United States Court of Appeals
For the First Circuit

No. 03-2367

ALPHONSE MOURAD, Petitioner, Appellant,

Entered: October 20, 2004

This cause came on to be heard on appeal from the decision of United States Tax Court, and was argued by counsel.

Upon consideration whereof, it is now here ordered, adjudged and decreed as follows: The ruling of the United States Tax Court is affirmed.

By the Court:
RICHARD CUSHING DONQVAN Richard Cushing Donovan,

[cc: Mr. Riordan, Mr. Mourad, Ms. O'Connor, Ms. DelSole, Mr. Rosenberg, Mr. Farber & Ms. McLaughlin.]__________________________________________
United States Court of Appeals
For the First Circuit

No. 03-2367

ALPHONSE MOURAD, Petitioner, Appellant, v.



Torruella, Circuit Judge, Coffin, Senior Circuit Judge. and Lynch, Circuit Judge.

Lester E. Riordan III for appellant.
Teresa E. McLaughlin, with whom Eileen J. 0'Connor, Assistant attorney General, Richard Farber, and Kenneth W. Rosenberg, were on brief for appellee.

October 20, 2004

COFFIM, Senior Circuit Judge. This case requires us to insider whether a company's filing of a bankruptcy petition and ie appointment of a trustee automatically terminates the election f its shareholders of "S Corporation" status under the Internal avenue Code. See 26 U.S.C. § 1361. Specifically at issue is a sarly $200,000 income tax deficiency assessed against appellant Alphonse Mourad stemming from the sale of assets of a corporation f which he was the sole shareholder. The United States Tax Court uled that Mourad was personally liable for the tax because his ompany, V & M Management, Inc., was an "S Corporation" whose gains nd losses are passed through to shareholders. See Mourad v. Comm'r. 121 T.C. 1, 8 (2003). The court rejected appellant's argument that V & M's bankruptcy filing had terminated the company's S election, and it further concluded that appellant was ot entitled to a low-income housing credit to offset the tax lability. On appeal, appellant challenges both the assessment and he denial of the credit. As we find no legal or factual error, we affirm.

I. Background

V & M Management owned and operated a 275-unit apartment complex known as Mandela Apartments in Roxbury, Massachusetts, from .981 until 1997. The property was sold in December 1997 for more than $2.8 million as part of a reorganization plan developed by an independent trustee after V & M filed a petition for reorganization
under Chapter 11 of the Bankruptcy Code. For a number of years if ore the bankruptcy filing, which occurred in January 1996, V & had been operated as an "S Corporation," a status available under Subchapter S of the Internal Revenue Code, 26 U.S.C. §§ 1361-1379.

Subchapter S was added to the Tax Code to lessen the tax burden on small businesses and to eliminate disincentives for them to adopt the corporate form. Bufferd v. Comm' r. 506 U.S. 523, 524-25 (1993) ; see also Durando v. United States, 70 F.3d 548, 551 (9th Cir. 1995) ("Congress created S corporations to give small businesses the benefits of the corporate form, such as limited Lability for shareholders, without the disadvantages of corporate taxation.") . When the shareholders of a qualified corporation make Subchapter S election, they switch from a multiple-level taxation system to

a "pass-through" taxation system under which income is subjected to only one level of taxation. . . . The corporation's profits [and losses] pass through directly to its shareholders on a pro rata basis and are reported on the shareholders' individual tax returns. See § 1366(a)(1)(A).

Gitlitz v. Comm'r, 531 U.S. 206, 209 (2001) (citing Bufferd. 506 .S. at 525).1

1 The income of corporations usually is subject to two levels E taxation; it is taxed when earned by the corporation, and the ame income is taxed again when it is distributed to shareholders in the form of dividends. See 26 U.S.C. §§ 301-385; Camilla Berit alesi, "Shareholders' Rights Regarding Termination of a Debtor ^rporation's S Status in a Bankruptcy Setting," 10 J. Bankr. L. & rac. 157, 159 (2001) ["Shareholders' Rights"].

Thus, for some number of years, V & M' s income and any offsetting expenses, including depreciation of the business's property, were passed through to appellant. Appellant contends that that arrangement - and the S corporation status that authorized it - should have come to an end when the trustee took aver V & M and he no longer had control of the business. In the alternative, he argues that, if he must bear the tax liability of the property sale, he is entitled to a low-income housing credit obtained by the trustee on behalf of the new owners of the property.

The appellee, the Commissioner of the Internal Revenue Service, maintains that V & M's S corporation election and the pass-through system of taxation remained in effect for the 1997 tax year, and that appellant does not qualify for a credit.2 We address each of these issues in turn.

A. Termination of Subchapter S status

The Tax Code provides that a shareholders' election to take S corporation status remains in effect until it is terminated under 26 U.S.C. § 1362(d). See 26 U.S.C. § 1362 (c) . Subsection (d) identifies three ways in which termination may occur: (1) if more than fifty percent of the corporation's shareholders vote to revoke

2 The trustee prepared and filed S corporation returns on behalf of V & M for the years 1995 through 1999, and on the 1997 form reported that appellant had realized a gain of $2,088,554 from the sale of Mandela Apartments. Appellant did not file individual federal income tax returns for 1996 or 1997. The election; (2) if the business ceases to be a "small business srporation," or (3) if the business"s passive investment income cceeds 25 percent of gross receipts for three consecutive years and the business earned profits each of those years) . See id. § 1362 (d) (1), (2), (3) .

Appellant asserts that section 1362(d)(2) is applicable here id that V & M's S corporation status ended when it entered bankruptcy because it no longer met the requirements of a "small jsiness corporation." Under the Tax Code, a small business Drporation must be a domestic corporation with fewer than 75 shareholders, all of whom must be individuals and none of whom may s a nonresident alien, and it may have only one class of stock. See id. § 1361(b). Appellant argues that, because the trustee took antrol of the company for the benefit of its creditors, appellant o longer was its real owner. This transfer of power, he aintains, left V & M with new shareholders - the corporate reditors - who were not individuals, and also generated more than ne class of stock because of the creditors' "different rights and references."

We reject appellant's theory that his tenure as shareholder nded when the trustee took over day-to-day operation of V & M. A bankruptcy trustee steps into the shoes of the debtor - in this case, the corporation - and the corporation and its shareholders re "separate entities, including 'in respect of tax problems,'"
Durando. 70 F.3d at 552 n.9 (quoting New Colonial Ice Co. v. Helvering, 292 U.S. 435, 442 (1934)); see also Banqor Punta )operations. Inc. v. Banqor & Aroostook R. R. Co.. 417 U.S. 703, 713 [1974) ("a corporation and its shareholders are deemed separate entities for most purposes," but the corporate form may be disregarded "where it is used to defeat an overriding public solicy"); Silverman & Sons Realty Trust v. Comm'r, 620 F.2d 314, il7 (1st Cir. 1980) (noting "general rule that corporation and stockholders are considered separate entities for tax purposes"). Although appellant's equity interest in V & M may have been without /*alue by the time the bankruptcy filing occurred, see In re V & M 4gmt.. Inc.. 321 F.3d 6, 8 (1st Cir. 2003), neither the trustee nor :he creditors displaced him as sole shareholder. Cf. Commodity futures Trading Comm. v. Weintraub. 471 U.S. 343, 353 (1985) ("[T]he trustee plays the role most closely analogous to that of a solvent corporation's management."); In re Sanders. 969 F.2d 591, 593 (7th Cir. 1992) ("[A] bankruptcy trustee succeeds only to the :itle and rights in property that the debtor had at the time [it] Filed the bankruptcy petition.").

Bankruptcy law, moreover, explicitly provides that any income 3f the estate in a bankruptcy case, with certain exceptions not asserted as relevant here, "may be taxed only as though such case iad not been commenced," see 11 U.S.C. § 346 (c) (1) , reinforcing the view that a Chapter 11 bankruptcy filing does not change the tax
relationship between a debtor corporation and its shareholders. tlis conclusion is further buttressed by the scant case law that xists. In In re Stadler Assocs.. Inc.. 186 B.R. 762 (Bankr. S.D. la. 1995) , the sole shareholder of an S corporation that had filed petition for relief under Chapter 7 of the Bankruptcy Code argued hat the bankruptcy filing had terminated the debtor's S orporation status. The bankruptcy court disagreed, holding that ermination was limited to the three methods set out in section 362(d) and that none of those had occurred. See id. at 764.

Other courts, while not directly considering whether a ankruptcy filing automatically ends Subchapter S status, mplicitly have adopted Stadler's view in the course of discussing hether shareholders may choose to terminate S status pursuant to ection 1362(d) when a bankruptcy filing is anticipated. See. !.Q. . In re Bakersfield Westar. Inc.. 226 B.R. 227, 235-37 (9th ir. BAP 1998); In re Trans-Lines West. Inc.. 203 B.R. 653, 659-60 Bankr. E.D. Tenn. 1996); see also "Shareholders' Rights," 10 J. lankr. L. & Prac. at 176-80. Such an inquiry would be unnecessary .f bankruptcy automatically effected termination.

Having concluded that V & M did not convert to a standard C :orporation by virtue of a change in its shareholders, we likewise
*eject appellant's assertion that the company lost its small msiness classification based on a change in the classes of stock. There is no evidence in the record that shareholders other than ppellant existed or exercised rights different from his.

Although we do not face in this case the question whether hareholders should be permitted to terminate S status pursuant to action 1362(d) when a bankruptcy filing is imminent or has ccurred, and thus need not consider the competing equities at ssue, we recognize the logic in appellant's contention that it is nfair to assess tax liability on shareholders who do not receive he income on which they are obliged to pay the tax. See Shareholders' Rights," 10 J. Bankr. L. & Practice at 157; Richard .. Shaw, "Taxing Shareholders on the Income of an S Corporation in ankruptcy," 1 No. 6 Bus. Entities 40, 47 (1999), 1999 WL 1419055, .t *47 (criticizing courts for disallowing new tax elections, which .as the effect of "sever [ing] the tax burden from the assets without the consent of the shareholders," and noting that this abuses the economics of both the tax and the bankruptcy systems") ;
*f. In re Forman Enters.. Inc.. 281 B.R. 600, 609-610 (W.D. Perm. ;002) (S corporation shareholders not unjustly enriched by retaining tax refunds for themselves rather than turning them over :o chapter 7 trustee for distribution to debtor's creditors).

Here, appellant did not attempt a statutory revocation of the I corporation election. Moreover, the record indicates that he was personally liable for V & M's debts. See Mourad. 121 T.C. at 6;
appendix at 336. To the extent that the proceeds from the sale of the apartment complex were applied to the company's debts, wherefore, appellant received benefit along with the tax burden.3

Accordingly, we conclude that V & M remained an S corporation following its entry into bankruptcy and that appellant properly was assessed pass-through tax liability on the asset sale.

B. Availability of the Low-income Housing Credit

Appellant argues that if he is to be assessed taxes on the Lncome generated by the sale of the Mandela Apartments property, he Ls entitled to the low-income housing credit available for such projects under 26 U.S.C. § 42.4 Under the statute and its related regulations, see 26 C.F.R. § 1.42-1T, a detailed series of steps oust be followed by a property owner seeking the credit, none of which appellant completed. The trustee, however, did help to secure the credit on behalf of the new owners of the Mandela apartments, and appellant argues that equity entitles him to jtilize the credit to offset his tax liability.

3 Appellant states in his brief that "[t]he proceeds from the iisposition of the corporation's assets were paid directly to a creditor's trust rather than the corporation."

4 Section 42 was added to the Internal Revenue Code in 1986 :o stimulate the production of low-income rental housing. See 'Joint Committee on Taxation's General Explanation of the Tax reform Act of 1986" (Blue Books), Title II, Section E(2) ("Congress relieved a more efficient mechanism for encouraging the production 3f low-income rental housing could be provided through the low-i-ncome rental housing tax credit.") ; Oti Kaga. Inc. v. South Dakota Jous. Dev. Auth.. 342 F.3d 871, 875 (8th Cir. 2003) (section 42's ;ax credit allocation program "encourages investment in low-income lousing projects").

This argument is entirely lacking in foundation. So far as he record on appeal shows, the tax credits granted to the project ere obtained for 1998. See Appendix at 169 ("Certificate of inding Commitment" from the Massachusetts Department of Housing nd Community Development for "$1,000,000 in 1998 Tax Credits for [andela Homes," granted under the "Low-Income Housing Tax Credit 'rogram as authorized by Section 42 (h) (1) (c) of the Internal revenue Code of 1986") . The tax liability at issue in this case is 'or 1997. Appellant thus appears to be seeking to use a tax credit ,hat does not exist. The record does not permit the conclusion *hat, had the trustee sought to obtain a tax credit for 1997, it rould have been granted.5 In these circumstances, we find no error .n the district court's conclusion that appellant is responsible 'or the full income tax liability generated from the sale of landela Apartments.


5 We note that appellant states in his brief that V & M [ualified for the tax credit in 1994, two years before the trustee ;ook over operation of the business. It appears that no effort to secure the credit was made until the trustee did so in anticipation >f the change of ownership that occurred in December 1997.

In re

Chapter 11


Case No. 96-10123-CJK

By the motion before me, Alphonse Mourad, the Debtor's sole officer, director, and shareholder, seeks two categories of relief: first, to revoke the order confirming the Joint Plan of Reorganization in this case, pursuant to which the Debtor's real estate (a 276-unit apartment complex known as the Mandela apartments) has been conveyed to a third party, and to return the property to the Debtor's control; and, second, for disgorgement of fees awarded in this case to the law firm ofHanify & King in its capacity as counsel to the Debtor, and to Stephen Gray in his capacity as Chapter 11 Trustee in this case. The motion must be denied for several reasons.

First, Mr. Mourad lacks standing to bring it. By virtue of the confirmed plan of reorganization and the order confirming it, Mr. Mourad's equity interest in the Debtor was quantified as having no value, and, accordingly, the plan awarded him nothing on account of his equity interest in the Debtor. That order is final and preclusive for purposes of this motion on the issue of the value and extent of Mr. Mourad's equity interest. Also, Mr. Mourad is not a creditor of this estate. He is entitled to no distribution whatsoever from its assets, and nothing in this motion would change that. For these reasons, he has no stake in the outcome of this motion and no standing to bring it.

Second, in so far as the motion seeks to revoke the order of confirmation--and to return control of the property to the Debtor, which is contingent on revocation of the confirmation order--it is untimely. A motion to revoke an order confirming a Chapter 11 plan of reorganization must be filed within 180 days after entry of the order. 11 U.S.C. § 1144;
FED.R.BANKR.P. 9024 (a complaint to revoke an order confirming a plan of reorganization may be filed only within the time allowed by § 1144). The confirmation order was entered on September 26, 1997, and Mr. Mourad filed this motion only on November 20, 1998.

Third, insofar as the motion seeks to vacate the orders allowing the fee requests of Stephen Gray and of Hanify & King, the motion is late. The orders allowing their fees were entered on September 19, 1997. A motion to vacate, whether predicated on newly discovered evidence or on the fraud, misrepresentation, or other misconduct of an adverse party, the bases of the present motion, must be filed "not more than one year after the ... order... was entered." FED.R.CIV.P. 60(b), made applicable by FED.R.BANKR.P. 9024. This motion was filed more than a year after entry of the relevant orders.
For these reasons, a separate order will enter denying the motion.

Date: W/W

cc: Mr. Alphonse Mourad
Paul Moore, Esq., for Stephen Gray
Harold Murphy, Esq., for Hanify & King
Paul J. Ricotta, Esq., for Beacon Residential Properties Limited Partnership
United States Trustee

September 8, 2000

Mr. Stephen Daige District Director For New England District JFK Federal Building Boston, MA 02203

Re: Letter 915(DO)

Dear Mr. Daige,

Alphonse Mourad, President of V&M Management, Inc. (Sub Chapter S Corporation) hereby protests and appeals the IRS findings to the Appeals Office. Mourad hereby request that all records and documents regarding V&M Management, Inc. and Mourad as a personal shareholder be transferred to the Appeals Office.

In a June 24,1999 letter, Greg Smith of the IRS states "During bankruptcy proceedings, income generated in an S Corporation flows through to the shareholders). In the case of V&M Management, Inc. you are the sole shareholder, therefor income and expenses reported to you on Form K-l for 1995 through 1997 are reportable on your Form 1040." What Greg Smith failed to acknowledge was the fact that tax credits also are required to flow only through the shareholders) and the tax credits application was submitted and approved in 1997 for $11,000,000. Mourad says that the tax credit belongs to him as the sole shareholder for V&M Management, Inc. Further Mourad says that he possessed site control of the Mandela Apartments for approximately fifteen years, whereas Trustee Gray had control as a manager (not a shareholder) for only two years. Mourad says that the IRS has not given him the right to the tax credits, but instead, has burdened him only with V&M Management's liabilities.

The Mandela Homes was sold to Beacon Properties on December 31,1997. The Chapter 11 Trustee Stephen Gray was the primary applicant in his tax credit application with Beacon as an additional applicant. How does Stephen Gray still qualify for 1998 tax credit dollars when Gray dissolved his partnership with Beacon on December 31, 1997? Furthermore, the tax credits should have gone through Mourad instead of Gray, for Mourad is the sole shareholder.

The IRS claims that the $2,088,554 capital gains came from the sale of corporate assets. Mourad disputes that claim, and says that the capital gain came only from HUD subsidies and rent from tenants. This money was kept by the Trustee and was never distributed to Mourad personally.

Mourad says that he is liable for debts exceeding $5,000,000 because he signed on all of his notes personally, and the creditors of the estate were paid only 9 cents on the dollar. Thus, there was no profit from the sale of the property. Then, Mourad received the tax returns for the years 1996 and 1997, and found that Trustee Gray had reported a profit which the Trustee kept after he sold the property. Mourad says that he should not be liable to pay income tax on money he had never received. If Mourad is liable to pay the taxes on the profits the Trustee kept for those years that he ran the development, then Mourad should also be entitled to all of the 'profit', as well as the tax credits, for all profits and liabilities and tax credits flow only through the shareholder.
IRS states "Fact: the 1994 form 1040 that Mr. Mourad filed shows a disallowed investment interest expense of $965,226 to be carried forward to 1995. The 1995 form 1040 that Mr. Mourad filed did not utilize any of the interest expense. Mourad says that that is not true and that the $965,226 was applied to the $2,088,554 capital gain. The IRS now asserts that Mourad owes $189,745 in taxes. Mourad disputed this claim. All losses prior to 1996 belong to Mourad personally. Mourad says that the income flowing from V&M Management for the years 1996 till the present is not his as he never received it. That income belongs to the trustee and not Mourad.

Mourad says that his prior losses should not be used to offset income of the trustee. Mourad wants to keep the prior losses to offset his future income.

Mourad says that he had only found out about his tax liability for the years 1996 and 1997 in an August 20,1998 letter from Trustee Gray's accountant stating that Mourad was responsible. Mourad says that this was deliberately done by the trustee so that Mourad would have no time to object or protest this assertion in the bankruptcy court.

Ultimately, Mourad says that he will accept any liability bestowed upon him from V&M Management, Inc. as long as all of the profits, and especially the tax credits flow through him as well. Mourad requests that the tax credits be awarded to him to offset his personal liabilities.
Mourad has attached further documents to support his claims. Mourad reserves the right to amend this appeal.

Under the penalties of perjury, I declare that I examined the facts stated in this protest, including any accompanying documents, and, to the best of my knowledge and belief, they are true, correct and complete.

Alphonse Mourad