# PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.T.C. Sum m ary Opi ni on 20 14 -4 3

UNITED STAT ES TAX COURT MOHAMED KADIR, Pet it io ne r v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 15 80 9- 12 S. File d M ay 6, 2 01 4.

Kath ryn J . Sed o, fo r pe ti ti on er. 1 Bl ai ne Ch arl es Hol id ay

an d J oh n S ch m it td ie l, fo r res po nd en t.

SUMM ARY OPINION HOLMES, Ju dg e: In 2 00 6 M oh am edKadi r refi na nc edhi s h om e m ortg ag e. He atfir stm ad e h is pa ym en ts on ti m e, bu t tho se pa ym en ts ke ptgo in g up. He
The C ou rt a ckno wled ge s t he ex cel le nt pr o b on o effo rt o f pe ti ti on er’s 1 co un se l fr om

th e Uni ve rs ity

of M in ne so taLaw Sch oo l’s Ro na ldM. Man ko ff Tax Cl in ic in th is cas e.- 2 -

th ou gh t the m ortg ag e co m pa ny hadli edto hi m , andhe su edforfrau d. He s et tl ed hi s ca se . One o f th e te rm s o f th e se tt le m en t ag reem en t re qu ire d t he m ortg ag e co m pa ny to p ay

hi m $1 0,0 00 , andan ot he r requi redhi m to pa ss th e $ 10 ,00 0 t o t wo m ortg ag e-s erv ic e co m

pa ni es . The m ortg ag e co m pany tol d t he Co m

m is si on er tha t itha d p ai d Kad ir $ 10 ,00 0, an d t he Co m m is si on er wan ts Kadi r to pa y tax on it . Kad ir arg ue s t ha t i t was n’t re al ly his in co m e si nc e h e h adto pa ss itonto th e m ortg ag e-s erv ic e co m

pa ni es . 2 Bac kg ro un d In20 01 , Mo ham

m edKadi r an d h is bro th er b ou gh t a h om e in Bro ok lyn Park , Min ne so tafor$1 41 ,00 0. Whil e b ot h b ro th ers ’ na m es were o n t he ti tl e, fo r a few y ears itwas Kad ir’s b ro th er wh o m ad e su re the m on th ly mortg ag e b il l g ot pa id . In 2 00 4, h owe ve r, he tra ns ferr edhi s i nt eres t i n t he ho m e to Kadi r whe n t he y wen t thr ou gh a refi na nc in g, an d Kad ir t he n s ta rte d p ay in g t he m ortg ag e b il l hi m se lf. Less th antwo y ears lat er, i n Au gu st20 06 , Kadi r de ci de d t o re fin an ce h is m ortg ag e ag ai n t o t ry

to lo wer h is m on th ly paym en ts . As a n on na ti ve Eng li sh Thi s ca se was t rie d und er In te rn al Rev enue Co de sec ti on 74 63 . Sin ce 2 Kad ir c ho se sm al l-c as e st atus , th e d eci si onis n’t re vi ewab le by any ot he r co urt, an d t hi s o pi ni on sh ou ld n’t b e ci te d a s p rece de nt . Unl es s we s ay ot he rwis e, al l se ct io n re fere nc es are t o t he Co de in effec t fo r th e y ear a t i ss ue , andRu le refe ren ces are t o t he Tax C ou rt Rul es of P ract ic e an d P ro cedur e.- 3 -

sp eak er (a t tria l the co urt u se d atra ns la to r who sp ok e Kad ir’s n at iv e Oro m o) , Kad ir r el ie d h eav il y

on ag en ts at Gre en Po in t M ortg ag e Fu nd in g, LLC (Gree nP oi nt ). He en de d up wi th two m ortg ag es , andGreen Po in t o rig in at edbo th . Bu t ea ch of the ne w m ortg ag es ha d adi ffer en t m ortg ag e se rv ic er. The fir st m ortg ag e--f

or $1 72 ,00 0- -u se d GM AC Mo rtg ag e, LLC (GMAC) a s i ts servi cer. The sec on d m ortg ag e--f

or $2 1,5 00 --u se d S pe ci al iz edLoan Serv ic in g, LLC (SLS) . The se two m ortg ag es to ta le d $ 19 3,5 00 . Mos t o f th e lo anpro ceed s wen t t o pa y off th e 2 00 4 m ortg ag e, bu t Kad ir k ep t a l it tl e le ss th an$1 1,0 00 . Andev en th ou gh th e to ta l l oan p rin ci pa l h adin crea se d, Kad ir c red ib ly test ifi edth athi s pu rp os e in refi na nc in g was to “ reduc e th e [m ortg ag e] paym en t p er m on th .” Bu t on ce al l the refi nanc in g was do ne , hi s m on th ly paym en ts co nt in ue d t o ri se . Kadi r ke ptpa y in g, b uthe was c on fu se d a ndfru st rat edaft er num ero us att em pt s t o c le ar up why hi s p aym en ts ke ptgo in g up. The re co rdis no t en ti rel y cle ar as to ho w 3
m uc h t he m on th ly m ortg ag e p aym en ts ha d i nc reas edby early 200 9, b utby tha t Tho ug h h e was m ak in g “ m in im um pa ym en ts ” o n h is m ortg ag es , th e fo lk s 3 who “ he lp ed ” Kad ir r efi na nc e fai le d t o a de qu at el y expl ai n t he co nc ep t o f a ne ga ti ve ly am orti zi ng m ortg ag e. The m on th ly paym en t tha t s to ps a ne ga ti ve ly am orti zi ng m ortg ag e fro m in crea si ng th e p rin ci pa l am ou ntof t he de btis oft enwell ab ov e th e m in im

um pa ym en t tha t the m ortg ag e requi res . The rec or d d oe sn ’t sh ow an y att em pt s b y th e m ortg ag e o r se rv ic in g c om pa ni es to ex pl ai n t o Kad ir the effe ct s o f m ak in g o nl y

th e m in im

um pa ym en ts on hi s l oa ns (whi ch , inpa rt, was th e b as is forth e fraudcas e Kad ir s ta rte d i n 2 00 9) . Andth e Co urt d ire ct ly ob se rv edth e d iff

ic ul ty of tr an sl at in g “ ne ga ti ve am orti zat io n” in to Orom o.- 4 -

po in t Kad ir h adha d e no ug h a ndst op pe d p ay in g a lt og ethe r. Thatsu m m er Kad ir ta lk edto lawyers atth e Hou si ng Pres erv at io n P ro ject, a n onpr of

itin St. Paul , and th ey he lp edhi m

su e Green Po in t, GMAC , andSLS in Octo be r. Kad ir s ai d h e h adth ree r eas on s fo r su in g the co m pa ni es : ! co m

m on -la w frau d, m ean in g t ha t the co m pa ni es ha d l ie d t o h im

when th ey pro m is edhi s p aym en ts wou ldgo do wn; ! a Mi nn es ot a st at e la w cal le d t he Mi nn es ot a Pre ve nt io n o f Co ns um er Frau d Act , see ge ne ral ly Min n. St at . Ann . sec . 32 5F .68 -3 25 F.7 0 (West 2 01 4) , th atst op s co m pa ni es fro m

co m m it ti ng any

“ frau d, fa ls e pr et en se , fal se pro m is e, m is rep res en ta ti on , m is le ad in g s ta te m en t o r de cep ti ve pra ct ic e; ” an d ! th e Fed eral Trut h In Lend in g Act , see ge ne ral ly 15 U.S.C. s ecs . 16 01 , whi ch ha s as it s g oa l t o “ as su re a m ean in gf ul di sc lo su re o f cre di t te rm s * * * an d t o p ro te ctth e co ns um er ag ai ns t i na ccurat e an d u nf ai r cred itbi ll in g.” The co m pa ni es m ov edth e cas e to fed eral co urt b ecau se Kadi r was su in g i n p art un de r a fed eral law. Th e p art ie s t he n m etwith am ag is tra te jud ge to try to s et tl e th e cas e. Thi s wo rk ed , andKadi r go t h is de bt --b ot h i nt eres t an d p rin ci pa l-- reduc edto whathe co ul d a ffo rd . The s et tl em en t ag reem en t, h owe ve r, was l on g an d n oteas y

to un de rs ta ndev enforso m eo ne who sp ok e Eng li sh , anditm us t h av e be enev enha rd er fo r Kad ir. An d wh atth is cas e is ab ou t i s a v ery un us ua l p artof th atset tl em en t. Itwas apro m is e b y Green Po in t i n o ne sec ti on of t he set tl em en t t o gi ve Kadi r a ch eckfor$1 0,0 00 . Butan ot he r se ct io n o f th e se tt le m en t t ol d Kad ir- 5 -

th athe ha d t o p ay

GMAC $ 5,7 00 “by ass ig nm en t o f $5 ,70 0.0 0 fr om th e Bo rro wer’s (Kad ir) Green Po in t Pa ym en t,” a ndto pa y SLS $4 ,30 0 “by ass ig nm en t of $4 ,30 0.0 0 fr om

th e Bo rro wer’s Green Po in t Pa ym en t.” Afte r ev eryone si gn edth e se tt le m en t, Gree nP oi ntke ptit s p ro m is e an d s en t a ch eckfor$1 0,0 00 to Kadi r’s at to rn ey , Mart in Carl so n. Carls on th ento ldKadi r to ta ke th e ch eckto th e b an k andge t two n ew ch eck s- -a $ 5,7 00 ch eckforGMAC an d a$4 ,30 0 c he ckforSLS. Kadi r di d wh atCarl so n t ol d h im , andCarl so n t he n se ntth es e n ew ch eck s t o GM AC an d S LS. The n Kad ir’s t ax tro ub le be ga n. Kad ir g ota Fo rm 10 99 -MI SC, Mi sc el lane ou s In co m e, fo r hi s 2 01 0 t ax y ear. Th e 1 09 9- MIS C s ai d t ha t the $1 0,0 00 pa ym en t m ad e o utto Kadi r was no ne m pl oym en t co m

pe ns at io n. GMAC an d S LS als o s en t Kad ir F orm s 1 09 9- C, Can cel la ti onof De bt . Thes e fo rm s s ai d th atKadi r ha d m or e th an$3 5,0 00 in can cel edde bt --an d the ge ne ral rul e is th at can cel edde btan d n on em pl oym en t co m

pe ns at io n are t ax ab le in co m e. Kadi r di dn ’t li steit he r of

th es e num

be rs on hi s t ax return a s i nc om e fo r 20 10 . The Co m m is si on er s en t Kad ir ano ti ce o f de fic ie nc y in Marc h 2 01 2. It st at edon ly tha t h e o wedtax on th e $ 10 ,00 0 t ha t h e rec ei ve d fr om Green Po in t. So Kad ir’s c as e co m es do wn t o t hi s: The IR S sa y s Kad ir s ho ul d h av e rep orte d- 6 -

$1 0,0 00 of m is cel la ne ou s i nc om e; an d Kad ir s ay s tha t thi s m on ey was i nt en de d fo r GMAC an d S LS, andno t fo r hi m , so he sh ou ld n’t h av e to pa y tax on itat a ll . 4 Dis cu ss io n The Co de in cl ud es ev erythi ng in in co m e. Sec. 6 1. Ex cep t wh enitdo es n’t. See g en eral ly sub ch . B, p. III , Ite m s Sp eci fic al ly E xc lu de d F ro m Gros s In co m e. Andth e Co de is n’t al way s p erfe ct ly clear , so co urts ha ve est ab li sh edrul es as we ll . An o ldcas e, Raythe on Pro d. Co rp . v. Co m m is si on er, 1 44 F.2d11 0 (1 stCir . 19 44 ), aff’g 1 T.C. 95 2 (1 94 3) , was o ne of t he fir stto di sc us s h ow t he IRS s ho ul d ta x m on ey

th ata ta xp ay er g et s wh enhe set tl es a la wsu it . AndRaytheo n a nd si m il ar ca se s t el l u s t o a sk : “ [I]n l ie u o f wha t wer e th e d am ag es award ed ? ” Id . at 11 3. We kn ow t ha t Kad ir s ue d fo r th e to rt ( a k in d o f le ga l wro ng ) of frau d, b ut th atalo ne do es n’t an swe r th e que st io n. The Co m m is si on er ar gu es th at“ [s ]ettl em en t p ro ceed s ar e in cl ud edin th e br oa d d efi ni ti on of i nc om e * * * un le ss th ey are d am ag es rece iv edon acco un t o f pe rs on al in

juri es or s ic kn es s.” Wors ha m v. Co m m is si on er, T.C. Mem o. 2 01 2- 21 9, sl ip op . at 8 -9 , aff’d, 5 31 Fed . App x. 3 10 (4t h C ir. 2 01 3) . W or sh am do es say thi s, bu t i t i s v ery im

po rta ntto un de rs ta ndwhatwe were d eci di ng inth atcas e. The The IR S rai se d t he can cel la ti on -o f-d eb t i ss ue on ly at tri al , whi ch we ru le d 4 was to o l at e. Andth e p art ie s s et tl edso m e o th er m in oris su es , m ak in g co m pu ta ti on s n eces sa ry .- 7 -

ta xp ay er i n Wors ha m

was m ak in g s il ly “ ta x p ro te st er” a rg um en ts . Thes e k in ds of arg um en ts ne ve r win , andwe do n’t ev ensp en d m uc h t im e d is cu ss in g t he m be cau se we’ve reject edth em ov er an d o ve r. So wh enwe were s ay in g wh y th e ta xp ay er i n Wors ha m

was l os in g, we wer e n otm ak in g age ne ral rul e o f whe n m on ey a ta xp ay er g et s i n s et tl in g acas e is tax ab le --we were de ci di ng on ly one ta xp ay er’s cas e. W e can th in k o f a num be r of si tu at io ns wher e se tt le m en t pr oc eed s wo ul d n otbe tax ab le (e.g ., a laws ui t t o c ol le cttax -fre e m un ic ip al bo nd in te res t). 5 So whatwe ne edto do is fin d c as es th atare m or e li ke th is on e th an W or sh am . Kadi r he lp s u s t o d o thi s b y m ak in g o ne ve ry

im po rta ntpo in t: th e se tt le m en t ag reem en t re qu ire d h im to tak e th e $ 10 ,00 0 c he ck , andfro m th at pa ym en t wri te ou t ch eck s t o GM AC an d S LS th atad de d up t o $ 10 ,00 0. Kad ir arg ue s t ha t thi s s tra ng e p ro vi si on in th e se tt le m en t ag reem en t m ean s t ha t h e’s li ke a m ai lm anwho pi ck s up a n e nv el op e wit h a$1 0,0 00 ch eckin itan d the n d el iv ers itto it s fi na l ad dr es s. No bo dy woul d e ve r acc us e th e m ai lm anof n otrep orti ng $1 0,0 00 of i nc om e if

th is happ en ed .

Kadi r hi m se lf g av e u s an ot he r ex am pl e--wh ere abu il de r win s a s et tl em en t 5 in a co ns tru ct io n c as e, an d d oe sn ’t hav e to pa y tax on itbe cau se th e se tt le m en t reduc es th e co st(or

ba si s, t o u se th e ta x wo rd ) of hi s b ui ld in g.- 8 -

The re ar e a l otof c as es in tax law t ha t u se a ru le cal le d t he “ st ep tra ns act io n do ctrin e.” Thi s ru le tel ls a co urt t o t reattwo st ep s as if the y were re al ly onl y

on e whe n the pa rti es in vo lv edha ve a “bi nd in g c omm it m en t” to tak e b ot h s te ps . The re’s ev ena ve ry

ol d c as e fro m

Mi nn es ot a ab ou t thi s ru le --b ackin 19 38 , th e Supr em e Co urt, i n M in n. TeaCo . v. Hel ve rin g, 3 02 U.S. 60 9 (1 93 8) , lo ok edat a de al in whi ch th e Mi nn es ot a Tea Co m pa ny sol d e ve ryth in g i t o wne d a ndsen t the m on ey to it s s ha reh ol de rs . The s ha reh ol de rs wou ldno rm al ly hav e to pa y tax on th is , bu t p artof t he de al in th e te a co m pany’ s ca se was t ha t the sh areh ol de rs all pr om is edto us e th e m on ey to pa y th e co m pa ny’ s d eb ts to ot he r pe op le . The Supr em e Co urt s ai d t hi s amoun te d t o t he co m pa ny’ s p ay in g i ts own de bt s as far as ta x l aw was co nc ern ed : “ A gi ve n re su ltat t he en d o f a s tra ig htpa th is no t m ad e a di ffer en t re su ltbe cau se reac he d b y fol lo win g ade vi ou s p ath.” Id. at61 3. Th e Tax Co urt fo ll ows th is same rul e. See, e.g ., Pen ro d v . Comm is si on er, 8 8 T.C. 14 15 , 14 28 (19 87 ). So th e que st io n i s wh ethe r th e se tt le m en t ag reem en t re qu ire d Gre en Po in t t o pa y Kadi r an d Kad ir t o p ay

GMAC an d S LS. The an swe r is eas y : Kad ir d id n’t g et to jus t t ak e th e $ 10 ,00 0; th e se tt le m en t ag reem en t t ol d h im to pa y $5 ,70 0 GM AC an d $ 4,3 00 to SLS, by “ as si gn m en t o f [$ 5,7 00 an d $ 4,3 00 ] fro m th e Bo rro wer’s Green Po in t p aym en t.” Th is m ean s t ha t the m on ey go in g t o GM AC an d S LS was- 9 -

th e sa m e m on ey

pa idto Kadi r. As h is lawyer to ldhi m , he ha d to do th is acco rd in g to th e se tt le m en t ag reem en t. Tha t m ad e ita “bi nd in g c omm it m en t.” W e wan t t o b e car efu l t o e xp la in th atalm os t ev ery ru le ha s ex cep ti on s. If Kad ir o wed$1 0,0 00 to so m eo ne els e, an d t he set tl em en t ag reem en t s ai d t ha t Greenpo in t wo ul d p ay

Kadi r’s de bt , th entax law wo ul d p ro babl y tre atth e $ 10 ,00 0 fir stas i nc om e to Kadi r an d t he n Kad ir’s p ay in g t he de bthi m se lf. Bu t tha t’s n ot wha t we h av e h ere- -n o o ne arg ue s t ha t Kad ir h im se lf o wedan yth in g t o GM AC or SLS b ecau se of t he laws ui t. We do no te th atth e se tt le m en t ag reem en t s ay s t ha t Kad ir’s p ro m is e to sen d $ 5,7 00 to GMAC an d $ 4,3 00 to SLS wou ld“ fu ll y sat is fy ” th e two m ortg ag e lo an s fr om Greenpo in t tha t GMAC an d S LS were s erv ic in g. Thi s m ig htm ak e th os e p aym en ts a co nd it io n fo r Kad ir’s g et ti ng in co m e in th e se ns e th athi s b ig m ortg ag e d eb t was be in g p art ly cance le d, b utwe’ve al read y sai d th atth e IRS m ad e th is arg um en t t oo lat e, an d we a re s tru ckby the factth atth e pr om is edpa ym en ts ha ve no rel at io n t o t he am ou nt s o f th e two lo an s tha t Kad ir was ge tt in g o utof a ndby the factth atth e p ro m is edpa y m en ts were g oi ng to GMAC an d S LS, andno t t o Gre enpo in t. We bel ie ve d Kad ir’s l awy er fro m th e Hou si ng Pres erv at io n P ro ject wh enhe tes ti fie d t ha t GMAC an d S LS were v ery co nc ern edwith h ow the set tl em en t wo ul d b e d iv id ed . He to ldus th at“ th ere was th is m on ey

th at[Greenpo in t] hadto co nt rib ut e, bu t al l o f th e d is cu ss io ns rel at edto- 10 -

wha t h ap pe ne d t o t ha t m on ey happ en edbe twee n [GM AC an d S LS] in term s o f ho w itwas g oi ng to ge t ap po rti on ed .” W e’re co nv in cedth atth e se tt le m en t was in te nd edto ge t s om e m on ey fro m Greenpo in t t o GM AC an d S LS--ev enif $ 10 ,00 0 wen t i nt o Kad ir’s a cco un t fo r a m om en t-- be cau se GMAC an d S LS were l os in g t he m on ey th atGreen Po in t wo ul d h av e p ai d t he m if Gre en Po in t h adno t re du cedth e am ou nt s, an d c ha ng edth e te rm s, o f Kad ir’s m ortg ag es . W e th eref

or e fi ndth atMo ha m edKadi r di d n otha ve $1 0,0 00 of u nr ep orte d in co m e fo r 20 10 .
Deci si on wil l b e en te red un de r Ru le 15 5.