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LLC v. United States

United States District Court, D. Idaho

December 20, 2016

C1 DESIGN GROUP, LLC., Plaintiff,
v.
UNITED STATES OF AMERICA, Internal Revenue Service, Defendant.

          MEMORANDUM DECISION AND ORDER RE: DEFENDANT'S MOTION FOR SUMMARY JUDGMENT (DKT. 41)

          Honorable Candy W. Dale United States Magistrate Judge

         INTRODUCTION

         Plaintiff C1 Design Group, LLC., (“C1 Design”) failed to timely pay its federal excise tax returns from Q3 2011 through Q1 2013. The IRS assessed late penalties totaling $28, 755.39. As required by law, C1 Design later paid the penalties and back taxes before bringing this action against the United States of America to obtain a refund of the penalties. Pending before the Court is the IRS's motion for summary judgment of C1 Design's refund claim. (Dkt. 41.)

         All parties have consented to the jurisdiction of a United States Magistrate Judge pursuant to 28 U.S.C. § 636(c). (Dkt. 28.) The Court heard oral argument from the parties on November 21, 2016, after which the Court requested further submissions and briefing. (Dkt. 58.) After review of the record, consideration of the parties' arguments and relevant legal authorities, and otherwise being fully advised, the Court will deny the IRS's motion.

         FACTUAL BACKGROUND[1]

         C1 Design is an innovator and manufacturer of outdoor gear, specializing in fishing reels.[2] (Dkt. 44-2 at 3.) Ryan Harrison is the President of C1 Design and one of its operating managers.[3] Harrison oversees C1 Design's financial matters, including the calculation and payment of excise taxes. (Dkt. 44-2 at 8.) Since C1 Design was founded, and until Q3 of 2010, C1 Design timely filed every tax return it was required to file and timely paid its employees' salaries, payroll withholding taxes, and excise taxes. (Dkt. 44-2 at 8.)

         In October of 2010, Harrison was involved in an auto accident on his return home from a trade show. (Dkt. 46-9 at 3.) As a result of the accident, Harrison broke his clavicle, sustained whiplash, and developed PTSD. (Dkt. 46-9 at 5.) Harrison never took an official leave of absence from C1 Design following the auto accident. (Dkt. 44-2 at 17.) However, due to his injuries, Harrison “relied more heavily” on one of C1 Design's other operating managers, John Talbot, to maintain and purchase C1 Design's supplies. (Id.) Talbot, the head of operations and the most senior C1 Design employee, was responsible for planning the purchase of parts needed for the future assembly of goods and managing suppliers so that parts arrived timely and of acceptable quality. (Id.) Following the accident, and unbeknownst to Harrison, Talbot was battling an alcohol problem, which interfered with his ability to effectively manage C1 Design's supply. (Id. at 18.)

         Historically, it was C1 Design's practice to pre-order supplies consistent with projected business growth so that adequate supply would be on hand to fulfill its orders. (Id.) In addition, the costs of parts, if ordered in advance, were substantially less expensive. During the time period at issue, Talbot began outsourcing supplies from a local supplier at premium prices to compensate for his inability to effectively plan for business growth. (Id.) This, in turn, caused C1 Design's products to be less profitable on a per-unit basis, which drove down C1 Design's profits. (Id. at 19.) Talbot's business decisions contributed to C1 Design's net loss of nearly $200, 000 in 2011. (Dkt. 44-2 at 12.)

         After being alerted to C1 Design's loss in gross profit margins, Harrison soon discovered the losses were a result of Talbot's poor business decisions and terminated Talbot's employment on December 5, 2011. (Dkt. 44-2 at 19.) Out of “human kindness, ” C1 Design provided Talbot a severance package consisting of a $2, 000 per month salary for four months, and payment of Talbot's health benefits for one year (approximately $500 per month). (Dkt. 44-2 at 20, 22.)

         C1 Design alleges the impact of Harrison's accident, Talbot's poor business decisions, and its 2011 net loss, caused the business to struggle in 2012, despite its reported net profit of $236, 040.[4] (Dkt. 42-6 at 2.) During C1 Design's ongoing financial struggle, C1 Design timely filed its tax returns; however, it did not timely pay the taxes reported on its excise tax returns for Q3 2010 through Q1 2013. (Dkt. 44-2 at 8.) C1 Design alleges that, although it posted a profit in 2012, it was not sitting on cash when its excise taxes were due. Rather, all incoming cash was used to pay other taxes, salaries, and suppliers to ensure the survival of C1 Design. The Court will discuss the debts paid or other payments made by C1 Design in lieu of making its excise tax payments to the IRS during the Q3 2010 through Q1 2013 periods below.

         I. Management Guaranteed Payments

         Pursuant to C1 Design policy, “[i]f a member is also a manager actively involved in the duties of the business, they receive a salary for that. That salary is called a guaranteed payment.” (Dkt. 44-2 at 9.) During the relevant tax quarters, Harrison alleges that operating managers' guaranteed payments were not paid in full or on time.[5] (Dkt. 45-7 at 4.)

         In 2010, Ryan Harrison was paid $116, 216 in guaranteed payments; Mark Farris, another C1 Design partner, was paid $102, 498 in guaranteed payments. (Dkt. 42-4 at 3-4.) In 2010, after all expenses including member salaries, other salaries, and taxes, C1 Design posted a profit of $85, 484. (Id. at 2.)

         In 2011, Ryan Harrison was paid $121, 320 in guaranteed payments; Mark Farris was paid $97, 055 in guaranteed payments; Michael Harrison, another C1 Design partner, was paid $368 in guaranteed payments. (Dkt. 42-5 at 3-5.) That year, after all expenses including member salaries, other salaries, and taxes, C1 Design posted a loss of $126, 240. (Id. at 2.)

         In 2012, Ryan Harrison was paid $204, 262 in guaranteed payments; Mark Farris was paid $106, 029 in guaranteed payments; Michael Harrison was paid $46, 961 in guaranteed payments. (Dkt. 42-6 at 3-5.) That year, after all expenses including guaranteed payments, other salaries, and taxes, C1 Design posted a profit of $236, 040. (Id. at 2.)

         In 2013, Ryan Harrison was paid $93, 342 in guaranteed payments; Mark Farris was paid $109, 435 in guaranteed payments; Michael Harrison was paid $68, 139 in guaranteed payments. (Dkt. 42-7 at 3-5.) That year, after all expenses including salary, other salaries, and taxes, C1 Design posted a profit of $353, 411. (Id. at 2.)

         Harrison contends that, had C1 Design paid less “guaranteed payments” to operating managers, it would have risked operating managers leaving C1 Design to seek alternate employment. (Dkt. 43-1 at 16.)

         II. Payments to Creditors

         During the relevant time period, C1 Design alleges “virtually all of its creditors were paid untimely… including the IRS, suppliers, and even landlords.” (Dkt. 43-1 at 2.) During this time, C1 Design paid Paul Davis, one of its biggest suppliers of parts, at times when C1 Design did not pay or did not pay in full the excise taxes that were due. On March 12, 2012, Harrison sent an email to Paul Davis explaining that the problem with John Talbot purchasing bad parts was in the past, and C1 Design Group was “now ‘fixed' and firing on all cylinders.” (Dkt. 45-2 at 2.) Harrison explained that profits were back where they needed to be, and that C1 Design “will have record sales with another % year, and [C1 Design] will post record profits.” (Id.) He explained also that C1 Design was “approaching the point where we'll be able to step up … payments per month and work toward current.” (Id.)

         III. Penalties and Re-payment to IRS

         The IRS assessed penalties as a result of C1 Design's failure to timely pay its excise taxes. After Q1 of 2013, Harrison contacted the IRS to arrange for an installment agreement. C1 Design made monthly payments of $25, 000 on past due excise tax balances in addition to timely payments on accrued taxes moving forward. C1 Design paid off its excise tax liability, including interest and penalties, on June 6, 2014.

         PROCEDURAL BACKGROUND

         On August 11, 2014, C1 Design sought abatement of the penalties associated with its failure to timely pay its excise taxes from Q3 2010 through Q1 2013 by submitting an appeal to the IRS. In the course of its investigation, the IRS agreed that reasonable cause existed for C1 Design's failure to pay the tax and abated penalties for the first four quarters of the relevant time period, from Q3 2010 through Q2 2011. However, the IRS denied abatement of penalties for the last seven quarters, ...


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