Franchise Tax Board of the State of California v. MacFarlane (In re MacFarlane)

We address in these appeals which party has the ultimate burden of proof in bankruptcy proceedings when a state files a claim for taxes alleging that a debtor’s bad debt deductions are invalid. Both the bankruptcy and district courts held that the state bears the burden of proving its claim. The bankruptcy court determined that the state failed to meet its burden and entered judgment in favor of the debtor; the district court reversed, ruling that inferences drawn from the evidence create triable issues of fact. We affirm the allocation of the burden of proof; we reverse the district court’s ruling and we reinstate and affirm the judgment of the bankruptcy court.

I.

Stephen B. Macfarlane (debtor) filed for bankruptcy in 1990. The Internal Revenue Service (IRS) filed a claim alleging that he owed additional taxes for 1988-89 because certain bad debt deductions were invalid. At issue were cash advances made by debtor to his financial consultant and accountant, William Cheng, in exchange for unsecured prom *1043 issory notes. The IRS contended that the advances were failed investments rather than loans. The claim was settled.

The California Franchise Tax Board (Board) thereafter…