T.C. Memo. 2011-46
UNITED STATES TAX COURT
DOMINICK DENAPLES AND MARY ANN DENAPLES, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
LOUIS DENAPLES AND BETTY A. DENAPLES, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent*
Docket Nos. 14357-08, 14359-08. Filed February 24, 2011.
Ps filed a motion for reconsideration of our opinion in
DeNaples v. Commissioner, T.C. Memo. 2010-171, and a motion
to vacate or revise the decisions entered thereunder,
arguing that our disposition of these cases constitutes
substantial error.
Held: Ps’ motions will be denied.
*
This opinion supplements our previously filed Memorandum
Opinion in DeNaples v. Commissioner, T.C. Memo. 2010-171.
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David B. Blair, Joel C. Weiss, Layla J. Aksakal, and Barry
H. Frank, for petitioners.
Peter James Gavagan, for respondent.
SUPPLEMENTAL MEMORANDUM OPINION
NIMS, Judge: These cases remain before the Court on
petitioners’ Motion for Reconsideration of Memorandum Opinion
Pursuant to Tax Court Rule 161 (Motion for Reconsideration) and
Motion to Vacate or Revise Decisions Pursuant to Tax Court Rule
162 (Motion to Vacate). Since the Motion for Reconsideration and
Motion to Vacate (collectively, the Motions) are interconnected,
we deal with them together. The Motions relate to our Memorandum
Opinion DeNaples v. Commissioner, T.C. Memo. 2010-171, filed
August 3, 2010, which we incorporate herein, and the decisions
entered thereunder.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
Background
We adopt the findings of fact in our prior Memorandum
Opinion, DeNaples v. Commissioner, supra. For convenience and
clarity, we will repeat the facts necessary to understand the
discussion that follows.
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The Pennsylvania Department of Transportation
(PENNDOT) took property, owned by Dominick and Louis DeNaples
(petitioners) through three passthrough entities (condemnees), by
eminent domain by filing a series of declarations of taking from
1993 to 1998. The condemnees ultimately settled with PENNDOT
(the Settlement Agreement), agreeing to a $40,900,000 payment
(the Settlement Amount) which was allocated $24,638,555 to
principal and $16,261,445 to interest (Settlement Interest).
Payment was to be made in installments, with interest accruing
annually on the unpaid Settlement Amount (Installment Payment
Interest) at the rate set by rule 238 of the Pennsylvania Rules
of Civil Procedure.
PENNDOT accordingly paid petitioners (who were responsible
for distributing the installment payments to the condemnees) each
$10,111,193 in 2003, $9,289,353 in 2004, and $17,739,276 in 2005.
On their 2003 through 2005 Forms 1040, U.S. Individual Income Tax
Return, each petitioner reported as taxable interest income only
the portion of the Settlement Interest representing interest on
the principal at the 6-percent rate of interest for delay damages
provided under 26 Pa. Stat. Ann. sec. 1-611 (West 2006) because
petitioners believed that PENNDOT was legally required to pay
only this amount. Petitioners believed that the remainder of the
Settlement Interest and all of the Installment Payment Interest
were instead paid pursuant to PENNDOT’s voluntary exercise of its
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borrowing power. Petitioners thus excluded those amounts from
gross income as tax-exempt interest under section 103.
Respondent issued notices of deficiency to each petitioner
determining that the excluded interest was not tax exempt. The
notices did not, however, dispute petitioners’ allocation of the
Settlement Amount between principal and interest.
In our Memorandum Opinion in DeNaples v. Commissioner,
supra, we found the rate at which the Settlement Interest had
accrued could not be determined because the settlement allocation
appeared to be the product of an arbitrary assignment by
petitioners and PENNDOT rather than a mathematical computation of
interest. We also held that the constitutional requirement of
just compensation obligated PENNDOT to pay interest at the
prevailing commercial loan rate of interest from the date of the
taking until the date of payment. Because petitioners submitted
no evidence of the commercial loan rates during that period, we
held that they had failed to carry their burden of proving that
PENNDOT paid any interest in excess of the legally required
amount. We therefore did not reach the issue of whether
petitioners could exclude any such excess interest. Thereafter,
we entered decisions in favor of respondent for the amounts set
forth in the notices of deficiency.
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Discussion
I. Motion for Reconsideration
Reconsideration under Rule 161 serves the limited purpose of
correcting manifest errors of fact or law or allowing for the
introduction of newly discovered evidence that could not have
been introduced before the filing of an opinion even if the
moving party had exercised due diligence. Estate of Quick v.
Commissioner, 110 T.C. 440, 441 (1998). The granting of a motion
for reconsideration rests within the discretion of the Court, and
taxpayers must show unusual circumstances or substantial error
for their motion to be granted. Id.
Petitioners argue that our Memorandum Opinion contains
substantial errors of fact and law regarding PENNDOT’s legal
obligation to pay the Installment Payment Interest because they
claim it ignores the Court of Appeals for the Ninth Circuit’s
instruction that “In * * * [cases involving an agreement entered
in connection with a condemnation proceeding], courts must
determine whether the agency’s obligation to pay interest arises
by operation of law, rather than as the result of voluntary
bargaining.” See Stewart v. Commissioner, 714 F.2d 977, 983 (9th
Cir. 1983) (Stewart I), affg. T.C. Memo. 1982-209. Petitioners
contend that PENNDOT lacked the necessary funds to immediately
pay the Settlement Amount and requested that payments be made on
an installment basis because it needed credit. Petitioners claim
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that the obligation to pay interest under an installment
agreement has been held in similar circumstances to be the
product of voluntary bargaining. See Stewart v. United States,
739 F.2d 411 (9th Cir. 1984) (Stewart II); Stewart v. United
States, 57 AFTR 2d 86-1093, 86-1 USTC par. 9372 (D. Ariz. 1986)
(Stewart III).
In Stewart II, the taxpayers sold their land to the city of
Phoenix under threat of condemnation. The city agreed to pay for
the property in installments with 6-percent interest accruing on
the unpaid balance. The Court of Appeals for the Ninth Circuit
remanded because the joint factual stipulation of the parties did
not address whether the taxpayers and the city had agreed to the
installment payments because the taxpayers wanted the benefit of
installment reporting or because the city wanted credit.
On remand, the District Court found in Stewart III that the
city did not have the cash necessary to purchase the taxpayers’
property and agreed to the installment agreement because it
wanted credit. The District Court therefore entered judgment
that the interest was excludable from the taxpayers’ gross income
by reason of section 103.
In Holley v. United States, 124 F.2d 909 (6th Cir. 1942),
the city of Detroit was in financial difficulty and entered into
an installment agreement with the taxpayer in contemplation of
the completion of condemnation proceedings. In holding that the
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interest on the installment payments was not exempt, the Court of
Appeals for the Sixth Circuit stated:
While the contract to defer payment was voluntary, the
taking was not, all the proceedings being under the power of
eminent domain and necessarily compulsory upon the
appellant. The compensation therefore had to be that
required in condemnation proceedings, namely, the full
equivalent of the value of the land at the time of the
taking. Under such circumstances, the interest is
considered to be a part of the award itself, and essential
to just compensation for the land where it is taken before
full payment is made. * * * [Id. at 910.]
In Drew v. United States, 551 F.2d 85 (5th Cir. 1977), and
King v. Commissioner, 77 T.C. 1113 (1981), the taxpayers sold
their property to the Trinity River Authority (TRA) under threat
of condemnation. The taxpayers elected to receive part of their
compensation in the form of interest-bearing warrants. In Drew
v. United States, supra at 89, the Court of Appeals for the Fifth
Circuit stated that “The fact that TRA allowed them and other
landowners to elect to receive compensation on a deferred basis,
and thereby to obtain the additional tax advantage of installment
reporting, did not convert the transaction to a voluntary one.”
In King v. Commissioner, supra, our Court adopted the reasoning
in Drew in also holding that the interest on the warrants was not
excludable.
Petitioners argue that their cases are distinguishable from
Drew in that PENNDOT did not have the funds necessary to pay the
Settlement Amount and that PENNDOT approached petitioners
regarding the installment payments.
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Petitioners contend that if we follow the Court of Appeals
for the Ninth Circuit’s approach in considering the Settlement
Agreement independently, we should treat PENNDOT’s obligation to
pay the Installment Payment Interest as having arisen under
PENNDOT’s exercise of its borrowing power because PENNDOT lacked
the money to pay the Settlement Amount. Petitioners rely on
Stewart II, where the court remanded to determine whether the
City needed credit because it lacked the money to purchase the
taxpayers’ property.
Our cases, however, are distinguishable from Stewart II in
that it involves a different type of transaction. Whereas
Stewart II dealt with a sale made under threat of condemnation,
PENNDOT acquired petitioners’ property by exercising its power of
eminent domain. The difference between these two types of
transactions is explained in Stewart II, 739 F.2d at 413: “This
case is different from Stewart [I] because here no condemnation
proceedings were ever instituted. Therefore, the City was under
no legal obligation to pay interest as it was in Stewart [I].”
In contrast, where condemnation proceedings have been
instituted, the government does have a legal obligation to pay
some amount of interest. In Stewart I, that amount of legally
required interest exactly equaled the amount of interest under
the financing agreement. As a result, the court held that the
city’s obligation to pay interest arose by operation of law.
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Here, it is unclear whether the Installment Payment Interest
exceeded the legally required amount because petitioners did not
submit any evidence of the legal rate of interest (i.e., the
commercial loan rate) during the relevant years. Therefore,
petitioners may not exclude any of the Installment Payment
Interest because they failed to satisfy their burden of proving
that PENNDOT paid any interest in excess of the legally required
amount. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933). Because petitioners have not shown any payment of excess
interest, we need not reach the question of whether a payment of
excess interest would be sufficient to entitle them to an
exclusion under section 103.
Although petitioners submitted an allocation of the
Settlement Amount between principal and interest, we rejected
that allocation as inaccurate. Since petitioners offered no
other evidence from which we can determine the correct
allocation, the record provides no basis for determining how much
of the Settlement Amount would represent interest.
Petitioners wish to perform alchemy by using the Settlement
Agreement to transmute legally required interest into tax-exempt
interest. The Court of Appeals for the Ninth Circuit did not
permit the taxpayers in Stewart I to do so by entering into a
financing agreement which called for the same amount of interest
as that which the City was required to pay by operation of law.
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Since petitioners have not proven that PENNDOT paid any amount in
excess of the legally required amount, they likewise cannot
convert the Installment Payment Interest into tax-exempt
interest.
Furthermore, because the Court of Appeals for the Third
Circuit has not examined the issue of interest under a financing
agreement entered into in connection with the condemnation of
property, our decision in King v. Commissioner, supra, remains
binding precedent. Our prior Memorandum Opinion is consistent
with the holding of King v. Commissioner, supra, and thus
contains no substantial error of fact or law.
For these reasons, we will deny petitioners’ Motion for
Reconsideration.
II. Motion to Vacate
Rule 162 allows a party to file a motion to vacate or revise
a decision within 30 days after the decision has been entered,
unless the Court permits that 30-day period to be extended. The
disposition of a motion to vacate or revise a decision lies
within the sound discretion of the Court. Vaughn v.
Commissioner, 87 T.C. 164, 166-167 (1986). Although Rule 162
does not provide any standard for evaluating such a motion, Rule
1(b) provides that we may give weight to the Federal Rules of
Civil Procedure (FRCP) “to the extent that they are suitably
adaptable to govern the matter at hand.”
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We have often referred to FRCP 60 and cases applying FRCP 60
to assist us in resolving issues raised in a motion to vacate
decision under Rule 162. See Cinema ’84 v. Commissioner, 122
T.C. 264, 267-268 (2004), affd. 412 F.3d 366 (2d Cir. 2005);
Brannon’s of Shawnee, Inc. v. Commissioner, 69 T.C. 999, 1001
(1978); Kun v. Commissioner, T.C. Memo. 2004-273. Grounds for
relief under FRCP 60 include mistake, newly discovered evidence
that could not have been discovered with reasonable diligence,
and “any other reason that justifies relief.” FRCP 60(b)(1),
(2), and (6). In the Court of Appeals for the Third Circuit,
relief under FRCP 60(b)(6) requires a showing of extraordinary
circumstances. Coltec Indus., Inc. v. Hobgood, 280 F.3d 262, 273
(3d Cir. 2002).
Petitioners claim that “Given the Court’s findings that the
allocation of $16,261,445 of the Settlement Amount to interest
did not reflect a genuine interest charge, it follows that
petitioners’ returns * * * overstated the portion * * * that
represented interest income, and understated * * * principal.”
Because the notices of deficiency are premised on the theory that
the amounts petitioners reported as tax-exempt interest are not
exempt but do not challenge the characterization of the reported
amounts, petitioners contend that the deficiencies determined by
respondent are excessive because they understate petitioners’
capital gains and overstate their ordinary income as a result of
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that understatement of principal. Petitioners contend that we
should have ordered the parties to recompute petitioners’
deficiencies under Rule 155. Petitioners ask us to vacate the
decisions because they argue that failure to do so will affect
the substantial rights of the parties and would be inconsistent
with substantial justice.
Petitioners misstate our findings regarding the allocation
of the Settlement Amount. We found only that the allocation was
inaccurate and that petitioners had therefore failed to meet
their burden of proof. That finding does not establish that
interest had been overstated.
In addition, directing the parties to recompute petitioners’
deficiencies under Rule 155 would have been inappropriate because
the Rule 155 computation process is not intended to provide
either party an opportunity to raise or relitigate issues. See
Cloes v. Commissioner, 79 T.C. 933, 935 (1982); Estate of Papson
v. Commissioner, 74 T.C. 1338, 1340 (1980). Petitioners already
had an opportunity to litigate the issue of the correct amount of
Settlement Interest. Petitioners chose to submit these cases
fully stipulated. Recomputation of petitioners’ deficiencies
would require relitigation of the issue because contrary to
petitioners’ contention, determining the correct amount of
Settlement Interest is not simply “a computational matter of
applying the appropriate discount rate to the known Settlement
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Amount over the known periods of delay.” The appropriate
discount rates are not part of the record, and establishing those
rates (which would be based on the prevailing commercial loan
rates of interest) would require the introduction of additional
evidence. Thus, we did not err in entering decisions based on
the deficiencies determined in the notices of deficiency rather
than directing the parties to recompute the deficiencies under
Rule 155. Petitioners are not entitled to relief because they
have not shown any error in our decisions.
Nor are petitioners entitled to relief under FRCP 60(b)(2)
because proof of the commercial loan rates would not be newly
discovered evidence.
We are not swayed by petitioners’ appeal to justice because
the deficiencies determined by respondent are based on the
figures that petitioners themselves reported on their returns.
Thus, if the notices of deficiency overstate the amounts of
interest and understate the amounts of principal, they do so
because petitioners misreported these amounts. Petitioners had
access to the information necessary to determine the correct
allocation of interest and principal in the Settlement Amount.
Yet from the time petitioners completed their returns until the
time we issued our Memorandum Opinion, petitioners claimed an
amount of interest which they now contend to be excessive when it
was presumptively to their advantage to allocate as much of the
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Settlement Amount to interest as possible. Since we held the
Settlement Interest is not excludable, petitioners would benefit
from allocating a greater portion of the Settlement Amount to
principal and now seek to do so. Allowing petitioners to game
the tax system in this manner would hardly serve the interests of
justice.
For these reasons, we will deny petitioners’ Motion to
Vacate.
To reflect the foregoing,
Appropriate orders will be
issued denying petitioners’
Motion for Reconsideration and
Motion to Vacate.