Opposition Brief — Martin v. United States, 119 S. Ct. 2338 (1999) (No. 98-1639)

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| S ipreme Court. US

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MAY 11 1999

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No. 98-1639

In the Supreme Court of the Gnited States

SUSAN TAYLOR MARTIN, PETITIONER

UNITED STATES OF AMERICA

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

BRIEF FOR THE UNITED STATES IN OPPOSITION

SETH P. WAXMAN

Solicitor General

Counsel of Record

LORETTA C. ARGRETT

Assistant Attorney

General

JONATHAN S. COHEN MICHELLE

B. O’CONNOR

Attorneys

Department of Justice

Washington, D.C. 20530-0001

(202) 514-2217

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QUESTION PRESENTED

Whether the payment received by petitioner from a

third party for the sale of her claims against a

bankruptcy estate is exempt from tax as a transfer of

“an asset from the estate to the debtor” under Section

1398(f)(2) of the Internal Revenue Code, 26 U.S.C.

1398(f)(2).

(1)

TABLE OF CONTENTS

Page

a a l

(RE TN ARSE Re Ne l

SRR a EGS Ro 2 a ee l

RETIREES HEGRE Baer eis GUN PS at a a 5

RISERS NOE SALAS TE eGR OER A A la 12

TABLE OF AUTHORITIES

Cases:

Alexander v. Internal Revenue Service, 72 F.3d

BORE EE SESE SRSA See OO RED 10

City of Cleburne v. Cleburne Living Center,

re i cssububbumagsicans 10

Commissioner v. Murdoch, 318 F.2d 414 (3d Cir.),

cert. denied, 375 U.S. 879 (1968) .........ccccccesecosecossesesssesseseees 10

Early v. Commissioner, 445 F.2d 166 (5th Cir.),

cert. denied, 404 U.S. 855 (1971) ........ccccccoscsccssssesesesceseseees 7,10

Graham, In re, 726 F.2d 1268 (8th Cir. 1984) oocccccccccccssosees 5

Helvering v. Safe Deposit & Trust Co., 316 U.S.

8 SRR OSASHHRLAETES AE RISC St NT 7

Kastner, In re, 197 B.R. 620 (Bankr. E.D. La.

| RES SEONES SSSR SLES ER A Be, SRD ESET 6

Kochell, In re, 804 F.2d 84 (7th Cir. 1986) co.cccccccccoccccsoccoeoees 6

Lyeth v. Hoey, 305 U.S. 188 (1988) ....c.cccccccccccssccsscseseseees 7, 8-9

Parker v. United States, 573 F.2d 42 (Ct. C1.),

cert. denied, 439 U.S. 1046 (1978) ..........csccssssssssssssesseeseeseee 10

Plyler v. Doe, 457 U.S, 202 (1982) .......<cscecercscscesecessssereseseses 10

Raytheon Prod. Corp. v. Commissioner,

144 F.2d 110 (ist Cir.), cert. denied, 323 U.S.

I as lichcaa mn a 7

Richard v. Hinson, 70 F.3d 415 (5th Cir. 1995),

cert. denied, 518 U.S. 1004 (1996) .........ccccccecescccsescecescceeeees 11

Schlesinger v. Ballard, 419 U.S. 498 (1975) ....c.ccccessesse- 10, 11

(IIT)

Cases—Continued: Page

Terjen, In re, 154 B.R. 456 (Bankr. E.D. Va. 1993),

atl G, BO FB 181 (GET Cir, 1GBE) scccceccccccacroccicesescescessnsccsccces 6

Turzilo v. Commissioner, 346 F.2d 884 (6th Cir.

| ROR SSS ERE ACR tee ethene hn PAD Bn TE ESL enc OM MED Fk 10

United States v. Davis, 370 U.S. 65 (1962) ....................... 4

United States v. Gilmore, 372 U.S. 39 (1968) .............000 s

United States v. Hilton Hotels Corp., 397 U.S.

SOCEED NUS Oe scsinpatoccicasiebsianianiizinctatersandcinensbilamindacaiaceasdiadaatalaslieshiaiiediplabinite &

Victor E. Gidwitz Family Trust v. Commissioner,

CE EAs GS CRM = cccccotinscacticstsiscolamcanmiiiicteamtsitaaiangacbiatcaaseaee 10

Woodward v. Commissioner, 397 U.S. 572

LUFTMED scestchcidansepniateteinsclins treetasovrabinnsibidab miaaaiinnaidcaale daa aibigeiias

Constitution and statutes::

U.S. Const. Amend. V (Due Process Clause) ..................00. 10

Bankruptcy Reform Act of 1978, 11 U.S.C, 101

et seq.:

Ch. 1:

Re Spe 5c: eine WED sccensncispsisubieinbiiialandesiidemmentaduniaamminiiatenn 10

11 U.S.C. TOUTS) ....cccccsces. sick dekenalnabonbeibisaliabanesabeanienas 6

Ch. 5:

EE E200 A ce SUA actdictenadeinuidesencscerttleanhcabentibenets tabaianehaimasass 10

11 U.S.C. 541(a) ...... ii a a 2

EE SSK BORIS Sccksteinntoctann dahiideccasendetsidagtanedmuaiaa 5

5 EE Fcea5y Cte Ma MAan dee adeeniseaschilbcietstcensuntiisenaabelierendnuncebaeans 10

RE EF cee c ED acta iaksvaacédbenseciesncbiaakskimiaiinn Sint 5

Ch. 7, 11 U.S.C. 701 et se D.. scccccuionnecesesecccsansebetunahonsrnannannsi 2

Internal Revenue Code (26 U.S.C.):

BRODIE cnpsciessausncdecetuiclhbbeabitdesscetbcedodasmssiapicanaiisiacaabelcepaliiaebechceadtbahaiiie 1

MI isc aie a cael aa a Oe 6

Be FORD iciscesviisnchdindanecuiigessldbintiniehhteaibgadanate 4,5, 6,8, 10, 11

Miscellaneous:

5 Collier on Bankruptcy (rev. 15th ed. 1999) .........cecesceeees 11

In the Supreme Court of the Anited States

No. 98-1639

SUSAN TAYLOR MARTIN, PETITIONER

Vv.

UNITED STATES OF AMERICA

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

BRIEF FOR THE UNITED STATES IN OPPOSITION

OPINIONS BELOW

The opinion of the court of appeals (Pet. App. 1-14) is

reported at 159 F.3d 932. The opinion of the district

court (Pet. App. 15-33) is unreported.

JURISDICTION

The judgment of the court of appeals was entered on

November 12, 1998. The petition for rehearing was

denied on January 13, 1999 (Pet. App. 36). The petition

for a writ of certiorari was filed on April 12, 1999. The

jurisdiction of this Court is invoked under 28 U.S.C.

1254(1).

STATEMENT

1. Petitioner married Ken Martin 1958. They lived

in Louisiana prior to their legal separation and divorce

(1)

2

in 1991, and all of the property that they possessed

while married was community property (Pet. App. 2).

On February 19, 1991, Ken Martin filed a petition for

relief under Chapter 7 of the Bankruptcy Code. Peti-

tioner did not join in the petition. Since her husband’s

bankruptcy petition was filed prior to any legal parti-

tion of the community property, the community

property became part of her husband’s bankruptcy

estate under 11 U.S.C. 541(a). To protect-her interest

in the community property, petitioner filed a proof of

claim in the bankruptcy case in which she asserted an

“undivided 1/2 interest in debtor’s community” (Pet.

App. 2-3 n.3). In an amended proof of claim, she further

asserted “claims for fraud, bad faith management of the

community, breach of [the] debtor’s fiduciary duty, and

any and all other delictual, contractual and quasi-con-

tractual claims” (ibid.).

One valuable asset of the community estate was a gas

purchase contract held by Martin Interstate Gas Com-

pany, a company formed and wholly owned by Ken

Martin (Pet. App. 3 n.4). The contract required

Louisiana Interstate Gas Company to purchase large

quantities of natural gas at a specified price that was

substantially higher than the prevailing market price

(ibid.). Tenneco, Inc., which had guaranteed the

buyer’s performance under the gas purchase contract

(ibid.), recognized that it would have substantial liabil-

ity under the contract. It therefore sought to acquire

the interests of all parties asserting rights thereunder

(id. at 18). Those parties included petitioner and the

trustee of her husband’s bankruptcy estate (ibid.).

On July 1, 1993, Tenneco entered into an agreement

with petitioner under which it paid her $5.75 million in

exchange for her release of her claims under the gas

purchase contract and her conveyance to Tenneco of all

3

of her claims against her husband’s bankruptcy estate

(Pet. App. 18-19). On July 2, 1993, Tenneco entered into

an agreement with the trustee of her husband’s bank-

ruptcy estate under which the trustee was paid $7

million for an option to purchase the estate’s rights

under the gas purchase contract (id. at 20).

On July 9, 1993, the trustee of the bankruptcy estate

commenced an adversary proceeding in which it

claimed that the $5.75 million that Tenneco had paid to

petitioner was property of the estate (Pet. App. 20).

Petitioner argued that she could not and did not sell to

Tenneco any assets belonging to her husband’s bank-

ruptcy estate. The bankruptcy court agreed, holding

that petitioner sold to Tenneco only her personal inter-

est as a claimant against the bankruptcy estate (ibid.).

On March 3, 1994, Tenneco and the trustee of her

husband’s bankruptcy estate amended the July 2, 1993,

agreement to provide a release of all outstanding claims

by each party to the various lawsuits concerning the

gas purchase contract and to effect a distribution of all

of the assets in the bankruptcy estate (Pet. App. 21).

No distribution was ever made from the estate to

Tenneco in satisfaction of the claims that it had ac-

quired from petitioner (id. at 21-22).

2. The trustee of the bankruptcy estate reported the

$7 million payment from Tenneco on the estate’s federal

income tax return for its fiscal year 1992 (Pet. App. 20,

22). Although petitioner disclosed the $5.75 million pay-

ment from Tenneco on her federal income tax return for

the year 1993, she took the position that the payment

was not subject to tax. The Internal Revenue Service

audited her return and determined that the payment

constituted taxable income. Petitioner paid the re-

sulting taxes and interest and brought this refund suit

in district court (ibid.). She contended that the

payment she received from Tenneco was excluded from

tax under Section 1898(f)(2) of the Internal Revenue

Code on the theory that it constituted a transfer “of an

asset from the estate to the debtor” (26 U.S.C.

1398(f)(2)).’

The district court granted the government’s motion

for summary judgment (Pet. App. 34-35). Noting that

all income from any source is presumptively taxable,

the court concluded that petitioner had failed to

demonstrate that the $5.75 million payment from

Tenneco falls within any specific exclusion from tax

under the Internal Revenue Code (id. at 23). The court

ruled, in particular, that Section 1398(f)(2) of the

Internal Revenue Code does not apply to this case

because petitioner was not a “debtor” to whom that

exclusion applies. Instead, petitioner “was a ‘nonfiling

spouse,’ which does not equate to a bankruptcy

‘debtor’” (id. at 25). Moreover, “there was no transfer

of an ‘asset,’ but rather the transaction was a sale of

[petitioner’s] claim against the [bankruptcy] estate”

and petitioner “did not receive the $5.75 million from

the ‘estate’ but from “Tenneco’” (id. at 26). Because this

1 Petitioner contended in the alternative that, under the

rationale of United States vy. Davis, 370 U.S. 65 (1962), the payment

from Tenneco should be viewed as if-it were a taxable sale of

marital property by her husband’s bankruptcy estate to petitioner

followed by a sale of that property by petitioner to Tenneco. The

district court and the court of appeals rejected that contention

(Pet. App. 13, 31-33), and petitioner has not raised that claim in her

petition in this case.

Petitioner also argued in the district court that the payment

was excluded from her income under Section 1041 of the Internal

Revenue Code as a transfer of property between spouses incident

to divorce (Pet. App. 24, 27-31). She waived that contention in the

court of appeals (id. at 11), however, and has not renewed it here.

5

case involves the sale of an asset by a non-debtor to a

third-party, and does not involve the transfer of an

asset from the estate to the debtor, the exclusion from

tax provided by Section 1398(f)(2) is “inapplicable here”

(id. at 25).

3. The court of appeals affirmed (Pet. App. 1-14).

The court concluded that Section 1398(f)(2) “is inap-

plicable to the facts of this case” because petitioner

“never received a transfer of an asset from the Estate

on termination of the Estate” (id. at 8). The court held

that the “origin of the claim doctrine” does not apply to

recharacterize the $5.75 million payment from Tenneco

to petitioner as a payment in satisfaction of petitioner's

marital claims against the bankruptcy estate (id. at 9-

11). The court explained that petitioner’s claims

against the bankruptcy estate “were not settled; * * *

th{e] [payment from Tenneco] did not extinguish her

underlying claims * * * ; rather, it expressly

transferred her claims to Tenneco” (id. at 10).

ARGUMENT

The decision of the court of appeals is correct and

does not conflict with any decision of this Court or any

other court of appeals. Further review is therefore not

warranted.

1. Ina liquidation or reorganization under the Bank-

ruptey Code, the bankruptcy estate includes “all legal

or equitable interests of the debtor in property as of the

commencement of the case” (11 U.S.C. 541(a)(1)) as well

as the “[p]roceeds * * * or profits of or from property

of the estate” (11 U.S.C. 541(a)(6)). See In re Graham,

726 F.2d 1268 (8th Cir. 1984). The bankruptcy estate

formed by the commencement of a bankruptcy case is a

separate taxable entity; it is directly liable for any taxes

owed with respect to the items of income that it

6

receives. 26 U.S.C. 1398. See In re Kochell, 804 F.2d

84, 87 (7th Cir. 1986).

Because the bankruptcy estate is itself to pay the tax

owed on the income it receives, Section 1398(f)(2) of the

Internal Revenue Code provides that, on “termination

of the estate, a transfer (other than by sale or ex-

change) of an asset from the estate to the debtor” is to

be treated as a tax-free exchange. 26 U.S.C. 1398(f)(2).

See In re Terjen, 154 B.R. 456, 458 (Bankr. E.D. Va.

1993), aff’d, 30 F.3d 131 (4th Cir. 1994). This statute

thereby avoids a double tax on the items of income

already subjected to tax in the hands of the bankruptcy

estate.

As the courts below correctly concluded (Pet. App. 8-

10, 25-26), Section 1398(f)(2) does not apply to this case.

That Section applies only to transfers “from the estate

to the debtor.” Petitioner, who neither filed nor joined

in the bankruptcy petition, plainly was not a “debtor” in

the bankruptcy case. See 11 U.S.C. 101(13); In re

Kastner, 197 B.R. 620, 623-624 (Bankr. E.D. La. 1996).

Moreover, as the court of appeals observed, petitioner

“never received a transfer of an asset from the Estate

on [the] termination of the Estate” (Pet. App. 8). In-

stead, she received a payment of $5.75 million from

Tenneco almost one year prior to the termination of

Ken’s bankruptcy estate (id. at 11).’

2 The present case involves a factually unique situation—the

purchase by an unrelated party of the nonfiling spouse’s claims

against a bankruptcy estate. Notwithstanding petitioner’s sugges-

tion that the number of nonfiling spouses whose interest in

community property is transferred to their spouses’ bankruptcy

estate is “probably substantial, perhaps in the thousands” (Pet. 11),

we are unaware of any similar pending cases. The specific issue

presented in this case is unlikely to recur with any frequency, if at

all.

7

2.a. Petitioner contends (Pet. 12-17) that, under the

“origin of the claim doctrine,” the payment that she

received from Tenneco should be recharacterized as a

payment from her husband’s bankruptcy estate. Under

the “origin of the claim doctrine,” amounts received in

settlement of a claim are treated for tax purposes as

having the same character as the claim itself. See, e.g.,

Helvering v. Safe Deposit Co., 316 U.S. 56 (1942); Lyeth

v. Hoey, 305 U.S. 188 (1938); Harly v. Commissioner,

445 F.2d 166 (5th Cir.), cert. denied, 404 U.S. 855 (1971);

Raytheon Production Corp. v. Commissioner, 144 F.2d

110, 113 (1st Cir.), cert. denied, 323 U.S. 779 (1944).

Petitioner errs, however, in asserting (Pet. 11) that the

payment she received from Tenneco released her hus-

band’s bankruptcy estate from petitioner’s marital

claims and should therefore be treated as a nontaxable

distribution from the bankruptcy estate to petitioner.

The court of appeals correctly rejected petitioner’s

attempted application of the “origin of the claim doc-

trine” to this case. As the court explained (Pet. App.

10):

[Petitioner’s] claims were not settled; she sold her

claims against Ken’s estate to Tenneco for a $5.75

million payment. This payment did not operate to

extinguish her underlying claims against the Estate;

rather, it expressly transferred her claims to Ten-

neco. Consequently, regardless of whether [peti-

tioner] might have thought subjectively that this

payment was in settlement of her claims—in lieu of

a tax-free Estate distribution—the fact is inescap-

able that the $5.75 million payment is the proceeds

of the sale of her unextinguished claims.

The agreement between petitioner and Tenneco did

not settle petitioner’s marital claims against the bank-

8

ruptcy estate; it merely transferred those claims to

Tenneco. The payment from Tenneco did not, in form

or substance, constitute a transfer from the estate to

petitioner. Moreover, even if it had, petitioner is not

the “debtor” to whom tax-free distributions may be

made under Section 1398(f)(2). She was instead a

claimant against the bankruptcy estate. The transfer of

assets from a bankruptcy estate to a claimant against

the estate does not qualify for tax-free treatment under

the plain text of Section 1398(f)(2).

b. Petitioner errs in contending (Pet. 12-16) that the

decision in this case narrows the “origin of the claim

doctrine” and thereby conflicts with Lyeth v. Hoey,

supra. The Lyeth case involved an heir who contested

a will that left him a small legacy while leaving the

residue of the estate to the founder of the Christian

Science religion. The heir claimed that the will was

invalid due to lack of capacity and undue influence.

Under the settlement of that will contest, the heir

received $140,000 from the residue of the estate. The

Internal Revenue Service treated the settlement pay-

ment as income to the heir in the year it was received.

This Court held, however, that the property had been

acquired “by bequest, devise, or inheritance” and was

therefore not subject to the federal income tax. 305

3 Petitioner also erroneously contends (Pet. 12-14) that the

decision in this case conflicts with United States v. Hilton Hotels

Corp., 397 U.S. 580 (1970), Woodward v. Commissioner, 397 U.S.

572 (1970). and United States v. Gilmore, 372 U.S. 39 (1963). Those

cases involve the deductibility of litigation costs in the context of

divorce and corporate restructuring transactions and are plainly

inapposite to the facts of this case.

a <r ee eccanee tae

9

U.S. at 195-197. The Court explained that (id. at 195-

196):

{Lyeth] was concededly an heir of his grandmother

under the Massachusetts statute. It was by virtue

of that heirship that he opposed probate of her

alleged will which constituted an obstacle to the

enforcement of his right. * * *

* * * * *

There is no question that [Lyeth] obtained that

portion [of the decedent’s estate], upon the value of

which he is sought to be taxed, because of his

standing as an heir and of his claim in that capacity.

The facts of Lyeth are, of course, quite different from

those of the present case. Moreover, the reasoning of

Lyeth contradicts petitioner’s position in this case. In

entering into the agreement with petitioner, Tenneco

was not acting on behalf of her husband’s bankruptcy

estate and did not seek to satisfy petitioner’s marital

claims. Instead, as the record demonstrates (Pet. App.

2-3, 18-19), Tenneco’s concern was to limit its potential

liability under the gas purchase contract. Under the

agreement with petitioner, Tenneco acquired her

claims against the bankruptcy estate; it did not extin-

guish those claims. Under the reasoning of Lyeth, since

payments made to petitioner pursuant to the gas pur-

chase contract would unquestionably have been tax-

able, the amounts paid to petitioner in settlement of her

claims under that contract should also have the same

character and are therefore plainly subject to tax. See

Lyeth v. Hoey, 305 U.S. at 195-197.

Petitioner errs in contending (Pet. 14-16) that the

decision in this case conflicts with the holdings of other

circuits. Those decisions, like Lyeth, simply hold that

10

the nature or character of amounts received in settle-

ment of a claim turns on the nature of the claim settled.

See, e.g., Alexander v. Internal Revenue Service, 72

F.3d 938, 942-944 (1st Cir. 1995); Parker v. United

States, 573 F.2d 42, 46-48 (Ct. Cl.), cert. denied, 439 U.S.

1046 (1978); Early v. Commissioner, 445 F.2d 166, 170

(5th Cir. 1971); Turzillo v. Commissioner, 346 F.2d 884,

887-888 (6th Cir. 1965); Commissioner v. Murdoch, 318

F.2d 414, 426-427 (3d Cir.), cert. denied, 375 U.S. 879

(1963); Victor E. Gidwitz Family Trust v. Commis-

sioner, 61 T.C. 664, 673 (1974). None of those decisions

holds that the purchase by an unrelated third party of a

taxpayer’s right to sue a debtor in a bankruptcy case is

to be characterized as a payment from the bankruptcy

estate to the “debtor” under Section 1398(f)(2) of the

Internal Revenue Code.

3. Petitioner errs in contending (Pet. 18-21) that a

failure to treat her as a “debtor” for purposes of Section

1398(f)(2) of the Internal Revenue Code would deny her

equal protection of the laws. A different tax treatment

of debtors and claimants against the bankruptcy estate

is constitutionally permissible.

The guarantee of equal protection under the Due

Process Clause of the Fifth Amendment is “essentially

a direction that all persons similarly situated should be

treated alike.” City of Cleburne v. Cleburne Living

Center, 473 U.S. 482, 439 (1985) (quoting Plyler v. Doe,

457 U.S. 202, 216 (1982)). See also Schlesinger v.

Ballard, 419 U.S. 498, 500 n.3, 507 (1975). A “debtor”

and a person who possesses a claim against the bank-

ruptcy estate are plainly not “similarly situated.” Asa

nonfiling spouse who had an interest in the community

property transferred to the bankruptcy estate pursuant

to 11 U.S.C. 541(a)(2), petitioner was entitled to and did

file a claim against the estate. 11 U.S.C. 101(10), 501.

11

By contrast, her husband, who was the “debtor” in the

bankruptcy case, retained no interest in the non-

exempt community property transferred to the

bankruptcy estate and was entitled only to any excess

property that might remain after satisfaction of all

claims. 5 Collier on Bankruptcy 4 541.04, at 541-12

(rev. 15th ed. 1999). Because a bankruptcy estate is a

separate taxable entity that directly recognizes and

pays tax upon the items of income to which the estate is

entitled (see page 5, swpra), the bankruptcy estate

involved in this case was required to and did pay

federal income taxes on the $7 million settlement

payment that it received from Tenneco (see page 3,

supra). After that tax was paid, if any property had

remained to be distributed to the “debtor,” Section

1398(f)(2) would operate to prevent a double tax being

imposed on that amount received by the “debtor.” By

contrast, since petitioner was not the “debtor,” the

bankruptcy estate paid no tax on the settlement she

made with Tenneco. As a claimant against the bank-

ruptcy estate, she was thus not similarly situated with

the “debtor” in the tax treatment of these transactions.

The different treatment of her settlement merely

reflects—and equalizes—these differences in the tax

treatment of “debtors” and non-debtors.

Section 1398(f)(2) is thus designed to achieve, not

undermine, equal taxation of similar items of income.

By recognizing these differences in the tax treatment of

debtors and non-debtors, Section 1398(f)(2) does not

deny equal protection of the laws. See Schlesinger v.

Ballard, 419 U.S. at 500 n.3, 507; Richard v. Hinson, 70

F.3d 415, 417 (5th Cir. 1995), cert. denied, 518 U.S. 1004

(1996). There is no conflict among the circuits nor other

reason to warrant review of the decision in this case.

12

CONCLUSION

The petition for a writ of certiorari should be denied.

Respectfully submitted.

SETH P. WAXMAN

Solicitor General

LORETTA C. ARGRETT

Assistant Attorney

General

JONATHAN 8S. COHEN MICHELLE

B. O’CONNOR

Attorneys

MAY 1999

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