Bertram Russell v. Commissioner , 2019 T.C. Memo. 146 ( 2019 )

T.C. Memo. 2019-146
UNITED STATES TAX COURT
BERTRAM RUSSELL, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18571-16. Filed October 30, 2019.
Bertram Russell, pro se.
Harry J. Negro, Kristina L. Rico, and Corey R. Clapper, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
RUWE, Judge: Respondent determined a $121,695 deficiency in
petitioner’s 2000 Federal income tax, a $91,271.25 civil fraud penalty under
section 6663,1 and a $29,749.75 addition to tax under section 6651(a)(1). The
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Unless otherwise indicated, all section references are to the Internal
(continued...)
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[*2] issues before this Court are: (1) whether petitioner received $328,440 in
unreported income in 2000, (2) whether petitioner is liable for a civil fraud penalty
under section 6663, and (3) whether petitioner is liable for an addition to tax under
section 6651(a)(1).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
When the petition was filed, petitioner resided in Pennsylvania.
Petitioner’s Background
Petitioner was a licensed physician for almost 30 years, practicing
radiology. Petitioner obtained a bachelor of science degree from Johns Hopkins
University and a medical degree from Thomas Jefferson University Medical
College in 1976. As part of his training petitioner had a radiology residency at
Mercy Catholic Medical Center for one year, switched to Bryn Mawr Hospital,
and then finished the fourth year of his residency at Thomas Jefferson University
Medical College.
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(...continued)
Revenue Code in effect at all relevant times, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
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[*3] As a radiologist petitioner specialized in diagnosing and treating disease
and injury through the use of medical imaging techniques such as x rays, CT
scans, and MRIs. Petitioner also acted as a consultant to referring physicians.
Petitioner’s Family
Petitioner was married to Dr. Pamela Russell, a neonatolgist, from 1977
until 2011, when their divorce was finalized. Petitioner and Dr. Russell have three
children. Dr. Russell worked as a doctor at the same hospital as petitioner in
2000, was a salaried employee, and received a Form W-2, Wage and Tax
Statement. Dr. Russell’s income was used to pay for daily management of the
household and children, while petitioner’s income was supposed to pay for school
tuition, taxes, and retirement. Petitioner and Dr. Russell each had a separate,
individual bank account, and Dr. Russell did not have access to petitioner’s bank
account or credit cards.
Petitioner’s History as an Independent Contractor
In 1980 petitioner became an associate with Chester County Radiology
Associates, P.C., at Chester County Hospital. When he started at the hospital, he
was a salaried employee paid by Chester County Radiology Associates, P.C., and
received a Form W-2. In either the late 1980s or early 1990s petitioner requested
to be treated as an independent contractor by Chester County Radiology
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[*4] Associates, P.C., which he was allowed to do. No other radiologists at
Chester County Radiology Associates, P.C., were classified as independent
contractors. Petitioner’s paychecks were sent to his home address and made
payable to Pennsylvania Physicians, P.C. (Pennsylvania Physicians). No Federal
income tax was withheld from the paychecks.
Chester County Radiology Associates, P.C., eventually merged into the
University of Pennsylvania Health System (UPHS). The Trustees of the
University of Pennsylvania own and operate UPHS and the Clinical Practices of
the University of Pennsylvania (CPUP). CPUP operates a radiology department
known as the Division of Community Radiology. Petitioner continued to provide
radiology services as an independent contractor after UPHS and CPUP took over.
Petitioner’s paycheck continued to be made payable to Pennsylvania Physicians,
rather than petitioner. All of the other radiologists working for UPHS and CPUP
were salaried employees receiving Forms W-2.
Pennsylvania Physicians
Pennsylvania Physicians was incorporated in 1996 by petitioner, Bernard J.
Bagdis, a tax attorney, and Dr. John P. Leichner. Petitioner was president of
Pennsylvania Physicians, which had its registered office at J. Bagdis’ office but
otherwise had no physical location. According to petitioner the main purpose of
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[*5] the corporation was to address a perceived malpractice crisis and to become a
self-insurer for physicians. Pennsylvania Physicians was purportedly supposed to
grow and acquire other doctors. In practice, no other doctors were acquired.
Pennsylvania Physicians never had employees, never filed employment tax
returns, and never filed corporate income tax returns reporting the income received
from CPUP, including for tax year 2000. Petitioner claimed that he lent money
that he had inherited to Pennsylvania Physicians to invest “equity” in
Pennsylvania Physicians although there is no documentary evidence of this loan.
Petitioner’s Pennsylvania Physicians Checking Account
Petitioner opened a checking account in the name of Pennsylvania
Physicians with First Union National Bank over which he had signatory authority.
Dr. Leichner also had his own Pennsylvania Physicians bank account. Dr.
Leichner never had access to petitioner’s Pennsylvania Physicians bank account,
nor was he aware of it.
Independent Contractor Agreement
In 1997 CPUP entered into an agreement with Pennsylvania Physicians
pursuant to which petitioner, as an independent contractor, would provide services
customarily performed by physicians practicing radiology to CPUP in exchange
for compensation of $5,900 per week. The agreement also stated that
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[*6] Pennsylvania Physicians was “responsible for all federal, state and local taxes
on the compensation paid” by Pennsylvania Physicians to petitioner. This
agreement was in effect in 2000.
During tax year 2000, 13 checks were written by CPUP to Pennsylvania
Physicians totaling $328,440. The checks were payment for services provided by
petitioner as a radiologist. Petitioner deposited the checks into the Pennsylvania
Physicians checking account that he maintained signatory control over. Petitioner
did not report the $328,440 on Pennsylvania Physicians’ corporate income tax
return or on his personal income tax return.
The 2000 Tax Return
For 2000 petitioner and Dr. Russell signed and filed a joint Form 1040, U.S.
Individual Income Tax Return, that was received by respondent on September 13,
2002, despite the fact that it was due on April 15, 2001. Petitioner did not request
an extension of time to file the return. The only wages included on the joint
income tax return were Dr. Russell’s wages totaling $163,793. The $328,440 that
Pennsylvania Physicians had been paid for the services petitioner supplied was not
reported anywhere on the return.
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[*7] Petitioner’s Criminal Conviction for Income Tax Evasion
Petitioner was indicted on November 27, 2007, in the case of United States
v. Bagdis, No. 07-cr-00730 (E.D. Pa. Nov. 27, 2007). The November 27, 2007,
indictment charged petitioner with various tax crimes, including evading income
tax in violation of section 7201 for tax year 2000. On April 22, 2009, petitioner
was convicted by a jury of 16 criminal offenses, including: one count of
conspiracy to defraud the United States in violation of 18 U.S.C. sec. 371 (2006)
for acts occurring between 1996 and 2006; seven counts of tax evasion under
section 7201 for tax years 2000 through 2006; two counts of subscribing a false
tax return in violation of section 7206(1) for tax years 1998 and 2000; and six
counts of failing to file tax returns or supply information under section 7203 for
tax years 2001 through 2006.
On May 14, 2010, petitioner was adjudged guilty by the U.S. District Court
for the Eastern District of Pennsylvania. Petitioner was sentenced to 66 months of
imprisonment and ordered to pay $1,158,914.99 in restitution.
The Examination Process of Petitioner’s 2000 Tax Return
Revenue Agent Kenneth Kelly conducted an examination of petitioner’s
2000 tax return in 2015. As part of this examination Agent Kelly assisted in
producing a Form 3198, Special Handling Notice for Examination Case
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[*8] Processing. This form internally proposed a civil fraud penalty under section
6663. The proposed section 6663 civil fraud penalty received written approval
from Agent Kelly’s immediate supervisor before August 23, 2015.
On June 29, 2016, respondent sent petitioner a notice of deficiency for 2000
in which respondent determined a deficiency in Federal income tax of $121,695, a
civil fraud penalty under section 6663 of $91,271.25, and an addition to tax under
section 6651(a)(1) of $29,749.75.
OPINION
I. Unreported Income
We first address the $121,695 deficiency based on petitioner’s purported
failure to report $328,440 in income for 2000. The Commissioner’s
determinations in a notice of deficiency are generally presumed correct, and the
taxpayer bears the burden of proving that the determinations are in error. See Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Where a case involving
unreported income is appealable to the Court of Appeals for the Third Circuit,
which is the case here absent a contrary written stipulation, see sec. 7482(b)(1)(A),
the Commissioner must produce evidence linking the taxpayer to the tax-
generating activity in order to benefit from the presumption of correctness,
Anastasato v. Commissioner, 794 F.2d 884, 887 (3d Cir. 1986) (citing Gerardo v.
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[*9] Commissioner, 552 F.2d 549, 554 (3d Cir. 1977), aff’g in part, rev’g in part
and remanding T.C. Memo. 1975-341), vacating and remanding T.C. Memo.
1985-101.
Respondent has produced evidence of 13 payments from CPUP to
Pennsylvania Physicians and the deposit of those funds into a checking account
controlled by petitioner. Respondent has also produced evidence that petitioner
performed medical services in exchange for the payments. Therefore,
respondent’s determination in the notice of deficiency is entitled to its
presumption of correctness.
Section 61(a) defines gross income to mean “all income from whatever
source derived”. Except as otherwise provided, gross income includes
“[c]ompensation for services, including fees, commissions, fringe benefits, and
similar items”. Sec. 61(a)(1). This definition is construed broadly and extends to
accession to wealth over which the taxpayer has complete control. See
Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
Taxpayers have the right to shape business transactions to minimize the
incidence of taxation, including the right to use corporate entities. Gregory v.
Helvering, 293 U.S. 465, 469 (1935). Furthering this pursuit, a “corporate entity
is deemed to exist as a separate taxpayer if it is organized to carry on a business
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[*10] activity or if, in fact, it has carried on such activity.” Pappas v.
Commissioner, T.C. Memo. 2002-127, 2002 WL 1035454, at *8; see also Moline
Props., Inc. v. Commissioner, 319 U.S. 436, 439 (1943) (“[S]o long as * * * [the
corporate purpose] is the equivalent of business activity or is followed by the
carrying on of business by the corporation, the corporation remains a separate
taxable entity.”). However, in “matters relating to the revenue, the corporate form
may be disregarded where it is a sham or unreal.” Pappas v. Commissioner, 2002
WL 1035454, at *8 (quoting Moline Props., Inc. v. Commissioner, 319 U.S. at
439).
Characteristics of a sham corporate entity include: “the intermingling of
corporate and personal funds, undercapitalization of the corporation, failure to
observe corporate formalities such as the maintenance of separate books and
records, failure to pay dividends, insolvency at the time of a transaction, siphoning
off of funds by the dominant shareholder, and the inactivity of other officers and
directors.” Id. at *9 (quoting LiButti v. United States, 107 F.3d 110, 119 (2d Cir.
1997)).
Pennsylvania Physicians’ activities reek of a sham corporate entity.
Pennsylvania Physicians filed no corporate income tax return for any year,
including 2000. The entity had no employees and no proper physical location, and
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[*11] it appears to have respected no corporate formalities. There is no evidence
that it ever paid any dividends. The 13 payments from CPUP to Pennsylvania
Physicians were deposited into a checking account that petitioner, and only
petitioner, exercised control over. Funds in this checking account were later used
to pay petitioner’s personal expenses, such as private school tuition for his
children. Petitioner observed no meaningful distinction between his personal
funds and the funds of Pennsylvania Physicians. We therefore find that
Pennsylvania Physicians is a sham corporate entity which is disregarded for
Federal income tax purposes.
Petitioner argued that Pennsylvania Physicians, rather than petitioner,
performed the radiology services for CPUP, but the independent contractor
agreement between the parties expressly states that petitioner would be performing
the services in his capacity as a physician. Petitioner also claims that the money
he received from Pennsylvania Physicians was repayment for a loan he made to
Pennsylvania Physicians, but he introduced no evidence of a loan other than his
own unconvincing testimony.
Accordingly, we hold that respondent’s determination of unreported
income as set forth in the notice of deficiency is correct, and that determination is
sustained.
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[*12] II. Section 6663 Civil Fraud Penalty
A. Section 6751(b)(1) Supervisory Approval
As a threshold matter with respect to the section 6663 civil fraud penalty,
the Commissioner’s burden of production under section 7491(c) includes
introducing sufficient evidence to establish compliance with the supervisory
approval requirements of section 6751(b)(1). See Graev v. Commissioner, 149
T.C. 485, 493 (2017), supplementing and overruling in part 147 T.C. 460 (2016).
Section 6751(b)(1) requires the Commissioner to show the section 6663 civil fraud
penalty was “personally approved (in writing) by the immediate supervisor of the
individual” making the initial penalty determination.
The record contains sufficient evidence that the requisite supervisory
approval for the section 6663 civil fraud penalty was obtained.
B. Collateral Estoppel
Respondent argues that petitioner’s previous conviction for tax evasion
under section 7201 collaterally estops petitioner from denying in the present civil
tax proceeding that (1) his failure to report income resulted in an underpayment of
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[*13] his 2000 Federal income tax and (2) at least part of the underpayment is due
to fraud within the meaning of section 6663. We agree.2
Section 6663(a) provides: “If any part of any underpayment of tax required
to be shown on a return is due to fraud, there shall be added to the tax an amount
equal to 75 percent of the portion of the underpayment which is attributable to
fraud.” Respondent bears the burden of proving fraud by clear and convincing
evidence. Sec. 7454(a); Rule 142(b). To satisfy this burden, respondent must
establish that: (1) an underpayment exists and (2) the taxpayer intended to evade
tax known to be owed by conduct intended to conceal, mislead, or otherwise
prevent the collection of tax. See Sadler v. Commissioner, 113 T.C. 99, 102
(1999); Parks v. Commissioner, 94 T.C. 654, 660-661 (1990).
In Montana v. United States, 440 U.S. 147, 153 (1979), the Supreme Court
explained the doctrine of collateral estoppel as follows: “Under collateral
estoppel, once an issue is actually and necessarily determined by a court of
competent jurisdiction, that determination is conclusive in subsequent suits based
on a different cause of action involving a party to the prior litigation.” Collateral
estoppel applies only if “(1) the issue sought to be precluded [is] the same as that
2
Respondent concedes that petitioner may still contest the precise amount of
unreported income for 2000, as the determination of the precise amount of
unreported income was not essential to his conviction.
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[*14] involved in the prior action; (2) that issue [was] actually litigated; (3) it
[was] determined by a final and valid judgment; and (4) the determination [was]
essential to the prior judgment.” Anderson v. Commissioner, 698 F.3d 160, 164
(3d Cir. 2012) (alterations in original) (quoting Graham v. IRS (In re Graham),
973 F.2d 1090, 1097 (3d Cir. 1992)), aff’g T.C. Memo. 2009-44.
It is well established that a conviction for criminal tax evasion under section
7201 conclusively establishes the defendant’s civil liability for tax fraud under
section 6663 when the conviction was for the same taxable year. See id. at 164;
DiLeo v. Commissioner, 96 T.C. 858, 885 (1991), aff’d, 959 F.2d 16 (2d Cir.
1992). The only practical difference between criminal tax evasion under section
7201 and civil tax fraud is the “larger quantum of proof required in a criminal
evasion case”. Edwards v. Commissioner, T.C. Memo. 2016-117, at *23 (quoting
Moore v. United States, 360 F.2d 353, 355 (4th Cir. 1965)).
Petitioner was convicted of tax evasion under section 7201 for tax year
2000, and that judgment has become final. Accordingly, petitioner is precluded
from denying that he underpaid his tax for tax year 2000 and that he filed a false
and fraudulent Federal income tax return with the requisite fraudulent intent.
Although petitioner is not precluded from contesting precisely how much he
underpaid his tax for tax year 2000, respondent has shown by clear and convincing
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[*15] evidence that petitioner did not report $328,440 in taxable income. We
therefore hold that petitioner is liable for the section 6663 civil fraud penalty.
III. Section 6651(a)(1) Addition to Tax
Respondent determined that petitioner was liable for an addition to tax
under section 6651(a)(1). Section 6651(a)(1) imposes an addition to tax when a
taxpayer fails to timely file a return unless the taxpayer establishes that the failure
was due to reasonable cause and not willful neglect.
The Commissioner has the burden of production with respect to the section
6651(a)(1) addition to tax. See sec. 7491(c). To meet this burden, the
Commissioner must produce evidence that the addition to tax is appropriate. See
id.; Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the Commissioner
satisfies this burden, the taxpayer has the burden of proof with respect to
exculpatory factors such as reasonable cause. Higbee v. Commissioner, 116 T.C.
at 446-447.3
Respondent has shown that petitioner’s return was due by April 15, 2001,
and that the return was not filed until September 13, 2002. Petitioner did not
3
Sec. 6751(b)(1), which requires respondent to show certain penalties were
“personally approved (in writing) by the immediate supervisor of the individual”
making the initial penalty determination, does not apply to sec. 6651 additions to
tax. See sec. 6751(b)(2)(A).
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[*16] request an extension. Further, petitioner did not show any reasonable cause
for his failure to timely file the return. Accordingly, we hold that petitioner is
liable for the addition to tax under section 6651(a).
In reaching our decision, we have considered all arguments made by the
parties, and to the extent not mentioned or addressed, they are irrelevant or
without merit.
To reflect the foregoing,
Decision will be entered for
respondent.