Alexander Shokai, Inc. v. C.I.R.

• Decision Date: 02 September 1994
• Docket Number: No. 93-70101,93-70101
• Citation: 34 F.3d 1480
• Parties: -6150, 94-2 USTC P 50,460 ALEXANDER SHOKAI, INC.; Edward Alexander; Estelle Alexander, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1480

34 F.3d 1480

74 A.F.T.R.2d 94-6150, 94-2 USTC P 50,460

ALEXANDER SHOKAI, INC.; Edward Alexander; Estelle Alexander, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Respondent-Appellee.

No. 93-70101.

United States Court of Appeals Ninth Circuit.

Argued and Submitted June 8, 1994.

Decided Sept. 2, 1994.

Ronald K. Van Wert, Newport Beach, CA, for petitioners-appellants.

Sara S. Holderness, Tax Div., U.S. Dept. of Justice, Washington, DC, for respondent-appellee.

Appeal from a Decision of the United States Tax Court.

Before: FARRIS, O'SCANNLAIN and TROTT, Circuit Judges.

FARRIS, Circuit Judge:

Taxpayers Alexander Shokai, Inc., Edward Alexander and Estelle Alexander appeal the decision of the tax court denying them a redetermination of approximately $2 million in back taxes and penalties asserted by the Commissioner. The tax court had jurisdiction under 26 U.S.C. Secs. 6213, 6214 and 7442. We have jurisdiction pursuant to 26 U.S.C. Sec. 7482, and we affirm.

I. Facts

In the 1960's, Gosen Co., Ltd., a Japanese manufacturer of tennis strings, granted Edward Alexander the right to sell its string as a wholesaler in the United States. The business began in the home of Mr. Alexander and his wife, Estelle Alexander. In the 1970's the business was incorporated under the name E. Alexander, Inc. (EAI), a California corporation. Mr. Alexander was the sole stockholder of EAI.

In the early stages of the business, Mrs. Alexander performed various duties for EAI. After an office assistant was hired in the late 1970's, Mrs. Alexander's duties were sharply curtailed. She nevertheless received a salary averaging $36,000 per year in 1980, 1981 and 1982. The salary payments were deducted from EAI's income.

In 1979, Gosen agreed to pay EAI a 10% commission on all sales made by Gosen to EAI and to all foreign customers of EAI. ¹ A currency exchange agreement was also entered into between EAI and Gosen. Pursuant to this agreement, if the exchange rate of yen to dollars fluctuated by a certain amount from the time Gosen billed EAI to the time EAI paid Gosen, Gosen agreed to repay that amount to EAI.

Gosen and Mr. Alexander also entered into an oral agreement that if the Japanese National Tax Administration ("JNTA") disallowed Gosen a deduction for any payment made to Mr. Alexander pursuant to the Gosen agreements, he would be required to personally repay Gosen. The JNTA completed an audit of Gosen in 1984, at which time it allowed Gosen deductions for the payments it had made to Mr. Alexander.

Although the written agreements were between EAI and Gosen, the commission and currency fluctuation payments (the Gosen payments) were made directly to a Japanese account owned by Mr. Alexander. Between March 4, 1980 and February 28, 1984, Gosen paid Mr. Alexander $944,269.22 pursuant to the commission and currency exchange agreements. From 1980 to 1983, Mr. Alexander withdrew $565,551 from the account to pay for traveling expenses while in Japan and to deposit into his personal bank accounts in the United States.

Mr. Alexander described the Gosen payments to his friend and retired accountant, Kenneth Bartelt. According to Mr. Alexander, Kenneth Bartelt advised him that the payments would not be taxable in the United States unless brought into the United States. Kenneth Bartelt's son, Edward Bartelt, was employed to prepare EAI's and the Alexanders' federal income tax returns. Mr. Alexander did not inform Edward Bartelt of the Gosen agreements or payments.

None of Gosen's payments to Mr. Alexander were deposited into EAI's corporate bank account or recorded on EAI's books. None of the payments were reported as income on Mr. Alexander or EAI's federal income tax returns for the 1980-1983 tax years.

After completing its audit of Gosen in 1984, the JNTA notified the IRS of the existence of the Gosen agreements, the Gosen payments and Mr. Alexander's Japanese bank account. After an IRS investigation had begun, Mr. Alexander met with Edward Bartelt and some other financial advisers. They concluded that the Gosen payments had not accrued as income until the JNTA had finished its 1984 audit because, until then, Mr. Alexander had the contingent obligation to repay Gosen in the event the JNTA disallowed the deductions. Alexander Shokai, Inc., a California corporation, was formed in 1982 with Mr. Alexander as its sole owner. In 1984, EAI and Alexander Shokai, Inc. merged, with Alexander Shokai, Inc. remaining as the surviving corporation. Alexander Shokai, Inc. reported the income from the Gosen payments on its 1984 income tax return. Mr. and Mrs. Alexander reported the income from the Gosen payments on their 1984 joint federal income tax return as well.

In 1989, the IRS issued a notice of deficiency to Alexander Shokai, Inc., as successor to EAI. The IRS claimed that EAI had received unreported income from Gosen and that the $36,000 salary paid to Mrs. Alexander from 1980-1982 was improperly deducted. The IRS also maintained that EAI was liable for additions to tax for tax fraud (1980-1983), 26 U.S.C. Sec. 6653(b), and substantially understating income (1982-1983), 26 U.S.C. Sec. 6651(a).

The IRS sent separate notices of deficiency to Mr. and Mrs. Alexander. It determined that the Gosen payments were gross receipts of EAI which had been diverted by Mr. Alexander for his own use and maintained that Mr. Alexander was liable for additions to tax for substantially understating income (1982-1983) and for tax fraud (1980-1983). Mrs. Alexander was not implicated in the alleged tax fraud.

The tax court agreed with the Commissioner that the Gosen payments constituted gross receipts of EAI which had been diverted by Mr. Alexander for personal use. The tax court ruled that both EAI and Mr. Alexander were liable for substantially underreporting income and tax fraud (Mr. Alexander's fraud was imputed to EAI). Mrs. Alexander was jointly and severally liable for Mr. Alexander's penalties pursuant to 26 U.S.C. Sec. 6013(d)(3). The tax court determined that EAI was not entitled to deduct the $36,000 salary payments to Mrs. Alexander from 1980-1982.

II. The Ex Parte Communications

Taxpayers argue that the tax court should have granted their motion for a new trial because improper ex parte communications took place between Commissioner's counsel and the tax court. We review facts that may have deprived Taxpayers of a fair trial de novo. United States v. Milner, 962 F.2d 908 (9th Cir.), cert. denied, --- U.S. ----, 113 S.Ct. 614, 121 L.Ed.2d 548 (1992). We have held that ex parte communications will be tolerated only in light of a "compelling justification." Guenther v. Commissioner, 939 F.2d 758, 760 (9th Cir.1991). To determine whether Taxpayers' due process rights were violated, we must determine whether Taxpayers were "unfairly prejudiced" by the ex parte communications. Id.

The ex parte communications Taxpayers complain of occurred on December 10, 1990 during a pretrial calendar call hearing. The only item noticed to be heard was a third party motion to quash a subpoena served by the Commissioner. Taxpayers' counsel was excused from attending the hearing.

Some of the discussions at the hearing related to the motion to quash. Those discussions were not improper because Taxpayers opted not to attend the hearing knowing that the tax court would rule on that motion.

However, after the tax court had ruled on the motion to quash, it allowed the Commissioner's counsel to file several documents, including (1) a motion in limine, (2) an opposition to Taxpayers' motion in limine, and (3) a motion to compel document production. In the absence of Taxpayers' counsel, the tax court and the Commissioner's counsel proceeded to discuss the merits of the documents that were filed. The tax court also inquired as to the status of the Commissioner's deposition of Yutaka Takashima, Gosen's president. The Commissioner's counsel responded that he felt as though he was being "stonewalled" by Gosen. Finally, the Commissioner's counsel informed the tax court that he was having serious problems reaching factual stipulations with Taxpayers' counsel. The tax court expressly stated that it would not make any rulings until Taxpayers' counsel could be heard.

We have carefully reviewed the record. What should have been limited to a hearing on the motion to quash a subpoena turned into a discussion of the merits of the case. The ex parte communications were improper. We must determine whether Taxpayers were "unfairly prejudiced."

In Guenther, the Commissioner's counsel filed a 32 page memorandum with the tax court without serving it on or disclosing it to taxpayers' counsel. The memorandum was highly partisan, alleging misconduct on the part of taxpayers and criticizing taxpayers' anticipated trial testimony. See Guenther, 939 F.2d at 760. We held that taxpayers were unfairly prejudiced because (1) "[t]he allegations raised [in the memorandum] were serious, going both to the merits of the case and to the Guenthers' character generally" and (2) the Guenthers did not have "an adequate opportunity to rebut the contentions effectively." Id. at 761.

The communications in this case were less egregious than those in Guenther. Taxpayers were served with every document filed with the tax court in their absence. The tax court expressly stated it would not rule on any of the motions until Taxpayers had a chance to respond. Taxpayers had an adequate opportunity to respond at trial. Our review of the trial transcript convinces us that the ex parte communications did not taint the trial. Although the ex parte communications were improper, we find that Taxpayers were not unfairly prejudiced.

III. Attacks on Taxpayers' Counsel

Taxpayers contend that the tax court and Commissioner's counsel improperly attacked the integrity of Taxpayers' counsel. They argue that the tax court should have exercised more control over Commissioner's counsel. They also point to...