Respondent determined the following deficiencies in and additions to petitioner's Federal income tax:
Year Deficiency Addition under sec. 6653(b) 1957 ----------------------- $9,572.28 $4,786.14 1958 ----------------------- 6,411.55 3,205.78 1959 ----------------------- 5,274.36 2,637.18 1960 ----------------------- 6,285.14 3,142.57 1961 ----------------------- 4,518.26 2,259.13 1962 ----------------------- 2,394.42 1,197.21 1963 ----------------------- 1,058.03 529.01
Petitioner admits that he received amounts of money from the source mentioned below in each of the years 1957-63 which he did not report on his tax returns for those years. Respondent concedes that the notice of deficiency was mailed after expiration of the statutory limitations period for all years except 1963. The issues are whether the unreported amounts received by petitioner were taxable income; if so,
FINDINGS OF FACT
The stipulated facts are incorporated herein by this reference.
George C. McGee, petitioner, was a resident of Groves, Tex., at the time of the filing of the petition herein. For the taxable years 1957 through 1963, petitioner filed individual income tax returns with the district director of internal revenue, Austin, Tex.
In each of the above taxable years, petitioner was employed by Gulf Oil Corp. (Gulf) as its port engineer in Port Arthur, Tex. Petitioner's general duty was to oversee the performance of maintenance and repairs on ships, tankers, barges, and other of Gulf's marine vessels in the Gulf Coast area. Petitioner thus inspected incoming and outgoing vessels, determined what work, if any, was necessary, arranged to employ marine contractors and service establishments, and supervised and directed repair operations. Within the scope of his employment, petitioner received, examined, and approved for payment invoices rendered by contractors and service establishments. Petitioner would initial invoices he approved and deliver them to Gulf for payment. Gulf would issue checks payable directly to the contractors and service establishments, but would deliver the checks to petitioner for transmittal to the payees.
Two marine contractors hired by petitioner in the taxable years 1957 through 1963 were Port Arthur Marine Engineering Works (PAMEW) and Gulf Copper & Manufacturing Co. (GCMC).
Petitioner obtained payments from PAMEW and GCMC as a condition to each firm's doing business with Gulf.
Payments from PAMEW originated with invoices submitted by that firm which contained either in whole or in part charges for services not actually performed. Such invoices were made at petitioner's request, typed on PAMEW invoice forms by PAMEW personnel, initialed by petitioner to indicate his approval for payment by Gulf, and taken by petitioner to Gulf for payment. Gulf never rejected or refused to pay such invoices, but always prepared checks payable to PAMEW. Petitioner would then either personally deliver Gulf's checks to PAMEW or, after notifying the latter, mail the checks to it.
Payments to petitioner were made in five ways: (1) In cash, given to petitioner in the office of PAMEW's president; (2) by check drawn on PAMEW payable to petitioner and endorsed by him; (3) by check drawn on PAMEW payable to petitioner and endorsed for deposit in petitioner's bank account by PAMEW's president; (4) by check drawn on PAMEW payable to PAMEW's president but endorsed payable to petitioner; and (5) by check payable to PAMEW's president, but endorsed for deposit to petitioner's bank account. One check payable to petitioner and two checks payable to the president of PAMEW but endorsed to petitioner totaling $2,455.86 were endorsed by an Alice Willingham as well as by petitioner.
In the taxable years at issue, petitioner received the following amounts by checks drawn on the bank account of PAMEW, which petitioner did not report on his income tax returns for those years:
Taxable year Receipts 1957 ------------------------ $10,511.41 1958 ------------------------ 6,807.91 1959 ------------------------ 6,917.77 1960 ------------------------ 7,287.59 1961 ------------------------ 6,898.61 1962 ------------------------ 2,784.00 1963 ------------------------ 2,800.00
In the taxable year 1957 petitioner received cash in at least the amount of $2,183.61, and in 1958 in at least the amount of $1,191.72, from PAMEW, which petitioner did not report on his income tax returns for those years.
On November 27, 1963, Gulf filed a complaint in the U.S. District Court for the Eastern District of Texas, seeking recovery of funds which, Gulf alleged, inter alia, petitioner had obtained from it by fraud and breach of fiduciary duty. Petitioner filed an answer denying liability; however, the action ultimately was settled, petitioner agreeing to pay Gulf $70,000.
During the taxable years 1957 through 1963, GCMC paid sums to petitioner which it reported on Treasury Forms 1099 and which petitioner reported on his income tax returns for those years. GCMC did not receive any of the sums paid petitioner from false or padded invoices to Gulf, but from work it actually performed for Gulf.
In the course of an audit of his returns in 1965 petitioner denied to the investigating revenue agent that he had received any funds from PAMEW that he had not reported on his returns for the years here involved. During the years here involved petitioner had a checking account in a bank in Port Arthur, Tex. Respondent made an extensive
Petitioner realized ordinary taxable income from the amounts he received from PAMEW in each of the years 1957-63, which he failed to report on his income tax returns for those years.
Petitioner's failure to include the above amounts in gross income reported on his returns for those years and his failure to pay tax thereon was due to fraud.
Petitioner's income tax returns for each of the years 1957-63 were false and fraudulent with intent to evade tax.
Petitioner admits that certain amounts of income were omitted from his returns for each of the years 1957 through 1963, but he does not admit that this income was taxable in the years 1957 through 1960, prior to the decision of the U.S. Supreme Court in James v. United States, 366 U.S. 213 (1961); he also questions the amount of such income received in the years 1957 and 1958. Petitioner contends that, because the notice of deficiency was mailed to petitioner more than 3 years after his returns for those years were filed, assessment of deficiencies for the years 1957 through 1962 is barred by the statute of limitations, sec. 6501(a), I.R.C. 1954;
The first issue is whether the unreported income received by petitioner from or through PAMEW in the years 1957-60 was taxable income; however, the issue of primary importance in the case is whether the omission of the items of income received by petitioner from PAMEW in each of the years 1957-63 was due to fraud with intent to evade tax.
Petitioner admits that he received amounts from PAMEW, under the scheme described in our Findings of Fact, in each of the years 1957-63 which he did not report on his returns, and admits that the amounts received in 1961-63 were taxable income. However, petitioner
In Commissioner v. Wilcox, 327 U.S. 404, 408-409 (1946), the Supreme Court held that proceeds of embezzlement did not constitute taxable income to the embezzler.
Six years later, in Rutkin v. United States, 343 U.S. 130 (1952), the Court held that extorted funds did constitute taxable income to the extortionist; Wilcox was held limited "to its facts." 343 U.S. at 138.
Finally, in James v. United States, supra at 221-222, the Court definitively overruled Wilcox:
We believe that Wilcox was wrongly decided and we find nothing in congressional history since then to persuade us that Congress intended to legislate the rule. Thus, we believe that we should now correct the error and the confusion resulting from it, certainly if we do so in a manner that will not prejudice those who might have relied on it. We should not continue to confound [sic] confusion, particularly when the result would be to perpetuate the injustice of relieving embezzlers of the duty of paying income taxes on the money they enrich themselves with through theft while honest people pay their taxes on every conceivable type of income.
But, we are dealing here with a felony conviction under statutes which apply to any person who "willfully" fails to account for his tax or who "willfully" attempts to evade his obligation. In Spies v. United States, 317 U.S. 492, 499, the Court said that § 145(b) of the 1939 Code embodied "the gravest of offenses against the revenues," and stated that willfulness must therefore include an evil motive and want of justification in view of all the circumstances. Willfulness "involves a specific intent which must be proven by independent evidence and which cannot be inferred from the mere understatement of income." Holland v. United States, 348 U.S. 121, 139.
We believe that the element of willfulness could not be proven in a criminal prosecution for failing to include embezzled funds in gross income in the year of misappropriation so long as the statute contained the gloss placed upon it by Wilcox at the time the alleged crime was committed. Therefore, we feel that petitioner's conviction may not stand and that the indictment against him must be dismissed.
Petitioner asserts that James by its own terms may not be applied retrospectively to find that he fraudulently understated his income for the years 1957 through 1960. James' language, however, makes clear that petitioner's assertion properly applies at most only to the issue of fraudulent intent and not to the question whether funds petitioner asserts he embezzled were in fact income before James was decided. Where no question has existed of willfulness or fraudulent intent,
The effect of * * * subsequent [judicial] decisions is not to make a new law but only to hold that the old law always meant what the court now says it means. The court has power to construe a legislative act, but it has no power by change in construction to date its passage as a law from the time of the later decision. * * * [Fleming v. Fleming, 264 U.S. 29, 31-32 (1924).]
We hold, therefore, that petitioner's returns for the years 1957 through 1960, as well as those for 1961 through 1963, did understate what was in fact his taxable income.
The crucial question is thus whether such understatements were fraudulent with intent to evade tax. As to the years 1961 through 1963, petitioner attacks only the sufficiency of the evidence, see infra. As to 1957 through 1960, however, petitioner's position is that James may not be applied retrospectively on the issue of intent and that if his improper receipt of funds in the years 1957 through 1960 was by embezzlement, he could not, as a matter of law,
We must, perforce, decide whether the Supreme Court decision in James prohibits a finding in this case that for the years 1957-60 petitioner's failure to report the amounts he received from PAMEW in his tax returns was fraudulent with intent to evade tax. We must keep in mind the particular circumstances of this case and the fact that we are concerned here with proof of civil fraud rather than the criminal tax evasion involved in the James case which requires proof of willfulness beyond a reasonable doubt. The opinion in James v. United States, supra, stated only that:
the element of willfulness could not be proven in a criminal prosecution for failing to include embezzled funds in gross income * * * so long as the statute contained the gloss placed upon it by Wilcox at the time the alleged crime was committed.
Petitioner relies heavily on Adame's Estate v. Commissioner, supra, a case decided by the Court of Appeals for the Fifth Circuit,
In Adame's Estate the taxpayer, who was a county superintendent of schools, devised a scheme to defraud the school districts by writing school district checks for more than the cost of supplies and pocketing the excess. In reversing this Court, 37 T.C. 807, the appellate court held that in the light of James, the failure to declare such unlawful gains (in the years 1948-53) could not be evidence of "fraudulent intent" and that whether the issue is the commission of crime by fraudulent evasion of taxes, or fraudulent intent which would toll a statute of limitations,
it would be equally improper to hold that the taxpayer's failure to declare monies was sufficient basis for inferring fraudulent intent when in both cases the law as it was understood at the time did not require him to report the monies as taxable income.
The court pointed out that there was no other evidence sufficient to support our findings, and a perusal of our opinion in Adame's Estate reveals that there was little evidence of fraud except the repeated failure to report the illegally obtained income. Here, as hereinafter pointed out, there is additional evidence of fraudulent intent.
We interpret the Court of Appeals opinion in Adame's Estate to mean that the failure to report embezzled income alone should not be used as evidence of fraudulent intent prior to the decision in James. We do not believe that it stands for the proposition that fraudulent intent, for civil tax purposes and the statute of limitations, in failing to report income illegally obtained by means other than embezzlement, cannot be proven by other evidence; or, necessarily, that fraudulent intent in failing to report embezzled income cannot be proven by other evidence.
In James the Court had before it a taxpayer who had been convicted of criminal tax evasion for failing to report as income funds
In addition, in James the Court defined willfulness as including "an evil motive and want of justification in view of all the circumstances."
Under the definition prevalent in the Fifth Circuit and in this Court, it is enough that a taxpayer intends to evade taxes which he believes are owed the Government. That the rationale behind the addition to tax for civil fraud is remedial and not punitive, as supra, is convincing that the definition using the term "believed" is correct. In cases such as the one at bar, the revenue may be protected and the Government indemnified for extra expense only if the intent to evade taxes is measured by belief that taxes are being evaded rather than by knowledge that they are. This distinction in the meaning of the word "fraud" is important in this case because of the confusion in the law of Texas and the uncertainty in the law generally as to what constitutes embezzlement.
It would be practically impossible for respondent to prove that petitioner "knew," in the legal sense, that the amounts he received from PAMEW were taxable income, and that tax was due thereon. Wilcox held that embezzled funds were not taxable in the year appropriated. James, upon which petitioner relies, held that willfulness could not be proven for failing to include embezzled funds in gross income while Wilcox was viable. Furthermore, by the time petitioner filed his returns for the years here involved, the Supreme Court had decided Rutkin v. United States, supra. In Rutkin the Court held that money obtained by extortion was taxable income and affirmed the conviction of the taxpayer for willfully attempting to defeat and evade income taxes by failing to report such income. In doing so, the Court concluded that unlawful gain, as well as lawful gain, constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it; and that unlawful gains secured by fraud of the taxpayer are taxable. The Court found it unnecessary to consider Wilcox because of the difference in factual situations involved, but limited Wilcox to the facts in that case. For respondent to prove fraudulent intent under James, or under the definition of those courts which have used "knows" instead of "believes," he would have to prove by clear and convincing evidence that petitioner had examined the statutes and the cases and concluded either that Rutkin had totally vitiated Wilcox, as the Supreme Court subsequently decided in James, or that his activities did not constitute "embezzlement," see infra.
Our conclusion here is buttressed by the existence of confusion in Texas law and uncertainty in the law generally as to what constitutes embezzlement.
Article 1534 of the Texas Penal Code provides, with respect to embezzlement, that if any officer, agent, or employee of a corporation or private person —
shall embezzle, fraudulently misapply or convert to his own use, without the consent of his principal or employer, any money * * * of such principal or employer which may have come into his possession or be under his care by virtue of such office, agency or employment, he shall be punished * * *
Article 1545 of the Penal Code defines "swindling" as:
the acquisition of * * * money * * * by means of some false or deceitful pretense or device, or fraudulent representation, with intent to appropriate the same to the use of the party so acquiring * * *
The Texas courts have defined embezzlement as the fraudulent appropriation of the personal property of another by one to whom it has been entrusted, Leonard v. State, 7 Tex. Crim. 417 (1879), while to constitute swindling, they require that some false pretense as to an existing fact or past event be made in order to obtain the property, Johnson v. State, 41 Tex. 65 (1874), and in Akers v. Scofield, 167 F.2d 718
Wilcox, again, dealt only with embezzlement, which, as noted above, seems unlikely to have been the exact means by which petitioner obtained the funds which he failed to report. As supra, the tax years here involved came after the Supreme Court had decided Rutkin which undercut the rationale of Wilcox and limited that decision to its facts. It was in the climate of the law created by the combination of Wilcox and Rutkin, not in the climate of Wilcox alone, that petitioner would have had to form the belief that the funds he received from PAMEW were nontaxable in order to escape liability here.
Since we have concluded that James does not prohibit a finding of fraudulent intent in this case, we now must turn to the evidence to determine whether fraud has been proven. Respondent has the burden of proving fraud by clear and convincing evidence. We find that he has done so, even without reliance on petitioner's mere failure to report the income as evidence of his fraudulent intent, which may (or may not) be prohibited by Adame's Estate v. Commissioner, supra.
It is clear from the evidence that petitioner devised a scheme to swindle and defraud his employer, Gulf, and that he carried out this
We also find significance in the fact that petitioner received kickbacks from PAMEW in cash which could not be identified in his accounts or in cash deposits to his bank account. The receipt of cash rather than checks from PAMEW would be unimportant in petitioner's efforts to conceal his fraud from Gulf, but it would be important in concealing his income from the Government. Weight can also be given to the fact that petitioner reported the kickbacks he received from GCMC, which reported these payments to the Government on Treasury Forms 1099. Petitioner argues that this was done because GCMC received no excess funds from Gulf and petitioner knew that nonembezzled kickbacks were taxable income even under Wilcox. However, we note that petitioner continued to treat the receipts from GCMC and PAMEW differently for tax-reporting purposes even after James had removed the distinction, taxwise, between embezzled funds and funds unlawfully obtained in other ways. We think it is more logical to assume that petitioner reported his receipts from GCMC prior to 1961 on his tax returns because he knew that the Government had notice of them but that he did not report his receipts from PAMEW because he thought he could conceal them from the Government as well as Gulf.
And finally, petitioner continued failing to report his income from PAMEW for several years after the James case was decided, which
We conclude from the record as a whole that respondent has carried his burden of proving fraud under both sections 6501(c) and 6653(b). This is particularly true with regard to the years 1961-63 when petitioner could not possibly have been relying on Wilcox and the rationale of James, and consideration is given to the repeated omissions of substantial amounts of taxable income as additional evidence of fraudulent intent. See Estate of Millard D. Hill, 59 T.C. 846, 856 (1973); Anderson v. Commissioner, 250 F.2d 242 (C.A. 5, 1957); Bryan v. Commissioner, 209 F.2d 822 (C.A. 5, 1954). Hence, assessment of the deficiencies for the years 1957-63 is not barred by the statute of limitations; and the 50-percent additions to tax determined to be due by respondent for each of those years is sustained. The purpose of the addition to tax is well served in this case: The precise amount by which petitioner's income was understated in the years in question appears still to be uncertain, and the record shows that the Government was indeed caused extra expense in attempting to undo petitioner's efforts at concealment. The addition is thus appropriate to protect the revenue and indemnify the Government.
As to the amount of the deficiencies asserted by respondent, petitioner's only challenge is to the size of the cash payments respondent determined petitioner received from PAMEW. Petitioner's assertion that he received no cash at all is contradicted by the record. While petitioner made some effort to rebut respondent's determination with reference to several cash payments reflected on PAMEW's books, we do not find that he has succeeded in showing that respondent's determination in this regard was arbitrary or unreasonable or in overcoming the presumptive correctness of respondent's determination; thus, respondent's determination must stand. Welch v. Helvering, 290 U.S. 111 (1933); Rule 32, Tax Court Rules of Practice.
Because of certain concessions made by the parties,
Decision will be entered under Rule 50.