U.S. v. Davenport, -- F.3d - (5th 2007) - Is it Res Judicata or is it collateral estoppel

If asked how many of us could succinctly tell a client the difference between res judicata and collateral estoppell? Well it appears that the 5th Circuit and the 10th Circuit have trouble differencing these judicial terms as well as the rest of us. Unfortunately for Davenport, the 5th Circuit’s definition of res judicata caused them to be found liable for the gift’s taxes under § 6324 while a co-personal representative of the same estate may be off the hook.

Birnie and Elizabeth Davenport held 3220 shares of Hondo Drilling Company. When Elizabeth passed away her will named three personal representatives of the estate - Gordon Davenport and Charles Botefuhr, and Patricia Vestal. Six months later, Birnie transferred half (1610 shares) of the Hondo stock to Gordon, Charles, and Patricia. First, she transferred 537 shares to Gordon and 536 shares Vestal through installment sale agreements, with the stock being valued in the agreements at $804 per share. Birnie Davenport reported the installment sales on her 1980 income tax return and indicated on that form that the sales were to related parties. Second, Birnie Davenport transferred 537 shares to Botefuhr as an outright gift. Botefuhr promised to file the appropriate gift tax return that would report the gift made by Birnie Davenport and to pay on her behalf the gift taxes associated with his gift. Botefuhr did not fulfill this responsibility. A year later, Hondo Drilling Company redeemed Botefuhr's shares at $2190 per share.

Ten years later Bernie passed away. Gordon, Charles, and Vestal were appointed personal representatives. At that time, the estate became aware that Botefuhr did not pay the gift taxes as promised and the estate filed a gift tax return reporting the value of the Hondo Stock at $804 per share. An audit ensued and the case was ultimately tried were the IRS alleged that the value of Hondo stock was $2730 per share resulting in an increase in gift taxes.

In Estate of Davenport v. Comm'r, 74 T.C.M. (CCH) 405 (1997). The tax court held that even though Birnie Davenport did not have legal title at the time of the transfers, she did in effect make an inter vivos gifts to Gordon, Vestal, and Botefuhr of the Hondo stock, which the tax court valued at $2000 per share.

The estate did not pay the taxes owed and the Government sought to reduce to judgment the estate's liability and the donees' liability as transferees pursuant to I.R.C. § 6324(b). In the District Court, Gordon was successful as the District Court held, in part, that although res judicata and collateral estoppel bound Gordon to the tax court's finding that he was a donee, neither doctrine established the value of the gift to him (the Hondo stock) or the amount of his liability.

The Fifth Circuit reversed finding that under the doctrine of res judicata Gordon was liable for the tax under § 6324. The Fifth Circuit found that for res judicata to apply the following four-part test must be satisfied: (1) the parties must be either "identical or in privity; (2) the judgment in the prior action [must have been] rendered by a court of competent jurisdiction; (3) the prior action must have been concluded to a final judgment on the merits; and (4) the same claim or cause of action [must have been] involved in both actions. The Court noted that only the fourth factor was at issue.

The Court then reversed the lower court and found:

[D]istrict court's focus was improper because it looked to the legal theories advanced, forms of relief requested, and types of rights asserted. The operative facts in this case and the tax court case are identical. Both cases are based on the same two transactions and factual events: (1) the July 1980 installment sale of the Hondo stock from Birnie Davenport to Vestal and Gordon Davenport and (2) the July 1980 gift of the Hondo stock to Botefuhr. The tax court was required to decide the value of the stock to calculate the tax owed by the estate. Accordingly, under the transactional test the same cause of action is involved in both cases, and the district court improperly focused on what was actually litigated rather than the operative facts. (Citations Omitted).

Ironically, the Fifth Circuit did not view the case as the Tenth Circuit had in United States v. Botefuhr, 309 F.3d 1263 (10th Cir. 2002), wherein the Tenth Circuit found that as it pertained to Vestal, the doctrine of collateral estoppel rather than res judicata was the governing doctrine. Instead the Fifth Circuit followed the Eleventh Circuit decision’s in Baptiste v. Comm'r, 29 F.3d 1533, 1539 (11th Cir. 1994); and the Eight Circuit's decision in Baptiste v. Comm'r, 29 F.3d 433, 436 (8th Cir. 1994).

In the Eight Circuit, Gabriel Baptiste argued that res judicata did not apply to bind him to the tax court's decision regarding the existence and amount of estate tax imposed for purposes of determining his transferee liability pursuant to § 6324(a)(2). The Eighth Circuit held that the causes of action in the two cases were identical, that is:

"the transferor and Gabriel’s respective obligation to pay the estate tax imposed on the transfer of the decedent's estate. Because the causes of action were identical, res judicata bound Gabriel Baptiste to the tax court's decision for purposes of determining both the transferee's obligation to pay the estate tax and the amount of the transferee's liability."

The Eleventh Circuit ruled similarly in the challenge brought by Richard Baptiste. However, unlike the Eight Circuit, Eleventh Circuit did not limit the amount of the government’s recovery to the up to the value of the gift the donee received. In the Eleventh Circuit, the transferee can go negative. Fortunately for Gordon it appears that the Fifth Circuit will follow the Eight and not the Eleventh and “limit” the Government’s recovery.

Observation: There is a distinction between collateral estoppel and res judicata but after reading Baptiste, Davenport, and Botefuhr that distinction just got a little bit more confusing.

On a different note - great column by Sheryl Stratton Cost of Certainty is Transparency, IRS says, 2007 TNT 72-2. After reading the article I am more than ever convinced that FIN 48 is going to generate a tremendous amount of litigation. So if you don’t know about FIN 48, you (Corporate management, accountants, attorneys, etc.) better because the IRS is going to be very aggressive in this area. Read the article and you will see why!!

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