Opinion
No. 96-37T.
Filed March 20, 2001.
Towner Leeper, El Paso, Texas, attorney of record for plaintiff.
William Charles Rapp, Department of Justice, Washington, D.C., with whom was Acting Assistant Attorney General Claire Fallon, for defendant. Mildred L. Seidman, Chief, Court of Federal Claims Section, David Gustafson, Assistant Chief.
2001-1 U.S. Tax Cas. (CCH) P50,332; 87 A.F.T.R.2d (RIA) 1587
[*1] Defendant's motion for summary judgment ALLOWED. Plaintiff's motion for summary judgment DENIED.
OPINION
This tax refund case is before the court on the parties' cross-motions for summary judgment. Plaintiff asserts a promissory note it received in 1990 for the sale of stock did not have an ascertainable value, and therefore, the Internal Revenue Service (IRS) should not have considered it taxable income for the 1990 tax year. Plaintiff invokes the open transaction method for reporting taxable income. Defendant contends the fair market value of the note was reasonably ascertainable at the time of sale, so the open transaction doctrine does not apply. Defendant asserts the Commissioner of the IRS (Commissioner) was correct in determining the proper method for reporting this transaction was as an installment[*2] sale.
Factual Background
Except where noted, the facts are undisputed as the parties have submitted a joint stipulation.
Plaintiff is Bernice Patton Testamentary Trust with Moody Patton as trustee. Plaintiff was established in the last will and testament of Bernice Patton, who died January 5, 1981. Plaintiff formerly owned 25% of the common stock of Western Packing Company (Western) and Braunfel Meats, Inc. (Braunfel). Moody Patton, acting individually, also owned 25% and Dick Patton owned 50%. Western and Braunfel were located in Sealy, Texas and were in the business of slaughtering cattle and processing beef for sale. Compared to other businesses in this industry, Western and Braunfel were relatively small, slaughtering approximately 400 head of cattle per day while larger packers slaughtered 10,000 to 12,000 head per day. Dick Patton ran the processing end of the business while sales were handled by both Dick and Moody Patton via telephone.
Plaintiff maintains the Pattons ran the business for 5-10 years before sale. Transcript of Oral Argument (Tr.) at 8. Defendant asserts they operated it for 20 years prior to sale. Tr. at 14.
[*3]
In 1990, a group of investors located in Chicago formed W-B Acquisition Corporation (W-B) for the purpose of acquiring Western and Braunfel stock. The Pattons were experiencing financial troubles and were interested in selling the two businesses. An outside party did an independent appraisal to determine the value of the companies. The Pattons and the investors from W-B executed documents in 1990 transferring the Pattons' stock to W-B in exchange for cash and a seller's note. Plaintiff's portion was $317,140 in cash and a note (Note) with the face amount of $507,424. Dick and Moody Patton continued to run Western and Braunfel on behalf of W-B after this transaction.
These investors had not previously invested in the beef industry.
At this time, small meat packing companies like Western and Braunfel were becoming obsolete as they could not compete with larger companies, and strict environmental standards were making it difficult to generate a profit. Also, in 1986 an ammonia explosion at one of the plants resulted in extensive litigation that drained the Pattons' financial resources.
Plaintiff has been unable to locate a copy of this outside appraisal but contends it is irrelevant. Tr. at 29-30. Defendant maintains that since an appraisal was done it was possible to ascertain the fair market value of the companies at the time of sale. Tr. at 25, 36.
Tr. at 12, 14.
Plaintiff's basis in the common stock of Western and Braunfel was $299,322. Plaintiff reported the sale on its 1990 income tax return as an open transaction with the Note having no ascertainable value. The $317,140 plaintiff received from the buyer was reduced by plaintiff's basis, leaving an excess amount of $17,818, which plaintiff reported as long term capital gain.
W-B was to pay the Note in full by September 1, 1995. Plaintiff would receive payments before that date if certain conditions materialized with respect to the net income of the business. Specifically, plaintiff was entitled to receive 40% of the remaining cash flow each year after a $150,000 management fee was allotted to the buyer. Also, plaintiff's rights were subordinated to Greyhound Financial Corporation and Creekwood Capital[*5] Corporation (Senior Lenders). In 1991, plaintiff and W-B modified the buyer's obligation by increasing the amount owed to plaintiff to $661,712. Plaintiff received no payment on the Note between 1990 and 1994 because the operations of the companies were insufficient to require annual payments.
The stock purchase agreement allowed for increasing or decreasing the Note to reflect operational changes. See Exhibit 1-A, Document 1 (Stock Purchase Agreement), §§ 1.03, 5.01-5.03.
In 1993, W-B's successor, Carlton Foods, Inc., assumed the buyer's obligation to the Pattons. Plaintiff and Carlton Foods modified the Note, effective January 15, 1993, reducing the required payment to $107,916 principal, $23,067 in interest and $2,914 in default interest. Carlton Foods paid plaintiff $14,116 in 1995, $104,704 in 1996, and $85,350 in 1997, upon which the buyer's obligations were released.
Upon audit of plaintiff's 1990 return, the IRS determined the buyer's obligation had an ascertainable value equal to the[*6] face amount of the Note given to plaintiff. The IRS also concluded plaintiff was entitled to use the installment sale method to report the resulting long term capital gain of $202,344. Plaintiff paid the resulting deficiency of $56,656, filed a timely claim for refund, which was denied, and then filed a complaint in this court on January 29, 1996, seeking a refund of the $56,656 as well as $12,126.53 in interest. Plaintiff filed a motion for summary judgment on July 5, 2000, asserting the Note had no ascertainable value in 1990 based on the open transaction doctrine. On October 26, 2000, defendant submitted its cross-motion for summary judgment claiming: (1) the IRS properly determined that plaintiff should report the Note using the installment sale method, and (2) the tax assessed in 1990 was proper. The court heard oral argument on Thursday, March 8, 2001.
Discussion
In a tax refund suit, the taxpayer bears the burden of proof and persuasion. Welch v. Helvering, 290 U.S. 111, 115, 78 L.Ed. 212, 54 S.Ct. 8 (1933). [*8]A decision by the Commissioner is presumed correct, and the taxpayer must rebut this presumption. United States v. Janis, 428 U.S. 433, 440-41, 49 L.Ed.2d 1046, 96 S.Ct. 3021 (1976); Bubble Room, Inc. v. United States, 159 F.3d 553, 561 (Fed. Cir. 1998). In addition, the taxpayer must establish entitlement to the specific refund claimed. Janis, 428 U.S. at 440 . This includes proving the exact dollar amount of the alleged overpayment. Id.
Plaintiff maintains the Note should not be included when computing its 1990 income tax because it was uncertain when the Note would be paid in full. Plaintiff relies on the open transaction method of tax valuation when making its assertion. Defendant contends the open transaction method is limited to rare circumstances that do not exist in this case. Defendant also asserts plaintiff has failed to prove, either through evidence or expert testimony, that the Note had no ascertainable value in 1990. The proper method for reporting income from the Note, according to defendant, is to consider the transaction an installment sale.
The United States Supreme Court established[*9] the open transaction method in Burnet v. Logan, 283 U.S. 404, 75 L.Ed. 1143, 51 S.Ct. 550 (1936). The doctrine applies in deferred payment cases with so much uncertainty that it is impossible to determine whether any profit will be realized, because income is contingent upon unknown factors. Id. at 413. Under these circumstances, the taxpayer first applies any payments received to his or her basis. Once they have recovered their basis, they report any additional payments as income. The taxpayer is not taxed on this income until there is certainty as to the amount of payments, if any, that should be taxed. Id. at 413-14.
For example, a person sells property in a deferred payment sale for $1,000 in which the person's basis is $300. Under the open transaction method, the first $300 the person receives over time will be applied to the basis and is not reported as taxable income. Any remaining payments are then considered taxable income.
[*10]
[*12]
Plaintiff relies heavily on Burnet v. Logan, maintaining the open transaction doctrine has retained viability and applies to this case. Plaintiff asserts the Note had no ascertainable value in 1990 because its payment was conditional on the future cash flow of Western and Braunfel, which were becoming economically obsolete. Plaintiff contends it was very uncertain whether it would ever receive payments because it was only entitled to 40% of the remaining cash flow after the buyer: (1) received a $150,000 management fee, and (2) paid principal and interest to the Senior Lenders. Indeed, plaintiff received no payments until five years after the closing.
The present case involves the same type of transaction as McCormac — the transfer of stock in exchange for a promise to repay in amounts dependent on the corporation's financial success. In fact, the present case contains even less uncertainty than McCormac because the Note was due in full by September 1, 1995. Plaintiff was well aware of the amount[*14] of the Note and the deadline for repayment. As held in McCormac, the entire proceeds plaintiff received in 1990 had an ascertainable fair market value. The face value of the Note represented this value.
Although the future success of Western and Braunfel was in doubt at the time of sale, this alone is not enough to require open transaction treatment. Plaintiff's business was not new and untested as it had been in operation for quite some time. Like the transaction in Campbell, the sale was not an inherently speculative undertaking. There was enough information in place at the time of sale for plaintiff and W-B to determine the value of the company, as evident in the outside appraisal done for W-B. Plaintiff and W-B agreed on a sale price, and the Note reflects a portion of this price. The fair market value of the Note in 1990, therefore, was its face value.
At oral argument, plaintiff asked the court to consider what actually happened to the value of the Note after the 1990 transaction, as proof that its value was unascertainable.10 In particular, plaintiff emphasized the modifications made to the Note's value and the actual dates payments were received. n11 This argument is unpersuasive. At issue in this case is[*16] plaintiff's 1990 tax liability. Therefore, the court will only look at the particular tax year in question and not consider events happening subsequent to that period. Modifications made to the Note's value in later years would presumably be taken into account in plaintiff's income tax liability for those particular years. Plaintiff has not contested its income tax liability for years other than 1990, so it is unnecessary for the court to consider these later periods.
The court determines, therefore, that plaintiff cannot invoke the open transaction doctrine in this case. The proper way for plaintiff to report the income from this transaction was as an installment sale. Indeed, this is what the Commissioner concluded when determining plaintiff owed a $56,656 deficiency. Plaintiff has failed to offer enough proof to rebut the presumption that the decision of the Commissioner was correct. Plaintiff solicited no expert testimony on valuation and offers no evidence, besides[*17] a naked assertion of the facts, to support its claim that the value of the Note was unascertainable in 1990. When considered in light of the large body of case law discouraging the use of the open transaction doctrine, this assertion is insufficient for plaintiff to rebut the presumption of correctness. See Celotex Corp. v. Catrett, 477 U.S. 317, 322, 91 L.Ed.2d 265, 106 S.Ct. 2548 (1986) ("the plain language of Rule 56(c) mandates the entry of summary judgment, after adequate time for discovery and upon motion, against a party who fails to make a showing sufficient to establish the existence of an element essential to that party's case, and on which the party will bear the burden of proof at trial.").
Conclusion
For the above-stated reasons, defendant's motion for summary judgment is hereby ALLOWED. Plaintiff's motion for summary judgment is DENIED. Accordingly, the Clerk is directed to dismiss plaintiff's complaint. No costs.
IT IS SO ORDERED.
Defendant offered an example in its brief to clarify installment sale reporting. Suppose a taxpayer sells for $1,000 property in which his basis is $300. His total gain is $700, and tax will eventually be due on that income. If he receives the $1,000 purchase price in five equal installments of $200 per year for five years, he will report $140 ($200 times 300/1000) each year as income from the transaction ($60 of his basis is subtracted from the income each year). The entire $700 gain is dispersed over the five years the taxpayer receives payments. Cross Motion Of The United States For Summary Judgment at 10, n. 6.