Barenholtz v. U.S., 85-2250
| Decision Date | 19 February 1986 |
| Docket Number | No. 85-2250,85-2250 |
| Citation | 784 F.2d 375 |
| Parties | -824, 86-1 USTC P 9238 Bernard M. BARENHOLTZ, Appellant, v. The UNITED STATES, Appellee. Appeal |
| Court | U.S. Court of Appeals — Federal Circuit |
David C. Sprafkin, New York City, argued for appellant. With him on the brief was Samuel M. Sprafkin.
Bruce Ellisen, Tax Div., Dept. of Justice, Washington, D.C., argued for appellee. With him on the brief were Glenn L. Archer, Jr., Asst. Atty. Gen., Michael L. Paup and Robert A. Bernstein.
Before MARKEY, Chief Judge, SMITH and NIES, Circuit Judges.
Plaintiff-appellant Bernard M. Barenholtz (Barenholtz) appeals from a United States Claims Court judgment dismissing his suit for refund of federal income taxes for the years 1975, 1976, and 1977. The Claims Court concluded that Barenholtz could not deduct interest on loans which were used to carry tax-exempt bonds to the extent the interest was attributable to the portions of the loans secured by the tax-exempt bonds. The court ruled that the Government's computation of tax liability was correct and that Barenholtz was not entitled to any refund. We affirm.
The two issues are: (1) whether the Claims Court was correct in its decision that Barenholtz' Pyne Press loans were used to carry tax-exempt bonds, within the meaning of section 265(2) of the Internal Revenue Code; and (2) whether the Claims Court was correct in its computations leading to the result that Barenholtz was not entitled to a refund for any of the 3 years in issue.
In July 1982, Barenholtz filed this action in the United States Court of Claims for a refund of federal income taxes. He sought to recover income taxes in the amounts of $7,093, $24,044, and $25,066, plus interest, for the taxable years 1975, 1976, and 1977, respectively. The Claims Court delivered an oral opinion from the bench after the trial. Subsequently, the parties disagreed as to whether Barenholtz was entitled to any refund pursuant to the court's ruling. The court issued an oral ruling that the Government's computation was correct and that Barenholtz was not entitled to any refund. The court entered its judgment on March 4, 1985. 1
The relevant facts are summarized below.
In July 1969, Barenholtz retained an investment management and counseling firm to manage his securities. From August through December 1969, Barenholtz acquired tax-exempt bonds having a value of $525,000. Thereafter, and through 1977, he neither sold nor bought any tax-exempt securities.
In 1969, Barenholtz' total assets were worth approximately $3,650,000. His stocks and bonds were worth approximately $3,000,000, of which amount $2,475,000 consisted of taxable securities and $525,000 consisted of tax-exempt securities.
Beginning in September 1970, and through 1977, Barenholtz owned and operated a book publishing business in Princeton, New Jersey. The business was conducted as a sole proprietorship under the name "The Pyne Press." In 1971, Pyne Press began to take out a series of loans from the First National Bank of Princeton (bank). Barenholtz signed the promissory notes. Barenholtz' loan balance totaled $487,000 at the end of 1973, and $567,000 at the end of 1974. The loans were fully repaid during the period from May 1975 through April 1977.
At first, the loans were either unsecured or secured by common stocks. Beginning in September 1973, Barenholtz, through his investment managers, sent tax-exempt bonds to the bank as collateral for the loans. Tax-exempt bonds valued at $425,000 were posted in 1973, and the remaining tax-exempt bonds valued at $100,000 were posted in 1974. The bank retained all the securities, including the tax-exempt bonds, until after the loans were repaid in full in 1977.
Barenholtz paid interest on the Pyne Press loans in each of the years 1971 through 1977 to the bank. He deducted the interest on his federal income tax return each year.
The Internal Revenue Service (IRS) examined Barenholtz' income tax returns for the years 1975, 1976, and 1977. For each of those years, the IRS concluded that his Pyne Press indebtedness was "indebtedness incurred or continued to purchase or carry" Barenholtz' tax-exempt bonds, within the meaning of section 265(2) of the Internal Revenue Code, which provides that no deduction shall be allowed for interest on such indebtedness. In computing Barenholtz' income tax liability, the IRS disallowed his claimed Pyne Press interest deduction in each year to the extent the deduction was equal to or less than the amount of tax-exempt income he received from his tax-exempt bonds.
Assessment of additional taxes for the years 1971, 1972, 1973, and 1974 was barred by the statute of limitations provided in section 6501(a) of the Internal Revenue Code (26 U.S.C.). For the years in issue, 1975, 1976, and 1977, Barenholtz claimed charitable contribution carryovers from the years 1971, 1972, 1973, and 1974. In addition, for the year 1975, he claimed a net operating loss carryover from 1974. In order to compute Barenholtz' correct tax liability for the years 1975, 1976, and 1977, the IRS had to compute his correct liability for the earlier years. Accordingly, the IRS also disallowed his Pyne Press interest deductions for the years 1971, 1972, 1973, and 1974. These disallowances resulted in upward adjustments to Barenholtz' 1971, 1972, 1973, and 1974 adjusted gross incomes. These upward adjustments in turn increased the allowable charitable contribution deduction for each of those years. This reduced his charitable contribution allowance carryover to the years 1975 through 1977, and accordingly increased his income for the years 1975 through 1977. The upward adjustment of Barenholtz' 1974 adjusted gross income also eliminated a 1974 net operating loss carried over from 1974 to 1975 and, accordingly, increased his income for 1975.
In addition to disallowing the interest deductions, the IRS disallowed certain deductions for investment and custodial fees claimed by Barenholtz on his 1975, 1976, and 1977 returns. The IRS also disallowed part of a deduction for obsolescence of a mailing list claimed on his 1976 return.
As a result of these various adjustments, the IRS determined that Barenholtz had additional income tax liability in the amounts of $7,093, $24,044, and $25,066, for the years 1975, 1976, and 1977, respectively. He paid these amounts, plus interest, and filed claims for refunds. After the claims were denied, he filed this refund action in the Claims Court.
Following a trial, the Claims Court delivered an oral opinion on the interest deduction issue. The court noted that section 265(2) applies to disallow interest on indebtedness only when there is a nexus between the indebtedness and the tax-exempt securities. It found that during the period before September 1973 when Barenholtz' tax-exempt bonds were not used as collateral for the Pyne Press loans, "there was not a sufficient nexus between the holding of the exempt securities and the conduct of the business." Therefore, section 265(2) did not apply to interest paid during that period. It further found that from the time when the tax-exempt bonds first were used as collateral, in September 1973, there was a sufficient nexus between the bonds and the loans. The court noted that the bonds could have been sold, but that "[t]he choice was made to keep the securities and use them as collateral for the loan, rather than to sell them." The trial judge concluded that interest deductions attributable to the portion of the loan secured by the tax-exempt bonds were disallowed under section 265(2). The trial court held that, for periods when the outstanding loan balance exceeded the amount of the bonds used as collateral, interest attributable to the portion of the loan balance secured by the bonds was not deductible. Any interest attributable to the excess loan balance was allowed to be deducted. The Claims Court's method of determining how much interest was deductible differed from the method which had been used by the IRS.
The court directed the parties to calculate the amount of any refund due Barenholtz pursuant to its ruling.
Prior to trial, the parties had agreed to settle two issues: (1) the investment and custodial fee deductions and (2) the mailing list deduction. The parties stipulated that Barenholtz would withdraw his claim for investment and custodial fee deductions, and that the Government would concede his claim for a mailing list deduction. At one point, the Government proposed to effectuate the settlement by dismissing the two settled issues from the case, and to process overpayment for these issues separately, in the amounts of $4,001 for 1976 and $1,179 for 1977. Barenholtz rejected the Government's proposal and insisted that the settlement of the two issues be incorporated into the judgment.
In their joint statement of facts and law, filed on November 26, 1984, the parties stated that they had stipulated to eliminate the two issues and that "[t]he judgment to be entered on the other issues in this case also shall set forth and incorporate the separate stipulation of the parties concerning their resolution of the [custodial fees and mailing list] issues." The actual stipulation was filed on January 28, 1985.
After the Claims Court's ruling of December 13, 1984, regarding the extent to which Barenholtz' interest deductions were allowable, it became apparent that for the years 1974 and 1975, he was subject to disallowances of claimed interest deductions in amounts ($61,691 and $47,570, respectively) that were greater than the amounts originally disallowed by the IRS ($37,597 for each year). The court found, however, that since bonds were not used as collateral in 1971, 1972, or part of 1973, Barenholtz was entitled to the entire amount of interest claimed for 1971 and 1972, and to most of the amount...
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