In the

United States Court of Appeals

For the Seventh Circuit

No. 07-3593

ALAN BILTHOUSE and PATRICIA BILTHOUSE,

Plaintiffs-Appellants,

v.

UNITED STATES OF AMERICA,

Defendant-Appellee.

Appeal from the United States District Court

for the Northern District of Illinois, Eastern Division.

No. 05 C 4442—Virginia M. Kendall, Judge.

ARGUED MAY 15, 2008—DECIDED JANUARY 15, 2009

Before RIPPLE, KANNE, and WILLIAMS, Circuit Judges.

WILLIAMS, Circuit Judge. Alan and Patricia Bilthouse

seek to recover a tax refund on the basis that their shares

of stock in a construction company became “worthless”

in 1997 and were therefore “dispose[d] of” under 26 U.S.C.

§ 469(g). The government denied the refund on the basis

that the company became worthless in 1995 rather than

1997. The Bilthouses do not dispute that the company
2 No. 07-3593

had no liquidating value in or after 1995 but contend

that the company expected a large financial recovery

from a lawsuit that would have allowed it to stay in

business. Because the record does not demonstrate that

the lawsuit represented a reasonable possibility that the

company would remain in business after 1995, we affirm

the district court’s decision granting the government

summary judgment.

I. BACKGROUND

In March 1993, the Bilthouses bought stock in a construction company called S&E Contractors, Inc. (“S&E”) for

$500,000. S&E was a heavy construction contractor that

performed public works projects for the State of Florida

and its cities and towns. In order to bid on these public

construction projects, S&E was required to obtain construction bonds. S&E obtained bonding through two

sureties: Fireman’s Fund Insurance Company and Safeco

Insurance Company.

From April 1994 through June 1995, S&E suffered

millions of dollars in losses as a result of cost overruns on

a large construction project for the City of Jacksonville

called the North Landfill Project. In 1995, S&E became

financially insolvent and defaulted on its bonds, which

meant it had to seek the assistance of its bonding companies to complete its bonded contracts. S&E’s open

projects were completed under the terms of its agreements with the bonding companies, which collected the

revenue from the projects. As a result, S&E had little to

no cash flow.
No. 07-3593 3

Also in 1995, S&E decided not to bid on any more

bonded work, and both of its bonding companies stopped

issuing bonds to S&E for new public construction projects.

Dean Akers, who was engaged by S&E as a consultant

in the spring of 1995, and who became its president

later that year, testified that this was a temporary measure;

S&E intended to stop seeking new government projects

only until it could obtain new bonding. However, there

is no evidence that S&E tried to obtain new bonding

after 1995.

In the fall of 1995, S&E filed a lawsuit against the City

of Jacksonville to recover its financial losses from the

North Landfill Project. The suit was settled in 1997 with

neither S&E nor either bonding company receiving any

money.

S&E had elected to be taxed as a subchapter S corporation, which means its income flows through and is taxed

as income to the corporation’s shareholders individually.

See 26 U.S.C. § 469; see generally St. Charles Inv. Co. v.

Comm’r, 232 F.3d 773, 775 (10th Cir. 2000). In 2001, Alan

Bilthouse and his wife Patricia Bilthouse filed for a

refund of paid income taxes with the Internal Revenue

Service based on their claim that their shares in S&E

became worthless in 1997 and therefore were “dispose[d]

of” at that time. The IRS denied the Bilthouses’ refund and

the Bilthouses sued to recover the refund in federal court.

The district court granted summary judgment to the

government, holding that the Bilthouses had failed to meet

their burden of demonstrating that S&E became “worthless” in 1997 rather than in 1995. The Bilthouses appeal

that decision.
4 No. 07-3593

II. ANALYSIS

This case comes to us on appeal from a grant of summary judgment, which we review de novo, drawing all

inferences in favor of the nonmoving parties. Breneisen v.

Motorola, Inc., 512 F.3d 972, 977 (7th Cir. 2008). Summary

judgment is appropriate where there are no genuine

issues of material fact and the moving party is entitled to

judgment as a matter of law. Fed. R. Civ. P. 56(c); Celotex

Corp. v. Catrett, 477 U.S. 317, 322-23 (1986).

The Bilthouses are “passive investors” in S&E, which

means they invested in a business in which they did not

materially participate. 26 U.S.C. § 469(c). S&E Contractors

is an S corporation so pursuant to section 469, the

Bilthouses could deduct losses stemming from their

investment in S&E but only to the extent of their passive

income. 26 U.S.C. § 469(d); see also 5 Mertens Law of

Federal Income Taxation § 24C:3 (2008) (“[A] taxpayer

cannot deduct losses from business activities in which

he or she does not materially participate . . . unless he

or she reports passive income on the tax return

against which to offset the losses.”).

However, surplus losses from passive activity are

suspended and carried over from year to year. Previously

suspended losses may be available to offset other

income without regard to the passive loss rules if the

taxpayer’s “entire interest in any passive activity” is

“dispose[d] of” in a taxable transaction. 26 U.S.C. § 469(g);

see also St. Charles Inv. Co., 232 F.3d at 776. Here, the

Bilthouses seek to take advantage of section 469(g) to

deduct previously suspended passive activity losses
No. 07-3593 5

arising from their investment in S&E. The parties agree

that the Bilthouses’ entire interest in S&E was “dispose[d]

of” for purposes of section 469(g) whenever their stock

in the corporation became “worthless.” See 26 U.S.C.

§ 165(g) (“If any security which is a capital asset becomes

worthless during the taxable year, the loss resulting

therefrom shall, for purposes of this subtitle, be treated

as a loss from the sale or exchange, on the last day of

the taxable year, of a capital asset.”). But the parties

disagree as to when the stock became worthless. The

Bilthouses contend their stock became worthless in 1997

(which, due to a number of circumstances not relevant

to this case, would result in a large tax deduction) while

the government contends the stock became worthless

two years prior, in 1995.

So the crucial question in this case is when exactly

S&E (and therefore its stock) became worthless. The

worthlessness of a stock as of a particular year is a

factual inquiry, varying according to the circumstances of

each case. Boehm v. Comm’r, 326 U.S. 287, 293 (1945); see

United States v. Davenport, 412 F. Supp. 2d 1201, 1207 (W.D.

Okla. 2005). Although section 165(g) does not define

“worthless,” most courts consider both the liquidating

value and the potential value of the company to determine

the year of worthlessness. See Morton v. Comm’r, 38 B.T.A.

1270, 1278 (B.T.A. 1938), aff’d 112 F.2d 320 (7th Cir. 1940)

(worthlessness of stock depends on current liquidating

value and potential value); see also Delk v. Comm’r., 113

F.3d 984, 986 (9th Cir. 1997); Figgie Int’l, Inc. v. Comm’r.,

807 F.2d 59, 62 (6th Cir. 1986).
6 No. 07-3593

Even where a company has no liquidating value, evidence of potential value can be used to demonstrate that

a company is not yet worthless during a particular year. If

a company’s assets are less than its liabilities but “there

is a reasonable hope and expectation that the assets will

exceed the liabilities of the corporation in the future, its

stock, while having no liquidating value, has potential

value” and cannot be said to be “worthless.” Morton,

38 B.T.A. at 1278; Delk, 113 F.3d at 986.

However, a taxpayer relying on the potential value of

a company to put off the year of worthlessness must

provide objective evidence of this value; merely asserting

his self-serving hopes will not do. See Boehm, 326 U.S. at

293; Davenport, 412 F. Supp. 2d at 1207. In Boehm, the

Supreme Court held that “a determination of whether a

loss was in fact sustained in a particular year cannot

fairly be made by confining the trier of facts to an examination of the taxpayer’s beliefs and actions.” 326 U.S. at

292; see also Keeney v. Comm’r, 116 F.2d 401, 403 (2d Cir.

1940) (a taxpayer cannot “postpone his claim of loss

until only an ‘incorrigible optimist’ would fail to know

that the stock had become worthless at an earlier date.”).

We are mindful that the Bilthouses bear the burden of

establishing that S&E was not worthless until 1997. See

Boehm, 326 U.S. at 293 (taxpayer bore the burden of establishing the fact that there was a deductible loss in 1937

rather than in the prior year). This means that the

Bilthouses must demonstrate that S&E retained some

value, either present or potential, until 1997.
No. 07-3593 7

The Bilthouses do not present any evidence that might

demonstrate that S&E had liquidating value after 1995.

In contrast, the government presents evidence that in

1995, S&E became financially insolvent, defaulted on its

bonds, and turned to the bonding companies to finance

the completion of its bonded work, at which point the

bonding companies stopped issuing bonds to S&E for

new projects. Because of S&E’s default, the bonding

companies took control over the revenue from S&E’s

open projects. S&E reported a loss of $18,377,151 on its

tax returns for that year.

Instead, the Bilthouses maintain that S&E retained

potential value through 1995 and up until 1997 because

during that time, the company expected an award of $15

to 27 million from the Jacksonville lawsuit. Had such

an award been given, the Bilthouses contend that S&E

would have been able to resume its operations after

1995. Of course, the lawsuit ultimately was resolved

unfavorably for S&E in 1997, and it received no money

from the litigation. But according to the Bilthouses, the

death knell did not sound for S&E until that particular

event occurred, and therefore S&E did not become worthless until 1997. They also argue that S&E maintained

its worth by pursuing private construction projects

through 1996 and 1997. We address each argument in turn.

A. The Jacksonville lawsuit does not demonstrate

that S&E retained potential value after 1995.

The linchpin of the Bilthouses’ argument is that two

S&E presidents, S&E’s bonding companies, and its bank all
8 No. 07-3593

expected a recovery from the lawsuit, and they expected

the recovery to be sufficient to repay the bonding companies and allow S&E to again obtain bonding for new

government projects. In other words, they believed the

lawsuit would save S&E. However, as the Supreme Court

has already noted, a determination of when a particular

loss was sustained cannot be made based on subjective

beliefs alone. See Boehm, 326 U.S. at 292. As discussed

further below, the Bilthouses present no objective evidence to demonstrate the reasonableness of the belief that

the lawsuit represented potential value for S&E, and

without that, they cannot meet their burden. See, e.g.,

Morton, 38 B.T.A. at 1278 (taxpayer must demonstrate

a “reasonable hope and expectation that the assets will

exceed the liabilities of the corporation in the future”)

(emphasis added).

In their affidavits, Douglas Ebbers (former president

of S&E) and Dean Akers (consultant and president of

S&E from 1995 through 1997) state that had the lawsuit

been successful, S&E would have been able to resume

bidding on contracts. Akers further states that S&E and

its bonding companies operated on the premise that a

favorable resolution of the litigation would provide a

cash infusion “sufficient to repay the sureties and keep

S&E a viable company.” The Bilthouses also submitted

evidence that an outside consultant valued the lawsuit

to be worth over $20 million.

But neither Ebbers nor Akers provides a basis for why

anyone thought the lawsuit would be successful. We

know nothing about the merits of the lawsuit or whether
No. 07-3593 9

We note that the damages estimate seems a bit high given 1

that the original contract amount on the project was $12 million.

S&E’s damages estimate was reasonable. Indeed, we do

not even know how the estimated damages were calculated. Evidence that S&E’s two presidents believed

1

the lawsuit would prevail and that it would save S&E

does not by itself demonstrate that their belief was reasonable. For all we know, they could have been

unusually optimistic. See, e.g., Boehm, 326 U.S. at 294-95

(upholding tax court’s determination that stockholders’

suit had no value where there was no evidence regarding “the merits of the suit, the probability of recovery

or any assurance of collection of an amount sufficient to

pay the creditors’ claim of more than $630,000 and to

provide a sufficient surplus for stockholders so as to

give any real value to their stock.”).

The actions of the bonding companies and S&E’s bank

are no more probative of the potential value of S&E. The

Bilthouses point out that although the bonding companies

and the bank “could have” stopped dealing with S&E in

1995, they chose to work with S&E until 1997. The

Bilthouses contend that this was because they were

waiting to see what happened with S&E’s lawsuit, and

that a jury could infer from this show of support that S&E

had a viable case and a reasonable expectation of recovery.

But there are several possible explanations for the

behavior of the bank and the bonding companies that

have nothing to do with the value of the company or even

the value of the lawsuit. And even if they were motivated
10 No. 07-3593

by the prospect of recovery from the lawsuit, we do not

know the basis for their putative belief that the lawsuit

would be resolved favorably or that the expected recovery

would be sufficient to allow S&E to resume its prior

operations.

Contrary to the Bilthouses’ assertion, a company’s

hope that it will prevail in a lawsuit is not the same for

purposes of this analysis as a company’s reasonable

expectation that its future operations will succeed. Cf.

Miami Beach Bay Shore Co. v. Comm’r, 136 F.2d 408 (5th

Cir. 1943) (stock in company was not “worthless” in 1936

because there was a reasonable prospect of reorganization until 1937 when the stockholders resolved to

liquidate the company instead); Benjamin v. Comm’r, 70

F.2d 719 (2d Cir. 1934) (stock in soapstone company not

“worthless” in 1926 because it continued to take options

and explore and drill for new sources of soapstone

into 1927). That is because no reasonable investor would

buy stock in an otherwise worthless company based on

such an inherently speculative endeavor. At minimum,

an investor would need to know more about the lawsuit

before investing in such a company. For example, if

the president of S&E had bought lottery tickets from

1995 until 1997 with the belief that a winning ticket

would save S&E, that would not demonstrate that S&E

had potential value during those two years because it

is purely speculative that he would win the lottery.

By 1995, S&E knew there would be no foreseeable

future operations unless it could pay off its bonding

companies. Although S&E may have hoped the Jacksonville lawsuit would enable it to recover, there is no rea-
No. 07-3593 11

sonable ground (as far as we can tell) for that hope. To

allow a jury to make a determination of worth based on

the subjective beliefs of S&E insiders and entities connected to it would subject this tax provision to endless

manipulation. Cf. Boehm, 326 U.S. at 293 (“The taxpayer’s

attitude and conduct are not to be ignored, but to

codify them as the decisive factor in every case is to

surround the clear language of [28 U.S.C. § 23(e)] and the

Treasury interpretations with an atmosphere of unreality

and to impose grave obstacles to efficient tax administration.”).

B. The private construction projects do not demonstrate that S&E retained potential value after 1995.

The Bilthouses also contend that S&E continued

business operations through 1995 and 1996 by pursuing

and working on private construction projects through SCI,

a division of S&E. (Recall that S&E could not work on

public projects because the bonding companies stopped

issuing bonds for new projects in 1995.) This is a closer

issue because continued operations of a company might

indicate that there was a reasonable hope and possibility

of success. See Benjamin, 70 F.2d at 719-20 (soapstone

company that continued to take options and explore

for soapstone even after shutting down its mill in 1926

did not become worthless for tax purposes until 1927).

However, there is no objective evidence in the record

that would allow us to ascertain whether SCI could have

saved S&E. The Bilthouses provide no evidence of how

much work SCI was doing, whether it was viable, or

whether it reasonably could have generated enough
12 No. 07-3593

money at some point to allow S&E to pay off the bonding

companies and resume its public projects. Indeed, by the

Bilthouses’ own admission, the mainstay of S&E’s

business was its public work, for which it needed to

obtain construction bonds. In other words, the Bilthouses

have not demonstrated that SCI represented “a reasonable

hope and expectation” that the assets of S&E would exceed

its liabilities in the future. Morton, 38 B.T.A. at 1278-79; see

also Keeney, 116 F.2d at 403 (while a taxpayer may have

“hoped” to make money by holding races, there was “no

reasonable ground for hoping by that [this would] liquidate that enormous debt; and only so would the stock

become of any value.”).

We acknowledge that there was no definitive event in

this case that might have signaled to investors in 1995

that their shares in S&E had become worthless. But our

examination of the facts and circumstances in this case

leads us to conclude that the Bilthouses have not met

their burden of demonstrating that S&E became worthless

in 1997 rather than 1995. To the extent there was some

possibility that S&E could have pulled itself out of the

mess it found itself in by 1995, the record does not demonstrate that the possibility was reasonable rather than

remote. As a result, we need not reach the Bilthouses’

argument regarding damages.

III. CONCLUSION

The judgment of the district court is AFFIRMED.

1-15-09