18 F. 3d 20 - Lewis v. Commissioner of Internal Revenue

Alan and Harriet Lewis appeal from a Tax Court decision assessing taxes upon $1,062,500, which a Lewis-controlled corporation called "ILT" distributed to the Lewises in 1984. In the Tax Court's view, that money represented an ILT "dividend," paid to the Lewises at that time. See I.R.C. Sec. 301(a), (c)(1)-(3) (1986). The Lewises disagree. They point out that a "dividend" must come from a corporation's "earnings and profits." See id. Sec. 316(a). And, they argue, ILT had no "earnings and profits," either in or before 1984, from which it might have paid a "dividend" in 1984. The Tax Court's contrary conclusion, they believe, rests upon a simple, and clear, factual error.

The Lewises further argue that, if ILT's distribution of the $1,062,500 is not a dividend, neither is it any other kind of 1984 taxable "income." See id. Sec. 61 (defining "gross income" as "all income from whatever source derived"). Rather, in their view, the 1984 distribution represents income that they constructively received in, and accumulated from, earlier years, namely from the years 1974 through 1980. The Lewises concede that they should have paid (but never have paid ) income tax on this money sometime between 1974 and 1981. But, as all parties concede, the statute of limitations now bars the Commissioner from assessing taxes for those earlier years. And, in the Lewises's view, the Commissioner cannot subvert the letter, and the spirit, of that statute by taxing now income that the government should have taxed then. The Lewises conclude that we should, therefore, simply reverse the Tax Court's determination.

In our view, the Lewises are correct about the Tax Court's factual error. The record makes clear that the 1984 distribution did not come from ILT's "earnings and profits." It is, as the Lewises say, some form of accumulated income that the Lewises "constructively received" in prior, and now-closed, tax years. But, whether or not the Lewises must pay taxes on that distribution is a different matter. In adjudicating tax cases, the courts have developed a type of estoppel known as "quasi estoppel" or the "duty of consistency," whereby a taxpayer may not take a position in one year to his advantage, and then at some later point, after correction for that year is barred by the statute of limitations, adopt a contrary position touching on the same facts or transaction. Jacob Mertens, Jr., The Law of Federal Income Taxation Sec. 60.05 (1992). Whether that doctrine requires the Lewises to treat the 1984 ILT distribution as taxable income is a matter so far addressed only superficially by the parties and upon which we wish the Tax Court's views. We therefore decline the Lewises's invitation to hold that the $1,062,500 is not taxable to them in 1984, and we remand this case to the Tax Court for further proceedings.

* Background Facts

To understand the Tax Court's factual error, one must have in mind a rather complex (and here undisputed) set of events, some of which took place before, and others after, December 1980, when ILT's bank account showed a zero balance.

* Before December 1980

This case arises out of an effort by Alan Lewis, and Steven Belkin, his business associate, to avoid paying federal income taxes on revenue generated primarily in Europe by their travel business, Trans National Travel ("TNT"). Two key sets of events took place before December 1980. First, between 1974 and 1980, Lewis and Belkin had TNT employees send TNT revenue generated by the sale of local (e.g., European city) tours in Europe to the Cayman Island bank account of ILT, a foreign corporation that they owned and controlled. ILT transferred some of the money received from TNT to two Cayman Island trusts. Those trusts, it later turned out, were "grantor" trusts of Lewis and Belkin (meaning, basically, that Lewis and Belkin should have paid income tax on the money those trusts received when the trusts received it.)

Second, and more important for present purposes, between 1977 and 1980 ILT "loaned" the rest of the money received from TNT to two limited partnerships formed and controlled by Lewis and Belkin. In effect, this was money "loaned" by Lewis and Belkin to themselves, for the purpose of making some personal investments. The total amount of these "loans" was approximately $2.075 million. There were three such "loans," each of which involved money that travelled a circuitous path, reaching Lewis and Belkin through paper intermediaries:

a) In 1977, ILT loaned $800,000 to Gran Compania De Comercio, which reloaned the money to Windikip Financieringsmaatschappij B.V., which in turn reloaned the money to Charlesgate West Associates. We assume that Gran Compania and Windikip were Lewis/Belkin-controlled entities that existed only on paper (though their use may have avoided the need to withhold U.S. taxes on interest payments). Charlesgate was a Lewis/Belkin real estate partnership, which used the money for the benefit of Lewis and Belkin.

b) In 1978, ILT loaned Charlesgate West Associates an additional $600,000, using the same intermediaries.

c) In 1980, ILT loaned $675,000 to a Lewis/Belkin-controlled real estate partnership named Taunton Boulevard Associates, which used the money for their benefit. This time the intermediaries consisted of two different foreign entities called "Mido Capital Venture, N.V." and "Bristol Realty Trust."

In each instance, the lending entity and all the borrowing entities created all the necessary loan-related documentation. Thus, on paper, it seemed as if Charlesgate owed Windikip (which owed Gran Compania, which owed ILT) regular payments of interest plus repayment of principal. Similarly, it seemed, on paper, as if Taunton owed Bristol (which owed Mido, which owed ILT) regular payments of interest plus repayment of principal. The Tax Court found, however, that neither Lewis nor Belkin, the persons in control of Charlesgate and Taunton Associates, ever intended to pay back the $2.075 million in "loans" to ILT. Hence, for tax purposes, they were not loans at all.

By the end of 1980, ILT apparently had paid out all the TNT money it had received either 1) to the Lewis/Belkin "grantor" trusts, or 2) to the Lewis/Belkin real estate partnerships by way of the $2.075 million Charlesgate and Taunton loans. As we have said, the Tax Court found that, as of December 31, 1980, ILT's bank balance was zero.

Three significant events occurred after 1980. First, in 1983, Belkin and Lewis ended their business association. As part of their consequent efforts to divide property jointly owned or controlled, they decided to repay the three "loans" from ILT. They therefore reversed the "money flow," having (in the one case) Gran Compania (paid by Windikip, paid by Charlesgate) pay ILT $1.4 million, and (in the other case) Mido Capital (paid by Bristol Realty, paid by Taunton) pay ILT $708,658.

Second, ILT, having received this money (plus related interest) from Gran Compania and Mido, divided it in half, distributing $1,079,329 to Belkin's "grantor" trust and $1,079,329 to Lewis's "grantor" trust. The adjusted amount ($1,062,500) of this distribution to Lewis's "grantor" trust in 1984 (which, as noted above, amounts for tax purposes to a distribution to Lewis himself) is the money at issue here.II

The factual record, as just described, suggests that the underlying, and possibly difficult, question in this case is not one of finding the facts, but rather, one of characterizing facts that are essentially beyond dispute. Is ILT's 1984 distribution of roughly $2.159 million taxable "income" to its recipients in light of the fact that that distribution originated in the repayment of sham loans (made in years now closed to review), the funds for which "loans," in turn, originally took the form of what may have been taxable (but untaxed) income to those same recipients (again, in years now closed to review)? The Tax Court avoided this question, however, by finding as fact that ILT had other "earnings and profits" out of which its 1984 distribution could have been made. The Tax Court found that

between 1981 and 1984, unidentified amounts were deposited into and/or credited to ILT's Cayman Islands bank account in the approximate amount of $4.5 million.

Since the law presumes that a corporate distribution comes from "earnings and profits," leaving the taxpayer to show the contrary, see Hagaman v. Commissioner, 958 F.2d 684, 695 n. 16 (6th Cir.1992) (citing cases), were it true that $4.5 million in "unidentified amounts" were (between 1981 and 1984) "deposited into and/or credited to ILT's Cayman Islands bank account," the law would simply presume that the $2.159 million payment in 1984 was a "dividend." (This is so because $4.5 million minus the $2.159 million loan repayment would still have left ILT with $2.341 million in "earnings and profits"--enough to support a $2.159 million dividend.) And, the Lewises would have to pay taxes upon that dividend income.

Unfortunately for the Commissioner, the record makes clear that it is not true that ILT had some other significant source of income. The 1981-1984 ILT bank account deposits are fully explained; and, ILT did not have $4.5 million in "earnings and profits," accumulated or otherwise. The Tax Court's finding to the contrary is "clearly erroneous." See, e.g., Hagaman, 958 F.2d at 690 (Tax Court's findings accepted on appeal unless "clearly erroneous").

We reach this conclusion because Lewis himself testified, without contradiction, that ILT had no other income. He said that ILT was formed to serve as a tax-saving entity for TNT's "local tour" money (in other words, that ILT was a sham corporation), that the transfers of that "local tour" money constituted ILT's sole significant source of "income," and that TNT did not transfer any money to ILT after 1980. Lewis's testimony is supported by the Tax Court's own explanation of the workings of the Lewis/Belkin tax avoidance plan, which fully accounts for the money that ILT received. Nothing in that explanation suggests that ILT had some other source of income.

Finally, and most important, the Commissioner introduced into evidence (over the Lewises's objection) ILT's 1981-1984 bank account records. Those records confirm that ILT's income during that period consisted of 1) interest paid on the Charlesgate and Taunton "loans," 2) interest earned on the account balance, and 3) the return of the Charlesgate and Taunton "loan" principals in 1984. (We attach that exhibit as an Appendix here.) The Lewises in their brief go through each entry, showing how it falls into one of these three categories (with the exception of two bank errors--a deposit notation of $1.415 million (4/26/84), reversed the same day, and a deposit notation of $37,625 (5/25/84), reversed about one month later). Their explanation is supported by the facts that 1) the bank statement shows large deposits in the very "loan return" amounts that the Tax Court mentions, 2) many smaller deposits refer to "Mido" or "Gran Compania," the entities that should have paid ILT interest on the loans, 3) the other deposits, totalling roughly $2.7 million, bear references of "from fixed [or 'call'] deposit," which is how banks sometimes label redeposits from interest-bearing instruments, and 4) the Lewises, in their amended tax returns for 1983 and 1984, described the interest payments as "interest" and paid taxes on them. Not a word in the record, or in the Commissioner's brief, casts doubt upon the Lewises's explanation of the record of ILT's account activity.

To understand the Lewises's explanation of the transfers to, and redeposits from, certain interest-bearing instruments labelled "fixed" or "call" "deposit," consider the following hypothetical example. Suppose a depositor instructs a bank to take money from his account and invest it in an interest-bearing instrument (contained, or not contained, in a separate interest-bearing account), and to "roll over" the investment from time to time as the interest-bearing instrument expires. Suppose, for example, that on January 1, John Smith deposits $10,000 in the local bank, along with an instruction to invest the money in Treasury Bills that expire every three months and that pay an annual interest of 5%. Smith's bank statement might look something like this:

Date              Deposit           Withdrawal        Balance
Jan 1             10,000                              10,000
Jan 1                               10,000 (to
                                    T'bills)          0
March 31          10,125 (from
                  T'bills)                            10,125
April 1                             10,000 (to
                                    T'bills)          125
June 30           10,125 (from
                  T'bills)                            10,250
July 1                              10,000 (to
                                    T'bills)          250
Sept 30           10,125 (from
                  T'bills)                            10,375
Oct 1                               10,000 (to
                                    T'bills)          375
Dec 31            10,125 (from
                  T'bills)                            10,500