Opinion
CIVIL ACTION NO. 99-1059
February 25, 2002
JUDGMENT
Pursuant to the Memorandum Ruling of this date,
IT IS HEREBY ORDERED, ADJUDGED AND DECREED that the Renewed Motion for Judgment as a Matter of Law (doc. 41) is GRANTED, setting aside the portion of the verdict awarding a refund of delinquency penalties for the 1990 and 1991 tax years, and
IT IS FURTHER ORDERED that the Motion to Set and Award Attorney Fees, Administrative Costs and Costs (doc. 39) is DENIED, and
IT IS FURTHER ORDERED that the Motion for an Evidentiary Hearing on the Issue of Net Worth Limitations (doc. 46) is DENIED AS MOOT, and
IT IS FURTHER ORDERED that the judgment of November 6, 2001 (doc. 38), for $113,325.12, is set aside, and that the Plaintiff Quality Homes, Inc., recover from the Defendant, the United States of America, $80,885.07, with interest thereon at the rate provided by 28 U.S.C. § 2411 from November 6, 2001, until paid in full.
THUS DONE AND SIGNED.
MEMORANDUM RULING
Presently before the Court are three post-trial motions. First, the United States renews its motion for judgment as a matter of law (doc. 41), pursuant to Federal Rule of Civil Procedure 50(b), seeking to partially set aside a jury verdict in favor of Quality Homes, Inc. ("Quality Homes"). Second, Quality Homes moves for an award of attorney's fees and costs (doc. 39) pursuant to 26 U.S.C. § 7430 and Federal Rule of Civil Procedure 54. Third, Quality Homes requests a hearing (doc. 46) to determine whether it satisfies the requirement of net worth restrictions for an award of attorney's fees set forth in 28 U.S.C. § 2412(d)(2)(B).
For the reasons stated below, the renewed motion for judgment as a matter of law will be GRANTED, setting aside the portion of the verdict awarding a refund of delinquency penalties for the 1990 and 1991 tax years, and the motion for attorney's fees and costs will be DENIED. Additionally, the motion for an evidentiary hearing on the issue of net worth limitations will be DENIED AS MOOT. Accordingly, the judgment of November 6, 2001 (doc. 38), for $113,325.12, will be reduced by $32,440.05. A new judgment will be entered for $80,885.07.
I. BACKGROUND
Quality Homes brought this action to recover penalties assessed by the Internal Revenue Service ("IRS") for late filing, pursuant to 26 U.S.C. § 6651(a)(1), and substantial understatement, pursuant to 26 U.S.C. § 6662(a), (b) and (d), of corporate income taxes for the 1990, 1991 and 1992 tax years. However, the 1992 penalties were abated and were not at issue during the trial of this matter. After a two-day trial, the jury returned a verdict awarding a refund of both the delinquency penalties and the substantial understatement penalties. The United States makes the present renewed motion for judgment as a matter of law only on the issue of the delinquency penalties. The delinquency penalty, or "addition to tax," was $8,318.00 for the 1990 tax year and $24,122.05 for the 1991 tax year, totaling $32,440.05.
Quality Homes is engaged in residential real estate development near New Llano, Louisiana. Quality Homes is wholly owned by its President, Teddy Dowden. Mr. Dowden is also the sole owner of another corporation, Teddy Dowden Construction Company, Inc., which engages in commercial real estate development. Additionally, Mr. Dowden owns one percent, and Quality Homes owns the remaining 99 percent, of a partnership, named QHI Development, that manages a multifamily housing complex.
Although Mr. Dowden is a successful real estate developer, he has great difficulty with reading. Mr. Dowden is a high school graduate, but has dyslexia and mild organic brain dysfunction. His measured intellectual functioning is below expectations for an individual of his age and business achievement. The uncontroverted testimony of Dr. Ronald Goebel, established that Mr. Dowden has an intelligence quotient of 83, which falls within the thirteenth percentile and the low average range. Mr. Dowden's reading ability scored in the second percentile. His spelling fell within the fifth percentile, and his arithmetic was in the nineteenth percentile.
To overcome his reading disability, Mr. Dowden has adapted by relying on others to read and interpret documents for him. He has, at times, asked his wife to read contracts to him, and he, ultimately, "just trusted people." Mr. Dowden's testimony established that his entrepreneurial career was furthered by close relationships with, among others, his banker, attorney and accountant.
Beginning in the 1970s, Mr. Dowden developed a close working relationship with his accountant, Michael Pettaway. Mr. Pettaway's firm maintained the monthly accounts of Quality Homes, determined its quarterly payroll tax payments and determined its annual income tax payments. The monthly bookkeeping activities performed by Mr. Pettaway for Quality Homes entailed calculating its checkbook balance, maintaining the general ledger and maintaining payroll records. Mr. Pettaway prepared Mr. Dowden's personal returns in addition to those for his two corporations and his partnership. Quality Homes provided Mr. Pettaway with all relevant information and records for filing tax returns. Quality Homes always paid its taxes on time while Mr. Pettaway was its accountant.
In 1989, Quality Homes changed accountants and employed Larry Bruce, a certified public accountant recommended by a friend and business associate. Mr. Dowden relied on Mr. Bruce to supply prepared returns and inform him when they were to be filed. Mr. Dowden relied on Mr. Bruce in the same manner that he had relied on Mr. Pettaway, but Mr. Dowden's trust in Mr. Bruce was misplaced.
Mr. Bruce, who knew that Mr. Dowden could not read, would have Mr. Dowden sign checks payable to Mr. Bruce purportedly for reimbursement of taxes that had been paid. Mr. Dowden did not know if he signed a return for the tax years at issue in this case, but he was led to believe that Mr. Bruce had paid the taxes and needed to be reimbursed. After the IRS notified Quality Homes by registered mail of its filing deficiencies, Mr. Dowden contacted Mr. Bruce, and Mr. Bruce's response was "Don't worry, I'll take care of it for you." Mr. Dowden only learned of the fraud regarding the purported reimbursements when some of Mr. Bruce's other clients informed Mr. Dowden that they also had been defrauded. Mr. Bruce was later convicted for his crimes, and Mr. Dowden rehired Mr. Pettaway to help extricate Quality Homes from the problems caused by Mr. Bruce.
II. LAW AND ANALYSIS
A. Renewed Motion for Judgment as a Matter of Law (doc. 41)
At the close of the Plaintiff's case and also at the close of all the evidence, the United States moved for judgment as a matter of law, preserving its right to bring the present renewed motion. See Fed.R.Civ.P. 50(b).
1. Legal Standard
After a jury trial, a district court should grant judgment as a matter of law when "a party has been fully heard on an issue and there is no legally sufficient evidentiary basis for a reasonable jury to find for that party on that issue." Fed.R.Civ.P. 50(a)(1). A court should grant judgment as a matter of law when there is a lack of "sufficient material evidence to support the jury's verdict." Vance v. Union Planters Corp., 209 F.3d 438, 441 (5th Cir. 2000). The findings of a jury must be upheld, unless the evidence is of such quality and weight that reasonable and impartial jurors could not arrive at such a verdict. See Douglas v. DynMcDermott Petroleum Operations Co., 144 F.3d 364, 369 (5th Cir. 1998).
When deciding a motion for judgment as a matter of law, the court should review all of the evidence in the record. See Reeves v. Sanderson Plumbing Products, Inc., 530 U.S. 133, 150, 120 S.Ct. 2097, 2110, 147 L.Ed.2d 105 (2000). The court must draw all reasonable inferences in favor of the nonmoving party, and it may not make credibility determinations or weigh the evidence. See Reeves, 530 U.S. 133 at 150, 120 S.Ct. at 2110. To create a jury question, "there must be a conflict in substantial evidence." Gaia Technologies, Inc. v. Recycled Products Corp., 175 F.3d 365, 374 (5th Cir. 1999). "Substantial evidence is defined as evidence of such quality and weight that reasonable and fair-mined [persons] in the exercise of impartial judgment might reach different conclusions." Gaia Technologies Inc., 175 F.3d at 374.
2. Delinquency Penalty
Failure to file a required tax return by the applicable deadline subjects a taxpayer to penalties. See 26 U.S.C. § 6651(a)(1). "To escape the penalty, the taxpayer bears the heavy burden of proving both (1) that the failure did not result from `willful neglect,' and (2) that the failure was due to `reasonable cause.'" United States v. Boyle, 469 U.S. 241, 245, 105 S.Ct. 687, 689-90, 83 L.Ed.2d 622 (1985) (quoting 26 U.S.C. § 6651(a)(1)). "Willful neglect" is not at issue for the purposes of the present motion for judgment as a matter of law. The issue here is, generally, whether the failure of Quality Homes to file returns for the 1990 and 1991 tax years was due to "reasonable cause," and, specifically, whether Larry Bruce gave Quality Homes substantive advice that Quality Homes did not need to file a return for the tax years in question.
"`Reasonable cause' is used in I.R.C. § 6651(a)(1) as a term of art." Denenburg v. United States, 920 F.2d 301, 304 (5th Cir. 1991). What elements are necessary to constitute "reasonable cause" is a question of law, but whether the elements that constitute "reasonable cause" are present in a given situation is a question of fact. See Boyle, 469 U.S. at 249 n. 8, 105 S.Ct. at 692 n. 8. The applicable Treasury Regulation equates "reasonable cause" with "ordinary business care and prudence." 26 C.F.R. § 301.6651-1(c)(1) ("If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time, then the delay is due to reasonable cause.").
Generally, the failure to file a tax return in a timely manner is not excused by the taxpayer's reliance on an agent to file the return, and such reliance is not "reasonable cause" for late filing. Boyle, 469 U.S. at 252, 105 S.Ct. at 693. Taxpayers cannot delegate the duty of prompt filing to an agent, "except in a very narrow range of situations." Boyle, 469 U.S. at 249-50, 105 S.Ct. at 692. Hiring an attorney or accountant to assist with tax preparation is an exercise of "ordinary business care and prudence," Boyle, 469 U.S. at 250, 105 S.Ct. at 692, "but that reliance cannot function as a substitute for compliance with an unambiguous statute." Boyle, 469 U.S. at 251, 105 S.Ct. at 692. While Boyle involved an executor's duty to file a timely estate tax return, the rule that a taxpayer cannot delegate the duty to file a timely return also applies to corporations. See, e.g., Atlas Therapy, Inc. v. United States, 66 F. Supp.2d 1203, 1207 (N.D. Ala. 1999).
As in Boyle, the duty to file a return in this case was unambiguous. All corporations subject to income taxation are required to file tax returns, regardless of the amount of the corporation's gross income or regardless of whether it has taxable income. See 26 U.S.C. § 6012(a)(2); 26 C.F.R. § 1.6012-2(a)(1); Rubber Research, Inc. v. Commissioner, 422 F.2d 1402, 1406-07 (8th Cir. 1970). Therefore, Quality Homes cannot simply delegate to Larry Bruce the responsibility to file timely returns, even if ordinary business care and prudence were exercised in his selection and supervision. See, e.g., Atlas Therapy, Inc., 66 F. Supp.2d at 1207.
However, reliance on an agent may constitute "reasonable cause" for failure to file timely returns in two situations. First, reliance on an accountant or attorney constitutes "reasonable cause" when the accountant or attorney gives substantive advice on a matter of tax law, such as whether liability exists, see Boyle, 469 U.S. at 251, 105 S.Ct. at 62, or whether a return is required. See Boyle, 469 U.S. at 250, 105 S.Ct. at 692. Second, reliance on an accountant or attorney to file a return constitutes "reasonable cause" when "the taxpayer was, for some reason, incapable by objective standards of meeting the criteria of 'ordinary business care and prudence.'" Boyle, 469 U.S. at 249 n. 6, 105 S.Ct. 692; see, e.g., Brown v. United States, 630 F. Supp. 57, 60 (M.D. Tenn. 1985) (refunding delinquency penalty when executor relied on attorney to file return because executor was not physically and mentally capable of complying with the filing deadline due to age, health and lack of experience).
Also, under certain circumstances, delinquency penalties are inappropriate in the corporate context when a corporation is "disabled" by the conduct of its officers. See In re American Biomaterials Co., 954 F.2d 919, 921, 927 (3rd Cir. 1993) (affirming district court's determination that embezzlement by CEO and CFO "incapacitated the corporation"); c.f. Valen Manufacturing Co. v. United States, 90 F.3d 1190, 1193 (6th Cir. 1996) (corporate taxpayer was not disabled when bookkeeper concealed failure to file employment tax returns); Conklin Bros. of Santa Rosa, Inc. v. United States, 986 F.2d 315, 319 (9th Cir. 1993) (corporation was not disabled in complying with its tax obligations when controller failed to timely file, pay, and deposit employment taxes); see also Van Camp Bennion, P.S. v. United States, 251 F.3d 862, 867 (9th Cir. 2001) (holding district court erroneously failed to consider whether the illness of the president of a professional service corporation was serious enough to establish reasonable cause).
Whether Quality Homes was disabled by Mr. Dowden's inability to supervise Mr. Bruce is not at issue in this case. While substantial evidence regarding Mr. Dowden's reading disability and his wife's inexperience with financial matters was adduced at trial, the issue of corporate disability was not argued at trial, presented to the jury through an appropriate instruction or argued in opposition to the present motion for judgment as a matter of law.
In this case, the jury was instructed that it must find that Larry Bruce advised Quality Homes that it was not necessary to file tax returns for the relevant tax years in order to find for Quality Homes on the issue of the delinquency penalties. However, even when drawing all inferences in favor of Quality Homes, a jury could not reasonably conclude that Quality Homes was advised that it did not need to file a return for the tax years at issue in this case, or that Quality Homes relied on other substantive advice concerning tax law.
Larry Bruce specifically advised Mr. Dowden that he was not required to file returns for Teddy Dowden Construction Company, Inc. (Pl.'s Ex. 13). However, Mr. Bruce did not advise Mr. Dowden that it was unnecessary for Quality Homes to file a return. Instead, Mr. Bruce led Mr. Dowden to believe that the taxes had been paid and that Quality Homes needed to reimburse Mr. Bruce. This fraud by Mr. Bruce merely demonstrates that Mr. Dowden relied on Mr. Bruce to prepare the returns, but it is not evidence of substantiative advice regarding tax law, such as whether a return is required. The Boyle decision directs that Mr. Dowden's reliance on Mr. Bruce does not constitute "reasonable cause" for late filing. See Boyle, 469 U.S. at 251, 105 S.Ct. at 692.
Quality Homes argues that Mr. Bruce's reassurances not to worry about the tax problems, and that he would take care of any problems, could reasonably be inferred as substantive advice that a tax return was not necessary. However, Mr. Bruce only told Mr. Dowden not to worry about his tax problems after Mr. Dowden confronted him with the letters from the IRS regarding filing deficiencies, and not before the deadline had passed. A reasonable jury could not conclude that Mr. Bruce even implicitly advised Quality Homes that a tax return was not necessary. Therefore, the Renewed Motion for Judgment as a Matter of Law (doc. 41) will be GRANTED.
B. Motion to Set and Award Attorney Fees, Administrative Costs and Costs (doc. 39)
In tax refund cases, a party may not recover attorney's fees from the United States unless it establishes that it is a "prevailing party" as defined by the Internal Revenue Code. See 26 U.S.C. § 7430; Smith v. United States, 850 F.2d 242, 245 (5th Cir. 1988). A "prevailing party" is defined as a party that (1) has substantially prevailed with respect to the amount in controversy or with respect to the most significant issue or set of issues presented; and (2) meets the appropriate net worth restriction set forth in 28 U.S.C. § 2412(d)(2)(b). See 26 U.S.C. § 7430(c)(4)(A). However, if the United States establishes that its position in the proceeding was "substantially justified," the moving party is not considered a "prevailing party" for the purposes of 26 U.S.C. § 7430. See 26 U.S.C. § 7430(c)(4)(B).
"Substantially justified means justified to a degree that could satisfy a reasonable person." Wilkerson v. United States, 67 F.3d 112, 119 (5th Cir. 1995) (quoting Lennox v. Commissioner, 998 F.2d 244, 248 (5th Cir. 1993). "[T]he Government's position must have a reasonable basis both in law and fact . . . prior to the onset of litigation." Wilkerson, 67 F.3d at 119 (citations omitted). In this case, the position of the United States had a reasonable basis in both law and fact. As discussed above, the United States will prevail on its motion for judgment as a matter of law regarding the delinquency penalties. Regarding the substantial understatement penalties, there was a reasonable basis in law and fact to argue at trial that Quality Homes did not disclose all relevant information to its accountant. The position of the United States was supported by the testimony of Revenue Agent Lud McNeely, who conducted the audit for 1990 and 1991. He requested all information from Mr. Bruce that he had regarding the tax years in question. Mr. Bruce did not provide records of bank accounts belonging to Quality Homes that corresponded with the amounts of the substantial understatement of tax liability. While the jury returned a verdict in favor of Quality Homes, the United States had a reasonable basis in law and fact for its position. Therefore, Quality Homes is not entitled to costs and fees pursuant to 26 U.S.C. § 7430.
Additionally, Quality Homes is not entitled to costs pursuant to Federal Rule of Civil Procedure 54 or 28 U.S.C. § 1920, because it did not satisfy the requirements of 28 U.S.C. § 1924. Rule 54 provides that "costs against the United States, its officers, and agencies shall be imposed only to the extent permitted by law." Fed.R.Civ.P. 54(d)(1). A party claiming any item of cost must provide an affidavit that the such costs are correct and have been necessarily incurred in the case. See 28 U.S.C. § 1924. Quality Homes has failed to satisfy this requirement, and leave to file an affidavit for the purposes of 28 U.S.C. § 1924 was denied as untimely on February 22, 2002. Therefore, Quality Homes is not entitled to attorney's fees or costs, and the Motion to Set and Award Attorney Fees, Administrative Costs and Costs (doc. 39) will be DENIED.
C. Motion for an Evidentiary Hearing on the Issue of Net Worth Limitations (doc. 46)
Since the position of the United States was "substantially justified" and Quality Homes is not entitled to litigation costs pursuant to 26 U.S.C. § 7430, it is unnecessary to hold a hearing to determine whether the other requirements of 26 U.S.C. § 7430 are satisfied, such as the net worth limitations set forth in 28 U.S.C. § 2412(d)(2)(B). Accordingly, the Motion for an Evidentiary Hearing on the Issue of Net Worth Limitations (doc. 46) will be DENIED AS MOOT.
III. CONCLUSION
For the reasons stated above, the renewed motion for judgment as a matter of law will be GRANTED, setting aside the portion of the verdict awarding a refund of delinquency penalties for the 1990 and 1991 tax years, and the motion for attorney's fees and costs will be DENIED. Additionally, the motion for an evidentiary hearing on the issue of net worth limitations will be DENIED AS MOOT. Accordingly, the judgment of November 6, 2001 for $113,325.12 will be reduced by $32,440.05. A new judgment will be entered for $80,885.07.
THUS DONE AND SIGNED.