East v. Comm'r of Internal Revenue

• Decision Date: 26 August 2013
• Docket Number: No. 12–2652.,12–2652.
• Citation: John E. v. Comm'r of Internal Revenue, 728 F.3d 673 (7th Cir. 2013)
• Parties: John E. and Frances L. ROGERS, Petitioners–Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

728 F.3d 673

John E. and Frances L. ROGERS, Petitioners–Appellants,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.

No. 12–2652.

United States Court of Appeals, Seventh Circuit.

Argued April 19, 2013.

Decided Aug. 26, 2013.

John Edward Rogers(submitted), Attorney, Rogers & Associates, Chicago, IL, for Petitioners–Appellants.

Ellen P. DelSole (submitted), Richard Farber, Attorneys, Department of Justice, Washington, DC, for Respondent–Appellee.

Before EASTERBROOK, Chief Judge, and POSNER and WILLIAMS, Circuit Judges.

POSNER, Circuit Judge.

A trial before the Tax Court resulted in a determination that in 2003John Rogers and his wife had failed without justification to report $984,655 of taxable income attributable to income of Portfolio Properties, Inc.(PPI), an S corporation wholly owned by Mr. Rogers, and to a distribution that he had received from PPI.T.C. Memo 2011–277, 102 T.C.M. (CCH) 536(2011).For tax purposes the income of an S Corporation is deemed the personal income of the shareholders, 26 U.S.C. § 1366, in this case the share-holder.After the Tax Court rejected Rogers' arguments—repeated in this appeal—that the disputed income had been held in trust for third parties and so wasn't taxable to him, the parties stipulated that if Rogers' arguments were rejected he had a tax deficiency of $269,107 and also owed the government a $5000 penalty.(We disregard his wife.Although the couple filed a joint return, she appears to have had nothing to do with the shenanigans that gave rise to the deficiency.)As a detail, we remark the minuteness of the penalty.The Tax Court determined that Rogers' $269,107 tax deficiency was attributable to his “substantial understatement of income tax,” which is penalized by 26 U.S.C. § 6662(a).The penalty specified in the statute is 20 percent of the deficiency, but the stipulation we mentioned states that only a 5 percent penalty would be imposed, we know not why.

This is a companion case to Superior Trading, LLC v. Commissioner,, 728 F.3d 676(7th Cir.2013), also decided today, in which we uphold the disallowance of losses claimed by companies created by Rogers to implement a distressed asset/debt tax-shelter (“DAD”) scheme.We also uphold the imposition of a “gross valuation misstatement” penalty.Though the éminence grise of the unlawful tax shelter, Rogers was not a party to that case, the deficiency and penalty assessed against him in this case arose from his creation of the shelter.

Rogers had created a partnership called Warwick Trading, LLC.The partners were a Brazilian retailer named Lojas Arapuã S.A. that contributed receivables to the partnership that were worth a small fraction of their face amount because they were largely uncollectible, and a company owned by Rogers named Jetstream Business Limited that was designated Warwick's managing partner, responsible for collecting the receivables.Because property contributed to a partnership retains its original basis no matter how far its market value has fallen, the receivables had the potential to generate losses that would be deductible from the taxable income of U.S. taxpayers who later entered the partnership, though in Superior Tradingwe hold that the potential could not be realized because, among other reasons, the partnership was a sham.

Rogers had created PPI—which plays a critical role in this case—to sit between himself and Jetstream.The tax shelter was sold to U.S. taxpayers for a total of $2.4 million.Half was the purchase price of partnership interests in Warwick.The other half appears to have been a payment to Rogers (via PPI) for creating the shelter.Rogers directed the buyers of the interests (the shelter investors) to wire the entire $2.4 million to PPI's bank account rather than Warwick's, telling them that Warwick lacked adequate banking facilities.PPI funneled half the money received from the investors to Warwick to pay Arapuã for the receivables that undergirded the partnership interests that the shelter investors were acquiring, but retained the other half.The Tax Court deems the half (i.e., $1.2 million) retained by PPI taxable income of Rogers; he reported less than half of it as income.

He argues that the $1.2 million retained by PPI (some of which, however, PPI distributed to him) was held in trust for the benefit of Warwick and that therefore the alleged tax deficiency was a “partnership item” and so should have been resolved “at the partnership level,”26 U.S.C. §§ 6221,6225,6226, and so not in this case, which is about personal not partnership income.Superior Trading is the case that deals with the partnership level of Rogers' tax shelter, and the issue of the Rogers' alleged tax deficiency was not raised in that case.But the Tax Court ruled in the present case that the money received by PPI and either retained by it or distributed to Rogers but not forwarded to Warwick was not held in trust for Warwick—it was PPI's money—and so the tax status of that money was not an issue for resolution in a partnership-level case.

There is no documentation evidencing a trust.Rogers describes the money as “imprest [ sic ] with a trust for the benefit of Warwick.”That sounds a little like a constructive trust, which indeed usually...