Major Paint Co. v. U.S., 02-5153.

Citation334 F.3d 1042
Decision Date27 June 2003
Docket NumberNo. 02-5153.,02-5153.
PartiesMAJOR PAINT COMPANY, Standard Brands Paint Company, Standard Brands Liquidating Creditor Trust, and Standard Brands Paint Co., Plaintiffs-Appellants, v. UNITED STATES, Defendant-Appellee.
CourtUnited States Courts of Appeals. United States Court of Appeals for the Federal Circuit

Thomas F. Joyce, Bell, Boyd & Lloyd LLC, of Chicago, IL, argued for plaintiffs-appellants. With him on the brief was David F. Heroy.

Charles Bricken, Attorney, Tax Division, Department of Justice, of Washington, DC, argued for defendant-appellee. With him on the brief were Eileen J. O'Connor, Assistant Attorney General, and Thomas J. Clark, Attorney.

Before MICHEL, Circuit Judge, ARCHER, Senior Circuit Judge, and LOURIE, Circuit Judge.

ARCHER, Senior Circuit Judge.

Major Paint Company, Standard Brands Paint Company, Standard Brands Liquidating Creditor Trust, and Standard Brands Paint Company ("Standard Brands" or "taxpayer") appeal the Court of Federal Claims' grant of summary judgment in favor of the government. Standard Brands Liquidating Creditor Trust v. United States, 53 Fed.Cl. 25 (2002). The Court of Federal Claims held that costs Standard Brands expended on the hiring of outside professionals during bankruptcy proceedings ("capitalized bankruptcy costs") were not "specified liability losses" under § 172(f)(1)(B) of the Internal Revenue Code ("Tax Code" or "I.R.C.") and thus did not qualify for the special ten-year net operating loss carry-back provided in I.R.C. § 172(b)(1)(C). I.R.C. § 172 (2000). Because we hold that the capitalized bankruptcy costs incurred by Standard Brands did not arise under a federal law, the Court of Federal Claims judgment is affirmed.

BACKGROUND

Standard Brands Paint Company and its subsidiaries ("The Company") manufactured, distributed, and sold paint and related products in retail stores. In 1992, The Company petitioned the United States Bankruptcy Court for the Central District of California for relief under Chapter 11 of Title 11 of the United States Code ("Bankruptcy Code"). Under the supervision of the bankruptcy court, Standard Brands employed various legal, accounting, and other professionals who incurred fees and expenses. The bankruptcy court eventually entered awards of final compensation to the various professionals.

In its federal income tax returns for the taxable years ending January 1993 and January 1994, Standard Brands deducted some of the professional fees and expenses resulting from the bankruptcy and capitalized the remaining $5,429,186.1 In 1998, Standard Brands filed a Form 1120X ("claim") for the taxable year ending January 1987. The claim applied a net operating loss deduction of $5,429,186 for the capitalized bankruptcy costs as a "specified liability loss" for the taxable year ending January 26, 1997, carried back to the taxable year ending January 25, 1987, pursuant to I.R.C. § 172. The claim sought a refund of $2,497,426 for that taxable year.

After reviewing Standard Brands' claim, the Internal Revenue Service ("IRS") issued a technical advice memorandum ("TAM") denying a loss deduction and in a later letter proposed disallowance of the claim. On April 5, 2000, Standard Brands filed a complaint seeking refund of taxes plus interest.

The Court of Federal Claims granted summary judgment in favor of the government. In its opinion, the court discussed the three cases that have dealt with this provision of the Tax Code: Sealy Corp. v. Comm'r of Internal Revenue, 171 F.3d 655 (9th Cir.1999) (Sealy II) (affirming Sealy Corp. v. Comm'r of Internal Revenue, 107 T.C. 177, 1996 WL 599766 (1996) (Sealy I)); Host Marriott Corp. v. United States, 113 F.Supp.2d 790 (D.Md.2000) (Host Marriott I), aff'd by Host Marriott Corp. v. United States, 267 F.3d 363 (4th Cir.2001) (Host Marriott II) (adopting the district court's reasoning); and Intermet Corp. v. Comm'r of Internal Revenue, 117 T.C. 133, 2001 WL 1164198 (2001). Finding Sealy II the most analogous to the present case, the court held that "the connection between [Standard Brands'] capitalized expenses and the [B]ankruptcy [C]ode [was] too attenuated to meet the requirements of section 172(f)(1)(B)." Standard Brands, 53 Fed.Cl. at 28.

Standard Brands appealed, and we have jurisdiction under 28 U.S.C. § 1295(a)(3).

ANALYSIS

The issue in this case is whether Standard Brands' capitalized bankruptcy costs were "specified liability losses" within the meaning of I.R.C. § 172(f)(1)(B). Such a question involves statutory construction, and we review the Court of Federal Claims' judgment de novo. See Doyon, Ltd. v. United States, 214 F.3d 1309, 1314 (Fed.Cir.2000).

During the relevant time period, Tax Code section 172(f) defined the term "specified liability loss" as follows:

(1) In general. — The term "specified liability loss" means the sum of the following amounts to the extent taken into account in computing the net operating loss for the taxable year....

(B) Any amount ... allowable as a deduction under this chapter with respect to a liability which arises under a Federal or State law, or out of any tort of the taxpayer if (i) In the case of a liability arising out of a Federal or State law, the act (or failure to act) giving rise to such liability occurs at least 3 years before the beginning of the taxable year.

I.R.C. § 172(f)(1)(B)(i). Thus, for this section to apply, there must have been an act which gave rise to liability under state or federal law and that act must have occurred more than three years prior to the tax year in question.

The IRS has not issued any regulations to aid us in interpreting I.R.C. § 172(f), nor does there appear to be any relevant legislative history. Additionally, whether the cost of hiring outside professionals during a bankruptcy proceeding is a liability arising under a federal law, and thus possibly eligible to be carried-back ten years as a specified liability loss under I.R.C. § 172(b)(1)(C), has not yet been determined by any appellate court. There are, however, several decisions in our sister circuits and the Tax Court which provide guidance for our analysis: Sealy II, 171 F.3d 655 (holding liabilities arising from professional fees paid to qualified public accountants to publish reports related to employee benefit plans as required by ERISA and those paid to lawyers and accountants to comply with an IRS audit did not arise under a federal law); Host Marriott II, 267 F.3d 363 (holding liabilities arising from a federal income tax deficiency and costs for workers' compensation payments did arise under federal and state law); and Intermet Corp., 117 T.C. 133, 2001 WL 1164198 (holding liabilities arising from federal and state income tax deficiencies did arise under federal and state law).

In Sealy II, the Ninth Circuit examined professional fees incurred by the taxpayer in connection with complying with various federal statutes and an IRS audit. Sealy II, 171 F.3d 655. In holding that these fees were not specified liability losses, the court explained "[i]t is ... not simply an expense incurred with respect to an obligation under federal law [that meets the statutory definition of a specified liability loss] but an act `giving rise' to the liability that qualifies as a specified liability under the statute." Id. at 657. The court explained that "[t]he act giving rise to each of the liabilities in question was the contractual act by which Sealy engaged lawyers or accountants." Id. The situation in Sealy II is easily contrasted with those in Host Marriott II and Intermet.

In Host Marriott II, the taxpayer sought, inter alia, to deduct the cost of federal income tax deficiency interest as a specified liability loss. Host Marriott II, 267 F.3d at 365. In that case, the Fourth Circuit adopted the district court's reasoning in Host Marriott I and affirmed its holding that the taxpayer's liability was a specified liability loss because the liability for federal income tax deficiency interest arose explicitly out of I.R.C. § 6601(a) under a rate established by § 6621.2 Id. (citing Host Marriott I, 113 F.Supp.2d 790). This holding was premised on the fact that the existence of the tax deficiency interest liability and its amount was expressly set by federal law and not based upon the taxpayer's choice. Host Marriott I, 113 F.Supp.2d at 794. Indeed, Host Marriott I distinguished the facts of Sealy I & II, explaining that there the liability for the accounting and professional fees at issue did not arise under federal law because the statutory provisions did not establish the taxpayer's liability to pay the amounts at issue; rather, the taxpayer's choice of the means of compliance determined the nature and amounts of the costs. Id.

Intermet also involved a claim that liability arising from federal income tax deficiency interest constituted a specified liability loss under I.R.C. § 172(f). Intermet Corp., 117 T.C. 133, 2001 WL 1164198. There the Tax Court, largely repeating the reasoning in Host Marriott I, ruled that such a liability did arise under a federal law because "Federal law expressly impose[d] the liabilities for tax and interest at issue in this case." Id. at 140. Additionally, the court's treatment of Sealy I & II was similar to that in Host Marriott I: the court noted that in Sealy I & II it was the taxpayer's choice of the means of compliance, not the regulatory provisions, which determined the nature and the amount of the liability. Id. at 138-39.

While these three cases are not binding on us, they are instructive. We agree with the Court of Federal Claims' conclusion here that two principles emerge from these cases: "arising out of a federal law" means more than just that the liability was incurred with respect to an obligation under a federal law; and the nature and amount of the liability must be traceable to a specific law and cannot be the result of choices made by the taxpayer or others. Standard Brands, 53 Fed.Cl. at 29. We adopt these principles.

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