Dmb Realco Llc et al v. United States of America

MOTION for Summary Judgment

D. Ariz.February 24, 2017

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 DAVID A. HUBBERT Acting Assistant Attorney General ADAM D. STRAIT (Mass. BBO No. 670484) ALEXANDER STEVKO (CA Bar No. 301359) Trial Attorney, Tax Division U.S. Department of Justice P.O. Box 683, Ben Franklin Station Washington, D.C. 20044-0683 Telephone: (202) 307-2135 Fax: (202) 307-0054 Email: adam.d.strait@usdoj.gov Of Counsel ELIZABETH A. STRANGE Acting United States Attorney, District of Arizona Attorneys for the United States of America UNITED STATES DISTRICT COURT DISTRICT OF ARIZONA DMB REALCO, LLC, Plaintiff, v. UNITED STATES OF AMERICA, Defendant. Civil No. 16-1585-NVW UNITED STATES’ MOTION FOR SUMMARY JUDGMENT (PHASE I) Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 1 of 23 U.S. Mot. Summ. J. (Phase I) Page i 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 TABLE OF CONTENTS I. Introduction. ............................................................................................................ 1 II. The Original Deed Failed the Requirements for a Qualified Conservation Contribution. ........................................................................................................... 3 III. The Original Deed Controls the Federal Tax Consequences of DMB’s Donation. ................................................................................................................... 6 A. The Supreme Court Effectively Overruled Flitcroft. ............................... 7 B. Applying Bosch, Reformation Nunc Pro Tunc Is Not Warranted. ....... 11 C. Even If Flitcroft Is Good Law, Its Factors Weigh Against Accepting the State Court Judgment. ....................................................... 13 D. In the Alternative, Flitcroft Should Be Overturned. .............................. 16 IV. DMB Never Received a Contemporaneous Written Acknowledgment from Buckeye. ........................................................................................................ 16 V. Conclusion .............................................................................................................. 17 Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 2 of 23 U.S. Mot. Summ. J. (Phase I) Page ii 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 TABLE OF AUTHORITIES Cases Addis v. Commissioner, 374 F.3d 881 (9th Cir. 2004) ...................................................... 16 Am. Nurseryman Pub. Co. v. Commissioner, 75 T.C. 271 (1980) .................................... 16 Averyt v. Commissioner, 104 T.C.M. (CCH) 65 (2012) ................................................... 17 Bond v. Commissioner, 100 T.C. 32 (1993) ........................................................................ 5 Botsford v. Riddell, 283 F.2d 298 (9th Cir. 1960) ............................................................... 8 Carpenter v. Commissioner, 106 T.C.M. (CCH) 62 (2013) ............................................... 4 Carroll v. Commissioner, 146 T.C. No. 13, 2016 WL 1757508 ..................................... 3, 6 Commissioner v. Bosch, 363 F.2d 1009 (2d Cir. 1966), rev’d, 387 U.S. 456 ..................... 9 Commissioner v. Estate of Bosch, 387 U.S. 456 (1967) ............................... 7, 9, 10, 11, 13 Erie R. Co. v. Tompkins, 304 U.S. 64 (1938) .................................................................... 10 Estate of Sanford v. Commissioner, 308 U.S. 39 (1939) .................................................. 11 Flitcroft v. Commissioner, 328 F.2d 449 (9th Cir. 1964) .............. 7, 8, 9, 10, 13, 14, 15, 16 French v. Commissioner, 111 T.C.M. (CCH) 1241 (2016) .............................................. 17 Friedman v. Commissioner, 99 T.C.M. (CCH) 1175 (2010) ............................................ 16 Gallagher v. Smith, 223 F.2d 218 (3d Cir. 1955) .......................................................... 9, 10 Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012) .......................................................... 4, 5 Mackey v. Philzona Petroleum Co., 378 P.2d 906 (Ariz. 1963) ....................................... 12 Miller v. Gammie, 335 F.3d 889 (9th Cir. 2003)........................................................... 7, 10 Minnick v. Commissioner, 104 T.C.M. (CCH) 755, 757 (2012), aff’d, 796 F.3d 1156 (9th Cir. 2015) ................................................................................................................. 6 Nussbaumer v. Superior Court in and for Yuma County, 489 P.2d 843 (Ariz. 1971) ....................................................................................................... 12, 13, 16 Pauley v. United States, 459 F.2d 624 (9th Cir. 1972) ..................................................... 11 Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 3 of 23 U.S. Mot. Summ. J. (Phase I) Page iii 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Sawyer v. Sonoma City, 719 F.2d 1001 (9th Cir. 1983) ...................................................... 5 United States v. Boulware, 384 F.3d 794 (9th Cir. 2004) ................................................. 10 United States v. Craft, 535 U.S. 274 (2002)........................................................................ 2 United States v. Irvine, 511 U.S. 224 (1994) .............................................................. 14, 15 United States v. Nordic Village Inc., 503 U.S. 30 (1992) ................................................. 15 United States v. Pelzer, 312 U.S. 399 (1941) .................................................................... 14 United States v. Sec. Tr. & Sav. Bank of San Diego, 340 U.S. 47 (1950)......................... 15 Van den Wymelenberg v. United States, 397 F.2d 443 (7th Cir. 1968) ............................ 16 Yano v. Yano, 697 P.2d 1132 (Ariz. App. 1985) ............................................................... 13 Statutes A.R.S. § 38-511 ................................................................................................................... 4 I.R.C. § 170(a) ......................................................................................................... 6, 11, 15 I.R.C. § 170(f) ......................................................................................................... 2, 16, 17 I.R.C. § 170(h) ................................................................................................................. 2, 5 I.R.C. § 6226 ....................................................................................................................... 1 I.R.C. § 673 (1954) .............................................................................................................. 8 I.R.C. § 701 ......................................................................................................................... 1 I.R.C. § 702 ......................................................................................................................... 1 Rules Federal Rule of Civil Procedure 56 ..................................................................................... 1 Regulations Treas. Reg. § 1.170A-1................................................................................................ 11, 15 Treas. Reg. § 1.170A-14(g)(5) .................................................................................... 3, 4, 5 Treas. Reg. § 1.170A-14(g)(6) .................................................................... 2, 3, 4, 5, 12, 14 Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 4 of 23 U.S. Mot. Summ. J. (Phase I) Page 1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Pursuant to Federal Rule of Civil Procedure 56, the United States of America respectfully moves for summary judgment with respect to the issue presented in Phase I of this case: Whether a donor can reach into the past and, through a state-court proceeding to which the United States was not a party, correct a mistake of federal tax law in order to receive a deduction. It cannot. The Internal Revenue Code tests whether a donation was actually paid during the tax year at issue. A state-law legal fiction can’t override that requirement. For the reasons set out below, the parties’ stipulated facts entitle the United States to summary judgment on this issue. I. INTRODUCTION. In this case, DMB is asking the Court to readjust the IRS’s decision to deny DMB’s claim, on its 2006 income tax return, of a $26,440,000 deduction for its donation of a conservation easement. (See Compl. (Dkt. 1); I.R.C. § 6226(a).)1 The easement DMB donated to the City of Buckeye in 2006 failed to meet the legal criteria for a deduction. After the IRS opened an audit of DMB’s return, DMB attempted to correct its mistakes by amending the deed of easement. Then, in 2016, after the IRS denied DMB’s deduction, DMB obtained a judgment in Arizona state court, reforming the 2006 deed to match the amended deed. DMB’s claim for a deduction in this case is based on its contention that the 2016 state-court judgment retroactively changed what rights it donated to Buckeye in 2006. In other words, DMB claims that it’s entitled to take the easement deduction on its 2006 federal tax return now, even though it wasn’t entitled to take the deduction in 2006. DMB is wrong. The 2006 deed, not the 2012 amendment, determines whether DMB can take a deduction on its 2006 return. 1 Because DMB files its tax returns as a partnership, the items on its return, as adjusted by the IRS and readjusted in judicial review, pass through to each of the partners. See I.R.C. §§ 701, 702. Resolving disputes at the partnership level ensures the item is treated consistently by each partner. Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 5 of 23 U.S. Mot. Summ. J. (Phase I) Page 2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 The facts relevant to this Motion are stipulated. (See Jt. Stip. of Facts (Dkt. 41).) To give the facts context, however, it’s useful to explain the legal backdrop concerning the deductibility of grants of conservation easements. Like other easements, conservation easements separate certain rights from the fee ownership of real property. To use a “common idiom,” rights in real property can be analogized to a “bundle of sticks.” See United States v. Craft, 535 U.S. 274, 278-79 (2002). Each “stick” represents a right associated with the holder’s interest in the property. See id. A conservation easement transfers “sticks” that represent rights inconsistent with the donor’s intent to conserve the land—for instance, the right to develop a piece of property. The tax code refers to conservation easements that meet certain requirements as a “qualified conservation contribution.” I.R.C. § 170(h). They are an exception to the general rule that a taxpayer cannot claim a deduction for the charitable donation of a partial interest in property. See § 170(f)(3). To qualify for a deduction, an easement must meet several criteria, including all of the general requirements for any charitable contribution. One criterion specific to conservation easements is that the easement must transfer a “qualified real property interest.” § 170(h)(1). To be a qualified real property interest, the easement must be “a restriction (granted in perpetuity) on the use which may be made of the real property.” § 170(h)(2)(C). Treasury Regulation § 1.170A-14 interprets what it means for a restriction to be “granted in perpetuity.” Two of the conditions the Regulation sets are pertinent here. First, the Regulation governs the terms under which the easement may be extinguished. § 1.170A-14(g)(6). The extinguishment must take place only by judicial proceeding (for example, an eminent domain case). § 1.170A-14(g)(6)(i). Furthermore, the easement must transfer to the donor a right to a proportion of any proceeds from extinguishment. The proportion of the funds must remain constant. § 1.170A-14(g)(6)(ii). Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 6 of 23 U.S. Mot. Summ. J. (Phase I) Page 3 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Second, the Regulation sets conditions on rights reserved to the donor. See § 1.170A-14(g)(5). If exercise of the reserved rights might impair the property’s conservation values, “the donor must make available to the donee,” before the donation is made, baseline documents that “establish the condition of the property at the time of the gift.” § 1.170A-14(g)(5)(i). The donor must provide written notice before exercising a reserved right. § 1.170A-14(g)(5)(ii). The 2006 deed of easement does not meet either of those two conditions. In 2012, after the IRS opened an audit, DMB amended the deed so that it did. But as explained below, it’s the 2006 Original Deed, not the 2012 Amended Deed, that governs whether DMB is entitled to a 2006 income tax deduction. II. THE ORIGINAL DEED FAILED THE REQUIREMENTS FOR A QUALIFIED CONSERVATION CONTRIBUTION. The Original Deed failed § 1.170A-14(g) in three ways, each of which was independently sufficient to disqualify the easement from a deduction. Those failures drove DMB to create the Amended Deed in the first place. (See Email from Mary Alexander to Scott Ruby, Jt. Ex. 5 (Dkt. 41-5).) In fact, DMB admitted to the state court that it failed at least one requirement. First, under § 6 of the Original Deed, if the easement were extinguished, Buckeye would have been entitled to a fixed sum—$26.44 million, the claimed fair market value of the easement at the time of donation. (Original Deed, Jt. Ex. 1 at 4 ¶ 6 (Dkt. 41-1).) That violated the requirement in § 1.170A-14(g)(6)(ii) that at extinguishment a donee must have a right to a proportion of the proceeds at least equal to the proportion of the value of the easement to the total value of the property at the time of donation. See Carroll v. Commissioner, 146 T.C. No. 13, 2016 WL 1757508, at *15 (holding that strict compliance with proportionate-funds requirement is prerequisite for deduction); Kaufman Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 7 of 23 U.S. Mot. Summ. J. (Phase I) Page 4 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 v. Shulman, 687 F.3d 21, 27 (1st Cir. 2012) (ruling for taxpayer on other grounds but stating that easement must grant an absolute right to the proportionate value). Indeed, DMB told the state court as much. It said in its verified complaint that § 6 of the Original Deed was “not in conformity with the requirements of [Treasury] Regulation § 1.170A- 14(g)(6)(ii).” (State Court Compl., Jt. Ex. 8 at 7 ¶ 23 (Dkt. 41-8).) DMB completely rewrote § 6 in the Amended Deed. (Compare Original Deed, Jt. Ex. 1 at 4 ¶ 6 (Dkt. 41-1) with Amended Deed, Jt. Ex. 6 at 4-5 ¶¶ 6.1-6.3 (Dkt. 41-6).) Second, § 15.8 of the Original Deed stated that Buckeye may unilaterally terminate the easement pursuant to A.R.S. § 38-511 if it determines that any town employee involved in the negotiation of the Deed had a conflict of interest. (See Jt. Ex. 1 at 7 ¶ 15.8 (Dkt. 41-1).) To be sure, A.R.S. § 38-511, standing alone, arguably doesn’t apply to a donation—the text of the statute only applies to “contracts.” But the principle behind the statute could apply to the negotiation of an easement as well, and DMB and Buckeye specifically chose to include a term in the Original Deed allowing Buckeye to terminate the easement. The most reasonable reading of the provision is that it allowed Buckeye to unilaterally terminate the easement if one of its employees had a conflict of interest. Therefore, the Original Deed allowed for a type of extinguishment outside of a judicial proceeding, which violates § 1.170A-14(g)(6)(i). See Carpenter v. Commissioner, 106 T.C.M. (CCH) 62, 67 (2013) (judicial proceeding alone is allowed for extinguishment). DMB eliminated this provision entirely in the Amended Deed. (See Amended Deed, Jt. Ex. 6 (Dkt. 41-6).) Third, § 3.1 of the Original Deed reserved to DMB the right to revegetate or otherwise improve a portion of the easement area within its sole discretion. (Jt. Ex. 1 at 3 ¶ 3.1 (Dkt. 41-1).) In such a situation, § 1.170A-14(g)(5) requires the donor to provide the donee with documentation sufficient to establish the property “at the time of the gift.” Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 8 of 23 U.S. Mot. Summ. J. (Phase I) Page 5 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 It also requires the donor to agree to notify the donee before exercising the reserved right. Section 3.1 does not require DMB to notify Buckeye before making improvements. And the only documents DMB provided about the condition of the property were (1) a 2000 biological evaluation that covered 8,800 acres (including the 182-acre easement area) and (2) a 2006 environmental assessment of an adjacent parcel. Much can change in six years, and an evaluation of 8,800 acres that does not split out the easement property is not sufficient to establish the condition of the 182 acres under easement. Nor is it necessarily true that two adjacent parcels have the same conservation values. Without more specific and up-to-date documentation, it would have been difficult for Buckeye to hold DMB accountable for changes to the condition of the property. The documentation provided by DMB fails to meet the requirement in § 1.170A-14(g)(5). And where the Original Deed reserved to DMB the right to “revegetate and otherwise improve” part of the property, the Amended Deed transferred that right to Buckeye. (Compare Original Deed, Jt. Ex. 1 at 3 ¶ 3.1 (Dkt. 41-1), with Amended Deed, Jt. Ex. 6 at 3 ¶ 3.1 (Dkt. 41-6).) For each of these rules, DMB was required to meet the letter of the law, not just the spirit. If a regulation relates to the substance or essence of a statute, strict compliance is required. See, e.g., Sawyer v. Sonoma City, 719 F.2d 1001, 1008 (9th Cir. 1983). Courts have sometimes permitted taxpayers to show “substantial compliance,” but only for procedural regulations that require taxpayers to report information, such as appraisal data, in a certain way. See, e.g., Bond v. Commissioner, 100 T.C. 32, 41-42 (1993). The requirements in § 1.170A-14(g)(5) and (6), by comparison, ensure that a conservation easement is actually granted in perpetuity. They go to the very purpose of § 170(h)(2). Courts considering the perpetuity regulations therefore require strict compliance. See, e.g., Kaufman, 687 F.3d at 26 (drawing a distinction between the “substantive requirements” for perpetuity in § 1.170A-14(g) and the recordkeeping Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 9 of 23 U.S. Mot. Summ. J. (Phase I) Page 6 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 regulations of § 1.170A-13); Minnick v. Commissioner, 104 T.C.M. (CCH) 755, 757 (2012), aff’d, 796 F.3d 1156 (9th Cir. 2015) (strictly applying the perpetuity regulations); Carroll, 2016 WL 1757508, at *11. III. THE ORIGINAL DEED CONTROLS THE FEDERAL TAX CONSEQUENCES OF DMB’S DONATION. Under I.R.C. § 170(a)(1), a deduction is only allowed for a donation “made within the taxable year.” Because, as explained above, DMB did not actually transfer all of the rights listed in the Amended Deed during 2006, it must rely on the state-law fiction that the 2016 reformation judgment incorporated the terms of the 2012 Amended Deed as of 2006, the tax year at issue. DMB obtained the 2016 State Court Judgment after suing the City of Buckeye in Maricopa County Superior Court. DMB told the state court that its wholesale rewriting of § 6 between the 2006 Original Deed and the 2012 Amended Deed was due to a “scrivener error.” (State Court Compl., Jt. Ex. 8 at 7 ¶ 23 (Dkt. 41-8); State Court Mot. Summ. J., Jt. Ex. 10, at 3, 6-7, 10-14 (Dkt. 41-10).) However, DMB did not highlight the changes it made to §§ 15.8 (permitting Buckeye to terminate the easement for a conflict of interest) and 3.1 (reserving the right to revegetate a portion of the property). It said only that in addition to § 6, the Amended Deed “made several [other] minor corrections.” (State Court Stmt. Material Facts, Jt. Ex. 11 at 8 ¶ 35 (Dkt. 41-11).) When DMB moved for summary judgment, Buckeye responded by stating that it “has no basis to dispute” the motion, and noted that its “primary concern in [the state-court] litigation [was] to ensure that any reformation of the conservation easement continues to provide an irrevocable easement to the City in perpetuity . . . .” (Jt. Ex. 12, at 1-2 (Dkt. 41-13) (emphasis added).) The state court eventually entered DMB’s proposed judgment, stating that “[t]here was a scrivener’s error in drafting the [Original Deed] . . . specifically in the Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 10 of 23 U.S. Mot. Summ. J. (Phase I) Page 7 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 drafting of Section 6” and that the Original Deed was “reformed nunc pro tunc to and effective as of the original recording date . . . to incorporate the terms of” the Amended Deed. (Jt. Ex. 13, at 2 ¶¶ 2a, 2c (Dkt. 41-14).) DMB says that the 2016 State Court Judgment regarding the 2006 deed entitles it to a 2006 deduction. While its position finds superficial support in a Ninth Circuit case, Flitcroft v. Commissioner, 328 F.2d 449 (9th Cir. 1964), its reliance on that case is ultimately unavailing. First, Flitcroft is not good law. The Supreme Court rejected the theory on which it rests in Commissioner v. Estate of Bosch, 387 U.S. 456 (1967). Bosch requires the Court to decide for itself whether the Amended Deed should be given retroactive effect. Second, even if Flitcroft still stands, its multifactor balancing test weighs against DMB. Finally, if Flitcroft squarely controls, it is wrongly decided and should be overruled. A. The Supreme Court Effectively Overruled Flitcroft. The Ninth Circuit’s opinion in Flitcroft is founded on a flawed understanding of the role state-court decisions play in determining federal tax liability. Flitcroft holds that state-court judgments are conclusive unless they were obtained through collusion. See 328 F.2d at 455. But in Bosch, the Supreme Court rejected the state-court-judgments-are- conclusive reasoning the Ninth Circuit employed in Flitcroft by overruling one of the key cases on which the Flitcroft court expressly relied. Instead of giving conclusive weight to a state court judgment, Bosch requires federal courts to examine the scope and purpose of the federal tax statute at issue. Then, with those principles in mind, federal courts afford a state trial court’s judgment the weight its persuasiveness deserves. See 387 U.S. at 463- 65. The Supreme Court’s later decision in Bosch thus “undercut the theory or reasoning underlying [Flitcroft] . . . in such a way that the cases are clearly irreconcilable.” Miller v. Gammie, 335 F.3d 889, 900 (9th Cir. 2003) (en banc). Flitcroft is not good law. Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 11 of 23 U.S. Mot. Summ. J. (Phase I) Page 8 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 To explain why the two cases are “clearly irreconcilable,” it’s helpful to review them both in detail. In Flitcroft, the taxpayers established three trusts with their children as beneficiaries and contributed income-producing property to each trust. 328 F.2d at 450-51. Under the tax laws then in force, the grantor of a trust was treated as the trust’s owner if the trust was revocable. I.R.C. § 673(a), (b) (1954). California law made every trust revocable unless the trust instrument expressly stated otherwise. Flitcroft, 328 F.2d at 451 n.4 (quoting Cal. Civil Code § 2280). Because the Flitcrofts’ trust documents did not expressly state that the trusts were irrevocable, the IRS required the Flitcrofts to pay tax on the trusts’ income. The Flitcrofts amended the trust instruments in 1954 to state expressly that the trusts were irrevocable. The trustees of the trusts filed a complaint in California court, naming the Flitcrofts and the District Director of Internal Revenue as defendants. The complaint sought nunc pro tunc reformation of the trust instruments. Botsford v. Riddell, 283 F.2d 298, 298 (9th Cir. 1960) (per curiam). The District Director removed the case to federal court and moved to be dismissed for lack of jurisdiction. The district court granted the motion and the Ninth Circuit affirmed. Id. After remand, the California court entered a judgment of reformation. Flitcroft, 328 F.2d at 452. The Tax Court upheld the IRS’s determination that the Flitcrofts should have paid tax on the trusts’ income, but the Ninth Circuit reversed. It held that “[i]t is clear that the trustors . . . intended to create irrevocable trusts in compliance with the [federal tax laws], and they would be so recognized” but for the California law requiring an express statement of irrevocability. 328 F.2d at 453. It explained that “[t]he omission of the words, ‘This trust is irrevocable’, was not due to any oversight or misconception with respect to the provisions of” federal law, but “solely the result of overlooking the . . . California law . . . .” Id. The Ninth Circuit reasoned that the Flitcrofts’ lack of resistance Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 12 of 23 U.S. Mot. Summ. J. (Phase I) Page 9 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 to the suit was “one factor to be considered” in determining whether the California court’s judgment was collusive. Id. at 455. “Other factors include (1) the nature of the right determined by the state court; (2) whether the federal tax authorities have notice of the state court action; and (3) whether the state court reached the correct result.” Id. Weighing those factors, the Ninth Circuit decided that the California judgment was not collusive. See id. at 455-57. And because it was not collusive, the Ninth Circuit relied on Gallagher v. Smith, 223 F.2d 218 (3d Cir. 1955), to hold that the judgment was binding— “‘not because it is res judicata . . . but because it is conclusive of the parties’ property rights which alone are to be taxed.’” Flitcroft, 328 F.2d at 455 (quoting Gallagher, 223 F.2d at 223). Two years after the Ninth Circuit issued its decision in Flitcroft, the Second Circuit relied on it in Bosch. See Commissioner v. Bosch, 363 F.2d 1009, 1014 (2d Cir. 1966), rev’d, 387 U.S. 456. In Bosch, a husband created a revocable trust and granted his wife a general power of appointment. Later, but before the husband died, the wife executed a document that purported to release a portion of her general power and take instead a special power of appointment. When the husband died, that choice proved counterproductive: the general power would have entitled the estate to take a marital deduction against the estate tax, but the special power did not. The executor of the husband’s estate asked a New York trial court to hold that the release was invalid. The New York trial court agreed that it was. See Bosch, 387 U.S. at 457-59. The Tax Court “accepted the state court judgment as being an authoritative exposition of New York law and adjudication of the property rights involved.” Id. at 459 (internal quotation marks omitted). The Second Circuit affirmed, holding that the state court “authoritatively determined the rights under state law of a party to the federal action.” 363 F.2d at 1013. For that proposition, it relied on Gallagher—and on Flitcroft. See id. at 1014. Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 13 of 23 U.S. Mot. Summ. J. (Phase I) Page 10 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 The Supreme Court reversed. It noted that the state court’s judgment had no preclusive effect. 387 U.S. at 463. It then considered the “statute that the Congress enacted and upon which we are here passing.” Id. According to the legislative history for the federal provision, only “proper regard” was due to state courts’ interpretations of wills. Id. Furthermore, it explained, that approach was consistent with the general congressional policy of the Rules of Decision Act and with Erie Railroad Co. v. Tompkins, 304 U.S. 64, 78 (1938), which together require federal courts to predict the course of state law but treat only the decisions of the state’s highest court as controlling. See Bosch, 387 U.S. at 465. The Court therefore reversed the Second Circuit opinion giving the state-court decision conclusive effect. See id. at 459, 466. The Bosch Court had before it, and clearly rejected, the position the Ninth Circuit took in Flitcroft. It quoted, but did not adopt, the Third Circuit’s decision in Gallagher on which Flitcroft relied. See id. at 463. Indeed, Flitcroft’s reasoning is very similar to the position Justice Douglas took in dissent. Compare Flitcroft, 328 F.2d at 455-56, 459, with Bosch, 387 U.S. at 466 (Douglas, J., dissenting). Bosch and Flitcroft are “clearly irreconcilable.” Miller, 335 F.3d at 900.2 The Court should follow Bosch. Bosch balances two competing concerns: the need for comity when a federal court is presented with an issue of state law decided by a state court and the need to protect the federal fisc from collusive, or merely erroneous, state-court decisions. See 387 U.S. at 465. Bosch resolves those concerns by requiring a federal court to reconsider the state- law issues. The court must follow any congressional instructions about what weight to 2 In United States v. Boulware, 384 F.3d 794, 804 (9th Cir. 2004), the Ninth Circuit noted that Flitcroft was “somewhat . . . called into question by” Bosch, but stated that “[w]hat effect, if any, Bosch has outside the context of the estate tax statute is unclear.” Boulware’s discussion of Flitcroft and Bosch is dictum: the court went on to rule against Boulware “[e]ven assuming that the state court judgment is binding.” See id. at 804-05. Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 14 of 23 U.S. Mot. Summ. J. (Phase I) Page 11 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 give the state trial court’s judgment and, in the absence of other congressional instruction, afford weight to that judgment according to its power to persuade. See id. at 463-65. B. Applying Bosch, Reformation Nunc Pro Tunc Is Not Warranted. The first consideration under Bosch is any congressional instruction about how to treat a state-court decision. See 387 U.S. at 463-64. Congress created the language of what is now § 170(a)(1) in 1938. Its aim was to eliminate deductions claimed when a binding pledge to make a donation was made in one year, but the transfer didn’t occur until a later year. Pauley v. United States, 459 F.2d 624, 626 (9th Cir. 1972). The focus of the statute, then, is on what rights were transferred at the time that the gift is claimed. Accord Treas. Reg. § 1.170A-1(a) (looking to whether donation was “actually paid”), (b) (“Ordinarily, a contribution is made at the time delivery is effected.”). For a donation to be complete, the property “must have been placed beyond the dominion and control of the donor.” See Pauley, 459 F.2d at 626-27 (citing Estate of Sanford v. Commissioner, 308 U.S. 39, 42-43 (1939)). The second consideration is the State Court Judgment’s power to persuade. Here, its persuasive value is minimal. The State Court didn’t have the benefit of a real opposition. (See Jt. Ex. 12 (Dkt. 41-13).) It didn’t issue a written opinion, instead adopting DMB’s proposed judgment. (See Jt. Ex. 13 (Dkt. 41-14).) And it’s not clear that DMB presented all of the facts the state court might have found relevant to its decision. As explained above, DMB said that its complete rewrite of one section of the Original Deed was the correction of a scrivener’s error, but didn’t point out other substantive changes it made—even though it sought reformation of the entire deed. Furthermore, DMB’s argument to the state court was based on a false equivalence between two different contexts for the word “perpetual.” DMB told the state court that the purported scrivener’s error meant that it failed to convey a perpetual interest in the Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 15 of 23 U.S. Mot. Summ. J. (Phase I) Page 12 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 property to Buckeye, emphasizing clauses in the Original Deed that referred to the permanence of the easement. (See, e.g., State Court Mot. Summ. J., Jt. Ex. 10 at 5-6 (Dkt. 41-10).) But the Original Deed did grant Buckeye a “perpetual” interest in the Property in the sense that the easement was permanent and irrevocable. (See Original Deed, Jt. Ex. 1 (Dkt. 41-1).) That’s the sense in which “perpetual” was used in the Original Deed. (See, e.g., id. at 1 ¶ C.) That meaning is also reflected in Buckeye’s response to DMB’s motion for summary judgment in the State Court Suit, which noted that the Original Deed already “provide[d] an irrevocable easement to the City in perpetuity.” (Jt. Ex. 12, at 2 (Dkt. 41-13).) But the Treasury Regulation requires more than a permanent, irrevocable easement. The donated interest must carry a proportionate share of the future value of any proceeds from extinguishment of the easement. See § 1.170A-14(g)(6)(ii). The rights transferred in the Original Deed can be permanently conveyed under Arizona law. The right to receive a proportionate share of proceeds is simply another right. Nothing in Arizona law required DMB to transfer the proportionate-proceeds right to create a permanent, irrevocable easement. There was no mistake of fact nor even state law here— just a mistake of federal tax law. That matters, because the Arizona Court failed to take into account an important limitation on the availability of reformation under Arizona law. Reformation is an equitable remedy. The Supreme Court of Arizona has distinguished between mistakes of fact and mistakes of law when considering whether equity is available. “Where the complaining party has access to all the facts surrounding the questioned transaction and merely makes a mistake as to the legal consequences of his act, equity should normally not interfere, especially where the rights of third parties might be prejudiced thereby.” Nussbaumer v. Superior Court in and for Yuma County, 489 P.2d 843, 846 (Ariz. 1971). See also Mackey v. Philzona Petroleum Co., 378 P.2d 906, 909 (Ariz. 1963). DMB didn’t Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 16 of 23 U.S. Mot. Summ. J. (Phase I) Page 13 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 mention that line of cases to the state court, instead citing the Restatement (Third) of Property (Wills & Donative Transfers). (See State Court Mot. Summ. J. at 13-14, Jt. Ex. 10 (Dkt. 41-10).) Thus, even though reformation is available for a unilateral mistake of fact by a donor, see Yano v. Yano, 697 P.2d 1132, 1135-36 (Ariz. App. 1985), the State Court Judgment erroneously extended the equitable remedy to correct a mistake of federal tax law that affected the rights of a third party, the United States. Because DMB’s mistake was legal, not factual, the State Court should not have reformed the Original Deed nunc pro tunc. The Original Deed, not the Amended Deed, is the proper instrument for the Court to examine with respect to DMB’s 2006 tax return. Congress intended for federal courts to look at what rights were actually transferred to the donor in the year the gift was claimed. Treasury Regulations interpret the statute the same way. And in this case, the rights that were actually transferred in 2006 did not meet the standard set out in the Regulation. This isn’t a case where the donor mistook what rights were actually transferred. Cf. Yano, 697 P.2d at 1135-36. DMB made a mistake of federal tax law—what transfers were required to obtain a deduction. See Nussbaumer, 489 P.2d at 846. Applying Bosch, the Court should disallow DMB’s claim for a deduction. C. Even If Flitcroft Is Good Law, Its Factors Weigh Against Accepting the State Court Judgment. Even if Flitcroft is good law and provides the correct legal standard for this case, it doesn’t compel the Court to defer to the State Court Judgment. The Ninth Circuit’s opinion identifies five factors that bear on whether a state court judgment should be considered “collusive,” and thus disregarded for purposes of federal tax law. Properly weighed, those factors indicate that the State Court Judgment should be disregarded. The first factor is whether the need for reformation was prompted by a mistake of federal tax law or, as in Flitcroft, by a mistake of state law. See 328 F.2d at 453. Here, as Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 17 of 23 U.S. Mot. Summ. J. (Phase I) Page 14 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 explained above, the mistake was plainly one of federal tax law. Indeed, in 2012, while the audit was going on, DMB told an attorney for Buckeye that it “ha[d] several legal challenges to address to preserve DMB’s tax deduction for [the] easement,” and that it was “presenting an Amended . . . Deed . . . to correct some language that the IRS found troublesome.” (Email, Jt. Ex. 5 (Dkt. 41-5).) In other words, the Original Deed did not conform to the requirements of Treasury Regulation § 1.170A-14(g)(6). The first Flitcroft factor weighs against treating the State Court Judgment as binding. Second, the Ninth Circuit looked to whether the state court action was resisted by the nominal defendant. 328 F.2d at 455 & n.11. Here, it wasn’t. Buckeye told the Court that its concern was to ensure that the rights that had already been transferred weren’t impaired by any reformation. (Jt. Ex. 12, at 1-2 (Dkt. 41-13).) Buckeye had no incentive to resist a reformation aimed at getting DMB a federal income tax deduction, and it didn’t do so. This factor weighs against giving the State Court Judgment binding effect. In the third Flitcroft factor, the Ninth Circuit analyzed the “nature of the right determined by the state court.” Id. at 455. This factor tests whether the state court was deciding rights defined by local law or federal law. See id. at 456. Here, the rights at issue are defined in an instrument subject to Arizona law. The key issue, however, is not what those rights are, but when they were created. The issue of when the amendment was effective for federal tax purposes is properly a matter of federal law, not state law. Federal tax laws “are not to be taken as subject to state control or limitation unless the language or necessary implication of the section involved makes its application dependent on state law.” United States v. Irvine, 511 U.S. 224, 238-39 (1994) (quoting United States v. Pelzer, 312 U.S. 399, 402-03 (1941)) (internal quotation marks omitted). In this case, as the statute says, a deduction is allowed for a charitable contribution, “payment of which is made within the taxable year.” Whether something occurred Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 18 of 23 U.S. Mot. Summ. J. (Phase I) Page 15 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 “within the [federal income] taxable year” is an issue of federal law. I.R.C. § 170(a)(1). See also Treas. Reg. § 1.170A-1(a), (b) (rules for timing of deduction). To be sure, Flitcroft treated nunc pro tunc reformation as a matter of state law. See 328 F.2d at 456. But the Flitcroft court didn’t have the benefit of later Supreme Court decisions clarifying that a federal court is not obliged to recognize state-law legal fictions when those fictions affect federal taxes. In Irvine, for instance, the Court considered the gift tax consequences of a 1979 disclaimer of five-sixteenths of an interest in the corpus of a trust created in 1917. 511 U.S. 224, 226-27 (1994). The gift tax laws were not enacted until 1932. Id. at 234. Under state law, the disclaimer related “back to the moment of the original transfer of the interest being disclaimed . . . substituting a single transfer from the original donor to the beneficiary of the disclaimer.” Id. at 239. But the Supreme Court rejected the argument that the federal gift tax statute incorporated state- law legal fictions. See id. at 240. See also, e.g., United States v. Sec. Tr. & Sav. Bank of San Diego, 340 U.S. 47, 50 (1950) (rejecting reliance on state-law relation back theory in context of lien priority dispute). The fourth Flitcroft factor is whether the federal tax authorities had notice of the state court suit. 328 F.2d at 455. The Ninth Circuit reasoned that notice tended to counteract the charge of “clandestine collusion.” Id. at 456 (internal quotation marks omitted). Perhaps, but the Ninth Circuit failed to consider that if this factor carries substantial weight, the United States must, as a practical matter, intervene in state-court suits in order to protect the public fisc—regardless of whether Congress expressly authorized a suit against the government. That runs counter to the fundamental principle that the federal government is immune from suit except as it consents. See, e.g., United States v. Nordic Village Inc., 503 U.S. 30, 33-34 (1992). No consent applies here. The Court should give this factor minimal weight. Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 19 of 23 U.S. Mot. Summ. J. (Phase I) Page 16 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 The fifth and final factor is whether the state court reached the right result. Flitcroft, 328 F.2d at 455. Here, as explained above, it didn’t. DMB’s error was legal, which precludes reformation under Arizona law. See Nussbaumer, 489 P.2d at 846. Of the five Flitcroft factors, four weigh against giving the State Court Judgment conclusive effect. One weighs in favor, but only weakly. Even if Flitcroft is good law, the Court should reject the State Court Judgment and hold that the Amended Deed does not relate back to 2006. D. In the Alternative, Flitcroft Should Be Overturned. If Flitcroft is good law and it controls here, it was wrongly decided and it should be overturned. Flitcroft unduly expanded the erroneous principle that state-court judgments are binding because, unlike the cases on which it relied, it gave retroactive effect to the judgment. The correct position is the one that the other Circuit Courts take: that “not even judicial reformation can operate to change the federal tax consequences of a completed transaction.” Van den Wymelenberg v. United States, 397 F.2d 443, 445 (7th Cir. 1968) (collecting cases); Am. Nurseryman Pub. Co. v. Commissioner, 75 T.C. 271, 275 (1980) (same). IV. DMB NEVER RECEIVED A CONTEMPORANEOUS WRITTEN ACKNOWLEDGMENT FROM BUCKEYE. DMB also isn’t entitled to a charitable deduction because it failed to secure a contemporary written acknowledgment from Buckeye stating whether DMB received goods or services from Buckeye in exchange for the gift. See I.R.C. § 170(f)(8). Even if Buckeye in fact did not provide goods or services, DMB must have a contemporaneous written acknowledgment affirmatively so stating. See, e.g., Friedman v. Commissioner, 99 T.C.M. (CCH) 1175, 1178 (2010). Failure to comply results in the disallowance of the deduction. See, e.g., Addis v. Commissioner, 374 F.3d 881, 887 (9th Cir. 2004). Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 20 of 23 U.S. Mot. Summ. J. (Phase I) Page 17 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 A contemporaneous written acknowledgment may take many forms, including the deed itself. French v. Commissioner, 111 T.C.M. (CCH) 1241, 1243 (2016). Under certain circumstances, courts have examined the whole deed to determine it was a sufficient written acknowledgment even without an explicit statement about the donee providing no goods or services. Id. But when a deed does not explicitly state this, it must contain an integration clause stating it is the entire agreement the parties. Compare id. (no integration clause leaves open possibility of exchange outside the deed), with Averyt v. Commissioner, 104 T.C.M. (CCH) 65 (2012) (integration clause allows inference no goods or services were exchanged). Here, DMB proffers the Original Deed; Buckeye Resolution No. 62-06; and a Request for Council Action. (Jt. Exs. 1, 2, 3 (Dkts. 41-1, -2, -3).)3 Taken alone or together, these documents are insufficient. None of them explicitly state that Buckeye provided no goods or services as consideration for the easement. They also do not state that the Original Deed constituted the entire agreement between the parties. The documents do state that their purpose is preservation of the easement area, but without an integration clause, it is possible there was another purpose, and DMB could have received something in return—a zoning concession, for instance. As a result, these documents are not a contemporaneous written acknowledgment. V. CONCLUSION The Court should determine as a matter of law that DMB is not entitled to claim a charitable contribution deduction for the easement. 3 DMB might contend that the Amended Deed satisfies this requirement, too. That’s incorrect. By statute, an acknowledgment is “contemporaneous” if it’s “obtain[ed]” on or before the return filing date or the return due date, whichever is earlier. I.R.C. § 170(f)(8)(C). DMB did not “obtain” the Amended Deed until 2012, far too late for a 2006 return. (See Jt. Ex. 6 (Dkt. 41-6).) Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 21 of 23 U.S. Mot. Summ. J. (Phase I) Page 18 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Respectfully submitted this 24th day of February, 2017. DAVID A. HUBBERT Acting Assistant Attorney General /s/ Adam Strait ADAM D. STRAIT (Mass. BBO No. 670484) ALEXANDER STEVKO (CA Bar No. 301359) Trial Attorney, Tax Division U.S. Department of Justice P.O. Box 683, Ben Franklin Station Washington, D.C. 20044-0683 Telephone: (202) 307-2135 Fax: (202) 307-0054 Email: adam.d.strait@usdoj.gov Of Counsel ELIZABETH A. STRANGE Acting U.S. Attorney, District of Arizona Attorneys for the United States of America Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 22 of 23 U.S. Mot. Summ. J. (Phase I) Page 19 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Certificate of Service I hereby certify that on February 24, 2017, I filed the foregoing with the Clerk of this Court through the Court’s CM/ECF system. Pursuant to LRCiv 5.5(h), through the CM/ECF filing, I served a copy of the foregoing on: • Clifford Eric Yin (ef-cey@cpdb.com) • Derek W Kaczmarek (dkaczmarek@frgalaw.com, lbommarito@frgalaw.com) • Fredrick C Crombie (ef-fcc@cpdb.com) • Jeffry A Bernstein (jbernstein@coblentzlaw.com) • Yale F Goldberg (ygoldberg@frgalaw.com) Respectfully submitted this 24th day of February, 2017. /s/ Adam Strait ADAM D. STRAIT (Mass. BBO No. 670484) Trial Attorney, Tax Division U.S. Department of Justice P.O. Box 683, Ben Franklin Station Washington, D.C. 20044-0683 Telephone: (202) 307-2135 Fax: (202) 307-0054 Email: adam.d.strait@usdoj.gov Case 2:16-cv-01585-NVW Document 42 Filed 02/24/17 Page 23 of 23 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 UNITED STATES DISTRICT COURT DISTRICT OF ARIZONA DMB REALCO, LLC, Plaintiff, v. UNITED STATES OF AMERICA, Defendant. Civil No. 16-1585-NVW [PROPOSED] ORDER GRANTING UNITED STATES’ MOTION FOR SUMMARY JUDGMENT (PHASE I) Before the Court is the United States’ Motion for Summary Judgment for Phase I. After considering the parties’ briefing and oral argument, it is HEREBY ORDERED that the United States’ Motion is GRANTED. \\ Case 2:16-cv-01585-NVW Document 42-1 Filed 02/24/17 Page 1 of 2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 IT IS FURTHER ORDERED that DMB was not entitled to claim a charitable contribution deduction for its donation of the conservation easement. IT IS SO ORDERED. Dated this ______ day of _________, 2017. ___________________________ HON. NEIL V. WAKE United States District Judge Case 2:16-cv-01585-NVW Document 42-1 Filed 02/24/17 Page 2 of 2