David D. Parrish v. CIR ( 1999 )

United States Court of Appeals
FOR THE EIGHTH CIRCUIT
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No. 98-1121
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David D. Parrish, *
*
Appellant, *
* Appeal from the
v. * United States Tax Court.
*
Commissioner of Internal Revenue, *
*
Appellee. *
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Submitted: November 18, 1998
Filed: February 23, 1999
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Before BOWMAN, Chief Judge, LOKEN, Circuit Judge, and SIPPEL,* District
Judge.
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LOKEN, Circuit Judge.
During tax years 1988, 1989, and 1990, David Parrish received sizeable
payments from M & L Business Machine Company (“M & L”) that he did not report
on his federal income tax returns. The Commissioner of Internal Revenue assessed
substantial tax deficiencies, plus penalties or additions to tax for each of those three
*
The HONORABLE RODNEY W. SIPPEL, United States District Judge for
the Eastern District of Missouri, sitting by designation.
years. The Tax Court substantially upheld the deficiencies. Parrish appeals, arguing
that the payments from M & L constituted a return of capital or principal, not taxable
income, and alternatively that he is entitled to a shareholder’s deduction for the pass-
through losses of M & L, a Subchapter S corporation. We affirm.
Parrish is a doctor of psychiatry. After selling his interest in a hospital in 1984,
Parrish and others purchased all the stock of M & L, an existing office machine repair
company. Parrish purchased twenty percent of M & L’s stock, becoming a vice
president and director. Parrish also solicited associates, relatives, and friends to
invest over $1,000,000 in M & L, which during this period was promising to pay
investors interest rates ranging from 24% to 520%. In October 1990, M & L filed for
bankruptcy. The bankruptcy trustee discovered M & L had operated ponzi and
check-kiting schemes, using contributions from later investors to pay interest
promised to earlier investors. Based upon an accounting firm’s analysis of M & L
financial transactions, the trustee sued Parrish for receiving pre-bankruptcy
preferential transfers and fraudulent conveyances and recovered a judgment of more
than $375,000.1
On his federal income tax returns for 1988, 1989, and 1990, Parrish reported
receiving from M & L $28,000 in annual wages plus interest payments of $22,655 in
1989. The Internal Revenue Service investigated the obvious discrepancy between
these amounts and the bankruptcy trustee’s $375,000 judgment. During the audit,
Parrish admitted also receiving from M & L monthly payments of $6,000, plus $1,000
a month to lease a Cadillac and undetermined amounts of finder’s fees for soliciting
investors. Parrish could not produce records substantiating either the amounts he
paid into M & L as treasury stock purchases, loans, and other “investments,” or the
1
The parties in this case stipulated that the “circumstances of M & L and the
nature of its activities during the 1980s are reflected in the finding[s]” of the Tax
Court in Premji v. Commissioner, 72 T.C.M. 16 (1996), 1996 WL 370999.
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substantial amounts he admittedly received from M & L during this period. After
obtaining bank statements and other relevant records, the IRS Agent conducting the
audit determined that Parrish’s records and tax returns did not accurately reflect his
income from M & L for the three years in issue.
Reconstructing Parrish’s taxable income using the bank deposits method for
1988 and 1989 and the specific items method for 1990, the Commissioner concluded
Parrish had unreported income of $72,415 in 1988, $236,834.27 in 1989, and
$163,822.31 in 1990. The Commissioner assessed tax deficiencies based upon this
unreported income, adding on self-employment tax on the entire amount plus
negligence, late filing, and accuracy related additions and penalties. Parrish
commenced this action to challenge the deficiencies. After a one day trial, the Tax
Court upheld the Commissioner on all issues except it reduced the amount of
unreported income subject to the self-employment tax. Parrish appeals, challenging
the following components of the assessed deficiencies.
I. Unreported Income. If a taxpayer fails to maintain adequate records of
taxable income, the Commissioner may reconstruct income using a method that
clearly reflects income. See 26 U.S.C. (I.R.C.) § 446(b); Caulfield v. Commissioner,
33 F.3d 991, 992-93 (8th Cir. 1994), cert. denied, 514 U.S. 1016 (1995). In this case,
Parrish does not challenge the Commissioner’s decision to reconstruct his income, the
methods used by the Commissioner to reconstruct his income, and the amount of the
payments from M & L used by the Commissioner in reconstructing his income.
Therefore, the Commissioner’s deficiency determinations are entitled to a
presumption of correctness, and Parrish must prove them arbitrary or erroneous. See
Welch v. Helvering, 290 U.S. 111, 115 (1933); Day v. Commissioner, 975 F.2d 534,
537 (8th Cir. 1992).2
2
Although the new statute does not apply to earlier tax years, it is worth noting
that a highly publicized 1998 amendment to the Internal Revenue Code that in many
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Parrish first argues the Commissioner erred by not treating the payments as a
return of his investment because M & L made the payments to conceal its fraudulent
misappropriation of that investment, like the payments to passive, defrauded investors
in Greenberg v. Commissioner, T.C. Mem. 1996-281. The Tax Court rejected this
argument because Parrish was not a passive investor in M & L, and because he failed
to prove what amounts of money he loaned to and received from M & L. Parrish
accuses the Tax Court of refusing to follow its prior Greenberg decision. The
Commissioner argues, in essence, “good riddance.” We need not debate whether the
rather unique Greenberg case was correctly decided. Here, Parrish did not prove how
much he loaned to or invested in M & L, nor did he prove he was a victim of fraud.
He has established no foundation for a conclusion that, under Greenberg, the
payments he received from M & L -- payments that are presumptively taxable income
-- should be treated as a return of a capital investment or the principal of a loan.
Thus, we agree with the Tax Court that this contention does not overcome the
Commissioner’s presumption of correctness.
Parrish next argues the Tax Court should have held that the payments he
received from M & L were the non-taxable recovery of capital or loan principal under
the “open transaction” doctrine established in Burnet v. Logan, 283 U.S. 404 (1931).
See also Commissioner v. Liftin, 317 F.2d 234 (4th Cir. 1963); Underhill v.
Commissioner, 45 T.C. 489 (1966). Even assuming this doctrine can be applied to
transform interest received on a loan into the return of principal on a speculative
investment, Parrish is again undone by his failure to prove either the amount or the
nature of his investment in or loans to M & L.3 The Tax Court found Parrish’s
cases will shift the burden of proof to the Commissioner does not apply to taxpayers
who fail to maintain adequate tax records. See I.R.C. § 7491(a)(2)(B) (1998).
3
Indeed, Parrish’s undocumented assertions as to the extent of his investment
have varied. Before the Tax Court, Parrish claimed to have purchased M & L stock
for $243,000 and to have loaned M & L $334,500. On appeal, he contends he
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documentation “scant and dubious.” At trial, he introduced a few loan agreements.
He also submitted a composite exhibit of bank records documenting payments to M
& L that the Tax Court found partially illegible and we cannot locate in the record on
appeal. There is nothing in the record permitting the Tax Court or this court to
determine whether Parrish’s loans to and investments in M & L had the requisite
uncertainty of recovery to warrant application of the open transaction doctrine. The
Tax Court properly refused to assume that the payments to Parrish were a return of
capital, as opposed to taxable interest, dividends, or finder’s fees. Thus, Parrish’s
reliance on the open transaction doctrine does not overcome the Commissioner’s
presumption of correctness. See Page v. Commissioner, 58 F.3d 1342, 1348 (8th Cir.
1995); Dodge v. Commissioner, 981 F.2d 350, 354 (8th Cir. 1992).
For the foregoing reasons, we affirm the Tax Court’s determination that Parrish
failed to report taxable income for the tax years in question in the amounts assessed
by the Commissioner.
II. Pass Through of Subchapter S Corporation Losses. Alternatively,
Parrish argues that as a shareholder of a Subchapter S corporation, M & L, he is
entitled to a deduction for his share of M & L’s losses during the 1988-1990 tax
years. See I.R.C. § 1366(a)(1). Parrish has the burden of proving he is entitled to the
deduction. Cf. Bennett Paper Corp. v. Commissioner, 699 F.2d 450, 453 (8th Cir.
1983). We have some doubt whether Subchapter S corporation losses may even be
claimed when M & L did not file tax returns for 1988, 1989, or 1990, and after 1990
filed returns as a Subchapter C corporation. But in any event, the Tax Court correctly
determined that Parrish failed to meet his burden of proof on this issue. First, he
failed to introduce documents or other evidence substantiating M & L losses.
Second, Subchapter S losses are limited to a taxpayer’s investment (basis) in the
corporation, and Parrish failed to establish his basis. See I.R.C. § 1366(d)(1).
invested at least $975,000 in M & L.
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Absent proof that Parrish is entitled to Subchapter S losses of an uncertain amount,
the Tax Court was not required to estimate his proportional share of M & L’s losses
under the principle announced in Cohan v. Commissioner, 39 F.2d 540, 543-44 (2d
Cir. 1930). See Coloman v. Commissioner, 540 F.2d 427, 431 (9th Cir. 1976); Oates
v. Commissioner, 316 F.2d 56, 58-59 (8th Cir. 1963). Thus, that Court properly
denied the claimed losses.
III. Self-Employment Tax. Parrish next challenges the assessment of self-
employment taxes on his unreported income. Self-employment income is defined as
“income derived by an individual from any trade or business carried on by such
individual.” I.R.C. § 1402(a); see Schelble v. Commissioner, 130 F.3d 1388, 1391
(10th Cir. 1997). In addition to arguing that the payments from M & L were not
income -- a contention we have rejected -- Parrish argues the payments were not
derived from a trade or business because he was an M & L outsider not responsible
for the ponzi scheme. Income such as finder’s fees is subject to self-employment tax.
To compute Parrish’s income subject to self-employment tax each year, the Tax Court
deducted interest, dividends, and reported income from the total M & L payments,
concluded Parrish failed to establish the remainder was not income from a trade or
business, and upheld to this extent the assessed deficiencies. We agree with this
analysis.
IV. Penalties and Additions To Tax. Finally, Parrish argues the Tax Court
erred in upholding the assessment of negligence and accuracy related penalties. The
Commissioner assessed a negligence addition to tax for 1988 and accuracy related
penalties for 1989 and 1990.4 Both penalties are owing when an underpayment is due
4
The negligence addition was assessed under I.R.C. § 6653(a). For returns due
after December 31, 1989, that provision was replaced by the accuracy related penalty
in I.R.C. § 6662. See Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101-
239, § 7721(c)(1), 103 Stat. 2106, 2395-2400.
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to the taxpayer’s negligence or disregard of rules or regulations. See §§ 6653(a),
6662(b). The Tax Court found that Parrish was negligent in failing to maintain
adequate books and records, and to exercise due care in reporting his income. We
review this factual determination for clear error. See Langer v. Commissioner, 989
F.2d 294, 296 (8th Cir. 1993). A negligence penalty or addition is appropriate when
the taxpayer failed to keep adequate records, absent an affirmative showing of no
negligence. See Caulfield, 33 F.3d at 994. Parrish failed to produce records relating
to his M & L investments. At trial, he offered only vague and incomplete
documentation of his dealings with M & L despite uncontested proof he received
substantial payments from M & L during the years in question. In these
circumstances, the Tax Court did not clearly err in finding negligence that warrants
the assessment of negligence and accuracy related penalties and additions to tax.
At oral argument, in response to a question from the court whether Parrish was
a participant in, or a victim of, the M & L ponzi scheme, his counsel replied that as
an investor Parrish was simply “a consummate doctor.” After reviewing the record,
we conclude that was an insult to the integrity of the members of the medical
profession. Parrish used M & L as a huge, undocumented piggy bank, while he
encouraged friends and relatives to squander their savings on this worthless venture.
His resulting tax problems are a predicament of his own making, not the product of
overzealous enforcement of the federal tax laws.
The judgment of the Tax Court is affirmed.
A true copy.
Attest:
CLERK, U. S. COURT OF APPEALS, EIGHTH CIRCUIT.
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