Gitlitz v. Comm'r of Internal Revenue

• Decision Date: 06 July 1999
• Docket Number: 98-9010,RESPONDENT-APPELLEE,PETITIONERS-APPELLANTS,Nos. 98-9009,s. 98-9009
• Citation: 182 F.3d 1143
• Parties: (10th Cir. 1999) DAVID A. GITLITZ; LOUISE A. GITLITZ,, v. COMMISSIONER OF INTERNAL REVENUE, and PHILIP D. WINN; ELEANOR G. WINN,, v. COMMISSIONER OF INTERNAL REVENUE,
• Court: U.S. Court of Appeals — Tenth Circuit

Page 1143

182 F.3d 1143 (10th Cir. 1999)

DAVID A. GITLITZ; LOUISE A. GITLITZ, PETITIONERS-APPELLANTS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT-APPELLEE and PHILIP D. WINN; ELEANOR G. WINN, PETITIONERS-APPELLANTS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT-APPELLEE.

Nos. 98-9009, 98-9010

U.S. Court of Appeals, Tenth Circuit

July 06, 1999

APPEALS FROM UNITED STATES TAX COURT (T.C. Nos. 5358-96 & 5359-96)

Darrell D. Hallett (John M. Colvin with him on the brief), of Chicoine & Hallett, P.S., Seattle, Washington, for the appellants.

Edward T. Perelmuter (Loretta C. Argrett, Assistant Attorney General, and Teresa E. McLaughlin with him on the brief), of the Tax Division, Department of Justice, Washington, D.C., for the appellee.

Before Tacha, Magill,^* and Briscoe, Circuit Judges.

Briscoe, Circuit Judge.

The Commissioner of Internal Revenue assessed tax deficiencies against David and Louise Gitlitz and Philip and Eleanor Winn after determining the taxpayers improperly utilized excluded discharge of indebtedness income to adjust their subchapter S corporate bases. The United States Tax Court upheld the Commissioner's deficiency determinations and taxpayers now appeal. We exercise jurisdiction pursuant to 26 U.S.C. § 7482(a)(1) and affirm.

I.

David Gitlitz and Philip Winn each owned a fifty-percent interest in PDW&A, Inc., a Colorado corporation that elected to be taxed under subchapter S of the Internal Revenue Code. PDW&A was a partner in Parker Properties Joint Venture, a real estate partnership. In 1991, Parker Properties realized $4,154,891 in discharge of indebtedness income; PDW&A's pro rata share was $2,021,296. At that time, PDW&A was insolvent to the extent of $2,181,748 and thus was excluded from tax liability for the discharged debt income. See 26 U.S.C. §§ 108(a)(1)(B), 108(d)(6).¹

Entering the 1991 tax year, both Gitlitz and Winn had suspended (i.e., unused) losses because each lacked sufficient basis in PDW&A to deduct losses in prior years. See 26 U.S.C. § 1366(d)(1)(A) (the "aggregate amount of losses and deductions taken into account by a shareholder under [§ 1366(a)] for any taxable year shall not exceed... the adjusted basis of the shareholder's stock in the S corporation"); 26 U.S.C. § 1366(d)(2) ("Any loss or deduction which is disallowed for any taxable year by reason of [§ 1366(d)(1)] shall be treated as incurred by the corporation in the succeeding taxable year with respect to that shareholder."). In 1991, Gitlitz and Winn each had additional losses from their association with PDW&A (i.e., pro rata shares of PDW&A's 1991 operating losses) which, when combined with their suspended losses, totaled $1,010,648.² Absent an increase in basis, Gitlitz and Winn would have had to treat these losses as suspended losses under § 1366(d)(1) because their bases in the corporation would have remained insufficient to permit contemporaneous recognition.

On their respective joint income tax returns for the relevant tax years, Gitlitz and Winn claimed increases in the bases of their PDW&A stock in the amount of their pro rata shares of the excluded discharge of indebtedness income.³ Gitlitz and Winn maintained the excluded discharged debt was an "item of income (including tax exempt income)," as that term is used in § 1366(a)(1)(A), thereby facilitating their basis increases pursuant to 26 U.S.C. § 1367(a)(1)(A). With the basis adjustments, the validity of which is at issue here, Gitlitz and Winn were able to claim the full amount of their pro rata share of PDW&A's ordinary losses.

The Commissioner determined the taxpayers could not use PDW&A's excluded discharge of indebtedness income to increase their bases in the corporation stock and denied the taxpayers' ordinary loss deductions. The taxpayers contested the deficiency determinations. The Tax Court initially issued a consolidated opinion in favor of the taxpayers, but later granted the Commissioner's motion for reconsideration. The court relied on its "reviewed decision" in Nelson v. Commissioner, 110 T.C. 114 (1998), and upheld the Commissioner's deficiency determinations, determining discharge of indebtedness income, which is excluded from gross income under § 108(a), does not pass through to shareholders of subchapter S corporations. Thus, the court concluded a subchapter S corporation's shareholder may not use the corporation's untaxed discharge of indebtedness income to increase the shareholder's adjusted basis of corporate stock.

II.

Decisions of the United States Tax Court are reviewed "in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury." 26 U.S.C. § 7482(a)(1). We review factual findings for clear error and legal Conclusions de novo. Schelble v. Commissioner, 130 F.3d 1388, 1391 (10th Cir. 1997). Because the only issue here is whether the law applied to the undisputed facts satisfies the relevant statutory standard, we review the Tax Court's decision de novo as we are equally competent to draw Conclusions from undisputed facts. Id. (citing Anderson v. Commissioner, 62 F.3d 1266, 1270 (10th Cir. 1995)).

III.

Before reaching the merits of taxpayers' arguments, we address their contention that the Commissioner waived in the Tax Court many of the arguments now asserted on appeal. The Commissioner made clear in its motion for reconsideration that, notwithstanding certain ambiguous comments of counsel during the summary judgment hearing, it did not intend to waive any arguments previously asserted in its summary judgment motion. The Tax court apparently accepted the Commissioner's clarification in the order granting reconsideration. Such a decision is committed to the lower court's sound discretion, see Elsken v. Network Multi-Family Sec. Corp., 49 F.3d 1470, 1476 (10th Cir. 1995), and we discern no abuse here. Further, "it is well-settled that a court is not bound by stipulations of the parties as to questions of law." Koch v. United States, 47 F.3d 1015, 1018 (10th Cir. 1995) (citations and internal alterations omitted). "[O]ur analysis, which may rest on any grounds for which there is a record sufficient to permit Conclusions of law, even grounds not relied on by the district court, is not constrained by the government's ill-considered concession." United States v. Furman, 112 F.3d 435, 438 n.2 (10th Cir. 1997) (citations omitted).

Subchapter S Corporations

Subchapter S of the Internal Revenue Code, 26 U.S.C. §§ 1361-1379, permits certain corporations to elect to be taxed in a similar, but not identical, fashion as partnerships. See 3 Boris I. Bittker and Lawrence Lokken, Federal Taxation of Income, Estates and Gifts ¶ 95.6.1 (2d ed. 1991) (highlighting major distinctions). A subchapter S corporation generally does not pay taxes as an entity. 26 U.S.C. § 1363(a). Instead, the corporation's profits and losses pass through directly to its shareholders on a pro rata basis and are then reported on the shareholders' individual tax returns. 26 U.S.C. § 1366(a). This conduit approach allows shareholders to avoid double taxation on corporate earnings. Tax integrity, meanwhile, is preserved by requiring shareholders to treat all income and deductions as if "realized directly from the source from which realized by the corporation, or incurred in the same manner as incurred by the corporation." 26 U.S.C. § 1366(b). In other words, "the items attain no greater dignity from being passed through the corporation." Boris I. Bittker and James S. Eustice, Federal Income Taxation of Corporations and Shareholders, ¶ 6.06[2][c] (6th ed. 1998).

To further prevent double taxation of subchapter S corporate income upon distribution to shareholders, § 1367(a) normally requires shareholders to adjust their corporate bases by the items identified in § 1366(a). In particular, basis must be increased by, inter alia, the items of income delineated in § 1366(a)(1)(A). Basis must be decreased by, inter alia, the items of loss and deduction set forth in § 1366(a)(1)(A), as well as corporate distributions previously excluded from shareholders' income pursuant to 26 U.S.C. § 1368(b). Section 1368(b) provides that distributions of a subchapter S corporation having no earnings and profits (as is the case with PDW&A) are treated as follows:

(1) Amount applied against basis. -- The distribution shall not be included in gross income to the extent that it does not exceed the adjusted basis of the stock.

(2) Amount in excess of basis. -- If the amount of the distribution exceeds the adjusted basis of the stock, such excess shall be treated as gain from the sale or exchange of property.

Two examples help explain how this statutory scheme operates. Assume the sole shareholder of a subchapter S corporation has a basis of $100 in the corporation's stock. The corporation realizes $200 in taxable income. At the end of the tax year, the shareholder pays tax on the $200 of income under the "pass through" principles described above. The corporation distributes the $200 to the shareholder the following year. In the absence of an upward basis adjustment, the shareholder would be liable for additional tax upon the distribution pursuant to § 1368(b)(2) because the amount of the distribution ($200) exceeds his pre-existing basis in the stock. Sections 1366 and 1367 prevent this double taxation by mandating a $200 basis increase when the corporation first realizes the income and a $200 basis decrease upon the corporation's distribution of the income.

A second example illustrates how the character of tax-exempt income is preserved under the subchapter S framework. Assume the same subchapter S corporation realizes $200 in tax-exempt income. Although a "pass through" technically occurs, the shareholder pays no tax on the income because, under § 1366(b), the income after "pass through" has the same character as if it was realized by the corporation. The corporation distributes the income to its shareholder...