U.S. v. Harvey, 93-1646

• Decision Date: 22 June 1993
• Docket Number: No. 93-1646,93-1646
• Citation: 996 F.2d 919
• Parties: 93-2 USTC P 50,368 UNITED STATES of America, Plaintiff-Appellee, v. James HARVEY, Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 919

996 F.2d 919

93-2 USTC P 50,368

UNITED STATES of America, Plaintiff-Appellee, v. James HARVEY, Defendant-Appellant.

No. 93-1646.

United States Court of Appeals Seventh Circuit.

Argued June 1, 1993.

Decided June 22, 1993.

William T. Grimmer, Asst. U.S. Atty. (argued), Office of the U.S. Atty., South Bend, IN, for plaintiff-appellee.

Mark S. Lenyo (argued), Allen, Fedder, Herendeen & Kowals, South Bend, IN, for defendant-appellant.

Before POSNER, COFFEY, and EASTERBROOK, Circuit Judges.

EASTERBROOK, Circuit Judge.

The Sentencing Guidelines use "tax loss" as the foundation for determining the appropriate sentence for tax evasion and other violations of the revenue laws. The Guidelines define "tax loss" as "28 percent of the amount by which the greater of gross income and taxable income was understated, plus 100 percent of the total amount of any false credits claimed against tax. If the taxpayer is a corporation, use 34 percent in lieu of 28 percent." U.S.S.G. § 2T1.3(a). This rough-and-ready calculation applies the highest marginal rate to the amount of concealed income, disregarding deductions that would have been available had the taxpayer filed an honest return.

Our case presents the question: What happens when a single crime causes both corporate and personal income to be understated? One common tax crime occurs when the manager and dominant investor in a closely held corporation distributes the firm's income to himself, not reporting it at either the corporate or personal level. Here is a simple example: the manager and principal shareholder of a corporation sells some of the corporation's inventory, producing a $100,000 profit that he diverts to his own use. This is a disguised dividend from the corporation, with income taxable at two levels: the corporation is supposed to pay an income tax on its profits, and the manager owes tax on the dividend income. United States v. Mews, 923 F.2d 67 (7th Cir.1991). Suppose the manager, responsible for both the corporation's and his own failure to pay, is convicted of tax evasion. There are at least three ways to compute the "tax loss": (a) apply the 28% rate to the manager's income of $100,000, for a tax loss of $28,000; (b) apply the corporate rate of 34% to the unreported profit of $100,000 and the personal rate of 28% to the unreported income of the same $100,000, for a tax loss of $62,000; (c) apply the corporate rate of 34% to the unreported profit of $100,000 and reduce the imputed dividend by the amount of imputed taxes, then apply the personal rate of 28% to the reduced dividend of $66,000, for a tax loss of $52,480. Method (c) assumes that the corporation, having paid $34,000 to the United States, distributes as a "dividend" only $66,000, the after-tax profit.

James Harvey pleaded guilty to tax evasion patterned after our example, except that the corporation distributed scrap aluminum rather than cash. Harvey sold the aluminum and kept the proceeds (some $81,000), reporting neither corporate nor personal income. The district court applied Method (b) to this amount. Insisting that Method (b) is "double taxation", Harvey argues for Method (a). We conclude that Method (c) is more accurate than either.

One may debate the wisdom of the corporate income tax, but our current system calls for sequential taxation of the same income. Corporate profits are taxed to the corporation, then taxed as personal income after distribution to the investors. Dividends, unlike repayments of debt, are not deductible at the corporate level even though both reflect the firm's cost of capital. When a single transaction bypasses both corporate and personal taxes, any effort to determine the "tax loss" must include both. (Harvey's corporations did not qualify under Subchapter S of the Internal Revenue Code, which ascribes corporate income directly to the investors and avoids sequential taxation.) Harvey refers to the last sentence of § 2T1.3(a): "If the taxpayer is a corporation, use 34 percent rather than 28 percent." This means, he insists, that the judge cannot apply both 28% and 34% to the same income. True enough: the personal rate is 28%, and the corporate rate 34%; no one has a rate of 62%. Still, the sentence speaks of "the taxpayer", not "the defendant" and does not speak directly to the person whose crime causes two taxpayers to understate their income and pay less to the Internal Revenue Service.

Application Note 3 to § 2T1.3 implies an answer to the multiple-taxpayer case in remarking: "In determining the total tax loss attributable to the offense ..., all conduct violating the tax laws should be considered as part of the same course of...