Dye v. US

• Decision Date: 08 August 1997
• Docket Number: No. 96-3055.,96-3055.
• Citation: 121 F.3d 1399
• Parties: Dorothy DYE, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

121 F.3d 1399

Dorothy DYE, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 96-3055.

United States Court of Appeals, Tenth Circuit.

August 8, 1997.

COPYRIGHT MATERIAL OMITTED

Ervin G. Johnston, Johnston, Ballweg & Tuley, Overland Park, KS, argued the cause for plaintiff-appellant.

Teresa E. McLaughlin, United States Department of Justice, Washington, DC, argued the cause for defendant-appellee. Regina S. Moriarty assisted on the brief.

Before PORFILIO, BARRETT,^* and EBEL, Circuit Judges.

EBEL, Circuit Judge.

During the 1980s, Dorothy Dye lost over $850,000 because of various improprieties committed by her stockbroker. When Dye became aware of these improprieties, she sued. In 1989, the stockbroker's former employers settled Dye's lawsuit for $572,905.97, of which $207,617.37 went to Dye's attorneys. On her 1989 tax return, Dye sought to characterize the settlement proceeds as a "longterm capital gain," and the attorneys' fees as a "capital expenditure." Dye reduced her total tax liability for 1989 by applying the "capital expenditure" against the settlement proceeds.

The IRS disallowed Dye's "capital expenditure" reduction, and demanded about $70,000 in additional 1989 tax, interest, and penalties. Dye paid the IRS the money it demanded, but timely sued for a refund under 28 U.S.C. § 1346(a)(1) (1994) and I.R.C. § 7422 (1994).

The district court granted summary judgment in favor of the IRS. Dye now appeals pursuant to 28 U.S.C. § 1291 (1994). Because the record adequately established that a substantial portion of Dye's legal expenditures were capital in nature, we conclude that it was error to have granted summary judgment to the IRS. Accordingly, we reverse and remand for further proceedings.

BACKGROUND

This is an appeal from a grant of summary judgment. Thus, the following facts are uncontroverted or are considered in the light most favorable to Dye, the non-movant. See Kaul v. Stephan, 83 F.3d 1208, 1212 (10th Cir.1996). All reasonable inferences from the factual record have been drawn in favor of Dye.

In 1982, plaintiff-appellant Dorothy Dye delivered certain tax free municipal bonds and 1,058 shares of Phillips Petroleum stock to her stockbroker William Rosenberger.¹ She instructed Rosenberger to hold the shares and bonds in an account for her benefit.

In January 1983, Rosenberger moved Dye's shares and bonds into a margin account. From 1983 to 1987, Rosenberger executed securities transactions on this margin account that resulted in $383,423.63 in trading losses to Dye. These trading losses created a negative balance in the margin account, forcing Dye to pay $170,991.71 in interest from 1985 to 1988. In addition, Dye lost $229,558 in interest on her tax-free municipal bonds between 1985 and 1988, during which time all such interest was applied to support securities transactions executed on the margin account. Because of the "churning" in Dye's account, Dye incurred $14,856.79 in commissions and transfer fees. Finally, Dye lost an additional $55,000 plus interest when Rosenberger borrowed that amount from Dye's margin account and failed to repay it.

Every tax year from 1984 to 1987, Dye reported capital losses on Schedule D of her federal income tax return, totaling her entire $383,423.63 in trading loss.² However, because I.R.C. § 1211(b) allows capital losses in a given tax year to be set off against gross income only to the extent of that tax year's realized capital gains, plus $3,000, Dye was able to set off against gross income a total of only $13,743.95 in capital losses on her 1984 through 1988 federal income tax returns.³ As a result, at the end of 1988, Dye had a "net long-term capital loss carryover" of $369,680, as permitted by I.R.C. § 1212(b). This figure was later "corrected" to $363,680.

On July 1, 1988, Dye sued Rosenberger and his former employers under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a et seq., alleging securities fraud and mismanagement of her investment accounts. On February 22, 1989, Dye amended her complaint. The amended complaint alleged "churning and unsuitable and unauthorized trading" in violation of Sections 10(b), 15(c)(1), and 20 of the Securities Exchange Act of 1934, and Rules 10b-5 and 15(c)(1)-(2) issued pursuant to that Act, as well as civil RICO violations under 18 U.S.C. §§ 1961-68, breach of fiduciary duty, negligence, common law fraud, and breach of contract regarding the unpaid $55,000 loan.

In late 1989, both of Rosenberger's former employers settled with Dye. Under the settlements, Dye received $302,500 in cash, forgiveness of her margin account debit balance of $270,405.97, and the release of some of her municipal bonds, which were being held as collateral on the margin account. The settlement proceeds were not specifically allocated by the settlement agreements to any category of claimed damages.

From the cash settlement proceeds, Dye's legal counsel withheld $207,617.37 for attorneys' fees and legal expenses. Thus, after paying her attorneys, Dye netted $365,288.60 ($94,882.63 in cash and $270,405.97 in margin account balance forgiveness), which was slightly less than the $383,423.63 in trading loss she had suffered and significantly less than her total losses.

In June 1990, Dye filed her 1989 federal income tax return, showing a total tax liability for 1989 of $5,198. On Schedule D of the tax return, Dye reported the $572,905.97 settlement proceeds from the Rosenberger suit as a long-term capital gain.⁴ From this capital gain, Dye deducted a "net long-term capital loss carryover" from 1988 of $369,680, leaving a "net capital gain" of $203,225.97. Dye characterized the gain as a "legal settlement pertaining to mis-handling of investments— prior years."

On Schedule A of her 1989 tax return, Dye reported the $207,617.37 in attorneys' fees and expenses she incurred in the Rosenberger Suit as a miscellaneous itemized expense. Subsequently, however, in August, 1990, Dye filed an amended 1989 return seeking to recharacterize these attorneys fees and expenses as a capital expenditure, in order to offset them against the settlement proceeds.

On December 10, 1990, the Internal Revenue Service ("IRS") notified Dye that because she had failed to compute her "alternative minimum tax" under I.R.C. § 56, Dye had underpaid her 1989 taxes by $49,470.03. In response, on December 24, 1990, Dye filed a corrected 1989 tax return. On this corrected return, Dye computed her alternative minimum tax, and also characterized the attorneys fees and expenses associated with the Rosenberger suit as a capital expenditure, as she had done on her amended return.

On October 15, 1991, Dye filed a second amended 1989 return that again characterized her attorneys' fees and expenses as capital expenditures. On April 9, 1992, the IRS disallowed Dye's two requests for a refund based on her amended 1989 return, on the grounds that the attorneys' fees and expenses associated with the "cost of recovery" of Dye's money were ordinary expenses that were properly reported on Schedule A, rather than capital expenses appropriate for reporting on Schedule D. On February 18, 1993, Dye filed a third amended 1989 return, again seeking to recharacterize the attorneys fees and expenses as a capital expenditure. On October 14, 1993, Dye paid to the IRS her current outstanding assessed 1989 federal income tax liability (including interest) of $54,442.63.⁵ On October 28, 1993, the IRS disallowed Dye's third claim for refund. On August 24, 1994, Dye filed a fourth amended return, again seeking to recharacterize the attorneys' fees and expenses as a capital expenditure, and claiming a refund of $69,989.74 based on her 1989 return. On October 11, 1994, the IRS disallowed this fourth claim for refund.

On January 20, 1995, Dye sued the IRS in federal district court, seeking a refund of $69,989.74 based on her 1989 federal income tax return, plus interest, attorneys' fees, and costs. The district court exercised jurisdiction pursuant to 28 U.S.C. § 1346(a)(1) (1994).

In connection with Dye's lawsuit, the IRS reviewed its computation of Dye's 1989 income tax, this time treating the settlement proceeds as ordinary income rather than as a capital gain. Under this computation, the IRS increased Dye's 1989 tax liability, including penalty and interest, by $75,743.00 (i.e. from $75,472.14 to $151,215.14). The IRS concedes it is barred by the applicable statute of limitations from pursuing the additional $75,743.00 from Dye. However, it contends that this sum should be offset against any refund Dye might otherwise receive as a result of the present litigation.

In the district court, both Dye and the IRS moved for summary judgment. On December 21, 1995, the court granted summary judgment in favor of the IRS, and correspondingly denied Dye's motion. Dye v. United States, 77 A.F.T.R.2d (P-H) ¶ 96-901, 96-1 U.S. Tax Cas. (CCH) ¶ 50,130, 1995 WL 775351 (D.Kan.1995). Pursuant to 28 U.S.C. § 1291 (1994), Dye now appeals.

DISCUSSION

We review a grant of summary judgment de novo. Applied Genetics Int'l, Inc. v. First Affiliated Sec., 912 F.2d 1238, 1241 (10th Cir.1990). We apply the same standard under Fed.R.Civ.P. 56(c) used by the district court: we determine whether any genuine issue of material fact was in dispute, and, if not, whether the moving party was entitled to judgment as a matter of law. Id. When considering a motion for summary judgment, we examine all evidence in the light most favorable to the non-moving party. Jones v. Unisys Corp., 54 F.3d 624, 628 (10th Cir.1995).

I.

A.

Whether litigation proceeds are properly characterized as "ordinary income" or "capital income" is governed by the "origin of the claim" test. Woodward v. Commissioner, 397 U.S. 572, 577, 90 S.Ct. 1302, 1305, 25 L.Ed.2d 577 (1969); Dolese v. United States, 605 F.2d 1146, 1150-51 (10th Cir. 1979), cert. denied, 445 U.S. 961, 100 S.Ct. 1647, 64 L.Ed.2d 236 (1980...