John M. and Rita K. Monahan v. Commissioner , 109 T.C. No. 11 ( 1997 )

109 T.C. No. 11UNITED STATES TAX COURT
JOHN M. AND RITA K. MONAHAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11062-95. Filed October 23, 1997.
1. Held: This Court may raise sua sponte the
doctrine of issue preclusion, or collateral estoppel.
2. Held, further, interest payments that were
credited to a partnership's bank account are taxable to
Ps because P controlled partnership matters and
benefited from and controlled the funds in that
account.
3. Held, further, a $25,000 payment that was
deposited in Ps' bank account is taxable to Ps because
Ps failed to prove that the payment represents
reimbursement of legal fees paid by P on behalf of a
corporation.
4. Held, further, sec. 6662(a), I.R.C., accuracy-
related penalty imposed for substantial understatement
of income tax.
- 2 -
F. Michael Kovach, Jr., for petitioners.
Cathy A. Goodson, for respondent.
OPINION
HALPERN, Judge: By notice of deficiency dated April 14,
1995, respondent determined a deficiency in petitioners' Federal
income tax for 1991 of $161,055 and a penalty under section
6662(a) of $32,211. Unless otherwise noted, all section
references are to the Internal Revenue Code in effect for the
year in issue, and all Rule references are to the Tax Court Rules
of Practice and Procedure. In addition, all references to
petitioner are to John M. Monahan.
After concessions by respondent, the issues for decision are
(1) whether certain interest payments that were credited to a
partnership's bank account are taxable to petitioners,
(2) whether a $25,000 payment that was deposited in petitioners'
bank account is taxable to petitioners, and (3) whether
petitioners are liable for the penalty. The parties have
stipulated various facts, which we so find. The stipulation of
facts, with accompanying exhibits, is incorporated herein by this
reference. We need find few facts in addition to those
stipulated; accordingly, we shall not separately set forth our
additional findings of fact and shall include those findings in
- 3 -
the discussion that follows. Petitioners bear the burden of
proof on all questions of fact. Rule 142(a).
I. Background
Petitioners resided in Seattle, Washington, when the
petition in this case was filed.
Petitioner is a lawyer specializing in corporate and
international trade law with emphasis in tax planning and complex
corporate transactions. Petitioner received an LL.M. (with
emphasis in taxation) from New York University School of Law.
Petitioners are calendar year taxpayers.
II. Interest Payments Credited to Aldergrove's Bank Account
A. Introduction
1. Aldergrove
Aldergrove Investments Co. (Aldergrove), was a partnership
between Grove Management Ltd. (GML), see infra sec. II.A.2., and
petitioner. Aldergrove's principal place of business was on
Anguilla (an island of the British West Indies). Aldergrove did
not file a U.S. Partnership Return of Income for 1991.
Petitioners did not report any income from Aldergrove for 1991.
Pursuant to the Aldergrove partnership agreement, effective
July 1, 1984, partnership interests and capital contributions
were as follows:
- 4 -
Class A Class B
GML 10 percent 100 percent
$1,000 $569,000
Petitioner 90 percent none
$9,000
Class B partnership units were nonvoting, and, in partnership
matters affecting both classes, partners voted in proportion to
their percentage ownership of Class A partnership units.
2. GML
GML was a wholly owned subsidiary of Span Corp., Ltd.,
which, in turn, was wholly owned by Lynwood S. Bell (Mr. Bell), a
Canadian citizen residing in Anguilla. Petitioner and GML
entered into an agreement, effective July 1, 1984, that required
petitioner to manage GML's investments and to provide investment
advice. GML transferred assets to Aldergrove for management.
3. Jaguar Holdings/Ihatsu Fudosan and Hansa Finance
Jaguar Holdings, Ltd. (Jaguar Holdings), was wholly owned
and controlled by Mr. Bell, and, on or about August 1, 1988, its
name was changed to Ihatsu Fudosan Capital, Ltd. (Ihatsu
Fudosan).
Hansa Finance and Trust, B.V. (Hansa Finance), was owned and
operated by Mr. Bell.
4. Chestnut Grove and Group M
During 1991, petitioner was a 45-percent shareholder of both
Chestnut Grove Investments, Inc. (Chestnut Grove), and Group M
- 5 -
Construction, Inc. (Group M). Petitioner's brothers, Timothy E.
Monahan and Peter J. Monahan, owned 45 percent and 10 percent,
respectively, of the outstanding stock of both Chestnut Grove and
Group M. Those corporations were organized for the purpose of
acquiring and developing a 16-acre parcel located in Yakima,
Washington (the Yakima property). That parcel was purchased in
March 1987 for $400,000.
B. Transactions in Issue
A check that was drawn on an account held by Chestnut Grove
and made payable to “Ihatsu Fudosan or Aldergrove Investment” in
the amount of $116,000 for “interest” was endorsed “Dep only” to
account number 250-0132969 at Security Pacific Bank (SP Bank),
which account was held in the name of Aldergrove (the Aldergrove
account). On December 26, 1991, SP Bank credited the Aldergrove
account in the amount of $116,000.
A check that was drawn on an account held by Group M and
made payable to “Ihatsu Fudosan or Aldergrove Investment” in the
amount of $84,700 for “interest” was endorsed “Dep only” to the
Aldergrove account. On December 26, 1991, SP Bank credited the
Aldergrove account in the amount of $84,700.
On December 31, 1991, SP Bank credited the Aldergrove
account in the amount of $140.66 for interest earned by the
account.
- 6 -
C. Analysis
1. Issue
The issue is whether the interest payments that were
credited to the Aldergrove account in the amounts of $116,000,
$84,700, and $140.66 (the 1991 interest payments), are taxable to
petitioners (the 1991 interest issue).
2. Arguments of the Parties
Petitioners argue that Mr. Bell and his wholly owned
corporations provided the financing that allowed Chestnut Grove
and Group M to acquire the Yakima property. Petitioners argue
that the checks in the amounts of $116,000 and $84,700, both made
payable to Ihatsu Fudosan or Aldergrove (the Yakima interest
payments), represent interest payments to Mr. Bell for the Yakima
property loans and were held in trust for Mr. Bell by Aldergrove
until those funds were transferred to a Bank of Bermuda account
over which petitioner did not exercise any control, and,
therefore, Mr. Bell is taxable on those payments, “regardless of
whether Aldergrove Investments Co. was Petitioner's alter ego.”
Alternatively, petitioners argue that petitioner lacked
sufficient dominion and control over the Aldergrove account to be
taxable on the 1991 interest payments. Petitioners argue that
- 7 -
petitioner has received no benefit from any of the 1991 interest
payments and that those funds were transferred to a Bank of
Bermuda account over which petitioner did not exercise any
control.
Lastly, petitioners assert that, even if the Court were to
find that Aldergrove must recognize the 1991 interest payments as
income, petitioners are taxable only on petitioner's distributive
share of that income.
Respondent asserts that this Court in Monahan v.
Commissioner, T.C. Memo. 1994-201 (Monahan I), affd. without
published opinion 86 F.3d 1162 (9th Cir. 1996),1 found that, in
1991, petitioner controlled Aldergrove partnership matters and
benefited from and controlled the funds in the Aldergrove
account. Relying on the doctrine of collateral estoppel,
respondent argues that petitioner is precluded from relitigating
those issues. Since the 1991 interest payments were deposited in
the Aldergrove account in 1991, respondent argues that those
payments are taxable to petitioner.
1
It should be noted that 9th Cir. R. 36-3 provides that
dispositions other than opinions or orders designated for
publication shall not be regarded as precedent and shall not be
cited to or by the Court of Appeals for the Ninth Circuit or any
district court of the Ninth Circuit, except when relevant under
the doctrines of law of the case, res judicata, or collateral
estoppel.
- 8 -
Respondent argues alternatively that, if the Court finds the
doctrine of collateral estoppel to be inapplicable, the 1991
interest payments are taxable to petitioners because petitioner
made acquisition and development loans for the Yakima property to
Chestnut Grove and Group M and benefited from and exercised
control over the 1991 interest payments.
3. Relevant Legal Principles
a. Interest Income
Section 61(a)(4) provides that gross income means all income
from whatever source derived, including interest. “Generally,
interest earned on investment is taxable to the person who
controls the principal.” P.R. Farms, Inc. v. Commissioner, 820
F.2d 1084, 1086 (9th Cir. 1987) (citing Helvering v. Horst, 311
U.S. 112, 116-117 (1940)), affg. T.C. Memo. 1984-549.
“`[C]ommand over property or enjoyment of its economic benefits
* * *'”, which is the mark of true ownership, is a question of
fact to be determined from all of the attendant facts and
circumstances. See Hang v. Commissioner, 95 T.C. 74, 80 (1990)
(quoting Anderson v. Commissioner, 164 F.2d 870, 873 (7th Cir.
1947), affg. 5 T.C. 443 (1945)). Mere legal title is not
determinative of beneficial ownership. See Serianni v.
Commissioner, 80 T.C. 1090, 1104 (1983), affd. 765 F.2d 1051(11th Cir. 1985).
- 9 -
b. The Doctrine of Issue Preclusion
The doctrine of issue preclusion, or collateral estoppel,
provides that, once an issue of fact or law is “actually and
necessarily determined by a court of competent jurisdiction, that
determination is conclusive in subsequent suits based on a
different cause of action involving a party to the prior
litigation.” Montana v. United States, 440 U.S. 147, 153 (1979)
(citing Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326 n.5
(1979)). Issue preclusion is a judicially created equitable
doctrine whose purposes are to protect parties from unnecessary
and redundant litigation, to conserve judicial resources, and to
foster certainty in and reliance on judicial action. See, e.g.,
id. at 153-154; United States v. ITT Rayonier, Inc., 627 F.2d
996, 1000 (9th Cir. 1980). This Court in Peck v. Commissioner,
90 T.C. 162, 166-167 (1988), affd. 904 F.2d 525 (9th Cir. 1990),
set forth the following five conditions that must be satisfied
prior to application of issue preclusion in the context of a
factual dispute (the Peck requirements):
(1) The issue in the second suit must be identical
in all respects with the one decided in the first suit.
(2) There must be a final judgment rendered by a
court of competent jurisdiction.
(3) Collateral estoppel may be invoked against
parties and their privies to the prior judgment.
(4) The parties must actually have litigated the
issues and the resolution of these issues must have
been essential to the prior decision.
- 10 -
(5) The controlling facts and applicable legal
rules must remain unchanged from those in the prior
litigation. [Citations omitted.]
See also Clark v. Bear Stearns & Co., 966 F.2d 1318, 1320 (9th
Cir. 1992) (highlighting conditions (1) and (4) above).
4. Discussion
a. Preliminary Matters
By order of this Court dated April 8, 1996, respondent's
motion for leave to file an amended answer to raise the
affirmative defense of collateral estoppel in this case was
granted. Respondent now bears the burden of proving the
applicability of that defense. Rule 142(a).
The jurisdictional competency of this Court in Monahan I is
not contested by the parties in this case. In addition, decision
in Monahan I was entered by this Court on August 29, 1994, and
was affirmed on appeal without modification by the Court of
Appeals for the Ninth Circuit on May 31, 1996. Cf. Hudson v.
Commissioner, 100 T.C. 590, 593-594 (1993) (refusing to apply the
doctrine of collateral estoppel when an appellate court affirms a
trial court's judgment on different grounds). No petition for
certiorari having been duly filed, decision in Monahan I has
become final under section 7481(a)(2)(A). Lastly, there is
complete identity of parties between Monahan I and this case.
Both petitioners and respondent were parties in Monahan I and are
- 11 -
bound by that decision. In sum, conditions (2) and (3) of the
Peck requirements are satisfied.
b. The 1991 Interest Issue
The ultimate issue with respect to the 1991 interest
payments is whether those payments constitute gross income to
petitioners. That issue was not litigated in Monahan I. Thus,
petitioners are not precluded from contesting respondent's
determination that the 1991 interest payments are taxable to
petitioners. Although this Court in Monahan I found that “funds
held in Aldergrove were used by and benefited petitioner
personally”, including funds credited to the Aldergrove account
on December 26, 1991, see infra sec. II.C.4.c., and command over
property or enjoyment of its economic benefits determines the
incidence of taxation, see supra sec. II.C.3.a., the Court did
not find that all interest payments credited to the Aldergrove
account in 1991 are taxable to petitioners. Certainly, this
Court in Monahan I did not decide the 1991 interest issue. The
equitable doctrine of issue preclusion requires that petitioners
be given an opportunity to litigate the 1991 interest issue.2
2
That may simply be a different way of saying that the
doctrine of claim preclusion does not apply. In this context,
the scope of the issue preclusion analysis blurs the distinction
between claim preclusion and issue preclusion. See McClain v.
Apodaca, 793 F.2d 1031, 1033 (9th Cir. 1986) (“The concept of res
judicata embraces two doctrines, claim preclusion and issue
(continued...)
- 12 -
Respondent directs our attention to this Court's holding in
Monahan I that interest income earned by Aldergrove on certified
deposit accounts in 1985 constituted income to petitioners. It
is unclear whether respondent believes that that determination is
dispositive of the 1991 interest issue. We believe, however,
that our holding in Monahan I with respect to the 1985 interest
income does not preclude petitioners from litigating the 1991
interest issue. The doctrine of issue preclusion must be applied
carefully so that fairness to litigants is not compromised for
efficiency and economy.3 Some courts have advised narrow
application of the doctrine in the context of tax litigation.
See, e.g., Kennedy v. Commissioner, 876 F.2d 1251, 1257 (6th Cir.
1989), affg. Gray v. Commissioner, 88 T.C. 1306 (1987); 18 Moore,
Moore's Federal Practice, par. 132.02, at 132-38 (3d ed. 1997).
That approach appears to be a product of the “separable facts”
doctrine, first enunciated in Commissioner v. Sunnen, 333 U.S.
591, 601 (1948). Although it is unclear whether the separable
2
(...continued)
preclusion (or collateral estoppel), that bar, respectively, a
subsequent action or the subsequent litigation of a particular
issue because of the adjudication of a prior action.” (fn. ref.
omitted)).
3
See United States v. Silliman, 167 F.2d 607, 614 (3d Cir.
1948) (“Such a rule of public policy [collateral estoppel] must
be watched in its application lest a blind adherence to it tend
to defeat the even firmer established policy of giving every
litigant a full and fair day in court.”).
- 13 -
facts doctrine is still good law in the tax context, see United
States v. Stauffer Chem. Co., 464 U.S. 165, 172 n.5 (1984); Peck
v. Commissioner, 904 F.2d 525, 527-528 (9th Cir. 1990), affg.
90 T.C. 162 (1988),4 we believe, in any event, that denying a
party the opportunity to litigate an issue is a matter that
requires circumspection. This Court will not use the doctrine of
issue preclusion as a blunt instrument for summarily denying
petitioners an opportunity to litigate the 1991 interest issue.
Instead, we prefer the approach that follows.
c. The Aldergrove Issue
Issue preclusion may operate to preclude relitigation of
evidentiary facts determined in a prior proceeding. See, e.g.,
Meier v. Commissioner, 91 T.C. 273, 286 (1988). Thus, facts that
a party is precluded from relitigating in conjunction with other
facts established by evidence in the latter proceeding may
provide a basis to sustain a deficiency determination by the
Commissioner. Id. at 288-289. The parties agree that the 1991
interest payments are interest payments that were credited to the
Aldergrove account in 1991. To establish that the 1991 interest
4
It should also be noted that the Court of Appeals for the
Ninth Circuit, to which an appeal in this case would likely lie,
stated that the Supreme Court limited the application of
Commissioner v. Sunnen, 333 U.S. 591 (1948), to cases where there
has been a significant change in the legal climate. See, e.g.,
Peck v. Commissioner, 904 F.2d 525, 527 (9th Cir. 1990), affg.
90 T.C. 162 (1988).
- 14 -
payments are taxable to petitioners, respondent asserts that, in
1991, petitioner controlled Aldergrove partnership matters and
that petitioner benefited from and controlled the funds in the
Aldergrove account. Respondent relies on Monahan I and the
doctrine of issue preclusion to establish those underlying facts.
In Monahan I, this Court considered the Commissioner's
determination of deficiencies in and additions to petitioners'
Federal income tax for 1984, 1985, 1986, 1987, and 1988. This
Court, among other things, found that petitioner's purported
repayment of his negative capital account in a partnership, Span
Services, lacked economic substance and that petitioner, thus,
recognized gain on the termination of his interest in that
partnership. In rejecting petitioner's assertion that he had an
obligation to repay Aldergrove for its payment of an obligation
incurred to repay the negative capital account, this Court
stated:
Petitioners contend that petitioner then had an
obligation to “contribute” to or repay Aldergrove as a
result of its satisfaction of the joint $400,000
obligation. However, there was no written agreement
regarding such an obligation. Petitioner's purported
payments to Aldergrove on that “obligation” also lacked
economic substance or remained in petitioner's control
by virtue of his control over Aldergrove. Petitioner's
first payment was made 2 years later, on February 25,
1988, when he transferred $125,000 to an Aldergrove
account over which he had signature authority. On the
same day, pursuant to petitioner's instructions
Aldergrove transferred $110,200 to Hansa Finance and
Trust, B.V. (Hansa Finance), an entity wholly owned and
- 15 -
controlled by Mr. Bell. On March 2, 1988, Hansa
Finance transferred $110,000 to Group M Construction,
Inc., a Washington corporation owned by petitioner
(from 45 to 50 percent during the years at issue) and
his brothers (from 50 to 55 percent during the years at
issue). On March 7, 1988, Hansa Finance transferred
$17,084.46 back to Aldergrove.
Petitioner made no additional payments to
Aldergrove on the $400,000 “obligation” prior to filing
his petition in this case on July 8, 1991. He made two
additional payments after this time. On December 26,
1991, petitioner transferred $25,000 to Aldergrove. On
December 18, 1992, petitioner issued a check for
$250,000 to Aldergrove and a check for $212,369 to
“Ihatsu Fudosan, Ltd. or Aldergrove Investment”. Both
checks were deposited into an Aldergrove account over
which petitioner had signature authority.
Neither of these additional payments had economic
substance. At this time, petitioner's right to
exercise his SAR's [stock appreciation rights] in GML
was unrestricted. The contribution to Aldergrove
increased the value of both petitioner's and GML's
partnership interest in Aldergrove. Thus, it also
increased the fair market value of GML's stock and
petitioner's SAR's. Petitioner exercised control over
all Aldergrove partnership matters by virtue of his
90-percent voting interest. Numerous other
transactions also support the conclusion that funds
held in Aldergrove were used by and benefited
petitioner personally, including other “loans” to
Group M Construction and Chestnut Grove Investments
(also partially owned by petitioner) made through Hansa
Finance. We find, therefore, that none of the payments
made by petitioner to Aldergrove in “repayment” of a
purported $400,000 loan had economic substance.
Petitioner argued at trial and on brief that
Mr. Bell had the ability to remove principal from GML
or Aldergrove, thus reducing the value of petitioner's
SAR's and placing Aldergrove funds beyond petitioner's
control. Mr. Bell apparently did make such a transfer
only once. However, even in this instance, the bulk of
the funds removed were immediately transferred to
Group M Construction and later back to Aldergrove. As
- 16 -
we have already discussed, petitioner was clearly in
control of the activities of both GML and Aldergrove.
The money held by Aldergrove was part of petitioner's
asset protection plan and primarily benefited
petitioner. The allocation of Aldergrove's profits was
subject to a partner vote, over which petitioner had
control. Moreover, GML assigned its interest in the
principal, issues, and profits of Aldergrove to
petitioner as security for payment upon any exercise by
petitioner of his SAR's. Finally, as discussed above,
the formation of Span/Hansa Management, an integral
part of petitioner's asset protection plan, provided an
additional device by which petitioner obtained the
benefits of funds flowing between Aldergrove, Span
Corp., and GML. Petitioner was, in fact, the primary
beneficiary of transactions between all these entities.
[Monahan I; fn. ref. omitted.]
The Court of Appeals for the Ninth Circuit agreed with this Court
and stated that the “taxpayers had ultimate control of the monies
involved in all of the transactions at issue.” Monahan v.
Commissioner, 77 AFTR 2d 96-2340, at 96-2340, 96-2 USTC par.
50,386, at 85,271-85,272 (9th Cir. 1996).
In sum, this Court examined petitioner's relationship with
Aldergrove Investments Co., the same partnership in issue in this
case, and determined that certain payments made to Aldergrove,
including a payment in the amount of $25,000 on December 26, 1991
(the $25,000 Aldergrove payment), lacked economic substance
because petitioner exercised control over all Aldergrove
partnership matters and benefited from and controlled the funds
held by Aldergrove. The $25,000 Aldergrove payment considered in
Monahan I was deposited in account number 250-0132969 at SP Bank,
- 17 -
the same account in which the 1991 interest payments were
deposited. Indeed, the $25,000 Aldergrove payment was credited
to the Aldergrove account on the same day as the Yakima interest
payments were credited to that account. Thus, petitioner's
control over Aldergrove partnership matters on December 26, 1991,
and his benefit from and control over funds in the Aldergrove
account on December 26, 1991 (together, the Aldergrove issue), is
an issue that was decided in Monahan I and is identical to a
factual issue relevant to respondent's determination of a
deficiency in this case.5
In addition, the Aldergrove issue was actually litigated in
Monahan I, and resolution of that issue was essential to the
decision in Monahan I. Petitioners do not dispute satisfaction
of that condition of the Peck requirements. Also, petitioners do
not claim that the applicable legal rules have changed; however,
they assert that issue preclusion does not apply because the
5
Although respondent seeks to preclude petitioners from
relitigating petitioner's control over Aldergrove partnership
matters in 1991 and his benefit from and control over funds in
the Aldergrove account in 1991, we believe that petitioner's
control over Aldergrove partnership matters on Dec. 26, 1991, and
his benefit from and control over funds in the Aldergrove account
on Dec. 26, 1991, are the only facts that are necessarily
established by this Court's finding in Monahan I that the $25,000
Aldergrove payment lacked economic substance. That is not to say
that this Court in Monahan I found that petitioner's relationship
with Aldergrove was any different on dates other than Dec. 26,
1991. See infra secs. II.C.4.d., e., and f.
- 18 -
controlling facts have changed. In particular, petitioners
assert that petitioner and Mr. Bell were no longer on friendly
terms in 1991 because Mr. Bell was being audited by the same
revenue agent who audited petitioners for the taxable years in
issue in Monahan I. As a result, petitioners claim that Geoffrey
Briant, a Canadian citizen, became involved as a mediator with
control over distributions from the Aldergrove account in 1991.
That purported change in the controlling facts, however, would
have been relevant to this Court in deciding Monahan I because
the Aldergrove issue was critical to the Court's conclusion that
petitioner's purported repayment of his negative capital account
in Span Services lacked economic substance, but petitioners
failed to raise Mr. Briant's alleged involvement in Aldergrove
despite the opportunity to present evidence on that issue in
Monahan I. The observation of the Court of Appeals for the Tenth
Circuit in Jones v. United States, 466 F.2d 131, 136 (10th Cir.
1972), is apt:
Evidence of this type is not the result of a
different factual situation or changed circumstances.
It is, instead, historical in nature and could have
been admitted at the first trial if properly submitted.
If the taxpayers' case was not effectively presented at
the first trial it was their fault; affording them a
second opportunity in which to litigate the matter,
with the benefit of hindsight, would contravene the
very principles upon which collateral estoppel is based
and should not be allowed. * * *
- 19 -
See also Yamaha Corp. of Am. v. United States, 961 F.2d 245, 257
(D.C. Cir. 1992) (quoting Jones v. United States, supra).
Petitioners also assert the following as another change in
the controlling facts:
[W]hen the case [Monahan I] was tried in January of
1993, Lyn Bell had not yet caused Grove Management
Limited to be stricken from the Registry of Companies.
His demonstrated and undisputed ability to dissolve
Grove Management demonstrates his control over that
company and proves that Aldergrove was not Petitioner's
alter ego.
That purported change in controlling facts, according to
petitioners, is sufficient to prevent application of issue
preclusion. Petitioners' assertion appears to be a variation of
an argument made in a memorandum in support of their motion for
reconsideration of Monahan I, filed June 13, 1994 (the
reconsideration motion). In that memorandum, petitioners argued
as follows:
When the case [Monahan I] was tried in January of
1993, Grove Management Limited was a solvent entity.
The Court might reasonably conclude, as it did, that
petitioner's SAR's in Grove Management, Ltd., were
valuable assets. In December of 1993, however,
petitioners were advised by Anguillan counsel that GML
was listed as an inactive corporation and was to be
stricken from the Anguillan Register of Companies.
Petitioners' SAR's were rendered worthless by the
striking, and the Court's conclusion that the Monahans'
retained control over funds placed in GML by virtue of
those SAR's became untenable.
The Court of Appeals for the Ninth Circuit, in reviewing this
Court's denial of the reconsideration motion, rejected that
- 20 -
argument by stating that this Court “relied on evidence clearly
showing that during the relevant time period taxpayers retained
control over the funds. That they lost their investments many
years later is not relevant to their tax liabilities for the
years at issue.” Monahan v. Commissioner, 77 AFTR 2d 96-2340, at
96-2341, 96-2 USTC par. 50,386, at 85,272 (9th Cir. 1996).
Similarly, we believe that this Court in Monahan I
determined that, on December 26, 1991, petitioner controlled
Aldergrove partnership matters and benefited from and controlled
the funds in the Aldergrove account, upon consideration of
evidence relating to the relevant time period. The fact that
Mr. Bell may have exercised control over GML in 1993 is
insufficient to deny preclusive effect to this Court's finding on
the Aldergrove issue in Monahan I. Essentially, petitioners
question the propriety of that finding by claiming the existence
of new evidence, but fail to show that the controlling facts
underlying the Aldergrove issue have changed. This Court, in
Monahan I, was presented with evidence and argument relating to
Mr. Bell's purported control over GML, but, upon consideration of
that evidence and countervailing evidence, the Court rejected
petitioners' assertion. New evidence of Mr. Bell's purported
control over GML would be cumulative only and does not alter the
controlling facts underlying the Aldergrove issue during the
- 21 -
relevant time period. Cf. Klein v. Commissioner, 880 F.2d 260,
263-264 (10th Cir. 1989) (this Court did not err in concluding
that new expert testimony regarding the taxpayer's mental
incompetency did not change the controlling facts for purposes of
collateral estoppel when similar evidence had been presented and
considered in the prior proceeding), affg. T.C. Memo. 1984-392.
In conclusion, we find that all five conditions of the Peck
requirements have been satisfied with respect to the Aldergrove
issue, and, therefore, petitioners are precluded from
relitigating that issue. Thus, we find that, on December 26,
1991, petitioner controlled Aldergrove partnership matters and
benefited from and controlled the funds in the Aldergrove
account.
d. Petitioners Attempt To Cast Doubt on the
Sufficiency of the Aldergrove Issue
We shall now turn to an examination of the evidence in this
case in light of the Aldergrove issue established in Monahan I.
There is no dispute that the 1991 interest payments are interest
payments that were credited to the Aldergrove account on
December 26, 1991, and December 31, 1991. That fact in
conjunction with our finding that, on December 26, 1991,
petitioner controlled Aldergrove partnership matters and
benefited from and controlled the funds in the Aldergrove account
permits this Court to infer that petitioner had control over and
- 22 -
benefited from the 1991 interest payments. That inference would
lead this Court to conclude that petitioners are taxable on the
1991 interest payments. See supra sec. II.C.3.a.
In an attempt to rebut the inference that petitioner had
control over and benefited from the Yakima interest payments
portion of the 1991 interest payments, petitioners assert the
following: (1) on March 1, 1987, petitioner borrowed $200,000
from Mr. Bell, through Hansa Finance, and loaned those funds to
Chestnut Grove and Group M to make the initial downpayment on the
Yakima property; (2) on March 1, 1987, Chestnut Grove and Group M
executed notes to petitioner for $23,382 and $176,618,
respectively; (3) on March 1, 1988, petitioner borrowed $110,000
from Mr. Bell, through Hansa Finance, and loaned those funds to
Group M to make a second payment for the Yakima property; (4) on
March 1, 1988, Group M executed a note to petitioner for
$110,000; (5) on August 1, 1988, Mr. Bell assigned petitioner's
promissory notes to Jaguar Holdings (which became Ihatsu
Fudosan); (6) on March 1, 1989, Group M borrowed $150,000 from
Ihatsu Fudosan to make the final payment on the Yakima property
and to maintain working capital; and (7) on November 1, 1991,
Chestnut Grove and Group M executed assumption of liabilities
agreements for the notes originally made by petitioner to Hansa
Finance. On the basis of those alleged facts, petitioners argue
- 23 -
that the Yakima interest payments represent interest payments to
Mr. Bell for the Yakima property loans and were held in trust for
Mr. Bell by Aldergrove until those funds were transferred to a
Bank of Bermuda account over which petitioner did not exercise
any control, and, therefore, petitioners are not taxable on those
payments.
Petitioners present the testimony of petitioner and of
Timothy Monahan, petitioner's brother and president of both
Chestnut Grove and Group M, and numerous documents to support
their assertion that the Yakima interest payments represent
interest paid to Mr. Bell. In response, respondent essentially
relies on the Aldergrove issue and petitioners' concession that
the funds allegedly loaned to petitioner by Hansa Finance were
previously transferred to Hansa Finance from Aldergrove
(petitioners' concession). Respondent asserts: “Hansa Finance
should be considered a mere `straw man': Aldergrove advanced at
least $200,000 of the money to Hansa before Hansa provided
$310,000 to Petitioner.” Petitioners respond as follows:
When Respondent ominously intones that John
Monahan “acknowledges on cross examination that Hansa
first received the initial land acquisition funds
($200,000) from Aldergrove,” * * * she forgets that
$570,000 of Aldergrove Investments [sic] initial
$579,000 of capital was contributed to Aldergrove by
Bell acting through Grove Management Ltd., the wholly
owned subsidiary of his wholly owned Span Corp., Ltd.
* * *. Lynwood S. Bell shifted those funds from
Aldergrove to Hansa Finance for the purpose of loaning
- 24 -
the money to John Monahan, whose own $9,000 capital
contribution to Aldergrove Investments played no
significant part in the transaction. Although
Respondent argues that Petitioner made the loans to
Group M and Chestnut Grove Investments, * * * the
partnership agreement reflects that Bell, and not John
Monahan, is the ultimate source of the funds used by
Group M and Chestnut Grove Investments to purchase the
16-acre Yakima parcel. Accordingly, Bell, and not
petitioners, is taxable on the interest paid by those
corporations regarding the loans.
We agree with petitioners that the Aldergrove issue and
petitioners' concession do not necessarily undermine petitioners'
assertion that the Yakima interest payments represent interest
paid to Mr. Bell because respondent has not established that
Aldergrove was anything other than what it purported to be when
funds were transferred to Hansa Finance. In other words, the
Aldergrove issue relates to petitioner's relationship with
Aldergrove on December 26, 1991, and may provide reasonable
inferences regarding petitioner's relationship with Aldergrove
during the entirety of 1991, but does not provide a sufficient
basis to undermine petitioners' contention that Mr. Bell was the
“ultimate source” of the funds loaned to Chestnut Grove and
Group M in 1987 and 1988.
e. Other Factual Issues Established in Monahan I
(1) Introduction
In respondent's brief, respondent asserts that this Court
should give effect to the unambiguous findings of
Monahan I and find that Petitioner is collaterally
- 25 -
estopped from relitigating the factual determinations
that the Petitioner controlled Aldergrove partnership
matters in 1991 and that the Petitioner benefitted from
and controlled the funds in the Aldergrove account in
1991.
Although respondent's affirmative defense is broad in one
respect, see supra note 5, respondent restrictively frames the
issue that respondent seeks to preclude petitioners from
relitigating. Since respondent directs our analysis of that
affirmative defense to the facts relating to 1991 and also bears
the burden of proving the applicability of the defense, we must
assume that respondent does not seek to preclude petitioners from
relitigating this Court's findings in Monahan I regarding
petitioner's relationship with Aldergrove and other entities
prior to 1991 (the pre-1991 issues).
(2) The Authority of This Court To Raise Issue
Preclusion Sua Sponte
Issue preclusion is an affirmative defense that must be
pleaded, Rule 39, otherwise, it is deemed to be waived. See,
e.g., Jefferson v. Commissioner, 50 T.C. 963, 966-967 (1968).
Whether a party is precluded from relitigating an issue requires
particularized analysis, and, thus, respondent must be deemed to
have waived the defense of issue preclusion with respect to the
pre-1991 issues even though respondent has properly raised that
defense with respect to the Aldergrove issue. This Court,
however, need not always accept waivers of the defense of issue
- 26 -
preclusion. This Court may raise the doctrine of issue
preclusion sua sponte. Cf. Holloway Constr. Co. v. United States
Dept. of Labor, 891 F.2d 1211, 1212 (6th Cir. 1989) (a district
court may raise the doctrine of res judicata sua sponte); McClain
v. Apodaca, 793 F.2d 1031, 1033 (9th Cir. 1986) (a bankruptcy
court may raise the doctrine of res judicata sua sponte when it
allowed the parties to submit posttrial briefs on the
applicability of the doctrine); Alyeska Pipeline Serv. Co. v.
United States, 231 Ct. Cl. 540, 688 F.2d 765, 771 (1982) (“when
necessary, the court may raise the question of claim or issue
preclusion sua sponte”); Fazi v. Commissioner, 105 T.C. 436, 444-
445 (1995) (this Court may raise the doctrine of judicial
estoppel sua sponte). The purposes of the doctrine of issue
preclusion include the conservation of judicial resources and the
promotion of certainty in and reliance on judicial action. See
supra sec. II.C.3.b. Courts have an independent interest in
advancing those purposes, see United States v. Sioux Nation of
Indians, 448 U.S. 371, 433 (1980) (Rehnquist, J., dissenting),
and, therefore, respondent's, perhaps inadvertent, consent to
relitigation of the pre-1991 issues cannot divest this Court of
the authority to preclude petitioners from denying certain facts
established after full and fair litigation in Monahan I.
- 27 -
Sua sponte consideration of issue preclusion generally
should be limited to circumstances where the parties are given an
opportunity to address the applicability of the doctrine to a
particular issue. See Nevada Employees Association, Inc. v.
Keating, 903 F.2d 1223, 1225-1226 (9th Cir. 1990); McClain v.
Apodaca, supra at 1033; see also Blonder-Tongue Labs., Inc. v.
University of Ill. Found., 402 U.S. 313, 350 (1971) (“The purpose
of * * * [requiring claim preclusion and issue preclusion to be
pleaded] is to give the opposing party notice of the plea of
estoppel and a chance to argue, if he can, why the imposition of
an estoppel would be inappropriate.” (emphasis added)). The
Court need not subject the issue preclusion decision to the
rigors of the adversarial process, however, if doing so would be
futile. Cf., e.g., McKinney v. Oklahoma Dept. of Human Servs.,
925 F.2d 363, 365 (10th Cir. 1991) (District Court may sua sponte
dismiss a complaint under Fed. R. Civ. P. 12(b)(6) without notice
and an opportunity to respond when it is “patently obvious” that
claimant could not prevail); Baker v. Director, U.S. Parole
Commn., 916 F.2d 725, 726-727 (D.C. Cir. 1990) (same); Omar v.
Sea-Land Serv., Inc., 813 F.2d 986, 991 (9th Cir. 1987) (where
counterclaimant cannot possibly win relief because its theory was
the same as its defense to a claim, which defense was rejected
after a hearing, the trial court did not err in effectively
- 28 -
dismissing counterclaim without notice and an opportunity to
oppose). But cf. Cochran v. Morris, 73 F.3d 1310, 1320-1321,
1321 n.2 (4th Cir. 1996) (Michael, J., dissenting) (argues for an
absolute prohibition against dismissals on the merits that are
entered without notice and an opportunity to respond).
(3) Application of Issue Preclusion Sua Sponte
This Court has been apprised of the decision in Monahan I
and finds it appropriate to consider sua sponte the preclusive
effect of facts established in that proceeding, which facts are
relevant to an issue in dispute in this case; i.e., whether
Mr. Bell was the ultimate source of the funds loaned to Chestnut
Grove and Group M. Petitioners are precluded from denying that,
on February 26, 1987, and December 22, 1988 (as will be explained
below, the dates on which Aldergrove received certain “interest”
payments), petitioner controlled Aldergrove partnership matters
and benefited from and controlled the funds held by Aldergrove
(the sua sponte issues).6 All five conditions of the Peck
requirements, see supra sec. II.C.3.b., are satisfied with
respect to the sua sponte issues, and, therefore, issue
6
This Court sua sponte could preclude petitioners from
denying certain facts established in Monahan I relating to
petitioner's transfer of $125,000 to Aldergrove on Feb. 25, 1988,
and subsequent transfers, but for convenience we shall examine
facts relating to certain interest payments made in 1987 and
1988.
- 29 -
preclusion applies. In addition, we believe that allowing
petitioners to examine and contest the application of issue
preclusion with respect to the sua sponte issues would be futile.
This Court's official file in Monahan I was admitted as evidence
for the purpose of deciding whether petitioners are precluded
from relitigating the Aldergrove issue, and posttrial briefs were
submitted by the parties to present their respective arguments.
The only difference between the Aldergrove issue and the sua
sponte issues is the date with respect to which this Court in
Monahan I examined petitioner's relationship with Aldergrove.
Under these circumstances, petitioners could add nothing to our
analysis of the sua sponte issues and, therefore, are not
prejudiced by the absence of notice and an opportunity to
respond.
In Monahan I, this Court, among other things, sustained
respondent's disallowance of certain interest deductions claimed
by petitioners for 1987 and 1988. Petitioners reported those
deductions as mortgage interest payments on an alleged loan of
$150,000 from Hansa Finance made in 1986. After concessions,
petitioners argued that they were entitled to deduct a portion of
the interest payments as personal interest under section 163(h),
and respondent argued that the loan and the interest payments
lacked economic substance.
- 30 -
This Court found the following facts: (1) “the ultimate
source and resting place for the $150,000 was Aldergrove”,
(2) the interest payments made by petitioners on February 26,
1987, and December 22, 1988, on the purported loan were
immediately transferred to Aldergrove, and (3) those payments
lacked economic substance because petitioner controlled
Aldergrove partnership matters and benefited from and controlled
the funds held by Aldergrove when the payments were made. We
stated:
We find that these various payments by petitioners
lacked economic substance. Petitioner testified that
the “mortgage” on his home was part of his asset
protection plan, and that by reducing his equity in his
home, he hoped to replace an “unknown liability that
could take the house away” with a “known liability that
you know you can repay,” i.e., the “loan” note.
Petitioner neglected to complete the picture in his
testimony however. For any real protection to occur,
petitioners would have also had to transfer the equity,
or loan amount to a place unreachable by “unknown”
creditors. From our analysis of the above
transactions, it appears that petitioners did just that
by transferring equity through Hansa Finance (or Ihatsu
Fudosan) to Aldergrove. This fits squarely into
petitioner's own testimony, since petitioner believed
that assets held in Aldergrove were protected. Of
course, petitioner had to have access and control over
Aldergrove's assets to make the plan truly beneficial
to him. He did, through his security interest in GML's
Aldergrove capital and profits, and through his SAR's
in GML. Thus, the purported loan amount was never
outside of petitioner's dominion and control and the
principal and interest payments made by petitioners
were nothing more than transfers from one beneficially
owned account to another. * * * [Monahan I; fn. ref.
omitted.]
- 31 -
As a preliminary matter, conditions (2) and (3) of the Peck
requirements are satisfied, and petitioners reasonably could not
have argued to the contrary. See supra sec. II.C.4.a. The sua
sponte issues are identical in all respects to factual issues
that were decided in Monahan I.7 The Court in Monahan I examined
petitioner's relationship with Aldergrove, the same partnership
in issue in this case, on February 26, 1987, and December 22,
1988, and determined that, on those dates, certain interest
payments made to Aldergrove lacked economic substance because
petitioner controlled Aldergrove partnership matters and
benefited from and controlled the funds held by Aldergrove. In
addition, the sua sponte issues were actually litigated in
Monahan I, and resolution of those issues was essential to the
decision in Monahan I that the interest payments made in 1987 and
1988 were not deductible. Therefore, conditions (1) and (4) of
the Peck requirements are satisfied with respect to the sua
sponte issues, and we believe that nothing petitioners could have
presented would change our conclusion. Lastly, condition (5) of
the Peck requirements is satisfied; any potential argument
relating to a change in the applicable legal rules would not be
tenable, and any potential argument relating to a change in the
7
That condition of the Peck requirements is, in fact,
satisfied because those factual issues decided in Monahan I are
relevant to the 1991 interest issue.
- 32 -
controlling facts would be dismissed in the same manner that
similar contentions of petitioners regarding the Aldergrove issue
were dismissed, see supra sec. II.C.4.c.
In conclusion, petitioners are precluded from denying that,
on February 26, 1987, and December 22, 1988, petitioner
controlled Aldergrove partnership matters and benefited from and
controlled the funds held by Aldergrove.
f. Are the 1991 Interest Payments Taxable to
Petitioners?
Promissory notes in evidence indicate that petitioner loaned
the following amounts to Chestnut Grove and Group M, and we so
find:
Date Maker Amount
March 1, 1987 Chestnut Grove $23,382
March 1, 1987 Group M 176,618
March 1, 1988 Group M 110,000
January 19, 1989 Group M 200,000
Petitioners present numerous documents and other evidence to
explain the fate of the first three of those notes and to support
their assertion that the Yakima interest payments represent
interest paid to Mr. Bell. The findings, however, that, on
February 26, 1987, and December 22, 1988, petitioner controlled
Aldergrove partnership matters and benefited from and controlled
- 33 -
the funds held by Aldergrove, in conjunction with petitioners'
concession that Aldergrove was the source of the funds allegedly
loaned to petitioner by Hansa Finance, $200,000 ($23,382 +
$176,618) on March 1, 1987, and $110,000 on March 1, 1988, cast
doubt on petitioners' version of the loan transactions.
A reasonable inference to be drawn from the sua sponte
issues is that petitioner's relationship with Aldergrove did not
change between February 26, 1987, and December 22, 1988, which
would mean that petitioner controlled Aldergrove partnership
matters and benefited from and controlled the funds held by
Aldergrove when Aldergrove likely transferred to Hansa Finance
the funds that were loaned back to petitioner. Therefore,
petitioners would have us believe that petitioner (1) in
substance, transferred funds to Hansa Finance, (2) borrowed those
funds back from Hansa Finance, (3) made loans with those funds to
Chestnut Grove and Group M, (4) removed himself from the loan
transactions by means of certain agreements, (5) received
interest payments from Chestnut Grove and Group M by means of his
relationship with Aldergrove on December 26, 1991, but (6) held
the interest in trust for Mr. Bell because Mr. Bell was the
ultimate source of the funds loaned to Chestnut Grove and
Group M.
- 34 -
We simply do not believe petitioners' paper trail of
promissory notes, deeds of trust, assignment agreements, and
assumption of liabilities agreements tells the whole story
because the funds that were loaned to Chestnut Grove and Group M
in 1987 and 1988 previously traveled a circuitous route, which
begins and ends with petitioner, in direct contradiction to
petitioners' assertion that Mr. Bell was the ultimate source of
those funds. In sum, we have considered all of the evidence
presented by petitioners, but, because the Yakima interest
payments were credited to the Aldergrove account on December 26,
1991, and, on that date, petitioner controlled Aldergrove
partnership matters and benefited from and controlled the funds
in the Aldergrove account, we are not persuaded that the Yakima
interest payments represent anything other than interest paid to
petitioner on account of loans made by petitioner.
D. Conclusion
We hold that the 1991 interest payments are taxable to
petitioners.
III. $25,000 Deposit
A. Introduction
In the notice of deficiency, respondent determined that
$317,160 was deposited in bank accounts held in the name of
petitioners during 1991 and that those deposits were unexplained.
- 35 -
Respondent increased petitioners' taxable income accordingly.
After concessions by respondent, a single $25,000 deposit remains
in dispute. The issue is whether that deposit is taxable to
petitioners.
B. Analysis
On December 26, 1991, petitioner transferred $25,000 from an
account held by Group M at SP Bank to an account held by
petitioners at the same bank (the payment). Petitioners, citing
Ingalls v. Patterson, 158 F. Supp. 627, 641-642 (N.D. Ala. 1958),
argue that the payment “represents a reimbursement of legal fees
paid by Petitioner on behalf of Group M Construction so that the
reimbursement is not income to Petitioner.” Respondent argues
that petitioners have failed to substantiate their explanation of
the payment. The parties' presentation of the issue with respect
to the $25,000 deposit requires this Court to examine only the
facts relating to the payment. Respondent does not contest the
legal basis upon which petitioners exclude that payment from
their income for 1991.
Timothy Monahan testified that, although petitioner did not
present any documents to Group M demonstrating the amount of the
legal expenses to be reimbursed, he was convinced that petitioner
spent at least $25,000 and, thus, authorized the payment. At
trial, petitioner stated that he did not remember the exact
- 36 -
amount paid for legal expenses on behalf of Group M, but stated
that the amount was substantially more than $25,000. There are
no documents in evidence that substantiate petitioners' claim
that petitioner incurred legal expenses on behalf of Group M.
Petitioners contend that the testimony of petitioner and his
brother “was straight forward and credible.” We disagree. The
self-serving testimony of petitioner, vaguely corroborated only
by the testimony of his brother, does not persuade us that the
payment represents reimbursement of legal fees paid by petitioner
on behalf of Group M. Cf. Day v. Commissioner, 975 F.2d 534, 538
(8th Cir. 1992) (“The Tax Court is not required to give credence
to the self-serving testimony of interested parties.”), affg. in
part and revg. in part T.C. Memo. 1991-140; Geiger v.
Commissioner, 440 F.2d 688 (9th Cir. 1971) (this Court did not
err when it found that taxpayer's uncontradicted testimony plus
the testimony of her accountant, both unsubstantiated by any
documentary evidence, did not carry the burden of proof), affg.
T.C. Memo. 1969-159. Petitioners have failed to carry their
burden of proof. Therefore, we conclude that the $25,000 deposit
is taxable to petitioners.
IV. Penalty
Section 6662(a) provides for an accuracy-related penalty in
the amount equal to 20 percent of the portion of an underpayment
- 37 -
of tax attributable to, among other things, any substantial
understatement of income tax. Sec. 6662(a), (b)(2). In the
notice of deficiency, respondent determined that the entire
underpayment of tax for the 1991 taxable year was due to a
substantial understatement of income tax. Petitioners bear the
burden of proving that respondent's determination is erroneous.
See Rule 142(a). In their briefs, petitioners simply assert that
there is no substantial understatement of income tax. On the
record before us, we find that respondent's determination of a
penalty under section 6662(a) is correct, except to the extent
that it relates to respondent's concessions regarding the
unexplained bank deposits discussed in supra section III.A.
V. Conclusion
Respondent's determinations of a deficiency in and penalty
on petitioners' Federal income tax for the 1991 taxable year are
sustained to the extent set forth in this report.
Decision will be entered
under Rule 155.