T.C. Memo. 2007-271
UNITED STATES TAX COURT
SARA J. BURNS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11924-04. Filed September 12, 2007.
John W. Sunnen, for petitioner.
Erin K. Huss, for respondent.
MEMORANDUM OPINION
CARLUZZO, Special Trial Judge: In a notice of deficiency
dated April 13, 2004, respondent determined a $41,723 deficiency
in petitioner’s 1999 Federal income tax. The issue for decision
is whether a reward payment (the reward) petitioner was entitled
to receive in 1999 is includable in her income for that year even
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though in a bankruptcy proceeding initiated by petitioner the
reward was determined to be subject to the claim of a creditor.
Background
Some of the facts have been stipulated and are so found.
At the time the petition was filed petitioner resided in
California.
On September 24, 1991, petitioner sued her former employer,
Family Practice Associates of San Diego (FPASD), for Medicare
fraud in what is commonly referred to as a qui tam action, filed
under the False Claims Act, 31 U.S.C. sec. 3729 (2000), in the
U.S. District Court for the Southern District of California (the
whistle-blower case). The whistle-blower case was settled
pursuant to an agreement between the United States and FPASD in
which FPASD agreed to pay $2 million to the United States in four
annual installments, beginning in 1996. Under the statutory
scheme, petitioner was entitled to a reward of 29 percent of the
$2 million settlement, or $580,000, also payable over a 4-year
period beginning in 1996.
Petitioner received the first three installment payments in
due course. In 1998, petitioner was sued in a California court
(the lawsuit) by Bradley Proulx (Proulx), a private investigator
who petitioner had hired to assist her in connection with the
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initiation, investigation, and prosecution of the whistle-blower
case. According to Proulx, petitioner had failed to pay him what
he was due pursuant to the contract between them.1 As a result
of the lawsuit, in October 1998 Proulx was awarded a $231,463
judgment against petitioner. In accordance with California law,
following the judgment Proulx initiated proceedings that gave
rise to a lien on petitioner’s nonexempt personal property,
including, as it turned out, the proceeds from the reward.
Aware that the fourth installment of the reward was soon
due and potentially subject to the above-referenced lien, on
January 25, 1999, petitioner initiated a voluntary chapter 13
bankruptcy proceeding in the U.S. Bankruptcy Court for the
Southern District of California (the first bankruptcy
proceeding). On February 2, 1999, Proulx filed an Ex Parte
Application for Order to Pay Trustee (the ex parte application)
in the first bankruptcy proceeding seeking an order from the
bankruptcy court authorizing the U.S. Government to pay the
chapter 13 trustee the final reward installment due petitioner
from the whistle-blower case.
1
The terms of the contract are unclear but apparently
involved a contingency fee based upon petitioner’s recovery.
If the contract was reduced to writing, the document was not
made part of the record in either the lawsuit or this proceeding.
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On February 4, 1999, petitioner filed an opposition to
Proulx’s ex parte application. Petitioner argued that the relief
sought by Proulx in the ex parte application was improper for
various reasons but offered to place the final reward installment
then due to her from the U.S. Government into a segregated,
interest-bearing special attorney-client trust account with her
bankruptcy counsel’s firm, Robbins & Keehn (the trust account),
under the conditions that there would be no withdrawals from the
trust account without: (1) An order from the bankruptcy court;
or (2) the consent of Proulx.
On February 22, 1999, the bankruptcy court directed the U.S.
Government to make the final installment of petitioner’s reward
and further
ordered that * * * [petitioner’s bankruptcy attorney
and his firm] are hereby instructed to place the funds
from * * * [the reward] into * * * [the trust account].
These funds may not be disbursed without further order
of this court. Further, in the event that * * *
[petitioner] dismisses her Chapter 13 action, the funds
shall remain in * * * [the trust account] pending
further order of this court.
The reward was paid to petitioner by U.S. Treasury check
dated February 26, 1999. The check represented the fourth
installment of the reward due petitioner as a result of the
settlement from the whistle-blower case. The check was issued to
petitioner “c/o Charles F. Robbins Esq., Robbins & Keehn, 530 B
Street, Ste. 2400, San Diego, CA 92101”. Petitioner endorsed the
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check and wrote “for deposit only * * * [trust account]” on the
back. During 1999, the $148,680 in settlement proceeds earned
$1,299 in interest while on deposit in the trust account.
Throughout the pendency of the first bankruptcy proceeding,
Proulx, through actions taken in that proceeding as well as
actions taken in California courts, attempted to collect on his
judgment against petitioner. Petitioner, at all times, resisted
his efforts.
On August 13, 1999, petitioner filed for chapter 7
bankruptcy (the second bankruptcy proceeding). Had petitioner
not filed the second bankruptcy petition, petitioner might have
been required to pay over the reward proceeds to Proulx pursuant
to a State court order. Pursuant to the second bankruptcy
proceeding, the reward proceeds were transferred from the trust
account to Richard Kipperman (Kipperman), the chapter 7 trustee.
On September 4, 2001, Kipperman initiated an adversary action
against Proulx in order to determine whether Proulx’s lien
attached to the reward proceeds. A series of proceedings
ultimately determined that it did. As it turned out, the
conflict between Proulx and petitioner would not be resolved
until the middle of 2003.
Taking into account an extension, petitioner’s 1999 Federal
income tax return was timely filed. Receipt of the $148,680
reward is disclosed on line 21 of that return. The amount of the
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reward is offset by $151,489 because, according to an explanation
contained on the return, petitioner “did not constructively
received [sic] these amounts”. The amount reported on line 21 of
petitioner’s 1999 return is a net loss of $2,809.
In the notice of deficiency that forms the basis for this
case, respondent proceeded as though the reward ($148,680) and
the interest earned on that amount while it was on deposit in the
trust fund ($1,299) were omitted from the income reported on
petitioner’s return.2 Other adjustments made in the notice of
deficiency have been agreed to by the parties and need not be
addressed. Furthermore, respondent now concedes that to the
extent that the reward is includable in petitioner’s 1999 income,
she is entitled to a deduction in the same amount. See secs.
212, 461(f).3
Discussion
Absent the complications that followed from Proulx’s
contractual claim against petitioner, the reward would be
includable in petitioner’s 1999 income, and neither party
2
Presumably, this case could be resolved by addressing
petitioner’s entitlement to what is, in effect, a $151,489
deduction, as the $148,680 reward is, in effect, included in the
income reported on petitioner’s return. In fairness to the
parties, however, the Court will address the issues as framed by
the pleadings and briefs.
3
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for 1999, and Rule references are
to the Tax Court Rules of Practice and Procedure.
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suggests otherwise. Secs. 61, 451(a); Commissioner v. Glenshaw
Glass Co., 348 U.S. 426 (1955); Roco v. Commissioner, 121 T.C.
160, 164-165 (2003) (payment made by the U.S. Government to the
taxpayer in a qui tam action is a reward and, as such, is
includable in gross income); sec. 1.61-2(a)(1), Income Tax Regs.
According to petitioner, however, the reward is not includable in
her 1999 income because she did not “constructively receive” the
reward during that year. In support of her position, petitioner
argues that because the distribution of the proceeds of the
reward was subject to an order of the bankruptcy court during
1999, she could not exercise the necessary dominion and control
over the reward to render it includable in her income for that
year. See sec. 1.451-2(a), Income Tax Regs.4
At the outset we should note that, as a general explanation
of the topic, we agree with petitioner’s discussion of the
doctrine of constructive receipt contained in her briefs. We
4
The term “constructive receipt” is defined in sec. 1.451-
2(a), Income Tax Regs., as follows:
(a) General rule. Income although not actually reduced
to a taxpayer’s possession is constructively received
by him in the taxable year during which it is credited
to his account, set apart for him, or otherwise made
available so that he may draw upon it at any time, or
so that he could have drawn upon it during the taxable
year if notice of intention to withdraw had been given.
However, income is not constructively received if the
taxpayer’s control of its receipt is subject to
substantial limitations or restrictions.
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further agree that petitioner did not “constructively” receive
the reward in 1999. Instead, as we view the situation, she
actually received the reward during that year.5 Petitioner’s
reliance upon the doctrine of constructive receipt ignores the
simple fact that it was petitioner who volunteered6 to place the
reward in the custody of the bankruptcy court. The “dominion and
control” over the reward implicit in her decision to do so
completely undermines petitioner’s claim that she lacked any
such dominion or control over the reward. See Sullivan v.
Commissioner, T.C. Memo. 1999-341. For what it’s worth, we think
it also important to note that the doctrine of constructive
receipt, in general, addresses questions regarding when, not
whether, income is realized by a cash basis taxpayer. Taken to
its extremes, petitioner’s argument would suggest that because
Proulx ultimately prevailed, the reward would never be includable
in her income. Such a conclusion is wholly inconsistent with the
5
Although not expressly addressed by the parties, it is
clear from their respective positions that petitioner computed
her 1999 Federal income tax liability in accordance with the cash
receipts and disbursements method of accounting (cash basis).
Sec. 1.446-1(c)(1)(i), Income Tax Regs., provides, in part, as
follows: “Generally, under the cash receipts and disbursements
method in the computation of taxable income, all items which
constitute gross income * * * are to be included for the taxable
year in which actually or constructively received.”
6
We appreciate petitioner’s point that it was a hard
choice. Nevertheless, it was her choice.
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principle that a taxpayer does not escape taxation on what is
otherwise the taxpayer’s income merely because the income was
paid directly to the taxpayer’s creditor. Helvering v. Horst,
311 U.S. 112 (1940); Parkford v. Commissioner, 133 F.2d 249, 251
(9th Cir. 1943).7
Furthermore, we think it appropriate to note that, contrary
to petitioner’s arguments, the above-described bankruptcy
proceedings are, for the most part, irrelevant. The bankruptcy
court did not focus on the nature of the reward as an item of
income but rather as an asset available as a source of payment to
petitioner’s creditors. See Parkford v. Commissioner, supra at
251.
Similarly, petitioner’s reliance on Cold Metal Process Co.
v. Commissioner, 17 T.C. 916 (1951), affd. per order 53-1 USTC
par. 9135 (6th Cir. 1952), Barnette v. Commissioner, T.C. Memo.
1992-371, affd. without published opinion 41 F.3d 667 (11th Cir.
1994), Stone v. Commissioner, T.C. Memo. 1984-187, Collins v.
Commissioner, T.C. Memo. 1972-170, and Hannaford v. Commissioner,
7
Curiously, and if only by implication, petitioner
recognizes this principle as she argues in the alternative that
to the extent that the reward is includable in her income, it
should be includable in her 1998 income because that was the year
Proulx’s lien arose. A creditor’s collection rights against a
taxpayer’s property, however, say little about when a cash basis
taxpayer realizes income.
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T.C. Memo. 1960-78, is misplaced.8 The taxpayer in Cold Metal
Process Co. was on the accrual method of accounting, and any
precedents established by that case simply have no application to
the issue in dispute here. In each of the other cases there was
a question regarding whether the taxpayer was entitled to receive
the disputed income. Unlike the taxpayers in those cases,
petitioner was clearly entitled to the reward in 1999; the only
question at the time was how much of the reward she would be
entitled to retain.
The reward is includable in petitioner’s 1999 income, and
respondent’s adjustment to that end is sustained. We need not
discuss the treatment of the $1,299 interest earned on the reward
proceeds while they were on deposit in the trust fund because the
parties have agreed on that treatment. Finally, as noted above,
respondent now agrees that petitioner is entitled to a
miscellaneous itemized deduction in an amount equal to the amount
includable in her income, and petitioner agrees that the
imposition of the section 55 alternative minimum tax that results
is computational.
8
Stone v. Commissioner, T.C. Memo. 1984-187, might very
well apply to the interest earned on the reward proceeds while
they were on deposit in the trust account. However, the parties
have by their agreement removed the treatment of the interest
from the Court’s consideration.
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To reflect the foregoing,
Decision will be entered
under Rule 155.