United States of America v. Reading et al

Filing 97

ORDER dismissing plaintiff's third claim with prejudice. IT IS FURTHER ORDERED denying 92 defendants' Motion for Leave to File surreply; denying 50 defendants' Motion to Dismiss and granting 52 plaintiff's Motion for Summary Judgment. Plaintiff is directed to submit a proposed judgment to the court within ten days of the filing of this order. See PDF document for details. Signed by Judge Frederick J Martone on 9/18/12.(LSP)

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IN THE UNITED STATES DISTRICT COURT

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FOR THE DISTRICT OF ARIZONA

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United States of America,
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Plaintiff,
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vs.
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James Leslie Reading, et al.,
Defendants.

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No. CV 11-00698-PHX-FJM
ORDER

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We have before us James Leslie Reading, Clare L. Reading, and Fox Group Trust's
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motion to dismiss complainant's seventh claim (doc. 50), defendants' memorandum in
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support (doc. 51), plaintiff's opposition (doc. 67), and defendants' reply (doc. 68). We also
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have before us plaintiff's motion for summary judgment (doc. 52), memorandum in support
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(doc. 52 ex. 1), and statement of material facts in support (doc. 52 ex. 2), James and Clare
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Reading's response (doc. 82), the Readings' memorandum in support of defendants' response
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(doc. 82 at 6), the Readings' response to plaintiff's statememt (sic) of facts (doc. 82 at 21),
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the Readings' separate statement of facts (doc. 82 at 67), the Readings' notice to amend
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defendants' separate statement of facts (doc. 96), plaintiff's reply (doc. 90), the Readings'
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motion for leave of court to file surreply (doc. 92), plaintiff's response (doc. 93), and the
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Readings' reply (doc. 95). Plaintiff seeks summary judgment on all claims except count
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three, which it voluntarily dismisses.
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I

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Plaintiff brings this action against James and Clare Reading, a married couple, to

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reduce tax assessments to judgment and foreclose statutory liens arising from assessments

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upon real property. The last time Mr. Reading voluntarily made a payment to the IRS was

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in 1989. He worked for three companies affiliated with Pilot Catastrophe Insurance ("Pilot")

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in 1993 and received $77,359.24 in compensation that year. On their 1993 joint federal

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income tax return, the Readings declared under oath that they had zero wages and salary and

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zero taxable income. In 1994, Mr. Reading received over $156,000 in compensation from

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Pilot companies, but reported zero wages and salary and zero taxable income on the

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Readings' 1994 joint tax return. Mr. Reading received over $117,000 in compensation from

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Pilot in 1995, but again reported zero wages and salary and zero taxable income on the

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Readings' 1995 joint return. The Readings filed their 1993, 1994, and 1995 returns on or

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after December 24, 2008. For all three years, Mr. Reading also submitted corrected 1099-

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MISC forms swearing that Pilot erroneously identified payments to him as gains, profit or

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income made in the course of a trade or business. Plaintiff contends that the IRS mailed a

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Notice of Deficiency to the Readings in 2000 for the tax years 1993, 1994, and 1995, but

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they declare they never received the notice.

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In 2008, Mr. Reading made $23,858 by working for Colonial Claims Corporation.

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The Readings declared under oath on their 2008 tax return that they had zero wages and

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salary and zero taxable income, and a concurrently filed 1099-MISC form stated that Mr.

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Reading received zero compensation from Colonial Claims Corporation. The IRS mailed a

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Notice of Deficiency to Mr. Reading on February 16, 2010 for his 2008 income tax year.

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In 1979, James and Clare Reading purchased a house in Mesa, Arizona as joint tenants

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with right of survivorship. The purchase price was approximately $68,000. On or about

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June 10, 2005, they transferred the house to Fox Group Trust by quit claim deed. The house

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was worth approximately $110,000 at the time. Fox Group Trust gave no consideration for

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this transfer other than allowing the Readings to continue living on the property as they did

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before the transfer. The Readings have not paid rent and they continue to be personally
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obligated on the note which is secured by a mortgage on the house. The Readings pay all

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utilities, county real estate taxes, and mortgage payments.

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administrative trustees for Fox Group Trust.

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The Readings act as

II

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When considering a motion to dismiss pursuant to Rule 12(b)(6), Fed. R. Civ. P., "a

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court must construe the complaint in the light most favorable to the plaintiff and must accept

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all well-pleaded factual allegations as true." Shwarz v. United States, 234 F.3d 428, 435 (9th

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Cir. 2000). On the other hand, a court is "not bound to accept as true a legal conclusion

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couched as a factual allegation." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555, 127 S. Ct.

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1955, 1965 (2007) (quoting Papasan v. Allain, 478 U.S. 265, 286, 106 S. Ct. 2932, 2944

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(1986)).

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Plaintiff's seventh claim asserts that the Readings' transfer of their house to Fox Group

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Trust was a fraudulent conveyance under the Arizona Uniform Fraudulent Transfer Act

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("AUFTA"). Section 44-1009 provides that a claim for fraudulent conveyance under A.R.S.

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§ 44-1004(A)(1) "is extinguished unless an action is brought . . . within four years after the

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transfer was made or the obligation was incurred or, if later, within one year after the

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fraudulent nature of the transfer or obligation was or through the exercise of reasonable

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diligence could have been discovered by the claimant." The Readings contend that § 44-

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1009 is a statute of repose which bars this claim, while plaintiff argues it is a statute of

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limitations and thus does not bind the federal government. See United States v. Summerlin,

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310 U.S. 414, 416, 60 S. Ct. 1019, 1020 (1940) ("the United States is not bound by state

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statutes of limitation"). Plaintiff filed its complaint April 8, 2011. Plaintiff does not rely on

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the one-year limitation period. Therefore, since the transfer occurred June 10, 2005, this

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claim is barred if the four-year limit applies to the United States. If § 1009 does not apply,

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then the United States has ten years from the date of the assessment to file an action. 26

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U.S.C. § 6502(a).

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In Bresson v. Commissioner of Internal Revenue, 213 F.3d 1173 (9th Cir. 2000), the

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United States Court of Appeals for the Ninth Circuit determined that the California Uniform
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Fraudulent Transfer Act's nearly identical extinguishment provision was a statute of

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limitations which did not bar the government's claim. Id. at 1178. As in this case, the

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government acted in its sovereign capacity by attempting to collect taxes and its underlying

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right to collect money derived from the Internal Revenue Code. Id.; cf. United States v. Cal.,

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507 U.S. 746, 113 S. Ct. 1784 (1993) (government became entitled to claim by indemifying

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a private contractor's state-law debt and could assert claim only through subrogation, an

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equitable action created by courts; therefore, Summerlin was "clearly distinguishable").

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"[S]tates 'transgress the limits of state power' when they attempt to set limitations periods on

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claims acquired by the United States in its governmental capacity." Id. at 1179. Thus, like

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California's statute, Arizona's "'extinguishment' provision cannot evade the rule of

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Summerlin." Bresson, 213 F.3d at 1178. Therefore defendants' motion to dismiss is denied.

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III

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Summary judgment is appropriate if there is no genuine dispute as to any material fact

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and the movant is entitled to judgment as a matter of law. Rule 56(a), Fed. R. Civ. P. When

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considering a motion for summary judgment, the court takes undisputed facts as true and

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evaluates disputed facts in the light most favorable to the non-moving party. Anthoine v. N.

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Cent. Cntys. Consortium, 605 F.3d 740, 745 (9th Cir. 2010).

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The United States' first two claims are to reduce tax and related assessments made

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against the Readings to judgment. Assessments against Mr. Reading for his 1993, 1994,

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1995, and 2008 tax years totaled $556,871.63 as of May 1, 2012. Assessments against Mrs.

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Reading for 1994 and 1995 totaled $116,632.96 as of May 1, 2012. These amounts include

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taxes, late filing penalties, failure to pay tax penalties, estimated tax penalties, and interest.

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Defendants dispute plaintiff's calculation of income for 1994 and 1995. The IRS

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taxed Mr. Reading on 100% of his compensation for those years and taxed Mrs. Reading on

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50% of her husband's compensation. In its reply brief, plaintiff agrees to reduce the amount

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of compensation received by Mr. Reading by 50% for his 1994 and 1995 tax years and

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recalculate interest and balances owed for those years.

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Defendants also dispute the IRS's calculation of capital gains for 1993 and 1994. The
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IRS issued the Notice of Deficiency and adjusted the amount of taxes owed in 2011 after the

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Readings provided the IRS with more information. Rather than a gain of $85,889 in 1993,

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the IRS calculated a loss of $214.59 for that year. The IRS reduced capital gains for 1994

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from $11,948 per person for Mr. and Mrs. Reading to $4,140.53 per person. The IRS also

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reduced a gain of $15,537 to a loss of $77.94 for the 1994 tax year. These capital gains

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adjustments resulted in tax decreases and downward penalty adjustments for the years 1993

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and 1994. Defendants' arguments on this issue ignore the IRS's adjusted calculations and the

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government's use of the lower revised numbers in this action.

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Defendants' remaining arguments against the assessments and penalties are without

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merit. The Readings apparently believe that compensation received from an employer is not

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taxable because money was received in exchange for labor and time. "The assertion that

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proceeds received for personal services cannot be given a 'zero-basis for the purpose of the

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assessment of taxation,' is frivolous." Carter v. Comm'r of Internal Revenue, 784 F.2d 1006,

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1009 (9th Cir. 1986); see also 26 U.S.C. § 61 ("gross income means all income from

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whatever source derived, including . . . [c]ompensation for services").

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The Readings contend that they are not liable for taxes because plaintiff has not

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identified a statute which makes them liable to pay a tax. This is frivolous. The Internal

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Revenue Code imposes a tax on the taxable income of individuals. 26 U.S.C. § 1(a)-(d).

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Every person whose gross income exceeds the exemption amount must file an income tax

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return. 26 U.S.C. § 6012(a). When a tax return is required, the taxpayer must pay the tax

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without assessment or notice and demand from the IRS. 26 U.S.C. § 6151(a). Many statutes

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make defendants liable to pay taxes on their income.

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Defendants assert that there is no evidence the Secretary of the Treasury properly

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delegated authority to IRS employees. "Relevant statutes and regulations demonstrate,

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however, that the Secretary does have the power to collect taxes, and that such power can be

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delegated to local IRS agents." Hughes v. United States, 953 F.2d 531, 536 (9th Cir. 1992).

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The Secretary is authorized to send a Notice of Deficiency to a taxpayer pursuant to 26

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U.S.C. § 6212(a). For purposes of this statute, "Secretary" also includes his delegate, which
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is defined as "any officer, employee, or agency of the Treasury Department." 26 U.S.C. §

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7701(a)(11)-(12). Regulations also specifically task district directors with collecting taxes

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and mailing Notices of Deficiency, see 26 C.F.R. §§ 301.6301-1, 301.6212-1, and allow them

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to redelegate these functions. 26 C.F.R. § 301.7701-9. Delegation down the chain of

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command is valid. There is no statutory requirement that the Secretary of the Treasury or his

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delegate sign a Notice of Deficiency for it to be valid. See Urban v. Comm'r of Internal

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Revenue, 964 F.2d 888, 889 (9th Cir. 1992). Defendants raise a related argument that the

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Secretary or his delegate violated the Internal Revenue Manual. This argument lacks merit

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because compliance with the Manual is not mandatory. Id. at 890.

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Defendants contend that they never received Notices of Deficiency or Notices and

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Demand pursuant to 26 U.S.C. § 6303. But evidence submitted by defendants shows that,

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at the very least, Mrs. Reading received a notice regarding her 1994 and 1995 tax years.

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(Doc. 83, ex. MM). Mr. Reading also admits that he received a notice for his 2008 tax year.

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The only notices left at issue are for Mr. Reading's 1993, 1994, and 1995 tax years. Even

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if he did not receive a notice for these years, actual receipt of the notice is not required.

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Evidence that the government mailed the notices to the taxpayer's "last known address" is

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sufficient. 26 U.S.C. § 6212(b)(1); Cohen v. United States, 297 F.2d 760, 771-73 (9th Cir.),

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cert. denied, 369 U.S. 865, 82 S. Ct. 1029 (1962). The government submits evidence

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showing that the notices were sent to defendants' home, and defendants fail to submit

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evidence in rebuttal. They cannot maintain their argument that summary judgment should

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be denied because notices were not issued.

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In addition, they argue that the notices of deficiency were invalid because plaintiff did

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not create returns on their behalf. "Deficiency procedures set out in the Internal Revenue

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Code, 26 U.S.C. §§ 6211-6213, do not require the Commissioner to prepare a return on a

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taxpayer's behalf before determining and issuing a notice of deficiency." Roat v. Comm'r of

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Internal Revenue, 847 F.2d 1379, 1381 (9th Cir. 1988).

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Defendants have failed to raise a genuine dispute of material fact. Their arguments

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against the assessments are meritless. The United States is entitled to summary judgment on
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its first and second claims.

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IV

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Plaintiff's next two claims are to reduce penalty assessments made against the

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Readings to judgment. The IRS made frivolous return penalty assessments against Mr. and

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Mrs. Reading which now total $16,739.18 for Mr. Reading and $16,793.78 for Mrs. Reading.

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Pursuant to 26 U.S.C. § 6702, a person who submits a frivolous return must pay a penalty.

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The government has the burden of proof on whether a taxpayer is liable for a penalty. 26

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U.S.C. § 7603(a).

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Defendants dispute that penalties can be assessed for frivolous tax returns. "[A] return

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which shows no tax liability and no recognizable basis for reaching such a conclusion" is a

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return which "does not contain information on which the substantial correctness of the self-

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assessment may be judged within the meaning of section 6702." Fuller v. United States, 786

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F.2d 1437, 1439 (9th Cir. 1986). The Readings' assessment of their taxes was substantially

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incorrect and their position on wages being exempt from income is without merit. As a

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result, the frivolous return penalties assessed under § 6702 are fully justified. The United

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States is entitled to summary judgment on its fourth and fifth claims seeking frivolous return

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penalty assessments.
V

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Plaintiff's final three claims relate to the transfer of real property from the Readings

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to Fox Group Trust. The United States asks that we set aside the transfer as a fraudulent

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conveyance or, in the alternative, find that Fox Group Trust holds title to the property as a

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nominee or alter ego of James and Clare Reading. Plaintiff also seeks to foreclose federal

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tax liens against the property. Defendants James and Clare Reading fail to address these

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causes of action in their response to the motion for summary judgment, and defendant Fox

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Group Trust did not file a response.

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Pursuant to 26 U.S.C. § 6321, if a person liable to pay taxes neglects or refuses to pay

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after demand, the amount "shall be a lien in favor of the United States upon all property and

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rights to property, whether real or personal, belonging to such person." This lien "shall arise
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at the time the assessment is made and shall continue until the liability for the amount so

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assessed (or a judgment against the taxpayer arising out of such liability) is satisfied or

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becomes unenforceable by reason of lapse of time." 26 U.S.C. § 6322. The IRS has made

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assessments and the Readings have failed to pay. Therefore, statutory tax liens have arisen

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and are currently in effect because the Readings have outstanding liabilities.

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The court looks "to state law to determines what rights the taxpayer has in the

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property the Government seeks to reach." Drye v. United States, 528 U.S. 49, 58, 120 S. Ct.

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474, 481 (1999). Federal law then determines whether these rights qualify as "property" or

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"rights to property" to which a federal lien may attach. Id.

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The United States first claims that the transfer of the house was a fraudulent

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conveyance made with "actual intent to hinder, delay or defraud any creditor of the debtor."

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A.R.S. § 44-1004(A)(1). Section 44-1004(B) lists eleven "badges of fraud" which tend to

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show the existence of fraudulent intent. Torosian v. Paulos, 82 Ariz. 304, 312, 313 P.2d 382,

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388 (1957). The most relevant here are that the debtors retained possession and control over

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the property after the transfer and that the value of the consideration received was not

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equivalent to the value of the asset transferred. In addition, the transfer was to a trust of

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which the transferors are the administrative trustees. There is also evidence that the debtors

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knew of their liabilities to the IRS and the potential that they would be sued to collect the

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debt at the time of the transfer.

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Actual intent to defraud plaintiff can be reasonably inferred from defendants' actions.

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"[S]trong, clear evidence will be required to repel the conclusion of fraudulent intent" when

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several badges of fraud are found in a single transaction. Id. Far from strong evidence, there

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is no evidence at all to rebut the inference of fraud. Plaintiff has shown a fraudulent conv

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eyance by clear and convincing evidence and thus the transfer should be set aside.

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Alternatively, the IRS can properly regard Fox Group Trust's assets as the Readings'

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property, subject to a lien in favor of the United States, if Fox Group Trust is a nominee of

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James and Clare Reading. G.M. Leasing Corp. v. United States, 429 U.S. 338, 350-51, 97

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S. Ct. 619, 627 (1977). State law governs the determination of whether an alter ego or
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nominee exists from whom the government may satisfy a taxpayer's obligations. Wolfe v.

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United States, 806 F.2d 1410, 1411 n.3 (9th Cir.1986). The parties did not cite, and the court

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did not find, any Arizona case which discusses factors relevant to determining whether a trust

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is a nominee of an individual. See United States v. Richardson, No. CV-04-0739-PCT-DGC,

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2006 WL 3388347, at *6 n.3 (D. Ariz. Nov. 21, 2006) (finding no reported Arizona case

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addressing nominee status). Factors which suggest nominee status include inadequate

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consideration paid by the nominee, property placed in the nominee's name in anticipation of

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a lawsuit while the transferor continues to exercise control over the property, a close

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relationship between transferor and nominee, failure to record the conveyance, retention of

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possession by the transferor, and continued enjoyment by the transferor of benefits of the

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transferred property. Id. at *6; Towe Antique Ford Found. v. IRS, 791 F. Supp. 1450, 1454

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(D. Mont. 1992). These factors support Fox Group Trust's status as a nominee. It gave no

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consideration for the property; the Readings exercise complete control over the house; the

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Readings are administrative trustees of Fox Group Trust; the Readings retained possession

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of the house after the transfer; and they continue to enjoy the benefits of the property. The

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uncontested evidence shows that Fox Group Trust is a nominee of James and Clare Reading.

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Under either the theory of fraudulent conveyance or nominee status, the house at issue

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is property of the Readings which may be reached by plaintiff. Where a party refuses or

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neglects to pay a tax, the government may file a civil action to enforce a lien with respect to

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such tax or to subject any property to the payment of such tax. 26 U.S.C. § 7403(a). "If the

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government proceeds under 26 U.S.C. § 7403 to enforce a lien, once a court declares a

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transfer fraudulent and void, the asset reverts back to the ownership of the debtor-transferor

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and federal law governs the foreclosure of the lien and the selling of the asset." United States

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v. Verduchi, 434 F.3d 17, 20 (1st Cir. 2006). In cases where a claim of the United States is

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established, the court "may decree a sale of such property, by the proper officer of the court,

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and a distribution of the proceeds of such sale according to the findings of the court in

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respect to the interests of the parties and of the United States." 26 U.S.C. § 7403(c).

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The transfer to Fox Group Trust is void and the United States has established its
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interest in the Readings' residence. Plaintiff may sell the house to satisfy its liens against

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James and Clare Reading. Plaintiff has entered into stipulations with other defendants

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regarding the priority of their liens (docs. 35, 36). The proceeds of the sale will be

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distributed according to these stipulations.

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VI

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James and Clare Reading request leave to file a sur-reply to plaintiff's reply in support

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of its motion for summary judgment (doc. 92). LRCiv 7.2 does not authorize a response to

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a reply. A sur-reply is also unnecessary here because plaintiff did not introduce new material

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in its reply. Nevertheless, the court has read defendants' lodged sur-reply and finds that the

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arguments contained therein are repetitious of defendants' response and would not change

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the court's ruling.

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VII

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IT IS ORDERED DISMISSING plaintiff's third claim with prejudice.

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IT IS ORDERED DENYING defendants' motion for leave of court to file surreply

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(doc. 92).

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IT IS ORDERED DENYING defendants' motion to dismiss (doc. 50).

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IT IS ORDERED GRANTING plaintiff's motion for summary judgment (doc. 52).

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Plaintiff is directed to submit a proposed judgment to the court within ten days of the filing

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of this order, including updated calculations for Mr. Reading's liabilities for his 1994 and

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1995 tax years. The proposed judgment shall include a proposed order of foreclosure and

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sale regarding the residence.

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DATED this 18th day of September, 2012.

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