J.H. Rutter Rex Mfg. Co., Inc. v. C.I.R.

• Decision Date: 07 September 1988
• Docket Number: No. 87-4699,87-4699
• Citation: 853 F.2d 1275
• Parties: -5600, 88-2 USTC P 9499 J.H. RUTTER REX MFG. COMPANY, INC., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 1275

853 F.2d 1275

62 A.F.T.R.2d 88-5600, 88-2 USTC P 9499

J.H. RUTTER REX MFG. COMPANY, INC., Petitioner-Appellant, v.COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 87-4699.

United States Court of Appeals Fifth Circuit.

Sept. 7, 1988.

Rehearing Denied Nov. 9, 1988.

Edward B. Benjamin, Jr., Jones, Walker, Waechter, Poitevent, Carrere & Denegre, Robert W. Nuzum, Deutsch, Kerrigan & Stiles, New Orleans, La., for petitioner-appellant.

Michael L. Paup, Chief, David I. Pincus, William A. Whitledge, Asst. Attys.Gen., Gary R. Allen, William Rose, Appellate Section, Tax Div., Dept. of Justice, Washington, D.C., for respondent-appellee.

Appeal from the Decision of the United States Tax Court.

Before THORNBERRY, WILLIAMS and SMITH, Circuit Judges.

JERRE S. WILLIAMS, Circuit Judge:

I.Factual Background and Prior Proceedings

We grapple with serious procedural and substantive issues involving the corporate accumulated earnings tax.We also consider a valid issue concerning an alleged taxpayer waiver of limitations.

J.H. Rutter Rex Manufacturing Company, Inc.("Rutter Rex") is a Louisiana corporation, incorporated July 1, 1930.The company manufactures work pants, work shirts, jeans, casual pants, casual shirts and other clothing items.Rutter Rex does not have any retail distribution facilities or networks but instead manufactures and supplies clothing items to large retailers like J.C. Penney, Sears, and Montgomery Ward, and to large manufacturers like Levi Strauss.Sales to J.C. Penney, for example, constituted 47.3% of Rutter Rex's total sales in 1976; 45% in 1977; 50% in 1978; and 78% in 1979.The company has also supplied clothing items to the military.¹James H. Rutter, chairman of the board of Rutter Rex and its chief executive officer, owns 99.908% of the stock of Rutter Rex and his wife Marie owns the remaining 0.092%.Their son, Eugene Rutter, president and chief operations officer of the company, owns no stock in the company.For additional background facts see the companion case, James H. Rutter and Marie R. Rutter v. Commissioner of Internal Revenue, 853 F.2d 1267(5th Cir.1988).

Rutter Rex claims that its business is heavily subject to changes in styles and fads and that it must constantly adapt its manufacturing facilities and retrain its employees to satisfy the fluctuating needs of its customers.The company asserts that the large amounts of accumulated earnings and profits it retains in its coffers ² are needed to cover, among other things, the expenses necessitated by this fluctuating market, especially in light of James Rutter's aversion to borrowing money.³

In March 1979, IRS Agent Joseph Benigno audited Rutter Rex's 1976, 1977, and 1978 income tax returns and proposed adjustments relating to boat expenses, travel deductions, general and administrative expenses, costs of goods sold calculations, maintenance and repair deductions, and depreciation deductions.These adjustments amounted to $26,915 for the three years.In his report Benigno considered and discussed the deductions Rutter Rex had taken for compensation it paid to James and Eugene Rutter and the company's accumulation of earnings, ⁴ but he did not propose any adjustments against Rutter Rex with respect to these two issues.In December 1979, Eugene Rutter, acting as president and chief operations officer of Rutter Rex, signed a Form 872 "Consent to Extend the Time to Assess Tax" on behalf of Rutter Rex, extending until December 31, 1980, the period for assessing the amount of any federal income tax due for taxable year 1976.Rutter Rex paid the income tax deficiencies attributable to Agent Benigno's adjustments on February 15, 1980.

Beginning on October 7, 1980, IRS Agent Richard McConnell tried to get an officer of Rutter Rex to sign another Form 872 to extend the period for assessing the amount of Rutter Rex's federal income taxes due for taxable years 1976 and 1977 to December 31, 1981.McConnell had been assigned the Rutter Rex audit to reevaluate the reasonable compensation and accumulated earnings issues.On October 10, 1980, Eugene Rutter told McConnell that any further conversations regarding Rutter Rex's tax liability should be made through its attorney, Mr. Edward B. Benjamin, Jr.On October 15, 1980, McConnell was sent a copy of a power of attorney (IRS Form 2848) exercised in Benjamin's favor by Eugene Rutter on behalf of Rutter Rex for tax year 1976-1978.

On November 25, 1980, Agent McConnell attended a meeting at Rutter Rex's offices in New Orleans to discuss his proposed adjustments regarding accumulated earnings and reasonable compensation.McConnell, however, had not yet determined the dollar amounts of these adjustments.James Rutter, Eugene Rutter, Mr. Benjamin, Rutter Rex's tax C.P.A. (Michael J. O'Rourke), Rutter Rex's audit C.P.A. (William Hogan), and Rutter Rex's controller (Jake Haney) were all in attendance.McConnell once again asked James or Eugene to sign a Form 872 for tax years 1976 and 1977, but Mr. Benjamin advised them not to sign until they knew the actual dollar amounts of the proposed adjustments.

After the meeting had concluded and after Benjamin and O'Rourke had left, McConnell finally persuaded Eugene Rutter in the presence of the others to execute the Form 872 consent by allegedly promising to bring the form to the next meeting scheduled on December 3, 1980, at Rutter Rex's offices and not to release the consent form to his supervisor until then.McConnell, however, left Rutter Rex's offices immediately and gave the Form 872 to his supervisor who signed the consent form that same day.After noting how quickly McConnell had left, Eugene Rutter called Mr. Benjamin and told him that he had signed the consent form.Evidently Mr. Benjamin was quite upset with Eugene for signing the form.

As specified in 26 I.R.C. Sec. 534(b), the IRS notified Rutter Rex on May 21, 1981, that it proposed to issue a notice of deficiency to assert that the company was liable for the accumulated earnings tax for 1976-1979.Rutter Rex timely submitted a statement in response as provided by Sec. 534(c), listing seven grounds justifying its accumulations of earnings and profits during the years at issue.On December 17, 1981, the Commissioner issued a notice of deficiency determining an accumulated earnings tax of $446,658 for 1977 and $598,077 for 1978.⁵In this notice, the Commissioner specified that Rutter Rex had retained current earnings and profits of $1,188,723 in 1977 and $1,582,018 in 1978 and that these entire amounts were subject to the accumulated earnings tax.The Commissioner did not assess an accumulated earnings tax on Rutter Rex for tax years 1976 or 1979.The notice of deficiency also notified Rutter Rex that the Commissioner was disallowing a substantial portion of the deductions the company had taken under 26 I.R.C. Sec. 162(a)(1) for compensation paid to James and Eugene Rutter, resulting in additional income taxes for Rutter Rex($367,621 for 1976; $199,800 for 1977; and $199,800 for 1978).On March 22, 1982, Rutter Rex filed a petition in the Tax Court disputing these proposed deficiencies.

On August 22, 1983, Rutter Rex filed a pretrial motion pursuant to Rule 142(e) of the Tax Court Rules of Practice and Procedure for a ruling on the burden of proof with respect to issue of accumulation of earnings.⁶A hearing was held on the accumulated earnings burden of proof issue on October 5, 1983.On December 12, 1983, the Tax Court issued an order and opinion denying Rutter Rex's motion to shift the burden of proof to the Commissioner with respect to five of the seven grounds asserted in the Sec. 534 statement.The court held that the statement failed to provide sufficient facts to show the basis of these five grounds for accumulating earnings.81 T.C. 937(1983).

Rutter Rex filed an immediate appeal of this burden of proof order to this Court.The Commissioner filed a motion to dismiss the appeal for lack of jurisdiction based on the ground that the Tax Court order was not a final decision.We granted the motion to dismiss.Rutter Rex petitioned the United States Supreme Court for writ of certiorari, which that court denied.469 U.S. 980, 105 S.Ct. 381, 83 L.Ed.2d 316(1984).

Trial before the Tax Court on the issues of accumulated earnings, the validity of the Form 872, and reasonable compensation took place June 17-21, 1985.After trial, the Tax Court concluded that Rutter Rex was indeed subject to the accumulated earnings tax for the tax years 1977 and 1978 and that the deficiencies attributable to the accumulated earnings tax were $433,953 for 1977 and $545,524 for 1978.The Tax Court also disallowed a substantial portion of the deductions under Sec. 162(a)(1)Rutter Rex had claimed for compensation paid to James and Eugene Rutter, which resulted in income tax deficiencies for Rutter Rex of $229,217 for 1976, $183,960 for 1977, and $134,280 for 1978.

The Tax Court's Memorandum Findings of Fact and Opinion was filed August 28, 1986.52 T.C.M. (CCH) 326(1986).Pursuant to a motion for reconsideration and revision of findings of fact and request for further trial the Tax Court, on November 24, 1986, issued an Order and Memorandum Sur Order which revised the earlier opinion.The 1979 reasonable compensation figures had been inadvertently left out of the earlier opinion, and the other revisions were necessary because of an error made by the Tax Court in calculating Rutter Rex's expenses.The court denied appellants' motion in all other respects.Appellants filed another motion for reconsideration which was denied by the Tax Court.On June 22, 1987, the Tax Court decision was entered, assessing federal income tax deficiencies against Rutter Rex of $229,217 for 1976, $617,913 for 1977, and $679,804 for 1978.Rutter Rex appeals.

II.Reasonable Compensation Deductions

In the companion case, James H. Rutter and Marie R. Rutter v. Commissioner, 853 F.2d 1267(5th Cir....