Litman v. United States

SUPPLEMENTAL OPINION AND ORDER FURTHER AMENDING TRIAL OPINION

This opinion addresses the one remaining issue after trial that continues to delay final entry of judgment on the claims presented. Defendant filed its status report pursuant to the court’s order, see Litman v. United States, 78 Fed.Cl. 90, 146 (2007) (the “trial *317opinion”),1 on December 7, 2007, advising that it seeks penalties against Hotels.com, Inc. & Subsidiaries (“Hotels.com”). Considering defendant’s equivocation on taking an adversarial position on the issue of Hotels.com’s liability for penalties, see Def.’s Br. filed Dec. 7, 2007, at 5, 6 (noting that two grounds for imposition of penalties against Hotels.com remain “potentially applicable”), the court conducted a status conference on December 14, 2007, and ordered post-trial supplemental briefing that concluded on January 28, 2008. At issue is Hotels.com’s potential liability for penalties which, following the court’s valuation of the HRN restricted shares, is totaled to $341,859.00 (twenty percent of $1,574,293.00, the amount of Hotels.eom’s tax underpayment). See id. at 5-7 (setting forth calculations of potentially applicable penalties based on difference in Hotels.com’s reporting of value of HRN restricted shares as compared with court’s valuation determined in trial opinion); see also 26 U.S.C. (“I.R.C.”) § 6662(a) (2000) (imposing penalty of “amount equal to 20 percent of the portion of the underpayment”).

BACKGROUND

Familiarity with the facts and background of the case, discussed at length in the court’s trial opinion, is presumed. See Litman, 78 Fed.Cl. at 91-105. Recitation of the facts and background germane to the issue of Hotels.com’s liability for penalties is incorporated in this section and the discussion. This supplemental opinion amends the trial opinion insofar as it resolves an issue that was the subject of trial.

On August 22, 2007, this court issued its trial opinion determining the value for tax purposes of approximately ten million restricted shares of HRN stock. Id. at 145 (“[T]he court finds and concludes that the value of the restricted stock transferred to TMF Liquidating Trust was $90,818,180 and the value of the restricted stock transferred to Mr. Pells was $3,919,920.”). The trial opinion also ruled that plaintiffs-counterde-fendants, David S. Litman and Malia A. Lit-man (collectively, the “Litmans”) and Robert B. Diener and Michelle S. Diener (collectively, the “Dieners”) had discharged their burden to defeat the IRS’s imposition of penalties pursuant to I.R.C. § 6662. Id. at 142-45. The court reserved decision on Hotels.com’s liability for penalties on the understanding that defendant had preserved the issue for resolution at a later time. Id. at 142-43 (citing Def.’s Br. filed Apr. 2, 2007, at 27 (“Whether Hotels.com substantially understated its tax or substantially overstated the value of HRN stock, and is subject to penalties for those reasons, is dependent on the value for the stock ultimately determined in this case.”)).

The court is mindful of the procedural posture of this case. In the notice of deficiency sent to Hotels.com, dated February 10, 2006, the IRS determined that Hotels.com was liable for penalties in the amount of $491, 33 8.00 because of its allegedly erroneous reporting of the value for the HRN restricted shares in its 2000 tax return. See JX 28 (this amount has now been reduced to $341,859.00 on the basis of the court’s determination of value in the trial opinion, see Def.’s Br. filed Dee. 7, 2007, at 7). Hotels.com paid the penalties on March 9, 2006, along with the additional taxes and interest that the IRS determined were due. See Compl. ¶ 27, Hotels.com, Inc. and Subsidiaries (f/k/a Hotel Reservations Network, Inc.) v. United States, No. 06-285T (Fed.Cl. Apr. 10, 2006). Hotels.com then sought a refund of the additional taxes, interest, and penalties paid pursuant to the IRS’s assessment. See id. ¶¶ 30-31. Hotels.eom’s liability for penalties, therefore, was put at issue in its complaint. Statements in the trial opinion that resolution of the penalties issue as it pertains to Hotels.com was pending defendant’s perfection of a counterclaim were incorrect. Litman, 78 Fed.Cl. at 92, 142. An errata sheet substituting corrected pages is entered by separate order this date.2

*318DISCUSSION

Defendant seeks penalties in the amount of $341,859.00 against Hotels.com pursuant to I.R.C. § 6662.3 Following the court’s determination of the value of the HRN restricted shares, defendant now asserts that two of the three “possible bases for the imposition of penalties under § 6662 ... remain applicable.” Def.’s Br. filed Dec. 7, 2007, at 5. Based on the court’s valuation of the HRN restricted shares at $90,818,180.00, Litmcm, 78 Fed.Cl. at 145, defendant concedes that Hotels.eom’s reporting of the HRN restricted shares at $159,998,400.00, id. at 103, does not meet the threshold liability for a “substantial valuation misstatement.” See I.R.C. § 6662(e)(1)(A) (2000) (“For purposes of this section, there is a substantial valuation misstatement under chapter 1 if ... the value of any property (or the adjusted basis of any property) claimed on any return of tax imposed by chapter 1 is 200 percent or more of the amount determined to be the correct amount of any such valuation or adjusted basis----”).4 However, defendant asserts that both a “substantial understatement of income tax” penalty, id. § 6662(b)(2), (d),5 and a “negligence or disregard of rules or regulations” penalty, id. § 6662(b)(1), (c),6 remain “potentially applicable” to Hotels.com. Def.’s Br. filed Dec. 7,2007, at 5, 6.

1. Standards of review for assessment of penalties

When reviewing the assessment of taxes and penalties, “ ‘[t]he ruling of the Commissioner of Internal Revenue enjoys a presumption of correctness and a taxpayer bears the burden of proving it to be wrong.’” Conway v. United States, 326 F.3d 1268, 1278 (Fed.Cir. 2003) (quoting Transamerica Corp. v. United States, 902 F.2d 1540, 1543 (Fed.Cir. 1990)); see also Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 78 L.Ed. 212 (1933). Pursuant to I.R.C. § 6664(c)(1) (2000), a taxpayer who carries his burden of showing “that there was a reasonable cause for [any portion of an underpayment] and that the taxpayer acted in good faith with respect to such portion,” is immune from imposition of penalties pursuant to I.R.C. § 6662 with respect to that portion. Trea*319sury Regulation § 1.6664-4(b) (2006), provides, in pertinent part:

The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances____Generally, the most important factor is the extent of the taxpayer’s effort to assess the taxpayer’s proper tax liability. Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of all of the facts and circumstances, including the experience, knowledge, and education of the taxpayer.... Reliance on an information return, professional advice, or other facts ... constitutes reasonable cause and good faith if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith.

Id.; see Treas. Reg. § 1.6664-4(e) (“[T]he taxpayer’s education, sophistication and business experience will be relevant in determining whether the taxpayer’s reliance on tax advice was reasonable and made in good faith.”). Hotels.com bears the burden of proving that it meets the reasonable cause/ good faith standard of I.R.C. § 6664(c)(1) and ultimately whether it is entitled to a refund of penalties paid.

2. Proper prosecution of penalties

Hotels.com has raised an issue of “first impression” concerning the Government’s proper prosecution of penalties in this ease. Hotels.com’s Br. filed Jan. 7, 2008, at 2. Hotels.com submits that defendant’s abandonment of the positions taken in the IRS’s “whipsaw” notices7 in favor of a new litigation position on the value of the HRN restricted shares and defendant’s “apparent unwillingness to inform the Court if it seeks penalties against Hotels.com,” id., should constitute a waiver. Hotels.com attaches importance to the fact that, under defendant’s valuation position taken in litigation, “penalties that were mathematically possible under the whipsaw Notice were no longer applicable.” Hotels.com’s Br. filed Jan. 28, 2008, at 3. Hotels.com also trumpets case law that rejects as waived arguments made for the first time in post-trial and post-decisional briefing. See id. at 3-4 (citing Goulding v. United States, 929 F.2d 329, 333 (7th Cir. 1991); Gingerich v. United States, 78 Fed.Cl. 164, 167-68 (2007); and Principal Life Ins. Co. & Subsidiaries v. United States, 76 Fed.Cl. 326, 328 (2007)); see also id. at 5 (“[N]o-where in the Government’s Pretrial Brief does it assert that a negligence penalty should be applied to Hotels.com----In fact, in the one paragraph of its Pretrial Brief addressing penalties with respect to Hotels.com, there is no cite or reference at all to the applicable section of the Internal Revenue Code (I.R.C. § 6662(c)).”)

As Hotels.com’s cases demonstrate, waiver of an argument or defense in a tax refund suit generally occurs where a position is advanced for the first time at a late stage of litigation. See Gingerich, 78 Fed Cl. at 167-68 (finding Government’s argument waived when raised for first time in post-trial, post-decision computational proceeding); Principal Life Ins., 76 Fed.Cl. at 328 (finding waiver of Government’s set-off defense when not previously raised in litigation). In the case at bar, however, the issue of penalties always has been properly before the court. The IRS first assessed penalties against Hotels.com pursuant to I.R.C. § 6662(b)(l)-(3) for negligence or disregard of rules or regulations, substantial understatement of income tax, and substantial valuation misstatement in the whipsaw notice issued on February 10, 2006. Hotels.com’s own complaint put penalties at issue when it sought a refund of penalties paid. See Hotels.com’s Compl. ¶¶ 27, 30-31. Furthermore, while defendant’s pretrial brief equivocated as to Hotels.com’s ultimate liability for penalties, which defendant conceded would be dependent on the court’s valuation of the HRN restricted shares, see Def.’s Br. filed *320Apr. 2, 2007, at 27, it put forward as an issue for trial “whether plaintiffs are hable for penalties under § 6662 ... [for] disregard of applicable rules, a substantial understatement of tax, or a substantial valuation misstatement, and whether plaintiffs acted with reasonable cause and in good faith with regard to any underpayment of tax.” Id. at 17.

The court deems unpersuasive Hotels.com’s argument that defendant waived its assertion of penalties by abandoning the whipsaw notice position in favor of a consistent litigation position on valuation. While “[u]nlike any other whipsaw case research has disclosed,” Hotels.com’s Br. filed Jan. 28, 2008, at 3, a rule that would require the “Government [to] maintain[] its protective whipsaw position throughout the litigation,” id., would straight-jacket the Government from ever asserting a litigation position inconsistent with the values assessed in its whipsaw notices, a practice that is widely regarded as appropriate. See Litman, 78 Fed.Cl. at 111 (citing cases upholding validity of whipsaw notices procedure). Furthermore, the fact that the Government took a litigation position that was inconsistent with the position advanced in the whipsaw notice to Hotels.com has no bearing on Hotels.com’s liability for penalties, which is a function of this court’s determination of the value of the restricted shares. The court thus rules that the Government has put Hotels.com’s liability for penalties properly at issue in this post-trial, post-opinion proceeding.

3. hiability for substantial understatement of income tax

Defendant contends, and Hotels.com concedes, see Hotels.com’s Br. filed Jan. 7, 2008, at 3, that based on this court’s valuation of the restricted shares, Hotels.com mathematically understated its tax by more than ten percent in 2000. See I.R.C. § 6662(d); see also Def.’s Br. filed Dec. 7, 2007, at 5-6 (Hotels.com understated its income by $1,574,293.00 and the amount of tax that should have been reported on the return was $12,991,420.00 resulting in a understatement of approximately twelve percent ($1,574,293.00/$12,991,420.00 = 0.12)). Nonetheless, Hotels.com asserts that it qualifies for exculpation under I.R.C. § 6664(c)(1) because it acted with reasonable cause and good faith in computing its 2000 taxes. Hotels.com “believed the value reported on its tax return was negotiated and agreed to by the parties, and its actions were consistent with this belief.” Hotels.com’s Br. filed Jan. 7, 2008, at 3. Defendant disputes Hotels.com’s characterization of its tax reporting position contending that “the $16 value was not initially included by [Ernst & Young] in the draft return because it believed the parties had agreed to it. Indeed it was later deleted from the Form 8594 specifically because HRN and USA knew that the Lit-man[s] and Dieners strenuously disagreed with it.” Def.’s Br. filed Jan. 17, 2008, at 15. Because Hotels.com advanced the agreed-value theory only at trial, defendant would counsel that the theory “cannot be the basis for a finding of good faith and reasonable cause when the evidence demonstrates that the theory was not actually relied upon at the time HRN filed its return.” Id. at 16.

The trial opinion determined that “while Hotels.com may have wanted Messrs. Lit-man and Diener to agree to a $160 million fair market value for the 9,999,900 shares of HRN restricted stock, such an agreement was never reached and/or reduced to writing.” Litman, 78 Fed.Cl. at 115. Thus, this court concluded that the Amended and Restated Asset Purchase Agreement (the “ARAPA”), which Hotels.com claimed embodied an agreement as to the fair market value of the HRN restricted shares for tax purposes, in fact, did not determine the value of the restricted shares. However, though the court “agree[d] with the Litmans, the Dieners, and defendant that the ARAPA is ambiguous and is not determinative of the value of the HRN restricted stock,” id. at 112, this finding does not purport to resolve whether Hotels.com actually believed that the ARA-PA embodied such an agreement at the time Hotels.com filed its return.

The court’s assessment of Hotels.eom’s intentions -with regard to the ARAPA supports a finding that Hotels.com acted with reasonable cause and in good faith in its tax reporting position on its 2000 return. The trial opinion stated:

*321Hotelsxom values the Section 7.11.3 Shares at $16.00 per share based on the language [in the ARAPA] “aggregate value (based on the price per share in the IPO).” Hotels.com’s Br. filed Feb. 26, 2007, at 11. While this language is consistent with an intention that the agreement value the stock at $16.00 per share for tax purposes, the plain language of the agreement does not encapsulate this understanding____ Mr. Lidji, transaction attorney for the Lit-mans and the Dieners, was persuasive that the ARAPA did not memorialize Hotels, corn’s intentions.

Id. at 114 (emphases added). Hotelsxom believed upon reasonable cause and in good faith, at the time of the filing of its 2000 tax return, that the ARAPA embodied a negotiated agreement with the Litmans and the Dieners conclusive as to the fair market value of the restricted shares for tax reporting purposes. That Hotelsxom learned prior to filing its 2000 tax return of Mr. Diener’s disagreement with Hotels.com’s reporting position and that Messrs. Litman and Diener had obtained a separate fair market valuation, see id. at 104, does not render Hotels.com’s belief that it had the protection of a valid and enforceable agreement to the fair market value, embodied in the ARAPA, in bad faith or unreasonable. Thus, the court concludes that Hotelsxom qualifies for the defense allowed by I.R.C. § 6664(c)(1).

4. Liability for negligence or disregard of rules or regulations

Defendant seeks a twenty-percent penalty assessment against Hotelsxom for the portion of its underpayment attributable to “[n]egligence or disregard of rules or regulations.” I.R.C. § 6662(b)(1). “[T]he term ‘negligence’ includes any failure to make a reasonable attempt to comply with the provisions of this title, and the term ‘disregard’ includes any careless, reckless, or intentional disregard,” of applicable rules and regulations. Id. § 6662(c).

Defendant asserts that Hotelsxom “negligently failed to compute, report and pay its taxes for 2000 based on a fair market valuation for the restricted stock, which it knew it was required to do.” Def.’s Br. filed Jan. 17, 2008, at 10 (citing I.R.C. § 6662(b)(1), (c)). Defendant argues that Hotels.com’s situation differs from the court’s findings with respect to the Litmans and the Dieners in that Hotels.com “did not base its 2000 tax return on a fair market valuation ____ [a]nd when HRN later obtained a valuation, it did not actually use it for computing and paying its 2000 taxes.” Id. at 11. Consequently, penalties apply not simply because Hotelsxom “failed to file a completed Form 8594”8 or because “Hotelsxom guessed wrong about a fair market valuation for the stock in computing its income tax for 2000,” id. at 14, but, *322rather, because Hotels.com’s negligence and disregard of applicable rules and regulations are demonstrated by evidence that Hotels.com “knew that the assumed $16 figure was not an attempt to determine a fair market value (and was wrong for tax purposes), but computed and paid its tax on that basis anyway, and never corrected it.” Id. at 13-14. To support its contention that Hotels.com knew that $16.00 was not a fair market value agreed upon by the parties for tax reporting purposes, defendant cites the fact that, in subsequent tax years, Hotels.com reported its amortization deductions at a value discounted twenty to forty percent from the $16.00 per share value reported on its 2000 tax return, in accordance with the post-filing valuation that it obtained from Deloitte & Touche. See id. at 6, 11. The Litmans and the Dieners, in their brief filed on January 17, 2008, echo this point. See Litmans/Dieners’ Br. filed Jan. 17, 2008, at 4.9

Hotels.com stands on its position that it reasonably believed that an agreement was negotiated and reached with the Litmans and the Dieners as to the fair market value of the restricted shares for tax reporting purposes. Moreover, Hotels.com counters that defendant’s own expert, Francis X. Burns, testified in corroboration of the position that the parties had negotiated and agreed to a fair market valuation between $11.00 and $16.00, with full knowledge of all of the restrictions on the shares. Transcript of Proceedings Litman v. United States, Nos. 05-956T, - 971T, & 06-285T, at 1689 (Fed. Cl. Apr. 30-May 9, 2007) (Burns) (The Litmans and the Dieners “agreed to a price of anywhere between [$] 11 and $16, so in my view, that’s an indication that they believed, even with all the restrictions piled on top of the stock, that a price between [$]11 and $16 was fair.”); id. at 1695 (the Litmans and the Dieners “did agree that it could be no less than $11 and no more than [$] 16, so in my mind, that frames what they believed to be a fair market value for those shares with all the restrictions contained therein.”).

The Litmans, the Dieners, and defendant are correct that the evidence establishes that, after learning that the Litmans and the Dien-ers obtained an independent valuation for the HRN restricted shares and reported on their respective tax returns a per share value consistent therewith, Hotels.com obtained an independent valuation from Deloitte & Touche. In subsequent tax years, Hotels.com reported its amortization deductions in accordance with the Deloitte & Touche valuation and never amended its 2000 tax return or re-filed a completed Form 8594. The Litmans, the Dieners, and defendant would have the court infer that Hotels.com never reasonably believed that an agreement existed as to the fair market value of the HRN restricted shares. However, that Hotels.com chose to adopt a more conservative tax reporting position for subsequent years in the face of a contradictory tax reporting position taken by the Litmans and the Dieners, does not assail, in and of itself, the reasonableness of the position taken by Hotels.com on its 2000 tax return.

The pertinent question is whether Hotels.com acted pursuant to reasonable cause and with good faith at the time it filed its 2000 tax return. As discussed above, Hotels.com acted upon reasonable cause and in good faith when it reported a value for the restricted shares consistent with what Hotels.com believed to be its agreement with the Litmans and the Dieners pursuant to the ARAPA. Hotels.com correctly asserts that *323“there is no general requirement to file an amended return and, in any event, the failure to file an amended return cannot support a negligence penalty.” Hotels.com’s Br. filed Jan. 28, 2008, at 8. Furthermore, because the direction to file the allegedly incomplete Form 8594 came from either Ernst & Young, Hotels.com’s tax advisors, or from Mr. Diener through his tax advisors at KPMG, see hitman, 78 Fed.Cl. at 104, reasonable cause and good faith in reliance on tax advice prevent the imposition of a negligence penalty on that basis. Hotels.com has carried its burden of showing its entitlement to the defenses recognized by I.R.C. § 6664(c)(1) because Hotels.com acted upon a reasonable cause and in good faith when it reported its 2000 taxes.

CONCLUSION

Accordingly, based on the foregoing,

IT IS ORDERED, as follows:

1. The opinion issued on August 22, 2007, is amended further by this supplemental opinion and order.

2. Further to ¶ 4 of the August 22, 2007 opinion, the Clerk of the Court shall enter judgment for Hotels.com on its claim for refund of penalties paid.

3. Pursuant to ¶ 5 of the order entered on December 17, 2007, the parties shall file a form of judgment by April 21, 2008, that sets forth the amount of judgment for the Lit-mans and the Dieners on their claim for refund, adjusted for interest due, and for Hotels.com on its claim of refund, adjusted for interest due.