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An Analysis of US v. Brown and It's Probable Impact on the Receiverships within the Ninth Court By Davidson, Peter* (Editor’s Note: The last issue of the RN featured a piece by Charles
F. Rosen, our resident tax guru, on a disturbing position taken by the
Internal Revenue Service in a 2003 Tenth Circuit case United States v.
Brown. In a nutshell, in that case the IRS took an expansive view of the
application of Treasury Regulation 1.468B-1(c) governing taxation of a
“Qualified Settlement Fund.” It appeared that the IRS believed that every
estate administered by a receiver was a “qualified settlement fund” for
purposes of the IRS Code, requiring onerous tax filings and tax payments
by every receiver at pain of personal liability for failure to do so. In
this piece Peter Davidson, Esq., our receivership law expert, discusses
Mr. Rosen’s article and the probable impact of United States v. Brown in
the Ninth Circuit.) A: Many receivers have contacted me alarmed about the implications of Charles Rosen’s article in the last edition of Receivership News “IRS Says All Receivership Estates are Qualified Settlement Funds”. Chuck and I both agree the IRS is misinterpreting the code sections and regulations, at least as they apply to receivership cases. As important, however, the case the IRS is apparently relying on, United States v. Brown, 348 F.3d 1200 (10th Cir. 2003), is unusual and should not be applied in the Ninth Circuit. The facts of the Brown case make it distinguishable from most receivership cases, even fraud cases such as the Brown case itself. One of the distinctions is that in the Brown case, the United States had settled with the defendants and already created a settlement fund prior to the establishment of the receivership. The fund included cash and property, which was then turned over to the receiver to administer. That is not the case in most government enforcement receivership cases. Normally, the government agency prosecuting the case gets the receiver appointed at the inception of the case with the receiver taking possession of whatever assets constitute the receivership estate. Another distinction is that the fund in the Brown case arose as a result of a criminal proceeding, not a civil proceeding. I believe the Brown case is misdecided and should not be followed in the Ninth Circuit because it appears that no one argued that the funds held by the receiver were held in constructive trust for the defrauded investors and that, as a result, there were no funds available in the receivership estate to pay any taxes the IRS might claim were due. This argument has been successful in a number of receivership cases. See Federal Trade Commission v. Crittenden, 823 F. Supp. 699 (C.D. Cal. 1993) which is right on point. See also a recent Ninth Circuit decision, U.S. v $4,224,958.57, 392 F.3d 1002 (9th Cir. 2004). While the Ninth Circuit decision deals with forfeiture proceedings, the Ninth Circuit adopted the same reasoning as the district court in Crittenden and held that money obtained by fraud from investors is held in constructive trust for the investors. Therefore, it is likely Brown would not have been decided the same way in the Ninth Circuit. It also does not appear that the decision in Brown would apply in most receivership cases. For example, it appears it would have no applicability in rents, issues and profits receivership cases. There the receiver is appointed pursuant to contract (language in the deed of trust) pursuant to which the receiver is appointed to take possession of real property and collect rents which are in fact additional security for the obligation owed to the secured creditor. The collection of the rents should not be income to the receivership estate. Indeed, that is why receivers in rents cases are advised to use the tax identification number of the property owner/obligor because the rent is income to him or her. The receiver is simply collecting the rent (the additional security) and eventually turning it over to the secured creditor, often only in partial payment of the loan. Taxes, therefore, are owed either by the property owner or the secured creditor, if the total amount of net rents turned over exceeds the principal obligation. It does not appear that Brown would be applicable in other types of receivership cases either. For example, in family law cases the receiver is often appointed to take possession of a business and operate it pending the family law court’s decision as to whether the business should be sold, delivered to one of the parties or somehow divided. If the business is incorporated the receiver should use the tax identification number of the corporation and estate should have no income tax liability. If the business is a partnership or wholly owned by the parties to the litigation, again the receiver should be using their tax identification numbers and any tax would be owed by those entities or individuals. Similarly, if the receiver is appointed because of some corporate or partnership dispute and ordered to operate, manage or sell a business, pending resolution of the dispute, the receiver again should be using the tax identification number of those entities and the income tax obligation should pass through. The Estate should not be separately taxed. In addition, in many of the receivership cases discussed above, the receiver is collecting at least some of the money to pay general trade creditors. The court in Brown acknowledges that §1.468 B-1(g)(3) excludes payments made to general trade creditors that relate to Title 11 or similar cases and acknowledges that a receivership is similar case. In the Brown case the court was able to hold that the defrauded investors were not general trade creditors and, therefore, the exception did not apply. In most cases there is some general trade debt which a receiver would pay unless, of course, all the funds are held in constructive trust for defrauded investors, in which case the estate has no money to pay tax claims. The final type of receivership case we generally see is a receiver in aid of execution. Again, however, the receiver is not given a fund, but is charged in trying to collect a judgment and the tax on any collection would depend on whether collection of the judgment would result in income tax to the judgment creditors because the receiver is simply collecting funds on a judgment for the judgment creditor’s benefit. It is also unclear what assets would be included and tax have to be paid on even if a receivership estate is treated as a Qualified Settlement Fund. The IRS is apparently taking the position that the receiver has an obligation to report any income from, among other things, the sale of receivership assets and that Treasury Regulation §468B imposes a tax on settlement fund taxable income. In the Brown case the court was looking at income tax on “its earnings” 348 F.3d at 1204 and noted at the end of the case that the estate’s gain or loss with respect to an asset is the difference between the value of the asset when the estate received it and the value of the asset when the estate distributed or sold it. Id. at 1219. Therefore, unless there are assets such as a house, a car, a painting, which will have a discernable value at the time they are turned over to the receiver and then can be revalued at the time of sale or distribution, the only “income” would appear to be interest income on the funds in the receivership estate. If the receiver is appointed and simply seizes bank accounts, there would apparently be no “income” because the value of the asset when the receivership estate took it would be the same when it was distributed (not counting interest income). Similarly, in many fraud cases where the receiver is suing people to recover funds one has to question what or whether the fact that the receiver’s sued someone to recover an asset would be income under a QSF. I am sure we all look forward to hearing more from Chuck on his efforts to clarify this important issue with the IRS. Another receivership – tax case that should be of interest is United States v. George, 420 F.3d 991 (9th Cir. 2005). George was a receiver for five radio stations. During the course of the receiverships George was paid interim compensation for his work. George did not report the payments he received on his personal tax returns, taking the position that because the interim payments he received were subject to final approval by the court at the end of each case, and possible disgorgement, he did not need to report the payments until that time. The IRS and the United States Attorney’s Office disagreed and George was indicted and then convicted of filing false tax returns. George was sentenced to 15 months imprisonment. George appealed his conviction and the Ninth Circuit affirmed. The Ninth Circuit held that because George was a cash-basis taxpayer, he was required to report any income he received in the year he received it. The fact that the receiver’s fees were subject to possible disgorgement and final approval at the time of the receiver’s final accounting did not remove them from what is called “the claim of right doctrine”, which looks at the taxpayer’s dominion and control of the funds he receives. If the taxpayer treats the funds “as belonging to him” he has to pay taxes on the funds in the year received. The court did note that if a receiver had to repay interim fees in a subsequent year he or she would be entitled to a deduction in the year of repayment. *PETER A. DAVIDSON, with Moldo Davidson Fraioli Seror & Sestanovich LLP located in Los Angeles, is a receiver and an attorney who specializes in representing receivers in state and federal court. |