Cavallaro v. Commissioner

United States Court of Appeals
For the First Circuit
Nos. 15-1368
15-1376
WILLIAM CAVALLARO AND PATRICIA CAVALLARO,
Donors,
Petitioners, Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent, Appellee.
APPEALS FROM THE UNITED STATES TAX COURT
[Hon. David Gustafson, U.S. Tax Court Judge]
Before
Howard, Chief Judge,
Lynch and Kayatta, Circuit Judges.
Andrew H. Good, with whom Philip G. Cormier, Good Schneider
Cormier, Edward DeFranceschi, DeFranceschi & Klemm, P.C., Jack W.
Pirozzolo, Joseph R. Guerra, Matthew Lerner, and Sidley Austin LLP
were on brief, for appellants.
Caroline D. Ciraolo, Acting Assistant Attorney General, with
whom Bruce R. Ellisen, Attorney, Tax Division, U.S. Department of
Justice, and Ivan C. Dale, Attorney, Tax Division, U.S. Department
of Justice, were on brief, for appellee.
November 18, 2016
HOWARD, Chief Judge. William Cavallaro and his wife
Patricia Cavallaro (together, "the Cavallaros") appeal from a Tax
Court decision affirming a determination by the Internal Revenue
Service ("IRS") Commissioner that they owed gift taxes on a
$29,670,000 gift to their sons. After careful consideration, we
affirm in part, reverse in part, and remand to the Tax Court for
further proceedings consistent with this opinion.
I. BACKGROUND
In 1979, the Cavallaros started Knight Tool Co.
("Knight"), a contract manufacturing company that made custom
tools and machine parts. William Cavallaro -- whose principal
work was making and selling the business's products -- owned 49%
of Knight's stock, while Patricia Cavallaro -- who acted as an
administrator and bookkeeper -- owned 51%. The Cavallaros' three
sons Ken, Paul, and James eventually joined the family business.
In 1982, Knight deviated from its traditional business
and developed a liquid-dispensing system for adhesives called
"CAM/ALOT." Although Knight invested substantial resources in
CAM/ALOT's development, the product had significant flaws, and
profits failed to outpace production costs. As a result, the
Cavallaros decided to refocus on their core business.
Ken, however, continued to believe in the CAM/ALOT
technology and asked his parents if he and his brothers could
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organize a new corporation, Camelot Systems, Inc. ("Camelot"), to
further develop it. The Cavallaros assented. After Camelot's
incorporation, Ken worked with William Cavallaro and other Knight
personnel to change CAM/ALOT's design in order to meet customers'
needs. Knight manufactured the CAM/ALOT systems, while Camelot
sold and distributed them to third parties.
Everyone who worked on CAM/ALOT systems after Camelot's
incorporation, including Ken, remained on the Knight payroll and
received all their wages from Knight. Knight's and Camelot's
financial affairs overlapped in other ways as well. For instance,
Camelot did not have its own bank accounts; with minor exceptions,
Camelot's bills were paid using Knight's funds. And, as a result
of how Knight billed Camelot, Knight effectively immunized Camelot
from risk of non-payment for CAM/ALOT systems.
In 1994, the Cavallaros hired both accountants and
lawyers to review their estate plan. There was significant
friction between these two groups of advisers. Essentially, the
lawyers wanted the Cavallaros to claim that the value of the
CAM/ALOT technology inhered in Camelot -- and so was already owned
by Ken, Paul, and James -- whereas the accountants objected to
this proposal because it was at odds with the overwhelming evidence
that Knight owned the technology and always had. Attorney Louis
Hamel argued in a letter to accountant Kevin McGillivray: "History
does not formulate itself, the historian has to give it form
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without being discouraged by having to squeeze a few embarrassing
facts into the suitcase by force."1 As a result of Hamel's
persuasive efforts, the lawyers' view prevailed. Both the lawyers
and accountants came to endorse Hamel's suggestion that a 1987
transfer of the CAM/ALOT technology be memorialized in affidavits
and a confirmatory bill of sale. Members of the Cavallaro family
signed these documents in May 1995.2
Knight and Camelot subsequently prepared to merge. As
part of their preparations, the Cavallaros hired accountant
Timothy Maio to determine the respective values of the two
companies. Using a market-based approach, Maio valued the proposed
combined entity at $70-$75 million and valued Knight's portion at
just $13-$15 million (or 19%). Notably, Maio assumed that Camelot
owned the CAM/ALOT technology and that Knight was a contractor for
Camelot.
On December 31, 1995, Knight and Camelot merged in a
tax-free merger that left Camelot as the surviving corporation.
William Cavallaro received 18 shares of stock in the merged
company; Patricia Cavallaro received 20 shares; Ken, Paul, and
1
This letter was cc'd to the Cavallaros and their three sons,
as well as to other advisers.
2 The affidavits executed by William and Ken averred that
Knight transferred "the original dispensing product" to Camelot
when the latter was formed in 1987, that Knight received no
compensation for this gift transfer, and that the gift had "no
ascertainable value."
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James received 54 shares each. The relative value of each company,
as determined by Maio, informed the distribution of shares. Seven
months later, Cookson America, Inc. purchased Camelot for $57
million in cash. On the basis of stock ownership, the Cavallaros
received a total of $10,830,000, and each son received $15,390,000.
In 1998, the IRS opened an examination of Knight's and
Camelot's 1994 and 1995 income tax returns. During the income tax
examination, the IRS identified a possible gift tax issue in
connection with the 1995 merger and opened a gift tax examination
as well. That examination resulted in litigation before this
court. See Cavallaro v. United States (Cavallaro I), 284 F.3d 236(1st Cir. 2002) (affirming denial of taxpayers' motion to quash a
third-party recordkeeper summons).
Ultimately, the IRS issued notices of deficiency to the
Cavallaros for tax year 1995. The IRS determined -- without first
having obtained an appraisal -- that Camelot had a pre-merger value
of $0. Thus, when Knight merged with Camelot, William and Patricia
Cavallaro each made a taxable gift of $23,085,000 to their sons.3
As a result, each of the Cavallaros incurred an increase in tax
liability in the amount of $12,696,750. The notices of deficiency
also imposed additions to tax for failure to file and fraud,
3 The Commissioner initially determined equal $23,085,000 gift
amounts for both William and Patricia Cavallaro but later revised
the amounts to reflect the actual division of ownership in Knight.
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pursuant to Internal Revenue Code §§ 6651(a)(1) and 6663(a),
respectively.
II. THE TAX COURT PROCEEDINGS
The Cavallaros filed a petition for review with the Tax
Court. During discovery, the Commissioner disclosed that -- after
the notices of deficiency were issued -- he directed accountant
Marc Bello to appraise the value of both Knight and Camelot at the
time of the merger. Working under the assumption that Knight
rather than Camelot owned the CAM/ALOT technology, Bello valued
the combined entities at approximately $64.5 million. Bello
concluded that Camelot was worth $22.6 million. The deficiencies
would, therefore, be lower than those set forth in the original
notices, which assumed that Camelot had no value.
The Cavallaros interpreted the Bello report to mean that
the Commissioner had changed his theory of liability. More
specifically, they surmised that the Commissioner was no longer
pursuing his original theory -- that Camelot was a shell
corporation formed to disguise a gift transfer from the Cavallaros
to their sons -- in favor of a new theory that Knight was merely
undervalued. Prior to trial, the Cavallaros used the Bello report
as the basis for their argument that the original notices of
deficiency were arbitrary and excessive, or, in the alternative,
that the Commissioner's new theory of liability was a "new matter"
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within the meaning of Tax Court Rule 142. They moved
unsuccessfully to shift the burden of proof to the Commissioner.
During the eight-day bench trial, the Commissioner
introduced the Bello valuation into evidence to support his revised
deficiency. The Cavallaros introduced both the 1995 Maio valuation
and a valuation by John Murphy of Atlantic Management Company,
which was consistent with the Maio valuation. Like Maio, Murphy
assumed that Camelot owned the CAM/ALOT technology. Ownership of
the CAM/ALOT-related technology was a central focus of the trial.
The Tax Court ultimately concluded that Knight owned all of it.
The Tax Court denied the Cavallaros' renewed motion to
shift the burden of proof to the Commissioner. While noting that
it was "evidently true that the Commissioner did not obtain an
appraisal before issuing the notices" of deficiency, the Tax Court
found that there was a sufficient basis for issuing the notices
and, thus, that they were not arbitrary. Further, the court found
unpersuasive the Cavallaros' argument that the Commissioner's
litigating position was a "new matter" and stated that the
Commissioner's "partial concessions as to Camelot's non-zero
value" did not require a new theory or change the issues for trial.
The Tax Court ultimately concluded that the Cavallaros
were deficient in paying the gift tax due for calendar year 1995:
William Cavallaro owed $7,652,980 and Patricia Cavallaro owed
$8,009,020. The court also determined -- favorably to the
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Cavallaros -- that no penalties for underpayment were due under
I.R.C. § 6662(a), § 6662(h), or § 6663(a), and there were no
additions to tax due under I.R.C. § 6651(a)(1) for failure to file
a gift tax return.
This appeal timely followed.
III. STANDARD OF REVIEW
"We review decisions of the [T]ax [C]ourt 'in the same
manner and to the same extent as decisions of the district courts
in civil actions tried without a jury.'" Interex, Inc. v. Comm'r,
321 F.3d 55, 58 (1st Cir. 2003) (quoting 26 U.S.C. § 7482(a)(1)).
Thus, we review the Tax Court's legal conclusions de novo and its
factual findings for clear error. Id. We have the authority "to
affirm or, if the decision of the Tax Court is not in accordance
with law, to modify or to reverse the decision of the Tax Court,
with or without remanding the case for a rehearing, as justice may
require." I.R.C. § 7482(c)(1).
IV. CLAIMS ON APPEAL
On appeal, the Cavallaros renew their claim that the Tax
Court erred by failing to shift the burden of proof to the
Commissioner for two independent reasons: because (1) the original
notices of deficiency were arbitrary and excessive, and (2) the
Commissioner relied on a new theory of liability. They make two
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additional arguments. First, they claim that the Tax Court
improperly concluded that Knight owned all of the CAM/ALOT-related
technology. Second, they contend that the Tax Court erred by
misstating their burden of proof and subsequently failing to
consider alleged flaws in Bello's valuation of the two companies.
We consider these claims in turn.
A. Burden Shifting
A rebuttable presumption of correctness cloaks an IRS
notice of deficiency.4 See, e.g., Bull v. United States, 295 U.S.
247, 259-60 (1935); Delaney v. Comm'r, 99 F.3d 20, 23 (1st Cir.
1996); Tax Ct. R. 142(a); see also United States v. Rexach, 482
F.2d 10, 16 (1st Cir. 1973) (explaining rationales for this
presumption). Thus, the taxpayer typically bears the burden of
proving by a preponderance of the evidence that the Commissioner's
tax assessment is erroneous. Helvering v. Taylor, 293 U.S. 507,
511 (1935); Delaney, 99 F.3d at 23. In some limited circumstances,
however, the Commissioner bears the burden of proving a tax
deficiency. See, e.g., Tax Ct. R. 142(a)(1) (outlining
circumstances that require burden shifting).
4 At trial, the Cavallaros pointed out that the rule applying
a presumption of correctness was substantially changed by the
Internal Revenue Service Restructuring and Reform Act of 1998.
See 26 U.S.C. § 7491. However, those changes are not applicable
here because the examination at issue began before the effective
date of the statute.
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The Cavallaros argue that the Tax Court erred by refusing
to shift the burden of proof to the Commissioner. We review their
claim de novo. See Estate of Abraham v. Comm'r, 408 F.3d 26, 35
(1st Cir. 2005).
1. For An Excessive and Arbitrary Deficiency Notice
Burden-shifting for an excessive-and-arbitrary
deficiency notice is a fairly narrow doctrine. See United States
v. Janis, 428 U.S. 433, 441-42 (1976). It involves "a challenge
to the deficiency assessment itself on the basis that it bears no
factual relationship to the taxpayer's liability, not a challenge
to any proof offered by the Commissioner at trial before the Tax
Court." Zuhone v. Comm'r, 883 F.2d 1317, 1325 (7th Cir. 1989).
Where an assessment is shown to be "naked" or utterly without
foundation, we remand the case for further action to determine the
amount that might lawfully be taxed. See Janis, 428 U.S. at 442
(citing Rexach, 482 F.2d at 16–17 & n.3). In this limited
circumstance, the presumption of correctness is overcome, and the
burden shifts to the Commissioner. See id.The threshold question, then, is whether the Cavallaros
have carried their burden of producing evidence from which it can
be concluded that their deficiency assessments utterly lacked
rational foundation. The Cavallaros' challenge falls short of the
mark. Cf. Pittman v. Comm'r, 100 F.3d 1308, 1313 (7th Cir. 1996)
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("[C]ourts commonly find this showing [that a deficiency
assessment lacks a rational foundation] to be made when the
Commissioner makes no evidentiary showing at all.").
The original deficiency notices assumed that, pre-
merger, Camelot had no value. According to the Cavallaros, the
Commissioner's later realignment with the Bello valuation
conclusively established that the Commissioner "used no formula at
all" and lacked "any support at all" for that initial $0 valuation.
Thus, they allege, the Commissioner's assessment was "without
rational foundation and excessive." Taylor, 293 U.S. at 514.
Without more, however, the fact that the Commissioner
later conceded a portion of the original deficiency does not compel
a conclusion that the initial assessments lacked a rational
foundation.5 Cf. McMurty v. Comm'r, 203 F.2d 659, 665–666 (1st
Cir. 1953) (declining to shift burden where Commissioner reduced
the amount of the claimed deficiency); Silverman v. Comm'r, 538
F.2d 927, 931 (2d Cir. 1976) ("The taxpayer does not carry his
burden of showing the determination invalid simply by pointing to
the fact that the Commissioner has reduced his original deficiency
claim prior to trial.").
5This is true even though the Commissioner's adoption of the
Bello report reduced the Cavallaros' alleged deficiency by roughly
one-third.
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Here, the Commissioner had discovered -- prior to
issuing the original notices of deficiency -- that the Cavallaros
had followed the advice of an estate-planning lawyer, Hamel, who
advocated "squeez[ing] a few embarrassing facts into the suitcase
by force" in order to memorialize technology transfers financially
advantageous to the Cavallaro family. See Cavallaro v. Comm'r
(Cavallaro II), T.C. Memo 2014-189, at *18. This, together with
associated documents, was a sufficient basis for concluding that
Camelot's value was de minimis. Cf. Silverman, 538 F.2d at 933("Valuation is . . . necessarily an approximation." (alteration in
original) (citation omitted)). For us to require more would
violate the general rule that courts will not look behind a
deficiency notice to question the Commissioner's motives and
procedures. Clapp v. Comm'r, 875 F.2d 1396, 1401 (9th Cir. 1989).
We need go no further.6
The original deficiency notices were not arbitrary and
excessive, and thus, no burden shifting was warranted.
6 The two circuit cases cited by the Cavallaros do not persuade
us otherwise. In Caracci v. Commissioner, 456 F.3d 444, 447, 456
(5th Cir. 2006), the Commissioner expressly conceded that the
excise tax deficiency, which was grounded on a "brief, intermediate
internal [valuation] analysis," was "excessive and erroneous." No
such concession exists here, nor are we convinced on this record
that the Bello report, standing alone, compels one. In Estate of
Mitchell v. Comm'r, 250 F.3d 696, 702 (9th Cir. 2001), the estate
tax deficiency notice rested on a stock valuation that the
appraiser had altered according to the Commissioner's
instructions, and that the IRS expert disavowed. The circumstances
in the instant case are not analogous.
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2. For a "New Matter"
Rule 142(a)(1) of the Tax Court's Rules of Practice and
Procedure states: "The burden of proof shall be upon the petitioner
. . . except that, in respect of any new matter, . . . it shall be
upon the respondent." Under the "new matter" exception, if the
Commissioner "seeks to establish the deficiency on a basis not
described in the Notice, the burden shifts to the Commissioner on
that new basis." Estate of Abraham, 408 F.3d at 35 (citing Shea
v. Comm'r, 112 T.C. 183, 197 (1999)). A new theory presented to
support a deficiency is "treated as a new matter when it either
alters the original deficiency or requires the presentation of
different evidence." Id. (quoting Wayne Bolt & Nut Co. v. Comm'r,
93 T.C. 500, 507 (1989)). If, however, the theory "merely
clarifies or develops the original determination," it is not a new
matter. Id.The Cavallaros argue that the Commissioner relied on a
new theory of liability at trial. Their claim is that the
Commissioner abandoned his initial theory that Camelot was a
worthless sham and then adopted a wholly new theory -- based on
Bello's valuation -- that Camelot was overvalued by the Cavallaros.
Therefore, the Cavallaros argue, the burden of proof with respect
to this "new matter" should have been placed on the Commissioner.
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The original deficiency notices do not allege that
Camelot was a sham company.7 Rather, they explain:
[U]nder IRC Section 2511[,] donor's merger of Knight Tool Co.
into Camelot Systems, Inc. in return for 19% of the stock of
Camelot Systems, Inc. resulted in a gift of $23,085,000.00 to
the other shareholders of Camelot Systems, Inc. Accordingly,
taxable gifts are increased $23,085,000.00.8
The clear implication was that, because Knight was undervalued,
the Knight-Camelot merger allowed for a disguised gift transfer
from the Cavallaros to their three sons.
The Commissioner's subsequent adoption of the Bello
report was simply a refinement of that original theory (i.e., a
clarification of the extent to which Knight was undervalued). We
have previously said that "if a deficiency notice is broadly worded
and the Commissioner later advances a theory not inconsistent with
that language, the theory does not constitute new matter, and the
burden of proof remains with the taxpayer." Estate of Abraham,
408 F.3d at 36 (citing Abatti v. Comm'r, 644 F.2d 1385, 1390 (9th
7 Although the Commissioner's Answers -- filed in response to
the Cavallaros' Petition for Re-determination -- do refer to
Camelot as a "shell" or "virtual shell" in several instances, these
references cannot bear the weight that the Cavallaros place on
them. The Answers' overriding message is that the Cavallaros'
share of the merged company was not "an accurate reflection of the
value of Knight before the merger." This is not in tension with
the Bello report.
8 This language, quoted from the notice of deficiency issued
to Patricia Cavallaro, does not appear in the notice of deficiency
issued to William Cavallaro. The Tax Court deemed this omission
inadvertent and non-prejudicial, and the Cavallaros do not
challenge this determination on appeal.
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Cir. 1981)). The original deficiency notices were more than
adequate to put the Cavallaros on notice that the Commissioner was
challenging the value of Knight as transferred within the merger.
Cf. Kikalos v. Comm'r, 434 F.3d 977, 983 (7th Cir. 2006) (holding
that the Commissioner's change in the method of calculation for
the income shortage was not a "new matter" and that the deficiency
notice clearly put the taxpayers on notice of the liability theory
underlying the new calculation). Indeed, the Cavallaros' Petition
for Re-determination makes it clear that they were aware all along
that the value of Knight, to the extent that it exceeded the value
of the stock they received at the time of the merger, would be
integral to determining their tax liability.9
As neither of the Cavallaros' two burden-shifting
theories succeed, we affirm the Tax Court's determination that the
Cavallaros had the burden of proof.
B. CAM/ALOT Technology
The Cavallaros also challenge the Tax Court's finding
that Knight owned all of the CAM/ALOT technology. Specifically,
they complain that the Tax Court's treatment of the "different
9 Further showing the importance of Knight's value, in
Cavallaro I, we stated: "The IRS suspected that the parties might
have undervalued the Cavallaros' Knight company and overvalued the
sons' Camelot company to disguise a gift to the sons in the form
of post-merger stock." 284 F.3d at 239.
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types of technology . . . as a single, undivided whole" was overly
simplistic. The record, however, amply supports the Tax Court's
determinations. See McMurray v. Comm'r, 985 F.2d 36, 40 (1st Cir.
1993) ("The tax court's ruling . . . is a factual finding that we
must affirm unless it is clearly erroneous.").
As detailed above, Knight created the first CAM/ALOT
system, and, even after Camelot's incorporation, the companies'
financial affairs overlapped significantly. Further, "[t]he few
public registrations of intellectual property were all owned by
Knight." Cavallaro II, T.C. Memo 2014-189, at *8. The CAM/ALOT
trademark was registered to Knight until December 31, 1995, and
four patent applications, each filed by William Cavallaro,
identified Knight -- not Camelot -- as his assignee. Id. In 1992,
before the instant controversy arose, the Cavallaros' accountants
"determined that a portion of the work . . . done in prior years
by Knight's engineers could be characterized as [research and
development ("R&D")] costs eligible for [a Section 41 R&D] tax
credit." Id. at *9. In light of that study, the accountants
prepared amended tax returns for Knight for 1990 to 1993. Id.Only after the involvement of the Cavallaros' estate-planning
attorneys did the accountants prepare another set of amended
returns for both Knight and Camelot, this time disclaiming the R&D
credits previously taken by Knight and claiming them for Camelot.
Id.- 16 -
The Cavallaros, the Tax Court concluded, "manifestly
gave no thought in 1987 to the question of which entity would own
what intangibles." Id. at *19. The Tax Court rejected attorney
Hamel's position that a transfer of CAM/ALOT technology occurred
in November 1987. That month, the Cavallaros attended a meeting
at which Ken, Paul, and James signed Camelot's articles of
incorporation. During the meeting, the lawyer started to hand
Camelot's corporate minute book to William Cavallaro, but William
deflected the suggestion that Camelot was his and immediately
handed the minute book to Ken, saying, "[t]ake it; it's yours."
Although Hamel testified at trial that he construed this as a
symbolic handoff of the CAM/ALOT technology, the court found no
documentation to support such a transfer. Id. at *9 n.13. The
court reasonably interpreted the 1995 affidavits and confirmatory
bill of sale as evidence of a view -- shared by the Cavallaro
family and their various advisers -- that the contemporaneous
document trail showed that Knight, not Camelot, owned the CAM/ALOT
technology and, therefore, supplemental documents were necessary
to counter that impression. Id. at *19.
Analyzing the ownership question through the lens of a
hypothetical bona fide purchaser at the time of the merger, see 26
C.F.R. §§ 25.2511-1(g)(1), 25.2512-8, the Tax Court concluded:
If Camelot had offered itself to the market for acquisition
claiming ownership of the CAM/ALOT technology, it is
inconceivable that a hypothetical acquirer would do anything
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other than demand to see documentation of Camelot's ownership
interest--documentation that we have found does not exist.
Id. It further found:
[I]f Knight were dealing with an unrelated party which sold
machines that had been manufactured at Knight's risk by Knight
employees on Knight premises using technology developed by
Knight personnel, where Knight had owned the only public
registrations of [IP] and had claimed ownership of the
technology in prior tax filings, it defies belief to suggest
that Knight would have simply disclaimed the technology and
allowed the unrelated party to take it.
Id.Against this backdrop, the Cavallaros complain that the
Tax Court erroneously treated CAM/ALOT as a "monolithic property
interest," rather than seeing it for its discrete proprietary
components. They contend that the Tax Court should have ruled
that Camelot owned two crucial property rights at the time of the
merger: the trade secrets embodied in Camelot's mechanical
drawings and the copyrighted CAM/ALOT operating software. We
disagree.
At trial, the Tax Court suggested that assessing
potentially discrete proprietary components of CAM/ALOT might be
a better approach. It invited the parties to consider such an
approach only insofar as it was helpful to framing the case and
clearly warned that such an approach might not "survive the expert
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testimony."10 The Cavallaros continued to press their views that
(1) Knight fully abandoned the CAM/ALOT enterprise in 1987, (2)
Camelot subsequently designed an entirely new machine through
Ken's innovation, and (3) Camelot paid Knight in full for using
its resources and original technology. In brief, their position
was that no gift transfer occurred in 1995. Accordingly, their
present appeal for a piecemeal approach to the ownership question,
as a belated alternative to avoid gift tax liability, is waived.
Cf. Ahern v. Shinseki, 629 F.3d 49, 58 (1st Cir. 2010) ("An
appellant cannot change horses in mid-stream, arguing one theory
below and a quite different theory on appeal.").11
10 The subsequent expert testimony -- by both Bello and Murphy
-- showed that their valuations were premised on CAM/ALOT
technology being a single asset.
11 In any event, the Cavallaros' argument that the Tax Court
missed or misevaluated the legal import of the software notices
and the legends for the mechanical drawings lacks merit. The
record shows that the Tax Court carefully considered the gravitas
of the Camelot name stamp and other proprietary claims from the
viewpoint of an unrelated purchaser. See Culbertson, 337 U.S. at
746. While these few pieces of evidence do not fit neatly with
the rest of the evidence suggesting that Knight owned the CAM/ALOT
technology and that Camelot merely sold it, they are not enough to
leave us "with the definite and firm conviction that a mistake has
been committed" by the Tax Court. Schussel v. Werfel, 758 F.3d
82, 87 (1st Cir. 2014) (quoting Interex, 321 F.3d at 58).
Attempting to secure a foothold in this uphill climb, the
Cavallaros contend that the Tax Court's evaluation of the
technology evidence rests on "an inaccurate appraisal of
controlling legal principles." This argument does not convince us
that the Tax Court committed a reversible error.
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We find the Cavallaros' remaining claims similarly
unavailing and dispense with them briefly. First, the record shows
that the Tax Court did not myopically focus on Knight's original
ownership of the CAM/ALOT technology; instead, it focused on
ownership at the time of the Knight-Camelot merger. Second, the
Tax Court viewed the lack of any document memorializing a
technology transfer between Knight and Camelot as material to the
overall inquiry, not as dispositive. Third, the Tax Court did not
improperly defer to the accountants' property rights
determination; rather, it saw their determination as indicative of
the family's contemporaneous belief that Knight owned the CAM/ALOT
technology.
The Cavallaros have advanced no argument that would
warrant overturning the Tax Court's finding that Knight owned all
of the CAM/ALOT technology at the time of the merger. Where, as
here, "there are two permissible views of the evidence, the
factfinder's choice between them cannot be clearly erroneous."
Anderson v. City of Bessemer City, N.C., 470 U.S. 564, 574 (1985);
see also Crowley v. Comm'r, 962 F.2d 1077, 1080 (1st Cir. 1992).
C. The Bello Valuation
In challenging the valuation provided by Bello and
relied upon by the Tax Court, the Cavallaros argue that the Tax
Court again erred with respect to the burden of proof. The Tax
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Court stated that the Cavallaros had "the burden of proof to show
the proper amount of their tax liability," but the Cavallaros argue
that their burden was actually to establish "that the alleged
deficiencies were erroneous." They contend that this "legal error"
by the Tax Court led to another: the court refused to consider
their evidence that the Bello valuation was "fatally flawed."
Accordingly, our inquiry proceeds in two steps: first,
we determine whether the Tax Court misstated the burden of proof;
second, we consider whether the court erred in adopting Bello's
valuation without considering its alleged defects.
1. Burden of Proof
Although the Tax Court did not misallocate the burden of
proof at trial, we agree with the Cavallaros that the Tax Court
misstated the content of that burden. The Commissioner's
deficiency notices enjoyed a presumption of correctness, and the
Cavallaros had the burden of proving by a preponderance of the
evidence that they were erroneous. See Rexach, 482 F.2d at 16
n.3; see also Delaney, 99 F.3d at 23 ("[A] tax deficiency
assessment is subject to reversal if the taxpayer establishes by
a preponderance of the evidence that it was erroneous.").
The Tax Court reasoned that "[i]t is the Cavallaros who
have the burden of proof to show the proper amount of their tax
liability," but that they could not meet that burden because
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neither of their valuations (i.e., neither Maio's nor Murphy's)
remained standing in light of the Tax Court's finding that Knight,
rather than Camelot, owned all of the CAM/ALOT-related technology.
Therefore, the Tax Court adopted the Commissioner's Bello
valuation in full, even while remarking on its "arguably flawed
analysis."
But this statement on the Cavallaros' burden of proof is
mistaken as a matter of law. In Taylor, the Supreme Court made it
clear that once the taxpayer shows the Commissioner's
determination to be "arbitrary and excessive," the taxpayer cannot
be made to pay the amount assessed against him -- even if he fails
to prove the correct amount of liability he owes. 293 U.S. at
515; see also Rexach, 482 F.2d at 16 n.3 ("[O]nce a taxpayer
. . . has borne his burden of proving the Commissioner's
determination invalid, he has no further obligation to show . . .
how much" money is owed.).
2. Criticisms of The Bello Valuation
The Cavallaros attempted to show that the Commissioner's
valuation was "arbitrary and excessive" by challenging Bello's
methodology, but the Tax Court refused to hear those challenges on
the grounds that, even if the Cavallaros were right, they could
not show the correct amount of their tax liability. This runs
squarely against the Supreme Court's holding in Taylor.
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The Cavallaros should have had the opportunity to rebut
the Bello report and to show that the Commissioner's assessment
was "arbitrary and excessive."12 If they succeeded in doing so,
the Tax Court should have then determined for itself the correct
amount of tax liability rather than simply adopting the
Commissioner's position. See Taylor, 293 U.S. at 515–16 (stating
that upon determining the Commissioner's valuation to be
arbitrary, the Board of Tax Appeals should have conducted a
"further hearing" in which it "heard evidence to show whether a
fair apportionment might be made and, if so, the correct amount of
the tax"); see also Worcester Cty. Tr. Co. v. Comm'r, 134 F.2d
578, 580–81 (1st Cir. 1943) (upon finding the Board's determination
of value of a stock to be "arbitrary and excessive," remanding for
"further action" on the correct value); Taylor v. Comm'r, 445 F.2d
455, 460 (1st Cir. 1971) ("[Under Taylor,] if a taxpayer proves
that a deficiency asserted by the Commissioner is wrong but fails
to prove there was no deficiency or the correct figure, the Tax
Court cannot accept the Commissioner's admittedly erroneous
12
Although, for reasons discussed at length above, the
Commissioner's present action is not a "naked" assessment of tax,
we grant the possibility that his method of arriving at the
$29,670,000 valuation for the gift may nonetheless have been
incorrect. Cf. Estate of Todisco, 757 F.2d at 5 ("[G]ranting for
the sake of argument that the Commissioner's method of arriving at
a ten percent gross profit margin was arbitrary . . ., it is clear
nonetheless that Todisco earned bookmaking income in 1972 and 1973.
The Commissioner's present action is thus not a naked assessment
of tax.").
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figure. Instead it must hold a hearing to determine what the
correct figure is.").
In accordance with those cases, we remand so that the
Tax Court can evaluate the Cavallaros' arguments that the Bello
valuation had methodological flaws that made it arbitrary and
excessive.13 If the Tax Court determines that the Commissioner's
assessment was arbitrary, then it must determine the proper amount
of tax liability for itself.14 "The court need not, in making this
determination, be able to precisely establish the correct figures;
reasonable approximations may be employed, provided the findings
disclose the method used in calculating the deficiency." Miller
13 The Cavallaros' brief explains the bases on which they
argue that the Bello valuation was without foundation and
excessive. The Commissioner suggests that those arguments are
meritless in light of the Tax Court's factual findings. But it
seems unwise for us to attempt to determine ourselves whether the
Cavallaros have valid criticisms that make the Bello valuation
arbitrary. Instead, the Tax Court ought to make that determination
in the first instance.
14 Estate of Elkins v. Commissioner, 767 F.3d 443 (5th Cir.
2014), which the Commissioner cites in opposition, is not to the
contrary. There, the Fifth Circuit held that the Tax Court had
erred in rejecting the taxpayer's evidence of fractional-ownership
discounts for the purpose of artwork valuation, where nothing in
the Commissioner's expert testimony, briefing, or oral argument
"detract[ed] from or call[ed] into question" the taxpayer's
evidence. Id. at 452. This case is entirely different because the
Commissioner's valuation, although the last one standing, is not
"uncontradicted, unimpeached, and eminently credible." Id. at 451.
Rather, the Cavallaros offered serious criticism of the
Commissioner's evidence.
Even if Elkins were correct, the Commissioner seems to concede
that Elkins spoke too broadly in prohibiting the Tax Court from
conducting its own valuation once the party with the burden of
proof is shown to be erroneous.
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v. United States, 296 F.2d 457, 460 (7th Cir. 1961). The court is
free to accept in whole or in part, or reject entirely, the expert
opinions presented by the parties on the subject. See Silverman,
538 F.2d at 933; see also Helvering v. Nat'l Grocery Co., 304 U.S.
282, 295 (1938). Further, the court may take new evidence,
including a new expert valuation.
V. CONCLUSION
For the above-stated reasons, we affirm the Tax Court's
determination that the burden of proof was on the taxpayers and
its finding that Knight owned the CAM/ALOT-related technology at
the time of the Knight-Camelot merger. However, insofar as the
court misstated the nature of the Cavallaros' burden of proof, we
reverse and remand the case for further proceedings in keeping
with this opinion. The extent of any further briefing, hearings,
or evidence is left to the Tax Court's sound discretion.
Affirmed in part, reversed in part, and remanded.
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