Opinion ID: 357068
Heading Depth: 1
Heading Rank: 4

Heading: the issue of fraud:

Text: 149 The district court found Loftin liable for fraud for the deficiencies in income assessed in calendar years 1963 and 1964. Contrary to the Commissioner's determinations, the district court did not find Woodard or the Corporation fraudulent for any of the years in question. The Government has raised the issue of corporate fraud on its cross-appeal. 150 At the outset, we note that we are obligated to affirm the district court's findings if we find that fraud taints any aspect of the deficiency for the year under review. Thus, the Government need only prove that some part of the underpayment in a particular year was fraudulent. Ruidoso Racing Association, Inc. v. Commissioner of Internal Revenue, 476 F.2d 502 (10th Cir. 1973). 64 151 During the years at issue on this appeal, Loftin and Woodard did a fair amount of traveling, ostensibly in pursuit of corporate objectives. In the course of these trips, the Corporation provided the taxpayers with cars, credit cards, and reimbursements for food, lodging, and expenses of a similar nature. In addition, both taxpayers periodically withdrew cash from the corporate coffers prior to embarking upon these trips. 152 At trial, neither taxpayer proffered an accounting of the uses made of these advances or any explanation of a connection between those payments made, for which they were reimbursed, and proper corporate objectives. 65 However, this, in itself, only supports a finding that such payments were not properly deductible as business expenses of the Corporation and/or that they constituted constructive dividends. 153 In pursuing a resolution of this matter, we note that it is clear that the Government bears the burden of proving, by clear and convincing evidence, that the taxpayer intended to evade a tax he believed to be owing to the Government. Carter v. Campbell, 264 F.2d 930 (5th Cir. 1959). Fraud is a question of fact. Determination of fraud must be supported by substantial evidence. Jaeger Motor Car Company v. Commissioner of Internal Revenue, 284 F.2d 127 (7th Cir. 1960). However, it is incumbent upon Loftin to prove to this court on review that the evidence of fraudulent intent placed before the district court did not cross the clear and convincing threshold. Webb v. Commissioner of Internal Revenue, 394 F.2d 366, 377-78 (5th Cir. 1968). 154 The Government's assertion of fraud against Loftin rests primarily upon four categories of expenditures: (i) the constructive dividend arising from the land clearing operation; (ii) the political campaign contributions received by Loftin for his ill-fated campaign; (iii) the Corporation's payments of family medical bills, insurance premiums, and improvements to residential real estate; and (iv) the corporate advances secured prior to certain trips, the corporate payment of travel expenses, and the corporate provision of college football tickets. We discuss these seriatim as we turn now to a consideration of the facts underlying the deficiencies in Loftin's 1963 and 1964 returns.
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.
181 Absent the constructive dividend as a potential support for the finding of fraud, we must focus on the remainder of the expenditures in question: the travel expenses; advances; political campaign contributions; and premium payments received by Loftin from corporate funds. In all likelihood, proof of fraud as to any one of these items would mandate approval of the district court's finding of fraud as to the entire deficiency in which it appeared. Webb, 394 F.2d at 378. However, such proof is not present herein. 182 First, Woodard was the recipient of all but one of these expenditures in the years at issue the political campaign contributions. Yet, the district court did not find Woodard liable for fraud in any of these years. Unless there is evidence supporting a distinction between Loftin and Woodard as to their intent in not reporting the income connected with the assorted funds received by each from corporate coffers or there is evidence supporting a finding of fraud as to the expenditure received by Loftin alone, we must remand on the issue of fraud. 183 One possible explanation for the decision to find only Loftin liable is that the district court believed that as to the expenditures received by both Loftin and Woodard, Loftin intended to evade the tax known to be owing while Woodard did not. While this could be a plausible explanation, it is not so here because there is no basis in the record or in the district court's findings to support such a distinction. 73 In fact, the record suggests that as to the corporate expenditures received by both taxpayers, Loftin and Woodard should be treated in pari materia on the issue of intent. 184 Perhaps, then, the court's distinction between the two taxpayers for 1963 and 1964 was based on the fact that Loftin had not declared income arising from the political campaign contributions he received from the Corporation an item that Woodard did not receive. 74 The political contributions for his race for the Louisiana legislature totaled slightly over $4,000. Although it is unclear whether these payments were received in both 1963 and 1964, 75 that they were received in at least one of those years is beyond peradventure. 185 Were the state of the law as to political contributions clear in 1963, there would be little problem in resolving this matter. However, such is not the case. 186 Louisiana law, as of 1963, dictated that contributions by a corporation to a political party or person were prohibited. La.R.S. 18:1483. There is no question, then, that this contribution may have been impermissible as a matter of law. But this fact stands independent from an inquiry into whether the recipient, Loftin, should have known that the receipt of the contribution was a taxable event and whether his failure to declare that contribution was willful. In this regard, it is significant that while the dividend statute generally indicates that if the distribution is to a shareholder and it is out of earnings, it is a dividend, not all such distributions are in fact found to be constructive dividends. 187 There is no dearth of case law refusing to designate certain corporate distributions as constructive dividends. See, John Kelley Co. v. Commissioner of Internal Revenue, 326 U.S. 521, 66 S.Ct. 299, 90 L.Ed. 278 (1946); Bogardus v. Commissioner of Internal Revenue, 302 U.S. 34, 58 S.Ct. 61, 82 L.Ed. 32 (1937); Limericks, Inc. v. Commissioner of Internal Revenue, 165 F.2d 483 (5th Cir. 1948); and Paramount-Richards Theatres, Inc. v. Commissioner of Internal Revenue, 153 F.2d 602 (5th Cir. 1946). The nature of the distribution only can be decided within the factual context of each case. 188 Simply stated, 189 Whether or not a corporate distribution is a dividend or something else, such as a gift, compensation for services, repayment of a loan, or payment of property purchased, presents a question of fact to be determined in each case. 190 Lengsfield v. Commissioner of Internal Revenue, 241 F.2d 508 (5th Cir. 1957). See, Hoover v. Commissioner, 27 T.C.M. 226 (1968). 191 Instances of corporate distributions which were not found to be  dividends are numerous. For example, when an interest payment is made by a corporation to a stockholder, the court must decide whether the relationship of the stockholder to the corporation is one of creditor and debtor. This is mandatory, despite the fact that such a payment from the corporation would fit within the language of 26 U.S.C. § 301, the statute describing a dividend. See, McSorley's Inc. v. United States, 323 F.2d 900 (10th Cir. 1963). The basic tenet underlying the decision not to categorize corporate distributions as dividends, despite their appearance to the contrary, is embodied in Regulation § 1.301-1(c). This regulation makes § 301, which sets forth (r) ules applicable with respect to distributions of money and other property (,) . . . not applicable to an amount paid by a corporation to a shareholder unless the amount is paid to the shareholder in his capacity as such. Thus, interest paid to a stockholder who is a bona fide creditor is not a dividend nor are payments made to a stockholder who is a bona fide lessor. 192 In a similar vein, Loftin may have believed that the political contributions made to him were not income as long as he utilized them for political purposes. The state of the law at that time does not preclude such a conclusion. In line with this, it is clear from the record that Loftin explained that his failure to declare these amounts as income rested upon a belief that he was acting in a manner beneficial to the Corporation since his election would redound to its benefit. See, testimony of IRS Agent French, App. 1043. 193 It is significant, in this regard, that by 1963, taxpayers still were bound by the guidance provided in Revenue Ruling 54-80: 194 Where a political gift is received by an individual or political organization and it is held or used for the purposes intended, i. e., for present or future expenses of a political campaign or for some similar purpose, it is not taxable income to the recipient. 195 1954-1 Cum.Bull. 11. At the same time, the ruling cautions, unlike its 1939 precursor, that funds diverted to personal use must be declared as taxable income. 196 This ruling provided a foundation for the court's opinion in O'Dwyer v. Commissioner of Internal Revenue, 266 F.2d 575 (4th Cir. 1959), a case concluding, under Ruling 54-80, that had the taxpayer not diverted political contributions to personal use, he would not have incurred taxable income therefrom. The O'Dwyer court decided, in 1959, that Revenue Ruling 54-80 was declaratory of judicial interpretation of existing law. O'Dwyer, 266 F.2d at 586. In United States v. Jett, a case involving a charge of criminal tax evasion premised on facts comparable to those found in the case sub judice, Revenue Ruling 54-80 was established as the reigning legal principle as of 1961. 352 F.2d 179, 182 (6th Cir. 1965). This trend was carried through at least as far as 1970 by United States v. Miriani, 422 F.2d 150, 152 (6th Cir. 1970) a date subsequent to the time frame at issue in this case. 197 Thus, in 1963, Loftin rightfully could have relied on Revenue Ruling 54-80 in seeking guidance with regard to the proper tax treatment of political contributions. According to this ruling, the receipt of the contribution, without more, did not signal a taxable event. The advice of this ruling, in combination with the fact that not all corporate distributions to shareholders were and are constructive dividends, suggest that an inference of fraudulent intent could not be supported atop the political campaign contribution alone. 198 The income tax characteristics of the political contributions received by Loftin are and were too uncertain to support a finding of fraud without more direct evidence that Loftin knew that he had an obligation to report such funds. This is not Webb, supra, where the taxpayer was found liable for fraud because he persistently failed to supply the proper information to the tax authorities after being warned to do so several times. Webb, 394 F.2d at 380. Nor is the present case comparable to Benes, supra, where the taxpayer did not admit to his accountant until the year in which his corporation completed its work for him four years after the work in question had been commenced that he may have withheld certain information from him. Finally, we are not faced here with the type of fraudulent taxpayer present in Merritt a taxpayer whose consistent and substantial understatement of income was accompanied by a failure to maintain complete and accurate records and by a decision to withhold from the bookkeeper a substantial amount of vital data needed in the maintenance of complete and accurate records. Indeed, the testimony that we have before us indicates that Loftin was cooperative and forthright in the course of the audit of these potentially fraudulent deficiencies. 199 In sum, while the Corporation would have been remiss had it taken deductions for the contributions made, both from the perspective of Revenue Ruling 54-80 and the Louisiana law prohibiting such contributions, this fact has no bearing on the issue of Loftin's fraud as an individual taxpayer. His involvement with potential corporate fraud in requesting certain deductions cannot support a finding of fraud on his individual tax return in this instance. 76 200 The evidence before us does not substantially support a finding of fraudulent intent as to Loftin. The trial court is directed to reconsider this issue on remand in a manner consistent with the above instructions.
201 A final matter, raised by the Government's cross-appeal, concerns the failure of the district court to find the Corporation liable for fraud. As noted above, we are unable to discern the reason behind the district court's decision to distinguish between Loftin and the Corporation on the issue of fraud. While Loftin's actions as President of the Corporation and its majority stockholder are, at best, tangentially available as foundations for Loftin's fraud as an individual taxpayer, they are quite relevant to the issue of the Corporation's fraud. 202 Loftin & Woodard, Inc. was controlled completely by Loftin and Woodard. They were the sole shareholders. In addition, they were the sole executive employees president and vice-president respectively. 203 In investigating the issue of corporate fraud, the court must determine whether the conduct and intentions of the corporation's officers and/ or agents may be imputed to the entity itself. Hicks Co. v. Commissioner, 56 T.C. 982 (1971), aff'd 470 F.2d 87 (1st Cir. 1972); Benes, supra. It is difficult to perceive how the actions of Loftin and Woodard could not have been attributable to the corporate entity in almost every instance. If Loftin and/or Woodard were fraudulently culpable for their actions with respect to the cash advances etc., it would be difficult to justify the district court's failure to impute the same motive to the Corporation. The Corporation benefitted from the expenses it paid on behalf of Loftin and Woodard in that those expenses were translated into deductions each year. More to the point, the very manner in which the Corporation was conducted by Loftin and Woodard suggests that the corporate entity had become their alter ego a fact in itself capable of providing a sufficient basis for the imputation of fraud. See, Ruidoso,supra. 77 Indeed, 204 (w)here fraud is alleged against a corporate taxpayer, the requisite proof of fraudulent intent is to be found in the acts of its officers, inasmuch as the corporation, being an artificial person created by law, can have no separate intent of its own apart from those who direct its affairs. 205 Benes, 42 T.C. at 382. 206 Thus, should the district court find Loftin liable for fraud on remand, it should reconsider the issue of corporate fraud in connection with those fraudulent elements of the deficiency which benefitted the Corporation in some fashion. 78
Fraud is not easily shown. It 207 implies bad faith, intentional wrongdoing, and a sinister motive. . . . Negligence, whether slight or great, is not equivalent to the fraud with intent to evade tax named in the statute. The fraud meant is actual, intentional wrongdoing, and the intent required is the specific purpose to evade a tax believed to be owing. . . . Added to this is the burden placed upon the Commissioner. 208 Lee v. United States, 466 F.2d 11, 14, n.5 (5th Cir. 1972). 209 The district court's decision to distinguish between Loftin and Woodard for purposes of fraud leads us to believe that a finding of fraud as to Loftin is not sufficiently supported by the record. To predicate fraud upon that portion of Loftin's deficiency attributable to the land clearing constructive dividend is not acceptable while that issue remains in limbo on remand. Second, the presence of similar components in Loftin and Woodard's deficiencies (including the constructive dividend, since it was received by both) save one eliminates these similar components as potential supports for the finding of fraud given the absence of evidence distinguishing the intent of Loftin from Woodard with regard to them. Thus, at the present time, we are left with only one component of the initial deficiencies for consideration as a support the political contributions which Loftin received and Woodard did not. However, given the unsettled nature of the law at the time that the contributions were received, this too is inadequate. 210 In short, we must remand the issue of fraud for further proceedings consistent with this opinion, 79 for 211 (b)oth Government and Taxpayer are entitled to a trial of the hotly contested inferences by a court consciously applying the correct legal standards. They will not have had such a trial merely by our undertaking to say that had the standard been applied, the evidence would have warranted the result. Trials are committed to trial courts. Our function is limited and circumscribed. 212 Carter v. Campbell, 264 F.2d 930, 941 (5th Cir. 1959). 213 The record does not provide clear and convincing evidence that Loftin intentionally avoided paying a tax that he knew to be owing. 214