Lead Opinion
In 1987, a stockbroker misappropriated $194,000 from petitioner-appellant Harv L. Jeppsen. Jeppsen claimed a deduction for this theft loss on his 1987 federal income tax return. In 1988, Jeppsen began a seven-year litigation campaign to recover his stolen money. In 1992, respondent-appellee Commissioner of Internal Revenue (“the IRS”) disallowed Jeppsen’s 1987 theft loss deduction, on the grounds that it was reasonably foreseeable by the end of 1987 that Jeppsen would recover the stolen money. Shortly thereafter, Jeppsen challenged this disallowance in tax court.
In March, 1995, Jeppsen’s campaign to recover his stolen money achieved fruition, when Jeppsen was awarded almost $1,500,-000 in general and punitive damages, interest, attorney’s fees, and costs. Four months later, after learning of this awayd, the tax court agreed with the IR.S that Jeppsen ,was. not entitled .to the theft loss deduction claimed on ■ his 1987 tax return. Jeppsen appeals the decision of the Tax Court. Because we find that as of December 31, 1987, it could not be ascertained with reasonable
BACKGROUND
The facts of the present case are largely undisputed. In February or March of 1986, appellant Harv L. Jeppsen, a self-employed carpet installer and -high school graduate, began investing money .through, .George Barker, a securities dealer with the E.F. Hutton Group brokerage firm. Jeppsen v. Commissioner,
Barker, who knew that Jeppsen was not experienced or sophisticated in securities investments, fraudulently established Jeppsen’s E.F. Hutton account as a discretionary account in order to authorize Barker to transact securities trades in the account. Shortly thereafter, Barker began to “churn” Jeppsen’s investments by purchasing and selling various call options.
In September, 1986, Barker left E.F. Hutton and began working at the brokerage securities firm of Piper, Jaffray and Hop-wood, Inc. (“PJ & H”). In December, 1986, Jeppsen transferred his E.F. Hutton account to PJ & H so that Barker could continue to act as his broker. At that time, Barker fraudulently obtained Jeppsen’s signature on documents needed to open a PJ & H margin account in Jeppsen’s name. In addition, without Jeppsen’s permission and without ever obtaining Jeppsen’s signature, Barker established Jeppsen’s primary PJ & H account as a discretionary account.. Barker then invested much of the money in this account in certain “penny stocks” whose price was manipulated by Barker and an accomplice through repeated purchases and sales.
In July, 1987, Jeppsen became aware of Barker’s activities, and ordered Barker to close his margin account immediately. Barker failed to close the account. When Jeppsen received his next monthly statement indicating that the margin account had not been closed, Jeppsen again ordered Barker to close the margin account. Barker again failed to close the account, and continued to execute new transactions in the account.
On October 7, 1987, Jeppsen specifically instructed Barker to immediately liquidate to cash the entire balance of Jeppsen’s PJ & H account, except for a mutual fund. Barker did so slowly, forging Jeppsen’s signature when necessary to liquidate certain high-risk derivative investments that Jeppsen had never authorized him to make.
On October 19, '1987, a date popularly known as “Black Monday,” the Dow Jones Industrial Average decreased in value by 22.6 percent. As a result, Jeppsen’s PJ & H account, which had not yet been liquidated, declined in value by approximately $194,000.
The following week, Jeppsen met with PJ & H’s branch manager and Barker’s supervisor, Don Larkin, to discuss the losses Jeppsen had suffered in his PJ & H account. Larkin initially told Jeppsen that because of the large negative balance in Jeppsen’s margin account all securities in his discretionary account would have to be sold to pay Jeppsen’s debt to PJ & H. When Jeppsen protested that the trading losses had been caused by Barker’s unauthorized activities in Jeppsen’s name, Larkin admitted to Jeppsen that Barker’s activities had been improper. Larkin then formally reprimanded Barker for the unauthorized discretionary trading in Jeppsen’s PJ & H account. Nonetheless, Larkin denied that PJ &. H was liable in any way for Barker’s actions. •
At the end of October, 1987, Jeppsen retained an attorney to investigate Barker’s actions with regard to Jeppsen’s brokerage accounts at E.F. Hutton and PJ & H. This attorney’s inquiries spurred PJ.& H’s legal counsel to send Jeppsen a letter dated December 21, 1987. The letter denied that PJ & H was in any way responsible for Jeppsen’s losses in his PJ & H account, and claimed that Jeppsen was merely a frustrated investor who had lost money as a result of the October 19,1987 fall in the stock market.
In December, 1987, a Salt Lake City law firm agreed to represent Jeppsen in an action to recover his losses, but required Jeppsen to pay on an hourly rather than contingency fee basis. The law firm told Jeppsen that he had a chance to win, but that the lawsuit would be long and costly. Jepps
On March 5, 1988, Jeppsen filed suit against Barker, PJ & H, and E.F. Hutton in federal district court in Utah. Jeppsen v. Piper, Jaffray & Hopwood, Inc.,
In July, 1988, while PJ & H’s motion was under consideration by the district court, Jeppsen filed his 1987 federal income tax return. On his return, Jeppsen claimed a theft loss deduction in the amount of $166,-627 relating to the losses he incurred in 1987 in his E.F. Hutton and in his PJ & H brokerage accounts.
On December 26, 1989, the district court granted PJ & H’s motion to stay proceedings pending arbitration and to compel arbitration. Jeppsen v. Piper, Jaffray & Hopwood, Inc.,
On August 31,1992, the IRS mailed Jeppsen a Notice of Deficiency regarding Jeppsen’s 1987 federal income tax. (R. Vol. III Doc. J Exh. 2-B). The claimed deficiency of $61,297.78
On March 17,1993, before his tax case was tried, Jeppsen filed his Statement of Claim with the National Association of Securities Dealers, which was to preside over the compelled arbitration against Piper, Jaffray and Barker & Larkin, Jeppsen v. Piper, Jaffray & Hopwood, Inc.,
On March 17, 1994, Jeppsen’s challenge to the IRS’s Notice of Deficiency was tried before the United States Tax Court in Salt Lake City, Utah. At that proceeding, the tax court was apprised that Jeppsen had won an award from the arbitration panel, but that the award was not final because the arbitration defendants still had until April 18, 1994 to appeal the award to the district court.
On March 6,1995, while Jeppsen’s tax case was still under advisement, the arbitration panel’s award in Jeppsen’s ease against PJ & H, Barker, and Larkin was confirmed by the United States District Court for the District of Utah. Jeppsen v. Piper, Jaffray & Hopwood, Inc.,
Shortly thereafter, an IRS attorney notified Jeppsen that the tax court had inquired as to whether a settlement had been reached
On July 24, 1995, the tax court denied Jeppsen’s Motion to Strike. In a brief Order, the court stated that it had requested information regarding the current status of Jeppsen’s lawsuits “solely for purposes of completeness.” It also noted that “the terms of the settlement of the lawsuit ... were not disclosed to the Court and that the confidentiality of the settlement was not breached.” (Aplt.’s App. at 78.)
Two days later, on July 26, 1995, the tax court issued a Memorandum Opinion sustaining the IRS’s disallowance of the theft loss deduction Jeppsen claimed for tax year 1987. Jeppsen v. Commissioner,
DISCUSSION
Under the Internal Revenue Code, a taxpayer may deduct from taxable income “any loss sustained during the taxable year and not compensated for by insurance or otherwise.” I.R.C. § 165(a). Under Section 165(c), such a loss includes “losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from ... theft.” I.R.C. § 165(c)(3). The IRS concedes that Barker’s actions constitute “theft,” and that Jeppsen’s loss therefore qualifies as a “theft loss” within the meaning of I.R.C. § 165. (Appellee’s Br. at 17). We agree. See Treas. Reg. § 1.165-8(d) (defining theft broadly to include larceny).
At issue here is whether Jeppsen’s theft loss was “sustained” during tax year 1987. Under the Internal Revenue Code, a theft loss is not “sustained” at the time the theft actually occurs. Rather, “any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss.” I.R.C. § 165(e). Further, the Treasury Regulations provide that even after a theft loss is discovered, if a claim for reimbursement exists during the year of the loss with respect to which there is a reasonable prospect of recovery, then a theft loss is treated as “sustained” only when “it can be ascertained with reasonable certainty whether or not such reimbursement [for the loss] will be obtained.” Treas. Reg. §§ 1.165 — l(d)(2)(i), 1.165 — 1(d)(3); accord Treas. Reg. § 1.165-8(a)(2). In essence, this has been interpreted to mean that the existence of a claim of reimbursement with a reasonable prospect of recovery will prevent a loss from being considered as “sustained” unless and until it is determined with reasonable certainty that such reimbursement will not be obtained. See, e.g. Rainbow Inn, Inc. v. Commissioner,
In the present case, based on the evidence before it the tax court found that, as of December 31, 1987, a viable legal claim for reimbursement existed and there was a reasonable prospect that Jeppsen would recover his stolen $194,000. For this reason, the tax court held that Jeppsen did not “sustain” a theft loss in 1987.
Jeppsen claims that the tax court erred in two principal respects. First, Jeppsen claims that the court should not have considered events that transpired after December 31, 1987, in determining whether Jeppsen had a reasonable prospect of recovering his stolen $194,000 by the end of 1987. Second and more fundamentally, Jeppsen claims that the tax court erred in concluding that by the end of .1987 Jeppsen had a reasonable prospect of recovering his stolen $194,000. We consider each of Jeppsen’s claims in turn.
I.
We review Tax Court decisions “in the same manner and to the same extent as
Although this question appears to be one of first impression in this circuit, it was addressed by the Supreme Court in a case involving a predecessor statute of the current I.R.C. § 165. In United States v. S.S. White Dental Mfg. Co.,
The Supreme Court agreed with the taxpayer’s reading of the statute. As the Court explained:
a loss may be complete enough for deduction without the taxpayer’s establishing that there is no possibility of an eventual recoupment. It would require a high degree of optimism to discern in the seizure of enemy property by the German government in 1918 more than a remote hope of ultimate salvage from the wreck of the war. The Taxing Act does not require the taxpayer to be an incorrigible optimist.'
Id. at 402-03,
By rejecting the I.R.S.’s exclusive reliance on events which transpired after 1918 as a basis for disallowing the taxpayer’s 1918 theft loss deduction, the S.S. White Dental Mfg. Co. court established that a taxpayer’s ultimate recovery does not control whether, at the end of a taxable year, that taxpayer enjoyed a reasonable prospect of recovering property stolen during that taxable year. However, S.S. White Dental Mfg.' Co. did not address the issue of whether the IRS or a court may consider a taxpayer’s ultimate recovery as one factor in its assessment of the reasonableness of the taxpayer’s ab initio prospect of recovery.
In perhaps the only case from any court to address this distinction directly, the tax court held that ultimate recovery is irrelevant if it was not reasonably foreseeable by the end of the pertinent tax year. The court said:
this Court must determine what was a “reasonable expectation” as of the close of the taxable year for which the deduction is claimed. The situation is not be viewed through the eyes of the “incorrigible optimist,” and hence, claims for recovery whose potential for success are remote or nebulous will not demand a postponement of the deduction. The standard is to be applied by foresight, and hence, we do not look at facts whose existence and production for use in later proceedings was not reasonably foreseeable as of the close of the particular year. Nor does the fact of a future settlement or favorable judicial action on the claim control our determination, if we find that as of the close of the particular year, no reasonable prospect of recovery existed.
Ramsay Scarlett & Co. v. Commissioner,
Both parties to the present ease agree with the court’s statement of the controlling legal principles in Ramsay Scarlett, although they disagree regarding the application of those principles to the present facts. We also agree with the court’s observation in Ramsay Scarlett that determination of a reasonable prospect of recovery is a question of foresight. See also Parmelee Transportation Co. v. United States,
Nonetheless, we reject Jeppsen’s claim that in the present case the tax court improperly considered evidence of Jeppsen’s ultimate recovery. We agree with Jeppsen that evidence of a recovery in 1995 should not have influenced the tax court’s ultimate finding regarding the reasonableness, as of December 31, 1987, of Jeppsen’s prospect of recovery. We note, however, that the tax court expressly stated that its finding was not influenced by its receipt of such evidence. Indeed, in its July, 24, 1995 Order denying Jeppsen’s Motion' to Strike, the tax court expressly stated 'that it had sought information regarding the current status of Jeppsen’s lawsuits against PJ & H, Barker, and Larkin, not for any purpose related to the court’s decision making process, but rather “solely for purposes of completeness.” In the same Order, the tax court also noted that “the terms of the [final] settlement of the lawsuit ... were not disclosed to the Court and ... the confidentiality of the settlement was not breached.” (Aplt.’s App. at 78.) Thus, although the tax court was privy to the details of the arbitration panel’s award to Jeppsen, it never learned how much money Jeppsen actually accepted in order to settle the defendants’ appeal to this court.
Two days after denying Jeppsen’s Motion to Strike, the tax court issued its Memorandum Opinion in the present case. Jeppsen v. Commissioner,
We agree with the tax court that a statement of the ultimate disposition of Jeppsen’s suits against PJ & H, Barker, and Larkin is helpful to the reader in understanding the facts of the case, and thus contributes to the “completeness” of that court’s written Memorandum Opinion.
We now consider the central issue in the case: whether the tax court erred in its determination that, as of Dec. 31, 1987, Jeppsen had a reasonable prospect of recovering his stolen $194,000. Pursuant to I.R.C. § 7482(a)(1) and Fed.R.Civ.P. 52(a), we review the tax court’s factual findings under the “clearly erroneous” standard. Anderson v. Commissioner,
We review mixed questions of law and fact either under the clearly erroneous standard or de novo, depending on whether the mixed question is primarily factual or legal. Id. Where, as here, the sole issue is whether the facts satisfied the statutory standard, we ordinarily would be inclined to review the Tax Court’s application of the law to the facts de novo. First Nat'l Bank v. Commissioner,
However, Treas. Reg. § 1.165-l(d)(2)(i) provides that “[wjhether a reasonable prospect of recovery exists with respect to a claim for reimbursement of a loss is a question of fact to be determined upon an examination of all facts and circumstances.” This regulation was promulgated pursuant to the Secretary of the Treasury’s express authority to “prescribe all needful rules and regulations for the enforcement of’ the Internal Revenue Code. I.R.C. §' 7805(a). It appears to reflect the longstanding maxim that losses claimed under I.R.C. § 165 are to be allowed or disallowed in accordance with practical or realistic considerations. See Estate of Scofield v. Commissioner,
This court has long held that “a regulation promulgated by an administrative agency charged with the administration of an Act has the force and effect of law if it is reasonably related to administrative enforcement and does not contravene statutory provisions.” Joudeh v. United States,
Even more pertinent to the ease at bar, the Supreme Court has long held that “ ‘[treasury regulations and interpretations long continued without substantial change, applying to unamended or substantially reenacted statutes, are deemed to have received congressional approval and have the effect of law.’ ” Cottage Sav. Ass’n,
Consequently, we conclude that “[w]hether a reasonable prospect of recovery exists with respect to a claim for reimbursement of a loss is a question of fact____” Treas. Reg. § 1.165 — 1 (d)(2) (i). Accordingly, we review the district court’s findings in that regard under the “clearly erroneous” standard.
In conducting our review, we note that Jeppsen bears the burden of proving his entitlement to the theft loss deduction. See Interstate Transit Lines v. Commissioner,
“A reasonable prospect of recovery exists when the taxpayer has bona fide claims for recoupment from third parties or otherwise, and when there is a substantial possibility that such claims will be decided in his favor.” Ramsay Scarlett,
The “reasonableness” of a taxpayer’s prospect of recovery is primarily tested objectively, although a court may'consider to a limited extent evidence of the táxpayer’s subjective contemporaneous assessment of his own prospect' of recovery. Ramsay Scarlett,
Under Treas. Reg. § 1.165 — l(d)(2)(i), a taxpayer’s prospects of recovery “may be ascertained with reasonable certainty, for example, by a settlement of the claim, by an adjudication of the claim, or by an abandonment-of the claim.” Courts have occasionally suggested that the fact that a taxpayer files a lawsuit may give rise to an inference that the taxpayer has a reasonable probability of recovering his loss. See Dawn v. Commissioner,
We agree that the fact that a taxpayer, in a given tax year, contemplates filing a suit to recover his losses may be considered in the mix of evaluating whether the taxpayer has a reasonable prospect of recovery. However, like any other subjective factor, this inference should not control the outcome of the case. See Boehm,
With these principles in mind, we review the tax court’s determination in the present case. In support of its position that Jeppsen was not entitled to a theft loss deduction in tax year 1987 for the losses he suffered that year at the hands of stockbroker Barker, the tax court found that, by the end of 1987:(1) Barker had engaged in conduct that was both illegal and actionable; (2) Jeppsen knew what Barker had done; (3) Jeppsen began shopping for lawyers immediately and never at any time ceased attempting to recover his money; (4) Barker’s former employers PJ & H and E.F. Hutton were proper co-defendants, both of whom had more than sufficient assets available to satisfy any judgment awards against them; and (5) Jeppsen filed suit in March, 1988, several months before he filed his 1987 tax return.
As Jeppsen points out, several countervailing facts indicate that Jeppsen’s prospects of recovery were never, until he prevailed, 100 percent. In particular, Jeppsen notes that: (1) both PJ & H and E.F. Hutton consistently disclaimed any liability; (2) no lawyer contacted by Jeppsen would take his ease on a contingency basis; and (3) several lawyers — including the firm he eventually retained — told Jeppsen that the case would be lengthy and expensive to pursue, with no guarantee of winning. Jeppsen asserts that these factors in the aggregate might have discouraged a reasonable, person from bringing even a meritorious suit.
We appreciate the substantial risk that Jeppsen faced, and the significant effort that was required in order for Jeppsen to recover his stolen money. Indeed, faced with such obstacles, Jeppsen might reasonably have had decided to abandon his claims against Barker et al. in 1987. However, Jeppsen did not abandon his claims, in 1987 or ever. Rather, he sought in 1987 to determine whether and how he could recover his lost $194,000, and then steadfastly pursued all available legal remedies. Further, his suit was not based on a meritless legal theory, compare Rainbow Inn, Inc.,
Accordingly, we cannot say that the tax court clearly erred in sustaining the IRS’s disallowance of Jeppsen’s claimed 1987 theft loss deduction. The judgment of the tax court is therefore AFFIRMED.
Notes
. Jeppsen’s theft loss deduction of $166,627 was less than his claimed actual theft loss of $193,712 because the IRS requires actual theft losses to be reduced by ten percent of adjusted gross income, plus $100, prior to being deducted. See 1987 IRS Form 4684 (R. Vol. Ill Doc. 1).
. The IRS also assessed Jeppsen an addition to tax of $9,735 under I.R.C. § 6651, due to Jeppsen’s delinquency in paying the deficiency of $61,-297.78 which the IRS claimed should have been paid with Jeppsen's 1987 tax return. (R. Vol. Ill Doc. J Ex. 2-B).
. See Jeppsen v. Commissioner,
. Indeed, we have included a statement regarding Jeppsen’s successful recovery in the "BACKGROUND” section of the present opinion.
. A finding is "clearly erroneous” when "the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed.” United States v. United States Gypsum Co.,
. Boehm did not involve the theft loss deduction at issue here, but rather a deduction available to holders of corporate stock that becomes worthless. However, the Fourth Circuit in Ramsay Scarlett analogized to Boehm in a very similar context, and we agree that the analogy is apt.
Dissenting Opinion
dissenting.
A.
The court places an insurmountable barrier on the taxpayer by requiring that he must
The “closed transaction doctrine,” on which the court relies, does not require proof that the loss will never be recovered. Rather, it merely requires that reasonable prospects of recovery must be exhausted before a transaction will be considered closed and completed. Ramsay Scarlett & Co. v. Commissioner,
B.
“Whether a reasonable prospect of recovery exists with respect to a claim for reimbursement of a loss is a question of fact to be determined upon an examination of all facts and circumstances.” Treas. Reg. § 1.165-l(d)(2)(i). The Tax Court’s finding in this case is reviewed under the “clearly erroneous” standard; “[a] finding is ‘clearly erroneous’ when although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed.” United States v. United States Gypsum Co.,
Several well-established principles guide review. In determining whether a reasonable prospect of recovery exists, the relevant facts and circumstances are those that are known or reasonably could been known as of the end of the tax year for which the loss deduction is claimed. See Halliburton Co. v. Commissioner,
One of the facts and circumstances deserving of consideration is the probability of success on the merits of any claim brought by the taxpayer. While it is true that the filing of a lawsuit may give rise to an inference of a reasonable prospect of recovery, Dawn v. Commissioner,
Surely a “reasonable prospect of recovery” encompasses an assessment of litigation risk at the time the deduction is claimed; given the uncertainty of trial and proof, there is a world of difference between pleading a claim, proving it and bringing it to judgment. Moreover, the obvious defenses to a claim cannot be ignored, nor can the financial capacity of a defendant to vigorously contest liability. At the Tax Court trial, the only testimony about the mechanics of the taxpayer’s claim and the defenses raised was the attorney who prosecutéd the claim, an expert in the field of securities litigation. No persuasive reason exists for disregarding his testimony. See Ramsay Scarlett,
Here, despite the taxpayer’s belief that he had been wronged, virtually no evidence existed to substantiate the taxpayer’s claims as of December 31, 1987. From a procedural perspective, the taxpayer had signed an account agreement with PJ & H that contained an arbitration clause that would limit discovery, so it was necessary to mount an attack on the validity of the arbitration clause in federal court (an attack that would ultimately prove unsuccessful), in part to obtain the liberal discovery allowed by the federal rules. The scope of discovery that was ultimately allowed in federal court greatly benefitted the taxpayer, but that scope was fortuitous.
The merits of the case depended not only upon credibility, but also a determination of whether PJ & H could be responsible for the activities of its broker. PJ & H denied liability and responsibility for its broker, despite an admission by the branch manager that the unauthorized discretionary trading was improper. The parties have stipulated that the broker’s actions constituted theft under Utah law, and only if taxpayer could prove that the broker’s conduct was in the course and scope of his employment would there be vicarious liability based upon respondeat superior. See Jackson v. Righter,
As of December 1987, PJ & H also could be expected to defend on the basis that (1) the taxpayer was a sophisticated, aggressive investor who authorized the transactions and sought return without regard for risk, (2) the taxpayer had received confirmations and account statements and therefore had ratified the transactions, and (3) the taxpayer was merely trying to avoid the consequences of the 1987 market fall. I am persuaded that all of these objective factors viewed as of December 1987, together with the taxpayer’s statement on cross-examination that he pursued the matter as a moral issue, despite advice that his chances were not very good, Aplt.App. at 155, render the Tax Court’s finding clearly erroneous.