UNITED STATES TAX COURT
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T.C. Memo. 1995-464
UNITED STATES TAX COURT
LEO N. LEVITT AND RUTH G. LEVITT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 27857-90.
Filed September 28, 1995.
Herbert L. Zuckerman, Robert J. Alter, and Richard J.
Sapinski, for petitioners.
Daniel O'Brien and Patrick E. Whalen, for respondent.
TABLE OF CONTENTS
Page
FINDINGS OF FACT
A.
B.
C.
D.
E.
F.
Petitioners...............................................4
Resyn Corporation.........................................7
Polymer Chemicals........................................11
Chemical Traders.........................................13
Resyn's Bankruptcy ......................................17
Respondent's Investigation of Petitioner and Resyn.......18
- 2 G.
H.
I.
J.
K.
L.
M.
N.
Third Party Information..................................23
Meetings With FBI Agents and Strike Force Attorney.......23
Referral of Case to the Justice Department...............24
Petitioner's Criminal Case...............................26
Resyn's Bankruptcy Trial.................................26
Sale of Resyn Corporation................................33
Notice of Deficiency.....................................34
Petitioners' 1963 Return.................................34
OPINION
A.
B.
C.
D.
E.
F.
G.
H.
Whether Respondent Violated Grand Jury Secrecy Rules.....35
Whether Petitioner Is Collaterally Estopped From
Denying Factual Findings of the Bankruptcy Court.........37
Whether Respondent's Determination Is Arbitrary..........45
Whether Petitioners Received Constructive Dividends......47
Whether Petitioner Is Liable for Fraud for 1963..........53
Whether Petitioner Is Liable for Fraud for 1964 to 1970..54
Statute of Limitations...................................64
Whether Ruth Levitt Is an Innocent Spouse................64
MEMORANDUM FINDINGS OF FACT AND OPINION
COLVIN, Judge:
Respondent determined that both petitioners
are liable for deficiencies in income tax and that petitioner Leo
Levitt is liable for additions to tax for fraud as follows:
Year
1963
1964
1965
1966
1967
1968
1969
1970
Deficiency
$180,853.16
225,591.07
67,160.06
241,895.20
98,213.03
221,132.70
258,763.57
17,945.61
Addition to Tax
Sec. 6653(b)
$90,732.96
113,118.26
34,407.72
120,947.60
49,106.52
122,893.86
134,598.39
21,129.21
Following concessions, we must decide the following issues:
1.
Whether respondent's use of Resyn Corporation's
business records violated grand jury secrecy rules.
it did not.
We hold that
- 3 2.
Whether petitioner Leo Levitt is collaterally estopped
from contesting factual findings made by the U.S. bankruptcy
court in a trial relating to respondent's tax claims against
Resyn Corp., which he controlled.
3.
We hold that he is.
Whether respondent's determination was arbitrary.
We
hold that it was not.
4.
Whether petitioners had unreported dividend income
during the years in issue.
5.
1963.
We hold that they did.
Whether petitioner Leo Levitt is liable for fraud for
We hold that he is not because there is no evidence of the
contents of that return.
6.
Whether petitioner Leo Levitt is liable for fraud for
1964 to 1970.
7.
We hold that he is.
Whether the statute of limitations bars assessment of
tax for petitioners for 1964 to 1970.
8.
We hold that it does not.
Whether petitioner Ruth Levitt is an innocent spouse
under section 6013(e) for any of the years in issue.
We hold
that she is not.
References to petitioner are to Leo Levitt.
Section
references are to the Internal Revenue Code in effect during the
years in issue.
Rule references are to the Tax Court Rules of
Practice and Procedure.
References to rule 6(e) are to rule 6(e)
of the Federal Rules of Criminal Procedure.
Some of the facts have been stipulated and are so found.
- 4 FINDINGS OF FACT
A.
Petitioners
1.
Generally
Petitioners were married and resided in Verona, New Jersey,
when they filed their petition.
Petitioner was born in 1914.
He graduated from Dartmouth
University in 1936 with a degree in chemical engineering and
worked for chemical companies until 1951.
As discussed in more
detail below in section B, petitioner owned and controlled the
Resyn Corporation (Resyn) during the years in issue.
Ruth Levitt was born in 1918.
school and secretarial school.
married in 1941.
She graduated from high
Petitioners met in 1938 and
Ruth Levitt never worked outside the home.
Petitioners had four daughters, born in 1943, 1946, 1952, and
1956.
Ruth Levitt took care of her ailing mother for a period of
time not specified in the record.
She did not visit or know much
about her husband's business.
Petitioners bought land in South Orange, New Jersey, in
1948.
Petitioners rented a dwelling until 1952 when they moved
into a home they built on their South Orange land.
Ruth Levitt
had sole ownership of that home.
Petitioner did not have a personal checking account.
Levitt had checking and savings accounts from 1960 to 1970.
Ruth
used those accounts for the family finances.
She
During the years
- 5 -
in issue, Ruth Levitt drove new cars and had a comfortable
standard of living.
Petitioners took regular vacations to Las
Vegas and Florida from 1963 to 1970.
2.
Welev of Pinellas County, Inc.
In 1959, a Brooklyn lawyer named Erwin Weiss (Weiss), who
had helped organize Resyn, recommended that petitioners buy 41
acres of land in St. Petersburg, Florida.
Petitioner, Ruth
Levitt, Fred Berger (Berger), a St. Petersburg realtor who knew
Weiss, and Weiss organized a group called Welev of Pinellas
County (Welev) to hold the 41 acres.
interest in Welev.
Each owned a one-fourth
In 1959, petitioner was president of Welev.
He signed the mortgage deed.
Ruth Levitt knew very little about
Welev.
Weiss incorporated Welev around 1960.
shares of stock when it was incorporated.
Welev issued 30
The original
subscribers to the stock were petitioner, Berger, Meyer
Tepperman, and Weiss.
Each had 7.5 shares.
In 1970, Resyn owed Hooker Chemical Co. (Hooker) about $2
million.
Hooker supplied folacin hydride to Resyn.
agreed to guarantee Resyn's debt.
Petitioner
Petitioner pledged the Welev
property as collateral to Hooker.
In 1986, Welev sold its Florida property.
separate returns for 1986.
Petitioners filed
Ruth Levitt reported on her return a
- 6 capital gain of $999,338 from the liquidation of Welev stock,
which she reported that she acquired in 1964.
3.
Petitioners' Income Tax Returns
Petitioners filed joint income tax returns for 1963 to 1970.
Harry Levenson (Levenson) prepared petitioners' income tax
returns for 1964, 1965, and 1966.
He was an accountant.
office was at 152 Clinton Avenue in Newark, New Jersey.
moved to 441 Springfield Avenue in Newark.
His
He later
Levenson previously
served as a revenue agent for the Internal Revenue Service (IRS).
Levenson's wife was Ruth Levitt's cousin.
Howard Goldstein (Goldstein) prepared petitioners' returns
for 1967, 1968, 1969, and 1970.
Goldstein was an accountant.
He
practiced at the certified public accounting firm of I. George
Goldstein & Co. (Goldstein & Co.).
Goldstein's father.
I. George Goldstein was
Petitioner gave Levenson and Goldstein
information to prepare his returns, including Forms 1099, Forms
W-2, and brokerage account statements.
Petitioners reported wages from Resyn of $35,000 per year
for 1964 and 1965, $50,000 for 1966, 1967, 1968, and 1969, and
$47,960 for 1970.
They reported withholding on those wages of
$10,000 per year in 1964 and 1965, $13,282.97 in 1966, $12,876 in
1967, $14,000 in 1968, $16,000 in 1969, and $11,887.85 in 1970.
Petitioners did not report as income any of the amounts Resyn
- 7 -
paid for their benefit.
See section B-3, below.
Petitioners
reported $27,300 in miscellaneous income for 1970.
B.
Resyn Corporation
1.
Formation of Resyn Corporation
Petitioner and about 11 other people formed a chemical
company called Resyn in 1951.
Resyn was incorporated in 1953.
Its principal offices were in Linden, New Jersey.
Petitioner
bought the stock of the other Resyn shareholders around 1956 for
the amount of their original investment in the company.
Petitioner controlled Resyn's operations during the years in
issue.
2.
Resyn Corporation's Operations
Resyn bought, manufactured, and sold resins and other
chemicals and oils used to manufacture paint.
In the late
1950's, Resyn began to produce a chemical resin used by the Ford
Motor Co. in automobile paint.
Oil Co.
Resyn made Mobil 1 for the Mobil
Resyn was the fourth company in the United States to
manufacture epoxy.
Atlas Paint and Varnish Co. (Atlas) was one of Resyn's
larger customers from 1963 to 1970.
(the Tepperman brothers) owned Atlas.
Meyer and Harry Tepperman
Atlas manufactured paint.
Atlas bought large amounts of alkyds from Resyn to make paint.
- 8 3.
Resyn's Payments for Petitioners' Personal Benefit
Resyn paid for many of petitioners' personal expenses and
personal stock investments.1
He had Resyn pay Ruth Levitt a
weekly allowance of about $350.
Ruth Levitt received Resyn
checks paid to cash totaling $25,737 in 1967, $24,930 in 1968,
and $25,761 in 1969.
expenses.
She used those funds to pay household
Petitioner had Resyn pay the mortgage on their home.
Resyn paid $3,477.42 for 1967, $4,463.67 for 1968, and $4,081.35
for 1969 for the mortgage on petitioners' home.
Petitioner had Resyn pay for many of Ruth Levitt's shopping
expenses.
In 1967, 1968, and 1969, Resyn also paid for Ruth
Levitt's purchases at Bloomingdale's, Saks Fifth Avenue, Fellers,
Lord & Taylor, and many other stores.
Resyn paid Evelyn Mejia, a nurse for petitioners' children,
and William Morrison, a handyman and chauffeur at petitioners'
home.
Resyn paid landscaping and gardening expenses at
petitioners' home.
Resyn paid petitioners' children's expenses
to attend Prospect Hill Country Day School, Newark Academy, and
Kenwood Camp for Girls from 1967 to 1969.
From 1967 to 1969,
Resyn paid Berkeley School and MacBrian Educational Consultants,
Inc.
Petitioners deducted $500 for 1967 and $100 for 1968 on
their income tax returns for charitable gifts to Camp Deal for
1
Resyn business records are missing except for parts of
1967, 1968, and 1969. There is no evidence that Resyn's
arrangements to pay petitioners' expenses were different from
1963 to 1966, or in 1970.
- 9 boys.
Resyn wrote checks to Camp Deal for Boys for $500 in 1967
and $100 in 1968.
Resyn paid Weiss and the Tax Collector, Sarasota, Florida,
for petitioners' purchase of Welev's land and Welev stock from
1963 to 1970.
Petitioner had Resyn pay some of his expenses for dry
cleaning, medications from his pharmacy, and individual income
taxes in 1967, 1968, and 1969.
Resyn paid petitioners' personal
expenses of about $261,789 in 1967, $431,592 in 1968, and
$341,725 in 1969, for a total of $1,035,106 during those years.
4.
Resyn's Bookkeeping and Tax Returns
Resyn maintained double entry books and records.
(Hall) was Resyn's first bookkeeper.
deposit tickets.
Ann Hall
Hall usually prepared the
As Resyn grew, Resyn hired Vera Philbin
(Philbin) and others to help Hall.
Philbin entered payables
in Resyn's purchases journal and made journal entries in the
general ledger.
Goldstein & Co. prepared the journals she used.
Petitioner was not involved in Resyn's bookkeeping.
Resyn filed income tax returns for 1963 to 1970.
Levenson
was Resyn's accountant and return preparer and an employee of
Resyn from Resyn's inception to 1965 or 1966.
Goldstein & Co.
also performed accounting services for Resyn.
Until 1965,
Goldstein & Co. compiled information for the Resyn tax return and
gave it to Levenson to prepare the return.
those returns for Goldstein & Co.
Goldstein approved
- 10 Resyn gradually reduced Levenson's function to checking
postings in the purchases journal by Resyn's bookkeepers.
Levenson worked about 1 day per week.
Goldstein & Co. prepared Resyn's returns for 1966 to 1969.
Goldstein began to supervise the Resyn account for Goldstein &
Co. in 1965 or 1966.
Goldstein spent 5 to 10 days per year at
Resyn closing the books and preparing the corporate tax return.
Resyn's bookkeepers gave Goldstein access to Resyn's books and
records.
Goldstein did not verify sales or check inventory
because he believed Resyn's staff handled those items correctly.
At the end of 1967, 1968, and 1969, Goldstein classified the
checks Resyn paid for the personal benefit of petitioners as
loans made by Resyn to petitioner.
Goldstein increased
petitioner's loan account by $69,815.09 in 1967, $214,376.58 in
1968, and $189,350.46 in 1969, and decreased it by $200,000 in
1968.
The decrease did not occur because petitioner repaid
Resyn.
Molly Goldstein, Goldstein's mother, lent $200,000 to
Resyn in 1967.
Resyn paid interest on the loan to Goldstein's
mother from 1967 to 1970.
Resyn paid $30,000 of interest to
Goldstein's mother after 1968.
In 1968, Goldstein transferred
the account payable from Resyn to petitioner and decreased
petitioner's loan account by $200,000.
At trial, Goldstein
conceded that he had no authority to do this and that it was not
an appropriate accounting practice to decrease petitioner's loan
account by $200,000 in 1968.
Goldstein's mother filed a claim in
- 11 the Resyn bankruptcy for $200,000 after 1970.
37-1/2 cents per dollar of claim.
She later received
Petitioner had not repaid
Resyn by the time of the bankruptcy trial in 1981.
Resyn did not report paying any dividends from 1963 to 1970.
C.
Polymer Chemicals
1.
Formation of Polymer Chemicals
Petitioner suggested that he and Levenson form a partnership
called Polymer Chemicals (Polymer).
On September 17, 1954,
Levenson registered the trade name Polymer Chemicals with the
State of New Jersey under his name alone.
The trade name
certificate stated that Polymer's address was 152 Clinton Avenue,
Newark, New Jersey, which was Levenson's office.
did business at that address.
Polymer
never
Polymer had a checking account at
the National State Bank, Hillside, New Jersey, from 1963 to 1970.
Although Levenson was authorized to sign checks on the Polymer
account, petitioner directed him to sign and endorse blank
Polymer checks.
Levenson never saw the proceeds from these
checks.
The monthly bank statements did not include a mailing
address for Polymer.
Petitioner went to the bank to get
Polymer's bank statements and canceled checks.
Polymer did not
file Federal income tax returns.
2.
Polymer Transactions
Unlike other Resyn transactions the Polymer purchase
invoices did not include any bills of lading.
Resyn's checks to
- 12 Polymer were for fictitious purchases.
Polymer account.
Petitioner controlled the
Petitioner diverted the following amounts from
Resyn to the Polymer checking account:
Year
1963
1964
1966
1967
1969
1970
Total
Amount
of Deposits
$108.404.48
238,555.24
87,750.12
40,517.47
122,649.81
5,370.72
603,247.84
Monthly
Statements
Available
5
11
1
12
12
12
In 1963, petitioner deposited in the Polymer account Resyn
checks payable to T.F. McAdam (not otherwise identified in the
record) dated July 2, 1963, for $11,798.81 and July 8, 1963, for
$11,785.89.
There were often long delays in negotiating the Resyn checks
deposited in the Polymer account.
Resyn checks totaling
$87,750.12, which petitioner deposited in the Polymer account in
1966, were written in 1963.
In 1968, petitioner deposited in the
Polymer account $10,000 of Resyn checks written in 1967.
In
1969, petitioner deposited in the Polymer account a Resyn check
for $517.83 written in 1967 and Resyn checks totaling $56,564.76
written in 1968.
Petitioner had Levenson sign and endorse blank checks on the
Polymer account which petitioner later wrote to cash as follows:
Date of Check
Jan. 15, 1968
Sep. 25, 1968
Nov. 29, 1968
Amount
$10,000
22,000
8,000
- 13 Mar. 17, 1969
Apr. 18, 1969
May 21, 1969
Jun. 20, 1969
Jul. 25, 1969
Sep. 19, 1969
Sep. 30, 1969
Oct. 8, 1969
Oct. 23, 1969
Oct. 31, 1969
Nov. 14, 1969
Nov. 29, 1969
Dec. 22, 1969
13,000
5,500
12,000
8,000
13,000
5,000
15,000
10,000
5,000
5,000
6,000
5,000
5,000
The checks were negotiated in the year written.
D.
Chemical Traders
1.
Petitioner's Formation and Use of Chemical Traders
On May 31, 1955, petitioner and his brother, Jesse Levitt,
registered the trade name Chemical Traders with the State of New
Jersey.
The trade name certificate stated that Chemical Traders
would do business at 128 Clinton Avenue, Newark, New Jersey.
Petitioner opened a Chemical Traders bank account on November 20,
1959.
Chemical Traders had a checking account at the National
State Bank, Hillside, New Jersey, from 1963 to 1970.
Petitioner
signed the signature card for the account and personally
conducted Chemical Traders' transactions at the National State
Bank.
Chemical Traders monthly bank statements did not have a
mailing address.
Petitioner picked up the Chemical Traders'
monthly bank statements and canceled checks.
Philbin, Levenson,
and Goldstein did not know about Chemical Traders or the Chemical
Traders bank account at the National State Bank during the years
in issue.
- 14 There was no Chemical Traders office or plant at 128 Clinton
Avenue, Newark, New Jersey, when respondent's agents investigated
this case in 1971 and 1972.
Respondent's agents did not find any
reference to Chemical Traders in a directory of chemical
suppliers.
Petitioner required Resyn's buyers to deliver their payments
to Chemical Traders to his home.
The checks from one buyer
totaled as follows:
Year
1963
1964
1965
1966
Amount of Checks
$24,276.40
59,042.36
18,015.00
199,037.00
Year
1967
1968
1969
1970
Amount of Checks
$38,254.00
- 0 2,766.35
15,600.00
Petitioner either cashed these checks or deposited them in the
Chemical Traders bank account.
Chemical Traders did not file income tax returns for the
years 1963 to 1970.
2.
Amounts Petitioner Diverted From Resyn to Chemical
Traders
Petitioner diverted the following amounts from Resyn to the
Chemical Traders' checking account:
Year
1963
1964
1965
1966
1967
1968
1969
1970
Total
Amount of Deposits
$163,497.44
297,115.19
248,435.81
526,815.33
253,767.62
66,554.58
70,878.23
15,600.00
$1,642,664.20
Monthly
Statements
Available
6
11
12
12
12
12
11
11
- 15 3.
Rambach Chemical Corp.
Rambach Chemical Corp. (Rambach) did business with Resyn
beginning in 1952.
From 1963 to 1967, Rambach paid Chemical
Traders' bills for chemicals Resyn supplied to Rambach as
follows:
Year
1963
1964
1965
1966
1967
1969
1970
Amount
$10,275.00
63,043.36
18,015.00
126,870.00
6,480.00
14,425.00
15,900.00
Petitioner told Rambach to mail payments for chemicals to
his home.
Harvey Rambach, president of Rambach, sent a letter to
Leo Levitt, Chemical Traders, 128 Clinton Avenue, Newark, New
Jersey, on March 10, 1969.
The Post Office returned the letter
undelivered, "Addressee Unknown".
Chemical Traders did not have
any production facilities when it dealt with Rambach.
4.
MacArthur Petroleum & Solvent Co.
From 1966 to 1969, MacArthur Petroleum & Solvent Co.
(MacArthur) paid Chemical Traders for commissions and discounts
on sales from Resyn to MacArthur.
Under the agreement between
Sande Wische, president of MacArthur, and petitioner on behalf of
Resyn, MacArthur billed Resyn full price for chemicals that Resyn
bought, and MacArthur paid Chemical Traders separately for any
commissions and discounts it owed to Resyn.
Petitioner deposited
the checks from MacArthur for Resyn's discounts and commissions
- 16 in the Chemical Traders account.
MacArthur paid the following
Resyn discounts and commissions to Chemical Traders:
Date
Nov. 15, 1966
Dec. 20, 1966
Feb. 18, 1967
Apr. 17, 1967
Apr. 17, 1967
Jun. 28, 1967
Sep. 22, 1967
Jan. 26, 1968
Mar. 8, 1968
Jul. 15, 1968
Jul. 15, 1968
Jul. 31, 1968
Sep. 13, 1968
Nov. 8, 1968
Dec. 10, 1968
May 23, 1969
Oct. 24, 1969
5.
Amount
$2,272.49
2,200.84
1,963.97
1,853.45
1,770.47
1,578.98
5,298.71
5,427.29
6,120.16
3,399.72
2,771.75
2,673.42
5,006.10
3,708.10
4,222.20
8,373.73
8,296.35
Spencer-Kellogg and Atlas Paint
Resyn bought linseed oil from Spencer-Kellogg Co. (SpencerKellogg) in 1967 and 1968.
oil.
Resyn paid Spencer-Kellogg for the
Spencer shipped the oil to Atlas.
Chemical Traders billed
and was paid by Atlas for the linseed oil.
As a result, Resyn
paid for the linseed oil but did not receive it, and Chemical
Traders sold it to Atlas without paying for it.
6.
Petitioner's Use of Funds in the Chemical Traders
Account
Petitioner wrote checks to cash from the Chemical Traders
account totaling:
$160,824 in 1965, $160,541 in 1966, $256,000
in 1967, $69,500 in 1968, $53,850 in 1969, and $19,500 in 1970.
He endorsed all but two of those checks (dated June 28, 1965, for
$1,625; and June 1, 1967, for $1,000).
The camp attended by
- 17 petitioners' children in 1965 endorsed the 1965 check.
A close
friend of petitioner endorsed the 1967 check.
Petitioner used the Chemical Traders checking account to buy
the following cashier's checks that he used to buy stock:
Year
1963
1963
Amount of
Checks
$30,000
28,000
Payee
Leo N. Levitt
Heller & Meyer
1964
1964
22,500
61,000
Leo N. Levitt
Heller & Meyer
1965
20,625
Heller & Meyer
1966
1966
1966
1966
23,300
26,690
15,000
88,445
Carl M. Loeb Rhodes & Co.
Bache & Co.
Edwards & Hanley
Heller & Meyer
1967
1967
1967
1967
30,000
16,000
2,000
78,500
Leo N. Levitt
Eastman Dillon
Edwards & Hanley
Bache & Co.
1968
2,007
Eastman Dillon
1969
1969
3,950
4,400
$452,417
Total
E.
Pressman, Frohlich & Frost
Heller & Meyer
Resyn's Bankruptcy
On September 3, 1970, Resyn filed a petition for chapter 11
reorganization with the U.S. bankruptcy court for the District of
New Jersey.
The bankruptcy court appointed a receiver to operate Resyn
during the bankruptcy proceedings.
The receiver unsuccessfully
tried to obtain Resyn's books and records for the years in issue.
- 18 In December 1970, petitioner filed a Statement of Affairs
with the bankruptcy court on behalf of Resyn, in which he
answered certain questions.
Question 7 was as follows:
Bank accounts and safe deposit boxes
a.
What bank accounts have you maintained,
alone or together with any other person and in your
name or any other name, within the two years
immediately preceding the filing of the original
petition herein?
(Give the name and address of each bank, the name
in which the deposit was maintained and the name of
every person authorized to make withdrawals from such
account.)
Petitioner answered question 7, but did not mention the Chemical
Traders or Polymer accounts.
The Commissioner filed a proof of claim on January 5, 1971,
and several amended proofs of claim between January 27, 1971, and
September 19, 1976.
The Commissioner filed a final amended claim
of $2,376,726.43 for unpaid corporate income taxes, interest, and
penalties for 1963 to 1970.
F.
Respondent's Investigation of Petitioner and Resyn
1.
Administrative Investigation
Respondent began a joint criminal and civil administrative
investigation of petitioner and Resyn in December 1970.
An
administrative investigation is an investigation that is
conducted solely by respondent's agents.
before a grand jury.
It is not conducted
A special agent and cooperating revenue
agents were assigned to the investigation.
- 19 A U.S. attorney, respondent's agents, and persons outside
the IRS sometimes help a grand jury to investigate a case.
Respondent did not participate in a grand jury investigation of
Resyn or petitioner.
2.
Strike Force
Respondent's administrative investigation of petitioner and
Resyn was part of a program to investigate persons suspected of
being involved with organized crime.
called a strike force.
The program was later
The strike force included the Federal
Bureau of Investigation (FBI), Secret Service, Bureau of
Narcotics and Dangerous Drugs, Bureau of Alcohol, Tobacco, &
Firearms, Customs Service, Postal Service, and IRS.
The IRS and
other agencies made progress reports to strike force attorneys.
Respondent's agents, and not strike force personnel,
controlled the joint civil and criminal tax investigation of
Resyn and petitioner.
Strike force attorneys helped agents of
different agencies conduct their investigations if needed.
Respondent's investigators in this case filed periodic status
reports with the strike force coordinator, Arthur Rubenstein
(Rubenstein), who forwarded them to the Regional Organized Crime
Drive Coordinator who monitored strike force cases.
The regional
coordinator forwarded the reports to respondent's Intelligence
Division at the national office in Washington, D.C.
Those status
reports did not go to the U.S. Attorney's Office or to any strike
force attorney.
- 20 3.
Early Stages of the Investigation
Special Agent Erich Fried (Fried) was the first agent
assigned to the investigation.
Revenue Agent Richard Cronin
(Cronin) was assigned to the investigation as the cooperating
agent.
He worked with Fried.
the investigation.
Irving B. Dubow (Dubow) supervised
Above Dubow in the chain of command were a
branch chief, an assistant division chief, and the Chief,
Intelligence Division in Washington, D.C.
Dubow's agents
believed that Ruth Levitt was related to an organized crime
racketeer.
Fried started the file on this case when he received a
newspaper clipping stating that the Union County prosecutor's
office had obtained an indictment of petitioner for chemical
theft.
records.
Fried immediately began trying to get Resyn's books and
Fried, Cronin, and Dubow wanted to calculate Resyn's
tax liability so the Commissioner could file a proof of claim in
the Resyn bankruptcy proceeding.
Fried and Cronin tried
unsuccessfully to obtain Resyn's records from the bankruptcy
trustee and receiver.
At that time, Fried and Dubow did not use
the administrative summons procedure under section 7602 because
they believed it took too long to enforce.
4.
Reluctant Witness Procedure
During the years respondent investigated this case,
respondent sometimes used the "reluctant witness" procedure to
obtain evidence.
Under this procedure, a special agent could
request IRS and Justice Department approval to subpoena a witness
- 21 to appear before a grand jury.
Respondent's reluctant witness
procedure at that time required the agent to show that the
investigation was stymied and to provide a summary of the
witness' anticipated testimony.
If the IRS and the Justice
Department approved the request, Justice Department attorneys
could use grand jury subpoenas to obtain evidence and could seek
a rule 6(e)2 order from a Federal District Court permitting them
to give that evidence to the IRS.
Around March 1971, Fried asked his supervisors for grand
jury assistance in this case.
He sent (via his supervisor) a
memorandum to the Chief, Intelligence Division, asking for
permission to issue a grand jury subpoena to petitioner to compel
2
Rule 6(e) provides:
(e) Secrecy of Proceedings and Disclosure.
Disclosure of matters occurring before the grand jury
other than its deliberations and the vote of any juror
may be made to the attorneys for the government for use
in the performance of their duties. Otherwise a juror,
attorney, interpreter, stenographer, operator of a
recording device, or any typist who transcribes
recorded testimony may disclose matters occurring
before the grand jury only when so directed by the
court preliminarily to or in connection with a judicial
proceeding or when permitted by the court at the
request of the defendant upon a showing that grounds
may exist for a motion to dismiss the indictment
because of matters occurring before the grand jury. No
obligation of secrecy may be imposed upon any person
except in accordance with this rule. The court may
direct that an indictment shall be kept secret until
the defendant is in custody or has given bail, and in
that event the clerk shall seal the indictment and no
person shall disclose the finding of the indictment
except when necessary for the issuance and execution of
a warrant or summons.
- 22 him to provide Resyn's records.
He explained that Resyn's
receiver in bankruptcy had been unable to get Resyn's records.
Fried sent the memorandum because he wanted to review Resyn's
books and records and because the cooperating revenue agent
needed those records to prepare a proof of claim.
request was approved.
Fried's
Fried served grand jury subpoenas on
petitioner and Goldstein on June 17, 1971, and Philbin on
June 28, 1971.
Philbin, Resyn's bookkeeper, gave Resyn's
business records to the grand jury.
Respondent obtained those
records from the grand jury.
In July 1971, Special Agent Frank O'Byrne (O'Byrne) replaced
Fried in the investigation of petitioner and Resyn.
the case file when he was assigned to the case.
O'Byrne read
It contained
certain of Resyn's ledgers, files, and canceled checks for 1967,
1968, and 1969.
The file also contained transcripts of the grand
jury testimony of Goldstein, Becker, and Philbin.
The file did
not include a copy of a rule 6(e) order.
Revenue Agents Paul A. Dorgeval, Jr. (Dorgeval), and Cronin
continued to investigate petitioner and Resyn for respondent.
Dorgeval and Cronin did not read the grand jury transcripts.
From July to October 1971, respondent's agents examined
Resyn's canceled checks.
They discovered a wide gap between the
time that certain Resyn checks were written and the time they
were deposited or negotiated by the payee.
- 23 G.
Third Party Information
Respondent's agents suspected that Resyn had made payments
to fictitious entities.
Based on that theory, Cronin, Dorgeval,
and O'Byrne issued 48 administrative summonses from November 3,
1971, to September 26, 1972.
They issued administrative
summonses to third parties including banks, businesses that
bought and sold Resyn products, and Goldstein, who prepared
petitioners' tax returns.
In the summons, they asked for bank
records, canceled checks, invoices, and other business records
pertaining to Resyn, Chemical Traders, Polymer, and petitioners.
Respondent's agents discovered the Chemical Traders account
between July 1971 and December 1972.
Respondent's agents could not reconstruct all of Resyn's
transactions because most of Resyn's business records for the
years in issue were missing.
Respondent's agents had only
Resyn's general ledger and journal for 1969, purchase journals
for 1968 and 1969, and canceled checks for 1967, 1968, and 1969.
H.
Meetings With FBI Agents and Strike Force Attorney
Rubenstein was an IRS employee who was the IRS liaison with
other strike force law enforcement agencies.
He also reviewed
strike force reports from other agencies for possible Internal
Revenue Code violations.
Cronin told the FBI that he suspected
that petitioner and Resyn might have violated bankruptcy laws.
Rubenstein arranged for Cronin to meet with two FBI agents from
the Newark Bankruptcy Fraud Squad.
The FBI did not investigate
- 24 petitioner or Resyn for bankruptcy fraud, and respondent took no
further action.
Rubenstein arranged a meeting with representatives of the
Justice Department to decide whether to grant immunity to
Goldstein.
Herbert Posner (Posner), a strike force attorney from
the Justice Department, attended the meeting.
receive immunity.
Goldstein did not
O'Byrne discussed this case with Posner
several other times and had several other incidental contacts
with Posner.
I.
Referral of Case to the Justice Department
O'Byrne completed his investigation in December 1972.
In
his special agent's report, filed December 29, 1972, he discussed
Fried's participation in the case.
subpoenas had been served.
He stated that grand jury
O'Byrne attached copies of the grand
jury transcripts to his report.
O'Byrne never saw a copy of a
rule 6(e) order in this case and did not include one in his
report.
Dubow's group told the strike force attorney the results
of the investigation after it was completed.
W.J. McElroy, a member of the Intelligence Division, Newark
District, signed the following cover letter sending O'Byrne's
report to the Regional Counsel's office in Philadelphia around
December 29, 1972:
"The Strike Force Attorney Newark, New Jersey
was advised of this investigation, the evidence obtained, and the
method of proving the unreported income, and has concurred in the
recommendation to prosecute".
- 25 James MacDonald (MacDonald) was a staff attorney who
reviewed criminal tax matters for respondent's Regional Counsel
in Newark.
His work was limited to criminal enforcement.
MacDonald did not have authority to stop a recommendation to
prosecute a strike force case.
MacDonald reviewed O'Byrne's
report and the file for respondent's Regional Counsel.
MacDonald
had a conference with Herbert Zuckerman (Zuckerman), petitioner's
counsel.
In March or April 1973, MacDonald contacted O'Byrne and
asked him for additional information including a copy of the rule
6(e) order.
O'Byrne did not obtain a copy of the rule 6(e)
order; he believed that his supervisor, Dubow, gave the rule 6(e)
order to MacDonald.
MacDonald sent a criminal referral letter to Scott P.
Crampton, Assistant Attorney General, Tax Division, Department of
Justice, dated May 17, 1973.
The letter stated:
The specific items of unreported income in this case
were discovered by review of Resyn Corporation's
cancelled checks gotten by the government as a result
of a grand jury subpoena (Special Agent's Report, Pages
12 and 13). The examining agents (acting pursuant to
the authority granted by the Court in a valid [Rule §
6(e)] order * * *) found checks payable to Polymer
Chemicals. Subsequent inquiries with the bank where
the Polymer Chemical account was held disclosed the
existence of the Chemical Trader account (Special
Agent's Report, Page 12). No evidence of the two bank
accounts was disclosed by Levitt, or by any of his
employees, pursuant to testimony in bankruptcy
proceedings.
MacDonald's criminal referral letter stated that a copy of the
rule 6(e) order was attached as exhibit C.
However, there is no
copy of the rule 6(e) order in respondent's file.
- 26 Posner obtained a blanket rule 6(e) order which he believed
allowed him to give any information, books, or records to any
Federal law enforcement officer.
order for each investigation.
He did not get a rule 6(e)
Instead, he got one that covered
all investigations of a grand jury which was usually good for
about a year and a half.
On April 4, 1974, O'Byrne testified before the grand jury
that indicted petitioner under section 7201 for willful tax
evasion for 1967 to 1969.
J.
Petitioner's Criminal Case
In 1974, petitioner pleaded nolo contendere to tax evasion
for 1970 and received a suspended sentence.
K.
Resyn's Bankruptcy Trial
In January 1978, Resyn asked the bankruptcy court to
expunge, reduce, or modify the Commissioner's corporate tax claim
for 1963 to 1967 and fraud penalties for 1963 to 1969.
The
bankruptcy court held a 6-day trial in February and March 1981,
during which the parties vigorously contested Resyn's tax
liability.
Zuckerman, one of petitioners' attorneys in the
instant case, was Resyn's attorney at the trial.
Zuckerman saw
no conflict in representing petitioner and Resyn in the
bankruptcy case.
Petitioner attended the Resyn bankruptcy trial
but did not testify.
The bankruptcy court issued its opinion on November 18,
1981.
That court decided that petitioner diverted Resyn income
- 27 into bank accounts of fictitious entities, resulting in
substantial tax deficiencies for Resyn and that the deficiencies
were due to fraud.
D.N.J. 1981).
In re Resyn Corp. 81-2 USTC par. 9808 (Bankr.
The bankruptcy court found the following facts:
Resyn understated its corporate income by
diverting to Chemical Traders receipts of sales of
goods owned by Resyn but never entered on the Resyn
books and records as Resyn sales.
As noted earlier, "Chemical Traders" was a trade
name controlled by Leo Levitt, but the record before
the Court discloses no evidence that any business
entity using that name was ever located at 128 Clinton
Avenue, Newark, New Jersey, the listed business address
of same. There is no evidence that Chemical Traders
had any employees, any business records, or books of
account, conducted any business, filed any state or
federal tax returns or paid any federal or state income
taxes. The only evidence of its existence was the bank
account maintained in that name at the National State
Bank of Elizabeth, New Jersey. It is noted that
neither the Resyn bookkeeper, its accountant, and its
comptroller had ever heard of Chemical Traders until
the commencement of the Chapter XI proceedings in 1970.
However, despite the fact that it conducted no
business operation, large sums of money were deposited
into the Chemical Traders' bank account. The amount of
the deposits during the years in question is as
follows:
Year
1963
1964
1965
1966
Amount Deposited
$163,497.44
297,115.00
248,437.13
526,815.53
Year
1967
1968
1969
1970
Amounted Deposited
$253,767.62
66,555.58
70,878.23
15,600.00
Many of the deposits in the Chemical Traders' bank
account resulted from transactions involving Rambach
Chemical Company or Rambach International Company.
During the years 1963 through 1970, the Rambach
companies purchased substantial amounts of chemicals
which belonged to Resyn but were shipped to Rambach on
invoices labeled Chemical Traders.
- 28 Deliveries of the chemicals sold to the Rambach
companies originated at the Resyn plant. An invoice
from the American Warehousing Corp., 96 Pine Street,
Jersey City, New Jersey to Rambach charges Rambach as
follows: "Chg 2nd attempt to pick up bags at Resyn
Corp. $50.00." A handwritten note on this invoice
reads: "Deduct from last Chemical Traders' bill we get
in about 2 or 3 weeks." Thereafter Rambach took a
deduction of $50.00 from the Chemical Traders' invoice
dated December 8, 1966.
An invoice of the American Warehouse Corp. dated
March 4, 1969 for the delivery of 2,200 bags of maleic
anhydride to Rambach reads:
"Ex:
2/24
2/28
Resyn Corp.
Delayed at Resyn 1/2 day $50.00
Delayed 2 trailers at Resyn, full day
$100.00"
With regard to this charge, Rambach wrote to Levitt at
Chemical Traders, 128 Clinton Avenue, Newark, New
Jersey. The latter was [returned] to Rambach stamped
"Addressee Unknown."
All of the payments made by Rambach for chemicals
purchased were mailed to Leo Levitt's home at 58
Whiteoak Drive, South Orange, New Jersey. This was
done at the direction of Leo Levitt who caused to be
attached to the Chemical Traders' invoices directions
that payments were to be mailed to him at the South
Orange, New Jersey address.
The checks issued by Rambach to Chemical Traders
and mailed to Levitt totalled as follows:
Year
1963
1964
1965
1966
Amount of Check
$14,276.40
59,042.36
18,015.00
199,037.00
Year
1967
1968
1969
1970
Amount of Check
$38,244.00
0
2,766.35
15,600.00
The checks received by Leo Levitt for the
chemicals sold to Rambach were either cashed or
deposited in the Chemical Traders' bank account. Many
of the Rambach checks to Chemical Traders bear the
notation "for deposit only, Chemical Traders."
The chemicals sold to Rambach were the property
of Resyn and the receipts from the sale of same were
- 29 diverted from Resyn to the Chemical Traders' bank
account which was under the sole control of Leo Levitt.
The said receipts were not entered as income on the
books of Resyn and not reported on Resyn's income tax
return.
The Chemical Traders' bank account was also used
in certain transactions involving the Witco Chemical
Company. During the course of the operation of its
business, Resyn would purchase chemicals from the Witco
Chemical Company and would be allowed discounts on bulk
purchases made. The discounts received were then
deposited not in the Resyn bank accounts but in the
Chemical Traders' bank account. The total amount of
deposits into the Chemical Traders' bank account which
resulted from bulk purchase discounts were as follows:
Year
1963
1965
1966
Deposits Resulting from
Bulk Purchase Discounts
$ 3,600.00
92,588.80
37,240.00
Total
$133,428.80
This diversion of the bulk purchase discounts resulted
in the overstatement of the cost of goods sold and the
understatement of income and income tax due on the
Resyn tax returns for 1963, 1965 and 1966.
Another graphic example of the diversion of income
from Resyn to Chemical Traders is found in the
transactions involving Spencer-Kellogg. Resyn would
purchase oil from Spencer-Kellogg and upon resale of
same, the bill or invoice was sent to Chemical Traders
and not Resyn.
On June 19, 1967 Spencer-Kellogg shipped 31,000
pounds of raw linseed oil to the Atlas Paint Company.
The Spencer-Kellogg invoice indicates that this
shipment was sold to Resyn. However, it is a Chemical
Traders' invoice dated, June 19, 1967, that bills Atlas
for 31,020 pounds of linseed oil.
Similarly, a Spencer-Kellogg invoice charges Resyn
for 4,000 pounds of 2-2 linseed oil which was sold to
Resyn but shipped to the Atlas Paint Company on
September 1, 1967. Resyn paid for this shipment by
Check No. 6135 but Atlas Paint Company was billed not
by Resyn, but, by Chemical Traders on a Chemical
Traders' invoice dated, inter alia, September 1, 1967.
- 30 Thereafter on October 4, 1967, Spencer-Kellogg
shipped 31,010 pounds of raw linseed oil to Atlas Paint
Company and billed Resyn $4,080.92 for this shipment.
Again, a Chemical Traders' invoice dated, inter alia,
October 4, 1967 bills Atlas Paint Company for 31,010
pounds of raw linseed oil.
In addition to understating income through the use
of the Chemical Traders' trade name, Resyn overstated
the cost of goods sold by the use of the Polymer
Chemicals' trade name.
As noted above, Polymer Chemicals maintained a
bank account at the National State Bank of Elizabeth,
New Jersey where the authorized signatory on the
account was Harry Levinson.
The record fails to disclose that Polymer
Chemicals maintained offices, engaged in any business
venture, had any employees, was incorporated as a
company in New Jersey, paid any New Jersey state
corporate taxes or any federal corporate taxes or filed
any such tax returns.
Irving Becker, employed by Resyn since 1967 as
an expediter of deliveries to Resyn customers and as
credit manager, was familiar with all of Resyn's
suppliers. He testified that he was not familiar with
Polymer Chemicals and knew nothing of the Polymer
Chemicals' account. A world-wide survey of companies
which deal in the chemicals purportedly sold by Polymer
Chemicals to Resyn showed that none of them had any
knowledge of a company called Polymer Chemicals. There
is not a scintilla of evidence in the record indicating
that Polymer Chemicals could or did deliver the large
quantities of chemicals to Resyn for which it received
payment from Resyn. In fact, the bookkeeper for Resyn
testified that when she prepared a bill for payment,
she would ordinarily receive an invoice and shipping
documents but that when she received a Polymer
Chemicals' invoice for payment, it was never
accompanied by shipping documents.
From 1963 through 1970, numerous checks totaling
$603,458.84, were drawn on the Resyn bank account
payable to the order of Polymer Chemicals. The Resyn
checks were signed by Leo Levitt and were deposited in
the Polymer Chemicals' bank account. The breakdown of
the checks deposited is as follows:
- 31 Year
Checks Deposited
1963
1964
1966
1968
1969
1970
$108,404.48
238,555.24
87,750.12
40,818.47
122,559.81
5,370.72
$603,458.84
Total
Between 1963 through 1970 Resyn paid various
Polymer Chemicals' invoices for fictitious purchases
of chemicals and listed said payments on the books of
Resyn as costs of goods sold. As a result, Resyn's
cost of goods sold was overstated in the following
manner:
Year
Amount of Overstatement
1963
1964
1967
1968
1969
1970
Total
196,154.00
238,555.00
10,517.83
87,082.23
69,518.99
3,420.51
$605,248.56
Many of the Resyn checks made payable to Polymer
Chemicals were not deposited but were withheld for
deposit for a year other than the one in which they
were written. However, the adjustment to the cost of
goods sold is effective for the tax year in which the
checks to Polymer Chemicals were written and not the
tax year in which they were negotiated.
During the same time period, 1963 through 1970,
Leo Levitt withdrew a total of $1,006,019.91 from the
Polymer Chemicals' bank account at the Hillside office
of the National State Bank. He was able to accomplish
this by having Harry Levinson sign the checks in blank.
- 32 The breakdown of the funds withdrawn is as
follows:
Year
Funds Withdrawn
1963
1964
1965
1966
1968
1969
$107,000.00
236,400.00
3,250.00
462,941.00
41,428.91
125,000.00
It is clear that the cost for goods allegedly
purchased from Polymer Chemicals was knowingly
overstated by Resyn on its books and it resulted in a
fraudulent understatement of corporate income tax due
on the Resyn corporate income tax returns for the years
1963, 1964, 1967, 1968 and 1969.
As to the above recited transactions involving
Chemical Traders, the Rambach companies, Witco Chemical
Company and Atlas Paint Company, it is clear that the
diversion to Chemical Traders of monies due Resyn
resulted in a fraudulent overstatement of cost of goods
sold regarding the Witco transactions and a fraudulent
understatement of income in the Rambach transactions.
The Court finds that as a result of the alleged
dealings involving Polymer Chemicals and Chemical
Traders, the Resyn corporate income tax due on its
return for the years 1963, 1964, 1965, 1966 and 1967
was underpaid and at least part of the underpayment for
each year was due to fraud.
*
*
*
*
*
*
*
In considering all of the evidence before it, the
Court is satisfied that both Chemical Traders and
Polymer Chemicals are fictional entities used by Resyn
for the fraudulent purpose of evading taxes and with
the express purpose of diverting large sums of money to
Leo Levitt, the sole shareholder of Resyn. Levitt
controlled the withdrawals from the bank accounts of
both Chemical Traders and Polymer Chemicals. While
Harry Levinson signed many checks on the Polymer
Chemicals' bank account, he signed them in blank, at
Levitt's request and never knew what was done with the
proceeds of the checks.
- 33 An analysis of the Chemical Traders' bank account
and checks drawn on it shows that in 1966 it issued
checks in the total amount of $462,921.00, of which
$115,000.00 was written to cash. Traced to Levitt's
personal accounts with various stock brokerage firms
was the sum of $84,941.00. Additionally, a check drawn
to an unknown payee was deposited to Levitt's account
at the Merchant's Bank of New York and another check
also payable to an unknown payee was deposited to
Levitt's account at Edwards & Hanley, a stock brokerage
firm.
In 1967 Chemical Traders issued checks totalling
$320,000.00. Of this sum, a total of $106,500.00 was
deposited into various personal accounts held by Levitt
with various stock brokerage firms while the
disposition of an additional $128,500.00 is unknown.
Given the total control Levitt had over this account
and his total control of the Resyn operation, his
failure to testify as to unidentified deposits and
withdrawals on the account is significant. * * *
In re Resyn Corp., 81-2 USTC par. 9808, at 88,686-88,691 (Bankr.
D.N.J. 1981).
The bankruptcy court entered a judgment against Resyn on
December 9, 1981.
The District Court for the District of New
Jersey entered opinions on November 22, 1982, August 19, 1986,
and December 31, 1986, on appeal from the bankruptcy court's
judgment.
The Court of Appeals for the Third Circuit issued two
opinions, Resyn Corp. v United States, 851 F.2d 660 (3d Cir.
1988), and In re Resyn Corp., 945 F.2d 1279 (3d Cir. 1991).
The
District Court entered its order on remand on July 9, 1992.
There has been no appeal from that order.
L.
Sale of Resyn Corporation
Petitioner sold Resyn to Celanese Corp. in August 1977.
1981, Resyn had no assets, but was liable for obligations to
Celanese Corp. and to respondent.
In
- 34 M.
Notice of Deficiency
Dorgeval investigated petitioners and Resyn from 1970 to at
least 1984.
He prepared a series of reports of proposed
adjustments for Resyn and petitioners.
report on March 14, 1984.
He completed the last
That report was the basis for the
notice of deficiency in this case.
Respondent mailed the notice
of deficiency on September 12, 1990.
Petitioners and Zuckerman
signed consents to extend the time to assess tax for 1969 and
1970, which kept those years open until terminated.
Respondent determined that petitioners received constructive
dividends from Resyn from 1963 to 1970 by analyzing Resyn's
earned surplus for that period.
Respondent determined that Resyn
paid checks for petitioners' benefit of $261,789 in 1967,
$431,593 in 1968, and $341,725 in 1969.
Respondent deducted from
those amounts the increases to petitioner's loan account, salary
paid to petitioner, capital items, and additional business
expenses.
Respondent determined that petitioners had unreported
income of $25,022 in 1967 and $41,245.21 in 1968 based on Resyn
checks used to pay petitioners' personal expenses. N.
Petitioners' 1963 Return
Petitioners timely filed their 1963 income tax return.
Respondent did not offer a copy of petitioners' 1963 return into
evidence.
Respondent's revenue agent's report for 1963 states
that petitioners reported taxable income of $30,499.50 and that
petitioner's total tax was $9,656.63.
Respondent had a copy of
- 35 an unsigned 1963 return for petitioners that also showed those
amounts as petitioners' reported taxable income and total tax.
The record does not show who prepared that purported return.
There is no evidence that the unsigned return is the same as the
return petitioners filed for 1963.
OPINION
A.
Whether Respondent Violated Grand Jury Secrecy Rules
Before trial, petitioners moved to suppress evidence that
respondent used in this case which petitioners contend includes
matters and fruits of matters occurring before a Federal grand
jury in violation of rule 6(e).
pretrial motion to suppress.
1.
The Court denied petitioners'
We reaffirm that ruling here.
Resyn Business Records Are Not Grand Jury Material in
This Case
Generally, matters occurring before a Federal grand jury may
not be disclosed.
Fed. R. Crim. P. 6(e); In re Grand Jury Matter
(Catania), 682 F.2d 61, 63 (3d Cir. 1982).
Petitioners contend
that Resyn's business records are matters occurring before a
grand jury for purposes of rule 6(e).
We disagree.
Resyn created its business records independently of a grand
jury proceeding.
Petitioners point out that business records
created independently of a grand jury proceeding may be grand
jury matters if disclosure of them will reveal the grand jury's
deliberative process.
See, e.g., In re Grand Jury Subpoena
(Under Seal), 920 F.2d 235, 241 (4th Cir. 1990); In re Grand Jury
Proceedings Relative to Perl, 838 F.2d 304, 306 (8th Cir. 1988);
- 36 Senate of Puerto Rico v. U.S. Dept. of Justice, 823 F.2d 574, 582
(D.C. Cir. 1987); Anaya v. United States, 815 F.2d 1373, 1379
(10th Cir. 1987); In re Special March 1981 Grand Jury (Almond
Pharmacy), 753 F.2d 575, 578 (7th Cir. 1985); In re Grand Jury
Matter (Garden Court), 697 F.2d 511, 512-513 (3d Cir. 1982); In
re Grand Jury Matter (Catania), supra at 63; In re Grand Jury
Matter (N.J. State Comm. of Investigation), 630 F.2d 996, 1000
(3d Cir. 1980).
Petitioners contend that disclosure of Resyn's records
would reveal grand jury deliberations.
We disagree.
requested the books and records of Resyn.
Respondent
Respondent did not
request all of the grand jury matter related to Resyn and
petitioners.
A general request for all grand jury records would,
in effect, be a disclosure of the grand jury proceedings.
See
United States v. Stanford, 589 F.2d 285, 291 n.6 (7th Cir. 1978);
In re Grand Jury Criminal Indictments 76-149 and 77-72, 469 F.
Supp. 666, 671 (M.D. Pa. 1978).3
We conclude that disclosure of
Resyn's business records would not reveal secret grand jury
deliberations.
3
Respondent contends that use of Resyn's business records
and other third party records that respondent obtained from the
grand jury is no longer restricted by rule 6(e) because the
bankruptcy court admitted those records into evidence at Resyn's
bankruptcy trial. We need not decide respondent's contention in
light of our conclusion that Resyn's business records are not
grand jury material subject to the secrecy provisions of rule
6(e).
- 37 2.
Grand Jury Transcripts
Petitioners allege that respondent relied on grand jury
transcripts to determine petitioner's civil tax liability in
this case.
Petitioner points out that O'Byrne mentioned the
transcripts in his criminal referral letter.
However, O'Byrne
testified and we believe that he did not rely on grand jury
testimony to develop petitioners' civil tax liability.
Revenue
Agents Cronin and Dorgeval did not read the grand jury
transcripts; they used Resyn's business records and third party
records, all of which existed independently of the grand jury.
Thus, we are convinced that respondent did not use grand jury
transcripts to develop the civil tax case.
B.
Whether Petitioner Is Collaterally Estopped From Denying
Factual Findings of the Bankruptcy Court
1.
Background
Petitioners contend that collateral estoppel does not
prevent petitioner from contesting factual findings made by the
bankruptcy court in In re Resyn Corp., 81-2 USTC par. 9808
(Bankr. D.N.J. 1981)
We disagree.
If collateral estoppel applies, issues which were litigated
and decided in an earlier case on a different cause of action
cannot be relitigated by the parties or their privies.
Montana
v. United States, 440 U.S. 147, 153 (1979); Parklane Hosiery Co.
v. Shore, 439 U.S. 322, 326 n.5 (1979); Commissioner v. Sunnen,
333 U.S. 591, 597 (1948).
Collateral estoppel protects
- 38 adversaries from the expense and vexation of multiple lawsuits,
conserves judicial resources, and fosters reliance on judicial
action by minimizing the possibility of inconsistent decisions.
Montana v. United States, supra at 153-154; Meier v.
Commissioner, 91 T.C. 273, 282-284 (1988).
can apply in Federal tax cases.
Collateral estoppel
Commissioner v. Sunnen, supra at
598.
Collateral estoppel applies in the following circumstances:
First, the matter at issue in the second suit is identical with
the one decided in the first suit.
Id. at 599-600.
Second,
there is a final judgment rendered by a court of competent
jurisdiction.
Peck v. Commissioner, 90 T.C. 162, 166 (1988),
affd. 904 F.2d 525 (9th Cir. 1990); Gammill v. Commissioner, 62
T.C. 607, 613 (1974).
Third, the parties to the second suit are
the same as the parties to the first suit or in privity with
them.
Peck v. Commissioner, supra at 166-167; Gammill v.
Commissioner, supra at 614-615.
Fourth, the parties have
actually litigated the matters at issue, and the resolution of
those matters was essential to the prior decision.
v. Sunnen, supra at 598, 601.
Commissioner
Fifth, the controlling facts and
legal principles remain unchanged.
Id. at 599-600.
Sixth, there
are no special circumstances that would warrant making exception
to the normal rules of preclusion.
Montana v. United States,
supra at 162; Meier v. Commissioner, supra at 291-292.
- 39 2.
Elements of Collateral Estoppel
a.
Identity of Matters at Issue
The first element for collateral estoppel is met because
there are identical matters at issue in the bankruptcy trial and
in the instant case, such as whether, and if so, how, petitioner
diverted Resyn income to Polymer and Chemical Traders from 1963
to 1970.
The Government had to prove fraud by clear and
convincing evidence in the bankruptcy case.
To prove fraud,
the Government proved that Leo Levitt created two sham entities,
Chemical Traders and Polymer, to conceal Resyn's income.
Resyn Corp., 81-2 USTC par. 9808 at 88,685-88,686.
In re
The accounts,
transactions, and entities in the bankruptcy case are the same as
those in the instant case.
The instant case also involves the
issue whether petitioners benefited from Resyn's unreported
income.
However, the fact that the instant case has additional
matters at issue does not bar collateral estoppel from applying
to matters at issue which are the same in both cases.
Bertoli v.
Commissioner, 103 T.C. 501, 508 (1994).
Petitioner points out that the bankruptcy court did not
decide whether petitioner committed civil tax fraud.
The fact
that the bankruptcy court did not decide whether petitioner was
personally liable for additions to tax under section 6653(b) does
not help petitioner.
The bankruptcy court found that petitioner
used Polymer and Chemical Traders to divert Resyn funds to
himself.
The bankruptcy court found that petitioner withdrew
- 40 from the Polymer account $107,000 in 1963, $236,400 in 1964,
$3,250 in 1965, $462,941 in 1966, $41,428 in 1968, and $125,000
in 1969.
The bankruptcy court found that Chemical Traders checks
totaling $115,000 were written to cash in 1966.
The bankruptcy
court traced $84,941 to petitioner's stock brokerage accounts.
The bankruptcy court found Chemical Traders checks totaling
$106,500 written to petitioner's personal accounts in 1967.
The
bankruptcy court was required to and did decide whether fraud was
present.
It found clear and convincing evidence that petitioner
diverted Resyn funds to himself through the Polymer and Chemical
Traders accounts.
Collateral estoppel precludes petitioner from
relitigating that matter.
Thus, petitioner may not relitigate
the fact that he controlled the Polymer and Chemical Traders bank
accounts and that Polymer and Chemical Traders were fictional
entities which he created to divert funds to himself from Resyn.
Petitioner may contest the extent to which he diverted funds from
Resyn to himself, beyond that found by the bankruptcy court.
b.
Final Prior Judgment
The second element for collateral estoppel is met because
the bankruptcy court's decision is final.
c.
Identity
of or Privity With Parties
The third element for collateral estoppel is met because
petitioner is in privity with Resyn.
A sole or controlling stockholder can be in privity with his
or her closely held corporation.
Marin v. Augedahl, 247 U.S.
- 41 142, 145-146 (1918); Bigelow v. Old Dominion Copper Mining &
Smelting Co., 225 U.S. 111, 141 (1912); Hawkins v. Glenn, 131
U.S. 319, 329 (1889); Sparks Nugget, Inc. v. Commissioner, T.C.
Memo. 1970-74 (sole shareholder in privity with corporation),
affd. 458 F.2d 631 (9th Cir. 1972); see also Seaboard Commercial
Corp. v. Commissioner, 28 T.C. 1034, 1047-1048 (1957) (successor
corporate sole shareholder in privity with prior corporation);
Estate of Egan v. Commissioner, 28 T.C. 998, 999 (1957), affd.
260 F.2d 779 (8th Cir. 1958) (transferee stockholder in privity
with transferor corporation); American Range Lines, Inc. v.
Commissioner, 17 T.C. 764, 771 (1951) (Court reviewed), affd. on
this issue, modified in part and remanded 200 F.2d 844 (2d Cir.
1952) (shareholder bound by corporation, but corporation not
bound by shareholder).
Petitioner was president and sole
shareholder of Resyn.
He controlled Resyn.
some of Resyn's unreported income.
He personally used
Petitioner attended the
bankruptcy trial and had the same lawyer as Resyn.
The fact that
the same attorney represents the parties in both actions is a
factor that may be considered in deciding whether the parties are
in privity.
See Crane v. Commissioner of Dept. of Agric., 602 F.
Supp. 280, 286 (D. Me. 1985).
Petitioner does not dispute that
he had an interest in opposing a finding that he caused Resyn to
commit tax fraud by creating fictitious entities and diverting
and not reporting Resyn income.
- 42 Petitioners contend that under the precedents of the Court
of Appeals for the Third Circuit a shareholder and a corporation
are not in privity.
Hornstein v. Kramer Bros. Freight Lines, 133
F.2d 143 (3d Cir. 1943).
In Hornstein, the Court of Appeals for
the Third Circuit held that under Pennsylvania law shareholders
and their corporations were not in privity in a tort case for
collateral estoppel purposes.
Id. at 146.
That interpretation
does not apply here because Pennsylvania law does not apply.
Petitioners do not cite cases under New Jersey law which hold
that a sole shareholder and his or her corporation are not in
privity for collateral estoppel purposes.4
Petitioners contend that petitioner and Resyn were not in
privity because the bankruptcy court had appointed a receiver to
be responsible for Resyn's operations at that time.
We disagree.
When a nonparty to an action has control over the conduct of the
litigation, it may be in privity with the party it controls and
bound by the results of the litigation.
American Safety Flight
Systems, Inc. v. Garrett Corp., 528 F.2d 288, 289 (9th Cir.
1975).
There is no evidence that the receiver controlled,
attended, or was involved in the bankruptcy litigation.
4
We
In their answering brief, petitioners cite a New Jersey
case involving whether the court would pierce the corporate veil
and disregard the corporate form where there was no fraud or
injustice. Lyon v. Barrett, 89 N.J. 294, 300, 445 A.2d 1153,
1156 (1982). That case does not hold or suggest that a sole
shareholder is not in privity with his corporation for purposes
of collateral estoppel.
- 43 believe petitioner controlled the bankruptcy litigation.
Petitioner's attorney represented Resyn at and petitioner
attended the bankruptcy trial.
We conclude that Resyn and
petitioner are in privity for collateral estoppel purposes.
d.
Actual and Necessary Litigation of the Matter in
Issue
The fourth element for collateral estoppel is met because,
during the 6-day bankruptcy trial, Resyn and the Commissioner
actually and necessarily litigated the facts relating to
petitioner's diversion of Resyn income.
The test for deciding
whether resolution of the litigated matters was essential to the
prior decision is whether the issue was recognized by the parties
in the prior proceeding as important and by the trier of fact as
necessary to the judgment.
n.14.
Meier v. Commissioner, 91 T.C. at 284
The parties to the bankruptcy case and the bankruptcy
court recognized that facts relating to petitioner's diversion of
Resyn's income were important and it was necessary for the
bankruptcy court to decide whether petitioner diverted Resyn's
income to Polymer and Chemical Traders and whether Resyn was
liable for fraud.
e.
Legal Principles Unchanged
The fifth element for collateral estoppel is present because
the controlling facts and legal principles have not changed. Id.
at 291.
- 44 f.
No Special Circumstances
The final element of collateral estoppel is present because
petitioners do not contend nor do we find that there are special
circumstances present that would warrant not applying the normal
rules of preclusion.
Montana v. United States, supra; Meier v.
Commissioner, supra at 291-292.
3.
Lack of Mutuality
Petitioners point out that there is no mutuality here
because respondent would not be collaterally estopped from
proceeding against petitioner even if respondent had lost the
bankruptcy case.
Petitioners contend that collateral estoppel
should not apply because there is no mutuality.
Gammill v.
Commissioner, 62 T.C. at 614-615; Divine v. Commissioner, 59 T.C.
152, 156 (1972), affd. on this issue, revd. and remanded in part
500 F.2d 1041 (2d Cir. 1974).
Under the doctrine of mutuality,
neither party may use a prior judgment to estop the other unless
the judgment binds both parties.
Meier v. Commissioner, supra at
283.
Other than arguing that mutuality would not apply because
the taxpayer here is not the same as that in In re Resyn Corp, 81
USTC par. 9808 (Bankr. D.N.J. 1981) (which we discussed in
section B-2-c, above), petitioners made no convincing argument
that mutuality would not apply here.
Further, mutuality is no
longer a requirement for applying collateral estoppel.
Parklane
Hosiery v. Shore, 439 U.S. 322 (1979); Meier v. Commissioner,
- 45 supra at 283; 1B Moore, Moore's Federal Practice, par. 0.441 [3.2] at 527-535 (2d ed. 1985).
Thus, petitioner's reliance on
Gammill and Divine is misplaced.
4.
Conclusion--Collateral Estoppel Applies
We conclude that petitioner is collaterally estopped from
contesting the factual findings of the bankruptcy court in In re
Resyn Corp., 81-2 USTC par. 9808 (Bankr. D.N.J. 1981).
Collateral estoppel establishes all of the facts found by the
bankruptcy court for purposes of the instant case.
However, our
findings of fact are also fully supported by the record in this
case.
The findings of fact by the bankruptcy court provide an
alternative basis for many of those facts.
C.
Whether Respondent's Determination Is Arbitrary
Respondent's determination is generally presumed to be
correct.
Welch v. Helvering, 290 U.S. 111, 115 (1933).
Petitioners contend that respondent's determination is arbitrary
and should not be presumed to be correct because respondent had
no rational basis for determining that petitioner received
constructive income from Chemical Traders and Polymer which he
diverted from Resyn.
We disagree.
A notice of deficiency that lacks a rational basis is
arbitrary and not presumed to be correct.
Llorente v.
Commissioner, 649 F.2d 152, 156 (2d Cir. 1981), affg. in part and
revg. and remanding in part on this issue 74 T.C. 260 (1980).
To
show that the Commissioner acted rationally, the record must link
- 46 the taxpayer to some tax-generating activity.
Id.; Schad v.
Commissioner, 87 T.C. 609, 620 (1986), affd. without published
opinion 827 F.2d 774 (11th Cir. 1987).
The record here clearly
links petitioners to the unreported income.
Traders had no business purpose.
Polymer and Chemical
Petitioner controlled the
Polymer and Chemical Traders accounts.
We conclude that
petitioner controlled Polymer because he caused Resyn to pay
Polymer for fictitious sales, he had Levenson sign blank Polymer
checks, and he withdrew substantial amounts of cash from the
Polymer account.
We conclude that petitioner controlled Chemical
Traders because he concealed it and its bank account from his
accountants and bookkeepers, he withdrew substantial amounts of
cash from the account, and he used funds from the account to buy
stock.
Resyn paid petitioner's personal expenses directly.
Petitioner paid at least $428,382 for personal stock investments
with funds from Chemical Traders.
Petitioner withdrew cash from
the Polymer and Chemical Traders accounts.
Records do not exist
showing how petitioner used all of the funds that he diverted
from Resyn to the Polymer and Chemical Traders accounts.
Petitioners contend that respondent's determination should
not be presumed to be correct because respondent did not consider
the possibility that petitioner replaced money he had previously
taken from his brokerage accounts and because respondent did not
analyze petitioners' net worth.
We know of no requirement and
petitioners cite none that respondent must conduct a net worth
- 47 analysis when there is other evidence that connects petitioner to
the diverted and unreported funds.
Petitioners have not
convinced us that respondent's determination was arbitrary.
We
therefore presume that respondent's determination is correct.
D.
Whether Petitioners Received Constructive Dividends
1.
Respondent's Determination
Respondent determined that petitioners received but did not
report constructive dividends from 1963 to 1970 which resulted in
the following deficiencies:
$180,853.16 for 1963, $225,591.07
for 1964, $67,160.06 for 1965, $241,895.20 for 1966, $98,213.03
for 1967, $221,132.70 for 1968, $258,763.57 for 1969, and
$17,945.61 for 1970.
Respondent based the determination on funds
that petitioner diverted to petitioners' benefit through the
Polymer and Chemical Traders bank accounts and on petitioners'
personal expenses that Resyn paid.
Petitioners did not report
these items on their income tax returns.
Respondent's
determination is presumed to be correct.
Welch v. Helvering,
supra at 115; Rule 142(a).
2.
Diversion of Funds to Polymer Account
Petitioners contend that petitioner's diversion of funds to
the Polymer bank account was not a constructive dividend to them
because petitioner used those diverted funds to pay business
expenses.
Petitioner testified that the alkyd resin business was
very competitive during the years in issue and that the Tepperman
brothers told him that they would give him business from Atlas if
- 48 petitioner paid them in cash.
10.5 cents per pound.
During that time, resin cost about
Petitioner said Atlas paid about 13 cents
per pound and petitioner paid Atlas 3 cents in cash.
Petitioner
said he got cash by forming Polymer and depositing in its bank
account the difference between the cost of resin and the amount
that Atlas paid.
checks.
Petitioner then bought and cashed cashier's
Resyn wrote checks totaling $87,750.12 in 1963, which
were deposited in the Polymer checking account in 1966.
A total
of $56,564.76 deposited in the Polymer checking account in 1969
was from checks written in 1968.
These delays are inconsistent
with petitioner's theory that he had to make cash payments to
Atlas.
It is implausible that the Tepperman brothers would wait
from 1963 to 1966 to be paid.
The Tepperman brothers died before trial was held in this
case.
The opinion of the bankruptcy court does not indicate, and
petitioners do not contend, that Resyn raised the business
expense theory at the bankruptcy trial.
Petitioner's claim that
he paid all the money in the Polymer account to the Tepperman
brothers is not persuasive.
3.
Diversion of Funds to Chemical Traders
Petitioner controlled the Chemical Traders account.
not tell his accountants and bookkeepers about it.
He did
He withdrew
funds from the Chemical Traders account during each of the years
from 1964 to 1969 to buy stock and did not report those amounts.
He withdrew cash in 1970 and other years.
- 49 4.
Short Term Loans
Petitioners contend that amounts Resyn paid for petitioners'
personal expenses which respondent contends were constructive
dividends were loans to petitioner from Resyn.
Courts apply
special scrutiny to the characterization by corporations that
advances made by them to their sole stockholders are loans.
Turner v. Commissioner, 812 F.2d 650, 654 (11th Cir. 1987), affg.
T.C. Memo. 1985-159.
Self-serving statements of intent, absent
objective economic indicia of debt, are of little value to sole
stockholders in unreported income cases.
Id. at 654.
Written
evidence of debt, such as consistent bookkeeping and consistent
financial reporting, may be little more than additional
declarations of intent.
Id.
The form of the transaction and the
labels used by the parties have less significance when the
corporation is closely held because the parties can mold the
transaction at their will.
Fin Hay Realty Co. v. United States,
398 F.2d 694, 697 (3d Cir. 1968); Calumet Indus., Inc. v.
Commissioner, 95 T.C. 257, 286 (1990).
In deciding whether a bona fide loan exists, we consider:
(a) Whether there is a note or other evidence of indebtedness and
whether the lender charges interest, Clark v. Commissioner, 18
T.C. 780, 783 (1952), affd. 205 F.2d 353 (2d Cir. 1953); (b)
whether there is a fixed repayment schedule, id. at 783;
Frierdich v. Commissioner, T.C. Memo. 1989-393, affd. 925 F.2d
180 (7th Cir. 1991); (c) whether the lender requests any security
- 50 or collateral, Zimmerman v. United States, 318 F.2d 611, 613 (9th
Cir. 1963); (d) whether there is a written loan agreement, Road
Materials, Inc. v. Commissioner, 407 F.2d 1121, 1123 (4th Cir.
1969), affg. T.C. Memo. 1967-187; (e) whether the parties'
records, if any, treat the transaction as a loan, id. at 11241125; and (f) whether the borrower has made any repayments,
Estate of Ames v. Commissioner, a Memorandum Opinion of this
Court dated Feb. 7, 1946.
The first four of these factors favor
respondent because there is no evidence that petitioner or Resyn
had a note, loan agreement, or any other written instrument of
indebtedness, or agreed to any rate of interest or a repayment
schedule, or provided security.
Finally, there is no evidence
that Resyn sought payments from petitioner.
Petitioners argue that petitioner repaid the loans by
forgoing salary and by making repayments.
Petitioners contend
that these repayments are recorded in Resyn's books.
However,
Resyn's books showing repayments are not in evidence.
There is
no evidence that petitioner forfeited any salary to make loan
repayments in excess of amounts taken into account by respondent.
Petitioners argue that the amounts that Resyn paid for their
personal benefit are loans because Resyn's records treat them as
a loan receivable.
We disagree.
This factor alone is not
sufficient to show that those payments are loans.
Road
Materials, Inc. v. Commissioner, supra at 1124; Calumet Indus.,
Inc. v. Commissioner, supra at 288; Baird v. Commissioner, 25
- 51 T.C. 387, 394 (1955).
Resyn's records are not sufficient to show
Resyn's and petitioner's intent; rather, we believe the recording
of petitioners' personal expenses as loans from Resyn was part of
petitioner's scheme to avoid reporting income.
Petitioners argue that the facts here are like those in
Boshwit Bros., Inc. v. Commissioner, T.C. Memo. 1982-156.
disagree.
We
In that case, we found that the corporation made loans
to its shareholder because we believed the shareholder's
testimony that he intended to repay the loans and because the
account showed regular credits and a decreasing balance.
Id.
Here, petitioner did not show that he intended to repay the loan
or that Resyn gave him regular credits for loan repayments.
Thus, petitioners' reliance on Boshwit Bros. is not persuasive.
5.
Traceable Amounts
Petitioners point out that respondent could not trace all of
the funds that petitioner diverted to the Polymer account.
This
fact does not help petitioner because the determination is valid
and, as discussed below at section F-2, respondent traced
significant amounts to petitioners for each year by clear and
convincing evidence.
Petitioners contend that petitioners should be charged with
constructive dividends only for amounts that respondent can prove
were spent for petitioners' personal benefit.
We disagree.
Respondent determined that all deposits in the Polymer and
Chemical Traders accounts during the years in issue are income to
- 52 petitioners because Polymer and Chemical Traders had no business
purpose, petitioner controlled the Polymer and Chemical Traders
bank accounts, and petitioner could and did use those accounts
for his benefit.
As discussed above, respondent's determination
is presumed to be correct, and petitioners have not proven
otherwise.
6.
Constructive Dividends for 1970
Respondent determined that petitioners did not report the
following income in 1970:
$5,371 from Polymer, $15,600 from
Chemical Traders, $4,910 from Factory Expense, and $41,095 from
Van Syckle Chemical Plant.
In 1970, petitioners reported $27,300
of income without identifying the source.
Petitioners contend
that we should reduce any constructive dividend for 1970 by
$27,300 because they reported that amount, which represents their
estimate of the value of Chemical Traders and Polymer Chemicals
transactions on their 1970 return.
We disagree.
Petitioners did
not show how the $27,300 they reported related to any of the
amounts respondent determined to be unreported income.
They rely
on Goldstein's testimony that it was to cover income adjustments
from respondent's audit for 1970.
Goldstein's testimony does not
prove respondent's determination to be incorrect because it does
not show how the reported income of $27,300 relates to any of
respondent's adjustments for 1970.
- 53 7.
Conclusion
We conclude that payments to or on behalf of petitioners by
Resyn, Chemical Traders, and Polymer were constructive dividends
to petitioners in the years paid in the amounts determined by
respondent.
E.
Whether Petitioner Is Liable For Fraud For 1963
Respondent determined that petitioner is liable for the
addition to tax for fraud under section 6653(b) for 1963 to 1970.
We discuss 1963 in this section because of certain facts
applicable only to that year.
We will discuss whther
petitioner
is liable for fraud for 1964 to 1970 in section F, below.
Petitioners contend that respondent did not prove that
petitioner committed fraud for 1963 because respondent did not
offer into evidence an original or copy of petitioners' 1963
return.
We agree.
A taxpayer is not liable for the addition to
tax for fraud for a year if the return for that year is not in
evidence and there is no evidence about the contents of the
return.
Drieborg v. Commissioner, 225 F.2d 216, 219-220 (6th
Cir. 1955), affg. in part and revg. in part a Memorandum Opinion
of this Court dated Feb. 24, 1954.
Secondary evidence is
admissible to prove the contents of a destroyed or lost income
tax return.
Granquist v. Harvey, 258 F.2d 599, 601 (9th Cir.
1958); Estate of Clarke v. Commissioner, 54 T.C. 1149, 1163
(1970); Rubinstein v. Commissioner, 29 T.C. 861 (1958), affd. per
curiam 264 F.2d 478 (3d Cir. 1959).
- 54 Respondent has shown that the amount of petitioners' income
for 1963 stated in the revenue agent's record is the same as
amounts stated on petitioners' unsigned return.
However, there
is no evidence that these amounts are the same as those reported
on petitioners' 1963 return.
We conclude that there is
insufficient evidence of petitioners' 1963 return to prove fraud.
Rubinstein v. Commissioner, 264 F.2d at 479.
F.
Whether Petitioner Is Liable For Fraud for 1964 to 1970
1.
Background
A taxpayer who commits fraud is liable for an addition to
tax equal to 50 percent of the underpayment.
Sec. 6653(b).
Respondent has the burden of proving fraud by clear and
convincing evidence.
Sec. 7454(a); Rule 142(b).
First,
respondent must prove the existence of an underpayment.
Commissioner, 94 T.C. 654, 660 (1990).
Parks v.
Respondent may not rely
on petitioners' failure to carry the burden of proving the
underlying deficiency.
92 T.C. 661, 700 (1989).
Id. at 660-661; Petzoldt v. Commissioner,
Second, respondent must show that
petitioner intended to evade taxes he believed to be owing by
conduct intended to conceal, mislead, or otherwise prevent tax
collection.
Stoltzfus v. United States, 398 F.2d 1002, 1004 (3d
Cir. 1968); Parks v. Commissioner, supra at 661; Rowlee v.
Commissioner, 80 T.C. 1111, 1123 (1983).
- 55 2.
Underpayment
Petitioners contend that respondent did not establish by
clear and convincing evidence that petitioner underpaid tax.
We
disagree.
A controlling shareholder who causes a corporation, for no
business purpose of its own, to transfer earnings to another
entity which the shareholder controls may be taxed as receiving
income in the amount of the funds transferred.
Commissioner v.
Makransky, 321 F.2d 598, 602 (3d Cir. 1963), affg. 36 T.C. 446
(1961); Biltmore Homes, Inc. v. Commissioner, 288 F.2d 336 (4th
Cir. 1961), affg. T.C. Memo. 1960-53; Helvering v. Gordon, 87
F.2d 663 (8th Cir. 1937); Lonsdale v. Commissioner, 32 F.2d 537
(8th Cir. 1929), affg. 11 B.T.A. 659 (1928).
The control which
the taxpayer has over the amounts transferred may cause those
amounts to be taxable income to the taxpayer.
McSpadden v.
Commissioner, 50 T.C. 478, 490 (1968) (false mortgage scheme).
Funds that petitioner diverted from Resyn to the Polymer and
Chemical Traders accounts were taxable income to him.
James v.
United States, 366 U.S. 213, 219 (1961) (embezzled funds over
which the taxpayer had complete dominion and control were taxable
income).
The Polymer and Chemical Traders accounts were nominee or
conduit bank accounts for petitioner during the years in issue.
Polymer and Chemical Traders had no business purpose.
completely controlled them.
Petitioner
Petitioner diverted Resyn funds to
- 56 the Polymer and Chemical Traders bank accounts.
He caused the
following amounts to be deposited into the Polymer bank account:
$238,555.24 in 1964, $87,750.12 in 1966, $40,818.47 in 1968,
$122,559.81 in 1969, and $5,370.72 in 1970.
He caused at least
the following amounts to be deposited into the Chemical Traders
bank account: $297,115.19 in 1964, $248,435.81 in 1965,
$526,815.33 in 1966, $253,767.62 in 1967, $66,554.58 in 1968,
$70,878.23 in 1969, and $15,600 in 1970.
Thus, petitioner
diverted funds from Resyn to the accounts he controlled in each
year from 1964 to 1970.
Petitioner wrote Chemical Traders checks
to cash of at least $140,199 in 1965, $76,000 in 1966, $167,000
in 1967, $89,500 in 1968, $45,500 in 1969, and $19,500 in 1970.
Petitioner wrote checks to cash on the Polymer account that
Levenson had signed.
Those checks totaled at least $40,000 in
1968 and $108,000 in 1969.
Petitioner did not report any of
these amounts on his income tax returns.
Petitioner contends that respondent did not prove an
underpayment by clear and convincing evidence because respondent
could not show what petitioner did with all of the diverted
funds.
We disagree.
As discussed above, we conclude that those
funds became taxable to petitioner when he diverted those funds
to the Polymer and Chemical Traders accounts.
Further, even if
respondent were required to show that petitioners used diverted
funds for each year from 1964 to 1970, we conclude that
respondent has done so by clear and convincing evidence.
- 57 Chemical Traders paid for petitioner's stock investments in at
least the following amounts:
$83,500 in 1964, $20,635 in 1965,
$153,035 in 1966, $128,007 in 1967, $2,007 in 1968, and $8,350
in 1969.
Petitioner did not report his receipt from Polymer of
checks made out to cash.
Resyn paid personal benefits for
petitioners of at least $261,789 in 1967, $431,592 in 1968, and
$341,725 in 1969 (total for those 3 years is $1,035,106).
Petitioners did not report those amounts.
We conclude that respondent has proven by clear and
convincing evidence that petitioner diverted funds from Resyn to
himself using the Polymer and Chemical Traders accounts from 1964
to 1970 and did not report them.
P.R. Farms, Inc. v.
Commissioner, 820 F.2d 1084 (9th Cir. 1987), affg. T.C. Memo.
1984-549; Worcester v. Commissioner, 370 F.2d 713, 715 (1st Cir.
1966), affg. in part and vacating and remanding in part T.C.
Memo. 1965-199; Biltmore Homes, Inc. v. Commissioner, supra at
340-341.
3.
Fraudulent Intent
Respondent must prove by clear and convincing evidence
that petitioner had fraudulent intent.
supra at 664.
Parks v. Commissioner,
For purposes of section 6653(b), fraud means
actual, intentional wrongdoing, Mitchell v. Commissioner, 118
F.2d 308, 310 (5th Cir. 1941), revg. 40 B.T.A. 424 (1939), or the
intentional commission of an act for the specific purpose of
evading a tax believed to be owing, Webb v. Commissioner, 394
- 58 F.2d 366, 377 (5th Cir. 1968), affg. T.C. Memo. 1966-81.
Fraud
may be proven by circumstantial evidence because direct evidence
of the taxpayer's intent is rarely available.
Stephenson v.
Commissioner, 79 T.C. 995, 1005-1006 (1982), affd. 748 F.2d 331
(6th Cir. 1984).
The courts have developed a number of objective indicators
or "badges" of fraud.
910 (1988).
Recklitis v. Commissioner, 91 T.C. 874,
Several badges of fraud are present in this case:
(a) Substantially understating income for several years; (b)
diverting corporate funds; (c) having inadequate books and
records; (d) dealing in large amounts of cash; (e) using
fictitious names; (f) concealing accounts from Resyn's and
petitioners' accountants; and (g) giving false, misleading, and
inconsistent testimony at trial.
Bradford v. Commissioner, 796
F.2d 303, 307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601;
Ruark v. Commissioner, 449 F.2d 311, 312-313 (9th Cir. 1971),
affg. T.C. Memo. 1969-48; Meier v. Commissioner, 91 T.C. at 298.
a.
Substantially Understating Income Tax Liability
A pattern of substantially underreporting income tax
liability over several years may be evidence of fraud.
Holland
v. United States, 348 U.S. 121, 137-139 (1954); Estate of Mazzoni
v. Commissioner, 451 F.2d 197, 202 (3d Cir. 1971), affg. T.C.
Memo. 1970-37; Rogers v. Commissioner, 111 F.2d 987, 989 (6th
Cir. 1940), affg. 38 B.T.A. 16 (1938).
Petitioner substantially
understated income tax liability by $225,591 for 1964, $67,160
- 59 for 1965, $241,895 for 1966, $98,213 for 1967, $221,132 for 1968,
$258,763 for 1969, and $17,945 for 1970.
b.
Corporate Diversions for Personal Use
A taxpayer's diversion of corporate funds to the taxpayer's
own use is evidence of fraud.
Solomon v. Commissioner, 732 F.2d
1459, 1460-1461 (6th Cir. 1984), affg. T.C. Memo. 1982-603;
United States v. Brill, 270 F.2d 525, 527 (3d Cir. 1959).
As
discussed above, petitioner diverted a substantial amount of
funds from Resyn using Polymer and Chemical Traders as nominee
accounts.
He diverted to Chemical Traders $297,115.19 in 1964,
$248,435.81 in 1965, $526,815.33 in 1966, $253,767.62 in 1967,
$66,554.58 in 1968, $70,878.23 in 1969, and $15,600 in 1970.
He
diverted to Polymer $238,556 in 1964, $87,750.02 in 1966,
$40,517.47 in 1968, $122,649.81 in 1969, and $5,370.72 in 1970.
After petitioner diverted funds to Polymer and Chemical Traders,
he withdrew cash from the Polymer and Chemical Traders accounts,
and used the Chemical Traders account to pay for his stock
investments.
In addition to the amounts petitioner diverted to
himself through Polymer and Chemical Traders, Resyn paid
substantial amounts for petitioners' personal expenses which
petitioners did not report.
c.
False or Inadequate Records
False entries in books and records and false purchase
invoices are compelling evidence of fraud.
Marienfeld v. United
States, 214 F.2d 632, 634-635 (8th Cir. 1954); United States v.
- 60 Lange, 161 F.2d 699, 703 (7th Cir. 1947).
Petitioner caused
Polymer to issue false purchase invoices to Resyn.
A taxpayer's failure to maintain accurate records may be a
badge of fraud.
Merritt v. Commissioner, 301 F.2d 484, 487 (5th
Cir. 1962), affg. T.C. Memo. 1959-172; Reaves v. Commissioner,
295 F.2d 336, 338 (5th Cir. 1961), affg. 31 T.C. 690 (1958);
Grosshandler v. Commissioner, 75 T.C. 1, 20 (1980).
Petitioner
did not have records showing what he did with most of the money
in the Polymer and Chemical Traders accounts.
d.
Dealing in Large Amounts of Cash
A taxpayer's use of cash and cashier's checks to conceal
income is evidence of fraud.
Bradford v. Commissioner, supra at
308; United States v. Chapman, 168 F.2d 997, 1000 (7th Cir.
1948).
We may infer that a taxpayer's excessive use of checks
drawn to cash was to conceal unreported income.
See Gariepy v.
United States, 189 F.2d 459, 463 (6th Cir. 1951).
used large cash transactions.
stock.
Petitioner
He used cashier's checks to buy
All of his Polymer withdrawals were in cash.
He wrote
Chemical Traders checks to cash totaling $160,824 in 1965,
$160,541 in 1966, $317,000 in 1967, $89,500 in 1968, $43,850 in
1969, and $19,500 in 1970.
There do not appear to be any valid
business reasons for these large cash transactions.
e.
Using Fictitious Names
Use of a bank account in the name of a nominee can be
evidence of fraud.
United States v. Ratner, 464 F.2d 101, 105
- 61 (9th Cir. 1972); Elwert v. United States, 231 F.2d 928, 935 (9th
Cir. 1956).
Petitioner used Chemical Traders and Polymer to
divert funds from Resyn for his personal use.
Petitioners contend that Chemical Traders and Polymer were
legitimate businesses.
We disagree.
estopped from so claiming.
Petitioner is collaterally
Even if petitioner were not
collaterally estopped, respondent has clearly shown that
petitioner used Chemical Traders and Polymer to divert and
conceal income from 1964 to 1970.
f.
Concealing Income From Return Preparers
Concealing income from a taxpayer's tax preparer can be
evidence of fraud.
Korecky v. Commissioner, 781 F.2d 1566,
1569 (11th Cir. 1986), affg. T.C. Memo. 1985-63; Farber v.
Commissioner, 43 T.C. 407, 420, modified 44 T.C. 408 (1965).
Petitioner did not give Levenson or Goldstein records showing
that Chemical Traders existed, that Resyn's payments to Polymer
were for fictitious transactions, that he diverted income from
Resyn to Polymer and Chemical Traders, or how he used funds in
the Polymer and Chemical Traders accounts.
g.
False and Misleading Testimony
False, misleading, and inconsistent testimony is a badge of
fraud.
Bradford v. Commissioner, supra at 307.
Petitioner
falsely testified (i) that Chemicals Traders and Polymer were
legitimate businesses; (ii) that Chemical Traders did business at
128 Clinton Avenue in Newark, New Jersey, and that he was in
- 62 charge of the offices there; (iii) that Chemical Traders and
Polymer were legitimate businesses that bought and sold products
under their own names; (iv) that secrecy was not the reason he
wrote checks to cash, and cashier's checks to withdraw funds from
the Polymer and Chemical Traders accounts; (v) that Levenson
suggested the Polymer scheme; and (vi) that he never stopped at
Levenson's house to have Levenson sign blank checks.
Petitioner
testified that petitioner Ruth Levitt was an original subscriber
of Welev stock.
not.
However, the corporate minutes show that she was
Finally, petitioner testified that he had nothing to do
with preparing Ruth Levitt's income tax return for 1986.
However, Ruth Levitt testified that he always handled their tax
returns and that she never participated in preparing income tax
returns.
4.
Petitioners' Contentions
Petitioners contend that petitioner's concealment in 1986 of
the Welev transaction is not relevant to proving that petitioner
committed fraud for the tax years in issue because it occurred
after the years in issue.
We do not consider petitioner's acts
of concealment in 1986 in deciding the fraud issue.
However, we
consider the fact that petitioner used Resyn to pay for Welev
during the years in issue but did not report the amounts that
Resyn paid.
Petitioners contend that the fact that Philbin never saw
petitioner involved in Resyn's bookkeeping or instructing anyone
- 63 to divert funds from Resyn shows that petitioner did not divert
funds.
We disagree.
Petitioner concealed the Chemical Traders
account from Philbin.
Petitioner knew that Resyn paid Polymer
for fictitious transactions.
Petitioner withdrew a substantial
amount of funds from the Polymer and Chemical Traders bank
accounts in cash and cashier's checks.
Philbin's testimony does
not lead us to change our conclusion based on the overwhelming
evidence that petitioner arranged the diversion of funds.
Petitioners contend that Levenson "was the architect of the
scheme".
The record clearly shows otherwise.
know about Chemical Traders.
Levenson did not
Petitioner directed Levenson to
sign and endorse all of the Polymer checks in blank.
Levenson
did not benefit from Polymer.
Petitioner controlled Resyn,
Polymer, and Chemical Traders.
Levenson did not.
Petitioners contend that respondent did not prove fraud
because respondent did not call Hall, who directed the postings,
to testify.
We disagree.
Even without Hall's testimony,
respondent has clearly shown that petitioner devised, operated,
and benefited from his scheme to divert income from Resyn through
Polymer and Chemical Traders to himself and his family.
5.
Conclusion
We conclude that part of petitioner's underpayment of tax
for each year from 1964 to 1970 is due to fraud.
- 64 G.
Statute of Limitations
Petitioners contend that the time to assess tax for
petitioners for 1963 to 1969 has expired.5
We disagree as to
1964 to 1969 and agree as to 1963.
The Commissioner is generally required to assess tax within
3 years of the date the return is filed or due, whichever is
later.
Sec. 6501(a).
There is no limit on the time to assess
tax if the Commissioner proves fraud.
Sec. 6501(c)(1).
We have
found that petitioner is liable for fraud for each of the years
1964 to 1970.
Thus, respondent may assess tax for those years.
Sec. 6501(c)(1).
However, the time to assess tax for 1963 has
expired because respondent has not proven fraud for that year.
H.
Whether Ruth Levitt Is an Innocent Spouse
1.
Background
Petitioners contend that Ruth Levitt is an innocent spouse
under section 6013(e).
Spouses who file joint tax returns are jointly and severally
liable for tax.
Sec. 6013(d)(3).
Petitioners argue that Ruth
Levitt is not liable for the deficiencies and the addition to tax
for substantial understatement of income tax because she is an
innocent spouse under section 6013(e).
To qualify as an innocent
spouse for any of the years in issue, petitioners must prove
that: (a) Ruth Levitt filed a joint return for the year; (b)
5
Petitioners concede that respondent may assess tax for
1970 under sec. 6501(c)(4).
- 65 there is a substantial understatement of income tax attributable
to grossly erroneous items of the other spouse on the return; (c)
she did not know or have reason to know of the substantial
understatement when she signed the return; and (d) it would be
inequitable to hold her liable for the deficiency attributable to
the substantial understatement.
Sec. 6013(e)(1).
Failure to
meet any of these requirements precludes a taxpayer from
qualifying as an innocent spouse.
Sec. 6013(e)(1); Purcell v.
Commissioner, 826 F.2d 470, 473 (6th Cir. 1987), affg. 86 T.C.
228 (1986).
Courts should construe the innocent spouse exception
in view of the congressional purpose of protecting innocent
taxpayers from injustice.
Sanders v. United States, 509
F.2d 162, 166-167 (5th Cir. 1975).
Respondent concedes that Ruth Levitt meets the requirements
to qualify as an innocent spouse under section 6013(e) except
that she knew or had no reason to know of the understatements
when she signed the returns and that it is inequitable to hold
her liable.
We need not decide whether Ruth Levitt knew or had
reason to know of the understatements because we conclude that it
is not inequitable to hold her liable.
2.
Whether It Is Inequitable to Hold Ruth Levitt Liable
A taxpayer who claims innocent spouse relief must prove
that, taking into account all the facts and circumstances, it
is inequitable to hold her or him liable for the deficiency.
Sec. 6013(e)(1)(D).
Normal support is not a significant
- 66 -
benefit for purposes of deciding whether denial of innocent
spouse relief is inequitable under section 6013(e)(1)(D).
Flynn v. Commissioner, 93 T.C. 355, 367 (1989).
Petitioners contend that Ruth Levitt did not significantly
benefit from the unreported income.
We disagree.
The statute
by its terms no longer bars relief if the purported innocent
spouse received a significant benefit, but it continues to be
a factor.
(1989).
Estate of Krock v. Commissioner, 93 T.C. 672, 678
The benefit may be direct or indirect.
Id. at 678.
Ruth Levitt enjoyed the benefits of the understatements during
the years in issue.
She drove new cars, had a nursemaid, sent
her children to camp, and lived materially well.
services of a chauffeur and handyman.
attended private schools.
She had the
Some of her children
She shopped extensively.
Resyn
paid about $1,035,106 for those personal expenses of petitioners
from 1967 to 1969.
She benefited from petitioners' tax
deductions for charitable contributions that Resyn paid in
1967 and 1968.
Resyn also paid for petitioners to buy Welev
stock that Ruth Levitt sold in 1986, reporting a capital gain
of $999,338.
There is no indication that Ruth Levitt's
benefit from unreported income was any different from 1964 to
1966.
We believe that petitioners' unreported income allowed
her to have the standard of living that she did during the
- 67 -
years in issue.
She remained married to petitioner during the
years in issue.
We believe that Ruth Levitt fully shared in
the benefits and the tax savings from the omitted income and
that the understatements enabled her to maintain a standard of
living that she would not have enjoyed otherwise.
Scarafile v. Commissioner, T.C. Memo. 1991-512.
See
Ruth Levitt
benefited significantly from the omitted income.
Petitioners rely on Kistner v. Commissioner, 18 F.3d 1521
(11th Cir. 1994) revg. and remanding T.C. Memo 1991-463, and
Flynn v. Commissioner, supra, for the proposition that a
spouse does not significantly benefit for purposes of section
6013(e)(1)(D) if the level of support received during the
years in issue was no different than before those years.
However, even with no change in the standard of living, the
spouse may fail to meet the requirement of section
6013(e)(1)(D).
In Flynn, we found that the spouse did not
benefit from the understatements.
Flynn v. Commissioner,
supra at 367-368.
Petitioners have not shown that it would be inequitable to
hold Ruth Levitt liable for the deficiency.
Consequently, we
hold that she is not entitled to relief as an innocent spouse
under section 6013(e).
- 68 To reflect the foregoing,
Decision will be
entered under Rule 155.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.