Webb v. IRS

• Court: Court of Appeals for the First Circuit
• Decided: February 3, 1994
• Docket: 93-1684
• Status: Published

Opinion

USCA1 Opinion

UNITED STATES COURT OF APPEALS
                                FOR THE FIRST CIRCUIT
                                                     
                                 ____________________

        No. 93-1684
                                  FREDERICK L. WEBB,

                                Plaintiff, Appellant,

                                          v.

                           INTERNAL REVENUE SERVICE OF THE
                              UNITED STATES OF AMERICA,

                                 Defendant, Appellee.

____________________

APPEAL FROM THE UNITED STATES DISTRICT COURT

                          FOR THE DISTRICT OF MASSACHUSETTS

                     [Hon. William G. Young, U.S. District Judge]
                                             ___________________

____________________

                                        Before

                                Selya, Circuit Judge,
                                       _____________

                            Bownes, Senior Circuit Judge,
                                    ____________________

                               and Cyr, Circuit Judge.
                                        _____________

____________________

Brendan J. Shea, with whom Joseph J. Brodigan and Langan, Dempsey
             _______________            __________________     _______________
        & Brodigan were on brief for appellant.
        __________
             Teresa T.  Milton, with  whom Michael  L. Paup,  Acting Assistant
             _________________             ________________
        Attorney General, A.  John Pappalardo, Acting United  States Attorney,
                          ___________________
        Gary R. Allen and David I. Pincus were on brief for appellee.
        _____________     _______________

____________________

                                   February 3, 1994
                                                     
                                 ____________________

CYR,  Circuit Judge.  We must decide whether government
                    CYR,  Circuit Judge.
                          _____________

          loan proceeds embezzled  with intent to repay are  taxable in the

          year of the embezzlement.

I.
                                          I.

Ronald  and  Sharon  Pomella  established River  Realty

          Trust ("Trust"), a qualified Massachusetts business trust, as the

          entity which  would operate the  South River Marina  in Scituate,

          Massachusetts.   Under the trust agreement, Sharon was designated

          sole trustee and Ronald received  title to all transferable Trust

          stock.   In April 1978, Ronald  sold his Trust stock to appellant

          Frederick L.  Webb, who also became sole trustee.  As sole trust-

          ee, Webb applied for a  United States Small Business  Administra-

          tion (SBA)  storm disaster  loan, representing  to  SBA that  the

          marina  had sustained  serious  damage  during  the  blizzard  of

          February 1978.  Under SBA loan eligibility rules, applicants must

          have owned (or contracted to buy) the property before the proper-

          ty  damage  occurred.   Appellant  Webb  therefore  backdated the

          marina purchase and sale agreement to January 3, 1978.

                    On July 15,  1978, SBA and  the Trust  executed a  loan

          agreement and promissory note which provided that the Trust would

          use the loan proceeds ($376,900) to repair the marina ($196,900),

          to replace  marina inventory ($2,000),  and to amortize  two out-

          standing Trust mortgages  ($178,000).   Webb signed  the note  as

2

"trustee."1   As  a condition of  the loan, Webb  was required to
           _______

          submit receipts evidencing payments for marina repairs.  Instead,

          in September and October 1978 Webb diverted part of the  SBA loan

          proceeds ($64,730) toward the purchase of a  garage and inventory

          on a lot adjacent to the marina, and to acquire land for the Webb

          Cranberry Company,  his personal  business.   The diverted  funds

          were not reported on Webb's 1978 federal income tax return.

                    Webb  was indicted  by a  federal grand  jury on  three

          counts of making false statements  on an SBA loan application, 15

          U.S.C.    645 (1993), five counts of "embezzling" or "converting"

          United  States government funds, 18 U.S.C.    641 (1993), and two

          counts  of obstructing justice,  18 U.S.C.    1503,  1510 (1993).

          Webb pled guilty to one  "false statement" count, relating to the

          backdated purchase  and sale agreement, and to all five embezzle-

          ment  counts, which encompassed the unauthorized diversion of the

          $64,730 to his   personal use.   Ultimately,  the SBA called  the

          loan, and Webb repaid the entire balance.

                    In  1986, the Internal Revenue Service (IRS) assessed a

          $37,369 deficiency against  Webb for the tax year  1978, based in

          part on the unreported $64,730.   After Webb paid the deficiency,

          he filed a  timely claim for refund with the  IRS, asserting that

          the $64,730 represented bona fide loan proceeds not includable in
                                  ____ ____

          gross  income.   After the  IRS rejected  the refund  claim, Webb

          brought the  present action to recover  a refund.  See  26 U.S.C.
                                                             ___

____________________

               1The loan  was personally  guaranteed by  Webb and  one John
          McNamara.

                                          3

7422(a).  The  district court granted summary  judgment to IRS.

          The court concluded,  in reliance on James v.  United States, 366
                                               _____     _____________

          U.S.  213 (1961),  that evidence  of Webb's  intent to  repay the

          embezzled SBA  loan proceeds was  immaterial as a matter  of law.

          Webb v. Internal Revenue Serv., 823 F.  Supp. 29, 31-33 (D. Mass.
          ____    ______________________

          1993).  We affirm. 

II.
                                         II.

We  review the  grant  of  summary  judgment  de  novo,
                                                                  __  ____

          employing the  same standards  incumbent on  the district  court.

          "Summary judgment is  appropriate where  'the pleadings,  deposi-

          tions,  answers  to  interrogatories,  and  admissions  on  file,

          together  with the  affidavits, if  any,  show that  there is  no

          genuine issue  as to any material fact  and that the moving party

          is entitled to  judgment as a  matter of law.'"   Gaskell v.  The
                                                            _______     ___

          Harvard Coop.  Soc'y, 3  F.3d 495, 497  (1st Cir.  1993) (quoting
          ____________________

          Fed. R. Civ.  P. 56(c)); Vanhaaren v. State  Farm Mut. Auto. Ins.
                                   _________    ___________________________

          Co., 989 F.2d  1, 3 (1st Cir.  1993).  In  a refund action  under
          ___

          section 7422(a),  the taxpayer  must bear  the burden  of proving

          that the challenged  IRS tax assessment was erroneous.   Lewis v.
                                                                   _____

          Reynolds, 284 U.S.  281, 283 (1932); see Bonilla-Aviles v. South-
          ________                             ___ ______________    ______

          mark  San Juan,  Inc.,  992 F.2d  391,  393 (1st  Cir. 1993)  (if
          _____________________

          nonmoving party bears ultimate  burden of proof, he must  present

          "definite" and "competent" evidence to survive summary judgment).

          Webb's  principal protest is  that the district  court mistakenly

          concluded that it is immaterial  whether he intended to repay the

4

SBA loan.

III.
                                         III.

The  issue presented is  centered at the  confluence of

          two fundamental principles of federal tax law.  On  the one hand,

          bona fide loan proceeds are not gross income to the borrower, see
          ____ ____                                                     ___

          Commissioner v.  Indianapolis Power  & Light  Co., 493 U.S.  203,
          ____________     ________________________________

          207-08  (1990),  because  the  contemporaneous  economic  benefit

          realized upon  receipt of the loan proceeds is counterbalanced by

          the borrower's legal obligation to repay the loan.  See McSpadden
                                                              ___ _________

          v. Commissioner, 50 T.C. 478, 491 (1968).  The factual determina-
             ____________

          tion  as to whether a particular transaction  is a bona fide loan
                                                             ____ ____

          turns  on whether  there are sufficient  indicia of  the parties'

          intention  that the  monies  advanced  were to  be  repaid.   See
                                                                        ___

          Crowley v.  Commissioner, 962 F.2d  1077, 1079  (1st Cir.  1992);
          _______     ____________

          Moore v. United  States, 412 F.2d 974,  978 (5th Cir. 1969).   At
          _____    ______________

          the  same time,  a line  of  Supreme Court  cases indicates  that

          monies  and other property  acquired by misappropriation  must be

          reported as income  in the year of  their receipt.  See  James v.
                                                              ___  _____

          United  States, 366 U.S. 213, 221 (1961) (embezzlement proceeds);
          ______________

          Rutkin v. United  States, 343 U.S. 130,  137-38 (1952) (extortion
          ______    ______________

          proceeds).

                    The  lot of  the  embezzler was  not  always so  bleak.

          Rather, in Commissioner v. Wilcox, 327 U.S. 404 (1945), the Court
                     ____________    ______

          held that embezzled  monies were not income because the embezzler
                                           ___

          held the  monies "without any semblance  of a bona fide  claim of

                                          5

right" and  "under an  unqualified duty  and obligation  to repay

          . . . ."   Id. at 408.   Later,  however, in a  closely analogous
                     ___

          context,  the Court held  that extortion generates  taxable earn-

          ings.  Rutkin, 343 U.S. at 138-39  (without explanation, limiting
                 ______

          Wilcox "to its facts").  The James Court, confronting the seeming
          ______                       _____

          anomaly created by Wilcox and Rutkin, overruled Wilcox and flatly
                             ______     ______            ______

          rejected the  taxpayer's  contention  that  "all  unlawful  gains

          [e.g.,  extortion earnings]  are taxable  except  those resulting
           ____                                     ______

          from embezzlement  . . . ."   James,  366 U.S.  at 219  (emphasis
                                        _____

          added).  The Court explicated its holding as follows:

                    Whenever a  taxpayer acquires  earnings, law-
                    fully or  unlawfully, without  the consensual
                                                   ___ __________
                    recognition, express or implied,  of an obli-
                    ___________                       __ __ _____
                    gation to repay and without restriction as to
                    ______ __ _____
                    their  disposition, "he  has received  income
                    which he  is required to return,  even though
                    it may  still be claimed that he is not enti-
                    tled  to retain the money, and even though he
                    may still be adjudged  liable to restore  its
                    equivalent."  In such case, the  taxpayer has
                    "actual  command over  the property  taxed   
                    the actual benefit  for which tax is paid . .
                    . ."  This standard brings wrongful appropri-
                    ations within the  broad sweep of  "gross in-
                    come"; it excludes loans.
                           __ ________ _____

          Id. at 219-20 (citations omitted) (emphasis added).  Since James,
          ___                                                        _____

          the mere fact that an embezzler originally acquired lawful access

          to monies  in  a  fiduciary capacity  does  not  foreclose  their

          taxation in the year of the embezzlement.

                    In a  refund action  under section  7422(a), therefore,

          James presumably requires that the taxpayer prove either (i) that
          _____                                             ______

          he did not "acquire" earnings or (ii) that any such earnings were
                                        __

          "acquired" in one  of two ways:  under  a "consensual recognition

6

of an  obligation to repay"  or subject to restrictions  on their

          disposition.   Since  the James  Court did  not elaborate  on the
                                    _____

          meaning  of "consensual recognition," however, see id. at 221-22,
                                                         ___ ___

          some  post-James case law  suggests that  a taxpayer  who misapp-
                     _____

          ropriates  monies, yet  casts the  transaction in  the form  of a
                                                                 ____

          "loan" obligation, may foreclose summary judgment by establishing

          a genuine issue as  to his subjective intention  to repay.   See,
                                                                       ___

          e.g., United States  v. Rosenthal, 470 F.2d 837,  841-42 (2d Cir.
          ____  _____________     _________

          1972)  (reviewing factual  findings of  intent  to repay),  cert.
                                                                      _____

          denied, 412 U.S. 909 (1973).
          ______

IV.
                                         IV.

Webb's argument seems to be  that the last three  words

          in the above-quoted passage from James ("it excludes loans"), see
                                           _____                        ___

          supra at p. 6, required the district court to consider whether he
          _____

          had a bona fide intention to repay.   Thus, Webb would character-
                ____ ____

          ize the events relevant  to tax year  1978 as follows:   although

          the Trust was the named borrower on the SBA note, Webb was the de
                                                                         __

          facto borrower, and his signature on the note, whether as trustee
          _____

          or guarantor, betokens  his continuing and binding  obligation to

          repay  SBA.2  Therefore, he  acquired the $376,900 (including the
                              
          ____________________

               2The parties have generated  considerable needless confusion
          concerning the nature and timing of the taxable event at issue in
          this case.   In  its appellate  brief and  at oral argument,  IRS
          suggested that Webb may have embezzled  the SBA loan funds at the
          time he  submitted the false  loan application and  the backdated
          purchase agreement to SBA, since  the SBA would not have approved
          the loan  to the  Trust "but for"  those misrepresentations.   In
          other words, Webb  was not qualified for the loan, hence he never
          acquired lawful access to the loan proceeds.

                                          7

$64,730)  under a  "consensual recognition  of  an obligation  to

          repay," James, 366 U.S. at 219,  and no taxable event occurred in
                  _____

          July 1978.   Moreover,  no taxable  event occurred in  September-

          October 1978  because either  (1) he did  not "acquire"  any loan

          funds in  September-October 1978 (but merely applied funds he had

          previously acquired  to a use  not authorized under the  SBA loan
          __________

          agreement),3  or (2)  if he  first "acquired"  the loan  funds in

          September-October  1978, either  from the  Trust or  the SBA,  he

          nonetheless had a preexisting contractual obligation to repay the
                                        ___________

          $376,000, which SBA could have enforced at any time.

V.
                                          V.

____________________

               We do not address this broader contention for three reasons.
          First, if  the IRS's  characterization were  correct, the  entire
          loan  proceeds of $376,900 would have been taxable to Webb, or at
          least the disbursements of $170,350  to the Trust and $178,000 to
          amortize the Trust mortgages.   IRS has never asserted that these
          portions of the loan proceeds  were taxable to Webb upon receipt.
          Second,  the record  is unclear  whether  Webb's false  statement
          (i.e.,  the backdating of the marina purchase-sale agreement) was
           ____
          "material" to SBA's decision to  grant the Trust loan, nor  is it
          clear  that Webb's guilty plea under 15  U.S.C.   645 would fore-
          close  relitigation of this  particular issue, see,  e.g., United
                                                         ___   ____  ______
          States  v. Carter,  526  F.2d  1276, 1278  (5th  Cir. 1976)  (any
          ______     ______                                             ___
          "false"  statement), especially  given the  record evidence  that
          Webb  induced the  SBA  loan  with the  aid  of unscrupulous  SBA
          insiders.   Finally,  the five  "embezzling"  counts charge  that
          Webb's  unlawful  "acquisition"  of the  loan  funds  occurred in
          September-October 1978, months after Webb's  loan application and
          ______________________
          the ensuing loan approval.

               3The  support for  Webb's implicit  assumptions is  unclear.
          See, e.g.,  United States  v. Kristofic,  847 F.2d  1295, 1296-97
          ___  ____   _____________     _________
          (7th Cir. 1988) (reversing   641 "embezzlement" conviction of SBA
          borrower who subsequently  used funds for  unauthorized purposes;
          following their disbursement,  SBA had "contract" rights,  but no
          "property" rights); see  also United States  v. Lawson, 925  F.2d
                              ___  ____ _____________     ______
          1207, 1209-10  (9th Cir. 1991)  (auctioneer for SBA could  not be
          convicted under   641 for unauthorized use of sale proceeds).

                                          8

The record belies  Webb's expedient characterization of

          these events.   Contrary to  his implicit assumption,  the record

          reflects that the  Trust, not Webb, was the  borrower, and there-
                                    ___ ____           ________

          fore, absent evidence or developed argumentation to the contrary,

          see  Rhode Island Hosp. Trust Nat'l Bank v. Howard Communications
          ___  ___________________________________    _____________________

          Corp., 980 F.2d 823,  828 n.8 (1st Cir. 1992), we  must treat the
          _____

          Trust  as  the  separate juridical  entity  which  "acquired" the

          entire loan proceeds ($376,900) in July 1978.  Cf. Moline Proper-
                                                         ___ ______________

          ties,  Inc. v.  Commissioner, 319  U.S. 436,  439 (1943)  (in tax
          ___________     ____________

          cases, corporate form will not  be disregarded to allow reassign-

          ment of corporate  tax consequences  to individual  shareholder);

          Burnet v. Commonwealth  Improvement Co., 287 U.S. 415, 419 (1932)
          ______    _____________________________

          (only in "unusual cases" will court disregard corporate form, and

          rarely where that formality was previously wielded by taxpayer to

          reap tax benefits);  Town of Brookline v. Gorsuch,  667 F.2d 215,
                               _________________    _______

          221 n.4 (1st Cir. 1982) ("It is  almost black-letter law that for

          purposes of  the Internal  Revenue Code,  distinctions between  a

          corporation and its  shareholders will be observed  . . . because

          the Code provides  both benefits and burdens  based explicitly on

          the  existence  of  at  least  formally  independent corporations

          . . . .").4  In  September-October 1978, Webb breached  his fidu-

          ciary duty and "acquired" the  $64,730 from the Trust by applying
                                                 ____ ___ _____
                              
          ____________________

               4Massachusetts  business  trusts   apparently  possess  many
          essential attributes of corporations, see Mass.  Gen. L. ch. 182,
                                                ___
              1-14 (1993);  Swartz  v.  Sher, 344  Mass.  636, 639  (1962).
                            ______      ____
          Moreover, the appellate  record contains evidence (a copy  of the
          1979 Trust corporate  income tax return) suggesting that Webb has
          found it  advantageous to treat  the Trust as a  discrete taxable
          entity.  See Burnet, 287 U.S. at 419.
                   ___ ______

                                          9

it to  his personal use.   Under James, Webb's  fiduciary duty as
                     ________              _____

          sole trustee, see Terrydale Liquidating Trust v. Barness,  642 F.
                        ___ ___________________________    _______

          Supp. 917, 919  (S.D.N.Y. 1986) (trustee of  Massachusetts "busi-

          ness  trust"  acts  under  a fiduciary  duty);  Loring  v. United
                                                          ______     ______

          States, 80  F. Supp.  781, 785 (D.  Mass. 1948)  (same), standing
          ______                                                   ________

          alone,  would be inadequate,  as a matter  of law, to  generate a
          _____

          trialworthy  issue respecting  his alleged  intent  to repay  the

          Trust.  Webb, who bears  the ultimate burden of proof, failed  to

          produce  any  evidence that  the  Trust formally  loaned  him the

          $64,730, or  that the Trust,  as the putative "lender"  under the

          relevant  James  analysis,   "consensually  recogni[zed]"  Webb's
                    _____

          obligation  to repay  the funds to  the Trust.   Cf. Crowley, 962
                                                           ___ _______

          F.2d at 1079 (listing indicia of nontaxable  "loan" to sharehold-

          er,  as  distinguished  from  taxable  "constructive   dividend,"

          including, inter alia, taxpayer's  control over corporation,  use
                     _____ ____

          of customary loan documents).  Thus, Webb's alleged obligation to

          repay  SBA is  immaterial  to the  taxability  of the  September-
                 ___

          October  1978 "acquisitions."5   Regardless of the  precise reach

          of  the  James  "consensual  recognition"  test, therefore,  Webb
                   _____

          failed  to demonstrate  a  genuine issue  of  material fact  with

          respectto hisintentionto repaythe $64,730embezzledfrom theTrust.6
                              
          ____________________

               5Webb's potential liability as guarantor or trustee does not
          alter the essential fact that  the Trust was the SBA  borrower to
          which the loan proceeds were disbursed.

               6Moreover,  by his guilty plea Webb is collaterally estopped
          from  claiming that he personally "acquired" the $376,900 (inclu-
                              __
          ding the $64,730) prior to  September-October 1978.  See 1B James
                                                               ___
          W. Moore, Jo  D. Lucas, Thomas S. Currier,  Moore's Federal Prac-
                                                      _____________________
          tice   0.418[1],  at 557 (2d ed. 1992) (guilty  pleas are conclu-
          ____

                                          10

Affirmed.
                    Affirmed.
                    ________

____________________

          sive against defendant  in subsequent civil suit as  to all facts
          necessarily  "decided"  as  predicate for  criminal  conviction);
          Fontneau v.  United States, 654 F.2d 8,  10 (1st Cir. 1981) ("Re-
          ________     _____________
          litigation  of such  issues  [in a  civil  tax proceeding]  . . .
          'simply because  the []  court's decision [to  accept the  guilty
          plea]  may have been erroneous'  is not . . . allowed.") (quoting
          Allen v.  McCurry, 449 U.S.  90, 101 (1980)).   In order  to have
          _____     _______
          been convicted of "embezzling" $64,730 in September-October 1978,
          as alleged in  the indictment, see supra note  2, Webb would have
                                         ___ _____
          had  to "acquire"  monies of a  third party at  that time, either
                                                      __  ____ ____
          directly from  the SBA, or from the Trust.   See United States v.
                                                       ___ _____________
          Lawson, 925 F.2d 1207, 1209 (9th Cir. 1991) (an essential element
          ______
          under  18 U.S.C.    641  is misappropriation  of property  of the
          United  States ("money  . . . or  thing  of value  of the  United
          States")).  One cannot embezzle  from oneself.  Thus, Webb effec-
          tively  conceded that  he "acquired"  the  $64,730 in  September-
          October 1978, at the earliest.
                        __ ___ ________

                                          11