Opinion
08 Civ. 7507 (SAS).
December 8, 2009
For Plaintiff: Kevin M. Flynn, Esq., Usman Mohammad, Esq., Kostelanetz Fink, LLP, New York, New York.
For Defendant: Joseph A. Pantoja, Assistant United States Attorney, United States Attorney's Office, Southern District of New York, New York, New York.
OPINION AND ORDER
I. INTRODUCTION
Daniel Gordon brings this action for a refund of federal income taxes, plus interest, that the Internal Revenue Service ("IRS") collected from him for the 2003 tax year. The Complaint has three counts: Count One seeks a refund based on an allegedly erroneous disallowance of a deduction for state and local income taxes; Count Two seeks a refund based on an allegedly erroneous inclusion of capital gains tax in connection with the sale of stock in 2003; and Count Three seeks a refund for overpaid taxes based on Gordon's alleged entitlement to a tax deduction for legal fees he incurred during 2003. Gordon also requests an award of attorneys' fees and costs associated with this action. Gordon subsequently withdrew Counts One and Two pursuant to a stipulation. The government now moves to dismiss Count Three for failure to state a claim, or, in the alternative, for summary judgement. Gordon cross-moves for summary judgement. For the reasons discussed below, the government's motion to dismiss is treated as a motion for summary judgment and is granted in part and denied in part. Gordon's motion for summary judgment is also granted in part and denied in part.
See Complaint ("Compl.") ¶¶ 30-32.
See id. ¶¶ 34-36.
See id. ¶¶ 38-40.
See id. at p. 11.
See Stipulation of Partial Dismissal, Docket Entry No. 14.
II. BACKGROUND
Except as noted, the following facts are undisputed.
1. Embezzlement
Gordon pled guilty to each of the criminal acts described herein. See Information, at 1-12, Ex. 2 to 9/25/09 Declaration of Joseph A Pantoja, Assistant United States Attorney ("Pantoja Decl.") ("Information"); Plea Allocution Transcript at Court Ex. 1, Ex. 3 to Pantoja Decl. ("Plea Tr.").
Beginning in 1998, Merrill Lynch Capital Services, Inc. and Merrill Lynch Co. (collectively "Merrill Lynch") hired Gordon to start an energy trading division of Merrill Lynch called Global Energy Markets ("GEM"). In 2000, Gordon became the president of GEM. As president, Gordon participate in negotiating an energy trade with Williams Energy Market and Trading Company ("Williams"). Gordon was directed to purchase insurance to hedge certain energy obligations Merrill Lynch had assumed under a long-term, multi-million dollar energy call agreement with Williams. After unsuccessful attempts to locate a willing party, Gordon falsely reported to Merrill Lynch that he had located an offshore fund willing to enter into a transaction that would hedge the Williams trade for the price of $43 million.
See Sentencing Memorandum on Behalf of Daniel L. Gordon at 8, Ex. 4 to Pantoja Decl. ("Sentencing Mem.").
See id.
See id. at 3.
See id.
See id.
In order to effectuate the transaction, Gordon engaged the services of Newport Pacific Financial Group to create Falcon Energy Holding, S.A. ("Falcon"). Gordon finalized a contract between Merrill Lynch and Falcon and Merrill Lynch wired approximately $43 million to Falcon's account at a private Swiss bank. Approximately one month later, Gordon transferred approximately $33 million from Falcon's account to other bank accounts he controlled. Gordon used a portion of the funds to purchase a majority interest in Daticon, Inc. ("Daticon"), a private document management services company.
See id. at 3-4.
See id. at 4.
See id.
See id.
2. Record Falsification
During 2000, Gordon, and other Merrill Lynch employees, falsified GEM's books and records to make it appear more profitable to potential buyers. Gordon alleges that his supervisors directed him to "make certain projections and other financial documents appear to be more appealing than they actually were." In January 2001, Allegheny Energy Services Corporation acquired GEM and Gordon became the president of its newly formed energy trading entity, Allegheny Energy Supply Company, LLP ("Allegheny").
See Plea Tr. at 27-28.
Deposition of Daniel L. Gordon, at 67, Ex. 1 to Pantoja Decl. ("Gordon Dep.").
See id. at 27-29.
B. Gordon's Guilty Plea and Forfeiture
C Gordon's 2003 Federal Tax Return
See Information, at 1-12; Plea Tr. at Court Ex. 1.
See Plaintiff's Response to Court's Order Relating to Attorneys' Fees ("Response to Court's Order") at 9, Docket Entry No. 29. Gordon initially claimed that he paid Kronish Lieb $339,761.00 in attorneys' fees in connection with the criminal prosecution. See 10/5/09 Affidavit of Daniel L. Gordon ¶¶ 14-15. However, in an Order dated November 13, 2009, I determined that the portion of those attorneys' fees that related to an employment dispute between Gordon and Allegheny were not fees incurred as a result of Gordon's defense against the criminal prosecution and ordered Gordon to submit billing records reflecting only those attorneys' fees incurred as a result of the 2003 criminal case. See Docket Entry No. 28.
See Plea Tr. at Court Ex. 1.
See 10/17/05 Final Order of Forfeiture, Ex. 10 to Pantoja Decl.
See Sentencing Mem. at 20.
See Plea Tr. at Court Ex. 1.
As initially filed, Gordon's 2003 federal income tax return did not seek a business expense deduction for the legal fees Gordon incurred as a result of Kronish Lieb's representation during the criminal prosecution. The IRS audited Gordon for the 2003 tax year and determined that Gordon owed additional taxes. The additional taxes were based, in part, on the IRS' determination that Gordon under-reported his capital gain from the sale of his Daticon stock by $7,535,815.
See Rider to Claim for Refund for Daniel L. Gordon ¶¶ 5-6, Ex. A to Compl. ("Rider").
See 10/6/09 Affidavit of Kevin M. Flynn, Plaintiff's Counsel ("Flynn Aff.") ¶¶ 5-6.
See id. ¶ 6.
On September 22, 2006, Gordon filed a protest with the appeals office of the IRS objecting to the IRS' determination. During the administrative appeal process, Gordon first raised the issue of his entitlement to a business expense deduction for legal fees that he paid to Kronish Lieb as a result of the criminal prosecution. Gordon alleges that, as part of the appeal process, a hearing occurred where the IRS conceded that Gordon was not liable for taxes on the additional capital gain of $7,535,815. Gordon further alleges that the IRS sent him a revised Notice of Deficiency, and he paid the tax and interest due under the revised Notice.
See id. ¶ 7.
See id. ¶ 11. Gordon never argued that he was entitled to a business expense deduction for fees he paid to Kronish Lieb in connection with the employment dispute with Allegheny.
See id. ¶ 9.
See id. ¶¶ 10, 13; 3/24/08 Notice of Deficiency, Ex. C to Flynn Aff.
After the appeal, the IRS denied Gordon's claim for a refund of his 2003 taxes. With respect to the business expense deduction for Gordon's legal fees, the IRS determined that Gordon had "not established that [he] paid or incurred legal fees for the amount claimed in the 2003 year or, if paid or incurred, that such fees are deductible as ordinary and necessary expenses of a trade or business."
See 6/25/08 letter from the IRS Appeals Office to Daniel L. Gordon, Ex. B to Compl.
Id.
D. Gordon's Tax Liability for 2000
On May 1, 2007, the IRS sent Gordon a Notice of Deficiency advising him that he owed additional taxes for the 2000 tax year. Based largely on Gordon's income from the embezzlement, the IRS determined that Gordon owed more than $30 million. The Notice of Deficiency advised Gordon of his right to "contest this determination in court before making any payment" by "filing a petition with the United States . . . Tax Court for a redetermination of the deficiency." Gordon contested the Notice of Deficiency in the United States Tax Court ("Tax Court") and the case is currently being litigated.
See 5/1/07 Notice of Deficiency, Ex. 7 to Pantoja Decl.
See id.
Id.
See Notice Setting Case for Trial, Ex. 8 to Pantoja Decl.
III. APPLICABLE LAW
A. Converting a Motion to Dismiss into a Motion for Summary Judgment
Rule 12(d) of the Federal Rules of Civil Procedure provides that, "[i]f, on a motion under Rule 12(b)(6) or 12(c), matters outside the pleadings are presented to and not excluded by the court, the motion must be treated as one for summary judgment under Rule 56." Ordinarily, the Second Circuit requires the court to notify the parties of its intention to treat the motion to dismiss as a motion for summary judgment and give the opposing party an opportunity to respond. However, "formal notice is not required where a party `should reasonably have recognized the possibility that the motion might be converted into one for summary judgment [and] was [neither] taken by surprise [nor] deprived of a reasonable opportunity to meet facts outside the pleadings.'"
See Hernandez v. Coffey, 582 F.3d 303, 307 (2d Cir. 2009).
Id. (alterations in original) (quoting Villante v. Department of Corr. of City of New York, 786 F.2d 516, 521 (2d Cir. 1986)).
B. Summary Judgment
Summary judgment is appropriate "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." "`An issue of fact is genuine if the evidence is such that a reasonable jury could return a verdict for the nonmoving party. A fact is material if it might affect the outcome of the suit under the governing law.'" "[T]he burden of demonstrating that no material fact exists lies with the moving party. . . ."
SCR Joint Venture L.P. v. Warshawsky, 559 F.3d 133, 137 (2d Cir. 2009) (quoting Roe v. City of Waterbury, 542 F.3d 31, 34 (2d Cir. 2008)).
Miner v. Clinton County, N.Y., 541 F.3d 464, 471 (2d Cir. 2008) (citing McCarthy v. Dun Bradstreet Corp., 482 F.3d 184, 202 (2d Cir. 2007)). Accord Vermont Teddy Bear Co. v. 1-800 Beargram Co., 373 F.3d 241, 244 (2d Cir. 2004).
In turn, to defeat a motion for summary judgment, the non-moving party must raise a genuine issue of material fact. "When the burden of proof at trial would fall on the nonmoving party, it ordinarily is sufficient for the movant to point to a lack of evidence to go to the trier of fact on an essential element of the nonmovant's claim." To do so, the non-moving party must do more than show that there is "`some metaphysical doubt as to the material facts,'" and it "`may not rely on conclusory allegations or unsubstantiated speculation.'" However, "`all that is required [from a non-moving party] is that sufficient evidence supporting the claimed factual dispute be shown to require a jury or judge to resolve the parties' differing versions of the truth at trial.'"
Jaramillo v. Weyerhaeuser Co., 536 F.3d 140, 145 (2d Cir. 2008). Accord In re September 11 Litig., No. 21 MC 97, 2007 WL 2332514, at *4 (S.D.N.Y. Aug. 15, 2007) ("Where the nonmoving party bears the burden of proof at trial, the burden on the moving party may be discharged by showing — that is, pointing out to the district court — that there is an absence of evidence to support the nonmoving party's case.") (quotation marks omitted).
Higazy v. Templeton, 505 F.3d 161, 169 (2d Cir. 2007) (quoting Matsushita Elec. Indus. v. Zenith Radio Corp., 475 U.S. 574, 586 (1986)).
Jeffreys v. City of New York, 426 F.3d 549, 554 (2d Cir. 2005) (quoting Fujitsu Ltd. v. Federal Express Corp., 247 F.3d 423, 428 (2d Cir. 2001)).
Kessler v. Westchester County Dep't of Soc. Servs., 461 F.3d 199, 206 (2d Cir. 2006) (quoting Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248-49 (1986)).
In determining whether a genuine issue of material fact exists, the court must "constru[e] the evidence in the light most favorable to the non-moving party and draw all reasonable inferences" in that party's favor. However, "[i]t is a settled rule that `[c]redibility assessments, choices between conflicting versions of the events, and the weighing of evidence are matters for the jury, not for the court on a motion for summary judgment.'" Summary judgment is therefore "appropriate only if there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law." C. Section 162(a) of the Internal Revenue Code
Sledge v. Kooi, 564 F.3d 105, 108 (2d Cir. 2009) (citing Anderson, 477 U.S. at 247-50, 255).
McClellan v. Smith, 439 F.3d 137, 144 (2d Cir. 2006) (quoting Fischl v. Armitage, 128 F.3d 50, 55 (2d Cir. 1997)). Accord Anderson, 477 U.S. at 249.
Pyke v. Cuomo, 567 F.3d 74, 76 (2d Cir. 2009).
Under section 162(a) of the Internal Revenue Code, a taxpayer is allowed to deduct from his gross income "the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." In order to deduct an item under this section, a taxpayer must show that "the item claimed as a deductible business expense: (1) [w]as paid or incurred during the taxable year; (2) was for carrying on its trade or business; (3) was an expense; (4) was a necessary expense; and (5) was an ordinary expense." "[W]hether an expenditure satisfies each of these requirements is a question of fact."
De Angelis v. Commissioner of Internal Revenue, 574 F.3d 789, 817 (2d Cir. 2009).
Id.
An expense is ordinary if it "relate[s] to a transaction `of common or frequent occurrence in the type of business involved.'" "`[A]n expense may be ordinary though it happened but once in the taxpayer's lifetime'" so long as "`the transaction which gives rise to it [is] of common or frequent occurrence in the type of business involved.'" "An expense is necessary if it is appropriate and helpful for the development of the business." An expense is for carrying on the taxpayer's trade or business if it is "`directly connected with'" or "`proximately resulted from'" the taxpayer's business activity. In determining whether a litigation expense is for carrying on the taxpayer's trade or business, the court should consider the origin and character of the claim litigated, and not the consequences of the litigation or the taxpayer's motive for defending the litigation. The Second Circuit has held that "legal expenses are deductible [under section 162(a)] where they arise out of and are immediately or proximately connected with, and are required for, the conduct of a trade or business." D. Section 6402 of the Internal Revenue Code
Tilman v. United States, No. 08 Civ. 2231, ___ F. Supp. 2d ___, 2009 WL 2370673, at *6 (S.D.N.Y. Aug. 3, 2009) (citing Langer v. Commissioner of Internal Revenue, T.C. Memo 2008-255 (2008)).
INDOPCO, Inc. v. Commissioner of Internal Revenue, 503 U.S. 79, 85-86 (1992) (quoting Deputy v. DuPont, 308 U.S. 488, 495 (1940)).
Tilman, 2009 WL 2370673, at *6. Accord Welch v. Helvering, 290 U.S. 111, 113 (1933).
Capital Video Corp. v. Commissioner of Internal Revenue, 311 F.3d 458, 464 (1st Cir. 2002) (quoting Kornhauser v. United States, 276 U.S. 145, 153 (1928)).
See Woodward v. Commissioner of Internal Revenue, 397 U.S. 572, 577-78 (1970) (citing United States v. Gilmore, 372 U.S. 39, 49 (1963)).
Tellier v. Commissioner of Internal Revenue, 342 F.2d 690, 695 (2d Cir. 1965).
Section 6402 of the Internal Revenue Code covers the general procedures for tax abatements, credits and refunds. Under this section, the IRS is given the authority to use tax overpayments to set off certain debts the taxpayer owes. The "[g]eneral rule" provides that, "[i]n the case of any overpayment, the [IRS] . . . may credit the amount of such overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment." When a taxpayer requests a refund based on overpayment, "the burden of proof is on the taxpayer to prove an overpayment of tax and the amount he is entitled to recover" in the form of a refund.
See 26 U.S.C. § 6402.
Id. § 6402(a).
Heublein, Inc. v. United States, 996 F.2d 1455, 1461 (2d Cir. 1993) (citations omitted).
IV. DISCUSSION
A. The Government's Motion to Dismiss Is Converted to a Motion for Summary Judgment
In support of its motion to dismiss, the government submitted a substantial amount of evidentiary material. Pursuant to Rule 12(d), I treated the government's motion to dismiss as a motion for summary judgment. I considered the government's evidence, as well as the evidence Gordon submitted in opposition to the government's motion to dismiss and in support of his motion for summary judgment. Several factors indicate that both parties recognized the possibility that the government's motion to dismiss would be converted to a motion for summary judgment. These factors include: (1) the government requested summary judgement in the alternative to dismissal, (2) both parties submitted extrinsic evidentiary materials for the Court's consideration, (3) both parties made arguments regarding summary judgment in their briefs, and (4) Gordon cross-moved for summary judgment. Accordingly, notice of my decision to convert the motion to dismiss into a motion for summary judgement is not required. Neither party will be taken by surprise and both parties had a reasonable opportunity to address the facts outside the pleadings.
B. Summary Judgment on the Tax Deduction for Legal Fees
Gordon asserts that he is entitled to a tax deduction under Section 162(a) for the legal fees he paid to Kronish Lieb in connection with his defense against the Information. Gordon relies on Tellier v. Commissioner of Internal Revenue to argue that his legal fees were an ordinary and necessary expense for the purpose of carrying out his trade or business as an employee of GEM and Allegheny. In Tellier, the plaintiff was a securities dealer who sought a tax deduction under section 162(a) for legal fees he incurred during his unsuccessful defense against charges of violating the fraud section of the Securities Act of 1933 and mail fraud. The Commissioner of Internal Revenue ("Commissioner") denied the deduction. The Tax Court sustained the Commissioner's denial, but the Second Circuit reversed finding that "the legal expenses of [the plaintiff] were directly connected with carrying on his business" and that "legal expenses for an unsuccessful defense connected with the carrying on of a trade of business . . . are ordinary and necessary within the meaning of [section 162(a)]." In his Appellate Brief, the Commissioner conceded that the legal fees were ordinary and necessary business expenses, but argued that the fees were not deductible as a matter of public policy. The Supreme Court held that allowing a deduction of the plaintiff's legal fees as an ordinary and necessary business expense did not offend public policy because income taxes are "not a sanction against wrongdoing" and "[n]o public policy is offended when a man faced with serious criminal charges employs a lawyer to help in his defense."
See Plaintiff's Memorandum of Law in Opposition to Defendant's Motion to Dismiss and/or for Summary Judgment, and in Support of Plaintiff's Cross-Motion for Summary Judgment ("Opp. Mem.") at 20.
See 383 U.S. 687 (1966); 342 F.2d 690 (2d Cir. 1965).
See Tellier, 383 U.S. at 688.
See id.
Tellier, 342 F.2d at 693, 695 (quotation marks omitted).
See Appellate Brief for The Commissioner of Internal Revenue at 6-14, 20, Commissioner of Internal Revenue v. Tellier, 383 U.S. 687 (1966) (No. 351), 1965 WL 130176.
Tellier, 383 U.S. at 691, 694.
The government argues that Tellier is inapplicable because the government does not oppose the tax deduction for Gordon's legal fees on public policy grounds. Rather, the government opposes the tax deduction on the grounds that Gordon "cannot show that the subject legal expenses were `ordinary and necessary' and incurred and paid in carrying out a `trade or business' within the meaning of [s]ection 162(a)" — issues that were not before the Supreme Court in Tellier.
Memorandum of Law in Support of Defendant's Motion to Dismiss the Complaint, or in the Alternative, for Summary Judgment ("Def. Mem.") at 18.
However, the government's argument fails. The Second Circuit's Tellier opinion is applicable and binding on this Court because the issues of whether the subject legal expenses were ordinary and necessary and incurred for the purpose of carrying on a trade or business within the meaning of section 162(a) were decided by the Second Circuit. The parties agree that prongs one and three of the test for deducting items under section 162(a) are satisfied — Gordon's legal fees were incurred in 2003 and they were expenses. Under Tellier, if legal fees are "connected with the carrying on of a trade or business," they are also necessary and ordinary within the meaning of section 162(a). The only question, then, is whether Gordon's legal fees were incurred for the purpose of carrying on of his trade or business.
Tellier, 342 F.2d at 695.
Gordon argues that all his legal fees were directly connected with carrying on his trade or business because the legal fees "had their source, or origin, . . . in [his] employment and profit seeking activities when he was the president of GEM and Allegheny." The charges in the Information arise from two separate and unrelated schemes — a scheme to embezzle money from Merrill Lynch (the "Embezzlement Scheme"), which led to the wire fraud and money laundering charges, and a scheme to falsify GEM's records in order to make GEM appear more profitable (the "Record Falsification Scheme"), which led to the conspiracy to falsify books and records charge. These schemes must be analyzed separately to determine if the legal fees resulting from either were connected to the carrying on of Gordon's employment as president of GEM or Allegheny.
Opp. Mem. at 23.
All of the government's arguments focus on whether Gordon's legal fees related to the Embezzlement Scheme are deductible under section 162(a). The government fails to address whether Gordon's legal fees related to the Record Falsification Scheme are deductible.
1) The Government Is Entitled to Summary Judgment on the Tax Deduction for Legal Fees Attributable to Gordon's Defense Against the Embezzlement Charges
Gordon's contention that his legal fees resulting from the Embezzlement Scheme were incurred for the purpose of carrying on his trade or business as an employee of Merrill Lynch or Allegheny is not supported by the evidence in the record. Courts that have addressed the issue, including the Second Circuit, have consistently found that expenses arising from embezzlement are not sufficiently related to carrying on a trade or business to qualify for a tax deduction as a business expense. This case is no different. The Embezzlement Scheme was only related to Gordon's trade or business because Gordon stole from his employer; it did not arise out of or proximately result from Gordon's employment as president of GEM or Allegheny. Because the Embezzlement Scheme itself was not connected to the carrying on of Gordon's trade or business, the legal fees for Gordon's defense against charges arising out of the Embezzlement Scheme are not business expenses within the meaning of section 162(a). Accordingly, the government is entitled to summary judgment regarding these legal fees.
See Stephens v. Commissioner of Internal Revenue, 905 F.2d 667, 670 (2d Cir. 1990) (noting that "the decided cases establish that a restitution payment [of embezzled funds] . . . is not an ordinary and necessary business expense as required by section 162(a)" (quotation marks omitted)); Hankins v. United States, 403 F. Supp. 257, 259 (N.D. Miss. 1975) (concluding that the plaintiff "was not engaged in a trade or business" when he "systematically embezzled funds from his employer"); Mannette v. Commissioner of Internal Revenue, 69 T.C. 990, 994 (1978) (finding that, under section 165(c) of the Internal Revenue Code, embezzlement is not "a proper function of the trade or business of being a salaried employee"); Yerkie v. Commissioner of Internal Revenue, 67 T.C. 388, 393 (1976) (rejecting "the concept that embezzlement and the repayment of embezzled funds constitute an aspect of the trade or business of a salaried employee" under section 165(c) of the Internal Revenue Code).
2. Gordon Is Entitled to Summary Judgment on the Tax Deduction for Legal Fees Attributable to His Defense Against the Record Falsification Charges
Gordon's contention that his legal fees resulting from the Record Falsification Scheme were incurred for the purpose of carrying on his trade or business as an employee of Merrill Lynch is supported by the evidence in the record. Gordon has testified that his supervisors directed him to falsify the relevant records. The government has offered no evidence to dispute this testimony. Actions taken at the direction of one's supervisor are undoubtedly connected with business activities. Even if Gordon had not been directed to falsify documents, his actions still maintain the necessary business connection.
See Gordon Dep. at 67.
Tellier makes clear that tax deductions for business expenses are not limited to expenses incurred in the course of lawful business activity. As a result, courts have consistently held that legal fees are business expenses within the meaning of section 162(a) when they are incurred as a result of illegal conduct that the taxpayer engaged in to further his business's interests. Gordon's participation in the Record Falsification Scheme was connected with and proximately resulted from his employment at Merrill Lynch because the Record Falsification Scheme was intended to further Merrill Lynch's business interests by enabling GEM to command a higher purchase price. In other words, Merrill Lynch was the direct beneficiary of the Record Falsification Scheme and any personal benefit Gordon may have derived resulted from his status as a Merrill Lynch employee. This is qualitatively different from the Embezzlement Scheme, which was inherently harmful to Merrill Lynch and directly beneficial to Gordon in his personal capacity rather than his employment capacity. Accordingly, there is no genuine issue of fact as to whether the Record Falsification Scheme was for the purpose of carrying on Gordon's trade or business. Because a portion of Gordon's legal fees were incurred in defending against the Record Falsification Scheme, those fees are tax deductible.
See Tellier, 342 F.2d at 693 (finding no support for "the rule that the legal expenses of an unsuccessful criminal defense when paid or incurred in connection with the carrying on of a trade or business are not deductible").
See id. at 695; McDonald v. United States, No. 96-0665-BH-S, 1997 WL 1108454, at *1 (S.D. Ala. 1997) (finding as a matter of law that the plaintiff was entitled to a tax deduction under section 162(a) for legal fees resulting from the plaintiff's unsuccessful defense against charges of racketeering because those legal fees were directly connected with the plaintiff's racketeering business); O'Malley v. Commissioner of Internal Revenue, 91 T.C. 352, 364 (1988) (finding legal fees resulting from the petitioner's unsuccessful defenses against charges of bribing a U.S. Senator deductible under section 162(a) because the bribe was made in an effort to thwart legislation that threatened the profitability of the petitioner's employer); Terry v. Commissioner of Internal Revenue, T.C. Memo 1979-284 (1979) (finding legal fees resulting from the petitioner's unsuccessful defenses against charges of helping others prepare false tax returns deductible under section 162(a) as an expense related to the petitioner's tax preparation service business).
In a telephone conference with the Court held on November 13, 2009, counsel for both parties informed me that there is no way to apportion Gordon's legal fees between the Embezzlement Scheme and the Record Falsification Scheme. Both Schemes resulted in criminal charges and Gordon's defense counsel did not distinguish between the Schemes when billing its time. I will therefore apportion one-third of the legal fees to the Record Falsification Scheme because two of the counts in the Information related to the Embezzlement Scheme and one related to the Record Falsification Scheme. Accordingly, Gordon is entitled to a tax deduction for $106,584.67 in attorneys' fees, plus interest.
Gordon requests that the Court "conform the pleadings to the proof' so that he can additionally recover the legal fees attributable to the employment dispute with Allegheny. See Response to Court's Order. Under section 7422(a) of the Internal Revenue Code, "[n]o suit or proceeding shall be maintained in any court for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected, . . . until a claim for refund or credit has been duly filed with the Secretary [of the Treasury], according to the provisions of law in that regard, and the regulations of the Secretary [of the Treasury] established in pursuance thereof." Gordon never filed a claim for a refund of the legal fees attributable to the employment dispute. Accordingly, Gordon cannot now claim an entitlement to a refund of those fees.
C. Whether the Government May Use Gordon's Overpayment to Offset Gordon's Tax Liabilities Raises a Question of Fact
The government argues that even if Gordon is entitled to a tax deduction under section 162(a), and therefore overpaid at least a portion of his taxes for the 2003 tax year, Gordon is not entitled to a tax refund because, under section 6402, the government may use the amount of the overpayment to offset Gordon's outstanding tax liability. Specifically, the government contends that it can use Gordon's overpayment to offset his outstanding tax liabilities for the 2000, 2003, and 2005 tax years.
See Def. Mem. at 24
See id. at 24 n. 8.
1. Gordon Has No Outstanding Tax Liability for the 2000 Tax Year
On May 1, 2007, the IRS sent Gordon a Notice of Deficiency for the 2000 tax year. The Notice of Deficiency advised Gordon that he could file a claim in Tax Court for a redetermination of the amount of tax he owed, without first paying the tax. Gordon did just that and the Tax Court has not redetermined Gordon's tax liability. Because Gordon does not currently owe any taxes for 2000, the IRS cannot use his 2003 overpayment to offset his tax liability for that year.
See 5/1/07 Notice of Deficiency. Accord 26 U.S.C. § 6213(a) ("[T]axpayer may file a petition with the Tax Court for a redetermination of the deficiency. . . . [N]o assessment of a deficiency in respect of any tax imposed . . . and no levy or proceeding in court for its collection shall be made, begun, or prosecuted . . . if a petition has been filed with the Tax Court, until the decision of the Tax Court has become final.").
See Baylor v. United States, No. 75 Civ. 762, 1976 WL 1120, at *1 (E.D.N.Y. 1976) (holding that after a taxpayer petitioned the Tax Court for a redetermination of the amount of taxes the taxpayer owed, the government could not retain the refund due to the taxpayer in order to offset the asserted deficiencies unless the government "in truth believe[d] that assessment and collection of those amounts [would] be jeopardized by delay and on that ground . . . immediately assessed the deficiencies").
The government relies on Lewis v. Reynolds to argue that Gordon has tax liability for the purposes of section 6402 for the 2000 tax year even though the IRS has not yet assessed that tax liability. However, the holding in Lewis is not as broad as the government contends. Nothing in Lewis permits the IRS to use an overpayment to offset taxes that are not yet due. Accordingly, the IRS is not entitled to use Gordon's 2003 overpayment to offset his tax liability as determined by the May 1, 2007 Notice of Deficiency because Gordon does not presently owe these taxes to the IRS.
See 284 U.S. 281, 283 (1931); Reply Mem. at 7-8.
In Lewis, the Supreme Court determined that the IRS could use a taxpayer's overpayment to offset tax deficiencies from the same tax year as the overpayment even though the statute of limitations barred the IRS from bringing a claim to collect those deficiencies. See 284 U.S. at 283. The IRS discovered the tax deficiencies in an audit commenced as a result of the taxpayer's claim for overpayment. See id. at 282. The portion of Lewis holding that the IRS can use tax overpayments to offset tax deficiencies when collection of those deficiencies is barred by the statute of limitations has been superceded by statute. See 26 U.S.C. § 6401 (defining the amount of the taxpayer's overpayment, and therefore the amount refundable under section 6402, as including "that part of the amount of the payment of any internal revenue tax which is assessed or collected after the expiration of the period of limitation properly applicable thereto"). However, Lewis is still good law in that a taxpayer who seeks a refund must show an overall overpayment for the tax year in question.
See, e.g., In re Chateaugay Corp., 94 F.3d 772, 780 (2d Cir. 1996) (explaining that "the principle of allowing setoff is intended to avoid the absurdity of making A pay B when B owes A" (quotation marks omitted)).
2. Gordon Has No Outstanding Tax Liability for the 2003 Tax Year
The March 24, 2008 Notice of Deficiency states that, as of that date, Gordon's outstanding tax liability for 2003 was $1,029.00. Gordon alleges he paid the IRS this amount and such payment is evidenced by a letter dated April 23, 2008 from Gordon's attorney to the IRS enclosing a check for $1,454.00. Furthermore, the government appears to concede that Gordon has no outstanding tax liability for 2003. Thus, the IRS may not use Gordon's overpayment to offset his tax liability for 2003 as Gordon has no outstanding tax liability for that year.
See 3/24/08 Notice of Deficiency.
See 4/23/08 Letter from Kevin Flynn, plaintiff's counsel, to James Borowski, Appeals Officer for the IRS. The amount of the check represented the amount of tax owed plus estimated interest.
See Reply Memorandum of Law in Further Support of Defendant's Motion to Dismiss the Complaint, or in the Alternative, for Summary Judgment, and in Opposition to Plaintiff's Cross-Motion for Summary Judgment at 8 ("Because of Gordon's tax liability for 2000 and 2005, Gordon cannot establish an actual overpayment of tax even if he were entitled to a credit for 2003." (citations omitted; emphasis added)).
3. Whether Gordon Has Outstanding Tax Liability for Any Other Tax Year Raises a Question of Fact
The government asserts that Gordon "owes taxes for 2005 to the extent that the proceeds from any forfeited property, including the Daticon stock, was [sic] applied to the Money Judgment [portion of Gordon's forfeiture obligations] on Gordon's behalf during 2005." There is no evidence in the record regarding Gordon's 2005 tax liability. Accordingly, the government has not shown as a matter of law that Gordon any has outstanding tax liability that makes him ineligible for a tax refund. However, in order to obtain a tax refund, Gordon has the burden of proving that he has no outstanding tax liability for any year. The record does not contain any evidence of Gordon's tax liabilities for years other than 2000 and 2003. Thus, an issue of fact remains as to whether Gordon has outstanding tax liabilities for other years, including 2005, and Gordon has not proved that he is entitled to a tax refund as opposed to a tax credit.
Def. Mem. at 24 n. 8.
See Heublein, Inc. v. United States, 996 F.2d 1455, 1461 (2d Cir. 1993).
V. CONCLUSION
For the foregoing reasons, the government's motion for summary judgement is granted as to the portion of Gordon's legal fees attributable to the Embezzlement Scheme and Gordon's motion for summary judgement is granted as to the portion of his legal fees attributable to the Record Falsification Scheme. An issue of fact remains as to whether Gordon has any outstanding tax liability that the government can offset with his 2003 overpayment. The Clerk of the Court is directed to close these motions (Docket Nos. 16 and 21). A conference is scheduled for December 21, 2009 at 5:00 p.m.
SO ORDERED: