AmBase Corp. v. United States

12-3563
AmBase Corp v. United States of America
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
____________________
August Term, 2012
(Argued: June 10, 2013 Decided: September 9, 2013)
Docket No. 12-3563-cv
____________________
AMBASE CORP.,
Plaintiff-Appellant,
v.
UNITED STATES OF AMERICA,
Defendant-Appellee.
____________________
Before: POOLER, CARNEY, Circuit Judges, and KORMAN,* District Judge.
Appeal from United States District Court for the District of Connecticut
(Warren W. Eginton, J.), granting in part and denying in part Plaintiff AmBase
Corp.’s claim for a refund for the 1989 tax year. Plaintiff’s refund claim is based
*
The Honorable Edward R. Korman, United States District Court for the
Eastern District of New York, sitting by designation.
on a proposed amendment to its consolidated return for the 1992 tax year, for
which it seeks to increase the bad debt deduction claimed on behalf of its affiliate,
Carteret Savings Bank F.A. Carteret, a thrift which calculates its bad debt
deduction under the reserve method, was seized by the Resolution Trust
Corporation in 1992. The district court, through its November 28, 2011
memorandum of decision, May 23, 2012 memorandum of decision, and July 5,
2012 final judgment and order, granted AmBase’s claim to the extent that the
claimed deduction offset Carteret’s post-seizure additional income in tax year
1992 but denied the claim in all other respects. On appeal, we agree that the
district court had subject-matter jurisdiction and affirm its grant of AmBase’s
claimed deduction to the extent that it offsets Carteret’s post-seizure income for
the 1992 tax year. We further hold that the district court should grant AmBase’s
claimed deduction to the extent that it derives from Carteret’s post-seizure bad
debts for the 1992 tax year. Accordingly, we AFFIRM in part and VACATE in
part the judgment of the district court and REMAND the case for further
proceedings consistent with this opinion.
____________________
2
PETER H. WINSLOW (Samuel A. Mitchell, Gregory K.
Oyler, on the brief), Scribner, Hall & Thompson, LLP,
Washington, DC, for Plaintiff-Appellant.
JENNIFER M. RUBIN, Attorney, Tax Division (David
Fein, United States Attorney for the District of
Connecticut, Kathryn Keneally, Assistant Attorney
General, Tax Division, Jonathan S. Cohen, Attorney, Tax
Division), Department of Justice, Washington, DC, for
Defendant-Appellee.
POOLER, Circuit Judge:
Plaintiff-Appellant AmBase Corp. (“AmBase”) brought a refund claim for
tax year 1989 based on a carryback1 generated from a proposed amendment to its
consolidated federal income tax return for the 1992 tax year. The proposed
amendment seeks to increase the bad debt deduction claimed on the return by
AmBase’s affiliate, Carteret Savings Bank F.A (“Carteret”). Carteret, a “thrift”2
which calculates its bad debt deduction under the reserve method, see I.R.C.
§§ 585, 593, was seized by the Resolution Trust Corporation (“RTC”) on
1
“Carrybacks” refer to when the taxpayer applies net operating losses for a
tax year to preceding tax years. See I.R.C. § 172(b).
2
“Thrifts” are defined as “any mutual savings bank not having capital
stock represented by shares, any domestic building and loan association, and any
cooperative bank without capital stock organized and operated for mutual
purposes and without profit.” Treas. Reg. § 1.593-4.
3
December 4, 1992. The United States District Court for the District of Connecticut
(Warren W. Eginton, J.), through its November 30, 2011 memorandum of
decision, AmBase Corp. v. United States, 834 F. Supp. 2d 71 (D. Conn. 2011), May
23, 2012 memorandum of decision, AmBase Corp. v. United States, No. 3:08-cv-651-
WWE, 2012 WL 1884874 (D. Conn. May 23, 2013), and July 5, 2012 final judgment
and order, granted AmBase’s claim to the extent that the bad debt deduction
offset Carteret’s additional post-seizure income in tax year 1992 but denied the
claim in all other respects. On appeal, we hold that the district court had subject-
matter jurisdiction and affirm its grant of AmBase’s claimed deduction to the
extent that it offsets Carteret’s post-seizure income for the 1992 tax year. We
further hold that the district court should grant AmBase’s claimed deduction to
the extent that it derives from Carteret’s post-seizure bad debts for the 1992 tax
year. Accordingly, we AFFIRM in part and VACATE in part the judgment of the
district court and REMAND the case for further proceedings consistent with this
opinion.
BACKGROUND
I. Factual Background
In August 1988, AmBase, the successor corporation to The Home Group,
Inc., purchased Carteret, a federally chartered stock savings bank or thrift. After
4
acquisition, AmBase filed consolidated federal income tax returns with Carteret.
On December 4, 1992, the Office of Thrift Supervision seized Carteret and put it
into the conservatorship of the RTC due to Carteret’s failure to satisfy capital
requirements under the Financial Institutions Reform, Recovery, and
Enforcement Act. In 1996, the RTC transferred receivership to the Federal
Deposit Insurance Company (“FDIC”).
The dispute in this appeal relates to AmBase’s 1992 consolidated federal
income tax return, filed on August 30, 1993. On its return, AmBase reported
Carteret’s tax items from January 1, 1992 through December 4, 1992. It did not,
however, include Carteret’s post-seizure tax items, as AmBase did not control
Carteret post-seizure, and the RTC had not provided AmBase with the relevant
records.3 At the time of filing, proposed regulations under I.R.C. § 597 allowed a
consolidated group to elect irrevocably to disaffiliate from an institution in its
affiliated group that had been placed in receivership. See Treatment of
Acquisition of Certain Financial Institutions; Certain Tax Consequences of
Federal Financial Assistance to Financial Institutions, 57 Fed. Reg. 14,804, 14,812-
814 (proposed April 23, 1992). However, such an election could not become
3
Both parties have stipulated that the RTC and FDIC failed to provide
AmBase with the relevant records until at least May 31, 1996.
5
binding until the regulations had been finalized, see id. at 14,817-818, which did
not occur until December 1995, T.D. 8641, 1996-6 I.R.B. 4, 60 Fed. Reg. 66,091; see
also Treas. Reg. § 1.597-4 (the final regulation). On its original 1992 return,
AmBase included a statement electing to disaffiliate from Carteret. On April 28,
1997, after having received an extension of time, AmBase timely notified the
Commissioner of Internal Revenue (the “Commissioner”) of its decision to
reverse its previous decision to disaffiliate from Carteret.
On March 14, 2000, AmBase filed an amended consolidated federal return
for 1992 in which it sought to amend its 1992 consolidated federal income tax
return to increase Carteret’s claimed bad debt deduction, calculated under the
reserve method, and generate a net operating loss. On that same date, AmBase
also filed an amended consolidated federal income tax return for 1989, on which
it sought to apply the 1992 net operating loss and create a refund. The IRS
denied the refund claim, and, on April 29, 2008, AmBase filed a complaint in the
district court against the United States (the “Government”).
Consideration of AmBase’s refund claim requires an understanding of the
reserve method for calculating bad debt deductions. We turn now to a
description of the applicable law.
6
II. Bad Debt Deductions and the Reserve Method
The Internal Revenue Code allows taxpayers to take a deduction relating to
worthless or “bad” debts. I.R.C. §§ 166, 585, 593. Two methods exist for
calculating this deduction: the specific charge-off method and the reserve
method. The specific charge-off method allows taxpayers to deduct the basis of a
bad debt in the year in which the debt becomes worthless. I.R.C. § 166. The
reserve method allows taxpayers to create a “reserve” of funds in anticipation of
bad debts, and deduct, instead of the basis in a particular bad debt, a “reasonable
addition to the reserve” for the year (the “Reasonable Addition”). I.R.C.
§§ 585(a), 593(a). A bad debt must be accounted for in the year in which it
becomes worthless. See I.R.C. § 166(a)(1) (specific charge-off method); Calavo, Inc.
v. Comm’r, 304 F.2d 650, 654 (9th Cir. 1962) (the reserve method). However, it can
be difficult for a taxpayer to determine the year in which a particular debt
becomes worthless. See, e.g., Boehm v. Comm’r, 326 U.S. 287, 292 (1945); Young v.
Comm’r, 123 F.2d 597, 600 (2d Cir. 1941). The advantage of the reserve method
over the specific charge-off method is that, under the former, the taxpayer’s bad-
debt deduction is not tied to a determination of worthlessness of any particular
debt. It allows the taxpayer to make a reasonable prediction of the amount of
7
debt that will become worthless in a given year without having to identify
specific worthless loans, and claim a deduction based on that amount.
Specific bad debts are still relevant to the reserve method. In the year in
which a bad debt becomes worthless, the taxpayer, instead of a taking another
deduction, charges off the debt by reducing the amount of the reserve. Nash v.
United States, 398 U.S. 1, 3-4 (1970). This increases the Reasonable Addition
otherwise allowable for the year. See Smith Elec. Co. v. United States, 461 F.2d 790,
791 (Ct. Cl. 1972). Similarly, in any year in which a bad debt is recovered, specific
charge-off method taxpayers include the recovery in gross income, while reserve
method taxpayers instead increase the amount of the reserve, decreasing the
Reasonable Addition otherwise allowable for the year. See United States v. Bank of
Am. Trust & Sav. Ass’n, 303 F.2d 304, 306 (9th Cir. 1962); see also 1 Mertens, Law of
Federal Income Taxation § 7:35 (2013). Upon liquidation, the taxpayer’s unused
bad debt reserve is included in gross income. W. Seattle Nat. Bank of Seattle v.
Comm’r, 288 F.2d 47, 48-50 (9th Cir. 1961). But see Nash, 398 U.S. at 3-4 (declining
to apply this “tax benefit rule” when accounts receivable net of reserves were
transferred by partnership during liquidation).
8
Use of the reserve method was formerly available to a broader group of
taxpayers, but in 1987 its use was restricted. See Pub. L. No. 99-514, § 805, 100
Stat. 2085, 2361 (1986) (repealing I.R.C. § 166 (c)); see also Staff of J. Comm. on
Taxation, 99th Cong., Tax Reform Proposals: Accounting Issues, 68 (Comm. Print
1985). However, certain financial institutions are still allowed to use the reserve
method. I.R.C. §§ 581, 585(a)(1), 593(a)(1). AmBase’s affiliate, Carteret, is a thrift
eligible to use the reserve method under I.R.C. § 593 and Treasury Regulation
§ 1.593-4. Thrifts are required to establish two separate reserves, one for
“nonqualifying loans” and one for “qualifying real property loans.”4 Treas. Reg.
§ 1.593-7(a)(1); see also Treas. Reg. § 1.593-11 (defining terms).
The reserve method gives the taxpayer a considerable degree of discretion
to determine the amount of its bad debt deduction and reduce tax liability. This
discretion is restricted by several requirements. First, the taxpayer must earmark
the amounts of the reserves, which “are not to be used for any purpose other
than to apply against bad debts as they occur.” Levelland Sav. & Loan Ass’n v.
United States, 421 F.2d 243, 246 (5th Cir. 1970) (citing Rio Grande Bldg. & Loan
Ass’n v. United States, 36 T.C. 657 (1961)).
4
Some thrifts are also required to establish a third “supplemental reserve
for losses on loans,” Treas Reg. § 1.593-7(a), additions to which do not lead to a
deduction, see I.R.C. § 593(b); Treas. Reg. § 1.593-5.
9
Second, the Reasonable Addition must be “reasonable,” as defined by the
Internal Revenue Code and Treasury Regulations, which describe several
methods for calculating the Reasonable Addition.5 Relevant to this appeal is the
“experience method,” also called the “six-year moving average” formula, see
I.R.C. §§ 585(b)(2), 593(b)(3), which “seeks to ascertain a ‘reasonable’ addition to a
bad-debt reserve in light of the taxpayer’s recent chargeoff history.” Thor Power
Tool Co. v. Comm’r, 439 U.S. 522, 547 (1979) (citing Black Motor Co. v. Comm’r, 41
B.T.A. 300, 302 (1940)). The experience method starts with the balance of the
reserve at the close of the taxable year and then calculates a maximum allowable
value for the reserve, based on a ratio which looks to total bad debts and total
loans for the current and five preceding taxable years. I.R.C. § 585(b)(2). The
difference between the maximum allowable value and current balance is the
maximum addition to the reserve that is permitted (the “Maximum Addition”).
The taxpayer may claim as a deduction a Reasonable Addition up to, but not
exceeding, the Maximum Addition. I.R.C. § 585(b)(2). “Because a bad debt
reserve is an estimate of future losses, the taxpayer will not invariably increase
5
The word “method” is used twice in this section. First, there is the
“method” for taking the deduction, either the specific charge-off method or the
reserve method. Second, under the reserve method, there is the “method” for
determining the amount of the deduction (i.e., the Reasonable Addition).
10
the reserve” based on its past history of bad debts. Roth Steel Tube Co. v. Comm’r,
620 F.2d 1176, 1179 (6th Cir. 1980) (emphasis added). The taxpayer’s Reasonable
Addition is calculated and credited at the close of the tax year. Treas. Reg. §
1.593-5(b)(1).
As a third qualification, “a taxpayer is not to be permitted to enlarge its
reserve account retroactively.” Rio Grande, 36 T.C. at 664; see also Rogan v.
Commercial Disc. Co., 149 F.2d 585, 588 (9th Cir. 1945); Wengel, Inc. v. United States,
306 F. Supp. 121, 123-24 (E.D. Mich. 1969); Treas. Reg. § 1.166-4(b)(2). This rule
follows from the purpose of the bad debt reserve as an estimate of future losses
for which the taxpayer freezes funds. A retrospective enlargement would allow
the taxpayer to claim a deduction based on funds that it did not have to freeze on
its books. This appeal asks us to consider exceptions to the rule of non-
retroactivity.6
6
The regulations provide one exception:
If an adjustment with respect to the income tax return for a taxable year is
made, and if such adjustment (whether initiated by the taxpayer or the
Commissioner) has the effect of permitting an increase, or requiring a
reduction, in the amount claimed on such return as an addition to the
reserve for losses on nonqualifying loans or to the reserve for losses on
qualifying real property loans, then the amount initially credited to such
reserve for such year pursuant to subparagraph (1) of this paragraph may
have to be increased or decreased, as the case may be, to the extent
necessary to reflect such adjustment.
11
III. AmBase’s Refund Claim
AmBase’s refund claim turns on a proposed amendment to its
consolidated federal income tax return for the 1992 tax year. On its initial return,
AmBase calculated a Maximum Addition of approximately $101 million but only
claimed as a deduction a Reasonable Addition of approximately $56 million.7 On
its amended return, AmBase seeks (1) to increase its Maximum Addition to
approximately $125 million and (2) to increase its claimed Reasonable Addition
deduction from approximately $56 million to the new maximum value. In other
words, AmBase is claiming an additional deduction of approximately $69
million. Approximately $24 million of that $69 million relates directly to
Carteret’s post-seizure activities. The remaining $45 million is the amount by
which AmBase could have, but chose not to, increase the reserve on its original
return, based on its initial calculation of the Maximum Addition.8 AmBase
Treas. Reg. § 1.593-5(b)(2). We discuss this exception further below. See infra
Discussion II.A.
7
As mentioned above, thrifts must keep two separate reserves. The values
of the Reasonable Addition and Maximum Addition discussed in this opinion
were calculated by separately determining the values for each reserve and then
adding the values together. For simplicity’s sake, we refer to the two reserves as
one.
8
In other words, the $45 million is the difference between the $101 million
Maximum Addition and the $56 million claimed Reasonable Addition from the
initial 1992 return.
12
argues that it is entitled to the entirety of this additional deduction based on its
decision to include Carteret, post-seizure, on its 1992 consolidated federal income
tax return.
The IRS denied AmBase’s refund claim, and, on April 29, 2008, AmBase
filed a complaint in the district court against the Government. Before the district
court, the Government moved to dismiss for lack of subject-matter jurisdiction.
On March 31, 2010, the district court conditionally dismissed AmBase’s claim, but
granted AmBase a limited discovery period in which to seek evidence
establishing subject-matter jurisdiction. On February 28, 2011, on AmBase’s
motion, the district court set aside its previous dismissal. In response to two
partial motions for summary judgment by AmBase, the district court issued a
November 28, 2011 memorandum of decision, AmBase Corp., 834 F. Supp. 2d 71,
and a May 23, 2013 memorandum of decision, AmBase Corp., 2012 WL 1884874,
which granted in part and denied in part AmBase’s refund claim. AmBase’s
claim was granted to the extent that it offset the additional income of Carteret
during the post-seizure period of tax year 1992, from December 5 to December
31, which was not included on AmBase’s original return. In all other respects,
the district court denied AmBase’s claim. The district court issued a July 5, 2012
final judgment and order consistent with its prior memoranda.
13
AmBase now appeals, arguing that the district court should have allowed
its amendment and refund claim in its entirety. On appeal, the Government
renews its argument that the district court did not have subject-matter
jurisdiction.
DISCUSSION
We review appeals from motions for summary judgment de novo.
Sotomayor v. City of New York, 713 F.3d 163, 164 (2d Cir. 2013). “In reviewing a
district court’s determination of whether it has subject matter jurisdiction, we
review factual findings for clear error and legal conclusions de novo.” Gualandi
v. Adams, 385 F.3d 236, 240 (2d Cir. 2004).
On appeal, we hold that the district court did have subject-matter
jurisdiction to hear AmBase’s claim. We agree with the district court that
AmBase may amend its 1992 return to increase its bad debt deduction based on
Carteret’s post-seizure income in 1992, and further hold that AmBase may amend
to increase its bad debt deduction based on Carteret’s post-seizure bad debts.
Accordingly, we affirm the district court in part and vacate in part, remanding
for further proceedings consistent with this opinion.
14
I. Subject-Matter Jurisdiction
“[T]he United States, as sovereign, is immune from suit save as it consents
to be sued[,] and the terms of its consent to be sued in any court define that
court’s jurisdiction to entertain the suit.” United States v. Testan, 424 U.S. 392, 399
(1976) (internal quotation marks omitted). “Congress has broadly consented to
suits against the United States in the district courts for the refund of any federal
taxes alleged to have been erroneously or illegally assessed or collected, or any
sum alleged to have been excessive or in any manner wrongfully collected under
the internal-revenue laws.” United States v. Forma, 42 F.3d 759, 763 (2d Cir. 1994)
(quoting 28 U.S.C. § 1346(a)(1)) (internal quotation marks and alterations
omitted). However, Congress has placed several conditions on a taxpayer’s right
to maintain a refund suit, including a requirement that the taxpayer satisfy the
applicable statute of limitations by filing a timely administrative claim. Id. at 763
& n.8. Under Section 6511(a) of the Internal Revenue Code, a taxpayer must file
an administrative refund claim “within 3 years from the time the return was filed
or 2 years from the time the tax was paid, whichever of such periods expires the
later.” I.R.C. § 6511(a). However, the three-year limitations period is replaced
with a seven-year period if the refund claim relates to the deductibility of a bad
debt. I.R.C. § 6511(d)(1).
15
While taxpayers may file a formal claim for a refund, see Treas. Reg.
§ 301.6402-3 (listing requirements for formal refund claim), “[i]nformal claims
have long been recognized as valid claims.” New Eng. Elec. Sys. v. United States,
32 Fed. Cl. 636, 641 (1995). As a type of informal claim, taxpayers may file
“protective claims,” which “preserve the taxpayers’ right to claim a refund when
the taxpayer’s right to the refund is contingent on future events and may not be
determinable until after the statute of limitations expires.” Chief Counsel
Advisory 200848045, 2008 WL 5030125 (2008); see also United States v. Kales, 314
U.S. 186, 196 (1941). Informal claims have three components: (1) they must
provide the IRS notice of the taxpayer’s claim to a refund; (2) they must “describe
the legal and factual basis for the refund;” and (3) they must have a written
component. New Eng. Elec. Sys., 32 Fed. Cl. at 641. After having timely filed an
initial claim, a taxpayer may make an amendment that relates back to the prior
claim, provided that “the facts upon which the amendment is based would
necessarily have been ascertained by the commissioner in determining the merits
of the original claim.” St. Joseph Lead Co. v. United States, 299 F.2d 348, 350 (2d Cir.
1962); see also Treas. Reg. § 301.6402-2(b)(1). A “claim seeking refund upon one
asserted fact situation may not be amended out of time so as to require an
16
investigation of matters not germane to the original claim.” Weisbart v. Dep’t of
Treasury, 222 F.3d 93, 98 (2d Cir. 2000) (internal quotation marks omitted),
abrogation on other grounds recognized by In re WorldCom, Inc., No. 12-803, 2013 WL
3779354, at *9 (2d Cir. July 22, 2013).
Here, the parties agree that, under Section 6511(a), AmBase had until
March 31, 1998 to file its claim. AmBase filed its amended return on March 14,
2000, after that date. Before the district court, the Government moved to dismiss
the refund claim for lack of subject-matter jurisdiction, but AmBase put forth
several arguments as to why its claim was timely. First, it argued that the reserve
method regulations required an amended return. Second, it argued that, under
the three-year limitations period, the 2000 claim was timely, because it related
back to four earlier claims: (1) an attachment to AmBase’s original 1992 return,
(2) a June 30, 1995 note made during a separate Government audit, (3) a June
1995 protective claim, and (4) a September 1996 protective claim filed by the
FDIC on behalf of Carteret. Third, AmBase argued that the seven-year
limitations period, under which the 2000 claim would be timely, applied to its
refund claim. The district court rejected these arguments and conditionally
dismissed the refund claim. With respect to AmBase’s argument relying on the
17
1996 FDIC claim, the court’s dismissal rested on the fact that the document was
not before the court, and the court granted AmBase a limited discovery period in
which to acquire the FDIC claim. After AmBase produced the 1996 FDIC claim,
the district court held that it had subject-matter jurisdiction and set aside the
order of dismissal.
On appeal, the Government renews its argument that the district court
lacked subject-matter jurisdiction to consider the refund claim, while AmBase
argues that “[t]he Government has not appealed th[e] jurisdictional holding.”
Appellant’s Br. at 2. While the Government has not cross-appealed, “we have an
independent obligation to consider the presence or absence of subject matter
jurisdiction sua sponte.” Joseph v. Leavitt, 465 F.3d 87, 89 (2d Cir. 2006). We
therefore review the basis on which the district court found subject-matter
jurisdiction and hold that the district court properly found that jurisdiction exists.
The district court held that it had subject-matter jurisdiction based on a
1996 formal protective claim, for tax years 1982 to 1992, filed by the FDIC when it
was Carteret’s receiver. See Treas. Reg. § 301.6402-7 (allowing agencies to file
returns on behalf of banks in receivership). We reproduce the relevant portions
18
of the claim in a footnote.9 The Government argues that AmBase’s 2000 claim
9
In an attachment to the protective claim, the FDIC stated, in relevant part,
the following:
The amended return that is being filed here, itself may be amended when
additional relevant information is discovered.
An increase/decrease in total deductions and/or total income and a
decrease in taxes due are due to the following:
...
3) Savings institutions that fail the “60% asset test” of IRC 7701(a)(19) are
not eligible to use the reserve method of accounting for bad debts under
IRC 593. Such an institution is treated as a bank and therefore must
compute its[] bad debts under IRC 585. If the institution is treated as a
“large bank”, as defined in IRC 585(c), it must compute its bad debts using
the specific charge-off method under IRC 166. Net operating losses
attributable to bad debts treated in this manner are eligible for a 10 year
carryback under IRC 172(b)(1)(D), instead of the usual 3. This refund claim
includes the carryback of the 1992 losses eligible for a 10 year carryback
under IRC 172(b)(1)(D) to the taxable year of the refund as a result of any
required use of the specific charge-off method of accounting for bad debts.
4) Under certain conditions, (such as the occurrence of a change in
underlying facts under Treas. Reg. 1.446-1(e)(2)(ii)(b)), banks using the
reserve method for deducting bad debts under IRC 585(b) can switch to the
specific charge-off method under IRC 166. Net operating losses
attributable to bad debts treated in this manner are eligible for a 10 year
carryback, as allowed under IRC 172(b)(1)(D), instead of the usual 3. This
refund claim represents the carryback of the 1992 losses to the taxable year
of the refund to the extent such losses are eligible [for] a 10 year carryback
period under IRC 172(b)(1)(D) as a result of switching to the specific
charge-off method of accounting for bad debts.
19
was “not germane” to the 1996 FDIC claim because the two claims have different
factual bases. We disagree. The 1996 FDIC claim addressed Carteret’s bad debts
and its method of calculating the bad debt deduction, and it specifically noted
potential net operating losses and carrybacks. Especially in light of AmBase’s
communications with the IRS regarding its decision to disaffiliate, we hold that
the facts relating to AmBase’s 2000 refund claim “would necessarily have been
ascertained” upon consideration of the 1996 FDIC claim. We decline to give the
FDIC claim “a crabbed or literal reading, ignoring all the surrounding
circumstances which give it body and content.” United States v. Commercial Nat.
Bank of Peoria, 874 F.2d 1165, 1171 (7th Cir. 1989) (internal quotation marks
omitted). “The focus is on the claim as a whole, not merely the written
component.” Id. (internal quotation marks omitted).
5) Under IRC 5511(d) a taxpayer has 7 years to determine whether a debt
or a security has become worthless. In the case of a failing financial
institution, management typically refrains from charging off their bad
debts in order to artificially retain capital and keep government regulators
at bay. This amended return reflects adjustments to deduct debts or
securities in the taxable year in which such debts actually became
worthless.
J.A. 840-41.
20
Because we agree with the district court’s holding that it had subject-
matter jurisdiction, we do not consider the other purported bases for jurisdiction.
II. AmBase’s Claim on the Merits
We next turn to the merits of AmBase’s claim. AmBase seeks to amend its
return and claim an additional $69 million Reasonable Addition deduction.
Approximately $24 million of that $69 million derives from Carteret’s post-
seizure activities, while the remaining $45 million is the difference between
AmBase’s original Maximum Addition and Reasonable Addition. AmBase
argues that it is entitled to the entirety of this additional deduction based on its
decision to include Carteret, post-seizure, on its 1992 consolidated federal income
tax return.
As discussed below, we hold, as the district court did, that AmBase may
increase its deduction to the extent that it offsets Carteret’s post-seizure
additional income for the 1992 tax year. We further hold that AmBase may also
increase its deduction to the extent it derives from Carteret’s post-seizure
additional bad debts for the 1992 tax year. In all other respects, we hold that the
21
district court properly denied AmBase’s claim.10
A. Carteret’s Post-Seizure Income
The district court held that AmBase could increase its bad debt deduction
in the amount necessary to offset Carteret’s post-seizure additional income for
tax year 1992. AmBase Corp., 834 F. Supp. 2d at 75-77. We agree and affirm the
district court. The Government, while contesting subject-matter jurisdiction,
does not dispute AmBase’s refund claim to the extent that it rests on this ground.
We pause to briefly explain the principle under which the district court
allowed AmBase to claim an additional deduction. As discussed above, a
taxpayer using the reserve method is generally “not to be permitted to enlarge its
reserve account retroactively.” Rio Grande, 36 T.C. at 664. However, the
Commissioner recognizes two related exceptions to this rule. First, if the
taxpayer in a tax year has taken a Reasonable Addition equal to the Maximum
Addition, and if an adjustment to the taxpayer’s income tax return (“whether
initiated by the taxpayer or the Commissioner”) permits an increase in the
Maximum Addition, the taxpayer may increase its Reasonable Addition to take
10
We leave for the district court on remand the determination of the actual
amount of the increased deduction and the amount of AmBase’s refund.
22
into account the new Maximum. AmBase, 834 F. Supp. 2d at 76; Treas. Reg.
§ 1.593-5(b)(2).11 The second exception, a “liberal interpretation” of Treasury
Regulation § 1.593-5(b)(2), applies to taxpayers who have taken a Reasonable
Addition for a tax year that is less than the Maximum Addition. I.R.S. Gen.
Couns. Mem. (“GCM”) 33,820, 1968 WL 16122 (May 10, 1968). The
Commissioner allows such taxpayers, if a subsequent adjustment increases the
taxpayer’s taxable income for the tax year, to increase the Reasonable Addition
deduction (capped by the Maximum Addition) in order to offset the additional
taxable income. Rev. Rul. 70-5, 1970-1 C.B. 142; GCM 33,820.12 This exception
stems from a policy of allowing a “taxpayer [who] has manifested an intent to
11
The regulation is reproduced at supra note 4.
12
We have described Revenue Rulings as “the official I.R.S. position on
application of tax law to specific facts,” Weisbart, 222 F.3d at 98 (internal
quotation marks omitted). Although not entitled to Chevron deference,
“particular revenue rulings may be given deference to the extent that they are
persuasive.” In re WorldCom, Inc., 2013 WL 3779354, at *9 (citing United States v.
Mead, 533 U.S. 218, 234-35 (2001); Skidmore v. Swift & Co., 323 U.S. 134, 139-40
(1944)). General Counsel Memoranda “are informal documents written by the
I.R.S. Chief Counsel’s office.” Nathel v. Comm’r, 615 F.3d 83, 93 (2d Cir. 2010).
They are also not entitled to Chevron deference. Id. We have stated in dicta that
General Counsel Memoranda may also, like Revenue Rulings, be entitled to
Skidmore deference. Id. We need not here determine if General Counsel
Memoranda are entitled to such deference because the relevant exception is
provided in both the Revenue Ruling and the Memorandum.
23
claim a bad debt reserve sufficient to offset its entire taxable income” to do so in
the face of additional income that it had previously not anticipated. GCM 33,820.
For the reasons described by both the district court and the cited Revenue
Ruling and General Counsel Memorandum, we hold that this second exception is
an appropriate exception to the rule that reserve method taxpayers cannot
retroactively claim an increased deduction. Based on this exception, the district
court allowed AmBase to increase its Reasonable Addition in an amount
necessary to offset Carteret’s post-seizure additional income, which was not
included on AmBase’s initial return. AmBase, 834 F. Supp. 2d at 75-77. We affirm
the district court on this ground.
B. Carteret’s Post-Seizure Bad Debts
The district court denied AmBase’s refund claim in all other respects.
AmBase, 2012 WL 1884874, at *4; AmBase, 834 F. Supp. 2d at 77. We disagree in
one respect and hold that AmBase’s claim should be granted to the extent that it
seeks to increase its deduction to account for Carteret’s post-seizure bad debts.
Our holding comes from the rule, discussed above, that bad debts must be
accounted for in the year in which they become worthless. Calavo, 304 F.2d at
654. With respect to reserve method taxpayers, this requires the taxpayer to
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charge off a specific bad debt against the reserve in the year such debt goes bad.
Id.; Smith Elec., 461 F.2d at 793. By reducing the amount of the reserve, the bad
debts increase the otherwise allowable Reasonable Addition. Smith Elec., 461
F.2d at 791. We hold that reserve method taxpayers must also be allowed to
increase the Reasonable Addition to account for such an increase.
Our holding is guided by the former Court of Claims’ reasoning in Smith
Electric. The Smith Electric Court, in discussing retroactive changes made by
reserve method taxpayers, gave the following example:
T charges a specific debt against the reserve in year 2. In year 5 the
Commissioner challenges the addition to the reserve on the ground that
this specific debt actually became worthless in year 1. If the Commissioner
prevails, T’s addition to the reserve for year 2 would be decreased. Since
the charges against the reserve for the bad debts would also be decreased
by the same amount, the reserve balance would remain the same [for year
2.] The regular statute of limitations would bar a claim for refund with
respect to year 1. Defendant argues that T could not utilize the special
seven-year statute and should therefore increase the addition to his reserve
in year 5, a year totally unrelated to the debt becoming worthless.
We cannot subscribe to such a rule of law.
461 F.2d at 793. The question in Smith Electric was whether the taxpayer was
permitted to account for an increase in the Reasonable Addition. In the above
example, with respect to year 2, both the charge offs and the Reasonable
Addition decrease, leaving the taxpayer’s reserve unchanged. With respect to
25
year 1, the charge offs increase, due to the redetermination of when the debt
became worthless. The Commissioner argued that the taxpayer should not be
permitted to also increase the Reasonable Addition. The case differs from this
appeal in that the Court of Claims did not look to the merits of the refund claim,
but rather considered the applicability to reserve method taxpayers of the
seven-year limitations period—a period which applies, under I.R.C. § 6511(d), to
refund claims on account of the deductibility of bad debts. Id. The Court of
Claims held that the seven-year limitations period was applicable to reserve
method taxpayers. Id. However, it would be illogical for the court to apply the
seven-year statue of limitations if such taxpayers could never claim a refund
based on the retroactive charge off of a bad debt. Extending Smith Electric’s
reasoning, we hold that reserve method taxpayers may claim such a deduction.
Our holding is also guided by the exceptions to the rule of non-
retroactivity discussed above. Under the first exception discussed, a taxpayer in
a tax year who has taken a Reasonable Addition equal to the Maximum Addition
may increase its Reasonable Addition upon an adjustment to the taxpayer’s
return which increases the permissible Maximum Addition. AmBase, 834 F.
Supp. 2d at 76; Treas. Reg. § 1.593-5(b)(2). With respect to the example in Smith
26
Electric, where a specific bad debt is deemed to be worthless in year 1 and not
year 2, this exception would mean that the taxpayer may increase his Reasonable
Addition in year 1 only if he previously took the Maximum Addition. We see no
reason why this exception should be so limited. The fact that the Commissioner
has adopted a “more liberal” reading of the rule in another context further
supports our reasoning here. See Rev. Rul. 70-5; GCM 33,820.
The instant appeal differs from the example discussed in one respect.
AmBase’s additional bad debts arise, not from a redetermination of the year in
which a debt has become worthless, but due to the post-seizure activity of
Carteret which AmBase previously did not include on its return. AmBase was
unable to properly calculate the Maximum Addition because, due to RTC’s
receivership and the RTC’s failure to provide AmBase with the relevant records,
AmBase was unable to account for Carteret’s post-seizure bad debts. We see no
reason why this circumstance should mandate a different result. Indeed, this
situation, in which AmBase has not accounted for the bad debt at all—in either
the proper year or another year—strengthens our reasoning that, in order to
properly account for the bad debt, AmBase must be able to both charge off debts
and increase the reserve.
27
Finally, the reasoning of Wengel, 306 F. Supp. 121, cited by the
Government, does not lead to a different result. Wengel relates to the
deductibility of partially worthless debts, which require both a partially worthless
debt and “that the taxpayer ascertained [the worthlessness of the debt] and made
the accounting entry within the taxable year.” Smith Elec., 461 F.2d at 793 n.3.
As “[t]hese latter criteria are not necessary with respect to wholly worthless
debts” under either the specific charge-off method or the reserve method, id.,
partially worthless debts provide an exception to the rule that bad debts must be
accounted for in the year in which they become worthless, and therefore Wengel
does not conflict with our reasoning.
C. Additional Increase in Deduction
In all other respects we affirm the judgment of the district court. In
particular, we find no authority that supports the proposition that AmBase,
which chose on its initial 1992 tax return to make a Reasonable Addition of $45
million less than the Maximum Addition, should be allowed to retroactively
claim the $45 million as a deduction. In general, “a taxpayer is not to be
permitted to enlarge its reserve account retroactively.” Rio Grande, 36 T.C. at 664.
The taxpayer must earmark the amounts in the reserves, which “are not to be
28
used for any purpose other than to apply against bad debts as they occur.”
Levelland, 421 F.2d at 246. AmBase is not permitted to enjoy the use of its funds
and then retroactively decide to place them in the reserve.
We reject AmBase’s argument that collateral estoppel applies to this case
due to prior litigation involving AmBase’s predecessor corporation, Home
Group, Inc., Home Group, Inc. v. Comm’r, 91 T.C. 265 (1988), aff’d on other grounds,
875 F.2d 377 (2d Cir. 1989). We use a three-part test to determine if collateral
estoppel applies: (1) whether the issues presented in the two proceedings “are in
substance the same;” (2) “whether controlling facts or legal principles have
changed significantly since” the first proceeding; and (3) “whether other special
circumstances warrant an exception to the normal rules of preclusion.” ITT Corp.
v. United States, 963 F.2d 561, 564 (2d Cir. 1992). Collateral estoppel is
inapplicable here because the Home Group litigation involved the interpretation of
Treasury Regulation § 1.593-6(a), a provision applicable for “taxable year[s]
beginning before July 12, 1969.” That provision is not at issue here, and therefore
the two proceedings are not in substance the same.
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CONCLUSION
For the foregoing reasons, the judgment of the district court is AFFIRMED
in part and VACATED in part, and the case is REMANDED to the district court
for further proceedings consistent with this opinion.
30