Sturrus v. Dep't of Treasury

• Decision Date: 19 May 2011
• Docket Number: Docket No. 295403.
• Citation: 809 N.W.2d 208,292 Mich.App. 639
• Parties: STURRUS v. DEPARTMENT OF TREASURY.
• Court: Court of Appeal of Michigan — District of US

292 Mich.App. 639

809 N.W.2d 208

STURRUS

v.DEPARTMENT OF TREASURY.

Docket No. 295403.

Court of Appeals of Michigan.

Submitted Feb. 1, 2011, at Lansing.Decided Feb. 8, 2011.Approved for publication May 19, 2011, at 9:00 a.m.

Varnum LLP, Novi (by Thomas J. Kenny and Marla Schwaller Carew) for plaintiffs.

Bill Schuette, Attorney General, B. Eric Restuccia, Solicitor General, and Heidi L. Johnson–Mehney, Assistant Attorney General, for defendant.

Before: MURPHY, C.J., and WHITBECK and MURRAY, JJ.

PER CURIAM.

In this dispute over the proper application of the tax-benefit rule, defendant, the Department of Treasury, appeals as of right the Court of Claims' order denying its motion for summary disposition, granting plaintiffs' motion for summary disposition, reversing the Department's decision and order of determination, and compelling the Department to refund plaintiffs $174,214, plus interest. We hold that although the Court of Claims correctly ruled that the Michigan Income Tax Act (ITA), MCL 206.1 et seq. , necessarily incorporates the federal tax-benefit rule, the rule was not applicable in this case. Therefore, we reverse the opinion and order of the Court of Claims.

I. BACKGROUND

This case finds its genesis in plaintiffs' attempt to recover their lost investment in the Pupler Distributing Company, an organization later discovered to be a Ponzi scheme.¹ Between 1998 and 2002, plaintiffs loaned over $4,000,000 to Pupler and, in return, received interest payments of $4,346,680. Plaintiffs reported and paid federal and state taxes on the interest payments for the years 1998 through 2002.

In late 2002, plaintiffs discovered that Pupler was a Ponzi scheme with no legitimate business purpose. Pupler's interest payments to plaintiffs ceased at that time, with Pupler owing plaintiffs $5,108,500 in outstanding loans. As a result, plaintiffs claimed a theft-loss deduction of $5,108,500 for this lost investment on their 2002 federal tax return pursuant to 26 U.S.C. § 165, and reduced their federal tax liability accordingly. Notably, the theft-loss deduction is taken “below the line” (i.e., after the determination of adjusted gross income). Consequently, because Michigan tax liability is based on the federal definitions of adjusted gross income,² the deduction had no effect on plaintiffs' Michigan income tax liability.

On November 14, 2002, an involuntary petition was filed in the United States Bankruptcy Court against Pupler pursuant to chapter 7 of the bankruptcy code, 11 U.S.C. § 701 et seq. The bankruptcy trustee subsequently demanded that plaintiffs return the $4,346,680 in interest payments they had received from Pupler, plus a 10 percent premium on the interest earned. Plaintiffs eventually entered into a settlement agreement with the bankruptcy trustee permitting them to offset the repayment of interest against their lost investment in Pupler. However, because the amount of plaintiff's interest repayment plus the premium totaled more than the lost investment, plaintiffs submitted a check in the amount of $350,000, representing the difference in the two figures.

Based on this transaction, plaintiffs reported a theft-loss recovery of $4,200,160 (the estimated total amount of their recovered lost investment) on their 2004 federal income tax return.³ Notably, a theft-loss recovery is added “above the line” and therefore is included in the calculation of a taxpayer's adjusted gross income. The report of the theft-loss recovery, therefore, had significant Michigan tax liability implications for plaintiffs because, as previously noted, the theft-loss deduction (for their lost principal investment) claimed by plaintiffs in 2002 was taken “below the line” and consequently provided plaintiffs no Michigan tax benefit. Thus, in order to avoid paying taxes twice on the same income, plaintiffs deducted the amount of the theft-loss recovery ($4,200,160) from the adjusted gross income of their 2004 Michigan income tax return. Plaintiffs based this action on the federal “tax benefit rule.” ⁴ Under this adjustment, plaintiffs claimed a Michigan tax refund of $171,348, plus interest.

The Department subsequently audited plaintiffs' 2004 income tax return and issued a notice of intent to assess on the ground that the tax-benefit rule did not apply and, therefore, the theft-loss recovery deduction was improper. Consequently, the Department denied plaintiffs' tax refund claim and found an income tax deficiency of $2,866, plus interest, for the 2004 tax year. At the request of plaintiffs, an informal conference with the Department was held on November 14, 2006. At the conclusion of the conference, the hearing referee recommended that the federal tax-benefit rule be incorporated into Michigan law and that the assessment be canceled. Two years later, however, the director of tax policy overruled that recommendation and affirmed the assessment.

Plaintiffs paid the assessed tax and interest before initiating suit in the Court of Claims on January 28, 2009. In their complaint, plaintiffs requested an order requiring the Department to apply the tax-benefit rule and claim-of-right doctrine and to issue a tax refund. The Department answered in due course, and plaintiffs filed their motion for summary disposition under MCR 2.116(C)(10) (no genuine issue of material fact).

According to plaintiffs, since the federal theft-loss deduction provided no Michigan income tax benefit, the theft-loss recovery was not includable in plaintiff's adjusted gross income under the tax-benefit rule because the Michigan ITA specifically incorporates definitions and deductions of the Internal Revenue Code. The Department responded that because plaintiffs failed to prove remission of their interest payment from Pupler to the trustee, who in any event did not have authority to require such a payment, and alternatively, because the ITA did not provide for the application of the tax-benefit rule to theft losses, the court should grant the Department summary disposition under MCR 2.116(I)(2) (opposing party entitled to judgment) and dismiss plaintiffs' complaint.

In a 10–page opinion and order, the Court of Claims held that the tax-benefit rule was applicable based on an apparent ambiguity in the law. Specifically, the court explained:

Based simply on the plain language of the Act itself, it appears that the tax benefit rule must be recognized in Michigan. After all, the Act adopts by reference the definitions and principles contained in federal law and the Internal Revenue Code, and the Internal Revenue Code, in turn, incorporates the tax benefit rule. Defendant, however, points to the fact that the Legislature in certain circumstances, explicitly provided in the Act for adjustments to one's taxable income to account for deductions that may be taken on one's federal taxes but not on one's Michigan income tax returns, such as state, city, and property tax refunds. Noting that the Legislature thus knew how to provide for such adjustments when it wanted to, but that it did not provide for such an adjustment based on Michigan's non-recognition of the Theft Loss Deduction, Defendant argues that clearly the Legislature did not intend to adopt the tax benefit rule in Michigan's Income Tax Act in such circumstances. This is an equally viable interpretation. [Emphasis in original.]

Noting that such an ambiguity must be construed in plaintiffs' favor, the court found that “the Michigan Income Tax Act itself provides for the recognition of the tax benefit principle.” Additionally, the court rejected the Department's argument that plaintiffs failed to remit their interest repayment to the trustee since plaintiffs had offset their interest repayment by the amount of their lost investment. Accordingly, the court granted summary disposition to plaintiffs, reversed the Department's decision and order of determination, and canceled plaintiffs' December 26, 2008, final bill for taxes due. Plaintiffs were therefore entitled to a refund of $174,214, plus interest. The instant appeal ensued.

II. ANALYSIS

On appeal, the Department reiterates its challenge to plaintiffs' eligibility for a tax refund. The Court reviews de novo an appeal from an order granting a motion for summary disposition. Dressel v. Ameribank, 468 Mich. 557, 561, 664 N.W.2d 151 (2003). A motion for summary disposition pursuant to MCR 2.116(C)(10) should be granted when the moving party is entitled to judgment as a matter of law because there is no genuine issue of material fact. Maiden v. Rozwood, 461 Mich. 109, 120, 597 N.W.2d 817 (1999). A genuine issue of material fact exists when reasonable minds could differ after drawing reasonable inferences from the record. West v. Gen. Motors Corp., 469 Mich. 177, 183, 665 N.W.2d 468 (2003). In reviewing this issue, the Court must consider the pleadings, affidavits, depositions, admissions, and other documentary evidence and construe them in a light most favorable to the nonmoving party. Corley v. Detroit Bd. of Ed., 470 Mich. 274, 278, 681 N.W.2d 342 (2004). Issues of statutory interpretation are also questions of law that we review de novo. USAA Ins. Co. v. Houston Gen. Ins. Co., 220 Mich.App. 386, 389, 559 N.W.2d 98 (1996).

A. PLAINTIFFS' PAYMENT TO THE TRUSTEE

Before reaching the merits of the applicability of the tax-benefit rule, we first address the Department's preliminary contention that plaintiffs are not entitled to a refund since they failed to remit to the bankruptcy trustee interest payments received from Pupler. The flaw of this argument is the failure to acknowledge that plaintiffs' actual repayment to the trustee of $350,000 was the difference between the Pupler interest payments and plaintiffs' lost investment. Further, as the lower court observed, the Department failed to submit any evidence calling into question the estimation of plaintiffs' accountant that plaintiffs recovered only $4,200,120 of their lost investment. An opposing party...