Dye v. United StatesDye v. United States
Before PORFILIO, BARRETT,* and EBEL, Circuit Judges.
EBEL, Circuit Judge.
During the 1980s, Dorothy Dye lost over $850,000 because of various improprieties committed by her stockbroker. When Dye became aware of these improprieties, she sued. In 1989, the stockbroker’s former employers settled Dye’s lawsuit for $572,905.97, of which $207,617.37 went to Dye’s attorneys. On her 1989 tax return, Dye sought to characterize the settlement proceeds as a “long-term capital gain,” and the attorneys’ fees as a “capital expenditure.” Dye reduced her total tax liability for 1989 by applying the “capital expenditure” against the settlement proceeds.
The IRS disallowed Dye’s “capital expenditure” reduction, and demanded about $70,000 in additional 1989 tax, interest, and penalties. Dye paid the IRS the money it demanded, but timely sued for a refund under
BACKGROUND
This is an appeal from a grant of summary judgment. Thus, the following facts are uncontroverted or are considered in the light most favorable to Dye, the non-movant. See Kaul v. Stephan, 83 F.3d 1208, 1212 (10th Cir.1996). All reasonable inferences from the factual record have been drawn in favоr of Dye.
Ervin G. Johnston, Johnston, Ballweg & Tuley, Overland Park, KS, argued the cause for plaintiff-appellant.
* Honorable James E. Barrett, Senior Circuit Judge, was unable to attend oral argument. However, Judge Barrett participated fully in the decision of the case.
In January 1983, Rosenberger moved Dye’s shares and bonds into a margin account. From 1983 to 1987, Rosenberger executed securities transactions on this margin account that resulted in $383,423.63 in trading losses to Dye. These trading losses created a negative balance in the margin account, forcing Dye to pay $170,991.71 in interest from 1985 to 1988. In addition, Dye lost $229,558 in interest on her tax-free municipal bonds between 1982 and 1988, during which time all such interest was applied to support securities transactions executed on the margin account. Because of the “churning” in Dye’s account, Dye incurred $14,856.79 in commissions and transfer fees. Finally, Dye lost an additional $55,000 plus interest when Rosenberger borrowed that amount from Dye’s margin account and failed to repay it.
Every tax year from 1984 to 1987, Dye reported capital losses on Schedule D of her federal income tax return, totaling her entire $383,423.63 in trading loss.2 However, because
On July 1, 1988, Dye sued Rosenberger and his former employers under Section 10(b) of the Securities Exchange Act of 1934,
In late 1989, both of Rosenberger’s fоrmer employers settled with Dye. Under the settlements, Dye received $302,500 in cash, forgiveness of her margin account debit balance of $270,405.97, and the release of some of her municipal bonds, which were being held as collateral on the margin account. The settlement proceeds were not specifically allocated by the settlement agreements to any category of claimed damages.
From the cash settlement proceeds, Dye’s legal counsel withheld $207,617.37 for attorneys’ fees and legal expenses. Thus, after paying her attorneys, Dye netted $365,288.60 ($94,882.63 in cash and $270,405.97 in margin account balance forgiveness), which was slightly less than the $383,423.63 in trading loss she had suffered and significantly less than her total losses.
In June 1990, Dye filed her 1989 federal income tax return, showing a totаl tax liability for 1989 of $5,198. On Schedule D of the tax return, Dye reported the $572,905.97 settlement proceeds from the Rosenberger suit as a long-term capital gain.4 From this capi-
On Schedule A of her 1989 tax return, Dye reported the $207,617.37 in attorneys’ fees and expenses she incurred in the Rosenberger suit as a miscellaneous itemized expense. Subsequently, however, in August, 1990, Dye filed an amended 1989 return seeking to recharacterize these attorneys fees and expenses as a capital expenditure, in order to offset them against the settlement proceeds.
On December 10, 1990, the Internal Revenue Service (“IRS”) notified Dye that because she had failed to compute her “alternative minimum tax” under
On October 15, 1991, Dye filed a second amended 1989 return that again characterized her attorneys’ fees and expenses as capital expenditures. On April 9, 1992, the IRS disallowed Dye’s two requests for a refund based on her amended 1989 return, on the grounds that the attorneys’ fees and expenses аssociated with the “cost of recovery” of Dye’s money were ordinary expenses that were properly reported on Schedule A, rather than capital expenses appropriate for reporting on Schedule D. On February 18, 1993, Dye filed a third amended 1989 return, again seeking to recharacterize the attorneys fees and expenses as a capital expenditure. On October 14, 1993, Dye paid to the IRS her current outstanding assessed 1989 federal income tax liability (including interest) of $54,442.63.5 On October 28, 1993, the IRS disallowed Dye’s third claim for refund. On August 24, 1994, Dye filed a fourth amended return, again seeking to recharacterize the attorneys’ fees and expenses as a capital expenditure, and claiming a refund of $69,989.74 based on her 1989 return. On October 11, 1994, the IRS disallowed this fоurth claim for refund.
On January 20, 1995, Dye sued the IRS in federal district court, seeking a refund of $69,989.74 based on her 1989 federal income tax return, plus interest, attorneys’ fees, and costs. The district court exercised jurisdiction pursuant to
In connection with Dye’s lawsuit, the IRS reviewed its computation of Dye’s 1989 income tax, this time treating the settlement proceeds as ordinary income rather than as a capital gain. Under this computation, the IRS increased Dye’s 1989 tax liability, including penalty and interest, by $75,743.00 (i.e. from $75,472.14 to $151,215.14). The IRS concedes it is barred by the applicable statute of limitations from pursuing the additional $75,743.00 from Dye. However, it contends that this sum should be offset against any refund Dye might otherwise receive as a result of the present litigation.
In the district court, both Dye and the IRS moved for summary judgment. On Decеmber 21, 1995, the court granted summary judgment in favor of the IRS, and correspondingly denied Dye’s motion. Dye v. United States, 77 A.F.T.R.2d (P-H) ¶ 96-901, 96-1 U.S. Tax Cas. (CCH) ¶ 50,130, 1995 WL 775351 (D.Kan.1995). Pursuant to
DISCUSSION
We review a grant of summary judgment de novo. Applied Genetics Int‘l Inc. v. First Affiliated Sec., 912 F.2d 1238, 1241 (10th Cir.1990). We apply the same standard under
I.
A.
Whether litigation proceeds are properly characterized as “ordinary income” or “capital income” is governed by the “origin of the claim” test. Woodward v. Commissioner, 397 U.S. 572, 577, 90 S.Ct. 1302, 1305, 25 L.Ed.2d 577 (1970); Dolese v. United States, 605 F.2d 1146, 1150-51 (10th Cir.1979), cert. denied, 445 U.S. 961, 100 S.Ct. 1647, 64 L.Ed.2d 236 (1980). Under the “origin of the claim test,” a court seeking to classify litigation proceeds as either “ordinary” or “capital” income must focus on the “origin and character of the claim....” Ransburg v. United States, 440 F.2d 1140, 1143 (10th Cir.1971). In particular, litigation proceeds are deemed “capital income” if “the origin of the claim litigated is in the process of acquisition itself,” Woodward, 397 U.S. at 577, 90 S.Ct. at 1305 or of disposition of property. Baylin v. United States, 43 F.3d 1451, 1454 (Fed.Cir.1995). As the district court noted:
the object of the “origin of the claim” test is to find the transaction or activity from which the taxable event proximately resulted, United States v. Gilmore, 372 U.S. 39, 47, 83 S.Ct. 623, 628, 9 L.Ed.2d 570 (1963), or the event that “led to the tax dispute.” Keller St. Dev. Co. v. Commissioner, 688 F.2d 675, 681 (9th Cir.1982). The origin is determined by analyzing the facts and determining what the nature of the transaction is. Keller, 688 F.2d at 681.
In the present case, the settlement agreements did not allocate the settlement proceeds by individual claim. Id. at 3. Thus, the “origin of the claim” test requires that a court determine how the settlement should be allocated among the various claims actually settled, and the court must then determine whether the damages associated with each settled claim were stated in terms of loss in value to Dye’s capital assets.
Applying the “origin of the claim” test in this way, the district court found that “[t]he amended complaint does not reflect litigation involving the process of acquiring or disposing of assets, but rather a lawsuit to compensate an investor for professional misconduct and to punish the alleged wrongdoers through the imposition of RICO treble damages or garden variety punitive damages.” Id. at 9. Thus, the district court characterized the origin of these claims as non-capital. Id. The court also found, however, that “Dye measured her damages in part in terms of the loss in value of her securities account ....” id. at 8, and therefore could contend that “at least some of her expenses should be attributed to the process of acquisition of property, in the sense that ... she was, in part, attemрting to recoup securities wrongfully disposed of....” Id. at 9.
A reading of the amended complaint reveals that Dye was asserting claims for impairment to her capital, as well as claims whose origin relate to lost income or claims which the law otherwise treats as claims for ordinary income. In particular, claims that would generate ordinary income include claims for: (1) lost interest on bonds;6 (2) interest on the loans to Rosenberger; (3) lost dividends; (4) excessive margin interest charges; (5) punitive or treble damages; and (6) prejudgment interest. Claims that would generate capital income include claims for: (1) diminution in value of Dye’s investments; (2) excessive commissions and transfer fees incurred in connection with securities transactions; and (3) recovery of the principal of
B.
On Schedule A of her 1989 tax return, Dye reported the $207,617.37 in attorneys’ fees and expenses she incurred in litigating the Rosenberger suit as a miscellaneous itemized (i.e.“ordinary”) expense. Subsequently, on her corrected 1989 tax return and each of her four amended 1989 tax returns, Dye sought to recharacterize these fees and expenses as “capital” rather than “ordinary” expenses, and thereby to report them on Schedule D rather than Schedule A. The IRS disallowed this recharacterization, contending that all of these expenses were ordinary expenses.8
Courts have long recognized, “as a general matter, that costs incurred in the acquisition or disрosition of a capital asset are to be treated as capital expenditures,” Woodward v. Commissioner, 397 U.S. 572, 575, 90 S.Ct. 1302, 1304, 25 L.Ed.2d 577 (1970), as are “costs incurred in defending or perfecting taxpayer’s claim to ownership of capital assets....” Spangler v. Commissioner, 323 F.2d 913, 919 (9th Cir.1963). In a case involving securities appraisal litigation, the Woodward Court affirmed that “legal, brokerage, accounting, and similar costs incurred in the acquisition or disposition of ... property are capital expenditures.” Id. at 576, 90 S.Ct. at 1305 (emphasis added) (citing cases). It opined that “[t]he law could hardly be otherwise, for such ancillary expenses incurred in acquiring or disposing of an asset are as much part of the cost of that asset as is the price paid for it.” Id. Capital expenditures are reported on Schedule D as “capital losses,” which may be set off against “capital income,” also cаlled “capital gains.”
To determine whether legal fees and expenses incurred in litigation are ordinary or capital in nature, once again the “origin of the claim” test is applied. Woodward, 397 U.S. at 577, 90 S.Ct. at 1306; Dolese, 605 F.2d at 1150-51; Ransburg, 440 F.2d at 1143; see generally Jean F. Rydstrom, Annotation, What kinds of legal costs incurred by taxpayer are deductible—current cases, 39 A.L.R. Fed 221 (1978 & Supp. 1995) (surveying eases). Legal expenses incurred to recover claims for ordinary income are ordinary expenses. Leonard v. Commissioner, 94 F.3d 523, 526 (9th Cir.1996). Thus, for example, attorneys’ fees paid to recover interest are ordinary expenses, id., as are attorneys’ fees paid to recover dividends,9 Nickell v. Commissioner, 831 F.2d 1265, 1275 (6th Cir.1987); see also id. at 1276 (Nelson, J., concurring in part and dissenting in part) (agreeing with the majority that “all legal expenses allocable to the recovery of dividends and interest” are ordinary expenses deductible under
The policy behind [
Treas. Reg. § 1.212-1(k) ] is that expenses incurred in acquiring income-producing property—such as brokerage fees incurred in the process of acquiring stocks—are part of the cost of the property, and are therefore treated as non-deductible capital expenditures. These expenditures are added to the basis of the capital asset in connection with which they are incurred, and are taken into account for tax purposes either through depreciation of the asset or through reduction of the capital gain (or augmentation of the loss) when the asset is sold.
Burch v. United States, 698 F.2d 575, 577 (2d Cir.1983) (citing Woodward, 397 U.S. at 575, 90 S.Ct. at 1304) (internal citations and quote marks omitted).
Here, the district court purported to apply the “origin of the claim” test to determine whether Dye’s $207,617.37 in legal expenses were “capital” or “ordinary.” In doing so, the court held that:
The amended complaint does not reflect litigation involving the process of acquiring or disposing of assets, but rather a lawsuit to compensate an investor for professional misconduct and to punish the alleged wrongdoers through the imposition of RICO treble damages or garden variety punitive damages. The expenses incurred in doing so are not capital in nature and are deductible, if at all, as ordinary business expenditures.
In our view, the district court erred in treating the legal expenses as a unified whole, rather than attempting to allocate them based on their respective “origins” in each of Dye’s legal claims. Where, as here, the litigation involves more than one claim, “[t]he origin [of the claim] test must be applied separately to each part.” Dolese v. United States, 605 F.2d 1146, 1151 (10th Cir.1979), cert. denied, 445 U.S. 961, 100 S.Ct. 1647, 64 L.Ed.2d 236 (1980). Legal fees, like other expenses, may, under certain circumstances, be partially deductible and partially nondeductible. See, e.g.,
II.
Having held that the “origin of the claim” test requires allocation of both the settlement proceeds and the litigation expenses to their “origins” in each of Dye’s claims, we must now address the issue of how suсh an allocation might be made. As the district court noted, the settlement proceeds from the Rosenberger suit were not specifically allocated by the settlement agreements to any category of claimed damages. Dye, slip op. at 3. Further, the attorneys’ fees were computed on a straight contingency basis, and the attorneys’ costs and expenses were similarly undifferentiated. Id. Thus, like her settlement proceeds, Dye’s legal expenditures are not easily allocated according to Dye’s individual legal claims.
A.
As a threshold matter, we note that on Dye’s 1989 tax return, Dye reported the entire $572,905.97 in settlement proceeds as “long-term capital income,” and that, prior to the present litigation, the IRS never challenged this characterization of the proceeds. The IRS now believes, however, that some portion of the settlement proceeds should have been characterized as “ordinary income” rather than “capital income.” The IRS concedes that it is time-barred under
It has been long settled that “the ultimate question presented for decision, upon a claim for refund, is whether the taxpayer has overpaid his tax. This involves a redetermination of the entire tax liability. While no new assessment can be made, after the bar of the statute [of limitations] has fallen, the taxpayer, nevertheless, is not entitled to a refund unless he has overpaid his tax.” Lewis v. Reynolds, 284 U.S. 281, 283, 52 S.Ct. 145, 146, 76 L.Ed. 293 (1932), modified, 284 U.S. 599, 52 S.Ct. 264, 76 L.Ed. 514 (1932) (quoting Lewis v. Reynolds, 48 F.2d 515, 516 (10th Cir.1931)). Thus:
While the statutes authorizing refunds do not specifically empower the Commissioner to reaudit a return whenever repayment is claimed, authority therefor is necessarily implied. An overpayment must appear before refund is authorized. Although the statute of limitations may have barred the assessment and collection of any additional sum, it does not obliterate the right of the United States to retain payments already received when they do not exceed the amount which might have been properly assessed and demanded.
Id.; see also Angle v. United States, 996 F.2d 252, 256 (10th Cir.1993) (verifying that Lewis v. Reynolds is still good law).
In sum,
B.
We must therefore proceed to discuss the allocation of Dye’s settlement proceeds and expenses into categories of “ordinary” and “capital” income. In the present case, the problem of allocation was exacerbated by the fact that, in their respective motions for summary judgment, neither Dye nor the IRS conceded that Dye’s settlement proceeds and legal expenditures might be partly ordinary and partly capital. Rather, Dye cоntended—and still contends—that all of her settlement proceeds and all of her expenditures were capital in nature. The IRS, by contrast, contended before the district court that all of Dye’s settlement proceeds and all of her expenditures were ordinary, although it now concedes otherwise.
Confronted with this stalemate, the district court held that it was Dye who shouldered the burden of allocating her settlement proceeds into capital and non-capital portions, and that Dye had failed to meet this burden. Specifically, the court found that “no evidence has been presented by Ms. Dye ... that would support any attribution of a portion of the expenses as capital in nature.” Noting that “Dye has the burden to prove she is entitled to а tax refund,” Dye, slip op. at 10, the court granted summary judgment in favor of the IRS. Id.
We believe that the district court overstated Dye’s evidentiary burden of production, and failed to account for the compelling evidence before it that the IRS had acted arbitrarily in asserting that no portion of Dye’s legal fees should be attributable to capital claims. We agree with the district court that in an action to recover taxes paid, the taxpayer has the burden to show not merely that the IRS’s assessment was erroneous, but also the amount of the refund to which the taxpayer is entitled.10 See United States v. Janis, 428 U.S. 433, 440, 96 S.Ct. 3021, 3025, 49 L.Ed.2d 1046 (1976) (“In a refund suit the taxpayer bears the burden of proving the amount he is entitled to recover. It is not enough for him to demonstrate that the assessment of the tax for which refund is sought is erroneous in some respects.”) (citing Lewis v. Reynolds, 284 U.S. 281, 52 S.Ct. 145, 76 L.Ed. 293 (1932)); accord Helvering v. Taylor, 293 U.S. 507, 514, 55 S.Ct. 287, 290, 79 L.Ed. 623 (1935); cf. Interstate Transit Lines v. Commissioner, 319 U.S. 590, 593, 63 S.Ct. 1279, 1281, 87 L.Ed. 1607 (1943) (“[A]n income tax deduction is a mаtter of legislative grace and ... the burden of clearly showing the right to the claimed deduction is on the taxpayer.”). As one court has explained, a taxpayer filing a tax refund case “bears the burdens both of production and of persuasion.” Ruth v. United States, 823 F.2d 1091, 1093 (7th Cir.1987) (citing Janis, 428 U.S. at 440, 96 S.Ct. at 3025).
Thus, in order to prevail, Dye must prove not only the incorrectness of the IRS’s determination, but also the correct amount that she is entitled to recover. The difficulty in the present case, however, is that Dye’s claims were denied at the summary judgment stage. Summary judgment is appropri-
Thus, in the present context, Dye, the non-movant for summary judgment, bears only the burden of production. On the issue of whether any genuine issues of material fact remain disputed, however, it is the IRS which bears the burden of persuasion. After the summary judgment stage, on the ultimate issue of whether Dye is entitled to a tax refund, the burden of persuasion reverts to Dye.
Applying these principles to the present ease, we note that the district court was faced with two motions for summary judgment, both of which were based on erroneous legal theories. See Part I, supra. In conjunction with thеse motions, Dye presented evidence that several of her claims against Rosenberger were capital in origin. She also presented evidence pertaining to the value of these capital claims,11 as well as the value of some of her non-capital claims.12 On that record, the IRS’s motion, premised on the theory that none of Dye’s settlement proceeds or litigation expenses were capital in nature, was arbitrary and insufficient to support summary judgment.
It is true that Dye did not present evidence pertaining to the value of all of her settled claims.13 However, most of the claims which Dye did not specifically valúate merely stated alternative legal bases for awarding the same damages specifically valuated in Dye’s principal claims.14 As several courts have noted, the relеvant inquiry “is not whether the action was one in tort or contract but rather the question to be asked is ‘In lieu of what were the damages awarded?’” Alexander v. IRS, 72 F.3d 938, 942 (1st Cir.1995) (quoting Raytheon Production Corp. v. Commissioner, 144 F.2d 110, 113 (1st Cir.), cert. denied, 323 U.S. 779, 65 S.Ct. 192, 89 L.Ed. 622 (1944)); accord Getty v. Commissioner, 913 F.2d 1486, 1490 (9th Cir.1990). Simply stated, the relevant issue is not the name of the claim, but rather the origin of the claim. See Woodward, 397 U.S. at 577, 90 S.Ct. at 1306.
Here, apparently Dye’s settlement was partly in lieu of her claims for $383,423.63 in trading losses, $14,856.79 in excess commissions, and $55,000 in unpaid principal. As the IRS now concedes, damages attributable to these claims are capital in origin. Dye’s settlement apparently was also partly in lieu of her $229,558 claim for lost interest on tax-free municipal bonds, which, even though tax free, is still considered ordinary income for present purposes—or at least it would not be considered capital income. Cf. Roemer v. Commissioner, 716 F.2d 693, 700 (9th Cir.1983) (distinguishing between “ordinary” tax-exemрt income and “capital” tax-exempt income for purposes of allocating recovery ex-
Under these circumstances, Dye has presented evidence adequate to overthrow the IRS’s assessment, and to establish that there is a genuine issue of material fact as to what proportion of the settlement proceeds were ordinary income and what proportion were capital income. Indeed, if all inferences are drawn in favor of Dye, the non-movant for summary judgment, the aforementioned evidence is sufficient to permit calculation of the correct amount of tax that is due, using at least one acceptable method of calculation. See Delaney v. Commissioner, 99 F.3d 20, 25 (1st Cir.1996) (approving Tax Court’s allocation of settlement proceeds based on percentage of damages represented by each element in jury award) (citing Robinson v. Commissioner, 70 F.3d 34, 38 (5th Cir.1995), cert. denied, 519 U.S. 822, 117 S.Ct. 83, 136 L.Ed.2d 40 (1996)); see generally Commissioner v. Miller, 914 F.2d 586, 592 (4th Cir.1990), aff‘d after remand, 60 F.3d 823 (4th Cir.1995) (table) (discussing “a myriad of ways” in which litigation proceeds which were not allocated by the parties might be allocated by the tax court).
Accordingly, we hold that the district cоurt erred in granting summary judgment in favor of the IRS. The parties should have been allowed to proceed until the court was able to resolve the ambiguities in the record regarding the respective percentages of the settlement which were “capital” and “ordinary,” and to allocate the settlement proceeds based on its findings.
C.
The problem of how to allocate Dye’s attorneys’ fees and legal expenses between capital expenditures and ordinary non-business profit making expenses is perhaps more difficult than the problem of how to allocate Dye’s settlement proceeds between ordinary and capital income. While, as discussed supra, Dye’s settlement proceeds may be (roughly) allocated in proportion to the categories of damages claimed by Dye, the relevance of the categories of damages claimed to the allocation of Dye’s legal expenditures is subject to debate.
Notably, at least one appellate court has held that, under the “origin of the claim” test, the tax treatment of legal expenditures should not necessarily be based on the relative amounts of capital and ordinary income ultimately received. Baylin v. United States, 43 F.3d 1451, 1453 (Fed.Cir.1995). Rather, under the Baylin court’s approach, legal expenditures should be allocated according to the approximate proportion of the lawyers’ efforts attributable to the pursuit of each claim. See id. at 1454. Thus, in Baylin, the court rejected as an “unsupported assumption” a taxpayеr’s attribution of half of his legal fees to “collection of income,” despite the facts that: (1) half of the recovery was ordinary income; and (2) half of the legal fees were paid out of that recovery. Id. The Baylin court predicated its rejection on the fact that “the evidence presented on the attorney’s allocation of his time suggests that he spent a de minimis amount attempting to increase the [ordinary income] portion of the award.” Id.
In the present context, we decline to choose a side in this debate. Rather, we note that under any method of allocation, it is clear that some of Dye’s legal expenses originated in capital claims, as the IRS now concedes. Thus, we merely hold that Dye’s legal expenses should have been allocated, in some rough or approximate way, between her “capital” and “ordinary” claims. Whether this allocation might best have been made according to the proportion of Dye’s lawyers’ efforts dedicated to pursuing each category of claims (the Baylin approach), or simply according to the proportion of the settlement proceeds representing each category of claims, or any other reasonable way (the Leonard approach), is not before us now.
CONCLUSION
We REVERSE the district court’s grant of summary judgment in favor of the IRS, and REMAND for further proceedings not inconsistent with this opinion. Upon remand, the district court should allocate Dye’s $207,617.37 in legal exрenses between ordinary and capital expenses. At the IRS’s request, the court should also allocate Dye’s $572,905.97 in settlement proceeds between ordinary and capital income, for purposes of establishing a set off to any refund that may be awarded to Dye.