Opinion
Docket Nos. 41930 41931 66600 69574.
1960-07-29
IRVING S. FEDERBUSH AND SYLVIA C. FEDERBUSH, ET AL.,1 PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Burnett Schwartz, Esq., Morris A. Shenker, Esq., and Bernard J. Mellman, Esq.; 2 Harry Malter, Esq., and George Delson, C.P.A.; 3 and Morris A. Shenker, Esq., and Bernard J. Mellman,Esq., 4 for the petitioners. John J. O'Toole, Esq., and John J. Madden, Esq., for the respondent.
Burnett Schwartz, Esq., Morris A. Shenker, Esq., and Bernard J. Mellman, Esq.;
Harry Malter, Esq., and George Delson, C.P.A.;
Counsel for the petitioners in Docket No. 41930.
and Morris A. Shenker, Esq., and Bernard J. Mellman,Esq.,
Counsel for the petitioner in Docket No. 66600.
for the petitioners. John J. O'Toole, Esq., and John J. Madden, Esq., for the respondent.
Counsel for the petitioner in Docket No. 69574.
1. Corporate petitioner's income tax returns held to have been false and fraudulent with intent to evade tax.
2. Beginning in September of 1942 and continuing through 1946, five brothers, who were the officers of petitioner corporation and who owned five-sixths of its outstanding stock, took possession of certain checks received by the corporation in payment for merchandise shipped to its customers and in payment of rent owed to it. After cashing the checks, they divided the proceeds. They also paid corporate funds to themselves in the guise of business expenses. Held, that petitioner corporation did not sustain embezzlement losses during the fiscal years involved within the meaning of section 23(f) of the Internal Revenue Code of 1939 in the amount of the corporate funds received by the five brothers.
3. The deficiencies determined against the corporation are due to fraud with intent to evade tax.
4. Held, that respondent did not err in his determination that funds thus siphoned from the corporation into the hands of petitioner Irving Federbush, one of the five brothers referred to above, constituted taxable income to him. Commissioner v. Wilcox, 327 U.S. 404, distinguished. Kann v. Commissioner, 210 F.2d 247, followed. Held, further, that Irving has not shown that the income so received by him was less in amount than respondent determined, and that the deficiencies in tax are due to fraud with intent to evade tax.
5. Income tax returns for 1942, 1943, 1944, 1945, 1946, and 1948 designated joint returns of Irving and Sylvia Federbush, held to have been intended as such, and pursuant to section 51(b) of the Internal Revenue Code of 1939 their liability is joint and several.
6. Deficiencies in income tax of Jack Federbush held to have been due to fraud with intent to evade tax.
The respondent determined deficiencies in tax and additions to tax against the petitioners as follows:
+--------+ ¦¦¦¦¦¦¦¦¦¦ +--------+
Declared Additions to tax under sections Docket Petitioner Year Income value Excess No. tax excess profits profits tax 293(b) 294(d) 294(d) tax (1)(A) (2) ( $3,399.67 $1,699.84 1942 41930 Irving S. ( 9,466.10 4,733.05 Federbush 1943 and Sylvia ( 7,115.98 3,557.99 C. 1944 Federbush. ( 3,993.24 1,996.62 1945 ( 14,426.78 7,213.39 1946 ( 1,165.06 2,622.12 1942 ( 9,176.79 5,996.40 1943 41931 Jack D. ( 19,896.11 9,948.06 Federbush 1944 ( 11,468.94 5,734.47 1945 ( 21,508.24 10,754.12 1946 ( $16,158.17 $142,022.98 79.870.44 1943 ( 10,329.55 119,757.46 65,043.51 1944 1 The ( 66600 Federbush 1945 4,048.00 73,488.61 38,768.61 Co ( 60,574.25 59,414.65 59,994.46 1946 69574 Sylvia 1948 3,398.42 1,699.21 $192.21 320.36 Federbush
For convenience the corporate petitioner, the Federbush Company (Docket No. 66600), will sometimes hereafter be referred to as the corporation, and the members of the Federbush family will sometimes be referred to by their first names.
Certain issues have been settled, and the adjustments will be reflected in the computations under Rule 50.
The respondent's motion to dismiss the proceeding for failure properly to prosecute with respect to the income tax deficiencies against Jack D. Federbush (Docket No. 41931) was granted because of the petitioner's failure to appear, but trial was held as to the additions to tax for fraud under section 293(b) of the Internal Revenue Code of 1939.
The issues for decision are:
(1) Whether the tax returns filed by the Federbush Company were ‘fraudulent * * * with intent to evade tax,‘ to the end that the period within which the tax may be assessed and collected as provided by section 276(a) of the 1939 Code has or has not expired.
(2) Whether the corporation sustained embezzlement losses in the amount of corporate funds which its officer-stockholders distributed among themselves, but which were not reflected as such in the corporate books of account.
(3) Whether the deficiencies determined against the corporation were due to fraud with intent to evade tax.
(4) Whether that part of the corporate funds distributed as above shown and received by petitioner Irving Federbush was taxable income to him; if so, whether the respondent correctly determined the amount of such income; and whether the deficiencies in tax were due to fraud with intent to evade tax.
(5) Whether Sylvia filed joint returns with Irving for the taxable years 1942 through 1946 and for 1948.
(6) Whether the deficiencies in income tax, or parts thereof, against Jack were due to fraud with intent to evade tax.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found as stipulated.
The Federbush Company was incorporated under the laws of New York on September 19, 1932. It filed its income tax returns on an accrual basis, using a fiscal year ending August 31. The returns for the years involved were filed with the collector of internal revenue for the second district of New York.
From its inception the corporation has been engaged in the business of manufacturing and selling looseleaf devices, ring binders, catalog covers, and zipper cases.
The corporate stock was owned in equal amounts by six Federbush brothers, Max, Irving, Samuel, Jack, Nathan, and Charles, until September 30, 1942, when Charles died intestate. His one-sixth interest passed to his wife, Regina, and to his daughter, Natalie, who was then 17 years of age.
After the death of Charles, the corporate stockholders were Max, Irving, Samuel, Jack, Nathan, Regina, and Natalie. Complete control of the business and affairs of the corporation was vested in the surviving brothers, who were the sole members of the board of directors. Except for the summer vacation period in 1943 when Natalie was employed as a part-time clerk, and up to August 1947, neither Regina nor Natalie was an officer or director, had anything to do with the management or operation of the corporation, or was employed by it.
During the taxable years involved, the surviving brothers diverted corporate funds to their own use in the amount of $500,060.44 by (1) taking the proceeds of unrecorded sales, (2) taking rental income owed to the corporation, and (3) paying money to themselves in the guise of business expenses.
To conceal the unrecorded sales, the brothers billed certain customers with unnumbered invoices which were never turned over to the bookkeeper for entry on the corporate books. The first brother to arrive at the office in the morning would open the mail and remove any checks in payment of unnumbered invoices. These checks were withheld from the bookkeeper. Other corporate sales were billed to customers on numbered invoices and were duly recorded by the bookkeeper on the books of the corporation.
In their stipulation of facts the parties have used the words divert, diverted, and diversion to describe the taking by the Federbush brothers of sales receipts, rents, and the like of the corporation and the dividing thereof among themselves without a proper recording of such items in the corporate books of account. They have, however, by paragraph 63 of the stipulation reserved ‘the right to argue that the substance, legal effect and significance for tax purposes of the transactions, acts or admissions stipulated herein are different from the form, labels, names and descriptions thereof used by the parties.’
Informal meetings were held with all of the Federbush brothers present to determine the sales in respect of which unnumbered invoices would be used.
All of the unrecorded sales were made by the corporation in transactions in the regular course of its business. The Federbush brothers never represented themselves to customers as other than corporate officers acting on behalf of the corporation, and the customers in making their purchases never dealt with them except as officers or representatives of the Federbush Company. They made their checks for the merchandise purchased payable to the corporation and regarded them as covering payments to the corporation.
Checks received in payment of the unnumbered invoices were cashed, and the division of the proceeds among the brothers was accomplished by three methods:
(1) Some checks were deposited in the corporate bank account without any record of their receipt on the corporation's books. Contemporaneously a withdrawal was made of a similar amount by using a check taken from the back of the corporate checkbook without any record being made of the withdrawal.
(2) Some checks were deposited in the personal bank account of Max or that of Irving without any record of receipt being made on the corporate records.
(3) Other checks were cashed by one or another of the brothers without any record being made of the transaction on the corporate records.
The amounts thus siphoned from the corporation or bypassing its books of account were as follows:
+----+ ¦¦¦¦¦¦ +----+
Year ending Aug. 31
1943 1944 1945 1946 Unrecorded sales $172,376.77 $114,208.12 $39,917.48 $148,978.45 Unrecorded rental income 450.00 1,000.00 1,200.00 False purchases 14,083.60 7,846.02
172,376.77 114,658.12 55,001.08 158,024.47
In the corporate tax returns filed for the taxable years involved, the unrecorded sales and rental income was not reported as income, and the false purchases were taken as deductions. The diversion of funds was not made known to the corporation's accountant who prepared the tax returns on the basis of information supplied by the corporate officers. The returns were signed on behalf of the corporation by Max in 1943, by Max and Samuel in 1944 and 1945, and by Irving in 1946.
In November of 1946, Max sold his stock in the corporation to Jack, Irving, Samuel, and Nathan as the result of a dispute over management of the corporation.
In possibly June of 1947, Regina and Natalie were told by their then attorney that the Federbush brothers had diverted to their own personal use substantial sums belonging to the corporation and that an investigation of the corporate tax returns had been initiated by the taxing authorities concerned. They had had no prior knowledge of the diversions and had never received any of the funds taken in that manner. The diversions were never ratified or approved by Regina and Natalie. Regina and Natalie had, however, received payments of $100 per week from the corporation beginning with the death of Charles. Except for such compensation as was paid to Natalie pursuant to her part-time vacation period employment in 1943, neither Regina nor Natalie received any payments from the corporation funds during the taxable years other than the said $100 per week.
A stockholders' derivative action was instituted in the Supreme Court of New York on June 27, 1947, by Regina, individually and as administratrix of the estate of her deceased husband, and by Natalie against the Federbush brothers with the corporation named as a nominal party defendant to comply with the procedural requirements of New York law. In August, upon the demand of Regina and Natalie, Jack resigned as a director and president of the corporation, Samuel resigned as a director and vice president, and Irving resigned as a director and secretary-treasurer. A voting trust agreement was entered into between Irving, Jack, Nathan, and Samuel as stockholders of the corporation whereby Ely M. Berman, then Natalie's fiance, and Lawrence S. Greenbaum, attorney for the corporation, were named as sole voting trustees. Harry Federbush, Samuel's son, was elected president and a director to replace Jack; and Natalie was elected secretary-treasurer and a director to replace Irving. It was also agreed that all corporate checks were to be signed by Natalie and Harry jointly.
On March 23, 1949, the court handed down its opinion in the stockholders' derivative action, holding the individual defendants jointly and severally liable and directing that ‘The Federbush Company, Inc., have and recover’ from Max, Irving, Samuel, Nathan, and Jack '$462,749.59 with interest on $357,749.59 from September 1, 1946, and on $105,000 from January 1, 1949, and costs.' Pursuant thereto, judgment in the total sum of $518,795.46 was entered March 30, 1949, against the Federbush brothers and each of them.
At a special meeting of the corporation's board of directors on June 20, 1949, Regina was elected as a director to occupy the office left vacant by the prior resignation of Samuel. Ely, who was then the husband of Natalie, replaced Harry as president and as a director. Thereupon the sole officers were Ely, president, and Natalie, secretary-treasurer. The sole directors were Ely, Natalie, and Regina.
In an effort to discover the assets of the Federbush brothers, the attorney for the corporation instituted proceedings supplementary to judgment. An order was issued by the Supreme Court of New York directing Irving, Jack, and Nathan to show cause why they should not be directed to deliver their voting trust certificates. In response, Irving, Jack, and Nathan commenced an action in the Supreme Court of New York seeking a permanent injunction restraining enforcement of the judgment against them in the stockholders' derivative suit. The entire controversy was referred to a referee for hearing and report.
During the course of the hearings before the referee, and under date of May 19, 1950, an agreement was made whereby Irving, Jack, and Nathan assigned their stock interests to the corporation in satisfaction of the judgment against them. They similarly assigned and surrendered stock certificate No. 9, issued in the name of Max, which previously had been transferred and assigned by Max to Irving, Jack, Nathan, and Samuel. They also terminated, settled, and discontinued the action they had instituted for permanent injunction against the enforcement of the judgment. The Federbush Company, in addition to the delivery of general releases to Irving, Jack, and Nathan, agreed to pay to Irving, Jack, and Nathan the sum of $60,000, $22,500 of which was to represent 6 months' severance pay of $7,500 to each of the three. Of the remaining $37,500, $4,250 was to be paid as fees to the attorneys who had represented the three brothers. The remainder was to be held in satisfaction of their respective liabilities for tax owed the State of New York, and any balance was to be paid to them in equal parts. All rights against Max and Samuel were expressly reserved by the corporation.
As a result of the proceedings supplementary to judgment, Samuel, by agreement dated September 1, 1950, agreed to pay the corporation $73,000, depositing his stock in escrow as security. Pursuant to the agreement, the payments on the stated amount were to be $35 per week, plus one-half of any dividends thereafter declared by the corporation and allocable to his stock so pledged. He was continued as an employee of the corporation in the capacity of foreman of its bindery plant. He did not thereafter hold any office, nor was he a director.
On February 12, 1950, the corporation discharged Irving, Jack, and Nathan as employees and stationed uniformed guards to keep them off the premises. Since then they have not been employed by or otherwise connected with the corporation.
The corporation, Max, and Irving were charged in 1948 with violating the tax laws of New York. Max and Irving were convicted and sentenced to the penitentiary, but the charge was dismissed against the corporation.
In November of 1952, the corporation and the Federbush brothers were indicted for evasion of Federal income taxes. Max, Irving, Jack, and Samuel pleaded ‘Guilty’ and were convicted. The United States attorney, with the approval of the judge then presiding, filed a nolle prosequi as to the corporation and Nathan, who had since died.
The corporation carried no insurance during the taxable years involved against loss based upon or arising out of diversions or conversions of its property.
There was no declaration of a dividend or payment of a dividend pursuant to declaration by the corporation from 1942 through 1946.
There is no evidence of record with respect to the amount of accumulated earnings and profits of the Federbush Company during the taxable years in issue. Irving, however, has raised no question in that respect as to the correctness of the respondent's determination.
Petitioners Irving and Sylvia Federbush are husband and wife, and reside in St. Louis, Missouri. They were married in 1930, and at all times thereafter to and including the date of trial herein have continued to live together as husband and wife. During the taxable years in question, they resided in Monroe, New York, and in Great Neck, New York. The income tax returns for the years 1942 through 1946 were filed with the collector of internal revenue for the second district of New York.
From 1942 through 1946, Irving was an officer and a director of the Federbush Company, as well as the owner of one-sixth of its stock. During those years he participated with his four brother-officer-stockholders in the division of corporate funds between themselves, as heretofore set forth, and in those years Irving so received as his own such corporate funds in the amount of at least $66,657.40, which the respondent allocated in his determination as follows:
+-----------------------------+ ¦Year¦Dividends¦Capital gains ¦ +----+---------+--------------¦ ¦1942¦$4,899.72¦$1,720.40 ¦ +----+---------+--------------¦ ¦1943¦10,186.46¦6,304.56 ¦ +----+---------+--------------¦ ¦1944¦ ¦13,280.05 ¦ +----+---------+--------------¦ ¦1945¦1,562.45 ¦4,669.45 ¦ +----+---------+--------------¦ ¦1946¦11,845.49¦12,188.82 ¦ +-----------------------------+
None of the diverted funds were reported as income in the returns filed by Irving and Sylvia for the taxable years in issue.
For each of the years 1942, 1943, 1945, and 1946, a return was filed that was signed by both petitioners. Their signatures appear at the bottom right-hand corner of the first page of these returns immediately over the printed instruction: ‘If this is a joint return (not made by agent), it must be signed by both husband and wife.’ The names of both Irving and Sylvia are contained in the caption at the top of the first page of these returns over the printed instructions: ‘(Use given names of both husband and wife, if this is a joint return.)‘ Sylvia was not listed as a dependent on these returns, and the full exemption allowable to both husband and wife for those years was claimed. Sylvia did not file separate returns for any of the indicated years.
The 1944 return was made out in exactly the same manner as the returns filed for the other taxable years. Irving, however, signed both his name and that of Sylvia thereon. Sylvia was not listed as a dependent, the full exemption for husband and wife was claimed, and Sylvia did not file a separate return for that year.
During 1942 Irving and Sylvia lived in Monroe, New York, in a house the title to which was in Sylvia's name. The house was sold in August of 1943, and they moved to Great Neck, New York, where another house was purchased, with Sylvia likewise having title. On the returns for 1942 through 1946, deductions were claimed for real estate taxes, as follows:
+---------------------------+ ¦Year ¦Real estate taxes ¦ +------+--------------------¦ ¦1942 ¦$150 ¦ +------+--------------------¦ ¦1943 ¦320 ¦ +------+--------------------¦ ¦1944 ¦647 ¦ +------+--------------------¦ ¦1945 ¦647 ¦ +------+--------------------¦ ¦1946 ¦647 ¦ +---------------------------+
In the 1942 and 1943 returns, the question whether a separate return was made by the husband and wife was left unanswered. However, in the 1944, 1945, and 1946 returns, the question was answered ‘no.’
Sylvia and Irving continued to reside in Great Neck during 1948. The return for 1948 was filed with the collector for the first district of New York.
Both Irving and Sylvia signed the 1948 return. Their signatures are at the bottom right-hand corner of the first page of the return immediately over the printed instruction that both husband and wife must sign a joint return. Both names are also typed in the caption at the top of the first page over the printed instruction that the given names of both the husband and wife should be used in a joint return. Sylvia was not listed as a dependent, and the full exemption allowable to both husband and wife was claimed. A deduction of $728 was claimed for real estate taxes. Sylvia did not file a separate return for 1948.
The returns for Irving and Sylvia were prepared by a certified public accountant from information supplied to him by Irving. His preparation of the returns as joint returns was the result of his determination based on the nature of the information supplied.
Sylvia did not participate in the management and operations of the Federbush Company, nor in Irving's business transactions. She did not know that Irving had received unreported income. It was her practice to sign papers and documents which Irving presented to her for signature, ‘whether they were income tax returns or any other papers.’ In signing an income tax return or other paper, she intended the signature to be her signature and to have effect as such on the return or paper signed. In such manner, Sylvia signed the joint income tax returns for 1942, 1943, 1945, 1946, and 1948.
At the time Irving presented the 1944 return to her for signature, they were experiencing some personal difficulties and she had refused to sign several documents. She also refused to sign the return. Since the refusal was on the last day for the filing of the return, Irving signed her name to the return in her stead.
The income tax returns filed by and for Irving and Sylvia for the years 1942, 1943, 1944, 1945, 1946, and 1948 were joint returns.
Petitioner Jack D. Federbush was a resident of New York City. He filed his income tax returns for the taxable years involved with the collector of internal revenue for the third district of New York.
From 1942 through 1946, Jack was at various times president, secretary, and sales manager of the Federbush Company. He participated in the diversion of funds from the corporation, receiving at least the following amounts, which he failed to report as income:
+-----------------+ ¦Year ¦Amount ¦ +------+----------¦ ¦1942 ¦$6,620.13 ¦ +------+----------¦ ¦1943 ¦16,491.03 ¦ +------+----------¦ ¦1944 ¦13,280.05 ¦ +------+----------¦ ¦1945 ¦6,231.90 ¦ +------+----------¦ ¦1946 ¦24,034.32 ¦ +-----------------+
The deficiencies, or a part thereof, for each of the taxable years against the corporation and against Jack were due to fraud with intent to evade tax. As to Irving and Sylvia, the deficiency, or a part thereof, for each of the years 1942 through 1946 was due to fraud with intent to evade tax.
The corporate returns filed for the taxable years were false and fraudulent with intent to evade tax.
OPINION.
TURNER, Judge:
Except for Docket No. 69574, each of these cases involves the tax consequences of the distribution or division of funds of the Federbush Company by and between its officer-stockholders without formal action as directors of the company and without recording the distributions on the corporate books.
With respect to the Federbush Company, the assessment of the deficiencies and the additions to tax for fraud is barred by the statute of limitations unless the returns were ‘fraudulent * * * with intent to evade tax,‘ within the meaning of section 276(a) of the Internal Revenue Code of 1939.
Respondent has the burden of proving that such intent existed.
SEC. 276. SAME— EXCEPTIONS.(a) FALSE RETURN OR NO RETURN.— In the case of a false or fraudulent return with intent to evade tax or of a failure to file a return the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time.
During the taxable years in issue the president of the corporation supplied false information to the accountant who prepared the corporate tax returns. As a result, the returns contained omissions of sales and rental income and deductions for fictitious purchases. The president, as well as the other corporate officers, was aware of the falsity of the returns. These returns were signed by the president and the signing of income tax returns was within the scope of his duties and authority. Under such circumstances, the evidence that the returns were filed by the corporation with fraudulent intent to evade tax is clear and convincing.
Nevertheless, the corporation contends that the fraud of its officers may not be imputed to it. This contention, however, does not take into account the fact that a corporation can act only through its officers and that it does not escape responsibility for the acts of its officers performed in that capacity. Corporate fraud necessarily depends upon the fraudulent intent of the corporate officer. Auerback Shoe Co. v. Commissioner, 216 F.2d 346; Saven Corporation, 45 B.T.A. 343; and L. Schepp Co., 25 B.T.A. 419. Where, as here, the fraudulent intent was on the part of all of the corporate officers who in addition owned five-sixths of the stock, the application of section 276(a) is manifest.
The Federbush Company no longer contends, as it did at the trial, that the unrecorded sales and rental income was the income of the Federbush brothers individually rather than of the corporation, but instead seeks deductions of corresponding amounts under section 23(f) of the 1939 Code,
on the theory that these funds, as well as the amounts taken through fictitious purchases, were embezzled by its officers.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(f) LOSSES BY CORPORATIONS.— In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise.
We do not have here the case of merely an employee who steals money which has been entrusted to his care by his employer. The Federbush brothers were controlling stockholders, completely in charge of the management of the corporation, who acted in concert and with mutual agreement to divide and distribute corporate funds among themselves and to their own unrestricted use and enjoyment. All of this they were able to do because of their ownership and their control of the corporation. That they were making the distributions between themselves under claim of right receives corroboration from their resistance in the suit brought against them by Regina and Natalie and their subsequent acts in attempting to defeat the judgment obtained on behalf of the corporation. As officers and stockholders, they could have formally authorized either dividend distributions or liquidating distributions,
and we do not understand it to follow that the absence of formal authorization in such circumstances makes of the distribution an embezzlement. A distribution of corporate earnings may constitute a dividend even though the formalities of a dividend declaration are not observed, even though the distribution is not recorded on the corporate books as such, even though it is not in proportion to the stockholdings, and even though some of the stockholders do not participate in its benefits. 58th Street Plaza Theatre, Inc. v. Commissioner, 195 F.2d 724, certiorari denied 344 U.S. 820, affirming 16 T.C. 469; Helvering v. Gordon, 87 F.2d 663; Christopher v. Burnet, 55 F.2d 527; Hadley v. Commissioner, 36 F.2d 543; and Chattanooga Savings Bank v. Brewer, 17 F.2d 79.
Under New York law, power to declare dividends is vested in the majority of the corporate board of directors. N.Y. Gen. Corp. Law, sec. 27; Liebman v. Auto Strop Co., 241 N.Y. 427, 150 N.E. 505. Moreover, a corporation may be dissolved without judicial proceedings upon the vote of two-thirds of its stockholders. N.Y. Stock Corp. Law, sec. 105.
Not only does the record indicate that the Federbush brothers had no intent to steal from the corporation, but rather, we think it reveals that they were interested primarily in reducing their taxes which was a more rewarding objective best accomplished through bypassing the corporate books with the corporate income. In this manner they would, if not detected, lighten the tax burden at both the corporate and shareholder level. Viewed realistically, the diversions had as their principal purpose the allowing of the corporate officer-stockholders to escape taxation by routing corporate income directly and secretly into their hands. Consequently, we have concluded that the funds received by the Federbush brothers were not embezzled from the corporation. See in that connection Drybrough v. Commissioner, 238 F.2d 735, affirming on that point 23 T.C. 1105; Kann v. Commissioner, 210 F.2d 247, certiorari denied 347 U.S. 967, affirming 18 T.C. 1032. See also and compare Currier v. United States, supra, and United Dressed Beef Co., 23 T.C. 879.
Nor is the result otherwise because of the rights and interests of Regina and Natalie in the corporation. Based on stock ownership, the $100 per week they were receiving from the corporation was somewhat less pro rata than the amounts the five brothers were distributing to and dividing among themselves, but that fact does not, in our opinion, supply the basis for a loss deduction for the corporation. In passing, it may be noted that if the amounts received by Irving were as determined by the respondent, the amounts received by him in 1942 and 1945 exceeded the $5,200 received by Regina and Natalie in those years by only $1,420.12 in 1942 and $1,031.90 in 1945.
In holding that the corporation is not entitled to deductions for embezzlement losses, we have not disregarded the corporate entity. We have merely determined that the Federbush brothers did not have the requisite intent to embezzle from the corporation. Without such intent there can be no act of embezzlement.
Although cases such as Currier v. United States, supra, and Ace Tool & Eng., Inc., 22 T.C. 833, may not be conclusive on the facts here since they involved diversions by sole stockholders while in this case the Federbush brothers owned only five-sixths of the stock of their company, the same underlying principle is in our opinion applicable. Under the rationale of those cases, it seems doubtful that a sole stockholder could ever intend to embezzle from his corporation. Whether a majority stockholder could have such an intent under some factual situations we need not decide here; it is enough to conclude that the Federbush brothers did not.
In support of its position, the corporate petitioner cites Summerill Tubing Co., 36 B.T.A. 347. There the president of the corporation, who with his wife owned about 91 per cent of the outstanding common stock, diverted approximately $76,000 from the corporation through fictitious purchases. The corporation was allowed a deduction for the loss under section 23(f) of the Revenue Act of 1928.
Though the case is not entirely clear in this respect, the decision is evidently based on the premise that there was an embezzlement of funds from the corporation. No consideration appears to have been given, however, to the possibility that there may have been an informal distribution of corporate income by the controlling stockholder. Since we have concluded that the Federbush brothers did not intend to embezzle funds from the corporation, we do not regard Summerill Tubing as determinative of the case at hand.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(f) LOSSES BY CORPORATIONS.— In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise.
Taking the position that the diversion of funds constituted embezzlement under the New York law, the petitioner corporation makes the further argument that whether for the purposes of the deduction claimed what occurred here was embezzlement depends upon applicable State law. This same contention was rejected by the United States Court of Appeals for the Third Circuit in Kann v. Commissioner, supra, and by the United States Court of Appeals for the Sixth Circuit in Drybrough v. Commissioner, supra. In the Kann case, the court stated that, ‘Such local law concept of embezzlement, while it may be useful to deter those in control of a corporation from defrauding creditors and minority stockholders, should not, in our opinion, be used as a vehicle for tax avoidance, absent a clear mandate to the contrary.’ Otherwise, as we have pointed out in United Mercantile Agencies, Inc., 23 T.C. 1105, affirmed on this point sub nom. Drybrough v. Commissioner, supra, stockholders could avoid corporate and individual taxes by diverting corporate funds and then claiming embezzlement if discovered.
Having found that the corporate returns for the taxable years involved were ‘fraudulent * * * with intent to evade tax,‘ we also hold that the deficiencies, or parts thereof, for such years were due to fraud with intent to evade tax, and the respondent was correct in determining the additions to tax for fraud under section 293(b) of the 1939 Code.
Irving now earnestly and urgently agrees with the corporate petitioner that beyond question he was guilty of embezzlement, and that Commissioner v. Wilcox, 327 U.S. 404, applies to relieve him of all tax on the distributions he and his brother-officer-stockholders made between themselves from the Federbush Company. What we have said above concerning the corporation's claim of a deduction is equally applicable here. Accordingly, there was no embezzlement within the meaning of the Wilcox case, and we hold that Irving is taxable on the funds distributed to him. Cf. Rutkin v. United States 343 U.S. 130.
In Wilcox, the taxpayer was a salaried employee, not an officer and controlling stockholder. The Federbush brothers, on the other hand, controlled the corporation during the taxable years in issue, owning together 83 1/3 per cent of its stock. They were also completely in charge of the corporate management. The taxpayer in Wilcox was indicted and convicted of embezzlement, while the Federbush brothers have never even been charged with that crime. Moreover, the taxpayer in Wilcox would never have received any of the proceeds of his wrongdoings except for his diversion, but in major portion the Federbush brothers were taking funds which they as stockholders had a right to have distributed to themselves. Their primary purpose in diverting the corporate funds was to secure the tax advantages gained thereby.
For Irving, it is argued that the Kann case is distinguishable, in that there the acts of the two brothers were condoned and here they were not. We can see some differences in facts, but not in principle. In neither case did the nonparticipating stockholders prefer criminal charges, but in both cases steps for restoration were taken, the only difference being that in the Kann case when the disclosures were made the two officer-stockholders who had been distributing corporate funds to themselves worked out a program of payment with the other stockholders. In the instant case, the Federbush brothers instead of agreeing to make restoration as was done in the Kann case resisted, rather obviously under claim of right, the suit brought against them, and further, Irving, Jack, and Nathan undertook to defeat the judgment after it was rendered. When those efforts failed, Irving, Jack, and Nathan made settlement by turning in their stock. Samuel, on the other hand, as did the brothers in the Kann case, worked out a payment program. He did not give up his stock but put it in escrow as security. For the purpose here the end results in the two cases were in effect the same.
As related to this case, it might seem at first glance that the opinion of the Third Circuit in Kann and that of the Second Circuit in J. J. Dix, Inc. v. Commissioner, 223 F.2d 436, certiorari denied 350 U.S. 894, reversing in part a Memorandum Opinion of this Court, are in conflict, and that the Dix case stands in support of Irving's claim that as to him the Wilcox case controls. Jacob Dix, the president of a family corporation, without the knowledge, authorization, or consent of the directors or other officers, withdrew and appropriated certain corporate funds to his own benefit. And in deception of his son, the only other responsible corporate officer, Jacob failed to record certain sales in the corporate books. The Court of Appeals for the Second Circuit, while sustaining the holding that the unrecorded items did represent corporate income, held, by a divided court, that the misappropriated funds did not constitute taxable income to Jacob, stating:
Jacob withdrew those moneys from the corporate bank accounts without the consent, coerced or otherwise, of the company. That he was the president did not amount to corporate consent. We have here a simple case of embezzlement, not one involving a receipt under any color of right. Accordingly, we think Commissioner of Internal Revenue v. Wilcox, 327 U.S. 404, 66 S.Ct. 546, 90 L.Ed. 752, governs, and that Rutkin v. United States, 343 U.S. 130, 72 S.Ct. 571, 96 L.Ed. 833, does not apply. We do not believe that Rutkin completely obliterated Wilcox. * * * In the instant case, the facts are close to those of Wilcox, and lack the distinguishing features found in United States v. Bruswitz, 2 Cir., 219 F.2d 59, and cases there cited. See also the dissent of Judge Kalodner in Kann v. Commissioner, 3 Cir., 210 F.2d 247, 253.
Unlike the Dix case, where the taking was by a corporate officer who although having the voting rights in one-fourth of the outstanding stock and by irrevocable trust was entitled for life to the dividends from such one-fourth of the stock, actually owned none of the stock outright, the taking in the instant case of the sales receipts, rents, and the like and the division thereof was by and between individuals who were not only the owners of 83 1/3 per cent of the corporate stock, but constituted the entire board of directors. It is our view that the Wilcox rule does not apply and on the facts here that the Dix case does not call for or require its application.
Since Irving has stipulated that the additions to tax for fraud should apply if the diverted funds were held to be taxable income to him, discussion of the fraud issue is unnecessary.
In his determination the respondent included in Irving's taxable income for the years in issue the amount of $66,657.40 as the result of his diversion of funds from the Federbush Company. Of this amount, the respondent allocated $28,494.12 to dividend income and $38,163.28 to long-term capital gains. The allocation indicates that the respondent has determined that the diversions by the Federbush brothers exceeded the corporate earnings and profits as well as their basis for their stock, although there is no evidence of record as to either the amount of accumulated earnings and profits or the basis of the stock. Irving has raised no question as to the respondent's allocation, however, and we are asked to decide only the total amount diverted by him. It is Irving's position that the amount does not exceed $43,000. This figure is comprised of $25,000 received from Max, ‘between seven and eight thousand dollars' diverted by Irving, and $10,000 as Irving's share of a United States Government bond purchased with funds diverted from the corporation.
Other than his vague unsupported testimony, Irving has failed to produce any evidence to overcome the presumption of correctness accompanying the determination made by the respondent. Though conceding that he received approximately $43,000 of diverted funds, Irving has not broken down this amount by years, or otherwise justified a finding by us of the lesser amount. He has failed to keep any records, although under the statute he was required to do so. His testimony leaves us entirely in the dark as to all of the essential details concerning the amount diverted. Under the circumstances, we hold that Irving has failed to overcome the presumption of correctness to which the respondent's determination is entitled under the law. See Prokop v. Commissioner, 254 F.2d 544, affirming a Memorandum Opinion of this Court.
Sylvia contends that the returns filed for 1942 through 1946 and for 1948 were not joint returns and that she is not liable for any part of the deficiencies and additions to tax found to be due for those years.
Under section 51(b) of the 1939 Cde,
if a joint return is filed by a husband and wife living together, they are jointly and severally liable for the full tax liability. Such liability covers not only the tax itself but also any addition to the tax on account of fraud, notwithstanding that the wife may have signed the return in blank or that she was innocent of the fraud. Myrna S. Howell, 10 T.C. 859, 866, affd. 175 F.2d 240, and Dora S. Hughes, 26 T.C. 23, 28, 29.
SEC. 51. INDIVIDUAL RETURNS.(b) HUSBAND AND WIFE.— A husband and wife may make a single return jointly. Such a return may be made even though one of the spouses has neither gross income nor deductions. If a joint return is made the tax shall be computed on the aggregate income and the liability with respect to the tax shall be joint and several. No joint return may be made if either the husband or wife is nonresident alien or if the husband and wife have different taxable years. The status of individuals as husband and wife shall be determined as of the last day of the taxable year.
On their face, the returns were the joint returns of Irving and Sylvia Federbush. All of the returns, except for 1944, were signed both by Irving and by Sylvia. The 1944 return was signed by Irving both for himself and Sylvia. The full credits or exemptions for three dependent children and for husband and wife were claimed on each return. Only one return for each year was filed. In none of the years did Sylvia file a separate return.
It is Sylvia's contention that she signed the returns under duress, and such being the case, the returns filed even though in joint names were not joint returns and were not her returns. For support of this contention, she relies on her own testimony to the effect that she did not know that she was signing income tax returns at the times when they were signed by her; that she signed anything her husband asked her to sign; and that in asking her to sign documents his tone was abusive. She also relies on her testimony to the effect that during the period the returns were signed, she and Irving were having personal difficulties and that during the same period she was under doctor's care and for a part of the period, at least, was undergoing psychiatric treatment. As supporting her testimony that the returns were signed under duress, she relies on the testimony of Irving that he had never given her any explanation, but would tell her to sign them ‘or else.’
Since, except for 1944, the returns filed were admittedly signed by both Sylvia and Irving, the question is as to their purpose and intent in so signing and filing them. Such being the case, we listened most attentively to their testimony as it was being given and carefully observed them while they were testifying, and we are convinced that the idea of disavowing the returns as joint returns was an afterthought. Not only is there nothing of record to indicate that Sylvia at any time opposed or resisted the thought or idea of making and filing joint returns, but to the contrary, the evidence has convinced us and we have found as a fact therefrom that in signing the returns Sylvia intended the signature to be her signature and to have effect as such on the returns filed.
Sylvia did not participate in the management and operation of the Federbush Company nor, according to the testimony, in any other business transactions. Irving looked after all such matters, and when he brought papers and documents to her for signature, it was, according to her testimony, her practice to sign them, ‘whether they were income tax returns or any other papers.’ It was Irving's testimony that he regarded himself as the breadwinner and if Sylvia's signature was necessary, he felt it was her duty to sign. According to Irving, Sylvia did not understand tax returns and he just gave them to her to sign, because the accountant had told him that he had made them out in ‘duplicate’ form and that they would have to be signed both by him and by Sylvia.
Although it may not be conclusive, the inclusion in the return of income and deduction items of the wife has been regarded as a factor supporting the conclusion that the return was the joint return of husband and wife, Myrna S. Howell, supra; Elsie S. Bour, 23 T.C. 237; and Walter M. Ferguson, 14 T.C. 846. At one point in her testimony, Sylvia, when asked whether to her knowledge she had taxable income, responded, ‘Not to my knowledge.’ At another point, she said she had no income. We will proceed on the premise that the last mentioned statement was correct.
Included in income in each return was an item of interest which has not been explained or otherwise identified. It was brought out in Sylvia's testimony that she did maintain one or more savings accounts. In that connection, she described herself as trustee for her children. Whether the accounts were so carried according to the passbook or passbooks does not appear.
With respect to the existence of items of deduction, the situation appears to have been otherwise. The facts show that in each and every year deduction was claimed for real estate taxes, and, so far as appears, Sylvia was the only one of the two who owned real estate. First the home in Monroe and next the home in Great Neck was shown to have been in her name, and it has been held that taxes paid by a husband on real estate occupied by himself and his wife as a home and owned by her and held in her name may not be deducted in the husband's separate return, even if he has given the property to her. Myrna S. Howell, supra, and William Ainslie Colston, 21 B.T.A. 396, affd. 59 F.2d 867, certiorari denied 287 U.S. 640. See also Inez H. Brown, 1 T.C. 225. It is to be noted that except for 1948, all of the years herein were prior to the Revenue Act of 1948, the statute which granted to a husband and wife the current tax computing advantages where a joint return is filed, and for years prior to 1948, the advantage of a joint return was all the more obvious, where the joining of the wife would bring additional deductions, as well as the dependency credit, to the return without any increase in gross income.
The evidence to support the claim of duress is to us neither convincing nor persuasive. In substance, it is limited to Sylvia's testimony that Irving's tone was abusive and Irving's statement that he did not explain anything to her, but would tell her to sign ‘or else.’ It does appear that Sylvia did not like living in Monroe, and we have no reason to doubt that for various periods of the time herein she was under a doctor's care and at various times received psychiatric treatment. Although according to Irving they had their ups and downs, it is to be noted that at all times material hereto they lived together as husband and wife, and have since continued to do so. There was no testimony of any specific incidents at the time of signing the returns which were signed by Sylvia. In fact, it was Sylvia's testimony that she did not know she was signing income tax returns, which, if the matter was of critical importance, we would be extremely hard pressed to believe; that is, if our impressions of Sylvia's alertness and intelligence as they appeared to us in the course of her testimony are to be taken into account. But whether she had little or extensive knowledge of the papers presented to her for signature, it was her practice to sign them when presented, whether they were income tax returns or any other papers, and we are not in doubt that she intended the signature made as her signature and to have effect as such. We are satisfied that the returns were not signed under duress.
The facts relating to the making and filing of the 1944 return are different, in that Irving signed Sylvia's name as well as his. It has been held that there can be a binding joint return even though one of the spouses failed to sign it, provided it was intended to be a joint return. Joseph Carroro, 29 B.T.A. 646, 650; Myrna S. Howell, supra; Kann v. Commissioner, supra, and Muriel Heim, 27 T.C. 270, affd. 251 F.2d 44. The record indicates that the 1944 return was prepared as a joint return in the same manner as the returns for other years. It so happened that when Irving presented the return to Sylvia for her signature they were experiencing some personal difficulties and she had refused to sign several other documents. She also refused to sign the return, and since the refusal was on the last day for the filing of the return, Irving signed her name to the return in her stead. There is no indication of record, even in Sylvia's own testimony, that her refusal to sign the return was because she did not wish to file a joint return or that she did not intend for it to have effect as a joint return when it was signed for her by Irving and filed. While we regard the situation relating to the filing of the 1944 return as a closer question, on the facts, we are persuaded that Sylvia's refusal to sign was due to matters wholly unrelated to the filing of the return and that she had no intention that the 1944 return should actually be different from the returns file for other years.
We conclude and hold that the returns for all of the years here in question were the joint returns of Irving and Sylvia, and under section 51(b), supra, their liability thereunder is joint and several.
With respect to Jack Federbush, the burden is on the respondent to prove by clear and convincing evidence that the deficiency, or a part thereof, for each of the taxable years was due to fraud with intent to evade tax. On the basis of all of the conditions and circumstances surrounding the diversion of funds, we have concluded that the deficiencies determined against Jack, or a part thereof, were due to fraud with intent to evade tax.
Jack was at various times during the taxable years involved, president, secretary, and sales manager of the Federbush Company. Like his brothers, he owned one-sixth of its stock and participated in the scheme to make informal distributions. The understatements of income plainly were not the result of his ignorance, oversight, or lack of comprehension. Moreover, none of the diverted funds were reported in Jack's income, although the amount taken was a substantial sum. The failure to report these diversions over a period of successive years strongly evidences an intent to defraud. Rogers v. Commissioner, 111 F.2d 987. Finally, the taking of the proceeds of unrecorded sales and rental income indicates an attempt to evade tax by concealing a source of income. See Spies v. United States, 317 U.S. 492.
The circumstances set forth above clearly evince a pattern of willful failure to report income. We are convinced that the deficiencies against Jack were due, at least in part, to fraud, and we so hold.
Decisions will be entered under Rule 50.