Larson, Matter of

• Decision Date: 02 December 1988
• Docket Number: No. 87-3001,87-3001
• Citation: 862 F.2d 112
• Parties: -5797, 88-2 USTC P 9590 In the Matter of Roger Roy LARSON and Joan Rosemary Larson, Debtors-Appellants.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 112

862 F.2d 112

62 A.F.T.R.2d 88-5797, 88-2 USTC P 9590

In the Matter of Roger Roy LARSON and Joan Rosemary Larson,

Debtors-Appellants.

No. 87-3001.

United States Court of Appeals, Seventh Circuit.

Argued April 20, 1988.

Decided Oct. 13, 1988.

Rehearing Denied Dec. 2, 1988.

Robert G. Kirchner, Greaves, Lerner & Kirchner, Champaign, Ill., for appellants.

Laura M. Conley, Tax Div., Dept. of Justice, Washington, D.C., Thomas A. Doyle, Baker & McKenzie, Chicago, Ill., for appellee.

Before BAUER, Chief Judge, COFFEY, and FLAUM, Circuit Judges.

BAUER, Chief Judge.

Debtors-appellants Roger and Joan Larson appeal from the district court's judgment affirming a decision of the bankruptcy court, which determined that the Internal Revenue Service (IRS) had correctly made deficiency assessments against the Larsons for tax years 1974 and 1975, and that the tax liability was not dischargeable in bankruptcy. We affirm.

I. Background

In 1973, the Larsons founded Pharmaco, Inc., an Illinois corporation, to exploit certain inventions of Roger Larson. Pharmaco issued 800 of its initial 1,000 shares of stock to the Larsons in exchange for patent rights in the inventions. ¹ The remaining 200 shares of Pharmaco stock were issued to 22 unrelated shareholders for a total capitalization of $25,000. By March 1974, Pharmaco needed to raise more funds to develop its products. Therefore, in 1974 and 1975, the Larsons sold most of their Pharmaco stock. The Larsons retained approximately $270,000 of the proceeds and transferred the remaining $1,000,000 to Pharmaco. The transfers to Pharmaco were made as soon as possible after the Larsons received the sales proceeds and always within one banking day of receipt. Despite this infusion of cash in '74 and '75, Pharmaco apparently continued to experience financial difficulties. In 1976, characterizing their earlier transfers of $1,000,000 of proceeds from their stock sales as "loans" to Pharmaco, the Larsons forgave the resultant "debts." Pharmaco nonetheless became insolvent in 1978.

Roger and Joan Larson reported only $130,000 of the proceeds of the 1974 stock sales--i.e., the amount they retained--on their 1974 individual income tax return. On their 1975 return they reported only the $140,000 they retained. The IRS subsequently determined that all of the gain on the sales of Pharmaco stock should have been treated as income to the Larsons and that their transfers of part of the proceeds to Pharmaco were contributions to capital. Thus, on September 12, 1979, the IRS made deficiency assessments against the Larsons for an additional $198,000 tax due for 1974 and 1975. On October 15, 1979, the Larsons filed a petition in bankruptcy pursuant to Chapter 7 of the Bankruptcy Code, 11 U.S.C. Sec. 701 et seq., which filing was, according to the Larsons, "precipitated by representations and assurances given to Larson by representatives of the Internal Revenue Service." The Larsons claim that IRS agents represented that "any deficiencies determined by an audit assessment could be discharged if they would file bankruptcy." On February 13, 1980, the bankruptcy court entered an order discharging the Larsons from all dischargeable debts. Despite the alleged "assurances" of its agents, the IRS then filed a proof of claim in the amount of approximately $432,000, which included the amount of the deficiency assessments for 1974 and 1975.

On March 19, 1981, the Larsons filed a complaint in the bankruptcy court to determine their tax liability and its dischargeability. In two decisions--one following a remand from the district court ²--the bankruptcy court held that: (1) the 1974 and 1975 deficiency assessments were not dischargeable in bankruptcy because they were assessed within 240 days of the filing of the bankruptcy petition; (2) the doctrine of equitable estoppel did not bar the IRS from collecting the taxes; (3) all of the gain from the Pharmaco stock sales should have been included in the Larsons' individual income; (4) the transfers of the proceeds of those sales to Pharmaco constituted contributions to capital rather than loans; (5) upon Pharmaco's insolvency, the Larsons' losses were deductible as capital losses rather than ordinary losses; and (6) pre-petition interest on the tax assessments was not dischargeable in bankruptcy. The district court affirmed all of these determinations. The Larsons appeal, challenging the latter five of the bankruptcy court's holdings. ³ For the reasons explained below, we find no merit in any of the Larsons' challenges.

II. Equitable Estoppel

The Larsons claim that they filed for bankruptcy less than 240 days after the tax assessment, making the taxes nondischargeable, in reliance on the statements of two IRS agents. They contend that they agreed to drop claims against certain other IRS agents and file for bankruptcy because these two agents assured them that the tax assessments would be discharged in bankruptcy. According to the Larsons, they reasonably relied on the misrepresentations of agents of the IRS in filing their bankruptcy petition on October 15, 1984, and the government is therefore estopped from collecting the taxes assessed.

"The general rule is that reliance on misinformation provided by a government employee does not provide a basis for an estoppel." Crown v. United States Railroad Retirement Bd., 811 F.2d 1017, 1021 (7th Cir.1987). Yet, in certain narrow circumstances "[t]his circuit ... [has] applied the estoppel doctrine to the Government. See United States v. Fox Lake State Bank, 366 F.2d 962 (7th Cir.1966). But we [have done] so reluctantly, noting that 'the doctrine of estoppel must be applied with great caution to the Government and its officials.' Id. at 965." Gressley v. Califano, 609 F.2d 1265, 1267 (7th Cir.1979). Thus, while it is not entirely clear what additional circumstances a party must establish before the doctrine of equitable estoppel will be applied to the government, ⁴ it is clear that at least the traditional prerequisites for the application of the doctrine are required.

"[T]o succeed on a traditional estoppel defense, the litigant must prove (1) a misrepresentation by another party (2) which he reasonably relied upon (3) to his detriment." United States v. Asmar, 827 F.2d 907, 912 (3d Cir.1987). See also In re Colonial Discount Corp., 807 F.2d 594, 599 (7th Cir.1986). The burden of proof is on the party claiming estoppel. Asmar, 827 F.2d at 912. We conclude, as did the courts below, that the Larsons failed to establish the elements of a traditional estoppel defense. First, the evidence that the two IRS agents in fact made the alleged misrepresentations is scant. Second, even assuming that the IRS agents did make the alleged misrepresentations, the Larsons could not have reasonably relied on them. The Larsons were represented by counsel when they filed their bankruptcy petition. It would not be reasonable for an attorney representing a party in a bankruptcy proceeding to rely on the "advice" of IRS agents regarding dischargeability in bankruptcy. This is at least true when, as in this case, the agents' advice is flatly contradicted by the clear provisions of the Bankruptcy Code.

Moreover, because the Larsons were dealing with the government, they are charged with knowledge of the law "and may not rely on the conduct of Government agents contrary to law." Heckler v. Community Health Services of Crawford, 467 U.S. 51, 63, 104 S.Ct. 2218, 2225, 81 L.Ed.2d 42 (1984). Similarly, " 'anyone entering into an arrangement with the Government takes the risk of having accurately ascertained that he who purports to act for the Government stays within the bounds of his authority.' " Id. at 63 n. 17, 104 S.Ct. at 2225 n. 17 (quoting Federal Crop Insurance Corp. v. Merrill, 332 U.S. 380, 384, 68 S.Ct. 1, 3, 92 L.Ed. 10 (1947)). Thus, the Second Circuit has stated, "[i]t is well established that 'estoppel cannot be set up against the Government on the basis of an unauthorized representation or act of an officer or employee who is without authority ... to bind the Government.' " Goldberg v. Weinberger, 546 F.2d 477, 480-81 (2d Cir.1976) (quoting Byrne Organization, Inc. v. United States, 287 F.2d 582, 587, 152 Ct.Cl. 578 (1961)), cert. denied, 431 U.S. 937, 97 S.Ct. 2648, 53 L.Ed.2d 255 (1977). As the government argues, it would appear that statements regarding the Bankruptcy Code are not within IRS agents' authority, and the Larsons make no attempt to show that such statements are authorized.

We therefore conclude, mindful of the "great caution" that we must exercise in applying the doctrine of equitable estoppel to the government, that both the bankruptcy court and the district court correctly refused to do so. The IRS is not estopped from assessing the taxes at issue.

III. Individual Income

The second determination that the Larsons challenge on appeal is the bankruptcy court's finding, affirmed by the district court, that all of the proceeds of the sales of their Pharmaco stock were properly included in their individual income. The bankruptcy court found that the Larsons control over the disposition of the proceeds was sufficient to require them to report receipt of the proceeds as income. The Larsons contend that this finding is clearly erroneous--that they acted as a mere "conduit" for that portion of the proceeds that were transferred to Pharmaco. In support of this contention, they rely on certain letters that Roger Larson sent to Pharmaco's other stockholders when offering the Pharmaco stock for sale. In one letter, dated September 28, 1974, Larson stated, "When you buy stock directly from me you know the bulk of the money is going to the company in the form of loans from me to Pharmaco." In a subsequent letter, dated October 7, 1974, Larson told the stockholders he was "willing to sell [his] stock and loan most of the proceeds to Pharmaco." Additionally, the Larsons emphasize that, although the proceeds were...