Individual’s Refund Claims Are Denied

PANKAJ MERCHIA,
Plaintiff,
v.
UNITED STATES OF AMERICA,
INTERNAL REVENUE SERVICE
DAVID KAUTTER, COMMISSIONER,
Defendant.

UNITED STATES DISTRICT COURT
DISTRICT OF MASSACHUSETTS

MEMORANDUM AND ORDER

September 30, 2021

Saris, D.J.

After reviewing plaintiff's objections and defendant's response de novo, and after hearing, the Court adopts the Magistrate Judge's thorough Report and Recommendation. The defendant's motion for summary judgment is ALLOWED and plaintiff's motion for summary judgment is DENIED. The Court assumes familiarity with the Report and Recommendation which sets forth the background facts. The Court addresses the primary objections in turn.

A. The “Uncashable” Check.

Plaintiff Merchia argues that he was entitled to a refund based on an “uncashable” $2.25 million check that he erroneously included in his Original 2012 Return. Dkt. 157 at 7. Because Merchia did not present the theory that this check was uncashable to the IRS, the Magistrate Judge properly disposed of this theory as unreviewable by this court under the variance doctrine. Under the variance doctrine, taxpayers may not raise claims for a refund that were not first presented in the administrative claim for a refund to the IRS. See Muskat v. United States, 554 F.3d 183, 195 (1st Cir. 2009) (“[A] claim or theory not explicitly or implicitly set forth in the taxpayer's administrative refund application cannot be broached for the first time in a court in which a subsequent refund suit is brought.”).

B. The Promissory Note.

Merchia's primary objection addresses the tax treatment of a promissory note he received in 2012 and reported as income that year. Merchia's girlfriend, the mother of his children, signed the note and is the sole member of SleepHeart of Virginia, LLC, which purchased his company. Merchia originally claimed to the IRS that he was owed an income tax refund for the value of a promissory note for the sale of his company. He averred that the promissory note he included in his Original 2012 Return was incorrectly included and, under regulation 15a.453-1, promulgated under 26 U.S.C. § 453, the note should not have been taxed. While a taxpayer's receipt of a payment for an installment sale in a later tax year is generally treated as income in that later year, section 453(f)(4) creates an exception for obligations “payable on demand.” 26 U.S.C. § 453(f)(4). Under Massachusetts law, a promissory note is payable on demand if it either “(i) states that it is payable on demand or at sight, or otherwise indicates that it is payable at the will of the holder, or (ii) does not state anytime of payment.” Mass. Gen. Laws ch.106, § 3-108(a) (emphasis added). Because the promissory note contains no date of repayment, the Magistrate Judge determined that it is payable on demand. See Shawmut Bank, N.A. v. Miller, 614 N.E.2d 668, 669 (Mass. 1993) (“The note is a demand note at least because it is an instrument in which no time for payment of principal is stated.”). A note “payable on demand” “shall be treated as a payment in the year received, not as installment obligations payable in future years.” 26 C.F.R. § 15a.453-1(e)(1)(i).

In his objection, Merchia for the first time argues that the “2012 note” was not a promissory note at all and is not subject to installment sale regulations. Dkt. 183 at 2. The promissory note reads:

PROMISSARY [sic] NOTE

SleepHeart of Virginia LLC, with an address at 11526 Seneca Woods Ct, Great Falls, VA 22066, hereby promises to pay Pankaj Merchia of 2715 Spanish River Rd, Boca Raton, FL 33432, the amount of $15,000,000 (fifteen million dollars) less any amounts previously paid to Pankaj Merchia for the purchase of SleepHeart LLC (a Massachusetts LLC) in 2008.

This promise is a part of the previously agreed upon payment of $30,000,000 (thirty million dollars) for SleepHeart of Virginia LLC's purchase of SleepHeart LLC (a Massachusetts LLC). This promisary [sic] note dated December 31, 2012 does not create any new or additional liabilities for SleepHeart of Virginia LLC that did not exist previously.

Dkt. 141-15. This theory is at odds with the argument presented to the IRS and the Magistrate Judge, and it is waived. See Fireman's Ins. Co. of Newark, N.J. v. Todesca Equipment Co., Inc., 310 F.3d 32, 38 (1st Cir. 2002) (waiving arguments raised only in objection to the magistrate judge's report) (citing Paterson-Leitch Co. v. Mass. Mun. Wholesale Elec. Co., 840 F.2d 985, 990-91 (1st Cir. 1988) (“We hold categorically that an unsuccessful party is not entitled as of right to de novo review by the judge of an argument never seasonably raised before the magistrate.”)).

Merchia also argues that the 2012 note could not be payable on demand because SleepHeart lacked the funds to pay. Again, because the alleged insolvency of SleepHeart was not part of Merchia's initial administrative claim to the IRS for refund, the court lacks jurisdiction over this factual claim under the variance doctrine. See Muskat, 554 F.3d at 195.

Next, Merchia asks that the allegedly newly discovered 2008 agreement be considered as evidence in summary judgment. He asserts that the Report and Recommendation erred in finding the promissory note to be a payment on demand given the conditional “best-effort basis” language of the 2008 agreement. Notably, Merchia avers that he newly discovered the 2008 agreement after filings for summary judgment were complete. He never submitted it to the Magistrate Judge. He says he found it on his girlfriend's father's computer, but he says the hard drive on which the agreement was discovered was later thrown out. The government moved for sanctions in response to Merchia's disclosure of the 2008 agreement because Merchia failed to provide the document during discovery or in response to the Magistrate Judge's discovery order granting, in part, the government's motion to compel. The motion was withdrawn without prejudice to refiling if the report was not adopted.

Plaintiff has not adequately explained why the 2008 agreement should be treated as newly discovered evidence. See U.S. Steel v. M. DeMatteo Const. Co., 315 F.3d 43, 52 (1st Cir. 2002) (noting that the party seeking relief based on newly discovered evidence bears the burden of showing the evidence was discovered after summary judgment, the movant could not have discovered the evidence with due diligence, the evidence is not merely cumulative, and the evidence would probably change the result). Because the 2008 agreement was not before the IRS or the Magistrate Judge, the Court declines to consider it. See Fireman's Ins. Co. of Newark, N.J., 310 F.3d at 38.

Merchia did argue that the payment was intended on an “as-is able” basis considering the earlier agreement. Because he said he could not find the 2008 agreement, he submitted a 2014 agreement that memorialized the prior agreement's terms. The Magistrate Judge discussed and rejected this argument, as the promissory note itself contains no language that payments were on an “as-is able” basis, nor does the note contain a date payment was due.

A condition in a contemporaneous or previous agreement may alter or modify a party's obligation to pay an instrument. See Mass. Gen. Laws. ch. 106 § 3-117. The Massachusetts Supreme Judicial Court held that “a note stating that it is due and payable on demand, when read in conjunction with other provisions in the note or other loan documents, might in fact be payable on demand only if the maker defaults on an obligation stated in the loan documents.” Shawmut Bank, N.A., 614 N.E.2d at 670. Even still, under Shawmut, the fact that a note is subject to conditions in another agreement does not strip it of its status as a demand note. Id. at 669-671. See also Ranieri v. Terzano, 457 N.E.2d 906, 909 (Ohio Ct. App. 1983) (classifying a note as due on demand because it “specified no maturity date” even though there was a provision that the notes were payable “if and when defendants were able to pay”). Thus, even though the promissory note was subject to an “as-is able” or “best efforts” condition, this contingency does not defeat the IRS's position.

Merchia argues it was unfair that he was taxed on income that he says he did not receive because of the company's insolvency. The IRS retorts that the rules for installment sales govern the transfer, and his only recourse for an unpaid note is a suit against SleepHeart of Virginia, rather than an income tax refund. While Merchia's argument has some traction, the issue of insolvency was never presented to the IRS in the administrative hearing. In sum, the Court concludes that the Magistrate Judge was correct in ruling that the promissory note is properly categorized as a payment on demand.

ORDER

The Court ADOPTS the Report and Recommendation, denies the plaintiff's motion for summary judgment (Dkt. 147) and allows the defendant's motion for summary judgment (Dkt. 140).

Patti B. Saris
United States District Judge

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REPORT AND RECOMMENDATION RE:
DEFENDANT UNITED STATES OF AMERICA'S MOTION FOR SUMMARY JUDGMENT (DOCKET ENTRY # 140); PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT (DOCKET ENTRY # 147)

July 28, 2021

BOWLER, U.S.M.J.

Pending before this court are two summary judgment motions: one filed by defendant United States of America Internal Revenue Service David Kautter, Commissioner (“defendant”), and the other filed by plaintiff Pankaj Merchia (“Merchia”). (Docket Entry ## 140, 147). Merchia opposes defendant's motion and defendant opposes Merchia's motion. (Docket Entry ## 157, 155). After conducting a hearing in January 2021, this court took the motions (Docket Entry ## 140, 147) under advisement.

PROCEDURAL BACKGROUND

Merchia initiated this action in March 2018 and moved to amend the complaint in December 2018. (Docket Entry ## 1, 35). In June 2019, this court allowed the motion to amend only as to Count Three. (Docket Entry # 49, pp. 3, 8, 22, nn.2, 5).¹ Count Three sets out a tax refund claim against defendant under 26 U.S.C. § 7422 (“section 7422”) for the erroneous or illegal assessment or collection of taxes for the 2012 tax year. (Docket Entry # 49, pp. 3, 8, nn.2, 5) (Docket Entry # 34).

STANDARD OF REVIEW

Summary judgment is designed “to 'pierce the boilerplate of the pleadings and assay the parties' proof in order to determine whether trial is actually required.'” Tobin v. Fed. Express Corp., 775 F.3d 448, 450 (1st Cir. 2014) (internal citation omitted). It is appropriate “if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed. R. Civ. P. 56(a).It is inappropriate “if the record is sufficiently open-ended to permit a rational factfinder to resolve a material factual dispute in favor of either side.”Pierce v. Cotuit Fire Dist., 741 F.3d 295, 301 (1st Cir. 2014).

“An issue is 'genuine' when a rational factfinder could resolve it [in] either direction,” and a “fact is 'material' when its (non)existence could change a case's outcome.” Mu v. Omni Hotels Mgmt. Corp., 882 F.3d 1, 5 (1st Cir. 2018) (internal citation omitted) (parentheses in original). The record is viewed in favor of the nonmoving party, and reasonable inferences are drawn in his favor. See Garcia-Garcia v. Costco Wholesale Corp., 878 F.3d 411, 417 (1st Cir. 2017). “'“[C]onclusory allegations, improbable inferences, and unsupported speculation”'” are ignored. Id. (internal citations omitted). Where, as here, Merchia and defendant each filed a summary judgment motion, each motion is reviewed separately with factual disputes resolved in favor of the nonmoving party. See OneBeacon America Ins. Co. v. Com. Union Assurance Co. of Can., 684 F.3d 237, 241 (1st Cir. 2012) (viewing cross motions for summary judgment “'separately,' in the light most favorable to the non-moving party, and draw[ing] all reasonable inferences in that party's favor”) (internal citation omitted).

I. Defendant's Summary Judgment Motion

FACTUAL BACKGROUND

The facts presented in the light most favorable to Merchia are as follows. Footnotes largely recount evidentiary rulings.

Merchia “signed and timely filed” a 2012 Form 1040, United States Individual Income Tax Return (“Original 2012 Return”), on which he reported $14,950,000 capital gain income, $14,963,484 taxable income, and “a total tax in the amount of $2,248,332.” (Docket Entry # 140, ¶ 1) (Docket Entry # 158, ¶ 1) (Docket Entry # 141-1, lines 13, 43, 61). Merchia's father, Jiwan Merchia, prepared and signed the return.² (Docket Entry # 141-1). The Original 2012 Return did not mention a promissory note.³ (Docket Entry # 141-1) (Docket Entry # 141-10, p. 3) (Docket Entry # 158-5, p. 3). The Internal Revenue Service (“IRS”) sent Merchia a letter 12C requesting more information to process the Original 2012 Return, but Merchia never received the letter. (Docket Entry # 158-3, ¶ 10) (Docket Entry # 141-4). In light of Merchia's failure to respond, the IRS taxed the $14,950,000 capital gain at the short-term rate. (Docket Entry # 158, ¶ 8).⁴ The IRS assessed Merchia's tax liability at $5,221,506.40 on August 19, 2013.⁵ (Docket Entry # 141-5, p. 3) (Docket Entry # 141-12, p. 6).

On January 14, 2014, Merchia faxed a Form 1040X, Amended United States Individual Income Tax Return, for the 2012 tax year to the IRS. (Docket Entry # 141-6). The Form 1040X was dated January 14, 2014 and set out $14,950,000 as long-term capital gain resulting in $14,973,234 adjusted gross income, $14,963,484 taxable income, and a total tax of $2,248,332. (Docket Entry # 141-6, pp. 7-8, 13). Merchia remitted $2,248,332 to the IRS with a check drawn on a “bank account of D3 Holdings LLC.” (Docket Entry # 158, p. 2, ¶ 6) (Docket Entry ## 141-2, 141-3). The Form 1040X contained the following explanation: “'Tax method used to figure Tax: IRS characterized gain as [s]hort term, whereas the tax payer had characterized it as long term. This is because IRS does not seem to have received Schedule D.'” (Docket Entry # 140, ¶ 12) (Docket Entry # 158, p. 4) (Docket Entry # 141-6, p. 9). Merchia maintains he did not exclude the amount of the promissory note from income in this filing because he had not yet been informed by Albert Kassis (“Kassis”), a certified public accountant, that he could exclude it.⁶ (Docket Entry # 158-10) (Docket Entry # 158-3, ¶¶ 12–13) (Docket Entry # 148-2, p. 56).

On March 31, 2014, Merchia sent another Form 1040X to the IRS similar to the January 14, 2014 Form 1040X. (Docket Entry ## 141-6, 141-8). Like the January 14, 2014 Form 1040X, there was no explicit mention of the promissory note, but $14,950,000 is listed as long-term capital gain along with the same explanation that the “IRS characterized gain as [s]hort term . . .” (Docket Entry # 141-8, pp. 5, 9).

On or about May 13, 2014, Merchia sent another Form 1040X to the IRS in which he decreased his adjusted gross income by $223,333 and claimed a refund of $41,134. (Docket Entry # 141-9, p. 3). The May 13, 2014 Form 1040X changed the previous long-term capital gain of $14,950,000 to $14,750,000 with the explanation that Merchia previously “wrongly entered” the basis “as $25,000” and was now correcting the basis to $250,000. As instructed, the May 13 Form 1040X included Form 8949 for “Sales and Other Dispositions of Capital Assets.” (Docket Entry # 141-9, pp. 10, 12-13). The Form 8949 described the property sold as “SleepHeart ein ____ [redacted] including a US Patent and custom written software and equipment” and reported the proceeds as $15,000,000 with $250,000 listed in a “Cost or other basis” column thereby yielding the $14,750,000 long-term capital gain. (Docket Entry # 141-9, pp. 5, 10, 12-13). On the form, Merchia listed his business income as $1, bringing the adjusted gross income to $14,750,001. (Docket Entry # 141-9, p. 5). Merchia later acknowledged he did not know how to fill out complex forms such as Form 8949. (Docket Entry # 158, p. 6). There is no explicit mention of a promissory note in the May 13, 2014 Form 1040X, although Merchia maintains the purported sum of the note (Docket Entry # 141-15, p. 2) is included in the above-noted gross income. (Docket Entry # 141-9, pp. 2-3, 13) (Docket Entry # 158, ¶ 19) (Docket Entry # 158-3, ¶¶ 12-13).

On May 29, 2014, Kassis met with Merchia.(Docket Entry ## 158-10, 158-17)⁷ (Docket Entry # 158-3, p. 5, ¶¶ 15-16).On June 5, 2014, Merchia filed another Form 1040X amended return for the 2012 tax year in which he claimed a decrease of $10,310,712 in the amount of adjusted gross income to a “correct amount” of $4,662,522 (from the previous $14,973,234), treated as long-term capital gain and installment sale income, and an entitlement to a refund of $1,564,368.⁸ (Docket Entry # 141-10, pp. 2, 4-5, 9-10, 15). This filing included the first mention of the promissory note and an explanation of why Merchia believed he should not be taxed on it, which included his citation of 26 C.F.R. § 15a.453-1 (“regulation 15a.453-1”). (Docket Entry # 141-10, pp. 3–4). Thus, in the June 5, 2014 Form 1040X, Merchia describes the note as part of an installment sale and “not a receipt of [payment].” (Docket Entry # 141-10, pp. 3–4). In pertinent part, Merchia's explanation and interpretation of the regulation in the amended return are that he:

Had taken 15,000,000 as Profit for an instalment [sic] sale. This included a promisory [sic] note of $10,300,000.⁹ Form 6252 and 4797 have been prepared to flow Capital Gain to Schedule D . . .

26 CFR 15a.453-1 — Installment method reporting for sales of property and casual sales of personal property . . .

Promissory note not a receipt of [payment] from an “Instalment [sic] Sale.”

(Docket Entry # 141-10, pp. 3–4). By affidavit filed in this action, Merchia belatedly explains that he mistakenly included a $2.25 million “un-depositable” or uncashable check in his income in the June 5, 2014 Form 1040X.¹⁰ (Docket Entry # 158-3, ¶ 13).

On September 1, 2015, the Small Business and Self-Employed division of the IRS reviewed Merchia's refund claim for the 2012 tax year and issued a Form 4559 Examination Report. The Form 4549 stated that: Merchia was entitled to a reduction in his taxable income of $47,583; the $14,950,000 capital gain should be “reclassed from short-term to long term”; his revised taxable income was $14,915,901; he had overpaid his taxes by $2,985,345; and his corrected income tax was $2,236,161. (Docket Entry # 141-12, pp. 6, 10). Thereafter, Merchia filed an appeal in which he claimed entitlement to a refund of $1,464,368. (Docket Entry # 141-13, p. 2). On June 2, 2016, the IRS Appeals Office issued a Form 5278 reflecting the same revised taxable income ($14,915.901) and overpayment ($2,985,345) set out in the Examination Report. (Docket Entry # 141-13). As stated in a cover letter, the Appeals Office declined to grant the entire claim because it did not reduce the $15,000,000 that was “originally reported as installment gain” and further stated that “[t]he $15,000,000 incorrectly classified as short term capital gain has been converted to long term gain and the tax reduced accordingly.” (Docket Entry # 141-13, p. 2). In May 2018, the certificate of assessment issued with the same deficiency ($2,985,345). (Docket Entry # 141-5).

On September 8, 2020, Merchia produced electronic files pursuant to this court's August 5, 2020 Order (Docket Entry # 135) allowing defendant's motion to compel. (Docket Entry # 140, ¶ 28) (Docket Entry # 158, ¶ 28). Merchia “produced by and through his counsel a Court-ordered affidavit and an Adobe PDF electronic file for a promissory note, dated December 31, 2012, in the amount of '$15,000,000 (fifteen million dollars) less any amount previously paid.'” (Docket Entry # 140, ¶ 28) (Docket Entry # 158, ¶ 28).

In his affidavit pursuant to the August 5, 2020 Court Order, Merchia stated that upon signing documents contained in “Exhibits 1 through 4,” “PDF files were created and native versions were deleted to avoid confusion with drafts.” (Docket Entry # 141-14, p. 2). “Exhibit 1” is a copy of the promissory note. (Docket Entry # 141-15). Merchia qualifies this by averring this is an “ideal practice” that he does not often follow. (Docket Entry # 158-3, ¶ 22). He further explains that because Shona Pendse (“Pendse”), not Merchia, last signed these documents, the note might not have been converted to a PDF right away, because Pendse does not follow his same practices.¹¹ (Docket Entry # 158-3, ¶¶ 18, 21). Pendse is SleepHeart of Virginia LLC's “sole member.”¹² (Docket Entry # 158-5, p. 1, ¶ 1). The promissory note, which Pendse signed as “Member” of SleepHeart of Virginia LLC, reflects that SleepHeart of Virginia LLC purchased for $30 million SleepHeart LLC, Merchia's medical technology company, from Merchia when he sold it in 2008, which Merchia confirms by affidavit.¹³ (Docket Entry # 141-15, p. 2) (Docket Entry # 158-5, p. 3) (Docket Entry # 148-2, ¶ 1).

The promissory note is a copy (Docket Entry # 141-21, pp. 15, 20-23) (Docket Entry # 158-3, ¶ 19) and was retrieved by Merchia from a SleepHeart of Virginia LLC hard disk or one of his computers (Docket Entry # 141-21, pp. 12-14, 20-21) (Docket Entry # 158-3, ¶ 19). Pendse states by affidavit that the promissory note is an “accurate depiction of the promissory note” she “signed” in 2012.¹⁴ (Docket Entry # 158-5, p. 2, ¶ 3).

It reads:

SleepHeart of Virginia LLC, with an address at 11526 Seneca Woods Ct, Great Falls, VA 22066, hereby promises to pay Pankaj Merchia of 2715 Spanish River Rd, Boca Raton, FL 33432, the amount of $15,000,000 (fifteen million dollars) less any amounts previously paid to Pankaj Merchia for the purchase of SleepHeart LLC (a Massachusetts LLC) in 2008.¹⁵

This promise is part of the previously agreed upon payment of $30,000,000 (thirty million dollars) for SleepHeart of Virginia LLC's purchase of SleepHeart LLC (a Massachusetts LLC). This promissory note dated December 31, 2012 does not create any new or additional liabilities for SleepHeart of Virginia LLC that did not exist previously.

(Docket Entry # 141-15, p. 2) (emphasis added); (Docket Entry # 158-5, p. 3) (emphasis added).The promissory note does not include a date for repayment. (Docket Entry # 141-15, p. 2) (Docket Entry # 158-5, p. 3). Merchia drafted the promissory note. (Docket Entry # 141-20, p. 29).

The PDF file produced by Merchia contained metadata including a “Created” date of September 4, 2014 at 9:04:51 a.m. and a “Modified” date of September 4, 2014 at 9:04:51 a.m.¹⁶ (Docket Entry # 141-16, p. 8). The metadata showed that the PDF was created from a Microsoft Word document. (Docket Entry # 158, ¶ 41) (Docket Entry # 140, ¶ 41). The metadata further revealed that the “PDF Producer was Acrobat Distiller 10.1.10 (Windows).” (Docket Entry # 158, ¶ 42) (Docket Entry # 140, ¶ 42). This version of Acrobat Distiller 10.1.10 (Windows) was a “planned update” on May 13, 2014.¹⁷ (Docket Entry # 141-23).

On June 10, 2014, Merchia faxed a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, to the IRS and reported he managed 14 business entities. (Docket Entry # 141-17). During this litigation, Merchia agreed to “'provide a precise accounting of every penny [SleepHeart of Virginia LLC] received or paid during the relevant periods.'” (Docket Entry # 158, ¶ 47) (Docket Entry # 140, ¶ 47). One document that Merchia could not locate, however, was the original 2008 sale agreement of his medical software company, SleepHeart LLC, to SleepHeart of Virginia LLC.¹⁸ (Docket Entry # 158-3, ¶ 23) (Docket Entry # 148-2, ¶ 1). Merchia testified at his deposition that “Sleepheart had loaned [him] some money in 2011 to purchase a property, and [he] repaid that money in 2012” (Docket Entry # 141-20, p. 40), and in 2012 SleepHeart of Virginia LLC and Merchia agreed to “'convert' the loan amount (with interest) into an installment payment for the sale at issue, so that Mr. Merchia did not have to repay the loan.” (Docket Entry # 158, ¶ 49); (Docket Entry # 140, ¶ 49) (Docket Entry # 141-20, p. 40); (Docket Entry # 153, p. 21) (loan repayment document dated August 2, 2012, reciting Merchia's acceptance of $1,214,064.53 as “installment payment” for 2008 sale of “SleepHeart (of Massachusetts) LLC”).¹⁹ “At least some of the payments received by” Merchia “for the $30 million sale were deposited directly into accounts held in the name of Mr. Merchia's business entities.” (Docket Entry # 158, ¶ 50) (Docket Entry # 140, ¶ 50).

DISCUSSION

Defendant seeks summary judgment on the tax refund claim under section 7422 for the erroneous or illegal assessment or collection of taxes for the 2012 tax year. (Docket Entry # 140). Defendant argues that: (1) Merchia does not meet the burden of proof of showing that the IRS' determination was wrong and, as a result, he is not entitled to a refund; (2) the promissory note upon which Merchia bases his entitlement for a refund is “a sham”; (3) the duty of consistency estops Merchia from arguing that he received the $14,950,000 or the $2.25 million check in a tax year now closed to review by the IRS; and (4) even if the promissory note is not a “sham,” it is not excludable from income in 2012 because it was payable on demand. (Docket Entry # 142). Merchia opposes the summary judgment motion and asserts that: (1) the burden of proof is on defendant to produce evidence that Merchia received the funds in question in 2012; (2) the promissory note is not a sham; (3) the installment payments not received by Merchia in 2012 should be excluded from 2012 income because the promissory note was not a demand note; and (4) because defendant “misapplies the 'duty of consistency,'” Merchia should not be estopped from recouping an overpayment of $1,778,332.80. (Docket Entry # 157). As explained below, defendant's third argument regarding the non-excludability of the promissory note coupled with the variance doctrine warrant allowing defendant's motion.

Regarding the burden of proof, “[i]t is beyond hope of contradiction that, in a tax refund suit, the complaining taxpayer bears the burden of proving the incorrectness of the challenged tax treatment.” Muskat v. United States, 554 F.3d 183, 188 (1st Cir. 2009). On summary judgment, Merchia therefore bears the underlying burden of proof at trial. In addition, Merchia's attempt to shift his burden under 26 U.S.C. § 7491(a) (“section 7491(a)”) (Docket Entry # 157, pp. 2-3) is unavailing largely for reasons stated by defendant (Docket Entry # 163, pp. 6-7) (explaining Merchia's noncompliance with section 7491(a) and incorporating arguments in defendant's opposition to Merchia's summary judgment motion); (Docket Entry # 155, pp. 14-16).²⁰ Merchia fails to provide “credible evidence with respect to any [material] factual issue.” 26 U.S.C. § 7491(a); see Esgar Corp. v. Comm'r of Internal Revenue, 744 F.3d 648, 653 & n.5 (10th Cir. 2014) (section 7491(a) “shifts the burden of proof to the Commissioner on any factual issue that the taxpayer supports with credible evidence”). Merchia has also not “maintained all records” and “cooperated with reasonable requests by the Secretary for witnesses, information, documents, meetings, and interviews.” 26 U.S.C. § 7491(a); see generally Syed v. Comm'r of Internal Revenue, T.C.M. (RIA) 2017-226 (T.C. 2017).

A. Variance Doctrine

In seeking summary judgment, defendant argues that the variance doctrine precludes Merchia from relying on arguments he did not make to the IRS during the administrative process, namely, “that income reported in 2012 was actually received and reported in another” tax year. (Docket Entry # 142, pp. 5, 8-9, 19-20) (Docket Entry # 158-15). In response, Merchia asserts that he reported and erroneously included the “uncashable check for $2.25 million” in the Original 2012 Return even though he did not receive the funds because SleepHeart of Virginia LLC lacked the funds to pay the check. (Docket Entry # 157, p. 7). Merchia also notes that the IRS Examiner performed a simplified bank deposit analysis summary which identified total deposits or credits in 2012 ($2,842,374.88) and nontaxable deposits and credits ($350,559.14).²¹ (Docket Entry # 157, p. 3, lines 2-3) (Docket Entry # 149, p. 7) (Docket Entry # 158-15) (Docket Entry 148-2, p. 76). Defendant's reply incorporates its opposition to Merchia's summary judgment motion, which addresses at length why the uncashable $2.25 million check argument is at variance with the administrative claim Merchia presented to the IRS. (Docket Entry # 163, p. 6) (Docket Entry # 155, pp. 5-12).

Merchia's original claim to the IRS for an income tax refund was that he incorrectly included the value of the promissory note for the sale of his company in the Original 2012 Return and that, under regulation 15a.453-1, promulgated under 26 U.S.C. § 453 (“section 453”), the amount of the promissory note should not have been taxed. (Docket Entry # 141-10, pp. 3– 4). Merchia also argued entitlement to capital gain income of $14,950,000 taxed at the long-term rate. (Docket Entry # 158, p. 4, ¶ 12) (Docket Entry # 140-6, pp. 9, 13). He now raises entitlement to a refund based on the “undepositable” $2.25 million check from SleepHeart of Virginia LLC because “the government cannot prove that the Plaintiff received $2.25 million at issue.” (Docket Entry # 147, p. 1); (Docket Entry # 149, p. 7) (SleepHeart of Virginia LLC “did not have sufficient funds in its bank account to allow cashing of a $2.25 million” check in 2012); (Docket Entry # 157, p. 3, lines 2-3). Contrary to this theory now raised, Merchia submitted financial materials to the IRS showing he received the $2.25 million check from SleepHeart of Virginia LLC in 2012 as part of the $5,455,372.46 “payments from [SleepHeart of Virginia LLC] to/for [Merchia] or his companies.”²² (Docket Entry # 148-2, p. 7) (Docket Entry # 158-18, p. 5).

Under the variance doctrine, taxpayers are prohibited from raising claims for a refund that were not presented in the administrative claim for the refund to the IRS. See Muskat, 554 F.3d at 195 (affirming district court's lack of jurisdiction over claim for refund not raised in administrative phase to IRS); 26 U.S.C. § 7422(a) (“section 7422(a)”); 26 C.F.R. § 301.6402–2(b)(1) (“regulation 301.6402–2(b)(1)”) (claim “must set forth in detail each ground upon which . . . refund is claimed and facts sufficient to apprise the Commissioner of the exact basis thereof”). Quoting regulation 301.6402–2(b)(1) and section 7422(a), the First Circuit in Muskat explains that “these provisions bar 'a taxpayer from presenting claims in a tax refund suit that “substantially vary” the legal theories and factual bases set forth in the tax refund claim presented to the IRS.'” Muskat, 554 F.3d at 194 (quoting Lockheed Martin Corp. v. United States, 210 F.3d 1366, 1371 (Fed. Cir. 2000)). A substantially varied legal theory is one “not explicitly or implicitly set forth in the taxpayer's administrative refund application.” Muskat, 554 F.3d at 195 (citing Lockheed, 210 F.3d at 1371); Lockheed, 210 F.3d at 1371 (describing “legal component of” variance rule as barring “'any legal theory not expressly or impliedly contained in the application for refund'”) (citation omitted).

Factual bases for refund “similarly may not substantially vary at trial” from those “raised in the refund claims presented to the IRS.” Lockheed, 210 F.3d at 1371. For example and pertinent to the case at bar, adding research expenses to a legal claim “would constitute a substantial variance of the factual basis of” a tax refund claim founded upon “particular research expenses” which entitle the taxpayer “to a tax credit.” Id. The First Circuit in Muskat also cautions that “it is not the IRS's responsibility to make a case for the taxpayer that the taxpayer himself has opted not to make.” Muskat, 554 F.3d at 195; see also Magnone v. United States, 733 F. Supp. 613, 618 (S.D.N.Y. 1989).

The purposes of the variance doctrine are threefold. See Lockheed, 210 F.3d at 1371. The doctrine “(1) gives the IRS notice as to the nature of the claim and the specific facts upon which it is predicated; (2) gives the IRS an opportunity to correct errors; and (3) limits any subsequent litigation to those grounds that the IRS had an opportunity to consider and is willing to defend.” Id.

In the case at bar, any effort by Merchia to substantially vary the legal or factual bases for a refund from the administrative claim he made to the IRS is therefore not reviewable by this court. In this litigation, Merchia raises the new theory regarding his entitlement to a refund based on the uncashable $2.25 million check from SleepHeart of Virginia LLC. The argument substantially varies in both factual and legal substance from his administrative claim with the IRS. Instead of seeking a refund from the IRS based the uncashable nature and therefore non-receipt of the $2.25 million check, Merchia argued that receipt of funds in 2012 under the installment method regarding the promissory note is the correct means to calculate payments under the $15 million promissory based on regulation 15a.453-1. The IRS had no notice regarding the uncashable $2.25 million as excluded from 2012 income. Although Merchia asserts he provided the IRS “all of his bank records” and that the IRS Examiner calculated deposits and credits for the 2012 tax year (Docket Entry # 157, p. 7) (Docket Entry # 149, p. 7) (Docket Entry # 158-15) (Docket Entry # 148-2, p. 76), there is little indication that Merchia adequately apprised the IRS with the factual detail that the $2.25 million check was not income because it was not cashable. Rather, he argued that installment payments under the promissory note are not income until the year the payment is received under regulation 15a.453-1 (Docket Entry # 141-10, pp. 3–4) and affirmatively represented receipt of the check (Docket Entry # 158-18, p. 5).

As set out in the January 14, 2014 Form 1040X, he also argued entitlement to capital gain income of $14,950,000 taxed at the long-term rate. (Docket Entry # 158, p. 4, ¶ 12) (Docket Entry # 140-6, pp. 9, 13).He repeated the long-term capital gain argument in the March 31, 2014 Form 1040X.²³ (Docket Entry # 140-8, p. 5).

The legal theories Merchia raised to the IRS in the administrative proceedings therefore consisted of: (1) treatment of the promissory note and payments under the installment method; and (2) treatment of $14,950,000 as long-term rather than short-term capital gain.²⁴ (Docket Entry # 141-13, p. 2). Merchia did not present the theory that the $2.25 million check was excludable from 2012 income as uncashable, and he submitted financial materials to the IRS showing he received a $2.25 million check in 2012.(Docket Entry # 148-2, p. 7). Instead, what Merchia did present to the IRS was the $15 million promissory note as taxable under the installment method pursuant to regulation 15a.453-1 and the classification of long-term capital gain incorrectly as short-term capital gain. An argument seeking a refund because the $2.25 million check was not cashable and therefore not received in 2012 (Docket Entry # 149, pp. 1-2, 7) is a substantial variance from an argument that defendant must prove that the promissory note is taxable or evidences an installment sale subject to the installment reporting method under regulation 15a.453-1 and that the amount is treated as long-term capital gain. The variance doctrine excludes the new argument and limits this court's review to the arguments Merchia raised administratively to the IRS.

B. Duty of Consistency

Defendant additionally argues that due to the duty of consistency, Merchia is estopped from arguing that the $14,950,000 reported on the Original 2012 Return and the $2.25 million check that he presented as received in 2012 (Docket Entry # 158-18, p. 5) were actually received in another year, which is now time-barred from an assessment. (Docket Entry # 163, pp. 14–15) (Docket Entry # 142, pp. 17-20). In response, Merchia argues that defendant “misapplies the 'duty of consistency'” as estopping him from recouping a significant overpayment of taxes and the duty does not pertain to the question of law in this case, i.e., whether the promissory note should be treated as income in 2012. (Docket Entry # 157, pp. 6-8). Merchia maintains that he did not receive the $14,950,000 income reported in the Original 2012 Return and SleepHeart of Virginia LLC did not have the funds to pay the “uncashable check for $2.25 million.” (Docket Entry # 157, p. 7).

As previously noted, Merchia maintains the $14,950,000 included the promissory note. For reasons explained in Roman numeral I(C), the payable-on-demand promissory note results in the entire amount treated as 2012 income. It is therefore not necessary to address defendant's duty of consistency argument regarding the $14,950,000 reported income to recommend allowance of defendant's summary judgment motion. Separately, the variance doctrine estops Merchia from claiming he erroneously included the “undepositable” $2.25 million check as income in 2012 thus entitling him to a refund.

C. Promissory Note as Not Excludable from Income

As noted, Merchia argued in his administrative filings with the IRS that the installment payments under the promissory note not received by Merchia in 2012 are excluded from his 2012 income under regulation 15a.453-1. (Docket Entry # 141-10, pp. 3–4). Defendant maintains that section 453(f)(4) creates an exception to the general rule that a taxpayer's receipt of a payment for an installment sale in a later tax year is treated as income in that later tax year. The exception is for obligations “'payable on demand,'” 26 U.S.C. § 453(f)(4), and the promissory note was payable on demand, under applicable state law, because it did not have a repayment date, according to defendant. (Docket Entry # 142, pp. 15-17) (Docket Entry # 163, pp. 5, 13-17).

The sale of Merchia's medical software company to SleepHeart of Virginia LLC was designed to be paid in installments. (Docket Entry # 141-10, pp. 3-4). Because of this structure, the transaction falls within the criteria set out in section 453 and regulation 15a.453-1, which governs the installment method. See Principal Life Ins. Co. v. United States, 70 Fed. Cl. 144, 146 n.3 (Fed. Cl. 2006); Holt v. United States, 39 Fed. Cl. 525, 525 n.1 (1997). An “'installment sale'” is a “disposition of property where at least [one] payment is to be received after the close of the taxable year in which the disposition [of property] occurs.” 26 U.S.C. § 453(b)(1); 26 C.F.R. § 15a.453-1(b)(1). The installment method is a method under which “income recognized for any taxable year from a disposition” of property “is that proportion of the payments received in that year which the gross profit (realized or to be realized when payment is completed) bears to the total contract price.” 26 U.S.C. § 453(c) (emphasis added); accord 26 C.F.R. § 15a.453-1(b)(2). Section 453(c) allows taxpayers to report income from installment “payments” in the year they receive the payment as opposed to when the sale is made. 26 U.S.C. § 453(c); accord 26 C.F.R. § 15a.453-1(b)(2).

Relatedly, section 453 defines “'payment'” to “not include the receipt of evidences of indebtedness of the person acquiring the property.” 26 U.S.C. § 453(f)(3). “'[E]vidence of indebtedness'” has been defined as, and is understood to include, “any printed or written instrument, signed or otherwise executed by the obligor(s), which evidences on its face a legally enforceable obligation to pay money.” River Cmty. Bank, N.A. v. Bank of N.C., Civil Action No. 4:14-00048, 2015 WL 3822385 at *6 (W.D. Va. June 19, 2015) (internal citations omitted); see United States v. Jones, 450 F.2d 523, 525 (5th Cir. 1971) (“[t]he term 'evidence of indebtedness' embraces only such documents as promissory notes which on their face establish a primary obligation to pay the holders thereof a sum of money”); see also United States v. Austin, 462 F.2d 724, 736 (10th Cir. 1972) (noting that evidence of indebtedness is defined as “not limited to a promissory note or other simple acknowledgment of a debt owing and is held to include all contractual obligations to pay in the future”). Promissory notes are thus commonly understood to constitute evidence of indebtedness, see In the Matter of Rego Crescent Corp. v. Tymon, 23 B.R. 958, 962 (E.D.N.Y. LBR 1982); Greenhouse v. Comm'r of Internal Revenue, Docket No. 40052, 1954 WL 262, (Aug. 30, 1954); Barry v. Snowden, 106 F. 571, 572 (Cir. Ct. D. Ind. 1901), and section 453(f)(3) therefore generally excludes promissory notes from constituting “payments” reported in the year received. 26 U.S.C. § 453(f)(3); see 26 U.S.C. § 453(c). The promissory note (Docket Entry # 158-5, p. 3) therefore constitutes evidence of indebtedness.

An exception to the above definition of “'payment'” as not including the seller's receipt of “evidences of indebtedness” from “the person acquiring the property” 26 U.S.C. § 453(f)(3), is when the evidence of indebtedness “is payable on demand, or readily tradable.” 26 U.S.C. § 453(f)(4); accord 26 C.F.R. §§ 15a.453-1(b)(3), 15a.453-1(e). Section 453 commands that “evidence of indebtedness” that is “payable on demand,” or “readily tradable, shall be treated as receipt of payment” for purposes of section 453. 26 U.S.C. 453(f)(4) (emphasis added); accord 26 C.F.R. §§ 15a.453-1(b)(3), 15a.453-1(e); see Applegate v. Comm'r of Internal Revenue, 980 F.2d 1125, 1128 (7th Cir. 1992) (interpreting section 453 under Illinois law and describing how receipt of “evidence of indebtedness which . . . is payable on demand . . . shall be treated as receipt of payment”); Barrett v. Comm'r of Internal Revenue, No. 12895-93, 1996 WL 196541, at *6 (T.C. Apr. 24, 1996) (“note was not a 'payment' within the meaning of the relevant sections because it was neither payable on demand nor readily tradable”); Estate of Silverman v. Comm'r of Internal Revenue, 98 T.C. 54, 69 (T.C. 1992) (“[s]ection 453(f)(3) provides that unless readily tradable or payable on demand, payment does not include purchaser evidences of indebtedness”); Ehlert v. Comm'r of Internal Revenue, Docket No. 21226-81, 1985 WL 15106, at *n.9 (T.C. Sept. 16, 1985) (note payable on installment plan that is “neither payable on demand nor readily tradable” will not constitute payment).

The accompanying treasury regulation provides further guidance on exceptions to the installment method of reporting income. 26 C.F.R. § 15a.453-1. In no uncertain terms, regulation 15a.453-1 clarifies that evidence of indebtedness that is “payable on demand shall be treated as a payment in the year received, not as installment obligations payable in future years.” 26 C.F.R. § 15a.453-1(e)(1)(i) (emphasis added); see Mueller v. Comm'r of Internal Revenue, No. 3336–95, 2001 WL 812253, at *7 (T.C. July 19, 2001) (finding demand debentures were “evidences of indebtedness payable on demand” and installment method unavailable such that there were no payments in years after sale of debentures). The regulation points to applicable state or local law for determining the meaning of “payable on demand.” 26 C.F.R. § 15a.453-1(e)(3) (“obligation shall be treated as payable on demand only if the obligation is treated as payable on demand under applicable state or local law”).

Massachusetts, having adopted the Uniform Commercial Code (“UCC”), defines “'payable on demand'” as a promise or order that either “(i) states that it is payable on demand or at sight, or otherwise indicates that it is payable at the will of the holder, or (ii) does not state any time of payment.”²⁵ Mass. Gen. Laws ch. 106, § 3-108(a) (emphasis added). Courts interpret this language, and language in similar statutes, to mean that if there is no specified date for when the balance is due, the note is considered payable on demand. See Blasco v. Money Servs. Ctr. d/b/a Cash Connection (In re Blasco), 352 B.R. 888, 894-95 (Bankr. N.D. Ala. R. 2006) (examining payable-on-demand statute containing language similar to Massachusetts' payable-on-demand statute and concluding that check issued in payday loan transaction was payable on demand because it did not state any time of payment); Ranieri v. Terzano, 457 N.E.2d 906, 910 (Ohio Ct. App. 1983) (examining payable-on-demand statute containing language similar to Massachusetts' payable-on-demand statute and concluding that notes were “due on demand, since they specified no maturity date”).

In the case at bar, the promissory note falls into the exception for the installment method outlined in section 453(f)(4) because it is “payable on demand.” 26 U.S.C. § 453(f)(4)(A); accord 26 C.F.R. § 15a.453-1(e)(1)(i). It is payable on demand because no date of repayment is listed anywhere on the promissory note. Mass. Gen. Laws ch. 106, § 3-108(a).

Merchia nevertheless argues that “[t]he terms embodied in the note [were] that payment was due 'as-is able'” and, because of this, the promissory note is not a demand note. (Docket Entry # 157, pp. 5-6). In particular, he submits that the promissory note's terms reflect that SleepHeart of Virginia LLC's payment was due “as-is able” contingent upon the company's “ability to pay an installment” or that receipt of a promissory note is not payment to discharge a debt. (Docket Entry # 157, pp. 5-6). Defendant disagrees and distinguishes three of the cases Merchia cites. (Docket Entry # 163, pp. 13-14). In the case at bar, the note does not contain any language that suggests the payments were to be made on an “as-is able” basis. (Docket Entry # 141-15). The cases that Merchia cites in opposition to defendant's motion to support his arguments (Docket Entry # 157, pp. 5-6) are distinguishable.²⁶

The decision in Dial concerned secured notes or bonds that were payable with principal and interest over a 24-month period. Dial, 24 T.C. at 118, 123. Decided in 1955, Dial did not pertain to the tax treatment of a promissory note in the context of an installment sale under section 453 and regulation 15a-453-1. See id. The circumstances in Dial therefore differ from those in the case at bar. The decision in Mellinger, decided in 1938, dealt with replacement notes given to replace two prior notes in default, which were then canceled, as well as interest on those notes. Mellinger, 21 F. Supp. at 966-67. The case did not involve a demand note or a promissory note falling within the exception in section 453(f)(4)(A). Mellinger, 21 F. Supp. at 966-67. Hence, the principle cited by Merchia (Docket Entry # 157, p. 5) and stated in Mellinger, 21 F. Supp. at 967 (absent “agreement or consent to receive it as such, a promissory note of the debtor, although accepted by the creditor, does not in itself constitute payment or amount to a discharge of the debt”), does not apply because the statute, 26 U.S.C. § 453(f)(4), instructs that the payable-on-demand promissory note is receipt of payment.²⁷ Merchia's reliance on the decision in Shawmut is actually harmful to his argument because Shawmut points out that “[t]he note is a demand note at least because it is an instrument in which no time for payment of principal is stated.” Shawmut, 614 N.E.2d at 669. The decision therefore supports defendant's argument that the promissory note at issue in this case is a demand note. Finally, the decision in Overnite involved whether an issuer of notes could deduct the resulting interest from his income. Overnite, 764 N.E.2d at 364-72. As defendant aptly describes in its reply (Docket Entry # 163), this case did not concern the tax treatment of a note in the context of an installment sale.

In sum, the promissory note is evidence of indebtedness because it is a legally enforceable promise to pay. See Mass. Gen. Laws ch. 106, § 3-303(a)(3); Austin, 462 F.2d at 736; Jones, 450 F.2d at 525; Bank of N.C., 2015 WL 3822385 at *6. It also lies within the exception in section 453(f)(4) as further clarified in regulation 15a.453-1(e) because it is payable on demand. Merchia was therefore correct to include the amount of the promissory note in the Original 2012 Return as opposed to limiting his reported income to installment payments received in 2012. The variance doctrine bars Merchia from arguing an overpayment exists based on the purportedly erroneous inclusion of the uncashable $2.25 million check. Accordingly, defendant is entitled to summary judgment on the section 7422 tax refund claim.²⁸

II. Merchia's Motion for Summary Judgment

Merchia seeks summary judgment “as to all allowed counts of his [a]mended [c]omplaint.” (Docket Entry # 147, p. 2). Viewing the facts in the light most favorable to defendant, they are as follows.

FACTUAL BACKGROUND

In 2008, Merchia sold his business, which included medical technology he had developed, to SleepHeart of Virginia LLC for $30 million. (Docket Entry # 152, pp. 2-3, ¶ 1) (Docket Entry # 148, ¶ 1). There are no original sale documents connected with this sale.²⁹ Notwithstanding Merchia's argument to the contrary, this action arose from the tax treatment of the promissory note. (Docket Entry # 148-2, pp. 103–104) (Docket Entry # 157, p. 2) (Docket Entry # 148, p. 1, ¶ 3) (Docket Entry # 147, p. 1).

Merchia purports to have received a $15 million promissory note in 2012 signed by Pendse as “Member” of SleepHeart of Virginia LLC.³⁰ (Docket Entry # 140, p. 9) (Docket Entry # 141-15, p. 2). By affidavit, Merchia attests he also received the “undepositable check” for $2.25 million and “$3,144,448 in installment payments” from SleepHeart of Virginia LLC in 2012.³¹ (Docket Entry # 148-2, p. 2, ¶ 3).Merchia reported receipt of $14,950,000 as capital gain income on the Original 2012 Return. (Docket Entry # 141-1).

On June 5, 2014, Merchia filed the Form 1040X amended return in which he first mentioned the promissory note and then excluded it from income.³² (Docket Entry # 141-10).The June 5, 2014 Form 1040X thus asserted a new taxable income of $4,650,634 for the 2012 tax year and entitlement to a $1,564,368 refund.³³ (Docket Entry # 141-10, pp. 2–4).After the filing of the June  5, 2014 Form 1040X, the IRS audited Merchia's Original 2012 Return and amended return. (Docket Entry # 148, ¶ 10) (Docket Entry # 152, ¶ 10) (Docket Entry # 148-2, p. 3, ¶ 8). During the examination, the IRS made three Information Document Requests to Merchia and requested meetings and interviews. (Docket Entry # 148, ¶ 11) (Docket Entry # 152, ¶ 11).

In September 2015, the IRS Small Business and Self-Employed division determined Merchia's new tax liability and did not allow all of the changes that he attempted to make. (Docket Entry # 141-12, pp. 5-17). Merchia filed an appeal. (Docket Entry # 148, ¶ 19) (Docket Entry # 152, ¶ 19). Ultimately, in June 2016 the IRS Appeals Office concurred with the September 2015 Examination Report, changed the $15 million installment gain from short-term to long-term capital gain, and did not allow the exclusion of the $15 million as “installment gain” from 2012 income. (Docket Entry # 141-13, p. 2) (italics omitted).

DISCUSSION

As noted, Merchia moves for summary judgment on “all allowed counts of his [a]mended [c]omplaint” against defendant, specifically, the tax refund claim against the United States under section 7422 for the erroneous or illegal assessment or collection of taxes for the 2012 tax year.³⁴ (Docket Entry # 147). Merchia argues that the burden shifts to defendant under section 7491(a) to prove that Merchia received payment from the $2.25 million check in 2012. (Docket Entry # 147). Specifically, he submits that defendant cannot prove that he received anything more than the aggregate $3,144,448.93 installment payment in 2012 and the $2.25 million check was “undepositable” thus warranting summary judgment in his favor. (Docket Entry ## 149, 164).

Defendant opposes the summary judgment motion on the grounds that: this court lacks jurisdiction over Merchia's additional grounds for a refund under the variance doctrine; Merchia has not met the standard to shift the burden to defendant under section 7491(a); the promissory note is a sham; and Merchia has not shown defendant's assessment was incorrect. (Docket Entry # 155). In opposing the summary judgment motion, defendant incorporates by reference all of the arguments it makes in support of its summary judgment motion. (Docket Entry # 155, p. 6). Accordingly, defendant argues that the promissory note is evidence of indebtedness that falls into the payable-on-demand exception under section 453(f)(4) and is therefore treated as receipt of payment in 2012.(Docket Entry # 155, p. 6) (Docket Entry # 142, pp. 15-17). Merchia does not directly address regulation 15a.453-1 in his motion for summary judgment or his reply to defendant's opposition.

A. Variance Doctrine

During the administrative proceedings, Merchia raised the promissory note's taxability in his claim for a refund to the IRS. (Docket Entry # 141-10, pp. 3-4). Defendant argues that the variance doctrine bars Merchia from changing his argument for seeking a refund now to argue that the $2.25 million check was “undepositable” and therefore not received in 2012. (Docket Entry # 155, pp. 6-7). Defendant is correct.

As discussed in Roman numeral I(A), taxpayers are prohibited from substantially varying, either legally or factually, a claim for a refund and are only permitted to rely on grounds specified in the claim presented to the IRS. Mobil Corp. v. United States, 52 Fed. Cl. 327, 331 (fed. Cl. 2002); see Lockheed, 210 F.3d at 1371; Ottawa Silica Co. v. United States, 699 F.2d 1124, 1138-39 (Fed. Cir. 1983). Merchia presently argues to this court that he “incorrectly continued to include the [$2.25 million] check” in the June 5, 2014 Form 1040X even after he spoke with Kassis and excluded the promissory note from income. (Docket Entry # 149, p. 2). Merchia further argues that defendant cannot prove that he received the $2.25 million cash amount of the check in 2012. (Docket Entry # 147). The argument that the $2.25 million check was not cashable and, as such, should not be included in 2012 income is a new factual basis and a new legal theory for Merchia's claim for a refund. See Muskat, 554 F.3d at 195; Lockheed, 210 F.3d at 1371.

The administrative filings with the IRS do not contain this substantially varied legal theory of the case. (Docket Entry ## 141-6, 141-8, 158-6). Throughout the administrative proceeding, Merchia's claim was based on regulation 15a.453-1, and how he believed that the promissory note was not taxable until the year payment was received as well as treatment of capital gain as long-term. (Docket Entry # 158-3, ¶ 12) (Docket Entry # 141-10, pp. 3-4). For example, in the June 5, 2014 Form 1040X amended return, Merchia set out what he believed was the relevant argument and the relevant section of regulation 15a.453-1: “the term 'payment' does not include the receipt of evidences of indebtedness of the person acquiring the property . . . [p]ayments include amounts actually or constructively received in the taxable year.” (Docket Entry # 141-10, p. 4) (emphasis omitted). As further reflected in the June 5, 2014 Form 1040X, Merchia interprets regulation 15a.453-1 to establish that a “[p]romissory note [is] not a receipt of [payment] from an 'instalment [sic] sale.'” (Docket Entry # 141-10, p. 4). Merchia does not provide sufficient evidence that he put the IRS on notice that the $2.25 million check was not cashable and the amount was therefore incorrectly included in his 2012 income.³⁵ This argument substantially varies legally and factually from the administrative claim Merchia made to the IRS.

Defendant also contends that Merchia's argument that he only received $3,144,448.93 of installment income in 2012 is at variance with his administrative claim. (Docket Entry # 155, p. 6). It is not necessary to address this aspect of defendant's variance argument. As discussed below, limiting installment payments to those received in the 2012 tax year (purportedly $3,144,448) is contrary to section 453(f)(4) and regulation 15a-453-1 because the payable-on-demand promissory note falls under the exception to the installment method pursuant to section 453(f)(4).

B. Section 453(f)(4) and Regulation 15a.453-1

Defendant argues that the promissory note was payable on demand and therefore considered evidence of indebtedness included as income in the year received rather than as an installment obligation payable in future years. (Docket Entry # 155, p. 6) (incorporating arguments made in defendant's summary judgment motion); (Docket Entry # 142, pp. 15-17). The law relative to section 453 and regulation 15a.453-1 is set out in Roman numeral I(C) and need not be repeated. Merchia's 2012 taxable income under section 453 and regulation 15a.453–1 is the dispositive issue for Merchia's summary judgment motion just as it was for defendant's motion. Because the promissory note does not specify a payment date, it is a demand note which falls under the exception in section 453(f)(4)(A) to the installment method, which treats a payment for an installment sale as income in the year the installment payment is received. See 26 U.S.C. § 453(f)(4)(A); 26 C.F.R. §§ 15a.453-1(b)(1)-(3), 15a.453-1(e); Mass. Gen. Laws ch. 106, § 3-108(a). As a result, the promissory note was properly reported as income in the 2012 tax year.

Here, Merchia's argument that he received no more than $3,144,448 from SleepHeart of Virginia LLC of “installment income” as “previously paid” income under the $15 million promissory note (Docket Entry # 149, pp. 1-2) is premised on the incorrect method of reporting income based on the amount of promissory note payments received in 2012. Merchia is therefore not entitled to summary judgment on the section 7422 tax refund claim.

In sum, the IRS rejected the installment method (Docket Entry # 141-5, 141-12, 141-13), and as previously discussed the payable-on-demand promissory note reflecting the installment sale purchase of SleepHeart LLC precludes attributing the payments to tax years other than 2012. Hence, even putting aside defendant's hearsay objection, the installment method in section 453 does not limit payments to those received in 2012 ($3,144,448). See 26 U.S.C. § 453(f)(4)(A). Assuming arguendo that the promissory note is not a sham, notwithstanding defendant's arguments to the contrary, the promissory note is payable-on-demand which, together with defendant's correctly premised variance argument, warrants the recommended denial of Merchia's summary judgment motion.³⁶

CONCLUSION

For the foregoing reasons, this court RECOMMENDS³⁷ that defendant's summary judgment motion (Docket Entry # 140) be ALLOWED, and Merchia's summary judgment motion (Docket Entry # 147) be DENIED.

MARIANNE B. BOWLER
United States Magistrate Judge