Peck v. C.I.R.

Decision Date05 June 1990
Docket NumberNo. 88-7484,88-7484
Citation904 F.2d 525
Parties-5037, 90-1 USTC P 50,311 Donald A. PECK; Judith W. Peck, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtU.S. Court of Appeals — Ninth Circuit

Harry J. Kaplan, San Jose, Cal., for petitioners.

James I.K. Knapp, Acting Asst. Atty. Gen., Gary R. Allen, David English Carmack, Kenneth W. Rosenberg, Tax Division, Dept. of Justice, Washington, D.C., for respondent.

Appeal from a Decision of the United States Tax Court.

Before WRIGHT, HUG, and LEAVY, Circuit Judges.

EUGENE A. WRIGHT, Circuit Judge:

This case requires us to apply collateral estoppel principles in the tax context. The taxpayers, Donald and Judith Peck, entered into a 30-year lease of real property in 1974 from their controlled corporation. The lease terms did not change for the first five years. In a prior action, the Tax Court found that the Pecks' rent deductions under the lease for 1974, 1975 and 1976 must be reduced by the full amount of gardening expenses and 25% of the property taxes and mortgage payments under 26 U.S.C. Sec. 482. 1 This court affirmed that decision, with one judge dissenting in part. Peck v. Commissioner, 752 F.2d 469 (9th Cir.1985) (per curiam) (Peck I ).

In this action, the IRS assessed deficiencies against the Pecks for 1977 and 1978 based on their rental deductions in connection with the same lease. The Tax Court applied collateral estoppel, and held that because the terms of the lease for these two years were the same as those for the first three years, the parties were bound by the courts' determination in Peck I in computing the amount of rent deductions. Peck v. Commissioner, 90 T.C. 162, 168 (1988).

ANALYSIS 2
I

The doctrine of collateral estoppel (issue preclusion) is intended to limit the number of times a defendant may be forced to litigate the same claim or issue, and to promote efficiency in the judicial system by putting an end to litigation. Gilbert v. Ben-Asher, 900 F.2d 1407, 1409-10 (9th Cir.1990). The doctrine provides that "once an issue is actually litigated and necessarily determined, that determination is conclusive in subsequent suits based on a different cause of action but involving a party or privy to the prior litigation." United States v. ITT Rayonier, Inc., 627 F.2d 996, 1000 (9th Cir.1980). 3

The Supreme Court explained the application of collateral estoppel in the tax context in Commissioner v. Sunnen, 333 U.S. 591, 68 S.Ct. 715, 92 L.Ed. 898 (1948). After articulating special concerns with respect to the doctrine's application in tax actions, id. at 598-99, 68 S.Ct. at 720, the Court adopted what has come to be known as the "separable facts" doctrine:

Of course, where a question of fact essential to the judgment is actually litigated and determined in the first tax proceeding, the parties are bound by that determination in a subsequent proceeding even though the cause of action is different.... And if the very same facts and no others are involved in the second case, a case relating to a different tax year, the prior judgment will be conclusive as to the same legal issues which appear, assuming no intervening doctrinal change. But if the relevant facts in the two cases are separable, even though they be similar or identical, collateral estoppel does not govern the legal issues which recur in the second case.

Id. 333 U.S. at 601, 68 S.Ct. at 721 (emphasis added) (citations omitted). The Court concluded:

Before a party can invoke the collateral estoppel doctrine ..., the legal matter raised in the second proceeding must involve the same set of events or documents and the same bundle of legal principles that contributed to the rendering of the first judgment.

Id. at 601-02, 68 S.Ct. at 721 (citing Tait v. Western Md. Ry. Co., 289 U.S. 620, 53 S.Ct. 706, 77 L.Ed. 1405 (1933)).

The Court's decision in Montana v. United States, 440 U.S. 147, 99 S.Ct. 970, 59 L.Ed.2d 210 (1979), calls Sunnen's separable facts doctrine into question. Starker v. United States, 602 F.2d 1341, 1346 (9th Cir.1979). The Court limited the application of Sunnen to cases where there has been a significant " 'change in the legal climate.' " Montana, 440 U.S. at 161, 99 S.Ct. at 977 (quoting Sunnen, 333 U.S. at 606, 68 S.Ct. at 723); Starker, 602 F.2d at 1347. Two circuits have concluded that the Sunnen separable facts doctrine is not good law after Montana. American Medical Int'l, Inc. v. Secretary of Health, Education and Welfare, 677 F.2d 118, 120 (D.C.Cir.1981) (per curiam); Hicks v. Quaker Oats Co., 662 F.2d 1158, 1167 (5th Cir.1981).

There is conflicting authority in this circuit as to whether Sunnen's separable facts doctrine is still alive. 4 The Supreme Court has rejected the separable facts doctrine in general terms, but has implied that it might have continuing validity in the tax context. United States v. Stauffer Chemical We need not decide whether the separable facts doctrine is still good law. Assuming, without deciding, that the more restrictive Sunnen test applies, we hold that the Tax Court properly used the collateral estoppel doctrine in this case.

                Co., 464 U.S. 165, 172 n. 5, 104 S.Ct. 575, 579 n. 5, 78 L.Ed.2d 388 (1984) ("Whatever applicability [the Sunnen separable facts doctrine] may have in the tax context, ... we reject its general applicability outside of that context.");    see also 18 C. Wright, A. Miller & E. Cooper, Federal Practice and Procedure Sec. 4425, at 255-57 (1981) (stating that tax litigation may present "the strongest case" for continued adherence to the Sunnen separable facts rule)
                
II

The issue litigated and decided in Peck I was the proper amount of rent deductions under the Pecks' 1974 lease with its controlled corporation. Applying the clearly erroneous standard, we upheld (1) the Tax Court's determination that it was " 'highly unlikely an unrelated lessee in petitioners' position would have paid $24,870 per year for the use of the land while also carrying responsibility for taxes, mortgage payments, and gardening expenses,' " and (2) the Tax Court's finding that the appropriate rent deductible under the lease for the three years at issue was the amount stated in the lease reduced by the gardening expenses and 25% of the property taxes and mortgage payments. Peck I, 752 F.2d at 472-73.

In deciding whether collateral estoppel applies under Sunnen, we must determine whether this proceeding involves "the same set of events or documents and the same bundle of legal principles that contributed to the rendering of the first judgment." 333 U.S. at 602, 68 S.Ct. at 721. We focus on whether the legal relationship changed over the relevant time period. See Southwest Exploration Co. v. Riddell, 362 F.2d 833, 837 (9th Cir.1966) (applying collateral estoppel in the computation of depletion deductions when the legal relationship between the parties had not changed from the time period which was the subject of the prior action); Jones v. United States, 466 F.2d 131, 135-36 (10th Cir.1972) (applying collateral estoppel in determining the character of payments received under a contract which contained terms which did not change over the relevant time period), cert. denied, 409 U.S. 1125, 93 S.Ct. 938, 35 L.Ed.2d 257 (1973); Sydnes v. Commissioner, 647 F.2d 813, 815 (8th Cir.1981) (applying collateral estoppel in determining the character of payments under the same mortgage considered in a prior action).

The legal relationship in this case is a lease. The test for determining whether rent payments are reasonable is "whether the sum paid is in excess of what the lessee would have been required to pay had he dealt at arm's length with a stranger." Mackinac Island Carriage Tours, Inc. v. Commissioner, 455 F.2d 98, 100 (6th Cir.1972) (applying 26 U.S.C. Sec. 162, which allows deductions from gross income for ordinary and necessary business expenses). 5

In the context of a long-term lease, the determination of what is a reasonable term is made as of the date of its inception. See Brown Printing Co. v. Commissioner, 255 F.2d 436, 440 (5th Cir.1958) (applying the predecessor to 26 U.S.C. Sec. 162); William E. Davis & Sons, Inc. v. Commissioner, 41 T.C.M. (CCH) 1263 (1981) (in determining whether the terms of a lease are reasonable, the court examines its provisions in light of the facts and circumstances existing at the time it was executed). 6

The only difference between this action and Peck I is the tax years involved. Peck I involved the first three years of the lease.

                This case involves the next two years of the same lease, the terms of which did not change over the entire five-year period.  When this court affirmed the Tax Court's determination of the arm's length rent amount at the lease's inception in 1974, we effectively determined the proper rent deduction for the first five years of the lease. 7   As the Tax Court noted, "[h]ad the present case been consolidated for trial with the first case, one uniform result would necessarily have obtained."    Peck, 90 T.C. at 168.    We therefore reject the Pecks' argument that annual changes in fair market rent are relevant in applying Sec. 482 to this lease. 8   This case does not involve separable facts. 9
                

The Pecks argue that their complaint in this action raises a factual issue different from those raised in Peck I. Specifically, they alleged here that they did not transfer to their controlled corporation in 1974 any liabilities on the real property subject to the lease. They added this fact to their complaint based on the dissenting opinion in Peck I, which stated that the Tax Court erred in reducing the rent amount by 25% of the mortgage payments because the corporation did not assume or pay any portion of the mortgage. 752 F.2d at 473 (Beezer, J., dissenting).

This fact is neither new nor separable. It existed at the inception of the lease in 1974. Moreover, the dissenting opinion itself...

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