United States District Court, W.D. Washington
WASHINGTON MUTUAL, INC. AS THE SUCCESSOR IN INTEREST TO H.F. AHMANSON & CO. AND SUBSIDIARIES, Plaintiff
UNITED STATES OF AMERICA, Defendant
For Washington Mutual Inc, as successor in interest to H.F. Ahmanson & Co. and Subsidiaries, Plaintiff: David J. Burman, LEAD ATTORNEY, Jeffrey M Hanson, PERKINS COIE (SEA), SEATTLE, WA; Maria O'Toole Jones, LEAD ATTORNEY, PRO HAC VICE, Steven R Dixon, PRO HAC VICE, MILLER & CHEVALIER, WASHINGTON, DC; Thomas D Johnston, LEAD ATTORNEY, PRO HAC VICE, SHERMAN & STERLING, WASHINGTON, DC; Richard J. Gagnon, Jr., PRO HAC VICE, SHERMAN & STERLING LLP, WASHINGTON, DC.
For United States of America, Defendant: David N. Geier, Henry C Darmstadter, James Edward Weaver, LEAD ATTORNEYS, U.S. DEPARTMENT OF JUSTICE (TAX - BOX 683), WASHINGTON, DC; Quinn Patrick Harrington, U.S. DEPARTMENT OF JUSTICE (TAX - BOX 683), TAX DIVISION, WASHINGTON, DC.
MEMORANDUM OPINION AND ORDER
Barbara Jacobs Rothstein, U.S. District Court Judge.
Plaintiff Washington Mutual, Inc. (" Plaintiff" ), as successor in interest to
Home Savings of America, FSB (" Home" ), brought this tax refund suit to recover taxes assessed by the Internal Revenue Service (" IRS" ) with respect to the 1990, 1992, and 1993 tax years. This case represents a chapter in a continuing saga that has its genesis in the savings and loan crisis of the late 1970's and early 1980's. Since that time, numerous lawsuits involving Home and other similarly situated litigants have wound their way through multiple courts, including the United States Supreme Court, the Federal Circuit, and the Ninth Circuit.
In the case before this Court, Plaintiff claims that it is entitled to refunds due to tax deductions and losses for certain intangible assets referred to by the parties as the " Branching Right" and the " RAP Right."  Plaintiff filed amended tax returns seeking the refunds on behalf of Home, and after the IRS denied the refund claims, Plaintiff filed suit against Defendant, the United States of America, on behalf of Home in the district court for the Western District of Washington. This case was originally assigned to the Honorable John C. Coughenour. Shortly thereafter, both parties moved for partial summary judgment on the issue of whether Home could establish a cost basis for the Branching and RAP Rights (a taxpayer must be able to establish a cost basis in an asset before the taxpayer is entitled to a tax refund). Judge Coughenour granted Defendant's motion for partial summary judgment, ruling that Home did not have a cost basis in the Rights, and therefore, was not entitled to a tax refund. Plaintiff appealed and the Ninth Circuit reversed. The Ninth Circuit determined that Home has a cost basis in the Branching and RAP Rights based on what it cost Home to acquire the Rights, and remanded the matter with instructions to the court to proceed with determining the cost basis.
Thereafter, the case was reassigned to this District Court Judge and a bench trial was held on December 12 through December 19, 2012. Having heard the testimony of the witnesses, reviewed the evidence in the record together with the briefs filed by the parties, this Court finds that Plaintiff has not proved, to a reasonable degree of certainty, Home's cost basis in the Branching and RAP Rights. Accordingly, the Court will GRANT judgment in favor of Defendant. The reasoning for this Court's determination follows.
II. FACTUAL BACKGROUND AND PROCEDURAL HISTORY
A. The Savings and Loan Crisis
As stated previously, this case arises out of the savings and loan crisis of the late 1970's and the early 1980's. Wash. Mut., Inc. v. United States, 2008 WL 8422136, at *1 (W.D. Wash. Aug. 12, 2008) (hereinafter referred to as " Washington Mut. I " ). By way of background, in the late 1970's and early 1980's, out of concern for rising inflation rates, the Federal Reserve saw fit to allow interest rates to rise to unprecedented levels. The effect of this phenomenon on savings and loan associations (also known as " thrifts" ) was disastrous. This is because thrifts derived their profitability from a spread between the interest they paid to depositors and the interest they charged on loans (which were almost exclusively long-term, fixed-rate mortgages). Id. ; s ee also United States v. Winstar Corp., 518 U.S. 839, 845, 116 S.Ct. 2432, 135 L.Ed.2d 964 (1996). In normal times, the spread was positive for the thrifts, that is, a thrift could pay a lower interest rate
to its depositors, while the interest rate it charged borrowers was sufficiently higher to ensure profitability. Wash. Mut., Inc. v. United States, 636 F.3d 1207, 1210 (9th Cir. 2011) (hereinafter referred to as " Washington Mut. II" ). When interest rates soared in the late 1970's and early 1980's, the world turned upside down for thrifts. Id. Given the higher interest rates that were available in the market, in order to attract more depositors, thrifts had to pay higher interest rates on their deposits. Id. Meanwhile, the thrifts' outstanding mortgage loans were locked in at long-term, fixed-rates that were significantly lower than the prevailing rates. Id. To make matters worse, given the high interest rates being charged for mortgage loans, housing purchases came to a near standstill, so there was little or no opportunity to lend out new mortgage money. Id. The entire thrift industry was insolvent to the tune of billions of dollars. This situation is commonly described as the savings and loan crisis. Winstar, 518 U.S. at 845.
The Federal Savings and Loan Insurance Corporation (hereinafter " FSLIC" ), in its capacity as thrift regulator and insurer of thrift deposits, was obligated to take over and liquidate any thrift that had liabilities that exceeded its assets. Dkt. No. 154 at p. 6 (Admitted Fact 5). " Realizing that FSLIC lacked the funds to liquidate all of the failing thrifts, the [Federal Home Loan Bank Board (hereinafter " Bank Board" )] chose to avoid the insurance liability by encouraging healthy thrifts ... to take over ailing [thrifts]" in transactions known as " supervisory mergers." Winstar, 518 U.S. at 847. Supervisory mergers--in which healthy thrifts assumed all of the obligations of failing thrifts--were not intrinsically attractive to healthy thrifts; nor did FSLIC have sufficient cash to promote the supervisory mergers through direct subsidies alone. Id. at 848. Instead, FSLIC had to devise other non-cash incentives to attract healthy thrifts to these transactions. Id. Two such incentives are central to this dispute.
Before the savings and loan crisis, regulations prohibited thrifts from opening branch offices outside states in which their home offices were located. Washington Mut. II, 636 F.3d at 1213. Healthy thrifts wanted to expand nationally into growing markets. FSLIC recognized this and issued regulations in September 1981 that allowed a thrift to operate branches in a state other than its home state, but only if the first branch in the non-home state was acquired in a supervisory merger. The parties refer to this as the " Branching Right."
In addition, thrifts were subject to regulations that required them to maintain a certain amount of capital, known as the " minimum regulatory capital requirement." See Home Sav. of Am. v. United States, 57 Fed. Cl. 694, 697 (Fed. Cl. 2003). During the height of the savings and loan crisis, a thrift was required to maintain minimum regulatory capital that equaled at least three percent of the thrift's liabilities. 47 Fed. Reg. 3543 (Jan. 14, 1982). FSLIC recognized that this requirement would be an impediment to supervisory mergers given that a healthy thrift would have to acquire the liabilities of a failing thrift, liabilities that exceeded the failing thrift's assets. Therefore, regulators allowed health thrifts to apply the " purchase method" of accounting to supervisory mergers. Washington Mut. II, 636 F.3d at 1210.
The purchase method of accounting permitted the acquiring thrift to designate the excess of the acquired thrift's liabilities over the acquired thrift's assets as an intangible asset known as " supervisory goodwill." Id. The supervisory goodwill could then be counted towards the acquiring thrift's minimum regulatory capital requirement. Id. (citing Winstar, 518 U.S. at 850- 51). Regulators also permitted the acquiring thrift to amortize the supervisory goodwill over a significant period of time, up to forty years in accordance with regulatory accounting principles. Id. The right to designate the excess liabilities of an acquired thrift as supervisory goodwill and to amortize the supervisory goodwill over a 40-year period became known as the " RAP Right."  Id.
B. Home Acquires Three Failing Thrifts through a Supervisory Merger
In 1981, Home was considered a " healthy" thrift, and in November of that same year, it agreed to a supervisory merger with three failing thrifts: Security Federal Savings and Loan Association (" Security" ) and Hamiltonian Federal Savings and Loan Association (" Hamiltonian" ), both thrifts located in Missouri, and Southern Federal Savings and Loan Association (" Southern" ), a thrift located in Florida (hereinafter the " Missouri-Florida Transaction). Washington Mutual I, 2008 WL 8422136 at *2. Under the terms of the Missouri-Florida Transaction, Home assumed all of the liabilities of the three failing thrifts in return for a " generous incentive package" from the government. Washington Mut. II, 636 F.3d at 1219. As part of this incentive package, Home received FSLIC assistance in the form of cash contributions (to the extent the book value of the failing thrifts' liabilities exceeded the book value of their respective assets), indemnities related to covered assets, and " other payments and/or credits to be accounted for through use of a 'special reserve account.'" Washington Mut. I, 2008 WL 8422136 at *2. Home also received Branching Rights in Missouri and Florida, which meant that California-based Home would be permitted to open branches in Missouri and Florida. Id. In addition, Home was given the RAP Right ( i.e., Home was permitted to count the excess of the failing thrifts' liabilities over their assets as " supervisory goodwill" and apply it to Home's minimum regulatory capital requirement). Id. Finally, Home was able to structure the transaction as a tax free " G" reorganization, which allowed Home to " carry over" the tax basis associated with the acquired assets and thereby realize substantial built-in losses by selling the loans of the acquired thrifts. Id.
C. Winstar and Related Litigation
In 1989, Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (" FIRREA" ), Pub.L. No. 101-73, 103 Stat. 183. Washington Mut. II, 636 F.3d at 1211. Among other changes, FIRREA no longer allowed thrifts to count supervisory goodwill toward their minimum regulatory capital requirement. Winstar, 518 U.S. at 857. This change had a significant impact on thrifts that had acquired failing thrifts through supervisory mergers, as the acquiring thrifts had relied on the supervisory goodwill granted to them at acquisition. Id. Three thrifts sued the United States for damages on both contractual and constitutional theories, arguing that the government had promised the thrifts that the supervisory goodwill could be counted toward their regulatory capital requirements and FIRREA was a breach of the government's promise. Id. at 858.
The Supreme Court agreed, holding that the government breached its contracts when, pursuant to the new regulatory capital requirements imposed by FIRREA, the federal regulatory agencies limited the use of supervisory goodwill and capital credits as acceptable regulatory capital. Id. at 870.
D. Current Litigation
In 1992 and 1993, Home sold its Missouri branch offices and in 1998 Plaintiff acquired Home. Id. at 1214. In 2005, Plaintiff filed amended income tax returns on behalf of Home, claiming refunds for tax years 1990, 1992, and 1993. Plaintiff asserted that the IRS had not credited Home for its RAP Right amortization deduction during those years. Id. Plaintiff also claimed a loss deduction during for 1993, alleging that Home had abandoned its Missouri Branching Right. Id. The IRS denied the refund requests and Plaintiff, on Home's behalf, brought this suit.
In order to establish that Home is entitled to a tax refund, Plaintiff must first establish that Home has a tax basis in the Branching and/or RAP Rights. When this matter first came to district court, the United States argued that Plaintiff's refund claims failed as a matter of law because Home did not have a tax basis in the Rights. As discussed previously in this Order, both parties moved for partial summary judgment on this issue. In its summary judgment motion, Plaintiff raised two alternative theories for establishing a tax basis for the Branching and RAP Rights. First, Plaintiff argued that it can establish a tax basis based on what it cost Home to acquire the Rights (this was Plaintiff's " cost basis theory" ). Id. at 1215. Under the cost basis theory, Plaintiff asserted that FSLIC effectively sold the Rights to Home in exchange for Home's assumption of the FSLIC's liability with respect to the three failing thrifts. Id. at 1217. On this theory, Plaintiff claimed a tax basis for the Rights since " [t]he assumption of liability in connection with the acquisition of property is part of the property's cost for Federal income tax purposes," and under the Internal Revenue Code, " the basis of property shall be the cost of such property...." Washington Mut. I, 2008 WL 8422136 at *3. Plaintiff argued that Home's cost to acquire the Rights was " the amount by which the acquired thrifts' liabilities exceeded the value of their assets." Id. Plaintiff therefore concluded that Home took a tax basis in the Rights equal to that excess liability.
In the alternative, Plaintiff argued that it could establish a tax basis for the Rights based on their fair market value (this was Plaintiff's " fair market value theory" ). Id. Under the fair market value theory, Plaintiff argued that the Branching and RAP Rights were provided by FSLIC to induce Home to enter into the supervisory merger, and as such, are considered income for tax purposes. Dkt. No. 49, Pl.'s Mot. for Summ. J. at 10. According to Plaintiff, " a taxpayer that receives property as income takes a fair-market-value basis in that property." Id. Therefore, Plaintiff argued, Home has a fair market value basis in the Branching and RAP Rights. Id.
The United States disputed both of Plaintiff's theories for establishing a tax basis. With respect to the cost basis theory, the Government argued that Plaintiff was " double-counting" Home's assumption of the failing thrifts' liabilities. In the
Government's view, the primary benefit of the supervisory merger to Home was that the merger was structured as a " tax-free merger commonly referred to as a 'G' reorganization." Dkt. No. 51, Def.'s Mot. for Summ. J. at 2. According to the Government, Home was willing to incur the failing thrifts' liabilities in return for the tax-free merger because the G reorganization allowed Home to realize sizable tax benefits by carrying over the failing thrifts' assets with " built-in tax losses." Id. However, the Government argued, 27 years after the transaction occurred, Plaintiff is now attempting to reap a second or " double" recovery for assuming the failed thrifts' liabilities by arguing that Home had assumed the liabilities as consideration for the Branching and RAP Rights. Id. at 3.
As for Plaintiff's fair market value theory, the Government argued that neither the Branching Right nor the RAP Right could qualify as income, and as such, Plaintiff cannot claim a fair-market-value basis in the Rights. Id.
Judge Coughenour rejected Plaintiff's two alternative theories for establishing a tax basis for the Branching and RAP Rights and granted partial summary judgment in favor of the United States. Id. at 1216. With respect to Plaintiff's cost basis theory, the district court: (1) rejected Plaintiff's argument that Home had assumed FSLIC's liabilities, stating that " while [the United States] had an undeniable interest in Home's acquisition of the failing thrifts, it was in no way relieved of its insurance obligations as a result of the transaction. Rather, those obligations were simply less likely to come to fruition,"  and (2) determined that Plaintiff had not bargained for the right to assign a separate tax basis to the Branching and/or RAP Rights. Washington Mut. I, 2008 WL 8422136 at *6. As to Plaintiff's fair market value theory, the district court held that the Rights did not qualify as income.
Plaintiff appealed the decision to the Ninth Circuit, which reversed and remanded. In reaching its decision, the Ninth Circuit " return[ed] to the very basics of tax law" to note that the term " basis" is a " fundamental concept and refers to a taxpayer's capital stake in an asset for tax purposes." Id. at 1217 (citing In re Lilly, 76 F.3d 568, 572 (4th Cir. 1996)). The Court further noted that " [g]enerally, a taxpayer's basis in an asset is equal to the cost to the taxpayer of acquiring the asset." Id. (citing 26 U.S.C. § 1012). With these principles in mind, the Ninth Circuit turned to the supervisory merger at issue here. It determined that the " documentary evidence, as well as the economic realities of the transaction, compel the conclusion" that the merger " comprised one, all-encompassing transaction" whereby the FSLIC benefited because three failing thrifts were assimilated into one healthy thrift, " thereby considerably reducing the FSLIC's own insurance liability exposure" and Home received " a generous incentive package," which included, among other items, the Branching and RAP Rights. Id. at 1218-19. Having determined that the Branching and RAP Rights were part of the consideration Home received in the supervised merger, the Ninth Circuit " appl[ied] basic tax principles regarding basis" and concluded that the cost to
Home for acquiring this incentive package " was the excess of the three failing thrifts' liabilities over the value of their assets." Id. at 1219. Therefore, the Court concluded, Home's cost basis in the Branching and RAP Rights is " equal to some part of the total amount of that excess liability." Id. (emphasis in original).
Accordingly, the Ninth Circuit reversed Judge Coughenour's holding that Plaintiff did not have a cost basis in the Branching and RAP Rights, and remanded with instructions to grant Plaintiff's motion for partial summary motions ( i.e., grant Plaintiff's motion that Home has a cost basis in the Rights) and proceed to determining what that cost basis is ( i.e., Plaintiff must still establish what the cost basis is for the Branching and RAP Rights). Stated differently, although the Ninth Circuit accepted Plaintiff's argument that, in theory, a taxpayer in Home's position has a cost basis in the Branching and RAP Rights, Plaintiff still had to meet its burden of establishing what that cost basis is.
A. Plaintiff Bears the Burden of Proof
Following the Ninth Circuit's lead, this Court returns to basic tax law principles. It is undisputed that a taxpayer may sue the government in district court to recover taxes erroneously collected or withheld. Oppel v. United States, 164 F.3d 631, 632 (9th Cir. 1998) (citing 28 U.S.C. § 1346(a)(1)). " In so doing, the taxpayer must prove that he is entitled to a refund, and must also establish the exact amount of refund owed." Id. (citing United States v. Janis, 428 U.S. 433, 440, 96 S.Ct. 3021, 49 L.Ed.2d 1046 (1975)); Fed-Mart Corp. v. United States, 572 F.2d 235, 238 (9th Cir. 1978) (" The taxpayer's burden in a refund suit in district court is to prove not only that the Commissioner erred in his determination of tax liability but also to establish the correct amount of the refund due." ); Moore v. Comm'r, 425 F.2d 713, 715 (9th Cir. 1970) (" [T]he taxpayer bears the burden of establishing the cost basis of property" ); United States v. Youngquist, 2013 WL 5268924, at *7 (D. Or. Apr. 17, 2013) (noting that if a taxpayer fails to establish the value of property (where that value is critical to the taxpayer's claim in a refund suit), the taxpayer loses).
It is not sufficient for a taxpayer to " demonstrate that the assessment of the tax for which refund is sought was erroneous in some respects." Trigon Ins. Co. v. United States, 234 F.Supp.2d 581, 586 (E.D. VA. 2002) (quoting Janis, 428 U.S. at 440). Rather, in order to prevail, Plaintiff " must establish the exact amount which [it] is entitled to recover." Compton v. United States, 334 F.2d 212, 216 (4th Cir. 1964); Trigon, 234 F.Supp.2d at 587 (a plaintiff cannot satisfy its burden " by showing merely that some refund is owed without proving the amount owed" ). In the case before the Court, this requires Plaintiff to prove, to a reasonable degree of certainty, Home's cost basis in the Branching and RAP Rights. See Better Beverages, Inc. v. United States, 619 F.2d 424, 428 (5th Cir. 1980).
The fact that the cost basis may be difficult to establish does not relieve Plaintiff of its burden. Coloman v. Commissioner, 540 F.2d 427, 430 (9th Cir. 1976) (citing O'Neill v. Comm'r, 271 F.2d 44 (9th Cir. 1959)); see also Estate of Marsack v. Comm'r, 288 F.2d 533, 535 (7th Cir. 1961) (noting that whether valuation is difficult or not, it must be established, and complex forms of property must be, and are, valued
for tax purposes); Better Beverages, 619 F.2d at 428 n.4 (" Where the taxpayer fails to carry [its] burden to prove a cost basis in the item in question, the basis utilized by IRS, which enjoys a presumption of correctness, must be accepted even where, as here, the IRS has accorded the item a zero basis." ); Compton, 334 F.2d at 216 (same). Lastly, this Court is not required to, and indeed cannot, derive the cost basis from unreliable evidence. See Norgaard v. Comm'r, 939 F.2d 874, 879 (9th Cir. 1991) (stating that any estimation of a deduction without that " assurance from the record...would be unguided largesse'" )
Plaintiff, relying on Cohan v. Comm'r, 39 F.2d 540, 544 (2d Cir. 1930), argues that under Cohan and its progeny, a taxpayer claiming a deduction may overcome the presumptive correctness of the IRS' denial, even where the taxpayer has failed to show the exact amount of the deduction, so long as the evidence shows that the taxpayer is entitled to the deduction, and there is sufficient evidence in the record from which the court may estimate the exact amount. Plaintiff is correct that courts have relied on Cohan to estimate the amount of a claimed deduction in cases where the taxpayer is unable to produce evidence substantiating the exact amount of a claimed deduction. Trigon, 234 F.Supp.2d at 589. However, courts are reluctant to accept invitations to follow Cohan where a taxpayer fails to provide evidence that would permit an informed estimate of the amount of deduction. Id. Indeed, the Ninth Circuit has cautioned that a liberal application of the Cohan rule " would be in essence to condone the use of that doctrine as a substitute for burden of proof." Coloman, 540 F.2d at 431-32. For this reason, courts decline to apply Cohan in cases where there is no doubt that the taxpayer incurred some deductible expense, but the taxpayer failed to present evidence sufficient to allow the court to make an accurate finding on the amount of the deduction. See, e.g., Norgaard, 939 F.2d at 879 (Ninth Circuit rejected taxpayer's argument that finder of fact was compelled to estimate a value based on the evidence provided); Coloman, 540 F.2d at 432. As the Trigon court aptly stated:
[Plaintiff] has cited, and the Court has found, no decision applying the rule of Cohan to complex valuation cases such as this one. And, where, as here, the basic evidentiary predicate for valuation has been found wanting in so many ways, to do so would offend fundamental ...