Hudspeth v. C.I.R.
| Decision Date | 13 September 1990 |
| Docket Number | No. 88-7040,88-7040 |
| Citation | 914 F.2d 1207 |
| Parties | -5582, 90-2 USTC P 50,501, 31 Fed. R. Evid. Serv. 187 Fred E. HUDSPETH, et al., Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Respondent-Appellee. |
| Court | U.S. Court of Appeals — Ninth Circuit |
Clarence H. Greenwood, Rappleyea, Beck, Helterline & Roskie, Portland, Oregon, for petitioners-appellants.
Gary R. Allen, Atty., Tax Div., U.S. Dept. of Justice, Washington, D.C., for respondent-appellee.
Appeal from a Decision of the United States Tax Court.
Before BROWNING and ALARCON, Circuit Judges, and TEVRIZIAN, District Judge. *
PRELIMINARY STATEMENT
This case presents questions concerning the proper interpretation of the tax benefit rule and Federal Rule of Evidence 408. We hold that the tax court properly construed the tax benefit rule. However, the tax court erroneously excluded certain evidence that should have been admitted under the bias exception to Federal Rule of Evidence 408.
The appellants are shareholders of Hudspeth Pine, Inc., which, during the period relevant to the present case, was a validly electing Subchapter S corporation pursuant to Subchapter S of the Internal Revenue Code. I.R.C. Sec. 1361 et seq.
At all relevant times, taxpayers/appellants John and Floreine Hudspeth owned 75% of the stock and bonds issued by Hudspeth Pine, Inc.; taxpayers/appellants Fred and Margaret Hudspeth owned the remaining 25% of the stock and bonds issued by Hudspeth Pine. (Hereinafter, appellants will be referred to collectively as "Taxpayers.")
In 1966, the Taxpayers' basis in their Hudspeth Pine stock and bonds were as follows:
Basis in Stock Basis in Bonds
John and Floreine Hudspeth $439,634.04 $217,262.83
Fred and Margaret Hudspeth 146,544.68 88,420.77
----------
In the 1967 tax year, Hudspeth Pine suffered a tax loss of $613,683.45. Taxpayers John and Floreine Hudspeth's pro rata share of this 1967 Hudspeth Pine loss was $460,262.59. Taxpayers Fred and Margaret Hudspeth's pro rata share of the Hudspeth Pine loss was $153,420.86. The Taxpayers claimed deductions for their respective shares of the Hudspeth Pine loss on their individual 1967 tax returns. Apparently, neither John and Floreine Hudspeth nor Fred and Margaret Hudspeth received a tax benefit for the full amount of their pro rata share of the loss. 1
In 1973, the Hudspeth bonds were redeemed. The present dispute involves the issue of whether an adjustment should be made to the Taxpayers' basis in the stock and bonds on account of the 1967 loss. Any basis adjustments will affect the tax treatment of the bond redemption to the individual taxpayers.
There is also a dispute as to the Taxpayers' liability for the tax years ending May 31, 1973 and May 31, 1974. During Hudspeth Pine's 1973 and 1974 tax years, Hudspeth Pine was engaged in the manufacture of lumber and related products. Prior to and during the taxable years at issue During the taxable year ended May 31, 1973, Hudspeth Pine harvested timber which qualified for treatment under I.R.C. Sec. 631(a). Hudspeth Pine harvested 26,602.28 MBF 2 of pine and 12,139.20 MBF of fir which qualified for capital gain treatment under I.R.C. Sec. 631(a).
Hudspeth Pine had made an I.R.C. Sec. 631(a) election which required that the fair market value of lumber harvested in the taxable year be determined as of the first day of the taxable year.
The Taxpayers and the Commissioner of the Internal Revenue Service (hereinafter "Commissioner") dispute the fair market value of the pine and fir. The Taxpayers claim that the fair market value of the pine and fir is substantially higher than the Commissioner's valuation. The Taxpayers desire a higher valuation in order to take advantage of the more favorable capital gain tax rates.
During the taxable year ended May 31, 1974, Hudspeth Pine harvested 29,312.79 MBF of pine and 12,296.18 MBF of fir which qualified for capital gain treatment under I.R.C. Sec. 631(a). The Taxpayers and the Commissioner also dispute the fair market value of the fir and pine for this taxable year; the Taxpayers claimed a higher value for the pine and fir than the Commissioner.
The Commissioner issued a notice of deficiency to Fred and Margaret Hudspeth asserting a deficiency in their individual joint income tax for the 1973 tax year. The Taxpayers filed a timely petition in the tax court contesting this deficiency.
The Commissioner also issued notices of deficiency to Taxpayers John and Floreine Hudspeth which asserted deficiencies in their individual joint income tax for the 1973, 1974, and 1975 tax years. John and Floreine Hudspeth filed timely petitions in the tax court contesting each deficiency notice.
In connection with the Taxpayers' preparation for trial before the tax court, the Taxpayers retained an expert in the valuation of standing timber, Mr. Gail Thomas. Mr. Thomas submitted a report to the tax court which valued the timber in question.
In preparing the report, Mr. Thomas relied upon information that he possessed which concerned the valuation of standing timber for another taxpayer. Pine Products Corporation (hereinafter "Pine Products"). Mr. Thomas previously had been retained by Pine Products in connection with a dispute over the valuation of timber between Pine Products and the Commissioner. That case was eventually settled with no deficiency assessment against Pine Products. The final settlement contained substantially higher pine and fir values than those asserted by the Service in the Taxpayers' case.
Prior to trial, the Commissioner moved for the exclusion of the Pine Products valuation data that Mr. Thomas had used. Counsel for the Taxpayers opposed that motion. The tax court granted the Commissioner's motion to exclude the valuation data from the trial on May 14, 1984.
The Taxpayers' case was tried on May 15 to 16, 1984. The tax court issued its formal written decision on December 30, 1985. The tax court upheld the position of the Commissioner with regard to the basis adjustment issue. It also decided the timber valuation issue in the Commissioner's favor. The decision of the tax court was entered on September 30, 1987, after tax court Rule 155 calculations were completed.
The Taxpayers mailed a notice of appeal on December 28, 1987. The notice was filed timely on December 30, 1987. See I.R.C. Secs. 7483, 7502. 3
One of the controversies in this case stems from a dispute over whether the Taxpayers were required to adjust their basis in their Hudspeth Pine stock and bonds pursuant to I.R.C. Sec. 1376.
During the years relevant to this case, the Taxpayers were the sole shareholders of Hudspeth Pine. From 1962 until the fiscal year ended May 31, 1975, Hudspeth Pine was a validly electing small business corporation subject to the provisions of Subchapter S of the Internal Revenue Code.
Corporations which elect to be treated as small business corporations under the provisions of Subchapter S receive tax treatment that is similar to that of partnerships. Shareholders of a Subchapter S corporation are required to include their respective pro rata shares of the undistributed taxable income of the corporation as part of their gross income on their individual income tax returns. I.R.C. Sec. 1373. In addition, shareholders in a Subchapter S corporation can deduct their pro rata share of any net operating loss of the corporation on their individual tax returns. I.R.C. Sec. 1374.
Consistent with the tax treatment contained in I.R.C. Sec. 1373 and I.R.C. Sec. 1374, I.R.C. Sec. 1376 provided that a shareholder had to make certain adjustments to the shareholder's basis in his or her stock and bonds in order to reflect the pass through of corporate profits and losses. Under I.R.C. Sec. 1376(a), the basis of the shareholder's stock was increased by the amount of any undistributed corporate income which the shareholder was required to recognize as income pursuant to I.R.C. Sec. 1373(b). Conversely, I.R.C. Sec. 1376(b)(1) provided that if a net operating loss was passed through to a shareholder, the net operating loss would reduce the basis of the shareholder's stock (but not below zero). Additionally, if the loss exceeded the basis of the stock, any excess loss was applied to reduce the basis (but not below zero) of any corporate indebtedness held by the shareholder. I.R.C. Sec. 1376(b)(2).
The purpose of Sec. 1376(a) was to prevent a double taxation of income. If there was no basis adjustment, the taxpayer would be liable for tax on the pro rata share of income of the corporation and would also be liable for tax upon gain from a sale of the stock, to the extent that earnings and profits were not distributed to the taxpayer.
I.R.C. Sec. 1376(b) is intended to prevent a double deduction. In the case of a loss, the taxpayer is entitled to deduct the net operating loss on his or her tax return. If Sec. 1376(b) were not present, the taxpayer could also have deducted a capital loss on the sale of any stock because such loss would not be incorporated into the basis of the stock; rather it would have been incorporated into the market value of the stock. 5
In the present case, I.R.C. Sec. 1376 required the Taxpayers to reduce the basis of their stock and bonds in the amount of their pro rata share of the net operating loss. In the case of John and Floreine Hudspeth, they had a 1966 basis of $439,634.00 in their Hudspeth Pine stock and a 1966 basis of $217,263.00 in their Hudspeth Pine bond. Under I.R.C. Sec. 1376, their basis in the stock would be reduced to zero and the remaining loss of $20,629.00 would be applied to reduce their basis in the bond.
In the case of Fred and Margaret Hudspeth, these appellants had a 1966 basis in their stock of $146,545.00 and a 1966 basis in their bond of $88,421.00. Under ...
To continue reading
Request your trial
-
Moroccanoil, Inc. v. Marc Anthony Cosmetics, Inc.
...the validity or amount of a disputed claim or to impeach by a prior inconsistent statement or a contradiction.” See Hudspeth v. C.I.R., 914 F.2d 1207, 1213 (9th Cir.1990) (“Rule 408 does apply to situations where the party seeking to introduce evidence of a compromise was not involved in th......
-
Bowers v. National Collegiate Athletic Ass'n
...party whether or not the party seeking to introduce the evidence was party to the compromise agreement. See, e.g., Hudspeth v. C.I.R., 914 F.2d 1207, 1213 (9th Cir.1990) ("Rule 408 does apply to situations where the party seeking to introduce evidence of a compromise was not involved in the......
-
Pacific Gas and Elec. Co. v. Lynch
...is generally not relevant, because settlements may be motivated by a variety of factors unrelated to liability. See Hudspeth v. CIR, 914 F.2d 1207, 1213-14 (9th Cir.1990). The court agrees with defendants that documents relating to the settlement between defendants and SCE are not relevant ......
-
McDevitt v. Guenther
...where the party seeking to introduce evidence of a compromise was not involved in the original compromise." Hudspeth v. C.I.R., 914 F.2d 1207, 1213 (9th Cir.1990); see also United States v. Contra Costa Water District, 678 F.2d 90, 92 (9th Cir.1982) (barring admission of amount of settlemen......
-
Recent ESI changes on discovery and privilege may broadly affect tax controversies.
...DHL Corp. v. Commissioner, T.C. Menlo. 1998-461 (court compelled IRS to produce economist report from audit); Hudspeth v. Commissioner, 914 F.2d 1207, 1214 (9th Cir. 1990) (valuation conducted by IRS expert in similar case admissible to show expert's bias); United States v. Cathcart, 102 AF......