Kraft v. U.S., No. 92-1552

• Court: United States Courts of Appeals. United States Court of Appeals (6th Circuit)
• Writing for the Court: CONTIE; MERRITT; DAVID A. NELSON
• Citation: 991 F.2d 292
• Parties: -1493, 93-1 USTC P 50,278 Jess KRAFT and Barbara Kraft, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
• Decision Date: 07 April 1993
• Docket Number: No. 92-1552

Page 292

991 F.2d 292 71 A.F.T.R.2d 93-1493, 93-1 USTC P 50,278 Jess KRAFT and Barbara Kraft, Plaintiffs-Appellants,
v.
UNITED STATES of America, Defendant-Appellee. No. 92-1552. United States Court of Appeals,
Sixth Circuit. Argued March 5, 1993.
Decided and Filed April 7, 1993.

Page 293

Richard A. Shapack (argued and briefed), Michael L. Geller (briefed), Shapack, McCullough & Kanter, Bloomfield Hills, MI, for plaintiffs-appellants.

Gary R. Allen, Acting Chief (briefed), Joan I. Oppenheimer (argued), Ann Belanger Durney, U.S. Dept. of Justice, Appellate Section Tax Div., Washington, DC, for defendant-appellee.

Before: MERRITT, Chief Judge; NELSON, Circuit Judge; and CONTIE, Senior Circuit Judge.

CONTIE, Senior Circuit Judge.

Jess and Barbara Kraft appeal the summary judgment dismissal of their 26 U.S.C. § 1341 claim for an income tax refund. For the following reasons, we affirm the district court's summary judgment dismissal.

I.

Plaintiff-appellant Jess Kraft ("Kraft"), a licensed physician, practiced podiatry at Joel H. Haber, D.P.M., and Jess Kraft, D.P.M., P.C., a Michigan professional corporation ("the Corporation"), from December, 1973 through September, 1985. Kraft, at all relevant times, was an employee, officer, director, and 50% shareholder of the Corporation. The Corporation was not a Subchapter S corporation.

From 1981 through 1984, the Corporation billed Blue Cross/Blue Shield of Michigan ("Blue Cross") approximately $2,245,000 for medical services performed by the Corporation. Once received, the Corporation included Blue Cross' payments in its gross income. The Corporation, in turn, paid Kraft wages for the fiscal years ending August 31, 1980 ($231,000), August 31, 1981 ($235,000), August 31, 1982 ($210,000), and August 31, 1983 ($249,000), which Kraft reported on the joint federal income tax returns he filed with his wife, plaintiff-appellant Barbara Kraft.

In September, 1984, a federal grand jury returned a 34-count Indictment charging Kraft with illegal distribution of controlled substances and mail fraud. Specifically, the Indictment alleged that Kraft performed unnecessary foot and toe surgeries on drug dealers and users by promising them Dilaudid, Percodan, and Demerol prescriptions. According to the Indictment, Kraft then submitted the bogus claims to Blue Cross which resulted in the wrongful payment of $84,160 to Kraft, though Blue Cross claims that Kraft actually defrauded it of $680,000, and Kraft claims that he "improperly billed" Blue Cross for only $19.

On or about April 3, 1985, the United States filed a one-count Information charging Kraft with mail fraud:

That beginning in or about January of 1981, and continuing up to in or about November, 1983, Dr. Jess Kraft, D.P.M., defendant herein, devised and intended to devise a scheme and artifice to defraud Blue Cross/Blue Shield of Michigan and to obtain money through the use of false, fictitious and fraudulent pretenses and representations in the manner and means as follows:

1. At all times pertinent to this information, Jess Kraft, D.P.M., was a licensed podiatrist and operated two facilities doing business as Dr. Joel Haber, D.P.M., and Dr. Jess Kraft, D.P.M., P.C.

2. It was a further part of the scheme and artifice that Dr. Kraft, D.P.M., billed and caused to be billed Blue Cross/Blue Shield of Michigan for services purportedly

Page 294

rendered to persons insured by Blue Cross/Blue Shield of Michigan, when in truth, and as the defendant Dr. Jess Kraft, D.P.M., well knew, the services had been performed on different persons not insured by Blue Cross/Blue Shield of Michigan.

That on or about August 13, 1983, in the Eastern District of Michigan, Southern Division, Jess Kraft, D.P.M., defendant herein, in furtherance of the aforesaid scheme and artifice to defraud and to obtain money by false and fraudulent representations, did cause to be placed in an authorized depository for mail, to be sent and delivered by the United States Postal Service, Blue Cross/Blue Shield of Michigan check number 008978836, in violation of Section 1341, Title 18, United States Code.

Information at 1-2.

On April 3, 1985, Kraft and the prosecutor executed a Rule 11 Plea Agreement ("Plea Agreement") whereby Kraft agreed to plead guilty to Count Eleven of the Indictment ("Distribution and Aiding and Abetting in the Distribution of Dilaudid") and Count One of the Information ("Mail Fraud"). In return, the government agreed: to dismiss the remaining counts in the Indictment; to not seek forfeiture of Kraft's medical license; to limit Kraft's sentence to 15 years for Count Eleven of the Indictment, and 5 years for Count One of the Information, to run concurrently. The Plea Agreement also provided that "Dr. Kraft agrees to pay Blue Cross/Blue Shield of Michigan $160,000 restitution prior to sentencing pursuant to the Victim-Witness Protection Act of 1982." Rule 11 Plea Agreement at 2. On September 13, 1985, the district court sentenced Kraft to seven years imprisonment, and fined him $26,000.

On December 20, 1986, the Krafts filed Form 1040X ("Amended U.S. Individual Income Tax Return") with the Internal Revenue Service ("IRS") seeking a $78,688 tax refund for the 1985 tax year pursuant to Internal Revenue Code § 1341 (26 U.S.C. § 1341) which provides (in relevant part):

§ 1341. Computation of tax where taxpayer restores substantial amount held under claim of right.

(a) General rule.--If--

(1) an item was included in gross income for a prior taxable year (or years) because it appeared that the taxpayer had an unrestricted right to such item;

(2) a deduction is allowable for the taxable year because it was established after the close of such prior taxable year (or years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item; and

(3) the amount of such deduction exceeds $3,000,

then the tax imposed by this chapter for the taxable year shall be the lesser of the following:

(4) the tax for the taxable year computed with such deduction; or

(5) an amount equal to--

(A) the tax for the taxable year computed without such deduction, minus

(B) the decrease in tax under this chapter (or the corresponding provisions of prior revenue laws) for the prior taxable year (or years) which would result solely from the exclusion of such item (or portion thereof) from gross income for such prior taxable year (or years).

26 U.S.C. § 1341 (1988). The IRS denied the Krafts' claim:

The claim of right has been disallowed since taxpayer knew at the time of filing the claim with Blue Cross and Blue Shield that he was not entitled to receive payment from the insurance company since wrong names were given to the company. Although the revenue ruling and court cases cited [above] deal mainly with embezzled funds, the facts clearly point that funds gained by wrongful or illegal means do not benefit from Section 1341 since the recipient knowingly accepted monies under false pretenses. Since the taxpayer submitted claims under false and fictitious individuals, he was aware that he had no "right" to the monies.

Page 295

Another factor in considering Dr. Kraft's case is the inclusion of the defrauded monies in income.

The payments went to the corporation of the doctor's which he shared with another doctor. The funds were reported by the corporation and the taxpayer drew his salary from it. The possibility remains to exist that the corporation paid taxes on this money, the taxpayer received this money in his salary and the other doctor received this in his salary. There is no audit trail of these monies to determine who the recipient of the monies is.

Section 165(c)(2) does allow a deduction as a non-business loss [the] restitution [of] illegally or wrongfully obtained monies, not a business loss. Only business losses qualify under Section 172 to be carried back as a net operating loss. Since the taxpayers' payment of the $160,000 would qualify as a non-business loss and not a business loss if allowed, the taxpayer is not entitled to claim a net operating loss back to 1981, 1982 and 1983 for the payback of funds to Blue Cross and Blue Shield.

Internal Revenue Service Form 886-A at 2-3.

The Krafts filed a second Form 1040X for 1985 seeking a $37,550.77 "ordinary and necessary trade or business expense" deduction, pursuant to 26 U.S.C. § 162(a), for legal fees paid defending against the criminal charges. The Internal Revenue Service denied this claim as well.

On November 27, 1990, the Krafts filed a Complaint against the United States in district court seeking a $91,301 income tax refund. Following cross-motions for summary judgment, the district court granted summary judgment to the United States with respect to Krafts' 26 U.S.C. § 1341 claim ($78,688), and granted summary judgment to the Krafts with respect to their 26 U.S.C. § 162(a) "ordinary and necessary trade or business expense" claim ($12,613):

26 U.S.C. § 1341 provides a special method for computing tax liability in circumstances where a taxpayer received an amount of income under a claim of right, included that sum as income, and in a subsequent taxable year was required to restore that amount because it was established that the taxpayer did not in fact have an unrestricted right to such amount. For purposes of § 1341, income included under a claim of right means income included as part of gross income because it appeared from facts then available that the taxpayer had an unrestricted right to such income. The test for the application of § 1341 is whether the obligation to repay arose from the same circumstances, terms and conditions of the transaction whereby the amount was included in income. It is clear that plaintiff Kraft's obligation to pay the $160,000 resulted from an obligation contained in a plea agreement.

Moreover, we find that 26 U.S.C. § 1341 does not support plaintiffs' claim to a deduction for the $160,000 because plaintiffs never made a claim of right...