McDermott v. John Baumgarth Company

• Decision Date: 21 February 1961
• Docket Number: 13004.,No. 13003,13003
• Citation: 286 F.2d 864
• Parties: John J. McDERMOTT, Special Agent, Intelligence Division, Internal Revenue Service, Chicago, Illinois, Petitioner-Appellant, Cross-Appellee, v. JOHN BAUMGARTH COMPANY, a corporation, Respondent-Appellee, Cross-Appellant. In the Matter of the Application for Enforcement of a Summons Issued by the Commissioner of Internal Revenue to John Baumgarth Company, a corporation.
• Court: U.S. Court of Appeals — Seventh Circuit

286 F.2d 864 (1961)

John J. McDERMOTT, Special Agent, Intelligence Division, Internal Revenue Service, Chicago, Illinois, Petitioner-Appellant, Cross-Appellee, v. JOHN BAUMGARTH COMPANY, a corporation, Respondent-Appellee, Cross-Appellant In the Matter of the Application for Enforcement of a Summons Issued by the Commissioner of Internal Revenue to John Baumgarth Company, a corporation.

Nos. 13003, 13004.

United States Court of Appeals Seventh Circuit.

February 21, 1961.

Charles K. Rice, Asst. Atty. Gen., John J. McGarvey, Atty., Tax Division, U. S. Dept. of Justice, Washington, D. C., Robert Tieken, U. S. Atty., Chicago, Ill., Meyer Rothwacks, Richard B. Buhrman, Attys., Dept. of Justice, Washington, D. C., Harvey M. Silets, Asst. U. S. Atty., Chicago, Ill., for appellant, cross-appellee.

A. Bradley Eben, Irving H. Goldberg, William R. Rivkin, Chicago, Ill., for appellee, cross-appellant; Goldberg, Weigle, Mallin & Rivkin, Chicago, Ill., of counsel.

Before HASTINGS, Chief Judge, and DUFFY and SCHNACKENBERG, Circuit Judges.

SCHNACKENBERG, Circuit Judge.

John Baumgarth Company, a corporation, herein referred to as the corporation, cross-appellant, contends that the district court erred in enforcing a summons requiring it to produce its books and records for the fiscal years ending February 28, 1951 and 1952, because John J. McDermott, Special Agent, Intelligence Division, Internal Revenue Service, Chicago, Illinois, cross-appellee, herein referred to as McDermott, was required to establish to the satisfaction of the district court "that there exists probable cause for him to believe that the Corporation was guilty of fraud in filing its returns for those years".

The order from which McDermott's appeal and the corporation's cross-appeal were taken, directed that the books and records for those two years be returned to the corporation and then made available to the agents because "there are reasonable grounds to suspect that false and fraudulent returns have been filed by the" corporation for those years. With respect to the fiscal years ended February 28, 1953, and February 28, 1954 (which were also covered by the summons), the order directed that the books and records be returned to the corporation unconditionally.

The corporation asserts that McDermott, in his petition to enforce the summons and the affidavit attached thereto, alleged only that "there are reasonable grounds for believing" the corporation "is guilty of fraud in connection with its tax liability" and that "the facts establishing reasonable grounds for his suspicion of fraud are that `there are grounds to believe that' the corporation in its returns for the years 1951-1952 understated its sales and overstated its travel and postage expense".

The district court held a hearing upon McDermott's petition and affidavit and the corporation's answer.

McDermott testified, inter alia, that he interviewed George Leavitt, whom he believed to be a former associate of John Baumgarth, president of the corporation, and a former vice-president thereof until 1952. Leavitt advised McDermott that the income tax returns filed by the corporation were false and fraudulent; that certain income was not reported; that the salaries paid to Edith and Gretchen Baumgarth — the sisters of Baumgarth — were "kicked back" to him; and that he (Leavitt) "was in possession of a document of twenty-one points which set forth the additional allegations against the corporation". The following day, Leavitt presented McDermott with a written statement bearing Leavitt's signature. It listed twenty-one "points", which were statements of alleged facts, in regard to operations of the corporation, which, if true, would obviously constitute fraudulent transactions and misrepresentations preventing a true disclosure of tax liability.

McDermott interviewed William J. Ireland, comptroller of the corporation from 1946 until 1952. Ireland advised McDermott that the corporation's tax returns were false and fraudulent; that some items of income had not been reported on the returns; that there had been some manipulation of inventory to reduce taxes; that there had been "kickbacks" of salaries of Edith and Gretchen Baumgarth as well as possibly other employees; that the sales of waste paper were not recorded on the books;¹ that travel expenses were overstated; and that certain other claimed expenses were entirely fictitious.

McDermott attempted to interview employees of the corporation, and issued nine or ten summonses requesting that they come in and testify. Only one of the employees appeared.

McDermott asked Edith what work she did for the corporation. She replied that she signed checks. He asked "What else do you do besides sign checks" and she replied only, "I sign checks." McDermott's interview with Edith, who was supposed to receive a salary of $15,000 to $20,000 a year, confirmed his suspicion that the tax returns were false and fraudulent.

The district court concluded that McDermott was justified in believing that "probable cause did exist in his mind so far as a probable fraud" is concerned as to the fiscal years ended February 28, 1951, and February 28, 1952. The court adjudged "that there are reasonable grounds to suspect" that the corporation had filed "false and fraudulent returns" for the years 1951-1952.

McDermott's counsel states that his appeal is for the limited purpose of assuring the continued existence and availability of the corporation's 1953-1954 books and records at a future time when the Internal Revenue Service anticipates it will be able to satisfy the district court that there is such evidence of fraud that a new summons calling for those documents should be judicially enforced. McDermott contends (1) that there is reason to believe that the return of the records to the corporation at this time would mean their destruction, (2) which would render it impossible for the Service to ascertain the amounts, if any, of the understatements of net income and income tax liability with respect to those years, and (3) the continued impoundment of the documents in question for a reasonable time will work no hardship on the corporation and will tend to serve the public need to protect the revenue against fraud. He asks us to modify the district court's order to provide for the continued impounding by the marshal of the books and records for a reasonable time after the 1951-1952 books have been made available to the Internal Revenue Service, in order to afford the Service an opportunity to satisfy the district court that a new summons for the 1953-1954 books should be judicially enforced.

In addition to its contention that the district court erred in enforcing the summons as to the books for 1951-1952, the corporation argues that it does not follow that, because books and records may reflect income tax fraud for a given year, it is probable that they will reflect fraud for succeeding years. It also contends that, under the circumstances of this case, there is no power in this court to impound indefinitely the corporation's books and records.

1. As to the summons pertaining to the production of the corporation's books and records for 1951-1952, we have set forth the nature and scope of the investigation made by McDermott. We hold that a sufficient showing has been made by the government, to support the order of the district court, under 26 U.S. C.A. § 7604(a), to enforce the summons issued by the Internal Revenue Service, under the authority of 26 U.S.C.A. § 7602. This is so, whether we apply the rule announced by the Second Circuit in Foster v. United States, 2 Cir., 265 F.2d 183, and United States v. United Distillers Products Corp., 2 Cir., 156 F.2d 872, that a § 7602 examination is for the purpose not only of ascertaining the correctness of any return but also for determining the liability of any person for any internal revenue tax and that the Commissioner is entitled to the examination, or the rule prevailing in the Fifth, Sixth and Ninth Circuits, that the Service must show reasonable grounds for suspicion of fraud, Falsone v. United States, 5 Cir., 205 F.2d 734, certiorari denied 346 U.S. 864, 74 S.Ct. 103, 98 L.Ed. 375; Globe Construction Co. v. Humphrey, 5 Cir., 229 F.2d 148; Peoples Deposit Bank & Trust Co., Paris, Ky., v. United States, 6 Cir., 212 F.2d 86, certiorari denied 348 U.S. 838, 75 S.Ct. 37, 99 L.Ed. 661; Corbin Deposit Bank of Corbin, Ky., v. United States, 6 Cir., 244 F.2d 177; Boren v. Tucker, 9 Cir., 239 F.2d 767.

It appeared from McDermott's verified petition, and his...