IN THE COMMONWEALTH COURT OF PENNSYLVANIA
John Thompson, :
Petitioner :
:
v. : No. 188 F.R. 2016
: Argued: June 6, 2018
Commonwealth of Pennsylvania, :
Respondent :
:
Commonwealth of Pennsylvania, :
Petitioner :
:
v. : No. 215 F.R. 2016
: Argued: June 6, 2018
John Thompson, :
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 NOT REPORTED
MEMORANDUM OPINION
BY JUDGE BROBSON FILED: November 2, 2018
This is one of several related matters, challenging the assessment of
Pennsylvania personal income tax (PIT) liability on nonresident investors on account
of the 2005 foreclosure of a commercial property located in the City of Pittsburgh
(Property). We resolved the first round of appeals through en banc opinions and
orders issued in 2012, which the Pennsylvania Supreme Court affirmed in Wirth v.
Commonwealth, 95 A.3d 822 (Pa. 2014), cert. denied sub nom. Houssels v.
Pennsylvania, 135 S. Ct. 1405 (2015).1 Petitioner John Thompson (Taxpayer), a
resident of the State of Texas, is among the second round of challengers.2
In a decision dated February 24, 2016, the Board of Finance and
Revenue (Board) assessed Taxpayer’s PIT liability on account of the foreclosure of
the Property at $102,952, “plus appropriate interest, less any payments and credits
to his account.” Both Taxpayer and the Pennsylvania Department of Revenue
(Department) challenge aspects of the Board’s decision. We affirm.
I. BACKGROUND3
600 Grant Street Associates Limited Partnership (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.
1
Our lead opinion disposing of those earlier appeals was 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).
2
Others in the second round include Craig S. and Christine L. Andrews (Docket
Nos. 185, 212 F.R. 2016), Ronald S. Leventhal (Docket Nos. 186, 213 F.R. 2016), and Annette
Sharpe (Docket Nos. 187, 214 F.R. 2016).
3
The background is drawn from the parties’ Joint Stipulation of Facts (Stipulation) and
accompanying exhibits, which we adopt as our findings of fact in this de novo tax appeal. In so
doing, we note that the Stipulation is largely consistent with the facts as found by this Court in
Marshall I.
2
Interest on the PMM Note accrued on a monthly basis at a rate
of 14.55%. If 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 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.
Taxpayer purchased a limited partnership interest (1 unit) in the
Partnership on or about December 31, 1984, for $148,889. His 1 unit interest
amounted to a 0.151281% interest in the Partnership. Taxpayer was a passive
investor. 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 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 Taxpayer. Taxpayer filed Pennsylvania PIT
returns for tax years 1985 through 2005, reporting thereon his pass-through share4
4
Under 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, partnerships as legal
entities are not subject to PIT. Rather, the partners of the partnership pay PIT on their respective
shares of the partnership’s income or gain. Section 306 of the Code provides:
Except as provided under section 306.2[ of the Code, added by the Act of
July 9, 2013, P.L. 270, 72 P.S. § 7306.2], a partnership as an entity shall not be
subject to the tax imposed by this article, but income or gain of a member of a
3
of the Partnership losses “derived from or in the form of rents, royalties, patents and
copyrights,” which is one of eight separate classes of income subject to PIT under
Section 303 of the Code.5 In these tax years, Taxpayer had no offsetting income of
the same class.
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 comprehensive “Offering Memorandum” shared with
investors, 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 proceeds upon sale of the Property at maturity
would be sufficient to pay off the principal and accrued interest on the PMM Note,
with excess 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 amount to offset its income from operations that
would otherwise have been subject to PIT. Neither the Partnership nor Taxpayer
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
partnership in respect of 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.
5
Act of March 4, 1971, P.L. 6, as amended, added by the Act of August 4, 1991, P.L. 97,
72 P.S. § 7303. Specifically, Section 303(a)(4) of the Code provides for a class of income
encompassing “[n]et gains or income derived from or in the form of rents, royalties, patents and
copyrights.”
4
a liability of more than $2.6 billion, of which only $308 million represented
principal. Neither the Partnership nor its individual limited partners received any
cash or other property as a result of the foreclosure. That same year, the Partnership
terminated operations and liquidated. Taxpayer did not recover his capital
investment in the Partnership at foreclosure or liquidation. Indeed, Taxpayer did not
receive any cash or other property upon liquidation of the Partnership.
The Partnership reported a gain on foreclosure of the Property for tax
year 2005 on federal Form 1065 and Pennsylvania Form PA-65 (information return),
the overwhelming majority of which is attributable to the full amount of the PMM
Note debt obligation (principal plus accrued but unpaid interest) discharged upon
foreclosure. The Partnership reported to Taxpayer on Pennsylvania Schedule
NRK-1 for tax year 2005 his pass-through share of the Partnership gain, $3,764,028,
in the class of “[n]et gains or income from the disposition of property.”
Section 303(a)(3) of the Code.6 It also reported to Taxpayer his pass-through share
of the Partnership’s operating losses that year as Section 303(a)(4) class income.
6
Section 303(a)(3) of the Code 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 72 P.S. § 7303(a)(3)(iii)-(vii). None of
these exceptions, however, apply to the particular type of property disposition in this case.
5
In a Notice of Assessment dated May 9, 2008, the Department assessed
Taxpayer $115,556 in PIT liability, plus penalties and interest of $50,094.16, for a
total assessment of $166,520.16 (Assessment). In doing so, the Department
determined that Taxpayer had a taxable gain from the foreclosure for PIT purposes
in the amount of his pass-through share of the gain reported by the Partnership in its
informational filing—$3,764,028. Taxpayer filed a petition for reassessment with
the Department’s Board of Appeals (BOA), challenging the Assessment. On
August 24, 2015,7 BOA rejected the majority of Taxpayer’s arguments. It,
nonetheless, abated the assessed penalties in full and recalculated the amount of gain
realized by the Partnership upon disposition of the Property, accounting for annual
straight-line depreciation of the Property dating back to the year the Partnership
acquired it.8 Taxpayer’s pass-through share of the Partnership’s revised gain was
$3,635,796, thereby reducing Taxpayer’s principal PIT liability from $115,556 to
$111,619. The Department issued a Notice of Reassessment (Reassessment)
consistent with BOA’s determination.
Taxpayer appealed the Reassessment to the Board. Citing Wirth,
Taxpayer contended that the tax benefit rule should be applied to exclude from the
amount of the gain realized by the Partnership upon foreclosure that amount of prior
year operating losses attributable to accrued but unpaid interest deductions for which
the Partnership derived no tax benefit. Under Taxpayer’s view, this would reduce
7
BOA stayed consideration of Taxpayer’s petition pending the Pennsylvania Supreme
Court’s decision in Wirth.
8
As this Court noted in Marshall I, a gain for PIT purposes is recognized “where the
amount realized from the disposition of the property exceeds the adjusted basis of the property at
the time of disposition.” Marshall I, 41 A.3d at 81. Further, depreciation, allowed or allowable,
is one of the factors that determines the adjusted basis of property at disposition. Depreciation
reduces the basis of the property.
6
the amount realized by the Partnership from $2.6 billion to just $429,600,000,
reducing the taxable gain for the Partnership from $2,362,812,499 to
just $163,914,948. Concomitantly, Taxpayer’s PIT liability for his pass-through
share of the Partnership’s taxable gain would be reduced by approximately 93%.
Taxpayer also challenged BOA’s determination that the Partnership
was required to reduce its basis in the Property by straight-line depreciation dating
back to the year that the Partnership acquired the Property. Section 303(a.2) was
added to the Code by section 9 of Act 89 of 2002.9 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) of
the Code 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.
Taxpayer also argued that Pennsylvania lacks the authority to impose
PIT liability on Taxpayer in this case, because doing so would violate the Commerce
Clause of the United States Constitution.10 Taxpayer also contended that, in reality,
9
Act of June 29, 2002, P.L. 559.
U.S. Const. art. I, § 8, cl. 3 (conferring on Congress power “[t]o regulate Commerce . . .
10
among the several States”).
7
he did not experience a taxable gain in 2005 and, therefore, should not have to pay
PIT, citing Commonwealth v. Rigling, 409 A.2d 936 (Pa. Cmwlth. 1980). Finally,
in a conclusory paragraph, Taxpayer cited a litany of state and federal constitutional
violations and requested attorney’s fees pursuant to 42 U.S.C. §§ 1983 and 1988.
The Board granted Taxpayer’s request for relief from the Reassessment
in part and denied it in part. The Board revised downward the amount of gain
realized by the Partnership, agreeing with Taxpayer that the Partnership was not
required to reduce its basis in the Property by straight-line depreciation until the
2001 tax year. Consequently, the Board revised downward Taxpayer’s pass-through
share of the Partnership’s gain to $3,353,492, thereby reducing Taxpayer’s principal
PIT liability to $102,952. The Board, however, rejected Taxpayer’s other challenges
to the Reassessment. Taxpayer now appeals the Board’s rejection of his tax benefit
rule and Commerce Clause arguments, and the Department appeals the Board’s
interpretation and application of Section 303(a.2) of the Code, relating to
straight-line depreciation.11
II. DISCUSSION
This Court adequately addressed all of the issues in this appeal in our
opinion in Andrews v. Commonwealth, ___ A.3d ___ (Pa. Cmwlth.,
Nos. 185, 212 F.R. 2016, filed _____________, 2018). We incorporate that opinion
by reference and reach the same conclusions in this case.
11
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.
Pa., 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).
8
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.
9
IN THE COMMONWEALTH COURT OF PENNSYLVANIA
John Thompson, :
Petitioner :
:
v. : No. 188 F.R. 2016
:
Commonwealth of Pennsylvania, :
Respondent :
:
Commonwealth of Pennsylvania, :
Petitioner :
:
v. : No. 215 F.R. 2016
:
John Thompson, :
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
John Thompson, :
Petitioner :
: No. 188 F.R. 2016
v. :
:
Commonwealth of Pennsylvania, :
Respondent :
Commonwealth of Pennsylvania, :
Petitioner :
: No. 215 F.R. 2016
v. :
: Argued: June 6, 2018
John Thompson, :
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 NOT REPORTED
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
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).
concerning minimum straight-line depreciation. However, I concur with the
Majority’s affirmance of the Board’s refusal to apply the tax benefit rule to reduce
the personal income tax (PIT) liability of John Thompson, for the reasons set forth
in my Concurring Opinion in Marshall v. Commonwealth of Pennsylvania, ___ A.3d
___ (Pa. Cmwlth., Nos. 863 F.R. 2015 and 50 F.R. 2016, filed November 2, 2018).
________________________________
PATRICIA A. McCULLOUGH, Judge
PAM - 2