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Ervin v. United States

United States District Court, W.D. Kentucky, Owensboro Division

August 23, 2017

GARY ERVIN, PLAINTIFFS
v.
UNITED STATES OF AMERICA DEFENDANT

          MEMORANDUM OPINION AND ORDER

          Joseph H. McKinley, Jr., Chief Judge United States

         This matter is before the Court on Defendant's Renewed Motion for Judgment as a Matter of Law under Rule 50(b) [DN 117]. Fully briefed, this matter is ripe for decision. For the following reasons, Defendant's Motion is DENIED.

         I. Background

         Plaintiffs, the Ervin brothers and their wives, originally filed this suit as a refund action against the Defendant, the United States, seeking a refund of the valuation misstatement penalty and penalty interest payments paid to the IRS on their tax returns in the years 1999 and 2000. As a basis for the suit, the Ervins asserted the reasonable cause defense, in which they alleged that they had reasonable cause to claim their tax losses because they relied in good faith upon the advice of competent tax advisors who advised them to do so. They purportedly relied on four advisors: BDO Seidman (an accounting firm), Curtis Mallet (a tax law firm), Jesse Mountjoy (their longtime attorney), and Martin McElroy (their longtime accountant).

         The reasonable cause defense is a “narrow exception” to liability for a tax-related penalty. Kerman v. Commissioner, 713 F.3d 849, 868 (6th Cir. 2013); see Stobie Creek Invs., LLC v. United States, 82 Fed.Cl. 636, 716-17 (2008), aff'd, 608 F.3d 1366 (Fed. Cir. 2010). This defense required the Ervins to prove “by a preponderance of the evidence . . . each of the following elements with respect to any advisor they claim reliance upon”: 1) “The advisor was a competent professional who had sufficient expertise to justify reliance”; 2) “The Ervins provided necessary and accurate information to the advisor”; and 3) “The Ervins actually received advice and relied in good faith on the advisor's judgment.” (Jury Instr. 4 [DN 115] at 8.)

         A trial was held beginning on March 13, 2017. At the close of proof, Defendant moved for entry of judgment as a matter of law pursuant to Fed.R.Civ.P. 50(a) on the theory that because the Ervins never received advice as to the economic substance of the transaction they could not adequately establish their reasonable cause defense. The Court considered and orally denied the motion. From there, the jury concluded that the Ervins reasonably relied on three of their four advisors: BDO Seidman, Curtis Mallet, and Jesse Mountjoy. Defendant has renewed its motion for judgment as a matter of law under Fed.R.Civ.P. 50(b), which is now before the Court.

         II. Standard of Review

         Fed. Civ. R. 50(b) provides that judgment as a matter of law may be granted when “a party has been fully heard on an issue and there is no legally sufficient evidentiary basis for a reasonable jury to find for that party on that issue.” Imwalle v. Reliance Med. Prod., Inc., 515 F.3d 531, 543 (6th Cir. 2008) (quoting Reeves v. Sanderson Plumbing Prod., Inc., 530 U.S. 133, 149 (2000)). In reviewing such motions, the Court views the evidence in the light most favorable to the non-moving party and gives him the benefit of all reasonable inferences. West v. Tyson Foods, Inc., No. CIV.A. 4:05-CV-183M, 2008 WL 5110957, at *2 (W.D. Ky. Dec. 3, 2008), aff'd, 374 F. App'x 624 (6th Cir. 2010) (citing Tarrant Serv. Agency, Inc. v. Am. Standard, Inc., 12 F.3d 609, 613 (6th Cir. 1993)). The Court should “not weigh the evidence, evaluate the credibility of the witnesses, or substitute its judgment for that of the jury.” Hogancamp v. Callaway, No. 5:08CV-00152-JHM, 2012 WL 2994264, at *2 (W.D. Ky. July 20, 2012) (citing Hometown Folks, LLC v. S & B Wilson, Inc., 643 F.3d 520, 530 (6th Cir. 2011); Adam v. J.B. Hunt Transp., Inc., 130 F.3d 219, 231 (6th Cir. 1997); Tarrant, 12 F.3d at 613). “A trial court must affirm the jury verdict unless there was “no legally sufficient evidentiary basis for a reasonable jury to find for [the prevailing] party.” White v. Burlington Northern & Santa Fe R. Co., 364 F.3d 789, 794 (6th Cir. 2004) (quoting Fed.R.Civ.P. 50(a)). In other words, “[t]he district court must ‘indulge all presumptions in favor of the validity of the jury's verdict, ' and ‘should refrain from interfering with a jury's verdict unless it is clear that the jury reached a seriously erroneous result.'” Williams v. Nashville Network, 132 F.3d 1123, 1131 (6th Cir. 1997) (quoting Brooks v. Toyotomi Co., 86 F.3d 582, 588 (6th Cir. 1996)).

         III. Discussion

         The United States argues that there was insufficient evidence adduced at trial to support the Ervins' reasonable cause defense, arguing: 1) that the Ervins never received any advice from their advisors regarding the economic substance of the transaction; 2) that any advice rendered was based on unreasonable assumptions as to future events by Gary Ervin; and 3) that these three advisors were not independent and therefore incapable of rendering advice upon which the Ervins could have reasonably relied.

         To combat this Motion, the Ervins assert that the United States waived its right to bring the first and third arguments because it did not address them in its oral Motion for Judgment as a Matter of Law under Rule 50(a). In making the Rule 50(a) Motion, the United States expressly stated that it wished to preserve and incorporate all arguments made in its pre-trial brief into its Rule 50(a) motion, which include the arguments that the Ervins were never advised as to the economic substance of the transaction and that the advisors were not truly independent. The Court permitted the United States to do this rather than requiring counsel to detail each argument after the close of proof. Because the Court allowed counsel this flexibility, the Court declines to treat these arguments as waived and will address each of the United States' arguments herein.

         A. Advice Regarding Economic Substance

         The United States first argues that the Ervins never received any advice from their advisors as to the economic substance of the transactions that form the basis of this tax refund suit. Rehashing a familiar argument, the United States begins its analysis by asserting that the transactions lacked economic substance. This issue was previously litigated and conclusively established by the Federal Court of Claims in Jade I, the Court of Appeals for the Federal Circuit in Jade II. Specifically, the Federal Court of Claims held that the “transaction's fictional loss, inability to realize a profit, lack of investment character, meaningless inclusion in a partnership, and disproportionate tax advantage as compared to the amount invested and potential return, compel a conclusion that the spread transaction objectively lacked economic substance.” Jade Trading, LLC v. United States, 80 Fed.Cl. 11, 14 (2007) [hereinafter Jade I], aff'd in part, vacated in part, rev'd in part sub nom. Jade Trading, LLC ex rel. Ervin v. United States, 598 F.3d 1372 (Fed. Cir. 2010) [hereinafter Jade II]. The Federal Circuit affirmed, stating “[t]he Ervin LLCs' transfer of the spread transactions to Jade lacked economic substance.” Jade II, 598 F.3d 1372, 1377. As seen, these decisions, and the Court's jury instructions that reflected this determination, it is well-understood that the transactions lacked economic substance. (Jury Instr. 2 [DN 115] at 6 (“[T]he transaction failed to meet the economic substance test.”).) Much of the parties' briefs are spent discussing whether or not the transaction had economic substance at the time the Ervins executed it. However, this was not the subject of the jury's inquiry and the Court will not consider these arguments to show that the advisors themselves did not consider and include an analysis of economic substance in their overall advice.

         The jury was simply charged with determining whether it was reasonable for the Ervins to rely on their advisors' advice. This advice, as the jury instructions directed, required the advisors to have “considered and concluded whether the transaction held economic substance as a part of their overall advice.” (Jury Instr. 4 [DN 115] at 9.) The United States contends that none of the advisors provided any advice regarding a non-tax purpose for the structure of the transactions, and, therefore, the Ervins' reasonable cause defense must fail as a matter of law. Despite this contention, the Ervins presented ample evidence upon which a jury could reasonably conclude that each of the advisors considered and concluded that the transaction had economic substance as a part of their overall advice.

         First, Jesse Mountjoy, the Ervins' longtime tax attorney, described in detail how he considered the economic substance of the transaction. He specifically stated that he follows “a general philosophy that says you don't do anything just to be tax motived” and that “profits, ” “good business, ” “and a lot of things” besides taxes are important in structuring a transaction. (Trial Tr. Vol. IV [DN 129] at 93:7-15.) He confirmed that, in 1999, he examined the transaction at issue under the economic substance test: he looked at “investment strategy, business planning, and tax” consequences of the paired transaction and determined that the transaction “passed the test.” (Id. at 101:16-19.) He further concluded that in terms of profit, he determined that “there was a reasonable possibility of making good profits absent tax aspects, ” and “there was a clear profit motive involved;” he did not believe that “the tax structure or the structure of the business entity detracted from the profit motive the Ervins engaged in.” (Id. at 102:9-15; 107:5-13.) Additionally, he engaged in this independent analysis and determined that the transaction was based on a business purpose rather than a tax concept alone. (Id. at 233:3- 22.) He communicated his advice, including the determination that the transaction had economic substance, to the Ervins by telling them that “this looked like a solid investment and tax-paired strategy going forward.” (Id. at 99:22-24; Ervin Trial Tr. Vol. I [DN 110] 97:19-20 (“[H]ad Mr. Mountjoy not been convinced, [Gary Ervin] wouldn't have proceeded with it.”).) Therefore, the Ervins presented sufficient evidence such that a jury could reasonably conclude that Jesse Mountjoy considered the economic substance of the transaction and included it in his overall advice.

         The United States next argues that BDO Seidman did not actually consider the economic substance of the transactions as a part of its overall advice to the Ervins. This is because, the United States posits, the BDO “opinion cannot constitute advice because it was based on hypothetical facts”; but, even if it could be considered advice, “it does not advise that there is a business reason to purchase the options outside of Jade and then contribute them to Jade”-it generally “does not identify or explain a non-tax business purpose for the structure of the transaction.” (Mot. [DN 132] at 9.) The United States focuses on the BDO opinion to prove that BDO did not consider economic substance even though the opinion states that the Ervins had “a reasonable expectation of making a profit on the transactions in excess of all associated fees and costs and not including any tax benefits.” (Id.) The United States alleges that there was no other evidence of advice provided to Gary Ervin regarding the non-tax business purpose of the transaction. In so doing, Defendant entirely ignores the advice given by David DiMuzio, Gary Ervin's main contact at BDO.

         DiMuzio was an accountant employed by BDO. In this role, he advised the Ervins as to the transactions that form the basis of this tax refund law suit. He took part in many of the conversations between BDO, Sentinel (an investment banking firm that participated in the Jade partnership), and the Ervins. (DiMuzio Trial Test. [DN 137-4] at 1543:4-17; 1544:5-15.) DiMuzio characterized the transaction as being a “dual purpose investment, ” as “there were tax advantages associated with the investment there were questions raised about tax principles that were involved.” (Id. at 1514:6-10.) He advised the Ervins and their advisors on these aspects of the transactions extensively throughout 1999. (Id. at 1513:16-25; 1514:1-21.) DiMuzio understood from these discussions and believed, as an accountant, that the Ervins could double their money on the purchased and written options that were part of the initial capital contribution. (Id. at 1545:12-22.) In the partnership, he understood that the Ervins stood to gain “upwards of 38 to one” on their investments, which could yield “several million dollars on a return.” (Id. at 1545:24-25; 1546:1-19.) On average, the Ervins could expect to gain “14 to one . . . for a significant percentage of time.” (Id. at 1547:1-4.) As a professional ...


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