UNITED STATES TAX COURT
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CAT
STAT.
T.C. Memo. 2002-148
UNITED STATES TAX COURT
STEVEN K. HAN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14649-94.
Filed June 12, 2002.
Richard L. Manning and Ira M. Burman, for petitioner.
Mariory A. Gilbert and Catherine M. Thayer, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GALE, Judge:
Respondent determined a deficiency in, and
additions to, petitioner's Federal income tax for 1988 as
follows:
BERVED
- 2 Additions to tax
Deficiency
Sec. 6651(a)
Sec. 6653(a)(1)
Sec. 6661
$31,101
$7,697
$1,766
$7,775
Unless otherwise indicated, all section references are to the
Internal Revenue Code in effect for the year in issue, and all
Rule references are to the Tax Court Rules of Practice and
Procedure.
In an amendment to petition, petitioner alleged that the
income reported on his 1988 return should be reduced by $27,992
because he erroneously reported interest income that was earned
on funds that belonged to his wholly owned corporation, N.A.
Tours, Inc.
In an amendment to answer to amendment to petition,
respondent asserted that an increased deficiency for 1988 arose
from (1) unreported income from theft of $986,856, dividend
income of $20,641, capital gains from real estate sales of
$107,021, and ordinary income from those sales of $2,638; and (:2)
a change in petitioner's filing status from single to married
filing separately.
Respondent further asserted that the
additions to tax determined in the notice of deficiency under
sections 6651(a), 6653(a)(1), and 6661 for 1988 should apply to
the increased deficiency.
- 3 After concessions,¹ the issues remaining for decision are:
(1) Whether petitioner had unreported income of $986,856
from funds diverted from his wholly owned corporations;
(2) whether petitioner had unreported income of $12,913 from
dividends earned from brokerage accounts held in his name;
(3) whether petitioner had unreported income of $20,641 from
dividends earned from brokerage accounts held in the names of
petitioner's nominees;
(4) whether petitioner had income of $27,992 from interest
earned on funds diverted from his wholly owned corporations;
(5) whether petitioner is entitled to depreciation
deductions of $9,963 claimed on his return;
(6) whether petitioner had unreported rental income of
$43,123.from two corporations owned by him;
(7) whether petitioner is subject to an addition to tax
under section 6653(a)(1) for negligence; and
(8) whether petitioner is subject to an addition to tax
under section 6661 for substantially understating his income tax.
¹ In addition to issues settled in a stipulation of settled
issues filed in this case, petitioner conceded on brief that he
is not entitled to a rental expense deduction of $19,410 or to an
investment interest expense deduction of $4,271 claimed on his
1988 return. He also conceded that he is liable for an addition
to tax under sec. 6651(a)(1) for failure to timely file his
return.
FINDINGS OF FACT
Some facts have been stipulated and are so found.
The
stipulation of facts, first supplemental stipulation of facts,
second supplemental stipulation of facts, and attached exhibits
are incorporated herein by this reference.
Petitioner resided in
Lincolnwood, Illinois, when he filed the petition in this case. '
Petitioner's Retail Travel and Consolidator Activities
In 1981, petitioner, who also is known as Kee Soo Han,
incorporated Air America Travel Services, Inc.
(Air America), an
Illinois corporation, the principal place of business of which
was in Chicago, Illinois.
America's sole shareholder.
At all times, petitioner was Air
Air America sold airline tickets to
the general public as a retail travel agent.
During 1984, Air
America also started doing business as a consolidator2 for
Northwest Airlines, Inc. (Northwest).³ Air America's
consolidator activities primarily involved selling airline
2 A consolidator is a third-party seller of airline tickets
written on blank tickets imprinted with the airline carrier's
name, called ticket stock, issued by an airline carrier. The
consolidator sells the ticket stock wholesale to retail travel
agents, called subagents, at a price lower than the price at
which retail travel agencies usually sell airline tickets to the
general public.
3 For some of the relevant period, Northwest Airlines, Inc.,
operated under the name "Northwest Orient Airlines".
- 5 tickets in Korean ethnic communities in the United States for
flights between the United States and Korea.
Beginning in 1984, petitioner incorporated six wholly owned
corporations, operating in different localities under the "NA
Tours" name, to conduct his consolidator business (hereinafter in
the aggregate referred to as the NA Tours companies).
1984, petitioner incorporated K-P Travel, Inc.
Illinois corporation.
In August
(K-P Travel), an
In June 1986, petitioner changed K-P
Travel's name to N.A. Tours, Inc.
(IL NA Tours).
place of business was Chicago, Illinois.
Its principal
In March 1986,
petitioner incorporated NA Tours of California, Inc.
(CA NA
Tours), a California corporation, whose principal place of
business was Los Angeles, California.
In June 1986, petitioner
incorporated NA Tour of New York, Inc.
(IU NA Tours), a New York
corporation, whose principal place of business was New York, New
York.
In September 1986, petitioner incorporated NA Tours of San
Francisco, Inc.
(SF NA Tours), a California corporation, whose
principal place of business was San Francisco, California.
At
some time, petitioner also incorporated NA Tours of Washington,
D.C., whose principal place of business was Washington, D.C., and
NA Tours of Seattle, Washington, whose principal place of
business was seattle, Washington.
From 1986 until the end of
1988, Air America did not operate as a consolidator, but during
- 6 -
that period it continued to operate as a retail travel agent.
Air America returned to doing consolidator business at the end of
1988.
Hereinafter, we will refer to Air America and the NA Tours
companies collectively as petitioner's or his corporations.
By 1987, petitioner's corporations were generating
approximately $50 million in annual gross receipts from their
operations as consolidators for Northwest and had between 70 and
80 employees.
During 1987, petitioner hired David Chung (Chung)
to serve as accountant for his corporations.
Sometime later,
petitioner promoted Chung to controller and vice president of IL
NA Tours.
Among other things, Chung was responsible for
preparing financial statements for the NA Tours companies.
Petitioner continued to be the sole shareholder and
president of Air America and each of the NA Tours companies
throughout 1988.
When he incorporated each NA Tours company,
petitioner did not contribute any money or property to the
capital of the corporation.
declared a dividend.
None of the NA Tours companies ever
IL NA Tours used the other NA Tours
companies, Air America, and unaffiliated subagents as its
subagents to distribute airline tickets.
The NA Tours companies continued to operate as consolidators
for Northwest into 1988.
In 1988 IL NA Tours also operated as a
- 7 -
consolidator for Korean Airlines, and the NA Tours companies sold
retail airline tickets.
Northwest did not require its consolidators to pay for
ticket stock at the time of transfer to the consolidator or upon
the transfer of that ticket stock to the consolidator's
subagents.
Rather, payment was not due, and a consolidator could
retain the proceeds of a sale of Northwest ticket stock, until
the submission of an "auditor's coupon" to Northwest.
(k1
auditor's coupon was one copy of the multiple-copy ticket that
served as a permanent record of a ticket sold.)
Before 1987,
auditor's coupons did not have to be submitted to Northwest until
45 days after each 2-week sales period, when coupons for all
tickets sold during the sales period were due, together with
payment for the tickets less the consolidator's commission.
Sometime in 1987, Northwest modified its procedures to reduce the
period during which proceeds from the sale of ticket stock could
be retained by a consolidator.
Under the new procedures,
consolidators were required to submit auditor's coupons for
tickets sold on a weekly basis; Northwest then prepared a sales
report based on the submitted coupons and invoiced the
consolidator, with payment due within 7 days of receipt of the
invoice.
- 8 As a consequence of Northwest's procedures for collecting
payment for ticket stock from its consolidators, petitioner's
corporations were able to postpone payment for ticket stock for
significant periods.
In addition, before 1987, IL NA Tours was
frequently late in remitting payment to Northwest; after the
initiation of the more expedited procedures in 1987, IL NA Tours'
payment delays intensified.
During the periods that petitioner's corporations held
ticket sales proceeds, petitioner would invest them in the stock
market.
Petitioner enjoyed speculating in the stock market,
frequently purchasing heavily margined4 stock.
Petitioner used
various brokerage accounts for purposes of investing his
corporations' funds, including ticket sales proceeds, in the
stock market.
During 1987, petitioner opened the following three brokerage
accounts, among others:
(1) Account No. 682-07658 at Merrill
4 "Margin" is a method of buying securities on credit
extended by the brokerage firm handling the purchases. The
securities are used as collateral for the loan. The brokerage
firm establishes a margin account for the customer. The initial
amount of funds in the margin account (initial margin) is
regulated by the Federal Reserve Board.
In addition, the
brokerage firm specifies the minimum amount (maintenance margin)
below which the balance in the margin account may not fall before
the brokerage firm will request that either more cash or
securities be added to the margin account or the securities be
sold (margin call). Modern Dictionary For the Legal Profession
517 (1993).
- 9 -
Lynch Pierce Fenner & Smith, Inc.
(Merrill Lynch5)
(Merrill Lynch
No. 1), which was opened in the name of Air America and under Air
America's taxpayer identification number (TIN) but considered to
be IL NA Tours' account;
(2) account No. 879 07787 at Merrill
Lynch (Merrill Lynch No. 2), which was opened in the name of NY
NA Tours and under NY NA Tours' TIN but considered to be IL NA
Tours' account; and (3) account No. A19 52547 at E.F. Hutton &
Co., Inc.
(Merrill Lynch No. 3), which was opened in the name of
IL NA Tours and under Air America's TIN and considered to be IL
NA Tours' account.
Hereinafter, we refer to those three accounts
collectively as the corporate accounts.
Transfers Out of Corporate Accounts In 19875
In June 1987 petitioner opened a brokerage account, account
No. 78-36391001 (Allied account), at Allied Capital Group under
his name and Social Security number, but with the designation
"d/b/a Tours of Illinois".
Notwithstanding this designation, the
s The brokerage firm's name changed during the periods
relevant to the instant case, and, at some time, it acquired the
brokerage firm E.F. Hutton & Co. For simplicity, hereinafter we
use the term "Merrill Lynch" to refer to the brokerage firm
Merrill Lynch Pierce Fenner & Smith regardless of the name it
used on a specific date.
5 The transfers of cash and assets from corporate accounts
to petitioner's personal accounts or accounts under his personal
control that are discussed in this section are not included in
the amounts that respondent alleges are includible in
petitioner's income in 1988.
- 10 -
account was petitioner's personal account, the securities
transactions from which were reported on his individual tax
returns.
On August 7 and October 7, 1987, petitioner transferred
$59,582 and $18,257, respectively, from IL NA Tours to the Allied
account.
In August 1987, petitioner transferred $109,777 of IL NA
Tours' funds to account No. 879 62934 (Chung No. 2) at Merrill
Lynch, an account which petitioner had opened at some time in
Chung's name and under Chung's Social Security number.
Chung,
however, was a nominee only as he had no ownership interest in
Chung No. 2 and received no benefit from the account.
Petitioner
closed Chung No. 2 on April 6, 1988, and transferred the assets
in the account at its closing to account No. 03T 115428 (Chung
No. 4) at Prudential-Bache Securities (Prudential-Bache7), which
he had opened in Chung's name on or before April 6, 1988.
Chung
No. 4 was funded with stock and money that came directly or
indirectly from IL NA Tours.
Between January 1 and October 18, 1987, an additional
$259,027 of IL NA Tours' corporate funds was transferred to
petitioner's personal control, as follows:
7 Prudential-Bache Securities ·at some time became known as
Prudential Securities, Inc. For simplicity, we will refer to the
brokerage firm throughout the opinion as Prudential-Bache,
regardless of it precise name at any particular time.
- 11 -
Description
Amount
Interbank transfers to bank accounts
in petitioner's individual name
Checks payable to petitioner
Checks payable to cash,
endorsed by petitioner
Checks payable to gambling casinos
Check for mortgage payment for property
at 4730 N. Hermitage Avenue, Chicago¹
Check payable to brokerage account
in name of On Sug Youn2
Check payable to brokerage account in
names of On Sug Youn and Si Joung Youn
Total
$59,500
32,359
48,100
52,.000
16,000
34,000
17,068
259,027
¹ This real property was purchased by petitioner in 1977,
and when it was sold in 1988, the proceeds were equally divided
between petitioner and his former spouse.
2.Other than the fact that she was not an employee of
petitioner or petitioner's corporations, the record does not
disclose On Sug Youn's relationship to petitioner. However, the
record does disclose that, in addition to the accounts noted
above, a joint brokerage account with right of survivorship was
established by petitioner under his name and that of On Sug Youn.
During 1987, one of the corporate accounts, Merrill Lynch
No. 1, held stock in the Gerber Products Co.
(Gerber stock).
On
October 13, 1987, petitioner transferred the Gerber stock to
account No. 682 35487 at Merrill Lynch (Chung No. 1), which
petitioner had opened sometime during 1987 in Chung's name and
under Chung's Social Security number.
a nominee only for Chung No. 1.
Chung, however, served as
He had no ownership interest in
that account and received no benefit from it.
Petitioner
controlled and directed all activities with respect to Chung No.
- 12 1, and it belonged to him personally.
Petitioner transferred the
Gerber stock to hide it from a margin call.
While in Chung No. 1, the Gerber stock was sold on December
24, 1987, for $335,563.
Assets purchased with the Gerber stock
proceeds were transferred from Chung No. 1 on February 16 and 24,
1988, to another account that petitioner had directed Chung to
open at Prudential-Bache, account No. ATY 065408 (Chung No. 38).
Assets in Chung No. 3 were transferred to an account in
petitioner's name, account No. ATY 066749 at Prudential-Bache (PB No. 2) on March 9, 1988.
Petitioner was actively buying and
selling securities in P-B No. 2 during March through May 1988.
The net balance in P-B No. 2 as of March 31, 1988, was $273,855.
The net balance as of April 30, 1988, was $305,642.
During 1988,
petitioner also used funds in P-B No. 2 to pay personal VISA
charges totaling $1,535.
On May 26, 1988, $271,836, which
petitioner's attorney represented to be the Gerber stock
proceeds, was transferred from P-B No. 2 to a client trust
account established by petitioner's attorney in connection with a
proposal by petitioner to secure a release from all personal
8 As with the other Chung accounts, although Chung No. 3 was
opened under Chung's name and Social Security number, Chung did
not have an ownership interest therein but instead served only as
petitioner's nominee. Petitioner owned Chung No. 3 personally.
- 13 liability to Northwest.
31, 1988, was zero.
The net balance in P-B No. 2 as of May
(See infra pp. 25-26.)
1987 Stock Market Crash
During October 1987, many stocks listed on the stock market
began to decline in value.
Then, on October 19, 1987, the stock
market declined dramatically (stock market crash) resulting in
substantial decreases in value for many stocks.
Petitioner had
purchased many of the stocks in the corporate accounts on margin,
and he was called upon to furnish additional margin.
When he was
unable to meet the margin calls, the stocks were sold at a loss.
On its 1987 corporate return, IL NA Tours reported net losses of
$6,472,649, some of which resulted from losses incurred by the
corporate accounts following the stock market crash.
Northwest Ticket Recall Program
The tickets that consolidators wrote on Northwest ticket
stock were not easily distinguishable from ticket stock
originating from other sources.
In 1987, Northwest decided to
redesign the ticket stock in order for consolidator tickets to be
more easily distinguishable.
Consequently, in December 1987
Northwest began a recall of all old ticket stock (ticket recall
program).
Under the terms of the ticket recall program, a
consolidator would not be issued new ticket stock until the
consolidator accounted for all old ticket stock.
The ticket
- 14 -
recall program would disclose any ticket stock that a
consolidator had sold but not yet reported to Northwest, because
a consolidator had to return either its old ticket stock or
payment for that stock by a specified date.
In December 1987, petitioner received notice of the ticket
recall program.
He realized the ticket recall program would
require him to account to Northwest for all amounts his
corporations owed for ticket stock Northwest had previously
issued to them.
Additionally, petitioner realized that neither
he nor his corporations had sufficient funds to pay Northwest
what his corporations owed it for previously issued ticket stock.
Petitioner feared that Northwest would seize his corporations'
assets as payment toward the debt they owed Northwest.
Transfers Out Of Corporate Accounts Into Petitioner's Personal
Accounts in 1988
After learning of the ticket recall program, petitioner in
early 1988 transferred approximately $1.3 million from IL NA
Tours corporate funds into a personal brokerage account to
purchase stock held in that account.
IL NA Tours maintained a
money market account, account No. 8-20911 (Albank No. 1), at
Albany Park Bank and Trust (Albank')..
Between January 7 and
Albany Park Bank & Trust operated under various names
throughout the years. For consistency, we will use the name
"Albank" to refer to that financial institution regardless of its
(continued...)
- 15 -
February 2, 1988, petitioner transferred $1,294,058 from IL NA
Tours' Albank No. 1 account into his personal brokerage account
at First Chicago Investment Services, account No. 518-069943
(FCIS account), to fund various purchases of stock for the FCIS
account.
The specific transfers and the stock purchases to which
they were applied were:
Date
Amount
Shares Purchased
2
$107,250.00
248,277.50
19,368.69
6,706.38
42,322.75
116,600.00
448,877.50
51,362.79
253,292.50
25,000 Navistar Intl.
10,000 Marion Labs
2,850 Fed. Natl. Mtg.
1,000 Fed. Natl. Mtg.
6,350 Fed. Natl. Mtg.
40,000 Pan Am
10,000 Kodak
5,000 Lorimar Telepi
10,000 Intel
Total
1,294,058.11
Jan.
Jan.
Jan.
Jan.
Jan.
Jan.
Feb.
Feb.
Feb.
7
20
21
22
22
22
1
1
Between January 28 and February 22, 1988, petitioner sold
•
all of the stock in the FCIS account that had been purchased with
funds from the Albank No. 1 account, except for the 10,000 shares
of Eastman Kodak Co.
Am Corp.
(Kodak stock) and the 40,000 shares of Pan
(Pan Am stock), and transferred the resulting proceeds
back to the Albank No. 1 account, in the following amounts:
(...continued)
exact name at any particular time.
- 16 Date
Jan.
Feb.
Feb.
Feb.
Feb.
Feb.
Amount
28
1
9
12
18
22
$79,914.32
195,071.36
60,979.35
54,798.16
256,692.50
105,246.38
Total
752,702.07
Shares Sold
10,200
7,600
2,400
5,000
10,000
25,000
Fed. Natl. Mtg.
Marion Labs
Marion Labs
Lorimar Telepi
Intel
Navistar Intl.
On April 4, 1988, petitioner transferred a $4,500 dividend paid
on the Kodak stock in the FCIS account from that account back to
Albank No. 1.
On his 1988 return, petitioner reported the gains
and losses on all of the foregoing sales except with respect to
the Federal National Mortgage Association (Fed. Natl. Mtg.)
stock.
As noted, the Kodak stock and Pan Am stock were not
liquidated and transferred back to Albank No. 1; instead, each
was subsequently transferred from petitioner's FCIS account to
other personal accounts of petitioner's.
The Kodak stock was transferred from petitioner's FCIS
account on March 4, 1988 (3 days after Northwest began an audit
of petitioner's corporations' consolidator activities, see infra
p. 22), to account No. 03T 112101 at Prudential-Bache (P-B No.
1), another personal account.
The Pan Am stock remained in the
FCIS account until April 11, 1988, when it was transferred to P-B
No. 2, another personal account.
then closed.
Petitioner's FCIS account was
- 17 -
Petitioner again transferred the Kodak stock on March 17,
1988 (1 day before signing a personal guaranty of his
corporations' outstanding debts to Northwest, see infra p. 23),
from his personal P-B No. 1 account to account No. 03T 110949 at
Prudential-Bache, which he had opened in January 1988 under the
name and Social Security number of his brother, Sam Han¹° (Sam
Han account).
Subsequently, on June 20, 1988, 3 days after
learning that Northwest would file suit against him, see infra
pp. 26-27, petitioner transferred the Kodak stock back to P-B No.
1.
Petitioner sold the Kodak stock on June 21, 1988, for
$445,596.
On June 24, this amount was transferred to a client
trust account pursuant to the terms of a temporary restraining
order obtained by Northwest against.petitioner the previous day.
See infra pp. 28-31.
On his 1988 return, petitioner claimed a loss of $3,280
relating to the sale of the Kodak stock; IL NA Tours did not
claim such a- loss on its own return.
Dividends totaling $4,500
were declared on the Kodak stock while it was held in
petitioner's FCIS account.
As previously noted, those dividends
were deposited into the FCIS account on April 4, 1988.
On the
same day, petitioner returned $4,500 to IL NA Tours' Albank No. 1
¹° Sam Han, also known as Seung Soo Han, was not an employee
of any of petitioner's corporations during 1988.
- 18 account.
Neither petitioner nor IL NA Tours reported this
dividend income on their 1988 returns.
Petitioner's P-B No. 2 account, into which the Pan Am stock
was transferred on April 11, 1988, had had a net balance of
$273,855 on March 31, 1988.
The Pan Am stock in P-B No. 2 was
sold in two portions in April and May 1988.
Petitioner sold
30,000 shares on April 22, 1988, for a net of $77,246 and the
remaining 10,000 shares on May 20, 1988, for a net of $26,897.12
Numerous other transactions occurred in P-B No. 2 during March
through May 1988.
The net balances in P-B No. 2 were $305,642
and zero as of April 30 and May 31, 1988, respectively.
January 1988 Agreement With Northwest Regarding Back Debt
In furtherance of its ticket recall program, Northwest
advised petitioner on January 21, 1988, that as of that date its
records indicated that the NA Tours companies owed Northwest a
net of $3,231,921 (back debt), and it requested that petitioner,
individually and as president of IL NA Tours, enter into a letter
agreement with Northwest (January agreement) providing for
periodic payment of the back debt.
At that time, Northwest's
ticket recall program was not complete.
Northwest's proposal.
Petitioner agreed to
When he signed the January agreement on
¹¹Thus, Pan Am stock purchased for $116,600 was sold for a
total of $104,143. Neither petitioner nor IL NA Tours reported
any loss from the sale of the Pan Am stock on their 1988 returns.
- 19 -
January 21, 1988, petitioner knew that IL NA Tours owed Northwest
significantly more than the amount set forth in the January
agreement.
Under the January agreement, petitioner, as president and
owner of IL NA Tours, agreed to pay Northwest $62,155 per week
toward the back debt.
Those payments were to be in addition to
any current amount petitioner's corporations owed Northwest for
ticket sales, in order for them to be current by the end of 1988.
IL NA Tours made at least seven payments of $62,155 each
between February 2 and March 18, 1988.22
Neither petitioner nor
any NA Tour company made any payments to Northwest under the
January agreement after March 18, 1988.
Transfers Out of Corporate Accounts Into the Sam Han Account in
1988
On January 19 and 20, 1988, immediately before executing the
January agreement, petitioner withdrew $100,000 and $200,000,
•
respectively, from IL NA Tours' Albank No. 1 account and placed
¹²We cannot determine from the record the source from which
IL NA Tours obtained the funds to make these payments to
Northwest. Petitioner contends on brief that the funds he
returned from his FCIS account to IL NA Tours' Albank No. 1
account were used to meet the corporation's obligations to
Northwest. The record, however, does not show that the funds
returned to Albank No. 1 from the FCIS account were used to make
those payments to Northwest. Statements in briefs are not
evidence, and they cannot be used as such to supplement the
record. See, e.g., Rule 143(b); Niedringhaus v. Commissioner, 99
T.C. 202, 214 n.7
(1992).
- 20 -
those amounts into the Sam Han account.
Petitioner owned and
controlled the Sam Han account; Sam Han had no ownership interest
in it.
Sometime in 1988 before March 8, petitioner placed
$70,000 of IL NA Tours' funds into Albank No. 3, one of his
personal accounts.
On March 8, 1988, petitioner withdrew $70,000
from Albank No. 3 and placed it into the Sam Han account.
On
March 9, 1988, petitioner withdrew $80,000 from a bank account
maintained by SF NA Tours and placed it into the Sam Han account.
The $80,000 had been transferred in 1987 to the SF NA Tours
account from IL NA Tours' funds.
Thus, between late January and
early March 1988, cash from IL NA Tours' accounts totaling
$450,000 was transferred into the Sam Han account.¹³
Other Transfers From Corporate Accounts to Personal Use in 1988
From January 1 through April 3, 1988, petitioner withdrew
$28,000 in cash from IL NA Tours' Albank No. 1 account for his
personal use.
On January 29, 1988, petitioner took $9,662 from account No.
1-26373 (Albank No. 2), maintained at Albank in the name of IL NA
Tours, and placed it into the Allied account (a personal
brokerage account of petitioner's).
¹³During 1988, in addition to the Sam Han account,
petitioner maintained four other brokerage accounts in Sam Han's
name into which petitioner placed corporate funds. The record
does not provide information as to the disposition of the assets
in those accounts, and they are not in issue in the instant case.
- 21 On February 8, 1988, petitioner took $22,000 from account
No. 4-35325 (Albank No. 3) maintained at Albank in his own name,
and put it into his Allied account.
On February 16, 1988,
petitioner transferred $22,000 from IL NA Tours' Albank No. 1
account to his Albank No. 3 account to cover an overdraft in the
latter caused by the February 8, 1988, transaction.
Also during 1988, petitioner used corporate funds to pay the
following personal expenses, loans, or gifts:
Item
Car insurance premiums
Car repairs
Real estate insurance premiums
Real estate taxes
American Express charges
Life insurance
Amount
.
Utilities
Beverly A. Seman
Florist bills
Attorney's fees
Total
$3,945
3,250
3,168
442
4,964
213
506
1,000
305
8,233
26,026
Petitioner did not include the corporate payments of personal
expenditures in income on his 1988 return.
Thus, in addition to the corporate funds used to purchase
the Pan Am and Kodak stock and the $450,000 in transfers of
corporate funds to the Sam Han account, petitioner transferred
- 22 -
into personal accounts, or took for personal use, additional
corporate funds totaling $85,688 in 1988."
Petitioner reported no dividend income on his 1988 return
from any of his corporations, and the total reported as wages or
salary was $37,500.
Northwest Audit
Northwest commenced an audit of petitioner's corporations'
consolidator activities on March 1, 1988.
Petitioner retained an
attorney, Sheldon Belofsky (Belofsky), to represent him and his
corporations in the matter of Northwest's audit of their
consolidator activities.
Northwest's audit of petitioner's corporations' consolidator
activities revealed large "round number" withdrawals from
.
corporate accounts going into' various brokerage firm accounts.
The brokerage account statements were not kept at petitioner's
corporations' offices, and Northwest had trouble obtaining copies
of the statements from petitioner or from the brokerage firms.
During the course of Northwest's audit of petitioner's
corporations' consolidator activities, petitioner refused to give
Northwest records of receipts from ticket sales to subagents.
Petitioner also refused to give Northwest's auditors personal
" This $85,688 does not form any part of the $986,856 in
funds at issue in this case that respondent asserts is taxable
income of petitioner in 1988.
- 23 financial information.
Joseph J. Hasman (Hasman), an attorney
representing Northwest, came to believe that petitioner's failure
to provide the records was deliberate.
In attempting to trace funds, Northwest concluded that
petitioner had opened more than 20 different brokerage accounts
in the names of various individuals into which he placed
corporate funds during 1987 and 1988.
Petitioner's Guaranty of Corporate Indebtedness to Northwest
By March 18, 1988, Northwest officials knew that
petitioner's corporations' debt to Northwest far exceeded the
$3,231,921 set forth in the January agreement.
Consequently, at
Northwest's request, on March 18, 1988, petitioner, individually
and on behalf of his corporations, executed a written personal
guaranty (Guaranty).
.
Under the Guaranty, petitioner personally
guaranteed the prompt payment to Northwest at maturity of all the
past and future monetary obligations of petitioner's corporations
which arose out of ticket sales.
One day before signing the Guaranty, petitioner transferred
the contents of P-B No. 1, an account in his name, to the Sam Han
account, registered in his brother's name.
This transfer
included the Kodak stock at issue in this case, as well as stocks
valued at $582,356 and debit memos of $573,610 not at issue in
this case.
In addition, as noted previously, on March 8, 1988,
- 24 -
petitioner had taken $70,000 from an account in his name (Albank
No. 3)
(which amount he had taken earlier in the year from IL NA
Tours) and placed it into the Sam Han account.
Also, on March 9,
petitioner had taken $80,000 from a corporate account of SF NA
Tours and placed it into the Sam Han account.
Belofsky was not made aware of the Guaranty or its terms
before petitioner signed it.
After learning of the Guaranty,
Belofsky on March 28 protested its execution and validity to
Hasman, arguing that petitioner had signed the Guaranty without
benefit of counsel and without consideration, and therefore that
it should be returned to petitioner.
Interim Agreement
On April 7, 1988, petitioner entered into an interim
agreement (Interim Agreement) with Northwest, on behalf of
himself, IL NA Tours, NY NA Tours, and Air America.
In the
Interim Agreement, Northwest agreed to give petitioner's
corporations 1,000 tickets of Northwest ticket stock subject to
prepayment requirements and strict accounting rules, which
included petitioner's agreement to pay Northwest $500,000 as a
partial prepayment for the ticket stock.
Petitioner admitted in
the Interim Agreement that petitioner's corporations had received
proceeds from the sale of Northwest ticket stock to subagents
which had not been forwarded to Northwest.
Petitioner further
- 25 -
admitted that, while the total amount not forwarded was unknown,
petitioner's corporations had not forwarded and now owed
Northwest an amount in excess of $8 million.
In addition, in the Interim Agreement petitioner personally
guaranteed the debts of petitioner's corporations arising from
the sale of Northwest tickets received in 1988 (but not before)
and agreed to pledge any unencumbered assets of petitioner's
corporations to secure future corporate debts to Northwest.
Petitioner further agreed to make a full and complete disclosure
to Northwest of all personal and corporate financial records,
including bank and brokerage accounts.
After the Interim Agreement was signed, Belofsky continued
to challenge the validity of the Guaranty and to request its
return.
Belofsky also asserted that the Guaranty did not form
any basis for the Interim Agreement.
Petitioner's Proposal for Release of His Liabilities Under the
Guaranty and the Interim Agreement
On May 20, 1988, Belofsky wrote a letter to Northwest
seeking a return of petitioner's Guaranty and his release from
liability under the Interim Agreement.
As consideration for the
release and the return of the Guaranty, Belofsky proposed that
petitioner would liquidate the "'Gerber' account" and give the
proceeds to Northwest to be applied first against the amounts
petitioner's corporations owed Northwest for ticket stock issued
- 26 -
to those corporations after January 1, 1988, and then to the
amounts owed for ticket stock issued before that date.
Belofsky
further advised Northwest that he would have petitioner deposit
with Belofsky the proceeds of the "'Gerber' account", which he
would then hold until he received appropriate documentation from
Northwest.
.
At the time this letter was written, the Gerber stock
proceeds, as well as numerous other assets, including the Pan Am
stock, had been transferred to one of petitioner's personal
accounts, P.B. No. 2."
On May 26, 1988, petitioner transferred
$271,836 in cash from P-B No. 2 to account No. 14196956
(1üU3 No.
2), a client trust account with American National Bank (American
National), which Belofsky had established for petitioner.
Northwest did not accept Belofsky's proposal.
Northwest's Litigation Against Petitioner and His Corporations
On June 16, 1988, Northwest advised Belofsky that
Northwest's analysis of petitioner's corporations' consolidator
activities showed that petitioner and his corporations owed
" As previously noted, the Gerber stock was transferred by
petitioner from one of the corporate accounts (Merrill Lynch No.
1) to petitioner's personal account, Chung No. 1, on Oct. 13,
1987. The stock was sold for $335,563 on Dec. 24, 1987, and the
proceeds were held in Chung No. 1 until Feb. 24, 1988, when all
assets in that account were transferred to another personal
account of petitioner's, Chung No. 3. On Mar. 9, 1988,
petitioner transferred the assets in Chung No. 3 to another
personal account, P.B. No. 2.
- 27 -
Northwest $14,947,176, computed on the basis of auditor's coupons
after giving credit for commissions earned.
The following day
Hasman informed Belofsky that Northwest intended to file suit
against petitioner and petitioner's corporations because,
Northwest maintained, petitioner had refused to cooperate or
comply with the Interim Agreement.
Thereafter, on June 20, 1988',
Northwest filed a multicount complaint against petitioner
individually and against petitioner's corporations for, among
other things, specific performance of the Interim Agreement,
breach of oral contract, express guaranty, fraudulent conversion,
unjust enrichment, imposition of a constructive trust, and
injunctive relief (Northwest litigation)."
In its complaint,
Northwest further alleged that petitioner had failed to comply
with the Interim Agreement by, inter alia, refusing to disclose
all of the bank and brokerage account records of petitioner and
his corporations.
Throughout the Northwest litigation, Belofsky
represented both petitioner and his corporations.
Northwest decided to sue petitioner individually and to
include a fraudulent conversion count against him because
Northwest's audit had revealed that substantial amounts of the
" Petitioner, IL NA Tours, and Air America filed answers in
the Northwest litigation, but NY NA Tours, CA NA Tours, and SF NA
Tours did not. A default judgment was subsequently entered
against the latter three corporations.
- 28 -
money petitioner's corporations owed Northwest had been
transferred from corporate accounts into individual accounts in
petitioner's name or the names of relatives or employees.
Throughout the Northwest litigation, petitioner denied any
personal liability to Northwest.
Northwest claimed damages in excess of $17.9 million in its
complaint," alleging that petitioner and his corporations had
fraudulently converted, and/or were unjustly enriched by, at
least $14.9 million.
Northwest included one count in its
complaint against petitioner alone, based upon the Guaranty.
From the initiation of the Northwest litigation until its
settlement, petitioner and his corporations conceded that his
corporations, but not petitioner individually, were liable to
Northwest for ticket sales proceeds that had not been remitted.
Petitioner and his corporations also did not agree with
Northwest's calculation of the amount owed Northwest, claiming
that petitioner's corporations owed Northwest just under $9
million.
On June 23, 1988, Northwest sought a temporary restraining
order (TRO) in an attempt to (i) prevent petitioner and his
" The $17.9 million included net sales proceeds of $14.9
million that Northwest alleged it was owed for ticket stock sold
by petitioner's corporations plus an estimated net value of $3
million for 4,800 tickets for which petitioner and his
corporations had not accounted to Northwest.
-
- 29 -
corporations from misappropriating, dissipating, or losing ticket
sales proceeds or assets in which the proceeds might have been
invested, as well as blank, unsold ticket stock, and (ii) require
petitioner and his corporations to disclose bank and brokerage
account information.
day.
Northwest was granted the TRO that same
The TRO, among other things, restrained petitioner and his
corporations from transferring, encumbering, investing,
dissipating, using, or otherwise disposing of proceeds from
Northwest tickets sold before April 8, 1988 (or any assets in
which the proceeds might have been invested), except to deposit
the proceeds in an account over which Northwest had signatory
authority and control or otherwise upon Northwest's or the
court's authorization.
The TRO further ordered petitioner and
his corporations to make a full disclosure of all books, records,
•
and documents pertaining to the sale of tickets and the proceeds
thereof, including bank and brokerage account statements.
Finally, the TRO prohibited petitioner and his corporations from
distributing, transferring, or otherwise disposing of any blank,
unsold Northwest tickets delivered to them on or before the date
of the Interim Agreement.
At the time the TRO was granted, the
sale of Northwest tickets constituted approximately 90 percent of
petitioner's corporations' business activity.
The TRO was
renewed periodically through at least November 22, 1988.
- 30 -
To effect compliance with the TRO, Hasman and Belofsky
agreed that Belofsky, as sole trustee, would hold in client trust
accounts those funds that Northwest discovered had been diverted
from petitioner's corporations' accounts.
Consequently, at
various times, in addition to ANB No. 2 (which contained the
proceeds from the sale of the Gerber stock), see supra pp. 25-26,
Belofsky established other client trust accounts at American
National to comply with the TRO.
Those client trust accounts
included account No. 80082106 (1d63 No. 1), account No. 14199580
(ANB No. 3) , account No. 14199939 (ANB No. 4) , account No.
322447700 (ANB No. 5) , and account No. 901679
(ANB No. 6)
(collectively the ANB accounts).¹8 Belofsky used petitioner's
Social Security number for the ANB accounts during their
existence.¹S Belofsky acted at all times in a custodial capacity
with respect to the ANB accounts.
On June 24, 1988, with Hasman's authorization, Belofsky
transferred $445,596, representing the proceeds of the sale of
¹8 The record indicates that other ANB accounts were
maintained to which petitioner's or petitioner's corporations'
funds may have been deposited directly or indirectly. However,
the record does not provide sufficient information relating to
those accounts to enable us to make further findings of fact with
respect to them. Accordingly, we do not address those accounts.
¹S Petitioner received various backup withholding tax
credits with respect to the ANB accounts in his name during 1989,
1990,.and 1991.
- 31 -
the Kodak stock, from petitioner's personal P-B No. 1 account
into ANB No. 1.
Notwithstanding the granting of the TRO, Northwest remained
frustrated in its efforts to obtain information from petitioner
regarding bank and brokerage accounts into which ticket sales
proceeds had been transferred.
On July 1, 1988, Hasman wrote
Belofsky advising him of petitioner's refusal to provide
financial documents and Hasman's opinion that such conduct
violated the TRO, and urging Belofsky to counsel petitioner on
the need to comply with the TRO so as to "resolve the growing
need for court supervision of your client's conduct".
More
specifically, Hasman wrote:
I was advised yesterday that our [Northwest's]
auditors' review of the sparse documents which Mr. Han
and Mr. Chung have made available disclosed s1x
brokerage accounts, about which Northwest had no prior
knowledge because of Mr. Han's prior refusal to
disclose those accounts, or documentation which would
lead to disclosure of those accounts. This appears to
be a pattern that your client has been following,
namely, withholding information and documentation which
would lead to the disclosure of relevant financial and
other information necessary to conduct the ongoing
audit. We believe that the withholding of
documentation which would lead to disclosure of
accounts in which Mr. Han and his companies have
transferred funds has been and continues to be
intentional and in violation of the requirement * * *
of the TRO, which requires the defendants to allow my
client "immediate access" to books, records and
documents.
- 32 Subsequently, on July 18, 1988, with Hasman's approval,
Belofsky deposited a check for $80,000, drawn on the Sam Han
account, to ANB No. 3, but Northwest was not made aware of the
existence of the Sam Han account at this time.2°
Northwest's
auditors uncovered the Sam Han account sometime shortly before
September 2, 1988, when Hasman wrote Belofsky demanding an
explanation.2¹ The Sam Han account was the subject of an
amendment to the TRO sought by Northwest and granted on October
14, 1988, which specifically identified and "froze" it.
As of
2° In an Aug. 4, 1998, letter to Belofsky, Hasman reiterated
complaints about petitioner's recalcitrance in disclosing
information:
Enclosed marked Attachments I through IV is the current
list of information and documents requested from Mr.
Han quite some time ago,. but still not turned over.
Even a cursory review of Attachments I through IV
belies your recent statements that we are close to
having all of the significant information that we need
to complete our audit. When I see unaccounted for wire
transfers and withdrawals in the quarter or half
million dollar ranges, I cannot help but become very
skeptical about the reasons Mr. Han has not been
forthcoming with this information.
* * * We are learning of new accounts, other
previously undisclosed assets and other information
suggesting that there may be "more out there" than Mr.
Han has misled us to believe.
2¹ Hasman's Sept. 2, 1988, letter states:
"We * * * demand
prompt written explanation of who Seung Soo Han is. Our ticket
money has been traced into Prudential-Bach account ATY-110949
[i.e., the Sam Han account], standing in that person's name".
- 33 -
December 31, 1988, the Sam Han account contained assets with a
value of $137,128.
The record does not reflect what happened to
the remainder ($232,872) of the $450,000 that petitioner had
transferred to the Sam Han account between January 19 and March
9, 1988.22
Thus, including the so-called Gerber account proceeds
transferred in May 1988 from P.B. No. 223 to ANB No. 2 (in
connection with Belofsky's proposal for gaining petitioner's
release from personal liability), by yearend 1988 the following
amounts were on deposit in accounts governed by the terms of the
TRO:
22 The foregoing analysis of the Sam Han account disregards
the transfers of the Kodak stock into and out of that account on
Mar. 17 and June 20, 1988, respectively.
23 By late May 1988, P-B No. 2 contained the proceeds from
the sale of the Gerber stock and from the sale of the Pan Am
stock, as well as other assets. The Gerber stock proceeds are
not included in the amounts that respondent alleges are
includible in petitioner's income in 1988, although the Pan Am
stock proceeds are.
- 34 Account
Amount
Source
ANB No. 2
$271,836
"Gerber account" proceeds from P-B
ANB No. 1
445,596
Kodak stock proceeds from P-B No. 1
ANB No. 3
80,000
Sam Han account
Sam Han acct.
137,128
TRO amended to cover 10/14/88
No. 2
Total
¹934,560
2 An additional client trust account established by Belofsky
at American National, account No. 14199939 (JUG3 No. 4), contained
$35,852 transferred thereto on Aug. 15, 1988, from petitioner's
Allied account pursuant to Hasman's Aug. 2 authorization.
Although the Allied account contained amounts transferred from
corporate accounts in 1987 and 1988, these transfers are not
included in the amounts that respondent alleges are includible in
petitioner's income in 1988.
Northwest's Exercise of Letters of Credit From Petitioner's
Corporations
On July 26, 1988, Northwest exercised a letter of credit in
the amount of $54,000 from petitioner's corporations.
Northwest
exercised a second letter of credit in the amount of $50,000 from
petitioner's corporations on August 22, 1988.
It exercised a
third letter of credit in the amount of $146,000 from
petitioner's corporations on August 24, 1988.
The foregoing letters of credit were secured by various
assets of petitioner's corporations held by Albank as well as
real property owned by petitioner personally.
- 35 -
Recordation of ANB Accounts in IL NA Tours' Workpapers
In August 1988, in connection with the preparation of
financial statements for IL NA Tours covering the period January
1 through June 30, 1988, Chung prepared workpapers that recorded
the balances in the ANB accounts at that time as assets of IL NA
Tours.
Chung obtained information for this purpose from
Belofsky.
Northwest's Conclusions From Its Audit
Northwest's auditors completed the audit of petitioner's
corporations' consolidator activities on or about August 31,
1988.
Northwest concluded that, as of August 31, 1988, after
crediting the letters of. credit exercised and the commissions
Northwest owed petitioner's corporations, petitioner and his
corporations owed Northwest approximately $15,439,468.
•
Petitioner did not agree with Northwest's calculation of the
amount owed.
As a result of the audit, Northwest's auditors concluded on
the basis of the information then available to Northwest that
during 1987 and 1988 petitioner had transferred $15,096,879 of
the proceeds from the sale of Northwest's ticket stock into
brokerage accounts of which Northwest then had knowledge
(contested accounts), he had transferred $4,102,049 from the
contested accounts into various other accounts, he had withdrawn
.
- 36 -
$2,355,319 which Northwest's audit could not trace, and only
$8,639,511 could be attributable to losses in the stock market.
Northwest's auditors never were able to determine what petitioner
had done with the $2,355,319 cash withdrawn from the contested
accounts.
Shortly after conclusion of the audit, on or about
September 2, 1988, Northwest reiterated to petitioner that he and
his corporations could no longer sell Northwest's tickets.
Disbursements From ANB Accounts During Northwest Litigation
During the pendency of the Northwest litigation (June 20,
1988, through its settlement on December 31, 1990), Northwest did
not receive any amount from the ANB accounts.
Northwest asked
petitioner and Belofsky to release the funds in the ANB accounts
to it during 1988, but petitioner refused because he wanted to
keep control over the funds for purposes of negotiating a
settlement.
In August 1989, with Northwest's permission, Belofsky used
$7,313 of the funds in ANB No. 3 to redeem petitioner's personal
residence from sale for back taxes.
Petitioner did not report
the $7,313 as income on his 1989 return.
Settlement of the Northwest Litigation
Petitioner and Northwest agreed to settle the Northwest
litigation and executed an agreement to that effect (settlement
agreement) on December 31, 1990.
In the settlement agreement,
- 37 -
petitioner and petitioner's corporations, among other things,
agreed to pay Northwest $865,000 from ANB account Nos. 2, 3, 4,
and 5,24 with any remaining balance to become the property of
petitioner and his corporations.
Pursuant thereto, Northwest
received $865,000 from ANB Nos. 2 and 5, and the remaining
balance of $5,674 in those two accounts was paid to petitioner
and his corporations.
The entire balance in ANB No. 3 ($94,722
including accrued interest) and in ANB No. 425 ($43,147 including
accrued interest) became the property of petitioner and his
corporations.
Northwest also acknowledged in the settlement
agreement that Belofsky held the ANB accounts solely as a
custodian pursuant to the terms of the TRO.
The settlement
agreement further provided that the entire balance in the Sam Han
account (then approximately $192,000) would be assigned by
petitioner and his corporations to Northwest, as well as any
amounts remaining in Chung Nos. 1, 2, 3, and 4.28
The record does
24 As of Jan. 2, 1991, ANB No. 5 contained funds that had
been transferred to it from ANB No. 6 in February 1989. At the
time of the transfer to ABN No. 5, ANB No. 6 contained funds that
had been transferred to it from ANB No. 1. Additionally, on May
1, 1989, $500 had been transferred from ANB No. 6 to ANB No. 5.
25 As noted previously, the corporate funds that were
transferred to ANB No. 4 form no part of the $986,856 that
respondent contends is includible in petitioner's income in 1988.
26 The source and disposition of funds in 1991 pursuant to
the settlement agreement were:
(continued...)
.
- 38 -
not show what amount, if any, Northwest received from Chung Nos.
1, 2, and 4.
The settlement agreement did not address the P-B
No. 2 account.
Subsequent to the execution öf the settlement agreement,
petitioner paid Belofsky $14,800 from ANB No. 3 and $31,400 from
ANB No. 4 for his services.
26(...continued)
Amount
from
Source
source
Interest
earned
1988-91
Amount and disposition to
Pet./Pet. Corp. Northwest
Chung#1 to
Chung#3
to P-B#2
to ANB#2
$271,836
$54,930
$3,749
$323,017
FCIS to
P-B#1 to
ANB#1 to
ANB#6 to
ANB#5
445,596
98,312
1,925
541,983
Albank #1 &
Albank #3
& Mayfair
Bank to
Sam Han
Chung #3
.
137,128
N/A
-0-
196,441
N/A
N/A
-0-
4,502
80,000
14,722
94,722
-0-
35,852
7,295
43,147
-0-
Albank#1 &
Albank#3
& Mayfair
Bank to
Sam Han
to ANB#3
.
Allied
to ANB#4
- 39 -
Corporate Returns and Other Corporate Information
For 1987, IL NA Tours filed a Form 1120, U.S. Corporation
Income Tax Return, which did not indicate that it constituted a
consolidated tax return.
The 1987 return reported gross receipts
of $34,146,381 and a net loss after net operating loss deduction
of $287,241.
The Schedule L, Balance Sheets, reflected total
assets of $10,159,061, accounts payable of $16,875,904, capital
losses of $6,472,649, and no stockholder equity as of yearend
1987.
For 1988, IL NA Tours filed a Form 1120 which did not
indicate that it constituted a consolidated tax return.
IL NA
Tours' 1988 return reported gross receipts of $9,272,913 and a
net loss of $2,211,399 before any net operating loss deduction.
As of yearend 1988, Schedule L reflected total assets of
$9,578,469, accounts payable of $18,597,355, capital losses of
$6,472,649, other liabilities of $100,967, and capital stock of
$10,000 (common stock).
The 1988 return does not reflect any
loans to or from shareholders at the beginning or close of the
year.
The return also does not reflect any purchases or sales of
stock, nor any income from interest or dividends.
For 1988, IL
NA Tours did not have any current earnings and profits nor any
accumulated earnings and profits.
- 40 -
IL NA Tours did not file any Federal income tax returns
after its 1988 return.
Air America filed returns for 1988 and 1989, but not for the
years 1990 through 1995.
Neither Air America's nor IL NA Tours' returns for 1987 or
1988 reported any transactions related to the brokerage accounts
under individual names to which Northwest had traced corporate
funds.
Regarding those brokerage accounts, for 1987 petitioner
reported on his return selected transactions relating only to his
FCIS account, his Allied account, and various other brokerage
accounts not at issue in this case.
For 1988, petitioner
reported only selected sales of stock in. his FCIS account, his
Allied account, and P-B No. 1 on his return.
.
Dividend Income Issue
During 1988, the following amounts of dividend income were
paid on stocks held in the accounts noted:
$3,525 in Chung No. 1
(on March 1), $211 in Chung No. 3, $4,500 in the FCIS account (on
April 4, 1988), $16,905 in the Sam Han account, and $8,412 in P-B
No. 2
(during March 1988).
Petitioner reported no dividend income on his 1988 return.
Interest Income Issue
On January 30, 1989, Belofsky forwarded Forms 1099, Interest
Income, to Chung which reported that ANB Nos. 1 through 4 had
- 41 -
earned interest income during 1988 totaling $27,992.
Petitioner
reported the $27,992 in interest as income on his 1988 return.
The $27,992 interest income remained in the ANB accounts during
1988.
Petitioner obtained backup withholding credits in 1989,
1990, and 1991 with respect to the ANB accounts.
Depreciation and Rental Income Issues
During 1988, petitioner, through a land trust, owned real
property at 5528 N. Lincoln Avenue, Chicago, Illinois (Lincoln
Avenue I property) and at 5524-5526 N. Lincoln Avenue (Lincoln
Avenue II property)
properties).
(collectively, the Lincoln Avenue
Petitioner was the sole owner of the Lincoln Avenue
properties.
During 1987 and 1988, the offices of Air America and IL NA
Tours were located on the first and second floors, respectively,
•
of the Lincoln Avenue.I property.
After 1988, Air America
occupied the entire Lincoln Avenue I property.
On its 1987
return, IL NA Tours claimed a deduction of $37,810 for rent
expense in the "Other deductions" category of expenses.
Air
America did not deduct rent expense on its 1987 return other than
a deduction for equipment rent.
On their 1988 returns, Air
America reported rent expense of $12,425 in the "Other
deductions"
(line 26) category of expenses, and IL NA Tours
reported rent expense of $41,127 in the "Other deductions"
- 42 category of expenses as well as in the "Rents" (line 16)
category.
During 1987, petitioner received rental income.
He
deposited checks received from rentals in an account at Albank.
On Schedule E, Supplemental Income Schedule, of his 1987 return,
petitioner reported $16,800 in rents received, $23,080 of
expenses other than depreciation, depreciation of $11,875, and a
net loss of $18,155 related to the Lincoln Avenue II property.
He did not report any rents or expenses related to the Lincoln
Avenue I property on th.at return.
On Schedule E of his 1988 return, petitioner reported rents
received of $10,430, other expenses other than depreciation of
$19,410, depreciation of $10,744, and a net loss of $19,724
related to the Lincoln Avenue II property; he reported no rental
activity related to the Lincoln Avenue I property.
During the audit of petitioner's 1988 return, petitioner
told the revenue agent conducting the audit that the $41,127
deducted by IL NA Tours and the $12,425 deducted by Air America
for rents, in total $53,552, constituted rents they had paid him
for use of space in the Lincoln Avenue I property.
The revenue
agent included $43,123 of unreported rental income relating to
the Lincoln Avenue I property in petitioner's income for purposes
of determining the deficiency for 1988.
The revenue agent
- 43 derived the $43,123 unreported rental income by subtracting
(erroneously) from the $53,552 rental income relating to the
Lincoln Avenue I property the $10,430 that petitioner had
received and reported in income relating to the Lincoln Avenue II
property.
During trial preparation, petitioner reiterated to
respondent's counsel that during 1988 Air America and IL NA Tours
had paid him $53,552 for use of the Lincoln Avenue I property.
Petitioner's 1988 Return
Petitioner did not review his 1988 return before he signed
it.
On that return, petitioner deducted $2,450 for real estate
taxes on Schedule A, Itemized Deductions, that were paid by his
corporations.
He also deducted $3,991 of unreimbursed employee
expenses even though his corporations paid his employee expenses.
In addition, petitioner deducted $4,271 of investment interest on
Schedule A of the return to which he concedes he is not entitled.
On Schedule E of the return, petitioner deducted $19,410 for
expenses other than depreciation related to the Lincoln Avenue II
property.
Respondent disallowed this deduction for lack of
substantiation, and petitioner now concedes that he is not
entitled to it.
- 44 -
OPINION
Diverted Corporate Funds Issue
In early 1988, petitioner transferred $1,294,058 from an
account of one of his corporations (Albank No. 1) into a personal
brokerage account, the FCIS account, to purchase stock held in
that account.
Before the end of February 1988, all but two
blocks of the stock purchased (i.e., the Pan Aal and Kodak stock)
had been sold, and the proceeds transferred from petitioner's
FCIS account back to his corporation's Albank No. 1 account.
stock so liquidated was generally sold at a profit.
The
As a result,
with respect to the $1,294,058 taken from the corporate account,
petitioner was able both to return $752,702 to the corporation
and to retain in his FCIS account stock purchased with $565,478
in corporate funds (i.e., $116,600 for the Pan Aal stock plus
$448,878 for the Kodak stock).
On March 4, 1988, petitioner transferred the Kodak stock
from his FCIS account to another personal account, P-B No. 1.
March 17, 1988, petitioner transferred the Kodak stock from P-B
No. 1 to the Sam Han account (which he controlled).
He
transferred the Kodak stock back to P-B No. 1 on June 20, 1988.
On June 24, 1988, petitioner sold the Kodak stock for a net of
On
- 45 -
$445,59827 and transferred the proceeds to ANB No. 1, a custodial
account governed by the TRO.
In January 1991, pursuant to the
settlement agreement, Northwest received $541,983 and petitioner
and his corporations received $1,925 from ANB No. 5 (which had
been funded with money transferred from ANB No. 1 through ANB No.
6).
See supra note 26.
On April 11, 1988, petitioner transferred the Pan Am stock
to another personal brokerage account, P-B No. 2, which contained
the proceeds of the Gerber stock (diverted from a corporate
account in 1987) as well as other assets of petitioner's.
The
Pan Am stock was then sold on April 22 and May 20, 1988, for a
net of $104,143.28
On May 26, 1988, petitioner transferred
$271,836 in cash from P-B No. 2 to ANB No. 2, a custodial account
governed by the TRO.
In January 1991, pursuant to the settlement
agreement in the Northwest litigation, Northwest received
$323,017 and petitioner and his corporations received $3,749 from
ANB No. 2.
See supra note 26.
With respect to the transfers between the corporate Albank
No. 1 account and petitioner's FCIS account, respondent
determined that the "net" amount taken from and not returned to
27 Petitioner reported the loss from the sale of the Kodak
stock on his individual return; IL NA Tours did not report it.
28 The loss on the sale of the Pan Am stock was not reported
by petitioner or by IL NA Tours on their respective returns.
- 46 the corporate account by yearend constituted taxable income to
petitioner; that is, respondent determined that the $1,294,058
transferred from the corporate account to purchase stock in the
personal brokerage account, less $757,20229 in stock sales
proceeds returned to the corporate account, or $536,856, was
additional income to petitioner in 1988.
Respondent proposed no
adjustment to petitioner's taxable income as a result of the
profitable (or losing) sales of the stocks for which the proceeds
were returned to Albank No. 1.3°
Thus, respondent's determination
of additional income as a result of the transfers between the
corporate Albank No. 1 account and petitioner's personal FCIS
account equaled $536,856, even though stocks purchased with
corporate funds totaling $565,478 were retained in petitioner's
FCIS account as the net result of the transfers.
In addition, during the first 3 months of 1988, petitioner
transferred a total of $450,000 in cash from corporate accounts
into the Sam Han account.
On July 18, 1988, a check for $80,000
.
29 For this purpose, respondent treated the stock proceeds
returned to the corporate account ($752,702), as well as a $4,500
dividend paid on the Kodak stock on Apr. 4, 1988, and transferred
from petitioner's FCIS account to the corporate Albank No. 1
account on the same day, as amounts returned.
3° Petitioner in any event reported the gains and losses
from the sale of all but one of these stocks on his 1988 return
(although he now contends that he held the stocks as an agent of
his corporations).
- 47 drawn on the Sam Han account was deposited into ANB No. 3, a
custodial account governed by the TRO.
On October 14, 1988, the
TRO was amended specifically to cover the Sam Han account.
account contained assets of $137,128 at yearend 1988.
to the settlement agreement,
The
Pursuant
(i) in January 1991, petitioner and
his corporations received $94,722 and Northwest received nothing
from ANB No. 3, and (ii) on April 1, 1991, Northwest received the
balance remaining in the Sam Han account, which at that time was
$196,441.
See supra note 26.
The $450,000 that petitioner transferred to the Sam Han
account from corporate accounts, together with the "net" of
$536,856 in funds taken from and not returned to the corporate
Albank No. 1 account by yearend, make up the $986,856 that
respondent asserts in an amendment to his answer was diverted by
•
petitioner from his corporations in 1988.
Respondent contends that the entire $986,856 is ordinary
income which must be included in petitioner's income for 1988.
In the alternative, respondent contends that the $986,856 should
be deemed a distribution from IL NA Tours in excess of
petitioner's basis in the stock which must be included in his
income for 1988.
The unreported income issue constitutes new
matter resulting in an increased deficiency.
Respondent has the
burden of proving any new matter or increased deficiency.
Rule
- 48 142(a); Truesdell v. Commissioner, 89 T.C. 1280, 1296 (1987).
Petitioner bears the burden of proof with respect to the
determinations made in the notice of deficiency.3¹ Rule 142(a).
Generally, unless otherwise provided, gross income under
section 61 includes net accessions to wealth from whatever source
derived.
(1955).
Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431
A gain
constitutes taxable income when its recipient has such
control over it that, as a practical matter, he derives
readily realizable economic value from it. That occurs
when cash * * * is delivered by its owner to the
taxpayer in a manner which allows the recipient freedom
to dispose of it at will, even though it may have been
obtained by fraud and his freedom to use it may be
assailable by someone with a better title to it.
[Rutkin v. United States, 343 U.S. 130,
137
(1952);
citations omitted.]
See also United States v. Rochelle, 384 F.2d 748, 751 (5th Cir.
1967); McSpadden v. Commissioner, 50 T.C. 478, 490
(1968).
The economic benefit accruing to the taxpayer is the controlling
factor in determining whether a gain is income.
Rutkin v. United
States, supra; United States v. Rochelle, supra.
Under the "claim of right" doctrine, it is well settled that
unlawful, as well as lawful, gains are included within the
3¹ Sec. 7491 does not apply to this case because the
examination commenced before July 22, 1998, the effective date of
that section.
See Internal Revenue Service Restructuring and
Reform Act of 1998, Pub. L. 105-206, sec. 3001(c)(1), 112 Stat.
727.
- 49 definition of gross income.
(1961)
James v. United States, 366 U.S. 213
(money obtained from embezzlement); Rutkin v. United
States, supra (money obtained by extortion); Leaf v.
Commissioner, 33 T.C. 1093 (1960)
(money diverted from wholly
owned insolvent corporation to defraud corporation's creditors),
affd. per curiam 295 F.2d 503 (6th Cir. 1961).
Generally, a
taxpayer who unlawfully and fraudulently obtains funds is liable
for taxes on the full amount of the funds if the taxpayer
receives the money without the consensual recognition of an
obligation to repay and there is no restriction on the
disposition of the money.
James v. United States, supra at 219;
Mais v. Commissioner, 51.T.C. 494, 498-499 (1968); Leaf v.
Commissioner, supra at 1096.
The mere possibility that demands
may eventually be made for refunds or that the taxpayer has an
•
obligation to make requested refunds in a later taxable year does
not relieve the taxpayer of tax on the diverted funds.
James v.
United States, supra; United States v. Rosenthal, 470 F.2d 837,
842
(2d Cir. 1972); Leaf v. Commissioner, supra; see also Stovall
v. Commissioner, 762 F.2d 891 (11th Cir. 1985), affg. T.C. Memo.
1983-450; Quinn v. Commissioner, 524 F.2d 617, 625
1975), affg. 62 T.C. 223
(1974).
(7th Cir.
.
However, where repayment is
effected during the same taxable year as the taking, the taxpayer
is not taxed on the amounts repaid.
Mais v. Commissioner, supra;
- 50 -
Leaf v. Commissioner, supra; Stovall v. Commissioner, T.C. Memo.
1983-450.
Funds distributed by a corporation to its shareholders with
respect to their stock over which the shareholders have dominion
and control generally are taxed under the provisions of section
301(c).
Where a shareholder diverts corporate funds or uses
corporate property for his personal benefit, not proximately
related to corporate business, the shareholder must include the
value of the benefit in income as a constructive dividend.
E.g.,
Truesdell v. Commissioner, supra at 1294-1295; Falsetti v.
Commissioner, 85 T.C. 332, 356 (1985).
However, "'Not every
corporate expenditure incidentally conferring economic benefit on
a shareholder is a constructive dividend.'"
Inc. v. United States, 577 F.2d 1206, 1215
Loftin & Woodard,
(5th Cir. 1978)
(quoting Crosby v. United States, 496 F.2d 1384, 1388
1974)); Hood v. Commissioner, 115 T.C. 172, 179-180
(5th Cir.
(2000).
The
determinative factor is whether the distribution was primarily
for the shareholder's benefit, in which case it is taxable to the
shareholder as a constructive dividend, or primarily for the
corporation's benefit, in which case it is not a constructive
dividend.
Crosby v. United States, supra at 1389; Hood v.
Commissioner, supra at 180.
- 51 -
Additionally, in general, "a taxpayer need not treat as
income moneys which he did not receive under a claim of right,
which were not his to keep, and which he was required to transmit
to someone else as a mere conduit."
T.C. 530, 541
Diamond v. Commissioner, 56
(1971), affd. 492 F.2d 286
(7th Cir. 1974).
Thus,
money a taxpayer receives in his or her capacity as a fiduciary
or agent does not constitute taxable income to that taxpayer,
Herman v. Commissioner, 84 T.C. 120, 134-136 (1985); Heminway v.
Commissioner, 44 T.C. 96, 101 (1965), and a shareholder who takes
personal control of corporate funds is not taxable on them so
long as it is shown that he held the funds as an agent of the
corporation and/or deployed them for a corporate purpose, AJF
Transp. Consultants, Inc. v. Commissioner, T.C. Memo. 1999-16,
affd. without published opinion 213 F.3d 625 (2d Cir. 2000); St_
G .
Augustine Trawlers, Inc. v. Commissioner, T.C. Memo. 1992-148,
affd. sub nom. O'Neal v. Commissioner, 20 F.3d 1174 (11th Cir.
1994); Alisa v. Commissioner, T.C. Memo. 1976-255.
In the instant case, petitioner admits that he transferred
corporate funds totaling $986,856 into his personal accounts
during early 1988.
Respondent contends that petitioner diverted
the $986,856 and hid it in brokerage accounts he controlled
because he intended to defraud Northwest of the moneys
petitioner's corporations owed it.
Respondent maintains that
- 52 -
petitioner increased his net wealth by $986,856 when he reduced
that amount to his personal dominion and control.
Therefore,
respondent asserts, petitioner's income should be increased by
$986,856 for 1988.
Petitioner contends, however, that the $986,856 is not
taxable to him because he did not withdraw those funds from the
corporate accounts for his own benefit; rather, he placed them
into his personal accounts in his capacity as an agent for IL NA
Tours and for its benefit to protect the funds from seizure by
Northwest.
Petitioner maintains that he did not use the $986,856
for personal purposes, but that he used the funds to benefit IL
NA Tours, including transferring funds from his personal accounts
to the ANB accounts which were used.first to negotiate a
settlement with Northwest in order for IL NA Tours to remain in
business and then to pay corporate debts owed Northwest.
Petitioner relies on Stone v. Commissioner, 865 F.2d 342,
343
(D.C. Cir. 1989), revg. and remanding Rosenbaum v.
Commissioner, T.C. Memo. 1983-113, in support of his agency
theory.
In Stone, the Commissioner determined that the
taxpayers, a corporate officer (who also was a shareholder in the
corporation) and the corporation's attorney (who also served as
one of its directors), had to include in income $4 million of
corporate funds which had been derived from a series of
- 53 -
transactions designed to defraud the U.S. Government and which
had been placed in secret Swiss bank accounts over which the
taxpayers exercised control.
The Court of Appeals concluded that
the funds need not be included in income.
The Court of Appeals
stated
even when a corporate officer is its sole shareholder
(and thus in ultimate control), and he transfers
corporate funds to his personal checking account, and
his dealings with the corporation are "extremely
informal," there is no constructive dividend so long as
he can show that his intent "was to use such funds for
corporate purposes as an agent of the corporation."
* * *
[Id (quoting Nasser v. United States, 257 F.
Supp. 443, 449
(N.D. Cal. 1966)).]
Petitioner contends that the following facts demonstrate
that he was acting on behalf of his corporations as an agent, to
benefit the corporations, when he withdrew corporate funds and
placed them into personal accounts:
(1) He returned funds to IL
NA Tours to facilitate IL NA Tours' meeting its obligations to
remit $62,155 per month to Northwest;
(2) except for a nominal
amount, he did not use the funds for personal purposes but
instead invested them for corporate purposes; i.e., in an effort
to save his corporations by earning money with which to repay
Northwest;
(3) he made personal guaranties of the corporate
debt;32 (4) he transferred funds to the ANB accounts, the control
32 Petitioner also argues in this connection that he
mortgaged personal assets in order to obtain letters of credit
(continued...)
- 54 over which he gave to Belofsky and the transfers to which were
made within 1988, so by yearend 1988 petitioner had ceded control
back to IL NA Tours;
(5) Belofsky used the funds in the ANB
accounts to settle the lawsuit with Northwest which related to
debts IL NA Tours owed Northwest; and (6) Chung recorded the ANB
accounts as assets of IL NA Tours on the June 30, 1988, balance
sheet and on IL NA Tours' 1988 corporate return.
Respondent disputes petitioner's claim that he had a
corporate purpose for depositing the $986,856 into his personal
brokerage accounts.
Respondent contends that petitioner diverted
the funds, and shuffled them through a maze of accounts, to
defraud Northwest so that he could keep the funds for himself.
Whether petitioner was acting as an agent of his corporation
is a question of fact.
See Pittman v. Commissioner, 100 F.3d
1308, 1314 (7th Cir. 1996)
(question of fact whether
shareholder's diversion of corporate funds constitutes
constructive dividend), affg. T.C. Memo. 1995-243.
We look to
petitioner's testimony and the objective facts to'ascertain
petitioner's intent.
See, e.g., Busch v. Commissioner, 728 F.2d
945, 948 (7th Cir. 1984)
(objective factors used to determine
intent), affg. T.C. Memo. 1983-98; Spheeris v. Commissioner, 284
32(...continued)
that were subsequently exercised by Northwest to satisfy
obligations of his corporations.
- 55 F.2d 928, 931 (7th Cir. 1960)
(legal relationship between closely
held corporation and its shareholders as to payments to the
latter "must be established by a consideration of all relevant
factors indicating the true intent of the parties."), affg. T.C.
Memo. 1959-225; Kaplan v. Commissioner, 43 T.C. 580, 595 (1965).
We note at the outset that petitioner was not a credible
witness.
We found his testimony implausible and unconvincing.
It was at times vague, evasive, self-serving, and contradictory.
He had selective recall relating to the 1987 and 1988
transactions and the assets in issue in the instant case.
We are
not required to accept self-serving testimony, particularly where
it is implausible and there is no persuasive corroborating
evidence.
E.g., Frierdich v. Commissioner, 925 F.2d 180, 185
(7th Cir. 1991)
("The statements of an interested party as to his
own intentions are not necessarily conclusive, even when they are
uncontradicted."), affg. T.C. Memo. 1989-103 as amended by T.C.
Memo. 1989-393; Lerch v. Commissioner, 877 F.2d 624, 631-632
(7th
Cir. 1989), affg. T.C. Memo. 1987-295; Tokarski v. Commissioner,
87 T.C. 74, 77 (1986).
Additionally, a taxpayer's testimony as
to intent is not determinative, particularly where it is
contradicted by the objective evidence.
Busch v. Commissioner,
supra at 948; Glimco v. Commissioner, 397 F.2d 537, 540-541
(7th
- 56 -
Cir. 1968)
(taxpayer's uncontradicted testimony need not be
accepted), affg. T.C. Memo. 1967-119.
The objective evidence in the record contradicts
petitioner's contention that he was acting as an agent in
furtherance of a corporate purpose.
Petitioner points first to
the fact that between January and February 1988, he returned
significant sums to IL NA Tours; that is, of the $1,294,058 that
he initially transferred from an IL NA Tours' corporate account
to his personal FCIS account, $752,702 was returned to IL NA
Tours before the end of February.33
It is true that this return
of funds to the corporation (which occurred almost exclusively in
February 1988) might support an inference that petitioner was
holding them as the corporation's agent.
relevant facts, we might be persuaded.
If these were the only
However, petitioner's
other actions during 1988, discussed below, belie the claim of
agency.
33 Petitioner contends that the $752,702 returned to IL NA
Tours was used to meet IL NA Tours' obligation under the January
agreement to make payments of $62,155 per week to Northwest. The
evidence in the record does not support this contention.
In any
event, for purposes of petitioner's argument that the return of
funds to IL NA Tours indicates agency, it is sufficient that the
funds were in fact returned to the corporation, which is
undisputed.
- 57 -
Petitioner's next argument is that he did not, except for
nominal amounts, use the funds at issue for personal purposes."
Instead, according to petitioner, he invested the funds in the
stock market in an effort to produce sufficient earnings so that
Northwest could be repaid and, petitioner further claims, all of
the funds transferred from corporate accounts to personal
accounts were eventually either transferred to the ANB accounts
or frozen by the TRO and used ultimately to negotiate a
settlement of IL NA Tours' debt to Northwest.
Petitioner's argument misstates the facts established by the
record.
Contrary to petitioner's argument, a significant portion
of the $986,856 at issue in this case has not been accounted for.
The record establishes that from late January through early March
1988, a.total of $450,000 was transferred from the accounts of
•
petitioner's corporations to the Sam Han account.
The record
further demonstrates that on July 18, 1988, $80,000 from the Sam
Han account was deposited into ANB No. 3 and that at yearend 1988
the balance in the Sam Han account was $137,128.
The record does
not reflect what happened to the remainder ($232,872), and
petitioner has made no effort to address this discrepancy.
" We treat this argument as referring to petitioner's
actions prior to the issuance of the TRO. Once the TRO was
issued, petitioner was under a court order proscribing his
personal use of the funds. See supra p. 29.
- 58 -
Because petitioner's argument relies on the premise that all of
the funds transferred from corporate accounts were accounted for,
it must fail.
Petitioner next argues that his making a personal guaranty
of his corporations' debts to Northwest (as requested by
Northwest in March 1988) is inconsistent with respondent's theory
that he transferred corporate funds to personal accounts for his
own benefit, and not as an agent of the corporation.
petitioner observes on brief:
As
"What would be the point in
putting corporate money in a personal account and then subjecting
the personal account to the corporate debt?"
A close examination
of the record in this case provides an answer to petitioner's
rhetorical question; namely, by the time petitioner signed the
Guaranty on March 18, 1988, he had succeeded in transferring the
bulk of the funds at issue into an account in his brother's name;
i.e., the Sam Han account.
Of the $986,856 at issue, $450,000
was in the Sam Han account, $300,000 of which was moved there
from corporate accounts in early 1988.
An additional $150,000
that had been earlier moved from corporate accounts to accounts
in petitioner's own name was moved on March 8 and 9, 1988, to the
Sam Han account.
Then, on March 17, 1 day before he signed the
Guaranty, the Kodak stock--which had been purchased with $488,877
of the remaining funds at issue--was transferred from
- 59 -
petitioner's personal account to the Sam Han account.
Thus, when
petitioner signed the Guaranty on March 18, he had already taken
steps to place all of the assets at issue except the Pan Am stock
in accounts that did not bear his name, thereby raising practical
barriers to enforcement of the Guaranty against the bulk of the
transferred corporate funds.
The very close proximity of the
Kodak stock transfer and the execution of the Guaranty creates a
strong inference that petitioner made the transfer in
anticipation of signing the Guaranty.
Viewed in that light, the
Guaranty appears to be a ruse designed to mislead Northwest with
respect to petitioner's good faith.35
Moreover, any conclusion regarding agency that petitioner
would have us infer from the Guaranty is substantially undermined
by the fact that petitioner almost immediately repudiated it.
•
Upon learning of the Guaranty a few days after it was signed,
35 The fact that petitioner left the Pan Am stock in a
personal account after signing the Guaranty is consistent with a
pattern we discern in his other conduct; namely, making it
possible for Northwest to recover relatively small amounts of the.
ticket sales proceeds, in an effort to convince Northwest that he
was cooperating in good faith. This pattern first surfaced at
the beginning of 1988, when petitioner executed the January
agreement acknowledging his corporations' indebtedness exceeding
$3 million (when he knew the figure was substantially higher) and
promising to retire the debt by yearend 1988 through weekly
payments of approximately $62,000. These weekly payments were in
fact made until mid-March, by which time Northwest had figured
out that petitioner's defalcations.were much greater than $3
million.
- 60 -
petitioner's attorney disavowed it as entered into without
benefit of counsel or adequate consideration.
Petitioner's
attorney argued that the Guaranty was void and repeatedly sought
its return until the time that Northwest filed suit.
Petitioner's position throughout the Northwest litigation was
that his corporations, but not he personally, owed Northwest for
whatever ticket sales proceeds were missing.
Petitioner next points to the transfer of certain of the
funds at issue to the ANB accounts between May and July 1988 as
evidence of his agency.
Petitioner first points to the transfer of $271,836 to ANB
No. 2, which occurred in May 1988 before Northwest filed suit.
Contrary to petitioner's position,. we believe that careful
scrutiny of that transfer shows that it was made to further
petitioner's personal interests, to the detriment of the
interests of his corporations.
The record in this case
demonstrates that the May 26, 1988, transfer of $271,836 referred
to by petitioner was from P-B No. 2, a personal account of
petitioner's, the contents of which are traceable both to the
Gerber stock transferred in 1987 from a corporate to a personal
account36 and to the proceeds of the Pan Am stock that had been
36 The Gerber stock had originally been transferred from a
corporate account to Chung No. 1, a personal account of
(continued...)
- 61 -
purchased with corporate funds in January 1988 and initially
placed in petitioner's FCIS account.37
The May 1988 transfer to
the ANB No. 2 trust account was effected in connection with a
proposal made to Northwest by Belofsky under which petitioner
would be released from all liability under the Guaranty and the
Interim Agreement in exchange for, inter alia, the payover to
Northwest of the proceeds in the "Gerber account".
Belofsky sent
a letter to Northwest on May 20, 1988, proposing the foregoing
terms and advising Northwest that "I am directing Mr. Han to
deposit with me the proceeds of the 'Gerber' account to be held
by me until appropriate documentation is furnished in accordance
with this letter".
On May 26, 1988, $271,836 was transferred
from P-B No. 2 to ANB No. 2, which had been established by .
Belofsky as a client trust account.
Northwest rejected Belofsky's offer.
Nonetheless, from the
standpoint of ascertaining whether petitioner was acting as an
agent to serve a corporate purpose, we believe his actions with
(...continued)
petitioner's, in October 1987, then sold in December 1987. The
Gerber proceeds remained in Chung No. 1 until all contents of
that account were transferred to Chung No. 3 during February
1988.
On Mar.
to P-B No. 2.
8,
1988,
$321,351 was transferred from Chung No. 3
37 As previously noted, the Pan Am stock was transferred
from the FCIS account to P-B No. 2 on Apr. 11, 1988, and
liquidated before the May 26, 1988, transfer of $271,836 from P-B
No. 2 to ANB No. 2.
- 62 -
respect to the $271,836 transferred in an effort to consummate
his lawyer's proposal are significant.
In transferring the $271,836 to ANB No. 2, petitioner was
attempting to secure release from any personal liability to
Northwest for the more than $8 million he had acknowledged his
corporations owed the airline company.
Under the Guaranty,
petitioner (without benefit of counsel) had guaranteed all past
and future monetary obligations of his corporations that arose
out of ticket sales.
In the Interim Agreement, entered into with
the benefit of counsel, petitioner (i) confined his personal
guaranty to debts arising from the receipt and sale of tickets
received from Northwest in 1988 (but not before); and (ii)
acknowledged on behalf of his corporations that with respect to
pre-1988 ticket sales, his corporations had retained sales
proceeds due and owing to Northwest in an amount exceeding $8
million.
Had petitioner been successful in securing his release
from all personal liability under the foregoing agreements, the
result would have been to saddle his corporations with the sole
liability for debts exceeding $8 million.
The consideration
petitioner proposed to use to secure his release consisted of
$271,836 from a personal account into which corporate funds had
been diverted.
Obviously, this attempt would have "primarily
benefitted" petitioner, see Loftin & Woodard, Inc. v. United
- 63 States, 577 F.2d at 1215, and been quite detrimental to
petitioner's corporations, which would have lost a guarantor on
acknowledged debts exceeding $8 million.
Petitioner's contention
that the transfer of the $271,836 to ANB No. 2 in May 1988
(before Northwest filed suit) indicates that he was acting on
behalf of his corporations is untenable.
Instead, this transfer
demonstrates that petitioner was exercising personal dominion and
control over the funds.
Petitioner also argues an agency theory with respect to the
remaining transfers of funds to the ANB accounts, all of which
occurred after Northwest filed suit.
Specifically, petitioner
contends that his intent.to act as an agent is shown because he
"funded the Belofsky trust accounts".
Petitioner argues that he
"willingly" relinquished control over the disputed funds to
•
Belofsky to be held by him in the ANB accounts as trustee, and
that once in the ANB accounts the funds were used in an effort
"to make a deal to keep IL NA Tours in business".
concludes:
The argument
"Petitioner used these funds as an agent of IL NA
Tours to keep it in business.
When that was no longer possible,
he used these funds to settle its debts."
Petitioner's argument is an attempt to make a virtue out of
.
a necessity.
Aside from the ANB No. 2 transfer in May,
petitioner did not "willingly" transfer anything to the remaining
- 64 ANB accounts.
Those transfers were made to comply with the TRO
that Northwest had obtained against petitioner, which mandated
that petitioner produce information on the whereabouts of ticket
sales proceeds and that those proceeds be transferred into
accounts over which Northwest and/or the court exercised control.
Indeed, the record in this case amply demonstrates that the
court's granting of a TRO against petitioner was insufficient to
cause him to identify all ticket sale assets and transfer them to
trust accounts.
Although an initial $445,596 was transferred to
ANB No. 1 on June 24, 1988, 1 day after the granting of the TRO,
the correspondence between petitioner's and Northwest's attorneys
shows that the struggle to force petitioner to provide
information regarding assets continued for several months
thereafter.
On July 1, Northwest's attorney wrote petitioner's
attorney (i) advising that the "sparse" documentation provided by
petitioner had enabled Northwest to unearth six additional
accounts;
(ii) complaining of petitioner's "pattern" of
.
withholding financial and account information to which Northwest
claimed entitlement under the TRO; and (iii) threatening to seek
court supervision if petitioner's pattern continued.
The
remaining transfers to the ANB accounts (Nos. 3 and 4) occurred
- 65 -
after this correspondence.38
The transfers made to the ANB
accounts after Northwest obtained the TRO do not reflect
petitioner's agency; they were involuntary.
Petitioner's claim that he used the funds at issue on behalf
of IL NA Tours, i.e., "to keep it in business", is contradicted
by the objective evidence in the record.
As late as April 1988,
Northwest remained willing to do business with petitioner and his
corporations, providing them with substantial ticket stock for
resale pursuant to the terms of the Interim Agreement,
notwithstanding that they had acknowledged selling Northwest's
tickets and failing to remit proceeds in an amount exceeding $8
million.
(Presumably, Northwest made the business calculation
that its chances of ever seeing its money were better if
petitioner's corporations were allowed to continue operations.)
However, what Northwest perceived as petitioner's unrelenting
efforts to hide the missing funds from Northwest's auditors--that
is, his refusal to cooperate in providing the information he had
agreed to provide in the Interim Agreement, even when both sides
acknowledged that ticket proceeds exceeding $8 million had not
been remitted--ultimately prompted Northwest to file suit and
38 An additional $137,128 of the funds that the record
establishes were taken from the IL NA Tours' account and placed
in the Sam Han account was not revealed and made subject to the
TRO until Oct.
14,
1988.
- 66 -
obtain a TRO that prohibited petitioner and his corporations from
dealing any further in Northwest tickets.
The record amply
demonstrates that between the execution of the Interim Agreement
in early April and Northwest's filing suit in mid-June, it became
obvious to Northwest that petitioner was hiding assets and.would
not cooperate in providing any restitution of amounts that he
acknowledged were owed by his corporations.
The record is
equally clear that it was petitioner's actions that caused the
change in Northwest's attitude, from reluctant creditor willing
to provide additional ticket stock to legal adversary determined
to prohibit petitioner and his corporations from any further
dealings in Northwest tickets.39
Belofsky conceded in his
testimony in this case that the sale of Northwest tickets
constituted 90 percent of petitioner's corporations' business
activity at the time.
On this record, we do not accept petitioner's contention
that his actions with respect to the funds at issue were for the
primary benefit of his corporations rather than himself.
It is
clear that petitioner's actions harmed his corporations,
effectively forfeiting their ability to do business with
39 In this regard, we look to petitioner's actions both in
the months leading up to Northwest·'s filing suit and after the
filing and granting of the TRO, when petitioner's conduct caused
Northwest to threaten to seek sanctions on several occasions and,
in our view, hardened Northwest's animosity towards petitioner.
- 67 -
Northwest.
We also conclude that it was reasonably foreseeable
by petitioner that his actions would have this result; we do not
believe petitioner could have thought otherwise, in view of his
conduct and the response it engendered in Northwest in the months
leading up to and following the f ling of Northwest's lawsuit.
We are satisfied from the record that petitioner's intentions by
mid-1988 were to keep for himself whatever ticket proceeds he
could hide from Northwest's auditors.
With the exception of ANB
No. 2, the funds in the ANB accounts subject to the TRO were
transferred there despite petitioner's best efforts.
Although
petitioner tried to thwart Northwest's discovery of the ticket
proceeds, by not cooperating in disclosing financial information
despite his obligation to do so under the Interim Agreement and
then the TRO, Northwest's auditors were able to trace and
identify the funds, thereby forcing petitioner to transfer them
to custodial accounts.
Because of petitioner's efforts to keep the funds hidden, we
find petitioner's remaining evidence of agency, namely, that
Chung recorded the funds in the ANB accounts as assets of IL NA
Tours in workpapers for the corporation's June 30, 1988,
financial statement and on its 1988 return, unpersuasive.
To the
extent these funds were so recorded, those compilations occurred
after Northwest had succeeded in tracing the funds and forcing
- 68 -
them into custodial accounts governed by the TRO.
Thus, these
recordations--the earliest of which occurred in August 1988--are
not probative regarding whether petitioner was holding the funds
as an agent before his actions were mandated by the TRO.4°
Petitioner's vigorous efforts to keep the funds that he had
taken from corporate accounts hidden from Northwest, even when
these actions harmed his corporations, also persuade us that
petitioner exercised personal dominion and control over those
funds in 1988.
In one instance, petitioner may have voluntarily
disclosed diverted corporate funds to Northwest; namely, when the
$271,836 identified by petitioner's attorney as the proceeds of
the "Gerber account" was transferred from P-B No. 2 to ANB No. 2
on May 26, 1988, in connection with petitioner's attorney's
proposal to secure petitioner's release from liability under the
.
Guaranty and Interim Agreement.4¹ However, in line with our
4° Respondent objected at trial to the admission of the
workpapers on grounds of authenticity, hearsay, and completeness.
We reserved ruling on those objections.
In a separate order, we
have overruled respondent's objections and admitted the
workpapers as evidence. However, in our view, the workpapers are
not probative regarding petitioner's intentions or agency, and we
do not rely on them in reaching our findings.
4¹ Whether petitioner voluntary disclosed to Northwest his
purchase of the Gerber stock with his corporations' funds or
Northwest's auditors instead traced the transaction is not clear
from the record.
In view of the record as a whole, however, the
latter is much more likely.
.
- 69 -
earlier analysis of this transaction, we conclude that petitioner
exercised personal dominion and control over the ANB No. 2 funds
when he sought to employ them to secure his release from any
personal liability with respect to his corporations' obligations
to Northwest.
Thus, by mid-1988 petitioner had exercised
personal dominion and control over all of the corporate funds
that he had transferred to personal accounts in early 1988.
Although we conclude petitioner had exercised dominion and
control over the funds at issue by mid-1988, the question remains
whether the taxability of the funds to petitioner is affected by
the fact that some of the funds were returned to custodial
accounts or otherwise made subject to the TRO before yearend
1988.
Funds over which a taxpayer has obtained dominion and
control, lawfully or unlawfully, are not taxable to him to the
extent they are repaid before yearend.
T.C. 494
Mais v. Commissioner, 51
(1968); Leaf v. Commissioner, 33 T.C. 1093
(1960);
Stovall v. Commissioner, T.C. Memo. 1983-450; see also Hammer v.
Commissioner, T.C. Memo. 1989-396 (amounts returned by
shareholder to corporation in subsequent year not taxable where
shareholder derives no benefit); Rev. Rul. 65-254, 1965-2 C.B. 50
(deduction allowable under section 165 with respect to embezzled
funds in the year of repayment).
In Leaf v. Commissioner, supra
at 1096, we held that a controlling shareholder who takes funds
- 70 from his corporation when it is insolvent is taxable on the
portion of the funds that he keeps for his own purposes but not
on the portion that is returned to the corporation or its
creditors before yearend.
A difficult issue in this case is
whether the transfer of funds into accounts subject to the TRO
constitutes a repayment to the corporation within the meaning of
the foregoing authorities.
Respondent's position is that it does not.
Respondent
argues that petitioner maintained dominion and control over the
funds after their transfer into the ANB accounts.
cites several factors:
Respondent
The ANB accounts were maintained in
petitioner's name and Social Security number with
petitioner's attorney as trustee; petitioner reported the
interest earned on ANB account funds in 1988 on his return and
received backup withholding credits in certain years;
disbursements were made from the ANB accounts to pay personal
expenses of petitioner; petitioner refused Northwest's repeated
requests that funds in the ANB accounts be released to Northwest
in payment of his corporations' acknowledged indebtedness; the
ANB accounts were used as security for petitioner's attorney's
fees and were used to negotiate and settle petitioner's personal
liability to Northwest.
- 71 We do not agree that petitioner maintained dominion and
control over the funds that were placed in accounts subject to
the TRO.
We note first that the relevant inquiry here is
petitioner's dominion and control vis-a-vis his corporations, not
in relation to Northwest.
Respondent at times appears to suggest
the contrary, as when he argues that petitioner's refusal to turh
the funds in the ANB accounts over to Northwest indicates
petitioner's exercise of dominion and control.
But in refusing
to release the ANB account funds to Northwest, petitioner could
have been acting equally on behalf of his corporations and of
himself, since both were defendants in Northwest's complaint, and
the funds subject to the TRO were being held, in effect, to
secure whatever claims Northwest might have against petitioner or
his corporations.
We also do not find persuasive of petitioner's dominion and
control such factors as the ANB accounts' being established under
petitioner's name and Social Security number, petitioner's
initially reporting the interest earned in the accounts on his
own 1988 return, or petitioner's being given backup withholding
credits with respect to the accounts.
Relying on petitioner's
nominal ownership would elevate form over substance.
Similarly,
the position a taxpayer takes on his return is relevant, but far
from dispositive.
Respondent's suggestion that petitioner's
- 72 -
attorney served as custodian for the accounts overlooks the fact
that Belofsky at all times served as counsel for both petitioner
and his corporations.
The one disbursement for petitioner's
personal expenses from an ANB account--to pay delinquent taxes on
petitioner's residence--was made with Northwest's permission.42
Respondent's contention that funds in the ANB accounts
served as security for petitioner's attorney's fees finds little
support in the record.
Pursuant to the settlement of the
Northwest litigation, petitioner and his corporations in 1991
received all amounts remaining in the ANB accounts after payment
to Northwest of $865,000.
The payment to Northwest was satisfied
with funds from ANB Nos. 2 and 5 (a successor to ANB No. 1), with
the remaining balance of $5,674 in those accounts going to
petitioner and his corporations.
Petitioner accordingly received
the entire contents of ANB Nos. 3 and 4, totaling $137,869.
Belofsky was subsequently paid a total of $14,800 from ANB No. 3
and $31,400 from ANB No. 4.43
Moreover, as noted, Belofsky
served as counsel to both petitioner and his corporations; thus
payment of his fees to some extent served a corporate purpose.
42 Moreover, this expenditure arguably served Northwest's
interests as a creditor, by preserving assets available to
satisfy a judgment.
43 The funds in ANB No. 4 are not at issue in this case.
- 73 -
Of singular importance, we disagree with respondent's
contention that the funds in the ANB accounts were used to
satisfy petitioner's personal liability to Northwest.
We do not
believe that respondent, who has the burden of proof, has shown
by a preponderance of the evidence that the ANB funds were used
to satisfy petitioner's, as opposed to his corporations',
liabilities to the airline.
Northwest's complaint was filed, and
the TRO obtained, against petitioner and his corporations.
Northwest at all times pursued its complaint against the
foregoing defendants44 and likewise entered the settlement
agreement with both petitioner and his corporations.
The
corporations, not petitioner, had operated as consolidators for
Northwest; i.e., Northwest's ticket.stock had been provided to
and sold by the corporations.
•
Thus, petitioner's corporations
were primarily liable to Northwest for the ticket stock or the
proceeds from its sale.
In our view, this is why Northwest, in
addition to filing suit against both petitioner and his
corporations, also had sought petitioner's personal guaranty of
his corporations' indebtedness to Northwest, refused to surrender
the Guaranty, and based one count of the complaint on it.
44 Default judgments were entered against NY NA Tours, CA NA
Tours, and SF NA Tours, but petitioner's other corporations
remained defendants until settlement.
- 74 -
Starting almost immediately after its execution, petitioner
vigorously challenged the validity of the Guaranty.
Respondent also attempts to demonstrate that the funds in
the ANB accounts were used to satisfy petitioner's personal
liabilities, and therefore remained under his personal dominion
and control, by emphasizing that Northwest had asserted claims of
fraudulent conversion and unjust enrichment against petitioner
personally.
Since Northwest had asserted claims against
petitioner personally, respondent's argument goes, use of the
funds in the custodial accounts to settle the Northwest
litigation satisfied petitioner's personal liabilities.
Respondent in effect attempts to negate any significance of the
transfer of the funds to custodial control by arguing that
petitioner incurred personal liability by virtue of taking funds
from his corporation that were owed to the corporation's
creditor, so that when the funds were paid over to the creditor,
the liabilities extinguished were those of petitioner rather than
the corporation.
In the circumstances of this case, we think the
argument is specious.
Any controlling shareholder who takes
funds from his corporation when it is insolvent will likely have
exposure to a claim of fraudulent conversion, unjust enrichment,
or similar charges from the corporation's creditors.
If, as
respondent argues, this factor means that the return of funds to
- 75 the corporation or its creditors satisfies the shareholder's
liability and therefore serves a shareholder rather than a
corporate purpose, we think the exception provided in Leaf v.
Commissioner, 33 T.C. 1093 (1960), for wrongfully appropriated
funds that are returned within the same year would be nullified.
Mr. Leaf received a criminal conviction for taking funds from his
insolvent corporation, but he was not taxable on the amounts
returned in the year of the taking.
Respondent's argument
regarding the satisfaction of petitioner's personal liabilities
to Northwest is inconsistent with the holding in Leaf, and we
accordingly reject it.
On this record, respondent has not shown that the funds in
the ANB accounts were held in 1988, or ultimately used in 1991,
to satisfy petitioner's, as opposed to his corporations',
obligations to Northwest.
As a consequence, we find that the deposit of funds into
accounts subject to the TRO represented a deployment of the funds
for corporate purposes.
The ANB accounts and the Sam Han account
were subject to the TRO.
As a result, no transfer or other
disposition of the funds in the accounts could be made without
Northwest's or the court's authorization.
The TRO was granted
upon a showing that Northwest had a substantial likelihood of
prevailing in its claim that the accounts contained proceeds from
- 76 -
the sale of Northwest's ticket stock that were owed to Northwest.
We find that in 1988 the accounts in effect served to secure
Northwest's rights against petitioner and his corporations, and
in 1991 a substantial portion of the accounts was in fact paid in
settlement of Northwest's claims asserted against petitioner and
his corporations.
Consequently, by yearend 1988 the funds in the
ANB accounts and the Sam Han account were being held under court
supervision to satisfy liabilities that were as much petitioner's
corporations' as petitioner's.
In these circumstances, we conclude that the funds in the
ANB accounts and the Sam Han account by yearend 1988 had been
repaid or returned to petitioner's corporations in that year and
accordingly are not taxable to petitioner under Leaf and like
cases applying the exception to the claim of right doctrine.
We
base our conclusion that these funds had been returned to the
corporations for purposes of this exception on several factors.
First, petitioner no longer had dominion and control over the
funds once they were subject to the TRO.
Although respondent
argues that petitioner's attorney's role as custodian of the ANB
accounts demonstrates petitioner's maintenance of dominion and
control, the facts do not support this characterization.
The
disbursements for petitioner's personal expenses were made only
with Northwest's approval.
Further, Northwest's attorney
- 77 -
testified in this proceeding that petitioner's attorney's actions
with respect to the ANB accounts were at all times consistent
with his custodial function.
Second, the cases that have considered the exception for the
repayment of taken funds within the same taxable year have
countenanced a range of circumstances as constituting repayment
or return.
In Leaf v. Commissioner, supra, the sole shareholder-
taxpayer had taken funds from his insolvent corporation.
After
the corporation's creditors filed an involuntary bankruptcy
petition against it and within the same year as the taking, the
taxpayer "repaid to * * * [the corporation] or its creditors" a
portion of the funds.
Id
at 1095.
We held the shareholder was
taxable only on the funds "not returned to the corporation or its
creditors" in the year of the taking.
Id
v. Commissioner, 51 T.C. 494, 499 (1968)
at 1096; see also Mais
(dicta)
(portion of
embezzled funds turned over in year of embezzlement to third
party to be held for victim not taxable); Stovall v.
Commissioner, T.C. Memo. 1983-450 (shareholder's diversions from
corporation not taxable to extent used in year of diversion to
purchase certificates of deposit in corporation's name).
We are
mindful that the Court of Appeals for the Seventh Circuit, to
which an appeal in this case would ordinarily lie, has for
purposes of the same-year repayment exception distinguished
- 78 -
between actual repayment and the giving of a promissory note,
holding the latter insufficient to prevent wrongfully taken funds
from being taxed to the taker.
617
Quinn v. Commissioner, 524 F.2d
(7th Cir. 1975), affg. 62 T.C. 223
(1974).
Nonetheless, we
are satisfied that petitioner's transfer of funds to the ANB
accounts and the subjection of the Sam Han account to the TRO
constitute repayments for purposes of the exception.
These
amounts were "returned to the corporation or its creditors"
because petitioner lost control of the funds to a third-party
custodian who held them as security for a creditor's claim
against his corporations.
We now apply our findings concerning petitioner's exercise
of dominion and control by mid-1988 over, and his return before
yearend of a portion of, the funds at issue in this case.
.
The $986,856 at issue is best understood as comprising (1)
the $536,856 "net" proceeds petitioner retained after the
multiple transfers in early 1988 between the corporate Albank No.
1 account and his personal FCIS account, and (2) the $450,000 in
cash transferred from corporate accounts to the Sam Han account.
The $536,856 "net" proceeds are traceable to the Kodak stock
and the Pan Am stock, purchased with $448,878 and $116,600 of
corporate funds, respectively."
" The total amount used to purchase these two blocks of
(continued...)
- 79 In accordance with our earlier analysis, petitioner
exercised dominion and control over the Kodak stock before
returning the proceeds from its sale to his corporations (by
virtue of the transfer of those proceeds to the ANB No. 1 account
on June 24, 1988).
Specifically, after being moved from
petitioner's FCIS account to the P-B No. 1 account, to the Sam
Han account and back to P-B No. 1, the Kodak stock was sold on
June 24, 1988, for a net of $445,598, which was transferred that
same day to ANB No. 1.
Since petitioner purchased the Kodak
stock with diverted corporate funds of $448,878 and returned only
$445,598 to his corporations, he is chargeable with $3,280 in
income as a result
•
($448,878 - $445,598 = $3,280)."
(...continued)
stock exceeds respondent's determination because petitioner sold
the other stocks purchased with corporate funds at a profit and
returned the augmented proceeds to a corporate account. Because
of this augmentation of the returned proceeds, respondent's
computation of the "net" proceeds retained by petitioner-measured by the amount taken less the amount returned--is less
than the actual corporate funds retained by petitioner and
invested in the Kodak and Pan Am stock. See discussion supra at
pp. 45-46.
" As noted earlier, petitioner reported the loss from the
sale of Kodak stock on his 1988 return. Since the diminution in
the stock's value occurred while it was under petitioner's
dominion and control, and he is chargeable with the income
resulting from his return to his corporations of Kodak stock
proceeds that were less than the corporate funds used to acquire
the stock, we conclude that petitioner is entitled to the loss as
claimed.
- 80 -
Similarly, with respect to the Pan Am stock, because we have
concluded that petitioner by mid-1988 had exercised personal
dominion and control over the assets diverted from his
corporations (and was not holding them as a mere agent of his
corporations), petitioner exercised dominion and control over the
Pan Am stock.
However, the evidence adduced by respondent shows
that, unlike the Kodak stock, neither the Pan Am stock nor its
proceeds were returned to petitioner's corporations before
yearend 1988.
The Pan Am stock remained in the FCIS account from
its purchase on January 22, 1988, until April 11, 1988, when
petitioner transferred it to another personal account, P-B No. 2.
P-B No. 2 already contained substantial assets, including the
proceeds from the Gerber stock, with a net value of $273,855 on
March 31, 1988, just prior to its receipt of the Pan Am stock.
(The Gerber stock had been liquidated on December 24, 1987, for
$335,563, and the contents of the account containing the Gerber
stock proceeds, then totaling $321,351, had been transferred to
P-B No. 2 on March 9, 1988.)
On May 26, 1988, petitioner
transferred $271,836 in cash from P-B No. 2 to ANB No. 2, a
custodial account that Belofsky had set up in connection with his
proposal to secure petitioner's release from any personal
liability to Northwest.
Belofsky represented to Northwest that
ANB No. 2 was being funded with the "'Gerber' account" proceeds.
- 81 -
Because the P-B No. 2 account had been the recipient of the
Gerber stock proceeds, the Pan Am stock proceeds, and other
assets of petitioner's before petitioner transferred $271,836 in
cash from the account to fund ANB No. 2, the question arises
whether the amount so transferred is traceable to the Gerber
stock, the Pan Am stock, or some other asset of petitioner's.
Petitioner was actively buying and selling securities
through the P-B No. 2 account in March through May 1988, as well
as making personal charges against the proceeds in the account by
means of a credit card.
The Gerber and Pan Am stock proceeds
were commingled with other personal funds of petitioner's and
were used to offset losses in other stocks in the account that
had been purchased on margin.
The statements for P-B No. 2 in
the record do not show a clear source of the funds for the
$271,836 transfer to ANB No. 2.
However, because petitioner's
attorney represented to Northwest that the $271,836 transfer to
ANB No. 2 was the proceeds of the "Gerber account", we treat this
as an admission by petitioner that the amount transferred was
from that source and no other.
Consequently, we find that no
portion of the Pan Am stock proceeds was transferred to ANB No.
2.
Instead, the record in this case establishes that the Pan Am
stock was transferred from petitioner's FCIS account to
petitioner's P-B No. 2 account on April 11, 1988, sold in two
- 82 -
blocks on April 22 and May 20, 1988, for a net total of $104,143,
and commingled with other personal funds of petitioner's.
Since
the record establishes that petitioner used $116,600 in corporate
funds to purchase the Pan Am stock and that the Pan Am stock and
its proceeds are traceable to a personal account of petitioner's,
respondent has met his burden of showing that petitioner had
unreported income of $116,600 in 1988 as a result of the Pan Am
stock transactions."
With respect to the $450,000 in cash that petitioner
transferred in early 1988 from corporate accounts to the Sam Han
account, petitioner's exercise of personal dominion and control
over all transferred assets by mid-1988 renders the cash in the
Sam Han account taxable to him except to the extent that the
record shows that amounts in the Sam Han account were transferred
to custodial accounts or otherwise made subject to the TRO.
The
record establishes that $80,000 was transferred on July 18, 1988,
from the Sam Han account to ANB No. 3, a custodial account
subject to the TRO.
In addition, Northwest's auditors discovered
the Sam Han account in August or early September 1988, and the
TRO was amended specifically to cover it on October 14, 1988.
Respondent has shown that $450,000 in cash from corporate
© Since petitioner sold the Pan Am stock for $104,143 in
1988, he may be entitled to a loss on its disposition. We
anticipate that the parties will address this matter in their
Rule 155 computations.
- 83 -
accounts was transferred into the Sam Han account in 1988, that
$80,000 was transferred to a custodial account, and that $137,128
in assets remained in the Sam Han account after it was discovered
and made subject to the TRO in late 1988, leaving $232,872 in
cash that petitioner took from his corporations unaccounted for.
Respondent has also shown petitioner's habit of spending
corporate funds for personal items; for example, respondent has
shown that in 1987 petitioner caused corporate funds of $52,000
to be paid to gambling casinos, $16,000 to be paid on the
mortgage loan on his personal residence, and $51,068 to be paid
into accounts in the names of women who were not employees of
petitioner's corporations,48 and in 1988 that petitioner diverted
to personal purposes additional corporate funds of $85,688 (that
are not included in the unreported income pled by respondent in
•
his answer).
Consequently, we find that respondent has shown that
petitioner dissipated for personal purposes or otherwise
exercised dominion and control over the $232,872 in cash
transferred to the Sam Han account that is not otherwise
accounted for.
Accordingly, we conclude that petitioner has
48 In this regard, it is also significant that the
diversions we note for 1987 occurred before the stock market
crash; that is, they occurred before the exigencies of the losses
from the stock market crash and Northwest's ticket recall program
that petitioner contends caused him to divert corporate assets in
order to "hide" them from Northwest.
- 84 -
unreported income in that amount as a result of diversions from
his corporations.
The amounts we conclude petitioner diverted from his
corporations to personal use in 1988 are:
Description
Amount
Kodak stock proceeds
Pan Am stock proceeds
Sam Han account
$3,280
116,600
232,872
Total
352,752
The question remains whether the amounts we have concluded are
unreported income of petitioner are taxable as ordinary income
under section 61(a) or as constructive dividends under section
301(c).
Respondent, relying principally on Leaf v. Commissioner,
33 T.C. at 1095, contends that the amounts are taxable under
section 61(a) because they were wrongfully appropriated in a
fraud upon a third party dealing with the corporation.
Petitioner, citing our opinion in Truesdell v. Commissioner, 89
T.C. 1280 (1987), contends that section 301(c) governs the
taxation of any amounts that we conclude were transferred from IL
NA Tours to him.
For the reasons outlined below, we agree with
petitioner.
In Leaf, we held that amounts that had been taken by a
shareholder from his wholly owned corporation for his own use
(and not returned within the year of the taking) at a time when
- 85 -
the corporation was insolvent were taxable to the shareholder
under the predecessor of section 61(a).4S
The taxpayer had not
argued, and we did not consider, whether these amounts were
constructive dividends taxable under section 301(c).
In a more
recent case, Truesdell v. Commissioner, supra, the Commissioner
likewise argued that a shareholder who diverted funds from his
wholly owned corporation was taxable under section 61(a).
The
taxpayer argued that the amounts were constructive dividends,
taxable pursuant to the terms of section 301(c).
We agreed with
the taxpayer, stating:
As a general proposition, where a taxpayer has dominion
and control over diverted funds, they are includable in
his gross income under section 61(a), unless some other
modifying Code section applies. The latter is the
situation here, since Congress has provided that funds
(or other property) distributed by a corporation to its
shareholders over which the shareholders have dominion
and control are to be taxed under the provisions of
section 301(c).
[11 at 1298; citation omitted.]
We distinguished Leaf on the grounds that the taxpayer therein
had fraudulently transferred funds that should have been
available to creditors, in contemplation of bankruptcy.
By
contrast, the diverted funds in Truesdell had not been wrongfully
appropriated from other shareholders or in fraud of creditors.
"We need not and do not express an opinion on the need to apply a
constructive dividend analysis in a situation where the
49 Sec. 22(a), I.R.C. 1939.
- 86 -
shareholder utilized the corporation to steal from, embezzle
from, or otherwise defraud other stockholders or third parties
dealing with the corporation or shareholder."
Id_ at 1297; see
also United States v. Peters, 153 F.3d 445 (7th Cir. 1998)
(citing Truesdell with approval).
Respondent contends that the instant case should be governed
by Leaf rather than Truesdell because petitioner took the funds
at issue to defraud a third party (Northwest) dealing with the
corporation.
We disagree.
The unreported income issue is new
matter which respondent raised by amendment to answer to the
amended petition.
on this issue.
Therefore, respondent has the burden of proof
Rule 142(a).
Respondent has not shown by a
preponderance of the evidence that the funds taken by petitioner
belonged to Northwest as opposed to IL NA Tours or one of the
other corporations of which petitioner was the sole shareholder.
Northwest issued the ticket stock to petitioner's corporations at
a large discount.
Money for the ticket stock was due after the
tickets were sold.
The corporations were entitled to substantial
commissions for the sold tickets.
There is no evidence that IL
NA Tours, or any of petitioner's other corporations, segregated
the funds due Northwest or that the consolidator agreement
required them to do so.
In addition, the NA Tours companies
served as consolidators for Korean Air Lines, and Air America and
- 87 -
IL NA Tours operated as retail travel agents, for which services
additional compensation could be earned.
Thus, at any time, the
funds commingled in corporate accounts could include IL NA Tours'
profit share from ticket sales and commissions earned, in
addition to any funds petitioner's corporations owed Northwest
and any other airline companies for which they sold tickets.
The fact that Northwest was not entitled to all the funds at
issue finds further support in the fact that pursuant to the
settlement of the Northwest litigation in 1990, Northwest agreed
that petitioner and his corporations would receive $143,543 of
the corporate funds (plus accrued interest) that Northwest
alleged, and petitioner concedes in the instant case, were taken
by him and placed in personal accounts.
The record does not
disclose why Northwest agreed that petitioner and his
•
corporations would receive some of the disputed funds.
What the
record does establish is that petitioner's corporations, unlike
the corporation in Leaf, were not adjudicated bankrupt; instead,
the creditor in the instant case compromised its claim for
something less than all the debtors' assets.
We accordingly conclude that respondent has failed to show
that the facts in the instant case bring it under the rule in
Leaf.
Our conclusion that the amounts petitioner took from his
corporations should be taxed pursuant to section 301(c) finds
- 88 -
further support in the fact that the record strongly suggests,
and respondent has certainly failed to show otherwise, that the
amounts in issue were previously subject to tax at the corporate
level.
IL NA Tours reported gross receipts exceeding $34 million
on its 1987 return.
Respondent concedes that the losses in
excess of $6 million in the corporate investment accounts
occasioned by the 1987 stock market crash were reported on that
return.
IL NA Tours reported gross receipts exceeding $9 million
on its 1988 return, a dropoff that is consistent with the
disruption in its sale of Northwest tickets in that year.
These
gross receipts figures suggest that the Northwest ticket sales
that were the source of petitioner's diversions were reported at
the corporate level.
In Truesdell, we quoted with approval the following
observation of the Court of Appeals for the Eighth Circuit:
"We
believe that the only way that the diverted income already taxed
to the corporation can be taxed to the individual taxpayers is by
the treatment of such diversions as dividends and corporate
distributions."
Truesdell v. Commissioner, 89 T.C. at 1299
(quoting Simon v. Commissioner, 248 F.2d 869, 876-877 (8th Cir.
1957)).
Because the record strongly suggests that the amounts
petitioner diverted from his corporations were subject to tax at
the corporate level, we are quite reluctant to find them taxable
- 89 -
to him pursuant to section 61(a); in the absence of better proof
by respondent, we decline to do so and hold that the taxation of
the amounts at issue is governed by section 301(c).
Under section 301, the distribution is treated as a dividend
if it meets the requirements of section 316.
Under section
316(a), dividends are taxable to the shareholder as ordinary
income to the extent of the earnings and profits of the
corporation, and any amount received by the shareholder in excess
of earnings and profits is considered a nontaxable return of
capital to the extent of the shareholder's basis in his stock.
Any amount received in excess of both the earnings and profits of
the corporation and the shareholder's basis in his stock is
treated as gain from the sale or exchange of property.
Respondent concedes that IL NA Tours had no current or
accumulated earnings and profits.
IL NA Tours stock.5°
Petitioner had no basis in his
Accordingly, the $352,752 that we have
5° IL NA Tours' 1988 return lists capital stock on its
balance sheet of $10,000, although petitioner testified that he
only lent money to his corporations. Even if petitioner
contributed $10,000 to IL NA Tours, we are satisfied that
petitioner had no basis in his IL NA Tours' stock. We have found
that petitioner took an additional $85,688 from IL NA Tours
during 1988 that was not included in the amount that respondent
has pled as unreported income, and petitioner reported salary
income of only $37,50Ò on his 1988 return. Thus there were
diversions from IL NA Tours in 1988 that exceeded any possible
basis petitioner had in the stock of the corporation.
- 90 -
.
found petitioner diverted from his corporations in 1988 is to be
treated as a gain from the sale or exchange of property.
Dividend Income Issue
In the notice of deficiency, respondent determined that
petitioner had unreported income for 1988 of $12,9125¹ relating
to dividend income credited to his FCIS account and to P-B No. 2.
Petitioner has the burden of proving that he did not underreport
his income relating to those accounts.
Rule 142(a).
Respondent
contends that petitioner did not offer any credible evidence
regarding this issue.
By amendment to his answer, respondent additionally asserted
that petitioner had unreported income for 1988 of $20,641
relating to dividends credited during 1988 to the Sam Han, Chung
No. 1, and Chung No. 2 accounts.
The parties agree that those
three accounts received dividend income totaling $20,641 during
1988.
Respondent has the burden of proving the increased
deficiency relating to the $20,641 dividend income.
Rule 142(a).
As previously noted, the Sam Han, Chung No. 1, and Chung No. 2
accounts were owned and controlled by petitioner.
Petitioner contends that none of the $33,554 in dividends in
the original determination or the amended pleadings is taxable
5¹ The parties have stipulated that the dividends paid on
stocks in the FCIS and P-B No. 2 accounts totaled.$12,912.
- 91 to him because he held the funds in his FCIS account, P-B No. 2,
the Sam Han account, Chung No. 1, and Chung No. 2 as an agent of
IL NA Tours.
Thus, petitioner contends, the funds belonged to IL
NA Tours, and it should have reported the dividend income for
1988 on its own return.
Respondent contends, however, that
petitioner must include the $33,554 in his income for 1988
because the principal in the foregoing brokerage accounts was
under his sole dominion and control when the dividends were
earned, and therefore such dividends were income to him under the
"fruit of the tree" doctrine in Lucas v. Earl, 281 U.S. 111
(1930).
We have concluded and held herein that petitioner exercised
dominion and control over the funds .diverted in 1988 and is
taxable on them except to the extent the funds were returned to
custodial accounts within the 1988 taxable year.
With respect to
respondent's original determination concerning the $12,912 in
dividends in the FCIS and P-B No. 2 accounts, we hold that
petitioner has failed to show error in the determination and
accordingly sustain it.
The $4,500 dividend on the Kodak stock
in the FCIS account was paid on April 4, 1988, when petitioner
had dominion and control over the FCIS account and before the
Kodak stock proceeds were transferred to a custodial account on
- 92 -
June 24, 1988.s2
The $8,412 in dividends recorded in the P-B No.
2 account was paid during March 1988, before any amounts in that
account were transferred to a custodial account.
Moreover, there
is no evidence that any portion of this dividend income was paid
over to a custodial account.
We turn to the remaining dividend income for which
respondent bears the burden of proof.
Stocks in the Sam Han
account earned dividends totaling $16,905 throughout 1988.
Although petitioner had dominion and control over the account at
least until Northwest's auditors discovered it in early September
1988 (which resulted in the TRO's being amended to specifically
cover it), a substantial portion of the contents of the account
was made subject to custodial control before yearend 1988;
specifically, $80,000 was transferred from the Sam Han account to
ANB No. 3 on July 18, 1988, and the remaining contents in the Sam
Han account at yearend 1988, after it had been made subject to
the TRO, equaled $137,128.
In these circumstances, we conclude
that respondent has failed to show that the dividends earned in
the Sam Han account were not transferred to custodial control
before yearend 1988.
We accordingly hold that petitioner is not
52 Although petitioner transferred $4,500 from his FCIS
account to IL NA Tours' Albank No. 1 account on the same day the
FCIS account received the $4,500 dividend, respondent effectively
reduced his deficiency assertion by that amount when he treated
this $4,500 as a return of funds to IL NA Tours.
- 93 -
taxable on the $16,905 in dividends earned in the Sam Han
account.
The balance of the dividend income for which respondent
bears the burden was earned in Chung No. 1 ($3,525 on March 1,
1988) and Chung No. 3 ($211).
Respondent has shown that
petitioner had dominion and control over Chung No. 1 when the
dividends were earned.
Further, respondent has shown that the
transfers out of Chung No. 1 into Chung No. 3, which are
traceable to ANB No. 2, occurred before the dividends at issue
were paid.
Accordingly, respondent has shown that the dividends
in Chung No. 1 were not transferred to ANB No. 2 or any other
custodial control.
Therefore, we sustain respondent's averment
that petitioner has unreported dividend income of $3,525 in
connection with his control of Chung No. 1.
With respect to
Chung No. 3, the record does not disclose when the $211 in
dividends (paid on a money market fund) in that account was paid.
Moreover, because there were transfers from Chung No. 3 to P-B
No. 2 to ANB No. 2, and the money market dividends could
reasonably be described as "Gerber account" proceeds (in
accordance with petitioner's characterization of those
transferred amounts that we have elsewhere treated as an
admission), we conclude that respondent has failed to show that
the dividends paid in the Chung No. 3 account were not
- 94 -
transferred to custodial control before yearend 1988.
We
therefore hold that petitioner does not have unreported dividend
income of $211 in connection with his control of the Chung No. 3
account.
Petitioner contends further, however, for the first time on
brief that respondent failed to give him the benefit of all of
the incidents of ownership of the brokerage accounts asserted to
be under his dominion and control.
According to petitioner,
these brokerage accounts in large part purchased stocks on
margin; and they incurred margin interest costs of $67,193, which
was deducted directly from the brokerage accounts and for which
respondent did not give petitioner credit.
Petitioner
additionally alleges that the brokerage accounts incurred capital
losses of $15,764 for which respondent did not give petitioner
credit.
Petitioner contends that if he must include the
dividends in his income, then he should also be allowed to claim
the capital losses of $15,764 and margin interest deductions of
$67,193.
Respondent counters that petitioner's untimely claim of
additional losses and deductions prejudices respondent because he
is effectively precluded from attempting to show that petitioner
had additional unreported gains from other personal brokerage
accounts into which corporate funds were diverted but which were
not included in the deficiencies asserted.
- 95 -
This Court generally will not consider issues that are
raised for the first time on brief, particularly where the
belated claim would prejudice a party.
Rules 34(b)(4), 41(a) and
(b); Foil v. Commissioner, 92 T.C. 376, 418
(1989), affd. 920
F.2d 1196 (5th Cir. 1990); Markwardt v. Commissioner, 64 T.C.
989, 997
(1975); see also Toyota Town, Inc. v. Commissioner, T.C.
Memo. 2000-40, affd. sub nom. Bob Wondries Motors, Inc. v.
Commissioner, 268 F.3d 1156 (9th Cir. 2001).
Leave to amend a
pleading should be given, however, "when justice so requires".
Rule 41(a).
We note first that we have concluded herein that petitioner
is effectively not the owner of the dividends respondent
attributed to him from the Sam Han and Chung No. 1 accounts.
These two accounts contain $54,372 of the $67,193 in margin
•
interest for which petitioner seeks an offset.
Moreover, the
evidence adduced by respondent in this case demonstrates that
petitioner had additional unreported income of $85,688 in 1988
that respondent nonetheless did not use as a basis to amend his
pleadings to assert an increased deficiency.
In these
circumstances, we conclude that respondent would be prejudiced if
petitioner were permitted to raise for the first time on brief
his entitlement to margin interest deductions and capital losses.
Also, the belated income offsets to which petitioner might be
- 96 entitled fall short of the additional unreported income noted
above.
Consequently, the interests of justice do not require
that petitioner be permitted to raise new issues on brief.
Interest Income Issue
On his 1988 return, petitioner included $27,992 of interest
income attributable to the ANB accounts.
The ANB accounts were
opened and maintained throughout 1988 and beyond under
petitioner's Social Security number.
Petitioner obtained backup
withholding tax credits in 1989, 1990, and 1991 for the ANB
accounts.
In an amendment to petition, petitioner alleged that
the interest income should not be included in his income because
the ANB accounts belonged to IL NA Tours, and therefore the
corporation should have reported it.
Petitioner contends that the ANB accounts were reflected as
.
assets on IL NA Tours' June 1988 financial statement and on its
1988 corporate return.
Petitioner maintains that he had no power
to control the ANB accounts after they were funded, he did not
receive the interest, and the funds in the ANB accounts,
including the interest earned on those funds, were not intended
to benefit him.
He further contends that money in the ANB
accounts was used for IL NA Tours' benefit and, ultimately, to
pay its debts.
Petitioner asserts that his accountant
erroneously included the interest on petitioner's return.
- 97 -
Respondent contends, however, that petitioner properly reported
the interest income on his return because it was earned on funds
he had taken from his corporations and converted to his own
dominion and control.
In line with our earlier holding that the transfer of funds
to the ANB accounts before yearend 1988 constitutes a return of
those funds to petitioner's corporations, it follows that the
interest earned on the funds in the ANB accounts in 1988 is not
taxable to petitioner.
We so hold.
Depreciation Issue
On his 1988 return, petitioner reported rental income of
$10,430 and deducted rental expenses of $19,410 in addition to
depreciation of $10,744° relating to the Lincoln Avenue II
property.
•
Respondent determined that petitioner was not entitled
to deduct the rental expenses or the depreciation.
Petitioner
has conceded that he is not entitled to deduct the rental
expenses.
Petitioner has the burden of proving that he is
entitled to the depreciation deduction.
Rule 142(a).
Petitioner contends that he is entitled to a depreciation
deduction of $9,963 relating to the Lincoln Avenue II property.
He maintains that he bought the property during 1984 for either
$150,000 or $160,000 and that he financed the purchase with a
" The parties have stipulated that the appropriate
depreciation, if any is allowable, is $9,963.
- 98 -
mortgage in his name which he paid.
Petitioner asserts that
respondent did not cross-examine him on his testimony nor offer
any evidence that petitioner did not pay for the property in
1984.
Respondent contends that petitioner has failed to establish
the cost of the property or that he used his own funds to acquire
it.
Accordingly, respondent contends, petitioner has failed to
prove his basis in the property or his entitlement to the
depreciation claimed.
To show entitlement to a deduction for depreciation,
petitioner must establish, among other things, the depreciable
basis of the property.
See Delsanter v. Commissioner, 28 T.C.
845, 863 (1957), affd. in part, revd. and remanded on another
issue 267 F.2d 39 (6th Cir. 1959).
The evidence in the record
relating to basis in the Lincoln Avenue II property consists
solely of petitioner's self-serving statements, which we reject
because they are uncertain, ambiguous, and uncorroborated.
See
Frierdich v. Commissioner, 925 F.2d at 185; Tokarski v.
Commissioner, 87 T.C. at 77.
Accordingly, petitioner has not
established basis and may not deduct depreciation with respect to
the Lincoln Avenue II property in 1988.
respondent's determination.
We therefore sustain
- 99 -
Rental Income Issue
During 1988, Air America and IL NA Tours occupied space on
the first and second floors, respectively, of the Lincoln Avenue
I property.
On their 1988 returns, Air America deducted $12,425
and IL NA Tours deducted $41,127 for rent in the "Other
deductions" category on the returns.
In addition, IL NA Tours
deducted $41,127 in the "Rent" category of its return."
On his 1988 return, petitioner reported $10,430 in rental
income relating to the Lincoln Avenue II property but did not
report any rental income relating to the Lincoln Avenue I
property.
During the examination of petitioner's 1988 return,
petitioner told the revenue agent conducting the examination that
the amounts deducted for rent by Air America ($12,425) and IL NA
Tours ($41,127), in total $53,552, were for the use of space in
the Lincoln Avenue I property.
In the notice of deficiency
respondent determined that petitioner had unreported income of
$43,123 relating to rental income attributable to the Lincoln
Avenue I property."
" Respondent has not put in issue any additional income
that might be associated with the duplicative $41,127 deduction.
" The revenue agent had erroneously subtracted the $10,430
rental income reported on petitioner's return relating to the
Lincoln Avenue II property from the $53,552 in unreported rental
income relating to the. Lincoln Avenue I property. Respondent has
not amended the answer further to include the additional
unreported rental income.
- 100 -
During trial preparation, petitioner reiterated to
respondent's counsel that during 1988 Air America and IL NA Tours
had paid him rent totaling $53,552 for their use of space in the
Lincoln Avenue I property.
Before trial commenced, however,
petitioner retracted that statement and instead informed
respondent's counsel that he had discovered he had not received
rent for use of space in the Lincoln Avenue I property from his
corporations.
He claimed further that the rent deducted by IL NA
Tours constituted rent the corporation had paid to various
commercial rental agents on behalf of various subagents of IL NA
Tours.
In support of his statement, petitioner submitted to
respondent's counsel a number of checks made payable to third
parties with addresses in cities where certain NA Tours companies
were located.
Those companies were separately incorporated
corporations wholly owned by petitioner.
Petitioner bears the
burden of proving that he did not receive the rental income in
issue during 1988.
Rule 142(a).
Petitioner contends that he did not receive rent from IL NA
Tours or Air America during 1988.
According to petitioner, he
told the revenue agent that he "thought" the $53,552 in rent had
been paid to him for the use of space in his Lincoln Avenue I
property.
He contends that he made the statement at a time when
he did not have any records relating to the transactions.
- 101 -
Petitioner maintains that checks he gave respondent's counsel
during trial preparation compared with cash disbursement
spreadsheets included in certain workpapers in evidence show that
the rent payments did not go to him but instead went to third-
party commercial rental agents that rented space to branch
offices of IL NA Tours.
Respondent contends that petitioner has not shown that IL NA
Tours and Air America did not pay him rent during 1988.
Respondent asserts that the evidence on which petitioner relies
is not relevant to the issue of rental payments made by IL NA
Tours and Air America to him because none of the checks or cash
disbursement recordations relate to payments for space used by IL
NA Tours or Air America.
Respondent asserts further that the checks petitioner
•
submitted do not add up to the $53,552 in total that Air America
and IL NA Tours deducted as rental expense on their corporate
returns.
Respondent contends that petitioner's pattern of taking
money from his corporations belies his claim that he passed up an
opportunity to take rental income from his corporations,
especially when his activities were being carefully monitored by
Northwest.
We are persuaded on the basis of the record that petitioner
was in error when he informed the revenue agent and respondent's
- 102 -
counsel that IL NA Tours paid him $41,127 in rent for the use of
space in his Lincoln Avenue I property.
We are persuaded that
the $41,127 deduçted on IL NA Tours' 1988 return consisted of
rental payments for commercial office space in cities where IL NA
Tours maintained branch offices.
The checks petitioner submitted for 1988 were drawn on bank
accounts maintained by IL NA Tours, NY NA Tours, or CA NA Tours
and total $41,672.28, which approximates the amount IL NA Tours
deducted as rental expense.
Chung signed most of the checks.
He
testified that the office rents reflected in the corporation's
workpapers were payments for office space rented by branch
offices maintained by IL NA Tours in various cities.
He also
testified that it would have been his practice to obtain the
numbers reflected in the workpapers from the listing of accounts
payable.
As controller of IL NA Tours, Chung would be in a
better position than petitioner to know the recipients of
payments that IL NA Tours had deducted on its 1988 return.
Respondent's argument that the payments do not add up to the
$53,552 in issue is misleading inasmuch as those checks relate to
payments made by IL NA Tours, which deducted $41,127.
The
balance of the $53,552 relates to the $12,425 deducted by Air
America.
Petitioner did not submit any checks written on
accounts maintained by Air America.
- 103 -
On the basis of Chung's corroborating testimoný, we are
persuaded that the rental expenses IL NA Tours claimed on its
corporate return did not relate to payments made to petitioner.
Thus, we hold that petitioner did not have unreported rental
income of $41,127 from IL NA Tours in 1988.56
The rationale we apply to decide whether IL NA Tours paid
petitioner $41,127 in rental income during 1988 does not apply,
however, to the $12,425 deducted by Air America for rental
expense in 1988.
Other than petitioner's self-serving retraction
of his statements to the revenue agent and respondent's counsel,
there is no proof that petitioner did not receive the $12,425 he
admitted receiving from Air America for use of space in the
Lincoln Avenue I property.
Petitioner's arguments relating to
the cash disbursement spreadsheets and to the checks he submitted
•
to respondent's counsel are not persuasive as to rental payments
made by Air America since those spreadsheet notations and checks
apply only to IL NA Tours.
Presumably, Air America maintained
its own books and records since it was a separate entity from IL
NA Tours.
ss The propriety of IL NA Tours' deduction of rental
payments for the benefit of other corporations owned by
petitioner is not before the Court and, therefore, we do not
address the question of whether the payments to the third-party
rental agents would have been a deductible expense of IL NA
Tours.
- 104 Petitioner told both the revenue agent and respondent's
counsel that Air America paid him rent for the use of space in
the Lincoln Avenue I property.
Air America maintained its office
at property owned by petitioner and deducted $12,425 for rent
expenses.
The record contains no proof that Air America paid
anyone other than petitioner for rent expenses.
As far as the
record reflects, Air America did not have branch offices.
The NA
Tours companies were separate entities from Air America.
We do not agree with petitioner that the corporate
workpapers in evidence show that he did not receive rental income
from Air America.
Those documents were records of IL NA Tours,
not Air America.
Moreover, in arguing for the receipt into
evidence of these workpapers, petitioner stressed that these
documents did not constitute all of the books and records for IL
NA Tours and were merely workpapers accumulated by Chung to
assist him in the preparation of IL NA Tours' tax returns.
Chung
did not testify that those documents constituted all of the
workpapers Chung gathered for that purpose.
Furthermore,
petitioner's counsel never asked Chung at trial whether Air
America paid rental income to petitioner during 1988.
The normal
inference is that testimony on that matter would have been
unfavorable to petitioner's position.
See Frierdich v.
Commissioner, 925 F.2d at 185; Tokarski v. Commissioner, 87 T.C.
- 105 -
at 77; Bresler v. Commissioner, 65 T.C. 182, 188 (1975); Wichita
Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946),
affd. 162 F.2d 513 (10th Cir. 1947).
We are not required to
accept petitioner's self-serving testimony that his corporations
did not pay him rent.
Frierdich v. Commissioner, supra; Liddy v.
Commissioner, 808 F.2d 312, 315 (4th Cir. 1986), affg. T.C. Memo.
1985-107; Laney v. Commissioner, 674 F.2d 342, 349-350
(5th Cir.
1982), affg. in part, revg. in part and remanding on another
issue T.C. Memo. 1979-491.
On the basis of the forëgoing, we hold that petitioner has
not met the burden of proving that he did not have $12,425 in
unreported rental income.from Air America in 1988.
Addition to Tax for Negligence Issue
In the notice of deficiency, respondent determined that
•
petitioner is liable for an addition to tax for negligence under
section 6653(a)(1) for 1988.
In the amendment to answer to
amendment to petition, respondent alleged that petitioner was
liable for the addition to tax for negligence for the issues
raised in the amendment to answer.
Section 6653(a)(1) imposes an addition to tax equal to 5
percent of the underpayment if any part of the deficiency was due
to negligence or intentional disregard of rules or regulations.
- 106 -
"Negligence" includes a failure to make a reasonable attempt to
comply with the provisions of the Internal Revenue Code.
6653(a)(3).
Sec.
"Disregard" includes any careless, reckless, or
intentional disregard of rules or regulations.
Id_; Crocker v.
Commissioner, 92 T.C. 899, 916-918 (1989); Neely v. Commissioner,
85 T.C. 934, 947-950 (1985).
The negligence addition to tax will
apply if, among other things, the taxpayer fails to maintain
adequate books and records with regard to the items in question.
Crocker v. Commissioner, supra.
In the stipulation of settled issues, petitioner has
conceded that he understated income and overstated deductions
relating to his 1988 return.
Petitioner has failed to prove that
those items were not due to negligence.
Furthermore, petitioner
has conceded that he would be liable for the addition to tax for
negligence if we decide, as we have in part, that the funds he
took from corporate accounts must be included in his income in
1988.
For 1988, the addition to tax for negligence applies to
the entire deficiency if any part of the deficiency is due to
negligence or intentional disregard of rules or regulations.
Accordingly, we conclude that petitioner is liable for the
addition to tax for negligence under section 6653(a)
for the
deficiencies determined in the notice of deficiency and the
- 107 -
increased deficiencies asserted in the amendment to answer to the
amended petition to the extent sustained herein.
Addition to Tax for Substantial Understatement of Income Tax
Issue
In the notice of deficiency, respondent determined that
petitioner is liable for the addition to tax under section 6661
for 1988 because he substantially understated his income tax.
In
the amendment to answer to amendment to petition, respondent
asserts that petitioner is liable for the addition to tax for
substantial understatement of income for the issues raised in the
amendment to answer.
Petitioner has the burden of proof as to
the issues raised in the notice of deficiency, and respondent has
the burden of proof for the new matter and increased deficiency
asserted in the amendment to answer.
Rule 142(a).
Section 6661(a) imposes an addition to tax equal to 25
percent of the underpayment attributable to an understatement
where there is a substantial understatement of income tax.
An
understatement is substantial if it exceeds the greater of 10
percent of the tax required to be shown or $5,000.
6661(b) (1) (A).
Sec.
An "understatement" is defined as the excess of
thestax required to be shown on the return over the tax actually
shown on the return.
The amount of the understatement is reduced
for section 6661 purposes by the portion of the understatement
which is attributable to the taxpayer's treatment of an item if
- 108 -
there is substantial authority for that treatment, or if relevant
facts affecting the item's tax treatment are adequately disclosed
in the return.
Sec. 6661(b)(2)(1B).
Petitioner contends merely that the addition to tax for
substantial understatement of tax is computational and will not
apply if we accept his arguments relating to the issues involved in the instant case.
Thus, petitioner provided no evidence that
he had substantial authority for the understatement, and his tax
return did not disclose the relevant facts sufficient to enable
respondent to identify the potential controversy involved.
Schirmer v. Commissioner, 89 T.C. 277, 285-286 (1987).
Respondent presented evidence at trial through testimony of
witnesses and documents and through the concessions at trial and
in the briefs, sufficient to meet the burden of proving certain
increased deficiencies raised in the amendment to answer to
.amendment to petition.
Accordingly, we sustain respondent as to
the imposition of the addition to tax for substantial
understatement of income tax.
To reflect the foregoing,
.
Decision will be entered
under Rule 155.
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