T.C. Memo. 2006-61
UNITED STATES TAX COURT
MAZHAR TABREZI, f.k.a. AGHA HUSSAIN, AND SAJIDA RAZVI,
Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5213-04. Filed March 30, 2006.
Richard D. Grossman, for petitioners.
Kathleen C. Schlenzig, for respondent.
MEMORANDUM OPINION
GOEKE, Judge: Respondent determined a deficiency in
petitioners’ 2001 Federal income tax of $43,829 and an accuracy-
related penalty of $8,765 pursuant to section 6662(a).1 After
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
(continued...)
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concessions,2 the remaining issues for decision are: (1) Whether
respondent has the burden of proof in this case under Rule
142(a); (2) whether petitioners must recognize cancellation of
indebtedness (COD) income under section 61(a)(12) of $62,707; and
(3) whether petitioners are liable for the accuracy-related
penalty under section 6662(a). We hold that (1) respondent has
the burden of proof in this case; (2) petitioners do not have to
recognize COD income because respondent failed to meet his burden
of proving that they were solvent on the date immediately
preceding the discharge of the debt (calculation date); and (3)
as a result, there is no accuracy-related penalty under section
6662(a).
1
(...continued)
Court Rules of Practice and Procedure.
2
On brief, respondent concedes that petitioners are not
liable for COD income attributable to the discharge of three
debts as determined in the notice of deficiency because that
income is excludable under sec. 108(a)(1)(B). However,
respondent also takes the position that petitioners must
recognize COD income of $62,707 from discharge of a fourth debt
that was not included in the notice of deficiency. In addition,
respondent continues to assert that petitioners are liable for
the accuracy-related penalty under sec. 6662(a). Respondent also
determined in the notice of deficiency that petitioners had gross
income of $13 in dividends received by Sajida Razvi from her
Mellon Investment Services account. Petitioners did not raise
this item of income in their petition or otherwise argue against
it throughout the litigation process. We therefore consider
petitioners to have conceded their liability on the dividend
issue.
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Background
Petitioners, who are husband and wife, resided in Glendale
Heights, Illinois, at the time of filing their petition. Between
December 1998 and May 1999, petitioners signed 22 notes as the
obligors in the aggregate principal of $2,529,700 and 22
mortgages securing those notes. Petitioner Sajida Razvi’s
brother, Syed Razvi, asked petitioners to sign the documents as a
personal favor to him. Petitioners signed the documents without
extensively reviewing them. Each note was used to purchase a
different property (all condominiums) and was secured by a
mortgage. There was a covenant in most of the notes and the
accompanying mortgages obligating either petitioner to pay the
full amount of principal and accrued interest of the debt.
Petitioners also signed 22 U.S. Department of Housing and Urban
Development (HUD) settlement statements in connection with each
mortgage. The principal amount due under each of the 22 notes
was over $100,000. Unknown to petitioners, the mortgages were
obtained by fraud because the fair market value of the properties
securing the mortgages was substantially inflated and, in some
cases, was in fact far less than the face amount of the notes
that petitioners signed.
In October 2004, Mr. Razvi was indicted for participating in
a scheme with others to defraud and obtain more than $27 million
of mortgage loan proceeds from various banks and mortgage lending
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institutions by means of materially false and fraudulent
pretenses. Petitioners, although mentioned in the indictment,
were not charged with any crime regarding their involvement in
Mr. Razvi’s fraudulent scheme, and there is no evidence in the
record that petitioners were aware of the fraudulent scheme.
Thereafter, most of the properties securing the mortgages were
foreclosed upon in separate actions, with petitioners named as
defendants. The sheriff then sold the properties in a judicial
sale pursuant to the decree of foreclosure. After the sale, the
Illinois State court where the actions were brought issued orders
approving the sales. Some sales resulted in deficiencies (i.e.,
the proceeds were less than the judgment amount). In those
cases, the plaintiffs (usually a bank or other type of commercial
lender) obtained an in rem deficiency judgment3 against the
properties but did not obtain an in personam judgment against
petitioners. Other sales resulted in zero deficiencies, and the
3
A judgment in rem affects the interests of all persons in
designated property, whereas a judgment in personam imposes a
personal liability or obligation on one person in favor of
another. Hanson v. Denckla, 357 U.S. 235 (1958). It is
characteristic of a judgment in rem that it operates on a thing
or status rather than against the person, and binds all persons
to the extent of their interest in the thing whether or not they
were parties to the proceedings. 50 C.J.S., Judgments, sec. 1054
(2005).
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outstanding debts were extinguished. During 2001, four of the
notes were partially discharged by the following lenders:
Initial Note Amount of Debt
Creditor Amount Canceled
Household $111,200 $62,707
Finance
Countrywide 127,200 74,670
Home Loans
Superior 111,200 103,171
Federal
Bank
Washington 111,200 75,615
Mutual
The Household Finance debt was canceled on April 27, 2001, and
the Superior Federal Bank debt was canceled on March 1, 2001.
The remaining debts listed were canceled in 2001. Petitioners
did not include the amounts of debts canceled as income in their
2001 joint Federal income tax return. Petitioners reported a
total income in 2001 of $78,416, comprising mostly wages.
On December 29, 2003, respondent issued petitioners a notice
of deficiency for the taxable year 2001. Respondent determined
that the amounts of canceled debt from Countrywide Home Loans,
Superior Federal Bank, and Washington Mutual should have been
included in petitioners’ gross income. Respondent did not
include the canceled debt of $62,707 from Household Finance in
the notice of deficiency but raised it at trial through the
stipulation of related exhibits without explaining that it was a
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new matter. In the posttrial brief, respondent conceded the
discharge of the other three mortgages did not result in COD
income because petitioners were insolvent on the calculation
dates and argued only for the inclusion of the Household Finance
debt in petitioners’ income. Also, respondent conceded that he
failed to include the Household Finance mortgage in the notice of
deficiency. Respondent did not attempt to amend any of his
pleadings.
Discussion
A. Petitioners’ Argument That Respondent’s Addition of the
Fourth Adjustment Increases the Overall Deficiency
Petitioners question whether respondent met the requirements
of section 6214(a), which provides:
SEC. 6214. DETERMINATIONS BY THE TAX COURT.
(a) Jurisdiction as to Increase of Deficiency,
Additional Amounts, or Additions to the Tax.--* * *
[T]he Tax Court shall have jurisdiction to redetermine
the correct amount of the deficiency even if the amount
so redetermined is greater than the amount of the
deficiency * * * and to determine whether any
additional amount, or any addition to the tax should be
assessed, if claim therefor is asserted by the
Secretary at or before the hearing or a rehearing.
Although respondent argued on brief that the Household Finance
mortgage gave rise to COD income without seeking to amend his
pleadings, see Henningsen v. Commissioner, 243 F.2d 954 (4th Cir.
1957), affg. 26 T.C. 528 (1956); Koufman v. Commissioner, T.C.
Memo. 1977-225; Mazzoni v. Commissioner, T.C. Memo. 1970-37,
supplemented T.C. Memo. 1970-144, affd. 451 F.2d 197 (3d Cir.
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1971); Cascade Milling & Elevator Co. v. Commissioner, 25 B.T.A.
946 (1932), respondent conceded that the COD income from the
discharge of the three mortgages (Countrywide Home Loans,
Superior Federal Bank, and Washington Mutual) identified in the
notice of deficiency qualified under the exception to COD income
provided in section 108(a)(1)(B) because petitioners were
insolvent on the dates those mortgages were discharged. The new
adjustment claimed by respondent to be COD income is $62,707,
while the three mortgages respondent treated in the notice of
deficiency as giving rise to COD income totaled $253,456.
Therefore, since there is no assertion of an overall increase in
deficiency, this case does not fall under section 6214. However,
by claiming that an amount arising from a different mortgage is
COD income, respondent has raised a new matter and therefore
under our Rules has the burden of proof in regard to that claim.
B. Burden of Proof
Gross income includes income from the cancellation of
indebtedness. Sec. 61(a)(12). However, an exception to the
inclusion of COD income in gross income is provided for taxpayers
who are insolvent at the time of cancellation of indebtedness.
Sec. 108(a)(1)(B). The determination of insolvency is based on
the taxpayer’s liabilities and assets immediately before the
discharge of debt. Sec. 108(d)(3). Petitioners claim that they
were insolvent on the calculation date. Normally, the burden of
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proof is on the taxpayers. Rule 142(a). Accordingly, the burden
of establishing that the insolvency exception applies is
generally placed on the taxpayers. Traci v. Commissioner, T.C.
Memo. 1992-708; Bressi v. Commissioner, T.C. Memo. 1991-651,
affd. 989 F.2d 486 (3d Cir. 1993). In order to prove insolvency
and therefore qualify for the exception under section
108(a)(1)(B), a taxpayer
must prove by a preponderance of the evidence that he
or she will be called upon [as of the date of
cancellation of the debt] to pay an obligation claimed
to be a liability and that the total amount of
liabilities so proved exceed the fair market value of
his or her assets.
Merkel v. Commissioner, 192 F.3d 844, 850 (9th Cir. 1999), affg.
109 T.C. 463, 468 (1997).
There are exceptions to the general rule that the taxpayers
bear the burden of proof. See Rule 142(a)(1). One of those
exceptions is if the Commissioner raises a “new matter”. Id. If
the new matter is allowed to be raised, Rule 142(a) requires that
the Commissioner bear the burden of proof. Shea v. Commissioner,
112 T.C. 183, 190-191 (1999). The Commissioner raises a new
matter when he “attempts to rely on a basis that is beyond the
scope of the original deficiency determination”. Id. In
particular, a new matter is raised when the Commissioner’s new
theory “‘either alters the original deficiency or requires the
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presentation of different evidence.’” Id. at 191 (quoting Wayne
Bolt & Nut Co. v. Commissioner, 93 T.C. 500, 507 (1989)).
Thus, we conclude that respondent has raised a new matter.
Respondent went beyond the scope of the original deficiency
determination by arguing in his posttrial brief that the
discharge of the Household Finance mortgage gave rise to COD
income. The deficiency determined in the notice of deficiency
was based on COD income from the discharge of three other
mortgages. Different evidence is required to show that the
Household Finance mortgage generated COD income, because the date
of its cancellation, and thus the date for determining
petitioners’ solvency for purposes of section 108(a)(1)(B) and
(d)(3), differs from the date on which any of the other three
mortgages was canceled. Therefore, respondent bears the burden
of proof and must show, by a preponderance of the evidence, that
petitioners were solvent under section 108(a)(1)(B) as of the
calculation date. For the reasons discussed below, we conclude
that respondent has failed to meet his burden of proof.
C. Respondent’s Failure To Meet His Burden of Proof
In order to establish petitioners’ solvency as of the
calculation date, respondent must prove by a preponderance of the
evidence that the fair market value of petitioners’ assets then
exceeded their liabilities. See Merkel v. Commissioner, 109 T.C.
483, 484 (1997). To exclude from that calculation any portion of
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an obligation claimed by petitioners to be a liability,
respondent must prove that it is more probable than not that
petitioners would not be called upon to pay that portion of the
obligation claimed. Id.
Respondent has failed to prove that the value of
petitioners’ assets exceeded their liabilities as of the
calculation date of April 26, 2001. The record shows that
petitioners had $210,764 in assets with known values, and
respondent concedes that petitioner had $213,120 in liabilities
on the calculation date. Respondent claims that petitioners
failed to introduce evidence with respect to the values of
several of their assets and therefore failed to prove that they
were insolvent. However, the burden of proof is on respondent.
Therefore, respondent had the burden to produce evidence that
petitioners were not insolvent. Respondent has not done so.
Petitioners argue that under Illinois State law they were
still personally liable for several of their mortgage debts as of
the calculation date of April 26, 2001, because the foreclosure
sales that took place with respect to those debts had not yet
been approved by the Illinois State court. See, e.g., Citicorp
Sav. v. First Chicago Trust Co., 645 N.E.2d 1038, 1045 (Ill. App.
Ct. 1995); 27A Ill. Law and Practice, Mortgages, sec. 87 (2005)
(quoting Morgan v. Sherwood, 53 Ill. 171 (1870)). Since we have
decided that respondent had the burden of proof in this case and
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failed to meet his burden, it is unnecessary for us to decide
whether petitioners’ liabilities on the calculation date were
greater than the amount respondent conceded.
Conclusion
Because he introduced a new matter, respondent has the
burden under Rule 142(a) of proving that petitioners were
insolvent. Rule 142(a). Respondent failed to meet that burden.
We therefore hold that no COD income is includable in
petitioners’ gross income for the year in suit. In addition,
because we find there is no COD income, there is no addition to
tax.
To reflect petitioners’ concession of the dividend income,
and the foregoing,
Decision will be
entered under Rule 155.