In re Carpenter

Decision Date15 September 2016
Docket NumberCase No. 13-61192-11
Citation558 B.R. 381
Parties In re Daniel Bruce Carpenter and Mary Esther Carpenter, Debtors.
CourtU.S. Bankruptcy Court — District of Montana

Harold V. Dye, Missoula, MT, for Debtors.

MEMORANDUM of DECISION

Honorable Ralph B. Kirscher, Chief U.S. Bankruptcy Judge

At Butte in said District this 15th day of September, 2016.

In this Chapter 11 bankruptcy case, after due notice, the Court held a hearing in Billings on July 19, 2016, on Debtors' Objection to Proof of Claim No. 4 filed by the Internal Revenue Service (“IRS”). Debtors were represented at the hearing by Harold V. Dye of Missoula, Montana, and the IRS was represented at the hearing by Ryan S. Watson of Washington, DC and Assistant U.S. Attorney Victoria L. Francis of Billings, Montana. Debtor Daniel Carpenter and IRS Revenue Agent Jerry Webb testified. Debtors' Exhibits 1, 2, 4-10 and the IRS's Exhibits A, B, D, E and F were admitted into evidence.

BACKGROUND

In 2006, Debtors purchased an existing fire suppression business and the real property associated with the business. At that time, Debtors separated the real property from the business operations so that Gavriel, LLC owned the real property and the business operations were conducted by Big Sky Fire Protection, Inc. Gavriel, LLC and Big Sky Fire Protection were both wholly owned by Debtors.

Big Sky Fire Protection occupied approximately one-half of the real estate owned by Gavriel, LLC, with the other half of the real estate occupied by other tenants. Roughly eighty percent of Big Sky Fire Protection's business stemmed from new construction. Big Sky Fire Protection's business suffered substantially in the 2008 recession and after.

For the fiscal year ending September 30, 2010, Big Sky Fire Protection's assets were valued at $966,367 (of which $523 was in cash), and its liabilities totaled $1,310,248. For the fiscal year ending September 30, 2011, Big Sky Fire Protection reported gross receipts of $3,427,573, negative taxable income of $531,758, assets valued at $1,092,040 (of which $989 was in cash), and liabilities totaling $1,664,861. For the fiscal year ending September 30, 2012, Big Sky Fire Protection reported gross receipts of $2,676,042, negative taxable income of $609,963, assets valued at $866,913 (of which $0 was in cash) and liabilities totaling $1,958,609. For the fiscal year ending September 30, 2013, Big Sky Fire Protection reported gross receipts of $1,984,416, negative taxable income of $606,140, assets valued at $731,187 (of which $0 was cash), and liabilities totaling $2,432,128. For the fiscal year ending September 30, 2014, Big Sky Fire Protection filed a final U.S. Corporation Income Tax Return, reporting no gross receipts, taxable income or assets as of September 30, 2014.

Debtor Daniel Carpenter testified that a line of credit from First Interstate Bank was essential for Big Sky Fire Protection's operations. First Interstate Bank closed Big Sky Fire Protection's line of credit in 2012. To compensate for the loss of the line of credit, Debtors, on or about September 20, 2012, caused Gavriel, LLC to sell its real property for $1,350,000. Proceeds from the sale were used to pay closing costs and to pay debts of Big Sky Fire Protection, including $560,000 owed to First Interstate Bank on the line of credit. Debtor Daniel Carpenter testified that he was not thinking clearly in 2012 and that in hindsight, the sale was a foolish move. Debtors continued to operate Big Sky Fire Protection until they filed bankruptcy in August of 2013. Sometime after September 30, 2013, First Interstate Bank seized and liquidated Big Sky Fire Protection's assets.

Debtors filed their bankruptcy case on August 30, 2013. The IRS filed its original Proof of Claim on September 12, 2013, asserting an estimated claim of $49,647.68 because Debtors had not yet filed their 2012 income tax return. Around this same time, Debtors filed their 2012 U.S. Individual Income Tax Return, reporting the long-term capital gain of $707,992 from Gavriel's September 2012, sale of its real property. Debtors did not, at this time, claim that their stock in Big Sky Fire Protection was worthless. The IRS amended its Proof of Claim several times thereafter, with the IRS filing its last amendment on May 2, 2014, asserting a priority claim in the amount of $1,069,780.52, consisting of various civil penalties and a 2012 income tax liability of $163,235, together with additional non-priority penalties of $4,158.87.

After the IRS filed its amended Proof of Claim on May 2, 2014, Debtors amended their 2012 U.S. Individual Income Tax Return seeking to offset the gain of $707,992 from the sale of Gavriel's real property with a write off of $1,128,842 representing the value of Debtors' stock in Big Sky Fire Protection. In Part III of the Amended Return, Debtors explain that the change is the result of Debtors: “RECOGNIZING A LOSS ON C CORPORATION STOCK FOR ENTITY THAT WAS DEEMED INSOLVENT AT PERIOD END. AS SUCH, THE SHAREHOLDERS' STOCKS WERE DEEMED WORTHLESS AT 12/31/2012.” Although the board of directors had not, as of December 31, 2012, voted to wind up Big Sky Fire Protection's affairs, Debtor Daniel Carpenter testified that in his opinion, Big Sky Fire Protection's stock was worthless as of December 31, 2012, even though Big Sky Fire Protection continued to do business and had not liquidated its assets. The amendment reduced Debtors' 2012 tax liability from $163,964 to approximately $35,000.

In a determination letter dated December 1, 2015, the IRS informed Debtors that they had provided inadequate information to justify the amendment. Consistent with the determination letter, the Examining Officer's Activity Record, Exhibit B, reflects under July 30, 2015, “Remarks, Notes, Actions Taken” that: “The taxpayer corporation was in full operation into 2013 with assets and infusions of cash from asset sales, indicating the taxpayer corporate stocks were not worthless as claimed. The taxpayers were claiming personal bankruptcy and the corporation was not. The taxpayers also had assets to satisfy a portion of the bankruptcy debt. The claim for abatement was to be disallowed in full.”

Debtors, still seeking to offset the gain from the sale of Gavriel's real property with a worthless stock deduction, filed an Objection to the IRS's proof of claim on December 22, 2015, requesting that the income tax component of Proof of Claim No. 4 be allowed in the sum of $34,271 rather than $163,235. In support of their Objection, Debtors argue:

d) Acting on advice of tax counsel, Debtors filed amended tax returns for 2012 on the theory that their stock in Big Sky was worthless at the end of 2012 and that they were entitled to offset their capital loss from Big Sky against their capital gain from Gravel [sic]. This resulted in reducing their 2012 federal income tax liability to $34,271.
e) The Montana Department of Revenue accepted the amended return as filed and filed an amended proof of claim in this matter reducing income tax liability for 2012. The IRS did not accept the amended return stating that “the information that you provided doesn't justify changing our prior adjustment.”
f) In fact, substantial, if not overwhelming, evidence supports the conclusion that Big Sky stock was worthless at the end of 2012 meaning (a) balance sheet insolvency and (b) a complete lack of future value including the following:
• At the end of the fiscal year ended 9/30/12, Big Sky had current liabilities of $1,554,908 compared with current assets of $450.221. The company's net worth was negative $1,151,196.
• The net loss for year ended 9/30/12 was $518,875; the loss for the prior year was $531,758.
• As of 9/30/12, Big Sky had unpaid payroll taxes of over $500,000.
• As of the end of 2012, the taxpayers' line of credit was exhausted and there was no realistic possibility of obtaining additional credit.
• Operations during the final quarter of 2012 showed a loss consistent with the past two years' losses.
APPLICABLE LAW and DISCUSSION

“A proof of claim executed and filed in accordance with [the Federal Rules of Bankruptcy...

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