Johnston v. Cir ( 2006 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
THOMAS E. JOHNSTON, and THOMAS 
E. JOHNSTON, SUCCESSOR IN INTEREST
TO SHIRLEY L. JOHNSTON,
No. 04-73833
DECEASED,
Petitioner-Appellant,
 Tax Ct. No.
26005-96/2266-97
v.
OPINION
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellee.

Appeal from a Decision of the
United States Tax Court
Submitted June 8, 2006*
Pasadena, California
Filed September 1, 2006
Before: Dorothy W. Nelson, Johnnie B. Rawlinson, and
Carlos T. Bea, Circuit Judges.
Opinion by Judge Bea
*This panel unanimously finds this case suitable for decision without
oral argument. See Fed. R. App. P. 34(a)(2).
10649
JOHNSTON v. CIR 10651
COUNSEL
Lorraine Howell, Costa Mesa, California, and Kenneth M.
Barish, Beverly Hills, California, for appellant Thomas E.
Johnston.
Thomas J. Clark and Karen D. Utiger, Washington, D.C., for
appellee Commissioner of Internal Revenue.
10652 JOHNSTON v. CIR
OPINION
BEA, Circuit Judge:
This case presents an attempt at “post-deal negotiation.” It
doesn’t usually work in business. Why should we treat the tax
collector differently?
Specifically, we address the following question: when a
taxpayer offers to pay the Internal Revenue Service a sum cer-
tain to “fully resolve all adjustments at issue” for certain tax
years, and the Commissioner accepts his offer, may the tax-
payer then apply net operating losses (“NOLs”) to reduce his
agreed payments under the settlement? Here, the answer is no.
The taxpayer did not reserve the right to use NOLs in the set-
tlement agreement, nor did he raise the issue of using the
NOLs before the Commissioner accepted his settlement offer.
A deal is a deal, even with the tax man. Therefore, we affirm.
Facts
Thomas E. Johnston, on his own behalf and as the
successor-in-interest to his late wife’s estate, appeals the order
of the tax court granting summary judgment for the Commis-
sioner of Internal Revenue (“the Commissioner”). Beginning
in the 1970s, Johnston conducted a real estate business in
Southern California. His business was successful for many
years, but, in 1988, it turned for the worse when the local real
estate market crashed. Consequently, Johnston reported large
tax losses for most of the tax years between 1988 and 1995,
including the three years at issue here. Disputing these
claimed losses, the Commissioner assessed tax deficiencies of
$1,546,160 for 1989, $289,396 for 1991, and $341,908 for
1992, plus penalties.1
1
The amount and type of penalties, which are immaterial here, are stated
in the tax court’s opinion. See Johnston v. Comm’r, 122 T.C. 124, 125
(2004).
JOHNSTON v. CIR 10653
In a letter dated January 31, 2003, Johnston offered to “re-
solve all adjustments at issues [sic] in the matters” docketed
for tax years 1989, 1991, and 1992 for $105,000, or $35,000
per year. Johnston designated his offer as a “qualified offer”
under I.R.C. § 7430(g). A qualified offer must “specif[y] the
offered amount of the taxpayer’s liability” for all adjustments
pending in the case at the time the offer is made. See I.R.C.
§ 7430(g)(1)(B); Temp. Treas. Reg. § 301.7430-7T(c)(3)
(2001).2 To comply with this provision, Johnston’s letter also
stated “the taxpayer is aware that his offer is to resolve all
adjustments in the court proceeding. Such offer will fully
resolve the taxpayer’s liability as to those adjustments[.]” In
a letter dated February 10, 2003, the Commissioner accepted
Johnston’s offer without discussion or negotiation.
Johnston then stated that he intended to apply NOLs to
reduce his liability under the settlement. If the NOLs Johnston
sought to use proved to be valid, Johnston would be able to
wipe out his stipulated tax deficiency for the settled tax years.3
The result: Johnston would not owe anything under the settle-
ment agreement.
The parties reserved the issue of NOLs in their stipulation
of settled issues. Next, the tax court granted Johnston’s
motion for leave to amend his petition to include the claimed
NOLs. Finally, upon the Commissioner’s motion for sum-
mary judgment, the tax court held that the parties entered into
a contract to settle the docketed cases and that Johnston could
not claim his NOLs for the first time after settlement. See
Johnston v. Comm’r, 122 T.C. 124, 129, 132-33 (2004).
2
The temporary regulations apply here because Johnston made his offer
before December 24, 2003. See Treas. Reg. § 301.7430-7(f) (2003).
3
Johnston claimed NOLs of over $1,000,000.
10654 JOHNSTON v. CIR
Analysis
We have jurisdiction under I.R.C. § 7482(a)(1), which pro-
vides for appellate review of final decisions of the tax court
“in the same manner and to the same extent as decisions of
the district courts in civil actions tried without a jury.” Thus,
we review de novo the tax court’s grant of summary judgment
to determine “whether there is a genuine issue of fact and
whether the tax court applied the substantive law correctly.”
Talley Industries Inc. v. Comm’r, 116 F.3d 382, 384 (9th Cir.
1997) (internal alterations omitted).
[1] As other circuits have held, a tax settlement is a contract
that should be interpreted according to ordinary principles of
contract law. See Goldman v. Comm’r, 39 F.3d 402, 405-06
(2d Cir. 1994); Treaty Pines Inv. P’ship v. Comm’r, 967 F.2d
206, 211 (5th Cir. 1992). Accordingly, our object is to ascer-
tain the intent of the parties from the language of their agree-
ment. See II E. ALLEN FARNSWORTH, FARNSWORTH ON
CONTRACTS § 7.9 (3d ed. 2004). A tax settlement’s meaning
“must be discerned within its four corners, and not by refer-
ence to what might satisfy the purposes of one of the parties
to it.” Yoo Han & Co., Ltd. v. Comm’r, 62 T.C.M. (CCH) 83(1991) (quoting United States v. Armour & Co., 402 U.S. 673,
681-82 (1971)) (emphasis and citation omitted); see also
Stamm Int’l Corp. v. Comm’r, 90 T.C. 315, 322 (1988). “Un-
less a different intention is manifested, . . . where language
has a generally prevailing meaning, it is interpreted in accor-
dance with that meaning . . . .” RESTATEMENT (SECOND) OF
CONTRACTS § 202(3) (1981).
[2] Johnston’s January 31, 2003, letter manifests an intent
to resolve the pending controversy over the 1989, 1991, and
1992 tax years for $105,000. The Commissioner accepted
Johnston’s offer by his February 10, 2003, letter. Thus, as the
tax court correctly determined, the parties reached a settle-
ment of the docketed tax years.
JOHNSTON v. CIR 10655
[3] Johnston’s offer—which purported to “resolve all
adjustments in the court proceeding” for the docketed years
and “fully resolve the taxpayer’s liability as to those
adjustments”—does not even mention NOLs, let alone
expressly reserve the right to offset NOLs against the agreed
payment. If Johnston subjectively intended to offset his NOLs
against the amounts to be paid under the settlement agree-
ment, he kept this intention to himself. At least, he certainly
never told the Commissioner. Since Johnston’s intent was not
objectively manifested before his offer was accepted, and he
had reason to know of the Commissioner’s intended meaning,4
we will not interpret the agreement as Johnston wishes. See
RESTATEMENT (SECOND) OF CONTRACTS § 201(2) (1981) (stating
that where one party has no reason to know of any other
meaning than that apparent from the other party’s own words,
and the other party did have reason to know the meaning the
first party would attach to his words, the first party’s under-
standing prevails).
[4] Johnston urges us to conclude that the qualified offer
regulations, Temp. Treas. Reg. § 301.7430-7T (2001), change
the preceding analysis. He claims that he could not raise the
issue of NOLs in his settlement offer because the regulations
governing qualified offers require the taxpayer to specify the
amount of liability “with respect to all of the adjustments at
issue in the administrative or court proceeding at the time the
offer is made and only those adjustments.” Temp. Treas. Reg.
§ 301.7430-7T(c)(3) (2001). Johnston’s reliance on the quali-
fied offer regulations, however, is misplaced. The regulations
do not address the circumstances under which a taxpayer may
apply NOLs as an offset to the resulting settlement. Instead,
the regulations provide the method for determining whether a
taxpayer who has succeeded in the litigation after the Com-
missioner rejects a qualified offer becomes a “prevailing
4
Specifically, in his letter of acceptance, the Commissioner recited the
amount offered for each tax year, and advised Johnston to send payment
immediately to stop the accumulation of interest.
10656 JOHNSTON v. CIR
party” entitled to attorney’s fees. See Temp. Treas. Reg.
§ 301.7430-7T(b) (2001). The rules set forth in this regulation
have no bearing on when the issue of NOLs must be raised.
[5] On that question, courts have consistently held that a
taxpayer cannot raise the issue of NOLs after settlement. See
Yoo Han & Co., Ltd., 62 T.C.M (CCH) 83; Himmelwright v.
Comm’r, 55 T.C.M. (CCH) 403 (1988), superseded in diff.
part, as stated in Corson v. Comm’r, 114 T.C. 354, 365
(2000); Hartzog v. United States, 6 Cl. Ct. 835, 838 (1984)
(“It is well established that each tax year is the origin of a new
liability and a separate cause of action. . . . Once a tax year
is closed, it is closed as to all claims concerning that tax year,
including those that could have been presented.”) (citations
omitted). Similarly, a taxpayer may not claim offsets similar
to NOLs for the first time after settlement or judgment. See
Estate of Kokernot, 112 F.3d 1290, 1295-96 (5th Cir. 1997)
(taxpayer could not claim special-use valuation after settling
estate tax deficiency); Cloes v. Comm’r, 79 T.C. 933, 935-36
(1982) (taxpayer could not apply income-averaging for the
first time by way of a Rule 155 motion). We agree with and
adopt those rules. As the tax court here explained, Johnston’s
attempt to raise the NOLs issue after the Commissioner’s
acceptance came “too late.” Johnston, 122 T.C. at 132. The
deal had been made; use of the NOLs to reduce tax payments
for the years 1989, 1991, and 1992 was simply not part of the
deal.
[6] In sum, when we apply ordinary principles of contract
law to Johnston’s offer and the Commissioner’s acceptance,
it is plain that Johnston may not use his NOLs to reduce his
liability under the settlement.
Accordingly, the judgment of the tax court is AFFIRMED.