employee stock ownership planet issue which we call the j m m e e s o p n r briefs was never lawful it was never a qualified plan under the internal revenue code the taxpayer state and their initial brief that aesop was never properly formed and the closing agreement for the entities that mr mckenny signed on behalf of those entities states that the j m and e sap was not qualified from its inception or not qualified not because it was per se legal but not qualified because the proper steps weren't taken right your honor that the record it does not actually specify what exactly was wrong with aesop but we know there are two things wrong with that one that it improperly held this ownership mckinney's ownership of the car dealership in florida but also that it was never qualified from its inception of the mckenney is list a laundry list of things that they claim went wrong but there's no evidence the record one way or the other about whether those things were done but we do know is that the plan was not in fact a qualified plan as it was done yes or words to district court the district court thought and you may have you may take issue with this but the district court thought that what the mckinney's were trying to accomplish could have been legally accomplished during that relevant time period even though the later said that's an abusive tax shelter and you cannot do it so you think the district court got that overall general background right or wrong it's a little more complicated for some center right or wrong and we're not we're certainly not from two thousand through two thousand and four remember the period goes all the way through two thousand and five that we're talking about but hypothetically if everything had been done right from two thousand to two thousand and four the ownership of the consulting business could have been lawful the ownership of the car dealership never could have been lawful and in two thousand and five the entire structure was unlawful so that's that's the full answer in those years the mechanics channel three million six hundred thousand dollars from those two businesses to this financial transactions that they engaged in and here they make enemies actually channel millions of dollars to an unlawful east up and didn't pay taxes on that income and then later acknowledged that they owed that hacks liabilities bad is the actual financial history that the tax consequences here must be based on and this is rooted in a broader framework about what is income under the internal revenue code and section sixty one dollars of the internal revenue code says that all income is gross income and glenn child last the supreme court said that congress intended to tax all gains except those that are specifically exempted and the mckenney is bear the burden of showing that the settlement payment is not taxable can i ask you a theoretical question just to try to get my head around the tax consequences if you say that the whole transaction could have been structured in a way from two thousand to two thousand and four to have allowed the consulting business to have the been done the way the mckinney's wanted to why isn't at least in part the settlement from grand thorton a return of capital i e taxes that would have been avoided had the structure been done the right way so that the the supreme court has made clear in a couple of cases that we discuss in our brief especially national alfalfa and safety car that tax effects are determined by what actually occurred and what actually occurred here is that the aesop was not in fact a qualified plan and that it could not in fact a for any income tax on the income that was put into the isa and so  don't discuss that issue which is our central argument in our brief and their response to our opening brief and they never explain and if waive the opportunity to explain how their position can be reconciled with that fundamental idea that taxpayers choose the transactions they enter into and once they've done that have to live at the tax consequences is it an exaggeration to say that your position is a very broad one that in a case like this where the transaction is structured in a way that violates the tax code and triggers substantial tax liability settlement obtained from a tax professional for a legal firm for professional malpractise is always going to be income well your honor you because if you say the taxpayer chose a transaction they entered into whether it was done the right way or the wrong way almost as a matter of law it seems to me you're arguing that those settlement proceeds from the tax professional for having committed malpractise can never ever ever be a return of capital but yes your hon taxpayer has paid the tax he or she actually owes based on the transactions and her that's always going to be the case even if the taxpayer hadn't paid the taxes you get a judgment against the and the judgment is let's say you don't have any money anymore and you get a judgment the judgment is you owe two million dollars plus in taxes because you did this to wrong way and this was not a qualified aesop except in that scenario any settlement proceeds could never be a return on capital under your theory theory yes or no that's true or a taxpayer pays the tax they owe that's not a loss and there's no reward doesn't pay it is just humanity is liable for the tax i'm sorry your honor is just liable for the tax not that he pays it your position would be the same even if the mckinney's had zero in their bank accounts wouldn't pay the money to the i r s right correct that's right and the return of capital a concept i'd like to say a few words about that we discuss it briefly and our briefs it's not a good fit in the tax contours the return of capital context comes into play when a taxpayer has basis in the internal revenue code defines what basis is has basis in an investment if for example let's say you buy fifty thousand dollars worth of stock and you sell that stock or seventy five thousand dollars down the road the taxable amount of course is the difference between fifty and seventy five thousand dollars it's the twenty five thousand dollars gain the fifty thousand dollars that one would get back on the stack sale that is a return of capital bad to the taxpayers basis here taxpayers don't have a basis in a tax liability the concept just simply was at issue there the clerks paid more than the minimum amount of tax they could have owed due to a mistake in reporting and in that situation the i r s has taken the administrative position that where attacks pay or pays more than the minimum amount of tax they could have paid again based on what they actually did that that can be seen as a loss and not is income but where a taxpayer pays the amount he or she owes which is the case here based on what actually the tax advisor filed a joint tax returns instead of separate tax returns because of just an error in reporting same financial tax for the year if they had filed separate returns they would have twenty thousand dollars less than they did having filed their joint returns but aren't aren't they stuck with what they filed under your theory so your honor again the supreme court cases in the other cases we cited in our brief focus on the financial transactions of the taxpayer entered into and so the i r s administratively has drawn that line between the actual financial history of the taxpayers versus the reporting but if clark is wrong and if the i r s is administrative position is wrong because it contradicts the supreme court certainly part of the analysis and an important part because that case stands for the idea that any payment of one's tax liability and of course a reimbursement for tax liability is economically the same is taxable income and i'd like to note that in addition to the legal issue that we've been discussing here and the mckenzies did not meet their summary judgement burden with respect to the taxation of the settlement payment they failed to show that they would not have the tax liabilities even based on their hypothetical history the in particular the income from the car dealership would have been taxable one way or the other and they never deal with that or address that are two other issues that the taxpayers raise and you see my time for my argument is up almost up so i would refer the court to our briefs on the legal expenses as well as the last action for the taxes they pay but you certainly have the opportunity in your rebuttal to respond to those arguments that's fair since it's there as your heel from those issues if you would like ok thank you your honor thank you very much  in the issue and the key is when you look at clark an election is a fact they made an election to file a joint return that fact is a fact if you can ignore it elections all the cases the i r s has against tax payers that involve change of accounting method wouldn't exist because an election is a fact so the government spends a lot of time talking about the kennedys didn't pay the right amount of tax they paid the right amount of tax that was two million two hundred thousand dollars with the tax the interest in the bentleys they paid the right amount of tax but we're dealing with here is the situation of being reimbursed for the last thing kurt for a tax they should never have had to pay for i think you know i think this bringer can correct me if i'm wrong and she gets back up again but i think the line that the government is trying to draw with clark is that clark involved a decision about how to file but did not involve a case where taxpayers were stuck with the financial transactions a entered into is a historical fact so in other words how you file may get you where you want to be in this case but the underlying transactions can't and so the argument here i think goes that your clients are stuck with the way that they structured things and not just the way that they file their taxes i don't know  that's a workable line but i think that's the line the government is trying to draw i think i agree with you that's what the government's trying to draw and i don't think it's about lying to attempt to draw because what the issues that you have yes you in fact h circumstance where if grant thornton done everything that we supposed to do it would have had a valid saw they would have had the earnings within that aesop stay within that aesop that's money still would not be taxed what's your response to the argument that the car dealership never could have really been in the saab it could have been it would have been done in a different structure you can invest in lots of different things they could have held within a c corp they could have done a variety of ways to make that work but they were advised inappropriately by grant thornton so that's part of the malpractise excels as well so the whole point is that if this would have been done right they wouldn't pay the two thousand dollars if we agree with you on the legal point that malpractise that leads to overpayment of taxes is it is not taxable do we have to figure out do we have to do our own tax analysis and  what your clients really really could have done or would have done i don't think you have to well i don't think you have to figure out what that tax amount is in this case because the government are really challenged that that was the amount  last means the only thing that they really raised was an issue about whether something should be allocated to punitive damages because the risk punitive damage claim within the petition against grant thornton but because the loss was less than what the amount of actual damages the district court got rid of that case so i don't think in this case you have to do that with respect to a general question if in  ability i think if you look at the at the statement of mr mckinney that's what we said in it and it wasn't challenged which which one of the two that there would have been no tax that there really were would have been a small of the now practice case against the accountants picked up eight hundred thousand that that is all that we in fact that's all that we can use in fact receipt if we agree with you if we agree with you that that eight hundred thousand is not taxable how can we agree with your arguments about the attorney's fees it seems that those arguments are rather inconsistent with one another i think that the court was incorrect as to the attorney fees because in my view when you look at it those the tourney fees were incurred with respect to the sole proprietorship i mean mr mckenny started his argument deep automobile dealership consulting business in large brokers type business advising people how to sell their their dealerships he started that in one thousand nine hundred he ran as a sole proprietorship he continued to run it until he talked to grant thornton in the late ninety's and which they then said you need to do this as an esquire piece op buys to do it he did it that advice was consistent with his  from prior ship when you in fact go look at that and then you look at the way the settlement treat it which way which they treated it as being earned directly by him and then after the stop was shut down he continued to do it as a sole proprietorship so in my view yes the legal fees are in fact business expense adoptions in fact there's a revenue ruling we cite to the talks about tax advice with respect to business is it is subject to a two percent limitation so that you can only deduct it to the extent that exceeds two percent of your just your gross income and then there's an additional three percent above a g i that you have to have of aggregate itemized deductions and finally the last element which is probably most important element is that a miscellaneous itemized deduction is not deductible for alternative minimum tax purposes and so effectively because of the levels of his income when you take that deduction away because you can't take it for alternative tax purposes effectively it really diminished as the value of the deduction tremendously but the difference is calculated th t we did calculated and i think it probably had an impact the a m t rate is a twenty eight percent rate the tat and the miscellaneous itemized deduction was about four hundred thousand dollars if i remember correctly so approximately one one hundred and twenty thousand dollars of tax liability i would guess just phone i mean if i was back in my office i could tell you clients for whatever ultimate reasons had to pay this two million two hundred thousand dollars due to professional malpractise but they agree they have to pay it they enter into an agreement with the government they say that's the amount we had to pay and now you get to deduct that on reimbursed amount from a later tax return explain that to me so the explanation of that and i will agree that is the weakest part of the argument but the explanation of that is quite simply this if you in fact look at clark and what clark specifically states clark basically says this is a loss that they realized and that that they realized was that they paid money that they should not have in fact paid the advice took away money they had their loss they would not have otherwise realized that loss and what clarke said when you look at the language clark is that what it said was that to the extent that the loss was they said that because the loss was fully reimbursed if you would it deducted the loss you wouldn't get it but because they had no deduction of the loss the income it's or the settlement proceeds were in fact tax free when you look at the settlement agreement the closing agreeing with the s and you go parse through the words that technically is not a loss attributable to that but i will agree that is by far the weakest argument that we have think they waived to that that's the inherent failure of what the government debt i mean they never challenge that this in fact was in fact what the loss was they challenge the only way they challenges they said that it was based on hearsay because mr mckenny wasn't knowledgeable enough about what all that the faults were in what grant thorton debt and mr mckenny probably didn't know all the details of the problems because i don't think many people understand aesop's and all this other stuff if i had to i could draft one up and i could do it and i talked to one of my partners before i came up here and i said could you throw together in fifteen minutes and he said yeah but mr mckinney lived the audit he lived the i r s pointing out what the problem us he dealt with counsel who represented him in that audit they told him what the problems were we had aesop counsel explained to him what the problems were the problems were so dramatic in this case it was crazy i mean they didn't even adopt the plan they didn't have the board of directors have the means to do the things to put to dot the i's to cross the t's to make even work  it was crazy that one would have done that little in doing this and so as a result there was really nothing that you could do but in fact pay the tax there was no basis to challenge because they just failed to do anything and if they failed to do anything you really couldn't do anything but if they would have done it right it could have worked and it could've worked very well mike did the same type of the state plan that i have everything in my pension plans go to charity but i don't know if mike has the same view of life that i have but to get around  well old conley i don't see is an issue because what we have here is that we have a situation in which this is a recovery of capital all conley has no relevance to it all calmly was a situation where an exact and actually was several executives of a corporation set go pay my income tax on my salary that has no relevance to here this is a circumstance where there was in fact a real loss this tax never should have been paid and if they would have gotten proper advice it would've been paid what's funny is that the government is selective in how they deal with clark because if you read send tax which the government specifically cites to and syntax a circumstance in which the government one group of the government the s and l group of the government tried to get people to buy companies and to use the tax benefits as incentives for other healthy savings and loans to save bad ones so that's what they encouraged to happen and what then happened is congress didn't like it so congress passed a law to abrogate the contracts and then send tax the taxpayer sued the government for abrogating the contract improperly and when they sued to do that the government said you have a right to damages under your contract that was a court of claims that held that the taxpayer is part of that set you've got to gross that up to cover my tax burden when i received that amount and what the government said was no clark that's a recovery of damages because of our abrogation the contract clarke says it's not taxable and centex the court of claims agreed with them agreed with the government that it was not taxable and therefore they didn't have to do anything and they did not gross the number up and i apologize i believe my time is up all right thank you so much thanks a lot before you get started what's your response to his waiver argument on the two million two hundred thousand your honor we respond to that argument on pages twenty four and twenty five of our reply brief and there we explain that  we did not only make a hearsay objection and the district court and the summary judgment briefing we also objected more broadly because the assertions were quote not supported by admissible evidence but that you make those arguments  your initial brief i mean did you was that part of your challenge in the initial brief to this court you mean or on a yes yes your honor we did argue that they failed to carry their burden of showing that even  contrast to national health and safety car they could hypothetically rewrite their history that they had not shown that they would not have owed the tax liabilities rangel do you made you made that argument i know you did but did you did you make th the hearsay ground argument and the other argument that at the end of the day the affidavit the declaration was insufficient as a matter of law or was it different than that well your honor we certainly argued that they did  not show that they did not know the tax liabilities and have to look back at our brief to see what specifically we said about that but we certainly raised that argument that they did not meet their burden and summary judgment of making those showings what  did you say that was on their reply brief your honor that's on page twenty four and twenty five in the opening brief around pages fifty seven dollars through sixty or so is where we argue that the mccann has failed to show that they hypothetically could have avoided the tax liabilities judge grant you asked if the court would have to do a new tax calculation here if the court accepted the argument that their taxes tree could be hypothetically rewritten such that the settlement payment could be excluded from tax the tax payers have the burden of showing that they would not have the tax liabilities and a tax refund suit of course the taxpayers bear the burden they didn't put in any evidence to support that idea mr mckenny is not qualified to go through the tax calculat and and as we've already discussed we said that there is insufficient evidence to show that they owed no tax liabilities now a key to that is this car dealership piece now perhaps it could have been structured in some other way but there's no way that i am aware of where no tax would have been owed on that car dealership if it was structured as a c corporation c corporations of course have their own income tax to pay so that would have been taxed and if mr mckenny owned it as he does today it also would have been taxed to him understanding that you don't have the burden in a refund suit of this type that the government put on any evidence to support what you just said no your honor the government  i would refer the court to our briefs with respect to the business loss deduction of the tax liability as they paid for any further questions from the court no thank you very much