Attorneys: William S. Seplowitz, for petitioner. Robin L. Peacock and Lydia A. Branche, for respondent.
Filed: Jul. 27, 2001
Latest Update: Nov. 21, 2020
Summary: T.C. Memo. 2001-194 UNITED STATES TAX COURT ESTATE OF HARVEY FEINSMITH, DECEASED, BETTY FEINSMITH, EXECUTRIX, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 16334-99. Filed July 27, 2001. William S. Seplowitz, for petitioner. Robin L. Peacock and Lydia A. Branche, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION LARO, Judge: Betty Feinsmith, in her individual capacity and as executrix of the Estate of Harvey Feinsmith, Deceased (the estate), petitioned the Court to
Summary: T.C. Memo. 2001-194 UNITED STATES TAX COURT ESTATE OF HARVEY FEINSMITH, DECEASED, BETTY FEINSMITH, EXECUTRIX, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 16334-99. Filed July 27, 2001. William S. Seplowitz, for petitioner. Robin L. Peacock and Lydia A. Branche, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION LARO, Judge: Betty Feinsmith, in her individual capacity and as executrix of the Estate of Harvey Feinsmith, Deceased (the estate), petitioned the Court to r..
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T.C. Memo. 2001-194
UNITED STATES TAX COURT
ESTATE OF HARVEY FEINSMITH, DECEASED, BETTY
FEINSMITH, EXECUTRIX, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 16334-99. Filed July 27, 2001.
William S. Seplowitz, for petitioner.
Robin L. Peacock and Lydia A. Branche, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: Betty Feinsmith, in her individual capacity
and as executrix of the Estate of Harvey Feinsmith, Deceased (the
estate), petitioned the Court to redetermine respondent’s
determination as to the 1983 and 1984 Federal income taxes of her
and her deceased husband, Harvey Feinsmith (Mr. Feinsmith).
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Respondent determined that Mr. Feinsmith was liable under section
6653(b)(1) for $5,812 and $17,476 in additions to his 1983 and
1984 taxes, respectively. Respondent also determined that Mr.
Feinsmith was liable for time-sensitive additions to those taxes
under section 6653(b)(2). Respondent determined no deficiency as
to Betty Feinsmith in her individual capacity.
Following the Court’s dismissal of Betty Feinsmith in her
individual capacity for lack of jurisdiction, and our amendment
to the caption to reflect the same, we must determine whether the
estate is liable for the additions to tax. We hold it is not.
Section references are to the Internal Revenue Code applicable to
the relevant years. Rule references are to the Tax Court Rules
of Practice and Procedure. Some dollar amounts have been
rounded.
FINDINGS OF FACT
Some facts have been stipulated. We incorporate herein by
this reference the parties’ stipulation of facts and the exhibits
submitted therewith. We find the stipulated facts accordingly.
Mr. Feinsmith, whose education lasted through high school and
possibly 1 year of college, died on June 6, 1995, at the age of
68. His widow, Betty Feinsmith, is the executrix of the estate.
She resided in Deal, New Jersey, when the petition was filed.
Mr. Feinsmith and Betty Feinsmith filed joint 1983 and 1984
Federal income tax returns. They filed their 1983 return on or
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about October 5, 1984. They filed their 1984 return on or about
October 17, 1985. Randy Hall, Inc. (Randy Hall), a corporation
in which petitioner was a shareholder, filed its 1982 Federal
income tax return for its fiscal year ended January 31, 1983, on
April 30, 1983. Randy Hall filed its 1983 Federal income tax
return for its fiscal year ended January 31, 1984, on April 28,
1984.
Randy Hall manufactured T-shirts and ladies sportswear.
During the subject years, its common stock was owned equally by
Mr. Feinsmith, Carl Perry (Mr. Perry), and Donald Rosenthal (Mr.
Rosenthal). Mr. Feinsmith served as its president and production
manager. Mr. Perry served as its secretary/treasurer and
salesman. Mr. Rosenthal served as its vice president and
designer. Randy Hall’s shareholders during its fiscal year ended
January 31, 1981, were Mr. Perry, Mr. Rosenthal, and Samuel
Mandel (Mr. Mandel). Mr. Feinsmith replaced Mr. Mandel as a
Randy Hall shareholder towards the end of 1982 and began working
for Randy Hall at that time. Mr. Mandel retired at the same
time.
During its fiscal years ended January 31, 1981, 1983, and
1984, Randy Hall participated in a massive false invoice scheme
(the scheme) in which it bought invoices listing falsely that it
purchased yarn from various vendors. The scheme was promoted by
Schnejer Zalman Gurary, Nochum Sternberg (Gurary’s son-in-law),
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and Esther Sternberg (Nochum’s wife) (collectively, the
promoters). Under the scheme, the promoters sold invoices to
corporations in the garment industry, falsely reflecting that one
of the promoters’ companies had sold yarn to the invoice-
purchasing company. Principals of the invoice-purchasing
companies provided the promoters with company checks in the
amounts of the false invoices, and the promoters returned cash to
the principals in the amount of the checks less a processing fee.
No actual yarn was involved. The invoice-purchasing companies
included the purported cost of the nonexistent yarn in their
calculations of cost-of-goods-sold for tax purposes, fraudulently
misstating their taxable income. The principals converted some
of the cash to their personal use without declaring those funds
as income on their tax returns. Ultimately, the promoters were
convicted for their parts in the scheme, and their convictions
were affirmed on appeal. See United States v. Gurary, 860 F.2d
521 (2d Cir. 1988).
Randy Hall began participating in the scheme before Mr.
Feinsmith was a Randy Hall shareholder. Mr. Mandel originally
purchased the false invoices on behalf of Randy Hall, and he did
so with the knowledge of the other two shareholders (i.e.,
Messrs. Perry and Rosenthal). Randy Hall continued to purchase
the false invoices after Mr. Mandel’s retirement. At all times,
Randy Hall paid for the false invoices by checks, and the
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promoters returned to Randy Hall cash equal to the amount of the
checks less the commission. Randy Hall bought the invoices to
generate documentation to support an inflated cost of goods sold
deduction reported on its tax returns.1 None of the yarn
referenced in the false invoices was ever delivered to Randy
Hall.
Randy Hall issued checks to the false invoice sellers for 35
false invoices. Randy Hall required that all of these checks be
signed by two of its shareholders. The date and amount of each
of the 35 false invoices is as follows:
Invoice Date Invoice Amount
Oct. 6, 1980 $13,328
Oct. 8, 1980 12,826
Oct. 9, 1980 10,472
Oct. 10, 1980 14,111
Oct. 15, 1980 8,119
Nov. 5, 1980 17,494
Nov. 6, 1980 6,098
Nov. 7, 1980 8,033
Nov. 10, 1980 10,151
Nov. 12, 1980 16,190
Nov. 14, 1980 13,619
Jan. 2, 1981 11,866
Jan. 5, 1981 14,345
Jan. 6, 1981 8,340
Jan. 8, 1981 15,406
Jan. 9, 1981 13,523
193,922 ($1 rounding error)
Dec. 8, 1982 $15,988
Dec. 10, 1982 13,812
Dec. 14, 1982 16,403
1
Although cost of goods sold is not actually a “deduction”,
the parties and many of the exhibits in evidence sometimes refer
to it as such. We do the same.
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Dec. 17, 1982 13,319
Jan. 10, 1983 15,477
Jan. 14, 1983 19,200
94,199
Dec. 2, 1983 $16,052
Dec. 5, 1983 16,933
Dec. 6, 1983 14,607
Dec. 7, 1983 15,701
Dec. 9, 1983 12,831
Dec. 12, 1983 14,644
Dec. 16, 1983 15,255
Dec. 20, 1983 17,231
Dec. 27, 1983 16,344
Jan. 4, 1984 17,363
156,961
Jan. 4, 1984 $17,363
Jan. 6, 1984 16,114
Jan. 9, 1984 15,702
49,179
The United States Attorney’s Office for the Southern
District of New York (U.S. Attorney’s Office) began investigating
the scheme and included Randy Hall and its shareholders within
its investigation. In connection therewith, the U.S. Attorney’s
Office proposed to Mr. Feinsmith an agreement (the cooperation
agreement) under which Mr. Feinsmith would agree with the U.S.
Attorney’s Office to cooperate in its investigation in exchange
for immunity from criminal prosecution for any offense connected
to the scheme. The U.S. Attorney’s Office proposed the agreement
to Mr. Feinsmith in order to secure his cooperation in its
investigation into the scheme. On March 29, 1985, Mr. Feinsmith
agreed to the terms of the cooperation agreement, which had been
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drafted by the U.S. Attorney’s Office.2 In part, Mr. Feinsmith
agreed in the cooperation agreement:
that Randy Hall, Inc. will pay to the Internal Revenue
Service all federal income taxes due and owing by Randy
Hall, Inc. for the fiscal years ending January 31, 1981
to the present; and that Harvey Feinsmith will pay all
personal income taxes due and owing for the period
February 1, 1980 to the present. Mr. Feinsmith
acknowledges that Randy Hall, Inc. claimed nonexistent
and fraudulent business deductions of approximately
$337,000 on its federal income tax returns for the
years 1980 to the present; and that Harvey Feinsmith
received approximately $48,000 of income which he did
not report on his federal income tax returns for the
years 1982 to the present. Mr. Feinsmith agrees that
he will set forth in a sworn affidavit the false
invoices (including date, amount and issuing company)
that created the fraudulent business deductions and the
unreported income and will admit in the affidavit that
Randy Hall, Inc. claimed nonexistent and fraudulent
business deductions of approximately $337,000 on its
federal income tax returns for the fiscal years ending
January 31, 1981 to the present, and that Harvey
Feinsmith received approximately $48,000 of income
which he did not report on his federal income tax
returns for the years 1982 to the present. Mr.
Feinsmith further agrees to provide this affidavit to
officials of the Internal Revenue Service at this
Office’s request. Mr. Feinsmith further agrees that
Randy Hall, Inc. will file amended federal income tax
returns with the affidavit attached as an exhibit for
the fiscal years ending January 31, 1981 to the present
no later than December 31, 1985; and Mr. Feinsmith
further agrees that he will file amended personal
2
The record does not indicate why Mr. Feinsmith agreed to
enter into the cooperation agreement. We surmise that he faced
the possibility of criminal prosecution, but whether that
prosecution would come in his capacity as Randy Hall’s president
or in his individual capacity we do not know. We do know,
however, that the assistant U.S. attorney who conducted the
investigation and drafted the cooperation agreement was unable in
this proceeding to acknowledge that Mr. Feinsmith knew at the
time of the agreement that Randy Hall’s 1982 and 1983 tax returns
contained false deductions.
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income tax returns for the period February 1, 1980 to
the present, attaching the affidavit to the returns as
an exhibit, no later than December 31, 1985.
Pursuant to the cooperation agreement, Mr. Feinsmith filed
an amended 1983 personal income tax return on January 6, 1986.
He reported on that return additional income of $31,667,
representing what he believed was his 1/3 share of Randy Hall’s
false invoice deduction attributable to its taxable year ended
January 31, 1983. Mr. Feinsmith’s 1/3 share was actually
$31,399.81. The parties agree that $31,399.81 is a constructive
dividend to Mr. Feinsmith for 1983, arising out of deductions not
allowable on Randy Hall’s 1982 corporate income tax return.
Pursuant to the cooperation agreement, Randy Hall filed an
amended 1983 return on January 7, 1986. Randy Hall reported on
that return a $49,179 increase in income resulting from its
reduction of its cost of goods sold as originally reported.
Randy Hall acknowledged on the return that the reduction was
required because it had originally included in its cost of goods
sold computation nonexistent business deductions totaling
$337,300. Randy Hall reported that the following shareholders
had “ADDITIONAL INCOME ARISING FROM THE AFOREMENTIONED
DEDUCTIONS” in the corresponding calendar years:3
3
The total of some of the rows and columns is off by $1.
This discrepancy is attributable to rounding.
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Total 1981 1983 1984
Mr. Perry $112,433 $64,641 $31,400 $16,393
Mr. Rosenthal 112,433 64,641 31,400 16,393
Mr. Mandel 64,641 64,641 0 0
Mr. Feinsmith 47,793 0 31,400 16,393
Total 337,300 193,922 94,199 49,179
Randy Hall attached to this amended return the affidavits of
Messrs. Rosenthal and Perry. Mr. Perry’s affidavit, which is
virtually verbatim with Mr. Rosenthal’s affidavit, stated as
follows:
CARL PERRY, being duly sworn, deposes and says:
1. I am the Secretary-Treasurer and a shareholder
of Randy Hall, Inc. Randy Hall, Inc. is filing amended
federal income tax returns (Form 1120) for the fiscal
years ending January 31, 1981, January 31, 1983, and
January 31, 1984. I am filing amended personal tax
returns (Form 1040) for calendar years 1981, 1983 and
1984. An original of this affidavit is being attached
to each of the above-described amended returns to
explain the purpose of the amendments and the nature of
the adjustments to income.
2. During the period for which amended returns
are being filed, Randy Hall, Inc. claimed false, non-
existent business deductions in the amount of
$337,300.28 for purported purchases which were not, in
fact, made. * * *
3. The false deductions claimed by Randy Hall,
Inc. were in the following amounts for each of the
years for which amended returns are being filed:
Amount of False
Fiscal Year Ending Deduction
1981 $193,922.15
1983 94,199,43
1984 49,178.70
Total: $337,300.28
4. During this same time period, and because of
the false deductions referred to above, I received a
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total of $112,433.43 in income which I did not report
on my personal income tax returns during the period.
The amount of additional income omitted in each of the
years for which amended returns are being filed by me
is as follows:
Amount of
Year Unreported Income
1981 $64,640.72
1983 31,399.81
1984 16,392.90
Total: $112,433.43
Randy Hall also filed an amended 1982 return in early 1986
pursuant to the cooperation agreement. On that return, Randy
Hall reported a $94,199 increase in income resulting from its
reduction of its cost of goods sold as originally reported.
Randy Hall acknowledged on that return that the reduction was
required because it had originally included in its cost of goods
sold computation nonexistent business deductions totaling
$337,300. Randy Hall reported that its four shareholders during
the relevant time period had “ADDITIONAL INCOME ARISING FROM THE
AFOREMENTIONED DEDUCTIONS” in the amounts set forth in the
schedule shown above as to Randy Hall’s amended 1983 return.
Randy Hall attached to its amended 1982 return the same
affidavits attached to its amended 1983 return.
Mr. Feinsmith filed an amended 1984 personal income tax
return in early 1986 (or possibly late 1985) pursuant to the
cooperation agreement. On that return, Mr. Feinsmith reported
additional income of $16,333, representing what he believed was
his 1/3 share of Randy Hall’s false invoice deduction
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attributable to its taxable year ended January 31, 1984. His 1/3
share was actually $16,392.90. The parties agree that $16,392.90
is a constructive dividend to Mr. Feinsmith arising out of
deductions not allowable on Randy Hall’s 1983 corporate income
tax return. Mr. Feinsmith attached to his amended 1984 return an
affidavit that stated in relevant part:
HARVEY FEINSMITH, being duly sworn, deposes and
says:
1. I am the President and a shareholder of Randy
Hall, Inc. Randy Hall, Inc. is filing amended federal
income tax returns (Form 1120) for the fiscal years
ending January 31, 1981, January 31, 1983, and January
31, 1984. I am filing amended personal tax returns
(Form 1040) for calendar years 1983 and 1984. An
original of this affidavit is being attached to each of
the above-described amended returns to explain the
purpose of the amendments and the nature of the
adjustments to income.
2. During the period for which amended returns
are being filed, Randy Hall, Inc. claimed false, non-
existent business deductions in the amount of
$337,300.28 for purported purchases which were not, in
fact, made. * * *
3. The false deductions claimed by Randy Hall,
Inc. were in the following amounts for each of the
years for which amended returns are being filed:
Amount of False
Fiscal Year Ending Deduction
1981 $193,922.15
1983 94,199,43
1984 49,178.70
Total: $337,300.28
4. During the years 1983 and 1984, and because of
the false deductions referred to above, I received a
total of $47,792.71 in income which I did not report on
my tax returns for those two years. I did not receive
any income as a result of Randy Hall, Inc.’s false
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deductions for the fiscal year ending January 31, 1981
because I was not a shareholder for any portion of that
year.
5. The amount of additional income omitted in
each of the years for which amended returns are being
filed by me is as follows:
Amount of
Year Unreported Income
1983 $31,399.81
1984 16,392.90
Total: $47,792.71
Pursuant to the cooperation agreement, Mr. Feinsmith filed a
second amended 1984 personal income tax return on September 2,
1987. On this return, Mr. Feinsmith reported that, in addition
to the income reported on his original and first amended return
for 1984, he received from Randy Hall during that year a
“Constructive Dividend” of $52,320. Mr. Feinsmith attached an
affidavit to this second amended return stating:
HARVEY FEINSMITH, being duly sworn, deposes and
says:
1. I am the President and a shareholder of Randy
Hall, Inc. On or about December 31, 1985, Randy Hall,
Inc. filed amended federal income tax returns (Form
1120) for the fiscal years ending January 31, 1981,
January 31, 1983, and January 31, 1984. At the same
time, I filed amended personal tax returns (Form 1040)
for calendar years 1983 and 1984. An affidavit was
attached to each of the above-described amended returns
to explain the purpose of the amendments and the nature
of the adjustments to income.
2. During the period for which amended returns
were filed, Randy Hall, Inc. claimed false, non-
existent business deductions for purported purchases
which were not, in fact, made. At the time of filing
the amended returns, the officers of Randy Hall, Inc.
believed that the false deductions totalled
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$337,300.28. During the years 1983 and 1984, and
because of the false deductions of $337,300.28 on the
corporate tax returns, I received a total of $47,792.71
in income which I did not report on my tax returns for
those two years, but which was reported on my amended
returns. I did not receive any income as a result of
Randy Hall, Inc.’s false deductions for the fiscal year
ending January 31, 1981 because I was not a shareholder
for any portion of that year.
3. Subsequent to the filing of these amended
returns, it came to our attention that certain
additional false deductions for non-existent purchases
had been claimed on one of the original corporate tax
returns, but these deductions had not been discovered
at the time of filing the amended returns.
4. The additional false deductions amounted to
$156,960.90, and affected the corporate tax return for
the tax year ending January 31, 1984, and my personal
return for the calendar year ended December 31, 1984.
* * * These false deductions resulted in additional
income to me of $52,320.20 which I did not report on my
original or amended tax return but which is being
reported on my second amended return which is being
filed along with a second amended corporate return.
Pursuant to the cooperation agreement, Randy Hall filed a
second amended 1983 return on or about September 2, 1987. On
that return, Randy Hall reported a $156,961 increase in income
resulting from a reduction of cost of goods sold due to
additional false deductions and an offset to that amount by a
$206,651 net operating loss carryback from its fiscal year ended
January 31, 1987. Randy Hall attached to its second amended
return a statement which provided that it had ascertained after
filing its first amended return for that year that it had claimed
on its original 1983 return additional false deductions
aggregating $156,961. The statement provided that these
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deductions resulted in $156,961 of additional income that was to
be reported $52,321 by Mr. Perry, $52,320 by Mr. Rosenthal, and
$52,320 by Mr. Feinsmith. Randy Hall attached to that second
amended return the affidavits of Messrs. Feinsmith, Rosenthal,
and Perry, which read virtually verbatim. The affidavit of Mr.
Feinsmith was the one that he attached to his second amended
return for 1984.4
OPINION
We decide whether the estate is liable for the additions to
tax for fraud determined by respondent. Respondent must prove
this determination by clear and convincing evidence. Sec.
7454(a); Rule 142(b); Rowlee v. Commissioner, 80 T.C. 1111, 1113
(1983). Fraud requires a showing that the taxpayer intended to
evade a tax known or believed to be owing. Stoltzfus v. United
States,
398 F.2d 1002, 1004 (3d Cir. 1968). Here, respondent
must prove: (1) Mr. Feinsmith underpaid his taxes for each of
the subject years and (2) some part of each underpayment was due
to fraud. Respondent must also prove for purposes of section
6653(b)(2) the portion of the underpayments attributable to
fraud. See sec. 6653(b)(2); see also Cooney v. Commissioner,
T.C. Memo. 1994-50.
4
The parties agree that Randy Hall’s second amended return
overstated by $17,362.80 its income for the fiscal year ended
Jan. 31, 1984, and that Mr. Feinsmith's 1984 income from the
scheme should be reduced by $5,787.60.
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We begin our analysis with the first prong of section
6653(b)(1); i.e., whether Mr. Feinsmith underpaid his taxes in
1983 and/or 1984. Mr. Feinsmith amended his personal income tax
returns for both of those years to report additional income.
Because those amended returns are admissions of tax
underpayments, Badaracco v. Commissioner, 464 U.S. 386, 399
(1984), we hold for respondent as to this prong.
Turning to the second prong of section 6653(b)(1), i.e., the
presence of fraud, the existence of fraud is a question of fact.
Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), affd. without
published opinion
578 F.3d 1383 (8th Cir. 1978). Fraud is never
presumed or imputed; it must be established by independent
evidence that establishes a fraudulent intent on the taxpayer's
part. Otsuki v. Commissioner,
53 T.C. 96 (1969). Because direct
proof of a taxpayer's intent is rarely available, fraud may be
proven by circumstantial evidence, and reasonable inferences may
be drawn from the relevant facts. Spies v. United States,
317 U.S. 492 (1943); Stephenson v. Commissioner,
79 T.C. 995
(1982), affd.
748 F.2d 331 (6th Cir. 1984).
We often rely on certain indicia of fraud to decide the
existence of fraud. The presence of several indicia is
persuasive circumstantial evidence of fraud. Beaver v.
Commissioner, 55 T.C. 85, 93 (1970). The "badges of fraud"
include: (1) The filing of false documents, (2) understatement
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of income, (2) maintenance of inadequate records, (3) implausible
or inconsistent explanations of behavior, (4) concealment of
assets, (5) failure to cooperate with tax authorities,
(6) engaging in an illegal activity, (7) attempting to conceal an
illegal activity, and (8) dealing in cash. Bradford v.
Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo.
1984-601; Petzoldt v. Commissioner,
92 T.C. 661, 700 (1989).
Respondent argues that he has clearly and convincingly
proven fraud by virtue of the following claimed actions on the
part of Mr. Feinsmith: (1) That he understated his income and
the income of Randy Hall for the relevant years, (2) that he
failed to maintain adequate records for Randy Hall, including
that some of the maintained records were false invoices, (3) that
his accountant testified that Mr. Feinsmith did not tell the
accountant when the accountant prepared Mr. Feinsmith’s 1983 and
1984 personal income tax returns that he had income from the
scheme, (4) that he was engaged in the scheme, an illegal
activity, (5) that the scheme involved the use of cash, and (6)
that he was an astute businessman. Petitioner argues that
respondent has not proven fraud either clearly or convincingly.
We agree with petitioner. We are unconvinced by the record that
Mr. Feinsmith filed either his 1983 or 1984 Federal income tax
return with the requisite intent to evade a personal Federal
income tax known or believed to be owing.
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Respondent focuses in part on the operations of Randy Hall
to deduce that Mr. Feinsmith had the requisite fraudulent intent.
We do not do similarly. The fact that Randy Hall may have been
involved in a fraudulent scheme to attempt to evade its Federal
income tax obligation, or that Mr. Feinsmith may have
participated in such an attempt, does not necessarily mean that
Mr. Feinsmith was involved in a scheme to attempt to evade his
Federal income tax obligation as well. Nor does the fact that
Randy Hall may have understated its income for the subject years,
or kept inadequate records, impute to Mr. Feinsmith the requisite
fraudulent intent to avoid his Federal income tax obligation.
The fact that Randy Hall may have participated in an illegal
activity (the scheme) and that this activity involved cash also
does not establish fraud on the part of Mr. Feinsmith in his
individual capacity.
When we focus as we should on Mr. Feinsmith’s personal
income tax obligation, we are unconvinced by the record that he
filed his 1983 and/or 1984 Federal income return intending to
evade that obligation. We simply cannot find that Mr. Feinsmith
was actually involved with the scheme in his individual capacity
or that he converted any of the proceeds from the scheme to his
personal use. In fact, when Mr. Feinsmith first became
affiliated with Randy Hall, it had been participating in the
scheme for at least 2 years. We find no reliable evidence in the
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record to suggest that Mr. Feinsmith, in his individual capacity,
was involved in the scheme either when he joined Randy Hall or at
any time thereafter. Although respondent invites the Court to
find as facts that Mr. Feinsmith was the mastermind of the scheme
as it related to Randy Hall, that he was in charge of Randy
Hall’s finances, that he handled all of the checks and cash which
passed between Randy Hall and the promoters, and that he
converted some of the cash to his personal use, we decline to do
so on the basis of the record.
Respondent relies solely on Mr. Perry’s answer to a question
asked by respondent’s counsel at trial to support a finding that
Mr. Feinsmith personally received cash from the scheme. The
question and answer are as follows:
Q Okay. And did you know if Harvey Feinsmith
also received income back?
A Of course, we were partners, so we shared
equally.
We find Mr. Perry’s testimony unpersuasive (both as to this
point and generally overall). Mr. Perry’s testimony was vague,
uncorroborated, and sometimes inconsistent. Mr. Perry testified,
for example, that Mr. Feinsmith maintained Randy Hall’s books but
later testified that Mr. Feinsmith asked him for the books so
that Mr. Feinsmith could give them to the Government. Mr. Perry
also testified adamantly that Randy Hall’s involvement with the
scheme began with the arrival of Mr. Feinsmith but later admitted
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that Randy Hall’s involvement in the scheme began before that
time. Mr. Perry also testified that Mr. Feinsmith was the only
one who dealt with the promoters on behalf of Randy Hall and that
Mr. Feinsmith was the only Randy Hall shareholder who actually
knew the promoters’ identity. The record indicates that Randy
Hall purchased almost half of the false invoices before Mr.
Feinsmith joined the company and that one of the promoters was
wary that either Mr. Perry or Mr. Rosenthal would reveal the
promoters’ identity to the authorities.
We also bear in mind that Mr. Perry is an indicted criminal
who pleaded guilty to his part in the scheme. Given the
additional fact that Mr. Feinsmith was not charged in the scheme
and that Mr. Feinsmith cooperated with the investigation of the
U.S. Attorney’s Office, including on at least one occasion
secretly recording a conversation with an unidentified
individual, we view Mr. Perry as a biased witness with animosity
towards Mr. Feinsmith. In fact, Mr. Perry even indicated during
his testimony that he has ill will towards Mr. Feinsmith and that
he has an amiable, longstanding relationship with the other
shareholder, Mr. Rosenthal.5 We also note that Mr. Feinsmith,
because he is dead, is unable to rebut personally Mr. Perry’s
testimony and that Mr. Perry displayed during his testimony a
poor memory as to many facts, even acknowledging on various
5
Mr. Perry even went so far as to testify baldly that Mr.
Rosenthal had received none of the cash paid by the promoters.
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occasions that he has trouble remembering events of the prior day
let alone events that occurred during the subject years.
For some undisclosed reason, respondent chose not to
introduce into evidence other testimony and/or exhibits to
support his proposed finding that Mr. Feinsmith actually received
cash from the scheme. Respondent could have presented the
testimony of one or more of the promoters as to which Randy Hall
shareholders they dealt with in the scheme. We understand from
the record that the promoters insisted that their identity be
known by only a limited number of individuals from each invoice-
purchasing company. We are skeptical that the promoters would
have agreed to deal with Mr. Feinsmith upon his joining Randy
Hall, when at that time their identity was already known by Mr.
Perry and/or Mr. Rosenthal. Such is especially true given the
fact that the promoters knew when Mr. Feinsmith joined Randy Hall
that respondent was investigating either or both of the other
shareholders and were edgy about respondent’s learning their (the
promoters’) identity. Respondent also could have presented the
testimony of Mr. Rosenthal as to his understanding of Mr.
Feinsmith’s involvement in the scheme. Respondent also could
have introduced into evidence one or more Randy Hall checks that
were paid to the promoters for the false invoices and that were
traceable to Mr. Feinsmith; e.g., by his signature. Although the
record contains many of the false invoices, it contains none of
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the Randy Hall checks which were given to the promoters in
consideration for those invoices.6
Nor do we read the cooperation agreement or affidavits to
support a finding of fraud. Mr. Feinsmith’s affidavits, for
example, merely state that he agrees that he received income
“because of the false deductions”. The cooperation agreement
states similarly that “the false invoices * * * created the
fraudulent business deductions and the unreported income”. None
of these documents states specifically that the income is
attributable to Mr. Feinsmith’s receipt (in either his individual
capacity or on behalf of Randy Hall) of any of the proceeds of
the scheme.7 Nor does either document indicate why Mr. Feinsmith
realized that income in the first place. The mere fact that a
closely held corporation has claimed improper deductions does not
necessarily mean that its shareholders have realized income in
the amount of the deductions. A shareholder such as Mr.
Feinsmith realizes income through a constructive distribution
6
We also would have liked to have heard from Mr. Feinsmith
as to his understanding of his part in the scheme. For some
unexplained reason, however, respondent waited until almost 4
years after Mr. Feinsmith’s death to issue the notice of
deficiency to his estate. In fact, respondent did not issue the
notice of deficiency to the estate until more than 10 years after
the Court of Appeals for the Second Circuit affirmed the
promoters’ convictions.
7
We also note that the parties have stipulated that Mr.
Feinsmith’s approximately $48,000 of income is taxable to him as
“constructive dividend income * * * arising out of deductions not
allowable on the corporate tax return of Randy Hall”.
- 22 -
only when the corporation uses its money or property primarily to
benefit the shareholder. See Laure v. Commissioner, 70 T.C.
1087, 1108 (1978), affd. in part, revd. in part and remanded
653
F.2d 253 (6th Cir. 1981); see also Wilkof v. Commissioner, T.C.
Memo. 1978-496 (“Laure does support the proposition * * * that to
the extent that a taxpayer can show an absence of direct benefit
to himself he may escape constructive dividend treatment”), affd.
636 F.2d 1139 (6th Cir. 1981). We are unable to find that Randy
Hall used its money or property primarily to benefit Mr.
Feinsmith.8
We also do not view Mr. Feinsmith’s amended returns as
indicating that he received cash from the scheme. The fact that
Mr. Feinsmith considered the reported income attributable to the
disallowed deductions, rather than to his conversion of corporate
cash, is seen quickly from the fact that he recognized most of
that income in years other than the years in which the cash was
purportedly received by him upon conversion. A shareholder’s
conversion of cash for his or her personal use is treated as a
constructive distribution of that cash, and such a distribution
is realized by a cash basis shareholder such as Mr. Feinsmith in
the year of conversion. See secs. 301(c), 316; Truesdell v.
8
Of course, a taxpayer such as Mr. Feinsmith may agree to
recognize an item as income in lieu of criminal prosecution. The
fact that he agrees to recognize that income in a year for which
a return has already been filed does not necessarily mean that he
filed that return fraudulently.
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Commissioner, 89 T.C. 1280, 1295 (1987); see also Toushin v.
Commissioner, T.C. Memo. 1999-171, affd.
223 F.3d 642 (7th Cir.
2000). The $31,667 recognized by Mr. Feinsmith as income for
1983 was mainly attributable to false invoices purchased in 1982.
The $52,320 recognized by Mr. Feinsmith as income for 1984 (by
way of the second amended return) was almost entirely
attributable to false invoices purchased in 1983. Given the fact
that the purchase of the false invoices by the corporations and
the conversion of the cash by the principals appears to us to
have occurred contemporaneously, that income, were it in fact
attributable to Mr. Feinsmith’s conversion of cash, as respondent
asserts, would have been properly recognized on Mr. Feinsmith’s
personal income tax returns for 1982 and 1983, respectively.
Moreover, Mr. Feinsmith recognized in income his portion of the
full amount of the false invoices which entered into the cost of
goods sold deductions. The Court of Appeals for the Second
Circuit stated that principals participating in the scheme
converted to their personal use only part of the false invoice
amounts.9
9
We also note that Mr. Feinsmith indicated explicitly in
his affidavits that his recognition of income from the scheme
rested on whether he was a Randy Hall shareholder, rather than on
whether he personally received cash from the scheme. As he
stated in his affidavits: “I did not receive any income as a
result of Randy Hall, Inc.’s false deductions for the fiscal year
ending January 31, 1981 because I was not a shareholder for any
portion of that year.”
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We are similarly unconvinced that Mr. Feinsmith knew that
either of his returns was fraudulent when he filed it. In order
to support a determination of fraud, respondent must prove
clearly and convincingly that Mr. Feinsmith had at the time he
filed his personal income tax returns the requisite intent to
evade taxes known or believed to be owing. As we read the
cooperation agreement and the affidavits, those documents were
carefully worded so as to speak as of the time that the documents
were prepared and not as of the time that the returns were filed.
Those documents merely establish that Mr. Feinsmith knew about
the unreported income when the documents were prepared. They do
not establish that he knew about that income when the returns
were filed.
Moreover, as of March 29, 1985, the date of the cooperation
agreement, Mr. Feinsmith’s 1984 return had not yet been filed.
The cooperation agreement provided explicitly that it would be
void (meaning that Mr. Feinsmith would be subject to prosecution,
including through the use of any statement or document that he
made or gave to the U.S. Attorney’s Office during its
investigation) were Mr. Feinsmith not to comply fully with the
expressed understandings of the parties thereto. One of those
understandings was that Mr. “Feinsmith must at all times give
complete, truthful and accurate information and testimony and
must not commit any further crimes whatsoever.” We find it
unlikely that Mr. Feinsmith would have intentionally omitted
- 25 -
income from his 1984 return had he known of the income.10 Such
an intentional omission would have voided the cooperation
agreement and would have subjected Mr. Feinsmith to criminal
prosecution in addition to any taxes payable on the omitted
income.11
We conclude that respondent has failed to carry his burden
of proving fraud for both of the subject years. Respondent has
failed to convince us clearly that Mr. Feinsmith was liable for
fraud in either year.
Decision will be entered
under Rule 155.
10
We also disagree with respondent’s assertion that Mr.
Feinsmith’s intent to file a false return may be found in the
fact that he did not tell his accountant about his income from
the scheme. As discussed above, we are unable to find as a fact
that Mr. Feinsmith knew about the unreported income when he filed
his returns. Thus, he could not have told his accountant about
it beforehand. Nor do we believe that Mr. Feinsmith was as
“astute” as respondent claims.
11
We note in passing that the cooperation agreement
provided that Mr. Feinsmith would “file amended personal income
tax returns for the period February 1, 1980 to the present [i.e.,
Mar. 29, 1985]” in order to report his agreed-upon income
attributable to the scheme. We do not understand this provision
to mean that Mr. Feinsmith knew that he would be filing a
fraudulent return for 1984 and would later have to amend it. We
read this provision simply to require that Mr. Feinsmith report
on his personal income tax returns all of the agreed-upon income,
let it be by way of an amended return or by way of an original
return. In fact, whereas the cooperation agreement literally
requires that Mr. Feinsmith amend each of his returns from 1980
through 1985, he actually amended only his 1983 and 1984 returns.
