In re Carmel, Bankruptcy No. 84 B 8411

• Decision Date: 20 December 1991
• Docket Number: No. 89 A 1134.,Bankruptcy No. 84 B 8411,89 A 1134.
• Citation: 134 BR 890
• Parties: In re Richard J. CARMEL, Debtor. Richard J. CARMEL, Plaintiff, v. UNITED STATES of America, Commissioner of Internal Revenue Service, Defendants.
• Court: U.S. Bankruptcy Court — Northern District of Illinois

134 B.R. 890 (1991)

In re Richard J. CARMEL, Debtor Richard J. CARMEL, Plaintiff, v. UNITED STATES of America, Commissioner of Internal Revenue Service, Defendants.

Bankruptcy No. 84 B 8411, No. 89 A 1134.

United States Bankruptcy Court, N.D. Illinois, E.D.

December 20, 1991.

COPYRIGHT MATERIAL OMITTED

Michael Hyman, Jeffrey Strange & Assoc. Wilmette, Ill., for plaintiff.

Benjamin Norris, Trial Atty., Tax Div., Dept. of Justice, Washington, D.C., for defendants.

MEMORANDUM OPINION

ERWIN I. KATZ, Bankruptcy Judge.

This matter comes before the Court on the Debtor's Complaint seeking a Determination of Tax Liability pursuant to section 505 of the Bankruptcy Code, Title 11, U.S.C. § 505. The Court has jurisdiction over this matter pursuant to Title 28, U.S.C. § 1334(b). The Complaint alleges that for the taxable years 1981 through 1984, the Commissioner erroneously determined that a tax deficiency existed by (1) treating funds embezzled by the debtor from various entities as taxable income; (2) treating funds reported as compensation to the Debtor on the corporate tax return of Debtor's professonal services corporation as taxable income when such funds actually represented loans to the Debtor; (3) disallowing the deduction of losses incurred through the Debtor's stock option trading activities from the Debtor's embezzlement and other income on the grounds that the Debtor was not a dealer in stock options; (4) disallowing certain tax shelter losses and adding a penalty under Internal Revenue Code § 6661 for substantial understatement of income; and (5) adding various penalties under Internal Revenue Code § 6653 for fraudulent nonpayment of tax, under § 6654 for failure to pay estimated income tax, and under § 6661 for substantial understatement of tax liability. The United States filed an Answer to the Complaint which denies that the Commissioner erred in determining the tax deficiency. An evidentiary hearing was held in this matter, the parties presented post-trial oral arguments to the Court, and this matter was taken under advisement.

Having fully reviewed the evidence presented and the arguments and submissions of the parties, the Court finds that: (1) the income embezzled by the Debtor constitutes ordinary income taxable to the Debtor; (2) the Debtor failed to prove that the funds received from his professional service corporation actually represented loans to the Debtor, and thus the funds were properly treated as ordinary income received as compensation for services rendered; (3) the Debtor's stock market trading activities represent a trade or business in which the Debtor was engaged within the meaning of Internal Revenue Code § 62 and § 162, so that the Debtor may deduct the ordinary and necessary expenses of producing such business income; (4) the losses incurred by the Debtor as a result of the stock market trading activities constitute capital losses within the meaning of Internal Revenue Code § 1211 and § 1221, since the stocks and options traded did not constitute property properly included in the Debtor's inventory and the Debtor was not a dealer in such property; and (5) the Debtor's alleged gambling disorder did not preclude him from forming the requisite fraudulent intent to willfully evade payment of taxes for any of the tax years in question so that fraud penalties were properly applied pursuant to Internal Revenue Code § 6653. The following shall constitute the Court's Findings of Fact and Conclusions of Law pursuant to Bankruptcy Rule 7052.

FACTS

The parties have submitted a limited Stipulation of Facts addressing the general magnitude and scope of the Debtor's trading activities for the years in question. A copy of this Stipulation is attached hereto and made a part hereof. In addition, the parties have asked the Court to take judicial notice of the decisions of the Seventh Circuit Court of Appeals and the District Court for the Northern District of Illinois regarding the Debtor's conviction for mail and wire fraud. United States v. Carmel, 801 F.2d 997 (7th Cir.1986); Carmel, 84 CR 508, Findings of Fact, Conclusions of Law, Opinion and Verdict (N.D.Ill.1985) (Will, J.). Based on this stipulation, the prior findings of these courts and the evidence presented therein, the Court makes the following findings of fact.

The Debtor in this proceeding, Richard J. Carmel, was a licensed attorney practicing in the State of Illinois since approximately 1960. The Debtor formed a professional service corporation, Richard J. Carmel, Ltd., in 1977 through which he engaged in the practice of law. The Debtor was the sole officer and shareholder of this corporation. The corporation subsequently became a partner in the law firm of Fischel & Kahn, with which the Debtor was associated. The Debtor's practice of law concentrated primarily in the area of real estate transactional law, with very limited income tax experience. In addition to his law practice, the Debtor engaged in heavy trading on the stock and options market. During the period in question, 1981 through 1984, the Debtor traded in stock options on the Chicago Board Options Exchange and the American Options Exchange, among others. The Debtor also traded in stocks with the following brokerage houses: Rodman & Renshaw, Cowen & Company, Interbank Equity Corporation, Dean Witter & Reynolds, among others. At no time, however, did the Debtor trade actively on the floor of any stock or options exchange. He was never a member of any exchange, nor was he a registered broker, dealer or underwriter of securities. He had no customers of his own and received no commissions for his trading activities. The Debtor's activities consisted solely of trading on his own behalf through brokerage houses.

The Debtor testified that, in connection with his trading activities, he would call his brokers several times throughout the trading day in order to obtain information regarding his positions and general market activity. He testified that during 1981 approximately 30% of his day was spent in trading activities; in 1982 approximately 50% of the day; in 1983, 60-65%, and in 1984, 75-80% of his day was spent in trading activities. He further testified that in 1981 the average dollar value of his trading transactions consisted of hundreds of thousands of dollars; in 1982, several hundred to several million dollars; in 1983, several hundreds of thousands to several million dollars, reaching a high of approximately $2.7 million; and in 1984 the magnitude of the transactions was several hundreds of thousands to several million dollars. The attached stipulation also addresses the general magnitude of the Debtor's activities, and without making an actual finding regarding the specific dollar values involved, the Court accepts the validity of these assertions. The Debtor testified that he was a day trader, meaning that he traded on the basis of certain technical considerations, attempting to take advantage of short-term movements in the marketplace. He was not concerned with profit due to dividends or long-term capital gain, focusing instead on short-term profits in his trading activities. The Debtor testified that he typically bought calls, although occasionally he dealt in puts also.¹ According to the Debtor, due to various downturns and fluctuations in the market, he suffered severe losses in his trading activities and was forced to discontinue these transactions in March of 1984.

In connection with losses incurred through his market activities, the Debtor began the practice of embezzling funds from the accounts of certain clients involved in his law practice and from family members. The Debtor devised a scheme through which he embezzled approximately $7.5 million by defrauding various entities over a ten-year period. The Debtor testified that this embezzlement and stock market activity began as early as 1972 and lasted through March of 1984. Certain checks were presented in evidence reflecting funds allegedly embezzled from the Debtor's various clients, and the Debtor testified regarding those transactions. The Court also takes judicial notice of the prior convictions for mail and wire fraud relating to these embezzlement activities entered by the District Court for the Northern District of Illinois, and the criminal appeal to the Seventh Circuit Court of Appeals upholding those convictions. United States v. Carmel, 801 F.2d 997 (7th Cir.1986); Carmel, 84 CR 508, Findings of Fact, Conclusions of Law, Opinion and Verdict (N.D.Ill.1985) (Will, J.). The Debtor testified that on March 14, 1984, he confessed his embezzlement and stock market gambling activities and a criminal investigation was begun shortly thereafter. As a result of this investigation, the Debtor was convicted of mail and wire fraud by the District Court for the Northern District of Illinois and was sentenced to a period of incarceration lasting from June 10, 1985 through March of 1988. At that time the Debtor was released to a half-way house where he remained until August 31, 1988, when his sentence was completed.

The Debtor testified that in connection with his trading activities, he would prepare certain records of his positions. According to the Debtor, he did not maintain these records in any systematic manner and would routinely destroy such records a few days after their preparation. In addition to his own calculations and hand-prepared records, the Debtor received trading slips and statements of his accounts from his various brokers which provide some evidence of the transactions involved in his trading activities during the period in question.

This matter is now before the Court in connection with the Debtor's failure to file tax returns reporting his embezzlement income and his stock market activities for the taxable years 1981 through 1984. The Debtor did not file personal income tax returns for any of the tax years in question. The Debtor testified that he did feel that he owed some...