Opinion ID: 357068
Heading Depth: 2
Heading Rank: 1

Heading: the land clearing operation:

Text: 155 The Government asserts that Loftin knew that if the Corporation cleared the land under the procedures established by the partnership, as it eventually did, a constructive dividend would accrue to the taxpayers, taxable to them. 156 One of the primary pieces of evidence cited by the Government in support of this assertion is a conversation between John Savage, the Corporation's accountant, and Loftin at an early stage of the clearing operation. In that conversation, Savage voiced his concern that the commencement of land clearing operations prior to the transfer of the property to the partnership might produce a constructive dividend, taxable to the stockholders. However, this statement, though seemingly supportive of the Government's position, is susceptible to an entirely different interpretation when one considers the context within which the advice was rendered. Savage was not concerned in general over the possibility of a constructive dividend arising from the land clearing work. He was concerned specifically with the dividend which could arise if the Corporation cleared part of the land prior to the sale to the partnership and that clearing enhanced the value of the land at sale, thereby producing an appreciation taxable to the Corporation upon such sale. 66 Such a statement hardly could be construed as evidence that Loftin knew that the land clearing operation would produce the constructive dividend eventually assessed against him on the basis of a comparison of the costs incurred and payments received by the Corporation for its clearing efforts. 157 In essence, Savage was concerned over one of two things. Either the Corporation would incur a tax on the sale of the property to the partnership at a price reflecting the increase in value of the land due to the clearing performed prior to transfer, or, if the Corporation did not increase the selling price over the price it had paid, the partnership eventually would incur a constructive dividend equivalent to the appreciated value purchased at no additional cost. App. 796-97. Thus, Savage's advice is hardly applicable to the facts that underlie the district court's constructive dividend finding. 158 The Government does offer further evidence of fraudulent intent though. It is clear, from the record, that Loftin directed the accountant and/or bookkeeper to conceal the initial expenses of the clearing operation on the corporate books by spreading them among ongoing accounts. 159 There can be no question that from April 17, 1963 through May 31, 1965, a separate ledger category for expenses relating to the Yazoo project was not maintained. This evidence, viewed alone, might compel an inference that Loftin was attempting to conceal the entire project from public exposure in order to avoid the assessment of a constructive dividend. There are, however, several mitigating circumstances in this instance. 67 160 First, it is difficult to reconcile a purported desire to hide an entire operation with the fact that numerous entries were made on the corporate and partnership books after May 31, 1965. Indeed, as early as December 31, 1964 one year after the partnership secured title to the property a payment was registered on the partnership books, according to the stipulation of both parties. 68 Moreover, it is especially significant that this initial entry was made prior to the commencement of the first I.R.S. audit. This was hardly the action of an individual furtively covering his tracks to avoid the snare of an investigator. 69 161 Second, Loftin explained that he failed to record the initial expenses in a separate category because the amount cleared prior to the first entry and the expenses attendant thereto were not worth saying grace over. 70 The amount cleared prior to the first entry totaled eight hundred acres. Although this would seem to be sufficiently sizeable to prompt an entry on the ledger, Loftin's belief to the contrary is not implausible given the total amount of acreage which was in fact cleared on this project: 9,617 acres. 71 At the very least, Loftin and Woodard contemplated the clearing of over six thousand acres at the time Loftin made this statement. We do not suggest that the district court was incorrect in the conclusions drawn from these circumstances. Rather, we suggest that independently, or in combination, these circumstances do not rise to the level of clear and convincing evidence of fraudulent intent the standard of proof which must be met before a finding of fraud can be made. 162 At the same time, we do not deny that the subjective aspect of fraud may often dominate the objective. 72 The natural intractability of a determination of fraudulent intent has been tamed gradually by the introduction of factual checklists which provide a framework that courts may use to avoid deciding each case viscerally. Webb, 394 F.2d at 378. These criteria make the necessarily subjective trek more feasible, despite its being obstacle-pocked because we have no cinematography of the mind . . . . Id. A titration of the many standards developed for the determination of tax fraud produces the following distillate of fraud indicia: 163
164 2. Intentional overstatement of deductions, substantial in amount . . .3. Recurrence of the understatement of income or overstatement of deductions for more than one tax year. 165 4. Secret bank deposits for income . . . 166 5. Undisclosed source of income from other than taxpayer's regular business . . . 167 6. Undisclosed income derived from illegal business . . . 168 7. Lack of adequate books and records which one would expect of the particular taxpayer, based on his business experience, education, knowledge of books and records, etc. 169 8. False entries and other falsifications in books . . . 170 9. No reasonably acceptable explanation made by the taxpayer . . . as to why falsity appeared in the return . . . 171 10. Conviction of the taxpayer on criminal evasion . . . 172 Webb, 394 F.2d at 378, n. 11 adopting criteria set forth in Balter, Tax Fraud and Evasion (3rd ed. 1963), pp. 8-54 and 8-55. 173 Of these ten criteria, only numbers one, two, three and seven truly are applicable herein. The lack of any substantial attempt to hide the clearing operation from public scrutiny and the fact that recordkeeping was begun prior to the initiation of the audit suggests that those criteria relating to a concerted cover-up criteria five, six, eight and nine are inapposite to a consideration of Loftin's actions. Clearly, criteria four and ten are inapplicable on their face. 174 Criterion three the recurrence of an understatement subsumes criteria one and two for present purposes. It is vitiated largely because the understatement recurred here for only three years and the existence of a constructive dividend in those years is now uncertain. For both 1963 and 1964, the bulk of the understatement was comprised of the constructive dividend found in connection with the clearing operation. That is why, for the most part, there was no deficiency in 1965. Under the district court's analysis, payments exceeded costs in that year. Thus, the ambiguity which presently surrounds the constructive dividend issue undercuts its use as a significant component of a finding of fraud. If Loftin honestly believed that the value of the clearing performed would be established at fifty dollars per acre (i. e. the fair market value testified to at trial), there would have been no constructive dividend in this case and, therefore, the use of the constructive dividend as a foundation for the finding of fraud would have been rendered nugatory. 175 Secondly, we note that two years in succession do not a pattern make. In any event, case law does not indicate that consistent and substantial understatement of income is sufficient, by itself, to support a finding of fraud. 176 The mere understatement of income, standing alone, is not enough to carry the burden cast upon the Commissioner in seeking to recover fraud penalties. But each case is to be considered in the light of its own facts. Consistent and substantial understatement of income is by itself strong evidence of fraud. This proof, coupled with the showing that the records were both incomplete and inaccurate, and that the petitioner did not supply the bookkeeper with all of the data necessary for maintaining complete and accurate records, is enough to warrant the Tax Court in finding fraud. 177 Merritt, 301 F.2d at 487. (emphasis added). Ours is not the type of situation which the courts meant to encompass within a rule linking a finding of fraud to the consistent and substantial understatement of income by a taxpayer. See, Merritt v. Commissioner of Internal Revenue, 301 F.2d 484 (5th Cir. 1962); Holland v. United States, 348 U.S. 121, 75 S.Ct. 127, 99 L.Ed. 150 (1954). 178 Thus, only criterion number seven remains in our review of the propriety of the fraud finding in connection with the constructive dividend. It is true that the books kept by the taxpayers were not as thorough as they should have been. However, given the custom of this taxpayer to defray initial corporate expenses of a project among ongoing expense categories from other projects, this point is somewhat blunted. Very little work was performed from January 1, 1963 to December 31, 1963 the first of two calendar years utilized by the lower court in support of its finding of fraud; and by the end of 1964, the only other year in which the district court found Loftin to be fraudulent, an entry already had been made upon the partnership books. 179 In short, Loftin and Woodard do not fit within the mold cast by the courts in this area, as may be seen by comparing this case to Estate of Upshaw v. Commissioner of Internal Revenue, 416 F.2d 737 (7th Cir. 1969). There, fraud was found only after taxpayer had consistently and materially understated his income; had failed to maintain adequate books; and had made a material misstatement to an Internal Revenue Agent. The only similarity to Upshaw that may be found in the present case is taxpayer's failure to declare a significant amount of income for three tax years and even this is not present if the constructive dividend found to have arisen atop the land clearing operation is deleted on remand. Loftin and Woodard were keeping records of these operations. Though those records were not impeccable, they did not reflect a concerted effort to conceal the nature of these operations. Even the failure to declare the initial expenses and income was explicable as part of a consistent pattern of conduct engaged in by the corporation on almost every project it undertook. In addition, the understatement of income, even with the presence of the constructive dividend from the land clearing operation, was not consistent. Finally, unlike Upshaw, neither taxpayer made material misstatements to the Internal Revenue Service. 180 Thus, we conclude that the clearing operation and the constructive dividend found in relation thereto cannot supply the foundation to support a finding of fraud as to any part of the deficiency for 1963 and 1964, given the record as it now stands. There are, however, other sources of undeclared income in those two years which must be considered in assessing the propriety of the district court's finding.