Ervin v. U.S. By & Through Its Agent
| Decision Date | 02 August 2016 |
| Docket Number | CIVIL ACTION NO. 4:13-cv-00127-JHM |
| Parties | GARY ERVIN AND LISA A. ERVIN, ROBERT ERVIN AND LAURA KAVANAUGH ERVIN, TIMOTHY ERVIN AND VICKI ERVIN PLAINTIFFS v. UNITED STATES OF AMERICA BY AND THROUGH ITS AGENT, THE COMMISSIONER OF THE INTERNAL REVENUE DEFENDANT |
| Court | U.S. District Court — Western District of Kentucky |
This matter is before the Court on Plaintiffs' and Defendant's cross Motions for Summary Judgment [DNs 59, 60]. Fully briefed, this matter is ripe for decision. For the following reasons, the Court holds that both Plaintiffs' and Defendant's Motions for Summary Judgment are DENIED.
This case has a long and convoluted history. It began in 1999 when brothers, Gary, Robert, and Timothy Ervin (hereinafter "Plaintiffs"), sold a cable television company they built in their hometown of Sturgis, Kentucky for around forty million dollars. Plaintiffs were then approached by numerous accounting and tax firms offering advice regarding the proper handling of this newly recognized capital gain. (Gary Ervin Dep. [DN 59-3] at pg. 25, 84:6-25;1 pg. 26, 85:1-25; 26, 86:1-25.) Gary Ervin, the brother in charge of handling most business and financial decisions, began discussing tax advantaged investments with David DiMuzio at BDOSeidman (hereinafter "BDO"), who offered to help Plaintiffs find a way to reduce or eliminate the taxes resulting from the sale of the company. (Def.'s Mem. Supp. Mot. Summ. J. [DN 59-1] at 3; Gary Ervin Dep. [DN 59-3] at pg. 27, 91:2-25.) With the help of BDO, Curtis Mallet (a tax law firm), and Sentinel Advisors (an investment banking firm), Plaintiffs entered into a series of transactions that form the basis of this action. (Gary Ervin Dep. [DN 59-3] at pg. 27, 95:9-25; pg. 27, 97:1-17.) Plaintiffs consulted their longtime advisors, Jesse Mountjoy (their tax attorney) and Martin McElroy (their tax accountant). (Gary Ervin Dep. [DN 59-3] at pg. 17, 50:10-18.) Though Mountjoy and McElroy were not responsible for structuring or implementing the transactions at issue, they advised Plaintiffs as to the legality and validity of the them. (Mountjoy Dep. [DN 59-3] at pg. 90, 21:4-23; McElroy Dep. [DN 59-3] at pg. 135, 43:13-25; pg. 135, 44:1-19.)
The precise nature of transactions are best described in Jade Trading, LLC ex rel. Ervin v. United States, 598 F.3d 1372, 1375-76 (Fed. Cir. 2010) [hereinafter Jade II], abrogated by United States v. Woods, 134 S. Ct. 557 (2013). Briefly, however, the transactions, referred to as spread transactions, involved each brother forming a limited liability corporation (LLC) which purchased and sold call options. Each LLC contributed the options it owned to a partnership formed by the LLC's that was named Jade. After two months, each LLC withdrew from the Jade partnership. On their individual tax returns for 1999, each brother claimed approximately fifteen million dollars in loss as a result the spread transactions and involvement in the Jade partnership. The tax loss resulted from each brother increasing the basis (outside basis) of his interest in the Jade partnership by the cost of the purchased call options and not decreasing this basis by the amount of the liability Jade assumed under the sold call options.
After an audit of the partnership return, the IRS issued a final partnership administrative adjustment ("FPAA") with respect to the 1999 tax year. The FPAA determined that the Jade partnership should be disregarded and it disallowed the deductions claimed for losses supposedly incurred from the contribution of the spread transactions to Jade. The losses claimed by Jade were disallowed and penalties were imposed.
After the IRS issued its final FPAA and imposed penalties on Jade, Jade filed a petition for readjustment of the partnership items in the Court of Federal Claims. Jade Trading, LLC v. United States, 80 Fed. Cl. 11, 43 (2007) [hereinafter Jade I], aff'd in part, vacated in part, rev'd in part sub nom. Jade II, 598 F.3d 1372. The Court of Federal Claims concluded that Jade had not met its burden of demonstrating that the contribution of the spread transactions objectively had economic substance and upheld the FPAA in disallowing the deductions claimed for losses. Jade I, 80 Fed. Cl. at 14. The court also upheld the valuation misstatement penalties which relied on the individual partner's outside bases. Id. at 60.2
On appeal, the Federal Circuit agreed that the spread transactions contributed to the Jade partnership lacked economic substance. However, at the urging of the Jade partnership, the Federal Circuit concluded that the trial court did not have jurisdiction to determine the applicability of the valuation misstatement penalty. The penalties were based on the partners' outside bases in the partnership. The Federal Circuit held that a partner's outside bases in the partnership was an affected item rather than a partnership item. Thus, it concluded that because 26 U.S.C. § 6226(f), only provides jurisdiction to the Court of Federal Claims to apply a penalty related to an adjustment of a partnership item, it had no jurisdiction to apply a penalty which wasrelated to the partner' outside bases. Jade II, 598 F.3d at 1376-80 (citing Petaluma FX Partners, LLC. v. Comm'r of Internal Revenue Serv., 591 F.3d 649 (D.C. Cir. 2010)). Therefore, the Federal Circuit remanded the action back to the Federal Court of Claims in order to determine whether any penalties could have been assessed without relying on the individual partners' outside bases. Id. at 1380.
On remand, the Federal Court of Claims concluded that no penalties could be assessed without relying on the individual partners' outside bases; and, since the Federal Circuit had concluded that the partners' outside bases were not partnership items that could be assessed for penalties in a partnership level proceeding, the court could not determine the applicability of any penalties. Jade Trading, LLC v. United States, 98 Fed. Cl. 453, 459-60 (2011) [hereinafter Jade III], aff'd sub nom. Jade Trading, LLC ex rel. Ervin v. United States, 451 F. App'x 954 (Fed. Cir. 2012) [hereinafter Jade IV]. Without issuing an opinion, the Federal Circuit affirmed the Jade III decision per curiam. Jade IV, 451 F. App'x at 955. Neither party sought further review of this decision.
Thereafter, the IRS issued two more protective assessments, and Plaintiffs filed this partner level suit in this Court, seeking a refund of taxes, penalties, and interest they have paid. Plaintiffs raise several claims related to the validity of the tax assessments and the applicability of the penalties, particularly raising the reasonable cause defense. However, Defendant asserts that all assessments were properly made and Plaintiffs are not entitled to a refund based on the reasonable cause defense. Both sides now seek summary judgment.
Before the Court may grant a motion for summary judgment, it must find that there is no genuine dispute as to any material fact and that the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(a). The moving party bears the initial burden of specifying the basis for its motion and identifying that portion of the record that demonstrates the absence of a genuine issue of material fact. Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986). Once the moving party satisfies this burden, the non-moving party thereafter must produce specific facts demonstrating a genuine issue of fact for trial. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247-48 (1986).
Although the Court must review the evidence in the light most favorable to the non-moving party, the non-moving party must do more than merely show that there is some "metaphysical doubt as to the material facts." Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574, 586 (1986). Instead, the Federal Rules of Civil Procedure require the non-moving party to present specific facts showing that a genuine factual issue exists by "citing to particular parts of materials in the record" or by "showing that the materials cited do not establish the absence . . . of a genuine dispute[.]" Fed. R. Civ. P. 56(c)(1). "The mere existence of a scintilla of evidence in support of the [non-moving party's] position will be insufficient; there must be evidence on which the jury could reasonably find for the [non-moving party]." Anderson, 477 U.S. at 252.
Here, the parties have both filed Motions for Summary Judgment based on the merits of the refund action. Plaintiffs argue that they are entitled to a refund of the tax and penalties paid because the assessments made by the IRS between 2004 and 2013 were invalid. Alternatively,Plaintiffs argue that the penalties are improper because they were never determined to be applicable by a court with proper jurisdiction. Defendant's Motion requests that the Court determine the Plaintiffs are liable for the valuation misstatement penalties and that the Plaintiffs' reasonable cause defense fails as a matter of law.
Plaintiffs bring this suit pursuant to 26 U.S.C. § 6230(c), which authorizes a claim for a refund by a taxpayer "on the grounds that . . . the Secretary erroneously imposed any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item." 26 U.S.C. § 6230(c)(1)(C). Plaintiffs argue that no court with proper jurisdiction has or can now determine that the gross valuation misstatement penalty applies and the IRS erroneously collected it in the first place; therefore, Plaintiffs are entitled to a refund of the penalty payments.
Plaintiffs' argument is made possible due to the United States Supreme Court's decision in United States v. Woods, 134 S. Ct. 557 (2013). After the Federal Circuit's decision in Jade, the Supreme Court reached the opposite conclusion and...
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