Estate of William R Cape et al v. United States of America

Filing 83

DECISION Granting the United States' Motion for Summary Judgment 70 and Denying Plaintiffs' Motion for Summary Judgment 61 and ORDER Dismissing Case. (cc: all counsel)((cef), C. N. Clevert, Jr.)

UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF WISCONSIN
ESTATE OF WILLIAM R. CAPE,
JENNIFER L. FELDMAN,
Plaintiffs,
v.

Case No. 11-C-0357

UNITED STATES OF AMERICA,
Defendant.
DECISION GRANTING THE UNITED STATES’ MOTION
FOR SUMMARY JUDGMENT (DOC. 70) AND DENYING PLAINTIFFS’ MOTION
FOR SUMMARY JUDGMENT (DOC. 61) AND ORDER DISMISSING CASE
The plaintiffs sue the United States for a refund of income taxes they allege were
erroneously assessed and collected for three tax years. The taxpayer, William R. Cape
(“William Cape”), passed away in 2002, and the refund claims are pressed by his estate
and his widow, Jennifer Cape, now known as Jennifer Feldman (“Feldman”). Initially, the
complaint asserted entitlement to refunds based on amounts that a now-defunct
S corporation, James Cape & Sons Company (“Cape & Sons”), allegedly passed through
to owner William Cape and various computational errors in the returns William Cape filed
with the Internal Revenue Service (“IRS”). The “pass-through claims adjustments” were
based on claimed overstatement of taxable income by Cape & Sons, which then were
reported as pass-through income by William Cape in 2001 and 2002. (Doc. 1, ¶ 31.) The
“computational adjustments” were said to “flow[] automatically from the proper application
of the Code to the 1999, 2001 and 20002 taxable years.” (Id.) The parties stipulated to
dismissal of the pass-through adjustments and most of the computational adjustments.

What remains are claims made on only three claimed computational errors as described
below.
The parties have filed cross-motions for summary judgment. Many of the pertinent
facts were submitted as stipulations, though each side submitted one or more additional
proposed findings of fact for the court’s consideration. At the heart of the case is whether
the records plaintiffs have presented to the IRS and this court are sufficient to substantiate
their claims for a refund. William Cape is deceased, Cape & Sons went into receivership
in 2005, another S corporation called Curkeet Services, Inc. (“Curkeet”) is dissolved, the
accounting company that prepared Cape’s taxes (Arthur Andersen LLP) has gone out of
business, and many years have passed, complicating plaintiffs’ task.
Summary judgment is proper if the depositions, documents or electronically stored
information, affidavits or declarations, stipulations, admissions, interrogatory answers or
other materials show that there is no genuine dispute of material fact and the moving party
is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(a), (c); Celotex Corp. v.
Catrett, 477 U.S. 317, 322 (1986).

The moving party bears the initial burden of

demonstrating it is entitled to summary judgment. Celotex, 477 U.S. at 323. Once this
burden is met, the nonmoving party must designate specific facts to support or defend
each element of its cause of action, showing that there is a genuine issue for trial. Id. at
322-24. In analyzing whether a question of fact exists, the court construes the evidence
in the light most favorable to the party opposing the motion. Anderson v. Liberty Lobby,
Inc., 477 U.S. 242, 255 (1986).
The mere existence of a factual dispute does not defeat a summary judgment
motion; there must be a genuine issue of material fact for the case to survive. Id. at 2472

48. “Material” means that the factual dispute must be outcome-determinative under
governing law. Contreras v. City of Chicago, 119 F.3d 1286, 1291 (7th Cir. 1997). Failure
to support any essential element of a claim renders all other facts immaterial. Celotex, 477
U.S. at 323. To establish that a question of fact is “genuine,” the nonmoving party must
present specific and sufficient evidence that, if believed by a jury, would support a verdict
in its favor. Fed. R. Civ. P. 56(e); Anderson, 477 U.S. at 249.
Even though the parties in this case have filed cross-motions for summary judgment
and many stipulated facts, each side still bears the burden of showing that no genuine
issues of material fact exist, taking the facts in the light most favorable to the opposing
party. That both parties have moved for summary judgment does not establish that a trial
is unnecessary. See 10A Charles Alan Wright et al., Federal Practice & Procedure § 2720
at 327-28 (3d ed. 1998). Failure of one party to satisfy that burden on its motion does not
automatically indicate that the opposing party has satisfied its burden on the other motion.
See id.
CHALLENGES TO EVIDENCE
Before setting forth the pertinent facts of the case, the court must address the
government’s challenge to two declarations submitted by plaintiffs. The United States
contends that the declarations fail the requirements of Fed. R. Civ. P. 56(c)(4), which
include that a declaration filed in support of a motion for summary judgment be made on
personal knowledge, set out facts that would be admissible in evidence, and show that the
declarant is competent to testify on the matters stated.
The declaration of William Walther fails these requirements. Walther states that he
was employed by Cape & Sons as the comptroller/vice-president of finance from the fall
3

of 2001 until early 2005. (Doc. 64, ¶ 2.) He then attests to the percentage ownership of
a different corporation, Curkeet, and states that accounting and financial information
regarding Cape & Sons was properly reflected on the federal income tax returns of
Curkeet; that attached documents were copies of Curkeet’s taxes for 1999, 2000, and
2001; that amounts reported on certain lines of Curkeet’s returns accurately reflected the
rental of equipment by Curkeet to Cape & Sons; and that the accounting and financial
information that served as the basis for the Curkeet returns “would have been maintained
in a manner adequate to substantiate the amounts reported on the Curkeet Returns.”
(Doc. 64, ¶¶ 4-9.) Most of these declarations are made to “the best of [Walther’s]
knowledge and belief.” (Doc. 64, ¶¶ 4, 6, 8, 9.) Declaring that a person believes
something or knows something to the best of one’s knowledge is not equivalent to saying
the person has personal knowledge.
Beyond the insufficient language of “best knowledge” and “belief,” Walther fails to
state how he knows anything about Curkeet. Walther worked at Cape & Sons, not
Curkeet. He states vaguely that in his capacity as an employee at Cape & Sons he was
“familiar” with Curkeet, which provided payroll services and equipment rentals to Cape &
Sons. (Doc. 64, ¶ 3.) Nothing indicates how Walther’s familiarity with Curkeet’s provision
of payroll services and equipment rentals makes him competent to testify to Curkeet’s
ownership, the validity and accuracy of Curkeet’s tax returns, and the maintenance of
Curkeet’s financial records. Thus, the court will disregard Walther’s declaration in its
entirety. Any proposed findings of fact relying solely on Walther’s declaration will be
disregarded as well.

4

Scott Harmsen declares that from September 1, 1998, to June 2, 2002, he was a
partner at Arthur Andersen at its Milwaukee office and was familiar with tax return
preparation procedures of Arthur Andersen’s Milwaukee office. (Doc. 65, ¶ 2.) Harmsen
avers that as an Arthur Andersen employee he “participated” in the preparation of the
federal income tax returns for William Cape for calendar tax years 1996 through 2001, and
recognizes his signature on William Cape’s returns as preparer for taxable years 1996,
1997, and 2001. (Doc. 65, ¶¶ 3-6.) He states that “[i]n preparing tax returns, it was the
practice of the Milwaukee Office to gather information from the taxpayer and reflect such
information on the tax return, and to the best of [his] knowledge and belief, the Tax Returns
were prepared in accordance with this process.” (Doc. 65, ¶ 7.) Harmsen adds that as the
signer of the 1996, 1997, and 2001 returns he was responsible for supervising the “abovedescribed process with respect to such returns, and, to the best of [his] knowledge and
belief, such returns were prepared in accordance with the process set forth above.” (Doc.
65, ¶ 8.)
Harmsen’s sworn statement establishes that he has some personal knowledge
concerning Arthur Andersen’s Milwaukee office, the preparation of William Cape’s tax
returns from 1996 through 2001, and the signature on William Cape’s tax returns for three
of those years. Thus, his declaration will be considered in part. However, certain
declarations by Harmsen do not get plaintiffs very far. For instance, that the practice of
Arthur Andersen’s Milwaukee office was to gather information from a taxpayer and to
reflect such information on a tax return does nothing to support the accuracy of William
Cape’s financial records or tax returns. Harmsen calls this vague practice a “process” but
provides no detail that verifies any information in William Cape’s returns. His declaration
5

lacks any indication of personal knowledge of the return as a whole or particular items in
William Cape’s tax returns or K-1s, especially for tax years during which he did not sign the
returns. Additionally, Harmsen’s statement that “to the best of [his] knowledge and belief”
William Cape’s taxes were prepared in accord with this vague process is inadequate for
the reasons discussed above regarding Walther’s statements.

Hence, Harmsen’s

statements made to the best of his knowledge and belief will be disregarded, and the
balance cited by plaintiff will be considered with a critical eye.
In addition to challenging the Walther and Harmsen declarations, the United States
challenges plaintiffs’ use of various documents for the truth of the matters asserted in
them. Plaintiffs rely predominantly on tax returns, Schedule K-1s, and documents from the
files of William Cape and their accountants to support their claim for refund. While the
documents may be used as evidence of what is written on them, they cannot be used for
the truth of the matters asserted in them. For instance, that a K-1 from Cape & Sons to
William Cape shows a charitable donation amount cannot be used to prove that Cape &
Sons actually made a charitable donation. The tax forms and schedules presented to this
court are not attested to by a custodian or other qualified witness who can state that the
records were made by someone with knowledge of underlying, supporting material.
Further, that the 2003 audit uncovered errors in some of the returns at issue suggests a
lack of trustworthiness regarding the prior filings. See Fed. R. Evid. 803(6). The court has
tried to adjust the plaintiffs’ proposed findings of fact as necessary to reflect the difference
between what a particular document states and the truth of what a particular document
states. This problem is addressed elsewhere below.

6

Finally, the court notes plaintiffs’ argument that tax returns and other records
retrieved from Baker Tilly Virchow Krause, LLP meet the business records exceptions for
hearsay, Fed. R. Evid 803(6), or the residual hearsay exceptions rule, Fed. R. Evid. 807.
That William Cape’s, Cape & Sons’, and Curkeet’s records were within Baker Tilly’s files
does not make them business records of Baker Tilly for purposes of Rule 803(6). Nor
should the residual exception be used to cure the failure to meet the specific requirements
in Rule 803(6).
UNDISPUTED FACTS
The Estate of William R. Cape (the “Estate”) is a probate estate for William Cape,
who died on August 3, 2002. The Estate was opened in Racine County, Wisconsin, on or
about September 20, 2002. (Doc. 58, ¶¶ 1, 2.1)
From January 1, 1998, through August 3, 2002, Cape & Sons elected to be taxed
as an S corporation under the Internal Revenue Code of 1986, as amended. (Doc. 58,
¶ 39.) For the 1998 calendar year, William Cape’s ownership percentage in Cape & Sons
for purposes of allocating pass-through items from Cape & Sons was 43.306075%. (Doc.
58, ¶ 41.) For the 2000 calendar year, William Cape’s ownership percentage in Cape &
Sons for purposes of allocating pass-through items from Cape & Sons was 43.551325%.
(Doc. 58, ¶ 44.)
Curkeet, a Wisconsin corporation, was incorporated on or about March 1, 1992.
(Doc. 58, ¶ 49.) From March 1, 1992 through August 3, 2002, Curkeet elected to be taxed

1

Docum ent 58 in the docket is the parties’ stipulated set of facts.

7

as an S corporation under the Code. (Doc. 58, ¶ 50.) William Cape owned 50% of the
outstanding stock of Curkeet from January 1, 1999, until his death. (Doc. 58, ¶ 52.)
William Cape was married to Elizabeth A. Cape (“Elizabeth Cape”) until her death
in 1996. (See Doc. 58, ¶¶ 4, 5.) On or about July 15, 1997, William Cape filed a joint
individual federal income tax return for his deceased wife and himself for the 1996 calendar
year (the “1996 return”). (Doc. 58, ¶ 4.) There was no total tax reported as due on the
1996 return. (Doc. 58, ¶ 7.) An Account Transcript for William Cape and Elizabeth Cape
from the IRS dated May 4, 2009, shows a $0 balance due for the 1996 calendar year.
(See Doc. 58, ¶ 8.)
On or about April 15, 1998, William Cape filed an individual federal income tax
return for the 1997 calendar year (the “1997 return”). (Doc. 58, ¶ 9.) The total tax reported
due on the 1997 return, $119,329, was paid in full. (Doc. 58, ¶ 11.) An Account Transcript
for William Cape from the IRS dated May 4, 2009, shows a $0 balance due for the 1997
calendar year. (Doc. 58, ¶ 12.)
On or about June 13, 1999, William Cape filed an individual federal income tax
return for the 1998 calendar year (the “1998 return”). (Doc. 58, ¶ 13.) The total tax
reported due on the 1998 return, $24, was paid in full. (Doc. 58, ¶ 15.) No charitable
deduction claim appears on William Cape’s 1998 tax return. (Doc. 63, ¶ 22; Doc. 72, ¶ 22;
Doc. 58, Ex. E at CAPEUSA000053 (line 18).) The 1998 return shows that charitable
contributions, including a contribution of $1075 to “St. Luke’s” and contributions from K-1's,
were "Reduced by AGI limitation" of negative $4588, equal to the amount of the
contributions. (Doc. 63, ¶ 25; Doc. 72, ¶ 25; Doc. 58, Ex. E at CAPEUSA000080.)

8

It appears that William Cape married Feldman during 1999. (See Doc. 58, ¶¶ 3, 16,
31.) On or about April 17, 2000, William Cape and Feldman filed a joint individual federal
income tax return for the 1999 calendar year (the “1999 return”). (Doc. 58, ¶ 16.) The total
tax reported due on the 1999 return, $161,913, was paid in full. (Doc. 58, ¶ 18.) An
Account Transcript for William Cape and Feldman from the IRS, dated May 4, 2009, shows
a $0 balance due for the 1999 calendar year. (Doc. 58, ¶ 19.)
On or about June 30, 2001, William Cape and Feldman filed a joint individual federal
income tax return for the 2000 calendar year (the “2000 return”). (Doc. 58, ¶ 22.) The total
tax reported due on the 2000 return, $16, was paid in full. (Doc. 58, ¶ 24.) An Account
Transcript for William Cape and Feldman from the IRS, dated May 4, 2009, shows a $0
balance due for the 2000 calendar year. (Doc. 58, ¶ 25.)
On or about April 15, 2002, William Cape and Feldman filed a joint individual federal
income tax return for the 2001 calendar year (the “2001 return”). (Doc. 58, ¶ 26.) The total
tax reported due on the 2001 return, $134,295, was paid in full. (Doc. 58, ¶ 28.) An
Account Transcript for William Cape and Feldman from the IRS, dated May 4, 2009, shows
a $0 balance due for the 2001 calendar year. (Doc. 58, ¶ 29.)
The 1996 return, the 1997 return, the 1998 return, the 1999 return, the 2000 return
and the 2001 return (together, the “96-01 returns”) were prepared by Arthur Andersen LLP.
(Doc. 58, ¶ 30.)
William Cape died in 2002. (See Doc. 58, ¶¶ 2, 31.) On or about October 15, 2003,
Feldman filed a joint individual federal income tax return for her deceased spouse and
herself for the 2002 calendar year (the “2002 return”). (Doc. 58, ¶ 31.) The total tax

9

reported due on the 2002 Return, $76,371, was paid in full. (Doc. 58, ¶ 34.) The 2002
Return was prepared by Berkley & Iselin, S.C. (Doc. 58, ¶ 33.)
Subsequently, the IRS audited the 1999 return, the 2000 return, and the 2001 return
(the “2003 audit”). (Doc. 58, ¶ 35.) Pursuant to the 2003 audit, the IRS prepared a Form
4549, Income Tax Examination Changes, dated October 15, 2003 (the “2003 Form 4549”),
reflecting changes to the income and/or alternative minimum taxes (“AMT”) owed on the
1999 return, the 2000 return, and the 2001 return. (Doc. 58, ¶ 36.) The 2003 Form 4549
included adjustments to income attributable to an audit of Cape & Sons for the 1999, 2000,
and 2001 calendar years and adjustments to William Cape and Feldman’s individual Form
1040 tax returns for those calendar years. (Doc. 58, ¶ 47.) The plaintiffs fully paid the
additional tax, interest and penalties assessed to William Cape and Feldman pursuant to
the 2003 audit. (Doc. 58, ¶ 38.)
Regarding the 1999 return, the 2003 Form 4549 shows a flow-through adjustment
from Cape & Sons’ Form 1120S in an amount of $152,009. (Doc. 72, ¶ 21; Doc. 58, Ex.
N at CAPEUSA000001; see Doc. 63, ¶ 21.) The 2003 Form 4549 shows a deficiency in
tax of $61,135 for the 1999 tax year. (Doc. 58, Ex. N at CAPEUSA000001.)
The 2000 return had deducted $7279 of charitable donations attributable to the
2000 calendar year, including William Cape’s share of the charitable donations made by
Cape & Sons in the 2000 calendar year. (Doc. 58, ¶ 45.) Pursuant to the 2003 audit,
William Cape and Jennifer Feldman’s adjusted gross income as reported on the 2000
return was reduced, resulting in the disallowance of the $7279 of charitable deductions.
(Doc. 58, ¶ 46; Doc. 72, ¶ 33; Doc. 58, Ex. N at CAPEUSA000008 (line 9); see Doc. 63,
¶ 33.)
10

Plaintiffs timely filed a Protective Claim for Refund for the taxable years 1999, 2000,
and 2001 with the Internal Revenue Service Center in Kansas City, Missouri, on or about
April 14, 2005. (Doc. 58, ¶ 71.) Moreover, they timely filed a Protective Claim for Refund
for the 2002 taxable year on or about April 14, 2006 (together, the “Refund Claims”). (Doc.
58, ¶ 72.) Notes made by an IRS Appeals Officer assigned to the Refund Claims stated
that “One small item for contribution carryover of <7279> (see item g on 2-9-09 schedule
submitted by rep.) s/b allowed.” (Doc. 58, ¶ 48.)
During the period in which the 96-01 returns were prepared, Harmsen worked for
Arthur Andersen primarily out of its office in Milwaukee, Wisconsin. (Doc. 63, ¶ 1; Doc. 72,
¶ 1.) Harmsen, as an employee and then as a partner of Arthur Andersen, participated in
the preparation of the 96-01 returns, and signed William Cape's 1996, 1997 and 2001 tax
returns as the tax return preparer. (Doc. 63, ¶ 1; Doc. 72, ¶ 2.) In preparing tax returns,
it was the practice of Arthur Andersen’s Milwaukee office “to gather information from the
taxpayer and reflect such information on the tax return.” (Doc. 65, ¶ 7.2)
Tax records from Arthur Andersen relating to William Cape's tax returns were
organized by calendar year. (See Doc. 63, ¶ 4; Doc. 72, ¶ 4.) Materials for William Cape's
1998 tax return begin with a cover page entitled "William Cape 1998 Tax Return," and
include an instruction sheet regarding filing, versions of Cape’s tax returns (signed by an
Arthur Andersen representative but not William Cape) and various other materials related
to William Cape’s 1998 federal and state tax income tax returns. (Doc. 63, ¶ 5; Doc. 72,
¶ 5; Doc. 67, Ex. B.) Arthur Andersen's 1998 tax records for William Cape include a

2

As stated above, Harm sen offers no further inform ation about this “process” of gathering inform ation
or reflection of inform ation on tax returns. (See Doc. 65.)

11

document entitled "IRS Tax Receipt," addressed to William Cape indicating charitable
contributions of $1075 during 1998 to St. Luke's Episcopal Church and stating "This is an
official receipt for IRS purposes" and that "[n]o goods or services were provided in
exchange for money given." (Doc. 63, ¶ 9; Doc. 72, ¶ 9; Doc. 58, Ex. P.) The 1998 receipt
is the only purported receipt plaintiffs identify as substantiation for charitable contributions
claimed as a basis for refund in this action. (Doc. 58, ¶ 42.)
Arthur Andersen's 1998 tax records for William Cape include a copy of a Schedule
K-1 from Cape & Sons for the 1998 calendar year; however, nothing confirms that it was
a final or authentic K-1 issued by Cape & Sons to William Cape for that year. (Doc. 63,
¶ 10; Doc. 72, ¶ 10.) This purported K-1 shows pass-through charitable contributions of
$4251 from Cape & Sons. (Doc. 63, ¶ 11; Doc. 72, ¶ 11.) Cape & Sons’ 1998 tax return
lists $9816 of deductible charitable contributions. (Doc. 63, ¶ 12; Doc. 72, ¶ 12.) The
amount derived by multiplying the charitable contributions listed on Cape & Sons' 1998 tax
return, $9816, by William Cape's ownership percentage for 1998, 43.306075%, is $4251.
(Doc. 63, ¶ 13; Doc. 72, ¶ 13.)
Also, this purported K-1 shows $954,623 in negative items, including the abovestated amount of charitable contributions, $948,965 in ordinary loss from trade or business
activities, and $1407 in net “section 1231 loss.” (Doc. 63, ¶ 14; Doc. 72, ¶ 14.) These
amounts were listed on lines 1, 2b, and 4 of the Form 6198 (At-Risk Limitations) included
in William Cape’s 1998 tax return. (Doc. 63, ¶ 15; Doc. 72, ¶ 14; Doc. 58, Ex. E at
CAPEUSA000064.) The Form 6198 showed an adjusted basis of $734,561 in Cape &
Sons and $54,328 of other income received from Cape & Sons during 1998. (Doc. 63,
¶ 16; Doc. 72, ¶ 16; Doc. 58, Ex. E at CAPEUSA000064.) Line 33 of William Cape's 1998
12

tax return reported a negative $520,764 as adjusted gross income. (Doc. 63, ¶ 23; Doc.
72, ¶ 23.)
The supporting materials for William Cape's 1998 tax return materials in Arthur
Andersen's records include a copy of a purported Schedule K-1 from Curkeet to William
Cape for the 1998 calendar year. (See Doc. 63, ¶ 45; Doc. 72, ¶ 45; Doc. 67, Ex. E.)
However, it is unclear whether this was the final K-1 issued to William Cape. (See Doc.
72, ¶ 45; Doc. 67, Ex. E.) This purported Schedule K-1 lists $39,022 of loss from rental
activities, which matches the corresponding number in William Cape's 1998 return. (Doc.
63, ¶ 46; Doc. 72, ¶ 46.)
As part of the 2003 audit, as shown on the 2003 Form 4549, the portion of the
regular tax passive activity losses allowed in 1999, 2000, and 2001 for rental activities was
not reduced or disallowed. (Doc. 63, ¶ 48; Doc. 72, ¶ 48.)
Statement 3 to William Cape's 1999 tax return reports $3,640 of "Contributions from
K-1s." (Doc. 63, ¶ 19; Doc. 72, ¶ 19.) The purported William Cape Schedule K-1 for the
1999 tax year represents that $2902 of charitable contributions passed through to William
Cape from Cape & Sons.

(Doc. 63, ¶ 20; Doc. 72, ¶ 20; Doc. 67, Ex. F at

CAPEUSA000908.)
William Cape's 2000 tax return claimed $7279 of deductions for charitable
contributions on line 18.

(Doc. 63, ¶ 27; Doc. 72, ¶ 27; Doc. 58, Ex. I at

CAPEUSA000125.) Statement 4 to Schedule A of William Cape's 2000 tax return provided
that $5269 of those contributions passed-through from Cape & Sons. (Doc. 63, ¶ 28; Doc.
72, ¶ 28; Doc. 58, Ex. I at CAPEUSA000156.) The same amount, $5269, is listed as
charitable contributions on the Schedule K-1 for William Cape included with Cape & Sons'
13

2000 tax return. (Doc. 63, ¶ 20; Doc. 72, ¶ 29; Doc. 67, Ex. G at CAPEUSA000968 (line
7).) That amount, $5269, may be calculated by multiplying the charitable contributions
listed on the Cape & Sons 2000 tax return, $12,099, by William Cape's ownership
percentage of Cape & Sons, 43.551325%. (Doc. 63, ¶ 30; Doc. 72, ¶ 30.)
William Cape's 2000 tax return reported adjusted gross income of $21,980 and a
net operating loss carryover of $63,016. (Doc. 63, ¶ 32; Doc. 72, ¶ 32; Doc. 58, Ex. I at
CAPEUSA000120 (lines 21 and 33).)
William Cape’s 2001 tax return reported adjusted gross income of $851,408 and a
net operating loss carryover of $17,976. (Doc. 92, ¶ 34; Doc. 58, Ex. N at CAPESA000001
(line 1.f.), CAPEUSA000014 (line E); see Doc. 63, ¶ 34.) His 2001 Schedule C listed $600
of self-employment income. (Doc. 63, ¶ 7; Doc. 72, ¶ 7.) William Cape’s tax records for
2001 contain a 1099-Misc from Johnson Bank stating that he received a $600 payment for
his services as a director that year. (Doc. 63, ¶ 6; Doc. 72, ¶ 6.)
Form 8582 for William Cape’s 1996 tax return lists $47,537 of passive activity losses
carried over from prior years (line 2d Cir.), $11,310 of passive losses for the 1996 calendar
year (line 2b), and $2,748 of passive activity losses allowed as a deduction in 1996 (line
11). (Doc. 63, ¶ 37; Doc. 72, ¶ 37; Doc. 58, Ex. A at BT0016.)
Purported Cape & Sons financial statements from 1998 and 1999 received by the
attorney for William Cape’s estate in probate proceedings from Cape & Sons indicate that
Cape & Sons rented equipment from Curkeet. (Doc. 66, ¶ 3, Ex. A at CAPE000462, ¶ 8.)
William Cape's 1997 to 2001 tax returns reported passive activity losses attributable to
Curkeet or to “Curkeet Rental” and other passive losses attributable to equipment rental.

14

(Doc. 58, Ex. C at BT0287, Ex. E at CAPEUSA000073, Ex. F at CAPEUSA00011, Ex. I at
CAPEUSA000157, Ex. K at CAPE000204-05; Doc. 63, ¶ 36; Doc. 72, ¶ 36.)
The following chart summarizes the regular tax passive activity losses reported on
William Cape’s 96–01 tax returns and associated forms and statements within the returns
for activities identified as equipment rental and Curkeet rental.

15

Regular Tax Passive Activity Losses

Curkeet
Rental

Individual
Rental

Total

Suspended losses carried over to 1996 Return

-

(47,537)

(47,537)

Losses incurred in 1996

-

(11,310)

(11,310)

Losses deducted on 1996 Return

-

2,748

2,748

Losses suspended in 1996, to be carried over to 1997
Return

-

(56,099)

(56,099)

(52,893)

-

(52,893)

3,943

4,183

8,126

Losses suspended in 1997, to be carried over to 1998
Return

(48,950)

(51,916)

(100,866)

Losses incurred in 1998

(39,022)

Losses incurred in 1997
Losses deducted on 1997 Return

Losses deducted on 1998 Return

(39,022)

3,392

2,002

5,394

Losses suspended in 1998, to be carried over to 1999
Return

(84,580)

(49,914)

(134,494)

Losses incurred in 1999

(16,569)

-

(16,569)

3,162

1,561

4,723

(97,987)

(48,353)

(146,340)

(3,964)

-

(3,964)

2,387

1,132

3,519

Losses suspended in 2000, to be carried over to 2001
Return

(99,564)

(47,221)

(146,785)

Losses incurred in 2001

(17,851)

-

(17,851)

3,638

1,463

5,101

(113,777)

(45,758)

(159,535)

Losses deducted on 1999 Return
Losses suspended in 1999, to be carried over to 2000
Return

Losses incurred in 2000
Losses deducted on 2000 Return

Losses deducted on 2001 Return
Losses suspended in 2001, to be carried over to 2002
Return

16

(Doc. 63, ¶ 38; Doc. 72, ¶ 38.) No deduction for $159,535 of purported losses as shown
in the bottom right cell of the above chart appears as a deduction on any of William Cape's
tax returns. (Doc. 63, ¶ 39; Doc. 72, ¶ 39.)
A Wisconsin tax depreciation schedule, obtained from the tax workpapers of Arthur
Andersen lists $11,310 of depreciation for the 1996 calendar year. (Doc. 58, ¶ 56.) Cover
letters from Arthur Andersen to William Cape from Arthur Andersen’s records referenced
a $56,099 regular tax passive activity loss carryover from 1996 to the 1997 calendar year;
a $100,866 regular tax passive activity loss carryover from 1997 to the 1998 calendar year;
a $146,340 regular tax passive activity loss carryover from 1999 to the 2000 calendar year;
and a $159,535 regular tax passive activity loss carryover from 2001 to the 2002 calendar
year. (Doc. 58, ¶¶ 57-60; Doc. 63, ¶¶ 40-44; Doc. 72, ¶¶ 40-44.).) These cover letters
discuss the passive activity losses that correspond to the above chart. (See Doc. 63, ¶¶
40-44; Doc. 72, ¶¶ 40-44.)
The following chart shows the AMT passive activity losses reported on William
Cape’s AMT Forms 8582 and associated statements for the 96–01 returns, including the
passive activity losses deducted each calendar year and the amounts disallowed each
calendar year then carried over to the subsequent calendar year:

17

Alternative M inimum Tax Passive Activity Losses

Curkeet
Rental

Equipment
Rental

Total

Suspended losses carried over to 1996 Return

(24,159)

(24,159)

Losses incurred in 1996

(11,310)

(11,310)

-

-

-

(35,469)

(35,469)

(38,768)

-

(38,768)

-

-

-

Losses suspended in 1997, to be carried over to 1998
Return

(38,768)

(35,469)

(74,237)

Losses incurred in 1998

(38,364)

Losses deducted on 1996 Return
Losses suspended in 1996, to be carried over to 1997
Return

Losses incurred in 1997
Losses allowed on 1997 Return

Losses allowed on 1998 Return

(33,634)

1,228

601

1,829

Losses suspended in 1998, to be carried over to 1999
Return

(71,174)

(34,868)

(106,042)

Losses incurred in 1999

(29,790)

(59,807)

(89,597)

2,016

1,890

3,906

(98,948)

(92,785)

(191,733)

(3,964)

-

(3,964)

1,851

1,668

3,519

(101,061)

(91,117)

(192,178)

(26,736)

-

(26,736)

2,292

2,809

5,101

(72,033)

(88,308)

(160,341)

Losses allowed on 1999 Return
Losses suspended in 1999, to be carried over to 2000
Return

Losses incurred in 2000
Losses allowed on 2000 Return
Losses suspended in 2000, to be carried over to 2001
Return

Losses incurred in 2001
Losses allowed on 2001 Return
Losses suspended in 2001, to be carried over to 2002
Return

18

(Doc. 63, ¶ 49; Doc. 72, ¶ 49.)
The purported Schedule K-1 from Curkeet to William Cape in the Arthur Andersen
files for the 1998 calendar year lists $39,022 of loss from rental activities and an AMT
adjustment of $5388. (Doc. 67, Ex. E.) Subtracting the $5388 adjustment from the
$39,022 rental loss leaves $33,634 for AMT passive activity loss, the sum reported on
William Cape's 1998 tax return and shown in the chart above. (Doc. 63, ¶ 51; Doc. 72, ¶
51.3)
Plaintiffs are unable to determine William Cape's actual basis in Curkeet Services,
Inc., for the tax years at issue in this action. (Doc. 60, ¶ 1.4) Curkeet's 1999, 2000, 2001
and 2002 tax returns reported that the amount paid for Curkeet's capital stock and paid in
capital was $1,000. (Doc. 63, ¶ 54; Doc. 72, ¶ 54; Doc. 58, 62.) The 2001 income tax
return for Curkeet reports, on Schedule M-2, that its accumulated adjustment account
(“AAA”) balance was equal to $90,292 as of December 31, 2001. (Doc. 58, 61; Doc. 63,
¶ 55; Doc. 72, ¶ 55.)
On or about October 31, 2003, Form 706, United States Estate (and
Generation-Skipping Transfer) Tax Return was filed for William Cape (“Form 706”). (Doc.
58, ¶ 63.) The Form 706 stated that the fair market value of the property received by the
Estate from William Cape was $13,652. (Doc. 63, ¶ 53; Doc. 72, ¶ 53.) Schedule B of
Form 706 listed the fair market value of William Cape’s 50% interest in Curkeet as

3

The proposed finding of fact states $32,634, but use of a calculator and reference to the chart
indicates the num ber should be $33,634. The United States denies this proposed finding of fact, but the
calculation, as corrected, appears accurate and the governm ent’s objection is not on point.
4

The United States proposed this one statem ent of undisputed fact and the plaintiffs did not dispute
it. (Doc. 68, ¶ 1.)

19

$13,652. (Doc. 58, ¶ 65.) No adjustment was made to the fair market value of William
Cape’s 50% interest in Curkeet as reported on Form 706. (Doc. 58, ¶ 67.)
Cape & Sons was placed into receivership in Racine County, Wisconsin, on or about
April 11, 2005. (Doc. 58, ¶ 68.) Curkeet’s activities were related to the business activities
of Cape & Sons, which served as the registered agent for Curkeet. (Doc. 58, ¶ 69.) Since
2006, Curkeet has been in delinquent status and on May 11. 2011, it was administratively
dissolved. (Doc. 58, ¶ 70.)
DISCUSSION
Three alleged computational adjustments remain at issue in this case, described in
the complaint as follows: (1) the allowance of charitable contributions that were disallowed
under the adjusted gross income limitation in calendar years 1998 and 2000 and are
eligible to be carried over to years 1999 and 2001 under 26 U.S.C. § 170(d)(1)(A); (2) the
use of itemized deduction and net operating loss deduction adjustments for the purpose
of the AMT in years 1999, 2001, and 2002; and (3) the allowance of suspended passive
losses upon William Cape’s death in year 2002 under 26 U.S.C. § 469(g)(2). (Doc. 1,
¶ 97(b), (d), (I); Docs. 55, 56.)

However, for practical purposes, these alleged

computational adjustments are better organized chronologically and by particular items for
discussion: (1) alleged personal and pass-through charitable contributions in 1998, which
were suspended as deductions because of tax code limitations for that year but were
eligible and should have been taken in 1999; (2) alleged personal and pass-through
charitable contributions in 2000, which were suspended as deductions in that year but were
eligible and should have been taken in 2001; and (3) alleged passive activity losses
attributable to Curkeet’s rental of items to Cape & Sons and other equipment rental activity,
20

which were suspended as deductions from 1996 to 2001 but were eligible and should have
been taken in 2002 upon William Cape’s death. (See Doc. 62 at 4-17.) Plaintiffs submit
that these adjustments entitle them to a refund of $56,800. (Doc. 74 at 2 n.2.)
In an action for a tax refund, the taxpayer must show by a preponderance of the
evidence that he is entitled to the claimed refund. United States v. Janis, 428 U.S. 433,
440 (1976); Sherwin-Williams Co. v. United States, 403 F.3d 793, 796 (6th Cir. 2005). The
IRS’s determination of the tax owed is presumed correct; the taxpayer bears the burden
of proving that the IRS’s assessment of taxes was wrong and the amount he should
recover. Janis, 428 U.S. at 440; Sherwin-Williams, 403 F.3d at 796; Mays v. United States,
763 F.2d 1295, 1297 (11th Cir. 1985). The presumption disappears when “credible
evidence” or “substantial evidence” is introduced to overcome it, showing deductibility.
26 U.S.C. § 7491(a)(1); KFOX, Inc. v. United States, 510 F.2d 1365, 1369 (Ct. Cl. 1975);
Ky. Tr. Co. v. Glenn, 217 F.2d 462, 465 (6th Cir. 1954). “Credible evidence” is the “quality
of evidence which, after critical analysis, the court would find sufficient upon which to base
a decision on the issue if no contrary evidence were submitted (without regard to the
judicial presumption of IRS correctness.” Rigas v. United States, No. H-09-3770, 2011 WL
1655579, *4 (S.D. Tex. May 2, 2011) (internal quotation marks omitted); In re Indus.
Commercial Elec., Inc., 319 B.R. 35, 55 (D. Mass. 2005).
“Once the taxpayer has met this burden the presumption disappears and the court
must resolve the question upon the basis of all of the evidence before it.” KFOX, 510 F.2d
at 1369. Overcoming the presumption results in the burden of proof shifting to the IRS.
See 26 U.S.C. § 7491(a)(1). However, the burden shifts only if the taxpayer has complied
with the requirements to substantiate any item, has maintained all records as required, and
21

has cooperated with reasonable requests by the IRS for information and documentation.
§ 7491(a)(2). “What a taxpayer needs to substantiate his deductions and losses are
records sufficient to permit verification of a deduction or loss.” Baker v. Comm’r of Internal
Revenue, T.C. Memo. 2008-247, 2008 WL 4756651, *4 (U.S. Tax Ct. Oct. 30, 2008).
Under 26 U.S.C. § 6001, every person liable for federal taxes “shall keep such records .
. . as the [IRS] may from time to time prescribe.”
The plaintiffs allege that their computational claims “flow[] automatically from the
proper application” of the tax code. (Doc. 1, ¶ 31.) They say that the refunds are
substantiated by tax returns, K-1s, and the Harmsen declaration.
A.

The Charitable Deductions
Charitable deductions are allowable “only if verified under regulations prescribed by

the Secretary.” 26 U.S.C. § 170(a)(1). A taxpayer making a charitable contribution must
maintain for each contribution a canceled check, a receipt from the donee, or “other
reliable written records showing the name of the donee, the date of the contribution, and
the amount of the contribution.” 26 C.F.R. § 1.170A-13(a)(1). The reliability of any other
written record is determined on the basis of all facts and circumstances of a particular
case, and the taxpayer bears the burden of establishing reliability. 26 C.F.R. § 1.170A13(a)(2). Factors to consider include the contemporaneous nature of the writing and the
regularity of the taxpayer’s record-keeping procedures. Id. Moreover, “[n]o deduction shall
be allowed . . . for any contribution of $250 or more unless the taxpayer substantiates the
contribution by a contemporaneous written acknowledgment of the contribution by the
donee organization that” includes the amount of cash (or description of property)
contributed, whether the donee organization provided any goods or services in
22

consideration for the donation, and a description and good faith estimate of the value of
any goods or services donated. 26 U.S.C. § 170(f)(8)(A), (B), (E). An acknowledgment
is contemporaneous if obtained by the date on which the taxpayer files the return for the
tax year in which the contribution was made or the due date for filing such a return.
§ 170(f)(8)(C).
If an S corporation makes a contribution of $250 or more, the entity must
substantiate the contribution with a contemporaneous acknowledgment and maintain that
acknowledgment in its records. A shareholder, even if his share of the gift is $250 or more,
is not required to obtain any additional substantiation for his share of the contribution.
26 C.F.R. § 1.170A-13(F)(15); Boris I. Bittker & Lawrence Lokken, Federal Taxation of
Income, Estates & Gifts ¶ 35.5.6, at S35-43 (Supp. 2012).
1.

The Alleged 1998 Deduction/1999 Carryover

William Cape’s 1998 tax return showed $5326 of deductible charitable contributions.
Arthur Andersen’s records for William Cape include the “IRS Tax Receipt” stating that
William Cape made $1075 in charitable donations during 1998 to St. Luke’s Episcopal
Church and that no goods or services were provided in exchange for the gifts. A purported
1998 K-1 from Cape & Sons to William Cape from Arthur Andersen’s files showed $4251
in pass-through charitable donations allocated to William Cape, and that amount matches
the amount of charitable contributions on Cape & Sons’ 1998 return multiplied by William
Cape’s ownership percentage.
As argued by plaintiffs, because of certain limitations on deductions for
contributions, the deduction could not be taken in 1998 but could be carried over to 1999.
However, William Cape took only $738 of the amount as a deduction in 1999. (See Doc.
23

62 at 6-7.) Plaintiff’s argue that the remainder of the 1998 charitable deductions, $4588,
should have been deducted in the 1999 year after the 2003 audit adjustment occurred. (Id.
at 7-8.)
Plaintiffs have not presented credible evidence of their right to refund on this basis.
Moreover, the evidence before this court indicates a lack of substantiation by Cape & Sons
for the deduction. Tax returns and K-1s are not evidence of the truth of the numbers stated
in them. Sparkman v. Comm’r of Internal Revenue, 509 F.3d 1149, 1157-58 (9th Cir.
2007); Baker, 2008 WL 4756651, *3-*4; see Mays, 763 F.2d at 1297 (“The claim must be
substantiated by something other than tax returns.”). As stated by the Baker tax court,
We finish our consideration by citing our long series of precedents in which
we have held that a taxpayer’s returns do not substantiate deductions or
losses because they are nothing more than a statement of his claims. To
hold otherwise would undermine our presumption that the Commissioner’s
determination is correct. For the same reason, we long ago established that
under circumstances like these, a taxpayer can’t undermine the rule that old
returns are not substantiation of deductions or losses by adding to them the
bare testimony that those old returns are correct, without records or credible
testimony about the individual items on the returns. . . .
Much the same rules apply to the K-1s that Baker offered to
substantiate the deductions from his pass through businesses; they, too, are
only statements of his claims, not proof of them.
2008 WL 4756651, at *3-*4 (citations omitted). The Massachusetts district court in In re
Industrial Commercial Electric noted that
[i]f Congress had wished to make offer of relevant tax returns—or testimony
that the relevant tax returns are accurate—sufficient to meet the “credible
evidence” requirement, presumably that intent would have manifested itself
in the language of the statute or in the legislative history, given that tax
returns and testimony as to their validity would likely appear in virtually every
case under Section 7491. There is no such indication in either place,
however. Thus, to meet the “credible evidence” standard, a taxpayer must
present other evidence, such as business records, building deeds, testimony
by customers or business partners, and so on.

24

319 B.R. at 55.
Plaintiffs contend that they should not face an impossible burden to substantiate the
content of the tax returns in this case and that the court should accept the content of those
tax returns as true. But the cases they cite do not go as far as plaintiffs wish. For instance,
Zeeman v. United States, 275 F. Supp. 235 (S.D.N.Y. 1967), addressed the use of tax
returns to meet a plaintiff’s initial burden to overcome the presumption, but the court noted
that accepting the returns was expedient as a means of limiting the issues to be litigated,
but “with an evidentiary foundation laid through a competent witness.” Id. at 256. Without
a foundation as to the correctness of the return, “standing by itself, the return is merely
self-serving hearsay if offered on behalf of the taxpayer.” Id. at 256 n.8. The court
indicated that an evidentiary foundation could be made by “a qualified accountant who
prepared the return and was familiar with the taxpayer’s books and records and sources
of income, where the books and records were available in court as a basis for crossexamination.” Id.
Here, plaintiffs have failed to provide such an evidentiary foundation. Harmsen has
set forth no familiarity with William Cape’s or Cape & Sons’ books and records and has not
said that he prepared the returns. Similarly, Rigas required more than simply the tax
returns or K-1s as evidence. There, the taxpayers sought to claim as capital gains a
distribution one entity received from another, and the determination turned on whether the
two entites were in a partnership. 2011 WL 1655579 at *4. Although the court found that
tax returns and K-1s supported the capital gains treatment, those documents were
accompanied by deposition testimony and agreements that supported the treatment as
partners. That verification constituted credible evidence to rebut the presumption of
25

correctness.

Id.

Moreover, as noted by the court, the taxpayers complied with

substantiation requirements by retaining not only the relevant tax returns and K-1s but also
“the relevant correspondence with the IRS, underlying documentation of the assets held
by [one of the companies], and the relevant agreements.” Id. at *5. Rigas does not stand
for the proposition that tax returns and K-1s alone, without the underlying documentation,
would suffice as credible evidence or compliance with substantiation requirements.
While William Cape did not need additional substantiation to take the pass-through
deduction, that did not excuse the S corporation, him, or his estate and widow from
presenting the S corporation’s substantiation for the deductions. Someone needed to
substantiate the deduction with the IRS. And the refusal of the IRS to adjust partially taken
charitable deductions during the 2003 audit does not eliminate plaintiffs’ obligation to
substantiate the deductions when they seek a refund. See Brown v. United States, 890
F.2d 1329, 1347 (5th Cir. 1989) (rejecting taxpayer’s argument that the IRS’s failure to
require changes in a previous audit estopped the United States from correcting its error in
later litigation).
The receipt from St. Luke’s church gives the court slightly more pause, because as
part of William Cape’s files at Arthur Andersen it likely came from William Cape. But it
does not meet the requirements of Fed. R. Evid. 803(6)(C) because the record was not
made by Arthur Andersen and it does not meet the requirements of Rule 803(6)(A)
because no information indicates when and by whom the record was made.

The

document does not qualify for the residual exception of Fed. R. Civ. P. 807 because Rule
803(6) addresses such a document. Schimpf v. Gerald, Inc., 52 F. Supp. 2d 976, 984
(E.D. Wis. 1999) (Adelman, J.).

Though evidentiary standards may differ from
26

substantiation requirements before the IRS, nothing indicates that this receipt was
contemporaneous to the date of the donation or verifies that it came from the church.
Plaintiffs argue that the substantiation rules should be relaxed in this case because
Cape & Sons was taken over by a receiver and is defunct, Curkeet was dissolved, Arthur
Andersen no longer exists, and William Cape is dead. However, this confluence of bad
events for recordkeeping does not mean the IRS should adjust its substantiation
requirements. Moreover, though the court does not base its decision on this point, plaintiffs
do not explain why they fail to possess William Cape’s personal charitable donation
records. They say that “there is no indication that either Mr. Cape or the Estate and its
beneficiaries did not adequately maintain records.” (Doc. 74 at 11.) But where are those
records now, then? The unfortunate demise of the Cape & Sons business or Arthur
Andersen cannot be considered the cause for the Estate’s or Feldman’s own lack of
records regarding William Capes personal charitable donations, for which plaintiffs now
wish to recover a refund. The “heavy burden of proof in tax refund cases is justified by the
strong need of the government to accomplish swift collection of revenues and encourage
record keeping by taxpayers.” Richmond v. United States, 699 F. Supp. 578, 584 (E.D. La.
1988).
For these reasons, plaintiffs’ claim for the $4588 carryover in 1999 is denied.
2.

The Alleged 2000 Deduction/2001 Carryover

William Cape’s 2000 return reflected $7279 of deductions for charitable
contributions. Statement 4 to Schedule A of that return provided that $5269 of those
contributions were passed-through from Cape & Sons, and that amount matches the
amount of charitable contributions listed on Cape & Sons’ 2000 tax return multiplied by
27

William Cape’s ownership percentage. According to plaintiffs, because after the 2003 audit
William Cape’s contribution base for 2000 was negative, following his 2003 audit and that
the $7279 was suspended for 2000. Consequently, plaintiffs submit that it was available
to be carried over and deducted in 2001. (Doc. 62 at 8-9.) Plaintiffs contend that an IRS
appeals officer acknowledged this deductibility by reviewing the refund claim and writing
that the carryover of $7279 should be allowed. (Doc. 62 at 9.)
Similar to the 1998 pass-through charitable deduction, the 2000 pass-through
charitable deduction is not substantiated by any documentation from Cape & Sons. Again,
although William Cape did not need to provide additional substantiation, that does not
excuse the S corporation’s failure to substantiate the deduction. For the same reasons as
stated above regarding the 1998 alleged deduction, plaintiffs have failed to substantiate
the pass-through deduction.
As for any personal charitable contribution, plaintiffs admit that the available records
from Arthur Andersen do not contain receipts for $1300 of the charitable contributions
made by William Cape in 2000.

(Doc. 62 at 21.)

They argue that “the direct

correspondence between the records that are available and the numbers reflected on
William Cape’s tax return clearly suggests that these other numbers reflected on his return
are accurate and reliable also.” (Id.) Citing to Cohan v. Commissioner of Internal
Revenue, 39 F.2d 540, 544 (2d Cir. 1930), they contend that a “taxpayer is not denied
relief altogether merely because he lacks the best possible evidence.” (Id.)
Cohan does not aid the plaintiffs here. Cohan involved a court finding that the
taxpayer had spent a significant amount on allowable business expenses, but the taxpayer
had not kept track of the amounts and provided only an estimate. 39 F.2d at 543-44. The
28

Second Circuit held that when the taxpayer established an allowable deduction but not the
exact amount, an approximation was permitted:
Absolute certainty in such matters is usually impossible and is not necessary;
the Board should make as close an approximation as it can, bearing heavily
if it chooses upon the taxpayer whose inexactitude is of his own making. But
to allow nothing at all appears to us inconsistent with saying that something
was spent.
Id. Cohan does not provide support for allowing approximation regarding whether an
allowable deduction has occurred or been substantiated in the first place. See Oates v.
Comm’r of Internal Revenue, 316 F.2d 56, 59 (8th Cir. 1963) (“We believe that
considerable discretion exists in the application of the Cohan rule, and that such rule
should be applied only in cases where the taxpayer has clearly shown that he is entitled
to some deduction and that uncertainty exists only as to the exact amount thereof.”).
The IRS appeals officer’s note is not evidence substantiating these charitable
deductions. That officer’s opinion did not sway the IRS in its final denial of the plaintiffs’
appeal. One IRS appeal officer’s belief that the plaintiffs’ refund claim had some merit
does not suffice as substantiation of an allowable deduction, not does it overcome the
presumption that a prior IRS determination that the amount was not deductible was correct.
For these reasons, the plaintiffs’ claim for $7279 in carryover for 2001 is denied.
B.

Passive Activity Losses
Plaintiffs further contend that whether calculated under regular tax rules or under

the alternative minimum tax rules, about $159,000 to $160,000 in passive activity losses
accrued for William Cape by the end of 2001 and should have been deductible upon his
death in 2002. (Doc. 62 at 9-17.)

29

Title 26 U.S.C. §§ 465 and 469 were passed as part of Congress’s attempt to limit
tax shelters. 1 Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates
& Gifts ¶ 28.1, at 28-2 (3d ed. 1999). Certain tax shelters operated by offsetting salaries
and business income of all types with deductions from rapid depreciation of equipment.
Id. at 28-3. Under § 465, taxpayers who finance investments with nonrecourse loans may
take deductions only against income from that investment. Id. at 28-5. And under § 469,
which is not limited to financed activities, “losses from passive activities may only be
deducted from income from other passive activities.” Id. at 28-5. Generally, a passive
activity is an investment in which the investor is not an active participant; a “limited
partnership interest in an equipment leasing partnership is a typical example.” Id. at 28-6.
Section 469 essentially creates a basket containing all of a taxpayer’s
investments from passive activities and isolates losses and credits within the
basket from other income. Losses from one passive activity can be
deducted against income from other passive activities, but a net loss from all
passive activities may not be deducted against other income.
Id. at 28-7. However, § 469 does not disallow the passive losses permanently; instead, the
usual effect is to suspend the losses until another year. Id. at 28-8. “A loss or credit made
nondeductible by § 469 is carried forward to succeeding years until it is allowed.” Id. And,
usually, suspended losses can be deductible against all income when the taxpayer’s entire
interest in the passive activity is sold or exchanged. Id. Section 469(g)(2) provides that
if an interest in an activity “is transferred by reason of the death of the taxpayer” previously
suspended passive losses become deductible on the decedent’s final return to the extent
greater than any step-up in basis for the estate. 26 U.S.C. § 469(g)(2).
Plaintiffs acknowledge that the available records from Arthur Andersen do not
contain William Cape’s records for years prior to 1996. (Doc. 62 at 21.) Again, they argue
30

that “the direct correspondence between the records that are available and the numbers
reflected on William Cape’s tax return clearly suggests that these other numbers reflected
on his return are accurate and reliable also” and cite Cohan. (Id.)
That amounts on tax returns and K-1s match does not mean that the facts
underlying those amounts are reliable or have been substantiated. Plaintiffs rely on tax
returns, K-1s, and documents from accountants’ files for the calculations in the tables
above regarding passive activity losses and carryovers, as well as the value of William
Cape’s interest in Curkeet. They attempt to show that these documents are reliable by
pointing to consistencies, that numbers discussed in letters from Arthur Andersen match
passive activity loss numbers on the tax forms, that the amount in a 1099-Misc from
Johnson Bank matches self-employment income listed by William Cape and that amounts
on an S corporation’s tax returns corresponded with what William Cape reported as his
ownership percentage. (See Doc. 62 at 4, 11-12, 19.) But the fact that amounts are
reported consistently in various documents prepared by the same accountants does not
make them more reliable. The information behind the numbers in the tax returns and K-1s
(assuming that the K-1s are true copies of the final versions, which is unknown) still must
be substantiated. That the plaintiffs’ ability to obtain records confirming the bases for their
refund claims is difficult does not support a judicial finding that IRS rules should be relaxed
to allow the refund sought in this case.
This court agrees with cases stating that such tax returns and K-1s alone do not
substantiate a refund claim or constitute credible evidence. And again, Cohan’s holding
permitting approximation of the amount of an otherwise substantiated deduction does not
aid the plaintiffs here, where an allowable deduction has not been substantiated in the first
31

place. Thus, plaintiffs have failed to meet their burden or proof for a refund; they have not
overcome the presumption that the taxes at issue were determined correctly.
Moreover, there are other obstacles to accepting related tax returns and K-1s of
other taxpayers or entities as substantiation. Importantly, the accuracy of those tax returns
and K-1s is drawn into question by the results of the 2003 audit, which adjusted William
Cape and Feldman’s tax liability thereby requiring them to pay more in taxes than they had
under the challenged tax returns as filed initially. The plaintiffs’ previous pass-through
claims representing that Cape & Sons overstated its income in its tax returns (see Doc. 1,
¶ 39) also suggests that the filed tax returns and final K-1s were not accurate. The court
notes that plaintiffs maintain that the financial statements of Cape & Sons and Curkeet
overstated income but now want the court to accept their financial records as reliable.
Further, even if the tax returns and K-1s were considered, nothing provided by
plaintiffs shows what exactly the vague “individual rental activity” or “equipment rental
activity” including Curkeet that is referenced in the documents (and the tables above)
consisted of such that passive activity losses could be confirmed. Plaintiffs provide no
information showing that rental activities occured, what Curkeet’s alleged rental activities
entailed, and what the “individual rental activity” comprised. Nothing verifies passive
activity losses carried over to 1996 from prior years. Because plaintiffs offer no information
regarding the nature of Curkeet’s purported rental business, nothing supports a finding that
the rental activity was passive in nature, whether actual losses were incurred, and whether
the returns properly represented the tax effects of the purported rental activities through
the years.

32

Also, plaintiffs concede that records substantiating William Cape’s basis in Curkeet
are not available, yet contend that his basis can be determined from capital stock and
accumulated adjustment account (AAA) numbers on his tax returns. (Doc. 62 at 15-16.)
They admit that other items could affect William Cape’s basis, but say “there are no facts
(disputed or undisputed) to suggest the presence of any such items.” (Doc. 62 at 15 n.13.)
This argument points again to the lack of evidence supporting plaintiffs’ refund claims. The
burden is on plaintiffs to show entitlement to a refund; a lack of evidence indicates that they
do not meet their burden.
CONCLUSION
In summary, the plaintiffs have not met their burden of proof in this tax refund case.
They argue that they have met their initial burden because nothing suggests that the
information on their tax returns and forms is incorrect, and contend that the United States
“cannot prove by a preponderance of evidence that Plaintiffs are not entitled to the
Deductions.” (Doc. 74 at 3.) But the plaintiffs have failed to satisfy their initial burden of
proof. No burden shift occurred, and plaintiffs have not provided evidence on which a
reasonable fact-finder could rely to find in their favor.
In their brief, plaintiffs cite the “unfortunate unavailability” of additional records to
support their claim. (Doc. 62 at 1.) They contend that in such situations a taxpayer should
be given flexibility to meet IRS substantiation requirements (see Doc. 74 at 4) and that their
substitute evidence of tax returns, tax forms, and vague statements by an employee of
their former accountant should be accepted as support for their refund claims. But the
plaintiffs’ inability to substantiate their claimed refunds does not provide a legal ground
circumventing the IRS’s substantiation rules.
33

For the reasons set forth above, the government’s motion for summary judgment
(Doc. 70) has been granted and plaintiffs’ motion for summary judgment (Doc. 61) has
been denied.
IT IS ORDERED that the case is dismissed.
Dated at Milwaukee, Wisconsin, this 2nd day of October, 2015.
BY THE COURT

/s/ C.N. Clevert, Jr.
C.N. CLEVERT, JR.
U.S. DISTRICT JUDGE

34