Court Opinion

ID: 9492641
Source: CourtListenerOpinion
Date Created: 2023-08-05 14:45:52.459791+00
Date Added: 2024-06-11T17:55:24.227608
License: Public Domain

CUDAHY, Circuit Judge,
concurring.
I write separately because, although there is much to support the majority opinion, there is considerable to throw it in doubt. And I am troubled that it ignores or excludes whole lines of authority. For example, the majority flatly rejects such cases as Pacific Transport Co. v. Commissioner, 483 F.2d 209 (9th Cir.1973), where *871the government successfully argued that a payment made by a parent corporation in discharge of a contested tort liability was not an ordinary loss and thus currently deductible. The tort claim in question was first asserted against a subsidiary corporation and necessarily assumed by the parent corporation upon liquidation. The Ninth Circuit held that the loss should have been capitalized and added to the parent’s basis in the assets acquired from the subsidiary. Pacific Transport is on all fours with the present case except that it involves the expense side rather than the income side. Arrowsmith v. Commissioner, 344 U.S. 6, 73 S.Ct. 71, 97 L.Ed. 6 (1952), involving payment of a judgment after a corporate liquidation, is to the same effect and the majority’s effort to distinguish it merely points to the unusual inequity of a contrary outcome. Nonetheless, the principles underlying Arrowsmith are the same as those argued by the taxpayer here. For, in Arrowsmith, what the majority calls an “intermediate transaction” determined the tax treatment of the payment of a judgment.
At oral argument, the panel asked questions of government counsel reflecting its concern that the government, after successfully arguing for capital treatment in cases like Pacific Transport involving the characterization of expenses, would continue to fight for ordinary income treatment when the issue involved the characterization of income. To no one’s surprise, government counsel refused to represent that in the future the government would accept ordinary expense treatment when the shoe was on the other foot. In fact, government counsel’s bottom line was “I don’t think it’s clear how the IRS would treat it if [Nahey] had paid out money.... I can’t speak for the IRS.” But this Court has, in related contexts in the past, aspired to treat settlement expenses and settlement income symmetrically. See e.g. Canal-Randolph v. United States, 568 F.2d 28, 33 (7th Cir.1977). In fact, in Canalr-Ran-dolph government counsel assured us that in that case at least the IRS would aim for symmetry even at a cost in revenue. But perhaps at this point the cause of symmetry has waned.
It may therefore be a little unrealistic and a little unfair to deny taxpayers the benefit of cases holding, in circumstances analogous to the present case, that expenses must be capitalized. It is unrealistic because we seem to entertain the hope that our result is so “simple” and so “neutral” that other courts will follow it (presumably in preference to their own precedents) equally in income and in expense cases. In the same vein, we hope that the government will be so persuaded by our analysis that it will cease taking a position in all kinds of cases that merely maximizes the revenue — whatever its logical inconsistencies. I think it is unrealistic — even naive — for us to have such expectations. It is unfair because we deny taxpayers the benefit of precedents that support in principle the capitalization of income, even though they deal immediately with issues of loss and expense.
Another consideration much esteemed by the government but a dubious contributor to simplicity and neutrality is the presence or absence of a sale or exchange. For the difference between a sale or exchange of a capital asset and its disposition by other means, such as by settlement, has never been simple or neutral. The congressional purpose in the distinction between capital gain and ordinary income seems to have been to distinguish “between recurring receipts such as salaries, wages, interest, rents, dividends, royalties, and the like on one hand, and the nonrecurrent realization of the appreciation in the value of property on the other.” Stanley S. Surrey, Definitional Problems in Capital Gains Taxation, 69 Harv. L. Rev. 985, 1003-4 (1956) (emphasis supplied). Courts have seized on “sale or exchange” language to limit the conversion of ordinary income into capital gains. The other side of the coin is that the “presence of a ‘sale or exchange’ requirement produces *872incongruous results when an admitted capital asset is disposed of by means other than sale or exchange.... ” Id. at 1007. It is hard to see how taxing Nahey’s gain as ordinary income is a simple or neutral rule when, if he had sold the claim for the settlement amount, he would have realized capital gain.
The majority says that the settlement of the lawsuit here yields ordinary income because the amount received in settlement replaced ordinary income of which Xerox had deprived Wehr. But the government seems to prefer the rationale that a settlement cannot generate a capital gain because a settlement is not a sale or exchange. However, if we could get beyond this linguistic hurdle, in the hands of Na-hey the settlement could arguably represent a reduction in Nahey’s cost basis in the other assets acquired from Wehr (a mirror image of Pacific Transport), not a replacement of ordinary income.
The majority has also adopted the principle that a corporate sale is “merely an intermediate transaction between the original claim, which was to recover ordinary income of which [the original taxpayer] had been wrongfully deprived, and the settlement of that claim after its transfer to [a new taxpayer].” This principle has a ring of clarity and simplicity about it, but it did not control in either Arrowsmith or Pacific Transport or in like cases, where an “intermediate transaction” is the key to the result. Perhaps this is not surprising because an “intermediate transaction” generally changes the identity, circumstances and economic function of the taxpayer in ways that ought to be recognized in the analysis. For example, if a car appreciates in the hands of a car dealer, the gain is generally ordinary. 26 U.S.C. § 1221(1). If it appreciates in the hands of a customer to whom the car has been sold, the gain is generally capital.
The problematic effort of the majority to make this puzzle appear simple is best illustrated by its bond analogy. Of course, coupon interest on a high-quality bond, periodically paid at prescribed intervals, is ordinary income, no matter how many corporate transfers have preceded the clipping of the coupons. But, unlike the claim in the present case, bond interest is earned almost contemporaneously with its receipt. In fact, in the example given in the majority opinion it is earned in the hands of the successor corporation. This is not unlike the yardage earned by the purchaser after the transfer in CanaV-Randolph. This is unlike the claim in the instant case where whatever is earned in the settlement reflects legal relations established before the transfer. In the case of bond interest, there is no reason to look at events before the transfer, since the interest is a wholly post-transfer phenomenon.
A junk bond might furnish a more helpful analogy. This is a bond that could be valued at the time of corporate transfer far below par because of the risk of nonpayment of interest or of non-recovery of capital. When the bond later is redeemed at face value in the hands of the transferee the part of the gain attributable to the time value of money would be treated as ordinary income and the balance as capital gain. The increase in value of a junk bond when redeemed, reflecting a reward for the transferee’s successful risk-taking, might be analogized to the settlement of the “speculative” lawsuit in the instant case.
Given all these important considerations, I think we must give proper weight to authoritative decisions like Pacific Transport, which require taxpayers to capitalize losses and which argue for symmetrical treatment on the income side. To ignore this authority adds to the mistaken impression that this is an easy case. It is far from an easy case, and efforts to make it into one may do more harm than good. My observations about various aspects of the majority opinion indicate why a strong tilt toward the tax collector is unwarranted. The arguments and authorities on both sides are so close to equipoise that a decision is difficult. To resolve the matter, *873I think that some deference is due the Tax Court, which deals regularly with the issues that trouble us. I, therefore, despite substantial doubt, elect to adopt the same outcome as the majority, even though I seriously question important aspects of its analysis.