In re Sternberg
| Decision Date | 12 November 1998 |
| Docket Number | 95-30552-BKC-SHF.,No. 97-8833-CIV-GOLD,97-8833-CIV-GOLD |
| Citation | 229 BR 238 |
| Parties | In re James Henry STERNBERG, Debtor. United States of America, Appellant, v. James Henry Sternberg, Appellee. |
| Court | U.S. District Court — Southern District of Florida |
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Jose de Leon, Tax Division, U.S. Department of Justice, Washington, DC, for Plaintiffs.
Tina M. Talarchyk, West Palm Beach, FL, for Defendants.
The United States appeals from a Bankruptcy Court order which found that the debtor's federal income tax liabilities for the years 1977 through 1981 were dischargeable. In the Bankruptcy Court, the United States argued that pursuant to section 523(a)(1)(C) of the Bankruptcy Code, the tax debt was not dischargeable because the debtor wilfully sought to evade payment of his taxes by transferring most of his attachable assets to his new wife as sole owner, or to himself and his wife as tenants by the entirety. On appeal from the order finding the debt dischargeable, the United States makes three arguments: (1) the evidence does not support the Bankruptcy Court's finding that there was adequate consideration for the asset transfer; (2) the Bankruptcy Court erroneously considered only the transfers made pursuant to an amendment to a prenuptial agreement; and (3) the Bankruptcy Court failed to consider the appropriate factors demonstrating fraud. After examining the record, and carefully considering the arguments of both parties, the Court concludes that the Bankruptcy Court's ruling was erroneous.
Dr. James Henry Sternberg filed a voluntary Chapter 7 proceeding in the Bankruptcy Court for the Southern District of Florida after the Internal Revenue Service (IRS) assessed substantial tax liabilities against him. When the IRS filed a proof of claim in the amount of $2,058,726.91 in the bankruptcy proceeding, Sternberg responded with a complaint seeking a determination that his debt to the IRS was dischargeable. The matter was tried before the Bankruptcy Court on February 12, 1996. Relying on section 523(a)(1)(C) of the Bankruptcy Code, the IRS argued that Dr. Sternberg's debt should not be discharged because he willfully attempted to evade or defeat his taxes by transferring almost all of his attachable assets to his new wife. Dr. Sternberg claimed he received adequate consideration from his wife for the transfer of assets. Finding the consideration adequate, the Bankruptcy Court ruled the debt dischargeable. The following facts are taken in substantial part from the Bankruptcy Court's final judgment.
A. The Tax Liability. Dr. Sternberg is a radiologist who has practiced in South Florida since 1974. From 1977 through 1981, he invested in a tax shelter known as Imperial Finance, N.V., a Netherlands Antilles corporation formed for the ostensible purpose of acquiring an option to lease mineral rights on certain land in South Africa. These rights were divided into "working interests" which were sublet to investors. According to the sublease agreements, each working interest gave the investor rights to mine and remove diamonds in return for a minimum annual royalty payment. Dr. Sternberg made annual royalty payments in various amounts, ranging from $25,000 to $43,000 per year. He claimed tax losses, however, of amounts far greater than his annual royalty payments. In 1977, Sternberg claimed a loss of $125,170; 1979's claimed loss was $310,000; 1980's claimed loss was $200,000, and 1981's claimed loss was $175,000.1 The IRS examined Sternberg's returns for those years and disallowed the deductions.
In March of 1985, Dr. Sternberg delivered an Offer in Compromise to the IRS offering to pay $200,000 at the time the offer was accepted, plus a percentage of his adjusted gross income over $100,000. This offer was rejected by the IRS. Later in 1985, the IRS issued statutory notices of deficiency to Sternberg for the tax years 1977 through 1981. The combined deficiency for those years was $479,777.62. Sternberg filed two petitions with the United States Tax Court contesting the deficiencies. His cases, as well as all other cases involving the Imperial Finance tax shelter, were assigned to Judge Charles E. Clapp, II, who tried two test cases related to Imperial Finance, Fredkin v. Commissioner, 51 T.C.M. (CCH) 865, 1986 WL 21867 (1986) and Cheng v. Commissioner, 51 T.C.M. (CCH) 861, 1986 WL 21866 (1986). In both cases, Judge Clapp ruled that the deductions taken by the taxpayers with respect to Imperial Finance were properly disallowed by the IRS. The Fredkin decision was affirmed by the First Circuit Court of Appeals on March 30, 1989. Citing to the appellate court's affirmance of his Fredkin decision, Judge Clapp entered orders in both of Sternberg's cases on November 1, 1989, requesting that the parties submit a decision document or show cause why a decision document should not be submitted.
B. The Prenuptial Agreement. Eleven months before Judge Clapp issued his November 1, 1989 decision, Sternberg married his fourth wife, Marsha May. Eleven years younger than her husband, May worked part-time as a reporter for the National Enquirer, earning $56,000 a year. By the time of his marriage to May, Dr. Sternberg had retired from the practice of radiology because of problems with his vision and was receiving tax-free disability payments which started at $6,500 per month and increased to payments of $9,500 per month at the time of trial. Dr. Sternberg also earned substantial wages by managing other radiologists.
Shortly before they were married, Sternberg and May had executed a prenuptial agreement prepared by Dr. Sternberg's attorney. The purpose of the agreement was to protect Dr. Sternberg's interests in the event of a divorce. Under the prenuptial agreement, each party retained independent control and management of their separate property, and each party's separate property was to be excluded from marital assets. "Separate property" was defined to include all property owned before the marriage, including property described in disclosures that were attached as Exhibits A and B, all earnings of each party after marriage, and all rents, dividends, profits, or other income derived from separate property. Under the agreement, May would receive a sum certain in the event of divorce, and a specified percentage of Dr. Sternberg's estate in the event of his death. The couple's principal residence was to be in Dr. Sternberg's name for three years, and then transferred to both Dr. Sternberg's and May's name if they were still married after three years. Any tax deficiencies arising from periods prior to the marriage would be the separate responsibility of the party for whom the deficiency was proposed.
Exhibit A to the prenuptial agreement is a Statement of Assets and Liabilities for Dr. Sternberg. This disclosure lists assets totaling $7,013,000 and liabilities of $1,541,000 for a net worth of $5,897,000. The disclosure listed "Other Assets" worth $6,175,000, including a fifty percent ownership in a professional association valued at $500,000, and partnership or shareholder interests in various magnetic resonance imaging MRI centers. Also listed were reading contracts, which were exclusive contracts with Dr. Sternberg's professional association of radiologists to "read" results from the MRI centers. Sternberg listed on his disclosure a contested tax liability of $1,500,000.
C. The Amendment and Transfer of Assets. In November 1989, just after the Tax Court entered its November 1, 1989 decision adverse to Sternberg, and only ten months after they had entered into the prenuptial agreement, May and Sternberg amended the prenuptial agreement. Under the new agreement, the property provisions set forth in the prenuptial agreement were revoked and Sternberg was required to immediately transfer certain property to May either into her name solely, or into a tenancy by the entirety. The Amendment recited that the reason for the transfers was to account for the "considerable disparity in age of the parties hereto, the potential professional liabilities inherent in Mr. Sternberg's practice of medicine, and the speculative nature of many of Mr. Sternberg's business ventures."
At trial, the IRS challenged the reasons for the transfers, arguing that the debtor made the transfers to evade payment of his taxes. The Bankruptcy Judge also expressed doubts about why the assets were transferred. He noted in the final judgment that the reasons for the transfer stated in the Amendment — age disparity, potential professional liabilities, and speculative nature of investments — were conditions that were known to the parties at the time they entered into the prenuptial agreement. Dr. Sternberg testified the Amendment was actually precipitated by his wish that May quit working, and his desire to provide May with some form of security in lieu of her decision to terminate her employment. The IRS challenged this reason also, arguing that nothing in the Amendment reflected this intent. Significantly, although the Amendment was prepared by Dr. Sternberg's lawyer, there was no language in the agreement obligating May to quit her job nor were there any promises by May to quit her job. In fact the evidence showed that May did not quit working after signing the Amendment. She continued to work in 1990, and no evidence was presented that she ever quit working.
The Amendment contained a clause that reaffirmed the value of the parties' respective assets. Dr. Sternberg had valued his assets at over five million dollars less than ten months before the Amendment. The Amendment reiterated that those estimates were fair and adequate.2 In accordance with the terms of the Amendment, almost all of Sternberg's attachable assets were transferred to May as sole owner, or to Sternberg and May as tenants by the entirety.3 The only assets remaining solely in Dr. Sternberg's name were a checking account with a balance of...
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