Gonzalez v. U.S.A
| Decision Date | 04 March 2011 |
| Docket Number | Dkts. 90, 92,Case No: C 08-3189 SBA |
| Parties | TOM GONZALEZ, as Personal Representative for the Estate of Thomas J. Gonzales, II, Plaintiff, v. UNITED STATES OF AMERICA, the DEPARTMENT OF TREASURY by its agency, the INTERNAL REVENUE SERVICE, Defendant. |
| Court | U.S. District Court — Northern District of California |
Plaintiff Tom Gonzalez ("Plaintiff), the personal representative for the estate of taxpayer Thomas J. Gonzales, II ("Taxpayer"), deceased, brings this suit for a refund of allegedly illegally-assessed Federal personal income taxes that Plaintiff (Taxpayer's father) paid in response to Defendant Internal Revenue Service's ("Defendant" or "IRS") Notice of Deficiency for the tax years ending December 31, 2000 and December 31, 2001.
The parties are presently before the Court on Defendant's Motion for Summary Judgment and Plaintiff s Motion for Partial Summary Judgment. Dkts. 90, 92. Having read and considered the papers filed in connection with these matters and being fully informed, the Court hereby GRANTS Defendant's Motion for Summary Judgment and DENIES Plaintiff's Motion for Partial Summary Judgment for reasons set forth below. The Court, in its discretion, finds these matters suitable for resolution without oral argument. See Fed.R.Civ.P. 78(b).
The principal issue in this case involves the tax consequences of a financial transaction undertaken by Taxpayer, which Plaintiff alleges resulted in a short-term capital loss to Taxpayer in the amount of $142,002,000 for the year 2000.
During the 2000 tax year, Taxpayer sold a large number of shares in his Commerce One stock resulting in a long-term capital gain of $132,521,496. Dkt. 90-3, Hendon Decl. Exs. 1 (Schedule D, Part II) & 15 (Smith Dep. Tr.) at 39:9-19. In September or October 2000, Taxpayer and his accountant, Steve Smith, met with John Larson, at Smith's suggestion. Id., Ex. 15 at 43:3-23. Larson was a founder of a number of related entities collectively referred to as "Presidio." Id. at 45:4-46:24. When Smith and Taxpayer first met with Larson, Larson told them that he did not have anything that would "work" for Taxpayer because it was too late in the year. Id. at 43:3-18.
Smith then learned of a tax shelter that was being sold by Ernst & Young known as The Personal Income Company or Personal Investment Corporation ("PICO"). Id. at 37:12-39:19; 43:3-23. PICO was designed primarily to defer the payment of taxes. Id. at 38:4-22. Smith recommended Taxpayer to Ernst & Young regarding PICO after Taxpayer was "rebuffed" by Larson. Id. at 43:3-18. Taxpayer was interested in participating in PICO because he wanted to see whether it would help out his "tax position." Id. at 39:15-19. Although Taxpayer was unhappy with some of the restrictions required in order to participate in PICO, he eventually entered into the PICO transaction. Id. at 39:20-40:24.
After Taxpayer entered into PICO, Smith received a telephone call from Larson, in December 2000, informing him that Larson had a "unique opportunity" for Taxpayer. Id. at 42:7-18. The "unique opportunity" was the transaction at issue in this case involving the acquisition of United States Treasury Bonds and the subsequent exchange of the interest in those bonds for preferred shares of stock in a Cayman Islands hedge fund, Bayside Diversification Fund, Ltd. ("Bayside"). Id. at 42:22-45:25. After Larson's call, Taxpayer ceased any further activity with respect to PICO and entered into the transaction at issue. Id. at 40:10-24; 54:1-25.
The Court next describes the details of that transaction.
One of Taxpayer's strategies was a leveraged investment in high-interest U. S. Treasury Bonds that were originally issued in 1985. Dkt. 92, Plf.'s Mtn. at 2. On December 8, 2000, investment company Blackvest Finance, LLC ("Blackvest"), an investment company wholly owned by Presidio, purchased from Deutsche Bank Securities, Inc. ("Deutsche Bank") such U.S. Treasury Bonds. Dkt. 92-2, Lemons Decl. ¶ 5. The Bonds had a face amount of $233,000,000. Id. The Bonds are 30-year U.S. Treasury Bonds, which pay coupon interest semi-annually at an above-market rate of 11.25%. Id. Due to the high interest rate, the fair market value of the bonds exceeded their face value. Id. Blackvest paid Deutsche Bank $368.5 million for the Bonds. Hendon Decl. Ex. 5 at TJG000119-122.
Blackvest's purchase of the Bonds was through a buy/sell repurchase transaction, also known as a "buy/sell repo" transaction. Lemons Decl. ¶ 5. This is a financial transaction in which securities are purchased subject to the purchaser's agreement, for valuable consideration paid to the seller, to sell them back to the seller at a future date. Dkt. 92-2, Schainbaum Decl. Ex. 26 (Doree Dep. Tr.) at 41-43; Lemons Decl. ¶ 5. The repo loan agreement between Blackvest and Deutsche Bank carried an interest rate of 6.5% and matured on January 8, 2001. Hendon Decl. Ex. 6.
Shortly after the Bond sale from Deutsche Bank to Blackvest, Blackvest and Deutsche Bank entered into an "interest swap transaction" with respect to the Bonds. Lemons Decl. ¶ 5. Pursuant to that transaction, Blackvest exchanged the fixed coupon U.S. Treasury Bond interest payments it received pursuant to its ownership of the Bonds for bi-annual interest payments based on a floating interest rate, which was determined by open market forces. Id.
On December 8, 2000, Blackvest sold its interest in the Bonds to Taxpayer. Id. Pursuant to that sale, Taxpayer contributed cash of $9,787,500 and received $233,000,000 in face value of the Bonds, valued at $372,800,000, financed with a nonrecourse "premium Note" ("Note").1 Dkt. 92-2, Miller Decl. ¶ 4. The Note to Blackvest carried principal of $226,883,000 at a fixed interest rate of 11.25% and a "premium" of $136,129,500. Id. Therefore, the total financing provided by Taxpayer was $363,012,500 (which is equal to the sum of $226,883,000 and $136,129,500). Id. In other words, the purchase of $372,800,000 of Bonds was made with $9,787,500 in cash and $363,012,500 in financing. Id.
The Note was an interest only loan-no principal was to be paid until maturity of the Note on February 15, 2015. Id. ¶ 5. The Note contained a prepayment provision that allowed Taxpayer to repay the obligation before the maturity date, at a price determined in accordance with a formula described in the Note, and after paying a breakage fee and accrued interest on the Note. Hendon Decl. Ex. 7. The prepayment formula was based on changing market interest rates, and may have been either greater or less than the premium amount. Miller Decl. ¶5.
Moreover, the Note was secured by the Bonds, which were pledged by Taxpayer as collateral, as well as Taxpayer's obligation to maintain a certain minimum value of the collateral. Hendon Decl. Ex. 8 at TJG000139.
On December 28, 2000, Taxpayer exchanged his interest in the Bonds for shares of preferred stock valued at $3,915,000 in Bayside, and the assumption of the Note by Bayside. Hendon Decl. Ex. 9. It was this exchange that triggered Taxpayer's claimed tax loss of $142,002,000. Bayside prepaid the Note and sold its interest in the Bonds back to Blackvest on January 8, 2001. Id. Ex. 10. On July 13, 2001, the preferred stock paid a dividend of $169,911to Taxpayer. Id. Ex. 12. On November 28, 2001, Taxpayer sold the preferred stock back to Bayside. Id. Ex. 13.2
On or about April 15, 2001, Taxpayer filed a Form 1040 2000 U.S. Individual Income Tax Return, on which he reported a short-term capital loss deduction of $142,002,000 from the sale of "Blackvest Bonds." Dkt. 92-2, Smith Decl. ¶ 11. On or about April 15, 2002, Taxpayer filed a Form 1040 2001 U.S. Individual Income Tax Return, on which he reported a net operating loss of $8,609,628. Id. ¶ 12.
On December 6, 2006, Defendant issued to Plaintiff, as the personal representative for Taxpayer's estate, a Notice of Deficiency asserting an income tax deficiency of $26,231,835 (exclusive of interest) and an accuracy-related penalty under 26 U.S.C. § 6662(a) of $5,246,367 for the tax year 2000. Id. ¶ 13; First Amended Complaint ("FAC") ¶14. The Notice of Deficiency also claimed a $2,130,142 decrease in Taxpayer's net tax loss for the tax year 2001, arising from disallowed itemized deductions and a disallowed deduction for a refund of State Income Tax. Smith Decl. ¶¶ 14-15; FAC ¶ 14. On April 13, 2007, Plaintiff paid $31,478,202 to Defendant under protest for the tax deficiency and related penalty. FAC ¶ 7.
On August 17, 2007, Plaintiff filed tax refund claims for overpayment of income taxes for tax years 2000 and 2001, which asserted, inter alia, that the capital loss generated by the Bond Purchase Agreement and Bayside Transaction (collectively, "the Transaction") is an allowable deduction. FAC ¶ 8. On June 11, 2008, Defendant "partially disallowed" Plaintiff's refund claims. FAC, Ex. 2.
Plaintiff filed this action on July 2, 2008. In his FAC, filed on March 19, 2009, Plaintiff contests the validity of the Notice of Deficiency and alleges the following errors: (1) it is error for Defendant to disallow a capital loss of $142,002,000 for the tax year 2000; (2) it is error for Defendant not to allow Taxpayer to carry back net operating ordinary losses from 2001 in the amount of $8,757,573, and to carry forward such remaining losses to each succeeding year until such tax benefit has been exhausted; (3) it is error for Defendant to disallow Taxpayer's claimed deductions with respect to his sale of stock in Xing Mail, Swing Solutions, and "Auto Parts, Etc." for the tax year 2000; (4) it is error for Defendant to disallow itemized deductions in the amount of $1,986,639 for the tax years 2000 and 2001; (5)...
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