Internal Revenue Serv. v. Highlanders Alloys, LLC (In re Highlanders Alloys, LLC)
| Decision Date | 30 September 2014 |
| Docket Number | CIVIL ACTION NO. 3:13–7897,C/w 3:13–7896,BANKRUPTCY NO. 05–30516 |
| Citation | 551 B.R. 235 |
| Court | U.S. District Court — Southern District of West Virginia |
| Parties | In re: Highlanders Alloys, LLC, Debtor. Internal Revenue Service, Appellant, v. Highlanders Alloys, LLC, Appellee. |
David L. Lerner, Plunkett Cooney, Thomas P. Vincent, Plunkett & Cooney, Bloomfield Hills, MI, Mark A. Ferguson, Sprouse & Ferguson, Charleston, WV, Robert O. Lampl, Pittsburgh, PA, for Debtor.
Benjamin J. Weir, U.S. Department of Justice, Washington, DC, Gary L. Call, U.S. Attorney's Office, Charleston, WV, for Appellant.
David L. Lerner, Plunkett Cooney, Thomas P. Vincent, Plunkett & Cooney, Bloomfield Hills, MI, Mark A. Ferguson, Sprouse & Ferguson, Charleston, WV, Robert O. Lampl, Pittsburgh, PA, for Appellee.
Pending before the Court is Appellant Internal Revenue Service's (“the Service” or “the IRS”) appeal (ECF No. 8) from the Bankruptcy Court's Order dated October 15, 2012. Appellee Highlanders Alloys, LLC (“Highlanders”), has filed a cross-appeal (ECF No. 11). For the reasons stated below, the Court AFFIRMS the Bankruptcy Court's allowance of the Binson deduction, AFFIRMS the Bankruptcy Court's allowance of the Industrial Development deduction, and AFFIRMS the Bankruptcy Court's reduction of the accuracy-related penalty.
This case stems from events surrounding the sale of assets by Highlanders and its accompanying tax liability. In 2006, Highlanders sold its assets to Felman Production for $20,000,000. In re: Highlanders Alloys, LLC, No. 05–30516, Final Order Granting Part Summ. J. Debtor at 1 (Bankr.S.D.W.Va. Oct. 15, 2012) (hereinafter “Final Order”),1 available in instant case at ECF No. 3–24. After this sale, Highlanders filed its tax returns for the years 2002 through 2006. Id. The IRS subsequently audited Highlanders' tax returns. Id. As a result of this audit, the IRS disallowed eight deductions claimed by Highlanders and imposed an accuracy-related penalty pursuant to 26 U.S.C. § 6662. Id. ; Appellant's Br. at 7, ECF No. 8 (hereinafter “IRS's Br.”).
Highlanders concurred with making adjustments for five of these flagged deductions and made a corresponding income tax payment to account for those five disallowed deductions. Final Order at 2. However, Highlanders contested the IRS's disallowance of the remaining flagged deductions: 1) a deduction of $3,200,000 for the so-called “Binson loan”; 2) a deduction of $2,171,013 for payment of claims assigned to Industrial Development; and 3) a deduction of $5,371,013 based on a change in Highlanders' net-operating loss (“NOL”).2 Id. Highlanders also contested the accuracy-related penalty of $508,843. Id. Highlanders and the IRS filed cross-motions for summary judgment seeking resolution of these contested issues. Id. at 1.
On October 15, 2012, United States Bankruptcy Judge Ronald G. Pearson issued a final order granting in part Highlanders' motion for summary judgment. Specifically, the Bankruptcy Court noted that Highlanders agreed to reduce the Binson deduction from $3,200,000 to $1,240,000, and it found a sufficient basis for allowing a deduction in that lesser amount. Id. at 2–5. The Bankruptcy Court also found that the deduction for payment to Industrial Development was proper. Id. at 6–7. Lastly, the Bankruptcy Court found that some penalty was proper but that the penalty imposed by the IRS should be reduced based on resolution of the Binson deduction and the Industrial Development deduction. Id. at 8.
Highlanders appealed the Bankruptcy Court's ruling, and its appeal was docketed with this District Court as Civil Action No. 3:13–7896. The IRS also appealed the Bankruptcy Court's ruling, and its appeal was docketed as Civil Action No. 3:13–cv–7897. However, the IRS and Highlanders “initially understood that [their appeals] would be a single appeal with a single action number” and, to that end, filed a joint motion to consolidate the appeals. ECF No. 9. The Court granted the motion, ordering that both appeals proceed under the instant case number. ECF No. 10. As noted above, the IRS filed its brief on appeal, ECF No. 8, and Highlanders filed a brief responding to the IRS's arguments and presenting its own arguments on appeal, ECF No. 11. The IRS subsequently filed a reply brief. ECF No. 12. The cross-appeals are now ripe for resolution.
In Section II, the Court discusses the standard of review applicable to these cross-appeals of the Bankruptcy Court's final order. In Section III, the Court examines the Binson deduction. In Section IV, the Court analyzes the Industrial Development deduction. Lastly, in section V, the Court examines the accuracy-related penalty.
On appeal, a district court reviews a bankruptcy court's findings of fact for clear error. In re Litton, 330 F.3d 636, 642 (4th Cir.2003) ; Fed. R. Bankr.P. 8013. This means that a finding of fact will only be reversed on appeal “when, although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed.” In re Green, 934 F.2d 568, 570 (4th Cir.1991). In contrast, questions of law are reviewed de novo. In re Litton, 330 F.3d at 642. “[I]n considering mixed questions of law and fact, we review the factual portion of the inquiry for clear error and the legal conclusions de novo.” Nelson–Salabes, Inc. v. Morningside Dev., LLC, 284 F.3d 505, 512 (4th Cir.2002) (citing Gilbane Bldg. Co. v. Fed. Reserve Bank of Richmond, Charlotte Branch, 80 F.3d 895, 905 (4th Cir.1996) ); see also U.S. Dep't of Health & Human Servs. v. Smitley, 347 F.3d 109, 116 (4th Cir.2003) (). Where there are mixed questions of law and fact in which legal issues predominate, de novo review applies. See Carter Enters. v. Ashland Specialty Co., 257 B.R. 797, 800 (S.D.W.Va.2001).
Highlanders claimed a deduction of $3,200,000 on its 2006 tax return based on a proof of claim submitted by Jacob Binson. Final Order at 2; IRS's Br. at 8. The underlying basis of this proof of claim was that Mr. Binson had sued Highlanders for damages; their dispute was eventually settled, with Highlanders agreeing to pay Mr. Binson $4,050,000, presumably using part of the $20,000,000 earned from sale of its assets. Final Order at 2. During that litigation, it was revealed that Mr. Binson has paid approximately $1,960,000 to Highlanders or its affiliates or owners, and Highlanders accordingly agreed to reduce its $3,200,000 deduction by $1,960,000. Id. at 2–3. Highlanders argued to the Bankruptcy Court that it should be able to claim a deduction of $1,240,000—the remaining amount—on its 2006 tax return.
In its final order, the Bankruptcy Court allowed Highlanders to take a deduction of $1,240,000 on its 2006 tax return for the Binson claim. Id. at 5. The Court noted that Highlanders had earlier moved for approval of a sale of assets free and clear of liens, claims, and encumbrances, presumably referring to the $20,000,000 sale of assets by Highlanders. Id. at 3. The Court further noted that it had approved Highlanders' motion and, “to protect the interests of all, including those who held the right for payment such as [Mr.] Binson, ... ordered the sale funds held by counsel for the Debtor.” Id. at 3–4. Additionally, “[n]o disbursements were to be made from those funds without specific Court order.” Id. at 4. The Court went on to note its earlier determination that “the sale proceeds would be adequate to pay all claims” and that “[t]he only other possible thing that could have been done by the Debtor or the Court to segregate funds for specific creditors would be to go through the unnecessary and burdensome step of estimating claims to identify which dollar was to be earmarked for every specific claim.” Id. The Court concluded that this arrangement satisfied bankruptcy law, including the requirements of 26 U.S.C. 461(f), known as the contested liabilities exception to the all-events test. Id. The Court further noted:
Even if the Court is found to have been in error with respect to allowing this deduction above in 2006, by reason of the order channeling all claims to the funds in escrow and the later deposits with the Clerk, there is no question the deduction would be allowable in 2008 having the effect of increasing an [N]OL carry back in 2008 and thus offsetting taxes due in 2006. The net result would be a very small timing difference because of the interest and the potential penalties.
The IRS argues that Highlanders should not be allowed to take a deduction for the Binson claim in 2006. In support of that position, the IRS argues that the Binson claim could only be treated as a deduction if and when the payment satisfied the requirements of 26 U.S.C. § 461(f). According to the IRS, the contested liabilities exception was not satisfied until Mr. Binson received payment in 2008. Highlanders argues that the Bankruptcy Court's ruling concerning the Binson deduction was proper.
The all-events test is used to determine when an accrual method taxpayer3 incurs an expense and, therefore, when the expense can be claimed as a deduction. According to the test, an expense can be deducted “in the taxable year in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability.” 26 C.F.R. § 1.461–1(a)(2)(i). The contest liabilities exception to the all-events test states in pertinent part as follows:
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