                                                                                                                           Opinions of the United
2002 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit


1-8-2002

Culnen v. Commissioner IRS
Precedential or Non-Precedential:

Docket 1-1138




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Recommended Citation
"Culnen v. Commissioner IRS" (2002). 2002 Decisions. Paper 7.
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                                               NOT PRECEDENTIAL

                 UNITED STATES COURT OF APPEALS
                     FOR THE THIRD CIRCUIT
                           __________

                          NO. 01-1138
                           __________

                       DANIEL J. CULNEN,
                                                        Appellant

                               v.

                COMMISSIONER OF INTERNAL REVENUE
                           _________

                   On Appeal from the Decision
                  of the United States Tax Court
             at Tax Court Nos. 94-06496 and 92-25551
          Tax Court Judge: Honorable James S. Halpern
                            __________

                    Argued November 7, 2001
Before:    BECKER, Chief Judge, McKEE and RENDELL, Circuit Judges

                    (Filed: January 7, 2002)
                        _______________

                                    Frank Agostino, Esq.   [ARGUED]
                                    Susan M. Flynn, Esq.
                                    Calo Agostino, Esq.
                                    27 Warren Street
                                    Hackensack, NJ   07601
                                    Counsel for Appellant

                                   Teresa E. McLaughlin, Esq.
                                   Andrea R. Tebbets, Esq.    [ARGUED]
                                   United States Department of Justice
                                   Tax Division
                                   P. O. Box 502
                                   Washington, DC   20044
                                   Counsel for Appellee
                           __________

                      OPINION OF THE COURT
                           __________

RENDELL, Circuit Judge.
     Daniel J. Culnen was a 73% stockholder in Wedgewood Associates, a
subchapter (s) corporation in the restaurant business. When Wedgewood
ceased doing
business, it made an assignment for the benefit of creditors, abandoned
its furniture and
fixtures, and reported a net loss of $2,410,941. Culnen's tax return for
the same year
showed his 73% share of the Form 4797 loss to be $1,759,987. The
Commissioner
disallowed Culnen's deduction of the loss. On appeal, the Tax Court ruled
not that the
loss was improperly deducted by Culnen, but, rather, that Wedgewood's loss
for tax
purposes was not the amount claimed, but was, instead, $515,243. We will
REVERSE
the Tax Court's ruling.
     The deficiency notice sent by the IRS to Culnen disallowed Culnen's
pro rata
share of Wedgewood's loss:
                     It has been determined that you did not sustain the
$1,759,987.00 loss,
           allegedly derived from your ownership interest in Wedgewood
Associates
           Inc., reported on your return for the 1990 taxable year. In the
event that a
           court of competent jurisdiction determines that you did sustain,
all or a
           portion of such reported loss, you are not entitled to a
deduction for such
           loss for the following reasons: (1) you have failed to establish
that you have
           adequate basis in your interest in Wedgewood Associates Inc. to
deduct
           any of this reported loss amount; (2) the amount of this
reported loss
           exceeds your basis in the stock and debt of Wedgewood Associates
Inc.
           pursuant to the provisions of I.R.C. Section 1366(d)(1); (3)
such reported
           loss exceeds the amount for which you were at risk during the
1990 taxable
           year under the provisions of I.R.C. Section 465; (4) the
reported loss is not
           deductible since such loss is considered a passive activity loss
which is not
           deductible under the provisions of I.R.C. Section 469; and (5)
the reported
           loss is not deductible under the provisions of I.R.C. Section
267(a) since
           the parties to the transaction(s) which generated such loss are
related
           parties under provisions of I.R.C. Section 267(b).

     Culnen was, therefore, put on notice that he had the burden to
establish his basis
in his stock and establish its deductibility, meeting the challenge that
it was passive
activity loss, and its disallowance based on the theory that the parties
to the transactions
were related parties. The deficiency notice did not challenge Wedgewood's
loss, but
only Culnen's ability to deduct his pro rata share of the loss. The
pleadings, pretrial
motions, status reports, trial memoranda, and trial transcripts all focus
on the amount of
his loss and his pro rata share.
     At trial, Wedgewood's tax preparer testified as to the nature and
amount of the
loss, specifically, that it consisted of the acquisition price of
furniture and fixtures less
depreciation based upon the fact that the corporation had essentially
abandoned the
furniture and fixtures to an assignee for the benefit of creditors.
Culnen offered evidence
to prove his basis, specifically the nature and amount of his investments
over time, many
of which were made through his partnership, Culnen & Hamilton, and he
offered
evidence to refute the IRS' contention regarding the related party and
passive activity
issues.
     At the conclusion of the trial, the government argued for the first
time, and the
Tax Court considered, whether Wedgewood correctly calculated the losses
resulting from
the assignment pursuant to I.R.C. Section 1001. Culnen objected to the
consideration of
this issue, since it had never been raised in the deficiency notice, or
raised in the course
of pre-trial proceedings. It is undisputed that the government produced
no evidence
relating to the corporate-level loss issue.
     In its opinion, the Tax Court framed the issue as follows:
                     Respondent disallowed petitioner's pro rata share of
Wedgewood's
           ordinary losses for 1987, 1989, and 1990 because petitioner
failed to
           convince respondent that he had an adequate basis with respect
to his
           investment in Wedgewood. We must determine that basis.
Respondent
           disallowed petitioner's share of the Form 4797 loss (the
$1,759,987 loss)
           for the same reason and because petitioner failed to convince
respondent
           that Wedgewood suffered the $1,759,987 loss. We must determine
both
           his basis and whether Wedgewood suffered any loss. (emphasis
added)
     The Tax Court then proceeded to review the evidence offered, and
concluded that
Culnen had indeed proven that he had an adequate basis with respect to his
investment in
Wedgewood. The Tax Court then turned its attention to the issue of the
Form 4797 loss
and embarked upon a discussion of Section 1001 of the Internal Revenue
Code and its
definition of "amount realized," noting that the regulations provide that,
for purposes of
that section, the sale or the disposition of property that secures a
nonrecourse liability
discharges that liability, and that, according to the regulations, the
"amount realized"
from the sale or disposition of the property includes the amount of
liabilities from which
the transferor is discharged as a result of the disposition. The court
then noted,
"Respondent's position is that Wedgewood did not realize any loss."
     The court then criticized Culnen's failure to adduce proof regarding
the amount
realized on the sale of the furniture and fixtures, and his failure to
show that the
indebtedness secured by the liens on those assets was nonrecourse. The
court then made
an assumption that the debt was nonrecourse and that the "amount realized"
for tax
purposes would include the amount of the liens, namely $1,865,000. After
making other
mathematical calculations, the court concluded that the "amount realized"
was
$1,991,001, and, since the adjusted basis was $2,506,244, Wedgewood's loss
was
$515,243, and petitioner's pro rata share was therefore $376,127.
     Culnen contends that we should either reverse the ruling of the Tax
Court based
upon the theory of "meet the hold," or should remand for a determination
regarding the
section 1001 issue, since the Tax Court ruled without any evidentiary
basis. We hold
that, whether based on "meet the hold," or simply notice principles of due
process, we
will reverse because the Tax Court improperly ruled against Culnen based
on an issue as
to which Culnen was never advised - namely a last minute challenge to the
amount of
Wedgewood's loss. The Court did determine, however, that Culnen did
prevail on the
issues raised in the deficiency notice. Accordingly, Culnen is entitled
to prevail on the
claims raised in the deficiency notice, and judgment should be entered in
his favor.
     At oral argument, counsel for the Commissioner urged that the
deficiency notice's
reference to "adequate basis in your interest" and "reported loss exceeds
your basis" were
sufficient to put Culnen on notice that the amount of the corporate loss
was under attack.
We disagree. To the contrary, the deficiency notice was addressed to
Culnen, and never
referenced Wedgewood except as it related to Culnen's stock or interest in
the
corporation. The notice stated, "It has been determined that you did not
sustain the
$1,759,987 loss allegedly derived from your ownership interest in
Wedgewood
Associates, Inc. reported on your return for the 1990 taxable year." The
emphasis on
"you" and "your" clearly communicates that the notice was addressed to
Culnen's loss,
not Wedgewood's. We note that Wedgewood's loss, and its amount, has never
been
challenged by the IRS, and there is no evidence that its loss was ever
determined to be an
amount other than the amount used by Culnen in calculating the amount of
his deduction
for purposes of the Form 4797. While the IRS would be free to attack the
amount of
Wedgewood's loss in a deficiency notice addressed to it, or as part of an
attack on
Culnen's deduction of a percentage thereof, this challenge was never made
since the
corporate loss issue was never raised in the deficiency notice, or in any
of the pretrial
proceedings. Rather, it appears to have surfaced only when it appeared
that Culnen
could in fact trace his investments and show his basis in the stock he
owned and, thus,
prove the allowability of the deduction he claimed.
     Among the principles animating our conclusion is the "meet the hold"
doctrine
Culnen suggests. That doctrine prohibits a party from changing his ground
and "putting
his conduct upon another and different consideration." Ohio & Mississippi
Railway Co.
v. McCarthy, 96 U.S. 258, 267 (1878).   The fairness concerns that
underlie this principle
are consistent with the most elementary requirements of due process.
Here, we are
troubled by the total lack of notice of the nature of the IRS's claim so
as to inform
Culnen of the proof he must present, given his burden in a proceeding to
challenge the
deficiency notice. More than an inequitable change of position, the
Commissioner
essentially asserted an entirely new claim. Perhaps the situation would
be different if the
notice of deficiency had consisted of a vague challenge to the loss, but
later proceedings
had made clear the nature of the IRS's theory. However, here, the
numerous stipulations
and record statements regarding the issues are devoid of any mention of
attack on
Wedgewood's loss, let alone specific contention that the "amount realized"
was being
challenged based on the provisions and regulations under section 1001
regarding
recourse debt and dischargeability. The stipulations and various
statements of the issues
say nothing remotely touching on this issue. Further, the surprise and
disadvantage to
Culnen are obvious from the record and result. In Commissioner v.
Transport Mfg. &
Equip. Co., 478 F.2d 731 (8th Cir. 1973) the court noted that the
taxpayer must be
advised of the theory being advanced by the Commissioner: "The failure to
advise the
taxpayer of such information is extremely prejudicial. Deficiency
assessments are
usually presumptively correct, and the taxpayer has the burden to prove
them wrong.
The taxpayer works at an extreme disadvantage in trying to invalidate
deficiency
assessments if he does not specifically know why the Commissioner is
challenging the
taxpayer." Id at 735.
     Here the theories set forth in the notice of deficiency were
successfully rebutted by
Culnen's evidence.       Accordingly, we will reverse the Tax Court's
order and remand for
entry of judgment in favor of Culnen.
________________________
________________________
TO THE CLERK OF COURT:
     Please file the foregoing Not Precedential Opinion.



                                   /s/Marjorie O. Rendell
                                   Circuit Judge
