Opinion ID: 2805897
Heading Depth: 3
Heading Rank: 2

Heading: Settlement Payments

Text: Count III of the Estate’s Complaint concerns the $41 million in payments the Estate made in 2004 to settle various lawsuits against Batchelor. In 2003, the Estate deducted the payments from Batchelor’s gross estate as claims against the estate pursuant to 26 U.S.C. § 2053(a)(3). The parties agree that this deduction was proper, and Batchelor’s estate tax liability was not at issue before the district court. However, after taking the estate tax deduction, the Estate also claimed an $8.3 million credit on its 2005 income tax return for the settlement payments. The IRS denied the claim, and the Estate then filed the instant suit seeking a refund for the perceived overpayment pursuant to 26 U.S.C. § 1341. The district court rejected the Estate’s claim, finding that 26 U.S.C. § 642(g) barred the Estate from claiming both an estate tax deduction under § 2053 and an income tax deduction for the same payment. We agree, and therefore affirm the district court’s ruling. The Estate’s position is straightforward. According to the Estate, 26 U.S.C. § 1341 entitles it to a return of the taxes Batchelor paid on the $41 million in IAL stock proceeds the Estate subsequently returned to IAL, IALPR, and the Rich 19 The parties dispute whether the two cases involve the same tax year. We need not resolve that issue, however, based on our determination that the underlying tax liabilities are distinct. 24 Case: 14-10742 Date Filed: 06/05/2015 Page: 25 of 38 plaintiffs as settlement payments. The Estate argues it is not seeking a tax windfall, but rather, because the $41 million at issue was originally reported as capital gain, by effectively returning that income, it should now be permitted a corresponding deduction or credit effectively consisting of a capital loss, and it insists § 1341 was designed to accomplish precisely that result. 20 The government maintains that the Estate cannot use the $41 million repayment to reduce both its estate and income tax obligations, and instead may only deduct the payments from either one tax or the other. We agree. Section 1341 accounts for the fact that discrete financial transactions sometimes implicate multiple tax years. In the ordinary case, deductions on a particular item of income are taken during the same year the income is earned and reported. See Mooney Aircraft, Inc. v. United States, 420 F.2d 400, 402-03 (5th Cir. 1969). It is not always possible, however, to match income and expenses in the same tax year, which may disadvantage the taxpayer due to changing circumstances across the two tax years. See id. at 404-05; see also Healy v. Comm’r, 345 U.S. 278, 284 (1953) (noting that when a taxpayer restores an item of income in a later tax year, changes in income or fluctuations in tax rates between the year of receipt and the year of repayment could disadvantage the taxpayer). In North American Oil v. Burnett, 286 U.S. 417 (1932), the United States Supreme 20 The Estate calculated a refund of $8,322,466 under § 1341. 25 Case: 14-10742 Date Filed: 06/05/2015 Page: 26 of 38 Court recognized that “[i]f a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to [report], even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent.” Id. at 424. This is known as the “claim of right” doctrine. Although the taxpayer in North American Oil was eventually entitled to keep the income, id. at 421, the Court explained that if the taxpayer, a corporation, “had been obliged to refund the [income] received in 1917, it would have been entitled to a deduction from the profits of 1922,” the year the dispute regarding the income was resolved. Id. at 424. Although this was a hypothetical statement when made in North American Oil, the Supreme Court later faced this very scenario in United States v. Lewis, 340 U.S. 590 (1951). In that case, an employer gave his employee a $22,000 bonus in 1944, which the employee reported as income in 1944. Id. at 590. In 1946, a court determined that half of the bonus had to be returned to the employer. Id. The taxpayer returned the money, and then sought to amend his 1944 tax return to reduce his income for that year. See id. at 591. Consistent with what it had said previously in North American Oil, the Supreme Court rejected this approach, deciding instead that the proper solution would be to permit a deduction in the year of repayment, 1946, for the amount of tax that had been erroneously paid in 1944. See id. at 591-92. According to Lewis, the tax year in which the 26 Case: 14-10742 Date Filed: 06/05/2015 Page: 27 of 38 contested amount was received could not be reopened, regardless of whether this would “result[] in an advantage or disadvantage to a taxpayer.” Id. at 592. 21 Congress later enacted 26 U.S.C. § 1341 to provide a statutory solution to the problem presented in cases like Lewis and to account for the tax disparities that may exist when a taxpayer claims a deduction in one year for an item of income received in an earlier year that the taxpayer was obliged to return. See United States v. Skelly Oil Co., 394 U.S. 678, 680-81 (1969) (“Section 1341 of the 1954 Code was enacted to alleviate some of the inequities which Congress felt existed in this area”); Maxwell v. United States, 334 F.2d 181, 183 (5th Cir. 1964) (“[O]rdinarily amounts received under a claim of right must be included in taxable income in the taxable year of receipt, although repaid in a later year. Section 1341 was designed to alleviate the harsh effect of this rule”). Under 26 U.S.C. § 1341, “a taxpayer is entitled to relief if in one year the taxpayer included an item as gross income and paid tax on that income, then in a subsequent year is compelled to return the item.” Steffen v. United States, 349 B.R. 734, 738 (M.D. Fla. 2006). The purpose of § 1341 is to “put the taxpayer in the same position he would have been in had he not included the item as gross income in the first place.” Fla. Progress Corp. v. Comm’r, 348 F.3d 954, 957 (11th Cir. 2003). When § 1341 applies, the taxpayer is entitled to either a “deduction” or a tax “credit” in the year 21 Justice Douglas dissented, noting that the decision might allow the government to exact tax on money that was not income to the taxpayer. See Lewis, 340 U.S. at 592 (Douglas, J., dissenting). 27 Case: 14-10742 Date Filed: 06/05/2015 Page: 28 of 38 of repayment; the taxes due for the year the income was received are not affected. See 26 U.S.C. § 1341(a)(4) & (5). For § 1341 to apply, the taxpayer must show the following: (1) an item was included in gross income for a prior taxable year (or years) because it appeared [at the time the income was received] that the taxpayer had an unrestricted right to such item; (2) a deduction is allowable for the [current] taxable year because it was established after the close of such prior taxable year (or years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item; and (3) the amount of such deduction exceeds $3,000. 26 U.S.C. § 1341(a). In addition to these statutory requirements, a taxpayer must demonstrate a “substantive nexus between the right to the income at the time of receipt and the subsequent circumstances necessitating a refund.” Steffen, 349 B.R. at 738. The taxpayer’s return of the income must not be the result of the taxpayer’s purely voluntary choice; rather, it must be “established,” for example, by a court, that the taxpayer did not have an unrestricted right to the income. See id. at 739. The Tax Court has determined that payments made to settle a lawsuit may satisfy this requirement. See Barrett v. Comm’r, 96 T.C. 713 (1991). When § 1341 applies, the taxpayer is required to pay the lesser of two computed tax payments in the year of repayment. See 26 U.S.C. § 1341(a) (“the tax imposed by this chapter for the taxable year shall be the lesser of” the two 28 Case: 14-10742 Date Filed: 06/05/2015 Page: 29 of 38 computations) (emphasis added). Under the statute’s first method of calculation, set forth in subsection (a)(4), the taxpayer simply computes the taxes owed in the year of repayment by deducting the restoration payment from his income in that year. 26 U.S.C. § 1341(a)(4). The second calculation method set forth in subsection (a)(5) is more complex, and results in a credit based on the taxes that would have been saved in the original year of receipt had the income never been received in that year. 22 See id. at § 1341(a)(5) & (b); see also Fla. Progress, 348 F.3d at 957 (explaining that the (a)(4) method of calculation results in a deduction from the current year’s taxes, whereas the (a)(5) method permits the taxpayer to claim a tax credit for the amount his tax was increased in the prior year by including the item of income). In Fla. Progress, this Court decided, based on the language of the statute and its corresponding regulations, that § 1341 does not, by itself, create an independent tax deduction and instead applies “only if another code section would provide a deduction for the item in the current year.” 348 F.3d at 963. See also id. at 958-59 (rejecting the argument that “§ 1341 stands on its own” as a source of a 22 Under 26 U.S.C. § 1341(a)(5), the taxpayer first computes his original, prior year tax with the restoration income included (as it was originally calculated in the year of receipt), then recomputes his tax for the prior year as if the item had not been included. The taxpayer then compares the two resulting tax obligations to determine the amount by which his tax would have been reduced had he not originally received the restored income. In the final step, the taxpayer reduces his current year’s tax obligation by the amount his tax liability would have been reduced in the year of receipt under the re-computation. 29 Case: 14-10742 Date Filed: 06/05/2015 Page: 30 of 38 deduction); see also Alcoa, Inc. v. United States, 509 F.3d 173, 178 n.4 (3d Cir. 2007) (“[I]t is a prerequisite for section 1341 treatment that the taxpayer be entitled to a deduction for all or part of the repaid amount under some other Code section.”). 23 Thus, contrary to the Estate’s argument, we cannot resolve the instant dispute simply by reference to § 1341. To determine whether “another code section would provide a deduction for the item in the current year,” Fla. Progress, 348 F.3d at 963, the district court found, and we agree, that the tax code provisions relating to overlapping estate and income tax deductions are relevant. In this context, 26 U.S.C. § 642(g), entitled “Disallowance of double deductions,” generally prevents an estate from claiming both an estate tax deduction under 26 U.S.C. § 2053 and an income tax deduction for the same payment. The statute provides: Amounts allowable under section 2053 or 2054 as a deduction in computing the taxable estate of a decedent shall not be allowed as a deduction . . . in computing the taxable income of the estate or of any other person, unless there is filed . . . a statement that the amounts have not been allowed as deductions under section 2053 or 2054 and a 23 In finding that § 1341 does not itself create an independent tax deduction, the Court reasoned: Subsection (a) of § 1341 provides that “if” three requirements are met, “then” the taxpayer is entitled to preferential treatment under [§ 1341]. 26 U.S.C. § 1341(a) (emphasis added). One of those requirements is that “a deduction” be “allowable for the taxable year because it was established after the close of such prior taxable year . . . that the taxpayer did not have an unrestricted right to such item. . . .” 26 U.S.C. § 1341(a)(2). The provision itself does not indicate whether a deduction should be allowable. That answer must be found in another provision of the code. . . . The regulations interpreting this provision confirm this conclusion. Fla. Progress, 348 F.3d at 958-59 (emphasis in original). 30 Case: 14-10742 Date Filed: 06/05/2015 Page: 31 of 38 waiver of the right to have such amounts allowed at any time as deductions under section 2053 or 2054. 26 U.S.C. § 642(g). Section 642 contains an exception, however, for “income in respect of decedents.” See id. (“subsection [g] shall not apply with respect to deductions allowed under part II (relating to income in respect of decedents)”). Thus, a double deduction is permitted for “taxes, interest, business expenses, and other items accrued at the date of a decedent’s death” that fall within § 2053(a)(3) as claims against the estate, as long as they are also allowable under § 691(b). See 26 C.F.R. § 1.642(g)-2. Section 691(b), in turn, provides that a decedent’s estate may claim both deductions if the expense falls within one of six statutes: sections 162, 163, 164, 212, 611, or 27.24 The district court in this case properly required the Estate to show that one of these statutes applied in order to claim both an estate tax deduction under § 2053 and an income tax deduction for the same payment. The Estate argues on appeal, as it did in the district court, that sections 162 and 212 provide the basis for permitting the “double deduction” of the settlement payments at issue because the payments arise out of Batchelor’s business activities 24 Section 691(b) provides, in pertinent part: The amount of any deduction specified in section 162, 163, 164, 212, or 611 . . . or credit specified in section 27 . . ., in respect of a decedent which is not properly allowable to the decedent in respect of the taxable period in which falls the date of his death, or a prior period, shall be allowed . . . in the taxable year when paid . . . to the estate of the decedent. 31 Case: 14-10742 Date Filed: 06/05/2015 Page: 32 of 38 in selling his IAL assets, and thus are ordinary and necessary business expenses.25 We disagree. The $41 million at issue derives from income Batchelor originally reported as capital gain through the sale of his IAL stock. Batchelor’s treatment of this income as capital gain determines the character of a subsequent repayment of that income pursuant to Kimbell v. United States, 490 F.2d 203 (5th Cir. 1974), in which this Court determined that “a payment made by a taxpayer in satisfaction of a liability arising from an earlier transaction, on which that taxpayer reported capital gain [as here], must be treated as a capital loss at least to the amount of the capital gain,” rather than as a § 162 business expense. Id. at 205. It is undisputed that Batchelor obtained the $41 million of income as a result of his sale of IAL stock. It is also undisputed that the settlement payments were made to resolve claims that Batchelor had received excess consideration in selling his interest in IAL, such that the Estate’s repayments are sufficiently linked to Batchelor’s original receipt of income. 26 Accordingly, Kimbell does not permit the Estate to 25 26 U.S.C. § 162(a) provides, “There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” 26 U.S.C. § 212 similarly provides, “In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year . . . (1) for the production or collection of income.” Although the provisions are similar, unlike § 162(a), § 212 lacks a “trade or business” requirement. See Estate of Yaeger, 889 F.2d 29, 33 (2d Cir. 1989). 26 The Estate concedes that if IAL was rendered insolvent by the stock sale and Batchelor received excess consideration, he was liable to return it to IAL or its creditors, including the plaintiffs in the four unrelated suits against Batchelor. Thus, we find that the amounts paid in settlement of those suits are sufficiently linked to the initial income so as to trigger Kimbell. 32 Case: 14-10742 Date Filed: 06/05/2015 Page: 33 of 38 claim a deduction under § 162, and the Estate thus fails to satisfy § 691(b) by way of § 162. The Estate also attempts to satisfy § 691(b) by invoking § 212, which, in pertinent part, permits a deduction to “an individual” for “ordinary and necessary expenses paid or incurred during the taxable year . . . for the production or collection of income.” 26 U.S.C. § 212(1). In this Circuit, however, “§ 162(a) and 212 are . . . considered in pari materia;” thus, “the restrictions and qualifications applicable to the deductibility of trade or business expenses [under § 162] are also applicable to expenses covered by section 212.” Sorrell v. Comm’r, 882 F.2d 484, 487 (11th Cir. 1989) (quoting Fishman v. Comm’r, 837 F.2d 309, 311 (7th Cir. 1988), cert. denied, 487 U.S. 1235 (1988)); Estate of Meade v. Comm’r, 489 F.2d 161, 164 n.6 (5th Cir. 1974) (“For purposes of this distinction between capital expenses and ordinary expenses, sections 162 and 212 are construed in the same manner . . . .”). Moreover, the rationale of Kimbell – that a taxpayer who initially reported income as capital gain may not receive the tax windfall that would result by recharacterizing a related expense as an ordinary business expense – applies with equal force to § 212. 27 See Estate of Meade, 489 F.2d at 163-66 (taxpayers who received settlement payments in a lawsuit and reported those proceeds as 27 The parties dispute whether Batchelor’s liability accrued before his death. Having determined that the Estate’s proffered income tax deduction is not allowable under section 691(b), we need not address this argument. 33 Case: 14-10742 Date Filed: 06/05/2015 Page: 34 of 38 capital gain were not permitted to deduct their legal fees associated with the suit as payments for the production of income under § 212). Thus, the Estate’s attempt to invoke § 212 also fails. In an attempt to circumvent the statutes, the Estate insists it should be allowed a double deduction because otherwise the government will receive a windfall from the income taxes Batchelor paid on the $41 million at issue. In effect, the Estate urges us to fashion an equitable result; however, doing so would require us to either disregard § 642(g), or to construe § 691(b) as though it also included § 1341 as an exception, neither of which we can do. The double deduction the Estate seeks is plainly prohibited by 26 U.S.C. § 642(g), see Estate of Luehrmann v. Comm’r, 287 F.2d 10, 12-13 (8th Cir. 1961) (recognizing that the purpose of § 642(g)’s predecessor statute “was to prevent taxpayers claiming the same items of administration expenses as deductions for both estate income tax and estate tax purposes”), and § 1341 is not one of the enumerated exceptions in § 691(b). Accordingly, we do not believe Congress intended to allow a double deduction based solely upon the potential application of § 1341. See Andrus v. Glover Constr. Co., 446 U.S. 608, 616-17 (1980) (“Where Congress explicitly enumerates certain exceptions to a general prohibition, additional exceptions are not to be implied, in the absence of evidence of a contrary legislative intent.”). See also CBS Inc. v. Prime Time 24 Joint Venture, 245 F.3d 1217, 1226 (11th Cir. 34 Case: 14-10742 Date Filed: 06/05/2015 Page: 35 of 38 2001) (“‘[W]here Congress knows how to say something but chooses not to, its silence is controlling.’”) (quoting In re Griffith, 206 F.3d 1389, 1394 (11th Cir. 2000) (en banc)); Harris v. Garner, 216 F.3d 970, 976 (11th Cir. 2000) (“[T]he role of the judicial branch is to apply statutory language, not to rewrite it.”). Thus, even assuming the equities actually favor the Estate, such concerns cannot trump the applicable statutes. See Long v. Comm’r, 772 F.3d 670, 678 (11th Cir. 2014) (“[D]eductions under the Internal Revenue Code are a matter of legislative grace and the taxpayer who claims the benefit must . . . ‘clearly establish’ his entitlement to a particular deduction.”) (internal marks and citations omitted); Estate of Luehrmann, 287 F.2d at 15 (“Tax exemptions and deductions do not turn upon general equitable considerations but depend upon legislative grace. Statutes authorizing tax exemptions and deductions are to be strictly and narrowly construed.”); Culley v. United States, 222 F.3d 1331, 1334 (Fed. Cir. 2000) (“It is basic tax law that deductions from taxable income, for purposes of computing tax due the United States, are matters of statutory grant”). Finally, the Estate points to three authorities as grounds for invoking § 1341 without reference to either 642(g) or 691(b): Revenue Ruling 77-322, which permits “[a]n estate [to] utilize . . . section 1341 . . . in computing its tax when it restores an item that was previously included in income by the decedent under a claim of right;” Estate of Good v. United States, 208 F.Supp. 521 (E.D. Mich. 35 Case: 14-10742 Date Filed: 06/05/2015 Page: 36 of 38 1962), in which the court determined that an estate was entitled to use § 1341 to obtain a refund of the income taxes a decedent had paid on income that the decedent’s employer later determined had been erroneously paid even though the estate also took an estate tax deduction for the repayment; and Nalty v. United States, No. 73-1574-B, 1975 WL 577 (E.D. La. Apr. 16, 1975), which followed Estate of Good. Aside from the fact that these authorities are not binding, see Redwing Carriers, Inc. v. Tomlinson, 399 F.2d 652, 657 (5th Cir. 1968) (noting that Revenue Rulings are merely persuasive), we disagree with their rationale. First, Estate of Good, Nalty, and Revenue Ruling 77-322 do not account for this Circuit’s requirement that a deduction must be allowable under another provision of the Tax Code for § 1341 to apply. See Fla. Progress, 348 F.3d at 958-59. Thus, it is not enough to merely conclude that the requirements of § 1341(a)(1)-(3) are met when the facts of the case implicate § 642(g). Second, although the Estate’s authorities purport to distinguish between the “credit” offered by subsection (a)(5) and the “deduction” offered by subsection (a)(4), see Estate of Good, 208 F.Supp. at 523; Nalty, 1975 WL 577, at  (relying on the same distinction); Rev. Rul. 77-322 (adopting Estate of Good without supporting explanation), we do not believe § 642(g)’s prohibition on double deductions would give way to § 1341 regardless of whether the Estate claimed a credit or a deduction. The deduction/credit 36 Case: 14-10742 Date Filed: 06/05/2015 Page: 37 of 38 distinction merely determines how to account for a § 1341 repayment on one’s return, nothing more. What matters is not whether a taxpayer may use § 1341 to reduce his present year taxes through a tax credit or a deduction, but rather whether a reduction in his income taxes is permitted at all (along with a corresponding estate tax deduction). In addition, whether a particular application of § 1341 would result in more favorable treatment to a taxpayer under subsection (a)(4) or (a)(5) depends on the fortuities of a given case, including changing tax rates and tax brackets between the year of receipt and the year of repayment. See Missouri Pac. R.R. Co. v. United States, 423 F.2d 727, 729-35 (Ct. Cl. 1970) (discussing the legislative history of § 1341 and its alternative methods of calculation in a case where the taxpayer’s tax rates varied widely over the tax years in question); cf. Skelly Oil Co., 394 U.S. at 681 (noting that, under the claim of right doctrine, “the tax benefit from the deduction in the year of repayment might differ from the increase in taxes attributable to the receipt; for example, tax rates might have changed, or the taxpayer might be in a different tax ‘bracket.’”). We do not believe Congress intended the availability of a double deduction under § 642(g) to turn on such fortuities. Regardless of whether a taxpayer would be entitled to a “deduction” under subsection (a)(4) or a “credit” under subsection (a)(5), section 642(g) and its accompanying regulations make clear that § 1341 alone does not determine whether a taxpayer may reduce both his income and estate tax liabilities 37 Case: 14-10742 Date Filed: 06/05/2015 Page: 38 of 38 for the same outlay without consideration of § 691(b). Thus, we reject the underlying rationale of the Estate’s authorities. Since the Estate has failed to identify an applicable deduction identified in § 691(b), we find no error in the district court’s determination that the Estate cannot avoid § 642(g)’s bar on double deductions, and therefore affirm on Count III. Accordingly, we reverse the district court’s judgment in favor of the Estate on Counts I and II and affirm the judgment in favor of the government on Count