Court Opinion

ID: 4166843
Source: CourtListenerOpinion
Date Created: 2017-05-08 15:05:37.197627+00
Date Added: 2024-06-11T14:23:48.462791
License: Public Domain

United States Court of Appeals
      for the Federal Circuit
               ______________________

     CHARLES P. ADKINS, JANE E. ADKINS,
             Plaintiffs-Appellants

                         v.

                 UNITED STATES,
                 Defendant-Appellee
               ______________________

                     2016-1961
               ______________________

    Appeal from the United States Court of Federal
Claims in No. 1:10-cv-00851-MMS, Judge Margaret M.
Sweeney.
               ______________________

                Decided: May 8, 2017
               ______________________

    JOHN FRANKLIN RODGERS, Redmon, Peyton & Bras-
well, LLP, Alexandria, VA, argued for plaintiffs-
appellants.

    ANTHONY T. SHEEHAN, Tax Division, United States
Department of Justice, Washington, DC, argued for
defendant-appellee.   Also represented by RICHARD
FARBER, CAROLINE D. CIRAOLO.
                ______________________

Before LOURIE, O’MALLEY, and TARANTO, Circuit Judges.
2                                              ADKINS   v. US

O’MALLEY, Circuit Judge.
    Charles P. Adkins and Jane E. Adkins seek review of
the February 23, 2016 decision of the Court of Federal
Claims (the “Claims Court”) dismissing with prejudice
their complaint for an income tax refund. Adkins v.
United States, 125 Fed. Cl. 304 (2016). For the following
reasons, we vacate and remand.
                       BACKGROUND
    This case concerns a federal income tax refund sought
by the Adkinses, based on financial losses they sustained
as victims of a fraudulent investment scheme. The main
facts are not in dispute—the central issue on appeal is
whether that loss was properly claimed as a deduction in
the 2004 tax year, as opposed to some other year. For
context, we reiterate the background facts as found by the
Claims Court.
     Beginning in 1997, the Adkinses began investing in
securities via Donald & Company, primarily through its
employee Mr. Otto Kozak. Unbeknownst to the Adkinses,
Donald & Co. was operating a “pump-and-dump”
scheme—(1)       purchasing     stock   in    a   company;
(2) encouraging its customers to do the same; (3) selling
stock in the company at the artificially increased price for
a profit; and (4) leaving its customers holding stock worth
significantly less due to the aforementioned sales. At
their peak in 2000, the Adkinses’ investments with Don-
ald & Co. were valued at $3.6 million. By the end of 2001,
as a result of the scheme, the value of their investments
had declined to $9,849. In February 2002, the Adkinses,
discovering that they had been the victims of fraud,
submitted a statement of claim to the National Associa-
tion of Securities Dealers (“NASD”) in support of arbitra-
tion against Donald & Co. and three of its principals:
David Stetson, Slava Volman, and Steven Ingrassia.
ADKINS   v. US                                          3

    In March 2003, the Adkinses requested that their ar-
bitration hearing (then scheduled for April) be postponed
in light of recent information from the Department of
Justice indicating that indictments would be handed
down against several Donald & Co. principals and em-
ployees in the near future. In particular, the Adkinses’
lawyers “suggested that the arbitration claim be left open
in the event that proceedings in the criminal matter
revealed pertinent information.” Adkins, 125 Fed. Cl. at
309. In May 2004, an indictment was returned in the
United States District Court for the Eastern District of
New York against Volman, Ingrassia, Kozak, and others,
charging conspiracy to commit securities fraud, securities
fraud, and conspiracy to commit money laundering. In
September and October of 2004, Volman, Ingrassia, and
Stetson pleaded guilty, receiving sentences including
imprisonment, supervised release, fines, mandatory
restitution, and forfeiture. Proceedings against other
Donald & Co. principals continued from 2005 to 2009.
    While the criminal proceedings were pending, in 2006,
the Adkinses attempted to recoup some of their losses by
claiming a federal income tax deduction for theft loss
under 26 U.S.C. § 165. Specifically, the Adkinses claimed
a loss of $2,118,725 for tax year 2004, with excess refund
portions carried back over the three previous years, 2001–
2003. On December 12, 2008, the IRS disallowed the
Adkinses’ refund claims for all tax years but 2002. 1 The
Adkinses protested at the IRS Office of Appeals, but
thereafter filed suit in the Claims Court before their
appeal was complete, removing the IRS’s jurisdictional

   1    It appears that the 2002 portion of the claim was
neither allowed nor formally denied, although no portion
of the record offers an explanation as to why. Neither
party, however, suggests that the treatment of the 2002
portion has any relevance to the issues now on appeal.
4                                              ADKINS   v. US

authority to settle the claim. After disposing of certain
preliminary disputes via summary judgment, the Claims
Court conducted a trial and concluded that the Adkinses
were “not entitled to a theft loss deduction for the 2004
tax year.” Adkins, 125 Fed. Cl. at 305. In particular, the
Claims Court found that the Adkinses had failed to satis-
fy the requirements of 26 C.F.R. § 1.165-1(d)(3) (i.e.,
Treas. Reg. § 1.165-1(d)(3)), insofar as they had not shown
that, in 2004, they could have “ascertained with reasona-
ble certainty that they would not receive reimbursement
of their losses.” Id. at 317. The Adkinses timely appealed
to this court.
                       DISCUSSION
    “The Claims Court’s legal determinations, including
interpretations of statutes and regulations, are subject to
de novo review and its factual determinations are re-
viewed for clear error.” Tinton Falls Lodging Realty, LLC
v. United States, 800 F.3d 1353, 1357–58 (Fed. Cir. 2015).
On appeal, the Adkinses make essentially four argu-
ments: (1) the Claims Court failed to correctly apply
Treas. Reg. § 1.165-1(d)(3)’s test for determining the year
in which a taxpayer can deduct a theft loss under 26
U.S.C. § 165; (2) even under the Claims Court’s interpre-
tation of Treas. Reg. § 1.165-1(d)(3), it improperly re-
quired abandonment of their arbitration claim; (3) the
Claims Court failed to apply Revenue Procedure 2009-20
in this case; and (4) if 2004 was not the correct loss year,
the Claims Court should have ruled in favor of the Ad-
kinses under the mitigation provisions of Treas. Reg.
§ 1.1311(c), using 2003 as the loss year instead. 2

    2  In their opening brief, in a single footnote, the
Adkinses also mention a Motion to Compel filed below
that was denied:
ADKINS   v. US                                            5

    First, we examine the requirements of Treas. Reg.
§ 1.165-1(d)(3):
   Any loss arising from theft shall be treated as sus-
   tained during the taxable year in which the tax-
   payer discovers the loss (see § 1.165-8, relating to
   theft losses). However, if in the year of discovery
   there exists a claim for reimbursement with re-
   spect to which there is a reasonable prospect of re-
   covery, no portion of the loss with respect to which
   reimbursement may be received is sustained, for
   purposes of section 165, until the taxable year in
   which it can be ascertained with reasonable cer-
   tainty whether or not such reimbursement will be
   received.
(emphases added). In interpreting and applying this
regulation, the Claims Court reiterated the conclusion
reached by another Claims Court judge in Johnson v.
United States, 74 Fed. Cl. 360 (2006). That is, although

   [We] were then prejudiced by the fact that the
   Trial Court failed to grant [our] Motion to compel
   discovery as [to] the contents of the Government’s
   copies of the Donald & Company records and the
   investigative files of the Service in the criminal
   investigations and the case should be remanded
   for a new trial.
Appellants’ Br. at 3 n.a. The Adkinses do not elaborate
further on this contention or, indeed, provide any relevant
legal authority or factual background. Because the dispo-
sition of a Motion to Compel is a matter “committed to the
discretion of the trial court,” the Adkinses’ threadbare
assertions are not a sufficient basis for this court to
second-guess the Claims Court’s reasoning. Florsheim
Shoe Co. v. United States, 744 F.2d 787, 797 (Fed. Cir.
1984).
6                                               ADKINS   v. US

other courts “tend[] to combine the ‘reasonable prospect of
recovery’ inquiry and the ‘ascertain with reasonable
certainty’ inquiry,” the “two inquiries are distinct and the
standards to be applied are different.” Adkins, 125 Fed.
Cl. at 318 (quoting Johnson, 74 Fed. Cl. at 365).
    Put differently, under Johnson, the “reasonable pro-
spect” language tolerates a greater probability of recovery
than the “reasonable certainty” language. In practice,
this means that plaintiffs are required to make a stronger
evidentiary showing when attempting to claim their loss
in any year subsequent to discovery. As the Claims Court
stated in Johnson, for example, an “estimate” made by
“lawyers and accountants may [be] sufficient to determine
whether there was a ‘reasonable prospect for recovery’ in
the year of discovery,” but it would not be “sufficient to
‘ascertain with reasonable certainty.’” Johnson, 74 Fed.
Cl. at 366 (emphasis added). Because the Adkinses
discovered their loss in 2002 and attempted to claim their
loss in 2004, the Claims Court applied the higher, more
stringent standard of “reasonable certainty”—and held
that the Adkinses failed to meet that standard.
    The Adkinses argue that Treas. Reg. § 1.165-1(d)(3),
properly interpreted, does not set forth two different
standards. Rather, Treas. Reg. § 1.165-1(d)(3) merely
describes two sides of the same probabilistic coin: a “rea-
sonable prospect for recovery” is the inverse of “reasona-
ble certainty” that there will be no recovery. 3 That is, the
test in Treas. Reg. § 1.165-1(d)(3) may be simplified as

    3   To put it in more explicit mathematical terms, we
know that Precovery + Pno recovery = 1. Let a “reasonable
prospect” for recovery mean that Precovery ≥ x for some
probability 𝑥𝑥. The Adkinses argue that “reasonable
certainty” of no recovery simply means that Pno recovery >
1 – x, so that Precovery < x. The threshold probability in
both inquiries is, therefore, identical: 𝑥𝑥.
ADKINS   v. US                                              7

follows: 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. 4 According-
ly, the Adkinses suggest, they should not have been held
to a stricter standard to claim their loss in 2004 than the
standard to which they are held for 2002.
    We agree with the Adkinses’ interpretation of the
regulation. Although few of our sister circuits have
addressed this issue explicitly, those few who have appear
to have reached the same conclusion. See, e.g., Vincentini
v. Comm’r of Internal Revenue, 429 F. App’x 560, 564 (6th
Cir. 2011) (describing Treas. Reg. § 1.165-1(d)(3) as set-
ting forth a single test, and describing that test as wheth-
er the claimant “demonstrate[d] with reasonable certainty
that there was no reasonabl[e] prospect of recovery”);
Jeppsen v. Comm’r of Internal Revenue, 128 F.3d 1410,
1414–17 (10th Cir. 1997) (using “reasonable prospect” and
“reasonable certainty” language interchangeably); Rain-
bow Inn, Inc. v. Comm’r of Internal Revenue, 433 F.2d
640, 644 (3d Cir. 1970) (describing “the test” under Treas.
Reg. § 1.165-1(d)(3) as “whether there was a reasonable
prospect of recovery at the time the deduction was
claimed”). We find no basis in the language of Treas. Reg.
§ 1.165-1(d)(3) to deviate from this straightforward and
sensible approach.
    This interpretation aligns, moreover, with common-
sense incentives for victims of theft. Good-faith efforts to
recover losses—such as lawsuits and arbitration—will
tend to push the claim year later than the year of discov-
ery by creating a probability of recovery. To the extent

    4   The test could be equivalently simplified as: the
proper year in which to claim a loss is the first year in
which it can be ascertained with reasonable certainty that
there will be no recovery, starting with the year of discov-
ery.
8                                               ADKINS   v. US

that it is rendered more difficult to succeed on a loss claim
in years subsequent to discovery, taxpayers will be dis-
suaded from those good-faith efforts. Neither the gov-
ernment nor the Claims Court has explained why such a
result possibly could have been intended by the Treasury
Department.
    Having addressed the proper application of Treas.
Reg. § 1.165-1(d)(3), we turn next to the Adkinses’ second
argument—whether, under either interpretation of
§ 1.165-1(d)(3), the Claims Court additionally erred by
treating abandonment of their arbitration claim as a
prerequisite to a reasonable certainty of no recovery.
Once again, we find the Adkinses’ argument persuasive,
and hold that the Claims Court so erred.
    In reaching that conclusion, we begin with Treas. Reg.
§ 1.165-1(d)(2)(i), which provides elaboration on what
constitutes “reasonable certainty” for purposes of § 1.165-
1(d)(3):
    Whether a reasonable prospect of recovery exists
    with respect to a claim for reimbursement is a
    question of fact to be determined upon an exami-
    nation of all facts and circumstances. Whether or
    not such reimbursement will be received may be
    ascertained with reasonable certainty, for example,
    by a settlement of the claim, by an adjudication of
    the claim, or by an abandonment of the claim.
    When a taxpayer claims that the taxable year in
    which a loss is sustained is fixed by his abandon-
    ment of the claim for reimbursement, he must be
    able to produce objective evidence of his having
    abandoned the claim, such as the execution of a
    release.
(emphasis added). The Adkinses contend that the Claims
Court effectively treated the emphasized section above as
an exhaustive list rather than a mere collection of exam-
ples. The Adkinses concede that their arbitration claim
ADKINS   v. US                                             9

with NASD was still pending in 2004; nevertheless, they
argue that a holistic examination of the facts and circum-
stances as of that time demonstrates a reasonable cer-
tainty of no recovery. The Adkinses note in particular
that, as of 2004, they had reason to believe that: (1) the
government intended to seize any documentation concern-
ing the identity and ownership of the defendants’ assets,
foreclosing independent investigation; (2) the government
intended to seize all of defendants’ discovered assets; and
(3) the defendants had no chance of generating future
assets given their plea agreements and debarments.
    In its opinion, the Claims Court acknowledges at the
outset that the list in the emphasized section above is
“expressly designated as ‘example[s],’” such that “a tax-
payer is not precluded from ascertaining the viability of
his claim in another manner.” Adkins, 125 Fed. Cl. at
319. Because the Adkinses had a live arbitration claim,
however, the Claims Court appeared to hold that aban-
donment of that claim became the only acceptable manner
to ascertain viability:
   Although plaintiffs do not say so explicitly, the
   court—based on the facts adduced at trial, plain-
   tiffs’ arguments, and the relevant regulations—
   infers that it is plaintiffs’ position that in 2004,
   they ascertained with reasonable certainty that
   they would not recover anything on their arbitra-
   tion claim. The facts further reflect that plaintiffs
   did not arrive at this conclusion because they set-
   tled or litigated the claim, but instead came to be-
   lieve that the claim was no longer viable because
   they would not be able to collect on it, and there-
   fore stopped actively pursuing it. In other words,
   notwithstanding their protestations otherwise,
   plaintiffs must be contending that they abandoned
   their arbitration claim.
   ....
10                                              ADKINS   v. US

     [Thus,] the objective evidence in the record sup-
     ports two other abandonment dates: (1) 2003,
     when plaintiffs’ arbitration attorneys requested
     that the NASD adjourn the scheduled hearing and
     when plaintiffs stopped paying their arbitration
     attorneys, or (2) 2008, when plaintiffs formally
     withdrew their arbitration claim. Accordingly,
     plaintiffs have not met their burden of establishing
     that they sustained their theft loss in 2004.
Id. at 320–21 (emphases added).        That holding cannot
stand.
    We read Treas. Reg. § 1.165-1(d)(2)(i) as setting forth
a general totality-of-the-circumstances standard, followed
by an alternative method for a plaintiff to demonstrate
that no reasonable prospect of recovery existed as of a
certain date. That is, rather than make their case under
the general “all facts and circumstances” standard, a
plaintiff may rely on the date that their arbitration or
lawsuit for the loss was settled, abandoned, or adjudicat-
ed. In the case of abandonment, because no dated court
order or settlement agreement exists, the plaintiff must
be able to provide some other form of “objective evidence”
as to when abandonment occurred. But even in cases
where the plaintiff does have a related arbitration or
lawsuit, we do not read Treas. Reg. § 1.165-1(d)(2)(i) as
precluding them from making their case under the more
general standard, should they so choose.
    This court recognizes that the existence of a live
arbitration or lawsuit typically is at least probative evi-
dence of the potential for recovery. A plaintiff’s decision
to incur the costs associated with maintaining such a
proceeding reveals something about their subjective
beliefs regarding the potential for recovery therein. But
the court must take into account what those costs actually
are. In this case, for example, the Claims Court noted
that “plaintiffs’ arbitration attorneys took no action” after
ADKINS   v. US                                            11

2004 other than “requests for further postponements.”
Adkins, 125 Fed. Cl. at 320. The Adkinses, for their part,
allege that they were no longer even paying their attor-
neys at this point. Where, as appears to be the case here,
the associated maintenance costs are almost zero, the
plaintiff’s decision to keep the proceeding open tells the
court exceedingly little about their beliefs as to the chanc-
es for recovery. No matter the odds, even a perfectly
rational actor doesn’t turn down a free lottery ticket.
    Accordingly, unless the plaintiff has chosen aban-
donment (or settlement or adjudication) as the factual
predicate for their loss date, the existence of an ongoing
lawsuit or arbitration is only one factor to be considered
among many—all facts and circumstances. Because the
Adkinses did not so choose, we direct the Claims Court on
remand to engage in this more holistic analysis, including
additional factfinding as necessary.
    Because we agree with the Adkinses that the Claims
Court both misinterpreted Treas. Reg. § 1.165-1(d)(3) and
improperly required abandonment of their arbitration
claim, we need not reach their alternative arguments
regarding Revenue Procedure 2009-20 and Treas. Reg.
§ 1.1311(c).
                       CONCLUSION
    For these reasons, the Claims Court’s opinion and or-
der dismissing the Adkinses’ complaint with prejudice is
vacated, and the case is remanded for further proceedings
consistent with this opinion.
                 VACATED AND REMANDED
                           COSTS
    Costs to appellants.