Court Opinion

ID: 6937294
Source: CourtListenerOpinion
Date Created: 2022-07-24 00:41:55.90974+00
Date Added: 2024-06-11T16:07:32.458095
License: Public Domain

Opinion by Judge KLEINFELD; Dissent by Judge REINHARDT.
KLEINFELD, Circuit Judge:
This case involves the duty of a “responsible person” to pay his company’s withholding taxes. More particularly, the issue is the definition of “willfully” failing to pay.
Facts
Mr. Wray founded South Pacific Island Airways, Inc., in American Samoa. He owned all the stock in the corporation, and ran it as president.
In 1984, Mr. Wray was paralyzed from the neck down in a swimming accident. While he was in the hospital, a company plane veered off course in Norway, into or near Soviet air space. The FAA revoked the company’s certification because of that and other violations. As a condition of recertifying, the FAA required Mr. Wray and others previously in charge to resign their corporate offices.
The company still belonged entirely to Mr. Wray, however, and he caused the bank account to be moved into one for which he would have signing authority. Mary Phillips, the plaintiff, became the person running the company on a day to day basis. During the first two quarters of 1985, while Mr. Wray was confined to his apartment by his paralysis, the company did not pay its employee withholding taxes over to the IRS.
The jury heard conflicting stories of how the withholding taxes for the first six months of 1985 came to be delinquent. According to Mr. Wray, Ms. Phillips had let the withholding taxes go into arrears in 1982, and when he found out about it from an IRS notice, he paid them and told her never to let that happen again. In 1985, after his accident, he heard that Ms. Phillips had laid off most employees, because the airline was not flying, yet kept all of her own staff. For that and other reasons, he moved the bulk of the company money into an account for which he, instead of Ms. Phillips, would have signing authority. But Mr. Wray could not physical*941ly perform the duties of a person running the company, and he had been required to resign by the FAA. Ms. Phillips would request funds from Mr. Wray, and he would make them available to her “as long as she gave a reason for it.” She would call Mr. Wray once or twice a week to request funds, and Mr. Wray would arrange for checks to be delivered to Ms. Phillips. Ms. Phillips never mentioned to Mr. Wray that the taxes were not being paid, and he would have paid them if he had known.
Ms. Phillips gave a conflicting account. She testified that after the FAA shut down operations, the airline was in desperate financial condition, and Mr. Wray said the top priority was to get it flying again. She testified that he picked which creditors should get paid. When she told him the company owed withholding taxes, he told her not to pay them. Even though he was confined by his injuries, Mr. Wray controlled the money, and she could not pay the taxes without his authorization.
Initially, the IRS sought the taxes from Ms. Phillips, as the “responsible person” under 26 U.S.C. § 6672 for the first two quarters of 1985. She paid enough so that she could sue for a refund in district court. Mr. Wray was joined as a defendant on the IRS counterclaim. Ms. Phillips wound up escaping liability for the taxes, and Mr. Wray, in a subsequent trial, was stuck with a judgment for $368,812 plus interest. Mr. Wray appeals.
Analysis
“The standard of review on appeal for an alleged error in jury instructions depends on the nature of the claimed error.” Oglesby v. Southern Pacific Transp. Co., 6 F.3d 603, 606 (9th Cir.1993). If it is the district court’s formulation of an instruction which is claimed to be in error, we review the instructions as a whole for abuse of discretion by determining whether the instructions, considered as a whole, were inadequate or misleading. Gizoni v. Southwest Marine Inc., 56 F.3d 1138, 1142 n. 5 (9th Cir.1995); Jenkins v. Union Pacific Railroad Co., 22 F.3d 206, 210 (9th Cir.1994); Oglesby, 6 F.3d at 606. When the claim of error is that the district court misstated the elements that must be proved at trial, however, we review the instruction de novo. Gizoni, 56 F.3d at 1142; Jenkins, 22 F.3d at 210; Oglesby, 6 F.3d at 606. In either case, reversal is unnecessary if it is more probable than not that the error in the instructions is harmless. Jenkins, 22 F.3d at 210.
In the present case, Mr. Wray does not dispute that the “willfulness” element for a violation of 26 U.S.C. § 6672 may be satisfied by a showing of “reckless disregard,” or that the district court misstated the elements of a violation of § 6672. Rather, he argues that the district court erred in formulating the definition of “reckless disregard.” We therefore review the instructions as a whole for an abuse of discretion.
We also review admission of evidence for abuse of discretion. United States v. Herrera-Medina, 609 F.2d 376, 379 (9th Cir.1979).
A. Willfulness.
Mr. Wray concedes that, despite his physical indisposition, he was a “responsible person.” He owned the company and controlled the bank account from which the money had to be drawn, and he directed which bills were to be paid. The issue is whether, as a responsible person, he “willfully” caused the money withheld for taxes not to be paid over to the IRS. His theory of the case was that he did not know the taxes were not being paid, so his failure to pay them was not “willful.”
The controlling statute makes a responsible individual personally liable for a company’s unpaid withholding taxes only if he “willfully” fails to pay them:
Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be hable to a penalty equal to the total *942amount of the tax evaded, or not collected, or not accounted for and paid over.
26 U.S.C. § 6672 (emphasis added).
If a responsible person knows that withholding taxes are delinquent, and uses corporate funds to pay other expenses, even to meet the payroll out of personal funds he lends the corporation, our precedents require that the failure to pay withholding taxes be deemed “willful.” Sorenson v. United States, 521 F.2d 325 (9th Cir.1975); Teel v. United States, 529 F.2d 903 (9th Cir.1976). This may seem oppressive to the employer and employees, Sorenson, 521 F.2d at 329, and amount to “unwittingly” willful, Teel, 529 F.2d at 905, which seems an oxymoron, but the proposition is established law.
Where a chief executive officer spent his time in the field making money for the business, left cosigned cheeks with his controller to pay the bills, and did not know his controller was failing to pay over the withholding taxes to the IRS, “[t]he question is one of fact” whether the nonpayment was willful, because the facts allowed for the possibility that the chief executive was “negligent, which is not willfulness.” United States v. Leuschner, 336 F.2d 246, 248 (9th Cir.1964). But when he did it again in a second company, with the same controller, when he knew that the controller had once failed in the past to pay over the withholding taxes, and the chief executive did nothing to prevent a recurrence, that was willfulness as a matter of law. Id.
We have construed the term “willfulness” for purposes of failing to pay over withholding taxes as a “voluntary, conscious and intentional act to prefer other creditors over the United States.” Klotz v. United States, 602 F.2d 920, 923 (9th Cir.1979); Davis v. United States, 961 F.2d 867, 871 (9th Cir.1992). No bad motive need be proved, and conduct motivated by reasonable cause, such as meeting the payroll, may be “willful.” Davis, 961 F.2d at 871; Sorenson, 521 F.2d at 327.
“But the Government must prove more than mere negligence.” Klotz, 602 F.2d at 924. Where a corporate officer sent the IRS a check, but the IRS did not negotiate it until a month later when the officer had been forced out of power and the corporation dishonored his check without his knowledge, his failure to pay the taxes was non-willful as a matter of law. Dudley v. United States, 428 F.2d 1196 (9th Cir.1970). Even if he was negligent, “negligence is not willfulness.” Id. at 1200.
We have said that “reckless disregard” of whether the taxes are being paid over, as distinguished from actual knowledge of whether they are being paid over, may suffice to establish willfulness. Sorenson, 521 F.2d at 329; Teel, 529 F.2d at 905. Other circuits so hold. See, e.g., Kalb v. United States, 505 F.2d 506, 511 (2d Cir.1974); Wood v. United States, 808 F.2d 411, 415 (5th Cir.1987); Sawyer v. United States, 831 F.2d 755, 758 (7th Cir.1987); Malloy v. United States, 17 F.3d 329, 332 (11th Cir.1994).
Mr. Wray’s argument on appeal is that the district court instruction allowed the jury to find willfulness based on mere negligence, by defining reckless disregard so that it meant no more than negligence. He does not dispute that reckless disregard of whether the taxes are paid over amounts to willfulness. Rather, he shows that the district court copied language from a Seventh Circuit case defining “gross negligence,” deleted the term “gross negligence,” and attached the definition to “reckless disregard.”
Here is the instruction which the district judge gave:
Liability is imposed on a responsible person, under Section 6672, only if the person willfully fails to collect, account for, or pay over withheld taxes. “Willfulness,” within the meaning of Section 6672, requires a voluntary, conscious and intentional act to prefer other creditors over the United States. Liability does not depend on the presence of an evil motive or specific intent to deprive the government of revenue. In fact, conduct motivated by a reasonable cause may, nonetheless, be willful. Rather, a responsible person acts willfully whenever he permits funds of the corporation to be paid to other creditors when he is aware that withholding taxes *943due the government have not been paid. In other words, when a responsible person does not use his authority to see that the withholding taxes are paid, but rather permits the corporation to continue its operation, paying suppliers and other creditors, his conduct is willful.
Further, even in the absence of express knowledge of a default and payment of withholding taxes, willfulness, for the purpose of Section 6672, exists where a responsible person pays other creditors with a reckless disregard as to whether trust fund taxes have been paid over to the government. For this purpose, recklessness is established if the party, first, clearly ought to have known that; second, there was a grave risk that withholding taxes were not being paid; and if, three, he was in a position to find out for certain very easily.
Recklessness is also established if a responsible person fails to investigate or correct mismanagement after being notified of a default in the payment of withholding tax.
(Emphasis added).
The district court took the emphasized language from Wright v. United States, 809 F.2d 425, 427 (7th Cir.1987) (defining § 6672 willfulness). In Wright, the Seventh Circuit said “we think gross negligence is enough to establish reckless disregard.” Id. at 427. The court reasoned that “if a high degree of recklessness were required the purpose of the statute would be thwarted, just by compartmentalizing responsibilities within a business (however small) and adopting a ‘hear no evil — see no evil’ policy_” Wright, 809 F.2d at 427. In Wright, a man bought out a failing company, knowing that the principal had failed to pay withholding taxes in the past, left the old principal in place, knew the company was still failing, directed payment of other creditors, and did not check on whether the withholding taxes were being paid over though he could have found out very easily. The Seventh Circuit used this language, from which district court drew the challenged language in the instruction:
Concretely we hold that the “responsible person” is liable if he (1) clearly ought to have known that (2) there was a grave risk that withholding taxes were not being paid and if (3) he was in a position to find out for certain very easily.

Id.

We conclude that in the facts of this case, the instruction was not erroneous. Though “mere negligence” is not willfulness, gross negligence is not “mere” negligence. The instruction is not poisoned by the use of language drawn from a definition of gross negligence. Not all cases would include evidence justifying the instruction, but in this case, a jury could have concluded that Mr. Wray clearly ought to have known there was a grave risk that the withholding taxes were not being paid over. He knew employees were being paid but no flights for hire were being made, and that Ms. Phillips had let the taxes go unpaid once before. Also, he was approving which bills were to be paid. Even if the jury believed Mr. Wray’s account entirely, it could conclude that he should have asked her if she was paying the taxes, in light of her failure to pay them three years earlier. The jury could also have thought that even if she did not mention that she was failing to pay the taxes, Mr. Wray clearly should have noticed that the withholding taxes were not among the checks for which she sought approval. A jury could also conclude from the evidence, even if it did not believe Ms. Phillips’ testimony, that all he needed to do to find out that Ms. Phillips was not paying over the withholding taxes was ask her.
As in many “responsible person” cases the result is not one we reach with any pleasure. The jury instruction allowed for a verdict against Mr. Wray even if the jury thought Ms. Phillips was lying and Mr. Wray was telling the truth. If so, a man who was then paralyzed from the neck down winds up paying an enormous bill to the government because he did not attend fully enough to the business which was failing in his forced absence, and did not discover that a trusted employee (who escaped legal responsibility) was not doing her duty. A jury could find, however, that under the Draconian enforcement power which the IRS has under the precedents we are compelled to follow, Mr. *944Wray recklessly disregarded his tax responsibility.1
B. Prejudicial evidence.
Mr. Wray challenges admission of certain evidence on the ground that it tended to show character rather than anything relevant to his conduct. A man who became controller a year after the delinquency period testified that when he was controller and the issue of delinquent 'withholding taxes came up, Mr. Wray emphasized to him the importance of paying other bills. A man who had directed operations testified that when he advised Mr. Wray, a year before the delinquency period, to hire more pilots in order to keep within FAA maximum hours limits, Mr. Wray said “let’s live dangerously.” Another former employee testified that when Ms. Phillips failed to pay over the withholding taxes in 1982, Mr. Wray said that the problem arose because Ms. Phillips had not paid the taxes on time, and he responded that she could not pay anything Mr. Wray did not approve. Mr. Wray objected to admission of all this testimony.
Mr. Wray argues that pre- and post-delinquency conduct was evidence of other wrongs to prove his character in order to show conduct conforming to bad character, so was inadmissible under Federal Rule of Evidence 404(b). Except for the “live dangerously” remark, the evidence did not really suggest other wrongs. That a man who owns a company controls which bills are paid, and that he takes care to see that his company’s debts to creditors without the coercive power of the IRS are paid, would not amount to “prior bad acts.” People of good character may choose to pay their employees and weak creditors instead of paying the strongest creditor of all, the IRS. This was evidence of opportunity to control which debts were paid, absence of mistake as to which debts were paid, and attention to which debts were paid, all tending to show that Mr. Wray probably controlled which debts were paid. It is not evidence of character from which an inference of bad conduct was suggested.
That the time period for this evidence was prior or subsequent to the delinquency period does not bar admission. Cf. United States v. Voorhies, 658 F.2d 710, 715 (9th Cir.1981) (“acts both prior and subsequent to the indictment period may be probative of the defendant’s state of mind”). The relevance was more attenuated than in most cases, because Mr. Wray’s control was probably less when he was paralyzed in his apartment than when he was physically capable of personal oversight in his office. Nevertheless his pattern of personal attention to the details of which bills were paid before and after the delinquency period affected the probability that he controlled which bills were paid during his period out of the office.
The “live dangerously” remark is more troublesome. Probably the remark should not have been allowed in. It would tend to make a jury think Mr. Wray purposely endangered passengers, and encourage the jury to punish him. This evidence had little tendency to prove that Mr. Wray willfully caused the withholding tax reserves to be *945diverted to other creditors. Proving that the defendant is a bad person, as opposed to proving that he did what he is accused of, so that a jury will wish to find against him even in the absence of sufficient evidence, is precisely the evil against which Federal Rule of Evidence 404 is directed.
We conclude, however, that admission of the “live dangerously” remark was harmless error. We therefore do not have to decide whether allowing it in was an abuse of discretion. We are required to disregard an error in the admission of evidence “which does not affect the substantial rights of the parties.” Fed.R.Civ.P. 61; Gray v. Shell Oil Co., 469 F.2d 742, 751-52 (9th Cir.1972). Wray bears the burden of showing that prejudice resulted. Palmer v. Hoffman, 318 U.S. 109, 116, 63 S.Ct. 477, 481-82, 87 L.Ed. 645 (1943). Even disregarding all the evidence which Mr. Wray’s defense impeached, he controlled which bills were paid, did not ask whether the withholding taxes were being paid, knew Ms. Phillips had let them go in arrears a few years before, and knew revenues had halted while overhead continued. When he did nothing to prevent Ms. Phillips from letting the withholding taxes go into arrears a second time, in these circumstances, and did not ask her whether she was paying the taxes, the jury had no basis on which to find an absence of willfulness. Cf. United States v. Leuschner, 336 F.2d 246, 248 (9th Cir.1964) (“He could no longer, in good faith, look to Anders to do his duty for him. His complete failure to do anything to see that Anders, or he himself, performed that duty, is, we think, as a matter of law, a “voluntary, conscious and intentional’ failure.”).
AFFIRMED.

. The dissent says that we have held that gross negligence is sufficient to establish willfulness under 26 U.S.C. § 6672. Our decision is not that gross negligence is willfulness, but rather that the instruction on reckless disregard was correct, even though it used some language with which the Seventh Circuit defined gross (as opposed to "mere”) negligence. We are bound by our precedents establishing that reckless disregard is willfulness for purposes of 26 U.S.C. § 6672. The instruction accurately defined reckless disregard for purposes of civil liability. The dissent says that “[t]he question, however, is whether gross negligence is sufficient to establish willful failure, not whether it suffices to prove reckless disregard." We do not agree that this is the question. Our precedents already bind us to the proposition that reckless disregard suffices to prove willful failure, so the question can only be whether the court's use of gross negligence language to define reckless disregard was correct. If reckless disregard amounts to willful failure, an established proposition in this circuit which we cannot overturn, and if the instructional language sufficiently defines reckless disregard, then reckless disregard so defined necessarily amounts to willfulness. There is also something to be said in favor of avoiding intercircuit conflict in interpretation of the tax laws, by maintaining consistency with the Seventh Circuit interpretation. Our dissenting colleague's citation of criminal cases would seem to intimate that the same state of mind which would subject a person to a civil tax penalty should subject him to criminal penalties, but he says "I do not mean to imply” that, and neither do we.