Articles Posted in U.S. 3rd Circuit Court of Appeals

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Between 2008 and 2011, Viacom Inc. paid three senior executives more than $100 million in bonus or incentive compensation. Compensation exceeding $1 million paid by a corporation to senior executives is not normally deductible under federal tax law, but a corporate taxpayer may deduct an executive’s otherwise nondeductible compensation over $1 million if an independent committee its board of directors approves the compensation on the basis of objective performance standards and the compensation is “approved by a majority of the vote in a separate shareholder vote” before being paid. In 2007, a majority of Viacom’s voting shareholders approved such a plan. Shareholder Freedman sued, claiming that Viacom’s Board failed to comply with the terms of the Plan and that, instead of using quantitative performance measures, the Board partially based its awards on qualitative, subjective factors, destroying the basis for their tax deductibility. Freedman claimed that this caused the Board to award executives more than $36 million of excess compensation. The plan was reauthorized in 2012. The district court dismissed. The Third Circuit affirmed. With respect to his derivative claim, Freedman did not make a pre-suit demand to the Board or present sufficient allegations explaining why a demand would have been futile. With respect to his direct claim regarding participation by stockholders without voting rights, federal law does not confer voting rights on shareholders not otherwise authorized to vote or affect Delaware law permit ting corporations to issue shares without voting rights. View "Freedman v. Redstone" on Justia Law

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Sir John Thouron died in 2007 at the age of 99, leaving a substantial estate. Thouron’s grandchildren are his only heirs. His named executor retained Smith, an experienced tax attorney. The Estate’s tax return and payment were due November 6, 2007. On that date, the Estate requested an extension of time and made a payment of $6.5 million, much less than it would ultimately owe. The Estate timely filed its return in May 2008 and requested an extension of time to pay. It made no election to defer taxes under 26 U.S.C. 6166, it had conclusively determined it did not qualify. The provision allows qualifying estates to elect to pay tax liability in installments over several years. The IRS denied as untimely the Estate’s request for an extension and notified the Estate that it was imposing a failure-to-pay penalty. The Estate unsuccessfully appealed administratively. The Estate then filed an appropriate form and paid all outstanding amounts, including a penalty of $999,072, plus accrued interest, then filed a request with the IRS for a refund. After not receiving a response from the IRS, the Estate filed a complaint, alleging that its failure to pay resulted from reasonable cause, reliance on Smith’s advice, and not willful neglect and was not subject to penalty. The district court granted the government summary judgment, holding that under Supreme Court precedent the Estate could not show reasonable cause. The Third Circuit vacated, reasoning that the precedent did not apply to reliance on expert advice. View "Estate of Thouron v. United States" on Justia Law

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New Jersey and Pennsylvania municipalities sued the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal Housing Finance Agency (FHFA) (collectively, the Enterprises). Fannie Mae and Freddie Mac are federally-chartered but privately owned corporations that issue publicly traded securities, created by Congress to establish and stabilize secondary markets for residential mortgages, 12 U.S.C. 1716; 12 U.S.C. 1451. Fannie and Freddie purchase mortgages from third-party lenders, pooling them together and selling securities backed by those mortgages. In the wake of the housing market collapse of 2008, Fannie and Freddie owned many defaulted and overvalued subprime mortgages. They went bankrupt, and Congress created the FHFA to act as conservator for Fannie and Freddie. Congress exempted the Enterprises from all state and local taxation, with an exception for taxes on real property. The plaintiffs sought declaratory judgments that the Enterprises were not exempt from paying state and local real estate transfer taxes. The district courts dismissed. In a consolidated appeal, the Third Circuit affirmed. View "Delaware Cnty. v. Fed. Hous. Fin. Agency" on Justia Law

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In 1997, the trusts acquired all shares of AIS with an aggregate basis of $5,612,555. In 1999, the trusts formed Wind River Corporation and contributed their AIS shares in exchange for all Wind River shares. Wind River designated itself a subchapter S Corporation. In 2003, Wind River elected to treat AIS as a qualified subchapter S subsidiary. Before that election, the trusts’ aggregate adjusted basis in Wind River was $15,246,099. After the Qsub election, the trusts increased their bases in that stock to $242,481,544. The trusts sold their Wind River interests to Fox. After transaction costs, the sale yielded $230,111,857 in cash and securities in exchange for the Wind River stock. The trusts claimed a loss of $12,247,229: the difference between the amount actually received for the sale and the new basis in the Wind River stock. The trusts shareholders’ 2003 tax returns showed that capital loss. The IRS determined that a capital gain of approximately $214 million had been realized from the sale to Fox, for a cumulative tax deficiency of $33,747,858. Deficiency notices stated “the Qsub election and the resulting deemed I.R.C. 332 liquidation did not give rise to an item of income under I.R.C. 1366(a)(1)(A); therefore, [the Trusts] could not increase the basis of their [Wind River] stock under I.R.C. 1367(a)(1)(A).” The Tax Court found the increase in basis and declared loss to be improper. The Third Circuit affirmed. View "Ball v. Comm'r of Internal Revenue Serv." on Justia Law

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Ottaviano, believing himself not bound by U.S. tax law, marketed his views to others through his company, Mid-Atlantic, which offered financial products he claimed would help others avoid taxation and have the government pay their debts. Ottoviano made many representations about himself and the financial products. Customers paid Mid-Atlantic $3,500 each ($5,000 if purchased jointly) to participate. After a trial at which he represented himself, Ottaviano was convicted of conspiracy to defraud the U.S. under 18 U.S.C. 371, eight counts of mail and wire fraud under 18 U.S.C. 1341 and 1343, money laundering under 18 U.S.C. 1957, and two counts of tax evasion under 26 U.S.C. 51. The Third Circuit affirmed, noting overwhelming evidence of guilt and rejecting arguments that the district court denied him a fair trial in violation of his Fifth Amendment right to due process of law when it cross-examined him and violated his Sixth Amendment right to represent himself when it ordered him to leave the courtroom during a discussion about a letter he sent to the Treasury Secretary. View "United States v. Ottaviano" on Justia Law

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BDI elected under I.R.C. 1362(a) to be treated as an S-corporation, not subject to federal taxation because its profits and losses passed through to Barden, its sole shareholder. MSC owns the Majestic Star Casino and Hotel. BDI acquired MSC in 2005. BDI elected to treat MSC as a QSub (I.R.C. 1361(b)(3)(B), not as a separate tax entity. MSC, therefore, paid no federal taxes. In 2009, MSC and its affiliates filed voluntary bankruptcy petitions. Barden and BDI were not debtors. After the petition, Barden caused revocation of BDI’s status as an S-corporation; MSC’s QSub status automatically terminated because it was no longer wholly owned by an S-corp. Neither BDI nor Barden sought authorization from the debtors or from the Bankruptcy Court. MSC allegedly was unaware that it had a new obligation to pay income taxes. As of first date federal taxes would have been due, the debtors had paid no federal income taxes. The Bankruptcy Court permitted conversion of MSC to a limited liability company, so that MSC would no longer qualify for QSub status, even if the Revocation had not occurred. The debtors sought to avoid the Revocation, which, they alleged, caused an unlawful post-petition transfer of property. The Bankruptcy Court granted summary judgment to the debtors. The Third Circuit vacated and directed that the petition be dismissed for lack of jurisdiction. View "In Re:Majestic Star Casino LLC" on Justia Law

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The Virgin Islands, a U.S. territory, does not share the same sovereign independence as the states; the power to pass rules and regulations governing territories rests with Congress. Congress passed legislation applying the Internal Revenue Code to the Virgin Islands, 48 U.S.C. 1397, “except that the proceeds of such taxes shall be paid into the treasuries of said islands.” Bona fide VI residents are granted a full exemption from paying federal income taxes if they file a territorial tax return and fully pay territorial taxes to the Virgin Islands Bureau of Internal Revenue (VIBIR), I.R.C. 932(c). This exemption is significant because Congress authorized the VI government to create an Economic Development Program granting substantial tax incentives to certain taxpayers. Between 2001 and 2004 Taxpayers claimed bona fide VI residency and eligibility for the tax benefits granted by the Economic Development Program; they filed tax returns with the VIBIR and paid taxes only to the VI government. Taxpayers did not file federal income tax returns. In late 2009-2010, Taxpayers were issued IRS tax prepayment deficiency notices challenging their claims of residency. The district court dismissed Taxpayers’ challenges on grounds that the Tax Court was the only proper forum. The Third Circuit affirmed. View "McGrogan v. Comm'r of Internal Revenue" on Justia Law

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Turner, the author of Tax Free!, instructed readers to escape income taxation by using common law trust organizations (colatos), and established FAR to assist in implementing colatos. In 1991, Turner enlisted Leveto, the owner of a veterinary clinic, as a FAR member. FAR created Center, a foreign colato, and appointed Leveto as the general manager and Turner as a consultant. Leveto “sold” his clinic to Center, which “hired” Leveto as its manager. Leveto continued to control the clinic, but stopped reporting its income. Center did not pay taxes because it distributed the income to other foreign colatos, which, Turner claimed, “transformed” it to untaxable foreign source income. Leveto began to market Tax Free! In 1995, the IRS began a criminal investigation. In 2001, Turner and Leveto were charged with conspiracy to defraud the IRS by concealing Leveto’s assets, 18 U.S.C. 371. Turner moved to exclude recorded conversations between Leveto and an undercover agent and foreign bank records seized from Leveto’s office and residence. The district court admitted the conversations, reasoning that they furthered an unindicted conspiracy to impede tax collection efforts, and held that the government properly authenticated the foreign bank documents. Turner was convicted, sentenced to 60 months’ imprisonment, and ordered to pay $408,043 in restitution, without any findings about his ability to pay. The Third Circuit affirmed. View "United States v. Turner" on Justia Law

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Vento co-founded a technology company, OSI. When OSI was sold, the Ventos, their daughters, and Vento-controlled entities realized $180 million in capital gains for the 2001 tax year. The Ventos previously lived in and still maintain homes in the U.S., but first visited the Virgin Islands in 2001 and bought a residence there. Residents of the Virgin Islands pay income taxes to the Virgin Islands Bureau of Internal Revenue (VIBIR) rather than the Internal Revenue Service (IRS). All of the Ventos filed 2001 income tax returns with the VIBIR. The United States claims that they should have filed those returns with the IRS and assessed deficiencies and penalties that totaled over $9 million more than those assessed by the VIBIR. The district court found that the Ventos were not bona fide residents of the Virgin Islands as of December 31, 2001. The Third Circuit reversed in part, concluding that the parents were bona fide residents of the Virgin Islands, but that the daughters, who were not dependents, were not. View "Vento v. Dir. of VI Bureau of Internal Revenue" on Justia Law

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Wiest worked in Tyco’s accounting department for 31 years, until his termination in 2010. Beginning in 2007, Wiest refused to process reimbursement claims that he believed were unlawful or constituted “parties” at resorts. Wiest sued Tyco and its officers and directors under the whistleblower protection provisions in Section 806 of the Sarbanes-Oxley Act, 18 U.S.C. 1514A, and under Pennsylvania law. The district court dismissed the federal whistleblower claims and declined to exercise supplemental jurisdiction. The Third Circuit reversed in part, holding that the court erred in requiring that Wiest allege that his communications to his supervisors “definitively and specifically relate to” an existing violation of a particular anti-fraud law, as opposed to expressing a reasonable belief that corporate managers are taking actions that could run afoul of a particular anti-fraud law. View "Wiest v. Lynch" on Justia Law