District Court Teaches Confusing Summary Judgment Lesson (2/19/20)

In United States v. Feldman, 2020 U.S. Dist. LEXIS 24162 (E.D. Mich 2/12/20), CL here (and docket entries here) in a collection suit, the Court denied the United States’ motion for summary judgment, starting the exegesis as follows (Slip Op. 1-2):

And the IRS says that every reasonable jury would agree with it and [*2]  so this Court should grant it summary judgment. But the Court believes that there is a genuine dispute over how much income Feldman received in 2001 and 2002, and thus a genuine dispute over whether the IRS has reasonably determined the amount of tax owed. Accordingly, as explained below, the Court will deny the IRS' motion for summary judgment.

The Court wanders around a bit in its discussion, and in the course of starting the wandering with the following comment (Slip Op.):

“Unfortunately, the parties in this case have put little effort into figuring out the proper summary-judgment burdens.”

So the Court sets about to instruct the parties.  Unfortunately, at least as I see it, the Court gets the analysis for the most significant issue wrong, in part because it does not understand the facts and the law of how stock transactions are reported in brokerage accounts.

I will try to summarize the key facts for purposes of this blog’s discussion. I note that I have not studied in detail the underlying submissions by the parties, but I spot checked a couple of the documents and incorporate them as background in this discussion.

I think the relevant facts are:

(i) Feldman did not file returns for 2001 and 2002;

(ii) the IRS assessed tax for those years based, according to the court, on a list of “seven payments from brokerage firms to Feldman;” The brokerage firms issued Forms 1099-B for stock transactions in Feldman’s account(s).  On Forms 1099-B a brokerage (or other financial) firm lists sales proceeds for stock (or other financial assets) sold in the client’s account(s).  Apparently, the list referred to was the IRS computer generated list of the amounts the brokerage firm reported as sales proceeds on the Forms 1099-B issued to Feldman for transactions in his account. Basically, the transactions would have been sales of stock (or other financial assets) where the sales proceeds were deposited into the taxpayer’s account with the brokerage firm.

(iii) the brokerage firm did not distribute to Feldman all of the proceeds it received and reported on Forms 1099-B.  Rather, because Feldman had written bad checks to the brokerage firm, the brokerage firm reduced any amounts ultimately paid to the taxpayer by the amount of its claim for bad check amounts.  There may have been some other offsets as well.  So, in sum, the amounts reported on the Forms 1099-B would have exceeded the amounts the brokerage firm actually distributed to the Feldman.

The relevant facts may be illustrated in a simple example: (i) brokerage firm sells stock from taxpayer’s account for $1,000 and receives that amount into the taxpayer’s account with the brokerage firm; (ii) brokerage firm collects from that $1,000 an amount of $200 for a bad check (or any other amount the taxpayer owes the brokerage firm); (iii) brokerage firm pays the taxpayer the net of $800.  In these facts, the Form 1099-B reports $1,000 proceeds (payments received by the brokerage firm on sale) and does not report the actual cash payment to the taxpayer of $800.  On his tax return, the taxpayer’s gain should be reported as follows: (i) amount realized $1,000 proceeds; (ii) less the taxpayer’s basis in the stock sold (the example does not quantify the basis and, in the years involved, basis was not a reporting item on Form 1099-B); and (iii) producing the taxable gain on the sale of the stock.

The IRS asserted tax against the taxpayer using the Form 1099-B reported proceeds without any basis offset.  The IRS did that because it did not have any information about the basis.  Usually, in any proceedings (audit, appeals and litigation) where the taxpayer wants the benefit of a basis to reduce the taxable gain, the taxpayer will produce evidence of the basis.  In a way it is like an affirmative defense or the functional equivalent of a deduction which courts frequently and rotely say are the taxpayer’s burden to prove.

Feldman produced no evidence of his basis in his stock, even in the litigation when the IRS inquired. So, the IRS moved for summary judgment based on the Forms 1099-B reported amounts realized without any reduction for basis.  Feldman argued that the Forms 1099-B were incorrect because he did not receive the amounts reported.  I think he is arguing that the brokerage firm distributed to him less than the amounts reported on the Forms 1099-B.  But, as I demonstrate above, the issue is not how much the brokerage house distributes but what the sales proceeds (amount realized) were.

The court, apparently, did not understand how Forms 1099-B work and the relationship of the proceeds reported and taxable gain.  The court somehow thought the tax was determined by distributions to the taxpayer rather than the amount realized on sales in the account.

So, let’s look at the Court’s analysis.

Immediately after making the swipe at the parties quoted above, the Court offers the standards for summary judgment and how it plays out for parties bearing and not bearing the burden of persuasion.  (Slip. Op. 5-6.)  I think the analysis is not as good as it may seem, but won't tarry on it because it was just a statement of the standard.  I turn now to how the Court supposedly applied any applicable standard.

The Court equates, incorrectly I think, the amount reported on the Forms 1099 with the amounts the taxpayer received from the brokerage firm.  As note above, the issue in quantifying the amount realized in computing taxable gain is not what the taxpayer receives from the brokerage firm but the proceeds the brokerage firm receives on taxpayer’s behalf.

The Court nevertheless treats the taxpayer’s claims that the brokerage firm actually paid him less than reported on the Forms 1099 as somehow relevant to the issue of the taxable gain and resulting tax liability.

So, with a proper view of the facts, the summary judgment analysis should be: (i) the IRS is entitled to rely upon the Forms 1099 to show the amount realized on the sale of stock owned by the taxpayer in the brokerage firm account;(ii) the trading in the account which taxpayer does not deny proves the likely source of the income; (iii) the taxpayer is entitled to reduce the reported amounts realized by his basis in the stock; and (iv) the taxpayer has not to date and in opposing summary judgment has not shown or made any claim as to basis.  The initial conclusion without further nuance should be that the taxpayer loses on the motion for summary judgment.

There is more nuance, however:

First, over time and ignoring calendar year interruptions, the amount distributed from a brokerage account should equal the amount the taxpayer put into the account, plus or minus the trading gain or loss in the account.  So, for simplicity, assume the taxpayer put $100 in the account and over the life of the account received distributions of $1,000, that would indicate a net gain of $900 over the life of the account.  The taxpayer’s net gain over the life of the account is not the same as the taxable gain that the taxpayer reports on his annual tax returns.  The taxpayer can have a number of gains and losses which ultimately net in the account to $900 gain, so that with the original $100, the $1,000 distributions over the life of the account can be paid.  And during the life of the account, the taxpayer is required to report the results of the individual stock sale producing the net gain of $900.  So, the amount of the gain that the taxpayer must report is independent of distributions from the account, although ultimately over time they may resolve.

Second, the key nuance, in my mind, is the one not discussed by the Court.  It all goes back to  Helvering v. Taylor, 293 U.S. 507 (1935), here, and indeed the case that it affirmed Taylor v. Commissioner, 70 F.2d 619 (2d Cir. 1934) (L. Hand, J.), here.  Helvering v. Taylor is the starting and often ending point of the determining what happens in the Tax Court when the IRS wants the Tax Court to enter a decision document quantifying the amount of the tax the taxpayer owes.  If the evidence shows that the amount asserted by the IRS is arbitrary or excessive, the IRS then bears the risk of nonpersuasion as to the amount of tax that the taxpayer owes.  So, if Feldman’s case had been tried in the Tax Court where Helvering v. Taylor controls, a persuasive argument could be made that, because the asserted tax liability did not include any reduction for basis, the asserted tax liability was arbitrary or, at least, certainly excessive because there is really no such thing as stock truly without a basis. (Well that is an overstatement without nuance, but certainly stock purchased and sold through brokerage accounts always has a basis when purchased because you can’t acquire stock without some payment.)

I won’t get into the Helvering v. Taylor analysis in detail here, but just point readers to my article the SSRN draft of my article being finalized for publication in the ABA Tax Lawyer publication.  Townsend, John A., Burden of Proof in Tax Cases: Valuation and Ranges - An Update pp. 19-21(November 5, 2019). Draft of Article for Publication in the ABA’s The Tax Lawyer (Spring 2020) (Forthcoming). Available at SSRN: https://ssrn.com/abstract=3489925.  In that case where the IRS had clearly not given the taxpayer sufficient basis credit to offset amount realized, both the Second Circuit and the Supreme Court held that the IRS had the risk of nonpersuasion.  (Note that there will be significant refinements in my article when published in the Tax Lawyer, so these interested in updates should be sure to read the final published article.)

And, to close the loop, since this was not a Tax Court proceeding, the question is whether it applies in a collection suit.  Logically, the same Helvering v. Taylor analysis applies to collection suits in the district courts where the Government seeks a judgment in an amount and has the risk of nonpersuasion if the evidence adduced shows that the amount it claims is arbitrary or excessive.  United States v. Janis, 428 U.S. 433, 440 (1976) (holding that the function of the presumption of correctness and burden of proof rules in collection suits accords “with the burden-of-proof rule which prevails in the usual preassessment proceeding in the United States Tax Court”); Bar L Ranch, Inc. v. Phinney, 426 F.2d 995, 998–99 (5th Cir. 1970) (concluding that “a taxpayer defending a collection suit need only show that the Government's assessment was arbitrary and that the burden is then on the Government to show whether any deficiency exists and, if so, in what amount”).

So, based on this Helvering v. Taylor analysis, I think that the analysis should be: (i) the evidence shows that the tax amount the Government seeks is excessive (and in a sense arbitrary) because it allows no basis offset in reaching taxable gain; (ii) the Government thus bears the risk that the evidence is not persuasive as to a lesser amount of gain; (iii) the Government has not met its burden of production as to any basis that would produce a lesser amount of gain; and (iv) therefore, Feldman should prevail on motion for summary judgment.