The interaction between bankruptcy proceedings and tax liability often creates complex evidentiary records. In Veeraswamy v. Comm’r of Internal Revenue, the United States Court of Appeals for the Second Circuit addressed a situation where a taxpayer attempted to disavow S Corporation ownership for tax purposes despite claiming equity ownership in concurrent bankruptcy proceedings to secure distributions. The Second Circuit’s summary order affirms the Tax Court’s decision, offering a stark reminder regarding the consistency required in taxpayer representations across different legal venues.

Factual Background and Procedural History

The core dispute involved the 2014 tax year and the ownership structure of Ashand Enterprises ("Ashand"), an S Corporation. The Commissioner assessed a deficiency against Karen Veeraswamy, the Petitioner, predicated on the determination that she was a 50 percent shareholder of Ashand, which had realized capital gains and rental income during that year.

Veeraswamy challenged this assessment in the Tax Court, arguing that the 2013–2015 bankruptcy proceedings of Ashand established her former husband, Velappan Veeraswamy, as the sole owner. She contended that "collateral and equitable estoppel precluded the assessment". The Tax Court rejected these arguments, finding she was a half-owner in 2014, and affirmed penalties for failure to file and pay.

On appeal to the Second Circuit, Veeraswamy argued that the Tax Court "(1) improperly found that she was a part owner of Ashand in 2014; (2) inaccurately calculated her income; (3) improperly failed to consider her computation of the amount she owed under Tax Court Rule 155; and (4) improperly imposed penalties pursuant to 26 U.S.C. § 6651(a)".

Analysis of Shareholder Ownership

The Second Circuit reviewed the Tax Court’s factual findings for clear error and its legal conclusions de novo. The Court found substantial evidence supporting the determination that Veeraswamy retained her interest in the S Corporation through 2014.

The record indicated that corporate minutes from 2000 established a 50/50 ownership structure, and the taxpayer "testified at trial that she participated in management of the enterprise after the Veeraswamys began living separately in 2004". Furthermore, "Ashand’s Forms 1120S and Schedules K-1... showed that Veeraswamy remained a half-owner of Ashand as of 2010".

Crucially, the Court looked to the taxpayer’s own representations in the bankruptcy litigation. The Court noted that in 2019, while seeking escrow funds, "Veeraswamy repeatedly asserted that she was '50 percent equity shareholder of Ashand Enterprises, Inc.'". Similarly, in 2021, she claimed entitlement to a distribution because she was a "fifty percent shareholder". The Court held that "Veeraswamy did not demonstrate that she abandoned her interest prior to 2014, and she submitted no evidence of such abandonment".

Preclusion and Estoppel

The taxpayer argued that the bankruptcy confirmation plan precluded the IRS from litigating her ownership status. The Second Circuit dismantled this argument by applying federal preclusion law, noting that claim preclusion requires a "final judgment on the merits" and issue preclusion requires that issues be "actually litigated and decided in the previous proceeding".

The Court found that neither the confirmation plan nor the final decree in the Ashand bankruptcy satisfied these elements regarding ownership. While a proposed plan indicated the husband was the sole owner, the final decree "expressly disclaimed that it 'settle[d] any issues as to the propriety of payments by the Debtor [Ashand] as between [its] equity holders'". Consequently, "the bankruptcy court’s order confirming Ashand’s plan of reorganization made no findings as to Ashand’s equity ownership". Therefore, the IRS was not precluded from asserting Veeraswamy’s part ownership.

Income Adjustments and Presumption of Correctness

Regarding the calculation of income under I.R.C. § 1366(c), the Court reiterated that a "notice of tax deficiency carries a presumption of correctness that requires the taxpayer to demonstrate that the deficiency is incorrect". This presumption holds as long as the assessment has a "rational basis".

The Court found a rational basis existed because the "petitioner represented to the U.S. Bankruptcy Court... that she was a 50% shareholder" and subsequently "petitioner was paid $486,038.47 from the bankruptcy estate... based on her assertions". Because the taxpayer failed to provide documents substantiating her contributions or lack thereof to the revenue agent, and "did not otherwise contest the agent’s calculations at trial," the Tax Court properly accepted the Commissioner’s calculations.

Rule 155 Computations and New Issues

A significant procedural point for practitioners arose regarding Tax Court Rule 155. Veeraswamy attempted to use the Rule 155 computation process to claim over one million dollars in deductions for taxes, utilities, and building expenses.

The Second Circuit affirmed the Tax Court’s refusal to consider these figures, citing Rule 155(c), which states that "no argument will be heard upon or consideration given to the issues or matters disposed of by the Court’s findings and conclusions or to any new issues". Since the Tax Court had already determined the allowable expenses in its post-trial opinion, and because Veeraswamy’s computation "exclusively sought to relitigate the issue of appropriate deductions," the Tax Court did not abuse its discretion in rejecting the computation.

Penalties and Reasonable Cause

Finally, the Court addressed the imposition of penalties under I.R.C. § 6651(a). The taxpayer argued reasonable cause, noting she had consulted with an accountant. However, the Court distinguished between consulting an advisor and relying on specific advice.

Veeraswamy testified that "the accountant did not advise her that she had no obligation to file". The Court held: "Because she did not rely on the accountant’s advice in failing to file, the Tax Court did not err in concluding this was not 'reasonable cause'".

Additionally, the Court rejected arguments regarding § 6654 estimated tax penalties. The taxpayer failed to show that "casualty, disaster, or other unusual circumstances" made the penalty "against equity and good conscience". The Court also dismissed her argument that filing a return claiming ownership would have risked criminal prosecution as "purely speculative".

Conclusion

The Veeraswamy summary order serves as a critical affirmation of the duty of consistency. A taxpayer cannot claim shareholder status to receive bankruptcy distributions while simultaneously denying that status to avoid tax liability. Furthermore, the decision underscores the strict limitations of Rule 155 proceedings; they are strictly for computation based on established findings, not a venue to introduce omitted deductions or relitigate the merits of the case.

Prepared with assistance from NotebookLM.