Bradshaw v. Commissioner

T.C. Memo. 1996-123

UNITED STATES TAX COURT

RONALD H. BRADSHAW AND MONICA I. BRADSHAW, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 19739-93. Filed March 12, 1996.

Bob J. Shelton and James L. Kissire, for petitioners.

Michael C. Prindible, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WHALEN, Judge: Respondent determined the following

deficiency in, and addition to, petitioners' 1989 income

tax:

Addition to Tax
Deficiency Sec. 6651(a)(1)

$254,336.56 $65,880.58
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All section references are to the Internal

Revenue Code, as in effect during 1989. References to

petitioner in this opinion are to Mr. Ronald H. Bradshaw.

The issues for decision are: (1) Whether income

realized by petitioners during 1989 in the amount of

$886,026 should be characterized as income from the

discharge of indebtedness or income from an illegal check-

kiting scheme; and (2) whether petitioners are liable for

the addition to tax under section 6651(a)(1) for failing to

file a timely return. As to the first issue, if we agree

with petitioners that the subject income is from the

discharge of indebtedness, pursuant to section 61(a)(12),

then it is not includable in petitioners' gross income

for 1989 because they were insolvent during that year by

more than the amount of the income. Sec. 108(a)(1)(B).

FINDINGS OF FACT

Some of the facts have been stipulated by the parties.

The Stipulation of Facts filed by the parties, together

with the exhibits attached thereto, is incorporated herein

by this reference. When petitioners filed the instant

petition, they resided in Arlington, Texas.

Petitioner was the sole stockholder and president of

Motion, Inc., a corporation engaged in the business of
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selling automobiles. Prior to 1988, Motion, Inc., had a

line of credit with Colonial National Bank (Colonial Bank)

located in Fort Worth, Texas, which Motion, Inc., used to

finance its purchase of automobiles. During the 1980's,

Colonial Bank's lending limit was approximately $300,000.

When, as sometimes happened, the balance of the amount

borrowed by Motion, Inc., under the line of credit exceeded

that limit, Colonial Savings & Loan, a related corporation,

funded the excess borrowing. Prior to 1988, the amount

borrowed under the line of credit reached a high of

approximately $750,000.

As collateral to secure the repayment of amounts

borrowed under the line of credit, petitioner executed a

security agreement on March 18, 1987, as "PRESIDENT/OWNER"

of Motion, Inc. The security agreement gave Colonial Bank

a security interest in all of the inventory, accounts, and

other rights to payment owned by Motion, Inc. As further

collateral, the bank maintained possession of the titles to

the automobiles that Motion, Inc., financed under the line

of credit. Petitioner was not personally liable for

repayment of the loans extended to Motion, Inc., under the

line of credit, and he did not personally guarantee their

repayment.

Sometime during 1988, the officers of both Colonial

Bank and Colonial Savings & Loan became uncomfortable with
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the line of credit extended to Motion, Inc. Both Colonial

Bank and Colonial Savings & Loan stopped making advances to

Motion, Inc., and the outstanding balance of the line of

credit was eventually paid off prior to 1989.

After 1988, petitioner continued to maintain a

checking account at Colonial Bank, and the bank provided

"draft services" to him. Under this arrangement,

petitioner would purchase an automobile and he would pay

for it with an "envelope draft", an instrument that

resembles a check. The seller of an automobile would place

the title to the automobile in the envelope and would send

the draft and the envelope through regular banking

channels. When the envelope draft arrived at Colonial

Bank, the bank would pay the draft to the presenting

institution out of funds provided by petitioner, and

petitioner would receive the title. The bank charged a

fee for this service.

Eventually, Colonial Bank was called upon to pay

drafts in the $200,000 range. Often, petitioner did not

have sufficient funds in his account at Colonial Bank to

pay an envelope draft, and a representative of the bank

would contact him to determine how petitioner intended to

pay the draft. From time to time, petitioner would deposit

a check drawn by Motion, Inc., on its account at Tarrant

Bank located in Fort Worth, Texas. Mr. Clark Kemble,
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president of Colonial Bank, would authorize the extension

of provisional credit to petitioner in the amount of the

deposit, and the bank would pay the envelope draft.

The tax deficiency at issue in this case is

based upon four checks that petitioner deposited into his

personal account at Colonial Bank in August 1989. Each of

those checks was drawn on Motion, Inc.'s account at Tarrant

Bank and was made payable to the "R.H. Bradshaw Car

Account", petitioner's personal account at Colonial Bank.

Motion, Inc., did not have sufficient funds in its Tarrant

account to pay the checks and, in due course, Tarrant Bank

returned the checks to Colonial Bank unpaid. The following

is a list of the checks that were deposited into

petitioner's account at Colonial Bank, the date each check

was deposited, and the date each check was returned unpaid:

Date
Check No. Amount Deposit Date Returned Unpaid
11401 $235,617 8/10/89 8/24/89
11423 237,488 8/14/89 8/22/89
11425 220,481 8/14/89 8/21/89
11426 192,440 8/15/89 8/22/89
Total 886,026

Based upon petitioner's deposits of the above checks
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into his account at Colonial Bank, the bank cleared for

payment and paid four outstanding checks that petitioner

had drawn on his account to the order of "Harbour View

Fleet & Leasing". The record does not describe the

relationship of that entity to petitioner or the nature of

the payments petitioner made to it. The following is a

list of the amounts and dates of the four checks cleared

from petitioner's account at Colonial Bank:

Check Amount Date Cleared

$235,533 8/11/89

216,149 8/14/89

241,819 8/14/89

192,439 8/16/89

Total 885,940

The parties to this case have stipulated that Colonial

Bank suffered a loss during 1989 in the amount of $886,026,

the aggregate amount of the checks that Tarrant Bank

returned due to insufficient funds, as opposed to $885,940,

the aggregate amount of the checks paid by Colonial Bank.

Similarly, petitioners admit receiving income from Colonial

Bank during 1989, in the amount of $886,026. At all times

during 1989, petitioners were insolvent by more than

$886,026.

When the Motion, Inc., checks were returned unpaid,
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officers of Colonial Bank concluded that petitioner had

engaged in a check-kiting scheme designed to defraud the

bank. Accordingly, on or about August 28, 1989, Colonial

Bank reported the check-kiting scheme to the Office of the

Comptroller of the Currency, the Federal Bureau of

Investigation, and the Office of the U.S. Attorney, using

a Criminal Referral Form (Long Form), prescribed by the

Office of the Comptroller of the Currency. The Criminal

Referral Form describes the scheme, as follows:

Mr. Bradshaw was depositing large items to his
personal account at Colonial National Bank (CNB)
drawn on his Motion, Inc. #013000871 account at
Tarrant Bank of Fort [sic] (TB). Items clearing
on his CNB account were in very similar large
amounts payable to a business in Canada, usually
dated a day or two before deposit at CNB. We
understand that a similar activity was occurring
at TB.

In addition to filing the Criminal Referral Form with

Federal authorities, Colonial Bank filed suit against

petitioner, Motion, Inc., and Tarrant Bank in a Texas court

seeking to recover the amount it had lost as a result of

petitioner's check-kiting scheme. Colonial Bank's petition

included a group of allegations entitled "CLAIM FOR

REIMBURSEMENT", under which the bank alleged that it had

relied upon the four checks drawn by Motion, Inc., in the

aggregate amount of $886,026, that had been deposited into

petitioner's account before it cleared for payment checks
 - 8 -

drawn by petitioner in the same approximate amount. Based

thereon, the bank alleged that petitioner and Motion, Inc.,

"are accountable and liable for the amount of the checks in

question." Colonial Bank's claim for reimbursement states

as follows:

7. Plaintiff [i.e., Colonial Bank] has informed
the Defendants Motion, Inc. and R.H. Bradshaw
that the Defendants are accountable to Plaintiff
for the amount of the checks in question and
demanded that the Defendants reimburse Plaintiff
for the sum of $886,026.00. Despite the demand
to pay Plaintiff, the Defendants have failed and
refused and still fail and refuse to pay
Plaintiff.

8. Plaintiff is in possession of the checks
with endorsement supplied by Plaintiff pursuant
to section 4.205 Tex. Bus. Comm. Code and were
delivered by R.H. Bradshaw to Plaintiff. Plain-
tiff took the checks for value, in good faith,
and without notice that they were overdue or had
been dishonored or of any defense against the
claim to them on the part of any person. By
reason thereof, Plaintiff is a holder in due
course. A copy of the August 14, 1989 checks
and the August 15, 1989 check is attached as
Exhibits "A", "B" and "C".

Colonial Bank's petition included another group of

allegations entitled "JUDICIAL FORECLOSURE OF SECURITY

INTEREST" under which Colonial Bank sought to recover the

amount of its loss from Motion, Inc., through foreclosure

of the bank's security interest in all of the assets of,

and payments due to Motion, Inc. Those allegations are as

follows:
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JUDICIAL FORECLOSURE OF SECURITY INTEREST

9. On March 18, 1987 Defendant Motion, Inc.
duly executed a security agreement to secure the
payment of every debt, liability and obligation
of every type and description which Motion, Inc.
may incur to Plaintiff. The security agreement
granted Plaintiff a security interest in all
inventory, accounts and other rights to payment.
A copy of this agreement is attached as Exhibit
"D" and incorporated by reference the same as if
fully copied and set forth at length.

10. As reflected above, the Defendant
Motion, Inc. is indebted to the Plaintiff in the
sum of $886,026.00. The Plaintiff has requested
that the Defendant pay the amount owed but the

Defendant has failed and
refused and still fails and
refuses to pay the Plaintiff.

11. By reason of these defaults, and in
accordance with the terms of the security
agreement, Plaintiff has made demand upon the
Defendant Motion, Inc. for the payments of the
amounts due and has notified the Defendant
Motion, Inc. of the debt being due.

12. On September 30, 1985, Plaintiff
perfected a security interest by filing a
financing statement in due form with the
Secretary of State, Travis County, Texas.

13. Plaintiff, by virtue of the security
agreement, is entitled to have the security
interest foreclosed, to have a sale directed, and
to have the proceeds applied to satisfy the debt
owing to Plaintiff by Defendant Motion, Inc.

14. The Defendant Tarrant Bank has filed a
financing statement claiming a security interest
inferior to the security interest of Plaintiff.
Plaintiff on information and belief alleges that
the proceeds from the sale of inventory of
Defendant Motion, Inc. subject to the superior
security interest of Plaintiff have been and may
be in the future paid to Tarrant Bank. These
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funds paid constitute proceeds in which Plaintiff
holds a valid superior security interest.
Therefore, all proceeds on or after August 14,
1989 received by Tarrant Bank are due and owing
to the Plaintiff. The Plaintiff has demanded
that the Tarrant Bank pay all proceeds from the
sale of inventory to the Plaintiff. The
Defendant Tarrant Bank has failed and refused
and still fails and refuses to pay Plaintiff.

Neither petitioner nor Motion, Inc., entered an

appearance when Colonial Bank's suit was called for trial

in the State court. On October 24, 1989, the State court

entered the following default judgment against petitioner

and Motion, Inc.:

IT IS THEREFORE ORDERED, ADJUDGED AND
DECREED that judgment by default is hereby
rendered against Defendants, R.H. Bradshaw
and Motion, Inc., in the total amount of
$887,026.00 plus all costs of court herein
expended and post-judgment interest at the
rate of 10% per annum until paid and Plain-
tiff's security interest in Defendant Motion,
Inc.'s inventory, accounts, and rights to
payment is deemed perfected, valid and of full
force and effect for which execution may issue.

In 1994, petitioner pled guilty in the U.S. District

Court for the Northern District of Texas to violating two

counts of 18 U.S.C. sec. 1344. The version of 18 U.S.C.

sec. 1344 that was in effect at the time petitioner

deposited the worthless checks provided as follows:

Whoever knowingly executes, or attempts to
execute, a scheme or artifice--
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(1) to defraud a financial
institution; or

(2) to obtain any of the moneys,
funds, credits, assets, securities, or
other property owned by, or under the
custody or control of, a financial
institution, by means of false or
fraudulent pretenses, representations,
or promises;

shall be fined not more than $1,000,000 or
imprisoned not more than 20 years, or both.
[Financial Institutions Reform, Recovery, and
Enforcement Act of 1989, Pub. L. 101-73, sec.
961(k), 103 Stat. 500.]

The criminal violations to which petitioner pled guilty

were based upon his deposit of the four worthless checks

into his account at Colonial Bank, as described above.

The District Court accepted petitioner's guilty plea and

sentenced him to a term in jail. It also ordered

petitioner to make restitution to Colonial Bank in the

amount of $886,026.

Sometime after petitioner's check-kiting scheme

collapsed, Colonial Bank was merged into Colonial Savings

& Loan. Neither Colonial Bank nor its successor, Colonial

Savings & Loan, has released or canceled the default

judgment that Colonial Bank obtained against petitioner

in the State court. Colonial Bank has recovered only

approximately $2,000 of the amount it lost from

petitioner's check-kiting scheme. As of the trial of the

instant case in this Court, Colonial Bank had made no other
 - 12 -

effort to collect under the default judgment rendered by

the State court, or the restitution ordered by the Federal

District Court. Colonial Bank has deducted the amount of

its loss for Federal income tax purposes.

Petitioners filed their joint 1989 income tax return

on or about August 3, 1992. There was attached to the

return a document entitled, "Disclosure Statement Under

Code Section 661 [sic] Schedule C, Line1 [sic]." That

document states as follows:

This return omits receipt of Income (Form
1099 from Colonial National Bank in the amount
of $886,069.00). 1989 [sic] under Code Section
108(a)(1), and as applicable, Sections 1017(a)
(1); 1017(2)(2) [sic], subsection (b)(2)(D) or
(b)(5) of Section 108.

The notice of deficiency issued to petitioners in this

case states as follows:

It is determined that since your income tax
return for the tax year 1989 was not filed
within the time prescribed by law and you have
not shown that the failure to file on time was
due to reasonable cause, twenty-five percent of
the tax is added as provided by section 6651(a)
of the Internal Revenue Code. * * *

* * * * * * *

Schedule 1-A
Explanation of Adjustments

A. It is determined that during the taxable
year 1989 you received taxable income of
$886,000.00 from Colonial National Bank
which was not reported on your income tax
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return. Accordingly, your taxable income
is increased $886,000.00.

OPINION

The issues in this case grow out of the fact that

in August 1989, petitioner deposited four worthless checks

totaling $886,026 into his account at Colonial Bank.

Petitioner had drawn the worthless checks to his order on

the account of his wholly owned corporation, Motion, Inc.,

at another bank. Relying on those deposits, Colonial Bank

paid four other checks that petitioner had drawn in the

same approximate amount. Petitioner thereby fraudulently

obtained approximately $886,000 from Colonial Bank. When

officials of the bank became aware that the checks

deposited into petitioner's account had been drawn on an

account in which there were insufficient funds to pay them,

Colonial Bank made a criminal referral of the check-kiting

scheme to the Office of the Comptroller of the Currency and

other Federal authorities, and it filed suit against

petitioner, and Motion, Inc., to recover the amount of its

loss. Subsequently, petitioner pled guilty to two counts

of violating 18 U.S.C. sec. 1344, relating to bank fraud.

In the notice of deficiency at issue in this case,

respondent determined that petitioner had realized taxable

income in the amount of $886,000, the proceeds of

petitioner's fraud against Colonial Bank. Petitioners
 - 14 -

bear the burden of disproving respondent's determination.

Rule 142, Tax Court Rules of Practice and Procedure.

Petitioners boldly assert that the funds obtained from

Colonial Bank "were neither swindled, embezzled or [sic]

misappropriated". According to petitioners, Mr. Bradshaw

obtained those funds from Colonial Bank as a loan. To

establish "a bona fide debt obligation", petitioners rely

on the prior course of dealing between Mr. Bradshaw and

Colonial Bank, the security agreement between Motion, Inc.,

and Colonial Bank, the original petition filed by Colonial

Bank in State court to initiate suit against petitioner and

Motion, Inc., and the default judgment rendered by the

State court in that case.

According to petitioners, a debt obligation to

Colonial Bank arose when the four worthless checks were

returned unpaid. Petitioners contend that "this is the

same type of transaction that Petitioner Ronald Bradshaw

[had] participated in numerous times with Colonial prior to

the date the four (4) checks were returned." They further

contend that "the Security Agreement was entered into for

the sole purpose of securing the type of extensions of

credit which is the subject of this dispute." Petitioners

point to Colonial Bank's suit in State court and assert

that "The Default Judgment was granted exclusively on the

Security Agreement and the banking relationship which
 - 15 -

existed between Petitioner and Colonial, further supporting

the fact that the transaction at issue created an

enforceable, and secure transaction."

Petitioners also take the position that the loan

obtained from Colonial Bank was discharged. While

petitioners are vague about when the discharge took place,

their position must be that the loan was discharged in

1989. In this connection, petitioners' brief asks the

Court to make the following findings of fact:

10. Colonial is no longer enforcing its
rights to pursue Petitioners for the recovery
of the $886,026.00.

11. Colonial has never sought to have a
Writ of Execution issued on the Default Judgment.
[Record references omitted.]

Petitioners' brief makes the following argument:

Colonial took a tax deduction for the loss
attributable to Petitioner, Ronald Bradshaw's
debt. Colonial has indicated that it is not
pursuing Petitioner, Ronald Bradshaw for the
repayment of the $886,026.00. Colonial has
also never asked the sheriff to issue a Writ of
Execution on the aforementioned Default Judgment.
Colonial's officers indicated that it was the
policy of Colonial to issue 1099's whether or
not such income related to kiting losses or any
losses on any loans.

In summary, petitioners concede that they received

income during 1989 in the amount of approximately $886,000.

However, they contend that the income was from the
 - 16 -

discharge of Colonial Bank's loan to Mr. Bradshaw, and not

from the illegal check-kiting scheme to which Mr. Bradshaw

pled guilty. Petitioners further contend that the income

from Colonial Bank's discharge of its loan is not

includable in petitioners' income because they were

insolvent by more than the amount discharged. Sec.

108(a)(1)(B).

We disagree with petitioners' factual contention that

Mr. Bradshaw received the proceeds of the illegal check-

kiting scheme as a loan or other bona fide indebtedness

from Colonial Bank. While petitioner may have had a legal

obligation to repay the funds that he had fraudulently

obtained from the bank, the transaction did not involve a

loan because a distinguishing characteristic of a loan, the

intention of the parties that the money advanced be repaid,

was missing. See Moore v. United States, 412 F.2d 974,

978-980 (5th Cir. 1969); United States v. Rochelle, 384

F.2d 748, 751 (5th Cir. 1967); Sowell v. Commissioner, 302

F.2d 177, 181 (5th Cir. 1962), revg. T.C. Memo. 1961-115.

In this case, there was no "consensual recognition" by both

petitioner and the bank of an obligation to repay and the

exact conditions of repayment. E.g., Moore v. United

States, supra at 979-980.

We do not accept petitioner's assertion that he

obtained the proceeds of his check-kiting scheme from
 - 17 -

Colonial Bank through the same course of dealing with the

bank as was involved with the draft services described

above, or that petitioner's prior course of dealing with

the bank involved loans from the bank. Contrary to

petitioner's assertions, his prior course of dealing with

Colonial Bank was limited to the extension of provisional

credit for deposits into his account. The record of this

case shows that the bank officials who authorized the

provisional credit expected that the checks deposited into

petitioner's account reflected funds on deposit in another

banking institution and that the funds would be collected

in due course. The situation in the case of each of the

four worthless checks is different. There is no evidence

that the bank officials knew that the four checks were

worthless or that they intended to make loans to petitioner

when the checks were returned unpaid.

In an attempt to support their position that

Mr. Bradshaw's course of dealing with the bank involved

loans, petitioners point to the fact that Colonial Bank had

extended a line of credit to Motion, Inc., and the fact

that the line of credit was secured by the security

agreement that had been executed on March 18, 1987,

between Motion, Inc., and the bank. Furthermore, at one

point, petitioners' reply brief states: "Motion, Inc.

is a sole proprietorship of petitioner."
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Contrary to these assertions, there is no evidence in

the record to suggest that Motion, Inc.'s line of credit

and security agreement had anything to do with petitioner

in his individual capacity, as opposed to his capacity as

corporate officer of Motion, Inc. There is also no

evidence to suggest that Motion, Inc., was not a validly

existing corporation and thus a separate entity from

petitioner. In fact, petitioner's opening brief refers to

Motion, Inc., as "a wholly owned corporation of Petitioner,

Ronald Bradshaw", and petitioners' reply brief refers to it

as "Petitioner's wholly owned corporation, Motion, Inc."

Colonial Bank's original petition, by which it

initiated suit against petitioner and Motion, Inc., does

not suggest that the proceeds of petitioner's check-kiting

scheme had been obtained through a bona fide indebtedness.

To the contrary, the principal claim in the original

complaint was a "CLAIM FOR REIMBURSEMENT" under which

Colonial Bank sought to hold petitioner and Motion, Inc.,

liable based upon the fact that petitioner had deposited

into his account at Colonial Bank worthless checks drawn on

the account of Motion, Inc., in Tarrant Bank, and the fact

that Colonial Bank was a holder in due course with respect

to each of those checks. The original petition also sought

to foreclose its security interest in assets owned by or

due to Motion, Inc., and to obtain any proceeds that had
 - 19 -

been received by Tarrant Bank from the sale of inventory

owned by Motion, Inc. The original petition filed by

Colonial Bank in State court cannot reasonably be read to

suggest that any of the funds at issue in that case had

been obtained by petitioner through a loan from Colonial

Bank.

Finally, the default judgment issued by the State

court deemed perfected Colonial Bank's security interest

in the inventory, accounts, and rights to payment owned by

Motion, Inc., and it rendered a default judgment against

petitioner and Motion, Inc., in the amount of Colonial

Bank's loss. However, the default judgment does not

constitute an adjudication that petitioner had obtained the

funds from Colonial Bank through a bona fide indebtedness.

The second issue in this case involves respondent's

determination that petitioners are liable for the addition

to tax under section 6651(a) for failing to file a timely

return. Petitioners bear the burden of disproving

respondent's determination. E.g., Reily v. Commissioner,

53 T.C. 8, 14 (1969).

Petitioners failed to introduce any testimony or other

evidence concerning this issue at trial, and they did not

raise the issue in their post-trial briefs. Therefore, we

find that petitioners, if they have not conceded the issue,

have failed to meet their burden of proof, and we sustain
 - 20 -

respondent's determination on this issue.

Decision will be entered

for respondent.