The Tax Court found that the rescission doctrine did not allow a taxpayer to exclude from income $400,000 that she received under what was held to be a fraudulently induced agreement with her elderly boyfriend in 2010 that she was forced to pay back in 2014. It further found that the IRS was not estopped from arguing that other transfers to the taxpayer were includible in income by a state court's ruling that the transfers were gifts.
Diane Blagaich and Lewis Burns were involved in a romantic relationship from November 2009 to March 2011. In 2010, Blagaich was 54 years old and Burns was 72 years old. During 2010, Burns, both wealthy and smitten, gave Blagaich cash and property worth $343,819. In addition, on Nov. 29, 2010, to formalize their relationship without getting married, the couple signed an agreement providing that they "shall respect each other and shall continue to spend time with each other consistent with their past practice," and that both "shall be faithful to each other and shall refrain from engaging in intimate or other romantic relations with any other individual." The agreement required Burns to make an immediate payment of $400,000 (the agreement payment) to Blagaich, which he did.
Blagaich left Burns on March 10, 2011, and Burns sent notice of termination of the agreement the next day. Shortly afterward, he came to believe, contrary to what Blagaich claimed, that she had been involved in a romance with another man during their entire relationship.
Burns filed suit in Illinois seeking nullification of the agreement and return of the various gifts he had given Blagaich in 2010 and the $400,000 payment made under the agreement. He also sent Blagaich a Form 1099-MISC, Miscellaneous Income, reporting the amount of the gifts and the payment. In November 2013, the state court found that Blagaich had fraudulently induced Burns to enter into the agreement and ordered her to pay back the $400,000. However, the court ruled that the other money and property Burns gave her were clearly gifts that she was entitled to keep.
Burns had died shortly after the trial in the case, so the executor of his estate issued a revised 2010 Form 1099-MISC for $400,000. In March 2014, the executor informed the IRS that Blagaich had paid the $400,000 in compliance with the court's order.
Having received the Form 1099-MISC from Burns, the IRS adjusted Blagaich's 2010 income to include the full amount reported as income on the form. Blagaich challenged the IRS determination in Tax Court. When the action in the case finally started after the state court case had ended, Blagaich moved for summary judgment, arguing that the IRS was collaterally estopped from litigating that the $343,819 of cash and property she received from Burns should be included in her income because the state court had held they were gifts. She also argued that the payment was not includible in her 2010 income under the doctrine of rescission, because she paid back the $400,000 agreement payment to Burns's estate.
The Tax Court's Decision
The Tax Court held that Blagaich had failed to prove that collateral estoppel applied to the $343,819 in cash and property and that whether they were nontaxable gifts remained a question of fact for trial. Likewise, it found the doctrine of rescission did not eliminate the $400,000 agreement payment from her 2010 income.
Collateral estoppel: In Peck, 90 T.C. 162 (1988), the Tax Court stated that under the doctrine of collateral estoppel, the parties in a case, and anyone in privity with the parties, cannot relitigate an issue that was litigated and decided in a final judgment by a court of competent jurisdiction. The IRS argued that it was not a party to the state court action between Burns and Blagaich and was not in privity with either of them, so collateral estoppel did not bar it from maintaining that the cash and property that the state court held were gifts were not gifts.
The Tax Court explained that privity requires a "substantial identity" between a party of record and an unnamed third party. This could be found where the third party played an active participatory role in the earlier litigation or where the interests of the third party were so closely aligned with a named party that the named party was essentially the third party's representative in the earlier litigation. Blagaich claimed that the IRS's monitoring of the state court case, its agreement to a continuance in the Tax Court case, and its acceptance of the state court's determination regarding the gifts after the case was concluded, indicated the IRS had privity.
The court found that the factual assertions that Blagaich made failed to show any collaboration or genuine alignment of interest between the IRS and either Blagaich or Burns in the state court case. Thus, the privity requirement for collateral estoppel was not met, and the IRS was not precluded from arguing that the cash and property transfers that the state court determined were gifts were not gifts.
Rescission: Under the claim-of-right doctrine, a taxpayer who receives income without restriction as to its disposition is required to include it in gross income in the year received, even though the taxpayer may later be required to repay the income. However, under the doctrine of rescission, if a taxpayer's right to income received under a claim of right is rescinded and the taxpayer must repay the income in the same year, the taxpayer is not required to include the amount in gross income for that year.
Blagaich argued that the rescission doctrine applied to the agreement payment, despite the fact that she repaid the income almost three years after it was received, citing two cases, Hope, 55 T.C. 1020 (1971), and Guffey, 339 F.2d 759 (9th Cir. 1964). However, the Tax Court easily distinguished both cases from Blagaich's on the facts. Therefore, it found that Blagaich had provided no reason for departing from the same-year requirement for rescission.
While, given the circumstances, it is comforting that the Tax Court did not give Blagaich an easy out from her tax troubles, she still may win with regard to some or all of the cash and property transfers. The IRS will still be required to prove at trial that the transfers were not gifts, which, even in the case of the agreement payment, is not a foregone conclusion.
Blagaich, T.C. Memo. 2016-2