Hamilton v. Comm'r of Internal Revenue

• Decision Date: 07 April 2020
• Docket Number: No. 19-9000,19-9000
• Citation: 955 F.3d 1169
• Parties: Vincent C. HAMILTON and Stephanie Hamilton, Petitioners - Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent - Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

955 F.3d 1169

Vincent C. HAMILTON and Stephanie Hamilton, Petitioners - Appellants,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent - Appellee.

No. 19-9000

United States Court of Appeals, Tenth Circuit.

FILED April 7, 2020

Paul W. Jones, Hale & Wood, LLP, Salt Lake City, Utah, for Appellants.

Julie Ciamporcero Avetta, Attorney, Tax Division (Richard E. Zuckerman, Principal Deputy Assistant Attorney General, and Francesca Ugolini, Attorney, Tax Division, with her on the brief), Department of Justice, Washington, D.C., for Appellee.

Before TYMKOVICH, Chief Judge, MATHESON and McHUGH, Circuit Judges.

TYMKOVICH, Chief Judge.

The Internal Revenue Code permits taxpayers who demonstrate insolvency to exclude discharged debts from their taxable income. Claiming insolvency, taxpayer Vincent Hamilton accordingly sought to exclude nearly $160,000 in student loans that were forgiven in the aftermath of a disabling injury. During the same tax year, however, he had received a non-taxable partnership distribution worth more than $300,000.

His wife transferred those funds into a previously-unused savings account held nominally by their adult son. Using login credentials provided by their son, Mrs. Hamilton incrementally transferred almost $120,000 back to the joint checking account she shared with her husband. The Hamiltons used these funds to support their living expenses.

In a late-filed joint tax return, they excluded the discharged student-loan debt on the theory that Mr. Hamilton was insolvent. In calculating his assets and liabilities, however, the Hamiltons did not include the funds transferred into the savings account. Had they done so, Mr. Hamilton would not have met the criteria for insolvency; and the couple would have owed federal income tax on the student-loan discharge.

The Commissioner of Internal Revenue eventually filed a Notice of Deficiency, reasoning that the partnership distribution rendered Mr. Hamilton solvent, such that the Hamiltons were required to pay income tax on the cancelled debt. The Hamiltons petitioned for review from the Tax Court, which sustained both the deficiency and a significant late-filing penalty. They timely appealed.

We AFFIRM. The Tax Court correctly concluded that the Hamiltons exercised effective control over the funds Mrs. Hamilton had transferred into the savings account.

I. Background

Prior to his disabling back injury in 2008, Mr. Hamilton borrowed more than $150,000 to pay costs associated with medical school for his son. Mrs. Hamilton, who managed the family’s finances in the aftermath of his injury, subsequently sought to discharge these student-loan obligations. Her efforts met with success, and these loans were fully discharged in 2011.

That same year, Mr. Hamilton received a non-taxable distribution worth more than $300,000 from his partnership interest in a movie-theater business. Mrs. Hamilton transferred these funds into a previously-unused savings account held by their son, who then provided her with login credentials for the account.¹ Throughout Tax Year 2011, she withdrew nearly $120,000 to finance household expenses for both parents.

The Hamiltons did not file a federal return for Tax Year 2011 until March 2014. Filing jointly, they reported just over $850,000 in liabilities and just under $680,000 in assets. But these figures made no mention of the funds that Mrs. Hamilton had moved into the savings account. One consequence of this omission now stands out as particularly important. Mr. Hamilton self-identified as insolvent, because—using these numbers—his liabilities exceeded his assets by roughly $170,000.² For this reason, the Hamiltons sought to pay no federal income tax on the discharged debt.

If they had included the partnership distribution as an asset for purposes of the insolvency determination, then Mr. Hamilton’s assets (around $1,000,000, under this new math) would have outnumbered his liabilities (still $850,000) by roughly $150,000. Obviously, this calculus would deprive Mr. Hamilton of his rationale for not paying federal income tax on the cancelled debt.

The Commissioner of Internal Revenue eventually filed a Notice of Deficiency, reasoning that—because, in light of the funds contained within the savings account, Mr. Hamilton’s assets outnumbered his liabilities—the couple could not exclude the discharged debt from their federal tax return. The Hamiltons disagreed, eventually taking the position that the funds Mrs. Hamilton transferred into the savings account should be considered their son’s assets, rather than their own.

The Hamiltons petitioned for review from the Tax Court, which—on the basis of this same stipulated record—applied the doctrine of "substance over form" to sustain the Notice of Deficiency. The Tax Court also sustained the late-filing penalties. On appeal, the Hamiltons primarily argue the Tax Court erred in characterizing the funds transferred into the savings account as their assets.

II. Analysis

We review decisions of the Tax Court in the same manner as civil actions tried without a jury. Petersen v. Comm’r , 924 F.3d 1111, 1114 (10th Cir. 2019) (citing Katz v. Comm’r , 335 F.3d 1121, 1125–26 (10th Cir. 2003) ); see also 26 U.S.C. § 7482(a)(1). We accordingly review legal conclusions de novo and factual determinations only for clear error.³ Id . (citing same).

A. Characterization of Assets

The Hamiltons contend the Tax Court erred in characterizing the funds contained within the savings account as their assets for purposes of the insolvency inquiry. As our application of governing law to these stipulated facts will demonstrate, we disagree.

1. Governing Law

The Internal Revenue Code broadly defines gross income to encompass "all income from whatever source derived," including income from the discharge of indebtedness. 26 U.S.C. § 61(a)(11). But a narrow statutory exception permits taxpayers to exclude debt from discharged income, so long as the discharge occurs at a time when the taxpayer is insolvent. 26 U.S.C. § 108(a)(1)(B).

This exception acknowledges the reality that insolvent taxpayers will realize no income from discharge because—as a practical matter—no assets become available to the taxpayer. See United States v. Kirby Lumber Co. , 284 U.S. 1, 52 S.Ct. 4, 76 L.Ed. 131 (1931). For this reason, the Code also limits the exclusion of discharge-of-indebtedness income to the amount by which the taxpayer’s liabilities exceed his assets. See 26 U.S.C. § 108(a)(3) ; see also Carlson v. Comm’r , 116 T.C. 87, 91 (2001) ("[T]he term ‘insolvent’ means the excess of liabilities over the fair market value of assets.") (quoting 26 U.S.C. § 108(d)(3) ).

It is well-settled that the taxpayer bears the burden of demonstrating that his liabilities outnumber his assets. E.g. , Shepherd v. Comm’r , 104 T.C.M. (CCH) 108 (2012) (citations omitted). Although the Code does not expressly define the term "assets," the Tax Court has, for these purposes, construed it to include any resource that "can give the taxpayer the ability to pay an immediate tax on income from the canceled debt." Schieber v. Comm’r , 113 T.C.M. (CCH) 1144 (2017) (internal quotation marks omitted) (quoting Carlson , 116 T.C. at 104–05 (observing that even assets beyond the reach of other creditors could constitute assets for the purposes of 26 U.S.C. § 108(d)(3) )).

In conducting this practical inquiry, the Internal Revenue Service may appropriately prioritize "substance over form." E.g. , Frank Lyon Co. v. United States , 435 U.S. 561, 572–73, 98 S.Ct. 1291, 55 L.Ed.2d 550 (1978) (citations omitted). In cases where, as here, a "transferor continues to retain significant control over the property transferred," the Service may set aside niceties like formal title. Id . Indeed, we have repeatedly ratified the propriety of prioritizing economic reality in place of the formal characterizations taxpayers may lend transactions. See Rogers v. United States , 281 F.3d 1108, 1116–17 (10th Cir. 2002) ("[T]he doctrine of substance over form has been recognized in a number of our precedents.").

2. Application

The Tax Court appropriately applied the substance-over-form doctrine to characterize the disputed funds as the Hamiltons’ assets for purposes of the insolvency calculation required by 26 U.S.C. § 108. Given the evidence disclosed by the stipulated record, the Tax Court properly concluded they exercised effective ongoing control over these funds.

Prior to the transfer, the record suggests their son used this savings account rarely, if at all. No evidence indicates the transfer represented a gift.⁴ Nor did their son pay any consideration in exchange for these funds. Moreover, he immediately provided Mrs. Hamilton with login credentials so that she could access these funds whenever she wanted. During Tax Year 2011, she withdrew nearly $120,000 to cover living expenses.⁵ Their son, by contrast, never withdrew any of these funds.

Although the Hamiltons now contend he could have changed the login credentials so as to lock out his mother, we think it more significant that he never did so. See, e.g. , Sanford’s Estate v. Comm’r , 308 U.S. 39, 43, 60 S.Ct. 51, 84 L.Ed. 20 (1939) ("[T]he essence of a transfer is the passage of control over the economic benefits of the property rather than any technical changes in its title."). Because the Hamiltons retained effective control over the disputed funds, we conclude the Tax Court did not err.

The Hamiltons also contend that—under Utah law—their son was the sole owner of the savings account.⁶ But this argument bears not at all on the substance-over-form inquiry. See Carlson , 116 T.C. at 104–05 (observing that assets beyond the reach of other creditors may nonetheless constitute assets for federal tax purposes). This is because "taxation is not so much concerned with the refinements of title as it is with the actual command over the property taxed." See Sanford's , 308 U.S. at 43, 60 S.Ct. 51 (internal quotation marks and citations omitted).

The Hamiltons...