Federal Circuit Holds That Excess State Tax Credit Was Taxable Income

(Parker Tax Publishing May 2019)

The Federal Circuit affirmed the Court of Federal Claims and held that the excess of a state brownfield redevelopment tax credit over a married couple's state tax liability was taxable income and did not qualify for any exception or exclusion from the federal definition of income. The court found that the excess state tax credit was an economic gain the taxpayers received for compliance with the brownfield cleanup program and rejected the taxpayers' arguments that the payment was a nontaxable return of capital or inducement payment. Ginsburg v. U.S., 2019 PTC 158 (Fed. Cir. 2019).

In New York, a tax credit is available for the redevelopment of a brownfield site as part of a brownfield cleanup program. The purpose of the brownfield cleanup program is to encourage the voluntary remediation of brownfield sites for reuse and redevelopment. Participants must sign a brownfield site cleanup agreement and obtain a certificate of completion for satisfaction of the remediation requirements. The issuance of the certificate of completion qualifies the applicant for a tax credit under the New York tax law. If the amount of the credit exceeds the taxpayer's tax for the year, the excess is treated as an overpayment of tax to be credited or refunded to the taxpayer. A certificate of completion may be revoked where certain conditions are met, in which case the credit amount is added back in the tax year in which the revocation is final.

In 2005, Samuel and Joan Ginsburg, through an entity they owned called Hawthorne Village, LLC, acquired property in Brooklyn, New York, and entered the brownfield cleanup program. They completed the development of the property, converting an old shoe factory into a residential rental building. The state issued a certificate of completion in 2011. Hawthorne applied for a brownfield redevelopment tax credit of around $6.5 million, with the Ginsburgs' share of the credit equaling $4.9 million. In 2013, the Ginsburgs received a refund of $1.9 million attributable to the brownfield redevelopment tax credit. The Ginsburgs did not report the payment on their federal income tax return, claiming instead that it constituted a nontaxable refund. After an examination, the IRS proposed adjustments to the Ginsburgs' 2013 income taxes, by including the excess credit payment in their taxable income. As a result of the proposed adjustments, the IRS determined the Ginsburgs owed an additional $690,628 in federal income tax. The Ginsburgs paid the tax and then sued for a refund in the Court of Federal Claims.

The Court of Federal Claims held that the payment was subject to federal income tax as substantively an undeniable accession to wealth over which the Ginsburgs had complete control. It rejected the Ginsburgs' theory that the credit was a recovery of capital and thus not income because it found that the Ginsburgs had not sold or transferred any capital asset and their investment was still ongoing. The Court of Federal Claims similarly rejected the Ginsburgs' theory that the payment was a nontaxable inducement payment. The Court of Federal Claims stated that, while the brownfield program provided an investment incentive, no inducement occurred; rather, the Ginsburgs freely chose to participate and take advantage of the program.

The Ginsburgs appealed to the Federal Circuit, which affirmed the decision of the Court of Federal Claims. The Federal Circuit explained that gross income is broadly defined in Code Sec. 61 and noted the Supreme Court's definition of gross income in Comm'r v. Glenshaw Glass Co., 348 U.S. 426 (1955), as "undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion." The Federal Circuit noted that income exclusions are narrowly construed and that the taxpayer bears the burden of establishing the right to a refund.

The Federal Circuit found that the excess credit received by the Ginsburgs was taxable gross income because it was an undeniable accession to wealth over which the Ginsburgs had complete dominion and control. In the court's view, the excess amount of the state credit paid to the Ginsburgs, based on their outlays in redeveloping a brownfield site, was an economic gain made for compliance with the brownfield cleanup program. The court also found that the Ginsburgs had complete control over the payment because there were no restrictions on its use and revocation of the certificate of completion did not depend on events outside of their control, but rather could occur only through the Ginsburgs' misconduct.

The Federal Circuit rejected the Ginsburgs' argument that the payment was a nontaxable return of capital. The court found that the Ginsburgs did not allege that a payment was ever made to New York nor explain why the payment of the excess amount of the brownfield redevelopment tax credit was a return of their basis to restore impaired capital. The court found that Hawthorne, not the Ginsburgs, made the capital investment, and that its investment in the property was still ongoing.

The Federal Circuit also disagreed with the Ginsburgs' argument that, under the common law inducement doctrine, the brownfield development tax credit was indistinguishable from inducement payments, rebates, and reimbursements that have been treated as not includable in gross income. The court reasoned that, unlike in cases where the inducement doctrine applied, in this case the state of New York did not hold a financial interest in the Ginsburgs' purchase, nor did New York enter into negotiations with the Ginsburgs to induce them into cleaning up the brownfield site. The Federal Circuit agreed with the Court of Federal Claims that the Ginsburgs freely chose to participate and take advantage of the state tax credit program.

Observation: The Federal Circuit noted that, although the government questioned the continued validity of the common law inducement doctrine following Glenshaw Glass, it did not need to reach a decision on that issue because it found that the Ginsburgs failed to demonstrate that, even if valid, the inducement doctrine applied.

For a discussion of the general rule for including amounts in gross income, see Parker Tax ¶70,101.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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