P v. United States
| Decision Date | 13 February 2015 |
| Docket Number | No. 14-288T,14-288T |
| Parties | JAMES P AND BEATRIZ N. DUFFY, Plaintiffs, v. UNITED STATES, Defendant. |
| Court | Court of Federal Claims |
ORIGINAL
Claim for refund of income lax paid on proceeds of a settlement agreement; ''origin of the claim" doctrine; inapplicability of exclusion from taxation under I.R.C. § 104(a)(2), proceeds taxable as ordinary income and not capital gains
James P. Duffy and Beatriz N. Duffy, pro se, Walnut Creek, California.
Carl D. Wasserman, Trial Attorney, Commercial Litigation Branch, Tax Division, United States Department of Justice, Washington, D.C., for defendant. With him on the briefs were Tamara W. Ashford, Acting Assistant Attorney General, Tax Division, and David I. Pincus, Chief, Court of Federal Claims Section, United States Department of Justice, Washington, D.C. Of counsel was Mary M. Abate, Assistant Chief Court of Federal Claims Section, United States Department of Justice, Washington, D.C.
In this tax-refund case, plaintiffs James P. and Beatriz N. Duffy (collectively, "the Duffys") seek a refund of $13,049 in income taxes allegedly overpaid for tax year 2007. Am. Compl. ¶ 1, ECF No. 3. In their complaint, the Duffys maintain that the proceeds of an agreement entered by Mr. Duffy to settle a claim he had made were not taxable pursuant to 26 U.S.C. ("I.R.C.") § 104(a)(2) because payment was on account of Mr. Duffy's "physical injury or physical sickness." Am. Compl. ¶ 135. In the alternative, the Duffys aver that the proceeds were not taxable as ordinary income, but rather were taxable as capital gains meant to restore impaired goodwill. Am. Compl. ¶¶ 119, 125. Pending before the court is the government's motion to dismiss for failure to state a claim upon which relief can be granted pursuant to Rule 12(b)(6) of the Rules of the Court of Federal Claims ("RCFC"). Mot. to Dismiss of UnitedStates ("Def.'s Mot."), ECF No. 7; see Hr'g Tr. at 8:19-22 (Jan. 27, 2015).1 For the reasons stated, the court converts the government's motion to dismiss under RCFC 12(b)(6) into a motion for summary judgment under RCFC 56 and concludes that the government is entitled to judgment as a matter of law on the Duffys' tax refund claim.
In 2004, Mr. Duffy maintained a private consulting business. Am. Compl. ¶ 6. He worked with the United Commercial Bank ("UCB" or "the Bank") in San Francisco, California, and then became Tax Director and First Vice President of the Bank. Id. While working at UCB, Mr. Duffy was responsible for ensuring that all accounting policies and procedures within his department complied with the Public Company Accounting Reform and Investor Protection Act of 2002 ("Sarbaues-Oxley Act"), Pub. L. 107-204, 116 Stat. 745. Am. Compl. ¶ 17, Ex. B.2 To that end, he "had the opportunity to observe UCB's compliance with various legal, accounting, and financial procedures and . . . participated in many significant decisions affecting UCB's financial statements." Am. Compl. ¶ 17. In 2006, Mr. Duffy witnessed an action at UCB that was allegedly fraudulent and not in compliance with the Sarbanes-Oxley Act. Am. Compl. ¶ 18. He subsequently reported the incident to management at UCB, including the Chief Financial Officer, the Controller, and the Sarbanes-Oxley Director. Am. Compl. ¶¶ 18-19, 22.3 Mr. Duffy was placed on administrative leave shortly thereafter. Am. Compl. at Ex. D. On November 9, 2006, UCB terminated his employment contract. Am. Compl. ¶¶ 70-71, Ex. H.
As a result, Mr. Duffy filed a claim against the Bank on February 2, 2007 with the Department of Labor alleging employment discrimination in violation of 18 U.S.C § 1514(a).4 Am. Compl. at Ex. D. Mr. Duffy maintained that "UCB terminated his employment because of his participation in an activity protected by the Sarbanes-Oxley Act, and that UCB retaliated against him to punish him for his refusal to participate in the unethical and illegal conduct of UCB." Am. Compl. ¶ 61, UCB filed an objection to Mr. Duffy's complaint on or about April 5, 2007. Am. Compl. at Ex. D.5 Following his departure from UCB, Mr. Duffy pursued other employment opportunities and attempted to expand his consulting practice, see Am. Compl. ¶¶ 73-74, but was not successful in these endeavors because "[potential employers and clients] required a reference from UCB[,] which was not possible," Am. Compl. ¶¶ 76-78. During this time, Mr. Duffy reportedly suffered stress and anxiety from the Sarbanes-Oxley retaliation, Hr'g Tr. 21:8-10, which allegedly "affects him even today," Am. Compl. ¶ 106.
Id. ¶ 8 (emphasis added). Under the terms of the settlement, UCB agreed to pay a total sum of $75,000, with $50,000 being awarded to Mr. Duffy and $25,000 being paid to his attorneys at the Popelka Law Group, A.P.C. Id. ¶¶ 1.1-1.2. According to the Settlement Agreement, Mr. Duffy was to immediately withdraw all claims against UCB currently pending before the Department of Labor, thus allowing the Secretary of Labor to enter a final order dismissing those claims with prejudice. Id. ¶ 5. Mr. Duffy also consented to the following stipulation:
Thereafter, the Duffys filed a Form 1040 (U.S. Individual Income lax Return) for 2007, acknowledging the receipt of $50,000 from a "lawsuit" and entering that sum as "other taxable income." Def.'s Mot at Ex. 8.7 The Duffys also included Schedule D (Capital Gains and Losses) with their income tax return, in which they reported long-term capital losses, but no capital gains. id. On December 1, 2008, the Duffys were issued a lax refund in the amount of $1,500 from the US, Department of the Treasury, Internal Revenue Service ("IRS"). Id. at Ex. 7. The Duffys proceeded to file a Form 1040X (Amended U.S. Individual Income Tax Return) on April 15, 2011 requesting a refund in the amount of $13,049 to be credited to their 2007 tax liability. Id. at Ex. 9. The amended return stated that the inclusion of $50,000 as income in the2007 tax return was incorrect because that amount ''was not taxable." Id. The Duffys subsequently filed a second amended tax return on October 4, 2011 to "explain[] why this income . . . [was] not subject to tax or [could] be offset against the taxpayer[s]' capital loss carry forward." Pls.' Opp'n at Ex. 2. In a statement attached to the second amended return, the Duffys made the following declaration:
Because of the physical injury and physical sickness that the taxpayer suffered as a result of the conduct of [UCB], [t]he settlement proceeds should be excluded from income taxation pursuant to [I.R.C, §] 104. In the alternative, the settlement proceeds should be treated as capital gain income because of the injury to the taxpayer's business reputation and business goodwill. The decline in value of the taxpayer's business reputation and business goodwill, as a result of the actions of others, should be treated as the disposition of a capital asset.
Id. The IRS disallowed the Duffys' request for a refund on April 12, 2012, stating that "[t]he $50,000 non-employee compensation from [UCB] is taxable as originally filed." Def.'s Mot. at Ex. 10; see also Pls.' Opp'n at Ex. 5-6.
Just short of two years after the notice of disallowance, on April 11, 2014, the Duffys filed suit in this court, arguing that the IRS erroneously denied their refund claim. An amended complaint was filed on May 2, 2014. In the pleadings, the Duffys presented identical arguments to those raised in the second amended tax return, i.e., that they are entitled to recover a tax refund of $13,049 because the settlement payment of $50,000 was excludable from gross income under I.R.C. § 104(a)(2), or alternatively, was taxable as capital gains for lost goodwill. Compl. at 1; see also Am. Compl. at 1. Notably absent from these pleadings was any reference to the second amended tax return or an accompanying attachment of either amended tax return. On July 28, 2014, the government responded with a motion to dismiss for lack of subject matter jurisdiction pursuant to RCEC 12(b)(1) and for failure to state a claim upon which relief can be granted pursuant to RCFC 12(b)(6). In opposition to the government's motion to dismiss, the Duffys proffered new documents, including the second amended return filed on October 4, 2011 See Pls.' Opp'n at Ex. 2. In light of these extra-pleading materials, the government withdrew its claim for lack of subject matter jurisdiction.8 Following briefing and a hearing, the case is ready for disposition.
The Tucker Act, 28 U.S.C. § 1346(a)(1), grants this court jurisdiction to consider federal tax refund claims. Smith v. United States, 495 Fed. Appx. 44, 48 (Fed. Cir....
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