Cooper v. Commissioner
877 F.3d 1086
| 9th Cir. | 2017Background
- James Cooper is an inventor with dozens of patents; he and his wife (petitioners) received royalties under agreements between Cooper (and an entity Pixel) and Technology Licensing Corporation (TLC), a company formed in 1997 with Walters and Coulter as majority owners and Cooper/trust owning 24%.
- Petitioners treated TLC royalties received in 2006–2008 as capital gains under 26 U.S.C. §1235(a), asserting they transferred “all substantial rights” in the patents to TLC.
- In 2006 TLC returned certain patents to Cooper for no consideration; the Tax Court found Walters and Coulter acted at Cooper’s direction and that Cooper effectively controlled TLC.
- Petitioners claimed a nonbusiness bad-debt deduction under 26 U.S.C. §166(d)(1)(B) for a Pixel promissory note they contended became worthless in 2008; Tax Court found the debt was not totally worthless in 2008.
- The Commissioner assessed deficiencies and accuracy-related penalties under 26 U.S.C. §6662; Tax Court upheld disallowance of capital gains and bad-debt deduction and imposed penalties; petitioners appealed.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether TLC royalties qualify as capital gains under §1235(a) (transfer of all substantial rights) | Cooper transferred all substantial rights to TLC; formal documents satisfy §1235 and should control | Commissioner: look at substance; Cooper effectively controlled TLC so he did not transfer all substantial rights | Court affirmed: substance-over-form; Tax Court did not clearly err that Cooper effectively controlled TLC (including rescission of patents), so royalties are ordinary income |
| Whether Pixel promissory note became a worthless nonbusiness debt in 2008 (deduction under §166) | Petitioners: Pixel was insolvent in 2008 and the note became worthless that year | Commissioner: Pixel had assets, ongoing receipts, and petitioners advanced additional funds in 2008, so debt was not totally worthless | Court affirmed: Tax Court’s factual finding not clearly erroneous; debt not totally worthless in 2008 |
| Whether accuracy-related penalties under §6662 should be abated for reasonable cause and good faith reliance on professional advice | Petitioners: relied in good faith on advice from counsel/accountant (Baker, Mitchell) | Commissioner: petitioners failed to show they actually relied on competent advice or provided necessary info; Baker didn’t advise post-formation or on control; no evidence for bad-debt advice | Court affirmed: Tax Court found no reasonable reliance; penalties sustained |
| Standard for assessing transfer under §1235(a) — formal documents only vs. practical/economic reality | (raised on appeal) Petitioners: court should consider formal transfer documents exclusively | Commissioner: statute/regulation and precedent require examination of entire transaction and economic reality | Court held: substance controls; must examine whole transaction and effective control; rejected narrow-formalistic approach |
Key Cases Cited
- Charlson v. United States, 525 F.2d 1046 (Ct. Cl. 1975) (retention of control by transferor can defeat §1235 treatment; practical control inquiry)
- United States v. Eurodif S.A., 555 U.S. 305 (2009) (substance over form in tax/regulatory interpretation)
- Helvering v. F. & R. Lazarus & Co., 308 U.S. 252 (1939) (tax law focuses on substance and realities over formal documents)
- Kueneman v. Comm’r, 628 F.2d 1196 (9th Cir. 1980) (deference to Treasury regulations and practical transfer inquiry)