Marretta v. Commissioner IRS

Opinions of the United
2006 Decisions States Court of Appeals
for the Third Circuit
2-23-2006
Marretta v. Commissioner IRS
Precedential or Non-Precedential: Non-Precedential
Docket No. 04-2679
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NOT PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
Case No. 04-2679
JOHN MARRETTA,
Appellant
v.
COMMISSIONER OF INTERNAL REVENUE
On Appeal from the United States Tax Court
(Tax Court Docket No. 2289-03)
Tax Court Judge: Arthur L. Nims, III
Argued: January 25, 2006
Before: RENDELL and STAPLETON, Circuit Judges,
and POLLAK*, District Judge
(Filed: February 23, 2006)
___________________________
* Honorable Louis H. Pollak, Judge of the United States District Court for the
Eastern District of Pennsylvania, sitting by designation.
Robert Kenny [ARGUED]
Suite 206
212 Carnegie Center
Princeton, NJ 08540
Counsel for Appellant
John Marretta
David I. Pincus
Sara A. Ketchum [ARGUED]
United States Department of Justice
Tax Division
P. O. Box 502
Washington, DC 20044
Counsel for Appellee
Commissioner of Internal Revenue
OPINION OF THE COURT
RENDELL, Circuit Judge.
The Commissioner of Internal Revenue assessed penalties against John Marretta
pursuant to section 6663 of the Internal Revenue Code (“I.R.C.”) for his failure to report
income he received from a “Ponzi” scheme during 1992, 1993, and 1994. The penalties
for these years amounted to $6,347, $22,350, and $28,454, respectively. The Tax Court
upheld the Commissioner’s determination, and Marretta appeals its Decision to us under
I.R.C. § 7482(a)(1). We have plenary review over the Tax Court’s findings of law,
including its construction and application of the Internal Revenue Code, and we review
the Tax Court’s factual findings for clear error. PNC Bancorp, Inc. v. Comm’r, 212 F.3d
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822, 827 (3d Cir. 2000).
The parties have stipulated to the key facts of this case. Marretta’s tax troubles
stem from his investment in CNC Trading Company (“CNC”), which was owned and
primarily operated by Charles N. Cugliari. Cugliari and CNC’s salespeople sold
investments in CNC “contracts” for approximately $25,000 and half shares at
approximately $12,500. Investors were told that CNC used their money to purchase food
products each month for resale to food wholesalers and supermarket chains. CNC sent
fixed monthly distributions to its investors, who were told that the distributions
constituted one half of the company’s profits. Unless an investor specified otherwise,
CNC would reinvest his or her principal investment and keep paying that investor
monthly distributions. Investors could receive their principal investment back from CNC
upon request.
CNC was a Ponzi scheme. Instead of purchasing food products with the money it
received from investors, CNC used that money to pay out cash or checks on a monthly
basis to prior investors. CNC did not report these payments to the IRS, nor did it provide
investors with annual 1099 forms. The company closed in February 1995.
Between November 1991 and January 1995, Marretta invested $250,657 in eleven
CNC contracts. During that time, he received monthly checks from the company totaling
$280,932. Marretta did not report any of these distributions from CNC on his tax returns
for 1992, 1993, or 1994.
Under I.R.C. § 6663, the IRS may seek a penalty for fraudulent underpayment of
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taxes “equal to 75 percent of the portion of the underpayment which is attributable to
fraud.” The government bears the burden of proving by clear and convincing evidence
that an underpayment is due to fraud. I.R.C. § 7454(a); Mazzoni’s Estate v. Comm’r, 451
F.2d 197, 201 (3d Cir. 1971). To satisfy this burden, the government must show that (1)
an underpayment exists, and (2) part of the underpayment was due to fraud. Morse v.
Comm’r, 419 F.3d 829, 832 (8th Cir. 2005); Sadler v. Comm’r, 113 T.C. 99, 102 (1999).
If the government “establishes that any portion of the underpayment is attributable to
fraud, the entire underpayment shall be treated as attributable to fraud, except with
respect to any portion of the underpayment that the taxpayer establishes (by a
preponderance of the evidence) is not attributable to fraud.” I.R.C. § 6663(b).
We agree with the Tax Court that the Commissioner has demonstrated that
Marretta failed to report gross income in 1992, 1993, and 1994, resulting in an
underpayment for those years. The Internal Revenue Code broadly defines “gross
income” as “all income from whatever source derived,” including income derived from
business, interest, and dividends. I.R.C. § 61. The Supreme Court gives “a liberal
construction to this broad phraseology in recognition of the intention of Congress to tax
all gains except those specifically exempted.” Comm’r v. Glenshaw Glass Co., 348 U.S.
426, 430 (1955). It is undisputed that Marretta received $280,932 in checks from CNC
that were monthly payments on the contracts he purchased. CNC represented that these
payments were a return on Marretta’s “investment.” The monthly vouchers Marretta
received with his checks showed the “realization” on his investment and his share of the
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margin. Given the breadth of I.R.C. § 61, these distributions were undoubtedly gross
income, unless they fell within an exception. See Rickel v. Comm’r, 900 F.2d 655,
657-58 (3d Cir. 1990) (“[A]ny accession to wealth is presumed to be gross income,
unless the taxpayer can demonstrate that the accession fits into one of the specific
exclusions created by other sections of the IRC.”).
Marretta makes alternative arguments for why these distributions were not
income. First, he claims that because CNC created no actual profits, it was impossible
for Marretta to have received “profit income” through the Ponzi scheme, as he admitted
at his 1999 plea hearing. This argument misses the point. The critical finding is not that
Marretta received any particular type of income, but rather that he received unreported
gross income from CNC, the nondisclosure of which resulted in an underpayment.
Whether or not CNC generated profits is irrelevant to the question of whether the checks
Marretta received constituted reportable income for his own tax purposes.
Marretta’s second contention is that the distributions from CNC constituted return
of capital. We disagree. The monthly vouchers CNC sent showed that the full amount of
Marretta’s original investment remained credited to his account after each distribution.
Moreover, Marretta stipulated that he could have received his principal investment at any
time simply by requesting it, which he never did. Thus, Marretta constructively received
and reinvested his principal each month, see 26 C.F.R. § 1.451-2(a) (defining
constructive receipt of income), and received a distribution check in addition to this
investment. These distribution checks were “accessions to wealth” that constituted
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income. See Rickel, 900 F.2d at 657.
We also agree with the Tax Court that the Commissioner carried the burden of
proving that the underpayment was due to fraud. Fraudulent intent is rarely established
by direct evidence. Rather, a court may infer it from various kinds of circumstantial
evidence, such as understatement of income, inadequate records, failure to file tax
returns, implausible or inconsistent explanations of behavior, concealing assets, and
failure to cooperate with tax authorities. Spies v. United States, 317 U.S. 492, 499
(1943); Mazzoni’s Estate, 451 F.2d at 202. The Tax Court’s finding of fraud is a
question of fact that will only be reversed if shown to be clearly erroneous. Solomon v.
Comm’r, 732 F.2d 1459, 1461 (6th Cir. 1984); Mazzoni’s Estate, 451 F.2d at 201.
We find no clear error in the Tax Court’s conclusion that Marretta’s
underpayments were due to fraud. Marretta admitted at his 1999 plea hearing that he
evaded taxes willfully and with the specific intent to violate a known legal duty in 1992,
1993, and 1994. The record also shows that Marretta never mentioned to his tax preparer
that he was receiving monthly distributions from CNC, or even that he had invested in
the company, supporting an inference that Marretta intended to conceal his true income.
Finally, we reject Marretta’s claim that the Tax Court erred by excluding from the
record a set of amended tax returns Marretta filed a week before his trial before the Tax
Court. Introduction of these returns would have violated a standing order of the Tax
Court requiring that evidence be submitted at least fourteen days prior to trial. It was not
an abuse of discretion for the Court to enforce its order. In any event, we do not rely on
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either the first or second set of amended returns Marretta filed in concluding that the Tax
Court appropriately sustained the penalties assessed against Marretta under I.R.C. § 6663
for 1992, 1993, and 1994.
For the foregoing reasons, we will AFFIRM the Tax Court’s Decision.
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