Craddock, In re

• Decision Date: 28 July 1998
• Docket Number: No. 95-1437,95-1437
• Citation: 149 F.3d 1249
• Parties: -5439, 98-2 USTC P 50,618, Bankr. L. Rep. P 77,753, 98 CJ C.A.R. 4135, 15 Colo. Bankr. Ct. Rep. 269 In re James Berry CRADDOCK, d/b/a Craddock Development Company, Debtor, UNITED STATES of America, INTERNAL REVENUE SERVICE, Claimant-Appellant, v. James Berry CRADDOCK, Debtor-Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 1249

149 F.3d 1249

82 A.F.T.R.2d 98-5439, 98-2 USTC P 50,618,

Bankr. L. Rep. P 77,753, 98 CJ C.A.R. 4135,

15 Colo. Bankr. Ct. Rep. 269

In re James Berry CRADDOCK, d/b/a Craddock Development Company, Debtor,

UNITED STATES of America, INTERNAL REVENUE SERVICE, Claimant-Appellant, v. James Berry CRADDOCK, Debtor-Appellee.

No. 95-1437.

United States Court of Appeals, Tenth Circuit.

July 28, 1998.

Laurie Snyder (Henry Lawrence Solano, United States Attorney, and Gary D. Gray with her on the briefs), Department of Justice, Washington, DC, for Claimant-Appellant.

John Lawrence Hamil (Richard C. Morris with him on the brief) of Hamil Professional Before BRORBY, Circuit Judge, McKAY, Senior Circuit Judge, and HENRY, Circuit Judge.

Corporation, Denver, Colorado, for Debtor-Appellee.

BRORBY, Circuit Judge.

Mr. James Berry Craddock petitions this court for rehearing on the issue of his substantial understatement of tax penalty addressed in our opinion, In re Craddock, 143 F.3d 595, 1998 WL 213685 (10th Cir. May 1, 1998). We grant Mr. Craddock's petition, in part, as to our standard of deference applicable to a treasury regulation, and the application of this standard to Treas. Reg. § 1.6661-2(c)-(d). We deny his petition as to all other issues and deny his suggestion for rehearing en banc. The original opinion is withdrawn. This opinion is ordered substituted for the original opinion filed in this case.

The Internal Revenue Service ("IRS") appeals the district court's denial of late filing penalties and computation of a substantial underpayment of tax penalty assessed against Mr. James Berry Craddock's Chapter 11 bankruptcy estate. The IRS contends the district court erred in reversing the bankruptcy court's finding that no reasonable cause existed for Mr. Craddock's failure to timely file his federal 1981, 1982, and 1985 tax returns, and affirming the bankruptcy court's computation of understatement of tax penalty for Mr. Craddock's 1985 tax liability. We exercise jurisdiction pursuant to 28 U.S.C. §§ 158(d) and 1291, and reverse.

BACKGROUND

The IRS filed proofs of claims for taxes, interest and penalties against Mr. Craddock's bankruptcy estate relating to tax years 1979-1986. ¹ Most the claims were resolved by agreement except for the two issues in this appeal. The relevant facts are as follows.

Failure to timely file tax returns

During the years 1981-1985, Mr. Craddock owned and operated a real estate development company, Craddock Development Company ("CDC"), as a sole proprietor. He reported his CDC income in his federal individual income tax returns for each of the relevant tax years. Despite obtaining extensions, Mr. Craddock filed each of his income tax returns for the years 1981, 1982, and 1985 over ten months late. Consequently, the IRS assessed late filing penalties under I.R.C. § 6651. ² Mr. Craddock objected on grounds his failure to timely file the returns was due to reasonable cause and not willful neglect, an excuse permitted by I.R.C. § 6651(a). In support of his objection, Mr. Craddock presented his testimony and testimony of Mr. Robert J. Rudnick, a former CDC accountant responsible for reviewing Mr. Craddock's tax returns from July 1982 through 1985. Their testimony provided the following evidence.

Mr. Craddock delegated his tax return preparation duties to CDC's accounting staff. During the years in question, CDC and its related businesses experienced exponential growth and complexity, resulting in the addition of at least twenty-five other businesses arranged as pass-through entities such as partnerships and S-corporations. To handle the additional workload, Mr. Craddock added another accounting department and increased his accounting personnel from five in the early 1980's to fifty by 1985. Mr. Craddock hired outside accounting firms to review the tax returns prepared by his accounting staff. From 1981 through 1985, Mr. Craddock paid approximately $1 million per year (about fifty percent of his total payroll) on accounting and tax staff, and more than $100,000 per year in fees to his independent certified public accounting firm.

Mr. Craddock also purchased a new accounting system, the Basic-4 system, to help manage his growing business. However the Mr. Rudnick testified the untimely filing of Mr. Craddock's tax returns was also due to a high rate of personnel turnover, extensive audits of prior years' tax returns which required substantial amounts of the accounting department's time, and the conversion to CDC's accounts from the accrual to the cash basis.

Basic-4 system failed to perform as quickly and effectively as represented. Despite his efforts, Mr. Craddock knew his tax returns were still not being timely filed. Yet, he did not instruct his staff to timely file the returns since he wanted the returns to be accurate. He also chose not to hire outside accounting firms to help prepare tax returns because he felt "[t]hey were too expensive."

The bankruptcy court allowed the IRS's late filing penalties for several reasons. The court cited United States v. Boyle, 469 U.S. 241, 105 S.Ct. 687, 83 L.Ed.2d 622 (1985) in concluding Mr. Craddock's reliance on his accounting staff for the ministerial task of filing tax returns was not "reasonable cause." In addition, the court held the growth and complexity of one's business does not constitute an excuse. Furthermore, the court ruled Mr. Craddock was liable for the penalties because it found "the circumstances were clearly within Mr. Craddock's ability to control."

The district court reversed, ruling the bankruptcy court improperly applied Boyle to the facts of this case since Mr. Craddock did more than merely rely on his accounting department. The court held the proper legal standard was whether Mr. Craddock exercised ordinary business care and prudence in attempting to file his returns on time. The court concluded Mr. Craddock exercised such care, and overruled the bankruptcy court's finding the circumstances were within Mr. Craddock's ability to control. The IRS appeals the district court's decision.

Substantial Understatement of Tax

The IRS assessed a $61,825 understatement of tax penalty under I.R.C. § 6661(a) (1985), ³ as an addition to Mr. Craddock's 1985 tax liability. Under the 1985 version of I.R.C. § 6661, an understatement of tax is the difference between the amount of tax required to be reported on a return, and the amount of tax actually reported, reduced by the amount of tax attributable to any item disclosed, but not reported in the tax return. I.R.C. § 6661(b)(2)(A), (B). Mr. Craddock's corrected tax required to be reported in his 1985 tax return was $247,299 after IRS audit adjustments. He reported no tax. He disclosed but did not report income of $3,378,385 from the "Airport Raintree" transaction. Following Treas. Reg. § 1.6661-2(c) and (d), the IRS computed Mr. Craddock's substantial understatement penalty by recomputing his tax shown on his return as if he had properly reported the Airport Raintree transaction for tax purposes, resulting in a revised tax shown on his return of $0, and a substantial understatement of tax of $247,299.

Mr. Craddock objected to the penalty on the ground that under the statute's plain language, if the understatement was reduced "by that portion of the understatement which is attributable to ... any item with respect to which the relevant facts affecting the item's tax treatment are adequately disclosed," he would not be liable for a penalty. I.R.C. § 6661(b)(2)(B). The bankruptcy court agreed, rejecting the IRS's calculation in accordance with Treas. Reg. § 1.6661-2(c) and ruling there was no understatement of tax within the meaning of I.R.C. § 6661. It found no understatement would exist if the income attributable to the Airport Raintree transaction was excluded from the computation of his corrected tax required to be shown on his return. The district court affirmed by deciding the bankruptcy court's computation was consistent with the purposes of I.R.C. § 6661(b)(2)(B)(ii) "to deter the use of undisclosed questionable reporting decisions" since it "reversed out" the effect of the disclosed Airport Raintree transaction. The IRS appeals.

The IRS also filed a motion in this court in July 1997 for leave to file a motion in the bankruptcy court to correct a mistake in the bankruptcy court's judgment filed January Under Fed.R.Civ.P. 60(a) made applicable to bankruptcy cases by Fed. R. Bankr.P. 9024, "[c]lerical mistakes in judgments, [or] orders may be corrected by the court at any time." However, "while the appeal is pending [such mistakes] may be so corrected with leave of the appellate court." Fed.R.Civ.P. 60(a). The IRS claims the district court's order is correctable under Fed.R.Civ.P. 60(a), ⁴ while Mr. Craddock claims the order is only correctable under Fed. R. Civ. P. 60(b), ⁵ as a correction of an error caused by inadvertence or mistake. Under Fed.R.Civ.P. 60(b), the district court can only amend its judgment for mistakes within one year from the date originally awarded. If Mr. Craddock is correct, the motion must be denied since it was filed beyond the one-year limitation. Based on our review of the record, it is unclear whether the difference between the stipulated interest and any interest stated in the judgment was due to a clerical error or mistake. Therefore, unable to rule on the motion, we remand this question to the bankruptcy court to determine whether the judgment contains a clerical error correctable under Fed.R.Civ.P. 60(a). ⁶ Despite our remand, we consider this judgment final for purposes of this appeal, since the parties treated the judgment as final, the interest is not an issue on direct appeal, and if the judgment contains a clerical error or mistake, such error generally does not render the judgment invalid. See Stone v. I.N.S., 514 U.S. 386, 401, 115 S.Ct. 1537, 131 L.Ed.2d 465 (1995) (stating the pendency of a Rule 60(b) motion does not affect the...