Benson v. C.I.R.

• Decision Date: 31 March 2009
• Docket Number: No. 07-72272.,07-72272.
• Parties: Burton O. BENSON; Elizabeth C. Benson, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

560 F.3d 1133

Burton O. BENSON; Elizabeth C. Benson, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 07-72272.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted January 12, 2009.

Filed March 31, 2009.

John M. Youngquist, San Francisco, CA, for petitioners Burton Benson and Elizabeth Benson.

Ellen Page DeSole, Department of Justice, Tax Division, Washington, D.C.; Michael J. Huangs, Department of Justice, Tax Division, Washington, D.C.; Nathan J. Hochman, Assistant Attorney General, for respondent Commissioner of Internal Revenue.

Appeal from a Decision of the United States Tax Court, Tax Ct. No. 12967-00.

Before: J. CLIFFORD WALLACE, JEROME FARRIS and M. MARGARET McKEOWN, Circuit Judges.

FARRIS, Senior Circuit Judge:

Burton and Elizabeth Benson, husband and wife, filed joint tax returns between September 1994 and December 1995 for the years 1989, 1990, 1993, and 1994.¹ Burton was a retired Navy admiral and engineer, and was the 100 percent owner of Energy Research and Generation. ERG, a subchapter C corporation, filed its own tax returns and paid its own taxes. Burton Benson also owned a controlling interest—varying between one-half and two-thirds in the years at issue—in New Process Industries. NPI was a subchapter S corporation, or a passthrough entity, and therefore filed information returns. For tax purposes, its income was attributable to its equity partners.

NPI had no employees, and no written contracts with ERG, but did maintain a bank account, certain patent rights, and three parcels of real property in Oakland, California. During the period at issue, ERG transferred millions of dollars to NPI. In 1989, ERG received $483,098 from Hercules Aerospace Co. for an equipment purchase, then transferred the money to NPI. In 1990, NPI bought patent rights from ERG, and then immediately licensed the rights back to ERG in a retroactive licensing agreement. The result was that, in each relevant year, 10 percent of ERG's profits flowed to NPI for "royalties." The remainder of ERG's profits in each relevant year, less about $75,000, flowed to NPI for "engineering services." In each relevant year, ERG also paid rent to NPI for the use of real property at two plants.

These transactions were without economic substance. NPI had no relation to the Hercules transaction; the licensing agreement made no economic sense for ERG; there was no evidence that NPI had performed engineering services sufficient to justify the transfers; and ERG paid rent far in excess of its contractual obligations. Thus, these transactions functioned only to funnel money from ERG to NPI. Benson then used NPI's bank account funds for the "sole and exclusive benefit of himself and his family." Benson v. Comm'r, 88 T.C.M. (CCH) 520 (2004).

Where a corporation provides an economic benefit to a shareholder with no expectation of reimbursement, the benefit is a "constructive dividend" and is taxable income. Inland Asphalt Co. v. Comm'r, 756 F.2d 1425, 1429 (9th Cir.1985). ERG's payments to NPI were constructive dividends to the Bensons.

The Bensons also received constructive dividends directly from ERG, without passing through NPI. These dividends included a corporate paid life insurance policy; corporate paid car expenses; "directors' fees" paid directly to Benson family members; corporate paid non-business travel expenses; corporate paid legal fees for personal matters; corporate paid recreational expenses drawn from the "ERG-Recreation Fund"; and finally the imputed value of ERG's purchase of a large plot of real estate immediately adjacent to the Bensons' personal residence.

Of the Bensons' tax returns for each of the years at issue, none reported the constructive dividends. Of NPI's information returns for each of the same years, none reported the constructive dividends. In some instances, the NPI returns referred to relevant transactions, but these references were incomplete, misleading, or otherwise ambiguous. Transfers pursuant to the exclusive licensing agreement were labeled as "royalties," the purported engineering services labeled as "engineering services," and the excessive rent labeled as "rent."

As a result of these deficiencies, the Internal Revenue Service opened investigations of the Bensons' 1993 return in August 1995, and their other returns in March 1997. The Service referred the Bensons' audits to its criminal investigation division in May 1997, but in August 2000, the Department of Justice declined to prosecute.

In September 2000, more than three but fewer than six years after the returns were received, the Commissioner issued the Bensons notices of alleged fraud and deficiency for tax years 1989, 1990, and 1993. About a year later, the Commissioner issued a notice of deficiency for tax year 1994.

The Bensons challenged the Commissioner's determinations in the Tax Court. The Tax Court found no evidence of fraud, but mostly upheld the Commissioner's substantive deficiency determinations. In addition to the constructive dividends, the Bensons failed to report miscellaneous income, including forgiveness of debt and dividend income from an account in their son's name, and had made certain improper deductions. Altogether, the Tax Court's found that the Bensons' "omitted" gross income of $629,177 in 1989; $456,500 in 1990; $3,831,923 in 1993; and $469,713 in 1994. Based on these figures, the total deficiencies were $139,889 for 1989; $104,701 for 1990; $1,496,254 for 1993; and $140,714 for 1994.

The Bensons filed a motion for reconsideration on the grounds that the Commissioner's assessment was time-barred by 26 U.S.C. § 6501(a)'s customary three-year statute of limitations. In response, the Tax Court issued a supplemental opinion. It held that, because the income "omitted" was more than 25 percent of the Bensons' reported gross income for each relevant year, the six-year statute of limitations applied under § 6501(e).² The court further found that, although the Bensons' misleading entries may have provided a "clue" about deficiencies, the entries did not adequately apprise the Commissioner of the nature or amount of the deficiencies, and therefore, the "adequate disclosure" or "safe harbor" clause of § 6501(e)(1)(A)(ii) did not apply.³ The Bensons timely bring this appeal.

Interpretation of 26 U.S.C. § 6501 is a question of law that we review de novo. Maciel v. Comm'r, 489 F.3d 1018, 1027 (9th Cir.2007). Section 6501(a) requires the IRS, after a return is filed, to assess taxes within three years. 26 U.S.C. § 6501(a). However, if the return omits gross income totaling more than 25 percent of the amount stated in the return, § 6501(e) extends the statute of limitations to six years. 26 U.S.C. § 6501(e)(1)(A). The three-year limit under § 6501(a) would bar assessment of deficient taxes for the Bensons' 1989, 1990, 1993, and 1994 returns. The six-year limit under § 6501(e) would not. The question is therefore whether the IRS is entitled to the six-year limit for those returns.

On appeal, the Bensons' do not dispute that for each of these years, their return did not properly account for income in excess of 25 percent of the income stated on the return. Nor do they dispute the Tax Court's computations or figures. Instead, the Bensons contend that their tax position was not an "omission" of gross income under the statute, but a "recharacterization" of the amounts in question.

In Colony, Inc. v. Comm'r, 357 U.S. 28, 36-38, 78 S.Ct. 1033, 2 L.Ed.2d 1119 (1958), the Supreme Court held that the extended limitations period in the predecessor statute to § 6501(e)(1)(A) did not apply where a taxpayer understated gross profits he earned on the sale of real property, because he erroneously overstated...