IN THE COMMONWEALTH COURT OF PENNSYLVANIA
Robert J. Marshall, Jr., :
Petitioner :
:
v. : No. 863 F.R. 2015
: Argued: June 6, 2018
Commonwealth of Pennsylvania, :
Respondent :
:
Commonwealth of Pennsylvania, :
Petitioner :
:
v. : No. 50 F.R. 2016
: Argued: June 6, 2018
Robert J. Marshall, Jr., :
Respondent :
BEFORE: HONORABLE MARY HANNAH LEAVITT, President Judge
HONORABLE RENÉE COHN JUBELIRER, Judge
HONORABLE P. KEVIN BROBSON, Judge
HONORABLE PATRICIA A. McCULLOUGH, Judge
HONORABLE ANNE E. COVEY, Judge
HONORABLE MICHAEL H. WOJCIK, Judge
HONORABLE ELLEN CEISLER, Judge
OPINION BY JUDGE BROBSON FILED: November 2, 2018
This personal income tax (PIT) matter returns to us following remand
to the Board of Finance and Revenue (Board) for recalculation of the amount of
Pennsylvania PIT owed by Petitioner Robert J. Marshall, Jr. (Taxpayer or Marshall).
See Marshall v. Commonwealth, 41 A.3d 67 (Pa. Cmwlth.) (en banc) (Marshall I),
exceptions overruled, 50 A.3d 287 (Pa. Cmwlth. 2012) (en banc) (Marshall II), aff’d
sub nom. Wirth v. Commonwealth, 95 A.3d 822 (Pa. 2014) (Wirth), cert. denied sub
nom. Houssels v. Pennsylvania, 135 S. Ct. 1405 (2015). On remand, the Board
reassessed Taxpayer’s PIT liability at “$102,620.00, plus appropriate penalties and
interest, less any payments and credits on his account.”1 Both Taxpayer and the
Pennsylvania Department of Revenue (Department or Revenue) challenge aspects
of the Board’s reassessment on remand. We affirm.
I. BACKGROUND
A. Marshall I, Marshall II, and Wirth
Taxpayer, a resident of the State of Texas, invested as a limited partner
in 600 Grant Street Associates Limited Partnership (Partnership), a Connecticut
limited partnership, which owned a building in the City of Pittsburgh (Property) that
went into foreclosure in 2005. In 2008, the Department assessed Taxpayer for his
pass-through share of the Partnership’s income2 realized from the foreclosure of the
Property. As we noted in Marshall I, Section 303 of the Code3 sets forth eight
separate classes of income subject to the PIT. The class of taxable income at issue
1
The Board issued two orders on remand, an original order dated September 16, 2015, and
a corrected order dated November 12, 2015. Neither party explains the occasion or necessity for
the corrected order. For purposes of our disposition, then, we will treat both as a single order.
2
With respect to taxability of partners, Section 306 of the Tax Reform Code of 1971
(Code), Act of March 4, 1971, P.L. 6, as amended, added by the Act of August 31, 1971, P.L. 362,
72 P.S. § 7306, provides, in relevant part:
[A] partnership as an entity shall not be subject to the tax imposed by this article,
but the income or gain of a member of the partnership in respect to said partnership
shall be subject to the tax and tax shall be imposed on his share, whether or not
distributed, of the income or gain received by the partnership for its taxable year
ending within or with the member’s taxable year.
3
Act of March 4, 1971, P.L. 6, as amended, added by the Act of August 4, 1971, P.L. 97,
72 P.S. § 7303.
2
here is “[n]et gains or income from disposition of property.” Section 303(a)(3) of
the Code.4
In Marshall I, we summarized the details of the financial arrangement
giving rise to the foreclosure and the assessed PIT liability therefrom:
[Partnership], organized under Connecticut law,
purchased the Property for $360 million. Of this $360
million purchase price, the Partnership financed $308
million with a Purchase Money Mortgage Note (PMM
Note) secured only by the Property. The PMM Note was
nonrecourse, meaning that the Partnership and the lender
agreed that the lender’s only recourse for nonpayment of
the obligations under the PMM Note was to pursue
foreclosure of the Property. As the name of the
Partnership suggests, the Partnership’s primary purpose
was the ownership and management of the Property.
Interest on the PMM Note accrued on a monthly
basis at a rate of 14.55%. If, however, the monthly
accrued interest exceeded the net operating income of the
Partnership, the Partnership was not required to pay the
excess (i.e., the amount of monthly accrued interest less
monthly net operating income). Instead, the accrued but
unpaid excess would be deferred and, thereafter,
compounded on an annual basis subject to the same
4
Section 303(a)(3) of the Code, setting forth the class of income at issue here is quite
lengthy. The general class description provides:
Net gains or income from disposition of property. Net gains or net income,
less net losses, derived from the sale, exchange or other disposition of property,
including real property, tangible personal property, intangible personal property or
obligations issued on or after the effective date of this amendatory act by the
Commonwealth; any public authority, commission, board or other agency created
by the Commonwealth; any political subdivision of the Commonwealth or any
public authority created by any such political subdivision; or by the Federal
Government as determined in accordance with accepted accounting principles and
practices.
In addition to providing this general description of the class, the General Assembly also expressly
exempted several specific transactions from the class. See id. § 7303(a)(3)(iii)-(vii). None of these
exceptions, however, apply to the particular type of property disposition in this case.
3
interest rate as the principal amount of the PMM Note.
The original maturity date of the PMM Note was
November 1, 2001. In 1998, the lender and the Partnership
amended the PMM Note to extend the maturity date to
January 2, 2005.
Marshall purchased a limited partnership interest
(one unit) in the Partnership on or about January 24, 1985,
for $148,889—$5,889 in cash and a promissory note of
$143,000. His one unit limited partnership interest
amounted to a 0.151281% interest in the Partnership.
Marshall paid the promissory note in full on or about
May 13, 1992. In March 1989, the Partnership returned a
portion of Marshall’s capital contribution in the amount of
$6,184. Marshall was a passive investor in the
Partnership. He never participated in the management of
the Partnership or the Property.
Over the years, the Partnership’s net income from
operations did not keep pace with projections. The
Partnership actually incurred losses from operations for
financial accounting, federal income tax, and PIT purposes
every year of its existence. For PIT purposes, the
Partnership allocated its annual losses from operations to
each partner, including Marshall. During this same time,
Marshall had no other Pennsylvania source of income or
loss. Marshall thus did not file a PIT return for tax
years 1985 through 2004.
Because of the Partnership’s dismal operations, the
Partnership paid less monthly interest on the PMM Note
than it had projected. Under the terms of the PMM Note,
this led to a greater amount of accrued but unpaid interest
over the years. According to the Offering Memorandum,
the Partnership projected accrued but unpaid interest on
the PMM Note at maturity (November 1, 2001, later
extended to January 2, 2005) to be approximately
$300 million. It also projected that upon sale of the
Property at maturity, there would be enough proceeds to
pay off the principal and accrued interest on the PMM
Note, with additional funds available to distribute to the
partners as a return on their investment. At the date of
foreclosure, the Partnership had an accrued but unpaid
interest obligation of approximately $2.32 billion. The
Partnership had used approximately $121,600,000 of this
4
amount to offset its income from operations that would
otherwise have been subject to PIT. Neither the
Partnership nor Marshall derived any PIT benefit from the
remainder.
The lender foreclosed on the Property on
June 30, 2005. By that time, what began as a $308 million
Partnership liability on the PMM Note had grown into a
liability of more than $2.6 billion, of which
only $308 million represented principal. Neither the
Partnership nor its individual partners received any cash
or other property as a result of the foreclosure. That same
year, the Partnership terminated operations and liquidated.
Marshall did not recover his $142,705 capital investment
(original investment less return of capital) in the
Partnership at foreclosure or liquidation. Indeed, Marshall
did not receive any cash or other property upon liquidation
of the Partnership.
In a Notice of Assessment dated March 28, 2008,
Revenue assessed Marshall $165,055.24 in PIT for
calendar year 2005 (inclusive of penalties and interest) as
a result of the foreclosure on the Property (Assessment).
Marshall filed a petition for reassessment with Revenue’s
Board of Appeals (BOA), challenging the imposition and,
in the alternative, amount of PIT set forth in the
Assessment. On September 12, 2008, BOA struck the
penalties from the Assessment, but otherwise held that the
amount of PIT due, with interest, was proper. Marshall
appealed BOA’s determination to the Board, which denied
Marshall’s request for relief from . . . BOA’s
determination on December 16, 2008.
Marshall I, 41 A.3d at 70-72 (footnotes omitted) (record citations omitted).
Taxpayer appealed the Board’s December 16, 2008 determination to
this Court. In his appeal, Taxpayer first questioned whether any PIT could be
imposed where neither the Partnership nor the individual partners received cash or
other property upon foreclosure. Taxpayer also contended Commonwealth v.
Rigling, 409 A.2d 936 (Pa. Cmwlth. 1980), and Commonwealth v. Columbia Steel
& Shafting Co., 83 Pa. D. & C. 326 (Dauphin 1951), exceptions dismissed,
5
62 Dauph. 296 (C.P. Pa. 1952), prohibit the imposition of an income tax on a
taxpayer, like himself, who actually derived no income from his investment.
Taxpayer also raised a disparate treatment argument, claiming he was being treated
differently from the partners who resided in Pennsylvania. Taxpayer further claimed
that the tax benefit rule should be applied to reduce his PIT liability. Finally,
Taxpayer argued that imposition of the PIT on him, a nonresident, would violate the
Commerce and Due Process Clauses of the United States Constitution.5 Marshall I,
41 A.3d at 72-73.
In Marshall I, we analyzed and ultimately rejected each of Taxpayer’s
challenges. Taking them out of order, we first held that Taxpayer waived his
Commerce Clause challenge. Id. at 73. We also rejected Taxpayer’s due
process/minimum contacts challenge, finding that Taxpayer purposefully availed
himself of the opportunity to invest in Pennsylvania real estate through the
Partnership, establishing “sufficient minimum contacts for the imposition of a tax
on Marshall and his fellow partners upon disposition by the Partnership of the
Property.” Id. at 74.
With respect to Taxpayer’s claim, in essence, that the foreclosure of the
Property did not yield a taxable event because neither he nor the Partnership received
any cash or property (or income from investment), this Court sided with the
Department’s interpretation of Section 303(a)(3) of the Code and the related
regulation, 61 Pa. Code § 103.13. We noted the similarities between the language
in the Code and regulation to that found in the federal counterpart, Section 1001 of
the Internal Revenue Code of 1986 (IRC), 26 U.S.C. § 1001. We also observed
5
U.S. Const. art. I, § 8, cl. 3; U.S. Const. amend. XIV, § 1.
6
Taxpayer’s accurate concession that for federal income tax purposes, a foreclosure
on a nonrecourse mortgage6 is treated as a sale or exchange for an amount equal to
the outstanding balance of the mortgage. Marshall I, 41 A.3d at 78 (citing Cox v.
Comm’r of Internal Revenue, 68 F.3d 128 (5th Cir. 1995)). Accordingly, we
affirmed the Department’s construction and application of the Code and the
regulation to real property foreclosures, “even when the mortgagor does not receive
any cash or other property (i.e., proceeds) upon foreclosure.” Id.
We also rejected Taxpayer’s reliance on the holdings in Rigling and
Columbia Steel. Neither of those cases dealt with the taxation of a partner’s
pass-through share of the partnership’s gain on disposition of real property.
Although we recognized that Taxpayer lost the entirety of the value of his investment
in the Partnership upon liquidation of the Partnership, we noted that Taxpayer’s loss
on his investment in the Partnership should not be conflated with whether the
Partnership experienced a taxable gain for PIT purposes upon the foreclosure of the
Property. Id. at 78-80. The latter is what is at issue in this case. Although both
involve the disposition of property, one tangible and the other intangible, because
Taxpayer is a nonresident, the loss on his partnership investment (intangible
property) must be sourced to his home state (Texas) and, therefore, cannot be taken
into account for purposes of calculating his PIT liability in Pennsylvania.
Id. at 97-98.
6
As noted above, “nonrecourse” means only that the lender and the borrower agree that
the lender will look only to the collateral pledged to secure the loan, here the Property, in the event
of a default and will not pursue the borrower for any deficiency. See Black’s Law Dictionary 1057
(6th ed. 1990). It represents a covenant between the borrower and the lender. Our research,
however, has yielded no authority for the proposition that this covenant also shields the borrower
from the tax consequences flowing from the discharge of the debt.
7
Concluding that the Department could impose PIT on Taxpayer for his
pass-through share of the Partnership’s gain from the disposition of the Property by
foreclosure, we turned our attention to Taxpayer’s challenges to the method of
calculating his PIT liability. We noted that “a gain is recognized where the amount
realized from the disposition of the property exceeds the adjusted basis of the
property at the time of disposition.” Id. at 81. With respect to the adjusted basis, we
held that the record was inadequate for the Court to determine the adjusted basis of
the Property at foreclosure, a point with which the parties agreed. We, therefore,
remanded the matter to the Board for recalculation. Id.
Turning to the more contested question of how to calculate the amount
realized by the Partnership7 as a result of the foreclosure, we noted that based upon
the United States Supreme Court’s decision in Commissioner of Internal Revenue v.
Tufts, 461 U.S. 300 (1983), the amount realized from the foreclosure must at a
minimum include the unpaid balance on the principal of the PMM Note
($308 million). We then held that the Tufts rule extended to accrued but unpaid
interest on the principal amount of the loan as of foreclosure, citing the United States
7
As noted previously, under Section 306 of the Code, the gain experienced by the
Partnership is taxable to the partners in their proportionate share. So, here, we must be focused
not on a particular gain experienced by Taxpayer, as a partner, but on whether and, if so, to what
extent the Partnership experienced a gain upon the foreclosure of the Property. On this point, the
United States Court of Appeals for the Third Circuit observed:
[A] partnership is required to file its own federal income tax return. Accordingly,
for the purpose of computing income and deductions, “the partnership is regarded
as an independently recognizable entity apart from the aggregate of its partners.”
After the partnership’s income and deductions are calculated and reported it is a
conduit through which income and deductions are distributed to individual partners.
Pleasant Summit Land Corp. v. Comm’r of Internal Revenue, 863 F.2d 263, 272 (3d Cir. 1988)
(quoting U.S. v. Basye, 410 U.S. 441, 448 (1973)), cert. denied, 493 U.S. 901 (1989).
8
Court of Appeals for the Eighth Circuit’s decision in Allan v. Commissioner of
Internal Revenue, 856 F.2d 1169 (8th Cir. 1988). Accordingly, this Court agreed
with the Department that the entire amount of the Partnership’s debt satisfied at
foreclosure is includable in the amount realized. Marshall I, 41 A.3d at 86.
We next addressed Taxpayer’s contention that the Department must
apply the “tax benefit rule”8 to reduce the amount realized from the foreclosure by
that portion of the Partnership’s annual deductions for accrued but unpaid interest
on the PMM Note over a twenty-year period that contributed to the Partnership’s net
operating losses over the same period, but for which the Partnership derived no tax
benefit. Taxpayer cited nothing in the Code, the Department’s regulations, or
precedent from this Court or the Pennsylvania Supreme Court recognizing the tax
benefit rule as a component of state tax law in the Commonwealth. Instead, he relied
on portions of a Department publication, the “PIT Guide,” wherein the Department
discussed the tax benefit rule and its application. According to the parties’
8
The tax benefit rule “is a product of federal common law, created by our federal courts in
response to anomalies arising out of application of the annual accounting system for taxes
contained in the IRC.” Marshall I, 41 A.3d at 91. As the Pennsylvania Supreme Court
summarized in Wirth:
In general, the rule applies when a deduction of some sort for a loss is taken
by a taxpayer in one year, only to have the amount previously deducted recovered
in a following tax year. Normally, the taxpayer would be responsible for including
the recovered income on his personal income tax return for the year in which
recovery occurred. The tax benefit rule states, however, that the recovery of the
previously deducted loss is not includible to the extent that the earlier deduction did
not reduce the amount of the tax owed in the year the initial deduction was
taken. Put differently, the “rule permits exclusion of the recovered item from
income [in a subsequent tax year] so long as its initial use as a deduction did not
provide a tax saving.”
Wirth, 95 A.3d at 845-46 (citations omitted) (emphasis added) (quoting Alice Phelan Sullivan
Corp. v. United States, 381 F.2d 399, 401-02 (Ct. Cl. 1967)).
9
stipulation of facts, over a span of twenty-two consecutive tax years, “the Partnership
used only $121,600,000 of the approximately $2.32 billion of unpaid interest that
accrued over that period, along with other deductions, to offset fully its gross
receipts from operations, leaving the Partnership with $0.00 in PIT liability for
operating income during those tax years.” Id. at 87 (emphasis added).
Relating Taxpayer’s request to the Code, Taxpayer, citing the tax
benefit rule, sought to offset the Partnership’s 2005 Section 303(a)(3) income (gain
on sale or disposition of property) by an unused/orphaned operations expense
deduction (accrued but unpaid interest on the PMM Note) from prior tax years,
which, under the Code, could only have been used in the year it was booked to reduce
income within the same class, not Section 303(a)(3) class income.9 In Marshall I,
we thoroughly examined the genesis under federal law of the tax benefit rule and
Taxpayer’s efforts to use it in this particular circumstance to reduce his Pennsylvania
PIT burden. Id. at 87-96.
Ultimately, but without deciding whether the tax benefit rule can or
should be applied when calculating Pennsylvania PIT,10 we declined to apply the
rule in this context for several reasons, which we summarized in Marshall II:
The majority [in Marshall I] concluded that the
so-called “tax benefit rule” did not require that the amount
realized for PIT purposes be limited to only the portion of
the accrued but unpaid interest that the Partnership was
able to deduct in prior years to reduce its PIT liability. The
majority rejected Marshall’s argument because it
conflicted with two principles embedded in Pennsylvania
law. First, unlike federal tax law, which taxes income as
9
See Marshall I, 41 A.3d at 89; Wettach v. Commonwealth, 620 A.2d 730 (Pa.
Cmwlth. 1993) (upholding validity of offset prohibition in Department’s regulations), aff’d per
curiam, 677 A.2d 831 (Pa. 1995); 61 Pa. Code §§ 101.1 (definition of “income”), 121.13(a).
10
See Marshall I, 41 A.3d at 95 n.35.
10
a single class “gross income[,”] Pennsylvania law
recognizes eight separate classes of income subject to PIT,
and the Regulations expressly prohibit taxpayers from
offsetting, or netting, income and losses across classes.
Income from sale or disposition of property, the income at
issue in this case, is Section 303(a)(3) income under the
Code. The interest on the PMM Note was an operations
expense and thus could only be used, as it was, to reduce
Section 303(a)(2) income under the Code—i.e., net
profits, or income from operations. To allow otherwise
would unquestionably be acting contrary to the express
and unambiguous terms of the Regulations, which prohibit
offsetting a gain in one class of income (gain on sale or
disposition of property) with a loss in another class of
income (net profits, or income from operations).
Along a similar vein, in Marshall I the majority
rejected Marshall’s contention that the tax benefit rule
should be applied to permit the Partnership to use
twenty-two years’ worth of net operating losses (NOLs) in
an amount in excess of $2 billion to reduce the amount
realized, and thereby reduce (or eliminate) the taxable gain
from a single taxable event in 2005—the sale or
disposition of the Property. The majority agreed with
Revenue that Marshall’s argument invites this Court to
recognize a NOL carryover deduction under Pennsylvania
tax law for PIT where the General Assembly, intentionally
it appears, has chosen to exclude NOL carryover
deductions from the calculation of PIT. To allow such a
deduction would be contrary to the General Assembly’s
intent as clearly expressed in the Code.
The majority further reasoned that the tax benefit
rule is not a generic doctrine prescribed by the courts to
remedy every apparent or perceived inequity or unfairness
in an income tax system, state or federal. To the contrary,
it was created to address a specific and particular
inequity in the tax system caused by the annual accounting
system for taxation. The rule is premised on the notion
that like transactions should have the same tax impact,
whether they occur in a single year or over a span of two
or more tax years—i.e., transactional equity. The rule
depends on a previously deducted expense that is
“recovered” in a subsequent tax year. To constitute a
11
“recovery” of a prior year deduction, the event in the
current tax year must be “fundamentally inconsistent with
the premise on which the deduction was initially based—
[t]hat is, if that event had occurred within the same taxable
year, it would have foreclosed the deduction,” such that it
warrants application of the tax benefit rule. Such
circumstances are not present in the case now before the
Court . . . .
Marshall II, 50 A.3d at 291-92 (footnote omitted) (quoting Hillsboro Nat’l Bank v.
Comm’r of Internal Revenue, 460 U.S. 370, 383-84 (1983)).11
After addressing and rejecting Taxpayer’s tax benefit rule argument,
the Court also rejected Taxpayer’s disparate impact argument. The Court recognized
that partners of the Partnership in Pennsylvania were able to offset their
proportionate share of the Partnership’s gain on disposition of the Property by the
investment loss each partner incurred upon liquidation of the Partnership. Both the
Property (tangible) and investment interest in the Partnership (intangible) are
property, subject to Section 303(a) class income treatment under the Code.
11
It merits emphasis here that by rejecting Taxpayer’s arguments, particularly his plea to
apply the tax benefit rule, the Department, as approved by this Court, calculated the amount
realized by the Partnership as a result of the foreclosure consistent with how the Partnership
reported its gain from the foreclosure for federal tax purposes, as reflected in the parties’ stipulation
of facts:
54. For federal income tax purposes, a foreclosure on a nonrecourse mortgage
is treated as a sale or exchange of the foreclosed property for an amount equal to
the outstanding balance of the mortgage.
55. For federal income tax purposes, the Partnership reported a gain on the
foreclosure of the Property in the amount of $2,362,812,499, which was the
difference between the outstanding balance of the nonrecourse PMM Note and the
federal tax basis of the Property.
(Joint Stipulation of Facts ¶¶ 54, 55, dated Feb. 11, 2011 (emphasis added).)
12
See Marshall I, 41 A.3d at 97.12 Taxpayer conceded, however, that because he is
not a resident of Pennsylvania, the gain/loss of disposition of his partnership interest,
as a matter of law, must be sourced to his home state of Texas. We explained:
“Pennsylvania simply lacks the authority, statutorily and constitutionally, to tax
income of nonresidents from sources outside of the Commonwealth. It likewise
cannot be compelled to take into account losses from sources outside of the
Commonwealth when assessing PIT on nonresidents.” Id. (emphasis in original).
For this reason, we rejected the disparate treatment argument, concluding:
Marshall’s PIT obligation in 2005 is more reflective of his
investment decisions and the constitutional limitations
placed on Pennsylvania’s ability to tax income of
nonresidents from sources outside of the Commonwealth
(i.e., Marshall’s partnership interest), than it is of
Marshall’s state of residence. We, therefore, reject his
constitutional challenge of disparate treatment.
Id. at 97-98 (emphasis in original).
In Wirth, the Pennsylvania Supreme Court affirmed our decision on
every issue. Specifically, the Supreme Court affirmed our determination that
12
According to the Supreme Court in Wirth, this Court in Marshall I suggested “that the
disposition of the Property and the investment loss are two different classes of income.” Wirth,
95 A.3d at 851. Respectfully, this is not an accurate characterization of our position in Marshall I.
Perhaps the Supreme Court was conflating our position on (a) operating losses of the Partnership,
which would pass through to the partners and offset income of the same class that the partner had
in the same year; with (b) losses of an investment (the partnership interest) upon dissolution of the
partnership. See id. at 852 n.27 (agreeing with this Court that (a) operating losses and (b) gains
from sale or disposition of property fall within separate classes of income under Code and thus
cannot be offset). As recounted above, in Marshall I this Court noted explicitly that gains and
losses from the sale or disposition of tangible (the Property) and intangible (the Partnership
investment) property both fall within the same class of income—Section 303(a)(3) under the Code.
As a result, investors in the Partnership that resided in Pennsylvania were able to offset their
pass-through share of the gain upon disposition of the Property with their investment loss in the
Partnership, as both occurred in the same tax year. Taxpayer, because he was not a resident of
Pennsylvania in 2005, could not benefit from the same offset. This was our reasoning, which the
Supreme Court generally followed in its affirming opinion. Id. at 853-58.
13
Taxpayer waived his Commerce Clause argument. Wirth, 95 A.3d at 837. It also
affirmed our rejection of Taxpayer’s due process/minimum contacts argument. Id.
at 839. The Supreme Court also agreed that, applying Tufts, gain on a nonrecourse
foreclosure is taxable under Section 303(a)(3) of the Code. Id. at 839-40. Turning
to the calculation of the amount realized, the Supreme Court, without “reluctance,”
agreed, consistent with Allan, that the entirety of the nonrecourse debt discharged
upon foreclosure, principal and interest, should be included in the amount realized.
Id. at 849-50.
With respect to the tax benefit rule, the Supreme Court opined that the
Department “has seemingly incorporated the rule into Pennsylvania Law through
Table 16-2 [of the PIT Guide].” Id. at 848 (emphasis added). Nonetheless, it
rejected its application in this particular context: “[A]s the Commonwealth Court
did, we easily agree with the Department that the exclusionary arm of the tax benefit
rule simply has no application in the instant appeal.” Id. The Supreme Court
explained that pursuant to federal law, the tax benefit rule requires
the attempted exclusion of realized gain be related to a
deduction without tax consequence from a prior year.
Appellants have not pointed to any jurisprudence,
regulation, or Department policy that states otherwise.
Through all of their protestations regarding the mandatory
application of the exclusionary arm of the tax benefit rule,
Appellants never address this salient point, nor, more
importantly, when they attempted to take the required
deduction. Thus, in our view, there simply can be no
application of the tax benefit rule in this case.
Id. at 848-49 (footnote omitted). In an accompanying footnote, the Supreme Court
did not foreclose the possibility that the tax benefit rule could be applied in another
factual scenario, perhaps even with respect to a nonrecourse mortgage foreclosure
situation: “We merely hold that Appellants have failed to demonstrate how the rule
14
could possibly be employed here given their failure to indicate where a failed
reduction in the assessment of tax liability occurred in a year prior to 2005.”
Id. at 848 n.24.
Finally, the Supreme Court rejected Taxpayer’s disparate treatment
argument, concluding that the Department’s “refusal . . . to grant Appellants’ [sic] a
deduction of their assessed PIT based upon the investment loss is constitutionally
permitted.” Id. at 858. The Supreme Court concluded with the following mandate:
[T]he order of the Commonwealth Court sustaining the
assessment of PIT is affirmed, and this matter will be
remanded to the Board of Finance and Revenue in accord
with the Commonwealth Court’s opinion for calculation
of the adjusted basis in the Property and determination of
the amount of tax to be assessed.
Id. at 858-59.
B. Proceedings Following Remand
After the Supreme Court issued its decision in Wirth, Taxpayer filed,
or refiled, Pennsylvania PIT returns for tax years 1985 through 2005, reporting
thereon his pass-through share of the operating losses of the Partnership during those
years. (Joint Supplemental Stipulation of Facts ¶ 3(a) (dated Oct. 25, 2017).) The
Court has reviewed copies of the returns filed under seal. As reflected in the parties’
stipulations, the Partnership took deductions on its federal tax forms, including a
deduction for the accrued but unpaid interest on the PMM Note, which contributed
to the Partnership’s annual operating loss and, consequently, zero tax liability from
inception through foreclosure. (Joint Stipulation ¶¶ 40, 53, 54.)
Taxpayer reported on the filed/refiled Pennsylvania returns his
pass-through share of the Partnership’s “[n]et income (loss) from rental real estate
activities,” as reported to him by the Partnership on IRS Schedule K-1 (Form 1065)
15
for each of these years. Taxpayer disclosed these annual losses on his Pennsylvania
Individual Income Tax Returns as Section 303(a)(4) class income—“Net gains or
income derived from or in the form of rents, royalties, patents and copyrights.”
72 P.S. § 7303(a)(4).13
Before the Board on remand, with respect to calculating the adjusted
basis of the Property upon foreclosure, the parties’ dispute focused on depreciation.
Specifically, Taxpayer and the Department offered competing views on how to apply
Section 303(a.2) of the Code, 72 P.S. § 7303(a.2). This section allows for a
depreciation deduction against income: “In computing income, a depreciation
deduction shall be allowed for the exhaustion, wear and tear and obsolescence of
property being employed in the operation of a business or held for the production of
income.” Section 303(a.2) of the Code. It also provides how to calculate the
adjusted basis of depreciated property:
The basis of property shall be reduced, but not below zero,
for depreciation by the greater of:
(1) The amount deducted on a return and not
disallowed, but only to the extent the deduction results in
a reduction of income; and
13
We acknowledge our view expressed in Marshall I that these pass-through losses should
be classified as Section 303(a)(2) income under the Code. The import of doing so was to
distinguish the pass-through operating loss from the Partnership’s rental activities from
Section 303(a)(3) income, which is the income at issue in this case. Neither Taxpayer nor the
Department has fully briefed the question of whether the pass-through losses from the Partnership
are subject to tax treatment under Section 303(a)(2) of the Code, as we indicated in Marshall I, or
Section 303(a)(4) of the Code, as Taxpayer has classified them, nor did they do so when this matter
was before us previously. Accordingly, our prior indications that the pass-through loss would be
classed for tax purposes under Section 303(a)(2) should be considered, at most, dicta.
The important and material point, however, remains. The pass-through operating losses of the
Partnership, to the extent reported by the partners on their Pennsylvania returns, are not reportable
under Section 303(a)(3) of the Code, and, therefore, are different in class and kind from the gain
realized upon foreclosure of the Property, at least for Pennsylvania income tax purposes.
16
(2) The amount allowable using the straight-line
method of depreciation computed on the basis of the
property’s adjusted basis at the time placed in service,
reasonably estimated useful life and net salvage value at
the end of its reasonably estimated useful economic life,
regardless of whether the deduction results in a reduction
of income.
Section 303(a.2) of the Code. Both parties refer to this provision as the “minimum
straight-line depreciation provision,” because regardless of the extent to which a
taxpayer benefits from the allowable depreciation deduction, the basis of the
depreciated property must be reduced, at a minimum, by the amount of depreciation
allowable using the straight-line method of depreciation.
The parties’ dispute centered around the effective date of the minimum
straight-line depreciation provision. Section 303(a.2) was added to the Code by
section 9 of Act 89 of 2002.14 Section 34 of Act 89 of 2002 provides that
Section 303(a.2) of the Code “shall apply to taxable years beginning after
December 31, 2000.” Taxpayer argued that this language meant that the minimum
straight-line depreciation provision should only be applied for tax years 2001 and
thereafter and, therefore, did not mandate a minimum downward basis adjustment
for straight-line depreciation in years preceding the 2001 tax year. The Department
offered a competing interpretation. In its view, Section 303(a.2) relates to the
calculation of income. In this case, the income in question is the gain on disposition
of the Property, which occurred in 2005. Accordingly, because the income event
occurred after the effective date of Section 303(a.2), the minimum straight-line
depreciation provision applied to calculate the adjusted basis of the Property from
inception through foreclosure and, consequently, any gain upon disposition.
14
Act of June 29, 2002, P.L. 559.
17
The Board refused to address Taxpayer’s tax benefit rule argument,
holding that this Court and the Pennsylvania Supreme Court ruled finally on the tax
benefit rule’s application in this case and that the tax benefit rule was not within the
scope of the remand order. With respect to the depreciation issue, the Board sided
with Taxpayer’s interpretation. Taxpayer now appeals the Board’s refusal to
consider his tax benefit rule argument, and the Department appeals the Board’s
interpretation and application of Section 303(a.2) of the Code.15
II. DISCUSSION
A. Taxpayer’s Appeal—Tax Benefit Rule
On appeal, Taxpayer renews the same arguments and themes that he
raised in Marshall I with respect to the tax benefit rule, without addressing the
several reasons why this Court rejected them. He then contends that in Wirth the
Pennsylvania Supreme Court clearly adopted the tax benefit rule as the law of the
Commonwealth, as reflected in the PIT Guide in effect at the time of
the 2005 foreclosure on the Property. In support, Taxpayer cites this Court’s
decision in Saturday Family L.P. v. Commonwealth, 148 A.3d 931 (Pa.
Cmwlth. 2016), exceptions overruled, 168 A.3d 400 (Pa. Cmwlth. 2017) (en banc),
wherein we held that an agency was bound to follow its duly promulgated
regulations. In Taxpayer’s view, Wirth only required Taxpayer to file Pennsylvania
income tax returns, showing a deduction for which he received no tax benefit in a
15
Our standard of review in this matter is covered by Rule 1571 of the Pennsylvania Rules
of Appellate Procedure. “Appeals taken from the Board of Finance and Revenue are de novo in
nature, with no record being certified by the board.” Tool Sales & Serv. Co. v. Bd. of Fin. &
Revenue, 637 A.2d 607, 610 (Pa. 1993), cert. denied sub nom. Tom Mistick & Sons, Inc. v.
Pennsylvania, 513 U.S. 822 (1994). “Although the Court hears these cases under its appellate
jurisdiction, the Court functions essentially as a trial court.” Scott Elec. Co. v. Commonwealth,
692 A.2d 289, 291 (Pa. Cmwlth. 1997), exceptions dismissed, 704 A.2d 205 (Pa. Cmwlth. 1998).
18
prior year, in order to avail himself of the tax benefit rule. He has now done that, by
filing/refiling Pennsylvania PIT returns, showing his pass-through share of the
Partnership’s operating losses for which he received no Pennsylvania PIT benefit in
prior years.
In response, the Department contends that nothing has changed since
Marshall I. Although Taxpayer has since filed Pennsylvania PIT returns for the tax
years preceding the year of the foreclosure, it was the Partnership that took an
interest deduction on its tax returns all those years, not the partners. Taxpayer’s
filed/refiled returns merely capture his pass-through share of the Partnership’s
operating losses, which this Court already considered in Marshall I and the
Pennsylvania Supreme Court considered in Wirth. The Department also highlights
one of the reasons why this Court rejected application of the tax benefit rule in this
matter. Allowing Taxpayer, through application of the tax benefit rule, to bring
forward operating losses from prior year returns to offset income in later years would
effectively create a net operating loss (NOL) carryover deduction for PIT, which
does not exist in the Code.16
In reply, Taxpayer advances again his arguments in favor of applying
the tax benefit rule in this situation. He contends that in Wirth the Supreme Court
held that the tax benefit rule could be used to exclude accrued but unpaid interest
from the amount realized at foreclosure, and that the partners needed only to file
Pennsylvania PIT returns reflecting the loss to avail themselves of the rule in this
case. They have since done that. Taxpayer acknowledges that the Partnership took
the interest deduction on its federal returns and that this deduction contributed to the
Partnership’s overall losses, which flowed through to the partners. Taxpayer insists,
16
Act of March 4, 1971, P.L. 6, as amended, 72 P.S. §§ 7101-10004.
19
however, that all Wirth requires is that he show some connection between the gain
on foreclosure of the Property and his inability to use the prior losses of the
Partnership to reduce his Pennsylvania PIT liability. He insists he has done that by
filing/refiling returns showing his pass-through share of the Partnership’s operating
losses. Because he was unable to use those losses to offset income in prior years,
the portion of those losses attributable to accrued but unpaid interest must be
excluded from the amount realized on foreclosure of the Property in 2005.
The Board appropriately refused to consider Taxpayer’s efforts to
revisit his tax benefit rule argument on remand from the Pennsylvania Supreme
Court. “[I]t has long been the law in Pennsylvania that following remand, a lower
court is permitted to proceed only in accordance with the remand order.”
Commonwealth v. Sepulveda, 144 A.3d 1270, 1280 n.19 (Pa. 2016). In Levy v.
Senate of Pennsylvania, 94 A.3d 436 (Pa. Cmwlth.), appeal denied, 106 A.3d 727
(Pa. 2014), which the Supreme Court cited with approval in Sepulveda, this Court
explained: “Where a case is remanded for a specific and limited purpose, ‘issues not
encompassed within the remand order’ may not be decided on remand. A remand
does not permit a litigant a ‘proverbial second bite at the apple.’” Levy, 94 A.3d
at 442 (quoting In re Indep. Sch. Dist. Consisting of the Borough of Wheatland,
912 A.2d 903, 908 (Pa. Cmwlth. 2006)).
Here, the Supreme Court remanded “in accord with the Commonwealth
Court’s opinion for calculation of the adjusted basis in the Property and
determination of the amount of tax to be assessed.” Wirth, 95 A.3d at 858-59.
In Marshall I, our remand was solely for the purpose of establishing “the adjusted
basis of the Property at the time of foreclosure” and not for reconsideration of the
amount realized. Marshall I, 41 A.3d at 98. If the Supreme Court intended to give
20
Taxpayer the opportunity to file amended returns, it would have vacated, not
affirmed, our decision in Marshall I, and it would clearly have used different
language in its mandate. Any further consideration of the amount realized by the
Partnership upon the foreclosure, including reconsideration of Taxpayer’s tax
benefit rule argument, is beyond the scope of this Court’s and the Supreme Court’s
remand orders. On this basis alone, we reject Taxpayer’s appeal.
If, however, we were again to look at the tax benefit rule, we would
reach the same conclusion as we reached in Marshall I and that the Pennsylvania
Supreme Court reached in Wirth. First, as noted above, the amount realized in 2005
is the amount realized by the Partnership upon foreclosure of the Property, not each
individual partner. In Wirth, the Pennsylvania Supreme Court, affirming this Court,
held that the amount realized must include the amount of the debt satisfied at
foreclosure, including principal and accrued but unpaid interest. In essence, the
amount realized for Pennsylvania PIT purposes is the same as the amount that the
Partnership realized from the foreclosure for federal income tax purposes. Taxpayer
does not adequately explain why Pennsylvania should recognize a different amount
realized for Pennsylvania PIT purposes than what the Partnership reported under the
IRC.17
Second, we reject Taxpayer’s claim that the Supreme Court in Wirth
ruled that the tax benefit rule is part of Pennsylvania law and could be applied in this
case only if the partners had filed Pennsylvania returns. To the contrary, the
Supreme Court acknowledged only that the Department “seemingly” adopted the
tax benefit rule in its PIT Guide and proceeded to analyze whether the rule should
17
26 U.S.C. §§ 1-9834.
21
be applied in this particular instance.18 Clearly, the Supreme Court left open the
possibility that it might adopt the tax benefit rule where the circumstances
support it, perhaps even in a nonrecourse mortgage foreclosure situation. Wirth,
95 A.3d at 848 n.24. Contrary to Taxpayer’s argument, however, the Supreme
Court did not say that the rule could be applied to exclude accrued but unpaid interest
from the amount realized from sale or disposition of property at foreclosure. The
Supreme Court most definitely said that it could not: “[I]n our view, there simply
can be no application of the tax benefit rule in this case.” Id. at 848-49.
Third, as we noted in Marshall I and as the Supreme Court emphasized
in Wirth, the tax benefit rule only applies where there is a deduction, without tax
benefit, taken in a prior year with a recovery in a subsequent year. Id. at 846. Here,
even considering Taxpayer’s refiled returns for the tax years preceding 2005, we
agree with the Department that Taxpayer did not take a deduction in prior years
without tax benefit for which there was a recovery in 2005. The Partnership took
the deduction for accrued but unpaid interest, leading to a net operating loss every
year of its existence. That loss flowed through to the partners. Taxpayer has now
filed returns showing his pass-through share of the operating loss as
Section 303(a)(4) class income. While it is true that he received no tax benefit from
that loss in prior years, that lack of tax benefit had everything to do with express
18
The Supreme Court’s phraseology appears to us to be intentional. As the Supreme Court
noted in Wirth, the tax benefit rule is a federal common law principle, later codified in federal
statute. In other words, it was created by a court and later enshrined in the law by an act of
Congress. Here, there is no state statute or court opinion ensconcing the tax benefit rule in
Pennsylvania law. Taxpayer cites this Court’s decision in Saturday Family L.P. for the proposition
that an agency is bound by its own regulations. As a legal principle, this is true. Here, however,
Taxpayer does not cite to a Department regulation that correlates to the portion of the PIT Guide
on which he relies, and the PIT Guide does not appear to be a regulation in and of itself.
22
limitations in governing Pennsylvania statutes (i.e., the Code) and regulations and
Taxpayer’s lack of offsetting income of the same class in those prior years, not
inequities created by the annual accounting system that prompted the creation of the
tax benefit rule through federal common law. See Marshall I, 41 A.3d at 91 (citing
Hillsboro Nat’l Bank, 460 U.S. at 377-79).19
Pennsylvania tax law is clear. Income/losses must be segregated by
class under Section 303(a) of the Code, and losses may only be used to offset income
of the same class in the same tax year (i.e., they may not be carried over). The IRC
does not have the same limitation and prohibition. Such incongruity warrants
caution when a state court is asked to apply a federal tax principle, like the tax benefit
rule, carte blanche to a state tax law scheme. See id. at 95 n.35. Refusing to address
let alone acknowledge this conflict between state and federal tax law, Taxpayer
continues to pound the proverbial square peg into the round hole. He fails to cite to
any statute or regulation in Pennsylvania that authorizes or recognizes a deduction
for accrued but unpaid interest expense to offset a gain from the disposition of
property (Section 303(a)(3) class income) in the same year, let alone subsequent
years. Putting aside for a moment the inability of Pennsylvania taxpayers to carry
over unused losses/deductions from year-to-year for PIT purposes, if the tax benefit
rule could even arguably apply in some context in Pennsylvania, the unused
deduction in the prior year would at least have to have been eligible to offset the
subsequent year gain. In other words, under Pennsylvania law the deduction would
have to be an allowable offset against the gain had both been booked in the same tax
19
See also Marshall I, 41 A.3d at 92 (providing example of how exclusionary tax benefit
rule works to smooth out inequity caused by annual accounting system).
23
year. That connection is clearly absent in this case. See Wirth, 95 A.3d at 848-49
(holding tax benefit rule has no application in this case).
B. The Department’s Appeal—Adjusted Basis (Depreciation)
In its appeal, the Department challenges the Board’s interpretation and
application of the minimum straight-line depreciation provision in
Section 303(a.2) of the Code. The Department contends that the provision is
unambiguous. The Department’s position is that the provision applies when
computing income for tax years beginning after December 31, 2000. Because the
tax year at issue in this case is 2005, the adjusted basis of the Property must be
reduced, at a minimum, by straight-line depreciation back to the year the Partnership
acquired the Property. Taxpayer responds simply that the minimum depreciation
provision does not apply to tax years before 2001. Accordingly, as the Board
concluded, imposing mandatory minimum straight-line depreciation for tax years
before 2001 would be contrary to the General Assembly’s intent. To the extent there
is any doubt about the interpretation of the provision, Taxpayer insists that the
section should be construed in his favor.
When interpreting a statute, this Court is guided by the Statutory
Construction Act of 1972, 1 Pa. C.S. §§ 1501-1991, which provides that “[t]he object
of all interpretation and construction of statutes is to ascertain and effectuate the
intention of the General Assembly.” 1 Pa. C.S. § 1921(a). “The clearest indication
of legislative intent is generally the plain language of a statute.” Walker v. Eleby,
842 A.2d 389, 400 (Pa. 2004). “When the words of a statute are clear and free from
all ambiguity, the letter of it is not to be disregarded under the pretext of pursuing
its spirit.” 1 Pa. C.S. § 1921(b). Only “[w]hen the words of the statute are not
explicit” may this Court resort to statutory construction. 1 Pa. C.S. § 1921(c).
24
“A statute is ambiguous or unclear if its language is subject to two or more
reasonable interpretations.” Bethenergy Mines, Inc. v. Dep’t of Envtl. Prot.,
676 A.2d 711, 715 (Pa. Cmwlth.), appeal denied, 685 A.2d 547 (Pa. 1996). Finally,
because Section 303(a.2) of the Code relates to the imposition of a tax, rather than
an exclusion from taxation, the provision must be strictly interpreted in favor of the
taxpayer. 1 Pa. C.S. § 1928(b)(3); Greenwood Gaming and Entm’t, Inc. v. Dep’t of
Revenue, 90 A.3d 699, 710-11 (Pa. 2014).
Upon consideration of the Board’s analysis and the parties’ arguments
on appeal, we conclude that both Taxpayer’s and the Department’s interpretations
of the minimum straight-line depreciation provision in Section 303(a.2) and the
effective date language in Section 34 of Act 89 of 2002 are reasonable. Accordingly,
we conclude that the provisions, read together, are ambiguous. Commonwealth v.
Giulian, 141 A.3d 1262, 1268 (Pa. 2016) (“When the parties read a statute in two
different ways and the statutory language is reasonably capable of either
construction, the language is ambiguous.”). We agree with Taxpayer that, in this
situation, the rules of statutory construction compel us to resolve the ambiguity in
his favor. Accordingly, we will affirm both the Board’s construction of the effective
date language in Section 34 of Act 89 of 2002 and its application of the minimum
straight-line depreciation provision in this matter.
III. CONCLUSION
For the reasons set forth above, we affirm the Board’s assessment of
Taxpayer’s PIT liability in all respects.
P. KEVIN BROBSON, Judge
Judge Fizzano Cannon did not participate in the decision of this case.
25
IN THE COMMONWEALTH COURT OF PENNSYLVANIA
Robert J. Marshall, Jr., :
Petitioner :
:
v. : No. 863 F.R. 2015
:
Commonwealth of Pennsylvania, :
Respondent :
:
Commonwealth of Pennsylvania, :
Petitioner :
:
v. : No. 50 F.R. 2016
:
Robert J. Marshall, Jr., :
Respondent :
ORDER
AND NOW, this 2nd day of November, 2018, the order of the Board of
Finance and Revenue is AFFIRMED.
Unless exceptions are filed within 30 days pursuant to
Pa. R.A.P. 1571(i), this order shall become final.
P. KEVIN BROBSON, Judge
IN THE COMMONWEALTH COURT OF PENNSYLVANIA
Robert J. Marshall, Jr., :
Petitioner :
: No. 863 F.R. 2015
v. :
:
Commonwealth of Pennsylvania, :
Respondent :
Commonwealth of Pennsylvania, :
Petitioner :
: No. 50 F.R. 2016
v. :
: Argued: June 6, 2018
Robert J. Marshall, Jr., :
Respondent :
BEFORE: HONORABLE MARY HANNAH LEAVITT, President Judge
HONORABLE RENÉE COHN JUBELIRER, Judge
HONORABLE P. KEVIN BROBSON, Judge
HONORABLE PATRICIA A. McCULLOUGH, Judge
HONORABLE ANNE E. COVEY, Judge
HONORABLE MICHAEL H. WOJCIK, Judge
HONORABLE ELLEN CEISLER, Judge
CONCURRING OPINION
BY JUDGE McCULLOUGH FILED: November 2, 2018
I join in the Majority’s affirmance of the Board of Finance and
Revenue’s application of section 303(a.2) of the Tax Reform Code of 19711
concerning minimum straight-line depreciation. However, I write separately to note
my concurrence as to its affirmance of the Board’s refusal to apply the tax benefit
1
Act of March 4, 1971, P.L. 6, as amended, added by the Act of June 29, 2002, P.L. 559,
72 P.S. §7303(a.2).
rule to reduce the personal income tax (PIT) liability of Robert J. Marshall, Jr.
(Marshall).
In my dissenting opinion in Marshall v. Commonwealth, 41 A.3d 67
(Pa. Cmwlth.) (en banc) (Marshall I), exceptions overruled, 50 A.3d 287 (Pa.
Cmwlth. 2012) (en banc), aff’d sub nom. Wirth v. Commonwealth, 95 A.3d 822 (Pa.
2014), cert. denied sub nom. Houssels v. Pennsylvania, 135 S. Ct. 1405 (2015), I
expressed the belief that the tax benefit rule should be applied to recognize the
economic reality in this case, i.e., Marshall lost his entire investment and did not
recognize anywhere near the amount attributed to him. On the contrary, Marshall
only realized $183,958.00, which is his pro rate share of the $121.6 million of
accrued but unpaid interest that was used to offset income from operations that was
subject to PIT. Under this scenario, Marshall would be subject to PIT in the amount
$5,648.00. However, given the clear precedent by our Supreme Court refuting the
use of the tax benefit rule in this case, I adopt the posture taken by Justice Sandra
Day O’Connor in Commissioner of Internal Revenue v. Tufts, 461 U.S. 300, 317
(1983); i.e., my preference is for “quite a different” approach if we were “writing on
a clean slate.”2
________________________________
PATRICIA A. McCULLOUGH, Judge
2
Tufts and its predecessor, Crane v. Commissioner, 331 U.S. 1 (1947), established the
notion that, for federal income tax purposes, the unamortized principal amount of a nonrecourse
loan is to be included in the amount realized from a sale or disposition of the real estate. However,
our United States Supreme Court in Tufts dealt with a specific provision of the Internal Revenue
Code, section 1001 (26 U.S.C. §1001), and not any provision of the PIT. Crane is factually
distinguishable as it involved the calculation of income tax on the sale of an apartment house which
had been acquired by a taxpayer by bequest and subject to an unassumed mortgage.
PAM - 2