Hamilton v. CIR

955 F.3d 1169

• Court: Court of Appeals for the Tenth Circuit
• Decided: April 7, 2020
• Docket: 19-9000
• Status: Published

Opinion

FILED United States Court of Appeals Tenth Circuit

PUBLISH April 7, 2020 Christopher M. Wolpert UNITED STATES COURT OF APPEALS Clerk of Court

TENTH CIRCUIT

VINCENT C. HAMILTON and STEPHANIE HAMILTON,

Petitioners - Appellants, v. No. 19-9000 COMMISSIONER OF INTERNAL REVENUE,

Respondent - Appellee.

APPEAL FROM THE UNITED STATES TAX COURT (NO. 1: 008037-16)

Paul W. Jones, Hale & Wood, LLP, Salt Lake City, Utah, for Appellants.

Julie Ciamporcero Avetta, Attorney, Tax Division (Richard E. Zuckerman, Principal Deputy Assistant Attorney General, and Francesca Ugolini, Attorney, Tax Division, with her on the brief), Department of Justice, Washington, D.C., for Appellee.

Before TYMKOVICH, Chief Judge, MATHESON and McHUGH, Circuit Judges.

TYMKOVICH, Chief Judge. The Internal Revenue Code permits taxpayers who demonstrate insolvency

to exclude discharged debts from their taxable income. Claiming insolvency,

taxpayer Vincent Hamilton accordingly sought to exclude nearly $160,000 in

student loans that were forgiven in the aftermath of a disabling injury. During the

same tax year, however, he had received a non-taxable partnership distribution

worth more than $300,000.

His wife transferred those funds into a previously-unused savings account

held nominally by their adult son. Using login credentials provided by their son,

Mrs. Hamilton incrementally transferred almost $120,000 back to the joint

checking account she shared with her husband. The Hamiltons used these funds

to support their living expenses.

In a late-filed joint tax return, they excluded the discharged student-loan

debt on the theory that Mr. Hamilton was insolvent. In calculating his assets and

liabilities, however, the Hamiltons did not include the funds transferred into the

savings account. Had they done so, Mr. Hamilton would not have met the criteria

for insolvency; and the couple would have owed federal income tax on the

student-loan discharge.

The Commissioner of Internal Revenue eventually filed a Notice of

Deficiency, reasoning that the partnership distribution rendered Mr. Hamilton

solvent, such that the Hamiltons were required to pay income tax on the cancelled

-2- debt. The Hamiltons petitioned for review from the Tax Court, which sustained

both the deficiency and a significant late-filing penalty. They timely appealed.

We AFFIRM. The Tax Court correctly concluded that the Hamiltons

exercised effective control over the funds Mrs. Hamilton had transferred into the

savings account.

I. Background

Prior to his disabling back injury in 2008, Mr. Hamilton borrowed more

than $150,000 to pay costs associated with medical school for his son. Mrs.

Hamilton, who managed the family’s finances in the aftermath of his injury,

subsequently sought to discharge these student-loan obligations. Her efforts met

with success, and these loans were fully discharged in 2011.

That same year, Mr. Hamilton received a non-taxable distribution worth

more than $300,000 from his partnership interest in a movie-theater business.

Mrs. Hamilton transferred these funds into a previously-unused savings account

held by their son, who then provided her with login credentials for the account. 1

Throughout Tax Year 2011, she withdrew nearly $120,000 to finance household

expenses for both parents.

1 Mrs. Hamilton included several thousand dollars that did not arise from the partnership distribution among the funds she transferred into the savings account. The total value of the funds transferred exceeded $320,000.

-3- The Hamiltons did not file a federal return for Tax Year 2011 until March

2014. Filing jointly, they reported just over $850,000 in liabilities and just under

$680,000 in assets. But these figures made no mention of the funds that Mrs.

Hamilton had moved into the savings account. One consequence of this omission

now stands out as particularly important. Mr. Hamilton self-identified as

insolvent, because—using these numbers—his liabilities exceeded his assets by

roughly $170,000. 2 For this reason, the Hamiltons sought to pay no federal

income tax on the discharged debt.

If they had included the partnership distribution as an asset for purposes of

the insolvency determination, then Mr. Hamilton’s assets (around $1,000,000,

under this new math) would have outnumbered his liabilities (still $850,000) by

roughly $150,000. Obviously, this calculus would deprive Mr. Hamilton of his

rationale for not paying federal income tax on the cancelled debt.

The Commissioner of Internal Revenue eventually filed a Notice of

Deficiency, reasoning that—because, in light of the funds contained within the

savings account, Mr. Hamilton’s assets outnumbered his liabilities—the couple

could not exclude the discharged debt from their federal tax return. The

Hamiltons disagreed, eventually taking the position that the funds Mrs. Hamilton

2 As the government acknowledged during oral argument, we assess insolvency for purposes of 26 U.S.C. § 108 on an individual basis, even when taxpayers file jointly.

-4- transferred into the savings account should be considered their son’s assets, rather

than their own.

The Hamiltons petitioned for review from the Tax Court, which—on the

basis of this same stipulated record—applied the doctrine of “substance over

form” to sustain the Notice of Deficiency. The Tax Court also sustained the late-

filing penalties. On appeal, the Hamiltons primarily argue the Tax Court erred in

characterizing the funds transferred into the savings account as their assets.

II. Analysis

We review decisions of the Tax Court in the same manner as civil actions

tried without a jury. Petersen v. Comm’r, 924 F.3d 1111, 1114 (10th Cir. 2019)

(citing Katz v. Comm’r, 335 F.3d 1121, 1125–26 (10th Cir. 2003)); see also 26

U.S.C. § 7482(a)(1). We accordingly review legal conclusions de novo and

factual determinations only for clear error. 3 Id. (citing same).

3 Because insolvency requires a factual determination, we review the Tax Court’s treatment of the cancellation-of-indebtedness income primarily for clear error. See Merkel v. Comm’r, 192 F.3d 844, 847 (9th Cir. 1999). The Hamiltons contend the Tax Court’s denial of their claim presents a question of law, such that we must engage in de novo review. Notwithstanding the legal arguments the Hamiltons raise, the outcome of this case rests almost entirely upon the Tax Court’s factual determination of their dominion over the assets contained within the savings account. No matter the standard of review, however, it is clear that the Hamiltons exercised effective control over the assets contained within the savings account.

-5- A. Characterization of Assets

The Hamiltons contend the Tax Court erred in characterizing the funds

contained within the savings account as their assets for purposes of the insolvency

inquiry. As our application of governing law to these stipulated facts will

demonstrate, we disagree.

1. Governing Law

The Internal Revenue Code broadly defines gross income to encompass “all

income from whatever source derived,” including income from the discharge of

indebtedness. 26 U.S.C. § 61(a)(11). But a narrow statutory exception permits

taxpayers to exclude debt from discharged income, so long as the discharge

occurs at a time when the taxpayer is insolvent. 26 U.S.C. § 108(a)(1)(B).

This exception acknowledges the reality that insolvent taxpayers will

realize no income from discharge because—as a practical matter—no assets

become available to the taxpayer. See United States v. Kirby Lumber Co., 284

U.S. 1 (1931). For this reason, the Code also limits the exclusion of discharge-of-

indebtedness income to the amount by which the taxpayer’s liabilities exceed his

assets. See 26 U.S.C. § 108(a)(3); see also Carlson v. Comm’r, 116 T.C. 87, 91

(2001) (“[T]he term ‘insolvent’ means the excess of liabilities over the fair

market value of assets.”) (quoting 26 U.S.C. § 108(d)(3)).

-6- It is well-settled that the taxpayer bears the burden of demonstrating that

his liabilities outnumber his assets. E.g., Shepherd v. Comm’r, 104 T.C.M.

(CCH) 108 (2012) (citations omitted). Although the Code does not expressly

define the term “assets,” the Tax Court has, for these purposes, construed it to

include any resource that “can give the taxpayer the ability to pay an immediate

tax on income from the canceled debt.” Schieber v. Comm’r, 113 T.C.M. (CCH)

1144 (2017) (internal quotation marks omitted) (quoting Carlson, 116 T.C. at

104–05 (observing that even assets beyond the reach of other creditors could

constitute assets for the purposes of 26 U.S.C. § 108(d)(3))).

In conducting this practical inquiry, the Internal Revenue Service may

appropriately prioritize “substance over form.” E.g., Frank Lyon Co. v. United

States, 435 U.S. 561, 572–73 (1978) (citations omitted). In cases where, as here,

a “transferor continues to retain significant control over the property transferred,”

the Service may set aside niceties like formal title. Id. Indeed, we have

repeatedly ratified the propriety of prioritizing economic reality in place of the

formal characterizations taxpayers may lend transactions. See Rogers v. United

States, 281 F.3d 1108, 1116–17 (10th Cir. 2002) (“[T]he doctrine of substance

over form has been recognized in a number of our precedents.”).

-7- 2. Application

The Tax Court appropriately applied the substance-over-form doctrine to

characterize the disputed funds as the Hamiltons’ assets for purposes of the

insolvency calculation required by 26 U.S.C. § 108. Given the evidence disclosed

by the stipulated record, the Tax Court properly concluded they exercised

effective ongoing control over these funds.

Prior to the transfer, the record suggests their son used this savings account

rarely, if at all. No evidence indicates the transfer represented a gift. 4 Nor did

their son pay any consideration in exchange for these funds. Moreover, he

immediately provided Mrs. Hamilton with login credentials so that she could

access these funds whenever she wanted. During Tax Year 2011, she withdrew

nearly $120,000 to cover living expenses. 5 Their son, by contrast, never withdrew

any of these funds.

Although the Hamiltons now contend he could have changed the login

credentials so as to lock out his mother, we think it more significant that he never

did so. See, e.g., Sanford’s Estate v. Comm’r, 308 U.S. 39, 43 (1939) (“[T]he

essence of a transfer is the passage of control over the economic benefits of the

4 The record discloses none of the tax documentation one might ordinarily expect for a gift of this size. 5 Although only Mrs. Hamilton accessed these funds, it is undisputed that she did so to pay joint living expenses.

-8- property rather than any technical changes in its title.”). Because the Hamiltons

retained effective control over the disputed funds, we conclude the Tax Court did

not err.

The Hamiltons also contend that—under Utah law—their son was the sole

owner of the savings account. 6 But this argument bears not at all on the

substance-over-form inquiry. See Carlson, 116 T.C. at 104–05 (observing that

assets beyond the reach of other creditors may nonetheless constitute assets for

federal tax purposes). This is because “taxation is not so much concerned with

the refinements of title as it is with the actual command over the property taxed.”

See Sanford, 308 U.S. at 43 (internal quotation marks and citations omitted).

The Hamiltons alternatively assert we should treat the disputed funds as

separate property owned solely by Mrs. Hamilton. This argument fails for much

the same reason, since—as we have seen—assets beyond the reach of ordinary

creditors may nonetheless constitute assets for federal tax purposes. See Carlson,

116 T.C. at 104–05. Here, the vast majority of the disputed funds arose from Mr.

6 On appeal, the Hamiltons advance a related argument—which they raised for the first time in their motion for reconsideration below—that the Tax Court lacked authority to apply the nominee inquiry to a deficiency proceeding. As the government observes, we ordinarily will not consider arguments previously available to litigants that were raised for the first time in post-judgment motions. See Servants of Paraclete v. Does, 204 F.3d 1005, 1012 (10th Cir. 2000). Even if we were to depart from that practice here, this argument would not disturb our conclusion that the Tax Court did not err.

-9- Hamilton’s partnership distribution; and the funds Mrs. Hamilton withdrew during

Tax Year 2011 supported both of their living expenses. We accordingly conclude

that Mr. Hamilton—with Mrs. Hamilton acting as his agent—exercised effective

control over these funds. See Sanford, 308 U.S. at 43.

In our view, the Tax Court erred neither factually nor legally in sustaining

the Notice of Deficiency. 7

B. The Late-Filing Penalties

As a result of their two-year delay in filing a federal return for Tax Year

2011, the Internal Revenue Service assessed the Hamiltons late-filing penalties

pursuant to 26 U.S.C. § 6651(a)(1). The Tax Court sustained these penalties,

concluding their failure to file stemmed from willful neglect, rather than

reasonable cause. The Hamiltons also appeal that determination.

7 The Hamiltons have also argued the Tax Court erred in refusing to shift the burden of persuasion to the government. Although taxpayers ordinarily must carry the burden of persuasion with respect to any claimed deduction, a statutory exception may shift this presumption back to the government on factual issues the taxpayer supports with credible evidence. E.g., Esgar Corp. v. Comm’r, 744 F.3d 648, 653 (10th Cir. 2014) (citing 26 U.S.C. § 7491). To benefit from this burden- shifting exercise, an individual taxpayer must have: (1) complied with the requirements to substantiate any item; (2) maintained all required records; and (3) cooperated with reasonable requests for witnesses, information, documents, meetings, and interviews. Id. at 654 n.5 (cleaned up). The Tax Court concluded the Hamiltons failed to abide by these requirements, such that the burden should not shift. But we have observed “there is no need to rule on whether the burden shifts” when “evidence is not equally balanced.” Id. at 654. Since the evidence in this case strongly favors the government, we decline to consider this argument.

-10- The Code provides a limited exception for “reasonable cause” from

otherwise-steep penalties when taxpayers fail to timely file their returns. See 26

U.S.C. § 6651(a)(1). Because the presence or absence of reasonable cause

requires a factual determination, we review the Tax Court’s treatment of late-

filing penalties assessed under 26 U.S.C. § 6651(a)(1) for clear error. See In re

Craddock, 149 F.3d 1249, 1255 (10th Cir. 1998) (citing United States v. Boyle,

469 U.S. 241, 249 n.8 (1985)).

Precedent tells us the Hamiltons bear a “heavy burden” in seeking to

demonstrate reasonable cause. See id. (quoting United States v. Boyle, 469 U.S.

241, 245 (1985)). Indeed, we have previously observed that “reasonable cause

exists ‘if the taxpayer exercised ordinary business care and prudence and was

nevertheless unable to file the return within the prescribed time.’” Id. (quoting

Treas. Reg. § 301.6651-1(c) (emphasis in original)).

Here, the stipulated record offers no explanation that would account for the

Hamiltons’ failure to file timely their 2011 Tax Return. In briefing, they contend

their attention was “consumed with [Mr. Hamilton’s] care and well[-]being.”

Aplt. Br. 24. But the record discloses no evidence of incapacity, save for Mr.

Hamilton’s injury. And—during this same period—Mrs. Hamilton successfully

managed the complex task of obtaining the student-loan discharge.

-11- In our view, the Tax Court did not clearly err in upholding the late-filing

penalties assessed under 26 U.S.C. § 6651(a)(1).

III. Conclusion

For the reasons stated herein, we accordingly AFFIRM the judgment of the

Tax Court.

-12-