Opinion ID: 4537743
Heading Depth: 2
Heading Rank: 1

Heading: The Claims Court Misconstrued

Text: 26 U.S.C. § 165(e) and 26 C.F.R. § 1.165-1(d) The Adkinses argue that the Claims Court miscon- strued 26 U.S.C. § 165(e) and 26 C.F.R. §§ 1.165-1(d)(2)(i) and (d)(3) because it allegedly ruled that “abandonment of a claim must be shown with reasonable certainty even when there was no reasonable likelihood of success.” Appellant Br. 1. Though it had required that showing before the first appeal, the Claims Court did not treat abandonment as the factual predicate for the Adkinses’ loss date on remand. See Adkins II, 140 Fed. Cl. at 318–21. Despite their mischaracterization, however, we agree with the Adkinses that the Claims Court misconstrued the relevant legal standard when it premised its holding on the erroneous assumptions that a taxpayer cannot establish lack of a “reasonable prospect of recovery” if (1) the prospect of recovery is “unknowable”; and (2) the taxpayer has not exhausted all avenues of recovery, at least those identified by the government as potential avenues, regardless of the likelihood of success or cost associated with pursuit of the potential avenues. See id. at 316.
Not Require a Showing of “Knowability” The Claims Court concluded that the Adkinses could not establish lack of a “reasonable prospect of recovery”— not because it affirmatively found evidence of a prospect but because any such prospect of recovery was “unknowable” in 2004. See also id. at 318 (“A reasonable taxpayer . . . could not have known in 2004 whether he had a reasonable prospect of recovery.”), 320 (“[The Adkinses’] reasonable prospect of recovery from Freeman was simply Case: 19-1356 Document: 37 Page: 18 Filed: 05/29/2020 18 ADKINS v. UNITED STATES unknowable in 2004.”), 321 (“[P]laintiffs’ reasonable prospect of recovering their losses was simply unknowable by the end of 2004.”). The Claims Court’s reliance on this “unknowable” standard was legally erroneous. This “unknowable” language comes from Jeppsen v. Commissioner, 128 F.3d 1410 (10th Cir. 1997). 4 In Jeppsen, a Tenth Circuit panel majority affirmed a Tax Court ruling that the taxpayer was not entitled to claim a deduction on his 1987 federal income tax return for the loss of money stolen by his stockbroker Barker. 128 F.3d at 1411. Having noted that Jeppsen actually ended up recovering his losses in full in 1995, after seven years of litigation against Barker and others, including Barker’s successive employers (E.F. Hutton and PJ & H), the majority laid out the bases on which the Tax Court had found that, in 1987, Jeppsen had a reasonable prospect of recovery: [B]y the end of 1987:(1) Barker had engaged in con- duct that was both illegal and actionable; (2) Jeppsen knew what Barker had done; (3) Jeppsen began shopping for lawyers immediately and never at any time ceased attempting to recover his money; (4) Barker’s former employers PJ & H and E.F. Hutton were proper co-defendants, both of whom had more than sufficient assets available to satisfy any judgment awards against them; and (5) Jeppsen filed suit in March, 1988, several months before he filed his 1987 tax return. Id. at 1419. 4 This language is echoed in one other case, Vincentini v. Comm’r, 429 F. App’x 560 (6th Cir. 2011), but the court did not rely on a finding of “unknowable” prospects when concluding that the taxpayer failed to establish that there was no reasonable prospect of recovery. Case: 19-1356 Document: 37 Page: 19 Filed: 05/29/2020 ADKINS v. UNITED STATES 19 The majority upheld the Tax Court’s determination, even while recognizing that “several countervailing facts indicate that Jeppsen’s prospects of recovery were never, until he prevailed, 100 percent.” Id. For example, the parties Jeppsen sued consistently disclaimed any liability, no lawyer would take Jeppsen’s case on a contingency basis, and several lawyers—including the firm he eventually retained—informed Jeppsen that the case would be lengthy and expensive, with no guarantee of winning. Id. Notwithstanding those facts, the majority explained, Jeppsen actively pursued his suit for years (until success), the suit was not based on a meritless legal theory (it ultimately succeeded), and his ultimate recovery did not depend on the outcome of some unforeseeable intervening event. Id. There were, moreover, no criminal charges or forfeiture counts brought against the defendants in Jeppsen’s civil suit. Id. The Tenth Circuit’s ruling, therefore, was based on a multiplicity of facts quite different from those in this case. Before reviewing the finding of a reasonable prospect of recovery, the majority discussed the governing legal standards. In the course of that discussion, the majority stated that “if Jeppsen’s prospect of recovery was simply unknowable as of December 31, 1987, then Jeppsen would not be entitled to take the theft loss deduction in 1987.” Id. at 1418. That statement, phrased as a conditional, appears to be dictum, i.e., not necessary to the judgment. In upholding the Tax Court’s finding that “as of Dec. 31, 1987, Jeppsen had a reasonable prospect of recovering” his loss, id. at 1417, the majority did not rely on the quoted statement, or declare that the prospects in Jeppsen’s case were “unknowable” in 1987 but instead set forth the multiple facts, recited above, providing substantial enough indications of reasonable recovery prospects as of 1987, id. at 1419. The Jeppsen dissent, besides disagreeing with the result, took issue with the “simply unknowable” language. Case: 19-1356 Document: 37 Page: 20 Filed: 05/29/2020 20 ADKINS v. UNITED STATES The dissent interpreted the majority’s statement that an “unknowable” prospect of recovery will always doom a loss claim as an implicit requirement of affirmative proof that the loss will never be recovered, and it characterized that as placing an “insurmountable barrier on the taxpayer.” Id. at 1419–20 (Kelly, J., dissenting). The dissent reasoned that the fact that Jeppsen ultimately recovered his losses did not mean he had a reasonable prospect of recovery in the years leading up to his civil victory. Id. We agree with the Jeppsen dissent as to the inappropriateness of an unknowability standard. The governing statute and regulations do not require affirmative proof that a taxpayer’s loss will never be recovered. The regulation is clear: a taxpayer must only demonstrate that he had no reasonable prospect of recovery at the time. Treas. Reg. §§ 1.165-1(d)(2)(i), (d)(3). A conclusion that the prospect of recovery was “unknowable” replaces that inquiry with a term that is at best confusingly unhelpful and at worst incorrect. It is confusingly unhelpful because on its face it leaves wholly undefined the crucial questions of what it means to “know” the prospect of recovery (to what degree of certainty?) and what it means for the prospect to be unknowable (understanding that pursuit of possibilities of recovery vary in cost and likelihood of bearing fruit). And the “unknowable” standard is a departure from the “reasonable prospect” regulation if the recovery prospect will always be deemed “unknowable” when the court can identify uncertainties in the information available as of the tax year at issue. Although it is possible that the Jeppsen majority did not intend to require a taxpayer to prove that “the loss would never be recovered,” the Claims Court’s application of this language had that effect here. The Claims Court never concluded that there was a reasonable prospect of recovery in 2004, or in 2003 or 2005 for that matter. Rather, the Claims Court repeatedly stated that a reasonable taxpayer “could not have known in 2004 whether he had a Case: 19-1356 Document: 37 Page: 21 Filed: 05/29/2020 ADKINS v. UNITED STATES 21 reasonable prospect of recovery” because such a prospect “would have been simply unknowable.” Adkins II, 140 Fed. Cl. at 318–22. In fact, the Claims Court doubled down on this rule when it found that any reasonable taxpayer “could not have known at the end of 2004 the impact that the plea agreements and SEC orders would have on the financial resources of Messrs. Stetson, Volman, and Ingrassia.” Id. at 318. The Claims Court’s reliance on this “unknowable” standard as a basis for its conclusion was erroneous because the correct inquiry focuses on a “reasonable prospect of recovery.” The taxpayer does bear the burden of proving his entitlement to a theft loss deduction, Interstate Transit Lines v. Comm’r, 319 U.S. 590, 593 (1943), and the question as to whether there was a reasonable prospect of recovery for a particular tax year requires a binary answer: yes or no. 5 But this new standard employed by the Claims Court—whether the prospect of recovering a taxpayer’s losses is unknowable—ignores the plain language of the regulation, heightens the evidentiary burden on the taxpayer, and punishes the victim for any factual ambiguity. We also reject the government’s argument that the Claims Court simply applied our holding in Adkins I. 5 Consistent with the general applicability of a preponderance standard of proof in civil matters, Herman & MacLean v. Huddleston, 459 U.S. 375, 390 (1983); United States v. Regan, 232 U.S. 37, 49 (1914), the taxpayer must make that showing only by a preponderance of the evidence, see Louisville Store of Liberty, Ky., Inc. v. United States, 376 F.2d 314, 318 (Ct. Cl. 1967); Dargie v. United States, 742 F.3d 243, 245 (6th Cir. 2014). Under that standard, the taxpayer must show simply that it was more likely than not that there was no reasonable prospect of recovery. See Herman & MacLean, 459 U.S. at 390 (preponderance means more likely than not). Case: 19-1356 Document: 37 Page: 22 Filed: 05/29/2020 22 ADKINS v. UNITED STATES Adkins v. United States, No. 19-1356, Oral Arg. at 16:25– 18:25. The Claims Court’s opinion did not find that the taxpayers failed to demonstrate no reasonable prospect of recovery in 2004. Rather, the Claims Court held that the presence of uncertainty will always foreclose a showing of “no reasonable prospect of recovery.” Such a holding is at odds with providing “common-sense incentives for victims of theft” to try to recover their losses from the perpetrators of the fraud before asking for tax relief. Adkins I, 856 F.3d at 918. Taxpayers would be incentivized to abandon avenues of recovery at the first sign of difficulty, rather than make good-faith efforts to recover losses. Id. (“To the extent that it is rendered more difficult to succeed on a loss claim in years subsequent to discovery [because they fear whether recovery is knowable], taxpayers will be dissuaded from these good-faith efforts.”). 6 6 The government erroneously characterizes our holding in Adkins I as espousing “two alternate formulations:” one pertaining to a reasonable prospect of recovery, and another pertaining to a reasonable certainty that there will be no recovery. Adkins v. United States, No. 19-1356, Oral Arg. at 16:58–17:45 (“This court gave two alternate formulations.”). As we explained in the prior appeal, Treasury Regulation § 1.165-1(d)(3) does not set forth two different standards. Adkins I, 856 F.3d at 917–18. It sets forth a single test: the proper year in which to claim a loss is the first year in which no reasonable prospect of recovery exists anymore, starting with the year of discovery. Id. at 917. When we explained, in a footnote, that this single test could be “equivalently simplified” to mean “the first year in which it can be ascertained with reasonable certainty that there will be no recovery,” we were not creating an “alternate” test. The government’s attempts to rely on this “equivalent” language to avoid the legal standard clearly set forth in Adkins I are unpersuasive. Case: 19-1356 Document: 37 Page: 23 Filed: 05/29/2020 ADKINS v. UNITED STATES 23 Accordingly, we conclude that the Claims Court misconstrued the governing statute and regulation when it concluded that the Adkinses could not establish a reasonable prospect of recovery because that prospect was “unknowable.”
of Recovery, Regardless of Relevance or Likelihood of Success The Claims Court also suggested that, for a taxpayer to prove that there is “no reasonable prospect of recovery” for a particular tax year, he must pursue every conceivable avenue of recovery, no matter the cost to the victim or the likelihood of success. In this case, the Claims Court suggested that the Adkinses should have pursued possible arbitration claims against Freeman, and restitution claims arising from the criminal proceedings against Ingrassia, Volman, and Stetson. Id. at 319–20. According to the Claims Court, the fact that certain Donald & Co. principals realized “significant profits from the pump-and-dump scheme” and owned attached assets superseded any weight afforded to the Adkinses’ knowledge that all of the criminal defendants intended to enter guilty pleas to the public indictments. Id. at 318–20. We disagree. A taxpayer need not exhaust every possible avenue of recovery in order to prove “no reasonable prospect of recovery.” Outside of the criminal defendants, the taxpayer likely has the greatest knowledge about the facts of his case and is the person best-equipped to decide, with the advice of counsel, which claims are worth pursuing. Notably, the Claims Court pointed to possible avenues of recovery but did not calculate either the cost of pursuing that recovery or attempt to balance those costs against the likelihood of victory. While a taxpayer is not free to put her head in the sand and ignore meaningful avenues of recovery, it would be a tremendous waste of resources and time for the taxpayer to pursue every option, regardless of the likelihood of Case: 19-1356 Document: 37 Page: 24 Filed: 05/29/2020 24 ADKINS v. UNITED STATES success or degree of difficulty. As the Supreme Court explained in United States v. S.S. White Dental Manufacturing Co., “a loss may become complete enough for deduction without the taxpayer’s establishing that there is no possibility of an eventual recoupment . . . . The Taxing Act does not require the taxpayer to be an incorrigible optimist.” 274 U.S. 398, 402–03 (1927). Treasury Regulation § 1.165-1(d)(2)(i) acknowledges this reality. It makes clear that we may ascertain whether a reasonable prospect of recovery exists based on an abandonment of a claim for reimbursement. Treas. Reg. § 1.165-1(d)(2)(i). If the IRS believed, as the Claims Court clearly did, that a taxpayer must follow through on every possible road to recovery, it would not have propagated a regulation that allows for abandonment. 7