Hudson v. CIR ( 2004 )

IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
_____________________
No. 95-60148
_____________________
James L. Hudson,
Plaintiff-Appellant,
versus
Commissioner of Internal Revenue,
Defendant-Appellee.
_________________________________________________________________
Appeal from the United States Tax Court
(4272-92)
_________________________________________________________________
November 13, 1995
Before KING, DeMOSS, and STEWART, Circuit Judges.
PER CURIAM*:
James L. Hudson appeals the United States Tax Court's
affirmance of the Commissioner's determination of deficiencies
for the tax years 1981 through 1985. Finding no error, we
affirm.
I. BACKGROUND
*
Local Rule 47.5 provides: "The publication of opinions
that have no precedential value and merely decide particular
cases on the basis of well-settled principles of law imposes
needless expense on the public and burdens on the legal
profession." Pursuant to that Rule, the court has determined
that this opinion should not be published.
From 1982 to 1985, James L. Hudson ("Hudson"), through his
wholly-owned subchapter S corporation named Texas Basic
Educational Systems, Inc. ("TBES"), engaged in an investment
program in which TBES purchased and then leased master audio
tapes. TBES leased the master tapes to investors who were to
make cassette copies and market the copies on a retail basis to
consumers. In August 1982, Educational Audio Resources, Inc.
("EAR") was formed by Michael Brovsky and Chet Hanson to produce
and sell the master tapes to TBES.
During 1982 and 1983, TBES entered into agreements with EAR
to purchase 423 master audio tapes for $200,000 each. The
$200,000 purchase price for each master tape was represented by a
$5,000 cash payment and a $195,000 promissory note bearing
interest at an annual rate of ten percent for a ten-year term.
Under the terms of the promissory notes, TBES had no obligation
to make principal or interest payments during the ten-year term
unless it realized profits from the lease of the master tapes.
If TBES did realize a profit, payments on the notes were to be
made to the extent of 30% of the net profits. At the end of the
ten-year term, the balance and accrued interest would become due.
TBES has made no payments on the promissory notes.
EAR began producing the master tapes in late 1982 and 1983.
EAR's budgeted and actual costs of production for each master
tape were approximately $500, including between $100 and $200 for
the script writer, the cost of recording, and art work. The tax
court found that the quality of the master tapes was poor, that
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the scripts were written by unknown authors, poorly written, and
too short, and that the recordings were made with the voices of
unknown individuals and contained mispronunciations and
grammatical errors.
During 1982 and 1983, TBES entered into lease agreements for
the master tapes with 423 investors. Each investor agreed to pay
$10,000 cash plus 60% of the revenue generated from the sale of
cassette copies of the master tape. Hudson represented to the
investors that each master tape had a fair market value of
$200,000. Hudson also advised the investors that each would be
entitled to claim an investment tax credit of $20,000--10% of the
fair market value of the leased master tape--regardless whether
the investor sold any copies.
In March 1985, the commissioner brought suit in the United
States District Court for the Southern District of Texas ("the
prior proceeding") under Internal Revenue Code ("IRC") sections
6700 and 7408 to enjoin Hudson's further promotion of the master
audio tape investment program, alleging that the program was an
abusive tax shelter and that the master tapes were overvalued by
more than 200%. On August 16, 1988, after trial, the district
court denied the injunction, finding that the master audio tapes
leased by Hudson were not overvalued by more than 200%, that each
master tape was worth at least $100,000, and that Hudson's
actions in promoting the master audio tape investment program
were not illegal.
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The commissioner appealed the district court's judgment to
the United States Court of Appeals for the Fifth Circuit. On
April 3, 1990, this court affirmed the district court's judgment
denying the injunction, but on different grounds ("the Fifth
Circuit opinion"). Our entire opinion reads as follows:
This is an appeal from a denial of an injunction by a
United States District Court. The Internal Revenue
Service requested that defendants be enjoined from
engaging in activities violative of statutes and rules
regulating tax shelters. We affirm the denial of
injunctive relief but not for the reasons stated by the
district court. Rather, we affirm the denial of
injunctive relief for the reason that the record is
bereft of evidence sufficient to warrant a conclusion
that continuing violations were threatened. The
transactions complained of by the government have
apparently collapsed of their own weight. We emphasize
that we do not suggest that the government was
incorrect in its contentions that the complained of
transactions were not legal.
On December 21, 1988, Hudson filed his untimely 1982 and
1983 individual federal income tax returns on which he claimed
substantial losses related to TBES and created by depreciation
deductions for the master audio tapes. The commissioner, after
an audit, disallowed the losses on the grounds that the master
audio tapes purchased by TBES had little or no value and did not
support the substantial depreciation deductions taken, that the
promissory notes issued as payment for the tapes were not
genuine, and that the master tapes were not "placed in service"
in 1982 and 1983.
On February 27, 1992, Hudson filed a petition in the tax
court challenging the deficiencies assessed by the commissioner
("the tax court proceeding"). After trial on March 5, 1993, the
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tax court requested that the parties brief the collateral
estoppel issue that had been raised by Hudson. On June 23, 1993,
the tax court entered an opinion holding that the commissioner
was not collaterally estopped from litigating the fair market
value of the master tapes by the district court's finding in the
prior proceeding that each tape was worth at least $100,000,
because the Fifth Circuit specifically declined to address this
fact finding in affirming the denial of the injunction.
On July 27, 1994, the tax court entered an opinion holding
that: (1) the promissory notes did not constitute genuine
indebtedness; (2) each master tape had a fair market value of
$5,000 or less; (3) no master tapes were placed in service in
1982, and 125 master tapes were placed in service in 1983; (4)
TBES is thus entitled to depreciation deductions for 125 master
tapes beginning in 1983 at a cost basis of $5,000; (5) no
depreciation is allowed for the remaining 298 master tapes
because they were not produced or placed in service in 1982 and
1983; and (6) because the promissory notes were not genuine,
Hudson did not realize any discharge of indebtedness income in
1984 and 1985. The tax court's decision assessing deficiencies
in income tax and additions to tax for the tax years 1981 through
1985 was entered on November 22, 1994. Hudson filed a timely
notice of appeal on February 16, 1995.
II. STANDARD OF REVIEW
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We review the decision of a tax court under the same
standards that apply to district court decisions. Thus, issues
of law are reviewed de novo, and findings of fact are reviewed
for clear error. Park v. Commissioner, 25 F.3d 1289, 1291 (5th
Cir.), cert. denied, 115 S. Ct. 673 (1994); McKnight v.
Commissioner, 7 F.3d 447, 450 (5th Cir. 1993). A finding of fact
is clearly erroneous when, although there is enough evidence to
support it, the reviewing court is left with a firm and definite
conviction that a mistake has been committed. Henderson v.
Belknap (In re Henderson), 18 F.3d 1305, 1307 (5th Cir.), cert.
denied, 115 S. Ct. 573 (1994).
III. DISCUSSION
On appeal, Hudson presents two arguments. First, he
contends that the tax court erred in holding that the
commissioner was not collaterally estopped from litigating the
fair market value of master audio tapes for which Hudson had
claimed depreciation deductions. Second, Hudson argues that the
tax court's determination that Hudson was entitled to
depreciation deductions with respect to only 125 master audio
tapes in 1983, and none in 1982, was clearly erroneous. We will
address each claim of error in turn.
A. Collateral Estoppel
Hudson argues that the doctrine of collateral estoppel
should have been applied by the tax court to preclude the
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commissioner from relitigating the fair market value of the
master tapes in the tax court proceeding because the district
court in the prior proceeding conclusively found that each master
tape had a fair market value of at least $100,000. The
government argues that the tax court correctly determined that
the district court's findings of fact in the prior proceeding do
not have preclusive effect.
The doctrine of collateral estoppel prevents relitigation
between the same parties of issues of fact or law that were
decided in an earlier proceeding on a different cause of action.
Montana v. United States, 440 U.S. 147, 154-55 (1979). The
purposes of collateral estoppel are to protect parties from the
burden of relitigating an issue that has been already decided and
to prevent inefficient use of judicial resources. Parklane
Hosiery Co. v. Shore, 439 U.S. 322, 326 (1979).
For collateral estoppel to apply, a court must decide
whether "(i) the issue at stake is identical to the one involved
in the prior litigation, (ii) the determination of the issue in
the prior litigation was a critical, necessary part of the
judgment in that earlier action, and (iii) special circumstances
exist which would render preclusion inappropriate or unfair."
McDuffie v. Estelle, 935 F.2d 682, 685 (5th Cir. 1991); Hicks v.
Quaker Oats Co., 662 F.2d 1158, 1166 (5th Cir. Unit A, 1981).
Although an issue has been fully litigated, the prior judgment
will not act as collateral estoppel if the issue was not
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necessary to the rendering of the prior judgment. Hicks, 662
F.2d at 1168.
When a trial court's judgment is vacated, reversed, or set
aside by an appellate court, collateral estoppel will not
preclude relitigation of the trial court's conclusions of law or
findings of fact. Id. Similarly, where a trial court's findings
are challenged on appeal, "once the appellate court has affirmed
on one ground and passed over another, preclusion does not attach
to the ground omitted from its decision." Dow Chemical v. EPA,
832 F.2d 319, 323 (5th Cir. 1987) (quoting C. Wright, A. Miller &
E. Cooper, Federal Practice and Procedure § 4421 (1981)); Hicks,
662 F.2d at 1168 ("the general rule is that if a judgment is
appealed, collateral estoppel only works as to those issues
specifically passed upon by the appellate court"); see also,
Borst v. Chevron Corp., 36 F.3d 1308, 1314 n.11 (5th Cir.)
(noting that because the court did not consider an issue, "the
district court's ruling on that issue is not conclusive between
the parties"), cert. denied, 115 S. Ct. 1699 (1994).
In the prior proceeding, the district court denied the
United States's request for an injunction on the grounds that
Hudson had done nothing illegal, finding, inter alia, that the
fair market value of the master audio tapes was at least $100,000
each. The Commissioner challenged those findings on appeal. The
Fifth Circuit affirmed the district court's denial of the
injunction, but did so on the grounds that no evidence was
presented that continuing violations were threatened. The court
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of appeals emphasized that "we do not suggest that the government
was incorrect in its contentions that the complained of
transactions were not legal." Because the Fifth Circuit in the
prior proceeding did not address the district court's fact
finding on the fair market value of the master tapes, that
finding could not preclude the Commissioner from contesting the
fair market value of the master tapes in the tax court
proceeding. See Dow Chemical, 832 F.2d at 323. Therefore, the
tax court did not err in determining that collateral estoppel
does not bar the Commissioner from arguing that the master audio
tapes had a fair market value of less than $100,000.
B. How many Master Tapes were Placed in Service?
Hudson contends that the tax court's determination that only
125 master tapes, rather than 423, were placed in service in
1983, and none in 1982, was clearly erroneous. The government
responds that the tax court's finding that no more than 125
master tapes had been placed in service in 1983 is amply
supported by the record and is not clearly erroneous. Before we
address Hudson's argument, we will first summarize the relevant
factual findings.
In its final opinion, the tax court found that "during 1982
and 1983, TBES entered into 423 lease agreements with individual
investors with respect to master tapes that were purportedly
produced and completed." However, the tax court additionally
found that "the record does not support a conclusion that the
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same number of actual master tapes had been produced and existed
during 1982 and 1983." The tax court stated that "by the end of
1983, only 125 tapes had been produced," and that "in 1982 and
1983 EAR sold to TBES only 125 master tapes." Finally, the tax
court found that because only 125 tapes had been produced by the
end of 1983, only 125 tapes had been placed in service for the
1983 tax year. Therefore, the tax court concluded that Hudson
could only claim depreciation deductions with respect to those
125 tapes for tax year 1983. The tax court also concluded that
Hudson could take no depreciation deductions for master tapes in
1982.
Hudson argues that the tax court should be estopped from
finding that only 125 master tapes were placed in service in 1983
because the Commissioner had conceded in the prior proceeding and
earlier in the tax court proceeding that 423 tapes were purchased
and leased during 1982 and 1983. Hudson contends that because
423 master tapes were leased by the end of 1983, 423 tapes were
placed in service for purposes of depreciation deductions.
The Commissioner concedes that 423 tapes were purchased by
TBES during 1982 and 1983. The Commissioner argues that,
although TBES entered into 423 lease agreements with investors by
the end of 1983, and even if it purchased 423 master tapes from
EAR, Hudson failed to demonstrate that more than 125 tapes had
been produced and actually existed by the end of 1983, or that
any tapes actually existed in 1982.
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The taxpayer bears the burden of proving his entitlement to
a deduction. Welch v. Helvering, 290 U.S. 111, 115 (1933).
Depreciation deductions are allowed in the year in which
qualifying property is placed in service by the taxpayer. 26
C.F.R. § 1.167(a)-10(b); Noonan v. Commissioner, 52 T.C.M.
534, 544 (1986), aff'd, 976 F.2d 737 (9th Cir. 1992). Property
is placed in service when it is first placed "in a condition or
state of readiness and availability for a specifically assigned
function." 26 C.F.R. § 1.167(a)-11(e)(1)(i); Noonan, 52 T.C.M.
(CCH) at 544. Property held for lease is placed in service when
it is ready and available for lease and is first held out for
lease. Waddell v. Commissioner, 86 T.C. 848, 898 (1986), aff'd,
841 F.2d 264 (9th Cir. 1988).
Hudson argues that because 423 leasing agreements were
entered into in 1982 and 1983, 423 master tapes were held out for
lease, thus placed in service, in 1982 and 1983. However,
Hudson's argument "exalt[s] form over substance." Noonan, 52
T.C.M. at 544. Although the leasing agreements existed in
1982 and 1983, and although TBES may have entered purchasing
agreements with EAR for 423 master tapes in 1982 and 1983, the
tax court found that the evidence demonstrated that only 125
master tapes actually existed by the end of 1983. Hudson cannot
take depreciation deductions for master tapes that were not yet
produced in the relevant tax year. Property that does not exist
cannot depreciate. See Donahue v. Commissioner, 61 T.C.M.
2460, 2469 (holding that a transaction lacked economic substance
11
because the taxpayer failed to produce evidence that the subject
matter of the transaction, a master recording, actually existed
at the end of the tax year), aff'd, 959 F.2d 234 (6th Cir.
1992).
Finally, we conclude that the tax court's finding that only
125 master tapes were produced, thus placed in service, by the
end of 1983, is not clearly erroneous. The evidence demonstrates
that as of July 29, 1983, EAR had produced and sold a total of
125 master audio tapes to TBES. Chet Hanson, one of the owners
of EAR, testified that EAR ceased producing tapes in 1983. Ms.
Raun, an employee of TBES and EAR, testified that many scripts
were unfinished at the end of 1983 and that she was still writing
scripts at the end of 1984. Ms. Raun testified further that she
did not even begin the art work for many tapes until 1984. One
investor testified that the tapes he leased during 1983 were not
finished until 1984. Testimony of an employee of Hallmark showed
that Hallmark's catalog, which was prepared during the period of
late 1983 through early 1984, included many tapes that had not
yet been produced.
There was also evidence that many of the tapes that were
"produced" and existed at the end of 1983 were nevertheless not
ready and available to be leased at that time. An employee of
Hallmark testified that Hudson considered a tape to have been
produced even if only "a sentence was read onto a reel to reel
tape," and considered "writing a real script and putting together
a real . . . total production" to be "post-production" work.
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This evidence supports the conclusion that by the end of
1983, only 125 master tapes were placed in service. Thus, we
affirm the tax court's disallowance of Hudson's depreciation
deductions for the remaining 298 master tapes in 1983, and for
all 423 master tapes in 1982.
IV. CONCLUSION
For the foregoing reasons, we AFFIRM the judgment of the tax
court.
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