Hamilton v. CIR ( 2020 )

FILED
United States Court of Appeals
Tenth Circuit
PUBLISH April 7, 2020
Christopher M. Wolpert
UNITED STATES COURT OF APPEALS Clerk of Court
TENTH CIRCUIT
VINCENT C. HAMILTON and
STEPHANIE HAMILTON,
Petitioners - Appellants,
v. No. 19-9000
COMMISSIONER OF INTERNAL
REVENUE,
Respondent - Appellee.
APPEAL FROM THE UNITED STATES
TAX COURT
(NO. 1: 008037-16)
Paul W. Jones, Hale & Wood, LLP, Salt Lake City, Utah, for Appellants.
Julie Ciamporcero Avetta, Attorney, Tax Division (Richard E. Zuckerman,
Principal Deputy Assistant Attorney General, and Francesca Ugolini, Attorney,
Tax Division, with her on the brief), Department of Justice, Washington, D.C., for
Appellee.
Before TYMKOVICH, Chief Judge, MATHESON and McHUGH, Circuit
Judges.
TYMKOVICH, Chief Judge.
The Internal Revenue Code permits taxpayers who demonstrate insolvency
to exclude discharged debts from their taxable income. Claiming insolvency,
taxpayer Vincent Hamilton accordingly sought to exclude nearly $160,000 in
student loans that were forgiven in the aftermath of a disabling injury. During the
same tax year, however, he had received a non-taxable partnership distribution
worth more than $300,000.
His wife transferred those funds into a previously-unused savings account
held nominally by their adult son. Using login credentials provided by their son,
Mrs. Hamilton incrementally transferred almost $120,000 back to the joint
checking account she shared with her husband. The Hamiltons used these funds
to support their living expenses.
In a late-filed joint tax return, they excluded the discharged student-loan
debt on the theory that Mr. Hamilton was insolvent. In calculating his assets and
liabilities, however, the Hamiltons did not include the funds transferred into the
savings account. Had they done so, Mr. Hamilton would not have met the criteria
for insolvency; and the couple would have owed federal income tax on the
student-loan discharge.
The Commissioner of Internal Revenue eventually filed a Notice of
Deficiency, reasoning that the partnership distribution rendered Mr. Hamilton
solvent, such that the Hamiltons were required to pay income tax on the cancelled
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debt. The Hamiltons petitioned for review from the Tax Court, which sustained
both the deficiency and a significant late-filing penalty. They timely appealed.
We AFFIRM. The Tax Court correctly concluded that the Hamiltons
exercised effective control over the funds Mrs. Hamilton had transferred into the
savings account.
I. Background
Prior to his disabling back injury in 2008, Mr. Hamilton borrowed more
than $150,000 to pay costs associated with medical school for his son. Mrs.
Hamilton, who managed the family’s finances in the aftermath of his injury,
subsequently sought to discharge these student-loan obligations. Her efforts met
with success, and these loans were fully discharged in 2011.
That same year, Mr. Hamilton received a non-taxable distribution worth
more than $300,000 from his partnership interest in a movie-theater business.
Mrs. Hamilton transferred these funds into a previously-unused savings account
held by their son, who then provided her with login credentials for the account. 1
Throughout Tax Year 2011, she withdrew nearly $120,000 to finance household
expenses for both parents.
1
Mrs. Hamilton included several thousand dollars that did not arise from
the partnership distribution among the funds she transferred into the savings
account. The total value of the funds transferred exceeded $320,000.
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The Hamiltons did not file a federal return for Tax Year 2011 until March
2014. Filing jointly, they reported just over $850,000 in liabilities and just under
$680,000 in assets. But these figures made no mention of the funds that Mrs.
Hamilton had moved into the savings account. One consequence of this omission
now stands out as particularly important. Mr. Hamilton self-identified as
insolvent, because—using these numbers—his liabilities exceeded his assets by
roughly $170,000. 2 For this reason, the Hamiltons sought to pay no federal
income tax on the discharged debt.
If they had included the partnership distribution as an asset for purposes of
the insolvency determination, then Mr. Hamilton’s assets (around $1,000,000,
under this new math) would have outnumbered his liabilities (still $850,000) by
roughly $150,000. Obviously, this calculus would deprive Mr. Hamilton of his
rationale for not paying federal income tax on the cancelled debt.
The Commissioner of Internal Revenue eventually filed a Notice of
Deficiency, reasoning that—because, in light of the funds contained within the
savings account, Mr. Hamilton’s assets outnumbered his liabilities—the couple
could not exclude the discharged debt from their federal tax return. The
Hamiltons disagreed, eventually taking the position that the funds Mrs. Hamilton
2
As the government acknowledged during oral argument, we assess
insolvency for purposes of 26 U.S.C. § 108 on an individual basis, even when
taxpayers file jointly.
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transferred into the savings account should be considered their son’s assets, rather
than their own.
The Hamiltons petitioned for review from the Tax Court, which—on the
basis of this same stipulated record—applied the doctrine of “substance over
form” to sustain the Notice of Deficiency. The Tax Court also sustained the late-
filing penalties. On appeal, the Hamiltons primarily argue the Tax Court erred in
characterizing the funds transferred into the savings account as their assets.
II. Analysis
We review decisions of the Tax Court in the same manner as civil actions
tried without a jury. Petersen v. Comm’r, 924 F.3d 1111, 1114 (10th Cir. 2019)
(citing Katz v. Comm’r, 335 F.3d 1121, 1125–26 (10th Cir. 2003)); see also 26
U.S.C. § 7482(a)(1). We accordingly review legal conclusions de novo and
factual determinations only for clear error. 3 Id. (citing same).
3
Because insolvency requires a factual determination, we review the Tax
Court’s treatment of the cancellation-of-indebtedness income primarily for clear
error. See Merkel v. Comm’r, 192 F.3d 844, 847 (9th Cir. 1999). The Hamiltons
contend the Tax Court’s denial of their claim presents a question of law, such that
we must engage in de novo review. Notwithstanding the legal arguments the
Hamiltons raise, the outcome of this case rests almost entirely upon the Tax
Court’s factual determination of their dominion over the assets contained within
the savings account. No matter the standard of review, however, it is clear that
the Hamiltons exercised effective control over the assets contained within the
savings account.
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A. Characterization of Assets
The Hamiltons contend the Tax Court erred in characterizing the funds
contained within the savings account as their assets for purposes of the insolvency
inquiry. As our application of governing law to these stipulated facts will
demonstrate, we disagree.
1. Governing Law
The Internal Revenue Code broadly defines gross income to encompass “all
income from whatever source derived,” including income from the discharge of
indebtedness. 26 U.S.C. § 61(a)(11). But a narrow statutory exception permits
taxpayers to exclude debt from discharged income, so long as the discharge
occurs at a time when the taxpayer is insolvent. 26 U.S.C. § 108(a)(1)(B).
This exception acknowledges the reality that insolvent taxpayers will
realize no income from discharge because—as a practical matter—no assets
become available to the taxpayer. See United States v. Kirby Lumber Co., 284
U.S. 1 (1931). For this reason, the Code also limits the exclusion of discharge-of-
indebtedness income to the amount by which the taxpayer’s liabilities exceed his
assets. See 26 U.S.C. § 108(a)(3); see also Carlson v. Comm’r, 116 T.C. 87, 91
(2001) (“[T]he term ‘insolvent’ means the excess of liabilities over the fair
market value of assets.”) (quoting 26 U.S.C. § 108(d)(3)).
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It is well-settled that the taxpayer bears the burden of demonstrating that
his liabilities outnumber his assets. E.g., Shepherd v. Comm’r, 104 T.C.M.
(CCH) 108 (2012) (citations omitted). Although the Code does not expressly
define the term “assets,” the Tax Court has, for these purposes, construed it to
include any resource that “can give the taxpayer the ability to pay an immediate
tax on income from the canceled debt.” Schieber v. Comm’r, 113 T.C.M. (CCH)
1144 (2017) (internal quotation marks omitted) (quoting Carlson, 116 T.C. at
104–05 (observing that even assets beyond the reach of other creditors could
constitute assets for the purposes of 26 U.S.C. § 108(d)(3))).
In conducting this practical inquiry, the Internal Revenue Service may
appropriately prioritize “substance over form.” E.g., Frank Lyon Co. v. United
States, 435 U.S. 561, 572–73 (1978) (citations omitted). In cases where, as here,
a “transferor continues to retain significant control over the property transferred,”
the Service may set aside niceties like formal title. Id. Indeed, we have
repeatedly ratified the propriety of prioritizing economic reality in place of the
formal characterizations taxpayers may lend transactions. See Rogers v. United
States, 281 F.3d 1108, 1116–17 (10th Cir. 2002) (“[T]he doctrine of substance
over form has been recognized in a number of our precedents.”).
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2. Application
The Tax Court appropriately applied the substance-over-form doctrine to
characterize the disputed funds as the Hamiltons’ assets for purposes of the
insolvency calculation required by 26 U.S.C. § 108. Given the evidence disclosed
by the stipulated record, the Tax Court properly concluded they exercised
effective ongoing control over these funds.
Prior to the transfer, the record suggests their son used this savings account
rarely, if at all. No evidence indicates the transfer represented a gift. 4 Nor did
their son pay any consideration in exchange for these funds. Moreover, he
immediately provided Mrs. Hamilton with login credentials so that she could
access these funds whenever she wanted. During Tax Year 2011, she withdrew
nearly $120,000 to cover living expenses. 5 Their son, by contrast, never withdrew
any of these funds.
Although the Hamiltons now contend he could have changed the login
credentials so as to lock out his mother, we think it more significant that he never
did so. See, e.g., Sanford’s Estate v. Comm’r, 308 U.S. 39, 43 (1939) (“[T]he
essence of a transfer is the passage of control over the economic benefits of the
4
The record discloses none of the tax documentation one might ordinarily
expect for a gift of this size.
5
Although only Mrs. Hamilton accessed these funds, it is undisputed that
she did so to pay joint living expenses.
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property rather than any technical changes in its title.”). Because the Hamiltons
retained effective control over the disputed funds, we conclude the Tax Court did
not err.
The Hamiltons also contend that—under Utah law—their son was the sole
owner of the savings account. 6 But this argument bears not at all on the
substance-over-form inquiry. See Carlson, 116 T.C. at 104–05 (observing that
assets beyond the reach of other creditors may nonetheless constitute assets for
federal tax purposes). This is because “taxation is not so much concerned with
the refinements of title as it is with the actual command over the property taxed.”
See Sanford, 308 U.S. at 43 (internal quotation marks and citations omitted).
The Hamiltons alternatively assert we should treat the disputed funds as
separate property owned solely by Mrs. Hamilton. This argument fails for much
the same reason, since—as we have seen—assets beyond the reach of ordinary
creditors may nonetheless constitute assets for federal tax purposes. See Carlson,
116 T.C. at 104–05. Here, the vast majority of the disputed funds arose from Mr.
6
On appeal, the Hamiltons advance a related argument—which they raised
for the first time in their motion for reconsideration below—that the Tax Court
lacked authority to apply the nominee inquiry to a deficiency proceeding. As the
government observes, we ordinarily will not consider arguments previously
available to litigants that were raised for the first time in post-judgment motions.
See Servants of Paraclete v. Does, 204 F.3d 1005, 1012 (10th Cir. 2000). Even if
we were to depart from that practice here, this argument would not disturb our
conclusion that the Tax Court did not err.
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Hamilton’s partnership distribution; and the funds Mrs. Hamilton withdrew during
Tax Year 2011 supported both of their living expenses. We accordingly conclude
that Mr. Hamilton—with Mrs. Hamilton acting as his agent—exercised effective
control over these funds. See Sanford, 308 U.S. at 43.
In our view, the Tax Court erred neither factually nor legally in sustaining
the Notice of Deficiency. 7
B. The Late-Filing Penalties
As a result of their two-year delay in filing a federal return for Tax Year
2011, the Internal Revenue Service assessed the Hamiltons late-filing penalties
pursuant to 26 U.S.C. § 6651(a)(1). The Tax Court sustained these penalties,
concluding their failure to file stemmed from willful neglect, rather than
reasonable cause. The Hamiltons also appeal that determination.
7
The Hamiltons have also argued the Tax Court erred in refusing to shift
the burden of persuasion to the government. Although taxpayers ordinarily must
carry the burden of persuasion with respect to any claimed deduction, a statutory
exception may shift this presumption back to the government on factual issues the
taxpayer supports with credible evidence. E.g., Esgar Corp. v. Comm’r, 744 F.3d
648, 653 (10th Cir. 2014) (citing 26 U.S.C. § 7491). To benefit from this burden-
shifting exercise, an individual taxpayer must have: (1) complied with the
requirements to substantiate any item; (2) maintained all required records; and (3)
cooperated with reasonable requests for witnesses, information, documents,
meetings, and interviews. Id. at 654 n.5 (cleaned up). The Tax Court concluded
the Hamiltons failed to abide by these requirements, such that the burden should
not shift. But we have observed “there is no need to rule on whether the burden
shifts” when “evidence is not equally balanced.” Id. at 654. Since the evidence
in this case strongly favors the government, we decline to consider this argument.
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The Code provides a limited exception for “reasonable cause” from
otherwise-steep penalties when taxpayers fail to timely file their returns. See 26
U.S.C. § 6651(a)(1). Because the presence or absence of reasonable cause
requires a factual determination, we review the Tax Court’s treatment of late-
filing penalties assessed under 26 U.S.C. § 6651(a)(1) for clear error. See In re
Craddock, 149 F.3d 1249, 1255 (10th Cir. 1998) (citing United States v. Boyle,
469 U.S. 241, 249 n.8 (1985)).
Precedent tells us the Hamiltons bear a “heavy burden” in seeking to
demonstrate reasonable cause. See id. (quoting United States v. Boyle, 469 U.S.
241, 245 (1985)). Indeed, we have previously observed that “reasonable cause
exists ‘if the taxpayer exercised ordinary business care and prudence and was
nevertheless unable to file the return within the prescribed time.’” Id. (quoting
Treas. Reg. § 301.6651-1(c) (emphasis in original)).
Here, the stipulated record offers no explanation that would account for the
Hamiltons’ failure to file timely their 2011 Tax Return. In briefing, they contend
their attention was “consumed with [Mr. Hamilton’s] care and well[-]being.”
Aplt. Br. 24. But the record discloses no evidence of incapacity, save for Mr.
Hamilton’s injury. And—during this same period—Mrs. Hamilton successfully
managed the complex task of obtaining the student-loan discharge.
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In our view, the Tax Court did not clearly err in upholding the late-filing
penalties assessed under 26 U.S.C. § 6651(a)(1).
III. Conclusion
For the reasons stated herein, we accordingly AFFIRM the judgment of the
Tax Court.
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