Case Law Update Reviewed by Momizat on . Revenge Porn, Ugg, VirnetX, and Apple This case law highlights a number of patent, copyright, and business valuation cases litigated in the first quarter of 201 Revenge Porn, Ugg, VirnetX, and Apple This case law highlights a number of patent, copyright, and business valuation cases litigated in the first quarter of 201 Rating: 0
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Case Law Update

Revenge Porn, Ugg, VirnetX, and Apple

This case law highlights a number of patent, copyright, and business valuation cases litigated in the first quarter of 2018. The revenge porn case highlights a distressing but potential opportunity for litigation support professionals. The VirnetX v. Apple and Deckers Outdoor Corporation v. Romeo & Juliette, Inc. cases highlight the perils of patent litigation and fleeting value of patents.

Deckers Outdoor Corporation v. Romeo & Juliette, Inc. et al., Case No. 2:15-cv-02812-ODW, (April 10, 2018).

A California jury returned a verdict in favor of Deckers Outdoor Corporation for $5.2 million.  Analysts speculate that the award could increase based on the willfulness finding and pending an estoppel appeal.  Decker Outdoor Corporation is maker of Ugg boots.  Almost a year ago, on June 13, 2017, the court granted in part (and denied in part) Romeo & Juliette’s motion for summary judgment with respect to patents D582,650 and D616,189.  Specifically, defendant argued that their affirmative defenses of laches and equitable estoppel barred the infringement action.  Although the court sided with defendant on the D616,189, it denied the motion with respect to the D582,650 patent.

The case provides valuable insight to litigation support and legal practitioners since it sets forth the standard of review when laches and equitable estoppel are raised as a defense to an infringement action and serves as a reminder that the value of patents is not just a function of the demand.

Jane Doe v. David Elam, II (U.S. District Court California).

On April 4, 2018, a California U.S. District Court entered a judgment against defendant for $6.4 million for copyright infringement and emotional distress.  This notable and one of the first cases involving “revenge porn”.  Briefly, sometime in 2013, plaintiff (whose named has been concealed to protect her identity) and her boyfriend, stopped seeing and dating each other.  According to court documents, shortly thereafter, the ex-boyfriend began to post sexual photographs and videos of her on pornography websites and to impersonate her in online dating forums.  He threatened to make her life “so miserable she would want to kill herself.”

It is alleged that strangers sent her explicit texts and e-mails.  Some said they were on their way to her home.  She began to fear for her life.  Jane Doe sued her ex-boyfriend in United States District Court in California to get him to stop.  Four years passed, until the court awarded her $6.4 million.  This is one of the biggest judgments ever in a so-called revenge porn case.

Practitioners interested in learning more about this issue, brought on partly in the proliferation of new technology, will be surprised and astounded by what a party must do to obtain copyright protection and that the protections by state law afforded to victims differ dramatically.  In addition, they may want to make a note regarding resources that have emerged to combat what may be an emerging area of employment and resource, namely the Cyber Civil Rights Legal Project, an initiative started in 2014 by K&L Gates, a Pittsburgh law firm, to litigate against online harassment and the nonconsensual posting of explicit material, often involving a former girlfriend or a spouse.

VirnetX v. Apple, Inc., (U.S.D.C. E.D. Texas) Case No. 6:12-cv-855-RWS (April 11, 2018).

On April 11, 2018, a Texas federal court ordered Apple to pay $502.6 million for patent infringement.  Plaintiff alleged that Apple’s FaceTime, VPN on Demand, and iMessage infringed on its Gabriel Collaboration Suite system.  This lawsuit is the latest action in a case that has been the subject of litigation for the past eight years and has been the subject of unusual twist and turns.  Will VirnetX collect?  That is the unanswered question.  In early 2016, Apple was ordered to pay $625.6 million and that verdict was overturned on the basis that two lawsuits that were joined, created a potential for juror confusion; this resulted in two new trials to deal with claims individually.  In 2016, the Patent Trial and Appeal Board ruled VirnetX patents invalid and declined to put the trials on hold opining that a verdict on appeal (from the Federal Circuit Court) would come before a final decision.   The Federal Circuit has not ruled on the validity of the patents that were the subject of this case.  Practitioners will want to read QuickRead for an update.

Mazzei v. Commissioner, 150 T.C. No. 7 (March 5, 2018).

This is roughly a 70 page decision that highlights the perils of aggressive sheltering.  Petitioner (P hereinafter) entered into a prepackaged plan to save taxes by routing funds from their family business through a Bermuda-based foreign sales corporation (FSC) and then into Roth IRAs created for this purpose.  Pursuant to this plan, in 1998, each P directly contributed $2,000, the applicable contribution limit, to his or her newly created Roth IRA, which then paid a nominal amount for stock in the FSC.  From 1998 to 2002 Ps routed payments totaling $533,057 from their family business, through the FSC, and into their Roth IRAs.

Ps contend that we should respect the form of these transactions as payments from Ps’ business to the FSC, followed by payments of dividends by the FSC to the Roth IRAs.  Respondent (R hereinafter) contends that the payments from the FSC to Ps’ Roth IRAs represented, in substance, contributions from Ps to their Roth IRAs.  R contends that because these payments exceeded Ps’ contribution limits for their Roth IRAs, Ps are liable for excise taxes under IRC sec. 4973.

Held: On the facts presented, Ps and not their Roth IRAs were the owners, for Federal tax purposes, of the FSC stock; in substance the FSC dividends were income to Ps, who contributed the funds to their Roth IRAs.  Summa Holdings, Inc. v. Commissioner, 848 F.3d 779 (6th Cir. 2017), rev’g T.C. Memo. 2015-119, distinguished.

Held, further, pursuant to IRC sec. 4973, Ps are liable for excise taxes on excess contributions to their Roth IRAs.

Held, further, R’s imposition of additions to tax under IRC sec. 6651(a)(1) and (2) is not sustained.

Wells v. Commissioner, T.C. Memo. 2018-11 (January 31, 2018).

The issue in the case involves whether deductions claimed by taxpayer where ordinary or capital expenditures.  The case involves an agricultural entity (a vineyard) operated by taxpayer.  The case will be of interest to CVAs that provide tax services in the ag sector and also, CVAs and professionals seeking to avoid the tax accuracy penalty.

Issues: (1) Whether petitioner may immediately deduct expenditures under section 162 totaling $199,031 and $47,630 for 2010 and 2011, respectively, and (2) whether petitioner is liable for an accuracy-related penalty under section 6662(a) for 2010.

Facts: Petitioner was a highway project engineer for the Colorado Department of Transportation until she retired in 1996.  She owns and lives on a 265-acre property in Garfield County, Colorado.  Petitioner has lived on the property continuously since 1983.  Before that, she had lived on the property intermittently since 1965 (her father owned the property before petitioner).

Petitioner cultivated approximately 700 white French hybrid rind grapevines on three patches of open land at the northern end of the property.  In better years, the vines produced up to four tons of grapes, which petitioner would sell to a local winery.  More recently, petitioner harvested only 600 to 1,200 pounds of grapes per year because adverse weather conditions (and bears, apparently) caused damage to her harvest.  As her harvest dwindled, petitioner took to crushing her grapes for juice, which she sold in gallon jugs to local buyers.

Petitioner also leased a portion of the southern part of the property for horse and cattle grazing, although drought-like weather conditions during parts of the year limited the number of animals she was able to graze on the land.  Petitioner reported $305 and $255 of gross income from farming for 2010 and 2011, respectively, on Schedules F, Profit or Loss From Farming, attached to her returns for 2010 and 2011.  Petitioner reported total farming expenses of $208,265 and $54,734 for 2010 and 2011, respectively.

There is a spring in the southern part of petitioner’s property.  In 1965 petitioner’s father installed an underground pipe to carry water from the spring to other areas of petitioner’s property (spring line).  The spring line runs downhill from south to north for about 3,800 feet and supplies, among other things, the grazing pasture and an irrigation system in the fields where petitioner grew grapes.  The spring line was originally constructed of two-inch black polyethylene pipe (black pipe), but at least 1,800 feet of the spring line was replaced in 2010 with two-inch blue pure-core pipe (blue pipe).  Sections of black pipe were connected with joints that fit together and are then secured with a hose clamp.  Sections of blue pipe were connected with compression fittings and can withstand higher pressures.  Blue pipe was more expensive, higher quality pipe.

Various roads, both public and private, traversed and border the property. One of the private roads runs from petitioner’s father’s house in the north to above the spring in the south (access road).  Another private road runs from the county road in the east to the access road (Kuiper Road).  Additionally, the “Stubbs Pad”, an oil or gas site, sits to the south of petitioner’s southern property line on a neighboring property (and above the spring in terms of elevation).

2010 Expenditures

In 2010 petitioner hired Robert Schwartz to perform work on her property.  Petitioner paid Mr. Schwartz $198,207 for labor, equipment, and materials costs relating to various projects in 2010.  The projects included: work on, or relating to, petitioner’s private roads; work on the spring line; digging holes for new grape vines; spreading manure; and construction of a storage yard.  Mr. Schwartz provided petitioner invoices listing the work completed and the costs.

Also in 2010 petitioner hired Mead Fencing to reset fences that had to be removed to complete work on the spring line and the storage yard.  Petitioner paid $824.30 for the fencing work.  Petitioner timely filed her 2010 Form 1040, U.S. Individual Income Tax Return, reporting adjusted gross income of $1,282,990 and total tax of $316,689.  In the notice of deficiency, respondent determined that none of the 2010 expenditures discussed above are deductible under section 162.  Respondent allowed an increase in a depreciation deduction and section 179 expense of $9,952 for 2010.

2011 Expenditures

In 2007 a wildfire burned approximately 26 acres of the property (burn area).  Before the fire, petitioner used a small part of that land for grazing.  In 2011 petitioner determined (after consulting a friend who had experience restoring burned land) that the fire had rendered the land hydrophobic, i.e., the heat of the fire had decreased or destroyed the land’s capacity to absorb water.  Petitioner hired Mr. Schwartz to remove burned tree stumps and boulders and turn the soil so that the entire 26-acre area could be used for forage.  Petitioner paid Mr. Schwartz $47,630 to rehabilitate the burn area in 2011.  Mr. Schwartz again provided petitioner invoices listing the work completed and the costs.

Petitioner timely filed her 2011 Form 1040, reporting adjusted gross income of $1,000,078 and total tax of $261,326.  In the notice of deficiency, respondent determined that the 2011 expenditures discussed above must be capitalized rather than deducted immediately.  Respondent allowed an increase in a depreciation deduction and section 179 expense of $21,289 for 2011.

Petitioner, who is a resident of Colorado, filed a timely petition contesting the notice of deficiency.

Held: The Court finds that all of the expenditures relating to the spring line must be capitalized and therefore are not deductible under section 162.

All of the work on the spring line (in both project categories; and including the related fencing cost and the cost of repairing the spring box) must be capitalized; the replacement of the access road must also be capitalized.  In total, $123,799.25 is attributable to these two projects on the basis of petitioner’s allocation.  This amount may not be deducted under section 162.

Petitioner claims that $16,202.50 was spent on construction of a storage yard, and $656.80 was spent on fencing work relating to the new construction.  Mr. Schwartz testified that the storage yard did not exist before he built it.  Petitioner’s testimony supports Mr. Schwartz’ testimony.  Petitioner has not offered any argument that construction of the storage yard was anything other than a capital improvement.  Moreover, nothing in the record supports a finding that the cost of work done to the storage yard was for any kind of repair or other deductible expense.  Petitioner’s implication appears to be that because she used the bare patch of earth where the storage yard now sits as a parking area before the new construction, the newly constructed yard is not a capital improvement because it is now used for the same purpose.  But new construction on top of previously unimproved land is necessarily an “improvement”, and consequently the costs must be capitalized.  Therefore, petitioner may not deduct under section 162 the $16,859.30 she estimated for the storage yard project.

The Court also concludes that none of the “Road Maintenance” expenditures on Invoice 7101-7102 are deductible.  A substantial portion of the “Road Maintenance” expenditures were for work done to “driveways” and work done around a “new barn”.  No evidence in the record suggests that the “driveways” are anything other than petitioner’s personal driveways.  The expenditures on driveways are therefore not deductible under section 162 by reason of section 262.  Mr. Schwartz testified that the barn was newly constructed, and that before the work listed on Invoice 7101-7102, there was no gravel around the barn.  The Court finds that the work done around the barn was part of the barn construction project.  It was therefore a capital improvement, and the costs may not be deducted under section 162.  Because the record provides no basis for estimating how much of the “Road Maintenance” amount is attributable to nondeductible expenditures, the Court finds that the whole category is not deductible under section 162.

The Court is satisfied, however, that petitioner is entitled to deduct $9,000 under section 162 with respect to the culvert, tree cutting, and manure spreading.  See Cohan v. Commissioner, 39 F.2d at 544 (the Court may estimate expenses if there is an adequate basis for doing so).

A penalty under section 6662(a) does not apply to any part of an underpayment of tax if there was reasonable cause for such portion and the taxpayer acted in good faith with respect to such portion.  Sec. 6664(c)(1).  Petitioner bears the burden of proving reasonable cause and good faith.  See Higbee v. Commissioner, 116 T.C. 438, 449 (2001).  “Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of all the facts and circumstances, including the experience, knowledge, and education of the taxpayer.”  Sec. 1.6664-4(b)(1), Income Tax Regs.

Respondent determined a section 6662(a) penalty with respect to 2010 only.  Petitioner was ultimately incorrect in her attempt to claim the deductions the Court has disallowed with respect to 2010.  Considering all of petitioner’s testimony and the documentary evidence she submitted, the Court is nevertheless satisfied that even though she spent extensive time and effort researching and preparing her tax return petitioner honestly misunderstood both the facts and the law applicable to her case.  Taking into account petitioner’s relative inexperience preparing tax returns, her lack of knowledge with respect to the sometimes complicated issue of whether an expenditure must be capitalized, and the fact that she did have extensive records showing, in detail, the expenditures that had been made, the Court concludes on the basis of the entire record that petitioner has shown reasonable cause and good faith with respect to her entire 2010 underpayment.  Accordingly, the Court did not sustain the section 6662(a) penalty.

Roberto H Castro, JD, MST, MBA, CVA, CPVA, CMEA, BCMHV, is an appraiser of closely held businesses, machinery, and equipment and Managing Member of Central Washington Appraisal, Economics & Forensics, LLC, which provides appraisal and litigation support services. Mr. Castro is also an attorney with a focus on business and succession planning with offices in Wenatchee and Chelan, WA. In addition, he is Technical Editor of QuickRead and writes case law columns for The Value Examiner.

Mr. Castro can be contacted at (509) 679-3668 or by e-mail to either rcastro@cwa-appraisal.com or rcastro@rcastrolaw.com.

The National Association of Certified Valuators and Analysts (NACVA) supports the users of business and intangible asset valuation services and financial forensic services, including damages determinations of all kinds and fraud detection and prevention, by training and certifying financial professionals in these disciplines.

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