Justice Thomas and Tax -- The Plot Sickens (10/29/23; 10/7/24)

Introduction: Today's topic is off-topic to tax procedure, although it does relate to trial of a tax case in problematic circumstances.

Justice Thomas’ most recently revealed conduct raising considerable controversy in ethics, legality (tax), and prudence is the alleged forgiveness in whole or part of a loan made to Justice Thomas by an alleged acquaintance (perhaps hanger-on) to acquire a luxury RV. Some alleged that, if the allegation is true, Justice Thomas had taxable income (lawyers call it cancellation of indebtedness (“COI”) income) or a nontaxable gift. Either characterization can create potential problems for Justice Thomas–if COI income, Justice Thomas might have tax reporting and paying obligations; if a gift, the “donor” would have tax reporting obligations.  I suggest in this post that the allegation it is both more subtle and potentially sinister than those claims.

From my days at DOJ Tax handling two cases, I believe that there is nuance that is missed in the claims discussed in the above paragraph. The two cases are Spartan Petroleum Company v. United States, 437 F. Supp. 733 (D.S.C. 1977) and Cooper v. United States, 1975 U.S. Dist. LEXIS 11633 (S.D. ALA 1975).

Together, those cases held correctly that 

(i) a cancellation of indebtedness is not treated as COI income if the cancellation is a medium to make a transfer with another tax character (in Spartan Petroleum, the cancellation of indebtedness was additional consideration for transfer of property; btw there was a Tax Management portfolio that wrongly recommended that shuffle); and 

(ii) following through on the Spartan Petroleum holding, a cancellation of indebtedness can be a means to benefit the debtor having some tax character other than COI income. Thus, the COI can represent a gift which is not taxable income to the donee (Thomas potentially) but is a reportable gift potentially subject to gift tax to the donor.  Gift tax status requires that the motive for the gift (here, if applicable, by COI) be detached and disinterested generosity which is the debtor’s (Thomas' burden to prove). If it is not detached and disinterested generosity, the teaching of Cooper is that it is taxable income, because the motive is likely expecting some benefit or advantage the debtor could provide. Cooper was a prominent Alabama politician in the Wallace governing circle and in a good position to benefit the Bank of Pineapple and its principals, one of whom by the way at the time had the highest grades ever recorded at University of Alabama and, at a very young age, had been General Stillwell’s top aide in China; and his bank held a large amount of interest free state deposits.)  I took the bank President's deposition in the Eglin Air Force prison (a country club prison); he delivered the goods. In other words, in that case the COI was income for influence–a bribe with an expected or hoped for benefit.

Now, using those concepts (which are good law), Thomas, like Cooper, will be hard pressed to prove that the cancellation of the debt was detached and disinterested generosity. Very wealthy persons buzzing around famous persona like Thomas seek some aggrandizement other than detached and disinterested generosity. (Conceivably it could just be the fame and glory of being in the famous persona’s circle; but that is not detached and disinterested generosity). 

Let a good DOJ Tax trial lawyer cross examine the “transferor” to Thomas of the benefit by COI, and I suspect that, with a good judge with integrity, the same conclusion would be reached as in Cooper, with all of the explosive inferences thus drawn.  Cooper’s power at the time was so great and entrenched that he didn’t care that the judge thought the COI was improper; a similar holding for Thomas would be explosive and likely result in him leaving the bench one way or the other). And, let Thomas also be cross-examined, and I suspect the inference that could a good judge with integrity would draw is that Thomas would have to be exceptionally naïve to think the COI was motivated by detached and disinterested generosity, with the further inference that Thomas committed tax fraud (civil and criminal  penalty potential), And, of course, a good panel of petit jurors with integrity could draw the same inference. That would be explosive.

Added 10/31/23 (unrelated to Halloween):

I am trying to finalize an article tentatively titled "Tax Deference Cases–the Rest of the Story in the Interpretation of APA § 706." In a footnote in that article, I include the following footnote where I discuss cases involving potential whipsaw of the Government in so-called "widow bonus" cases where the motivation of the party conferring the economic benefit may not be detached and disinterested generosity as required for the benefit to be treated as a gift to the beneficiary (the widow in widow bonus cases or the debtor in COI cases).

I thought I would offer here a footnote addressing the issue in the current draft of the article. The footnote is as follows (currently in the draft footnote 178 but that and even the text of the footnote certainly will change by finalization):

   n178  Analogous differing outcomes on common facts are built into our system driven by different  burdens of proof at the trial level and the unified standard of review on appeal of the outcomes in the trials. This commonly happens where taxpayers on both sides of a transaction seek their preferred but opposing tax results and each can prevail at trial based on burden of proof and  then on appeal because of the standard of review for the trial court results. (This is referred to as a whipsaw.) Consider the so-called widow bonus cases where, upon death of a valued employee, a business pays the surviving spouse (often a woman, hence the cases are sometimes referred to as “widow bonus cases”) a legally unrequired amount to recognize the services of a valued employee and treats it as a deductible bonus but the employee treats it as a nontaxable gift. The IRS can lose both sides of that issue on the same facts. For example, if the IRS believes compensation was the proper characterization, it will either not make a protective claim against the business or make a protective claim with the business certain to win. The widow can litigate the issue before a jury in a refund suit and get a result that the appellate court acknowledges is likely wrong but because of the limitations on review of jury verdicts will not overturn. See Grinstead v. United States, 447 F. 2d 937 (7th Cir. 1971)(“Viewing the evidence as a whole, we find ourselves (to paraphrase Judge Parsons) firmly "convinced that, had we been the jury, we would have ruled against Mrs. Grinstead” but being reminded that “appellate review of determinations in this field must be quite restricted," Duberstein, supra, at 290, 80 S.Ct. at 1199, we find that we cannot say that the evidence adduced at trial so preponderated against Mrs. Grinstead that reasonable men could not have found for her.”). On that same set of facts, in a tax contest with the employer as to the deductibility, a judge would find that it was not a gift and, if the judge held otherwise, a court of appeals would reverse, allowing the employer a deduction despite the widow's case treating it as a gift. At least in theory, the IRS could win both sides of the dispute–i.e., at trial, the widow loses the gift issue and, in a separate trial, the employeeloses the deductibility issue. One instance where this could happen is if, in both trials, the trier of fact is in equipoise on the key motivation for the payment, in the business suit, the business will lose and in the widow suit, the widow will lose, all because each had not met the burden of proof to win the respective cases. (Disclosure: I handled Grinstead while with DOJ Tax Appellate.) 

For a current topical illustration of how whipsaw may occur is the brouhaha around Justice Thomas' receipt of valuable benefits (including expensive trips and cancellation of indebtedness from ultra-wealthy persons where the issue of the person’s motivation for conferring the valuable benefits (e.g., detached and disinterested generosity required for tax gift treatment or potentially other motivations than detached and disinterested generosity with a different tax treatment to the parties, with significant ethicalm civil and criminalt tax penalties, and potentially bribery or some such treatment) see Justice Thomas and Tax -- The Plot Sickens (Federal Tax Proccedure Blog 10/29/23), here.

I add here (not in the article) a "war story" on how the Government lost the Grinstead case at trial and thus on appeal. The trial judge was Judge Parsons of the Northern District of Illinois. The Government asked for a jury instruction based literally on the wording of Duberstein ("detached and disinterested generosity"). Judge Parsons, often law-challenged and otherwise a wild card, refused to give the instruction because, as reported in the transcript, Duberstein was not good authority, expounding on the record that he personally knew that no Justice on the Supreme Court believed Duberstein was correctly decided (rather, he asserted, that the opinion was drafted by a clerk with no Justice agreeing, despite the fact that Justice Brennan appears as the author on the reported opinion). I wanted to highlight Judge Parsons' stated reason in my opening appellant's brief. My reviewer would not let me put anything about it in the brief. (DOJ Tax Appellate was rightly cautious about saying anything potentially negative about a judge if it could be avoided; the issue we raised on appeal was whether the instructions Judge Parson gave were insufficient, rather than his reasons for denying the Government's proffered instruction; that, of course, is right, but I thought that the reasons added color to the case that might help the Government's case.  During my opening appellant argument, one of the judges (I don't recall specifically, but I seem to recall was Judge Reynolds of ED WI, sitting by designation who, being out of Judge Parsons' district might not have known his wild card proclivities) asked why Judge Parsons did not give the instruction the Government requested. I responded, starting with "I'm glad you asked that question"  (or maybe I toned down the introduction with "I am pleased to answer that question" or even "thank you for the question;" and then gave Judge Parsons' stated reasons in the transcript. At least one of the panel members (as I recall) gave a knowing chuckle (knowing because it was common knowledge at least for the 7th Circuit Judges that Judge Parsons was a wild card).

Still, the panel affirmed the jury's verdict because, as it viewed Judge Parson's jury instruction (not  based on Duberstein) was close enough to fairly instruct the jury as to the law so that the stringent requirements for reversing a jury verdict were not met.

Oh well, handling cases at trial and on appeal offers many opportunities for such trial and appellate dispositions.

Added 10/7/24 12:00pm:

In the "war story" above, I identified Justice Brennan as the author of Duberstein. It is reported that Justice Brennan's law clerks drafted his opinions based on key points guidance Justice Brennan gave them, but of course Justice Brennan made appropriate revisions and approved the final opinion. Luke McGrath, On Judge Jed Rakoff (Judicial Profile Federal Bar 2019). I don't think that changes the war story, but does put some nuance on it.