Brian L. Nahey and Carol J. Nahey v. Commissioner of Internal Revenue

in a later federal statute. provision at — - —, 118 S.Ct. at

U.S. 1486-87. Brian L. NAHEY and Carol J. recognized an exception Court Petitioners-Appellants, rule, general Insolvency Federal Statute v. later, it did light so “more COMMISSIONER OF INTERNAL specific namely, the Tax Lien statute” — REVENUE, Respondent- -just Act of prior as it had done so in 1966— Act, cases involving the Bank Appellee. National Transportation Act of and the Bank No. 99-1149. Romani, Act of 1898. Estate ruptcy at — - —, U.S. 118 S.Ct. at 1486-87. United States Appeals, Court of Seventh Circuit. Illinois has failеd to show that its tax liens fall within specifically enumerat- Argued Sept. 1999. categories Act, ed in the Tax Lien as did Decided Nov. 1999. Romani, the creditor in Estate nor can Illinois applicable, another subse- Rehearing and En Rehearing Banc quent statutory provision that is inconsis- Denied 2000. Jan. tent with Insolvency the Federal Statute’s commands. See Illinois ex rel. Gordon 8, 11-12, U.S. (1946) 90 L.Ed. 1049 (noting pre-

vious cases which predeces- held that the

sor statute to Section 3713 did not give the

United States over priority certain other

types claims “did so because later Acts

were found to provisions plainly contain

inconsistent with priority”). United States

Absent such a showing, general federal

priority governs, rule court district

was therefore correct in denying Illinois’

attempts to shoehorn its tax liens into the

rule’s narrow exceptions.1

Conclusion herein,

For the reasons stated we Af-

firm the district court’s decision in favor of

the United States’ motion for summary Illinois’ motion for

summary judgment.

Affirmed agree 1. We also purposes district court that priority statute.” ‍​‌‌‌​​‌​‌​‌​​​‌‌​​‌​‌‌‌‌‌‌‌​​​‌‌​​‌‌‌​‌‌​‌‌​​‌‌​‍523 U.S. at —, Illinois priority cannot claim under the еx 118 S.Ct. at 1486. Illinois did not ception parties gained posses who have possession divest Tasemkin title to sion or title to property. debtor's priority when the federal ac Supreme Court in Estate Romani "[a]s crued under the Insolvency Federal Statute. Therefore, validity pos sumedfed] of this 'title or specific, it did have a perfect deciding session’ test for whether a excepted lien on ed lien that was from the federal personal property sufficiently priоrity choate for rule.

867 unpaid portion counterclaimed for the $650,000. price, the contract some While pending, the suit was share- company holder Wehr offered to sell the president, to Brian for $100 million. The sale took the form of a lever- buyout (meaning that the assets of aged secure a loan company pledged were to with the funds provided necessary pay purchase price) subchapter corporations two S formed and (His by Nahey. party owned wife is a litigation only couple because the filed return.) joint tax purposes, For a sub- Michael, (argued), Robert A. Schnur chapter corporation is identical to its S Friedrich, Milwaukee, WI, for Peti- Best & shareholders, Nahey’s so we’ll refer to two tioners-Appellants. simply “Nahey.” In al- corporations S David I. Pin- (argued), J. Tobin Donald price million locating purchase the $100 Division, Justice, cus, Tax Department assets, specific an ac- Wehr across Wehr’s DC, Section, Washington, Appellate counting by Nahey assigned firm hired no Bezold, Internal Revenue Ser- George W. Xerox, against regarding value to the suit Milwaukee, WI, vice, F. Ham- William speculative it as too to be valued. Service, mack, Internal Revenue Office Dallas, TX, (Midstates), Nahey place The sale of took Wehr Regional Counsel (now later, years the suit Na- 1986. Six Respondent-Appellee. hey’s) Xerox was settled. Xerox against POSNER, Judge, and Before Chief Nаhey million and to agreed pay $6 KANNE, Judges. Circuit CUDAHY Nahey dismiss its counterclaim. concedes if it had that if hadn’t been Wehr POSNER, Judge. Chief settled its suit Xerox on the same from a decision the Tax appeal This did, entire settle- Nahey terms that taxpayers, Brian Court of million would have been ment $6 wife, that one presents question his ordinary income rather taxed to Wehr as supposed resolved might (wrongly) have amount than as a because the long ere now: if a claim for lost would have re- received income is sold as of the sale ordinary income of which Xerox placed settled, corporation, and is later Alexander v. Commis- deprived had Wehr. of the settlement Cir.1995). (1st sioner, 72 F.3d 942-44 capital gain? The Tax Court (The arbitrarily different in the rule is 111 ordinary income. T.C. they held were injuries; only personal case of suits for 256, 1998 WL eases are taxable in such punitive damages judgment if or settlement a manufacturer of even Corporation, Wehr mainly earnings fоr lost that would Corpora- sued Xerox equipment, industrial because of ordinary income not lost damages arising from Xerox’s al- been tion for by the defendant’s disability caused leged breach of a contract with Wehr 104(a); see system wrongdoing. that would satis- U.S.C. computer sell it a States, v. United data-processing needs. O’Gilvie fy all of Wehr’s (1996); 136 L.Ed.2d 454 charged simple fraud as well as The suit Lokken, ‍​‌‌‌​​‌​‌​‌​​​‌‌​​‌​‌‌‌‌‌‌‌​​​‌‌​​‌‌‌​‌‌​‌‌​​‌‌​‍Fed- Lawrence sought profits. Boris I. Bittker & of contract and lost breach Estates, Income, Taxation (including of million eral Damages excess $5 ¶ (3d ed.1999).) If the settle- Xerox 13.1.4 damages) were claimed. punitive Gifts ment replaced capital gain, judgment, resembles a sale because it ex- would have been taxed as a tinguishes plaintiffs claim. But our Coupling Anchor Co. hypothetical example shows the difference (7th Cir.1970). between assigning enforcing That all Coupling, that Anchor on which claim. If a settlement or were relies, held, Nahey help and it doesn’t him asset, the sаle of an then had Wehr not origin since the claim his was a claim to sold to but had instead ob- income, ordinary a capital gain. not itself, tained the settlement with Xerox (we’re proceeds would assuming) a capi- be It is true that when a sells tal yet Nahey concedes asset, the income he receives from Wehr — ordinary would be income to capital gain. sale is a 26 U.S.C. Wehr. The compelled concession is by §§ 1222. And we assume that principle that “the [tax] classification of the suit against Xerox was a capital asset amounts received in settlement of litiga- of Wehr and was acquired together with tion is to be determined the nature and Wehr’s other assets in the purchase of the settled, basis of the action and amounts corporation by Nahey. A capital asset is compromise received in of a claim must be “property taxpayer,” held 26 U.S.C. having considered as 1221; the same nature as Corp. Arkansas Best v. Commis right sioner, compromised.” 212, 217-18, 108 Alexander v. supra, 72 F.3d at 942. and while there are exceptions in section 1221 none of them down, To nail suppose let’s claims, legal embraces although there is $1,000 Wehr had owned a face-amount cou- authority some for refusing classify a pon bond due in 1992 paying percent right ordinary asset, income as a capital interest, annual and the accountants had see id. at 217 n. $1,000 valued it at in the sale of Wehr’s Wehr’s claim Xerox could be so Nahey. assets to Between 1986 and characterized. That is we merely Nahey would have clipped coupons assuming that a sale of the claim would ($500 received per year interest of $50 produced have gain, rather than total) taxable as ordinary income. Then income, ordinary to Wehr. For the sake 1992 he would have cashed in the bond for that, of completeness we add on this as amount, its face a nontaxable return of sumption, the fаct that the accountants principal. Compare that to a variant of declined to value this asset because it was this case in which the accountants value speculative would undermine its char the suit Xerox at million. Then $1 asset; acter as a capital it would million of the $1 million would $6 a zero basis. been the cost of the asset But even if the sale of the suit would be deducted from the proceeds of (or loss) would have produced capitаl gain in computing Nahey’s in- seller, the purchaser, when pros he come from the settlement. The balance of ecuted the suit to judgment and collected income, million would ordinary just be $5 the judgment, or when he settled the case like the interest on the bond. It shouldn’t proceeds received the (the of the settle make a difference that Wisconsin law ment, would be case) taxable on the net gain at governing law the Xerox cut off ordinary-income Ogilvie rate. Nahey’s right Com to recover for Wehr’s lost missioner, Cir.1954) 216 F.2d 748 profits as of the date of the sale of the curiam). This is critical him, because Nahey corporation to while in the case of the suit; did not sell the prosecuted he it to bond the interest is received after the settlement himself. pro The settlement acquisition. of the settle- ceeds were therefore settlement, to ment were received after the settlement, him. A equally a litigated just as the interest on the bond was re- an added incentive for Why cation? create purchased. the bond ceived after (have we a corporate reorganizations represented of the settlement them?), would shortage of which income, but that didn’t overdue tax- consequence of the rule for which the cases, In both what capital gain. make it a payers contend which as was transferred substantial assets corporation has yields ordi- was an asset acquisition сlaims the enforcement of legal form of an asset that yield ordinary income to for that income it were “milks” as corporation. selling the asset. company when a Sometimes too foregoing analysis seem Lest claims retains some or all of its seller tastes, that we we add formalistic for some (more liabilities, commonly, why for reason any practical cannot find Co., 11 Pipe v. Line Chaveriat Williams a suit proceeds of the the tax treatment (7th Cir.1993)), 1420, 1424 for exam- F.3d an inter- change because should newly off the claims into a ple by spinning Recall the ownership. vening change purchaser corporation, formed because that Wehr taxpayers’ concession good to form a idea of may not be able proceeds obtained contingent their merits or fear the to Wehr as ordi- have been taxable of a claim prosecution that the liabilities Recall capital not as Xerox’s cоunter- often entails —remember to assigned the suit that if Wehr had too claim, rul- depending which on the court’s else, else would that someone someone being worth ings might up have ended the net pay had to tax on Why complicate than claim. more Wehr’s (net, that judgment any settlement from of the distort the business is, assignment) at ordi- ‍​‌‌‌​​‌​‌​‌​​​‌‌​​‌​‌‌‌‌‌‌‌​​​‌‌​​‌‌‌​‌‌​‌‌​​‌‌​‍of the assign to retain or parties as to whether capital-gains than nary-income rather tax incentive to by creating a claims it make a diffеrence Why should rates. assign them? packaged was with assignment that the (the An- bring In to himself within rest of Wehr’s an effort of other assets assets) Nahey argues that Coupling, v. chor Canal-Randolph Corp. as well? in ori- 28, 30, was settled was claim which United But that is Cir.1977) origin being the LBO. curiam), gin, assumes sensible, It more for difference, just a conclusion. consistent with makes no fully as just explained, as well the reasons corporate or other merger that a principle formalities, re- compliant nоt alter the tax status acquisition does merely an intermediate the LBO as gard E.g., in it. the assets involved claim, original between transaction Corp., Hilton Hotels 397 U.S. States v. ordinary income of was to recover 1307, 25 L.Ed.2d 585 90 S.Ct. deprived, wrongfully had been which Wehr assign- only permitting effect of claim after its the settlement of that change the tax classification ment to Nahey. transfer an would be to eventual spin legal claims an incentive taxation owner of It that rules of is desirablе neutral, sell corporation in the them off into new be simple and be selling judg corporation, influencing business sense of attempt partic to obtain of a directly. purpose when the except claims ments influence for the of tax law is to provision favorable tax treatment ular (and behavior, contended to be higher purchase price) which is not hence stan by this twofold Judged the “sub- here. might be thwarted this route sound; a doctrine, see, the Tax Court’s deсision e.g., Yosha dard stance over form” not affect the Commissioner, acquisition should F.2d v. that are trans- claims (7th Cir.1988), tax treatment compli- invite that acquisition. Against ferred this the incurred obtaining the settle- taxpayers gov- to cases which the ment were capital rather than ordinary —a ernment successfully argued that a deduc- government’s contention the lawyer dis- respect tion taken with to an asset ac- argument claimed at Tax Court will —the quired corporatе acquisition required reject the contention. was a loss. The leading case is Nahey tries to fit the “open case into the Arrowsmith 344 U.S. doctrine, transactions” which in its sim- (1952), 97 L.Ed. 6 but as plest version person allows a who sells explained in United v. Skelly States Oil property exchange for a stream pay- Co., contingent ments profits generated on the all it stands for is the by the property to treat the stream aas unexceptionable proposition money that “if cаpital gain, though it looks like special taxed at a lower rate when income. The designed doctrine is received, taxpayer would be accorded cases in which neither nor an unfair tax windfall if repayments [of the contingent mode of payment for it can money] generally were deductible sale, be valued at the time of the so that from receipts taxable at higher rate cannot be accused having applicable income.” See also 2 attempted to transform ordinary income Lokken, Boris I. Bittker & Lawrence Fed- into a capital gain; he took the capital gain Income, eral Taxation Estates and Gifts in only the form that was 2 feasible. 52.1.9, (2d ed.1990). § p. 52-19 That prop- Lokken, 52.1.9, Bittker & supra, p. 52- osition underlies the Tax Court’s decision 18. The presupposes doctrine that if the in this requires that property could have been sold a defi- the tax classification of a legal claim re- sum, nite that sum would have main been tax- through unaltered transfer of the able as a capital gain, claim income. by assignment whether or as an Had Wehr sold its claim incident to a Xerox corporate acquisition or other (whether reorganization. directly or through a reorganization) Nahey in exchange for a Suppose that had sold the suit “cut” of judgment or pro- settlement against Xerox rather than prosecuting it ceeds, and if—the question we open left $10,000 expense incurred an in earlier —the sale of a claim to ordi- ‍​‌‌‌​​‌​‌​‌​​​‌‌​​‌​‌‌‌‌‌‌‌​​​‌‌​​‌‌‌​‌‌​‌‌​​‌‌​‍sale, negotiating the and that on nary income yield can ever a capital gain the sale was taxable at capital-gain rates. rather than ordinary seller, income to the He would permitted not be to deduct that then conceivably Wehr could have treated expense income; from ordinary he would that “cut” when received as a have to deduct it from the But the Nahey’s issue is liability, tax thus reduce his rathеr than his to that open transactions doctrine is ordinary income. Woodward v. Commis irrelevant. sioner, In some of the cases AFFIRMED. cites, that Nahey may the court have mis (he expenditure classifíed an points chiefly CUDAHY, Circuit Judge, concurring. Transport Co. v. Pacific (9th Cir.1973) I curiam)), because, 483 F.2d 209 write separately although there treated an is much expense support as a capi (which tal one. If decide), opinion, so we needn’t there is considerable to thrоw it in incorrect; those cases are doubt. there is no And I am troubled that it ignores principle that an incorrect decision creates excludes whole authority. lines of For right a in taxpayer to whom that example, decision the majority flatly rejects such has never applied. gov Should cases as Transport Co. v. Commis- Pacific ernment ever claim sioner, legal expenses Cir.1973), 483 F.2d 209 at a cost in revenue. But symmetry even successfully argued that a government symme- at this cause of corporation perhaps made payment parent liability tort was try of a contested waned. discharge has currently thus ordinary loss and not an a little It therefore be unrealistic question tort claim deductible. deny taxpayers and a little unfair subsidiary corpora- first asserted holding, of cases circumstances benefit par- necessarily assumed tion and case, that ex- analogous present upon liquidation. corporation ent It capitalized. must is unrealis- penses should the loss held that Ninth Circuit hope entertain the tic because we seem to and added to the capitalized have been and so “neu- “simple” result is so our from acquired in the assets parent’s basis it (pre- courts will follow tral” that other is on all Transport subsidiary. prece- their own sumably preference that it except present fours dents) in expense equally than the expense side involves vein, hope wе that the In the same cases. Arrowsmith Commission- income side. our persuaded by so government will be L.Ed. 6 er, U.S. taking position analysis that it will cease of a involving payment merely maximizes in all kinds of cases that is to the same corporate liquidation, after a inconsis- logical distin- majority’s effort to the revenue —whatever effect ineq- the unusual merely points to I think it is unrealistic —even guish it tencies. Nonetheless, contrary uity expectations. outcome. naive—for us to hаve such Arrowsmith principles underlying deny we taxpayers It is because unfair argued as those same support prin- precedents benefit of Arrowsmith, For, the ma- what here. even capitalization ciple “intermediate transaction” jority calls an immediately with issues they deal though pay- the tax treatment determined expense. of loss and judgment. ment of a much esteemed Another consideration panel ques- asked argument, At oral the contribu but a dubious by govеrnment the reflecting its counsel government tions of pres is the neutrality simplicity tor to after suc- government, concern exchange. or of a sale ence or absence treatment in capital for cessfully arguing a or ex sale For the difference between involving the Transport cases like Pacific disposition and its capital change of asset would contin- expenses, of characterization settlement, means, has such as by other ordinary income treatment fight ue The con neutral. simple or never the characteriza- the issue when involved be in the distinction gressional purpose gov- surprise, income. To no one’s tion of ordinary income tween represent counsel refused ernment “be distinguish to have been seems accept government in future the salaries, receipts such as recurring tween the shoe when ordinary expense treatment rents, dividends, interest, royalties, wages, faсt, govern- In foot. was on the other hand, and the nonre like on one “I don’t line was ment counsel’s bottom in appreciation of the current realization would treat think it’s clear how the IRS on the other.” Stan value I can’t money.... [Nahey] paid if out Problems in ley Surrey, S. has, in this Court for the IRS.” But speak Definitional Taxation, L. Rev. 69 Harv. Capital Gains past, aspired contexts related (1956) supplied). (emphasis and settlement expenses treat settlement exchange” or on “sаle Courts seized e.g. See Canal- symmetrically. income ordi to limit the conversion language Randolph v. United The other gains. capital income into Cir.1977). fact, In Canalr-Ran- “presence the coin is that side of us that counsel assured dolph government produces exchange’ requirement ‘sale or would aim for at least the IRS in that case incongruous results when an cap- admitted periodically paid at prescribed intervals, is ital asset is disposed means ordinary income, other no matter how many cor- ” exchange.... sale or Id. at 1007. porate transfers have preceded clip- It is hard to how taxing Nahey’s gain see ping But, coupons. of the unlike the claim as ordinary simple is a income or neutral present bond interest is earned when, rule if he had sold the claim for the almost contemporaneously with receipt. amount, settlement he would have realized fact, In example given majori- caрital gain. ty opinion it is earned in the hands of the corporation. successor This is not unlike

The majority says that the settlement of the yardage earned after the lawsuit yields ordinary here transfer CanaV-Randolph. This is because the amount received in settlement unlike the claim in the instant case replaced ordinary income of which Xerox whatever is earned the settlement re- had deprived But government Wehr. flects relations established before the рrefer seems to the rationale that a settle- In interest, transfer. the case of bond generate ment cannot gain be- there is no reason to look at events cause settlement before is not ex- transfer, However, since the interest change. is a wholly get beyond we could post-transfer hurdle, phenomenon. linguistic in the hands of Na- hey the could repre- settlement arguably junkA might bond furnish a more help- sent a in Nahey’s reduction cost basis in analogy. ful This is a bond could be (a the other acquired ‍​‌‌‌​​‌​‌​‌​​​‌‌​​‌​‌‌‌‌‌‌‌​​​‌‌​​‌‌‌​‌‌​‌‌​​‌‌​‍assets from Wehr valued at the time of corporate transfer far image mirror Transport), not a below par because of the risk of non- replacement of ordinary income. payment of interest or non-recovery capital. adopted has also When prin- the bond later is redeemed ciple that a at face corporate sale is value in “merely an the hands of the transferee intermediate transaction between orig- attributable to the claim, inal which was to recover time value of money would be treated as income of original [the taxpayer] ordinary income and the balance had been wrongfully deprived, and the set- The increase in junk value of a bond tlement of that claim after its redeemed, transfer to when reflecting a reward for taxpayer].” [a new principle This has a the transferee’s successful risk-taking, ring clarity it, аnd simplicity about might analogized to the settlement of it did control either Arrowsmith or the “speculative” lawsuit the instant cases, Transport or in like case. Pacific an “intermediate transaction” the key is Given all these important considerations, Perhaps result. this is not surprising I think we must proper weight because an “intermediate gen- transaction” authoritative decisions like Trans- erally changes identity, circumstances port, require taxpayers capitalizе and economic function of the losses and which argue symmetrical

ways that ought to be recognized in the on treatment side. To ignore analysis. For example, if a appreci- car authority this adds to the mistaken im- ates in dealer, of a car gain hands pression that this is an easy case. It is far generally ordinary. 26 U.S.C. from easy an and efforts to make it 1221(1). If it appreciates in the hands into one do more harm than good. of a customer to whom the car has been My observations about aspects various capital. generally the majority opinion indicate a strong problematic effort tilt toward the tax collector is unwarrant- make puzzle appear simple is best ed. arguments and authorities on illustrated analogy. course, its bond Of both sides are so close equipoise that a coupon bond, interest on a high-quality matter, decision is difficult. To resolve the Tax is due the deference I think that some with the is-

Court, regularly which deals therefore, I, despite that trouble us.

sues doubt, the same adopt elect to

substantial though I majority, even as the

outcome of its important aspects

seriously question

analysis. SIMPSON,

Virginia Plaintiff-

Appellant, AUTOMOTIVE,

BORG-WARNER

INC., Defendant-Appellee. 99-1048.

No. Appeals, States Court Circuit.

Seventh 1, 1999.

Argued Oct. Nov. 1999.

Decided

Case Details

Case Name: Brian L. Nahey and Carol J. Nahey v. Commissioner of Internal Revenue

Court Name: Court of Appeals for the Seventh Circuit

Date Published: Jan 28, 2000

Citation: 196 F.3d 866

Docket Number: 99-1149

Court Abbreviation: 7th Cir.