Opinion ID: 3010913
Heading Depth: 3
Heading Rank: 1

Heading: Any income received by Taxpayers on government

Text: contracts was used to pay either taxes owed to the IRS or employees' wages. 2. Consequently, the Taxpayers did not pay suppliers, rent, health and welfare premiums, employees' union dues, and workers' compensation insurance premiums. 3. Utility companies were only paid from D'Antonio's personal funds at the eleventh hour after the companies threatened to shut off service. 4. Suppliers were not paid any amounts owed from 1982-1986. Ultimately the Taxpayers owed approximately $7 million to their suppliers. D'Antonio had to personally guarantee payment to the suppliers so that they would continue providing suppliers without payments. As a result, D'Antonio was sued and several liens were placed against his personal assets. _________________________________________________________________ payment of the employment taxes, it would have reached the same conclusion. East Wind Industries, 33 F.Supp.2d at 346 n.6. The only factor that the District Court appears to have considered, however, is the Taxpayers' participation in the bribery scheme. 10. The dissent implies that we have construed Treas. Reg. S 301.6651- 1(c)(1) to create a general ordinary business care and prudence standard for judging how a taxpayer has conducted its business. We do not intend to create such a general standard in applying the regulation to the Taxpayers' case. Rather, we have evaluated whether the Taxpayers exercised ordinary business care and prudence in providing for payment of the trust fund taxes in light of all the facts and circumstances bearing on their financial situation. 20 5. D'Antonio secured a mortgage on his personal residence and sold several personal assets to obtain cash to pay creditors. In return, D'Antonio accepted several notes from the Taxpayers which became worthless. 6. The Taxpayers' bookkeeper lent $65,000 of her personal funds to Taxpayers to pay creditors after D'Antonio's personal funds were depleted. None of these actions reveals any spendthrift tendencies on the part of the Taxpayers. Moreover, D'Antonio sought the advice of professional consultants on financial and legal matters with regard to the bribery scheme and the cash flow problems. He also consulted with similarly situated manufacturers to learn how they dealt with the bribery demands of the Defense Agencies' employees. D'Antonio testified that he was required to keep the plant operating so that the Defense Agencies would pay for the inventory. Inspectors from the Defense Agencies visited the plant frequently to make sure the work was being completed. Even when the Taxpayers were unable to procure new government contracts they were required to retain a reduced workforce to rework inventory that had been unjustifiably and wrongly rejected by the Defense Agencies. At the time the Taxpayers filed for bankruptcy, inventory worth $750,000 was sitting in the Taxpayers' plant. Finally, the evidence shows, by virtue of the testimonies of both D'Antonio and Mooney, that if the Defense Agencies had paid the Taxpayers what was owed under the contracts, the Taxpayers would have had sufficient funds to pay their employment taxes and other debts when due. Thus, it appears that the Taxpayers made reasonable efforts to conserve sufficient assets in marketable form, by maintaining $750,000 of inventory for the Defense Agencies, to satisfy their tax liability and, despite such efforts, were unable to pay their employment taxes when they became due. Although all of these factors support a finding that the Taxpayers exercised ordinary business care and prudence, 21 the Taxpayers' participation in the bribery scheme raises some concern. The District Court concluded, as a matter of law, that the Taxpayers' course of conduct in initially acceding to the demands of the corrupt officials, and later refusing to pay when the demands became unrealistic, established that the Taxpayers failed to exercise ordinary business care and prudence during the periods in question. 33 F. Supp.2d at 346 n.6. In reaching this conclusion, the District Court was influenced by the fact that the Taxpayers had a long history of problems with the corrupt employees of the Defense Agencies and, therefore, the District Court opined that the employees' actions in rejecting goods and holding back payments should have been foreseen by the Taxpayers (as distinguished from the Navy's refusal to comply with the requirements of the Disputes Clause and of the Armed Services Procurement Regulations in GlenwalSchmidt, 78-2 U.S.T.C. P 9610, which was not foreseeable). East Wind Industries, 33 F. Supp.2d at 346 n.6. The District Court also found significant the fact that the Taxpayers' delinquencies spanned a period of six years. Id. In this appeal, the Government raises the same bases as the District Court in support of its argument that the Taxpayers failed to exercise ordinary business care and prudence. The Taxpayers counter that the payment of bribes by companies doing business with the Defense Agencies was considered the ordinary business practice in the industry. D'Antonio testified in his deposition that the bribery scheme was widespread and the only way to obtain government contracts with the Defense Agencies was to participate in the bribery scheme. His testimony is borne out by the sworn statement of Special Agent Ford of the FBI, in which Agent Ford indicated that D'Antonio, in an undercover capacity: recorded conversations with DPSC contractors who freely admitted to the payments of bribes and illegal gratuities to DPSC and DCAS employees. In most cases, D'ANTONIO travelled outside the Philadelphia metropolitan area to meet with the government contractors. The contractors' admissions widened the investigation and initiated new investigation [sic] of 22 DPSC contractors and DCAS employees in other FBI Field Offices, DCIS Field Offices and U.S. Attorneys' Offices. Affidavit of Joseph L. Ford, dated May 13, 1987, at p. 4. While not directly on point, we held in In re American Biomaterials Corp. 954 F.2d 919, 927 (3d Cir. 1992), that where the failure to file timely returns, make deposits and pay taxes was the result of embezzlement by the company's officers, the failure was due to reasonable cause since their criminal actions prevented the corporation from fulfilling its duties under the Code. Our decision was predicated upon our conclusion that the officers acted without apparent authority when they committed the embezzlement and the corporation could not be vicariously responsible for the penalties resulting from the failure to file returns, make deposits and pay taxes. Id. At the very least, American Biomaterials held that criminal conduct does not automatically foreclose a finding of reasonable cause. Thus, based on our holding in American Biomaterials, we cannot automatically conclude that the Taxpayers' participation in the illegal procurement scheme warrants a finding that they failed to exercise ordinary business care and prudence. Moreover, we are not persuaded by the Government's arguments that the facts established that the Taxpayers did not exercise ordinary business care and prudence. With regard to the Taxpayers' six-year history with corrupt officials, we must consider this period in the proper context. The delinquency began in 1982, sometime after the Taxpayers refused to pay the bribes. The Taxpayers attempted to put a stop to the bribery scheme beginning in 1983 when they contacted the legal staff at the Defense Department, and again in 1984, when they contacted other authorities. The Taxpayers filed a bankruptcy petition in 1984, and the FBI began its investigation later that same year. The Taxpayers eventually paid off their delinquent employment taxes, plus penalties and interest after the Bankruptcy Court enforced the Taxpayers' claims against the Defense Agencies, resulting in the $2.1 million settlement in 1991. The Government also contends the Defense Agencies' 23 refusal to pay on the contracts and unjustified rejection of goods was foreseeable to the Taxpayers. Essentially, the Government contends that because the Taxpayers participated in the bribery scheme, they should have foreseen the consequences. We disagree that these actions were necessarily foreseeable. The bribery scheme started in 1976 and consisted of requests for minor favors and gratuities, which the Taxpayers apparently provided. The Taxpayers did not start to experience financial difficulties, however, until 1982.11 In light of these facts, we do not believe the Taxpayers could have anticipated that providing minor favors and gratuities to the corrupt employees would eventually result in the financial ruin of their business. Although the Taxpayers' participation in the bribery scheme presents a close question, we nonetheless conclude that in light of all the facts and circumstances, the Taxpayers exercised ordinary business care and prudence. The parties should not read our decision as condoning the Taxpayers' conduct. We do not. We believe, however, that the Taxpayers have made a substantial attempt at righting their wrongdoing -- D'Antonio entered guilty pleas to two counts of violating 18 U.S.C. S 287, the False Claims statute, and he assisted the FBI in obtaining sufficient evidence of criminal activity to indict the corrupt officials and in bringing a stop to the bribery scheme. Moreover, the Taxpayers paid the ultimate price -- financial ruin of their business. In reality, the illegal conduct of the corrupt employees of the Defense Agencies, after the Taxpayers refused to accede to the bribery demands, caused the financial distress which resulted in the Taxpayers' inability to pay its employment taxes timely. By its actions, the Government, through the Defense Agencies, became a willing partner in afloundering _________________________________________________________________ 11. It appears that the Taxpayers' cash flow problems began after the bribery demands took on a new dimension -- demands for cash payments approximating 50 percent of the profits from the Taxpayers' business. When the Taxpayers refused to pay the demands for cash payments, the corrupt employees of the Defense Agencies refused to pay on the government procurement contracts and unjustifiably rejected the Taxpayers' goods. Consequently, inventory began to accumulate, cash flow was severely reduced, and new contracts were not forthcoming. 24 business. Therefore, this case presents that rare situation described in Fran, supra, where the Taxpayers should be relieved of the penalty for failing to pay and deposit their employment taxes when due. 164 F.3d at 819. We therefore hold that because the Taxpayers exercised ordinary business care and prudence and would have suffered undue financial hardship if they would have paid their taxes when due, the nonpayment of trust fund taxes was due to reasonable cause and not willful neglect. Accordingly, the Taxpayers are entitled to an abatement of the penalties.