Federated Indus. Inc v. Reisin

• Decision Date: 05 May 2010
• Docket Number: No. 1-09-1487.,1-09-1487.
• Citation: 927 N.E.2d 1253,340 Ill.Dec. 242
• Parties: FEDERATED INDUSTRIES, INC., James L. Edelstein, Individually and as Trustee of the James L. Edelstein Revocable Trust U/A/D 817/80, the JLE Gift Trust, and the JLE Discretionary Trust, Joel Lee Edelstein, Individually and as Trustee of the Joel E. Support Trust and the Joel E. Discretionary Trust and Marcy Edelstein, Plaintiffs-Appellants,v.Richard A. REISIN and Ostrow Reisin Berk and Abrams, Ltd., Defendants-Appellees.
• Court: United States Appellate Court of Illinois

927 N.E.2d 1253

340 Ill.Dec. 242

FEDERATED INDUSTRIES, INC., James L. Edelstein, Individually and as Trustee of the James L. Edelstein Revocable Trust U/A/D 817/80, the JLE Gift Trust, and the JLE Discretionary Trust, Joel Lee Edelstein, Individually and as Trustee of the Joel E. Support Trust and the Joel E. Discretionary Trust and Marcy Edelstein, Plaintiffs-Appellants,v.Richard A. REISIN and Ostrow Reisin Berk and Abrams, Ltd., Defendants-Appellees.

No. 1-09-1487.

Appellate Court of Illinois,

First District, Third Division.

Opinion filed May 5, 2010.

Neal, Gerber & Eisenberg, LLP, of Chicago (Stephen Fedo and Patrick Frye, of counsel), for Appellants.

Cassidy & Schade, LLP, of Chicago (Julie A. Teuscher and Scott J. Brown, of counsel), for Appellees.

MODIFIED UPON REHEARING

Justice QUINN delivered the opinion of the court:

Plaintiffs filed an accountant malpractice action against defendants, Richard A. Reisin and Ostrow, Reisin, Berk & Abrams, Ltd. (ORBA), alleging that defendants negligently provided accounting services resulting in additional taxes and penalties to plaintiffs. The circuit court granted defendants' motion under section 2-619(a)(5) of the Code of Civil Procedure to dismiss (735 ILCS 5/2-619(a)(5) (West 2008)), finding that plaintiffs' lawsuit had not been filed within the applicable statute of limitations period. Plaintiffs appeal from that dismissal order. For the following reasons, we affirm.

I. BACKGROUND

Plaintiff, Federated Industries, Inc. (Federated), is a holding company which, since 1990, was classified as an “S-Corporation” for federal tax purposes. The remaining plaintiffs (the Edelsteins) are the direct and beneficial owners of Federated's stock. Since Federated is a subchapter S corporation, Federated's income is treated as income to the shareholders for federal tax purposes.

Defendants ORBA and its director, Richard A. Reisin, were hired by Federated to perform accounting and consulting services. Defendants prepared Federated's tax returns for calendar years 2002, 2003, and 2004. Defendants' responsibilities included aiding Federated in maintaining its tax status as a subchapter S corporation, including computation of Federated's “passive investment income,” as defined by the Internal Revenue Code, for each year. If defendants determined that Federated's passive investment income was likely to exceed 25% of Federated's “gross receipts” for the taxable year and, therefore, subject Federated to taxation on its yearly income, defendants were responsible for advising Federated to shift its investments to investments yielding nonpassive investment income. Defendants were to advise Federated in this manner because Federated's status as a subchapter S corporation would be terminated if Federated's passive investment income exceeded 25% of its gross receipts for three consecutive taxable years.

Defendants undercalculated Federated's passive investment income for three consecutive years (the 2002, 2003, and 2004 tax years) and did not advise Federated to shift investments so as to avoid passive investment income in excess of 25% of its gross receipts for each of these years. As a result, Federated's status as a subchapter S corporation was jeopardized where it had passive investment income in excess of 25% of its gross receipts for three consecutive taxable years.

On September 27, 2004, plaintiffs were notified by the Internal Revenue Service (IRS) that Federated's federal income tax return for the year 2002 had been selected for examination. On November 8, 2004, the IRS held its opening appointment with Federated and defendants at defendants' offices, relative to the examination of the year ending December 31, 2002. The purpose of the opening appointment was to discuss procedures concerning the IRS examination.

On February 28, 2005, the IRS issued a “Form 4764-Large Case Audit Plan,” which expanded the scope of its audit to cover the 2003 tax year. On March 9, 2005, the IRS issued a document request upon Federated for general information with respect to the 2003 tax year. On the same date, the IRS also issued a document request upon Federated, seeking information for the 2002 and 2003 tax years on the calculation of Federated's net passive income tax. On March 21, 2005, the IRS issued another document request upon Federated, requesting calculations for Federated's net passive income tax for the years 2000 and 2001.

On or about April 19, 2005, the IRS provided its initial conclusions about the 2002 and 2003 calendar-year audits of Federated. One of the issues raised by the IRS at that time was that Federated's passive income test failed for calendar years 2002 and 2003 and also for a third consecutive tax year, which could result in Federated's subchapter S corporation election being involuntarily terminated. On May 26, 2005, the IRS issued a “Form 4764-Large Case Audit Plan,” which confirmed several examination issues for the years 2002 and 2003, including passive income in excess of 25% of gross receipts and tax on that net passive income.

On July 15, 2005, Thomas Kosinski, a director at ORBA, authored a memorandum concerning the examination issues identified by the IRS in preparation for a meeting with plaintiffs' attorneys. Kosinski's memorandum included the IRS' conclusion that Federated's passive income was in excess of 25% of gross receipts for the tax years 2000, 2001, and 2002; and since the passive income test failed for three consecutive tax years, Federated's subchapter S corporation election should be terminated. The purpose of the meeting between defendants and plaintiffs' attorneys was to review the IRS examination issues and create a plan for future discussions with the IRS. The meeting took place on August 30, 3005, and the parties discussed the net passive income test and involuntary termination of Federated's subchapter S corporation election.

On September 15, 2005, the IRS issued “Form 5701-Notice of Proposed Adjustment” with respect to its examination issues. In this document, the IRS concluded that Federated had passive investment income in excess of 25% of gross receipts for the taxable years 2000, 2001, and 2002. The IRS advised that Federated's subchapter S corporation status would be terminated, effective January 1, 2003, based upon the IRS' finding that Federated had passive investment income in excess of 25% of gross receipts for three consecutive taxable years.

On October 18, 2005, Federated's attorneys met with the IRS and Thomas Kosinski from ORBA. During the meeting, the IRS presented a settlement proposal for the purpose of closing the Federated audit and to avoid the termination of Federate's subchapter S corporation status. The settlement proposal and issues discussed during the meeting were communicated to plaintiffs on October 19, 2005. In an affidavit, Kosinski stated that, based on meetings with the IRS, he prepared “a summary of proposed audit adjustments to provide to the [IRS] consistent with Federated Industries, Inc.'s agreement to these adjustments.” Kosinski attested, “As part of this process, the [IRS] requested the full agreement of all shareholders of Federated Industries, Inc. to consent to the proposed adjustments for calendar years 2002 and 2003.” Kosinski further attested that he “he prepared a letter to the [IRS] dated December 27, 2005, which set forth the summary of these audit adjustments.”

Pursuant to this letter, dated December 27, 2005, “Federated and its shareholders * * * unanimously consented” to the IRS' proposed audit adjustments, including accepting a passive income tax for calendar year 2002 in exchange for the subchapter S corporation election not to be terminated for that year. Federated also elected to distribute its remaining earnings and profits with respect to calendar year 2003 ($60,887,937) in exchange for Federated's subchapter S corporation election not being terminated after the 2003 tax year. Federated also acknowledged that the IRS could perform a “limited scope” examination of Federated's 2004 tax return, limited to the issues raised in the 2002 and 2003 examinations.

On April 25, 2006, the IRS issued a letter to Federated enclosing its examination report and the proposed adjustments to Federated's federal income tax for calendar years 2002 and 2003. The IRS indicated that it would send separate examination reports to each partner, shareholder, beneficiary, or grantor of Federated. In this letter, the IRS requested that, “If our findings are acceptable, please sign and return the enclosed acceptance form.”

On May 17, 2006, Federated's representatives returned to the IRS the acceptance of the adjustments proposed in the IRS' examination report. Federated also issued a check, dated May 12, 2006, to the United States Treasury in the amount of $140,816 in payment of the excess net passive income tax for the 2002 taxable year in the amount of $119,349, and interest in the amount of $21,467.

On May 15, 2008, plaintiffs filed a two-count complaint, which was subsequently amended. Count I alleged accountant malpractice and count II alleged breach of an unwritten contract. Both counts were premised on defendants' alleged miscalculation of Federated's passive investment income for the years 2002, 2003, and 2004. Plaintiffs alleged that as a result of defendants' miscalculation, plaintiffs were required to pay a total in excess of $14 million in additional taxes, interest and penalties.

Defendants filed a motion to dismiss plaintiffs' complaint pursuant to section 2-619(a)(5) (735 ILCS 5/2-619(a)(5) (West 2008)), asserting that plaintiffs' complaint was filed beyond the applicable statute of limitations for accounting malpractice actions (735 ILCS 5/13-214.2(a) (West 2008)). On December 16, 2008, the circuit court entered an order denying defendants' motion to dismiss and defendants filed a motion to reconsider. On May 11, 2009, the circuit court entered an order granting defendants' motion to...