New Capital Fire, Inc.

T.C. Memo. 2021-67

UNITED STATES TAX COURT

NEW CAPITAL FIRE, INC., Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 25505-06. Filed June 2, 2021.

Upon a merger with T on Dec. 4, 2002, P acquired appreciated

assets, sold the assets, reported a carryover basis in the assets and

capital gains on the asset sale, and engaged in option transactions to

generate loss deductions to offset the reported gains. T did not file its

own tax return for its 2002 taxable year. Instead, P attached a pro

forma return for T to P’s return for the year of the merger. R prepared

a substitute for return for T for a short taxable year ending on the

merger date. R issued a notice of deficiency to T determining that the

merger was a taxable event and T had capital gains on the transfer of

its assets to P. We held in New Capital Fire, Inc. v. Commissioner,

T.C. Memo. 2017-177, that P’s return began the running of the period

of limitations as to T’s 2002 taxable year, the notice of deficiency

issued to T was untimely, and the statute of limitations barred

assessment of the determined deficiency for that year.

After our decision there had become final, P filed an amended

petition in this case alleging that it did not realize capital gains on the

sale of T’s assets on the basis that the merger was a taxable event, i.e.,

the position that R had taken against T in T.C. Memo. 2017-177.

Served 06/02/21

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[*2] Accordingly, P asserted that it did not realize the capital gains it had

reported on its return. P and T are in privity for tax reporting

purposes.

R argues, in part, that P should be estopped from changing its

reporting of the asset sale after T’s tax year has closed to the

detriment of R, under the doctrine of equitable estoppel. P argues

that the doctrine of equitable estoppel does not apply.

Held: P is estopped under the doctrine of equitable estoppel

from changing its reporting of its bases in T’s assets that P acquired

in the merger because the statute of limitations bars assessment of tax

against T.

Held, further, P realized capital gains on the sale of T’s assets

in the amount that P reported on its return.

Jasper G. Taylor III and Richard L. Hunn, for petitioner.

Courtney L. Frola, Jeffrey B. Fienberg, Ruba Nasrallah, and M. Jeanne

Peterson, for respondent.

MEMORANDUM OPINION

GOEKE, Judge: Respondent issued to petitioner a notice of deficiency for

its short taxable year November 6 through December 31, 2002 (2002 tax year), in

which he disallowed the deductions of $9,662,707 in short-term capital losses

from the sale of digital S&P 500 Index options (SPX options), interest, and

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[*3] consulting fees and determined a 40% accuracy-related penalty for a gross

valuation misstatement on the portion of the underpayment attributable to the SPX

option capital losses and a 20% accuracy-related penalty on the remaining portion

of the underpayment. Respondent disallowed the SPX option capital loss

deduction on the basis that the SPX option transactions were tax shelters. He

determined that petitioner entered into the transactions for tax avoidance purposes

and the transactions had no business purpose other than tax avoidance, lacked

economic substance, and were economic shams. Petitioner concedes the

disallowance of the SPX option loss, interest, and consulting fee deductions that

respondent disallowed in the notice of deficiency. The parties have settled the

penalties.

Petitioner engaged in the SPX options to generate losses to offset capital

gains of approximately $7.6 million from the sale of marketable securities.

Petitioner reported the capital gains but now argues that it should not have.

Without such capital gains, there would have been no need for any artificially

generated losses as an offset. Petitioner acquired the securities in a merger and

argues that the target corporation that merged out of existence should have

reported the capital gains. The target corporation did not report the capital gains,

and the statute of limitations bars assessment against it.

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[*4] The sole issue is whether the capital gains are includible in determining

petitioner’s taxable income for its 2002 tax year. We hold they are. The

resolution depends on whether petitioner is equitably estopped from changing its

tax reporting of the capital gains. We hold it is.

Background

The parties have submitted this case for decision without trial under Rule

122.1 After filing simultaneous opening briefs, the parties filed a joint motion to

supplement the record, which we granted on March 9, 2020. After filing

answering briefs, the parties also filed a joint motion for leave to file simultaneous

reply briefs, which we granted on July 7, 2020. When the petition was filed,

petitioner had its principal place of business in New York.

I. Merger Transaction

Petitioner was organized as a Delaware corporation on November 6, 2002,

as a wholly owned subsidiary of the Capital Fire Insurance Co., which we refer to

as Old Capital. Old Capital was the sole owner of petitioner from November 6,

2002, until December 4, 2002. On December 4, 2002, petitioner and Old Capital

1

Unless otherwise indicated, all statutory references are to the Internal

Revenue Code (Code), title 26, U.S.C., in effect for the year at issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

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[*5] merged with petitioner surviving. The merger of Old Capital and petitioner

was the first step in a two-step merger.

To accomplish the two-step merger, two other corporations were organized,

CF Merger Corp. (CF Merger), on October 4, 2002, and CF Acquisition Corp. (CF

Acquisition), on October 28, 2002, which became the sole owner of CF Merger.

The second step of the merger was a merger of petitioner into CF Merger with

petitioner surviving. Both steps of the mergers occurred on the same date, one

hour apart. After the two-step merger, petitioner was wholly owned by CF

Acquisition.

At the time of the merger, Old Capital held a portfolio of marketable

securities worth approximately $16.3 million that had appreciated by

approximately $7.9 million over their cost basis, i.e., built-in capital gains (Old

Capital’s securities). As explained further below, Old Capital’s shareholders

wanted to divest themselves of ownership in a manner that would minimize the

overall tax on the built-in gains at the corporate and shareholder levels. The two-

step merger was structured with the help of Diversified Group, Inc. (DGI), and

James Haber, its founder and president. DGI represents itself as being in the

business of designing tax-oriented structures and solving tax problems. Mr.

Harber was the president, secretary, and treasurer of CF Acquisition.

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[*6] Under the first step of the merger, Old Capital’s securities were transferred

to petitioner. One day before the merger, December 3, 2002, Mr. Haber executed

a binding agreement for CF Acquisition to sell substantially all of Old Capital’s

securities to PaineWebber, and Old Capital transferred the securities to a newly

opened account in its own name at PaineWebber to facilitate the subsequent sale

by CF Acquisition. CF Acquisition sold the securities on December 5, 9, or 12,

2002, pursuant to the binding agreement. On December 5, 2002, PaineWebber

transferred $13.5 million in connection with its agreement to purchase Old

Capital’s securities. The $13.5 million payment was transferred to repay a loan

that was used to buy Old Capital’s stock. Thus, in substance, the built-in gains

funded the payout to Old Capital’s shareholders for their stock.

On December 9, 2002, petitioner purchased stock in Northmoy Ltd.

(Northmoy), foreign private limited company (Northmoy stock purchase). On

December 10, 16, and 30, 2002, Northmoy purchased the SPX options. It sold the

SPX options on December 30, 2002, for a capital loss of $9,662,707, as follows:

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[*7] Name Acquired Cost basis Sale price Gain/loss

Call Dec. 10 $18,957,641 $15,784,081 ($3,173,560)

CMBO Dec. 16 25,055,881 -0- (25,055,881)

Call Dec. 30 433,266 19,000,000 18,566,734

Total 44,446,788 34,784,081 (9,662,707)

II. Return Reporting

Petitioner filed Form 1120, U.S. Corporation Income Tax Return, for its

2002 tax year, listing its business activity as investment. It reported that it was

wholly owned by CF Acquisition at the end of the tax year. On the first page of

the return, it reported that it had assets of over $13.8 million as of the end of the

tax year. Mr. Haber signed the return as petitioner’s president.

Petitioner reported that it had merged with Old Capital with petitioner

surviving, with the following statement attached to the return:

On December 4, 2002, The Capital Fire Insurance Company, a New

Hampshire insurance corporation, was merged into New Capital Fire,

Inc. a Delaware (non-insurance) corporation. At the time of the

merger, The Capital Fire Insurance Company ceased its insurance

operations. * * *

The operations of The Capital Fire Insurance Company are included

in this return on Form 1120-PC Statement.

A copy of the certificate of merger and an incumbency certificate for CF

Acquisition were attached to the return. The certificate of merger stated that the

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[*8] merger agreement was on file with the New Hampshire Insurance Department

(NHID). The incumbency certificate stated that there was a merger agreement

among CF Acquisition, CF Merger, Old Capital, and petitioner. The return did not

report that the first step of the merger was a reorganization under section

368(a)(1)(F) (F reorganization) or any other Code section. Nor did it use the terms

nontaxable or tax free to describe the first merger. It did not expressly identify the

first merger as a taxable or nontaxable event. The return did not disclose the

second step of the merger.

Petitioner attached an unsigned Form 1120-PC, U.S. Property and Casualty

Insurance Company Income Tax Return (pro forma return), to its return and

marked it as Old Capital’s final return. The pro forma return did not report an end

date for Old Capital’s 2002 tax year. It reported that Old Capital owed tax of

$12,454. Schedule L, Balance Sheets per Books, of the pro forma return reported

that Old Capital had yearend assets of approximately $13 million.

On its return, petitioner reported Old Capital’s $12,454 tax as the total tax it

owed for its 2002 tax year. Petitioner’s return included Schedule D (Form 1120),

Capital Gains and Losses, which reported that it sold the securities between

December 5 and 12, 2002, for total proceeds of $13,369,020. It reported long-

term capital gains of $7,528,027 from the sale of Old Capital’s securities and net

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[*9] short-term capital losses of $9,399,285, including short-term capital losses of

$9,662,707 attributable to the SPX options. Accordingly, petitioner reported net

capital gain of zero. On an attachment to the Schedule D, petitioner reported its

acquisition dates using Old Capital’s acquisition dates, which ranged from 1981 to

September 1, 2002, and reported Old Capital’s basis in the securities as its own

cost basis. The reporting is consistent with treating the first step of the merger as a

nontaxable event. However, nowhere on the return did petitioner expressly

indicate that it obtained the securities in the merger or was reporting Old Capital’s

acquisition dates or bases as its own. On Schedule L petitioner reported yearend

assets of over $13.8 million including shareholder loans of approximately $13.5

million.

Old Capital did not file its own income tax return for the short tax year

ending on the merger date, December 4, 2002. The nonfiling of a separate return

is consistent with treating the first step as a nontaxable event under section

368(a)(1)(F). See sec. 1.381(b)-1(a)(2), Income Tax Regs. (requiring the

surviving corporation in an F reorganization to file a single full-year return

reporting the operations of both the surviving and the terminating corporations for

the periods before and after the reorganization).

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[*10] CF Acquisition filed consolidated tax returns for the tax years 2003 through

2005 that reported that it was in the business of investments. These returns

continued to report yearend assets of approximately $13.5 million.

III. History of Old Capital

Old Capital was founded in 1886 as a closely held property and casualty

insurance company. On the merger date, most of its 36 shareholders were

descendants and heirs of the company’s founder. Old Capital’s corporate charter

gave it power to engage in insurance activity and to own a limited amount of real

estate. It was regulated by the NHID and was required to hold assets sufficient to

pay its potential insurance claims. Since 1952 Old Capital’s insurance business

had been limited to reinsurance, and by the 1990s its insurance business was

minimal. It had no employees and did not market itself as an insurance company.

Old Capital’s primary activity was serving as a family investment company.

Most of its assets consisted of publicly traded securities that it managed under a

buy-and-hold strategy. Its $16.3 million in assets on the merger date far exceeded

the amount of investments required under State law for purposes of the level of its

insurance business. On the merger date, it held only two reinsurance contracts

with a related company. From 1998 through 2001, the four years proceeding the

merger, Old Capital reported net underwriting losses.

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[*11] IV. Decision To Sell

By 2000 a substantial number of Old Capital shareholders had expressed a

desire to divest themselves of their ownership in the company. In late 2000 Old

Capital’s board of directors began making inquiries about a sale or liquidation. In

December 2000 Rolf Gesen, a shareholder and a member of Old Capital’s board of

directors, prepared a report for the board that outlined four possible scenarios:

continuing the business in its current form, liquidating Old Capital’s assets and

terminating its existence, selling Old Capital in a stock sale “as is”, or liquidating

Old Capital’s assets and selling the company as a shell. The report stated that

liquidation would result in high tax on the capital gains from the sale of Old

Capital’s securities and an as-is stock sale would minimize tax. Mr. Gesen

indicated in the report that it was unlikely that a buyer would purchase Old Capital

as an insurance company.

In 2001 the board of directors began to explore a potential sale of the

company, making inquiries with an investment bank and a broker. From these

discussions, the board concluded that it was unlikely that Old Capital could be

sold as is and that the most suitable outcome would be to liquidate Old Capital’s

securities and sell the insurance charter as a shell company. The board engaged

Steven Lauwers and William Ardinger of Rath, Young, and Pignatelli, P.A.

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[*12] (RYP), for advice on a sale of the company or its assets and the tax

consequences of a sale. Mr. Lauwers has legal experience in the insurance

industry, and Mr. Ardingers is a tax attorney. The board made clear to the

attorneys that they wanted to structure the divestiture in a manner that would

minimize corporate and shareholder tax. In his solicitation for a prospective

purchaser, Mr. Lauwers described Old Capital as owning an investment portfolio

with significant unrecognized built-in capital gains and stated that the

shareholders wanted to avoid two levels of tax on those built-in gains, i.e., at the

shareholder and corporate levels, and preferred to sell the company with its

investments in place.

In September 2001 Mr. Haber sent a letter to Old Capital’s board expressing

an interest in purchasing 100% of Old Capital’s stock for a price computed on the

basis of Old Capital’s cash and 90% of the fair market value of its securities. Mr.

Haber provided an overview of DGI that described DGI’s business as designing

tax-oriented structures and assisting corporations in solving tax problems. The

board decided to pursue DGI’s proposal. In December 2001 Mr. Lauwers sent a

confidential offering memorandum for Old Capital to DGI. Mr. Lauwers

represented that Old Capital anticipated that its insurance license would transfer to

the purchaser.

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[*13] On January 2, 2002, DGI made a nonbinding expression of interest to

purchase Old Capital’s stock for a price equal to 100% of Old Capital’s cash and

92.5% of the fair market value of its securities (purchase offer). The purchase

offer stated that DGI intended “to enter into a stand alone tax strategy intended to

generate a taxable loss that would largely or entirely offset any taxable gain

resulting from the sale of the Company’s investment assets.” The purchase offer

was conditioned on Old Capital’s terminating its insurance licence. DGI was the

only prospective buyer to make a firm offer for Old Capital.

In February 2002 Mr. Lauwers, Mr. Haber, and John Huber, also from DGI,

presented the purchase offer to the board as a stock sale that would allow Old

Capital’s shareholders to avoid corporate-level tax on the built-in capital gains

from the securities. The board voted to pursue DGI’s purchase offer, and

negotiations over the terms of the sale continued through the spring and summer

of 2002. The negotiations show deliberate consideration of tax issues, the

proposal to structure the transaction as a two-step merger, discussions over the

classification of the first step of the merger as a nontaxable event for Old Capital,

and agreement to report the first step as an F reorganization. Throughout this

process, the board sought advice from the RYP attorneys on the shareholders’

potential tax liability from a sale to DGI. Mr. Lauwers and Mr. Ardinger

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[*14] recommended structuring the purchase as a merger to minimize tax and

regulatory issues and recommended that DGI form a new company to purchase

Old Capital’s stock, advising that such a structure could address concerns with the

continuity of business enterprise requirement of section 1.368-1(d)(1), Income Tax

Regs. DGI’s tax counsel advised that the first step of the merger would qualify as

an F reorganization.

In a September 2002 email to Old Capital’s shareholders Mr. Gesen

explained that the divestiture transaction would likely occur through a merger and

Old Capital would not report the built-in capital gains on the securities. Old

Capital’s shareholders unanimously approved the merger. If a shareholder had

dissented, he would not have had the right to retain his Old Capital stock. The

proxy statement sent to Old Capital’s shareholders sought approval of both steps

of the merger. It stated that the merger agreement contemplated that the merger of

Old Capital into petitioner would be a nontaxable F reorganization under section

368(a)(1)(F) and that each share of Old Capital would convert into a share of

petitioner. It further stated that outside tax counsel had advised that the first step

should be treated as a nontaxable F reorganization. It further stated that petitioner

agreed to file its tax returns in accordance with the classification of the merger as

an F reorganization.

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[*15] At petitioner’s incorporation, Mr. Gesen was its president, secretary,

treasurer, and sole board member. After the merger, Mr. Haber was petitioner’s

president. Mr. Haber was also the president of CF Acquisition and CF Merger.

V. Merger Agreement

On November 13, 2002, petitioner, Old Capital, CF Acquisition, and CF

Merger executed a merger agreement and an amendment to the merger agreement

for the terms of both steps of the merger. Pursuant to the merger agreement, Old

Capital terminated its insurance license and entered into agreements that

discharged its insurance obligations. Petitioner has never held an insurance

license and has not engaged in any insurance activities.

Pursuant to the merger agreement, upon the first step of the merger (Old

Capital with petitioner) each share of Old Capital would automatically convert

into a share of petitioner and Old Capital’s stock certificates would be deemed to

represent shares in petitioner. Old Capital’s shareholders were not issued stock in

petitioner. Upon the second step of the merger (CF Merger into petitioner) Old

Capital’s shareholders would receive cash consideration as defined in the merger

agreement in exchange for their shares in petitioner. In substance, the cash

consideration came from the sale of Old Capital’s securities facilitated through an

acquisition loan. The merger consideration was $13.5 million computed under the

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[*16] formula of the sum of 100% of Old Capital’s cash and 92.5% of the fair

market value of its securities on the merger date. Upon the second step of the

merger, each share of CF Merger, which was wholly owned by CF Acquisition,

would automatically convert into a share of petitioner. After the two steps of the

merger, CF Acquisition wholly owned petitioner.

The merger agreement stated that the parties intended for the first step to

constitute a nontaxable F reorganization and agreed to report the merger as such

for tax purposes. To this end, the merger agreement addressed the requirements of

an F reorganization including a “Continuity of Business Enterprise” provision in

which Old Capital and petitioner represented and warranted that petitioner

“operates at least one significant historic business line, or owns at least a

significant portion of Target’s [Old Capital’s] historic business assets” and CF

Merger and CF Acquisition represented and warranted that they “presently intend

to continue at least one significant historic business line of Target after the Second

Merger * * * or to use at least a significant portion of Target’s historic business

assets in a business” and CF Acquisition “will continue at least one significant

historic business line of Target, or use at least a significant portion of Target’s

historic business assets”. In other sections of the merger agreement, the parties

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[*17] represented and warranted that CF Acquisition and CF Merger did not

intend to operate petitioner as an insurance company.

Under the merger agreement, petitioner agreed to timely file all required tax

returns to “properly report the transactions consummated pursuant to this

Agreement and properly reflect the tax treatment intended by the Parties”. The

merger agreement further provided that any amended return or refund claim would

not be inconsistent with the intended treatment of the first step of the merger as an

F reorganization and the second step as a sale of petitioner’s stock to CF

Acquisition. It did not expressly prohibit petitioner from taking a position in

litigation, such as the present one, that the first step of the merger was not an F

reorganization so long as petitioner did not file a refund claim or an amended

return.

Old Capital’s merger into petitioner required approval from NHID. In his

correspondence with NHID requesting approval, Mr. Lauwers represented that the

merger would terminate Old Capital’s existence as an insurance company. He

further represented that DGI was not interested in owning or operating an

insurance business and was primarily interested in purchasing Old Capital’s

securities. He represented that the merger was necessary to accomplish the sale of

Old Capital to DGI, petitioner was incorporated for the purpose of effecting the

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[*18] merger, and the merger of Old Capital into petitioner would be nontaxable.

On November 27, 2002, NHID approved the merger and ordered the termination

of Old Capital’s existence as an insurance company effective on the merger date.

Petitioner also sought an exemption from certain State corporate filing

requirements for the first step of the merger on the basis that it was merely an

interim step of the two-step merger. It represented that “[i]n substance, the

transaction is a cash merger” and further represented that the sale of Old Capital

was structured as a two-step merger to achieve certain tax objectives and terminate

Old Capital’s insurance business. Finally, it represented that it would not issue

stock certificates to Old Capital’s shareholders.

DGI financed the purchase of Old Capital’s stock with a $16.5 million

acquisition loan issued to CF Acquisition. In a letter soliciting the loan, DGI

represented that Old Capital owned cash and securities worth approximately $18

million and estimated that the loan would be outstanding for three days. DGI

pledged Old Capital’s securities as collateral and agreed to obtain a firm

commitment for the sale of the securities before it received the loan proceeds and

use the sale proceeds to repay the loan. For the loan approval, the lending bank

prepared a credit report on CF Acquisition that stated Old Capital’s securities

would be sold as soon as CF Acquisition purchased Old Capital’s stock with the

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[*19] loan proceeds pursuant to a fixed price contract. The credit report further

stated that CF Acquisition would immediately use the sale proceeds to repay the

loan.

VI. Audit and Notices of Deficiency

In January 2006 respondent began an audit for petitioner’s 2002 tax year.

Revenue Agent (RA) Richard Davis was assigned to the audit, and Joni Politzer, a

tax shelter technical advisor, was assigned to assist him. By letter dated April 18,

2006, RA Davis informed petitioner of the audit and requested a meeting.

Petitioner did not respond to this letter, refused delivery of other correspondence,

and did not cooperate with the audit. The initial focus of the audit was whether

petitioner engaged in a tax shelter transaction through the SPX options. During

the audit, respondent had a copy of the Northmoy stock purchase agreement that

he obtained from a third party, which is the basis for petitioner’s SPX loss

deductions. The audit did not consider the structure of the merger or whether any

part of the merger transaction was taxable event.

During the course of the audit, RA Davis and Ms. Politzer had minimal

information about the merger. They did not have a copy of the merger agreement.

They were not aware that the merger occurred in two steps. They understood that

Old Capital stock was sold to CF Acquisition and then Old Capital merged with

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[*20] petitioner. Thus, they understood that CF Acquisition was the owner of

petitioner before and after the merger. RA Davis and Ms. Politzer did not know or

have any reason to know that there was a second step of the merger. There is no

indication that the revenue agents questioned whether it was correct for petitioner

to report the merger of petitioner and Old Capital as nontaxable or considered

what position petitioner was taking to support its reporting of the merger as

nontaxable, or whether the merger was an F reorganization.

On September 11, 2006, respondent issued a notice of deficiency to

petitioner for the 2002 tax year disallowing the deductions for the SPX option

loss, consulting fees, and interest expense. Respondent did not adjust petitioner’s

reported capital gain from the sale of Old Capital’s securities. On the basis of

respondent’s adjustments, petitioner’s taxable income increased by the amount of

its reported capital gain. Respondent received a copy of the merger agreement in

November 2006. After issuance of the deficiency notice, petitioner failed to

comply with a summons issued by respondent, and respondent sent a “last-chance”

letter to petitioner advising that legal proceedings might be brought for continued

noncompliance with the summons.

In 2012, after discovery in this case, respondent opened an audit for Old

Capital’s 2002 tax year and prepared a substitute for return for Old Capital for that

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[*21] year. On July 25, 2012, respondent issued a notice of deficiency to Old

Capital for 2002 determining that Old Capital was required to file a return for its

2002 tax year ending on the merger date. He also determined that its merger with

petitioner did not qualify as an F reorganization and Old Capital realized capital

gains on the deemed sale of the securities to petitioner on the merger date.

Petitioner, as successor in interest to Old Capital, filed a petition with this Court

assigned docket no. 25858-12. In New Capital Fire, Inc. v. Commissioner (New

Capital), T.C. Memo. 2017-177, we held that the notice of deficiency issued to

Old Capital was untimely and the statute of limitations barred assessment against

Old Capital for 2002. In that case, petitioner argued that the first step of the

merger qualified as an F reorganization. We did not reach the merits of that issue.

After our decision in New Capital had become final, petitioner filed an

amended petition in this case alleging that it did not realize the capital gains from

Old Capital’s securities that it had reported on its 2002 return. In the amended

petition, petitioner adopted the substantive position that respondent asserted

against Old Capital in New Capital: The first step of the merger did not qualify as

an F reorganization, Old Capital realized capital gains from a deemed sale of the

securities on the merger date, petitioner received a basis in the securities equal to

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[*22] their fair market value on the merger date, and thus it did not have the gain it

reported on the sale of the securities.

In the amended petition, petitioner alleged that respondent erred in

determining that petitioner had realized the capital gains of approximately $7.8

million that petitioner had reported on its 2002 return. In a stipulation of settled

issues filed November 5, 2018, petitioner conceded that respondent did not adjust

petitioner’s reported capital gains in the notice of deficiency. The notice of

deficiency reflected an adjustment to income of $7.8 million on the basis of

respondent’s determination to disallow the capital loss deductions from the SPX

options.

Discussion

Respondent argues that petitioner is estopped under the duty of consistency

or the doctrine of equitable estoppel from changing its reporting of the capital

gains after the period of limitations expired for Old Capital’s 2002 tax year. He

argues that we should not permit petitioner to treat the merger of petitioner and

Old Capital as a taxable event.2 Had petitioner treated the merger as taxable, it

2

Petitioner argues that respondent should be barred from raising the doctrine

of equitable estoppel because he did not clearly indicate his intent to assert that

doctrine in his discovery responses. Such an argument is without merit and does

not warrant further discussion. Respondent alleged the doctrine in his answer to

(continued...)

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[*23] would have reported the bases in the Old Capital securities equal to their fair

market values on the merger date, at or near their sale prices, and would have had

minimal or no capital gains on the sales. Therefore, respondent argues that we

should not allow petitioner to argue that Old Capital should have recognized

capital gains on the deemed sale of the securities on the merger date and that

petitioner had bases in the securities equal to their fair market values on the

merger date.

I. Background on F Reorganizations

Section 1001 requires taxpayers to recognize any gain or loss realized on

the sale or exchange of property unless an exception exists. One such exception is

an F reorganization under section 368(a)(1)(F). An F reorganization is defined as

a “mere change in identity, form, or place of organization of one corporation,

however effected”. Sec. 368(a)(1)(F). An F reorganization

encompass[es] only the simplest and least significant of corporate

changes * * * [and] presumes that the surviving corporation is the

same corporation as the predecessor in every respect, except for

minor or technical differences * * * [It] typically has been understood

to comprehend only such insignificant modifications as the

2

(...continued)

petitioner’s amended petition. There is no basis for petitioner to claim unfair

prejudice or undue surprise by respondent’s assertion of equitable estoppel in this

fully stipulated case.

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[*24] reincorporation of the same corporate business with the same assets

and the same stockholders * * *

Berghash v. Commissioner, 43 T.C. 743, 752 (1965), aff’d, 361 F.2d 257 (2d Cir.

1966).

To qualify, the reorganization must occur pursuant to a plan of

reorganization, have a valid business purpose, and have continuity of business

enterprise and continuity of interest.3 Sec. 1.368-1(c), (d), and (e), Income Tax

Regs. Continuity of business enterprise generally requires the surviving

corporation to continue at least one line of the target’s historic business or use a

significant portion of the target’s historic business assets in a business after the

reorganization, and continuity of interest generally requires a substantial portion

of the target’s shareholders to have a continuing ownership interest in the

successor corporation after the reorganization. Id. paras. (d)(1), (e).

In an F reorganization the target’s tax year does not terminate on the

reorganization and the surviving corporation must file a full-year return on the

basis of a single tax year that includes the operations of the target before the

reorganization and the surviving corporation for the remainder of the year. Sec.

3

The F reorganization regulations were amended after the merger date to

eliminate the continuity of business enterprise and continuity of interest

requirements. Sec. 1.368-1(b), Income Tax Regs.; T.D. 9182, 2005-1 C.B. 713.

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[*25] 381(b); New Capital, at *6; sec. 1.381(b)-1(a)(2), Income Tax Regs.

Significant for this case, the transfer of the target’s assets to the successor

corporation in an F reorganization is not a taxable disposition. When a transaction

does not qualify as an F reorganization, the target must recognize gain on its assets

as if it had sold the assets to the surviving corporation for their fair market values.

Honbarrier v. Commissioner, 115 T.C. 300, 315 (2000); Rev. Rul. 69-6, 1969-1

C.B. 104.

Petitioner maintains that we should treat the two steps of the merger as two

separate transactions.4 We do not decide this issue as the parties agree the first

step of the merger was not an F reorganization. For convenience, we refer to the

first step as the first merger for the remainder of this opinion and the second step

as the second merger. The parties address at length how the first merger failed to

qualify as an F reorganization. We consider below the terms of the first merger as

it relates to the requirements of an F reorganization for purposes of ascertaining

whether petitioner misrepresented material facts. Significantly, the return did not

accurately disclose the entire transaction and did not disclose that there were two

4

Petitioner argues that the first merger had a business purpose, to terminate

the insurance license. However, the termination of the insurance license was

required only to accomplish the entire transaction. Petitioner knew that there was

no purpose for the transaction except tax avoidance.

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[*26] mergers. Petitioner chose to disclose only the first merger and did not make

adequate disclosures of that merger.

II. Estoppel

Respondent argues that we should apply the doctrine of equitable estoppel

or the duty of consistency to preclude petitioner from asserting that it did not

realize gain on the sale of Old Capital’s marketable securities. Petitioner argues

that the Court of Appeals for the Second Circuit, to which this case is appealable,

does not recognize a duty of consistency. Respondent argues that the Court of

Appeals would recognize a duty of consistency under the particular circumstances

of this case, namely, that petitioner did not make an innocent mistake and is

seeking to change its own reporting through an amended petition. As explained

below, we find that equitable estoppel applies here and we do not apply the duty of

consistency.

The Supreme Court has long recognized that the doctrine of equitable

estoppel applies in tax cases. See R.H. Stearns Co. of Bos., Mass. v. United

States, 291 U.S. 54 (1934). In holding the taxpayer estopped from obtaining a

refund, the Supreme Court stated: “[N]o one shall be permitted to found any claim

upon his own inequity or take advantage of his own wrong.” Id. at 61-62. The

Court of Appeals for the Second Circuit has stated that “equity plays a very

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[*27] limited role in tax cases.” Callaway v. Commissioner, 231 F.3d 106, 134

(2d Cir. 2000), rev’g T.C. Memo. 1998-99. It has applied the doctrine of equitable

estoppel to tax issues. See, e.g., United States v. Wynshaw, 697 F.2d 85, 87 (2d

Cir. 1983); United States v. Matheson, 532 F.2d 809, 819 (2d Cir. 1976); Askin &

Marine Co. v. Commissioner, 66 F.2d 776, 778 (2d Cir. 1933), aff’g 26 B.T.A.

409 (1932). The duty of consistency, also referred to as quasi-estoppel, originates

in similar principles of equity but is seen as having broader application than

equitable estoppel. See, e.g., Estate of Ashman v. Commissioner, 231 F.3d 541,

543 (9th Cir. 2000), aff’g T.C. Memo. 1998-145; Estate of Letts v. Commissioner,

109 T.C. 290, 296 (1997), aff’d without published opinion, 212 F.3d 600 (11th

Cir. 2000). Both doctrines are affirmative defenses. S. Pac. Transp. Co. v.

Commissioner, 75 T.C. 497, 838 (1980); McCulloch Corp. v. Commissioner, T.C.

Memo. 1984-422. The party asserting them bears the burden of proof. Rule

142(a).

The Court of Appeals for the Second Circuit has identified four

requirements for applying equitable estoppel against a taxpayer: (1) the taxpayer

made a false representation or engaged in a wrongful misleading silence, (2) the

error originated in a statement of fact and was not a mistake of law, (3) the

Commissioner did not know the correct facts, and (4) the Commissioner is

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[*28] adversely affected by the taxpayer’s acts or statements. Lignos v. United

States, 439 F.2d 1365, 1368 (2d Cir. 1971); see Stair v. United States, 516 F.2d

560, 564 (2d Cir. 1975) (citing Lignos). Equitable estoppel can apply to bind a

taxpayer to a representation made by another taxpayer where the two taxpayers are

in privity, i.e., where there is sufficient identity of interests between them. Milton

H. Greene Archives, Inc. v. Marilyn Monroe LLC, 692 F.3d 983, 996 (9th Cir.

2012); see Estate of Letts v. Commissioner, 109 T.C. at 298 (stating the duty of

consistency applies to taxpayers that are in privity); see also Ag Processing, Inc. v.

Commissioner, 153 T.C. 34, 55-56 (2019) (dismissing the Commissioner’s

argument to apply the duty of consistency “to one taxpayer where the period of

limitations has expired with respect to a different taxpayer”). Petitioner concedes

that it was in privity with Old Capital for the 2002 tax year.

Respondent argues that the requirements of both equitable estoppel and the

duty of consistency are met here. Under the duty of consistency, the

Commissioner may treat the taxpayer’s representations with respect to a prior,

closed tax year as true and estop the taxpayer from asserting a contrary position in

a subsequent year regardless of whether the earlier position was correct.

Herrington v. Commissioner, 854 F.2d 755, 758 (5th Cir. 1988), aff’g Glass v.

Commissioner, 87 T.C. 1087 (1986); Estate of Letts v. Commissioner, 109 T.C.

- 29 -

[*29] at 297. Applying duty of consistency requires that the Commissioner

acquiesced in or relied on the representation made for the closed year but does not

examine whether the misrepresentation was innocently or intentionally made.

Beltzer v. United States, 495 F.2d 211, 212 (8th Cir. 1974) (applying a duty of

consistency where the taxpayer’s mistake is “innocent or otherwise”); Estate of

Letts v. Commissioner, 109 T.C. at 297. Courts have recognized their respective

applicability to an innocent mistake as the primary difference between the two

doctrines. Equitable estoppel would not apply to an innocent mistake. LeFever v.

Commissioner, 100 F.3d 778, 786 (10th Cir. 1996), aff’g 103 T.C. 525 (1994). In

LeFever, the court stated that equitable estoppel requires “a showing that the

taxpayer made an intentional misrepresentation”. Id.

The Court of Appeals for the Second Circuit has been reluctant to expand

the reach of equitable considerations to adopt a duty of consistency. See Uinta

Livestock Corp. v. United States, 355 F.2d 761, 766 (10th Cir. 1966) (stating that

the Second Circuit “adhered to a more strict reading of the * * * estoppel

elements”); Zuhovitzky v. Commissioner, T.C. Memo. 2018-158, at *7 n.5 (stating

that the Second Circuit “does not seem to recognize the duty of consistency”). But

see Unvert v. Commissioner, 72 T.C. 810, 815 (1979) (citing the Second Circuit

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[*30] case of Askin & Marine Co. as recognizing a duty of consistency), aff’d, 656

F.2d 483 (9th Cir. 1981).

Petitioner cites the following cases to argue that the Court of Appeals for

Second Circuit does not recognize a duty of consistency, the most recent of which

was decided nearly 70 years ago: Commissioner v. Dwyer, 203 F.2d 522, 524-525

(2d Cir. 1953); Bennet v. Helvering, 137 F.2d 537, 539 (2d Cir. 1943); Helvering

v. Schine Chain Theatres, Inc., 121 F.2d 948 (2d Cir. 1941); and Helvering v.

Brooklyn City R. Co., 72 F.2d 274 (2d Cir. 1934), aff’g 27 B.T.A. 77 (1932). The

most recent case to raise the duty of consistency before the Court of Appeals for

the Second Circuit is Janis v. Commissioner, 469 F.3d 256 (2d Cir. 2006), aff’g

T.C. Memo. 2004-117, in which the taxpayer challenged our application of a duty

of consistency between an estate and its heirs with respect to basis in inherited

property. The Court of Appeals affirmed “for different reasons” on the basis of

the technical requirements of the law that an heir’s basis in inherited property be

the fair market value properly determined for purposes of estate tax.5 Id. at 257,

5

Our decision was also appealed by another heir to the Court of Appeals for

the Ninth Circuit, which affirmed on the basis of the duty of consistency. Janis v.

Commissioner, 461 F.3d 1080, 1085-1087 (9th Cir. 2006), aff’g T.C. Memo.

2004-117.

- 31 -

[*31] 261. Notably, the Court of Appeals did not address the applicability of a

duty of consistency or otherwise indicate its position with respect to such a duty.

Bennet is often cited for the proposition that the Court of Appeals for the

Second Circuit does not recognize a taxpayer’s duty of consistency. Petitioner

also relies on that case. In Bennet v. Helvering, 137 F.2d at 538, the court stated:

“We can see no reason why an innocent mistake should deprive the taxpayer of

protection” of the statute of limitations. It reasoned that statutes of limitations

“presuppose that the original decision may have been erroneous.” Id. Bennet was

a deficiency proceeding. The Commissioner disallowed a loss deduction for

worthless stock that the taxpayer had received as compensation in a prior year,

arguing that the taxpayer had no basis in the stock because he had not reported the

stock as income when he received it 14 years before. Id.; see Alsop v.

Commissioner, 290 F.2d 726, 728 (2d Cir. 1961), aff’g 34 T.C. 606 (1960). In

rejecting the Commissioner’s arguments for estoppel, the Court of Appeals for the

Second Circuit also opined that the Commissioner was equitably in a weaker

position in a deficiency proceeding than in refund cases. Bennet v. Helvering, 137

F.2d at 539. The court also explained that there was no indication that the tax

from a denial of a deduction would equal the tax if the income had been reported

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[*32] for the prior year. Id. But see Estate of Ashman v. Commissioner, 231 F.3d

at 544 (questioning the underpinnings of Bennet).

The Court of Appeals for the Second Circuit later explained in

Commissioner v. Dwyer, 203 F.2d at 524-525:

Although there have been exceptions, it is established by the great

weight of authority that, if a taxpayer has not misrepresented or

suppressed the facts, the statute of limitations not only prevents any

reassessment of the tax after the prescribed period has passed; but that

the Treasury may not assess a tax for a later year to make up for a

credit erroneously allowed, or a charge erroneously omitted, in an

earlier year. * * *

On the basis of Bennet v. Helvering, 137 F.2d at 538, we accept for

purposes of this case petitioner’s position that that Court of Appeals would not

apply equitable principles to estop a taxpayer who has made an innocent mistake.6

However, the Court of Appeals has applied equitable principles to estop taxpayers

who have knowingly misrepresented facts. See Matheson, 532 F.2d at 819-820

(estopping an estate from denying the decedent was a U.S. citizen where the

6

The last time that the Court of Appeals for the Second Circuit cited Bennet

was in Alsop v. Commissioner, 290 F.2d 726 (2d Cir. 1961), aff’g 34 T.C. 606

(1960). It stated that our decision in that case could not be reconciled with

Bennet, distinguished Bennet, and affirmed on other grounds without relying on a

duty of consistency or equitable estoppel. Alsop involved a taxpayer who claimed

a loss deduction for embezzled income. The court held that the taxpayer was not

entitled to a loss deduction because the taxpayer had not received the embezzled

money and had not reported it as income.

- 33 -

[*33] decedent knowingly represented her U.S. citizenship to obtain benefits of

citizen and did not innocently misunderstand the law); Askin & Marine Co. v.

Commissioner, 66 F.2d at 778 (applying principles of equitable estoppel so that “a

taxpayer may not benefit at the expense of the government by misrepresenting

facts under oath”).

We believe that equitable estoppel applies in this case because petitioner

knowingly misrepresented facts relating to the first merger and concealed that the

merger occurred in two steps, petitioner’s misrepresentations were not innocent,

and respondent did not know or have reason to know the correct facts before the

limitations period expired for Old Capital’s 2002 tax year. Petitioner also misled

respondent through wrongful misleading silence including Old Capital’s not filing

a separate return for its 2002 tax year. Petitioner’s misrepresentations related to

questions of fact; it did not make a mistake of law. Respondent reasonably relied

on petitioner’s misrepresentations and silence and has been adversely affected.

A. Misrepresentation of Fact or Misleading Silence

The Court of Appeals for the Second Circuit recognizes the doctrine of

equitable estoppel where “[t]he taxpayer, by his conduct, which includes language,

acts or silence, knowingly makes a representation or conceals material facts which

he intends or expects will be acted upon by taxing officials in determining his

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[*34] tax.” Wynshaw, 697 F.2d at 87 (quoting Robinson v. Commissioner, 100

F.2d 847, 849 (6th Cir. 1939)). In Wynshaw, the Court of Appeals applied

equitable estoppel against a taxpayer in a collection action to preclude her from

claiming the signature on her joint return was not hers where she had previously

represented in a separate court proceeding that it was her signature. See

Matheson, 532 F.2d at 820 (applying equitable estoppel on the basis of the

“deliberate and devious nature” of the taxpayer’s misrepresentation); Bennet v.

Helvering, 137 F.2d at 538 (differentiating an “innocent” mistake from one

“consciously made”). The Court of Appeals has previously declined to estop a

taxpayer who made an innocent mistake of fact from correcting the mistake in a

subsequent year. Bennet v. Helvering, 137 F.2d at 538.

“[A] taxpayer’s treatment of an item on a return can be a representation that

facts exist which are consistent with how the taxpayer reports the item on the

return.” Estate of Letts v. Commissioner, 109 T.C. at 299-300; see Becker v.

Bemis, 104 F.2d 871, 875 (8th Cir. 1939) (holding that a taxpayer’s claimed

deductions were “an assertion * * * [of] the facts upon which the claims for

deductions were based”). Likewise, the failure to report an item of income may be

treated as a representation of the underlying facts of that item’s tax effect. Estate

of Letts v. Commissioner, 109 T.C. at 300. Failure to report income from a

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[*35] transaction is a representation that the transaction is nontaxable. Crane v.

Commissioner, 68 F.2d 640, 641 (1st Cir. 1934), aff’g 37 B.T.A. 360 (1932);

Bartel v. Commissioner, 54 T.C. 25 (1970). A taxpayer’s reporting of the loss leg

of a straddle is a factual representation that the straddle had economic substance.

Herrington v. Commissioner, 854 F.2d at 758; see also Arberg v. Commissioner,

T.C. Memo. 2007-244, 2007 WL 2416230 (holding that the reporting of capital

gain is a factual representation that the taxpayer owned the investment account).

Petitioner maintains that the correct facts were set out on its return and that

it made no factual misrepresentations in its reporting of the first merger. However,

petitioner did not set forth the correct facts on its return. Notably, the return did

not expressly state that the first merger was nontaxable. In fact, petitioner’s return

did not identify the basis on which petitioner claimed the merger of petitioner and

Old Capital was a nontaxable event. It did not identify section 386(a)(1)(F) as the

basis for its nontaxable treatment. Nevertheless, by reporting carryover bases in

the Old Capital securities and reporting Old Capital’s activities before the merger

on a single full-year return, petitioner reported that the first merger was a

nontaxable event.

We disagree with petitioner’s assertion that the only factual statement that it

made on its return was that it was in the business of investment. Petitioner further

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[*36] argues that such a misrepresentation of the facts relating to its business

activity is immaterial. It argues that its reporting of its business activity as

investments does not constitute a knowing false representation of fact because

taxpayers are required to identify a business activity on their returns and

investment is the most accurate description of its activities from the options

available for purposes of return reporting. It argues that any other choice would

have been more false. Petitioner appears to argue that because the return

requirements forced it to make this false statement, it should not be counted

against it. It now argues that it had no business. Despite petitioner’s overly

imaginative argument, reporting requirements do not excuse petitioner’s knowing

factual misrepresentation that it was engaged in an investment business and do not

render the misrepresentation innocent.

Petitioner knowingly misrepresented its business activity. We infer that it

did so to misrepresent the first merger as qualifying as nontaxable. Although

petitioner maintains otherwise, its business activity is a material fact. Petitioner

concedes that Old Capital engaged in both an investment business and an

insurance business. Petitioner never had any intention of continuing Old Capital’s

investment business and knew when it filed its 2002 return that it would not

engage in an investment business. It continued to report its business as investment

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[*37] through the 2005 tax year even though it conducted no business activity. On

the basis of the transaction documents, it is clear to us that the purpose of

petitioner’s existence was for Old Capital’s shareholders to achieve a tax strategy

to avoid a corporate-level tax on the built-in capital gains on Old Capital’s

securities. The Internal Revenue Service (IRS) had published Notice 2001-16,

2001-1 C.B. 730, before petitioner filed its 2002 tax return; and it is highly

unlikely that Mr. Harber was unaware of that Notice or its classification of the

intermediary transactions such as the subject transaction as abusive tax shelters.

Petitioner knowingly made numerous factual representations on its return

including its claim of carryover bases in Old Capital’s securities. As we stated,

nowhere on the return did petitioner identify the first merger as an F

reorganization or otherwise expressly state it was nontaxable. By claiming the

carryover bases it knowingly reported the first merger as a nontaxable event.

Petitioner’s decision for Old Capital not to file a separate return for the 2002 tax

year again represented that facts existed to support treating the first merger as a

nontaxable disposition of Old Capital’s assets. Instead, petitioner attached a pro

forma return for Old Capital to petitioner’s return, a further representation that the

first merger was a nontaxable transaction. The decision not to file a separate

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[*38] return for Old Capital was a conscious and deliberate decision and not an

innocent mistake. It was part of the planned tax avoidance transaction.

Petitioner ignores our caselaw, which holds that a return reporting position

is a representation that the facts underlying the income or expense item support

such reporting. By reporting the first merger as nontaxable, petitioner knowingly

represented that Old Capital’s shareholders continued to own petitioner after the

merger. They did so but only for one hour. Petitioner argues that the shareholders

never held stock in petitioner because petitioner’s stock was not actually issued.

However, the merger agreement provided that Old Capital stock automatically

converted into petitioner’s stock.

Petitioner now asserts that the following material facts represented on its

return are not correct: (1) petitioner was in the investment business, (2) petitioner

acquired carryover bases in the Old Capital securities, and (3) Old Capital was not

required to file a separate return for 2002. Petitioner reported that the first merger

was nontaxable and in so doing represented that the facts of the first merger were

in accordance with such reporting. In so doing, it made representations that it

knew were not the correct facts. These misrepresentations were not innocent

mistakes. Petitioner knew that neither Old Capital’s investment business nor its

insurance business would continue and knew that Old Capital’s shareholders

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[*39] would continue as shareholders for only one hour. Petitioner knew the

representations were incorrect.

We further note that in the cases that petitioner cites, the Court of Appeals

for the Second Circuit did not use the term “intentional” with respect to the

requirement for the misrepresentation. The court requires a knowing

representation. Wynshaw, 697 F.2d at 87. Petitioner knew that the first merger

did not satisfy the requirements of an F reorganization including the continuity of

business enterprise, continuity of interest, or business purpose requirement.

Petitioner knew that it would not continue Old Capital’s insurance business or its

investment business, Old Capital’s shareholders owned an interest in petitioner for

only one hour and did not own any interest in petitioner or CF Acquisition after

the second merger, and Old Capital’s shareholders received cash consideration for

the stock in petitioner one hour after the first merger.

Petitioner also made factual representations through its failure to disclose

material facts. Significantly, it did not disclose on its 2002 return that there was a

second merger in which Old Capital’s shareholders received cash for their stock in

petitioner. Thus, petitioner did not disclose, and respondent was unaware, that

Old Capital’s shareholders received a cashout. This is a wrongful misleading

silence. Petitioner argues that respondent should have suspected that the SPX

- 40 -

[*40] options involved an intermediary transaction and points to the revenue

agents’ communications with intermediary transaction advisers during the audit.

Tax shelters of the type petitioner engaged in traditionally involve intermediary

transactions. See Notice 2001-16, supra (identifying listed intermediary

transactions as abusive tax shelters).

Petitioner admits on brief that it was a “party to a classic intermediary

transaction”. However, petitioner’s return did not indicate that an intermediary

transaction occurred. Petitioner represented a continuity of ownership, which is

inconsistent with the second merger, and concealed from respondent the facts that

might have indicated that the first merger was a taxable event. Its reporting that

CF Acquisition wholly owned petitioner as of the end of the 2002 tax year is not

adequate disclosure of the second merger or an intermediary transaction.

Petitioner knowingly misrepresented the facts of the two-step merger and

that the first merger was a nontaxable event so that petitioner rather than Old

Capital was the taxpayer that reported the capital gains from the prearranged sales

of the securities. Petitioner knew that it was misrepresenting material facts so that

it could claim the first merger was a nontaxable disposition of Old Capital’s assets.

It is enough for purposes of equitable estoppel that petitioner knew these factual

representations were false, but it also likely knew that the first merger did not

- 41 -

[*41] qualify as an F reorganization. Petitioner’s reporting was not an innocent

mistake but a deliberate and purposeful representation that was a part of a broader

scheme to avoid tax on the built-in gains from Old Capital’s securities. Petitioner

misrepresented that it was the entity that recognized the capital gains because it

engaged in SPX option transactions and attempted to use the SPX option losses to

avoid any tax on the capital gains. The IRS subsequently identified the SPX

option transactions as an abusive tax shelter referred to as a loss importation

transaction in Notice 2007-57, 2007-2 C.B. 87. Petitioner misrepresented that the

facts of the first merger supported its reporting as nontaxable to further

petitioner’s tax avoidance scheme.

The purchase price under the merger agreement was simply a method for

Old Capital’s shareholders to pay DGI for a tax strategy provided by the SPX

option transactions. Petitioner together with Old Capital’s shareholders and DGI

planned the two-part merger to avoid tax on Old Capital’s built-in gains on its

portfolio of securities. This was the reason for Old Capital’s shareholders’

decision to work with DGI. They wanted to avoid corporate-level tax on Old

Capital’s securities. This was also the reason for petitioner’s existence. DGI

offered a tax strategy and purposefully structured the transaction so that petitioner

would be the entity to sell the securities and recognize the gain because Mr. Haber

- 42 -

[*42] and DGI planned for petitioner to engage in a tax avoidance transaction so

that no tax would be reported as owed. An essential part of that plan was for Old

Capital and petitioner to treat the first merger as a nontaxable event. There is

nothing innocent about petitioner’s misstatements or silence. Petitioner’s

reporting and Old Capital’s silence omitted, concealed, and misrepresented the

facts of the two-part merger.

To the extent that petitioner argues otherwise, it is irrelevant that petitioner

did not initially plan when it filed its 2002 return to later contradict itself. The

structure of the two-part merger and the reporting of the first merger as nontaxable

were the result of conscious tax planning between Old Capital’s shareholders and

DGI. In the merger documents, petitioner agreed to report the merger as an F

reorganization and thus agreed that it would be the entity to report the capital

gains on the securities. It was aware of the tax consequences of such reporting

and sought those tax consequences as part of its tax strategy.

The record establishes petitioner’s knowledge of its misrepresentation on its

return reporting and the lack of any innocence in reporting the first merger as

nontaxable as part of a purposefully designed transaction to avoid tax on the

capital gains. Old Capital’s shareholders wanted to divest themselves of their

ownership in a transaction that would minimize corporate- and shareholder-level

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[*43] tax. Mr. Haber offered a tax strategy. From the beginning, DGI presented

its business as designing and selling tax strategies and assisting corporations in

solving tax problems. Mr. Haber, a sophisticated tax adviser with experience in

designing tax-motivated transactions, had no intention for petitioner to pay tax on

the capital gains but agreed to report the sale of the securities in such a manner

that Old Capital’s shareholders could also avoid tax. The parties to the merger

sought and negotiated for reporting of the first merger as an F reorganization.

Documents in the record demonstrate the importance of tax considerations in

structuring the transaction between DGI and Old Capital, the parties’ concern with

tax on the capital gains, and assurances to Old Capital’s shareholders that the

transaction would be structured to avoid corporate-level tax on the built-in capital

gains.

We have described Mr. Haber as “a sophisticated tax planner” who has

repeatedly attempted to “deliberately exploit[] a perceived loophole” in the tax

law. See Markell Co. v. Commissioner, T.C. Memo. 2014-86, at *38; see also

Humboldt Shelby Holding Corp. v. Commissioner, T.C. Memo. 2014-47, at *25,

aff’d, 606 F. App’x 20 (2d Cir. 2015). DGI has a history of deliberate use of tax

shelters to help its clients avoid tax. See, e.g., Diversified Grp. Inc. v. United

States, 841 F.3d 975 (Fed. Cir. 2016); Namm Tr. v. Commissioner, T.C. Memo.

- 44 -

[*44] 2018-182, at *4-*7; Tucker v. Commissioner, T.C. Memo. 2017-183, at *25,

aff’d, 766 F. App’x 132 (5th Cir. 2019); Markell Co. v. Commissioner, T.C.

Memo. 2014-86 (involving a son of BOSS tax shelter). Mr. Haber has repeatedly

used various option transactions similar to the SPX option transactions to generate

artificial losses to offset built-in capital gains on assets held by a target

corporation that DGI acquired indirectly through newly formed partnerships and

corporations.

Respondent also argues that petitioner’s failure to cooperate during the audit

of its 2002 return further demonstrates its lack of innocence. The audit file

contains RA Davis’ statements that petitioner failed to cooperate with the audit,

refused to meet with him, and withheld requested information.7 Withholding

requested information during an audit can be wrongful misleading silence. Unvert

v. Commissioner, 72 T.C. at 814-818. Even when a taxpayer has innocently

misstated facts on a return, equitable estoppel may nevertheless apply where the

taxpayer later learns of the mistake but fails to provide the corrected facts to the

Commissioner during an audit. Id. at 818. Petitioner objects to RA Davis’

7

For the first time in its reply brief, the third brief it filed, petitioner

contends that there is no proof of mailing or receipt of RA Davis’ April 18, 2006,

letter notifying petitioner of the audit. Petitioner stipulated this letter without

reserving an objection.

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[*45] description of its conduct as uncooperative. We have not based our findings

that petitioner knowingly misrepresented facts on its alleged conduct during the

audit. We have found that petitioner deliberately made statements of facts in its

reporting that it knew were incorrect. We address petitioner’s alleged conduct

during the audit below in connection with the requirement that respondent lacked

actual or constructive knowledge of the correct facts before the limitations period

expired.

B. Mistake of Law

Equitable estoppel does not apply to a mistake of law. Bennet v. Helvering,

137 F.2d at 539. The Court of Appeals for the Second Circuit has explained its

refusal to apply equitable estoppel to a mistake of law, referring to it as “a kind of

estoppel as to the law”:

That theory is, not that the taxpayer was here “estopped” as to

any fact by his earlier return, but that if the earlier assessment were

made upon one theory of law, the same theory must be consistently

followed thereafter * * * [E]ven if the taxpayer had no part in

inducing that error--justice demands that that assumption shall be

carried over into any future year * * * With deference * * * [this

theory] seems to us, not only to have all the vices of an estoppel as to

the facts, but not to have even the excuse which that doctrine has:

i.e., that in making his return a taxpayer does represent that it contains

his complete gross income; something which the Commissioner

cannot know. * * *

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[*46] Id.; see also Crosley Corp. v. United States, 229 F.2d 376 (6th Cir. 1956);

Ag Processing, Inc. v. Commissioner, 153 T.C. at 55-56 (involving an issue of

first impression); S. Pac. Transp. Co. v. Commissioner, 75 T.C. at 560; Garavaglia

v. Commissioner, T.C. Memo. 2011-228, 2011 WL 4448913, aff’d, 521 F. App’x

476 (6th Cir. 2013); McCulloch Corp. v. Commissioner, T.C. Memo. 1984-422.

Courts have applied equitable principles to estop taxpayers who have made false

representations with respect to questions of fact and mixed questions of fact and

law. Eagen v. United States, 80 F.3d 13, 17 (1st Cir. 1996); Herrington v.

Commissioner, 854 F.2d at 758.

Courts have stated that a mistake of law occurs when both parties have

knowledge of all relevant facts before the period of limitations expired. See

Crosley Corp., 229 F.2d at 381 (holding that a business expense deduction for a

tool with a three-year useful life was a mutual mistake of law where the

Commissioner knew the facts related to the deduction from an audit for the prior

year); Garavaglia v. Commissioner, 2011 WL 4448913, at *18 (refusing to apply

the duty of consistency to require the taxpayer to treat a corporation as an S

corporation where the Commissioner knew the election form was incomplete and

thus invalid). However, the Court of Appeals for the Second Circuit considers the

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[*47] Commissioner’s knowledge a separate requirement under the doctrine of

equitable estoppel.

Petitioner argues that if it did make any misstatements, they were mistakes

of law and not mistakes of fact. It argues that whether the first merger qualifies as

an F reorganization is a question of law. We disagree. Whether a merger qualifies

as an F reorganization depends on whether the circumstances and terms of the

merger satisfy the legal requirements of the Code and the regulations. Each

requirement set forth in the Code and the regulations for an F reorganization is

predicated on questions of fact. The issue is a question of fact or a mixed question

of fact and law. For example, the continuity of interest requirement is a question

of fact. See Russell v. Commissioner, 832 F.2d 349, 352 (6th Cir. 1987), aff’g

T.C. Memo. 1986-150. Likewise, the existence of a plan of reorganization is “a

pure question of fact”. Swanson v. United States, 479 F.2d 539, 545 (9th Cir.

1973). Whether the taxpayer had a business purpose for the merger is also a

question of fact. Lewis v. Commissioner, 160 F.2d 839, 844 (1st Cir. 1947)

(distinguishing the question of whether a business purpose is required, a question

of law, from whether the taxpayer had a business purpose, a question of fact),

vacating 6 T.C. 455 (1946). The propriety of classifying the merger as an F

reorganization involves applying the law to the facts. Petitioner’s mistake is one

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[*48] of fact or a mixed question of fact and law to which equitable estoppel may

apply. See LeFever v. Commissioner, 100 F.3d at 788. All parties to the merger

agreement understood the law and were concerned with representing to respondent

that the first merger was nontaxable.

Petitioner relies heavily on Manhattan Bldg. Co. v. Commissioner, 27 T.C.

1032 (1957), to argue that the tax treatment of the first merger is a question of law.

However, the case does not support petitioner’s position. Rather, it stands for the

proposition that there is no basis for equitable estoppel when the Commissioner

has knowledge of the facts. Manhattan Bldg. Co. involved a taxpayer who for a

prior, closed year erroneously treated a transfer of real property as nontaxable

under the predecessor to section 351. The Commissioner had audited the prior

year’s return and did not adjust the claimed carryover basis. Id. at 1037, 1039,

1041-1042. On the sale of the real property nearly 20 years later, the taxpayer

argued that the prior transfer was taxable and that it did not receive a carryover

basis for purposes of calculating its gain or loss on the sale of the property. We

held that equitable estoppel did not require the taxpayer to use the carryover basis.

We stated repeatedly in our Opinion that the Commissioner was aware of the facts

and on the basis of that knowledge there was no evidence of any misrepresentation

by the taxpayer or evidence that the Commissioner was misled. Id. at 1041-1043.

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[*49] The proper treatment of a merger as taxable or nontaxable primarily affects

the acquiring corporation’s bases in the target’s assets. The regulations addressing

adjustments to basis require that principles of equitable estoppel apply in

determining basis and adjustments to basis. See sec. 1.1016-6(b), Income Tax

Regs. Petitioner sold the securities and must report the sales. The issue is the

amount of gain that petitioner realized on the sales, which depends on whether

petitioner received carryover bases in Old Capital’s securities from an F

reorganization or bases equal to the securities’ fair market values on the merger

date, in which case the sales days after the merger would not likely result in any

gain. Equitable estoppel is appropriate with respect to the basis issues involved

here.

C. Respondent’s Knowledge

The Court of Appeals for the Second Circuit has declined to apply equitable

estoppel where the Commissioner had actual or constructive knowledge of the

correct facts while the prior year was open. Lignos v. United States, 439 F.2d at

1368; Helvering v. Brooklyn City R. Co., 72 F.2d at 275 (refusing to apply

equitable estoppel where the Commissioner had “immediate access” to the

taxpayer’s books and records); see Ross v. Commissioner, 169 F.2d 483 (1st Cir.

1948) (a case cited by petitioner, refusing to apply equitable principles where the

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[*50] Commissioner was fully aware of the facts shortly after they occurred and

substantially before the statute of limitations barred assessment).

As stated above, courts characterize a taxpayer’s error to be a mistake of

law, rather than fact, where the Commissioner had knowledge of the correct facts

while the prior year was open. Unvert v. Commissioner, 72 T.C. at 816 (stating

that before a mutual mistake of law can occur, both parties must know the facts).

The Commissioner is not entitled to equitable estoppel where the Commissioner

had knowledge of the material facts while the prior year was open but did not

make an adjustment to correct the taxpayer’s error in reporting. See Crosley

Corp., 229 F.2d at 377-378, 380-381 (finding that the Commissioner had

knowledge that the cost of a tool should have been capitalized and the taxpayer

was not entitled to the claimed business expense deduction); Garavaglia v.

Commissioner, 2011 WL 4448913, at *16-*18 (finding that the Commissioner

knew that an S corporation election was incomplete and thus invalid); Estate of

Posner v. Commissioner, T.C. Memo. 2004-112 (finding that the Commissioner

knew of the error where a decedent’s will was attached to the estate tax return

filed in the prior, closed year).

For purposes of equitable estoppel, the Commissioner is entitled to rely on

the presumption of correctness of a return, i.e., the factual representations on a

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[*51] return signed under penalties of perjury. The Commissioner acquiesces or

relies on a taxpayer’s reporting of an item when the Commissioner accepts a return

as filed and allows the period of limitations to expire. Herrington v.

Commissioner, 854 F.2d at 758; Estate of Letts v. Commissioner, 109 T.C. at 300.

However, the taxpayer’s “misstatement must be one on which the government

reasonably relied, in the sense that it neither knew, nor ought to have known, the

true nature of the transaction mischaracterized by the taxpayer.” Lewis v.

Commissioner, 18 F.3d 20, 26 (1st Cir. 1994), vacating and remanding T.C.

Memo. 1992-391; see also United States v. Boccanfuso, 882 F.2d 666, 670 (2d

Cir. 1989) (requiring a taxpayer’s reliance on any Government misrepresentation

to be reasonable).

The Commissioner is not required to audit a return or to examine every

representation made by a taxpayer on an audited return. Estate of Letts v.

Commissioner, 109 T.C. at 300-301; Arberg v. Commissioner, 2007 WL 2416230,

at *13; see Commissioner v. Liberty Bank & Tr. Co., 59 F.2d 320, 325 (6th Cir.

1932), rev’g on other grounds 14 B.T.A. 1428 (1929). However, the

Commissioner is not entitled to equitable estoppel where the material facts were

readily available to him through adequate disclosure on the return or obtained

through an audit. Crosley Corp., 229 F.2d 376; Unvert v. Commissioner, 72 T.C.

- 52 -

[*52] at 816, Mayfair Minerals, Inc. v. Commissioner, 56 T.C. 82, 93 (1971), aff’d

per curiam, 456 F.2d 622 (5th Cir. 1972); Faidley v. Commissioner, 8 T.C. 1170,

1173 (1947); Garavaglia v. Commissioner, 2011 WL 4448913, at *18. Thus,

equitable estoppel will not apply against a taxpayer where the Commissioner

audited the return for the prior year, learned about an error or omission, but failed

to correct it. Helvering v. Schine Chain Theatres, Inc., 121 F.2d at 949-950;

Gmelin v. Commissioner, T.C. Memo. 1988-338, aff’d without published opinion,

891 F.2d 280 (3d Cir. 1989).

In Helvering v. Schine Chain Theatres, Inc., 121 F.2d at 948-949, the

taxpayer provided information to the Commissioner about how it calculated and

reported its income from prepaid rents from various leases, specifically providing

an amortization schedule for income recognition during an audit; but the

Commissioner failed to correct the error in the taxpayer’s recognition of the rental

income using amortization. The leases were later canceled, and the Commissioner

determined that the taxpayer was required to report the income remaining

unreported under the amortization schedule in the year of cancellation. All of the

rental income should have been recognized for the year when received. There is

no indication in the court’s opinion that the taxpayer argued that it should not have

to report the income pursuant to the amortization schedule for the remainder of the

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[*53] lease term or sought to avoid tax on the unreported portion of the lease

payments.

The Court of Appeals for the Second Circuit held that there was no basis to

apply equitable estoppel against the taxpayer because the Commissioner had all

the facts and accepted the taxpayer’s reporting. Id. at 950. The court reasoned

that the Commissioner did not rely on the taxpayer’s representations but verified

the facts through the audit and reached an independent conclusion that the income

should be recognized as reported. Id.; see also Gmelin v. Commissioner, T.C.

Memo. 1988-338 (refusing to apply equitable estoppel against a partner where the

IRS had audited the partnership return while the prior year was open and made

partnership-level adjustments but inadvertently failed to issue a notice of

deficiency to the partner).

An audit alone does not preclude equitable estoppel. Rather, the

information in the Commissioner’s possession is determinative. See Helvering v.

Schine Chain Theatres, Inc., 121 F.2d 948; Gmelin v. Commissioner, T.C. Memo.

1988-338. Equitable estoppel is appropriate where the taxpayer failed to provide

requested information during the audit or the Commissioner did not obtain the

pertinent information until after the period of limitations expired. Unvert v.

Commissioner, 72 T.C. at 816. We have had held that the Commissioner did not

- 54 -

[*54] have sufficient knowledge of a reporting error where he learned of facts that

suggested that there might have been an issue with the taxpayer’s reporting two

months before the limitations period expired. Spencer Med. Assocs. v.

Commissioner, T.C. Memo. 1997-130; see Bentley Court II Ltd. P’ship v.

Commissioner, T.C. Memo. 2006-113 (holding that a criminal proceeding begun

after the limitations period expired does not negate the Commissioner’s initial

acceptance of the return as filed).

Petitioner argues that respondent knew or should have known the following

facts: (1) petitioner was not an insurance company, did not report premium

income, and did not file Form 1120-PC, the required form for insurance

companies, (2) Old Capital was an insurance company on the basis that the pro

forma return was Form 1120-PC and reported premium income and the term

insurance was in Old Capital’s name, (3) petitioner acquired Old Capital’s

securities and immediately sold them, (4) petitioner was newly incorporated,

(5) petitioner purchased the Old Capital stock with an acquisition loan, as

respondent issued a summons to the lending bank shortly before the limitations

period expired, and (6) there was an intermediary transaction. Petitioner asserts

that respondent’s actual or constructive knowledge of these facts was sufficient to

make him aware that the first merger did not qualify as an F reorganization. It also

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[*55] argues that respondent’s lack of actual knowledge of the second merger is

not material.

Petitioner reported on its return that there was a merger of Old Capital into

petitioner. It did not explicitly state that the merger was nontaxable or identify it

as an F reorganization. On an attachment to its return, it represented that a merger

occurred, i.e., there was a change of the name and a change in the place of

incorporation. Use of Form 1120-PC and the term “insurance” in one entity’s

name are not sufficient disclosures to establish respondent had actual or

constructive knowledge that there was no continuity of business enterprise

especially in the light of petitioner’s concession that Old Capital engaged in two

lines of business, insurance and investment. The description of petitioner as a

noninsurance company in the attachment to the return does not cause respondent

to have knowledge that there was not a continuity of business enterprise.

Petitioner described investment management as Old Capital’s primary business.

Accordingly, termination of the insurance business is not determinative even if we

assume that respondent should have been aware of the termination.

Petitioner further represented that it held certain assets. It reported

carryover bases in the securities but did not specifically indicate that it claimed

carryover bases. Petitioner argues that respondent should have been aware that it

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[*56] used claimed carryover bases because it reported acquisition dates that

predated its recent incorporation. Even if we assume this knowledge, it supports

only constructive knowledge that petitioner claimed it acquired the assets in a

nontaxable event. It does not establish knowledge that such a claim by petitioner

was incorrect. Moreover, petitioner did not specify that the securities were

acquired in the first step of a two-part merger. Reported acquisition dates are not

adequate disclosure to hold respondent to actual or constructive knowledge. In the

light of the minimal information that respondent had about the first merger and no

awareness of the second merger, we do not hold him to actual or constructive

knowledge that the first merger failed to qualify as an F reorganization on the

basis of the above facts. See Baldwin v. Commissioner, T.C. Memo. 2002-162

(holding the Commissioner’s knowledge of a dispute in a divorce proceeding over

an entity’s ownership is not sufficient to hold him with constructive knowledge

that the entity’s S corporation election was invalid).

The only relevant fact that petitioner disclosed on the return was that there

was a merger of Old Capital into petitioner with petitioner surviving. Reporting of

the sale of the securities does not result in constructive knowledge that petitioner

did not have any business activity. Regardless of Old Capital’s status as a

regulated insurance company, petitioner admitted that Old Capital engaged in an

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[*57] investment activity as a second line of business. The possibility that

respondent may have been aware that petitioner sold substantially all of Old

Capital’s securities is not sufficient for us to hold respondent to actual or

constructive knowledge that petitioner did not intend to operate an investment

business or that the first merger was taxable. Petitioner’s 2002 return

misrepresented that it was in the investment business and reported that it had

$13.5 million in assets at the end of the 2002 tax year to engage in such a business.

Respondent did not have sufficient information about petitioner’s business

operations such that he had actual or constructive knowledge that petitioner did

not intend to operate an investment business.

Significantly, respondent did not understand the structure of the merger. He

was not aware that there was a two-step merger or that the second step occurred

one hour after the first or that it occurred at all. Respondent’s misunderstanding of

the structure of Old Capital’s and petitioner’s merger was reasonable on the basis

of the information that petitioner provided or that was otherwise in respondent’s

possession. Petitioner argues that the facts that there were two parts to the

transaction and that the first merger preceded CF Acquisition’s stock acquisition

are irrelevant because neither fact is material.

- 58 -

[*58] Respondent’s misunderstanding of the structure of the merger was

reasonable. Because of petitioner’s inadequate disclosures, the revenue agents

mistakenly understood that Old Capital’s shareholders sold their stock to CF

Acquisition before the first merger and CF Acquisition was Old Capital’s and

petitioner’s sole shareholder before the first merger. Notably, the pro forma return

stated that no corporation owned more than 50% of Old Capital at the end of its

2002 tax year, which petitioner calls a red flag. We disagree with petitioner’s

contention that respondent should have known that the stock sale to CF

Acquisition could not have occurred before the first merger.

Petitioner further argues that even if it represented that the first merger was

an F reorganization, there is no evidence that respondent relied on such a

representation because the administrative file does not state such an understanding

of petitioner’s position. However, this lack of evidence further supports

respondent’s contention that he did not have sufficient information to understand

the structure of the merger and did not consider petitioner’s reporting of the first

merger as nontaxable during the audit for petitioner’s 2002 tax year. The minimal

level of disclosure on petitioner’s return is not enough to hold respondent to actual

or constructive knowledge of the correct structure of the two-step merger.

Petitioner’s return did not adequately disclose who owned Old Capital or

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[*59] petitioner immediately before the first merger. Respondent did not have

actual or constructive knowledge that Old Capital shareholders received cash after

the second merger.

During the audit, the only transactional documents that respondent had in

his possession were the certificate of merger and documents related to the SPX

option transactions. Respondent did not fully understand the SPX option

transactions and suspected that petitioner had engaged in a son of BOSS tax

shelter, which typically involves an intermediary transaction. Petitioner argues

that any intermediary transaction is by its nature inconsistent with a nontaxable

reorganization. However, a suspicion of an intermediary transaction is not

grounds for holding respondent to actual or constructive knowledge that a second

merger or an intermediary transaction occurred.

Respondent did not obtain the material facts during the audit to put him on

notice that the first merger was taxable. He did not learn of the material facts until

discovery in this case after Old Capital’s 2002 tax year had closed. Petitioner

appears to argue that respondent should have questioned petitioner’s reporting of

the first step as nontaxable on the basis of his position that the SPX loss

transactions were motivated by tax avoidance. We do not hold respondent to such

a standard. Petitioner’s 2002 return disclosed only that a merger of petitioner and

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[*60] Old Capital occurred and that petitioner was wholly owned by CF

Acquisition at the end of the tax year. Respondent lacked sufficient information to

know or have reason to know that petitioner’s reporting of the merger as

nontaxable was incorrect. In fact, to support its arguments that the first merger did

not qualify as an F reorganization, petitioner relies on numerous facts that

respondent did not know or have reason to know and documents which respondent

did not have in his possession while Old Capital’s tax year was open.

Petitioner also denies that it was unresponsive or uncooperative during the

audit. The audit file indicates that petitioner failed to respond to RA Davis’

request for a meeting, failed to respond to requests for information, and failed to

respond to a summons after issuance of the notice of deficiency causing

respondent to send a last-chance letter threatening legal action for continued

noncompliance. Even if it were true that petitioner fully cooperated with the audit,

respondent still did not obtain sufficient information during the audit for us to hold

him to actual or constructive knowledge. Furthermore, petitioner incorrectly

characterizes the audit as extensive and involving over 45 IRS employees. Two

revenue agents were assigned to the audit. The revenue agents consulted with

employees in various IRS groups including the technical service unit to prepare

and issue the notice of deficiency and the summons and the intermediary

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[*61] transactions unit for advice on the SPX option transactions. The

Commissioner may rely on a presumption of correctness of a return that is given to

him under penalties of perjury. See, e.g., Estate of Letts v. Commissioner, 109

T.C. at 300. More importantly, the Commissioner does not have a duty of

investigation to discover information that the taxpayer has not provided. Lofquist

Realty Co. v. Commissioner, 102 F.2d 945, 949 (7th Cir. 1939) (holding that the

Commissioner is not required to search public records for information that may

contradict representations that taxpayers made on their returns or for information

omitted from their returns). Nor is the Commissioner treated as having notice of

facts that a taxpayer has reported on returns filed for subsequent years. Mayfair

Minerals, Inc. v. Commissioner, 56 T.C. at 91.

Finally, petitioner argues that respondent did not rely on the reporting of the

merger as nontaxable because he issued a notice of deficiency to Old Capital. It

argues that the fact that the notice of deficiency was untimely is irrelevant because

respondent already knew the material facts during the audit of petitioner. In New

Capital we did not need to address whether respondent was aware of the facts

relating to the two-part merger to hold him to actual or constructive knowledge

that the first merger was a taxable disposition of Old Capital’s assets. Rather, we

considered whether petitioner’s 2002 return, which included Old Capital’s pro

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[*62] forma return as an attachment, constituted a return of Old Capital for

purposes of the running of the period of limitations under the test set forth in

Beard v. Commissioner, 82 T.C. 766 (1984), aff’d, 793 F.2d 139 (6th Cir. 1986).

New Capital, at *8-*9. We held petitioner’s 2002 return with the pro forma return

was a return of Old Capital and Old Capital did not fail to file a return for

purposes of the section 6501(c) exception to the statute of limitations. We

reasoned that even a “misleading” return is a return for purposes of starting the

limitations period. Id. at *7-*8. The standard for what constitutes a return under

the Beard test is not the same as the determination of the Commissioner’s

constructive knowledge on the basis of the representations on a purported return.

Accordingly, our decision in New Capital does not support petitioner’s position

here.

D. Respondent Adversely Affected

Equitable estoppel applies only where the Commissioner will be adversely

affected by the taxpayer’s change in reporting. Lignos, 439 F.2d at 1368-1369.

The Commissioner is adversely affected when a taxpayer changes its reporting

after the period of limitations has expired and the change harms the

Commissioner. Id. We have applied the duty of consistency where taxpayers

would obtain an “unfair advantage” by taking inconsistent positions. Cluck v.

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[*63] Commissioner, 105 T.C. 324, 332 (1995). However, the Court of Appeals

for the Second Circuit is more conservative. In Bennet, the Court of Appeals

indicated a need for a tax calculation to determine the harm to the Commissioner.

See also Estate of Ashman v. Commissioner, 231 F.3d at 543 (calling the need for

a tax calculation “dubious”); Commissioner v. Dwyer, 203 F.2d at 524-525

(allowing taxpayers to take inconsistent positions with respect to ending and

beginning inventory, i.e., a double deduction for the same expense).

In Askin & Marine Co. v. Commissioner, 66 F.2d 776, the Court of Appeals

applied equitable estoppel where the taxpayer erroneously deducted accounts

receivable unpaid at the end of the year as worthless and later collected a portion

of the receivables. The court stated that

a taxpayer who gets an unlawful deduction in this way not only cuts

down his taxable income in the year the deduction is taken, but gets

immunity from income taxation on the account receivable which was

deducted whenever it, or any part of it, is received. A result so unjust

is not to be reached unless plainly required by the law. Having

represented * * * these accounts * * * to be worthless and having

received the benefit of the deduction it claimed when the

commissioner took its representation of the ascertainment of

worthlessness at its face value, we think the petitioner is now clearly

estopped from denying, to the prejudice of the government, the truth

of the representations * * *. [Id. at 778.]

The court went on to explain that “a taxpayer may not benefit at the expense

of the government by misrepresenting facts under oath; by succeeding in having

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[*64] the commissioner accept its representations as the truth; and by claiming

later that what it represented to be true might have been found false had the

commissioner refused to have faith in the sworn return.” Id.

Petitioner suggests that respondent was not harmed because he conducted

an audit for Old Capital’s 2002 tax year. It appears to argue that the audit for Old

Capital’s 2002 tax year, which began after the limitations period expired, and the

untimely issuance of a notice of deficiency somehow negate any harm to

respondent or any reliance on his part. Respondent decided on an audit for Old

Capital’s 2002 tax year after he obtained additional information through discovery

in this case about the first merger that petitioner had not adequately disclosed on

its return. Respondent did not have sufficient information about Old Capital’s

2002 tax year to determine that Old Capital should have reported gain from a

disposition of the securities on the merger before the limitations period expired.

Old Capital’s subsequent audit and notice of deficiency are not reason to preclude

equitable estoppel against petitioner.

Respondent was adversely affected by petitioner’s and Old Capital’s

reporting. Petitioner filed an amended petition to assert a change from its

reporting after the statute of limitations barred assessment of tax for Old Capital’s

2002 tax year. This assertion contradicts petitioner’s reporting and Old Capital’s

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[*65] failure to file a return. It is also inconsistent with the position that petitioner

asserted in New Capital, where it maintained as an alternative argument that the

merger was an F reorganization, an issue we did not consider. Petitioner sought to

change its reporting only after our holding that the statute of limitations barred

assessment against Old Capital. Petitioner’s new position would result in both its

and Old Capital’s escaping tax on the sale of the securities.

Respondent argues the posture of this case adds to the equities in favor of

equitable estoppel. He equates the amended petition to a refund claim. Principles

of equitable estoppel first arose in refund claims. In Bennet v. Helvering, 137

F.2d at 538-539, the Court of Appeals for the Second Circuit distinguished R.H.

Stearns Co., a refund case, and opined that the Commissioner was equitably in a

weaker position in a deficiency proceeding than in a refund case. See also

Helvering v. Schine Chain Theatres, Inc., 121 F.2d at 950. The court reasoned

that in a refund case fairness justified a setoff for tax owed by the taxpayer even if

the statute of limitation barred assessment of the setoff. Bennet v. Helvering, 137

F.2d at 539. Petitioner argues that the amended petition does not have the same

equitable considerations as a refund claim because it is not seeking to recover tax

that it has already paid. This case is easily distinguishable from Bennet, and the

equities weigh in favor of equitable estoppel.

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[*66] Equitable estoppel contributes to our system of self-reporting. Cluck v.

Commissioner, 105 T.C. at 332. The term “self-assessment” is often used to

describe taxpayers’ self-reporting of tax on their returns. See sec. 6702(a)

(imposing a civil penalty for frivolous tax returns). However, only the

Commissioner may assess tax. Sec. 6201(a)(1) (stating that the Secretary shall

assess all taxes determined by the taxpayer or the Secretary). When a taxpayer

files its return and admits to owing tax, traditionally it has an opportunity to

contest such a liability through a refund suit. See sec. 6512(b) (granting the Court

authority to consider overpayments in deficiency proceedings).

Respondent is not asserting that petitioner should have reported gains that it

failed to report. Petitioner reported the capital gains on its return. Petitioner is

attempting to change its own reporting to deny that it realized gains that it

previously admitted it recognized. In such a case, equities weigh more heavily

against petitioner. Had petitioner not claimed the SPX loss deductions it now

concedes, respondent would have been permitted to summarily assess tax on the

capital gains within the limitations period in accordance with his practice of

assessing the amount of tax reported on a tax return. See sec. 6201(a)(1). He

would not have been required to issue a notice of deficiency before the

assessment.

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[*67] The Court of Appeals for the Second Circuit explained the policy behind

statutes of limitations as follows:

As a general matter, “[s]tatutes of limitations find their justification in

necessity and convenience rather than in logic. They represent

expedients, rather than principles. They are practical and pragmatic

devices to spare the courts from litigation of stale claims, and the

citizen from being put to his defense after memories have faded,

witnesses have died or disappeared, and evidence has been lost.”

***

Becker v. IRS (In re Becker), 407 F.3d 89, 96 (2d Cir. 2005) (quoting Chase Sec.

Corp. v. Donaldson, 325 U.S. 304, 314 (1945)). The court further observed that

with respect to tax laws:

[i]t probably would be all but intolerable, at least Congress has

regarded it as ill-advised, to have an income tax system under which

there never would come a day of final settlement and which required

both the taxpayer and the Government to stand ready forever and a

day to produce vouchers, prove events, establish values and recall

details of all that goes into an income tax contest. Hence, a statute of

limitation is an almost indispensable element of fairness as well as of

practical administration of an income tax policy.

. . . . Statutes of limitation * * * in their conclusive effects are

designed to promote justice by preventing surprises through the

revival of claims that have been allowed to slumber until evidence

has been lost, memories have faded, and witnesses have disappeared.

The theory is that even if one has a just claim it is unjust not to put

the adversary on notice to defend within the period of limitation and

that the right to be free of stale claims in time comes to prevail over

the right to prosecute them.

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[*68] Id. at 96-97 (quoting Rothensies v. Elec. Storage Battery Co., 329 U.S. 296,

301 (1946)).

Respondent has not changed his view as to petitioner’s reporting of the

capital gains. He is not asserting that petitioner has failed to report income.

Petitioner is not being asked to defend a stale claim. The policies underlying

statutes of limitations are not compromised by estopping petitioner from changing

its own reporting. Petitioner reported the capital gains and had the opportunity to

preserve the relevant evidence. It is not respondent who is claiming an error

occurred. There is no basis for petitioner to claim it is unfairly surprised.

III. Conclusion

Respondent has established that the requirements for applying equitable

estoppel against petitioner are met. The equities clearly weigh in favor of

estopping petitioner from changing its return reporting. Accordingly, we decline

to let petitioner change its reporting and hold that petitioner had capital gains in

the amount it reported on its 2002 return from the sale of Old Capital’s securities.

- 69 -

[*69] In reaching our holdings herein, we have considered all arguments made,

and, to the extent not mentioned above, we conclude they are moot, irrelevant, or

without merit. To reflect the foregoing,

Decision will be entered under

Rule 155.