Nora L. Mihelick v. United States

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[PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT
________________________
No. 17-14975
________________________
D.C. Docket No. 2:16-cv-00741-SPC-MRM
NORA L. MIHELICK,
Plaintiff - Appellant,
versus
UNITED STATES OF AMERICA,
Defendant - Appellee.
________________________
Appeal from the United States District Court
for the Middle District of Florida
________________________
(June 18, 2019)
Before CARNES, Chief Judge, and ROSENBAUM and DUBINA, Circuit Judges.
ROSENBAUM, Circuit Judge:
Inscribed above the main entrance of the Internal Revenue Service office in
Washington, D.C., is a quotation from Supreme Court Justice Oliver Wendell
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Holmes Jr.: “Taxes are what we pay for a civilized society.” Civil servants at the
IRS pursue an honorable mission, Washington Post, https://www.washingtonpost.
com/opinions/civil-servants-at-the-irs-pursue-an-honorable-mission/2018/07/24/
75268f5e-8ea8-11e8-ae59-01880eac5f1d_story.html?utm_term=.61e3f74f5f8c,
(last visited June 18, 2019). An admirable outlook, yet even Justice Holmes would
likely agree that it is uncivilized to impose taxes on citizens for income they did not
ultimately receive. But that is precisely the result the government asks us to uphold
today.
When they were married, Nora Mihelick and her ex-husband Michael Bluso
earned and paid taxes on income from Gotham Staple Company (“Gotham”). After
the couple divorced, they learned they had to return $600,000 of the income they
had received from Gotham. This meant that the couple had paid income taxes on
$600,000 they turned out not to have.
Since the two had equally benefitted from and contributed to the income at
issue, they agreed to split the liability evenly, consistent with Ohio law: Bluso would
return $300,000 and Mihelick the other $300,000. So Bluso returned the full
$600,000, and Mihelick reimbursed him for half that amount.
Then, under 26 U.S.C. § 1341—which allows a taxpayer who paid taxes on
what he erroneously believed to be his income to recoup those unnecessary tax
payments—Bluso recovered the taxes he had previously paid on the $300,000. But
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when Mihelick tried to do the same thing for the taxes she had paid on the other
since-returned $300,000, the government denied her request, simply because she had
paid the money to Bluso instead of returning the money directly herself.
Under § 1341, though, Mihelick had just as much of a right to recover the
taxes she previously paid on the $300,000 she received and then gave back as did
Bluso to recover the taxes he paid on his $300,000 that he returned. So we reverse
the district court’s entry of summary judgment for the government and remand for
further proceedings consistent with this opinion.
I. BACKGROUND
Petitioner Nora Mihelick and her ex-husband Michael Bluso married in Ohio
in 1978. From 1999 to 2004, the couple lived in Ohio and worked at Gotham Staple
Company, a closely held Ohio corporation owned by Bluso’s family. Mihelick
worked for the company, planning events, caring for and maintaining the homes of
Bluso’s parents, and handling administrative tasks. Bluso was the chief executive
officer of Gotham at the time, and he eventually became majority shareholder as
well. Both Mihelick and Bluso earned income for their roles at Gotham, and the
couple filed joint tax returns that included Bluso’s income during those years. The
couple likewise paid taxes on the taxable income they earned from Gotham during
that time.
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In September 2004, Mihelick filed for divorce. While the divorce was
pending, Pamela Barnes—one of Bluso’s sisters, who was a minority shareholder at
Gotham—sued Bluso, Gotham, and others. Among other things, Barnes claimed
that Bluso had breached his fiduciary duties by excessively compensating himself at
Gotham’s expense.
Mihelick was not a party to the litigation, but Bluso wanted Mihelick to share
any resulting liability from Barnes’s lawsuit. To Bluso, Mihelick had also reaped
the benefits of his compensation, so she should share the burdens of his
compensation as well.
At first, Mihelick opposed the idea of sharing liability for the Barnes
litigation—she wanted the separation agreement to provide that she was “not liable
for anything that Pam Barnes comes up with.” But when Bluso threatened to have
a judge decide Mihelick’s responsibility, Mihelick relented and agreed to share
liability for the Barnes lawsuit.
After some back and forth between the parties about how to divide the
liability, they agreed to Article 5 of their separation agreement, which provided that
any liability from the Barnes litigation would be considered a marital liability for
which Bluso and Mihelick would be jointly and severally liable. Specifically, the
section clarified that the liability “arose all or in part from the acquisition of marital
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assets,” and that since the marital assets had been equally divided, the liability “shall
be deemed to be a marital liability,” too.
Mihelick and Bluso finalized their divorce on August 31, 2005, but the Barnes
litigation continued. Eventually, in 2007, Bluso settled with Barnes. Under the
terms of the settlement, Bluso disclaimed any wrongdoing but paid Barnes $600,000
to settle her excess-compensation claims.
After paying Barnes $600,000, Bluso took a tax deduction for $300,000.
When asked whether he considered deducting the entirety of his $600,000 payment
to Barnes, Bluso explained that he did not feel that it was right to do so, since
Mihelick had to shoulder the burden of the other half of the $600,000 payment and
since the couple had shared benefits and liabilities evenly during the marriage:
[T]he divorce decree said she would have to pay back half
of it since she, you know, benefited in half, and all these
1040s you gave me both my name and her name is on it.
We both paid income tax on that. We paid income tax on
her salary. She paid income tax on my salary. When I
paid back the money to my sister, that was for excess
compensation. I only felt that I was due $300,000 of it . .
..
Bluso accordingly looked to Mihelick to cover her half of the $600,000
liability, but Mihelick again resisted paying. So Bluso withheld alimony for a month
and threatened to deprive her of more support. After contentious negotiations
between Mihelick’s lawyer and Bluso, and after Mihelick’s lawyer advised her that
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she had an “obligation” to pay, Mihelick finally acquiesced and paid Bluso $300,000
in 2009. 1
In the meantime, Bluso successfully obtained tax relief for his $300,000
payment. Viewing herself in the same position as Bluso, Mihelick then sought tax
relief for her $300,000 payment. On her 2009 tax return, she pursued a tax refund
under 26 U.S.C. §§ 1341 and 165. But unlike what it had done with Bluso, the IRS
denied Mihelick’s claim for a refund. Mihelick sought relief in court. The district
court agreed with the government and granted summary judgment against Mihelick.
Mihelick now appeals.
II. STANDARD OF REVIEW
“We review de novo the grant of summary judgment and construe the
evidence and draw all reasonable inferences in the light most favorable to the
nonmoving party.” Ziegler v. Martin Cty. Sch. Dist., 831 F.3d 1309, 1318 (11th Cir.
2016).
III. DISCUSSION
Congress enacted § 1341 as a direct response to the Supreme Court’s decision
in United States v. Lewis, 340 U.S. 590 (1951). Fla. Progress Corp. & Subsidiaries
v. Comm’r, 348 F.3d 954, 957 (11th Cir. 2003). Therefore, before we analyze
1
Mihelick actually wrote a check for $323,700, but only $300,000 went to covering the
overcompensation settlement.
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Mihelick’s § 1341 claim, we first briefly review Lewis, so we can be aware of the
problem Congress set out to fix when it enacted § 1341.
In Lewis, a taxpayer reported a $22,000 bonus that he had received in his 1944
income statement. Lewis, 340 U.S. at 590. Two years later, it came to light that his
bonus was improperly computed, so the taxpayer had to return $11,000 of that bonus.
Id. The taxpayer tried to recalculate his 1944 taxes to reflect the fact that he had a
bonus of only $11,000 that year, but the Supreme Court ruled that he could deduct
$11,000 from his 1946 return only, not the 1944 one. Id. at 592.
Some felt the Lewis decision was unfair. For example, since factors like tax
rates and income brackets may change from year to year, the taxpayer in Lewis still
may have unnecessarily paid taxes on income that he turned out not to have. See
Fla. Progress, 348 F.3d at 957; Robb Evans & Assocs., LLC v. United States, 850
F.3d 24, 30-31 (1st Cir. 2017). To remedy this perceived inequity, Congress enacted
§ 1341, the object of which is “to put the taxpayer in the same position he would
have been in had he not included the item as gross income in the first place.” Fla.
Progress, 348 F.3d at 957.
To obtain relief under § 1341, a taxpayer must satisfy four requirements. First,
an item of income must have been included in a prior year’s gross income “because
it appeared that the taxpayer had an unrestricted right to such item.” § 1341 (a)(1).
Second, the taxpayer must have later learned that she actually “did not have an
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unrestricted right” to that income. See § 1341(a)(2). Third and fourth, the amount
the taxpayer did not have an unrestricted right to must have exceeded $3,000 and be
deductible under another provision of the tax code. Fla. Progress, 348 F.3d at 957,
959. If the taxpayer can demonstrate these elements, then she has a choice between
two options: “[s]he can deduct the item from the current year’s taxes, or [s]he can
claim a tax credit for the amount [her] tax was increased in the prior year by
including that item.” Id. at 957.
In this case, no party disputes that the putative deduction exceeds $3,000. We
therefore examine the remaining elements of § 1341, beginning with whether
Mihelick appeared to have an unrestricted right to the relevant income. Next, we
turn to whether Mihelick proved that she actually lacked an unrestricted right to that
income. Finally, we study whether Mihelick can deduct her $300,000 payment
under another provision of the tax code.
A. Mihelick appeared to have an unrestricted right to the income in question.
The government contends that Mihelick did not appear to have an unrestricted
right to the income in question. According to the government, Mihelick had no
presumptive right to Bluso’s income. And even if she did, the government asserts,
Bluso could not have claimed an unrestricted right to the income he allotted himself
from Gotham because those funds were misappropriated.
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We address this two-part argument in reverse order, beginning with whether
Bluso appeared to have an unrestricted right to the Gotham income. The
government’s position that he did not rests on its assumption that Bluso knowingly
misappropriated money from Gotham. If a taxpayer stole or otherwise knowingly
improperly acquired income, then he could not have a sincere belief that he had an
unrestricted right to that income. See, e.g., Robb Evans, 850 F.3d at 32 (“In short,
section 1341(a)’s ‘unrestricted right’ language excludes all income reaped by
taxpayers who know at the time of receipt that they have no right to the income.”).
But here, the record lacks any proof that Bluso knowingly misappropriated income,
since his settlement agreement with Barnes expressly disclaimed any wrongdoing.
Since we must take the facts in the light most favorable to Mihelick, the
government’s contention that Bluso did not believe he had an unrestricted right to
his income necessarily fails.
The government’s claim that Mihelick had no presumptive right to Bluso’s
income fares no better. First, even if the government’s assertion were correct, it
makes no difference to the § 1341 analysis. What matters is whether Mihelick
sincerely believed she had a right to Bluso’s income, not the correctness of her belief.
McKinney v. United States, 574 F.2d 1240, 1243 (5th Cir. 1978) 2 (“The language of
2
Decisions handed down by the Fifth Circuit by the close of business on September 30,
1981, are binding on this Court.
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[§] 1341(a)(1), i.e.[,] ‘because it appeared that the taxpayer had an unrestricted right
to such item,’ must necessarily mean ‘because it appeared (to the taxpayer) that (he)
had an unrestricted right to such item.’” (emphasis added)). After all, if a taxpayer
had to correctly believe that she had an unrestricted right to income to qualify for
§ 1341, then the taxpayer would have correctly paid her income taxes in the first
place, and § 1341 would never come into play, since the second element of § 1341
requires a showing that the taxpayer did not, in fact, have an unrestricted right to the
income. So Mihelick did not need to be right that she had an unrestricted right to
Bluso’s income; she just needed to sincerely believe it. 3
Looking at the facts in the light most favorable to Mihelick and making all
reasonable inferences in her favor, we conclude that enough evidence in the record
shows that Mihelick genuinely believed she had an unrestricted right to Bluso’s
income from 1999 to 2004, when the two were married. The separation agreement,
for example, reflected the couple’s belief that each spouse had an equal right to the
family income, as it provided that the marital property was to be divided equally
3
The taxpayer need only subjectively believe that she was entitled to an item of income—
even if some may consider her belief to be unreasonable. As stated, the object of § 1341 is “to put
the taxpayer in the same position he would have been in had he not included the item as gross
income in the first place.” Fla. Progress, 348 F.3d at 957. The section does not discriminate
between those who reasonably or unreasonably paid excess taxes—its aim is to return to the
taxpayer excess taxes paid. And this makes good sense: no one would report and pay taxes on
income to which she does not believe herself to be entitled, only to take the trouble of going
through § 1341 to return herself to her starting position.
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between Mihelick and Bluso and that each would be equally responsible for any
liability arising from Bluso’s compensation.
Second, the government is incorrect in any event in its assertion that Mihelick
had no presumptive right to Bluso’s income. Although Ohio is not a community
property state, it does treat income from labor—as opposed to passive income—as
marital property, and “[e]ach spouse shall be considered to have contributed equally
to the production and acquisition of marital property.” Ohio Rev. Code § 3105.171.
Marital property is to be divided equally upon divorce, unless doing so would be
inequitable. Id. So it appears that under Ohio law, Bluso’s income was marital
property, and Mihelick presumptively had an equal right to it.
Nor, as the government suggests, did the fact that Mihelick and Bluso did not
initiate divorce proceedings until September 2004 preclude Mihelick from relying
on § 3105.171’s presumption as it related to Bluso’s income from 1999 to 2004. The
government argues that § 3105.171’s presumption that the wife contributed equally
to the couple’s income during marriage applies only after the commencement of
divorce proceedings. During marriage, the government contends, property rights of
each spouse are different because under Ohio law, a husband or wife may take, hold,
and dispose of property as if unmarried, and neither husband nor wife has any
interest in the property of the other.
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Essentially the government argues that Ohio acknowledges a spouse’s
contributions to and interest in the couple’s marital estate only when a couple
divorces, not when the couple is married. The only potentially precedential case the
government cites for this contention is State v. Garber, 709 N.E.2d 218 (Ohio Ct.
App. 1998). There, a wife was convicted for knocking out the windows of her
husband’s 1996 Dodge pickup truck. Id. at 218-19. She argued the truck constituted
marital property under § 3105.171 and it was not criminal to damage her own
property. Id. at 219. But the court in Garber disagreed and held that § 3105.171
applied only during divorce proceedings and that §§ 3103.04 and 3103.07, Ohio Rev.
Code, which respectively provide that “[n]either husband nor wife has any interest
in the property of the other” and that “[a] married person may take, hold, and dispose
of property, real or personal, the same as if unmarried,” meant that the truck, which
was leased in the husband’s name, was the husband’s property. Id. at 617-18; Ohio
Rev. Code §§ 3103.04, 3103.07.
We would normally follow Garber unless persuasive evidence indicated that
the Ohio Supreme Court would rule otherwise. Pendergast v. Sprint Nextel Corp.,
592 F.3d 1119, 1133 (11th Cir. 2010). Here, there is. In fact, the Ohio Supreme
Court has abrogated Garber’s discussion of §§ 3103.04, 3103.07, and 3105.171. A
year after Garber, the Ohio Supreme Court explained that § 3103.04 has no
applicability in criminal cases, since “[p]rivileges of a husband and wife with respect
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to the property of the other were not meant to be enforced criminally and do not
affect criminal liabilities.” State v. Lilly, 717 N.E.2d 322, 326 (Ohio 1999). As §§
3103.07 and 3105.171 are similarly civil statutes that deal with the privileges of
husband and wife with respect to property, they too are inapplicable in the criminal
context. So we are not bound by Garber’s interpretation of those statutes but by
Lilly’s.
And after examining Ohio law, we are convinced that the Ohio Supreme Court
would not hesitate to use § 3105.171, Ohio Rev. Code, to help define the property
rights of married couples even absent a pending divorce. True, “[n]either husband
nor wife has any interest in the property of the other.” Ohio Rev. Code § 3103.04.
And “[a] married person may take, hold, and dispose of property, real or personal,
the same as if unmarried.” Id. § 3103.07. But as the Ohio Supreme Court has
explained, those provisions were largely designed to protect married women: at
common law, “the wife was incapable of making contracts, of acquiring property, or
of disposing of property without her husband’s consent.” Lilly, 717 N.E.2d at 325.
“[T]o relieve the married woman from the disabilities imposed upon her as a femme
covert by the common law,” and to prevent the husband from just absorbing the
wife’s property as his own, the Ohio General Assembly enacted what is now §
3103.04, Ohio Rev. Code, to make sure that separate property of either spouse stays
separate even after marriage. See id.
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These provisions do not conflict with § 3105.171, Ohio Rev. Code. Rather, §
3105.171 simply appreciates that spouses generally tend to work as a unit, with the
efforts and sacrifices of one spouse assisting the other in earning a wage for the
family. So the provision treats income from labor as the fruit of the collective efforts
of both spouses. In short, Ohio Courts have long been able to maintain the integrity
of separate property while crediting marital property that results from the efforts of
either spouse during marriage. See Palmer v. Palmer, 455 N.E.2d 1049, 1051 (Ohio
Ct. App. 1982) (explaining that an increase in the value of separate property
continues to be separate property, unless the increase was the “result of work
furnished by either or both parties during the marriage,” which would make the
increase marital property).
And ironically, the government’s suggestion to the contrary would require us
to read § 3103.04, a provision conceived to protect married women, to curtail the
scope of Ohio Rev. Code § 3105.171, which recognizes the traditional contributions
of women during marriage. We are persuaded that Ohio would not have recognized
the contributions of each spouse to the marital estate during divorce proceedings
only to inexplicably decline to recognize that reality while the couple remains
together.
The upshot is that it appeared—correctly—to Mihelick that she presumptively
had the same unrestricted right as Bluso to the income at issue in this case.
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B. It turned out that Mihelick did not have an unrestricted right to that
income.
The second element of a § 1341 claim requires the taxpayer to establish that,
after the close of a taxable year, “the taxpayer did not have an unrestricted right” to
some amount she initially reported as taxable income. To make this showing, the
taxpayer must demonstrate that she involuntarily gave away the relevant income
because of some obligation, and the obligation had a substantive nexus to the original
receipt of the income. See Batchelor-Robjohns v. United States, 788 F.3d 1280,
1293-94 (11th Cir. 2015). Mihelick satisfies both requirements.
Mihelick involuntarily gave away $300,000 of the relevant income to which
she previously believed she had an unrestricted right. We have explained that
“payments made to settle a lawsuit” may constitute an involuntary obligation for §
1341 purposes. Batchelor-Robjohns, 788 F.3d at 1293-94 (citing Barrett v.
Commissioner, 96 T.C. 713 (1991)). 4 In Barrett, two groups of securities brokers
sued Barrett and several other shareholders at his brokerage firm after the Securities
and Exchange Commission instituted administrative proceedings against the brokers
for suspected insider-trading violations. Barrett, 96 T.C. 715. At a hearing, the
4
In Batchelor-Robjohns, we adopted Barrett’s reasoning as to what constitutes an
involuntary obligation, but we did not adopt all aspects of Barrett. Part of Barrett’s reasoning
rested on the distinction between taking a tax credit and a deduction under § 1341. See Barrett,
96 T.C. 718. But in Batchelor-Robjohns, we ruled that the “deduction/credit distinction merely
determines how to account for a § 1341 repayment on one’s return, nothing more.” Batchelor-
Robjohns, 788 F.3d at 1297.
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magistrate judge advised Barrett and his co-defendants to settle the suits to “avoid
the hazards of litigation,” “substantial legal fees,” and “adverse trial publicity,” all
of which would be harmful for Barrett and his brokerage business. Id. Barrett
heeded the magistrate judge’s advice and without admitting wrongdoing, settled the
civil suits for $54,000. Id. He then sought a tax credit through § 1341. Id. at 716.
The government fought Barrett’s attempt to obtain the § 1341 credit. It argued
that Barrett’s payment was voluntary, so he failed to establish that he did not have
an unrestricted right to the $54,000 he paid to settle the suits. Id. at 718. In
particular, the government complained that Barrett “merely settled the lawsuits”
while continuing to deny his liability and “was not compelled to pay out $54,000 by
a judicial decree after a trial on the merits.” Id.
The Barrett Court was unmoved by the government’s arguments. It would be
“ludicrous,” the Barrett Court explained, “[t]o conclude that [Barrett] restored the
$54,000 voluntarily without regard to any legal obligation.” Id. at 719. Pointing out
the risks that Barrett faced—losing his license, facing up to $10 million in liability,
not knowing the type of evidence the plaintiffs wielded—and the fact that “[t]he
policy of the law is to foster the peaceful settlement of disputes without litigation,”
Barrett held that the settlement was “made in good faith and at arm’s length.” Id. at
719-20. That good-faith settlement, “whether or not embodied in a judgment,
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established the fact and the amount of [Barrett’s] legal obligation” and showed that
Barrett did not have an unrestricted right to the $54,000 for § 1341 purposes. Id.
Mihelick’s situation is materially indistinguishable. As with Barrett,
Mihelick’s obligation to pay arose not from a final judgment, but from an agreement
she entered in good-faith to avoid litigation. And it would be equally as
“ludicrous”—as it was in Barrett to say that Barrett voluntarily paid his $54,000—
to conclude that Mihelick voluntarily paid $300,000 of her income without regard
to any legal obligation.
Indeed, Mihelick initially opposed paying Bluso for any liability arising from
the Barnes lawsuit. Only after Bluso threatened her with litigation did she agree to
be bound to do so and enter into Article 5 of her separation agreement. And even
that did not occur without a battle: the parties actually negotiated Article 5 of the
separation agreement—Bluso asked Mihelick to simply give him $150,000, but
Mihelick turned down that offer because she judged that Barnes’s lawsuit would not
produce that much liability. Then, even after Bluso settled the Barnes lawsuit for
$600,000 and attempted to collect $300,000 from Mihelick, she resisted paying,
prompting Bluso to withhold alimony for a month.
Mihelick also paid an attorney to advise her of her rights, and that attorney
told her that she had an “obligation” to pay Bluso. Under these circumstances—and
particularly in light of the desirability of fostering settlements without litigation—
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Mihelick did not need to wait to be sued before settling and paying for her payment
to be considered involuntary. Because the record reflects Mihelick reasonably
anticipated litigation and settled in good faith in the shadow of litigation, her
$300,000 payment was involuntary for purposes of § 1341.
But as we have mentioned, that a payment is involuntary does not, in and of
itself, suffice to show an unrestricted right to the money paid. Rather, the taxpayer
must also show that the obligation to pay had a substantive nexus to the original
receipt of the income. Batchelor-Robjohns, 788 F.3d at 1293.
Here, that substantive nexus between Mihelick’s obligation to pay and the
receipt of the original income is straightforward. As we have noted, the $300,000
of income in question was presumptively for Mihelick and Bluso’s shared marital
estate. See supra at Section III-A. But that Mihelick and Bluso took that $300,000
as income is also the very reason why Barnes brought her lawsuit—to recover that
money because it was allegedly wrongfully dispensed to Bluso (and Mihelick) as
income. And since Bluso and Mihelick agreed to split the $600,000 liability from
Barnes’s lawsuit over allegedly wrongfully paid income to Bluso (and Mihelick),
Mihelick paid the $300,000 in settlement of the claim. So Mihelick’s payment
ultimately stemmed from the original receipt of the income at issue.
The government’s attempts to convince us otherwise are unavailing.
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The government first argues that the income from Gotham had nothing to do
with Mihelick. But as we have explained, as a matter of Ohio law, the income was
marital property to which Mihelick had a presumptive right.
Next, the government argues that Mihelick cannot satisfy the substantive-
nexus requirement, because “[t]he terms of the couple’s divorce agreement were
negotiated many years after [Mihelick’s] husband reported this income on the
couple’s joint federal tax returns.” But the government has offered no reason why
the passage of time alone should preclude a finding of a substantive nexus. That
Barnes waited to sue does not change the fact that her lawsuit arose from the original
receipt of income.
Finally, the government posits that “while [Mihelick’s] payment may have
incorporated funds traceable to the wages paid to [Mihelick’s] ex-husband, the mere
receipt of wage income does not establish a nexus under . . . § 1341 with every
subsequent expense paid with that income.” But this is a strawman argument: no
party has argued that every expense traceable to income must—or even should—
receive § 1341 treatment.
The government next suggests a new requirement that the taxpayer must meet.
According to the government, a taxpayer lacks an unrestricted right to an item of
income only if she returned the income to the “actual owner.” Although the
government cites no caselaw for support, its contention is not unprecedented. See
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Alcoa, Inc. v. United States, 509 F.3d 173, 180-82 (3d Cir. 2007). Nevertheless, we
decline to adopt a new requirement for this Circuit that lacks a basis in the statutory
text and is inconsistent with § 1341’s purpose—namely, returning the taxpayer who
unnecessarily pays taxes on income she did not have to “the same position [s]he
would have been in had [s]he not included the item as gross income in the first
place.” Fla. Progress, 348 F.3d at 957. It is sufficient on this record that Barnes
effectively and reasonably claimed to be the rightful owner of the $300,000, and
Bluso and Mihelick—who otherwise had a claim to be the rightful owners of the
$300,000—agreed in a legally binding way not to challenge that.
C. Mihelick can deduct her $300,000 payment under another section of the tax
code, namely, 26 U.S.C. § 165(c)(1).
Finally, to qualify for § 1341 relief, Mihelick must show that her $300,000
payment is deductible under another provision of the tax code. Fla. Progress, 348
F.3d at 958-59. Mihelick can meet this element, as she can deduct her payment
under 26 U.S.C. § 165(c)(1), which allows deductions for an individual’s
uncompensated “losses incurred in a trade or business” during the taxable year. 26
U.S.C. § 165(c)(1).
Under § 165(c)(1), a corporate officer may deduct the amount to settle a bona
fide suit alleging mismanagement of corporate affairs, if the allegations are directly
connected with the taxpayer’s business activity. See Butler v. Comm’r, 17 T.C. 675,
679 (1951). In Butler, Butler was an officer of a company, and his wife had profited
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from the purchase and sale of the company’s bonds. Id. at 677, 679. The plaintiff
in that case sued Butler and other fiduciaries of the company for an accounting of
profits the officers and their close relatives had made from the purchase and sale of
the company’s bonds. Id. at 677. Butler settled the lawsuit and tried to deduct the
amount of the settlement and corresponding legal fees from his tax return. See id. at
678. The IRS disallowed Butler’s deduction, and Butler appealed. See id.
On appeal, the Butler Court noted that Butler was engaged in the business of
acting as an officer to the corporation. Id. at 679. It then held that “payment in
settlement of a suit for breach of trust or mismanagement of funds by a fiduciary,
where the threatened litigation is bona fide, is deductible in those instances where
the threatened litigation arises . . . out of the business of the taxpayer.” Id. The court
continued, explaining that allowing Butler’s deduction would not frustrate public
policy, since his settlement did not necessarily mean that he was guilty of breaching
fiduciary duties or mismanaging funds—in Butler’s case, neither side was entirely
convinced that it would win, and Butler had settled “to prevent further damage to his
business reputation.” See id. at 680. Under those circumstances, the court allowed
Butler to deduct the amount of his settlement because it arose from his business of
acting as an officer for the company and allowing such a settlement would not
frustrate public policy. See id. at 680-81.
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The rule from Butler applies here. As CEO and majority shareholder, Bluso
carried out the trade or business of serving as a fiduciary and employee of Gotham.
Barnes’s lawsuit alleged that Bluso breached his fiduciary duty by misappropriating
funds from Gotham as he was acting as CEO. The two sides then settled the lawsuit.
So the settlement payment was made “in settlement of a suit for breach of trust or
mismanagement of funds by a fiduciary, where the threatened litigation is bona fide”
and “arises . . . out of the business of the taxpayer.” Butler, 17 T.C. 679. And,
like the case in Butler, there is no public policy issue with allowing the deduction
because Bluso may well be innocent, since his settlement disclaimed wrongdoing.
Thus, as was the case with the settlement amount in Butler, the $600,000 settlement
here was deductible as a loss incurred in Bluso’s business as a fiduciary.
Since Mihelick was presumed to have contributed equally to the production
and acquisition of the income from Gotham, she also was presumed to have
contributed equally to the ensuing $600,000 liability. And the couple affirmed that
presumption through their actions, as Mihelick did pay for her share of that liability.
Because she paid for half the liability that she helped create, and because that liability
was deductible under § 165(c)(1), Mihelick can take a deduction for her payment
under § 165(c)(1).
This result reflects the reality that Mihelick made the actual payment to
service the deductible liability and comports with the goal of having “[s]ubstance
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and not mere form . . . govern in determining a deductible loss.” 26 C.F.R. § 1.165-
1. Indeed, as far as we can tell, had Bluso sought relief for the entirety of the
$600,000 payment under § 1341, he would have had no problem obtaining it. 5 On
this record, we cannot see why the result should differ, simply because post-divorce,
Mihelick—who jointly paid taxes with Bluso on the $600,000 in the first place—
separately sought relief for her $300,000 share of the payment.
IV. CONCLUSION
When viewed in the light most favorable to Mihelick, the evidence supports
the conclusion that Mihelick satisfies all the elements of § 1341. She is therefore
entitled to survive summary judgment. To reach the contrary conclusion would
punish Mihelick for not being her husband and in the process, would create a tax
windfall for the government. We reverse the district court’s grant of summary
judgment for the government and remand to the district court for further proceedings
consistent with this opinion.
On remand, the district court should ascertain whether any genuine dispute as
to any factual issues necessary to resolve the inquiry on each of the § 1341 factors
5
At oral argument, Chief Judge Carnes asked the government whether Bluso should have
just taken the entire $600,000 deduction and then given half the benefit to Mihelick. The
government neither answered that question nor contested its premise. Oral Argument Recording
for Nora Mihelick v. United States, United States Court of Appeals for the Eleventh Circuit,
http://www.ca11.uscourts.gov/oral-argument-recordings?title=&field_oar_case_name_value=
mihelick&field_oral_argument_date_value%5Bvalue%5D%5Byear%5D=&field_oral_argument
_date_value%5Bvalue%5D%5Bmonth%5D= (last visited June 18, 2019).
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exists (e.g., whether Mihelick believed that she had an unrestricted right to the
income in question, and whether Mihelick paid Bluso to avert a lawsuit or because
she felt legally obligated to do so after consulting her attorney). If so, any dispute
should proceed to trial. And if there is no such factual dispute, the district court
should enter judgment for Mihelick.
REVERSED AND REMANDED.
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