Marshall v. Commonwealth

• Decision Date: 02 November 2018
• Docket Number: No. 863 F.R. 2015,No. 50 F.R. 2016,863 F.R. 2015,50 F.R. 2016
• Citation: 197 A.3d 294
• Parties: Robert J. MARSHALL, Jr., Petitioner v. COMMONWEALTH of Pennsylvania, Respondent Commonwealth of Pennsylvania, Petitioner v. Robert J. Marshall, Jr., Respondent
• Court: Pennsylvania Commonwealth Court

197 A.3d 294

Robert J. MARSHALL, Jr., Petitioner

v.COMMONWEALTH of Pennsylvania, Respondent

Commonwealth of Pennsylvania, Petitioner

v.Robert J. Marshall, Jr., Respondent

No. 863 F.R. 2015

No. 50 F.R. 2016

Commonwealth Court of Pennsylvania.

Argued June 6, 2018

Decided November 2, 2018

Joseph C. Bright, Philadelphia, for petitioner Robert J. Marshall, Jr.

Matthew S. Salkowski, Deputy Attorney General, Harrisburg, for respondent Commonwealth of Pennsylvania.

BEFORE: HONORABLE MARY HANNAH LEAVITT, President Judge, HONORABLE RENÉE COHN JUBELIRER, Judge, HONORABLE P. KEVIN BROBSON, Judge, HONORABLE PATRICIA A. McCULLOUGH, Judge, HONORABLE ANNE E. COVEY, Judge, HONORABLE MICHAEL H. WOJCIK, Judge, HONORABLE ELLEN CEISLER, Judge

OPINION BY JUDGE BROBSON

This personal income tax (PIT) matter returns to us following remand to the Board of Finance and Revenue (Board) for recalculation of the amount of Pennsylvania PIT owed by Petitioner Robert J. Marshall, Jr. (Taxpayer or Marshall). See Marshall v. Commonwealth , 41 A.3d 67 (Pa. Cmwlth.) (en banc) ( Marshall I ), exceptions overruled , 50 A.3d 287 (Pa. Cmwlth. 2012) (en banc) ( Marshall II ), aff'd sub nom. Wirth v. Commonwealth , 626 Pa. 124, 95 A.3d 822 (2014) ( Wirth ), cert. denied sub nom. Houssels v. Pennsylvania , ––– U.S. ––––, 135 S.Ct. 1405, 191 L.Ed.2d 362 (2015). On remand, the Board reassessed Taxpayer's PIT liability at "$102,620.00, plus appropriate penalties and interest, less any payments and credits on his account."¹ Both Taxpayer and the Pennsylvania Department of Revenue (Department or Revenue) challenge aspects of the Board's reassessment on remand. We affirm.

I. BACKGROUND

A. Marshall I , Marshall II , and Wirth

Taxpayer, a resident of the State of Texas, invested as a limited partner in 600 Grant Street Associates Limited Partnership (Partnership), a Connecticut limited partnership, which owned a building in the City of Pittsburgh (Property) that went into foreclosure in 2005. In 2008, the Department assessed Taxpayer for his pass-through share of the Partnership's income² realized from the foreclosure of the Property. As we noted in Marshall I , Section 303 of the Code³ sets forth eight separate classes of income subject to the PIT. The class of taxable income at issue here is "[n]et gains or income from disposition of property." Section 303(a)(3) of the Code.⁴

In Marshall I , we summarized the details of the financial arrangement giving rise to the foreclosure and the assessed PIT liability therefrom:

[Partnership], organized under Connecticut law, purchased the Property for $360 million. Of this $360 million purchase price, the Partnership financed $308 million with a Purchase Money Mortgage Note (PMM Note) secured only by the Property. The PMM Note was nonrecourse, meaning that the Partnership and the lender agreed that the lender's only recourse for nonpayment of the obligations under the PMM Note was to pursue foreclosure of the Property. As the name of the Partnership suggests, the Partnership's primary purpose was the ownership and management of the Property.

Interest on the PMM Note accrued on a monthly basis at a rate of 14.55%. If, however, the monthly accrued interest exceeded the net operating income of the Partnership, the Partnership was not required to pay the excess (i.e. , the amount of monthly accrued interest less monthly net operating income). Instead, the accrued but unpaid excess would be deferred and, thereafter, compounded on an annual basis subject to the same interest rate as the principal amount of the PMM Note. The original maturity date of the PMM Note was November 1, 2001. In 1998, the lender and the Partnership amended the PMM Note to extend the maturity date to January 2, 2005.

Marshall purchased a limited partnership interest (one unit) in the Partnership on or about January 24, 1985, for $148,889—$5,889 in cash and a promissory note of $143,000. His one unit limited partnership interest amounted to a 0.151281% interest in the Partnership. Marshall paid the promissory note in full on or about May 13, 1992. In March 1989, the Partnership returned a portion of Marshall's capital contribution in the amount of $6,184. Marshall was a passive investor in the Partnership. He never participated in the management of the Partnership or the Property.

Over the years, the Partnership's net income from operations did not keep pace with projections. The Partnership actually incurred losses from operations for financial accounting, federal income tax, and PIT purposes every year of its existence. For PIT purposes, the Partnership allocated its annual losses from operations to each partner, including Marshall. During this same time, Marshall had no other Pennsylvania source of income or loss. Marshall thus did not file a PIT return for tax years 1985 through 2004.

Because of the Partnership's dismal operations, the Partnership paid less monthly interest on the PMM Note than it had projected. Under the terms of the PMM Note, this led to a greater amount of accrued but unpaid interest over the years. According to the Offering Memorandum, the Partnership projected accrued but unpaid interest on the PMM Note at maturity (November 1, 2001, later extended to January 2, 2005) to be approximately $300 million. It also projected that upon sale of the Property at maturity, there would be enough proceeds to pay off the principal and accrued interest on the PMM Note, with additional funds available to distribute to the partners as a return on their investment. At the date of foreclosure, the Partnership had an accrued but unpaid interest obligation of approximately $2.32 billion. The Partnership had used approximately $121,600,000 of this amount to offset its income from operations that would otherwise have been subject to PIT. Neither the Partnership nor Marshall derived any PIT benefit from the remainder.

The lender foreclosed on the Property on June 30, 2005. By that time, what began as a $308 million Partnership liability on the PMM Note had grown into a liability of more than $2.6 billion, of which only $308 million represented principal. Neither the Partnership nor its individual partners received any cash or other property as a result of the foreclosure. That same year, the Partnership terminated operations and liquidated. Marshall did not recover his $142,705 capital investment (original investment less return of capital) in the Partnership at foreclosure or liquidation. Indeed, Marshall did not receive any cash or other property upon liquidation of the Partnership.

In a Notice of Assessment dated March 28, 2008, Revenue assessed Marshall $165,055.24 in PIT for calendar year 2005 (inclusive of penalties and interest) as a result of the foreclosure on the Property (Assessment). Marshall filed a petition for reassessment with Revenue's Board of Appeals (BOA), challenging the imposition and, in the alternative, amount of PIT set forth in the Assessment. On September 12, 2008, BOA struck the penalties from the Assessment, but otherwise held that the amount of PIT due, with interest, was proper. Marshall appealed BOA's determination to the Board, which denied Marshall's request for relief from ... BOA's determination on December 16, 2008.

Marshall I , 41 A.3d at 70-72 (footnotes omitted) (record citations omitted).

Taxpayer appealed the Board's December 16, 2008 determination to this Court. In his appeal, Taxpayer first questioned whether any PIT could be imposed where neither the Partnership nor the individual partners received cash or other property upon foreclosure. Taxpayer also contended Commonwealth v. Rigling , 48 Pa.Cmwlth. 303, 409 A.2d 936 (1980), and Commonwealth v. Columbia Steel & Shafting Co. , 83 Pa. D. & C. 326 (Dauphin 1951), exceptions dismissed , 62 Dauph. 296 (C.P. Pa. 1952), prohibit the imposition of an income tax on a taxpayer, like himself, who actually derived no income from his investment. Taxpayer also raised a disparate treatment argument, claiming he was being treated differently from the partners who resided in Pennsylvania. Taxpayer further claimed that the tax benefit rule should be applied to reduce his PIT liability. Finally, Taxpayer argued that imposition of the PIT on him, a nonresident, would violate the Commerce and Due Process Clauses of the United States Constitution.⁵ Marshall I , 41 A.3d at 72-73.

In Marshall I , we analyzed and ultimately rejected each of Taxpayer's challenges. Taking them out of order, we first held that Taxpayer waived his Commerce Clause challenge. Id. at 73. We also rejected Taxpayer's due process/minimum contacts challenge, finding that Taxpayer purposefully availed himself of the opportunity to invest in Pennsylvania real estate through the Partnership, establishing "sufficient minimum contacts for the imposition of a tax on Marshall and his fellow partners upon disposition by the Partnership of the Property." Id. at 74.

With respect to Taxpayer's claim, in essence, that the foreclosure of the Property did not yield a taxable event because neither he nor the Partnership received any cash or property (or income from investment), this Court sided with the Department's interpretation of Section 303(a)(3) of the Code and the related regulation, 61 Pa. Code § 103.13. We noted the similarities between the language in the Code and regulation to that found in the federal counterpart, Section 1001 of the Internal Revenue Code of 1986 (IRC), 26 U.S.C. § 1001. We also observed Taxpayer's accurate concession that for federal income tax purposes, a foreclosure on a nonrecourse mortgage⁶ is treated as a sale or exchange for an amount equal to the outstanding balance of the mortgage. Marshall I , 41 A.3d at 78 (citing Cox v. Comm'r of Internal Revenue , 68 F.3d 128 (5th Cir. 1995) ). Accordingly, we affirmed the Department's construction and application of the Code and the regulation to real property foreclosures, "even when the mortgagor does not receive any cash or other property (i.e. , proceeds) upon...