In re Katz
| Decision Date | 10 June 1994 |
| Docket Number | Bankruptcy No. 90-39248-BKC-RAM,92-0566-BKC-RAM-A. |
| Citation | 168 BR 781 |
| Parties | In re Scott William KATZ, Debtor. Daniel L. BAKST, Trustee and Scott William Katz, Plaintiffs, v. UNITED STATES of America, Defendant. |
| Court | U.S. Bankruptcy Court — Southern District of Florida |
David S. Meisel, Daniel L. Bakst, Ackerman, Bakst, Cloyd & Scherer, West Palm Beach, FL, for plaintiffs.
David R. Smith, Dist. Counsel, IRS, Kendall B. Coffey, U.S. Atty., Civ. Div., Miami, FL, A.B. Phillips, Tax Div., U.S. Dept. of Justice, Washington, DC, for defendant.
The Court has before it the complaint of the trustee, Daniel L. Bakst, as trustee of the estate of Scott William Katz (Debtor), to Determine Tax Liability under 11 U.S.C. § 505 and Objection to Claims of the Internal Revenue Service (the "Government"). The Government filed a proof of claim on April 10, 1991 in the amount of $1,426,123.78 based on alleged deficiencies, interest and penalties for the years 1985 through 1988. On June 11, 1992 the trustee filed a Complaint to Determine Tax Liability and Objection to Claims of Internal Revenue Service. After the Government answered the complaint, the Debtor sought, and on June 22, 1993 was granted, leave to intervene as a party plaintiff. (The Debtor and the trustee will hereafter be referred to as the "Plaintiffs.") On June 28, 1993 the Government filed a Motion in Limine regarding the burden of proof in the adversary proceeding. On October 12, 1993 a hearing was held on the Motion in Limine, and on October 20, 1993, reading his findings and conclusions into the record, Judge Mark entered an interlocutory order placing the burden of proof on the Government. The Government appealed the October 20 ruling, and filed a Motion for Stay Pending Appeal on November 4, 1993. The Motion for Stay Pending Appeal was argued before the Court on November 9, 1993. Finding no likelihood of success on the appeal, citing In re Rasbury, 141 B.R. 752 (N.D.Ala.1992) and In re Premo, 116 B.R. 515 (Bankr.E.D.Mich.1990), Judge Mark denied the motion. That appeal is pending before the district court.2 Trial was held and post-trial briefs have been submitted. During the course of the trial, the parties stipulated, and the Court found, that the Debtor's total revised net taxable income for 1988 amounted to $9,542.72. The parties further stipulated that there were no outstanding issues regarding the 1988 tax year. Therefore, the Court will only address the years 1985 through 1987.3
The Government based the part of its case relating to the Debtor's purportedly unreported income on the theory that any deposits into the Debtor's bank accounts during the years in question that were not otherwise demonstrated to be nontaxable transfers constituted income. This method of calculating tax liability is referred to as the "bank deposits" method.4
After considering the arguments and evidence, the Court finds that (1) the Debtor's income for 1985, 1986 and 1987 is accurately reflected in his income tax returns; (2) the Debtor shall be allowed Schedule C deductions in the amount of $11,350 for 1985 and $8,540 for 1986; and no Schedule C deductions shall be allowed for 1987; and (3) the Debtor shall be allowed a deduction for investment interest for 1987 in the amount of $66,691.
The Court's jurisdiction to hear this matter derives from 28 U.S.C. § 1334. It is a core proceeding under 28 U.S.C. § 157(b)(2)(B). This memorandum opinion constitutes the Court's findings of fact and conclusions of law in accordance with Fed. R.Bankr.P. 7052.
The Debtor testified without rebuttal regarding his accumulation of wealth and his professional and business activities. He practiced law from 1981 until he was disbarred in July, 1986. He maintained a solo practice and handled proceedings from simple divorce matters to DWI's out of an office located at 3923 Lake Worth Road. During the first half of 1986, he was under criminal indictment and sanctions of the Florida Supreme Court. His criminal trial was held on June 30, 1986, resulting in a dismissal of the charges. The parties have stipulated that he ceased practicing law on July 26, 1986 after he was disbarred by the Florida and Oklahoma state courts.
The Debtor testified that he had accumulated considerable wealth prior to 1985. He testified to a net worth in 1985 of roughly $1,400,000, derived from inheritances and gifts from his father and grandmother, the law practice, real estate ventures, running two restaurants, and interest from savings accounts and CD's. He testified that money from his family went into the accounts prior to 1985, and that most of the deposits during 1985 were from share loans.5 He testified that he took out share loans of at least $250,000 from City Federal Savings and Loan ("City Federal") to purchase investment vehicles in 1985. He testified that he borrowed over $100,000 from private sources, and that he took at least $120,000 in cash advances on his credit cards, half in 1985 and half in 1986. He testified that the private loans and cash advances went towards paying attorney's fees in defending against the pending criminal charges and towards taking care of his sick mother. He also testified that during 1985 and 1986 he deposited in increments, at Atlantic Federal Savings & Loan ("Atlantic Federal") and City Federal, $50,000 cash that he had kept in a safe in his office. He testified that he made these deposits to cover checks for court fees, expert witness fees and other expenses related to the criminal trial. He testified that the remainder of the deposits were roll-over CD's.
The Debtor testified that after being disbarred he was unemployed for the remainder of 1986, and that he did not have any income from business interests other than the practice of law during 1985 or 1986. He testified that he was self-employed in 1987, trying mobile home sales, and running an advertising agency and a security guard agency. He testified that these businesses suffered considerable losses without ever producing any profits. He produced neither business records to substantiate his claimed Schedule C expenses for the years in question nor records of any businesses other than the law practice. In March of 1986, his office was fire-bombed with two molotov cocktails, destroying two shopping bags that the Debtor testified contained his records of business expenses for 1985 and the first few months of 1986. The Debtor's landlord, Alice Simcina, corroborated his testimony that he kept his business records in the shopping bags and that they were destroyed in the fire. Another office worker, Beverly Baker, also testified that she had seen the Debtor putting business receipts in the bags, and that after the fire she saw burned and wet business papers where the bags had been kept. The Debtor testified that his records for the balance of 1986 were removed by personnel of the Florida Bar. He testified that he maintained records for 1987, but that they had been lost during his move to Arkansas.
On his 1985 tax return, the Debtor reported $11,350 in wages and $50,372 in interest income, and claimed $91,604 in Schedule C ("Profit or (Loss) From Business or Profession") deductions.
On his 1986 tax return, the Debtor reported no wages and $131,856.74 in interest income and claimed $194,161 in Schedule C deductions.
On his 1987 tax return, the Debtor reported no wages and $147,360 in interest income and claimed $154,866 in Schedule C deductions.
The Government audited the Debtor's tax returns for 1985-1988, resulting in two Revenue Agent's Reports: one with respect to tax years 1985 and 1986 and the other with respect to the tax years 1987 and 1988. On June 27, 1989, the Government timely issued a Statutory Notice of Deficiency with respect to the tax years 1985 and 1986. The Notice of Deficiency reflected the Government's determination that a deficiency existed for 1985 in the amount of $125,222, plus certain additions to tax under 26 U.S.C. §§ 6651(a)(1), 6653(a)(1), 6653(a)(2) and 6661; and for 1986 in the amount of $231,464, plus certain additions under 26 U.S.C. §§ 6651(a)(1), 6653(a)(1)(a), 6653(a)(1)(b) and 6661.
On May 14, 1990, the Government timely issued a Statutory Notice of Deficiency with respect to 1987 and 1988. For 1987, the Notice of Deficiency reflected the Government's determination that a deficiency existed in the tax of the Debtor in the amount of $168,094, plus certain additions under 26 U.S.C. §§ 6653(a)(1)(a), 6653(a)(1)(b) and 6661. The Debtor began proceedings in the United States Tax Court on July 10, 1989 to contest the Notice of Deficiency with respect to 1985 and 1986, and on June 18, 1990 with respect to 1987 and 1988.
The Government produced a group of summary exhibits it prepared for trial, reflecting its revisions to its previous determinations of the Debtor's unreported income and allowable deductions for each of the years included in the audit. The Government revised its initial determinations based on the analysis of the available records by the trustee's expert witness, Cecilia Garber, provided to the Government the week before trial. In addition to supplementing its analysis with information it had originally omitted regarding activity of nearly a million dollars in an account (the "422 Account") at Atlantic Federal, it also adopted Garber's reductions to its deficiency determination in the amount of over $300,000 for 1986 and 1987. The Government indicates on its summary exhibits that it disputes Garber's determination of additional reductions in the amount of $163,281.34 for 1986 and $127,500 for 1987. The Government's revisions indicate: for 1985, unreported income of $205,101.79, and allowable deductions of $12,390; for 1986, unreported income of $328,627.46 and allowable deductions of $9,620; and for 1987, unreported income of $243,762.78 and allowable deductions of...
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