: Not Applicable

Index Number: 71.00-00

Person To Contact: , ID No. Telephone Number:

Refer Reply To: CC:ITA:B03 PLR-131321-06

Date: 2/12/07

TY:TY:

Legend

Taxpayer = Ex-spouse = Court = Year 1 = Year 2 = $x = $y = Chapter X = State Code = b = —–

c =

d = —–

Section Z $z Section Y e

= = = = —–

f = g = —-h = —-i = —-

j = —-k =

Dear : PLR-131321-06 2

This ruling responds to a letter dated Year 1 submitted by your authorized representative, requesting a ruling that payments made to taxpayer by her Ex-spouse and labeled as contractual alimony under a Decree of Divorce do not constitute alimony under section 71 of the Internal Revenue Code.

FACTS

Taxpayer was divorced from Ex-spouse by the Court in Year 2. The divorce decree ordered Ex-spouse to pay contractual alimony in monthly payments of $x until a total amount of $y had been paid in full. The Divorce Decree was signed by the presiding Judge in Year 2.

The agreement provided that the contractual alimony were support payments voluntarily undertaken by Ex-Spouse and were intended to qualify as contractual alimony. Under the heading ‘Contractual Alimony’, the Decree provided:

It is the mutual desire of the parties to provide a continuing measure of support for [Taxpayer], Receiving Party, after divorce. These support payments undertaken by [Ex-spouse], Paying Party, are intended to qualify as contractual alimony as that term is defined in Section 71(a) of the Internal Revenue Code.

The Decree did not provide any provision allowing for the termination of the payments upon the death of taxpayer, the payee spouse. Further, the Decree specifies that upon the death of Ex-spouse, the payor spouse, the payments are a fully binding obligation upon the estate of Ex-spouse.

LAW AND ANALYSIS

Section 61(a) provides that gross income means all income from whatever source derived, including alimony.

Section 71(a) provides that gross income includes amounts received as alimony or separate maintenance payments. Section 71(b) provides that the term ‘alimony or separate maintenance payment’ means any payment in cash if: (1) such payment is received by, or on behalf of, a spouse under a divorce or separation instrument; (2) the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under section 71 and not allowable as a deduction under section 215; (3) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee and payor are not members of the same household at the time such payment is made; and (4) there is no liability to make such payment for any period after the death of the payee and no liability PLR-131321-06 3

to make any payment as a substitute for such payments after the death of the payee. A payment must meet all of these factors to qualify as alimony.

Notice 87-9, 1987-1 C.B. 421, states that the termination of the liability does not have to be expressly stated in the instrument if the termination would occur by operation of State law. This amendment applies to any divorce or separation instrument executed after December 31, 1984. See also Hoover v. Commissioner, 102 F.3d 842 (6th Cir. 1996) (holding that federal courts look to the state family law if the divorce decree is silent on the issue of whether payments terminate upon payee spouse’s death).

Chapter X of the State Code provides that the court may order maintenance payments as temporary payments to allow a spouse a rehabilitation period to develop work skills and obtain employment with the goal of self-sufficiency. Such payments must be court ordered and based on detailed findings by the court. See b; c; d. Maintenance payments are subject to a three year cap and the amount is limited to minimum reasonable needs of the recipient, as determined by the court. Section Z of the State Code provides that maintenance payments cannot exceed the lesser of $z of payor’s average gross monthly income. See b, supra. Under Section Y, maintenance payments are terminated upon the death of either party or upon the remarriage of the obligee.

The state legislature has drawn a distinction between contractual alimony and contractual maintenance. Under state law, the legal force and meaning of marital property settlement agreements are governed by the law of contracts. See e; f; g. Further, in h, these agreements, though incorporated into the final divorce decree, do not transform the contractual payments into court ordered alimony and distinguish between court-ordered alimony payments and assumed contractual obligations for support. In contrast, maintenance payments are ordered by the court and are subject to a number of very stringent requirements.

The divorce decree specifically describes Ex-spouse’s obligation as ‘contractual alimony’. Nothing in the divorce decree refers to the spousal maintenance provisions of Chapter X of the State Code. The only statutory reference is to the definition of ‘contractual alimony’ pursuant to the Internal Revenue Code. There are no references to the payee spouse’s eligibility for maintenance or the factors considered in determining nature, amount, duration and manner of payments, pursuant to Chapter X. Furthermore, the monthly payments exceed the statutory provisions for maintenance and continue for a set period of time, regardless of remarriage or death of either spouse. Consequently, Chapter X of the State Code does not apply to the divorce decree and therefore, the termination provision of Section Y does not apply. For similar analysis, see i; j; k. Based on this, we hold that the contractual alimony payments do not qualify as alimony as that term is defined under section 71 of the Internal Revenue Code because the payments do not terminate upon the death of the payee spouse. No PLR-131321-06 4

opinion is expressed as to whether these payments still constitute income under section 61 of the Code.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter ruling.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

Sincerely,

Christopher F. Kane Branch Chief, Branch 3 (Income Tax & Accounting)

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May 18th, 2007 | 1 Comment »

Chief Counsel Memorandum 200720015 (2007).

Office of Chief Counsel Internal Revenue Service

Memorandum

Number: 200720015

Release Date: 5/18/2007

CC:PA:CBS:B03 GL15360206

UILC: 6672.0000

subject: TFRP Calculation Sequence of Payment Application for Partial Payments of Employer Tax Liability in light of Revenue Procedure 200226

This Chief Counsel Advice responds to your request for assistance. This advice may not be used or cited as precedent.

ISSUE

How does the Internal Revenue Service apply partial payments made by a business entity before January 1, 2003 on its Form 941 employer tax liability where the Trust Fund Recovery Penalty (“TFRP”) liability has been assessed and the Letter 1153 (DO) has been sent to the responsible person before June 19, 2000?

CONCLUSION

A voluntary partial payment made by a business entity before January 1, 2003 on its Form 941 employer tax liability, where the TFRP liability has been assessed and the Letter 1153 (DO) has been sent to the responsible person before June 19, 2000, will be applied pursuant to the taxpayer’s written instructions. A partial involuntary and/or undesignated payment made under the same circumstances will be applied first to the nontrust fund portion of tax, then to assessed lien fees and collection costs, then assessed penalties, then assessed interest, then accrued penalties and accrued interest, and then finally to the trust fund portion of the tax.

GL15360206 2

LAW AND ANALYSIS

Revenue Procedure 200226, 20021 C.B. 746, 200215 I.R.B. 746, applies to all taxes under the Internal Revenue Code, except alcohol, tobacco, and firearms taxes and harbor maintenance taxes. Rev. Proc. 200226 § 2. This guidance states the Service’s position regarding the application, by the Service, of partial payments of tax, penalty, and interest to one or more taxable periods. See Rev. Proc. 200226 § 1.

Revenue Procedure 200226, section 3.02, provides that a voluntary partial payment accompanied by written directions as to its application will be applied pursuant to the taxpayer’s written instructions. Revenue Procedure 200226, section 3.02, provides that partial payments remitted to the Service without written direction as to the designation will be applied by the Service “in the order of priority that the Service determines will serve its best interest.” (emphasis added). Generally, the order of priority that the Service determines will serve its best interest means that undesignated payments are applied first to the liability with the shortest or most imminent statute of limitations for collections, then to the liability with the next shortest statue and so on and so forth.1

In the context of assessments where the TFRP notice, Letter 1153, was issued prior to June 19, 2000, and the undesignated and/or involuntary partial payment of tax was received through December 31, 2002, the Service determined that it was in its best interest to apply undesignated payments in a manner other than “for successive periods in descending order of priority until the payment is absorbed.” Effective for these assessments, the Service applied any undesignated and/or involuntary partial payment of tax received through December 31, 2002 first to the nontrust fund portion of tax, then to assessed lien fees and collection costs, then assessed penalties, then assessed interest, then accrued penalties and accrued interest, and then finally to the trust fund portion of the tax.

Insofar as this policy reflected the Service’s interest in maximizing collection of trust fund taxes, it is consistent with Revenue Procedure 200226. As noted above, the Service will generally apply undesignated payments “for successive periods in descending order of priority until the payment is absorbed” but the Service is not required to do so if such application does not serve its best interest. Rev. Proc. 200226 § 3.02. If a different allocation is determined to be in the Service’s best interest, the Service is not required to apply the payment “in descending order of priority.”

Once a payment is applied or allocated, however, it should not be moved or reallocated unless the Service determines that the initial application was erroneous, e.g., the payment was designated and it was applied to the wrong period or the payment was obtained pursuant to a levy and it was applied to a period not listed on a levy. A

1 The tax period or liability with the shortest collection statute is not always the earliest or oldest tax period or liability.

GL15360206 3 payment should never be moved or reallocated solely to maximize collection potential or to maximize trust fund recovery penalty assessment. CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

This writing may contain privileged information. Any unauthorized disclosure of this writing may undermine our ability to protect the privileged information. If disclosure is determined to be necessary, please contact this office for our views.

Please call (202) 6223630 if you have any further questions.

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May 18th, 2007 | No Comments »

Private Letter Ruling 200720017 (2007).

Internal Revenue Service Department of the Treasury

Washington, DC 20224

Number: 200720017

[Third Party Communication:Release Date: 5/18/2007 Date of Communication: Month DD, YYYY]

Index Number: 61.30-00, 3101.00-00,

, ID No.

Dear :

This is in response to your request for a private letter ruling dated November 6, 2006, submitted by the authorized representatives of Taxpayer. Rulings are requested below concerning Taxpayer’s income tax withholding and employment tax obligations with respect to leave transferred by employees of Taxpayer to other employees of Taxpayer under the Policy currently maintained by Taxpayer. Similar rulings are also requested concerning leave transferred pursuant to the Modified Policy currently being considered by Taxpayer for implementation.

FACTS

Taxpayer is a publicly traded healthcare services company with facilities in numerous states. Taxpayer’s accounting period is the calendar year, and it uses the accrual method of accounting for maintaining its books and records and for filing its federal tax returns. Taxpayer’s corporate headquarters is in State A.

Taxpayer maintains various programs under which its employees accrue paid leave time that may be used for various reasons, including vacation, personal days and sick days. Employee requests for time off must request be approved by Taxpayer. If a request is approved, but the employee lacks sufficient hours of paid leave time under the applicable paid leave program at the time leave is to begin, the employee will not receive pay for the time off.

Taxpayer currently maintains Policy pursuant to which employees are allowed to surrender accrued hours of paid leave (“Donor Employee”) for the benefit of other employees who need more time off than they have accumulated personally (“Recipient Employee”). Under Policy as currently in effect, an eligible employee may request additional paid leave if the employee experiences a medical emergency, is caring for a spouse or child in the event of a medical emergency, or needs extended time off following the death of a parent, spouse or child. To be eligible to receive surrendered leave under Policy, an employee must be employed by Taxpayer for at least 90 days and must be eligible to accrue paid leave time under the applicable paid leave program. Policy defines “medical emergency” as a major illness or other medical condition (e.g., heart attack, cancer, etc) that requires a prolonged absence from work, including intermittent absences that are related to the same illness or condition. In order to receive surrendered paid leave time, an eligible employee must have exhausted all of his or her own paid leave time, must complete a written request and authorization form, and must have the scheduled time off or leave of absence approved by Taxpayer. The Donor Employee also must complete an authorization form, which must be approved by Taxpayer, before leave can be surrendered. Leave time must be donated to a specific employee who is eligible to receive donated leave time under the Policy (i.e., the Recipient Employee). Policy also includes restrictions on the amount and type of paid leave time that may be surrendered by a Donor Employee. Once surrendered, paid leave hours cannot be returned to the Donor Employee, but will remain available for use by the specific Recipient Employee.

If a Recipient Employee receives paid leave hours under the Policy from a Donor Employee with a different pay rate, the leave time is converted based on the Recipient Employee’s pay rate, so that the dollar value of the surrendered leave remains the same, but leave taken by the Recipient Employee is always paid at the Recipient Employee’s regular rate of pay. For example, if Donor Employee is regularly paid $15.00 per hour and surrenders eight hours of paid leave to a Recipient Employee who is regularly paid $10.00 per hour, the Recipient Employee will receive 12 hours of paid leave, paid at $10.00 per hour (8 hours x $15.00 = $120 value, and $120.00 value/ $10.00 per hour = 12 hours).

Taxpayer is considering whether to implement certain modifications to Policy (“Modified Policy”) that would allow eligible employees who experience “catastrophic casualty losses” due to terrorist attack, fire or other natural disaster (i.e., hurricane, flood, tornado or other highly destructive storm) to request surrendered paid time off as well. For purposes of the Modified Policy, a “catastrophic casualty loss” would include severe damage to or destruction of the employee’s primary residence, which requires immediate action by the employee to secure the premises. The Modified Policy may permit employees to donate leave hours to a leave “bank” in the event of a terrorist attack, natural disaster or public health crisis that affects a large number of employees. Leave hours donated to the bank would be available on a first-come, first-served basis, to affected employees whose leave donation requests are approved. The leave bank would be available only for a limited period of time following the crisis event.

Taxpayer is requesting the following four rulings:

LAW AND ANALYSIS -GROSS INCOME ISSUE

Section 61 of the Code provides that, except as otherwise provided by law, gross income means all income from whatever source derived, including compensation for services.

A basic principle of tax law is that a taxpayer’s assignment to another person of his or her right to receive compensation for personal services does not relieve the taxpayer of the tax liability on the assigned income. See Lucas v. Earl, 281 U.S. 111, 50 S. Ct. 241, 74 L. Ed. 731 (1930), and Helvering v. Eubank, 311 U.S. 122, 61 S. Ct. 149, 85 L. Ed. 81, 1940-2 C.B. 209 (1940), 1940-2 C.B. 209. However, this general “assignment of income” rule does not apply to certain situations involving employer-sponsored leave plans. One situation involves bona fide employer-sponsored (medical) leave-sharing arrangements. Another involves certain qualified employer-sponsored major disaster leave-sharing plans.

The first exception to this general assignment of income rule involves the bona fide employer-sponsored (medical) leave-sharing arrangement described in Rev. Rul. 90-29, 1990-1 C.B. 11. Under the plan in the ruling, employees who suffer medical emergencies may qualify to receive leave surrendered to the employer by other employees or leave deposited by its employees in an employer sponsored leave bank. The ruling holds that the amounts paid by the employer to a leave recipient pursuant to the plan are includable in the gross income of the recipient under § 61 of the Code as compensation for services provided by that recipient to the employer. Rev. Rul. 90-29 further concludes that these amounts are considered “wages” for employment tax purposes, including the Federal Insurance Contributions Act (“FICA”), the Federal Unemployment Tax Act (“FUTA”), the Railroad Retirement Tax Act (“RRTA”), and the Railroad Unemployment Repayment Tax (“RURT”), and for income tax withholding purposes, unless otherwise excluded by a specific provision of the Code. The revenue ruling also holds that an employee who surrenders leave to the employer or deposits leave in the leave bank does not realize any income and incurs no deductible expense or loss either upon surrender or deposit of the leave or its use by the recipient employee.

Another exception involves qualified employer-sponsored major disaster leave-sharing plans such as plans that involve amounts paid pursuant to a leave-sharing plan to assist employees affected by a major disaster declared by the President of the United States. Notice 2006-59, 2006-28 I.R.B. 60, provides that the Internal Revenue Service will not assert that a leave donor who deposits leave into an employer-sponsored leave bank under a major disaster leave-sharing plan that meets the requirements set forth in Notice 2006-59 realizes income or has wages, compensation, or rail wages with respect to the deposited leave, provided that the plan treats payments made by the employer to the leave recipient as “wages” for purposes of FICA, FUTA, and income tax withholding, and as “compensation” for purposes of RRTA and “rail wages” for purposes of RURT, unless excluded therefrom under a specific provision of the Code. A leave donor may not claim an expense, charitable contribution, or loss deduction on account of the deposit of the leave or its use by a leave recipient. Notice 2006-59 defines “major disaster” to mean (a) a major disaster as declared by the President under § 401 of the Stafford Act, 42 U.S.C. § 5170, that warrants individual assistance or individual and public assistance from the federal government under that Act, or (b) a major disaster or emergency as declared by the President pursuant to 5 U.S.C. § 6391, in the case of employees described in that statute.

In this case, Recipient Employees under the Policy as currently in effect are limited to those employees who experience a medical emergency, care for a spouse or child in the event of a medical emergency, or need extended time off following the death of a parent, spouse or child. The Policy defines “medical emergency” as a major illness or other medical condition (e.g., heart attack, cancer, etc) that requires a prolonged absence from work, including intermittent absences that are related to the same illness or condition. The facts surrounding Policy as currently in effect in this case are close to the facts surrounding the employer-sponsored (medical) leave-sharing arrangement described in Rev. Rul. 90-29. We therefore conclude that, under the facts presented and the representations made, the payments made under the Policy as currently in effect are includible in the Recipient Employee’s gross income under § 61 of the Code. Such payments are not includable in the Donor Employee’s gross income under § 61.

However, Modified Policy with the changes proposed above is distinguishable from the narrow exceptions described above. Because Modified Policy provides a Recipient Employee with paid leave during a time that he or she is facing a catastrophic casualty loss that may or may not involve a personal or family medical emergency, Modified Policy is not limited to a medical emergency leave program. Consequently, it is not within the scope of employer-sponsored (medical) leave-sharing arrangement described in Rev. Rul. 90-29. Modified Policy is also outside the scope of qualified employer-sponsored major disaster leave-sharing plans that meet the requirements of Notice 2006-59 because it is not designed to be limited specifically to aid the victims of a “major disaster” as declared by the President of the United States.

Because the Modified Policy does not meet any of the exceptions described above, the tax consequences to Donor Employees who transfer leave pursuant to the Modified Policy will be governed by the assignment of income doctrine. Applying the doctrine to the facts here, we conclude that a Donor Employee’s assignment of his or her right to receive vacation and other similar accrued paid leave under the Modified Policy will not relieve the Donor Employee of the income tax liability on the assigned leave. Therefore, a Donor Employee must include the cash value of any vacation and other similar accrued paid leave that the Donor Employee transfers pursuant to the Modified Policy in his or her gross income under § 61 as compensation for services provided by that employee to Taxpayer.

LAW AND ANALYSIS -EMPLOYMENT TAX ISSUE

Generally, every employer making payment of “wages” must withhold federal income tax pursuant to § 3402 of the Code. For income tax withholding purposes, the term “wages” means all remuneration for services performed by an employee for his employer unless a specific exemption under § 3401(a) applies. In general, income tax is withheld from an employee’s wages when the wages are actually or constructively paid to the employee. See Treas. Reg. § 31.3402(a)-1. Federal Insurance Contribution Act (FICA) taxes are imposed on employees and employers under §§ 3101 and 3111, respectively. Employers have a duty to collect the employee’s share of FICA taxes under § 3101 by withholding the amount of the tax from the employee’s “wages.” The term “wages” for purposes of FICA means, with certain exceptions, all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash. See § 3121(a). Typically, wages are subject to FICA tax when they are actually or constructively paid to the employee. See Treas. Reg. § 31.3121(a)-2. Additionally, the employer must pay an excise tax (FUTA tax) on the total “wages” the employer pays to an employee. The term “wages” for purposes of FUTA is similar to the FICA wage definition. See § 3306(b). Again, FUTA taxes are imposed when an employee is actually or constructively paid. See Treas. Reg. §§ 31.3301-2, 31.3301-3(b) and 31.3301-4.

As noted above, the amounts an employer pays to an employee who receives paid leave pursuant to a bona fide employer sponsored (medical) leave-sharing plan, like the one in Rev. Rul. 90-29, are includible in that employee’s gross income under § 61 of the Code, and they are considered “wages” of that employee for employment tax purposes (unless otherwise excluded by the Code). Moreover, pursuant to Rev. Rul. 90-29, an employee who surrenders leave to the employer or deposits leave into a leave bank maintained by the employer does not realize any income.

Because the Policy in this case is a bona fide employer sponsored (medical) leave-sharing plan similar to the one described in Rev. Rul. 90-29, we conclude that the payments made by Taxpayer to a Recipient Employee with respect to the paid leave time surrendered by the Donor Employee under the Policy are includable in the Recipient Employee’s gross income under § 61 of the Code, and that they should be treated as “wages” of the Recipient Employee for employment tax purposes. Therefore, such payments made by Taxpayer to the Recipient Employee are subject to the tax withholding requirements and taxes provided by §§ 3402, 3101, 3102, 3111, 3121, and § 3301, respectively, at the time of payment. .

Moreover, in accordance with Rev. Rul. 90-29, the Donor Employee who surrenders leave under the Policy does not have income under § 61 of the Code, and thus is not treated as the recipient of “wages” subject to employment taxes in connection with the surrendered leave. The Donor Employee therefore is not subject to any withholding or employment tax obligations relating to the payments.

However, the Modified Policy, as proposed, does not qualify as a bona fide (medical) leave-sharing plan or a qualified major disaster leave-sharing plan. Therefore, the cash value of the surrendered paid leave is includable in the Donor Employee’s gross income under § 61 of the Code, and thus should also be treated as the “wages” of the Donor Employee for employment tax purposes. Accordingly, these wages are subject to the tax withholding requirements and taxes provided by §§ 3402, 3101, 3102, 3111, 3121, and § 3301, respectively.

In addition, the Recipient Employee who receives payments of surrendered paid leave under the Modified Policy is not treated as the recipient of “wages” subject to employment tax. The Recipient Employee is not subject to any withholding or employment tax obligations relating to the payments. However, with respect to whether the Recipient Employee has gross income under § 61 of the Code for reasons other than compensation for services provided to Taxpayer, we note that under section 4.02(1) of Rev. Proc. 2006-3, 2006-1 I.R.B. 122, 129, the Service ordinarily will not issue letter rulings on any matter in which the determination is primarily one of fact. Because the reasons that Donor Employees of Taxpayer may transfer paid leave under the Modified Policy is primarily one of fact, we cannot express an opinion regarding the federal income tax consequences of the subject payments to the Recipient Employees who receive the cash value of the surrendered paid leave under the Modified Policy.

HOLDINGS

We hold that payments with respect to surrendered paid leave under the Policy, as currently in effect, made to a Recipient Employee are includable in the Recipient Employee’s gross income under § 61 of the Code and are “wages” subject to withholding taxes under §§ 3401, 3121 and 3306 at the time the Recipient Employee receives the payment. Moreover, the Recipient Employee who receives the payments with respect to the surrendered paid leave is the sole individual subject to withholding and income tax liability at the time the payment is made. The Donor Employee who surrendered the paid leave is not subject to income tax liability or withholding tax liability, either at the time he or she applies to donate the leave hours or at the time a payment is made by Taxpayer to the Recipient Employee in connection with the surrendered paid leave time.

We further hold that payments with respect to surrendered paid leave under the Modified Policy, after the implementation of the changes contemplated by Taxpayer, are includible in the Donor Employee’s gross income under § 61 of the Code and are “wages” subject to withholding taxes under §§ 3401, 3121 and 3306. The Donor Employee is the sole individual subject to wage withholding tax liability at the time the payment is made.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

We express no opinion, except as specifically ruled above, as to the federal income tax treatment of the transaction under any other provisions of the Code and regulations that may be applicable or under any other general principles of federal income taxation. Neither is any opinion expressed as to the tax treatment of any conditions existing at the time of, or effects resulting from, the transaction(s) that are not specifically covered by the above ruling.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representatives.

A copy of this letter must be attached to any income tax return to which it is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter ruling.

The rulings contained in this letter are based upon information and representations submitted by Taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

Sincerely yours,

William A. Jackson Branch Chief, Branch 5 Office of Associate Chief Counsel (Income Tax & Accounting)

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May 18th, 2007 | 1 Comment »

United States v. Baucom, 2007 U.S. App. LEXIS 11423 (4th Cir. 2007).

2007 U.S. App. LEXIS 11423,*

UNITED STATES OF AMERICA, Plaintiff-Appellee, v. MARTIN LOUIS BAUCOM, Defendant-Appellant. No. 06-4229. UNITED STATES OF AMERICA, Plaintiff-Appellee, v. PATRICK GRANT DAVIS, Defendant-Appellant. No. 06-4230. UNITED STATES OF AMERICA, Plaintiff-Appellee, v. MARTIN LOUIS BAUCOM, Defendant-Appellant. No. 06-4273. UNITED STATES OF AMERICA, Plaintiff-Appellant, v. MARTIN LOUIS BAUCOM, Defendant-Appellee. No. 06-4396. UNITED STATES OF AMERICA, Plaintiff-Appellant, v. PATRICK GRANT DAVIS, Defendant-Appellee. No. 06-4398. UNITED STATES OF AMERICA, Plaintiff-Appellant, v. MARTIN LOUIS BAUCOM, Defendant-Appellee. No. 06-4418.

No. 06-4229, No. 06-4230, No. 06-4273, No. 06-4396, No. 06-4398, No. 06-4418

UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT

2007 U.S. App. LEXIS 11423

March 16, 2007, Argued

May 16, 2007, Decided

PRIOR HISTORY:    [*1]  Appeals from the United States District Court for the Western District of North Carolina, at Charlotte and Statesville. Graham C. Mullen, Senior District Judge. (5:02-cr-00026-1; 5:02-cr-00026-2; 3:02-cr-00147).

DISPOSITION:   AFFIRMED IN PART; VACATED AND REMANDED IN PART.

COUNSEL:   ARGUED: Thomas Kieran Maher, Chapel Hill, North Carolina, for Martin Louis Baucom and Patrick Grant Davis.

David Alan Brown, Assistant United States Attorney, OFFICE OF THE UNITED STATES ATTORNEY, Charlotte, North Carolina, for the United States.

ON BRIEF: Gretchen C. F. Shappert, United States Attorney, Charlotte, North Carolina, for the United States.

JUDGES:   Before WILKINS, Chief Judge, and WILKINSON and TRAXLER, Circuit Judges. Chief Judge Wilkins wrote the opinion, in which Judge Wilkinson and Judge Traxler joined.

OPINION BY:   WILKINS

OPINION:   WILKINS, Chief Judge:

Martin Louis Baucom and Patrick Grant Davis (collectively, “Appellants”) appeal their convictions for conspiracy to defraud the United States, see 18 U.S.C.A. § 371 (West 2000), and willful failure to file tax returns, see 26 U.S.C.A. § 7203 (West 2002). The Government challenges the variance sentences  [*2]  imposed by the district court, contending that the district court improperly calculated the advisory guidelines range and that the sentences imposed were unreasonable. For the reasons set forth below, we affirm Appellants’ convictions, vacate their sentences, and remand for resentencing.

I.

Appellants operated Baucom-Davis and Associates, a land surveying and computer consulting business. From 1990 until 2002, Appellants failed to file personal income tax returns. They also failed to file income and employment tax returns for the business.

Appellants were charged in separate indictments on May 7, 2002. On June 3, before his initial appearance, Davis requested a 60-day continuance “to seek competent assistance of counsel to represent [him] on constitutional grounds.” J.A. 39. Davis’ motion stated that he had “NEVER Waived [his] RIGHT TO COUNSEL” and that he “object[ed] to this court’s attempt to force counsel on [him] against [his] will.” Id. at 41. Magistrate Judge H. Brent McKnight granted Davis’ request for additional time.

At his initial appearance on June 17, Baucom also requested additional time to obtain counsel. This request was granted by Magistrate Judge  [*3]  Carl Horn, III. Telephone calls from the office of the clerk on July 2 and 18 indicated that Baucom had not yet obtained counsel. At a hearing on August 12, Baucom informed the court that he had sent nine questionnaires to attorneys in the hope of obtaining counsel but had been unsuccessful. Magistrate Judge Horn granted Baucom an additional four weeks, advising him that he should consider another method of contacting potential attorneys and warning him that he would be required to appear pro se at his arraignment if he did not obtain counsel.

Meanwhile, on July 9, Davis filed another request for a continuance to seek counsel. Davis asserted the right to have a “friend” act as counsel, arguing that the right to “Counsel” guaranteed by the Sixth Amendment, U.S. Const. amend. VI, was not limited to professional attorneys. Davis’ 28-page memorandum in support of his motion provided, in part:

Defendant . . . has little confidence in the legal profession . . . . Defendant is aware of a few attorneys he trusts, but their multi-thousand dollar fees are out of the question . . . . He does NOT trust just any attorney out of a grab-bag whom the government is willing to furnish; neither  [*4]  would this defendant be satisfied with such an “attorney’s” concept of the Constitution of the United States after the average attorney, full of law-school brainwashing, thinks that the Constitution is what the judges say it is, rather than what the Constitution itself, says it is.

J.A. 75. At a hearing regarding the motion, Magistrate Judge McKnight offered to appoint counsel for Davis, but Davis declined. The judge granted Davis an additional 60 days.

At a hearing on August 8, Davis informed the judge that he still had not obtained counsel. Davis assured Magistrate Judge McKnight that he did not plan to ask for another extension of time. Despite this pledge, on September 3 Davis filed yet another request for a 60-day continuance to obtain counsel. The motion indicated that Davis had contacted only three attorneys since the previous hearing. Baucom filed an identical motion on the same day, naming the same three attorneys and providing copies of the same certified mail receipts that Davis had used as proof that he was attempting to obtain counsel.

Magistrate Judge Horn conducted Baucom’s arraignment on September 9, at which time Baucom stated that he still did not have  [*5]  counsel. Magistrate Judge Horn justifiably admonished Baucom for continuing to send questionnaires to potential attorneys after having been advised that this was not an effective means of obtaining counsel. The judge then ruled that Baucom had had adequate time to obtain counsel, deemed him to be representing himself for purposes of the arraignment, and asked Baucom whether he pleaded guilty or not guilty. When Baucom refused to enter a plea, Magistrate Judge Horn entered a plea of not guilty on Baucom’s behalf.

On October 23, Davis filed a document entitled “AFFIDAVIT & DECLARATION OF CONTINUED EFFORTS TO SEEK COMPETENT COUNSEL.” Id. at 156. The document contained numerous citations of Washington State cases and procedural rules. Among other things, Davis asserted that “[t]his court has NO authority to appoint me counsel over my objections”; “I can and will sue any Attorney for ineffective assistance of counsel who is appointed to my case over my objections”; and that “I can and will sue the person who picked my attorney and appointed him to me over my objections if said attorney loses my case.” Id. at 163. The “affidavit” was witnessed by Davis’ wife (who also notarized  [*6]  it) and by Baucom.

On November 4, United States District Judge Richard L. Voorhees entered an order denying Davis additional time to seek counsel. Judge Voorhees concluded that Davis “has been given ample time to secure counsel, and his failure to do so is a result of his unjustifiable failure to avail himself of the opportunities fairly given.” Id. at 183.

At a hearing regarding counsel on November 6, Davis stated,

I’m of the opinion that this indictment is invalid and I don’t think that I should have to plead to an invalid indictment. It fails to state the specific tax that they are alleging I have never paid. . . . [T]he section that is listed on this indictment is a section that specifies the penalty for failing to obey some other section, but they did not specify the section that I have supposedly failed to comply with.

Id. at 191-92. Davis further asserted that even to plead “not guilty” would amount to accepting the validity of the Government’s claim that there was a tax that Davis owed. Judge Voorhees rejected this argument, noted that Davis had had adequate time to obtain counsel, and stated that Davis had the option of proceeding pro se with  [*7]  or without standby counsel or having counsel appointed. Responding to Davis’ protest, Judge Voorhees observed that Davis “seem[ed] to take an attitude that [he was] not going to do anything affirmatively that might help address the stalemate that now exists in the case and consequently the court has to take its own initiative in the matter.” Id. at 196. The court therefore appointed counsel.

A superseding indictment was filed on December 3, essentially consolidating the charges against Appellants. Several days later, Davis filed yet another motion seeking an extension of time to seek counsel. He also filed several documents purporting to terminate appointed counsel. At Davis’ arraignment on December 12, Magistrate Judge Horn discussed the situation with Davis and with appointed counsel and decided to leave matters as they stood. When Davis refused to enter a plea, Magistrate Judge Horn entered a plea of “not guilty” on Davis’ behalf.

Davis filed a fifth request for a continuance on December 30, 2002. Baucom filed an identical request–his third–on the same day. At Baucom’s rearraignment, also on December 30, Magistrate Judge Horn warned Baucom that the onus was on him to  [*8]  obtain a lawyer, and if the scheduled trial date arrived and Baucom did not have counsel, he would be required to proceed pro se. Baucom acknowledged this.

Magistrate Judge Horn conducted a status-of-counsel hearing regarding Davis on March 6, 2003. In light of Davis’ refusal to cooperate with appointed counsel, Magistrate Judge Horn relieved appointed counsel. The judge then warned Davis that his trial was scheduled for early April and stated, “You do not have a right to delay the trial any further. That will be up to the [district court] whether [it] wants to exercise the discretion and give you more time or not. If you get to the April term and you haven’t found someone to represent you, you will be representing yourself . . . .” Id. at 283.

Despite the warnings given to both Appellants, neither had retained counsel by the April term of court. United States District Judge Graham Mullen (hereinafter “the district court”) continued the case to the July term of court.

On April 10, the district court filed a document from one Lewis Anthony Ewing, which the court construed as a motion to appear pro hac vice. The motion included a declaration in which Ewing claimed to be “admitted  [*9]  to practice in the Superior Courts of the State of Washington” and five tribal courts in that state, and “a member in good standing” of several bar associations. Id. at 302. Ewing’s declaration identified “Alan Richey” as co-counsel but provided no information regarding him. Id. The motion was referred to Magistrate Judge Horn. In a written order, the judge noted that despite Ewing’s purported membership in bar associations, the declaration did not indicate whether Ewing had graduated from an accredited law school, whether he had passed a state bar exam, and whether he had been admitted to any state bar. Further, Magistrate Judge Horn’s order stated that he had called the telephone number supplied in the declaration to inquire about these matters. “Mr. Ewing’s message did not appear to be that of a law office, but the undersigned identified himself and recorded the three points of inquiry on Mr. Ewing’s voice mail.” Id. at 309. This call was not returned. In light of these problems, Magistrate Judge Horn denied the motion.

Appellants’ case was called for trial on August 4, 2003. At that time, Appellants still were not represented by counsel, and they requested another  [*10]  continuance. The district court denied the motion, commenting, “It sure looks like you fellows have gamed the system and it’s time for it to be over with . . . .” Id. at 344. The case then proceeded to trial, and Appellants were convicted.

II.

We first consider Appellants’ challenge to their convictions. Appellants maintain that their Sixth Amendment right to counsel was violated by the refusal of the district court to grant a further continuance to allow them to obtain counsel. We disagree.

The Constitution generally entitles a defendant to representation by counsel of his choice. See United States v. Gonzalez-Lopez, 126 S. Ct. 2557, 2561, 165 L. Ed. 2d 409 (2006). This right may be violated when the district court refuses to continue a trial despite the fact that the defendant does not have counsel, or when defendant’s counsel is unprepared to proceed. See Sampley v. Att’y Gen., 786 F.2d 610, 612-13 (4th Cir. 1986). At the same time, however, a defendant cannot delay trial indefinitely “by simply showing up without counsel, or with allegedly unsatisfactory counsel, whenever his case is called for trial.” Id. at 613. In considering  [*11]  a request for continuance on the basis of absence of counsel, the court must “make a judgment whether [the lack of counsel] results from the lack of a fair opportunity to secure counsel or rather from the defendant’s unjustifiable failure to avail himself of an opportunity fairly given.” Id. This judgment is reviewed for abuse of discretion. See id.

The district court clearly did not abuse its discretion here. Nearly 15 months elapsed between Appellants’ initial indictments and the date their case was called for trial. The record reveals that this lengthy delay was due entirely to the desire of the magistrate and district court judges to provide Appellants ample opportunity to obtain counsel of their choice. Under the circumstances, Appellants were given a fair opportunity to obtain counsel, and the denial of their motion to continue on the day of trial was not an abuse of discretion.

III.

Having affirmed Appellants’ convictions, we now consider the Government’s challenges to the sentences imposed by the district court. In United States v. Booker, 543 U.S. 220, 244, 125 S. Ct. 738, 160 L. Ed. 2d 621 (2005), the Supreme Court held that the Sixth Amendment right to a jury  [*12]  trial is violated when the district court, acting pursuant to a mandatory guidelines system, imposes a sentence greater than the maximum authorized by the facts found by the jury alone. To remedy this problem, the Court severed and excised the provisions of the Sentencing Reform Act, see Sentencing Reform Act of 1984, Pub. L. No. 98-473, ch. II, 98 Stat. 1987-2040 (1984) (codified as amended at 18 U.S.C.A. §§ 3551-3742 (West 2000 & Supp. 2006) and at 28 U.S.C.A. §§ 991-998 (West 2006)), that mandated sentencing and appellate review in conformance with the guidelines. See Booker, 543 U.S. at 259. This excision rendered the guidelines “effectively advisory,” id. at 245, and replaced the previous standard of review with review for reasonableness, see id. at 261.

We have previously described the necessary procedure for imposing sentence under the now-advisory sentencing guidelines:

First, the court must correctly determine, after making appropriate findings of fact, the applicable guideline range. Next, the court must determine whether  [*13]  a sentence within that range serves the factors set forth in [18 U.S.C.A.] § 3553(a) [(West 2000 & Supp. 2006)] and, if not, select a sentence within statutory limits that does serve those factors. In doing so, the district court should first look to whether a departure is appropriate based on the Guidelines Manual or relevant case law. . . . If an appropriate basis for departure exists, the district court may depart. If the resulting departure range still does not serve the factors set forth in § 3553(a), the court may then elect to impose a non-guideline sentence (a “variance sentence”). The district court must articulate the reasons for the sentence imposed, particularly explaining any departure or variance from the guideline range. The explanation of a variance sentence must be tied to the factors set forth in § 3553(a) and must be accompanied by findings of fact as necessary. The district court need not discuss each factor set forth in § 3553(a) in checklist fashion; it is enough to calculate the range accurately and explain why (if the sentence lies outside it) this defendant deserves more or less.

United States v. Moreland, 437 F.3d 424, 432 (4th Cir.) (citations, internal quotation marks, & alterations omitted), cert. denied, 126 S. Ct. 2054, 164 L. Ed. 2d 804 (2006). We review a sentence for reasonableness, considering “the extent to which the sentence . . . comports with the various, and sometimes competing, goals of § 3553(a).” Id. at 433.

We begin our analysis by recounting the manner in which the district court calculated Appellants’ advisory guideline ranges. Baucom’s presentence report (PSR) estimated his unpaid taxes at $ 347,134.40; this amount included approximately $ 36,000 in unpaid state taxes. See United States Sentencing Guidelines Manual § 2T4.1(G) (2003) (providing a base offense level of 18 for tax loss of more than $ 200,000 but less than $ 400,000). The PSR recommended a downward adjustment of two levels for acceptance of responsibility, see U.S.S.G. § 3E1.1(a). The resulting final offense level of 16, combined with Baucom’s Criminal History Category of I, resulted in an advisory guideline range of 21-27 months. Davis’ guideline range was calculated in the same manner, except that Davis’ PSR estimated  [*15]  his unpaid taxes to be approximately $ 20,000 more than Baucom’s.

At Baucom’s sentencing hearing in November 2004, the district court refused to include the state taxes in relevant conduct:

I don’t think I have the . . . jurisdiction to sentence this man for [a] violation of North Carolina law. I mean, it’s inconceivable to me that a federal judge would be sitting up here and saying you violated North Carolina law and I’m putting you in jail for it. It’s just–what happened to the whole notion of federalism? I don’t think I have the power to do that. And if I do, if I have discretion, I decline to exercise the discretion to do that. It’s not fair and I ain’t gonna. Y’all can all go to Richmond and they can tell some other judge what to do.

J.A. 702-03. The district court also overruled the Government’s objection to the acceptance of responsibility reduction. The court found that Appellants had gone to trial solely for the purpose of challenging the constitutionality of the federal tax system and therefore the acceptance of responsibility reduction was available to them even though they had gone to trial. See U.S.S.G. § 3E1.1, comment. (n.2)  [*16]  (noting that a defendant who goes to trial may still receive an acceptance of responsibility deduction when, for example, he “goes to trial to assert and preserve issues that do not relate to factual guilt,” such as a constitutional challenge to the statutory scheme).

The district court announced a sentence for Baucom of 21 months imprisonment but delayed entering a judgment until Davis’ sentence had been imposed. In the interim, the Supreme Court decided Booker, and the district court reconvened the sentencing hearing in February 2006. The court considered the factors set forth in 18 U.S.C.A. § 3553(a), and imposed a sentence of 15 months imprisonment. The court found that after being a “scofflaw” for 12 years, J.A. 778, Baucom had not made adequate efforts to rectify the situation. However, the court ruled that there was no need to deter Baucom from further criminal conduct or to protect the public.

At Davis’ sentencing, conducted the same day, the court imposed a sentence of four years probation, conditioned on the service of 12 months of house arrest. In articulating the reasons for this sentence, the court first noted Davis’ “extraordinary  [*17]  charitable works,” id. at 761, which consisted of his involvement with a group that each summer brought children living in the area of the Chernobyl nuclear disaster to the United States for medical treatment. The court also noted Davis’ efforts to become current on his tax liability and the fact that if Davis were incarcerated, the employees of his business would suffer. As it did in Baucom’s case, the court found little need for the sentence imposed to deter future criminal conduct or to protect the public.

A.

The Government first maintains that the district court erred by excluding state tax amounts from Appellants’ relevant conduct. This is a question involving the legal interpretation of the guidelines, and as such it is subject to de novo review. See United States v. Schaal, 340 F.3d 196, 198 (4th Cir. 2003).

The question here is whether state tax loss is relevant conduct to a federal tax offense; if so, the district court erred in not including the state tax amounts in its guideline calculations. See United States v. Hayes, 322 F.3d 792, 802 (4th Cir. 2003) (holding that “a court has no discretion to disregard relevant conduct in order  [*18]  to achieve the sentence it considers appropriate”). Relevant conduct includes “all acts and omissions . . . that were part of the same course of conduct or common scheme or plan as the offense of conviction.” U.S.S.G. § 1B1.3(a)(2). Under the plain language of the guideline, state tax losses caused by Appellants are relevant conduct to the extent that they “were part of the same course of conduct or common scheme or plan” as Appellants’ failure to file federal tax returns. See United States v. Powell, 124 F.3d 655, 665-66 (5th Cir. 1997).

The record indicates that Appellants failed to file state tax returns as part of the course of conduct for which they were convicted. Therefore, it was error for the district court to refuse to include the state tax amounts when calculating the advisory guideline range. Although Appellants contend that inclusion of the state tax loss would not alter their base offense levels, it is not clear that this is correct. The Government notes that the district court did not include in its calculations tax losses from the years 1998 through 2002, nor did it consider updated figures offered by the Government at  [*19]  Davis’ sentencing hearing. We leave to the district court the task of calculating the correct amount of tax loss upon resentencing.

B.

The Government also contends that the district court erred in granting Appellants a two-level reduction for acceptance of responsibility. We review this ruling for clear error. See United States v. Kise, 369 F.3d 766, 771 (4th Cir. 2004). “A finding is clearly erroneous when, although there is evidence to support it, on the entire evidence the reviewing court is left with the definite and firm conviction that a mistake has been committed.” Faulconer v. Comm’r, 748 F.2d 890, 895 (4th Cir. 1984).

Ordinarily, a reduction for acceptance of responsibility is not available to “a defendant who puts the government to its burden of proof at trial by denying the essential factual elements of guilt, is convicted, and only then admits guilt and expresses remorse.” U.S.S.G. § 3E1.1, comment. (n.2). However, when the defendant does not contest factual guilt but goes to trial only for the sake of raising and preserving a constitutional challenge to the statutory scheme he is charged with violating,  [*20]  an acceptance of responsibility reduction may still be available. See id.”In each such instance, however, a determination that a defendant has accepted responsibility will be based primarily upon pretrial statements and conduct.” Id.

Seizing on the above-quoted sentence, the Government maintains that Appellants’ pretrial conduct was uniformly obstructive and was “exactly the opposite of the expression of remorse that the acceptance of responsibility guideline contemplates.” Br. for the United States at 36 (internal quotation marks omitted). We agree. Furthermore, we conclude that the district court clearly erred in finding that Appellants proceeded to trial solely for the purpose of preserving their constitutional challenge to the validity of the tax code. A cursory review of the trial transcript demonstrates that Appellants in fact challenged their factual guilt by contesting the element of willfulness. Therefore, the district court improperly granted Appellants reductions for acceptance of responsibility.

C.

Finally, the Government contends that the sentences ultimately imposed by the district court were unreasonable, even if premised on proper guidelines calculations.  [*21]  Although we have already determined that the district court improperly calculated the advisory guideline ranges for Appellants, we will provide some brief comments regarding the reasonableness of Appellants’ sentences as an aid to the district court on remand.

First, we note that in both of Appellants’ cases, the district court discounted the value of deterrence in so-called “tax protestor” cases. The Government argues that this ruling is inconsistent with the policies set forth in the guidelines, and we are inclined to agree. In commentary preceding the tax guidelines, the Sentencing Commission states:

The criminal tax laws are designed to protect the public interest in preserving the integrity of the nation’s tax system. Criminal tax prosecutions serve to punish the violator and promote respect for the tax laws. Because of the limited number of criminal tax prosecutions relative to the estimated incidence of such violations, deterring others from violating the tax laws is a primary consideration underlying these guidelines. Recognition that the sentence for a criminal tax case will be commensurate with the gravity of the offense should act as a deterrent to would-be  [*22]  violators.

U.S.S.G. Ch. 2, Pt. T, intro. comment. (emphasis added). Even if the district court is correct that deterrence is of less value in tax protestor cases than in run-of-the-mill tax evasion cases, we remain of the opinion that the district court acted unreasonably in entirely discarding deterrence as a consideration in imposing sentence.

We also think that the sentences imposed by the district court fail to reflect the seriousness of the offense and do not provide just punishment, as required by 18 U.S.C.A. § 3553(a)(2)(A). Appellants failed to file taxes of any sort for twelve years before they were apprehended. Moreover, as the Government notes, neither Appellant began paying taxes until 2004, after his conviction. Finally, we note with respect to Davis’ sentence that we are troubled by the heavy reliance of the district court on Davis’ charitable works. Cf. U.S.S.G. § 5H1.11, p.s. (providing that a defendant’s charitable works are ordinarily not a basis for departing from the guidelines).

IV.

For the reasons set forth above, we affirm Appellants’ convictions. We vacate their sentences and remand  [*23]  for resentencing consistent with this opinion.

AFFIRMED IN PART; VACATED AND REMANDED IN PART

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Toth v. Comm’r, 128 T.C. No. 1 (2007).

128 T.C. No. 1

UNITED STATES TAX COURT

JULIE A. TOTH, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 12452-04, 12862-04. Filed January 18, 2007.

P began operating a horse boarding and training
facility for profit in 1998. P has continued carrying
on these activities through the date of trial. P
claims the expenses paid for these activities are
deductible pursuant to sec. 212, I.R.C., in 1998 and
2001, the years at issue.

R denied the deductions, claiming that the
expenses were nondeductible startup expenditures under
sec. 195(a), I.R.C., which must be capitalized because
they were incurred in anticipation of the sec. 212,
I.R.C., activity’s becoming a trade or business.

Held: Sec. 195(a), I.R.C., does not require the
expenses of P’s sec. 212, I.R.C., activity to be
capitalized as startup expenditures. The expenses paid
or incurred in the sec. 212, I.R.C., activity are
deductible.

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Russell R. Kilkenny, for petitioner.

Shirley M. Francis, for respondent.

HAINES, Judge: Respondent determined deficiencies in
petitioner’s Federal income taxes for 1998 and 2001 (years at
issue) of $112,461 and $84,388, as well as additions to tax under
section 6651(a)(1) of $19,512 and $13,920, under section
6651(a)(2) to be computed, and under section 6654(a) of $3,806
and $2,349, respectively.

The issue for decision as framed by the parties is: whether
petitioner may deduct expenses in connection with her horse
boarding and training activities for the years at issue pursuant
to section 212 or instead is required by section 195(a) to
capitalize them as startup expenditures.1

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 lived in
Oregon when she filed her petition.

Petitioner was employed by the pharmaceutical firm Pfizer,
Inc. (Pfizer), from 1988 to May 9, 2000. In March 1997,

1 Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended. All Rule references are
to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated. Amounts are rounded to the nearest dollar.

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petitioner fell from her horse during a stadium jumping clinic
and suffered a head injury which caused continuing episodes of
severe fatigue, mental apathy, dizziness, and nausea.2 Her
illness resulted in permanent disability and caused her to lose
her job with Pfizer on May 9, 2000.

Petitioner is one of six individuals in the Pacific
Northwest qualified to teach Eventing3 at the beginning novice,
novice, training, and preliminary levels.4 In 1998 petitioner
purchased 17 acres of land in Newberg, Oregon (Newberg property),
between Portland and Salem, Oregon, in an area well known within
the equestrian community for horse boarding, training, and
lessons.

In 1998, petitioner began operating a horse boarding and
training facility upon the Newberg property for profit. Although
income from the activities in 1998 was modest, it gradually
increased as improvements were made to the Newberg property and
petitioner was able to hire additional staff. By early 2004,

2 Petitioner was initially diagnosed with chronic fatigue
syndrome. However, in June 2001, a cardiologist diagnosed her as
suffering from neurocardiogenic syncope, an incurable disease
caused by the nerve damage she suffered from her head injury.

3 Eventing is an Olympic sport made up of three disciplines
in which a horse and rider compete in dressage, stadium jumping,
and cross-country jumping.

4 Eventing has six levels of difficulty which are in order
of difficulty: Beginning novice; novice; training; preliminary;
intermediate; and advanced.

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petitioner had established a limited liability company called
Ghost Oak Farm, L.L.C., to operate the Newberg property. She
currently earns approximately $3,000 per month from Ghost Oak
Farm, L.L.C.

Petitioner filed her Federal income tax returns for the
years at issue on April 5, 2004. Respondent sent petitioner
notices of deficiency for the years at issue on April 19 and 26,
2004, respectively. The notices of deficiency for the years at
issue were based upon third party payor information and not upon
information reported on petitioner’s filed returns.

The parties have stipulated that the income reported on
petitioner’s Federal income tax returns for 1998 and 2001 is
correct. Petitioner’s claimed itemized deductions are not in
dispute. Petitioner reported the income and expenses from her
horse boarding and training activities on Schedule C, Profit or
Loss From Business, but concedes that the expenses attributable
to the activities are not deductible pursuant to section 162.
Rather, petitioner contends that the horse boarding and training
expenses are deductible pursuant to section 212. Respondent
concedes petitioner engaged in horse boarding and training
activities for profit5 beginning in 1998 and does not dispute the

5 Respondent does not argue the application of sec. 183.

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amounts of the expenses claimed, but contends they are
nondeductible startup expenditures under section 195(a).6

Petitioner filed her petitions for 1998 and 2001 on July 21
and 15, 2004, respectively. The Court consolidated the cases for
trial, briefing, and decision on December 5, 2005.

OPINION

The relevant portion of section 195, as amended, provides:

SEC. 195. START-UP EXPENDITURES.

(a) Capitalization of Expenditures. Except as otherwise provided in this section, no deduction shall
be allowed for start-up expenditures.
* * * * * * *

(c) Definitions. For purposes of this section-(1) Start-up expenditures. The term “start-up expenditure” means any amount-(A) paid or incurred in connection with-** * * * * * (iii) any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of such activity becoming an active trade or business, and (B) which, if paid or incurred in connection with the operation of an existing active trade or business (in the same field as the trade or business referred to in subparagraph (A)), would 6 The parties have also stipulated that petitioner is entitled to personal exemptions for the years at issue. If additional income tax is owing from petitioner, she concedes the additions to tax under secs. 6651(a)(1) and (2) and 6654.
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be allowable as a deduction for the taxable year in which paid or incurred. [Emphasis added.]

Respondent, citing the underlined portion of section 195, contends that petitioner anticipated that her income-producing
activities would become an active trade or business. Therefore, respondent argues, expenses paid or incurred in the income-producing activity must be capitalized. Respondent’s argument fails for several reasons.

Ordinary and necessary expenses for all income-producing activities, whether they are for business under section 162 or
nonbusiness under section 212, are intended to be on equal footing. Snyder v. United States, 674 F.2d 1359, 1364 (10th Cir. 1982); Looney v. Commissioner, T.C. Memo. 1985-326, affd. without published opinion 810 F.2d 205 (9th Cir. 1987). This means that the distinction between an ordinary expense and a capital expenditure should be applied in the same manner under both sections. Woodward v. Commissioner, 397 U.S. 572, 575 n.3 (1970). This Court construes the term “startup expenditure” to denote an expenditure that is capital rather than ordinary. This Court will not interpret section 195 to override the deductibility of ordinary and necessary expenses petitioner incurred in an ongoing section 212 activity any more than it would do so for an ongoing section 162 activity. See Crane v. Commissioner, 331 U.S. 1, 13 (1947) (“one section of the act must

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be construed so as not to defeat the intention of another or to frustrate the Act as a whole”); Brons Hotels, Inc. v.
Commissioner, 34 B.T.A. 376, 381 (1936) (“The various sections of the Act should be so construed that one section will explain and support and not defeat or destroy another section”). Once her section 212 activity has begun, the deduction of ordinary and necessary expenses paid or incurred in that activity is not precluded by section 195 regardless of whether that activity is subsequently transformed into a trade or business. This interpretation is consistent with section 195 and its legislative history.

In the 1980s several Federal Courts of Appeals were asked to decide whether expenses paid or incurred during the preoperating phase of a profit-seeking activity were deductible or had to be capitalized. Each of the cases involved tax years arising before the effective date of section 195. Six Courts of Appeals held that, because section 212 and section 162 are in pari materia, preopening expenses7 for either a section 212 activity or a 7 Before the enactment of sec. 195 in the Miscellaneous Revenue Act of 1980, Pub. L. 96-605, sec. 102(a), 94 Stat. 3522, a taxpayer was required to capitalize investigatory expenses and startup costs of a new business under a body of law known as the pre-opening expense doctrine, which was based upon sec. 162 and the clear reflection of income principle. Richmond Television Corp. v. United States, 345 F.2d 901, 904-907 (4th Cir. 1965), vacated per curiam on other grounds 382 U.S. 68 (1965). Under
this doctrine, a taxpayer could recover preopening expenses only by depreciating them over the life of the asset or deducting them

(continued…)

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section 162 activity must be capitalized. See Sorrell v. Commissioner, 882 F.2d 484, 487-488 (11th Cir. 1989), revg. T.C.
Memo. 1987-351; Lewis v. Commissioner, 861 F.2d 1232, 1233 (10th Cir. 1988), revg. T.C. Memo. 1986-155; Fishman v. Commissioner, 837 F.2d 309 (7th Cir. 1988), revg. T.C. Memo. 1986-127; Johnsen v. Commissioner, 794 F.2d 1157, 1162 (6th Cir. 1986), revg. 83 T.C. 103 (1984); Aboussie v. United States, 779 F.2d 424, 428 n.6 (8th Cir. 1985). The Court of Appeals for the Ninth Circuit affirmed a holding of the Tax Court which found preopening expenditures of a section 212 activity could be deducted.  Hoopengarner v. Commissioner, 80 T.C. 538 (1983), affd. without published opinion 745 F.2d 66 (9th Cir. 1984).87(…continued) as a loss when the asset was sold. See Commissioner v. Idaho Power Co., 418 U.S. 1 (1974). 8 In Hardy v. Commissioner, 93 T.C. 684, 693 (1989), affd. in part and remanded in part (10th Cir., Oct. 29, 1990), we overruled our Opinion in Hoopengarner v. Commissioner, 80 T.C. 538 (1983), affd. without published opinion 745 F.2d 66 (9th Cir. 1984). The year in suit in Hardy was 1982, to which the 1984 amendment of sec. 195 did not apply.

- 9

Observing that section 195 as originally enacted9 in the Miscellaneous Revenue Act of 1980, Pub. L. 96-605, sec. 102(a),
94 Stat. 3522, was ambiguous and caused excessive litigation, in 1984 Congress amended the statute. Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 94(a), 98 Stat. 614; S. Prt. 98-169 (Vol. I), at 282-283 (1984). The Senate print accompanying the Deficit Reduction Act of 1984 stated that the intent of Congress in amending the statute was to “decrease the controversy and litigation arising under present law with respect to the proper tax treatment of start-up expenditures” by requiring expenses similar to those allowed as deductions in Hoopengarner to be capitalized. S. Prt. 98-169 (Vol. I), supra at 283. The purpose of the 1984 amendment to section 195 was to bring sections 212
and 162 into parity when determining whether an expenditure has been incurred in a startup activity.

9 As originally enacted sec. 195(b) defined “startup expenditures” to mean any amount:

(1) paid or incurred in connection with-(A) investigating the creation or acquisition of an active trade or business, or (B) creating an active trade or business, and (2) which, if paid or incurred in connection with the expansion of an existing trade or business * * * would be allowable as a deduction for the taxable year in which paid or incurred.

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We have found that petitioner operated her horse boarding and training activities for profit in 1998 and has continued to
engage in these same activities through the date of trial. Respondent concedes petitioner engaged in these activities for
profit during the years at issue. Additionally, respondent does not argue the application of section 183 and does not dispute the amounts of the expenses or that they were ordinary or necessary.  Therefore, the Court holds that petitioner’s expenses attributable to her horse boarding and training activities during the years at issue are deductible pursuant to section 212.

Decisions will be entered
under Rule 155.

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Beth-El All Nations Church v. City of Chicago, 2007 U.S. App. LEXIS 11262 (7th Cir. 2007).

2007 U.S. App. LEXIS 11262,*

BETH-EL ALL NATIONS CHURCH and BISHOP EDGAR JACKSON, Plaintiffs-Appellees, v. CITY OF CHICAGO, Defendant-Appellant.

No. 06-2082

UNITED STATES COURT OF APPEALS FOR THE SEVENTH CIRCUIT

2007 U.S. App. LEXIS 11262

February 7, 2007, Argued

May 14, 2007, Decided

PRIOR HISTORY:    [*1]  Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 06 C 1111–Samuel Der-Yeghiayan, Judge.

COUNSEL:   For BETH-EL ALL NATIONS CHURCH, EDGAR JACKSON, Bishop, Plaintiffs-Appellees: Andy R. Norman, MAUCK & BAKER, Chicago, IL USA.

For CITY OF CHICAGO, Defendant-Appellant: Sara K. Hornstra, Myriam Z. Kasper, OFFICE OF THE CORPORATION COUNSEL, Appeals Division, Chicago, IL USA.

JUDGES:   Before FLAUM, ROVNER, and EVANS, Circuit Judges.

OPINION BY:   EVANS

OPINION:   EVANS, Circuit Judge. An employee of the City of Chicago mistakenly addressed a notice to Beth-El All Nations Church at 1534 East 63rd Street, instead of Beth-El’s true address, 1534 West 63rd Street. The notice was pretty important: it advised the Church of its right to redeem title to the 63rd Street property after the parcel was sold for delinquent taxes. Despite the misaddressed notice, the City acquired a tax deed to the 63rd Street property in 1998. Finally, after Beth-El’s failed attempts to challenge the tax deed through state postjudgment proceedings, the City sought to oust Beth-El from the property in 2006. On the very day in March 2006 when the City came to take the property,  [*2]  Beth-El turned to federal court and filed a complaint claiming violations of the Fourth Amendment. It also sought a temporary restraining order, which the district court granted after an ex parte hearing. The Church then amended its complaint to state a procedural due-process claim and moved for a preliminary injunction. The City opposed the injunction, claiming that the district court lacked subject-matter jurisdiction over the suit under the Rooker-Feldman doctrine; according to the City, the Church had already litigated the property dispute in state court. See D.C. Court of Appeals v. Feldman, 460 U.S. 462, 103 S. Ct. 1303, 75 L. Ed. 2d 206 (1983); Rooker v. Fid. Trust Co., 263 U.S. 413, 44 S. Ct. 149, 68 L. Ed. 362 (1923). After an evidentiary hearing, the district court granted the preliminary injunction, reasoning that Rooker-Feldman was inapplicable because the Church never had an opportunity to challenge the City’s acquisition of the tax deed in state court. The City now appeals.

Beth-El, an African-American church in the Chicago neighborhood of Englewood, took title to the 63rd Street property in 1976. Beth-El rehabilitated the property and began operating there  [*3]  in 1984. The Church was not, however, deemed to be tax-exempt during the period from 1986 to 1995, and so real estate taxes, totaling over $ 100,000, were assessed by Cook County against the property. Because of the delinquent taxes, the property was sold at a “scavenger sale,” a sale authorized by Illinois law for properties that have been tax delinquent for more than two years, if annual forfeiture sales have not satisfied the delinquency. See 35 ILL. COMP. STAT. 200/21-145, 200/21-260 (2000); see also People v. Meyers, 158 Ill. 2d 46, 630 N.E.2d 811, 819, 196 Ill. Dec. 646 (Ill. 1994) (noting primary purpose of scavenger sales is to return tax-delinquent property to the tax rolls). Under the rules governing these sales, Cook County itself could acquire the property if no private purchaser bid the full amount of the unpaid taxes. See 35 ILL. COMP. STAT. 200/21-260(g). Apparently no purchaser bid the full amount of the taxes here because Cook County acquired a certificate of purchase to Beth-El’s property on August 7, 1997, which was confirmed by the Circuit Court of Cook County about a month  [*4]  later.

Cook County did not own the property yet, though. The certificate of purchase gave it the right to, among other things, assign the certificate of purchase “to any party, including taxing districts.” See 35 ILL. COMP. STAT. 200/21-90. The City of Chicago happens to be a “taxing district,” so Cook County assigned the certificate of purchase to it as part of the City’s “Tax Reactivation Program,” which, as its name suggests, attempts to reintroduce chronically tax-delinquent property to the tax rolls.

With the certificate in hand, the City’s next step was to obtain a tax deed by filing a petition in the circuit court, which the City did in January 1998. But before a tax deed issues, the owner whose taxes are delinquent is entitled to notice of the right to redeem the property by paying the full amount of taxes and penalties. See 35 ILL. COMP. STAT. 200/21-260(f); Meyers, 630 N.E.2d at 819. And this is where the mistake happened: when the City addressed the notice, required by § 22-10 of the Illinois Property Tax Code, see 35 ILL. COMP. STAT. 200/22-10, it  [*5]  used the wrong address. The City was relying on a document from the Chicago Title Insurance Company, which was also apparently incorrect. At the City’s request, Chicago Title performed a tract index search on property described by the City by pin number. The search revealed that the last recorded conveyance of the property was to “Beythel Outcast Church” (a name Beth-El All Nations Church formerly used), and referred to the address as “1534 E. 63rd St. Chicago, Illinois.”

There were two other notices that the Tax Code requires, one under § 22-5, and one under § 22-15. See 35 ILL. COMP. STAT. 200/22-5, 200/22-15. The former requires the purchaser, within four months and 15 days following a tax sale, to deliver to the county clerk a notice of the tax sale addressed to the party in whose name taxes were last assessed. See 35 ILL. COMP. STAT. 200/22-5. Section 22-15 requires a purchaser to publish notice of the tax sale in the newspaper. The City complied with the former section by delivering to the county clerk a notice that, this time, was properly address to Beth-El at 1534 W. 63rd Street. The City also published  [*6]  notice of the sale and redemption period–with the correct address on West 63rd Street–in the Chicago Daily Law Bulletin.

After the City filed its petition for a tax deed, and the redemption period expired, the City filed an “Application for an Order Directing the County Clerk to Issue a Tax Deed.” The application recites that the required notices–under §§ 22-5, 22-10, and 22-15–had been served, and the City’s counsel represented orally to the circuit court that all required notices had been served. Based on these representations, on July 7, 1998, the circuit court ordered the county clerk to issue the City a tax deed (the “tax-deed judgment”). The county clerk issued the City’s tax deed that day, and the City recorded it seven months later.

The next thing we know for sure is that five years after taking title to the property the City filed an application in the Circuit Court of Cook County seeking actual possession of the property. Nine days later Beth-El, through counsel, moved to vacate the tax-deed judgment by filing a petition under § 2-1401 of the Illinois Code of Civil Procedure, 735 ILL. COMP. STAT. 5/2-1401. The petition alleged, among  [*7]  other things, that the City fraudulently concealed the 1998 proceedings by sending the § 22-10 notice of the right of redemption to Beth-El at the wrong address. As for the notice required by § 22-5, counsel for the Church told the circuit court that he had “no argument there” and conceded that someone walked the correctly addressed notice to the county clerk’s office. But still the Church claimed that under § 22-45(3) of the Tax Code, 35 ILL. COMP. STAT. 200/22-45, the judgment awarding the City a tax deed should be set aside because “the tax deed had been procured by fraud or deception.” Attached to the petition was an affidavit from Bishop Edgar Jackson, a pastor at Beth-El since 1995, who attested that the Church has never been located at 1534 East 63d Street, and that he was always under the impression that the Church was tax exempt.

The City moved to dismiss Beth-El’s petition under § 2-619.1, 735 ILL. COMP. STAT. 5/2-619.1, arguing that the petition was filed outside § 2-1401’s two-year statute of limitations. See § 2-1401(c). Moreover, argued the City, what Beth-El alleged did not amount to fraudulent  [*8]  concealment. At the outset of the hearing on the cross-motions, Beth-El’s counsel stated that he would like to “reserve, if possible” an argument that taxes should never have been assessed against the Church because it was tax exempt. He then stated: “I’m not asking this Court to hold this case up because that can be brought at any time. That would make it absolutely void because there would be no jurisdiction.” But then, puzzlingly, counsel focused on his argument that the tax deed was void because the tax sale had been fraudulently concealed. (Counsel undoubtedly meant that he wanted to “preserve” the issue of tax exemption, rather than reserve it–but he never actually made the argument in order to preserve it.)

The circuit court ultimately held that the City’s mistake in addressing the § 22-10 notice did not amount to fraudulent concealment of the tax sale. Thus, the court continued, Beth-El provided nothing to circumvent the two-year statute of limitations for actions under § 2-1401, and the motion to dismiss had to be granted. The court denied a petition for rehearing. The Appellate Court of Illinois affirmed, City of Chi. v. Beth-El All Nations Church of God in Christ , No. 1-04-0364 (Ill. App. Ct. Mar. 31, 2005)  [*9]  (unpublished order), and the Supreme Court of Illinois denied leave to appeal, City of Chi. v. Beth-El All Nations Church of God in Christ, 216 Ill. 2d 687, 839 N.E.2d 1024, 298 Ill. Dec. 377 (Ill. 2005) (unpublished order).

Once the mandate issued, the City renewed its application for possession of the property, which was pending during the § 2-1401 proceedings. The circuit court held a hearing on the application in early January 2006, at which Beth-El agreed to an order granting possession to the City, provided that the order be stayed until February 28, 2006. On March 1, 2006, when a City employee came to put new locks on the property pursuant to the agreement transferring possession, he was asked by Bishop Jackson (by telephone) if the Church could have just one more day. After discussing the matter with counsel for the City, the employee agreed and left.

Bishop Jackson spoke with the employee by phone because at that very moment he was filing this lawsuit, and a motion for a temporary restraining order, in the federal district court. The 57-page pro se complaint named various parties, including the City,  [*10]  the mayor, and the state-court judge who issued the tax deed and decided the § 2-1401 petition (they were the same). The Church claimed violations of the Fourth Amendment for “unreasonable search and seizure” of the Church’s property. The district court held a hearing, but the City attorneys did not learn of the suit in time to appear, so based on Bishop Jackson’s representations the court entered a TRO and enjoined the named defendants from attempting to evict Beth-El. The City subsequently moved to dismiss the case and to vacate the TRO primarily on grounds that the suit was barred by the Rooker-Feldman doctrine and the Tax Injunction Act, 28 U.S.C. § 1341. The district court denied the motion. During all this, Beth-El filed a motion for a preliminary injunction, which the court was scheduled to hear on March 13, 2006.

On that date, both parties appeared with counsel. The Church’s counsel stated that the Church would file an amended complaint raising claims under 42 U.S.C. § 1983 for violations of the First Amendment and the Due Process Clause of the United States Constitution, as well as under the Religious Land Use and Institutionalized  [*11]  Persons Act, 42 U.S.C. §§ 2000cc to 2000cc-5 (”RLUIPA”), and the Illinois Religious Freedom Restoration Act, 775 ILL. COMP. STAT. 35/15 (”IRFRA”). The City again argued that the district court lacked subject-matter jurisdiction to entertain the lawsuit, but the district court put jurisdictional considerations to one side and told the City to “present your side why preliminary injunction factors shouldn’t apply.” The City then shoehorned its jurisdictional argument into the likelihood-of-success-on-the-merits prong for issuing injunctions, arguing that under Rooker-Feldman lower federal district courts lack subject-matter jurisdiction to overturn state-court judgments. The Church, relying on cases like Taylor v. Fannie Mae, 374 F.3d 529, 534 (7th Cir. 2004), replied that this case fits into one of the exceptions to Rooker-Feldman, namely, that if a plaintiff in federal court did not have a “reasonable opportunity” to raise its claims in state-court proceedings, the doctrine does not apply and a district court has jurisdiction to consider the case.

The Church’s sole  [*12]  witness at the hearing was Bishop Jackson, who testified that Beth-El had never paid property taxes while it occupied the property. Bishop Jackson explained that Beth-El had never received a tax bill, and he believed he was the person who would have received one. Bishop Jackson further testified that he did not discover that the property had been sold until, at the earliest, late in 2001.

Mark Davis, an attorney who handled the acquisition of the tax deed, was the principal witness on the City’s behalf. According to Davis, the City sent the Church several letters in the years following the tax sale encouraging it to obtain a tax exemption for the property. For example, in a letter dated September 20, 1999, an attorney representing the City, Marguerite Quinn, advised Bishop Jackson that the City had taken title to the property in a tax proceeding. Quinn encouraged the Bishop to consult an attorney. Receiving no response, Quinn wrote again to Bishop Jackson three months later, encouraging him to obtain legal representation and advising him that if the City received no response it may be forced to evict Beth-El. In February 2000 Quinn received a letter from Bishop James Baker, Presiding  [*13]  Regional Bishop of the Church of God in Christ United (which, according to Bishop Jackson, is Beth-El’s “canopy international organization”), advising the City of a partial exemption for the Church’s property (which, ironically, Bishop Baker identifies by that nasty address: 1638 East 63rd Street). Bishop Baker attached an exemption certificate from the Illinois Department of Revenue dated July 1, 1999, which provides that the Church’s parcel is tax exempt, except for a resale shop on the first floor and meeting rooms on the second floor. The certificate was procured by Beth-El having filed an application for the exemption on March 26, 1998, just two months before the redemption period was set to expire. The application is attached to the Church’s complaint, and it is signed by Bishop Jackson. (The application also identifies the property as “1534 E. 63rd Street”; apparently no one could keep the address straight.) Bishop Baker’s letter to Quinn says that the partial exemption should have been a full exemption because all the operations on the property related to activities of the Church. He advised that Bishop Jackson was planning to retain a law firm to apply for a retroactive  [*14]  full exemption. But according to Davis, the City heard nothing from the Church for the next two years. So the City sent two more letters, one in May 2002, and one in April 2003, advising the Church yet again that the City owned the property, and that Beth-El should obtain counsel to pursue a tax exemption.

On the last day of testimony, after the City presented its witnesses, Bishop Jackson took the stand again as a rebuttal witness. He denied seeing any of the letters the City produced. He testified that, despite his signature appearing on the application, he did not know who applied for the partial exemption granted by the Illinois Department of Revenue or what Bishop Baker had written to Quinn. He also testified for the first time about his interactions with a man named Charles Bowen, a mayoral assistant who acts as a liaison to community churches. According to Bishop Jackson, he believed the City would return the title even after it was acquired because Bowen assured him that it would be done.

The district court concluded that it had subject-matter jurisdiction because the misaddressed notice deprived Beth-El of a reasonable opportunity to have its claims heard in state court.  [*15]  Therefore, continued the court, neither Rooker-Feldman nor the Tax Injunction Act barred this suit in federal court. The court then ruled that “the likelihood of success on the merits factor favors the Church,” but the court did not identify under what theory the Church was likely to prevail or why. The court also reasoned that the two-year statute of limitations for claims under 42 U.S.C. § 1983 did not apply in light of Bowen’s representations to the Church that the City would return the deed. Finally, the court concluded that the balance of harms and public interest favored Beth-El. “In this country,” the court concluded, “even a church is entitled to its day in court. That did not happen in this case.” The court then entered a preliminary injunction enjoining the defendants and their agents from “exercising any ownership or property rights, including any eviction attempts, over the property located at 1534 W. 63rd Street [Ah, the address was correct!] Chicago, Illinois.”

On appeal, the City renews its arguments that the Tax Injunction Act and Rooker-Feldman deprived the district court of jurisdiction over this case. Because federal courts must  [*16]  determine that they have jurisdiction before proceeding to the merits, see Lance v. Coffman, 127 S. Ct. 1194, 1196, 167 L. Ed. 2d 29 (2007), we begin, as the district court did, with the Rooker-Feldman doctrine. (Whether we address Rooker-Feldman or the Tax Injunction Act first matters not because either one, if applicable, would bar this case in federal court. See Crestview Vill. Apts. v. United States HUD, 383 F.3d 552, 557 (7th Cir. 2004) (Rooker-Feldman is jurisdictional); Platteville Area Apartment Ass’n v. City of Platteville, 179 F.3d 574, 582 (7th Cir. 1999) (Tax Injunction Act is jurisdictional).)

The City begins by arguing that Rooker-Feldman applies because Beth-El seeks directly to overturn a state-court judgment. Beth-El’s response is that the district court correctly refused to apply Rooker-Feldman because the Church lacked a reasonable opportunity to challenge the state-court judgment. Under the Rooker-Feldman doctrine, lower federal courts lack subject-matter jurisdiction when, after state proceedings have ended, a losing party in state court files suit in federal court complaining of an  [*17]  injury caused by the state-court judgment and seeking review and rejection of that judgment. See Exxon Mobil Corp. v. Saudi Basic Indus. Corp., 544 U.S. 280, 284, 125 S. Ct. 1517, 161 L. Ed. 2d 454 (2005). In determining whether a federal plaintiff seeks review of a state-court judgment, we ask whether the injury alleged resulted from the state-court judgment itself. See Centres, Inc. v. Town of Brookfield, Wis., 148 F.3d 699, 701-02 (7th Cir. 1998). If it does, Rooker-Feldman bars the claim. Id. at 702. If the injury is independent of the state-court judgment, or if the federal claim alleges “a prior injury that a state court failed to remedy,” Rooker-Feldman is no barrier to the federal suit. Id. Rooker-Feldman also applies to bar federal claims that are “inextricably intertwined” with a state-court judgment, except where the plaintiff lacked a reasonable opportunity to present those claims in state court. See Taylor, 374 F.3d at 534-35; Brokaw v. Weaver, 305 F.3d 660, 668 (7th Cir. 2002); Long v. Shorebank Dev. Corp., 182 F.3d 548, 556-57 (7th Cir. 1999).

In this case, the Church has  [*18]  sought all along to retain possession and regain title to the property. Beth-El has never identified any injury separate from the tax deed judgment; it has not alleged, for example, that the City’s very act of misaddressing the notice violated a state or federal statute, cf. Long, 182 F.3d at 556 (holding Rooker-Feldman inapplicable to claim that defendants violated Fair Debt Collection Practices Act by sending fraudulent notice of overdue rent even though notice ultimately led to eviction order because sending of fraudulent notice itself was an injury independent of eviction order). Thus, Beth-El’s injury was caused by–and its federal due-process claim arises directly out of–the tax deed judgment. See Holt v. Lake County Bd. of Comm’rs, 408 F.3d 335, 336 (7th Cir. 2005); Ritter v. Ross, 992 F.2d 750, 754-55 (7th Cir. 1993). But when Beth-El argues that it lacked a reasonable opportunity to be heard in state court, it also challenges the § 2-1401 proceeding and the judgment that resulted from it. So what we have here is an attack on not one, but two state-court judgments. And, as Beth-El sees it, the interplay of these two state-court  [*19]  proceedings, by peculiarities specific to tax sale proceedings, deprived it of a reasonable opportunity to challenge to the tax sale.

In deciding whether Beth-El lacked a reasonable opportunity to present its claims in state court, we focus on difficulties caused not by opposing parties, but by state-court rules or procedures. See Taylor, 374 F.3d at 534-35; Long, 182 F.3d at 558. In Long, for example, we held that Rooker-Feldman did not apply because the state court’s forcible entry and detainer proceedings were so summary that they did not give the plaintiff a reasonable opportunity to contest an allegation of overdue rent. 182 F.3d at 559-60. Beth-El maintains that Illinois’ post-judgment procedures for challenging tax-deed judgments are similarly limited because a petition to vacate a judgment must be brought within two years unless “the ground for relief is fraudulently concealed,” 735 ILL. COMP. STAT. 5/2-1401 (emphasis added). According to the Church, the only way it could dodge dismissal under the statute of limitations was to show that the ground for relief was fraudulently concealed.

But there was another way. Void  [*20]  judgments may be attacked at any time. § 2-1401(f); Sarkissian v. Chi. Bd. Of Ed., 201 Ill. 2d 95, 776 N.E.2d 195, 201-02, 267 Ill. Dec. 58 (Ill. 2002). The Church acknowledged this principle in the state-court proceedings, but it now shifts its position to contend that there is no ground under Illinois law on which to argue that the tax-deed judgment was void. As the Church says, it could not argue that the misaddressed notice deprived the circuit court of jurisdiction and consequently voided the tax-deed judgment because the tax-deed proceeding requires only in rem jurisdiction, which the circuit court had. Although that appears to be a correct statement of Illinois law, see e.g., In re Application of County Treasurer, 194 Ill. App. 3d 721, 551 N.E.2d 343, 346, 141 Ill. Dec. 350 (Ill. App. Ct. 1990), it misses the point. Under Illinois law, a judgment approving a tax sale for tax-exempt property is void and may be attacked at any time. See Emalfarb v. Krater, 266 Ill. App. 3d 243, 640 N.E.2d 325, 330, 203 Ill. Dec. 666 (Ill. App. Ct. 1994); In re Application of Cook County Collector, 228 Ill. App. 3d 719, 593 N.E.2d 538, 547, 170 Ill. Dec. 649 (Ill. App. Ct. 1991); Novak v. Smith, 197 Ill. App. 3d 390, 554 N.E.2d 652, 655, 143 Ill. Dec. 717 (Ill. App. Ct. 1990).  [*21]  The Church’s postjudgment counsel recognized this. In fact, the Church’s underlying gripe about the tax sale (aside from lack of notice) stems from its belief that the property was tax exempt. If Beth-El had shown up at the prove up prior to the issuance of the tax deed, it would presumably have argued that a tax deed should not issue because the property sold was tax exempt.

But the Church has simply never made the argument; instead, this is the very argument that postjudgment counsel “reserved” because he recognized he could raise it at any time. When we asked at oral argument why this issue was not explored earlier, the Church’s counsel informed us that an argument about tax exemption would have been fruitless because Beth-El did not own the property after 1998 and could not obtain a tax exemption for it. The Church followed up with a post-argument letter, citing the Illinois Department of Revenue’s website for the proposition that, to qualify for a property-tax exemption, an organization must own the property and use it exclusively for religious purposes. For its part, the City contends that the test for tax exemption is “use, not ownership.”

Illinois courts look to the Illinois  [*22]  constitution and the Illinois Property Tax Code to determine if a parcel is tax exempt. See Swank v. Dep’t of Rev., 336 Ill. App. 3d 851, 785 N.E.2d 204, 208, 271 Ill. Dec. 553 (Ill. App. Ct. 2003); In re Ward, 311 Ill. App. 3d 314, 724 N.E.2d 1, 3-4, 243 Ill. Dec. 692 (Ill. App. Ct. 2000). The Illinois constitution provides that the General Assembly may exempt from taxation property used exclusively for religious purposes. ILL. CONST., art. IX, § 6. Under the Tax Code, property that is used exclusively for “religious purposes” qualifies for exemption so long as it is not used with “a view to profit.” 35 ILL. COMP. STAT. 200/15-40(a)(1). Thus, if the Church uses the property for religious purposes and without a view to profit, as it has always claimed that it does, the property would have qualified for a tax exemption both before and even after the City bought it in 1998. That is to say, the Church could have–and should have–argued in the § 2-1401 proceeding that the tax-deed judgment was void because the property sold was tax exempt.

At least one virtually identical claim has been successful in an Illinois court. See New Holy Temple Missionary Baptist Church v. Disc. Inn, Inc., 371 Ill. App. 3d 443, 862 N.E.2d 1198, 308 Ill. Dec. 995, 2007 WL 438254, *4 (Ill. App. Ct. 2007). n1  [*23]  In Discount Inn, two parcels of land belonging to New Holy Temple Missionary Baptist Church were sold for delinquent taxes. One parcel housed New Holy Temple’s church building, while the other was the church’s parking lot. Both parcels were tax exempt from 1976 to 1998, but from 1999 through 2003 they were listed as taxable on Cook County’s assessment rolls. After a forfeiture tax sale, the parking-lot parcel of the property was assigned to Discount Inn, who later applied for an order directing the county clerk to issue a tax deed. After a hearing, the circuit court issued the order. New Holy Temple filed a petition under § 2-1401 seeking to vacate the circuit court’s order, and Discount Inn moved to dismiss the petition. The circuit court granted Discount Inn’s motion, but the Appellate Court of Illinois reversed. According to the appellate court, New Holy Temple had a meritorious defense to the tax sale because the parking lot should have been exempt from taxation. As the appellate court found, “[t]he church presented uncontroverted evidence that the parking lot had been used solely and continuously for church purposes and without a view  [*24]  to profit.”

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n1 Decided two days after we heard oral argument in this case.

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Because Beth-El, like New Holy Temple, could have argued in the § 2-1401 proceeding that the property sold was tax exempt, the state-court system was not closed to the Church as it may have been to the plaintiff in Long, a case we cited earlier. The Church has simply never pursued its right to a retroactive tax exemption. Whether it may do so now will be governed by Illinois’ law on successive petitions under § 2-1401. The point here is that federal court is not the place for Beth-El to obtain the relief it seeks. See Manley v. City of Chi., 236 F.3d 392, 397 (7th Cir. 2001) (stating that a plaintiff “cannot avoid Rooker-Feldman by simply not submitting his claim in state court”). Beth-El’s claims under § 1983, RLUIPA, and IRFRA are all targeted to overturn the state-court judgments, and as such, they are barred by Rooker-Feldman. Accordingly, we VACATE the grant of the preliminary injunction and REMAND  [*25]  with instructions to dismiss this case for lack of subject-matter jurisdiction. No costs are awarded.

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May 15th, 2007 | 1 Comment »

Office of Chief Counsel Notice 2007-012 (2007).

Department Internal Office of of the Revenue Chief CounselTreasury Service

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Notice

CC-2007-012

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May 14, 2007

Procedure and Administration Subject: Realignment Cancel Date: May 14, 2008

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Purpose

This notice is intended to advise Chief Counsel employees of the realignment within the office of the Associate Chief Counsel (Procedure and Administration). The realignment eliminates the existing subsidiary divisions within PA and creates seven branches. Procedure & Administration’s subject matter has been realigned into four practice areas.

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Description of Realignment:

Effective May 14, 2007, Procedure and Administration will be realigned. The Office will continue to be led by the Associate Chief Counsel (Procedure and Administration). There will now be three Deputy Associate Chief Counsel (Procedure and Administration). PA’s subsidiary legal divisions, Administrative Provisions and Judicial Practice, Collection, Bankruptcy and Summonses, and Disclosure and Privacy Law, will no longer exist. Instead, PA’s attorney staff will be assigned to one of seven branches. Each branch will be responsible for one of four practice areas and will report to the Associate. The organization and management of the Legal Processing Division will not be affected by this realignment.

The following are brief descriptions of the new branches’ subject matter.

Branches 1 and 2

Subject areas: Returns, information returns, withholding, statutes of limitations, interest, penalties, sanctions, ethics, practice before the IRS, Circular 230, innocent spouse, electronic tax administration, powers of attorney.

Branches 3 and 4

Subject areas: Payment, assessment, collection, liens, levies, collection due process, period of limitations on collections, trust fund recovery penalty, jeopardy and termination assessments, refunds, erroneous refunds, joint committee.

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Branch 5

Subject Areas: Bankruptcy, installment agreements, offers in compromise, receiverships, closing agreements, attorney fees, low income tax clinics, user fees.

Branches 6 and 7

Subject Areas: Court procedure, confidentiality of return information, privacy act, FOIA, summonses, burden of proof, disaster relief, combat zone, examinations, informants, arbitration, mediation and alternative dispute resolution, Appeals, rules of evidence, mitigation and equitable doctrines, discover, Fed/State issues, judicial doctrines, privileges, Religious Freedom Restoration Act, Right to Financial Privacy Act.

The complete lists of subject matter responsibilities and branch contact information are set out in the

- attachments. PA’s entries in the code and subject directory have been revised to reflect the new issue responsibilities and may be accessed on the Chief Counsel intranet at:: —————————————————————————————————- (listed by code section) and for noncode issues at: ————————————————————————————————————————————————————————————————————————-.The organization and management of the Legal Processing Division will not be affected by this realignment.

Every effort is being made to ensure that the transition to the new structure is made as efficiently as possible so that the completion of pending work assignments will not be significantly delayed. Emails regarding pending assignments have been sent (or will shortly be sent) to the offices that have requested the assignment.

Please contact my office with any questions at 622-3400.

________/s/____________

Deborah A. Butler

Associate Chief Counsel

(Procedure & Administration) .

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PA Front Office

Associate Chief Counsel: Deborah A. Butler Deputy Associate Chief Counsel (Guidance): Dominic A. Paris Deputy Associate Chief Counsel (Enforcement): Gary Gray Deputy Associate Chief Counsel (Legislation & Privacy): Margo L. Stevens Special Counsel (Tax Practice and Procedure): Peter Reilly Special Counsel:

George Bowden Richard Goldstein (on detail to Branch 7) Tom Kane Phil Lindenmuth (on detail to Branch 7) Kristine Roth Henry Schneiderman Kathryn Zuba

Front Office Contact Number: 202-622-3400

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FAQ Regarding PA Realignment

Q1. Did PA give up any of its jurisdiction to the other organizations?

No, PA retained the subject matter jurisdiction that was within the three former PA subsidiary legal divisions.

Q2. I deal with a person in LPD when I need documents released to the public. Who do I talk to now?

Your LPD contact will not change. No changes have been made to the organizational structure of LPD. You should expect to conduct business as usual with that organization.

Q3. Before the organizational change I was working with an attorney in APJP Br3 on a particular issue. Who do I talk to now?

You should initially call the same former APJP Br3 attorney. In some cases that attorney will continue to work on the project with you. If that particular project has been reassigned, the attorney will ensure that you get to the right person. You should also receive an email that will notify you of the attorney who is responsible for the assignment in the new branches.

Q4. If I don’t know who to talk to about a particular subject or Code section who should I call?

You should initially consult the Code and Subject Matter directory which will direct you to the correct branch within PA.

Q5. I have an advice request currently pending in a PA branch. How will I know who to contact regarding the request after standup.

A5. On standup, the current PA branches are sending emails to all originators of pending work items in PA advising them as to whom the work item is now assigned and providing contact information. If you did not receive one of these emails, you should contact the original attorney or branch chief, who will be able to provide you with the needed contact information.

Q6. How can I contact the original attorney? Won’t the phone number have changed?

A6. The phone numbers in Outlook and in the CC Phone Directory will be updated immediately upon reorganization. Attorneys’ email addresses will remain unchanged as will their direct phone numbers.

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PA Branch Managers and Contact Numbers

Branch 1:

Chief: James Gibbons STR: Blaise Dusenberry STR: Charles Hall

Contact Telephone Number: 202-622-4910

Branch 2:

Chief: Hap Trice STR: Carol Nachman STR: Brinton Warren

Contact Telephone Number: 202-622-4940

Branch 3:

Chief: Pam Fuller STR: Mitch Hyman STR: Gerry Ryan

Contact Telephone Number: 202-622-3600

Branch 4:

Chief: Peter Devlin STR: Joe Clark STR: Nancy Galib

Contact Telephone Number: 202-622-3630

Branch 5:

Branch chief: Larry Schattner STR: Joe Conley STR: Susan Mosley

Contact Telephone Number: 202-622-3620

Branch 6:

Branch Chief: Richard Goldman STR: Bob Miller STR: Don Squires

Contact Telephone Number: 202-622-7950

Branch 7:

Branch Chief: Charles Christopher STR: Richard Goldstein (Acting for 90 days) STR: Phil Lindenmuth (Acting for 90 days)

Contact Telephone Number: 202-622-4570

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PA Subject Matter by New Branch

Branches 1 & 2

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- 6511-33, except 6532(b)Sanctions 6503, except (b),(c),(e),(f),(h),(j) Suspension of limitations period RRA § 3707 Illegal tax protester designation ,(c), Limitations provisions -

PA Subject Matter by New Branch

Branches 3 & 4

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PA Subject Matter by New Branch

Branch 5

- 11 U.S.C. Bankruptcy 6159 Installment agreements ) 6658 Coordination with title 11 6871-73 Receiverships 7122 Compromises 7526 Low income tax clinics 7528 User fee 31 U.S.C. § 3713 Priority of government claims against decedent’s estates and insolvencies 1398-99 Rules relating to title 11 6036 Notice of qualification as executor or receiver 6408 State escheat laws 6503(b),(h) Suspension of limitations periods (assets in custody of court, cases under title 117121 Closing agreements 7402(a) Jurisdiction of district courts to issues orders 7430 Costs and fees 7432 Civil damages for failure to release lien 7433 Civil damages for unauthorized collection Federal Rules of Bankruptcy Procedure -

PA Subject Matter by New Branch

Branches 6 & 7

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May 14th, 2007 | 1 Comment »