Blanco et al v. USA
Filing
27
ORDER denying 18 and 19 Motions for Summary Judgment; granting 22 Motion to File Response Out of Time. By Judge R. Brooke Jackson on 01/06/2016. (athom, )
IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLORADO
Judge R. Brooke Jackson
Civil Action No 14-cv-02987-RBJ
RICHARD BLANCO and PATRICIA DUKE,
Plaintiffs,
v.
UNITED STATES OF AMERICA,
Defendant.
ORDER
The parties have filed cross-motions for summary judgment. For the reasons expressed
in this order, both motions are denied.
BACKGROUND
This case arises from a tax return filed by Richard Blanco and Patricia Duke, husband
and wife, for the 2009 tax year. Plaintiffs later were notified by the IRS that they had
underreported their income, and that additional tax was due. After further investigation,
plaintiffs agreed and paid the additional tax, interest and penalties assessed. They did not,
however, believe that the penalty should have been assessed. This lawsuit was filed to challenge
the Commissioner’s rejection of plaintiffs’ claim for a refund of the penalty payment. ECF No.
1. The Court has jurisdiction pursuant to 28 U.S.C. § 1346(a)(1).
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FACTS
Plaintiffs support their motion for summary judgment with, among other things, Mr.
Blanco’s affidavit. ECF No. 18-8. He relates that sometime before 2009 he informed his
Certified Public Accountant, Mark Rohn, that he might receive a monetary settlement from an
age discrimination case against his previous employer. Mr. Rohn told him that the settlement
might be structured to minimize the amount that was taxable as income. After Mr. Blanco
received a settlement, he told Mr. Rohn that his attorney told him that the settlement was not
taxable. 1 Mr. Rohn responded that “they must have consider [sic] the monetary settlement [to
be] for pain and suffering.” Id. at ¶2. Therefore, “we did not include the settlement in income
on my 2009 tax return.” Id. at ¶3. Mr. Blanco states that he relied on the advice of his attorney
and his CPA. Id.
Mr. Blanco continues that when he was audited he learned that awards for pain and
suffering are only excluded from income if they were related to a physical injury. Therefore, he
agreed to pay additional tax, interest and penalties as assessed by the IRS agent. However, the
IRS agent told him that the penalty could be abated based upon reasonable reliance on his CPA’s
advice. An IRS document submitted in support of the plaintiff’s motion confirms that the
original IRS agent agreed to abate the penalty based on a letter she received from Mr. Rohn; the
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Plaintiffs’ portion of the proposed (and entered) Scheduling Order states that the attorney who handled
the suit against Morgan Stanley told Mr. Blanco that he would receive a Form 1099 for any portion of the
award that was taxable. He did not receive a 1099, and he conferred again with his attorney. The
attorney told him that if he did not receive the 1099, the award was not taxable. Plaintiffs indicated that
Mr. Blanco disclosed these facts to his CPA who responded that because he did not receive a 1099, the
IRS must have considered the entire award to be for pain and suffering, so the income need not be
reported on his tax return. ECF No. 12 at 2-3.
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agent interpreted the Rohn letter as indicating that Mr. Rohn had told Mr. Blanco that a
“settlement” he had received was not taxable income. ECF No. 18-2 at 4, ECF No. 18-3 at 1.
Plaintiffs submitted an affidavit from Mr. Rohn that repeats, in virtually identical
language, this portion of Mr. Blanco’s account. ECF No. 18-9. It even relates that he too
learned after Mr. Blanco was audited that monetary awards for pain and suffering are only
excluded from income if related to a physical injury. Id. at ¶5.
Mr. Blanco’s affidavit goes on to state that the IRS agent later told him that she was
unable to get the refund processed properly. The IRS document indicates that the “field” was
overruled by a “division,” to the consternation of the original agent. ECF No. 18-3 at 1. Mr.
Blanco then contacted a “Taxpayer Advocate Service,” which looked into it but told him that he
would receive a letter denying the refund and informing him of his right to go to court. Id. at ¶¶
4-7. This suit followed.
In its cross-motion for summary judgment the government provides additional details
gleaned from depositions and other materials. Mr. Blanco has a B.S. in Marketing and has
received further training in finance, insurance and compliance issues. ECF No. 19-1 at 10 (depo.
p. 10). He is, and apparently throughout much of his career has been, a financial advisor. Id. at
8-11 (depo. pp. 10-13). He has held management positions, including his two years as the
branch manager of Morgan Stanley Denver office. Id. at 11-12(depo. pp. 13-14).
After he was terminated by Morgan Stanley, Mr. Blanco pursued a wrongful discharge
claim that initially was based on age discrimination. Id. at 13 (depo. p. 20). However, the claim
that was ultimately presented to the FINRA arbitration panel did not include any claim based on
age discrimination. ECF Nos. 19-1 at 72-79. The written arbitration decision listed the claims as
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breach of contract, unjust enrichment, fraudulent inducement to contract, negligence and
misrepresentation in connection with employment. ECF No. 19-2 at 7. Mr. Blanco was awarded
compensatory damages of $390,000 without discussion of the nature of the damages. Id.
In January 2010 Morgan Stanley sent Mr. Blanco a Form 1099-MISC Tax Statement.
The Form 1099 classified the arbitration award as “other income” and stated, “Generally, report
this amount on the ‘Other income’ line of Form 1040 and identify the payment.” ECF No. 19-2
at 19-20. In his deposition Mr. Blanco denied that he had seen the document, noting that it was
incorrectly addressed, but he also testified that he could not remember whether he ever received
a Form 1099 from Morgan Stanley. ECF No. 19-1 at 29 (depo. p. 48) and 21 (depo. p. 32).
Mr. Blanco was asked about the advice he had received from his CPA, Mr. Rohn. He
testified that the year before he received the arbitration award he alerted Mr. Rohn to the
possibility that he might receive an award, and he was told that those awards are often not
taxable “due to age discrimination, things like that.” Id. at 35 (depo. p. 35). He talked with Mr.
Rohn after receiving the award, but he did not provide any information about the arbitration. Id.
at 23 (depo. p. 34). Mr. Rohn “said he presumed it was nontaxable due [sic] the fact of the way
the lawsuit was – or the arbitration came about.” Id. Mr. Blanco admitted that he thought that
Mr. Rohn based that presumption on “age discrimination and personal – I don’t know what you
call that.” Id. at 25 (depo. p. 37). He thought that was because of what he had told Mr. Rohn
about his suit the previous year. Id.
Mr. Rohn testified in his deposition that he did not get a copy of the “settlement
agreement” (the arbitration award). ECF No. 19-1 at 60 (depo. p. 28). He assumed the suit was
based on age discrimination based on what Mr. Blanco had told him. Id. at 61 (depo. p. 29).
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When asked what advice he gave Mr. Blanco about the taxability of the award, Mr. Rohn
testified, “I talked with Rick about it, and I guess I was wrong on this. I thought maybe there
could be some pain and suffering or something like that attached to the suit, that it might exempt
him from income taxes.” Id. at 62-63 (depo. pp. 30-31). Mr. Rohn’s letter to the original IRS
agent, to which she referred in explanation of her decision to abate the penalty, states that when
Mr. Blanco’s suit was initiated “there was some discussion that a portion of any settlement could
be exempt from income taxes if it addressed pain and suffering resulting in personal injuries.”
ECF No. 18-5 at 1. The letter also states that the income “was the result of arbitration on an age
discrimination suit brought against a former employer,” and that “the final arbitration did not
disclose any methods or calculations as to how the final monetary settlement of $390,000 was
reached.” Id.
The attorney who handled Mr. Blanco’s claims against Morgan Stanley, Otto K. Hilbert,
II, testified in his deposition that his practice does not include tax law. ECF No. 19-2 at 26
(depo. p. 5). He was asked whether he gave Mr. Blanco tax advice, and he responded, “I tell all
my clients, call your accountant . . . I do not give tax advice.” Id. at 27 (depo. p. 10). He was
asked a second time whether he gave Mr. Blanco advice about whether or not he should report
the arbitration award on his tax return, and his answer was, “I told him to call his accountant.”
Id. at 28 (depo. p. 11).
It is undisputed that plaintiffs’ tax return did not disclose the arbitration award. It
reflected taxes due of $26,602. However, the amount actually due was $114,568. Therefore,
plaintiffs’ underreporting resulted in their underpaying taxes by $87,966. An accuracy-related
penalty of 20% of the underpayment was assessed pursuant to 26 U.S.C. § 6662(a).
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The government also provides evidence that Mr. Blanco made two additional deposits
into his bank account in 2009 that totaled $110,000. ECF No. 19-7. The two payments came
from Mr. Blanco’s then employer, Bank of the West. ECF No. 19-1 at 34-36 (depo. pp. 59-60,
64). Mr. Blanco testified that he does not know what they were for or whether they were
included in income on his 2009 tax return. Id. Neither payment appears to have been reported
on his original or his amended 2009 tax return. See ECF Nos. 19-3 and 11. In response to the
government’s motion plaintiffs assert that these payments were non-taxable returns of principle
from stock accounts. ECF No. 21 at 5. As the government notes in its reply, however, no
evidence was submitted in support of that assertion.
STANDARD OF REVIEW
The Court may grant summary judgment if “there is no genuine dispute as to any material
fact and the movant is entitled to judgment as a matter of law.” Fed. R. Civ. P. 56(a). A fact is
material “if under the substantive law it is essential to the proper disposition of the claim.” Adler
v. Wal-Mart Stores, Inc., 144 F.3d 664, 670 (10th Cir. 1998) (citing Anderson v. Liberty Lobby,
Inc., 477 U.S. 242, 248 (1986)). A material fact is genuine if “the evidence is such that a
reasonable jury could return a verdict for the nonmoving party.” Anderson, 477 U.S. at 248.
The Court will draw reasonable inferences and resolve fact disputes in favor of the party
opposing summary judgment. Yousuf v. Cohlmia, 741 F.3d 31, 37 (10th Cir. 2014). In the
present case both parties seek summary judgment. However, “the fact that both parties have
moved for summary judgment does not permit the entry of a summary judgment if disputes
remain as to material facts.” Harrison Western Corp. v. Gulf Oil Co., 662 F.2d 690, 692 (10th
Cir. 1981).
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CONCLUSIONS
A. Accuracy-Related Penalty on Underpayment: § 6662.
Under the Internal Revenue Code, specifically 26 U.S.C. § 6662(a), a 20 percent penalty
is applied to any portion of an underpayment to which the section applies. Section 6662(b) lists
eight types of underpayments to which the section applies. The government contends that two of
the eight categories apply here:
•
An underpayment attributable to “negligence or disregard of rules or regulations.” 26
U.S.S. §§ 6662(b)(1). “[T]he term ‘negligence’ includes any failure to make a reasonable
attempt to comply with the provisions of this title, and the term ‘disregard’ includes any
careless, reckless, or intentional disregard.” 26 U.S.C. § 6662(c).
•
“Any substantial understatement of income tax.” 26 U.S.S. §§ 6662(b)(2). This occurs if
the amount of the understatement exceeds the greater of (i) 10 percent of the tax required
to be shown on the return for the taxable year, or (ii) $5,000. 226 U.S.S. §
6662(d)(1)(A).
I need not reach or decide whether Mr. Blanco’s underpayment was attributable to
“negligence” or “disregard,” which in any event would involve disputed facts, because it is
beyond dispute that plaintiffs’ income tax was substantially understated within the meaning of
the Code. The tax owed (not considering the alleged additional $110,000 not declared) was
$114,568. The amount paid was $26,602. The underpayment therefore was $87,966. Ten
percent of the tax owed is $11,457. Obviously, the underpayment greatly exceeded that number.
Therefore, plaintiff’s understatement of the tax they owed was “substantial” as that term is
defined in section §6662(d)(1)(A).
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But that is not the end of the § 6662 analysis because:
The amount of the understatement under subparagraph (A) shall be reduced by
that portion of the understatement which is attributable to – (i) the tax treatment of
any item by the taxpayer if there is or was substantial authority for such treatment,
or (ii) any item if – (I) the relevant facts affecting the item’s tax treatment are
adequately disclosed in the return or in a statement attached to the return, and (II)
there is a reasonable basis for the tax treatment of such item by the taxpayer.
26 U.S.C. § 6662(d)(2)(B).
Unfortunately for the plaintiffs, I do not find that this relief valve operates in their favor
here. Plaintiffs have provided no authority, substantial or otherwise, supportive of the treatment
that was given to the $390,000 payment. Even resolving factual disputes and construing
inferences in plaintiffs’ favor, it was undeniably wrong to exclude the payment from income.
Gross income does not include damages “on account of personal physical injuries or physical
illness.” 26 U.S.C. § 104(a)(2). However, there is no evidence that the arbitration award
compensated Mr. Blanco, in whole or in part, for physical injury or physical illness. Nor were
the relevant facts affecting the award’s tax treatment adequately disclosed in the return. The
arbitration award was not disclosed at all.
The Court concludes, therefore, as a matter of law, that the accuracy-related penalty
arising from a substantial understatement of income tax as described in § 6662(b)(2) was
properly assessed, unless the reasonable cause exception in § 6664(c) applies.
B. Reasonable Cause Exception for Underpayments: § 6664.
Section 6664(c)(1) of the Code provides, “[n]o penalty shall be imposed under section
6662 . . . with respect to any portion of an underpayment if it is shown that there was a
reasonable cause for such portion and that the taxpayer acted in good faith with respect to such
portion.” In Blum v. Commissioner of Internal Revenue, 737 F.3d 1303 (10th Cir. 2013), the
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court, applying § 6664(c)(1), held that the “accuracy-based penalty for negligence is not
available if the taxpayer reasonably and in good faith relied upon professional tax advice.” Id. at
1317. Although the court there dealt with an understatement penalty resulting from negligence
pursuant to § 6662(b)(1), an issue that I did not resolve for purposes of the pending motions, the
analysis logically applies as well to a penalty for substantial understatement of income tax under
§ 6662(b)(2).
Nevertheless, as the government notes in its motion for summary judgment, Blum
characterized this as a “narrow defense.” Id. The court explained,
In determining whether reasonable cause and good faith exist, the most important
factor is ‘the extent of the taxpayer’s effort to assess the taxpayer’s proper tax
liability’ judged in light of his experience, knowledge, and education. 26 C.F.R. §
6664-4(b). A common issue within the reasonable cause analysis is the
taxpayer’s reliance on the advice of a professional tax advisor. Such reliance,
however, ‘does not necessarily demonstrate reasonable cause.’ 26 C.F.R. §
1.6664-4(b).
Professional advice providing the basis of a reasonable cause defense typically
exhibits certain characteristics, of which three are particularly applicable in this
case. First, the advice must be independent. Second, the advice must be based on
all relevant facts and no inaccurate factual representations. And third, reasonable
cause requires that the taxpayer actually receive the advice and rely upon it before
claiming the tax benefit.
Id. at 1317-18.
The government has produced evidence that it contends establishes that Mr. Blanco did
not reasonably and in good faith rely on the advice he claims to have been provided by his
attorney and his CPA. The government began with Mr. Blanco’s education, experience and
knowledge in area of financial matters. The government then produced evidence that seems to
contradict Mr. Blanco’s representation that he was told by his attorney that the award was not
taxable. The government’s evidence also indicated that Mr. Blanco failed to clarify for his CPA
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the nature of his claim once he got to arbitration, and that he did not provide the CPA with a
copy of the written arbitration award. The CPA’s letter to the IRS agent is not clear about the
specific representations of Mr. Blanco or the specific advice he gave to Mr. Blanco. The
government’s evidence tending to indicate that Mr. Rohn did not question Mr. Blanco’s
representations gives me pause about the CPA’s “independence,” as does the fact that Mr. Rohn
signed an affidavit that in substantial part is a near copy Mr. Blanco’s affidavit. The mystery
concerning the two payments Mr. Blanco received from his employer Bank of the West in 2009
but were not declared on his tax return also remains unresolved at this point.
That said, Mr. Blanco has come forward with at least some evidence that, if construed in
his favor for purposes of a summary judgment motion, supports his position. He has claimed in
his affidavit, under oath, that he was told by his attorney that the award was not taxable. The
attorney’s response to questions about any tax-related advice he might have given Mr. Blanco
fell short of an unequivocal denial. Despite the vagueness of the CPA’s letter to the original IRS
agent, it is possible that the CPA (despite the quality and quantity of information Mr. Blanco
provided) told Mr. Blanco unequivocally that the arbitration award was not taxable. Construing
all evidence and inferences in Mr. Blanco’s favor, I am willing at this point to infer that Mr.
Rohn was competent to provide tax advice, and that he maintained his independence.
The Court finds there are genuine issues of material fact concerning what professional
advice Mr. Blanco received and whether he relied on the advice of his professional advisors
reasonably and in good faith. A significant factor in the Court’s resolution of these issues will be
the Court’s assessment of the credibility of witnesses, particularly Mr. Blanco, Mr. Hilbert and
Mr. Rohn. Such an assessment is difficult to make from affidavits drafted by lawyers. For those
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reasons, the Court concludes that the § 6664(c)(1) issue is not appropriate for summary
disposition.
ORDER
Plaintiffs’ motion for summary judgment, ECF No. 18, is denied. Defendant’s motion
for summary judgment, ECF No. 19, is denied. Plaintiffs’ unopposed motion to file their
response out of time based on counsel’s calendaring error, ECF No. 22, is granted.
DATED this 6th day of January, 2016.
BY THE COURT:
___________________________________
R. Brooke Jackson
United States District Judge
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