Jaques v. C.I.R., 90-1657

• Decision Date: 08 July 1991
• Docket Number: No. 90-1657,90-1657
• Citation: 935 F.2d 104
• Parties: -1108, 91-1 USTC P 50,292 Leonard C. JAQUES, Sybil J. Jaques, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 104

935 F.2d 104

67 A.F.T.R.2d 91-1108, 91-1 USTC P 50,292

Leonard C. JAQUES, Sybil J. Jaques, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 90-1657.

United States Court of Appeals,

Sixth Circuit.

Argued March 11, 1991.

Decided June 5, 1991.

Rehearing Denied July 8, 1991.

Robert J. Zinkel, Jr., Detroit, Mich., Joseph Falcone (argued), Southfield, Mich., for petitioners-appellants.

Abraham N.M. Shashy, Jr., Chief Counsel, I.R.S., Gary R. Allen, Acting Chief, Regina S. Moriarty, Ann Belanger Durney (argued), U.S. Dept. of Justice, Appellate Section, Tax Div., Washington, D.C., for respondent-appellee.

Before MARTIN and MILBURN, Circuit Judges, and WELLFORD, Senior Circuit Judge.

BOYCE F. MARTIN, Jr., Circuit Judge.

Leonard C. and Sybil J. Jaques appeal the decision of the United States Tax Court finding that certain withdrawals made by Leonard Jaques from his wholly-owned professional corporation were taxable dividends under Sec. 316 of the Internal Revenue Code, 26 U.S.C. Sec. 316, rather than non-taxable loans. ¹ This determination resulted in deficiencies in their income tax for the taxable years 1983, 1984, and 1985, in the amounts of $24,255, $120,384, and $301,970, respectively. See 58 T.C.M. (CCH) 1026 (1989). For the following reasons, we affirm the decision of the tax court.

Leonard C. Jaques is an attorney specializing in the practice of plaintiffs' class action law. In 1971, Jaques formed a professional corporation, Leonard C. Jaques, P.C. From the time of incorporation, Jaques has always been the sole shareholder of the corporation. Jaques' basis in the stock of the corporation was $20,000. Prior to the years at issue, the corporation had established a defined pension plan. Beginning in 1977 and continuing throughout the years in issue, Jaques began making withdrawals from the corporation. Jaques used the amounts withdrawn from the corporation during the years at issue to pay day-to-day personal living expenses. The following amounts were withdrawn:

                                Year Ended October 31  Amount
                1983  $ 14,687
                1984   275,682
                1985   803,398
                

These withdrawals were reflected as "Accounts Receivable-Officer" by bookkeeping entries made on the books and records of the corporation. Jaques did not execute notes for these withdrawals nor was there a maturity date set for repayment. There was no collateral pledged as security for the repayment of the amounts withdrawn by Jaques. On its income tax returns, the corporation reflected the loans to stockholders as assets as follows:

                Year Ended October 31  Amount
                1983                   $  764,166.72
                1984                    1,007,119.02
                1985                    1,820,837.25
                

Withdrawals were also made by the corporation from its pension plan. These withdrawals were reflected in executed promissory notes carrying an interest rate of 15 percent. During the years at issue, the corporation made monthly interest payments to the pension plan. The amount of these loans for the years 1983, 1984, and 1985 were $14,750.00, $56,818.77, and $165,502.05, respectively.

During each of the years in issue, the corporation paid Jaques a salary of $150,000.24. During 1984 and 1985, the corporation also reported on its W-2 Forms $37,093 and $131,416, respectively, as other compensation paid to Jaques for imputed interest on the withdrawals.

Jaques' personal financial statement prepared as of December 17, 1987, noted that "Leonard C. Jaques owes his law firm $2,645,000.00, but since the professional corporation stock is wholly owned by Leonard C. Jaques, the 'loan' is a wash." Jaques' personal financial statement prepared as of November 30, 1988, reflected loans payable to the corporation in the amount of $3,042,000. In the note to the financial statement, petitioner disclosed that "The $3,042,000.00 represents monies I have borrowed over the years from the P.C. to be repaid whenever convenience may focus."

This case illustrates the tension which arises when individual professional practitioners are permitted to create separate corporate identities. For the better part of the history of our country, lawyers were prohibited from utilizing such incorporation. See, e.g., In re N.H. Bar Ass'n, 110 N.H. 356, 266 A.2d 853 (1970); In re Florida Bar, 133 So.2d 554 (Fla.1961). Currently, every state and the District of Columbia have statutes permitting such a procedure. See Phillips, McNider, & Riley, Origins of Tax Law: The History of the Professional Service Corporation, 40 Wash. & Lee L.Rev. 433, 439 (1983). The taxpayer in this case, a lawyer by trade, like many accountants, physicians, architects, and other professionals, found it to be financially beneficial to incorporate his legal practice as a professional corporation. See Cooper, The Taming of the Shrewd: Identifying and Controlling Income Tax Avoidance, 85 Colum.L.Rev. 657, 665 n. 24 (1985). There is Leonard Jaques the private citizen and Leonard Jaques the professional corporation. In the eyes of the federal tax law, these are two separate taxable entities; in reality, they are a single individual. Not surprisingly, problems frequently arise when the two entities engage in transactions which have federal tax implications.

In the typical business context, business persons engage in business transactions with one another at arms-length. Therefore, it is usually safe to assume that a particular transaction is entered into because each party concludes that it is in his own self-interest to do so. This assumption breaks down, however, when the parties engaging in the transaction are in reality the same individual; the self-interest test usually employed to judge a contemplated transaction ceases to be applied by each party to the transaction. In this case, Leonard Jaques the professional corporation "loaned" Leonard Jaques the private citizen large amounts of money. Because in reality these transactions resulted in nothing more than Jaques lending himself his own money, it is very difficult to characterize the relationship between Jaques and his corporation as one of debtor and creditor. The potential for tax evasion is clear. A sole shareholder of a professional corporation could withdraw large sums from the corporation without incurring any tax liability simply by characterizing the withdrawals as loans, repayment of which could be postponed indefinitely.

The tax court determined that the amounts withdrawn by Jaques were not intended to be loans, but were taxable distributions under Section 316 of the Internal Revenue Code. 26 U.S.C. Sec. 316. The court found that Jaques failed to prove that the withdrawals were intended to be loans because he did not offer any "objective manifestations of contemporaneous intent to repay" other than his "own unsupported testimony." Other factors which the tax court relied upon in reaching its conclusion were: (1) the withdrawals were not represented by interest-bearing notes; (2) Jaques did not periodically repay the principal or interest; (3) the withdrawals were unsecured and were not subject to a fixed repayment schedule; (4) the withdrawals were in proportion to his holdings as the sole shareholder; and (5) the corporation had substantial current earnings but did not pay any dividends during this period.

Jaques argues that the tax court erred in finding that the withdrawals in question were constructive dividends and not loans. We may not disturb the tax court's findings of fact unless they are clearly erroneous. Commissioner v. Duberstein, 363 U.S. 278, 80 S.Ct. 1190, 4 L.Ed.2d 1218 (1960); see also Rose v. Commissioner, 868 F.2d 851, 853 (6th Cir.1989) (citing cases). There is some dispute as to whether the loan verses dividend question is one of fact or law. See, e.g., Busch v. Commissioner, 728 F.2d 945 (7th Cir.1984) (whether shareholder's withdrawals from corporation constituted loans or dividends is purely a question of fact); Dolese v. United States, 605 F.2d 1146 (10th Cir.1979) (question of debt or dividend normally a question of fact, but when there is no dispute in the evidence, whether the facts add up to debt or equity is a question of law), cert. denied, 445 U.S. 961, 100 S.Ct. 1647, 64 L.Ed.2d 236 (1980); Alterman Foods, Inc. v. United States, 505 F.2d 873 (5th Cir.1974) (whether operative facts add up to dividend or loan is a question of law). This court has held on a number of occasions that whether a payment is a loan or a dividend is a factual question. Dietrick v. Commissioner, 881 F.2d 336 (6th Cir.), cert. denied, --- U.S. ----, 110 S.Ct. 565, 107 L.Ed.2d 559 (1989); Estate of DeNiro v. Commissioner, 746 F.2d 327 (6th Cir.1984); Wilkof v. Commissioner, 636 F.2d 1139 (6th Cir.1981) (per curiam); Berthold v. Commissioner, 404 F.2d 119 (6th Cir.1968). Thus, we review the tax court's determination that the withdrawals made by Jaques were constructive dividends and not loans only for clear error.

Whether the withdrawals made by Jaques from his professional corporation are treated for tax purposes as loans or dividends turns on the intention of the parties at the time the withdrawals were made. Dietrick, 881 F.2d at 340; Livernois Trust v. Commissioner, 433 F.2d 879 (6th Cir.1970); Berthold, 404 F.2d at 122. To determine whether the taxpayer intended to repay the withdrawals, courts have looked to a number of objective factors. See Alterman, 505 F.2d at 876 n. 6 (listing factors). The taxpayer's testimony that he intended to repay is one factor which is considered, but such self-serving testimony "can appropriately be viewed with some diffidence unless supported by other facts which bring the transaction much closer to a normal arms-length loan." Berthold, 404 F.2d at 122; Tyler v. Tomlinson, 414 F.2d 844, 850 (5th Cir.1969) ("We therefore look not to mere labels or to the self-serving declarations of the parties, but to more reliable criteria of the circumstances surrounding the transaction.").

Jaques argues that...