USCA1 Opinion
UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
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No. 93-1365
ALAN E. LEWIS AND HARRIET R. LEWIS,
Petitioners, Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent, Appellee.
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ON APPEAL FROM A DECISION
OF THE UNITED STATES TAX COURT
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Before
Breyer, Chief Judge,
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Rosenn,* Senior Circuit Judge,
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and Cyr, Circuit Judge.
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David R. Andelman with whom Edward F. Fay, Colleen A. Brady and
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Lourie & Cutler, P.C. were on brief for appellants.
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Kenneth L. Greene, Attorney, Tax Division, U.S. Department of
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Justice, with whom Michael L. Paup, Acting Assistant Attorney General,
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Gary R. Allen and Curtis C. Pett, Attorneys, Tax Division, U.S.
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Department of Justice, were on brief for appellee.
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March 17, 1994
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*Of the Third Circuit, sitting by designation.
BREYER, Chief Judge. Alan and Harriet Lewis
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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. 301(a), (c)(1)-
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(3) (1986). The Lewises disagree. They point out that a
"dividend" must come from a corporation's "earnings and
profits." See id. 316(a). And, they argue, ILT had no
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"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.
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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. 61
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(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
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paid (but never have paid) income tax on this money sometime
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between 1974 and 1981. But, as all parties concede, the
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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
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the government should have taxed then. The Lewises
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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
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Federal Income Taxation 60.05 (1992). Whether that
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doctrine requires the Lewises to treat the 1984 ILT
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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.
I
Background Facts
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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.
A
Before December 1980
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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
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Island bank account of ILT, a foreign corporation that they
owned and controlled. ILT transferred some of the money
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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
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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.
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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
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Charlesgate and Taunton loans. As we have said, the Tax
Court found that, as of December 31, 1980, ILT's bank
balance was zero.
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B
After 1980
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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 Tax Court's Error
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The factual record, as just described, suggests
that the underlying, and possibly difficult, question in
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this case is not one of finding the facts, but rather, one
of characterizing facts that are essentially beyond dispute.
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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
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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
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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
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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
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$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
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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
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(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
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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
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of "income," and that TNT did not transfer any money to ILT
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after 1980. Lewis's testimony is supported by the Tax
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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.
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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
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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
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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
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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
The Commissioner might use this kind of bank statement as
evidence that Smith had interest income of $500, or even as
evidence that Smith had income of $10,500 (if the source of
the initial $10,000 deposit is not otherwise explained).
But, we do not see how the Commissioner -- or, as in this
case, the Tax Court -- could add up all the deposits and
then use this statement as evidence that Smith had income of
$50,500. The statement shows the contrary.
In our view, ILT's bank account, in respect to its
"fixed/call deposit" references, is that of our
hypothetical. The Lewises say in their brief that the back-
and-forth transfers of money between ILT's account and
"fixed [or 'call'] deposit" represent intra-account
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transfers to and from the "checking" and "investment"
portions of the single account. This explanation makes
sense given what we understand about standard banking
activity (i.e., "fixed deposit" may denote a fixed-term,
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interest-bearing certificate of deposit, and "call deposit"
may denote an interest-bearing instrument, say an investment
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in a money market fund, which can be recalled on demand of
the depositor). Moreover, nowhere does the government deny
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that these transfers of money were short-term investments of
the kind just described. In essence, the government
concedes the point.
The government argues that the Lewises should
lose, even if their bank deposit explanation is believed,
because they did not advance that explanation at the Tax
Court's initial proceeding. The Lewises did advance that
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explanation, however, in a motion for reconsideration,
immediately after they saw what the Tax Court had written.
One can meet a burden of proof without disproving, in
advance, all logical alternative possibilities. It seems
reasonable for them not to have made an issue of the matter
earlier, and to have assumed that the government and the Tax
Court would read a bank deposit statement in accordance with
ordinary commercial banking practices.
Of course, one might wonder how we can be so
certain that the Lewises are right about the meaning of the
bank deposit statement. The truthful answer is that we
cannot be completely certain, for we are not experts in
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banking practices. But, the Lewises's explanation is
plausible; it is consistent with what we know of the
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commercial world; and, the government could easily have
provided a counter-explanation, grounded in accounting or
banking principles, were the Lewises's explanation wrong.
The government failed even to advance a contrary argument.
If we put the matter in terms of "burdens of
proof," the Lewises satisfied that burden, initially through
testimony that would have proved sufficient had the IRS and
the Tax Court read the bank deposit statement as reflecting
ordinary banking activity; and, then, through a rehearing
motion with a full, and uncontroverted, explanation of the
statement. If we put the matter in practical terms, we
recall Abraham Lincoln's famous question and reply. Lincoln
asked his cabinet members, "How many legs would a sheep have
if you call a tail a leg?" "Five," they answered. "Wrong,"
said Lincoln, "the answer is four; calling a tail a leg does
not make it one."
In sum, the record here shows that Lewis explained
the sources and amounts of ILT's income at trial. Nothing
in the record suggests that his unrebutted testimony was
"improbable, unreasonable, or [even] questionable," such
that the Tax Court could choose to disregard it. See Estate
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of DeNiro v. Commissioner, 746 F.2d 327, 331 (6th Cir. 1984)
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(citing Commissioner v. Smith, 285 F.2d 91, 96 (5th Cir.
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1960)). And, ILT's bank statement supports that testimony.
ILT did not have "unexplained deposits . . . in the
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approximate amount of $4.5 million." Insofar as it rests
upon this factual error, the Tax Court's finding that ILT
had "earnings and profits" in 1984 sufficient to support a
$2.159 million "dividend" distribution is "clearly
erroneous."
III
Proceedings on Remand
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Our conclusion about the facts of this case
returns it to where we believe it should have begun. How,
for tax purposes, should one characterize the funds that
flowed to, and then through, ILT in 1984?
Some of those funds represent "interest" payments
to ILT. The Lewises agree that they must pay income tax on
the 1984 distribution to the extent that ILT received any
such interest. But, those sums account for only a small
part of the distribution. The more important part consists
of ILT's receipt and subsequent return to Lewis and Belkin
(through their "grantor" trusts) of the $2.159 million in
sham loan proceeds.
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The Tax Court seemed to find that this undisputed
transfer of funds to ILT reflected possible ILT "earnings
and profits," for it said that
Petitioners have failed to show . . .
how a transfer between separate taxable
entities, i.e., a transfer from
petitioner and Belkin to ILT, would not
be includable in ILT's taxable income or
in ILT's earnings and profits.
But, the question at issue here is not factual; it is legal.
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The Lewises did show, and indeed, the Tax Court
acknowledged, what the transfer consisted of, as a matter of
fact. It consisted of an effort by Lewis and Belkin to send
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themselves some money in the manner described in Part I of
this opinion, namely, by repaying "loans" obtained from ILT
several years before, and flowing the repayment through ILT
to themselves (in the form of their "grantor" trusts). The
Lewises themselves now concede that the original "loans"
were shams. They now dispute, not the facts, but how to
characterize them as a legal matter. That is, they deny the
Commissioner's legal right to tax in 1984 money that should
have been taxed earlier, in now-closed years.
The law either does, or does not, permit the
government to tax this money now. The taxpayer has no
greater burden of "proving" the law than does the
Commissioner, or, for that matter, the courts. Our problem
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is that neither the Tax Court, nor the Commissioner, seems
thoroughly to have considered a portion of the law that may
answer the legal question. Our own research has led us to
conclude that a type of estoppel known as "quasi estoppel"
or the "duty of consistency" might operate in a way as to
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prevent the Lewises from denying the taxability, in 1984, of
the $1,062,500 distribution. This "duty of consistency"
prevents a taxpayer who has already had the advantage of a
past misrepresentation -- in a year now closed to review by
the government -- from changing his position and, by
claiming he should have paid more tax before, avoiding the
present tax. See Beltzer v. United States, 495 F.2d 211,
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212-13 (8th Cir. 1974).
The "duty of consistency" seems to apply when the
earlier taxpayer position amounts to a misstatement of fact,
not of law. See, e.g., Herrington v. Commissioner, 854 F.2d
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755, 758 (5th Cir. 1988), cert. denied, 490 U.S. 1065
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(1989); Beltzer, 495 F.2d at 213; Mayfair Minerals, Inc. v.
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Commissioner, 456 F.2d 622, 623 (5th Cir. 1972); Crosley
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Corp. v. United States, 229 F.2d 376, 380 (6th Cir. 1956);
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Ross v. Commissioner, 169 F.2d 483, 496 (1st Cir. 1948)
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(simple failure to report income "is not a representation
that such income has in fact not been received" and does
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not, without more, furnish grounds for estoppel); Mertens,
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supra, 60.05 ("Where there is a mistake of law and no
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factual misrepresentations, the doctrine of consistency does
not apply."). Moreover, the misstatement must be one on
which the government reasonably relied, in the sense that it
neither knew, nor ought to have known, the true nature of
the transaction mischaracterized by the taxpayer. See
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Herrington, 854 F.2d at 758; Mayfair Minerals, 456 F.2d at
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623; Ross, 169 F.2d at 495-96.
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In this case, it seems possible that Lewis made
representations of key facts regarding the genuine business
activities of ILT throughout the 1970's and the genuine
intent on his and Belkin's part to repay the ILT "loans."
If such representations of fact were made, then holding
Lewis to them now might generate a 1984 tax liability.
We stress, however, that we are uncertain about
this matter. Since it has not been argued here, and since
factual history is at issue, both the Lewises and the
Commissioner should have a full opportunity to argue the
issue before the Tax Court. We therefore vacate the Tax
Court's judgment insofar as it is inconsistent with this
opinion. And, we remand the case to the Tax Court for
further proceedings.
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So ordered.
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NOTE: See Slip Opinion for Appendix.
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