Baumgardner v. Commissioner of Internal Revenue

• Decision Date: 21 December 1957
• Docket Number: No. 15397.,15397.
• Citation: 251 F.2d 311
• Parties: Milford R. BAUMGARDNER and Pearl E. Baumgardner, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

251 F.2d 311 (1957)

Milford R. BAUMGARDNER and Pearl E. Baumgardner, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 15397.

United States Court of Appeals Ninth Circuit.

December 21, 1957.

COPYRIGHT MATERIAL OMITTED

George Bouchard, Los Angeles, Cal., for appellants.

Charles K. Rice, Asst. Atty. Gen., Arthur I. Gould, John N. Stull, A. F. Prescott, Attys., Dept. of Justice, Washington, D. C., for appellee.

Before LEMMON and BARNES, Circuit Judges, and YANKWICH, District Judge.

YANKWICH, District Judge.

The problems involved in this petition to review the decision of the Tax Court entered on August 30, 1956, determining deficiencies for the years, 1942, 1944, 1947, 1948, 1949, 1950 and 1951, and assessing penalties for some of the years involved, 1945, 1947, 1948, 1949, 1950 and 1951, which included fraud penalties for some of the years are chiefly factual.¹ This court has repeatedly stated the limited scope of our review of Findings of the Tax Court.²

Given the opportunity of the trial court to appraise the credibility of witnesses in front of it, we will not ordinarily hold a ruling to be clearly erroneous unless

"the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed."³

This Court has summed up the problem succinctly in one of the cases just cited:

"It is not our function to retry the case. Unless clear error appears, we cannot disturb a Tax Court\'s finding or conclusion."⁴

I.

The Net Worth Method.

The real party in interest in this case is Milford R. Baumgardner. His wife was joined merely because, under the community property law of California, she joined in making some of the returns. The Court found her guiltless of any fraud. So when we refer to the "taxpayer", we are referring to Baumgardner.

The Tax Court modified in some respects the determinations of deficiencies made by the Commissioner. As they were favorable to the taxpayer, he is not complaining of them. So in what follows we will refer only to the Findings to which objection is made. Before doing so, it is well to advert to the fact that where the taxpayer, a man who for many years had held office in the police department and for several years was Chief of Police of a small city, has a fair education and enjoys membership in religious and fraternal organizations, having held official positions in some of them, chooses not to keep books to record his business transactions, or preserve records and data from which exact computations can be made, he bears the responsibility for the consequent lack of certitude in estimating his tax:

"Absolute certainty in such matters is usually impossible and is not necessary; the Board should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making."⁵

This Court applied the principle in a case involving a taxicab driver who objected to a determination of a deficiency based upon an approximation of his annual earnings:

"The petitioner had kept no books. So the Tax Court had to determine the amount from such evidence as was presented to them. If the result is an approximation, the lack of exactitude is traceable to the petitioner\'s own failure to keep accurate accounts."⁶

II.

The Badges of Fraud.

Failure to make or keep records usual in business transactions is one of the badges of fraud in tax cases.⁷ The burden, of course, is upon the Commissioner to prove fraud.⁸ Where books are not available and the Commissioner resorts to the net worth method of proving the tax due, the Tax Court must follow the cautionary considerations laid down by the Supreme Court in the cases dealing with matters of this character.⁹ However, the Supreme Court did not lay down any rigid formulas by which fraud in tax cases, whether civil or criminal, should be determined. It merely pointed to the unreliability of some of the methods used in computing net worth. Significantly, in none of the cases referred to was there a reversal because of the use of the method. And the only one in which the Court of Appeals had reversed the conviction the Supreme Court affirmed.¹⁰ And Courts of Appeals, since the promulgation of these decisions, have adhered to the view that even in net worth cases, the conclusions and inferences drawn from admitted facts by the Tax Court will not be disturbed unless there is clear or palpable error.¹¹ This principle will be applied although the tax reported corresponds with the books of the taxpayer. The Court of Appeals for the Seventh Circuit has summed up the matter in this language:

"Taxpayer obviously overlooks the fact that the net worth technique of computing income is not a method of accounting. It is no more than proof of income by circumstantial or indirect evidence. If a taxpayer\'s net worth has increased over a period of time and the increase is not due to nontaxable receipts or nontaxable appreciation of assets, the conclusion is inescapable that taxable income has been received. The fact that the taxpayer\'s books and other records are consistent * * * proves nothing more than that they are * * * truthful or accurate. See Holland v. United States, 348 U.S. at pages 131-132, 75 S.Ct. at page 133. In short, the apparent adequacy of the taxpayer\'s books is the very thing that the net worth method attacks by independently demonstrating the receipt of unrecorded and unreported taxable income. The Holland decision makes it clear that there are no conditions precedent to the utilization of the net worth technique."¹²

III.

The Facts Proved.

Many of the facts in the case are not questioned either because shown by undisputed testimony or by stipulations and exhibits in the record. A detailed statement of the facts is found in the Tax Court's opinion. We will give a brief summary only. For in this proceeding the only findings actually in dispute are those relating to cash on hand at the beginning of the net worth period, December 31, 1940, the taxpayer's interest in the Embassy Club, a legalized card club at Gardena, California, and the general finding of fraud which reads:

"The returns for each of the years in which there is a deficiency, except those for the years 1945 and 1947 filed by Pearl, were false or fraudulent with intent to evade tax and part of the deficiency in each of such years was due to fraud with intent to evade tax."

A. Ownership of Interest in Card Club

We will dispose of the card club ownership first. It is argued that the taxpayer did not receive any profits from the Club.

The finding as to his interest in the Club is amply sustained in the record. There is on file an amendment to the Articles of Incorporation of the Club signed and verified by the taxpayer on January 1, 1951, which shows his ownership of a 5% interest in the net profits of the club as a limited partner. This was a gift to him by another of the partners. The amended articles were filed in the official records of Los Angeles County on February 5, 1951. The income tax return filed by the Club showed the sum of $1,116.54 as his distributive share of the profits for the year 1951. On March 10, 1952, the accountant for the Club notified the taxpayer of that fact, "showing the figures that he should use on his personal return", as he testified at the trial. So the Tax Court was right in considering this unreported amount in determining the taxable income.

B. The Taxpayer's Business Activities

Before considering the other two items, certain facts culled from the record should be referred to.

The taxpayer has resided in the City of Hawthorne, California, since 1924. He came from Oklahoma where he was born in 1903. While he claimed that he had saved two or three thousand dollars while working in Oklahoma, there was no positive evidence produced to show how he accumulated the money on the small salary he received. After working as a fireman he began to work for the Police Department of Hawthorne in 1930. He became Chief of Police in 1937, — a position he occupied until retirement in June, 1953. Joint returns were filed for all years except 1945 and 1947 for which years separate returns were filed. His work for the City of Hawthorne began in 1925. At that time he evidently worked for a brief period only, for his income from the City was $45. In 1926, his income was $1,770. He received no income from the City of Hawthorne in 1933, his services having been terminated on October 24, 1932. But he was rehired May 14, 1934. In 1944, his salary was $2,820.07. From then it rose until in 1951 when it was $6,061.70. Prior to 1942, the taxpayer had paid no income tax. Indeed, he did not file income tax returns for the years 1930 to 1939 inclusive. For the years 1940 and 1941, he filed returns showing no tax.

Other facts which have special significance should also be referred to. They are given with slight modification in the form in which they appear in the Findings of the Tax Court. For, in the main, they are not disputed.

In June of 1937, the taxpayer applied to the Bank of America for a loan of $200 to pay off another obligation with the bank which then had a balance of $65.98 and to take care of funeral expenses of $140. This loan was rejected. On the loan application, which was signed by the taxpayer, appears the information that there was at this time $250 owing by the taxpayer to Acme Loan which was being paid off in monthly installments of $32.08, $105 owing to Inglewood Furniture which was being paid off in monthly installments of $5 and $70 owing to Federal Outfitting Company which was being paid off in monthly installments of $4. On this application, the taxpayer listed no other income or no source of income other than from the Police Department, although the application specifically asked for this information, under the typed headings "other income" and "source of other income". The application was filled out in handwriting (print). Through the...