Sahadi v. Scheaffer

• Decision Date: 25 September 2007
• Docket Number: No. H029782.,H029782.
• Court: California Court of Appeals Court of Appeals
• Parties: Fred SAHADI et al., Plaintiffs and Appellants, v. Raymond E. SCHEAFFER et al., Defendants and Respondents.

66 Cal.Rptr.3d 517

155 Cal.App.4th 704

Fred SAHADI et al., Plaintiffs and Appellants, v. Raymond E. SCHEAFFER et al., Defendants and Respondents.

No. H029782.

Court of Appeal, Sixth District.

September 25, 2007.

[66 Cal.Rptr.3d 520]

Donald J. Putterman, Constance J. Yu, Sideman & Bancroft, San Francisco, Jon B. Eisenberg, Eisenberg & Hancock, Oakland, for Plaintiffs and Appellants.

Arthur V. Pearson, Joan E. Low, Murphy, Pearson, Bradley & Feeney, San Francisco, Daniel U. Smith, Law Offices of Daniel U. Smith, Kentfield, for Defendants and Respondents.

DUFFY, J.

Accounting malpractice actions are governed by a two-year statute of limitations under Code of Civil Procedure section 339, subdivision (1).¹ Courts have construed the statute as requiring commencement of the suit no later than two years after the client discovered (or reasonably should have discovered) the accountant's negligence, and has suffered actual injury resulting from that negligence. International Engine Parts, Inc. v. Feddersen & Co. (1995) 9 Cal.4th 606, 38 Cal.Rptr.2d 150, 888 P.2d 1279 (Feddersen) concerned the accrual of the statute of limitations for an accountant's negligent preparation of tax returns. The Supreme Court in Feddersen held that where the client, after being audited, is determined by the Internal Revenue Service (IRS) to owe additional taxes, the two-year statute of limitations does not commence—i.e., the client-taxpayer does not sustain actual injury—until the IRS has made a final determination that there is a tax deficiency. The case before us tests the limits of Feddersen. We must decide whether the statute of limitations for accounting malpractice (negligent preparation of income tax returns) commences at the conclusion of the audit, where the IRS tentatively concludes that substantial additional taxes, interest, and penalties are owed but later makes a final determination that there is no tax deficiency.

Appellants Fred Sahadi and Helen Sahadi (collectively the Sahadis) retained respondents Raymond E. Scheaffer (Scheaffer) and the accounting firm of Abbot, Stringham & Lynch, Inc. (Accounting Firm) to prepare and file their federal and state income tax returns.² Separate audits of the Sahadis' tax returns by the state Franchise Tax Board (FTB) and the IRS thereafter commenced in 1993 and 1994, respectively. The state tax audit concluded with the FTB's issuing a notice of action assessing additional taxes for 1991 of $618,055. The IRS in January 1997 notified the Sahadis of a proposed deficiency assessment of $35,000,000 (including taxes, interest, and penalties). The Sahadis challenged the proposed tax deficiency assessment in protracted proceedings before the IRS. In a remarkable reversal of fortune, occurring after more than five years of negotiation, the IRS formally withdrew the proposed deficiency assessment and determined that the Sahadis were entitled to a substantial refund.

The Sahadis brought a negligence suit against Accountants on October 10, 2003, less than two years after the IRS formally withdrew its proposed tax deficiency assessment. In bifurcated trial proceedings, the court concluded the action was barred by the applicable statute of limitations and entered judgment in Accountants' favor. The Sahadis appeal from that judgment. They claim that under Feddersen, supra, 9 Cal.4th 606, 38 Cal.Rptr.2d 150, 888 P.2d 1279, the statute of limitations on their malpractice claim was tolled until the audit process was concluded by the IRS's formal withdrawal of its proposed tax deficiency assessment. The Sahadis contend that the action was timely because their accounting malpractice suit was filed within two years of that formal withdrawal.

We conclude that the court below erred in concluding that the Sahadis' claims were time-barred. Under Feddersen, supra, 9 Cal.4th 606, 38 Cal.Rptr.2d 150, 888 P.2d 1279, the two-year statute of limitations under section 339, subdivision (1) commenced when the IRS administrative appeal process was concluded with the formal withdrawal of the proposed tax deficiency assessment. Since the audit process formally concluded when an agreement settling the issues in the audit with no tax deficiency was executed by the Sahadis and the IRS in August 2002, less than two years prior to the initiation of this action, the statute of limitations had not run. Accordingly, we will reverse the judgment.

FACTUAL BACKGROUND³

The Sahadis retained Scheaffer's former accounting firm, Weber Sanford & Co., in April 1992 to prepare their 1991 federal and state income tax returns. They filed their 1991 returns, prepared by Scheaffer, on April 15, 2002. The returns reflected federal and state tax liabilities of $400,794 and $1,828,130, respectively. The Sahadis filed amended 1991 tax returns, prepared by Scheaffer, on May 12, 1992; the federal and state tax liabilities reported—reflecting a reduction from the amounts listed on the original returns—were $224,209 and $1,018,785, respectively. On April 10, 1993, the Sahadis filed second amended 1991 tax returns that had been prepared by Scheaffer, then employed by Accounting Firm. The second amended returns reported federal and state tax liabilities of zero, based upon a reduction in the stated fair market values of certain properties.

A major issue confronting the Sahadis and Scheaffer in the preparation of the 1991 returns—and a major subject of the subsequent audits of those returns—was the tax treatment of a complicated transaction that had occurred in January 1991 in which the Sahadis transferred their ownership interest in The Pruneyard (a complex consisting of a high-rise office building, shopping center, and hotels in Campbell, California) to their lender through a deed in lieu of foreclosure. That issue turned on the Sahadis' insolvency when the transfer occurred, and, more specifically, the amount of that insolvency as determined largely by the fair market values of their property, including The Pruneyard, and the amount of the debt forgiven as a result of the deed-in-lieu transfer.

On June 3, 1993, the FTB commenced its audit of the Sahadis' 1989 through 1991 tax returns. On January 3, 1996, the FTB issued a document entitled "Notice of Action on Cancellation, Credit, or Refund" (notice of action) in which it determined that there was $618,055 in additional tax due (exclusive of interest). The Sahadis then retained attorney Richard Greene, who filed an appeal of the FTB assessment on April 1, 1996. The state Board of Equalization rejected the Sahadis' FTB appeal in November 1996 because they had not paid the full tax assessment; the Board advised the Sahadis to pay the assessment and then file a claim for refund. The Sahadis paid the assessment in installments between 1997 and 2002. After commencing payments, the Sahadis submitted a claim for refund with the FTB. On April 17, 2000, the FTB notified the Sahadis in response to their refund claim that because there was an appeal pending with the IRS, and "[s]ince the issue pending resolution is the same, we will suspend our examination pending the outcome of the IRS appeal."

On September 28, 1994, the IRS announced that it was auditing the Sahadis' 1991 income tax return. The IRS agent conducting the audit wrote several letters to Scheaffer in April 1996. In an information document request of April 19, 1996, the IRS agent stated: "`In December you offered to provide your position on this issue. Since you have not provided anything, even after my third request in January, the issue will be audited.'" On April 25, 1996, the agent confirmed that Scheaffer had not submitted appraisals for any of the Sahadis' property, noting: "`Now is the time to submit your appraisals.'" And on April 30, 1996, the agent wrote that Scheaffer had delayed the audit and had not responded to the agent's requests for various information.

On January 28, 1997, the IRS completed its examination of the Sahadis' tax returns, and in two revenue agents reports (or "30-day letters"), the IRS indicated proposed deficiencies (taxes, penalties, and interest) of $31,000,000 (for tax years 1990 through 1992), and of $4,000,000 (for 1993 through 1995). The reports included criticisms of Scheaffer for failing to (1) provide information the IRS had requested, and (2) offer support for tax positions he had asserted during the audit process.⁴

In February 1997, the Sahadis retained the law firm of Heller, Ehrman, White & McAullife (Heller Ehrman), as well as other tax, appraisal, and accounting professionals, to challenge the tax deficiencies proposed by the IRS. On March 31, 1997, Heller Ehrman filed a protest on behalf of the Sahadis to the IRS's proposed tax deficiency. By March 31, 1998, Accountants were no longer providing services to the Sahadis, who engaged other tax professionals to prepare their 1997 income tax returns.

In May 2002, the IRS administrative appeal process concluded with the IRS issuing an appeals audit statement and a form 870 (an IRS document used to settle cases with taxpayers).⁵ The appeals audit statement reflected that there were no tax deficiencies owed by the Sahadis and that there were net operating loss carryovers that would result in the subsequent issuance of substantial tax refunds. The Sahadis signed that form 870 on May 28, 2002, and the IRS countersigned the document on August 9, 2002.

On December 23, 2002, the FTB advised the Sahadis, through Heller Ehrman, that it was "closing the 1991 and 1996 claims [of the Sahadis] and allowing them in full." The FTB noted in its letter that it had "followed all of the adjustments made by the [IRS] during the appeal."

CHRONOLOGY

To facilitate our discussion below concerning Accountants' statute of limitations defense, we present a chronology of potentially relevant events here:

                04/15/92   Scheaffer files the Sahadis' 1991 tax returns
                05/12/92   Scheaffer files the Sahadis' amended 1991
                           tax returns
                04/10/93   Accountants file the

...