T.C. Memo. 1995-593
UNITED STATES TAX COURT
DAVID RENDEL AND RACHEL RENDEL, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11878-93. Filed December 14, 1995.
David M. Kirsch, for petitioners.
Allan D. Hill, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined a deficiency in
petitioners' 1983 Federal income tax and additions to tax for
fraud and for a substantial underpayment of tax as follows:
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Additions to Tax
Sec. Sec. Sec.
Deficiency 6653(b)(1) 6653(b)(2) 6661
$49,846 $24,923 * $12,462
* 50 percent of interest due on portion of
underpayment attributable to fraud.
All section references are to the Internal Revenue Code in
effect for 1983, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
Petitioners assert that offshore trusts that they
established in 1982 constituted sham trusts that lacked economic
substance and that should be disregarded for Federal income tax
purposes. Petitioners and respondent, however, disagree on the
year in which funds relating to such trusts should be taxable to
petitioners.
The issues for decision are: (1) Whether the funds in
question should be treated as taxable to petitioners under the
constructive receipt doctrine in 1982 -- a year not before the
Court -- or as taxable to petitioners in 1983 -- the year in
which petitioners actually received and used the funds; and
(2) whether petitioners filed a fraudulent 1983 joint Federal
income tax return, but for which the period of limitations on
assessment against petitioners for 1983 is barred.
FINDINGS OF FACT
Many of the facts have been stipulated and are so found.
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At the time the petition was filed, petitioners resided in
Alameda, California.
In 1980, petitioners formed Columbia Cosmetics
Manufacturing, Inc. (CCMI), as a California corporation to market
and distribute cosmetics. CCMI was formed and operated as a
subchapter C corporation. Petitioners were the sole shareholders
and officers of CCMI. Petitioner David Rendel (David) was
president, and petitioner Rachel Rendel (Rachel) was vice
president of CCMI. The offices and principal place of business
of CCMI were located in San Leandro, California.
Petitioners' books and records were maintained on the cash
method of accounting. CCMI's books and records were maintained
on the accrual method of accounting. Both sets of books and
records were maintained by Crudup C. Howard (Howard), an
accountant petitioners hired for that purpose. Howard met
monthly with Rachel to reconcile CCMI's bank statements and to
discuss with Rachel the accounting for various transactions.
By late 1981, CCMI was earning a significant profit. In
late 1981, Howard and petitioners consulted with a number of tax
shelter promoters (namely, Gil Armstrong (Armstrong) who was a
representative of the American Law Association (ALA),1 John Green
(Green), and Michael Panatelli (Panatelli)). These individuals
1
The ALA was founded by Karl Dahlstrom for the purpose of
promoting offshore trusts.
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advised Howard and petitioners regarding the purported tax
benefits of offshore trusts.
In 1982, with the assistance of Howard, Armstrong, and
Green, petitioners established an ALA-type of offshore trust
program. Five sham trusts were established and domiciled in
Grand Turk, the capital of the Turks and Caicos Islands, located
in the British West Indies, under the names of five shell
companies (namely, DCH Management (DCH), Ledner Consulting Co.
(Ledner), DARA Co. (DARA), Cosmos Investment Co. (Cosmos), and
Alpha Associates (Alpha)).
Bank accounts were then opened in California, one account
each under the name of four of the five trusts. Howard was a
trustee and an agent for Alpha, and Howard held signatory
authority over the DCH, Ledner, DARA, and Cosmos bank accounts.
An interest-bearing investment account was also maintained
in California under Alpha’s name with the Capital Preservation
Fund of the First Interstate Bank of California (the Alpha
account). The Alpha account was maintained under CCMI's
corporate identification number. Rachel held signatory authority
over the Alpha account.
Pursuant to petitioners' offshore trust program, funds
transferred into the trusts represented profits realized by CCMI.
During 1982 and 1983, $174,308 in profits of CCMI was
transferred from CCMI through the offshore trusts and ultimately
to the Alpha account. With Howard's participation, the profits
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transferred out of CCMI and into the offshore trusts were
incorrectly recorded on CCMI's books and records as payroll
expenses.
The schedule below describes the transfers that occurred
between January 10, 1982, and February 2, 1983, of CCMI's profits
from CCMI to and among the offshore trusts and into the Alpha
account:
Date Transferred Transferred Date Deposited
Amount From CCMI Through Trusts Into Alpha Acct.
$ 35,500 1/10/82 DCH-DARA-Cosmos 2/23/82
23,350 3/15/82 DCH-DARA-Cosmos 3/31/82
26,650 3/22/82 Ledner-DCH-DARA-Cosmos 4/14/82
27,696 5/12/82 DCH-DARA-Cosmos 5/26/82
35,699 9/8/82 DCH-DARA-Cosmos 9/20/82
9,115 11/23/82 DCH-DARA-Cosmos 12/7/82
16,298 12/29/82 DCH-DARA-Cosmos 2/2/83
$174,308
In 1983, certain additional transfers occurred of the same
profits or funds of CCMI that had been transferred out of CCMI in
1982 and into the offshore trust bank accounts. In particular,
on June 9, 1983, $135,000 was transferred out of the Alpha
account and back into CCMI's bank account. Between June 11,
1983, and June 17, 1983, this same $135,000 was transferred yet
again from CCMI through the above offshore trusts and back into
the Alpha account.
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On June 24, 1983, $184,630 was withdrawn from the Alpha
account2 by the purchase of a cashier's check and was used by
petitioners as part payment on the purchase of a new personal
residence for petitioners in Alameda, California (referred to
hereinafter as the Oyster Pond Property). An installment note
from petitioners to Alpha with respect to this $184,630 was
drafted but was never signed by petitioners, and petitioners made
no repayments to Alpha of this $184,630. Alpha did receive a
deed of trust on the Oyster Pond Property as stated security
relating to this $184,630. Petitioners have implicitly conceded
that petitioners' withdrawal of this $184,630 did not constitute
a valid loan from Alpha.
In August and September of 1983, petitioners purchased
appliances and other items for the Oyster Pond Property using
$3,148 in CCMI's funds. The schedule below describes these
purchases:
Date Item Cost
8/11/83 Home appliances $2,051
8/31/83 Wallpaper 800
9/8/83 Other expenses 297
$3,148
On November 8, 1982, this Court decided Zmuda v.
Commissioner, 79 T.C. 714 (1982), affd. 731 F.2d 1417 (9th Cir.
2
This amount includes accrued interest and appears to have
been the entire balance of the Alpha account at the time of
withdrawal.
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1984). In the Zmuda case, we held that certain offshore trust
programs similar to those established by petitioners herein
constituted shams, lacked economic substance, and were to be
disregarded for Federal income tax purposes.
The $174,308 in profits from CCMI that in 1982 was
transferred out of CCMI and through the above offshore trusts
into the Alpha account was not reported on petitioners' 1982
Federal income tax return.
Howard alleges that in August of 1983 he first learned that
this Court had decided Zmuda v. Commissioner, supra, under the
authority of which the $174,308 transferred in 1982 out of CCMI,
through the offshore trusts, and into the Alpha account arguably
should be treated as taxable income to petitioners in 1982. On
August 24, 1983, Howard conveyed the information about Zmuda and
its ramifications to petitioners.
On August 31, 1983, Howard, on behalf of petitioners,
"discontinued" the DCH, Ledner, DARA, Cosmos, and Alpha trusts
and closed the accounts of Ledner, DARA, and Cosmos. The record
does not reflect whether or when the bank accounts of DCH and
Alpha were closed.
Also in August or early September of 1983, Howard prepared
for petitioners a proposed amended joint 1982 Federal income tax
return (proposed amended 1982 return). On this proposed amended
1982 return, the $174,308 in profits of CCMI that had been
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transferred in 1982 into the offshore trusts was reflected as
taxable income to petitioners.
On September 14, 1983, Howard gave petitioners the proposed
amended 1982 return. Petitioners, however, refused to sign the
proposed amended 1982 return, and Rachel tore it in two, stating,
"We'll wait until * * * [respondent] catches us."
On petitioners' 1983 joint Federal income tax return that
was timely filed with respondent, neither the $174,308
transferred out of CCMI through the offshore trusts and into the
Alpha account, nor the $184,630 withdrawn in 1983 from the Alpha
account and used by petitioners to purchase the Oyster Pond
Property was reported as income by petitioners. On petitioners'
1983 Federal income tax return, petitioners did report as
miscellaneous income $21,058 relating to their personal use of
CCMI funds. This amount was not otherwise described.
On CCMI's 1983 Federal corporate income tax return, $3,158
in interest income earned on the Alpha account in 1983 was
reported as interest income.
On November 24, 1984, Howard, as trustee for Alpha, and
without consideration, signed a reconveyance deed transferring
Alpha's purported security interest in the Oyster Pond Property
from Alpha to petitioners.
On April 10, 1991, a Federal Grand Jury indicted petitioners
for conspiracy to defraud the United States during 1981 through
1986 with regard to petitioners' joint individual and CCMI's
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corporate Federal income taxes and for tax evasion for 1984 and
1985 with regard both to petitioners' joint individual and CCMI's
corporate Federal income taxes.
On August 5, 1992, respondent determined deficiencies in and
additions to petitioners' joint Federal income taxes and CCMI's
corporate Federal income taxes for 1984 and 1985 in the total
amount of $299,908. The tax deficiencies and additions to tax
determined by respondent against petitioners for 1984 and 1985
bore no specific relationship to the offshore trust tax shelter
scheme at issue in this case but did relate to petitioners'
diversion of CCMI funds for their personal benefit in 1984 and
1985 through other schemes.
On October 17, 1991, petitioners paid to respondent the
total of $299,908 in Federal income tax deficiencies determined
against petitioners and CCMI for 1984 and 1985.
On October 22, 1991, petitioners each pleaded guilty to one
count of tax evasion for 1984. The Government dropped the
remaining counts of the above criminal indictment.
On March 16, 1993, respondent mailed to petitioners the
notice of deficiency for 1983 that is at issue in this case, in
which respondent determined that petitioners received in 1983,
not in 1982, unreported distributions from CCMI of $191,2783 as a
3
Respondent computed the $191,278 in distributions based on
the $184,630 withdrawn in 1983 from the Alpha account to purchase
the Oyster Pond Property, plus the $3,148 in furnishings paid
(continued...)
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result of petitioners' use in 1983 of the profits of CCMI for
personal purposes (namely, to purchase and improve the Oyster
Pond Property), and respondent determined that, as a result of
petitioners' alleged fraudulent failure to report such
distributions on their 1983 joint Federal income tax return, the
period of limitations on assessment was still open.
OPINION
1983 Constructive Dividends
Numerous court opinions establish that if shareholders of a
corporation receive distributions of corporate funds or other
corporate property for their personal use or benefit, the
distributions from the corporation may be taxed to the
shareholders as constructive dividends to the extent of the
corporation's earnings and profits. Ireland v. United States,
621 F.2d 731, 735 (5th Cir. 1980); Loftin & Woodard, Inc. v.
United States, 577 F.2d 1206, 1214 (5th Cir. 1978); Commissioner
v. Riss, 374 F.2d 161, 166-167 (8th Cir. 1967), affg. in part,
revg. in part, and dismissing in part T.C. Memo. 1964-190; Melvin
v. Commissioner, 88 T.C. 63 (1987), affd. per curiam 894 F.2d
1072 (9th Cir. 1990); Challenge Manufacturing Co. v.
Commissioner, 37 T.C. 650, 663 (1962); American Properties, Inc.
3
(...continued)
with CCMI funds, plus $3,500 in allegedly omitted commission
income paid by CCMI to David. Respondent now concedes that the
$3,500 treated as commission income represents a nontaxable
repayment by CCMI of a loan CCMI had received from David.
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v. Commissioner, 28 T.C. 1100, 1115 (1957), affd. 262 F.2d 150
(9th Cir. 1958).
In Zmuda v. Commissioner, supra, and in the decisions that
followed,4 the courts held that funds received by certain
offshore trusts were taxable in the year of receipt to the
taxpayers who controlled the trusts.
Petitioners herein argue that the offshore trust program in
which they participated is not distinguishable from the offshore
trust program that in Zmuda v. Commissioner, supra, was held to
constitute a sham and that was disregarded for Federal income tax
purposes. Petitioners then argue that, in light of the holdings
in Zmuda and its progeny, and under the claim of right doctrine,
the profits or funds of CCMI that, at the end of 1982, were
transferred into the offshore trusts should be treated as
constructively received by petitioners in 1982, not in 1983.
Petitioners, in other words, contend that respondent has chosen
4
See Sandvall v. Commissioner, 898 F.2d 455 (5th Cir. 1990),
affg. on consolidated appeal T.C. Memo. 1989-56 and T.C. Memo.
1989-189; Akland v. Commissioner, 767 F.2d 618 (9th Cir. 1985),
affg. T.C. Memo. 1983-249; Professional Serv. v. Commissioner, 79
T.C. 888 (1982); Spencer v. Commissioner, T.C. Memo. 1994-531;
Dahlstrom v. Commissioner, T.C. Memo. 1991-265, affd. without
published opinion 999 F.2d 1579 (5th Cir. 1993); Dahlstrom v.
Commissioner, T.C. Memo. 1991-264, affd. without published
opinion 999 F.2d 1579 (5th Cir. 1993); Able Co. v. Commissioner,
T.C. Memo. 1990-500; Denali Dental Serv. v. Commissioner, T.C.
Memo. 1989-482; Pauli v. Commissioner, T.C. Memo. 1989-481;
Melvin L. Cochran, D.D.S., Inc. v. Commissioner, T.C. Memo.
1989-102.
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the wrong year in which to tax petitioners on the $174,308
withdrawn from CCMI and deposited into the offshore trusts.
Respondent argues that the $184,630 that in June of 1983
petitioners withdrew from the Alpha account and used to purchase
the Oyster Pond Property should be treated as a constructive
dividend taxable to petitioners in 1983.
We agree with respondent. In the instant case, during 1982
and early 1983, sufficient control over the offshore trust bank
accounts was maintained and exercised on behalf of CCMI so that
the funds transferred by CCMI in 1982 through the trusts and into
the Alpha account are to be treated as properly taxable to
petitioners in 1983, the year in which CCMI's funds were first
used by petitioners for petitioners' personal benefit.
During June of 1983, before petitioners withdrew the
$184,630 from the Alpha account, $135,000 of the funds in that
account was transferred to CCMI, and then from CCMI through the
offshore trusts, back to the Alpha account. Interest of $3,158
that was earned on the Alpha account in 1983 was reported on
CCMI's 1983 corporate Federal income tax return. From the
inception of the Alpha account, CCMI's taxpayer identification
number was used for the Alpha account. Lastly, petitioners made
no personal use of the funds in the Alpha account until June 24,
1983, when $184,630 was withdrawn from the account for purchase
by petitioners of the Oyster Pond Property.
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We conclude that the $184,630 first withdrawn on June 24,
1983, from the Alpha account for petitioners' personal use and
benefit, is properly treated as constructive dividend income
taxable to petitioners in 1983.
In light of the fact that petitioners did report on their
1983 joint Federal income tax return $21,078 relating to their
personal use of CCMI funds, we conclude, however, that
petitioners are not taxable on the $3,148 relating to the items
purchased for the Oyster Pond Property.
Fraud Addition to Tax
Respondent has the burden of establishing fraud by clear and
convincing evidence. Sec. 7454(a); Rule 142(b); Bradford v.
Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo.
1984-601. Respondent must prove both that an underpayment in tax
exists and that a portion of the underpayment was due to fraud.
Laurins v. Commissioner, 889 F.2d 910, 913 (9th Cir. 1989), affg.
T.C. Memo. 1987-265; Edelson v. Commissioner, 829 F.2d 828, 832
(9th Cir. 1987), affg. T.C. Memo. 1986-223; King's Court Mobile
Home Park, Inc. v. Commissioner, 98 T.C. 511, 515 (1992); Wenz v.
Commissioner, T.C. Memo. 1995-277.
Respondent has shown that the $184,630 withdrawn from the
Alpha account is taxable to petitioners for 1983 and that the tax
reflected on petitioners' 1983 Federal income tax return was
therefore understated.
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Fraudulent intent consists of an intentional wrongdoing for
the purpose of avoiding the payment of taxes known to be owed.
Powell v. Granquist, 252 F.2d 56, 60 (9th Cir. 1958); DiLeo v.
Commissioner, 96 T.C. 858, 874 (1991), affd. 959 F.2d 16 (2d Cir.
1992). Fraud may be inferred from certain "badges of fraud,"
such as understatements of income, inadequate records, the
failure to file tax returns, the concealment of assets,
implausible or inconsistent behavior, and the failure to
cooperate with tax authorities. Bradford v. Commissioner, 796
F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo. 1984-601.
Because fraud can rarely be proved by direct evidence, fraud
is often established by circumstantial evidence. Spies v. United
States, 317 U.S. 492, 499 (1943); Bradford v. Commissioner, 796
F.2d at 307; Akland v. Commissioner, 767 F.2d 618, 621 (9th Cir.
1985), affg. T.C. Memo. 1983-249. Consistent and substantial
understatements of income may constitute evidence of fraud.
Marcus v. Commissioner, 70 T.C. 562, 577 (1978), affd. without
published opinion 621 F.2d 439 (5th Cir. 1980); Merritt v.
Commissioner, 301 F.2d 484, 487 (5th Cir. 1962), affg. T.C. Memo.
1959-172.
Fraud determinations against taxpayers who have participated
in sham offshore trust programs similar to that in which
petitioners participated generally have been sustained. See
Akland v. Commissioner, supra; Professional Serv. v.
Commissioner, 79 T.C. 888, 930-931 (1982); Dahlstrom v.
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Commissioner, T.C. Memo. 1991-265, affd. without published
opinion 999 F.2d 1579 (5th Cir. 1993); Dahlstrom v. Commissioner,
T.C. Memo. 1991-264, affd. without published opinion 999 F.2d
1579 (5th Cir. 1993); Able Co. v. Commissioner, T.C. Memo. 1990-
500. But see Spencer v. Commissioner, T.C. Memo. 1994-531;
Denali Dental Serv. v. Commissioner, T.C. Memo. 1989-482; Pauli
v. Commissioner, T.C. Memo. 1989-481.
Petitioners, citing United States v. Claiborne, 765 F.2d
784, 798 (9th Cir. 1985), argue that they did not have the
requisite fraudulent intent to conceal their income because they
in good faith relied on the advice of Howard, Armstrong, Green,
and Panatelli to the effect that their offshore trust program was
a legitimate tax shelter.
We disagree. Petitioners falsely reflected the withdrawals
from CCMI and the deposits to the trust bank accounts as payroll
expenses of CCMI. Petitioners attempted to conceal the $184,630
they used to purchase the Oyster Pond Property through a sham
loan transaction. Petitioners participated in a pattern of
fraudulent underreporting of income in 1984 and 1985 that we
believe began in 1983, if not earlier. We conclude that the
underpayment of petitioners’ income tax for 1983 resulting from
their participation in the sham offshore trust program was due to
fraud. See Akland v. Commissioner, supra at 622; Dahlstrom v.
Commissioner, T.C. Memo. 1991-264.
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We also sustain respondent's determination under section
6661, which provides for an addition to tax where the taxpayer
makes a substantial understatement of income tax liability. A
"substantial understatement" is described as an understatement
that exceeds the greater of 10 percent of the tax required to be
shown on the return or $5,000. Sec. 6661(b)(1)(A). The evidence
establishes that petitioners' tax liability falls within these
parameters, and we sustain respondent's determination on this
issue.5
Decision will be entered
under Rule 155.
5
Petitioners, for the first time in their reply brief, raise
a new issue as to whether CCMI in 1983 had sufficient earnings
and profits to support the taxability of the $184,630 in
constructive distributions from CCMI that we have concluded
petitioners received in 1983. This issue is untimely raised by
petitioners. It would now be prejudicial to respondent to allow
this new issue to be raised, and we treat this issue as waived.
See Seligman v. Commissioner, 84 T.C. 191, 198 (1985), affd. on
other grounds 796 F.2d 116 (5th Cir. 1986); Graham v.
Commissioner, 79 T.C. 415, 423-424 (1982). Nevertheless, we have
examined the record and find nothing to support petitioners’
argument as to the lack of earnings and profits. To the
contrary, Howard's uncontroverted testimony indicates that the
offshore trusts were funded with net profits of CCMI.