In this dispute over the proper application of the tax-benefit rule, defendant, the Department of Treasury, appeals as of right the Court of Claims’ order denying its motion for summary disposition, granting plaintiffs’ motion for summary disposition, reversing the Department’s decision and order of determination, and compelling the Department to refund plaintiffs $174,214, plus interest. We hold that although the Court of Claims correctly ruled that the Income Tax Act (ITA), MCL 206.1 et seq., necessarily incorporates the federal tax-benefit rule, the rule was not applicable in this case. Therefore, we reverse the opinion and order of the Court of Claims.
I. BACKGROUND
This case finds its genesis in plaintiffs’ attempt to recover their lost investment in the Pupler Distributing
In late 2002, plaintiffs discovered that Pupler was a Ponzi scheme with no legitimate business purpose. Pupler’s interest payments to plaintiffs ceased at that time, with Pupler owing plaintiffs $5,108,500 in outstanding loans. As a result, plaintiffs claimed a theft-loss deduction of $5,108,500 for this lost investment on their 2002 federal tax return pursuant to 26 USC 165, and reduced their federal tax liability accordingly. Notably, the theft-loss deduction is taken “below the line” (i.e., after the determination of adjusted gross income). Consequently, because Michigan tax liability is based on the federal definitions of adjusted gross income,
On November 14, 2002, an involuntary petition was filed in the United States Bankruptcy Court against Pupler pursuant to chapter 7 of the bankruptcy code, 11 USC 701 et seq. The bankruptcy trustee subsequently demanded that plaintiffs return the $4,346,680 in interest payments they had received from Pupler, plus a 10 percent premium on the interest earned. Plaintiffs eventually entered into a settlement agreement with the bankruptcy trustee permitting them to offset the
Based on this transaction, plaintiffs reported a theft-loss recovery of $4,200,160 (the estimated total amount of their recovered lost investment) on their 2004 federal income tax return.
The Department subsequently audited plaintiffs’ 2004 income tax return and issued a notice of intent to assess on the ground that the tax-benefit rule did not apply and,
Plaintiffs paid the assessed tax and interest before initiating suit in the Court of Claims on January 28,2009. In their complaint, plaintiffs requested an order requiring the Department to apply the tax-benefit rule and claim-of-right doctrine and to issue a tax refund. The Department answered in due course, and plaintiffs filed their motion for summary disposition under MCR 2.116(0(10) (no genuine issue of material fact).
According to plaintiffs, since the federal theft-loss deduction provided no Michigan income tax benefit, the theft-loss recovery was not includable in plaintiffs adjusted gross income under the tax-benefit rule because the ITA specifically incorporates definitions and deductions of the Internal Revenue Code. The Department responded that because plaintiffs failed to prove remission of their interest payment from Pupler to the trustee, who in any event did not have authority to require such a payment, and alternatively, because the ITA did not provide for the application of the tax-benefit rule to theft losses, the court should grant the Department summary disposition under MCR 2.116(I)(2) (opposing party entitled to judgment) and dismiss plaintiffs’ complaint.
In a 10-page opinion and order, the Court of Claims held that the tax-benefit rule was applicable based on
Based simply on the plain language of the Act itself, it appears that the tax benefit rule must be recognized in Michigan. After all, the Act adopts by reference the definitions and principles contained in federal law and the Internal Revenue Code, and the Internal Revenue Code, in turn, incorporates the tax benefit rule. Defendant, however, points to the fact that the Legislature in certain circumstances, explicitly provided in the Act for adjustments to one’s taxable income to account for deductions that may be taken on one’s federal taxes but not on one’s Michigan income tax returns, such as state, city, and property tax refunds. Noting that the Legislature thus knew how to provide for such adjustments when it wanted to, but that it did not provide for such an adjustment based on Michigan’s non-recognition of the Theft Loss Deduction, Defendant argues that clearly the Legislature did not intend to adopt the tax benefit rule in Michigan’s Income Tax Act in such circumstances. This is an equally viable interpretation. [Emphasis in original.]
Noting that such an ambiguity must be construed in plaintiffs’ favor, the court found that “the Michigan Income Tax Act itself provides for the recognition of the tax benefit principle.” Additionally, the court rejected the Department’s argument that plaintiffs failed to remit their interest repayment to the trustee since plaintiffs had offset their interest repayment by the amount of their lost investment. Accordingly, the court granted summary disposition to plaintiffs, reversed the Department’s decision and order of determination, and canceled plaintiffs’ December 26, 2008, final bill for taxes due. Plaintiffs were therefore entitled to a refund of $174,214, plus interest. The instant appeal ensued.
II. ANALYSIS
On appeal, the Department reiterates its challenge to plaintiffs’ eligibility for a tax refund. The Court reviews de
A. PLAINTIFFS’ PAYMENT TO THE TRUSTEE
Before reaching the merits of the applicability of the tax-benefit rule, we first address the Department’s preliminary contention that plaintiffs are not entitled to a refund since they failed to remit to the bankruptcy trustee interest payments received from Pupler. The flaw of this argument is the failure to acknowledge that plaintiffs’ actual repayment to the trustee of $350,000 was the difference between the Pupler interest payments and plaintiffs’ lost investment. Further, as the lower court observed, the Department failed to submit any evidence calling into question the estimation of plaintiffs’ accountant that plaintiffs recovered only $4,200,120 of their lost investment. An opposing party’s allegations without documentary support are insufficient to create a genuine issue
Additionally, we reject the Department’s claim that the bankruptcy trustee lacked the legal authority to recover the interest payments from plaintiffs. In making this argument, the Department asserts that the trustee was only entitled to recover interest payments made within 90 days of the filing of the bankruptcy petition since the trustee found that no fraudulent transfers were made to plaintiffs. See 11 USC 547. The record reveals no such finding by the trustee, however. Instead, the trustee determined that plaintiffs were without fraudulent transfer liability because they had no net “Ponzi Profits.” In other words, the trustee’s determination pertained to the effect of plaintiffs’ offsetting their lost investment against the repayment of their interest payments as opposed to any fraudulent transfers per se.
And in any event, it is well established that in the absence of a defense under 11 USC 548(c) a bankruptcy trustee may recover the full amount paid to Ponzi scheme investors under 11 USC 548(a)(1)(A), because the question of intent to defraud is not debatable. See, e.g., Fisher v Sellis (In re Lake States Commodities, Inc),
B. THE TAX-BENEFIT RULE
We now turn to the central issue in this case: whether the tax-benefit rule permitted plaintiffs to deduct their theft-loss recovery in calculating their tax liability. This
1. DOES THE ITA RECOGNIZE THE TAX-BENEFIT RULE?
The ITA subjects the “taxable income” of every individual other than a corporation to a state income tax. MCL 206.51(1). Notably, the ITA expressly incorporates federal principles in calculating taxable income so that terms in the ITA have the same meaning as when used in a comparable context in federal law. MCL 206.2 provides, in relevant part:
(2) Any term used in this act shall have the same meaning as when used in comparable context in the laws of the United States relating to federal income taxes unless a different meaning is clearly required. Any reference in this act to the internal revenue code shall include other provisions of the laws of the United States relating to federal income taxes.
(3) It is the intention of this Act that the income subject to tax be the same as taxable income as defined and applicable to the subject taxpayer in the internal revenue code, except as otherwise provided in this act.
Both “adjusted gross income” and “taxable income” are defined in the Internal Revenue Code (IRC) as gross income minus allowable deductions. 26 USC 62; 26 USC 63. The ITA, in turn, defines “taxable income” as “adjusted gross income as defined in the internal revenue code” minus certain specified adjustments. MCL 206.30(1).
The federal provision under which plaintiffs seek to deduct their theft-loss recovery is the tax-benefit rule.
Instructive in applying the tax-benefit rule are the cases of Preston v Dep’t of Treasury,
Cook followed the reasoning of Preston, but concluded that the taxpayers in that case were not entitled to a deduction. At issue in Cook was whether oil and gas expenses are deductible even though oil and gas proceeds are exempt from tax under the ITA. Cook,
From these cases, it is clear that taxable income in Michigan is to be calculated using the definitions in the IRC. Indeed, this is precisely what the plain language of MCL 206.2(3) mandates. This is, of course, different than saying taxable income in a Michigan tax return is identical to taxable income in a federal tax return.
To determine whether the ITA recognizes the federal tax-benefit rule, then, we must turn to the relevant definitions. Regarding taxable income, the ITA directs that we look to the IRC’s definition of adjusted gross income. MCL 206.30(1). That definition provides that the starting point in calculating adjusted gross income is gross income. 26 USC 62. This definition is key because the tax-benefit rule pertains directly to the calculation of gross income. 26 USC 111(a); Allstate Ins Co v United States, 936 F2d 1271, 1275 (CAFed, 1991). Therefore, it follows that since the tax-benefit rule is one part of the calculus in determining a taxpayer’s federal adjusted gross income, the ITA’s own definition of taxable income necessarily permits plaintiffs to invoke the provisions of the tax-benefit rule if they are applicable to their circumstances.
2. DOES THE TAX-BENEFIT RULE APPLY HERE?
As previously noted, the plain language of the tax-benefit rule permits a taxpayer to exclude from gross income any income that is recovered during the taxable year that was previously deducted in a prior taxable year as long as that previous deduction did not reduce the taxpayer’s tax liability under the IRC. 26 USC
Plaintiffs point out that because they previously claimed a theft-loss deduction on their 2002 federal tax return, the tax-benefit rule is applicable in calculating their 2004 Michigan tax liability because they received no Michigan tax benefit for the deduction. This argument, however, ignores that the theft-loss deduction in 2002 was taken only in calculating plaintiffs’ federal tax return and reducing their 2002 federal tax liability for that year. Indeed, it is because the theft-loss deduction did result in a reduced tax that plaintiffs could not invoke the tax-benefit rule in calculating their 2004 federal tax return. For somewhat similar reasons, because the ITA does not provide for a theft-loss deduction, the tax-benefit rule does not apply by its very terms.
The deduction permitted in MCL 206.30(l)(s), however, would be an exception to the rule enunciated in the analysis above since it would permit a federal deduction to trigger the tax-benefit rule to a Michigan tax return. Notwithstanding, in this respect the benefit of MCL 206.30(l)(s) is not an application of the tax-benefit rule as implicitly recognized by MCL 206.2, since the tax-benefit rule recognized by MCL 206.2 looks to previous deductions on a Michigan tax return in calculating income subject to state tax. Thus, MCL 206.2’s recognition of the tax-benefit rule does not render MCL 206.30(l)(s) surplusage or nugatory as the Department claims, nor does it create an ambiguity in the law as the Court of Claims ruled.
Nevertheless, the fact that the ITA specifically permits a taxpayer to use a deduction from federal tax returns in calculating Michigan adjusted gross income in certain circumstances (i.e., state and city taxes) and not in others (i.e., the theft-loss deduction) strongly implies that the Legislature did not intend to permit application of the tax-benefit rule to the situation at hand. See American Federation of State, Co & Muni Employees v Detroit,
III. CONCLUSION
In view of the foregoing analysis, we hold that although the ITA necessarily incorporates the federal tax-benefit rule, the rule was not applicable in this case. Plaintiffs were not entitled to deduct their theft-loss recovery from their 2004 Michigan tax return. We are aware that because of our ruling today, plaintiffs will receive no Michigan tax benefit for their losses in a Ponzi scheme and, in fact, must pay additional taxes because of their theft-loss recovery. The proper forum to address this problem, however, is the Legislature and not this Court. Casco Twp v Secretary of State,
The opinion and order of the Court of Claims is hereby reversed.
No costs, a public question being involved.
Notes
A “Ponzi” or “Ponzi scheme” is defined as “a swindle in which a quick return on an initial investment paid out of funds from new investors lures the victim into bigger risks.” Random, House Webster’s College Dictionary (2d ed, 1997). It is named after Charles Ponzi, who was the organizer of such a scheme during 1919 and 1920. Id.
See MCL 206.30.
Plaintiffs also reported a claim-of-right deduction of $4,346,680 on their federal tax return to account for their interest repayment. When reduced by the theft-loss recovery, plaintiffs claimed a net deduction on their federal taxes of $146,520 for the bankruptcy transaction.
The tax-benefit rule provides that “[g]ross income does not include income attributable to the recovery during the taxable year of any amount deducted in any prior taxable year to the extent such amount did not reduce the amount of tax imposed by this chapter.” 26 USC 111(a).
The ITA was subsequently amended to provide for such a deduction. MCL 206.30(l)(o) and (p).
Michigan law does not provide for a,theft-loss deduction. This is so because the theft-loss deduction is taken below the line and consequently is not included in the ITA’s definition of adjusted gross income. Neither party disputes this point.