Court Declines to Apply Tax Estoppel on Summary Judgment

On January 28, 2020, Justice Cohen of the New York County Commercial Division issued a decision in Shyer v. Shyer, 2020 NY Slip Op. 30252(U), declining to apply the doctrine of tax estoppel on summary judgment, explaining:

Under the doctrine of tax estoppel, a party to litigation may not take a position contrary to a position taken in an income tax return. The doctrine grew out of the principle of judicial estoppel, which prevents a party from asserting a factual position in a legal proceeding that is contrary to a position previously taken by the same party in a prior legal proceeding, to avoid the successive assertion of factually contradictory statements as the truth. As with legal proceedings, tax returns serve as sworn attestations about certain facts - such as how much income was earned, and what sort of income it was - made under the penalty of perjury.

In effect, tax estoppel prevents a party to litigation from making factual assertions that flatly contradict the facts asserted in prior tax returns. For example, the income reported on one's income tax forms is considered the final word as to the amount of income received that year: a litigant cannot later argue that he or she actually received more, or less. This logic also extends to the treatment of taxable events. Once a taxpayer expressly characterizes a transaction one way on tax returns, the taxpayer is held to that designation in litigation. In Mahoney-Buntzman, a divorce case, the husband had claimed $1.8 million as business income on his federal income tax returns, then claimed during the divorce that those same proceeds should be characterized as from the sale of stock he owned in a prior marriage, in order to shield that money from distribution in the divorce. The Court of Appeals held that the husband was estopped from making that argument because the Court cannot, as a matter of policy, permit parties to assert positions in legal proceedings that are contrary to declarations made under the penalty of perjury on income tax returns. Similarly, a transaction reported as a sale cannot be recast as a loan, just as a loan cannot be transfigured into an investment. In all these cases, tax estoppel serves a potent, simplifying purpose, insisting on a single version of the facts.

Even so, the doctrine has limits. Tax estoppel applies to factual inconsistencies, not the legal meaning of certain facts. As with judicial estoppel, the submission of a legal argument is of a different character than an inconsistent framing of one's factual pleadings, and therefore not a basis for the doctrine. Reporting one's income accurately to the government cannot fairly be construed as a release of one's legal rights. As the court noted in Corrente v. Pollack, No. 653833/12, 2013 WL 230377, at *4 (Sup. Ct. N.Y. Cty. Jan. 18, 2013), attesting to the amounts declared in a party's corporate tax returns does not amount to a concession that said amounts were justified. Rather, the tax returns simply represent the amounts that were in fact received for the subject year. In Corrente, the plaintiffs' tax returns did not estop them from arguing that the amount they received from the defendants was less than what was due, as a result of the defendants' alleged tortious acts and breach of fiduciary duties. This is a fundamentally different point from the one advanced in Naghavi and Pon, supra, which held that a taxpayer cannot restate the amount of income documented on tax returns. Tax estoppel prevents someone (like the plaintiff in Pon) from reporting income on tax returns and then arguing in court that he or she received none; it does not prevent someone, however, from arguing that he or she should have received more, but for some illegal act. The doctrine is circumscribed in other ways too. The First Department and other courts have made clear that the characterization of ownership of a company on tax returns is not necessarily dispositive on the question of ownership in other contexts. Courts have also recognized that certain designations on tax returns give way, in litigation, to controlling statutory definitions, and that the failure to pay taxes does not require a holding of estoppel.

In view of the purposes and limits of tax estoppel, the Court finds that the doctrine does not warrant partial summary judgment in Zyloware's favor. At bottom, the Estate is disputing the legality of Zyloware' s exercise of the options, based on provisions in the Succession Agreements. The Estate's argument is that none of the options allocated to Zyloware to purchase Robert's shares were ever properly and lawfully exercised, because (among other things) the prices calculated by Zyloware allegedly violated the Shareholders Agreement. In other words, none of Zyloware's attempts to exercise the options were legally effective because none of these attempts complied with the requirements of the Shareholders Agreement. If the Estate were contesting, instead, how much money Robert received from Zyloware for his Option Shares or how those proceeds should be reported to the IRS, the Tax Returns could provide conclusive documentary evidence of those facts. But the Estate is not disputing what is on the Tax Returns. Instead, the Estate's arguments raise questions of law, not just of fact, resolution of which will require a legal determination about the terms of the Succession Agreements and the propriety of Zyloware' s actions. The amounts listed on the Tax Returns, and the rates at which those amounts are taxed, do not answer the dispositive questions in this case. Therefore, Zyloware's tax estoppel theory is inapplicable here.

The precedent on which Zyloware relies stakes the same analytical ground covered above - that tax estoppel, as a conceptual matter, precludes only restatements of past facts. Missing from these cases is support for Zyloware's extension of the doctrine into a waiver of legal rights. To reiterate, the Estate is not seeking to restate the facts reflected on the Tax Returns as to the amount received from Zyloware. The case turns, instead, on whether the amounts reported on the Tax Returns violated the Succession Agreements. Zyloware's argument also poses some vexing practical problems. It is unclear what, in Zyloware's view, Robert and Catherine could have done to preserve their legal arguments with respect to the Option Shares without violating federal law. One of the basic aspects of the federal income tax is that there be an annual accounting of income, such that each item of income must be reported in the year in which it is properly reportable and in no other. The Shyers, like everyone else, must pay taxes on the income they receive in the year they actually receive it, regardless of additional sums they hope to one day win.

(Internal quotations and citations omitted) (emphasis added).

The results in a complex commercial litigation often turn on the facts more than the law (which is why it is complex). The rule of tax estoppel, discussed above, is one tool the courts use to force people to keep their stories straight when it comes to their finances. If you or a client have questions regarding the evidentiary relevance of tax returns, contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com.