Opinion
Case No. 8:03-CV-315-T-23EAJ.
June 23, 2004
REPORT AND RECOMMENDATION
Before the court is Defendant's Motion For Summary Judgment (Dkt. 14). In response, Plaintiffs filed Plaintiffs' Response to Defendant's Motion for Summary Judgment and Plaintiffs' Cross Motion for Partial Summary Judgment (Dkt. 15). Oral argument was held on May 4, 2004. I. BACKGROUND
This matter has been referred to the undersigned by the district court for consideration and a Report and Recommendation.See Local Rules 6.01(b) and 6.01(c), M.D. Fla.
Subsequent to oral argument, with leave of court, the parties filed supplemental citations of authority which have also been considered.
This is an action by Plaintiffs, Emery and Burchie Ellinger, ("Plaintiffs" or "Ellingers") seeking a refund of federal income taxes for years 1994 and 1995. (Dkt. 1) According to the complaint, Plaintiffs allegedly overpaid taxes because the Internal Revenue Service ("IRS") incorrectly disallowed deductions for losses incurred by two Subchapter S corporations. (Dkt. 1 at 5-8) Plaintiffs base their claim for a refund on the Supreme Court decision in Gitlitz v. Commissioner, 531 U.S. 206 (2001), which held that the cancellation of indebtedness ("COD") of a Subchapter S corporation is an item of income that passes through to shareholders and increases their basis in stock of the Subchapter S corporation, thereby allowing more losses to flow through to the shareholders. (Dkt. 1 at 3-4)
Emery Ellinger ("Plaintiff" or "Ellinger"), was an officer and fifty percent shareholder of three closely held Subchapter S Corporations: Aberdeen Marketing, Inc. ("Aberdeen"), GlobalTel, Inc., ("GlobalTel"), and ProMail, Inc. ("ProMail"). (Dkt. 14 at Ex. A; Ex. B; and Ex. C) In 1995, Aberdeen advanced $78,659 in funds to GlobalTel and $469,916 in funds to ProMail. (Id.) Initially, the advances were booked as debt obligations by Aberdeen. (Dkt. 14, Ex. B at 1) Later in 1995, year-end adjustments were made to Aberdeen's books that reclassified the advances as capital contributions by shareholders. (Id.) In turn, GlobalTel and ProMail treated the advances by Aberdeen as contributions to capital by its shareholders. (Id.)
In 1996, Aberdeen shareholders authorized Aberdeen to acquire all of the assets and third party debt of GlobalTel and ProMail. (Dkt. 14, Ex. D at 15-16, 45-49) Subsequently, Aberdeen wrote the GlobalTel and ProMail debts off its books. (Dkt. 14, Ex. D at 39-40) GlobalTel and ProMail ceased operations in 1996. (Dkt. 1 at 3)
The IRS examined the Ellingers' 1995 return and questioned the treatment of the advances. (Dkt. 14, Ex. A; Ex. B; Ex. C) A dispute arose between the parties over whether the advances were loans from Aberdeen to GlobalTel and ProMail, or whether the advances constituted capital contributions. (Dkt. 14, Ex. A at 2; Ex. B at 1; Ex. C at 1) The IRS asserted that the advances by Aberdeen were "genuine indebtedness" due from the debtor corporations to Aberdeen. (Id.) According to the IRS' determination, because the advances were not capital contributions, the Ellingers were not entitled to include the amount of the debts in calculating the cost basis for GlobalTel and ProMail shares. (Dkt. 15, Ex. A) Therefore, the IRS disallowed the deductions the Ellingers claimed for the higher cost basis of GlobalTel and ProMail shares. (Id.)
The Ellingers filed an appeal with the United States Tax Court ("Tax Court") regarding the IRS' determination of their 1995 tax return. See Ellingers v. Commissioner of Internal Revenue, United States Tax Court, No. 012822-98. One of the issues raised in the Tax Court case was the treatment of advances by Aberdeen. (Dkt. 15, Ex. A) Neither party raised the Gitlitz issue during the Tax Court litigation. (Dkt. 14, Ex. D at 21-24)
In Tax Court, the IRS and the Ellingers settled the dispute over the 1995 tax return. (Dkt. 14, Ex. A; Ex. B; Ex. C) In December of 1999, the United States executed three separate closing agreements with Aberdeen, GlobalTel and ProMail. (Id.) No closing agreement was signed with the Ellingers. (Id.)
The Aberdeen closing agreement classified the advances made from Aberdeen to GlobalTel and ProMail as "genuine indebtedness." The Aberdeen closing agreement provides in pertinent part:
1. The taxpayer's [Aberdeen's] year-end adjustment for the tax year ending December 31, 1995, to reclassify the advances to GlobalTel and ProMail from receivable due from GlobalTel and ProMail to distributions to its shareholders, Ellinger and Farr, are disregarded, and the effect of the transaction will be viewed only as advances made by the taxpayer [Aberdeen] to GlobalTel and ProMail.
2. Advances made by the taxpayer [Aberdeen] to GlobalTel in the amount of $78,659 and to ProMail in the amount of $469,916 constitute genuine indebtedness owed by GlobalTel and ProMail to the taxpayer [Aberdeen] as of December 31, 1995.
(Dkt. 14, Exhibit A) (emphasis added).
The closing agreements for GlobalTel and ProMail differ from the Aberdeen closing agreement. (Dkt. 14, Ex. A; Ex. B; Ex. C) Contrary to the Aberdeen closing agreement, the GlobalTel and ProMail closing agreements refer to the advances as transactions, not as "genuine indebtedness." (Dkt. 14, Ex. B; Ex. C) The GlobalTel and ProMail closing agreements provide in pertinent part:
1. The taxpayer's year-end adjustment for the tax year ending December 31, 1995, to reclassify the advances made by Aberdeen to the taxpayer [GlobalTel and ProMail] to distributions made by its shareholders, Ellinger and Farr, are disregarded, and the effect of the transaction will be viewed only as advances made by Aberdeen to the taxpayer [GlobalTel and ProMail].
2. None of the amount of [GlobalTel-$78,659; ProMail-$469,916] advanced by Aberdeen to the taxpayer in 1995 is attributable to loans from, or paid-in capital contributed by, the taxpayer's shareholders for purposes of determining shareholder basis under I.R.C. section 1367.
(Dkt. 14, Exhibits B and C) (emphasis added).
A shareholder of a Subchapter S corporation may elect a pass through taxation system in which the corporation's profits pass through to the shareholders pro rata and are reported on the shareholder's income tax return. 26 U.S.C. § 1366(a) (1) (A). To prevent double taxation of distributed income, shareholders may increase their basis in corporate stock by certain items of income. 26 U.S.C. § 1367 (a) (1) (A). Corporate losses and deductions are passed through in a similar manner. 26 U.S.C. § 1366 (a) (1) (A). These decrease the shareholder's basis in stock accordingly. 26 U.S.C. §§ 1367 (a) (2) (B) and (b) (2) (A). When the losses and deductions exceed a shareholder's basis, the excess is suspended until the basis becomes large enough to permit the deduction.
These closing agreements were signed at the same time as the Aberdeen closing agreement. The closing agreements of GlobalTel and ProMail are essentially the same, except for the amounts of the advances referred to in the agreements. (Dkt. 14, Ex. B; Ex. C) Similar to the Aberdeen closing agreements, the GlobalTel and ProMail closing agreements provide that "[t]his agreement is final and conclusive except . . ." that ". . . the matter may be reopened in the event of fraud, malfeasance, or misrepresentation of material fact . . ." and that the agreements are ". . . subject to the Internal Revenue Code sections that expressly provide that effect be given to their provisions. . . ." (Id.)
In response to Plaintiffs' discovery request, the IRS produced an agency document, the Appeal Transmittal Memorandum and Case Memo ("Appeal Memo"). (Dkt. 15, Ex. A) The Appeal Memo, dated March 2, 2000, was drafted by the IRS after the settlement of the Ellinger Tax Court litigation and in anticipation of closing the case. (Id.) The Appeal Memo provided in pertinent part:
These cases indicate that the debt-equity rule applicable to C corporations should not be applicable to deciding similar issues in S corporations. Therefore, although the advances probably would not satisfy the normal debt considerations, such as existence of notes, interest, definite payment date, etc., this type of transaction cannot provide basis for the shareholders in the loss corporations. . . .
As discussed above, the identical issue has not been litigated, and the government may have substantial hazards in the event it is determined that the debt-equity test should be applied in the S corporation cases. The Closing Agreements executed by the S corporations resolve the issue in full with respect to the shareholder-petitioner.
(Docket 15, Ex. A at 7) II. DISCUSSION
A. Standard of Review
Summary judgment should be entered when there is no genuine issue regarding any material fact when all the evidence is viewed in the light most favorable to the non-moving party. See Rule 56, Fed.R.Civ.P.; Celotex Corp. v. Catrett, 477 U.S. 317, 322-23 (1986). A genuine issue of material fact exists when there is sufficient evidence in favor of the non-moving party for a reasonable jury to return a verdict in its favor. See Haves v. City of Miami, 52 F.3d 918, 921 (11th Cir. 1995) (citations omitted).
In a suit for a tax refund, the taxpayer bears the burden of proof, including the burden of going forward and the burden of persuasion. Helvering v. Taylor, 293 U.S. 507, 515 (1935). Title 26, United States Code, Section 7491 states that "if, in any court proceeding, a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the liability of the taxpayer of any tax imposed by subtitle A or B, the Secretary shall have the burden of proof with respect to such issue." 26 U.S.C. § 7491(a) (1). However, there is a strong presumption that the assessment of taxes owed as determined by the IRS is correct. Stubbs, Overbeck Associates, Inc. v. United States, 445 F.2d 1142, 1148 (5th Cir. 1971). To rebut this presumption of correctness, the taxpayer must come forward with enough evidence to support a finding contrary to the Commissioner's determination. May v. United States, 763 F.2d 1295, 1297 (11th Cir. 1985). Like a plaintiff in any civil action in district court, the taxpayer bears the burden in a tax-refund case of proving by a preponderance of the evidence the claim as to liability and amount. Carson v. United States, 560 F.2d 693, 695-96, (5th Cir. 1977).
In Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11 Cir. 1981), the Eleventh Circuit adopted as precedent all decisions of the former Fifth Circuit rendered before October 1, 1981.
Similarly, a taxpayer does not have an inherent right to take tax deductions. Deductions are a matter of legislative grace, and a taxpayer must show that the deduction sought comes within the express provisions of the statute. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).
Thus, to prevail in this case, Plaintiffs must prove by a preponderance of evidence that they are entitled to a tax refund. Under the holding of Gitlitz, to receive a tax refund, the Ellingers must establish that the Aberdeen advances are "genuine indebtedness." In addition, the Ellingers must prove that the debts owed by GlobalTel and ProMail were cancelled by Aberdeen.
In their cross motion for partial summary judgment, Plaintiffs assert that they are entitled to take a deduction for losses resulting from the cancellation of the debts, and in turn, are entitled to a refund for tax years 1994 and 1995. (Dkt. 15) Plaintiffs concede that many of the traditional indicia of a bona fide debt are not present in the Aberdeen advances. (Id. at 6-7) Nonetheless, Plaintiffs argue that the "traditional indicia of bona fide indebtedness became irrelevant when the Government and the parties executed the Closing Agreements." (Dkt. 15 at 6)
Plaintiffs assert that they are entitled to partial summary judgment on the principal claims. (Dkt. 15 at 15) After entry of partial summary judgment for Plaintiffs, Plaintiffs request the court to schedule further proceedings for the determination and award of reasonable litigation costs and interest. (Id.)
According to Plaintiffs, the GlobalTel and ProMail closing agreements must be read in conjunction with the Aberdeen closing agreement as well as the Appeal Memo. (Dkt. 15 at 9-10) When these documents are read together, Plaintiffs assert that the advances constitute "genuine indebtedness." (Id. at 9) To prove the debts were cancelled, Plaintiffs rely on two events: the amount was written off by Aberdeen, and GlobalTel and ProMail ceased to have further income generating operations when those corporations sold their assets to Aberdeen. (Dkt. 15 at 10-11).
The United States concedes that, if Plaintiffs could establish that GlobalTel and ProMail recognized COD in 1996, Plaintiffs would be entitled to a refund under the holding of Gitlitz. (Dkt. 14 at 4) The United States, however, contends that no refund is owing to the Ellingers because the advances made to GlobalTel and ProMail were not bona fide debts and no debts were canceled. (Dkt. 14 at 4-5) The United States argues that the GlobalTel and ProMail closing agreements are separate agreements from the Aberdeen closing agreement. (Id. at 7-9) Unlike the Aberdeen closing agreement, which defines the advances as "genuine indebtedness," there is no such language in the GlobalTel and ProMail agreements. As such, the GlobalTel and ProMail closing agreements do not establish that the Aberdeen advances are debt. Instead, the United States maintains that these two closing agreements evidence an intent by the parties to "agree to disagree" on the classification of the advances. (Id. at 5)
B. Classification of the Aberdeen Advances
A taxpayer is entitled to take a deduction for any debt which becomes worthless in that taxable year. 26 U.S.C. § 166(a) (1). A bona fide debt is a debt that arises from a debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed or determinable sum of money. Treas. Reg. § 1.166-1(c). A court should consider all pertinent evidence in determining whether a bona fide debtor-creditor relationship exists. Treas. Reg. § 1.166-2(a). Generally, shareholders place their money "at risk of the business" while lenders seek a more reliable return.Slappey Drive Ind. Park v. United States, 561 F.2d 572, 581 (5th Cir. 1977).
The Eleventh Circuit enunciated the standards which govern the classification of advances as either debt or equity in In re Lane, 742 F.2d 1311 (11th Cir. 1984). A court should seek to determine the actual manner, not the form, in which the parties intended to structure the advance at issue and should examine the following factors in making a determination of whether an advance is genuine indebtedness or a capital contribution:
(1) the names given to the certificates evidencing the indebtedness;
(2) the presence or absence of a fixed maturity date;
(3) the source of payments;
(4) the right to enforce payment of principal and interest;
(5) participation in management flowing as a result;
(6) the status of the contribution in relation to regular corporate creditors;
(7) the intent of the parties;
(8) "thin" or inadequate capitalization;
(9) identity of interest between creditor and stockholder;
(10) source of interest payments;
(11) the ability of the corporation to obtain loans from outside lending institutions;
(12) the extent to which the advance was used to acquire capital assets; and,
(13) the failure of the debtor to repay on the due date or to seek a postponement.Id. at 1314-15, quoting Estate of Mixon v. United States, 464 F.2d 394, 402 (5th Cir. 1972)). A court is not required to consider all the factors, and the facts of each case will help dictate those factors most relevant to a court's inquiry. In re Lane, 742 F.2d at 1315.
The parties agree that there are no genuine issues of material fact in dispute. (Dkt. 14; Dkt. 15) Rather, the parties differ on the inferences to be drawn from the facts of this case and the legal conclusions. (Id.)
In support of their cross motion, Plaintiffs first cite to Ellinger's deposition testimony and affidavit as evidence that the Aberdeen advances are considered indebtedness and were treated as such by Plaintiffs and the S corporations. (Dkt. 15 at 7-8; Dkt. 15, Ex. B at 2; Dkt. 14, Ex. D, at 27-29) Despite Plaintiffs' suggestion, a review of Ellinger's deposition testimony does not establish that the advances are "genuine indebtedness." In his deposition, Ellinger admits that there were no promissory notes executed for the advances. (Dkt. 14, Ex. D at 27) Ellinger cannot recall if any interest rate was applied to the repayment of the advances. (Id. at 28) In reference to efforts to collect the funds advanced to GlobalTel and ProMail, Ellinger testified that they "[t]ried to fix the businesses so we could collect the money." (Id.) Aberdeen did not hire attorneys to collect the advances. (Id.) Ellinger admitted that GlobalTel and ProMail did not repay any of the advances back to Aberdeen. (Id. at 29) Moreover, there was no collateral securing the money advanced by Aberdeen. (Dkt. 14, Ex. E at 58)
Pursuant to the multi-factor analysis of the debt-equity relationship as set forth in In re Lane, the court concludes that Ellinger's testimony does not support a finding that the Aberdeen advances constitute debt.
Ellinger's affidavit is equally unhelpful in demonstrating that the Aberdeen advances are debts. (Dkt. 15, Ex. B) Ellinger states that, when the advances were written off as debts by Aberdeen, "neither Aberdeen nor its shareholders intended a gift by Aberdeen to GlobalTel, ProMail or their shareholders." (Dkt. 15, Ex. B at 2) In deciding whether an advance is equity or debt, the subjective intent of the party "will not alter the relationship or duties created by an otherwise objectively indicated intent."In re Lane, 742 F.2d at 1316, citing Estate of Mixon, 464 F.2d at 407. The court must examine the objective facts and circumstances surrounding the advances to determine whether the parties intended the advances to constitute equity or debt. Id.
In this case, Plaintiffs point out that the advances were initially booked as debt obligations by Aberdeen, a Georgia corporation. (Dkt. 15 at 3; Dkt. 14, Ex. D at 9-10) Under Georgia law, an entry on the corporate books is sufficient formality to establish an intercorporate loan. United States v. Fidelity Capital Corp., 920 F.2d 827, 838 (11th Cir. 1991). Although the fact that an advance is treated on the books as debt is some evidence of the nature of the transactions, it is not determinative and does not compel a court to conclude the advance is a debt. In re Lane, 742 F.2d at 1314-15; Rouse v. Commissioner of Internal Revenue, 1964 Tax Ct. Memo LEXIS 41 * 43-44 (Nov. 17, 1964).
Moreover, Plaintiffs do not dispute the lack of formalities associated with the loan of money from Aberdeen to GlobalTel and ProMail. (Dkt. 15 at 6) The lack of formalities indicates objectively that the parties intended the Aberdeen advances to constitute contributions to capital rather than debt. Most telling is Ellinger's testimony that no collection efforts were made because they were trying ". . . to fix the businesses so that we could collect the money." (Dkt. 14, Ex. D at 28) When a party seeks a return on his advances only when it would be in the best interest of the corporation, the advances are placed "at risk of the business." In re Lane, 742 F.2d at 1318. Seeking a return on advances only when the corporation achieved a level of success does not fit within the definition of a debt relationship. Id. Thus, neither Ellinger's deposition testimony nor Ellinger's affidavit establish that the Aberdeen advances are "genuine indebtedness."
In an apparent recognition of the weakness of their first argument, Plaintiffs alternatively contend that the traditional indicia of bona fide debt became irrelevant when the IRS and the parties executed the three closing agreements. (Dkt. 15 at 6) Plaintiffs assert the objective of the Aberdeen closing agreement was to establish that the funds advanced by Aberdeen to GlobalTel and ProMail constituted "genuine indebtedness." (Id. at 8) In Plaintiffs' view, the fact that the GlobalTel and ProMail closing agreements fail to define the advances as "genuine indebtedness" is of no consequence. Since the characterization of the advances had been established in the Aberdeen closing agreement, Plaintiffs contend it was unnecessary for the GlobalTel or ProMail closing agreements to define the advances as debt. (Id. at 9)
Plaintiffs are essentially arguing that the GlobalTel and ProMail closing agreements are partially integrated agreements. To interpret these closing agreements properly, Plaintiffs insist that the court adopt the Aberdeen closing agreement's definition of advances. (Dkt. 15 at 8-10) Similarly, Plaintiffs urge the court to consider the Government's allegedly inconsistent position in the Tax Court litigation and set forth in the Appeal Memo. (Dkt. 15 at 6-10)
During the Tax Court litigation, the IRS argued that the Aberdeen advances were not capital contributions, but the advances were loans from Aberdeen to GlobalTel and ProMail. Likewise, in the Appeal Memo, which was written by the IRS after the case was settled, the IRS stated that the advances should be considered debt even though ". . . the advances would not satisfy the normal debt considerations. . . ." (Dkt. 15, Ex. A at 7) The significance of this evidence is discussed infra.
As a preliminary matter, Plaintiffs' integration argument addresses both the 1994 and 1995 tax refund claims. Although these Form 906 closing agreements are limited to the 1995 tax year, a closing agreement is a final determination as to the specific matters covered and insures consistent treatment of similar issues in other taxable periods. 26 C.F.R. § 601.202(b) (Form 906 closing agreement insures consistent treatment of similar issues in other taxable years).
Plaintiffs' integration argument ignores the statutory language authorizing closing agreements and the plain reading of the closing agreements. The question before this court is whether the GlobalTel and ProMail closing agreements defined the Aberdeen advances as "genuine indebtedness." This is a matter of contract interpretation.
Closing agreements are expressly authorized by statute. 26 U.S.C. § 7121. The statute permits the Commissioner to enter into agreements in writing with taxpayers to determine their total tax liability for any internal revenue tax for any taxable period.Id. The provision further states that, if the agreement is approved by the Commissioner:
such agreement shall be final and conclusive, and except upon a showing of fraud or malfeasance, or misrepresentation of material fact —
(1) the case shall not be opened as to the matters agreed upon or agreement modified by any officer, employee, or agent of the United States. . . .26 U.S.C. § 7121(b).
A closing agreement is a contract, and ordinary principles of contract law govern its interpretation. Hempel v. United States, 14 F.3d 572, 575-76 (11th Cir. 1994). Closing agreements are not governed by state contract law, but rather by federal common law contract principles. United States v. National Steel Corp., 75 F.3d 1146, 1150 (7th Cir. 1996).
The interpretation of closing agreements is ordinarily a question for courts and not the jury. See Overhauser v. United States, No. 4:92CV23AS, 1994 U.S. Dist. Lexis 7947 *6 (N.D. Ind. May 31, 1994), aff'd, 45 F.3d 1085 (7th Cir. 1995). Contractual language that lends itself to only one reasonable interpretation is not ambiguous and, therefore, can be construed as a matter of law. Id. Furthermore, a case involving the interpretation of a closing agreement seems to be even more appropriate for construction by a court as a matter of law when the party challenging the court's interpretation fails to support its proffered interpretation with extrinsic evidence. Id. If a court can make sense of a closing agreement without hearing testimony, his duty is to construe the contract without letting the parties introduce any evidence other than the contract itself. LaSalle Nat'l Bank v. General Mills Restaurant Group, Inc., 854 F.2d 1050, 1052 (7th Cir. 1988). When interpreting a closing agreement, a court should "strive more mightily than would otherwise be the case to make sense of the contract without ordering a hearing." National Steel, 75 F.3d at 1150.
In view of the statutory requirements the court must follow, Plaintiffs' partial integration argument is unpersuasive. Section 7121(a) states that the "Secretary is authorized to enter into an agreement in writing with any person relating the liability of such person . . . in respect of any internal revenue tax for any taxable period." 26 U.S.C. § 7121(a) (emphasis added). While traditional contract principles apply to interpreting the closing agreements, the statutory requirements of a closing agreement are exclusive and strictly construed. Klein v. Commissioner of Internal Revenue, 899 F.2d 1149, 1152 (11th Cir. 1990).
In this case, the GlobalTel and ProMail closing agreements state that the year-end 1995 adjustment to reclassify the Aberdeen advances are disregarded and "the effect of the transaction will be viewed only as advances made by Aberdeen to the taxpayer." (Dkt. 14, Ex. B at 2; Ex. C at 2.) The agreements do not define the advances as "genuine indebtedness." This court may not add, subtract or modify the terms of the closing agreement. Marathon Oil Company v. United States, 42 Fed. Cl. 267, 275 (1998). Pursuant to the plain reading of the clause dealing with advances, the Aberdeen advances are merely transactions.
Only matters specifically spelled out in a closing agreement will be treated as settled. Marathon Oil Company, 42 Fed. Cl. at 274-75, citing Zaentz v. Commissioner of Internal Revenue, 90 T.C. 753 (1988). If Plaintiffs intended the term "advance" as used in the GlobalTel and ProMail agreements to mean "genuine indebtedness," it was incumbent upon Plaintiffs to insure that their understanding was incorporated into the language of the agreement. See National Steel, 75 F.3d at 1152; Last v. United States, 37 Fed. Cl. 1, 7 (1996). Indeed, the statute expressly requires that the closing agreement relate to the taxpayer who executes it. 26 U.S.C. § 7121(a). The closing agreement signed by Aberdeen, therefore, does not relate to the tax liabilities of GlobalTel, ProMail, or the shareholders of these two companies. See Phillips v. Commissioner of Internal Revenue, 178 F.2d 270, 271 (3rd Cir. 1949), cert. denied, 33 U.S. 932 (1950).
In reaching this conclusion, the court has considered the evidence of the IRS's allegedly inconsistent position taken in the Tax Court and set forth in the Appeal Memo. Even if the court accepted Plaintiffs' argument that the IRS took an inconsistent position in the prior litigation and in an agency memo, it would not change the analysis in this case. Premises underlying a closing agreement, and even recited in the closing agreement but not specifically noted as settled, are not binding on the parties to the agreement. Geringer v. Commissioner of Internal Revenue, 1991 Tax Ct. Memo LEXIS 52 at *8-9 (Jan. 28, 1991). Importantly, the GlobalTel and ProMail closing agreements expressly preclude the Ellingers from treating the Aberdeen advances as loans or capital contributions for purposes of determining their basis in GlobalTel and ProMail. The closing agreements provide in pertinent part that:
2. None of the amount of [GlobalTel-$78,659; Promail-$469,916] advanced by Aberdeen to the taxpayer in 1995 is attributable to loans from, or paid-in capital contributed by, the taxpayer's shareholders for purposes of determining shareholder basis under I.R.C. section 1367.
(Dkt. 14, Ex. B and Ex. C) (emphasis added). The terms of the closing agreements prohibit Plaintiffs from treating the advances as either debt or equity for purposes of determining the shareholders' basis of their stock in GlobalTel and ProMail. Hence, Plaintiffs' partial integration argument in is direct conflict with the clear and unambiguous language of the closing agreements.
During oral argument, Plaintiffs' counsel raised an additional argument. If the court should conclude the GlobalTel and ProMail closing agreements are ambiguous, then Plaintiffs urge the court to consider parole evidence to explain or clarify the ambiguity. (Dkt. 28 at 2) The closing agreements at issue in this case are not ambiguous simply because they do not mirror the Aberdeen closing agreement by defining the term advances as "genuine indebtedness." Geringer, 1991 Tax Ct. Memo LEXIS 52 at *8 (the limited scope of a closing agreement does not make it ambiguous). As previously explained, the unambiguous language of the closing agreements expressly prohibit Plaintiffs from treating the Aberdeen advances as debt for purposes of determining their basis in GlobalTel and ProMail stock. The court, therefore, declines to look beyond the four corners of the closing agreements for an implied definition of advances.
C. Plaintiffs Cannot Establish the Cancellation of the Alleged Debt
Because the Aberdeen advances are not debt, GlobalTel and ProMail did not recognize a COD in 1996. Accordingly, under the holding of Gitlitz, Plaintiffs are not entitled to a deduction for losses, in turn, entitled to a tax refund. Even assuming Plaintiffs could demonstrate that the Aberdeen advances constitute debt, Plaintiffs have not met their burden of proof that these debts were cancelled.
As evidence that the alleged debts were cancelled, Plaintiffs assert that the Aberdeen advances were written off on Aberdeen's books. A journal entry is insufficient to establish the cancellation of a debt. Vanguard Recording Society v. Commissioner, 418 F.2d 829, 831 (2nd Cir. 1969).
Furthermore, Plaintiffs contend that the debts were cancelled when Aberdeen acquired the assets and liabilities of GlobalTel and ProMail. (Dkt. 15 at 10-11) It is undisputed that Aberdeen's shareholders authorized Aberdeen to acquire all of the assets and third-party debts of GlobalTel and ProMail. (Dkt. 14, Ex. D at 15-16, 45-49) According to Ellinger, "third-party debts" referred to debts that GlobalTel and ProMail owed to outside vendors. (Id. at 16) However, the advances that GlobalTel and ProMail allegedly owed to Aberdeen were not included in the acquisition of debts. Instead, Aberdeen wrote-off the Aberdeen advances allegedly owed by the corporations. These facts do not demonstrate that the debts were cancelled. Rather than cancelling these alleged debts, Plaintiffs transferred the assets of GlobalTel and ProMail to Aberdeen, thereby depriving the companies of the ability to generate income and precluding the companies from repaying the purported debts. Thus, Plaintiffs have failed to establish that these alleged debts were cancelled.
III. CONCLUSION
In sum, Plaintiffs have failed to establish that the Aberdeen advances are "genuine indebtedness." Given the language and purpose of the statute authorizing the Commissioner to enter closing agreements, this court cannot incorporate language from the Aberdeen closing agreement into the GlobalTel and ProMail closing agreements. In the absence of specific language defining the Aberdeen advances as debt, there is no evidence that the GlobalTel and ProMail closing agreements defined the advances as "genuine indebtedness." Indeed, such an interpretation would be contrary to the unambiguous terms of the closing agreements. Nor have Plaintiffs carried their burden of proof by establishing that the debts were cancelled. Accordingly, summary judgment should be entered in favor of Defendant.
Accordingly, it is hereby RECOMMENDED that:
(1) Defendant's Motion For Summary Judgment (Dkt. 14) is GRANTED;
(2) Plaintiffs' Response to Defendant's Motion for Summary Judgment and Plaintiffs' Cross Motion for Partial Summary Judgment is DENIED. (Dkt. 15)