Herrmann v. United States
| Decision Date | 23 October 2015 |
| Docket Number | No. 14-941T,14-941T |
| Parties | JEFFREY W. HERRMANN and MINA GEROWIN HERRMANN, Plaintiffs, v. UNITED STATES, Defendant. |
| Court | U.S. Claims Court |
Tax case; claim for refund of individual income taxes paid pursuant to a notice by the IRS of computational adjustments following an audit of a partnership return; submission by a non-tax matters partner of an administrative adjustment request ("AAR") on Form 8082; compliance with instructions attendant to Form 8082; effect of I.R.C. §§ 6227(d), 6228(b)(2)(A)(i), 7422(h), Treasury Reg. § 301.6227(d)-1; jurisdiction to address the partnership items raised in the AAR in this partner-level refund proceeding; claim of right to participate meaningfully in administrative proceeding relating to the determination of partnership items; I.R.C. § 6224(a)
Nathan E. Clukey, King & Spalding LLP, Washington, D.C. for plaintiffs. With Mr. Clukey on the briefs and at the hearing were Abraham N.M. Shashy, Jr. and Ariana Wallizada, King & Spalding LLP, Washington, D.C.
Matthew D. Lucey, Attorney, Tax Division, United States Department of Justice, Washington, D.C. for defendant. With Mr. Lucey on the briefs were Caroline D. Ciraolo, Acting Assistant Attorney General, Tax Division, and David I. Pincus, Chief, Court of Federal Claims Section, and G. Robson Stewart, Assistant Chief, Court of Federal Claims Section, Tax Division, United States Department of Justice, Washington, D.C.
At the heart of this case is a payment in the amount of $18,748,838 ("$18 million payment") to plaintiff Mina Gerowin Herrmann from her employer, Paulson Europe LLP ("PELLP"). PELLP ordered this payment to be issued on New Year's Eve in 2008, but Ms. Herrmann did not receive it until a few days later. Mr. and Ms. Herrmann were and are U.S. citizens resident in London, and they paid taxes on the $18 million payment to the United Kingdom in 2009 at a rate higher than that which was applicable in the U.S. In a subsequentaudit of PELLP, the Internal Revenue Service ("IRS" or "government") determined that this payment was a partnership distribution to Ms. Herrmann, and therefore it should have been reported as income on plaintiffs' U.S. federal tax return for 2008. The Herrmanns dispute this characterization of the payment, as well as the IRS's determination that they owed $7,860,434.87 in taxes and interest for the 2008 tax year, on grounds that raise complex issues of partnership taxation and U.S. tax credits for foreign taxes paid.
In Count One of their complaint, the Herrmanns assert that even if they were obligated to report the $18 million payment on their 2008 U.S. tax return, the IRS overcharged them by approximately $5.2 million because it failed to carry back a foreign tax credit to which they were entitled based on income taxes they paid to the United Kingdom in 2009. In Count Two, the Herrmanns contend that the $18 million payment was not a partnership distribution but a bonus paid to Ms. Herrmann in her capacity other than as a partner, and therefore the plaintiffs—as cash-basis taxpayers—did not need to report the payment until they received it in 2009. The Herrmanns claim in Count Three that the IRS improperly denied their request to adopt the accrual accounting method for the purposes of the foreign tax credit in 2008. Finally, in Count Four plaintiffs assert that during the audit of PELLP in 2011 and 2012, the IRS violated certain provisions of the Tax Equity and Fiscal Responsibility Act ("TEFRA"), Pub. L. No. 97-248, 96 Stat. 324 (1982) .
The government has moved to dismiss Counts Two and Four of the complaint under Rules 12(b)(1) and (6) of the Rules of the United States Court of Federal Claims ("RCFC") for lack of subject matter jurisdiction and for failure to state a claim. Def.'s Mot. for Partial Dismissal ("Def.'s Mot."), ECF No. 21. Relatedly, plaintiffs have moved under RCFC 12(f) to strike as insufficient defendant's affirmative defense that this court does not have subject matter jurisdiction over Count Two. Pls.' Mot. to Strike, ECF No. 19. Plaintiffs have also moved under RCFC 56(a) for summary judgment on Count One. Pls.' Mot. for Partial Summ. Judgment , ECF No. 20. These motions have been fully briefed and were addressed at a hearing held on October 7, 2015. The court concludes that defendant's motion to dismiss should be denied. The court has jurisdiction over Counts Two and Four under I.R.C. §§ 6228(b) and 7422(h) because plaintiffs are challenging the IRS's denial of a properly submitted administrative adjustment request ("AAR") and seeking de novo consideration of determinations made during an audit subject to TEFRA. This decision moots plaintiffs' motion to strike. The court has also concluded that plaintiffs' motion for partial summary judgment should be denied because the court must consider all claims related to the same tax year before issuing any final judgment respecting that tax year.
From 2005 to 2007, plaintiffs lived in New Rochelle, New York and Ms. Herrmann worked at Paulson & Co. Inc. ("Paulson & Co."), which is wholly controlled by John Paulson. Compl. ¶ 9. Her responsibilities included analyzing investment opportunities for various hedge funds sponsored by Paulson & Co. Compl. ¶ 9. Each year, Ms. Herrmann received from Paulson & Co. both a draw of $350,000 and a bonus, the latter of which was determined by John Paulson based on fees from certain hedge funds managed by the company. Compl. ¶ 10. Ms. Herrmann typically received the annual bonus in December. Compl. ¶ 11. The Herrmanns reported these bonuses and all other income on their U.S. federal tax returns for the years in which they were received, based on the "cash" accounting method. Compl. ¶ 11.
In mid-2007, Paulson & Co. asked Ms. Herrmann to move to London to work for its affiliate, PELLP, a U.K. limited liability partnership. Compl. ¶ 12. At the time, PELLP had one majority partner (Paulson Ltd., which was wholly owned by Paulson & Co.) and two individual minority partners. Compl. ¶¶ 12, 14; Def.'s Mot. at 2.2 Ms. Herrmann's responsibilities did not change substantially when she transferred to PELLP. Compl. ¶¶ 12, 17. On January 8, 2008, Ms. Herrmann joined PELLP as a member by signing a Deed of Adherence and contributing £30,000 to the partnership. Compl. ¶ 15, Def.'s Mot. Ex. 1 (Deed of Adherence).3
After her transfer, Ms. Herrmann received monthly draws from PELLP equivalent to the annual draw of $350,000 she had previously received from Paulson & Co. Compl. ¶¶ 13, 17; Def.'s Mot. at 3. On December 31, 2008, PELLP directed that a payment be made to Ms. Herrmann in the amount of £12,764,732 (equivalent to $18,748,838). Compl. ¶¶ 18-19; Def.'s Mot. at 3. Ms. Herrmann's bank received this payment on January 5, 2009, and it was credited to her account on January 6, 2009. Compl. ¶ 19; Answer ¶ 19.
The Herrmanns engaged Frank Hirth plc. ("Frank Hirth") for assistance in preparing their U.S. federal tax return for 2008. Compl. ¶¶ 22-23 & Ex. 6C, at HER-901 to -02.4 Plaintiffs did not receive a Schedule K-1 or equivalent partnership U.S. tax information from PELLP for the 2008 tax year. Compl. ¶ 23-24; Hr'g Tr. 9:3-11 (Oct. 7, 2015).5 As a result, plaintiffs reported the monthly draws Ms. Herrmann received from PELLP in 2008 on their U.S. tax return, but not the $18 million payment they received on January 6, 2009. Compl. ¶¶ 23, 25 & Ex. 6C, at HER-901 to -02, -912, -921 to -22, -940 to -42; Def.'s Mot. at 3.
The Herrmanns also engaged Frank Hirth to prepare their U.K. tax return for the U.K. tax year ending on April 5, 2008 ("2008 U.K. tax return"). Compl. ¶ 22. Plaintiffs filed their 2008 U.K. tax return on October 9, 2008, reporting Ms. Herrmann's income from PELLP during the relatively short period beginning January 15, 2008 and extending through March 31, 2008 in the amount of £106,382. Def.'s Mot. Ex. 5 (2008 U.K. Tax Return).6 For the U.K. 2008 tax year, Ms. Herrmann paid £177,704 ($270,289) in taxes to the U.K. Compl. Ex. 5, at HER-16 (Excerpts from IRS Claim Disallowance Letter). Based on this tax payment to the U.K., plaintiffs claimed a foreign tax credit of $87,871 on their original 2008 U.S. tax return. Compl. Ex. 5, at HER-17.
On December 19, 2009, plaintiffs filed their U.K. tax return for the U.K. tax year ending on April 5, 2009 ("2009 U.K. tax return"). Compl. ¶ 27 & Ex. 5, at HER-17; Answer ¶ 27. The2009 U.K. tax return included the $18 million payment from PELLP, and the Herrmanns paid £6,035,448.77 ($9,777,427) in taxes to the U.K. for the 2009 U.K. tax year, at a tax rate higher than the highest U.S. tax rate. Compl. ¶ 27 & Ex.5, at HER-17; Answer ¶ 27. Based on this payment of taxes to the U.K., plaintiffs claimed a foreign tax credit of $5,087,454 on their 2009 U.S. tax return. Compl. Ex. 5, at HER-17.
In the fall of 2010, the Herrmanns received a Schedule K-1 from PELLP for the 2009 U.S. tax year. Compl. ¶ 28. This Schedule K-1 did not include the $18 million payment that Ms. Herrmann received from PELLP in January 2009. Compl. ¶¶ 28-29. The Herrmanns subsequently filed their 2009 U.S. tax return, reporting Ms. Herrmann's 2009 income from PELLP as indicated on the Schedule K-1, but not the $18 million payment. Compl. ¶ 29.
In October 2011, the IRS began an administrative proceeding at the partnership level to audit PELLP. Compl. ¶ 30; Def.'s Mot. at 3 & Ex. 6, at 95 (Notice of Beginning of Administrative Proceeding). The IRS issued Ms. Herrmann a Notice of Beginning of Administrative Proceeding on October 17, 2011, identifying her as a partner in PELLP. Def.'s Mot. Ex. 6, at 95. The notice instructed Ms. Herrmann to contact PELLP's Tax Matters Partner if she would like to participate in the proceedings, and...
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