St. Charles Inv. V. Comm. Of Internal Revenue

• Decision Date: 14 November 2000
• Docket Number: No. 99-9020,99-9020
• Citation: 232 F.3d 773
• Parties: (10th Cir. 2000) ST. CHARLES INVESTMENT CO., BURTON C. BOOTHBY, Tax Matters Person, Petitioners - Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee
• Court: U.S. Court of Appeals — Tenth Circuit

Page 773

232 F.3d 773 (10th Cir. 2000)

ST. CHARLES INVESTMENT CO., BURTON C. BOOTHBY, Tax Matters Person, Petitioners - Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 99-9020

UNITED STATES COURT OF APPEALS TENTH CIRCUIT

November 14, 2000

APPEAL FROM THE UNITED STATES TAX COURT. (T. Ct. No. 5793-96)

Darrell D. Hallett (John M. Colvin, with him on the briefs), Chicoine & Hallett, P.S., Seattle, Washington, for Petitioners-Appellants.

Ellen Page DelSole (Gilbert S. Rothenberg, with her on the brief), Attorneys, Tax Division, Department of Justice, Washington, D.C., for Respondent-Appellee.

Before TACHA, McWILLIAMS, and MURPHY, Circuit Judges.

TACHA, Circuit Judge.

The Commissioner of Internal Revenue ("Commissioner") disallowed certain deductions claimed by St. Charles Investment Co., Burton C. Boothby, Tax Matters Person ("St. Charles") after determining that St. Charles had improperly carried forward certain passive activity losses from years in which St. Charles had been a C corporation to the year in which St. Charles became an S corporation. The tax court granted summary judgment in favor of the Commissioner and St. Charles appeals. We exercise jurisdiction pursuant to 26 U.S.C. 7482 and reverse.

I. BACKGROUND

Prior to 1991, St. Charles was a closely held C corporation as defined by 469(j)(1).¹ During the years 1988-1990, St. Charles had been engaged in the real estate rental business. St. Charles's real estate rental activity was a passive activity as defined by 469(c). In each of the years 1988, 1989, and 1990, St. Charles's passive activities generated total deductions in excess of the total gross income from the activities. Such losses, passive activity losses ("PALs"), are non-deductible pursuant to 469(a). Section 469(b), however, provides that PALs can be suspended and "carried forward" to the following year. Furthermore, 469(g)(1)(A) provides that in the year of disposition of the passive activity, any remaining PAL, after the application of 469(b)'s carry over provision (and after utilizing the PAL to offset gain from the passive activity) shall be treated as a non-passive loss.

Effective January 1, 1991, St. Charles elected to be taxed as an S corporation. Also in 1991, St. Charles sold several of its rental properties for which there existed suspended PALs for the years 1988, 1989, and 1990. On its 1991 tax return, St. Charles identified the suspended PALs that were associated with the sold properties and claimed those deductions in full pursuant to 469(g)(1)(A). Furthermore, on its 1991 tax return St. Charles reduced its cost basis with respect to the activities sold in 1991 to reflect the depreciation portion of the PAL deductions taken.

On January 2, 1996, the Commissioner issued a Notice of Final S Corporation Administrative Adjustment for St. Charles's tax year ending December 31, 1991. The Commissioner's adjustment disallowed the deduction of $4,879,852 in suspended PALs and the use of $6,038,001 in suspended PALs for purposes of calculating the Alternative Minimum Tax. The adjustments were based on 1371(b)(1) which prohibits an S corporation from carrying any "carryforward" from a year in which the corporation was a C corporation to a year in which the corporation is an S corporation. St. Charles petitioned the tax court challenging the Commissioner's adjustments.² In addition, St. Charles argued that if the PAL deductions were disallowed, St. Charles ought to be able to readjust its cost basis in the sold properties upwards in order to reflect the fact that the depreciation deductions had been disallowed.

In the tax court, the parties cross-moved for partial summary judgment on both issues: (1) whether 1371(b)(1) precluded St. Charles's deduction in 1991 of suspended PALs that had been incurred between 1988 and 1990 when St. Charles had been a closely held C corporation; and (2) whether, if the Commissioner had properly disallowed the carryover of the suspended PALs, St. Charles was entitled to recalculate its cost basis in the sold properties. The tax court ruled in favor of the Commissioner on both issues, and both rulings are now before this Court on appeal.

II. ANALYSIS

We review a grant of summary judgment de novo, applying the same legal standard as the court below. Bullington v. United Air Lines, Inc., 186 F.3d 1301, 1313 (10th Cir. 1999). There is no genuine dispute of material facts, therefore we need only determine whether the lower court correctly applied the substantive law. We review de novo the tax court's interpretation of the various provisions of the Internal Revenue Code. Gitlitz v. C.I.R., 182 F.3d 1143, 1145 (10th Cir. 1999).

The issue is before us as a matter of first impression and, insofar as we can determine, has not been addressed in any other circuit. The parties present diametrically opposed interpretations of what, by any measure, is a complex set of statutory provisions. We begin with a review of each section's place in the broader context of the Internal Revenue Code and then consider and construe the specific statutory language.

Congress enacted the Subchapter S Revision Act of 1982 as part of an ongoing effort to give corporate shareholders the flexibility to be taxed in large measure as if they were a partnership. See generally 5 Jacob Mertens, Jr., The Law of Federal Income Taxation 41B:239 (1997). Under Subchapter S, the income of a corporation that elects S status is not taxed at the corporation level, but rather, flows through and is taxed as income to the corporation's shareholders individually. Recognizing, however, the potential for abuse inherent in this system, Congress made 1371(b) a part of subchapter S in order to prevent corporate losses incurred prior to its electing S status from inuring to the benefit of the corporation's shareholders after an S status election. See generally Id. 41B:02 (The 1982 Act was intended to "prevent unwarranted tax benefits under Subchapter S."); Rosenberg v. C.I.R., 96 T.C. 451, 455 (1991) ("Section 1371(b)(1) . . . is only one of several provisions designed to prevent abuses of the S corporation election.").

Four years later, in 1986, Congress enacted 469 out of concern that taxpayers were "front-loading" deductions arising from activities in which the taxpayers did not participate (passive activities) and using those deductions to reduce the taxpayers' other income. See generally 5 Merten, supra 24C:02. Section 469, therefore, is a comprehensive, cradle-to-the-grave statutory scheme governing gain and loss from passive activities. Section 469 allows PALs to be deducted only to the extent the taxpayer has passive activity gains. Any remaining PAL is suspended, and carried over to the next year, again becoming available to offset passive activity gains. Only upon the disposition of the passive activity does the entire PAL, including the suspended PALs from previous years, become available as a deduction against both passive activity gains and other, ordinary income.

It is our primary task in interpreting statutes to "determine congressional intent, using 'traditional tools of statutory construction.'" NLRB v. United Food & Commercial Workers Union, 484 U.S. 112, 123 (1987) (quoting INS v. Cardoza-Fonseca, 480 U.S. 421, 446 (1987)). As in all cases requiring statutory construction, "we begin with the plain language of the law." United States v. Morgan, 922 F.2d 1495, 1496 (10th Cir. 1991). In so doing, we will assume that Congress's intent is expressed correctly in the ordinary meaning of the words it employs. Park 'N Fly, Inc. v. Dollar Park & Fly, Inc., 469 U.S. 189, 194, 105 S. Ct. 658, 83 L. Ed. 582 (1985). Therefore, "[i]t is a well established law of statutory construction that, absent ambiguity or irrational result, the literal language of a statute controls." Edwards v. Valdez, 789 F.2d 1477, 1481 (10th Cir. 1986). Where the language of the statute is plain, it is improper for this Court to consult legislative history in determining congressional intent. United States v. Richards, 583 F.2d 491, 495 (10th Cir. 1978). Furthermore, legislative history may not be used to create ambiguity in the statutory language. Id. Our role in construing statutes was summarized by Justice Holmes: "'We do not inquire what the legislature meant; we ask only what the statute means.'" Edwards, 789 F.2d at 1481 n.7 (quoting Oliver Wendell Holmes, Collected Legal Papers 207 (1920)). Therefore, despite each party's reliance on legislative history to buttress its position, we rely first on the language of the statute.

The crux of the statutory dispute centers on the conflict between the two specific carryover provisions: 469(b) and 1371(b)(1). Section 469(b) states: "Except as otherwise provided in this section, any loss or credit from an activity which is disallowed under subsection (a) shall be treated as a deduction or credit allocable to such activity in the next taxable year." Section 1371(b)(1), on the other hand, provides that "[n]o carryforward, and no carryback, arising for a taxable year for which a corporation is a C corporation may be carried to a taxable year for which such corporation is an S corporation." We must decide which statutory section governs the treatment of suspended PALs after a corporate changeover from a C year to an S year. Either the language of 469(b) functions as a statutory "traffic cop," preventing any provision of the Code outside of 469 itself from negating the general rule of 469(b), or, 1371(b)(1)'s clear prohibition on carryovers effectively trumps the general rules of 469. We hold that the plain language of 469 precludes application of 1371 to the suspended PALs of a corporation in the first year of its S election. Because we hold that St. Charles's suspended PALs are deductible in 1991, we need not reach a conclusion on the question of whether St. Charles is entitled to a cost basis readjustment.

It is a general rule of statutory...