McKinney v. U.S., 76-4260
| Decision Date | 13 June 1978 |
| Docket Number | No. 76-4260,76-4260 |
| Parties | , 78-2 USTC P 9508 Herman E. and Mary E. McKINNEY, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee. |
| Court | U.S. Court of Appeals — Fifth Circuit |
Douglass D. Hearne, Philip C. Joseph, Austin, Tex., for plaintiffs-appellants.
Jamie C. Boyd, U. S. Atty., San Antonio, Tex., Arthur L. Bailey, Atty., Scott P. Crampton, Asst. Atty. Gen., Tax Div., Gary R. Allen, Atty., Myron C. Baum, Acting Asst. Atty. Gen., Gilbert E. Andrews, Acting Chief, Appellate Section, Richard Farber, Atty., U. S. Dept. of Justice, Washington, D. C., for defendant-appellee.
Appeal from the United States District Court for the Western District of Texas.
Before TUTTLE, GEE and FAY, Circuit Judges.
The taxpayer, 1 Herman E. McKinney, having embezzled the sum of $91,702.06 from his employer, reported and paid taxes on the fund in 1966. He refunded the entire amount in 1969 and now seeks to be made whole tax-wise under the terms of a special statutory relief provision of the Internal Revenue Code, 26 U.S.C. § 1341.
The facts are not in dispute. Over a period of years McKinney, who was employed by the Texas Employment Commission, arranged matters in such a manner that in 1966 he was able to siphon off $91,702.06 of the state's money. Because of the requirements of the federal taxing statutes following the Supreme Court's decision in James v. United States, 366 U.S. 213, 81 S.Ct. 1052, 6 L.Ed.2d 246 (1961), McKinney reported the embezzled funds as "miscellaneous income" on his 1966 federal income tax return. Subsequently, the embezzlement was discovered, and McKinney was convicted in the state courts of embezzlement. He repaid the embezzled funds in 1969. On his tax return for that year, taxpayer claimed a deduction for this repayment as a trade or business loss, resulting in a reported "net operating loss" for that year. He then claimed a net operating loss carryback deduction for 1966. Alternatively, taxpayer filed a claim for refund for 1969, claiming the benefit of the provisions of § 1341. 2
The Government does not dispute the taxpayer's entitlement to a deduction for the year 1969, but this does not give him the full benefits that would be enjoyed if he could treat the loss as if it had occurred in 1966, the year of payment. The taxpayer has abandoned his original claim that he is entitled to a carryback of the loss as a "net operating loss," a point decided against him by the trial court. He therefore relies solely on his contention that by the enactment of § 1341, Congress intended that a taxpayer, who reported as income funds acquired by theft or embezzlement, be able to obtain, if required subsequently to refund the amounts, the full benefit of a deduction in the year of repayment that would effectively wipe out the economic loss suffered from the prior payment of taxes on the illegally acquired funds.
In 1954, Congress enacted § 1341 to alleviate perceived inequities created by operation of the so-called "claim-of-right doctrine." The classic formulation of the doctrine is that:
If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent.
North American Oil Consolidated v. Burnet, 286 U.S. 417, 424, 52 S.Ct. 613, 615, 76 L.Ed. 1197 (1952) (emphasis added). The statute merely allows, as an alternative to a deduction in the year of repayment, taxes for the current year to be reduced by the amount taxes were increased in the year of receipt because the funds in question were included in gross income.
The Court first applied the doctrine in the context of embezzled funds in Commissioner of Internal Revenue v. Wilcox, 327 U.S. 404, 66 S.Ct. 546, 90 L.Ed. 752 (1946). In Wilcox the IRS argued that embezzled funds should be treated as taxable income to the wrongdoer under § 22(a) of the Code. The Court disagreed. After noting that the essence of taxable income is "the accrual of some gain, profit or benefit to the taxpayer," id. at 407, 66 S.Ct. at 548, the Court held:
For present purposes . . . it is enough to note that a taxable gain is conditioned upon (1) the presence of a claim of right to the alleged gain and (2) the absence of a definite, unconditional obligation to repay or return that which would otherwise constitute a gain. Without some bona fide legal or equitable claim, . . . the taxpayer cannot be said to have received any gain or profit within the reach of § 22(a).
It is obvious that the taxpayer in this instance, in embezzling the $12,748.60, received the money without any semblance of a bona fide claim of right. And he was at all times under an unqualified duty and obligation to repay the money . . . .
Id. at 408, 66 S.Ct. at 549 (emphasis added) (citation omitted). On this basis the Court concluded that embezzled money did not constitute taxable income to the embezzler.
Fifteen years later, the Court expressly overruled Wilcox in James v. United States, 366 U.S. 213, 81 S.Ct. 1052, 6 L.Ed.2d 246 (1961). The Court reasoned:
A gain "constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it," Rutkin v. United States, (343 U.S. 130, 137, 72 S.Ct. 571, 575, 96 L.Ed. 833). Under these broad principles, we believe that petitioner's contention, that all unlawful gains are taxable except those resulting from embezzlement, should fail.
When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition, express or implied, of an obligation 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 entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent." North American Oil Consolidated v. Burnet, (286 U.S. 417, 424, 52 S.Ct. 613, 615, 76 L.Ed. 1197). Corliss v. Bowers, (281 U.S. 376, 378, 50 S.Ct. 336, 74 L.Ed. 916). This standard brings wrongful appropriations within the broad sweep of "gross income" . . . .
Because the benefit conferred by the statute depends upon whether it "appear(s) that the taxpayer had an unrestricted right to such item", it is necessary for us to determine whether in its James decision, the Supreme Court modified its conclusion in Wilcox that in embezzling funds a taxpayer "received the money without any semblance of a bona fide claim of right", 327 U.S. at 408, 66 S.Ct. at 549, or whether the Court merely said that embezzled funds are to be returned for tax purposes as part of gross income regardless of whether they were held under a "claim of right."
We agree with the reasoning of the trial court here:
The decision . . . in James cannot properly be read to say that the Supreme Court concluded that embezzled funds are held under a claim of right. On the contrary, James does not in any way contradict or weaken the Court's statement ...
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