Rogers v. Comm'r , 102 T.C.M. 536 ( 2011 )

T.C. Memo. 2011-277
UNITED STATES TAX COURT
JOHN E. AND FRANCES L. ROGERS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 22667-07. Filed November 23, 2011.
Paul J. Kozacky and Nicholas C. Mowbray, for petitioners.
Laurie A. Nasky, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined a deficiency in
petitioners’ Federal income tax of $1,302,102 and an accuracy-
related penalty under section 6662(a) of $260,420 for 2003.1
1
Unless otherwise indicated, section references are to the
Internal Revenue Code, as amended and in effect for the year in
issue. Rule references are to the Tax Court Rules of Practice
(continued...)
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After stipulations2 the issues remaining for decision are:
(1) Whether Portfolio Properties, Inc. (PPI), an S corporation
incorporated under the laws of Illinois, must include $1,190,500
in income for 2003;3 (2) whether PPI is entitled to deduct in
2003 legal and professional fees attributable to the $1,190,500;
and (3) whether a $218,499 distribution from PPI to its sole
shareholder, petitioner John Rogers (Rogers), is includable in
petitioners’ gross income for 2003.
Some of the facts have been stipulated and are so found.
The stipulation of facts, the supplemental stipulation of facts,
the stipulation of settled issues, and the exhibits attached
thereto are incorporated herein by this reference. At the time
they filed their petition, petitioners resided in Illinois.
1
(...continued)
and Procedure. Amounts are rounded to the nearest dollar.
2
On Feb. 5, 2010, the Court filed the parties’ stipulation
of settled issues, resolving many of the issues set forth in the
notice of deficiency. On Mar. 4, 2010, the Court filed the
parties’ supplemental stipulation of settled issues, resolving
additional issues, including the accuracy-related penalty under
sec. 6662(a).
3
Petitioner John Rogers is the sole shareholder of PPI.
Because PPI is an S corporation, we must determine the income and
deduction items of PPI before determining petitioners’ income.
Where a notice of deficiency includes adjustments for S
corporation items with other adjustments, we have jurisdiction to
determine the correctness of all adjustments. See Winter v.
Commissioner, 135 T.C. 238 (2010).
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FINDINGS OF FACT
Rogers is a tax attorney with over 40 years of experience.
He received a law degree from Harvard University in 1967 and a
master’s degree in business administration from the University of
Chicago. He worked in the tax department of Arthur Andersen for
over 24 years before serving for 7 years as the tax director and
assistant treasurer at FMC Corp. In 2003 Rogers was a partner
with the law firm Altheimer & Gray until its bankruptcy on June
30, 2003. For the remainder of the year Rogers was a partner
with the law firm Seyfarth Shaw, LLP.
Rogers promoted to clients “tax advantaged” transactions
that dealt with the acquisition of, and sales of indirect
interests in, Brazilian consumer receivables.4 The instant case
is an offshoot of those transactions. Our concern is not with
the consumer receivables transactions themselves, but with the
income tax, if any, resulting from the receipt of money from
investors by Rogers’ controlled entities and by Rogers himself.
Rogers set up three business entities to manage numerous
holding and trading companies used in the Brazilian receivable
transactions. The first, PPI, was incorporated under the laws of
Illinois on April 1, 1989, and elected on January 1, 1992, to be
treated as an S corporation under section 1361(a)(1). Rogers was
4
For the details of these transactions, see Superior
Trading, LLC v. Commissioner, 137 T.C. 70 (2011).
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its sole shareholder. The second, Jetstream Business Limited
(Jetstream), a British Virgin Islands limited company, was formed
by Rogers with PPI as its sole shareholder. Rogers was
Jetstream’s only director. In 2003 Jetstream was treated as a
disregarded entity for Federal tax purposes. The third, Warwick
Trading, LLC (Warwick), an Illinois limited liability company
(LLC), was formed in 2001. In 2003 Jetstream was the managing
member of Warwick. Consequently, in 2003 Rogers had sole control
over PPI, Jetstream, and Warwick.
In 2003 Warwick entered into transactions directly and
through affiliated entities for, in effect, purchasing Brazilian
consumer receivables and selling interests in them to numerous
investors through trading and holding companies.5 The investors
paid an aggregate of $2,381,000, all apparently for acquiring
such interests. Of the $2,381,000, Warwick received and
transferred $1,190,500 to Multicred Investamentos Limitada
(Multicred), a Brazilian collection company. The other
$1,190,500 was deposited directly in PPI’s bank account on behalf
of Jetstream. None of Warwick, Jetstream, or PPI had any
obligation to transfer the $1,190,500 deposited directly in PPI’s
bank account to anyone, hold the funds in escrow, or segregate
the funds from any other use.
5
See id.
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Rogers prepared PPI’s 2003 Form 1120S, U.S. Income Tax
Return for an S Corporation. PPI reported $1,958,877 of gross
receipts or sales, including income of $27,877 from transactions
unrelated to the receivables, and a deduction of $1,190,500 for
the $1,190,500 transferred to Multicred. Lucas & Rogers Capital,
Inc. (L&R), a second S corporation with Rogers as its sole
shareholder, reported $450,000 of gross receipts in 2003
attributable to investor money for the receivables. The parties
agree that the $450,000 L&R reported as gross receipts in 2003
should have been reported by PPI. Further, the parties agree
that the $1,190,500 transferred to Multicred is not includable in
PPI’s income and does not entitle PPI to a deduction.
PPI distributed $732,000 to Rogers in 2003. Petitioners
deposited this amount in their joint bank account. PPI deducted
$513,501 of this amount as legal and professional fees paid to
Rogers.6 In turn, petitioners included the $513,501 Rogers
received from PPI as income on their Schedule C, Profit or Loss
From Business. Petitioners did not report the remaining $218,499
distribution as income in 2003. Petitioners had no obligation to
transfer the $218,499 to anyone, hold the funds in escrow, or
segregate the funds from their personal funds.
6
PPI also deducted $22,039 of legal and professional fees
paid to Altheimer & Gray and Seyfarth Shaw.
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On August 24, 2007, respondent issued a statutory notice of
deficiency to petitioners determining, among other things, that
the $218,499 was income to petitioners in 2003. On October 2,
2007, the Court filed petitioners’ timely petition.
OPINION
I. Burden of Proof
The Commissioner’s determinations in the notice of
deficiency are generally presumed correct, and the taxpayers bear
the burden of proving them incorrect. See Rule 142(a)(1).
Petitioners do not argue that the burden of proof shifts to
respondent pursuant to section 7491(a), nor have they shown that
the threshold requirements of section 7491(a) have been met. The
burden therefore remains on petitioners with respect to all
issues to prove that respondent’s determination of the deficiency
in income tax is erroneous.
II. PPI
A. Gross Income
Generally, unless otherwise provided, gross income under
section 61 includes all accessions to wealth from whatever source
derived. Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431
(1955). Moreover,
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. That occurs when
cash * * * is delivered by its owner to the taxpayer in a
manner which allows the recipient freedom to dispose of it
at will, even though it may have been obtained by fraud and
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his freedom to use it may be assailable by someone with a
better title to it. [Rutkin v. United States, 343 U.S. 130,
137 (1952); citations omitted.]
See also United States v. Rochelle, 384 F.2d 748, 751 (5th Cir.
1967); McSpadden v. Commissioner, 50 T.C. 478, 490 (1968).
The economic benefit accruing to the taxpayer is the controlling
factor in determining whether a gain is income. Rutkin v. United
States, supra at 137; United States v. Rochelle, supra at 751.
In 2003 PPI reported $1,958,877 of gross receipts or sales,
including income of $27,877 from transactions unrelated to the
receivables and the $1,190,500 transferred to Multicred.
Additionally, PPI deducted the $1,190,500 transferred to
Multicred. The parties subsequently have agreed that the
$450,000 L&R reported as gross receipts in 2003 should have been
reported by PPI, and the $1,190,500 transferred to Multicred (1)
is not includable in PPI’s income, and (2) does not entitle PPI
to a deduction. Therefore, PPI’s gross income for 2003 is its
reported gross receipts or sales of $1,958,877, plus $450,000
from L&R, less the $1,190,500 that was transferred to Multicred,
for a total of $1,218,377.
Inconsistent with PPI’s 2003 Form 1120S, as prepared by
Rogers, petitioners argue that the $1,190,500 PPI received from
investors was not income to PPI. Rather, petitioners argue that
the $1,190,500 was: (1) Held in trust on behalf of Warwick or
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Jetstream; or (2) income to Warwick. Neither of these
contentions has merit.
In Superior Trading, LLC v. Commissioner, 137 T.C. 70(2011), we held that Warwick was not a partnership for Federal
tax purposes. Rather, Warwick was a single-member LLC with
Jetstream as its only member. Because Warwick did not make an
election to be treated as an association under the so-called
check-the-box regulations, it was a disregarded entity in 2003
for Federal tax purposes. See sec. 301.7701-3(b)(1)(ii), Proced.
& Admin. Regs.
Jetstream was also a disregarded entity in 2003 for Federal
tax purposes. Because both Warwick and Jetstream were
disregarded entities for Federal tax purposes, the $1,190,500
received from the investors is attributable only to PPI. Nothing
in the record supports petitioners’ argument that PPI was
required to hold these funds on behalf of or for the benefit of
any other person or entity. The $1,190,500 deposited in PPI’s
bank account constituted unrestricted funds. In fact, PPI
distributed $732,000 of these funds to Rogers. Consequently, the
$1,190,500 PPI received from the investors is income to PPI in
2003.
B. Deductions
Deductions are a matter of legislative grace, and the
taxpayer must prove he is entitled to the deductions claimed.
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Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934). Section 162(a) provides that “There shall be allowed as
a deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business”.
In 2003 PPI deducted legal and professional fees of $513,501
paid to Rogers and $22,039 paid to Altheimer & Gray and Seyfarth
Shaw. In turn, petitioners included the $513,501 Rogers received
from PPI as income on their Schedule C. The parties agree that
if PPI must include in income the $1,190,500 received from
investors, it is entitled to a deduction for legal and
professional fees incurred with respect to the $1,190,500. We
agree with this position. Consistent with our holding that the
$1,190,500 is PPI’s income, PPI is entitled to deduct legal and
professional fees of $513,501 paid to Rogers and $22,039 paid to
Altheimer & Gray and Seyfarth Shaw.
III. The $218,499 Distribution
A. S Corporation Rules
On its face, the $218,499 transfer from PPI to Rogers is a
distribution from an S corporation to a shareholder. Generally,
section 1368(b) provides that distributions from an S corporation
with no accumulated earnings and profits (E&P) of a predecessor C
corporation are not included in the gross income of the
shareholder to the extent that they do not exceed the adjusted
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basis of the shareholder’s stock, and any excess over adjusted
basis is treated as gain from the sale or exchange of property.
If the S corporation has accumulated E&P of a predecessor C
corporation, then the portion of the distributions in excess of
the S corporation’s accumulated adjustment account (AAA) is
treated as a dividend to the extent it does not exceed the
accumulated E&P. Sec. 1368(c)(1) and (2). The AAA is intended
to measure the accumulated taxable income of an S corporation
that has not been distributed to the shareholders. See Williams
v. Commissioner, 110 T.C. 27, 30 (1998). The portion of a
distribution to a shareholder that does not exceed the AAA is a
nontaxable return of capital to the extent of the shareholder’s
adjusted basis in S corporation stock. Sec. 1368(b) and (c)(1).
The AAA is increased for the S corporation’s income and decreased
for the S corporation’s losses and deductions and for nontaxable
distributions to shareholders. See secs. 1367 and 1368.
Section 1366(a)(1) provides that a shareholder shall
take into account his or her pro rata share of the S
corporation’s items of income, loss, deduction, or credit for the
S corporation’s taxable year ending with or in the shareholder’s
taxable year. Section 1367 provides that basis in S corporation
stock is increased by income passed through to the shareholder
under section 1366(a)(1), and decreased by, inter alia,
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distributions not includable in the shareholder’s income pursuant
to section 1368.
Unless a statutory or legal principle applies to remove the
$218,499 distribution from the S corporation rules described
above, these rules will govern whether the $218,499 distribution
from PPI to Rogers is income to petitioners and, if so, the
character of that income. Petitioners argue that the rules
should not apply because the $218,499 distribution from PPI to
Rogers was not a distribution from an S corporation to a
shareholder, but rather, a distribution to a fiduciary to be held
in trust.
B. Petitioners’ Trust Argument
Petitioners argue that Rogers held the $218,499 distribution
from PPI in trust pursuant to a duty of loyalty to Warwick under
the Illinois Limited Liability Company Act (Illinois LLC Act).
The Illinois LLC Act requires the manager of an Illinois LLC to
“account to the company and to hold as trustee for it any
property, profit, or benefit derived by the member in the conduct
or winding up of the company’s business”. 805 Ill. Comp. Stat.
Ann. 180/15-3(b)(1) (West 2010). Petitioners contend that the
$218,499 distribution from PPI to Rogers is not income to
petitioners because Rogers held this amount in a fiduciary
capacity as manager of Warwick through Jetstream.
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Petitioners’ reliance on the Illinois LLC Act is illogical
and misguided. PPI, and not Warwick, distributed the $218,499 in
question to Rogers. PPI is an S corporation and is not subject
to the Illinois LLC Act. We have no reason to view the
transaction at issue as anything more than a distribution from an
S corporation to a shareholder. Therefore, PPI’s $218,499
distribution to Rogers does not give rise to a duty of loyalty
pursuant to the Illinois LLC Act.
Rogers did not have a fiduciary duty to PPI under the
Illinois LLC Act, but he was a shareholder, officer, and director
of PPI. Generally, “a taxpayer need not treat as income moneys
which he did not receive under a claim of right, which were not
his to keep, and which he was required to transmit to someone
else as a mere conduit.” Diamond v. Commissioner, 56 T.C. 530,
541 (1971), affd. 492 F.2d 286 (7th Cir. 1974). Thus, money a
taxpayer receives in his or her capacity as a fiduciary or agent
does not constitute income to that taxpayer, Herman v.
Commissioner, 84 T.C. 120, 134-136 (1985); Heminway v.
Commissioner, 44 T.C. 96, 101 (1965), and a shareholder who takes
personal control of corporate funds is not taxable on them so
long as it is shown that he held the funds as an agent of the
corporation and/or deployed them for a corporate purpose, AJF
Transp. Consultants, Inc. v. Commissioner, T.C. Memo. 1999-16,
affd. without published opinion 213 F.3d 625 (2d Cir. 2000); St.
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Augustine Trawlers, Inc. v. Commissioner, T.C. Memo. 1992-148,
affd. sub nom. O’Neal v. Commissioner, 20 F.3d 1174 (11th Cir.
1994); Alisa v. Commissioner, T.C. Memo. 1976-255.
Whether Rogers was acting as an agent of PPI is a question
of fact. See Pittman v. Commissioner, 100 F.3d 1308, 1314 (7th
Cir. 1996) (question of fact whether C corporation’s
shareholder’s diversion of corporate funds constitutes
constructive dividend), affg. T.C. Memo. 1995-243. We look to
Rogers’ testimony and the objective facts to ascertain his
intent. See, e.g., Busch v. Commissioner, 728 F.2d 945, 948 (7th
Cir. 1984) (objective factors used to determine intent), affg.
T.C. Memo. 1983-98; Spheeris v. Commissioner, 284 F.2d 928, 931
(7th Cir. 1960) (legal relationship between a closely held
corporation and its shareholders as to payments to the latter
“must be established by a consideration of all relevant factors
indicating the true intent of the parties”), affg. T.C. Memo.
1959-225; Kaplan v. Commissioner, 43 T.C. 580, 595 (1965).
Petitioners rely on Seven-Up Co. v. Commissioner, 14 T.C.
965 (1950), and Mich. Retailers Association v. United States, 676
F. Supp. 151 (W.D. Mich. 1988), to support their fiduciary
theory. In Seven-Up Co., Seven-Up Co. (7-Up) manufactured and
sold extract for a soft drink to various franchised bottlers. To
fund a national advertising campaign, participating bottlers were
required to pay 7-Up $17.50 per gallon of extract purchased. The
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funds were administered by 7-Up and were to be spent solely for
advertising purposes. The funds were accounted for separately on
the company’s books but were not placed in a separate bank
account. This arrangement was the result of a well-documented
arm’s-length negotiation between 7-Up and the bottlers. Further,
in a letter sent to each bottler 7-Up acknowledged its role as a
trustee handling the bottlers’ money for the purpose of a
national advertising campaign.
The Commissioner contended that the excess of the amounts
received by 7-Up over the advertising expenses incurred and paid
constituted income to 7-Up. In holding that the excess was not
taxable, we stated:
While petitioner had the right to receive the bottlers’
contributions under its agreements with them, all the facts
and circumstances surrounding the transaction clearly
indicate that it was the intention of all of the parties
concerned that these contributions were to be used to
acquire national advertising for the 7-Up bottled beverage
and for that purpose only, and that petitioner was to be a
conduit for passing on the funds contributed to the
advertising agency which was to arrange for and supply the
national advertising. * * * Although the funds were not all
expended in the year received, for reasons set forth in our
findings, petitioner did expend them for national
advertising, did not use them for general corporate
purposes, treated the amounts on hand in the fund on its
books as a liability to the bottlers, and considered itself,
as evidenced by its letter of May 2, 1944, to one of the
participating bottlers, merely as a trustee, handling the
bottlers’ money. [Seven-Up Co. v. Commissioner, supra at
977-978.]
In Mich. Retailers Association v. United States, supra,
Michigan Retailers Association (MRA), a not-for-profit
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corporation, was the master policy holder of two group health
insurance policies for its members. As master policy holder, MRA
received premium credits from insurance companies in 1976 and
1977 because premiums received from its members exceeded claims
paid for their benefit. The Internal Revenue Service determined
that MRA should have reported these premiums as income. MRA
argued that the premiums were received and held in trust for the
benefit of its members.
The premiums were commingled with other funds; however, they
were segregated in MRA’s financial records, earmarked for the
benefit of its members, and credited to a liability account.
Further, MRA’s chief officer and board of directors believed that
they were obligated to use the premium credits for the benefit of
its members. In 1978 MRA executed a declaration of trust
acknowledging its rights and responsibilities with respect to the
excess premiums. Citing these facts and circumstances, the Court
held that MRA was merely a conduit through which excess premiums
were returned for the benefit of its members.
Both Seven-Up Co. v. Commissioner, supra, and Mich.
Retailers Association v. United States, supra, are clearly
distinguishable from the case at hand. In each of those cases,
the record supported an understanding among all parties that the
moneys received were held in trust for the benefit of others.
Here, Rogers testified that he held the $218,499 in trust to pay
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administrative costs and to invest further in Brazilian
receivables in 2005. However, petitioners have failed to support
this claim with any documentation or outside testimony. We are
not required to accept self-serving testimony, particularly where
it is implausible and there is no persuasive corroborating
evidence. E.g., Frierdich v. Commissioner, 925 F.2d 180, 185
(7th Cir. 1991) (“The statements of an interested party as to his
own intentions are not necessarily conclusive, even when they are
uncontradicted.”), affg. T.C. Memo. 1989-393; Lerch v.
Commissioner, 877 F.2d 624, 631-632 (7th Cir. 1989), affg. T.C.
Memo. 1987-295; Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).
Additionally, a taxpayer’s testimony as to intent is not
determinative, particularly where it is contradicted by the
objective evidence. Busch v. Commissioner, supra at 948; Glimco
v. Commissioner, 397 F.2d 537, 540-541 (7th Cir. 1968)
(taxpayer’s uncontradicted testimony need not be accepted), affg.
T.C. Memo. 1967-119.
The objective evidence in the record contradicts Rogers’
contention that he was acting as an agent of PPI in furtherance
of a corporate purpose. Rogers did not hold the $218,499 in
escrow or segregate the funds for PPI’s use. Rather, Rogers held
and used the funds without restriction. The $218,499 was
transferred to petitioners’ joint bank account. The record is
devoid of any evidence establishing either an express or
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constructive trust between Rogers and PPI. Further, petitioners
have not presented any written agreement providing that Rogers,
through PPI, acted as a trustee to hold the $218,499 for the
benefit of any other entity. Rogers controlled Warwick,
Jetstream, and PPI. Nothing in the record indicates that Rogers
used the funds from the sale of the receivables to serve the
interest of any of these entities. Rather, Rogers’ actions with
respect to these funds clearly show that his only interest was to
use Warwick, Jetstream, and PPI to avoid tax on his income.
Accordingly, we sustain respondent’s determination with respect
to the trust issue.
IV. Rule 155 Computation
The $218,499 distribution from PPI to Rogers was nothing
more than a distribution from an S corporation to a shareholder.
PPI was incorporated on April 1, 1989, but did not elect to be
treated as an S corporation until January 1, 1992. As a result,
it is possible that PPI has accumulated E&P from its predecessor
C corporation. Pursuant to the S corporation rules discussed
above, if PPI has accumulated E&P then the $218,499 distribution
is a dividend to Rogers to the extent it exceeds PPI’s AAA but
does not exceed its accumulated E&P. If PPI does not have
accumulated E&P, then the $218,499 distribution must be treated
as a gain from the sale or exchange of property to the extent it
exceeds Rogers’ basis in his PPI stock. A Rule 155 computation
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of PPI’s E&P and AAA, as well as Rogers’ basis in his PPI stock,
is required to make a final determination.
The Court, in reaching its holdings, has considered all
arguments made, and, to the extent not mentioned, concludes that
they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.