Opinion
Case No. 6:01-cv-1044-Orl-22DAB
November 25, 2002
AMENDED REPORT AND RECOMMENDATION
TO THE UNITED STATES DISTRICT COURT
This cause came on for consideration without oral argument on the following motions filed herein:
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MOTION: MOTION FOR SUMMARY JUDGMENT (UNITED STATES) (Doc. No. 19)
FILED: July 30, 2002
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THEREON it is RECOMMENDED that the motion be DENIED.
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MOTION: MOTION FOR SUMMARY JUDGMENT (PLAINTIFFS) (Doc. No. 24)
FILED: August 14, 2002
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THEREON it is RECOMMENDED that the motion be GRANTED in part and DENIED in part. ____________________________________________________________
BACKGROUND
This matter is before the Court pursuant to a request by the District Court (Doc. No. 39). On September 19, 2002, the undersigned entered a Report and Recommendation on the instant motions, concluding that there was no genuine issue of material fact that Plaintiffs were due a refund (as counsel for the United States had stipulated to same in his papers), but that there was insufficient evidence of record to support a finding as to the amount of the refund (Doc. No. 29). The United States objected to the Report, and supplemented the record with an affidavit of Grady Boles, IRS Senior Reviewer (Doc. No. 30). Plaintiffs filed their Reply to the Report on October 7, 2002 (Doc. No. 31). Upon review, the District Judge construed the Government's objection as a request for reconsideration of the supplemented record, and referred the motions anew to the undersigned for reconsideration and issuance of an amended report and recommendation (Doc. No. 39).The Court has reviewed the record, the arguments of the parties, and the applicable law. It is the conclusion of this Court that the Government is bound by its stipulation that the Plaintiffs are due a refund, and that genuine issues of material fact still exist as to the amount of that refund.
FACTS
As set forth in the prior Report, the parties agree on most of the relevant facts. Plaintiffs, Mr. and Mrs. Heatley, appearing pro se, filed this lawsuit with respect to their 2000 federal income tax return. Plaintiff Frank Heatley purchased 200 shares of common stock in the Walt Disney Corporation on July 9, 1979, for $7,047.81 (Deposition of Heatley, at 11-13). Through dividend reinvestment and several stock splits, Mr. Heatley's 200 shares grew to 11,088 shares. ( Id. at 12). Including dividend reinvestment, Mr. Heatley paid $10,764.37 total for the shares. ( Id., Exhibit #2, p. 3). On August 3, 2000, Mr. Heatley sold all of these shares for a total of $442,827.00, realizing a net gain of $432,062.32. ( Id. at 23, 25).
As only one deposition was filed in this matter, the Court refers to the deposition of Mr. Heatley as "Deposition."
According to the government, during calendar year 2000, Plaintiffs made four estimated tax payments of $800.00 to the Internal Revenue Service ("the IRS"), an additional payment of $43,204.26 on August 24, 2000, and another payment of $43,204.26 on September 28, 2000. Certfied Literal Transcript of Assessments and Payments, Doc. No. 21. As explained by Mr. Heatley:
When I sold the stock in August 2000 I did not know what percentage was to be paid to the IRS as I did not know my taxable income on my 1040 form for the year 2000. Naturally, it was in August. I thought I would remain in the fifteen percent bracket, so I made out a check to the IRS of $43,204.26 on August 22, 2000, which was approximately 10 percent. After reviewing my records I concluded that I may fall into the twenty percent bracket long term, so I made another check out of forty three thousand two hundred four twenty six on September 22, 2000. I sent this to the IRS thinking it would be a fair estimate, fair figure. I did enclose a letter with the second check to the IRS stating that I did not know my status at that time of capital gains, and it would be — and when I do they will be informed.
(Deposition of Heatley, at 31, quoting the Complaint.)
In February 2001, Mr. Heatley completed a Form 1040, listing taxable income of $37,512. (Deposition, Exhibit 4). Mr. Heatley calculated a tax of $5,629.00 and an amount owed of $209, which payment was included with the return. The Heatleys did not complete or return a schedule with respect to the Capital Gain. The IRS assessed the reported tax liability of $5,629 on April 30, 2001, and wrote the Heatleys that they were due a refund of $86,408.52. (Deposition, Exhibit 5). As stated by Mr. Heatley in his Complaint, "This was an obvious error as I did owe them at least $43,204.26 for my Capital Gains." Nonetheless, on April 30, 2001, the IRS took the position that the correct tax liability was $5,629 and the Heatleys were due a refund of $86,408.52.
The IRS requested that Plaintiffs complete and return an Amended U.S. Individual Income Tax return, Form 1040X, claim for refund. (Deposition, Exhibit 2). Mr. Heatley completed Parts I and II of Schedule D of the Form, reporting a long-term gain of $432,062.63, but did not complete Parts III and IV.
Mr. Heatley turned 80 years old on October 2, 2002. ( Id. at 7). He prepared and filed Plaintiffs' 2000 tax return without the assistance of an accountant or other tax professional ( Id. at 40-41).
According to the government's brief, the IRS:
Although the Brief cites to "Ex. C" for these assertions, the Court was unable to locate an "Ex. C" to either the brief or the Deposition. As such, these assertions are without record support, save for the ultimate conclusion of tax owed found in the Literal Transcript.
corrected the return for what was considered a mathematical error and computed the plaintiff's liability anew. The IRS included the capital gain of $432,062 as income and thus calculated the plaintiffs' adjusted gross income to be $484,224.63. The IRS reduced the plaintiffs' exemptions to $0, applying the phase-out provisions of 26 U.S.C. § 151(d)(3)(C). The IRS computed the plaintiffs' federal income tax liability to be $92,808.26. (Brief, at 3).
The IRS determined that the Plaintiffs owed an additional $792.18 (including $21.70 interest), which the Plaintiffs paid on September 4, 2001, along with their claim for refund. (Doc. No. 21). Thus, on August 27, 2001, the IRS took the position that the correct tax liability was $92,808.26 and the Heatleys owed an additional $792.18 (including interest).
Plaintiffs assert that due to the amount of non-capital gains income they reported in tax year 2000, they are in the 15% tax bracket and thus, the capital gain should have been taxed at a 10% rate, and not at the 20% rate applied by the IRS. Plaintiffs claim a refund of $43,206.26. While originally denying that Plaintiffs were due any refund, in its motion for summary judgment the government asserts, without citation to the record, that "the IRS incorrectly calculated . . . the plaintiffs' liability for tax year 2000", asserted that Plaintiffs "correct tax liability for tax year 2000 is $92,806.66" and acknowledges that Plaintiffs are due a refund of $1.00, plus applicable interest. (Brief at 8). Thus, on July 30, 2002, the United States took the position that the correct tax liability was $92,806.66 and Plaintiffs were due a refund of $1.00, plus interest.
Unaccountably, the government, in making this concession, refers to the Plaintiffs as "Debtor." (Doc. No. 19 at 8).
In the Objection to the Report and Recommendation, the United States incorporates the Declaration of Gradey Boles (Doc. No. 30, Exhibit 1). Mr. Boles, senior reviewer employed by the IRS, prepared a Capital Gains computation with respect to income tax year 2000 for Plaintiffs. In his Declaration, Mr. Boles, under penalty of perjury, declares that "the total tax for Frank R. and Betty C. Heatley for the year 2000" is "$92,807.66". Id. The Capital Gains Computation attached to that Declaration, however, states that the total tax due is "$92,807. 63" (emphasis added). Thus, on September 30, 2002, the IRS took the position that the correct tax liability was $92,807.66 and $92,807.63.
In the Joint Final Pretrial Statement (Doc. No. 37), filed on October 30, 2002, the IRS takes the position that "the plaintiffs are not due any refund for tax year 2000."
In summary, the United States, while claiming that there is no genuine issue of material fact as to the amount of the Heatley's tax liability for 2000, has asserted:
____________________________________________________________________ DATE TAX LIABILITY REFUND ____________________________________________________________________ April 30, 2001 $5,629.00 $86,408.52 ____________________________________________________________________ August 27, 2001 $92,808.26 none: $729.18 owed ____________________________________________________________________ July 30, 2002 $92,806.66 $1.00 plus interest ____________________________________________________________________ September 30, 2002 $92,807.66 none ____________________________________________________________________ September 30, 2002 $92,807.63 none ____________________________________________________________________SUMMARY JUDGMENT STANDARD
A party is entitled to judgment as a matter of law when the party can show that there is no genuine issue as to any material fact. Fed.R.Civ.Pro. 56(c). The substantive law applicable to the case determines which facts are material. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986). Summary judgment is mandated "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 that party will bear the burden of proof." Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986). The moving party bears the burden of proving that no genuine issue of material fact exists. Id. at 323. In determining whether the moving party has satisfied its burden, the court considers all inferences drawn from the underlying facts in a light most favorable to the party opposing the motion, and resolves all reasonable doubts against the moving party. Anderson, 477 U.S. at 255. A party faced with summary judgment is obligated to come forward with extrinsic evidence which is "sufficient to establish the existence of an element essential to that party's case, and on which that party will bear the burden of proof at trial" in order to avoid the entry of a summary judgment. Hilburn v. Murata Electronics North America, Inc. 181 F.3d 1220, 1225 (11th Cir. 1999) (internal citation omitted).ANALYSIS
As set forth in this Court's prior analysis, the basic issue in this case is the correct interpretation of the provisions of the Internal Revenue Code dealing with the taxation of long-term capital gains for tax year 2000. This provision, charitably called "highly technical" by the government in its brief, reads:
h) Maximum capital gains rate. —
(1) In general. — If a taxpayer has a net capital gain for any taxable year, the tax imposed by this section for such taxable year shall not exceed the sum of —
(A) a tax computed at the rates and in the same manner as if this subsection had not been enacted on the greater of —
(i) taxable income reduced by the net capital gain; or
(ii) the lesser of —
(I) the amount of taxable income taxed at a rate below 28 percent; or
(II) taxable income reduced by the adjusted net capital gain;
(B) 10 percent of so much of the adjusted net capital gain (or, if less, taxable income) as does not exceed the excess (if any) of —
(i) the amount of taxable income which would (without regard to this paragraph) be taxed at a rate below 28 percent, over
(ii) the taxable income reduced by the adjusted net capital gain;
(C) 20 percent of the adjusted net capital gain (or, if less, taxable income) in excess of the amount on which a tax is determined under subparagraph (B);
(D) 25 percent of the excess (if any) of —
(i) the unrecaptured section 1250 gain (or, if less, the net capital gain), over
(ii) the excess (if any) of —
(I) the sum of the amount on which tax is determined under subparagraph (A) plus the net capital gain, over
(II) taxable income; and
(E) 28 percent of the amount of taxable income in excess of the sum of the amounts on which tax is determined under the preceding subparagraphs of this paragraph.26 U.S.C.A. § 1(h).
In somewhat plainer English, with certain exceptions not applicable here, under the Taxpayer Relief Act of 1997, any net long-term capital gain which would otherwise be taxed at 15 percent is taxed at 10 percent. Individuals in higher tax brackets pay tax at a maximum rate of 20 percent on net capital gains. See Corpus Juris Secundum: Internal Revenue § 115 (2002 edition). There is no question that but for the sale of the Disney stock, Plaintiffs would remain within the 15% tax bracket. See Internal Revenue Code § 1(a). There is also no question that if the monies received from the sale of the stock are credited as income to the Plaintiffs, Plaintiffs move into the 39.6% marginal tax bracket.
Plaintiffs argue that the gains should be taxed at 10%, as Plaintiffs are otherwise in the 15% tax bracket. The government contends that most of the gains should be taxed at the maximum rate of 20%, as Plaintiffs are in the higher tax bracket. Contrary to Plaintiffs' arguments, having total non-capital gain income within the 15% bracket does not allow a taxpayer to take advantage of the 10% capital gain rate for an unlimited amount of capital gains.
Having a larger gross income also reduces or eliminates the availability of other tax advantages, such as deductions, exemptions and eligibility for various tax deferral accounts. This feature of the progressive tax system has grown considerably in complexity in recent years, well beyond applying higher marginal rates to higher income individuals. The potential unfairness created by recognizing all of a truly long term capital gain in a single year is a topic that tax theorists have debated for years. Ameliorating this effect is one justification for creating lower capital gains tax rates.
Section 61(a) of the Code states that gross income includes "all income from whatever source derived" (unless otherwise provided), and section 61(a)(3) expressly provides that gross income includes gains derived from dealings in property. Thus, as argued by the government, one must first include the gain as income, in order to carry out the calculations applicable to the capital gains portion of total income. Though the Court agrees with this aspect of the government's argument, the computation of Plaintiffs' actual tax liability and payment credits is not adequately supported on this record so as to allow entry of summary judgment.
Commentators have noted that the calculation of capital gains liability involves a complex series of netting and layering. See, e.g., West Federal Taxation — Individual Income Taxes, Chapter 16, Doc. 5 (2001 edition) (available online at 2001 WL 423759). According to the commentators, after computing tax on ordinary taxable income using the regular tax rates, a taxpayer is to compute tax on the capital gain by calculating the portion of the 10%/20% capital gain that is taxed at 10% (available only if ordinary taxable income plus 25% and 28% capital gain layers do not put taxpayer above the 15% bracket; 10% rate is no longer available once income including the portion of the gain taxed at 10% puts taxpayer out of the 15% bracket) plus the 20% long term capital gain (remaining portion of 10%/20% capital gain.) Id. Translated, this means that Plaintiffs' tax liability is computed by computing the tax on their ordinary taxable income plus the portion of their capital gain that is taxed at 10% up until that amount exceeds the 15% tax bracket, plus the remaining amount of the capital gain taxed at 20%. Thus, the applicable rate is not necessarily 10% or 20%, but will be a combination of the two. Because the 10% rate for capital gains lasts only to the point where the taxpayer continues to be in the 15% tax bracket, to the extent Plaintiffs contend that the entire capital gain of $432,062 should be taxed at 10%, this contention cannot stand.
Although it is plain that Plaintiffs are not entitled to a 10% capital tax rate on the full amount of the capital gain, the government has not met its burden of proof with respect to the correct amount to be refunded to Plaintiffs. Although the IRS argues that the material facts are not disputed and computation of the correct tax is a question of law for the Court, this argument is misguided. In a refund suit, it is the function of the Court on summary judgment to review the IRS' assessment of tax liability, not to calculate the liability for the IRS in the first instance. Here, the IRS has taken numerous inconsistent positions as to Plaintiffs' correct tax liability, both before and after the assessment. Further, there is no evidence in the record of how the IRS arrived at the tax liability they ultimately imposed and plenty of record evidence that the IRS itself cannot consistently apply the "undisputed facts" to the law and arrive at a correct assessment. Moreover, the government admits in its papers that the IRS miscalculated the tax liability of Plaintiffs and that Plaintiffs are owed a refund. Thus, while the Court concludes that there is no genuine issue of material fact that Plaintiffs are due a refund (due to the government's apparent stipulation as to this issue), there is still no evidence sufficient to support a finding of the amount of that refund. Under the law, on this record, even as supplemented by the United States, summary judgment in the government's favor is not appropriate.
This is a problem not unique to the IRS. In a recent article in the Wall Street Journal, a writer took a tax situation to five different tax preparers and received five different "widely varying" results. Patrick Barta, The Cranky Consumer: Testing the Way to Happy Returns, The Wall Street Journal, April 9, 2002, at D3, also available on Westlaw at 2002 WL-WSJ 3391152.
The United States never directly addresses this issue in its later pleadings, but seems to be reneging on this stipulation by stating in the Pretrial Statement that no refund is due. This inconsistency alone is sufficient to deny summary judgment for the Government.
In so finding, the Court is cognizant of the extended proceedings already undertaken with respect to resolving this matter. The Court suggests the following course of action, should the District Court approve this Report. As admitted by the United States, and as is abundantly clear from this record, the tax code provision on Capital Gains is highly technical. As such, the Court should consider referring this matter to a Special Master, with expertise in tax matters, as is contemplated by Rule 53(b), Fed.R.Civ.P. Alternatively, the matter could go to a short trial, where Plaintiffs will ultimately bear the burden of showing entitlement to a specific refund and where presumably expert testimony will be offered to assist the Court.
As this is a non-jury matter involving "matters of account and of difficult computation of damages," referral to an accountant or other Special Master with significant tax expertise is appropriate under the Rule. The Master could meet with the parties, determine if any additional information regarding Plaintiffs' finances is needed, and perform the analysis necessary to calculate their taxes and payments.
Failure to file written objections to the proposed findings and recommendations contained in this report within ten (10) days from the date of its filing shall bar an aggrieved party from attacking the factual findings on appeal.
Recommended.