Gerald E. TOBERMAN and Nancy J. Toberman, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee., United States Court of Appeals, Eighth Circuit., 294 F.3d 985, No. 01-1398., June 20, 2002
Gerald E. TOBERMAN and Nancy J. Toberman, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
United States Court of Appeals, Eighth Circuit.
294 F.3d 985
June 20, 2002.
Argued: Oct. 18, 2001.
Submitted After Supplemental
Briefing: April 22, 2002.
Filed: June 20, 2002.
Daniel W. Schermer, argued, Minne╜apolis, MN, for appellant.
Kenneth W. Rosenberg, argued, DOJ, Washington, DC, for appellee.
BEFORE: BOWMAN, RICHARD S. ARNOLD, and HANSEN, Circuit Judges.
RICHARD S. ARNOLD, Circuit Judge.
Appellant Gerald E. Toberman 1 appeals from a decision of the United States Tax Court upholding a determination by the Internal Revenue Service that he owed $1,194,503 in income tax and $238,900.60 in penalties for the tax year 1993. In reach╜ing its decision, the Court held that in 1993 Mr. Toberman realized $2,781,810 in in╜come from discharge of indebtedness, also known as cancellation-of-debt income, that Mr. Toberman did not establish that he was insolvent, so as to come under the insolvency exception to this sort of income, that the taxpayer did not establish that his wholly owned Subchapter S corporations had net operating losses of $3,992,234 for the tax years 1986 to 1991, so as to entitle him to net-operating-loss carryforwards in that amount, and that he should pay a twenty percent penalty for underpayment of taxes.
1 Appellant Nancy J. Toberman, Mr. Tober╜man's wife, is a party in this case only be╜cause she filed a joint income tax return with Mr. Toberman.
For the reasons that follow, we reverse the Tax Court's decision with respect to the discharge-of-indebtedness income, af╜firm the Tax Court's decision with respect to the net-operating-loss carryforwards, and affirm the imposition of a twenty per cent. penalty on the amount of underpay╜ment. We remand the case to the Tax Court to recalculate Mr. Toberman's tax liability and the amount of the penalty for underpayment based on the recalculated tax liability.
From 1986 to 1993, Mr. Toberman was the sole shareholder of Bonnevista Ter╜race, Inc., and Castle Towers, Inc., corpo╜rations located in Minnetonka, Minnesota, that elected to be taxed under Subchapter S of the Internal Revenue Code. 26 U.S.C. ╖╖ 1361-1379. Bonnevista Terrace and Castle Towers owned and operated mobile home parks in Minnesota and Indiana.
Bonnevista Terrace filed its last federal corporate income tax return for the tax year 1991. At the end of 1990, Bonnevista Terrace's balance sheet, submitted with its tax return, reflected loans to Mr. Toberman in the amount of $2,148,481. 2 Castle Towers filed its last federal corporate income tax return for the tax year 1990. At the end of 1990, Castle Towers' balance sheet reflected loans to Mr. Toberman in the amount of $633,329. The record does not reveal how or when these corporations ceased to exist.
2 At the end of 1991, Bonnevista Terrace's balance sheet reflected loans to Mr. Toberman in the amount of $2,244,164. In its brief, the IRS asserts that it could have as╜sessed income using the (larger) amount of indebtedness at the end of 1991, but that it used the amount of indebtedness at the end of 1990 instead. Commissioner's Brief at 7, n. 9.
In 1990, Mr. Toberman filed a petition for relief under Chapter 11 of the Bank╜ruptcy Code. On May 21, 1991, the bank╜ruptcy court dismissed the case because of Mr. Toberman's failure to file a disclosure statement and plan of reorganization. Be╜tween 1990 and 1992, a number of judg╜ments were entered against Mr. Toberman in favor of various creditors.
On March 3, 1993, Mr. Toberman sub╜mitted to the IRS Form 433-A, Collection Information Statement for Individuals (CIS). On the CIS, he reported assets of $50 in cash and real estate worth $850,000, subject to encumbrances of $460,000, and liabilities of $400 in credit card debt, for a net worth of $389,650. He did not report any debts to Bonnevista Terrace or Castle Towers on the CIS; nor did he report any judgments against him.
On his 1993 income tax return, taxpayer claimed a net-operating-loss deduction of $3,992,234, composed of net-operating-loss carryforwards from prior years in the fol╜lowing amounts: $134,414 (1986); $424,283 (1987); $306,907 (1988); $1,627,007 (1989); $1,417,445 (1990); and $82,178 (1991). He did not report any income from discharge of indebtedness.
Basing its decision on the last income tax returns of Bonne-vista Terrace and Castle Towers and on taxpayer's CIS and 1993 income tax return, the IRS deter╜mined that the debts that taxpayer owed to Bonnevista Terrace and Castle Towers had been discharged and, therefore, that taxpayer had realized unreported income in the 1993 tax year in the amount of $2,781,810. The IRS also disallowed tax╜payer's claimed net-operating-loss deductions. As a result of these adjustments, the IRS determined that taxpayer was lia╜ble for a deficiency in tax in the amount of $1,194,503. The IRS also determined that taxpayer was liable for an accuracy-related penalty of twenty per cent. of the under╜payment, or $238,900.60, under 26 U.S.C. ╖ 6662(a).
Following trial in the Tax Court, the Court, in an opinion dated July 24, 2000, upheld the IRS's determinations. Tober╜man v. Commissioner , 80 T.C.M. (CCH) 81 (2000). The Court held that the IRS's notice of deficiency was entitled to a pre╜sumption of correctness. Regarding the discharge-of-indebtedness income, the Court held that taxpayer's CIS and the various income tax returns were sufficient to establish that the IRS's determination was not arbitrary or capricious, and that taxpayer had not overcome the presump╜tion of correctness. The Court also deter╜mined that taxpayer was not entitled to the exemption from discharge-of-indebted╜ness income that applies when the taxpay╜er is insolvent, 26 U.S.C. ╖ 108(a)(1)(B), because the CIS established that taxpayer had a positive net worth. Moreover, the Court held, the CIS actually underreport╜ed taxpayer's net worth because it omitted his ownership interest in another business, Fantastic Foods, Inc., as well as a debt in the amount of $457,072 that Fantastic Foods reported owing him on its 1992 tax return.
Regarding the net-operating-loss carry╜forwards, the Court held that the IRS need not have provided even a minimal evidentiary foundation to disallow the de╜ductions, and that taxpayer bore the bur╜den of proving entitlement to the deduc╜tions. It found that the evidence offered by taxpayer-individual income tax re╜turns for the years in which the losses arose, S corporation returns showing the origin of part of the losses, and the testimony of taxpayer's accountant-did not meet this burden.
Finally, the Court held that the accura╜cy-related penalty was appropriate on ac╜count of taxpayer's failure to establish ei╜ther that he kept adequate books and records or that he provided complete in╜formation to his accountant.
We must decide whether the Tax Court was correct in approving (1) the assess╜ment of tax liability based on discharge-of-╜indebtedness income, (2) the disallowance of the net-operating-loss carryforwards, and (3) the imposition of a penalty.
A. The Discharge-of-Indebtedness Income
Section 61(a) of the Internal Reve╜nue Code provides that gross income in╜cludes all income from whatever source derived, including "income from discharge of indebtedness." 26 U.S.C. ╖ 61(a)(12). This treatment of discharge-of-indebted╜ness income parallels the Code's treatment of loans: a taxpayer does not include bor╜rowed funds in gross income, even though such funds increase assets, because the taxpayer has a corresponding liability to repay the loans. The justification for tax╜ing discharge-of-indebtedness income is that the elimination of the liability (the obligation to repay the funds previously borrowed) makes available to the taxpayer assets that were previously offset by liabil╜ities. See United States v. Kirby Lumber Co ., 284 U.S. 1, 3, 52 S.Ct. 4, 76 L.Ed. 131 (1931).
However, the Code provides excep╜tions to this general rule. Section 108(a)(1) states:
Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness to the taxpayer if-(A) the discharge occurs in a title 11 case, (B) the discharge occurs when the taxpayer is insolvent, or (C) the indebt╜edness discharged is qualified farm in╜debtedness.
26 U.S.C. ╖ 108(a)(1). For purposes of subsection (B), the insolvency exception, " 'insolvent' means the excess of liabilities over the fair market value of assets." Id . ╖ 108(d)(3). "[A]n insolvent debtor real╜izes income just to the extent his assets exceed his liabilities after the cancellation." Commissioner v. Tufts , 461 U.S. 300, 310 n. 11, 103 S.Ct. 1826, 75 L.Ed.2d 863 (1983). This exception recognizes the fact that an insolvent debtor does not suddenly acquire assets simply because an obli╜gation to pay off loans has been removed.
Regarding the discharge-of-indebted╜ness income, taxpayer argues that the IRS's assessment was arbitrary and capri╜cious and so is not entitled to the presump╜tion of correctness to which IRS assess╜ments usually are entitled, 3 that the Tax Court erred by continuing to rely on the presumption of correctness and by failing to shift the burden of proof to the IRS even after taxpayer presented evidence re╜futing the accuracy of the assessment, and that taxpayer produced sufficient evidence of his insolvency to qualify for the insol╜vency exemption to discharge-of-indebted╜ness income. The IRS counters that it did present evidence of discharge-of-indebted╜ness income-the corporate tax returns and the CIS statement-so as to be enti╜tled to the presumption of correctness, and that none of the evidence presented by taxpayer established that he was insolvent at the time that he realized the discharge-of-indebtedness income (when he filed the CIS statement indicating positive net worth and no debt).
3 Both parties agree that 26 U.S.C. ╖ 7491, which was enacted as part of the Internal Revenue Service Restructuring and Reform Act of 1998, Pub.L. No. 105-206, 112 Stat. 726, ╖ 3001(a), and places the burden of proof on the IRS in certain circumstances, applies only to court proceedings arising in connection with examinations commencing after July 22, 1998. Act ╖ 301(c). Because the examination in this case was commenced prior to that date, ╖ 7491 does not apply, again as both parties agree.
Focusing on the insolvency exception, the Tax Court found, relying on the CIS, that the exception did not apply. The Court determined that taxpayer had a pos╜itive net worth in 1993 of approximately $389,650, with assets comprising $50 in cash and $850,000 in real estate (subject to encumbrances of $460,000) and with his sole liability being $400 in credit card debt. Tobarman , 80 T.C.M. (CCH) 81, slip op. at 5 & n. 7. The Court further found that taxpayer's contention that, despite his statement on the CIS, he was indeed insol╜vent by at least two to three million dollars was "vague and conclusory" and that tax╜payer "has failed to provide any details ... as to ... the specific liabilities he claims to have owed." Id. at 15. More╜over, the Court concluded that the CIS actually understated taxpayer's assets be╜cause it did not include his ownership interest in Fantastic Foods and the $457,072 debt that Fantastic Foods owed to him. Id.
Mr. Toberman contends that it was im╜proper for the Court to disregard his and his accountant's uncontradicted testimony regarding his insolvency. Moreover, he argues that he did in fact introduce specif╜ic liabilities into evidence, namely actual judgments showing that he owed millions of dollars. Tax Court Exhibits 25-P, 26-P, 29-P, 33-P, 34-P, and 35-P. He also testified as to millions of dollars of addi╜tional judgments against him. Finally, he contends that Fantastic Foods was itself insolvent and lacked any obvious means to repay him for its debt and, therefore, that his ownership interests in the equity and debt of the company had little or no mar╜ket value. See 26 U.S.C. ╖ 108(a)(1)(B) (noting that, for purposes of insolvency exception, assets are judged at "fair mar╜ket value").
We find taxpayer's arguments per╜suasive. Although the Tax Court stated that taxpayer failed to provide evidence of specific liabilities, the Court also noted that "the record contains notices of judg╜ment against petitioner." Toberman, 80 T.C.M. (CCH) 81, slip op. at 13. The Court referred specifically to a "Federal District Court order, dated Sept. 22, 1992, entering judgment of $832,806 against pe╜titioner[ ]." Id . at 13 n. 11. Moreover, the parties stipulated that various trial court exhibits, presented by taxpayer, were true and correct copies of judgments entered against Mr. Toberman. Joint Appendix 22-23. These judgments were entered on the following dates in the following amounts: September 23, 1992, $835,772.37; June 22, 1992, $969,063.00 (not paid as of January 26, 1995); May 8, 1992, $206,064.04; September 11, 1991, $1,205,600.34; August 9, 1991, $408,528.65. These judgments alone total $3,625,028.40, far greater than the taxpayer's net worth as determined by the Court, $389,650, even considering the loan from Fantastic Foods, $457,072, and a reasonable ownership in╜terest in the company.
In response, the IRS contends that, "[w]ith the exception of one of the judg╜ments, [footnote 16] there is no evidence that they were extant and enforceable in [March] 1993." Footnote 16 states: "Ex. 25-P, a judgment in the amount of $969,063, includes as an attachment a writ of execution issued on January 26, 1995." Commissioner's Brief 29 & n. 16. Thus, even were we not to consider the four judgments that the IRS contends were somehow satisfied by March 1993, the one judgment that the IRS admits was extant in March 1993, by itself, is greater than the fair market value of taxpayer's assets at that time. Moreover, it is not reason╜able to conclude, in the absence of any evidence, that the judgments had been sat╜isfied in the one to two year period prior to discharge of taxpayer's debt. Therefore, we hold that the Court's determination that taxpayer was not insolvent at the time of the discharge of his debt to his Sub╜chapter S corporations was clear error. It is our definite and firm conviction that taxpayer met the insolvency exception to discharge-of-indebtedness income. The Tax Court's demand for explicit proof that recent judgments remained unsatisfied, was, in the circumstances of this case, wholly unreasonable.
B. The Net-Operating╜ Loss Carryforwards
Taxpayer also argues that the Tax Court erred by sustaining the IRS's disallowance of his claimed net-operating-loss carryfor╜wards. He contends that the IRS bore the burden of establishing that the claimed deductions were erroneous, that he provid╜ed sufficient evidence to be entitled to the deductions, and that the IRS provided no evidence to support its disallowance.
Regarding the burden of proof, tax╜payer is incorrect. The taxpayer bears the burden of establishing entitlement to claimed deductions. 26 U.S.C. ╖ 7453; Tax Court Rule 142(a); Bennett Paper Corp. v. Commissioner, 699 F.2d 450, 453 (8th Cir.1983). In this case, the original books and records of the two S corpora╜tions were lost, and taxpayer furnished no explanation for their absence. In their place, taxpayer submitted his individual tax returns for the years 1986 to 1992, some of the relevant S corporations' tax returns, and the testimony of his accoun╜tant. The Tax Court held that this evidence did not meet taxpayer's burden of proof.
We hold that the decision of the Tax Court-that taxpayer failed to sustain his burden of proof-is not clearly errone╜ous. The trial court is not required to accept even uncontradicted testimony. Askew v. Commissioner, 805 F.2d 830, 832 (8th Cir.1986). Here, the lack of tax returns from the Subchapter S corporations for all of the relevant years, in addition to the complete absence of underlying record evidence, affected the Tax Court's determi╜nation. And it was within the Court's discretion not to credit the testimony of taxpayer and his accountant.
C. The Penalty
Finally, the Tax Court upheld the IRS's assessment of an accuracy-related penalty under 26 U.S.C. ╖ 6662(a). This section imposes a penalty in the amount of twenty per cent. of the underpayment of tax that is attributable to "[n]egligence or disre╜gard of rules or regulations" or "[a]ny substantial understatement of income tax" on the part of the taxpayer. Id. ╖ 6662(b) . Taxpayers otherwise subject to this section are allowed a "[r]easonable cause excep╜tion," that prevents imposition of a penalty if a taxpayer can show both reasonable cause for the underpayment and good faith. Id. ╖ 6664(c). The Tax Court held that taxpayer failed to prove either that he provided his accountant complete informa╜tion for preparing his 1993 federal income tax return, or that he kept adequate books and records to substantiate the net-operating-loss deductions. Moreover, the Court held, he failed to show reasonable cause or that he acted in good faith.
Taxpayer argues that his accoun╜tant not only prepared the tax return, but also kept the books and records for the Subchapter S corporations, so there was nothing further for him to provide to the accountant. He also argues that he kept excellent records but that the records were lost,, and that any missing records were beyond the three-year statute of limita╜tions contained in 26 U.S.C. ╖ 6501. The IRS counters that the accountant worked only part time for taxpayer in 1993 and was not in control of the books and rec╜ords, that taxpayer has offered no explana╜tion for the loss of the records, and that taxpayer's and his accountant's testimony is insufficient evidence. Moreover, the IRS contends, ╖ 6501 bars the IRS only from assessing taxes on tax years more than three years old, not from requiring evidence for deductions claimed from prior years in an assessment of a tax return less than three years old. We review the Tax Court's decision for clear error. Parrish v. Commissioner, 168 F.3d 1098, 1102 (8th Cir.1999).
We hold that the Tax Court did not clearly err. There is sufficient justifica╜tion-the lack of documentary evidence and the lack of an explanation for the disappearance of the records-for the Tax Court to determine that taxpayer was neg╜ligent in failing to keep adequate books and records and that he failed to meet the requirements of the reasonable-cause ex╜ception. However, although the assess╜ment of a twenty per cent. penalty was not improper, the exact amount of the penalty will need to be recalculated in light of the change in taxpayer's tax liability based on our holding that there was no discharge-of-indebtedness income.
For the foregoing reasons, the judgment of the Tax Court is reversed with respect to the discharge-of-indebtedness income and affirmed with respect to the disallow╜ance of the net-operating-loss carryfor╜wards and the imposition of a twenty per cent. penalty on any underpayment. The case is remanded to the Tax Court for recalculation of taxpayer's tax liability and the amount of the penalty.