On Jan. 5, 2012, three co-personal representatives of the estate of George Batchelor (collectively, the Estate) filed a three-count complaint seeking federal income tax refunds. Later that year, in Anne Batchelor-Robjohns, et al. v. United States, Case No. 12-20038-CIV-MORENO (S.D. Fla. Aug. 27, 2013), the Estate and the United States filed motions for summary judgment on Counts I and III of the original complaint. In Count I, the Estate sought a refund for personal income taxes that allegedly arose out of a purchase of option assets during the 1999 sale of George’s aviation business, International Air Leases (IAL). In Count III, the Estate requested an additional income tax refund for 2005, claiming that it was entitled for an income tax deduction for settlement payments made in 2004.
Regarding summary judgment on Count I, the Estate argued that res judicata bars the United States from contesting the refund claim. The Estate claimed that in 2005, in United States v. Batchelor-Robjohns (Batchelor I), No. 03-20164-CIV-UNGARO-BENAGES (Oct. 31, 2005), this court had already granted summary judgment as a final judgment on the merits on the same cause of action that existed the present case.
Regarding summary judgment on Count III, the United States argued that Internal Revenue Code Section 642(g) precludes the Estate from taking an income tax deduction for the settlement payments, because it previously took an estate tax deduction for those payments in 2003.
The court granted summary judgment for the Estate on Count I, agreeing that the present case involves the same cause of action as Batchelor I and involved a claim that could have been raised in Batchelor I. On the other hand, the court granted summary judgment to the United States on Count III, finding that the settlement payments arose from liabilities arising out of the sale of IAL. George had reported a capital gain on the sale; thus, the court found that the Estate couldn’t identify an allowable deduction under IRC Section 691(b), and IRC Section 642(g)’s bar on double deductions applied.
Count I: Personal Income Tax Refund
In 1999, George sold IAL to International Air Lease of P.R., Inc. (IALPR) for about $502 million. IAL paid George almost $235 million in cash and marketable securities in exchange for almost half of his IAL stock. For the remaining stock, IALPR offered George about $118 million in cash equivalents and a promissory note for $150 million. IAL and IALPR negotiated an option for George to buy back some of the transferred assets, decreasing the balance of the promissory note by a specific price for each asset George bought back. The assets included aircrafts, engines and IAL’s ownership of joint ventures. In 1999, George exercised his option to buy back the assets for about $92.5 million, reducing the $150 million note. In 2000, IALPR paid the balance of the note off. George declared his income from the sale as a capital gain and paid capital gains tax.
George wasn’t the only one who realized a capital gain on the sale of the option assets—so did IAL. The United States tried to collect from George IAL’s corporate income tax obligation under the theory of transferee liability. However, George died in 2003, and the United States filed Batchelor I against his estate. In Batchelor I, the court struck down all of the United States’ experts for failing to comply with the expert disclosure requirements. Thus, the court granted summary judgment in favor of the Estate on Oct. 31, 2005. The court never addressed the merits of the United States’ claim that George received excess consideration from the transfer of the option assets.
In 2004, the United States filed a statement of claim in probate court for unpaid personal income taxes, including liability from the 1999 transfer of option assets. The Estate filed an objection to the statement of claim, and the United States filed a new suit (Batchelor III) in 2004. The United States filed the claim prior to the Internal Revenue Service issuing a notice of deficiency to the Estate. The IRS filed the notice in 2005, and the Estate paid the tax. The Estate and the United States then filed a stipulation for dismissal without prejudice in Batchelor III, acknowledging that the Estate paid the tax liability, but retained the right to assert a refund claim.
Count I of the present case is the refund claim. It was filed in January 2012, after the IRS denied the Estate’s request for a refund. The court referred the motion to Magistrate Judge Alicia M. Otazo-Reyes for a recommendation. On May 13, 2013, she recommended that the court deny the Estates’ motion for summary judgment on Count I.
Count III: Settlement Refund
After George sold his IAL interest to IALPR, IAL sued the Estate to set aside the sale as a fraudulent transfer. IALPR also filed a lawsuit against the Estate, seeking damages from George’s allegedly fraudulent sale of his ownership interest. The Estate also inherited two other lawsuits—one arising out of George’s involvement with Rich International Airways (Rich), a company that subsequently filed for Chapter 11 bankruptcy, and another initiated by a shareholder claiming breach of contract and tortious interference of contract.
During the period 2002 to 2004, the Estate settled all four lawsuits. It paid $2 million in the shareholder lawsuit; $25 million in the Rich lawsuit; $12 million in the IALPR lawsuit; and $1 million in the IAL lawsuit. In October 2003, the Estate filed a Form 706 federal estate tax return, on which it deducted all of the settlement amounts except the settlement amount in the IAL lawsuit. The Estate later claimed the omission was a mistake. In July 2004, the Estate had collectively paid about $41 million in settlements, taken from the proceeds from the IAL sale.
In 2006, the Estate filed a claim for an income tax refund of $8.3 million, based on the settlement payments in all four lawsuits. The IRS denied the refund claim, and that refund claim is the basis of Count III in this case. The court referred the motion to Magistrate Otazo-Reyes for a recommendation. On May 13, 2013, she recommended that the court grant the United States’ motion for summary judgment on Count III.
Summary Judgment: Granted as to Count I
The Estate correctly argued that because of Batchelor I, res judicata precludes the United States from contesting the Estate’s claim for a refund of personal income taxes. The court noted four elements, articulated in Ragsdale v. Rubbermaid, Inc., 193 F.3d 1235 (11th Cir. 1999), which must be met for res judicata to bar a claim: 1) there’s a final judgment on the merits; 2) the decision was rendered by a court of competent jurisdiction; 3) the parties are identical in both suits; and 4) the same cause of action is involved in both cases. Moreover, a court must also ascertain whether the claim in the new suit “was or could have been raised in the prior action.” (In re Piper Aircraft Corp., 244 F.3d 1289, 1296 (11th Cir. 2001)).
Magistrate Judge Otazo-Reyes concluded that the Estate failed to establish that the same cause of action raised in Batchelor I is present in the instant case. She asserted that Batchelor I involved a different tax claim in a different tax year: Batchelor I was a claim for IAL’s corporate income tax during the corporation’s April 1999 to March 2000 tax year; the instant case focuses on George’s personal income tax for calendar year 1999. She also found that the United States couldn’t have brought George’s personal income tax claim in Batchelor I:under IRC Section 6213(a), the IRS couldn’t make a deficiency assessment or initiate a court proceeding until 90 days after mailing a deficiency notice. In the instant case, the IRS issued the deficiency notice in April 2005, precluding the United States from pursuing the claim until July 2005.
The Estate disagreed with the magistrate and argued that both claims arose out of the same transaction: the 1999 transfer of option assets. The Estate also argued that the claims do, in fact, involve the same tax year: Batchelor I involved the exact same transfer on the exact same date as the instant case. Finally, the Estate argued that the personal income tax claim against George existed at the time the complaint was filed in Batchelor I because it came into existence the moment the deficient return was filed in 2000. The Estate contended that the IRS could have mailed the deficiency notice prior to the filing of the complaint in Batchelor I.
The United States reiterated the magistrate’s conclusion that the claims in both cases are distinct. It relied on Towe v. Comm’r, 64 T.C.M. (CCH) 1424 (1992), a case in which the Tax Court found that two separate tax claims arising from the same transaction created separate causes of action.
The court rejected the magistrate’s conclusion and the United States’ reliance on Towe. Instead, it compared the substance of the actions involved in Batchelor I and the instant case and found that both cases had the same nucleus of operative fact and based on the same factual predicate: the tax implications of the 1999 transfer of the option assets. The court also rejected the argument that the present case involved claims from different tax years:
Though the transaction technically fell on different tax years for IAL and Batchelor, that is only because their taxable years were measured differently. This does not change the fact that the transaction occurred on the same calendar date for both IAL and Batchelor.
Finally, the court found that the present claim could have been raised in Batchelor I, because, despite that the deficiency wasn’t issued until April 2005, nothing prevented the government from doing so earlier.
Thus, because the Estate established that the present case involved the same cause of action as Batchelor I, and the personal income tax claim against George could have been brought in Batchelor I, res judicata bars the government from contesting the Estate’s request for refund. The Estate’s motion for summary judgment as to Count I was therefore granted.
Summary Judgment: Denied as to Count III
The United States argued that IRC Section 642(g) prevents the Estate from seeking a second or double deduction for the settlement payments. Under Section 642, an estate can’t claim both an estate tax deduction and an income tax deduction for the same expense. Moreover, the government argued that the Estate failed to satisfy the “independent deduction” requirement under IRC Section 1341.
Because the Estate claimed the settlement payments as deductions from George’s gross estate in 2003, the magistrate applied Section 642(g) and found that the provision barred the double deduction. She found that George wasn’t “liable” for the settlement payments at the time of his death or any time prior to his death. George died in 2002, but the Estate didn’t make the settlement payments until 2004. In fact, she noted that the settlement payments may not have ever occurred, had George lived.
In its analysis, the court addressed an issue not addressed by the magistrate: the fact that the Estate failed to identify an appropriate deduction provision that both satisfies Section 1341’s independent deduction requirement and satisfies IRC Section 691(b)’s exception to Section 642(g). Because Section 1341 doesn’t independently create a deduction, a taxpayer must demonstrate he’s entitled to a deduction under another provision of the IRC. The Estate argued that the settlement payments are independently deductible as expenses under IRC Section 162 or IRC Section 212.
The court rejected the Estate’s reliance on Section 162. It found that the Estate must treat the settlement payments as a capital loss—because they arose out of a prior transaction in which the Estate reported a capital gain. Therefore, the payments can’t be treated as a business expense. Moreover, because the proceeds of the IAL sale was a capital gain, disgorgement of those proceeds into the settlement payments couldn’t constitute a deductible business expense under Section 162. Finally, the court noted that the Estate’s reliance on Section 212 was similarly misplaced, because as a matter of statutory construction, whatever restriction applies to Section 162 barring the Estate’s business expense claim, applies to any Section 212 claim, under the theory of pari materia.
Thus, because the Estate failed to point to any deduction provision covered by Section 691(b), the Estate couldn’t avoid Section 642(g)’s prohibition on double deductions. As such, the court granted the United States’ motion for summary judgment as to Count III.