909 F.2d 915 (6th Cir. 1990), 89-1706, United States v. Walton
|Citation:||909 F.2d 915|
|Party Name:||UNITED STATES of America, Plaintiff-Appellee, v. William L. WALTON, also known as Chris Walton; Belle Isle Riding Academy, Defendants-Appellants.|
|Case Date:||July 31, 1990|
|Court:||United States Courts of Appeals, Court of Appeals for the Sixth Circuit|
Argued May 8, 1990.
Gary R. Allen, Acting Chief, Charles E. Brookhart, Kenneth W. Rosenberg (argued), U.S. Dept. of Justice, Appellate Section, Tax Div., Washington, D.C., for plaintiff-appellee.
Jonathan B. Simon, Donald J. Morbach & Associates, Detroit, Mich., John B. Payne, Jr. (argued), Dearborn, Mich., for defendants-appellants.
Before MARTIN and GUY, Circuit Judges, and DOWD, District Judge. [*]
RALPH B. GUY, Jr., Circuit Judge.
Defendants, William Walton and the Belle Isle Riding Academy, Inc. (BIRA or the Academy), appeal a district court judgment holding them jointly and severally liable for payment of federal income taxes and fraud penalties assessed by the Internal Revenue Service (IRS). The defendants allege three general grounds for reversal of the court's order: (1) that the tax deficiencies calculated by the IRS for both defendants were arbitrary and excessive; (2) that neither defendant committed civil fraud in failing to pay the assessed taxes; and (3) that there is no basis for disregarding BIRA's corporate identity by holding each defendant jointly and severally liable for the total amount of the judgment against them both. Finding merit in only one of Walton's challenges to the amount of tax assessed, we affirm, but remand for a modification of the judgment.
Walton is an entrepreneur who appears to have engaged in a wide range of business ventures during the years 1976 through 1979. In this appeal we are primarily concerned with his activities in connection with the Belle Isle Riding Academy, a horse riding concession on Belle Isle Park in Detroit, Michigan, which he founded in early 1976 and incorporated several months later. At all times relevant to this action, Walton was the president and sole director of the Academy.
In July of 1977, investigators from the United States Department of Justice contacted Walton seeking information in connection with a criminal investigation being conducted into possible narcotics trafficking by the only other Academy shareholder, Rondal Rucker. 1 In connection with its investigation, the Justice Department discovered that neither the Academy nor Walton had filed income tax returns for 1976 or 1977, and that the Academy had failed to file at any time between 1976 and 1979. This information was relayed to the Criminal Investigation Unit of the IRS for possible criminal fraud prosecution. The criminal investigation was later dropped and a civil inquiry initiated. After encountering considerable resistance from Walton, including his failure to provide complete business records, IRS Agent Backaitis began to compute the tax liability of both defendants. Due to the inadequacy of the available financial records, Backaitis calculated Walton's taxable income by reconstructing his net worth at the beginning and end of each year for which he had failed to file a return. The IRS completed its audit of Walton in late 1981 and mailed him a notice stating the deficiencies in his tax payments for 1976 and 1977. When Walton did not pay the deficiencies or file a petition in the Tax Court, the IRS assessed taxes, with penalties and interest, yielding a total liability of $140,162.09 for 1976 and $328,079.90 for 1977.
The IRS also reconstructed the Academy's income, using information from the corporation's books and records and from third persons, and mailed BIRA deficiency notices for the years 1976 through 1979. When the Academy failed to pay or contest the deficiencies, the IRS assessed taxes, penalties, and interest of $1,404.21 for 1976, $21,722.45 for 1977, $10,617.76 for 1978, and $13,118.45 for 1979. Both defendants refused to pay the amounts assessed, leading the government to file this suit in the United States District Court for the Eastern District of Michigan to reduce the unpaid assessments to judgment.
After a three-day bench trial, the court rendered judgment against Walton for $468,241.99 and against BIRA for $46,862.88, plus interest, penalties, and costs. The court also ordered that because the Academy was Walton's "alter ego," as evidenced by the commingling of corporate and personal assets and the failure to observe corporate formalities, both defendants
would be jointly and severally liable for the full amount of the assessments against each--a total liability of $515,104.87. After the court denied their request for a new trial, defendants filed this appeal.
II. The Net Worth Method and the Burden of Proof
The Treasury Regulations on Procedure and Administration require each taxpayer to maintain records sufficient to enable the Commissioner to determine his tax liabilities. 26 C.F.R. Sec. 1.6001-1(a). When a taxpayer keeps no books, or keeps books that are inadequate or demonstrably inaccurate, section 446(b) of the Internal Revenue Code authorizes the IRS to compute the taxpayer's income by any method that clearly reflects his income. 26 U.S.C. Sec. 446(b). The "net worth method" used to ascertain Walton's personal tax liability has been accepted by the courts as satisfying the legislative mandate. See Holland v. United States, 348 U.S. 121, 75 S.Ct. 127, 99 L.Ed. 150 (1954). The method has not changed since it was described by the Supreme Court in Holland:
In a typical net worth prosecution, the Government, having concluded that the taxpayer's records are inadequate as a basis for determining income tax liability, attempts to establish an "opening net worth" or total net value of the taxpayer's assets at the beginning of a given year. It then proves increases in the taxpayer's net worth for each succeeding year during the period under examination and calculates the difference between the adjusted net values of the taxpayer's assets at the beginning and end of each of the years involved. The taxpayer's nondeductible expenditures, including living expenses, are added to these increases, and if the resulting figure for any year is substantially greater than the taxable income reported by the taxpayer for that year, the Government claims the excess represents unreported taxable income.
The Commissioner's determination of tax liability, if calculated according to an acceptable procedure, such as the net worth method, is presumptively correct and places the burden of producing contrary evidence upon the taxpayer. Helvering v. Taylor, 293 U.S. 507, 515, 55 S.Ct. 287, 290, 79 L.Ed. 623 (1935); Traficant v. Commissioner, 884 F.2d 258, 263 (6th Cir.1989); Calderone v. United States, 799 F.2d 254, 258 (6th Cir.1986); Schrader v. Commissioner, 420 F.2d 443, 444 (6th Cir.1970). Generally, the taxpayer will bear not only the burden of production, but also the burden of proving by a preponderance of the evidence that the Commissioner's assessment is "arbitrary and excessive." Helvering, 293 U.S. at 515, 55 S.Ct. at 290; Traficant, 884 F.2d at 263; Calderone, 799 F.2d at 258. When, for example, the IRS bases an assessment on the disallowance of deductions, "placing the burden of proof on the taxpayer is reasonable because the taxpayer has better access to evidence of the underlying transactions." Note, Proving a Negative--When the Taxpayer Denies Receipt, 70 Cornell L.Rev. 141 (1984). Where the taxpayer is confronted with the daunting task of proving that he did not receive income attributed to him in an assessment, however, this circuit has established a less severe rule. In United States v. Besase, 623 F.2d 463, 465 (6th Cir.), cert. denied, 449 U.S. 1062, 101 S.Ct. 785, 66 L.Ed.2d 605 (1980), we wrote:
Where it is a negative assertion that a successful taxpayer would have to prove ... the "law imposes much less of a burden upon a taxpayer." Weir v. Commissioner of Internal Revenue, 283 F.2d 675, 679 (6th Cir.1960). Reasonable denials of the assessment's validity have sufficed in such cases to shift the burden back to the government. Id. The government then bears the task of substantiating its assessment in cases of this type.
As in Weir, the defendants ultimately had to prove their non-receipt of income in order to prevail. They denied the existence of, and the receipt of income
from, a common partnership. They characterized the nature of their relationship as social, and offered testimony to support the explanation. The nature of their proof justified use of the lighter burden and allocation of the ultimate risk of nonpersuasion to the government.
Whether the issue in dispute is the taxpayer's receipt of income, in which case the government must bear the ultimate burden of persuasion, or the payment of expenses, in which case the burden of persuasion remains with the taxpayer, the government can never rest its case on an assessment that lacks a minimal evidentiary foundation. In Helvering, 293 U.S. at 514, 55 S.Ct. at 290, the Supreme Court wrote: "We find nothing ... that gives any support to the idea that the commissioner's determination, shown to be without rational foundation and excessive, will be enforced unless the taxpayer proves he owes nothing or ... shows the correct amount." In United States v. Janis, 428 U.S. 433, 96 S.Ct. 3021, 49 L.Ed.2d 1046 (1976), the Court explained that debates between the circuits over shifts in the burden of...
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