Court Opinion

ID: 9470138
Source: CourtListenerOpinion
Date Created: 2023-08-05 02:58:09.039113+00
Date Added: 2024-06-11T17:41:45.279215
License: Public Domain

VAN GRAAFEILAND, Circuit Judge,
dissenting:
If I understand my colleagues’ position, it is that, to the extent the Commissioner’s disallowance of deductions from a Subchapter S corporation’s gross income moves the corporation’s taxable income from the red into the black, the amount involved should be treated as an “increase”, or actually the creation, of taxable income. That amount, my colleagues hold, can then be treated, under section 6013(e) of the Internal Revenue Code, as omitted income of the wife of the corporation’s sole shareholder. I respectfully disagree.
The existence vel non of income is not determined by bookkeeping entries or tax return figures, but by the facts. See Doyle v. Mitchell Brothers Co., 247 U.S. 179, 185-88, 38 S.Ct. 467, 469-470, 62 L.Ed. 1054 (1918); Slaff v. CIR, 220 F.2d 65, 68 (9th Cir.1955); Commissioner v. Union Pac. R. Co., 86 F.2d 637, 639 (2d Cir.1936). “[Tjaxation deals with realities” and “substance not form controls in the determination of tax problems.” 1 Mertens Laws of Fed Income Tax § 5.09. Accordingly, an audit which discloses false or fraudulent deductions does not “increase” taxable income; it merely restates it correctly. Lowy v. CIR, 288 F.2d 517, 519-20 (2d Cir.1961), cert. denied, 368 U.S. 984, 82 S.Ct. 596, 7 L.Ed.2d 523 (1962). Since a Subchapter S corporation’s income, whether or not distributed, is passed through or attributed to its shareholders, Pants Rack, Inc. v. United States, 669 F.2d 198, 200 (4th Cir.1982); United States v. Richardson, 469 F.2d 349 (10th Cir.1972); 7 Mertens Law of Fed Income Tax § 41B.24, it is not correct, in my opinion, to treat improper deductions therefrom as omitted income of the taxpaying shareholders. It is the shareholder’s duty to pay the tax, United States v. Nathan, 536 F.2d 988, 990 n. 2 (2d Cir.1976); William H. Leonhart, 27 T.C.M. (CCH) 443, 462 (1968), aff’d sub nom. Leonhart v. C.I.R., 414 F.2d 749 (4th Cir.1969), and the amount paid should be based on an accurate report of corporate income, id. at 750.
Assuming for the argument that, despite the provisions of Treasury Regulation, 1.6013-5(d), 26 CFR 1.6013-5(d), erroneous *473deductions might in some instances be treated as omissions from income, the Tax Court correctly held that the omissions in the instant ease were disclosed “in the return or in a statement attached to the return”, see 26 U.S.C. § 6501(e)(l)(A)(ii), and therefore could not be taken into account in determining the amount omitted from the taxpayer’s gross income. See Colony, Inc. v. CIR, 357 U.S. 28, 36, 78 S.Ct. 1033, 1037, 2 L.Ed.2d 1119 (1958); Uptegrove Lumber Co. v. CIR, 204 F.2d 570, 573 (3d Cir.1953); 10 Mertens Law of Fed Income Tax § 57.-37.
The corporate return, which must be treated as part of the taxpayer’s return, see Estate of Klein v. CIR, 537 F.2d 701, 703-06 (2d Cir.1976), shows gross receipts of $30,-841.59. Against these, the following deductions were claimed but disallowed:
Loan Reduction and Interest $ 828.00
Equipment 1,948.00
Miscellaneous (Transportation and Entertainment) 41,297.00
Interest Expense 10,500.00
Fire Loss 13,666.00
Error in Addition in Return 30.00
Depreciation 5.807.00
$ 74,076.00
These deductions were not simply disclosed in the returns; they were disclosed with a red flag flying. The provisions of section 6501(e)(l)(A)(ii) clearly were applicable. I agree with the Tax Court that there was no omission from the gross income of the taxpayer and would affirm.1

. The addition of footnotes 4 and 5 to the majority opinion seems to indicate that my colleagues agree with the basic premises of this dissent. If this is so, I confess that I do not understand how my colleagues arrive at their ultimate holding.
Each shareholder of a Subchapter S corporation is required “to assume that, on the last day of the corporation’s taxable year, there occurred a pro rata distribution of the corporation’s ‘undistributed taxable income’ for that year, and there is attributed to each shareholder the amount he would have received as a dividend if there had been such a distribution. This amount must be included by the shareholder as a dividend distributed by the corporation on the last day of its taxable year, and is included in the shareholder’s gross income for his taxable year in or with which the corporation’s year ends.” 7 Mertens Law of Fed Income Tax § 41B.26 at 48. Section 6501(e)(l)(A)(ii) provides that “[i]n determining the amount omitted from gross income, there shall not be taken into account any amount which is omitted from gross income stated in the return if such amount is disclosed in the return, or in a statement attached to the return, in a manner adequate to apprise the Secretary or his delegate of the nature and amount of such item” (emphasis supplied).
The erroneous deductions from the gross income of both the corporation and the Ketchums were “disclosed” when these amounts were included in the corporation’s 1120S form attached to the Ketchum’s return. “The language of the statute does not require a specific disclosure of the dollar amount omitted. All the statute does require is a clue to the existence of the omitted item. The clue need not be a detailed revelation of each and every underlying fact, but it must be sufficient so that if the Service had made a reasonable follow-up of the clue, the adjustment ultimately made would have been disclosed.” 10 Mertens, supra, § 57.37 at 65. Certainly the unitemized deduction of $41,297 for “Miscellaneous (Transportation and Entertainment)” meets this requirement. If section 6501(e)(l)(A)(ii) and Treasury Regulation 1.6013-5(d) mean what they say, I cannot conclude, as do my colleagues, that there was an “omission” from the Ketchums’ joint return so as to qualify Mrs. Ketchum for relief under 26 U.S.C. § 6013(e)(1)(A).