Charles E. TRANTINA and Linda Trantina, Husband and Wife, Plaintiffs, v. UNITED STATES of America, Defendant., United States District Court, D. Arizona., 381 F.Supp.2d 1100, No. CIV 03-2579-PHX-SRB., May 17, 2005

Charles E. TRANTINA and Linda Trantina, Husband and Wife, Plaintiffs, v. UNITED STATES of America, Defendant.

United States District Court, D. Arizona.

381 F.Supp.2d 1100

No. CIV 03-2579-PHX-SRB.

May 17, 2005.

Christopher Lee Raddatz, Robert P. Solliday, Thomas M. Quigley, Mohr Hack╜ett Pederson Blakley & Randolph PC, Phoenix, AZ, for Plaintiffs.

John B. Snyder, III, U.S. Dept. of Jus╜tice, Washington, DC, Paul Kipp Charlton, U.S. Attorney's Office, Phoenix, AZ, for Defendant.

ORDER

BOLTON, District Judge.

This matter arises out of Plaintiffs Charles and Linda Trantina's alleged over╜payment of income taxes and the Internal Revenue Service (IRS) Commissioner's de╜nial of their claim for a refund. The Court now rules on Plaintiffs' pending Motion for Summary Judgment (Doc. 17) and Defen╜dant's Cross-Motion for Summary Judg╜ment (Doc. 19).

I. BACKGROUND

Plaintiff Charles Trantina was employed as an independent insurance agent of State Farm Life Insurance Companies ("State Farm"), first in his individual capacity and later on behalf of the Trantina Insurance Agency, Inc. (the "Corporation"), an Ari╜zona corporation formed in 1978. Follow╜ing incorporation, State Farm executed a Corporation Agent Agreement ("Corporate Agreement") with the Corporation, which replaced Trantina's previous Individual Agent Agreement ("Individual Agree╜ment"). Trantina was at all times the sole shareholder in the Corporation; he held 1100 shares of capital stock obtained in exchange for cash and other property paid to the Corporation.

In 1996, Trantina wished to retire and the Corporation advised State Farm of the termination of the Corporate Agreement as of June 30, 1996. Pursuant to the Corporate Agreement, the Corporation be╜came entitled to termination payments af╜ter fulfilling certain requirements such as the return of State Farm's property within ten days. State Farm commenced making such payments to the Corporation in July 1996.

In March 1997, the Corporation formally adopted a plan of complete liquidation. Trantina exchanged his stock for all of the assets then-owned by the Corporation, in╜cluding the right to collect termination payments under the Corporate Agree╜ment. The Corporation's liquidation con╜cluded on March 13, 1997 and in Septem╜ber 1997 State Farm commenced making termination payments to Trantina rather than to the Corporation.

On Plaintiffs' 1997, 1998, and 1999 in╜come tax returns, as reflected by the IRS Form 1040 filed for each calendar year, Plaintiffs reported the termination pay╜ments received from State Farm as ordi╜nary income and fully paid all tax thereon. Plaintiffs subsequently amended their 1997 and 1998 returns by completing IRS Form 1040X for each year, reporting the termi╜nation payments as long-term capital gains rather than ordinary income. The IRS accepted the 1997 and 1998 amendments and refunded the difference in taxes be╜tween ordinary income and long-term capi╜tal gains.

On April 10, 2003, Plaintiffs filed Form 1040X for the 1999 calendar year (the "Amended 1999 Return"), again amending their return to report the termination pay╜ments as long-term capital gains rather than ordinary income. As stated on the Amended 1999 Return, "the Return is amended to reflect the reclassification of payments from State Farm Insurance Companies on the sale of the taxpayer's agency back to the company. Payments are now reported as capital gain rather than ordinary income. Form 8594 is at╜tached." (Snyder Decl., Ex. A, Form 8594.) The difference in tax liability amounted to $15,982, plus interest. On June 30, 2003, the IRS denied Plaintiffs' claim for a refund.

Plaintiffs thereafter filed suit in this Court on December 24, 2003, seeking a refund of $15,982 plus interest in taxes allegedly overpaid for the 1999 calendar year. Plaintiffs moved for summary judgment on October 22, 2004 (Doc. 17) and Defendant cross-moved on November 2, 2004 (Doc. 19).

II. LEGAL STANDARDS AND ANALY SIS

A. Subject Matter Jurisdiction

Defendant challenges this Court's jurisdiction to hear the instant ac╜tion on the grounds now argued by Plain╜tiffs, contending that Plaintiffs' current ar╜guments in favor of their right to a refund differ from those made to the IRS on Plaintiffs' Amended 1999 Return, their ad╜ministrative claim for refund. The law makes clear that filing with the IRS a claim or demand for a refund is a prereq╜uisite to filing suit for such a refund. 26 U.S.C. ╖ 7422(a); 26 C.F.R. ╖ 301.6402-2; Real Estate Land Title & Trust Co. v. United States, 309 U.S. 13, 18, 60 S.Ct. 371, 373, 84 L.Ed. 542 (1940); United States v. Felt & Tarrant Mfg. Co. , 283 U.S. 269, 272, 51 S.Ct. 376, 377, 75 L.Ed. 1025 (1931). A claim "must set forth in detail each ground upon which a credit or refund is claimed and facts sufficient to apprise the Commissioner of the exact basis there╜of." 26 C.F.R. ╖ 301.6402-2(b). Because this prerequisite is jurisdictional, failure to file a claim for a refund which specifies "all grounds and supporting facts upon which a claim for refund is based" deprives the Court of jurisdiction-over any claims not pursued before the IRS. Quarty v. United States, 170 F.3d 961, 972 (9th Cir.1999) ("Compliance with these specificity re╜quirements is a prerequisite to subject matter jurisdiction over a claim for a re╜fund."); Martinez v. United States, 595 F.2d 1147, 1148 (9th Cir.1979); Estate of Bird v. United States, 534 F.2d 1214, 1219 (6th Cir.1976) (finding that a court is with╜out jurisdiction to consider claims not spe╜cifically set forth in the claim for refund); Alabama By-Products Corp. v. Patterson, 258 F.2d 892, 900 (5th Cir.1958) ("All grounds upon which a taxpayer relies must be stated in the original claim for refund so as to apprise the Commissioner of what to look into; the Commissioner can take the claim at its face value and examine only those points to which his attention is necessarily directed. Anything not raised at that time cannot be raised later in a suit for refund.") (citations omitted). Whether or not this Court possesses subject matter jurisdiction under the doctrine of variance, then, depends on whether or not the argu╜ments made here were also made in the claim for refund filed with the IRS Com╜missioner.

There is no dispute between the parties that Plaintiffs allege they are entitled to a refund of taxes because the income in question should be classified as long-term capital gains under 26 U.S.C. ╖ 1222(3) ("Section 1222(3)") as income resulting from the sale or exchange of a capital asset held for more than one year. It is also undisputed that Plaintiffs now con╜tend that the liquidation of the Corpora╜tion and the attendant exchange of Tranti╜na's stock for the Corporation's assets, including the right to receive termination payments from State Farm, satisfies the criteria of Section 1222(3). While Plain╜tiffs ardently maintain that this factual basis for the Section 1222(3) classification was presented to and rejected by the Com╜mission through the Amended 1999 Re╜turn, Defendant asserts that the only fac╜tual basis for a Section 1222(3) sale or exchange presented in the Amended 1999 Return consists of the exchange triggered by the termination of the Corporate Agreement, when the Corporation signed a covenant not to compete and surrendered the agency to State Farm in accord with the terms of the Corporate Agreement.

The Amended 1999 Return itself must determine which party has the better part of the argument. At the bottom of page two of the Amended 1999 Return, Plaintiffs explain that they wish to reclassify payments received from State Farm Insur╜ance Companies following the "sale" of Trantina's agency back to State Farm. On Form 8594, the Asset Acquisition State╜ment attached to the Amended 1999 Re╜turn, Plaintiffs stated that "[t]he sale is provided for in the agent's agreement com╜bined with the schedule of payments." Also, on Line 6 of Form 8594, Plaintiffs indicated that "State Farm purchased a covenant not to compete as part of the agreement" in exchange for the assets (termination payments). These state╜ments make clear that Plaintiffs were claiming entitlement to reclassification of the termination payments as long-term capital gains on the basis of the alleged sale of Trantina's agency back to State Farm. No other factual basis for reclassifi╜cation, such as the liquidation of the Cor╜poration's assets, was ever provided to the IRS via the claim for refund.

The Court finds that the informa╜tion provided on the Amended 1999 Re╜turn was legally insufficient to inform the IRS Commissioner that the refund was sought not only on the basis of the termi╜nation of the Corporate Agreement, but also on the basis of Trantina's exchange of his stock for the Corporation's assets dur╜ing the Corporation's liquidation. The ter╜mination of the Corporate Agreement and the liquidation of the Corporation are two distinct transactions occurring more than eight months apart. The parties to the two transactions differed. ¹ Nothing in Plaintiffs' refund claim notified the IRS of the need to investigate the Corporation's liquidation as a sale or exchange within the meaning of Section 1222(3). See Boyd v. United States, 762 F.2d 1369, 1372 (9th Cir.1985) (claiming one type of loss as an expense did not direct the IRS to other costs or losses for investigatory purposes). Merely apprising the Commissioner of their argument that the termination pay╜ments constituted long-term capital gains is insufficient where the factual basis for such an argument is not specified at all, or where the factual basis specified is differ╜ent from the one later pursued in court. Nemours Corp. v. United States, 188 F.2d 745, 750 (3d Cir.1951) ("It is to be noted that both the grounds for recovery and the facts supporting them must be shown."); see also 26 C.F.R. ╖ 301.6402-2(b) (stating that a claim "must set forth in detail . . . facts sufficient to apprise the Commission╜er of the exact basis" for the claim). The IRS had no opportunity to investigate and determine whether the Corporation's liqui╜dation provided an adequate factual basis for treatment of the payments as long-term capital gains. See First Nat'l Bank of Fayetteville, Ark., v. United States, 727 F.2d 741, 744 (8th Cir.1984) (noting that the chance for administrative investigation and determination is the reason for the specificity requirement). In addition, no evidence has been presented that the IRS waived Plaintiffs' lack of factual specificity by investigating the Corporation's liqui╜dation as possible grounds for treatment of the payments as long-term capital gains. Cf. Quarty, 170 F.3d at 973.

********

^1. While State Farm was involved in the termi╜nation of the Corporate Agreement, it was not directly involved in the Corporation's liqui╜dation of its assets. Similarly, Trantina in his individual capacity had little to do with the termination of the Corporate Agreement, al╜though his participation in the liquidation of the Corporation's assets occurred in his indi╜vidual capacity.

********

Plaintiffs argue that any objec╜tions based on the doctrine of variance have been waived by Defendant as a result of its failure to raise such objections earli╜er in its pleadings. To the contrary, a lack of subject matter jurisdiction cannot be waived and may be raised at any time before final judgment. Grupo D ataflux v. Atlas Global Group, LP, 541 U.S. 567, 124 S.Ct. 1920, 1924, 158 L.Ed.2d 866 (2004); Quarty, 170 F.3d at 973 n. 7. For this reason, Plaintiffs' Motion to Strike Defen╜dant's Reply will be denied and Plaintiffs' Motion for Sur-Reply granted. Although Defendant raised the issue in its reply to its own cross-motion for summary judg╜ment, and the issue could have been raised earlier, it may still be considered here. This Court lacks subject matter jurisdic╜tion over Plaintiffs' claim that the Corpora╜tion's liquidation justified classification of the termination payments as long-term capital gains because this argument was not properly raised in Plaintiffs' claim for a refund. Dismissal of the matter is ap╜propriate with respect to the Corporation liquidation argument (the "Section 331 ar╜gument").

B. Summary Judgment

Having found that jurisdiction fails with respect to one of Plaintiffs' bases for their suit for refund, the Court must neverthe╜less address the remaining argument for relief. Plaintiffs maintain that they are entitled to classify the termination pay╜ments as long-term capital gains under Section 1222(3) as a result of the termi╜nation of the Corporate Agreement, which Plaintiffs term a "sale" of the agency back to State Farm. According to Plaintiffs, this reclassification then requires summary judgment for a refund of Plaintiffs' over╜payment of the taxes on the termination payments.

The standard for summary judgment is set forth in Rule 56(c) of the Federal Rules of Civil Procedure. Under this rule, sum╜mary judgment is properly granted when: (1) no genuine issues of material fact re╜main; and (2) after viewing the evidence most favorably to the non-moving party, the movant is clearly entitled to prevail as a matter of law. Fed.R.Civ.P. 56; Celotex Corp. v. Catrett, 477 U.S. 317, 322-23, 106 S.Ct. 2548, 2552-53, 91 L.Ed.2d 265 (1986); Eisenberg v. Ins. Co. of N. Am. , 815 F.2d 1285, 1288-89 (9th Cir.1987).

In considering a motion for summary judgment, the court must regard as true the non-moving party's evidence if it is supported by affidavits or other evidentia╜ry material. Celotex, 477 U.S. at 324, 106 S.Ct. at 2548; Eisenberg, 815 F.2d at 1289. However, the non-moving party may not merely rest on its pleadings, he must pro╜duce some significant probative evidence tending to contradict the moving party's allegations, thereby creating a material question of fact. Anderson v. Liberty Lob╜by, Inc., 477 U.S. 242, 256-57, 106 S.Ct. 2505, 2513-14, 91 L.Ed.2d 202 (1986) (hold╜ing that the plaintiff must present affirma╜tive evidence in order to defeat a properly supported motion for summary judgment); First Nat'l Bank v. Cities Serv. Co., 391 U.S. 253, 289, 88 S.Ct. 1575, 1592, 20 L.Ed.2d 569 (1968).

Section 1222(3) defines long-term capital gain as "gain from the sale or exchange of a capital asset held for more than one year . . . ." 26 U.S.C. ╖ 1222(3). In order to treat the termination payments as long-term capital gain, Plaintiffs must prove both (1) that Trantina owned a capital asset and (2) that he sold the capital asset in exchange for the termination payments. 26 U.S.C. ╖ 1222(3); see also Baker v. Comm'r of Internal Revenue, 338 F.3d 789, 793 (7th Cir.2003). The Court will address each of these elements in turn.

Plaintiffs do not argue that policy╜holder information, policy manuals, draft╜ing tools, or other implements of the insur╜ance trade are the capital assets at issue in this case. Indeed, such an argument would fail, as State Farm owned all such property under the terms of the Corporate Agreement. See Baker, 338 F.3d at 793 (finding that taxpayer owned no capital assets under a nearly identical insurance agent agreement with State Farm). In╜stead, Plaintiffs assert that the Corporate Agreement itself constituted the capital as╜set sold in exchange for the termination payments. The Court finds this argument unconvincing.

The suggestion that the Corporate Agreement is itself an asset, when it de╜clares that all assets pertaining to Plain╜tiffs' insurance agency belong to State Farm, is paradoxical. As a matter of logic, it is difficult to see how a contract declar╜ing that Plaintiffs own no assets may be an asset itself. Although Plaintiffs possessed certain rights under the Corporate Agree╜ment, such as the right to solicit custom╜ers, submit applications for insurance, and collect premiums, Plaintiffs could not sell, assign, or pledge any of these interests without the prior written consent of State Farm. Unlike the taxpayer in the case of Commissioner of Internal Revenue v. Ferrer, 304 F.2d 125 (1962), cited by Plain╜tiffs in support of the proposition that contractual rights may be assets, Plaintiffs lacked even a "negative power" to prevent State Farm from certain behavior. Plain╜tiffs had no ability to obtain value from the Corporate Agreement other than through compliance with its terms. Even the sim╜ple termination of Plaintiffs' rights under the Corporate Agreement would not result in the accretion of value through termi╜nation payments unless Plaintiffs also com╜plied with additional terms pertaining to the return of State Farm property and solicitation of policyholders.

Even assuming arguendo that the Cor╜porate Agreement may be deemed an as╜set belonging to Plaintiffs, Plaintiffs must nevertheless prove that this asset was sold or exchanged for the termination pay╜ments. This interpretation of events sim╜ply does not fit the facts at hand. The termination payments were not received in exchange for the sale of the Corporate Agreement; they were received under the Corporate Agreement in exchange for compliance with other terms thereof, such as the return of all property belonging to State Farm within a given period of time and the signature of a covenant not to compete. The discharge of a contract by payment in accordance with its terms does not constitute the sale or exchange of property. See Spray Water Power & Land Co. v. Comm'r of Internal Revenue, 20 T.C.M. (CCH) 353 (1961); Gann v. Comm'r of Internal Revenue, 41 B.T.A. 388, 395-96 (1940).

As a matter of law, the termination pay╜ments do not qualify as long-term capital gains because Plaintiffs possessed no capi╜tal assets to sell, and even if the Corporate Agreement were to be construed as a capi╜tal asset, it was not sold or exchanged in consideration of the termination payments. Defendant is entitled to summary judg╜ment on this argument.

C. Doctrine of Consistency

The parties expend considerable time arguing about the doctrine of consistency and its applicability with respect to the timing of the reporting of the termination payments. The Court will not repeat these arguments at length. Defendant ap╜pears to have initiated the argument based on the mistaken belief that Plaintiffs were contending that termination payments made in 1999 need not be reported as any kind of income unless the termination pay╜ments were entitled to treatment as long-term capital gains. As Plaintiffs do not actually make this argument, further dis╜cussion of the doctrine of consistency is unnecessary.

IT IS ORDERED denying Plaintiffs' Motion to Strike (Doc. 30-1).

IT IS FURTHER ORDERED granting Plaintiffs' Motion for Sur-Reply (Doc. 30-2).

IT IS FURTHER ORDERED denying Plaintiffs' Motion for Summary Judgment (Doc. 17).

IT IS FURTHER ORDERED granting Defendant's Cross-Motion for Summary Judgment with respect to the argument that the termination of the Corporate Agreement between State Farm and Tran╜tina requires taxation of the termination payments as long-term capital gains (Doc. 19).

IT IS FURTHER ORDERED dismiss╜ing for lack of subject matter jurisdiction the portion of Plaintiffs' complaint advanc╜ing the argument that the liquidation of the Corporation's assets requires taxation of the termination payments as long-term capital gains (the "Section 331 argument").

IT IS FURTHER ORDERED directing the Clerk of the Court to enter judgment in favor of Defendant, thereby terminating this case.

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