Nerem v. Comm'r of Internal Revenue

• Decision Date: 03 December 1963
• Docket Number: Docket No. 3087-62.
• Citation: 41 T.C. 338
• Parties: MARVIN E. NEREM AND EVELYN L. NEREM, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

41 T.C. 338

MARVIN E. NEREM AND EVELYN L. NEREM, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 3087-62.

Tax Court of the United States.

Filed December 3, 1963.

Nels W. Branstad, for the petitioners.

David A. Pierce, for the respondent

During the years 1959 and 1960, the petitioner husband embezzled funds of the United States while employed as an assistant postmaster. In those years the decision of the Supreme Court in Commissioner v. Wilcox, 327 U.S. 404, was in effect, and it held that funds obtained through embezzlement did not constitute taxable income to the embezzler. Thereafter in 1961, the decision in the Wilcox case was expressly overruled by the Supreme Court in James v. United States, 336 U.S. 213. Held, that the funds embezzled by petitioner in 1959 and 1960 constitute taxable income to him within the meaning of section 61(a) of the 1954 Code. Principles of Rutkin v. United States, 343 U.S. 130, and James v. United States, supra, applied.

OPINION

PIERCE, Judge:

The Commissioner determined deficiencies in the income taxes of the petitioners for the years 1959 and 1960 in the respective amounts of $73.72 and $1,918.92.

The sole issue for decision is whether the amount of $315 which the petitioner husband embezzled from the United States in 1959 while employed as an assistant postmaster at Forest City, Iowa, and also the amount of $12,752.99 which he similarly embezzled in 1960, less reimbursement made in said year of $4,585.63, constitute taxable income to him for the respective years in which said embezzlements occurred.

All the facts have been stipulated and are so found. The pertinent facts so stipulated may be summarized as follows.

Marvin E. Nerem (herein referred to as the petitioner) and his wife, Evelyn L. Nerem, were residents of Forest City, Iowa, during each of the taxable years involved. They filed a joint Federal income tax return for each of said years with the district director of internal revenue at Des Moines.

The petitioner, during the year 1959 and until June 6, 1960, was employed by the U.S. Post Office Department as assistant postmaster at Forest City. While so employed in 1959, he unlawfully used and converted to his use funds belonging to the United States in the amount of $315; and while so employed in 1960, he similarly unlawfully used and converted to his use funds belonging to the United States in the amount of $12,752.99.

During the year 1960 said conversions of funds were discovered by the Post Office Department. Thereupon on June 6, 1960, petitioner submitted his resignation to said Department; and also during said year he forfeited and voluntarily assigned to said Department in partial reimbursement of the amounts so embezzled, the following:

+------------------------------------------+
                ¦Retirement fund for his benefit ¦$3,853.01¦
                +--------------------------------+---------¦
                ¦Interest on said retirement fund¦363.51   ¦
                +--------------------------------+---------¦
                ¦Accumulated annual leave        ¦255.94   ¦
                +--------------------------------+---------¦
                ¦Unpaid salary                   ¦113.17   ¦
                +--------------------------------+---------¦
                ¦Total                           ¦4,585.63 ¦
                +------------------------------------------+
                

As regards that portion of the embezzled amounts not so reimbursed ($315 plus $12,752.99, total $13,067.99, less $4,585.63, being a balance of $8,482.36), this was paid to the United States on February 21, 1961, by the Liberty Mutual Insurance Co. pursuant to a blanket policy which the Government carried with that company to protect it from loss due to defalcation of moneys handled by employees of its Post Office Department. And thereafter on June 22, 1961, petitioner executed and delivered to said insurance company, his non-interest-bearing demand note in said amount of $8,482.36, representing the amount which he expressly recognized to be his liability to said insurance company for reimbursement of the amount that it had paid to the Government.

On June 13, 1960, petitioner appeared before a U.S. Commissioner in Mason City, Iowa, respecting said embezzlements, and waived preliminary hearing; bond was set and posted. Thereafter on June 21, 1960 a grand jury impaneled by the U.S. District Court for the Northern District of Iowa returned a criminal indictment against the petitioner on six counts, under which he was charged with violation of various specified provisions of the United States Code, by reason of his having unlawfully converted to his use in 1959 and 1960 certain funds of the United States (being portions of the embezzled funds here involved); and also by reason of his having made false and fictitious entries in the records of the post office, through recording the issuance of various money orders in sums less than the amounts of the money orders actually issued. Subsequently on June 28, 1960, petitioner was duly arraigned before said U.S. District Court; and he there entered a plea of guilty to each of the six counts of the indictment. On July 20, 1960, he was sentenced to serve 9 months in a U.S. Federal correctional institution. On January 9, 1961, he was paroled and returned to his home in Forest City.

In the joint income tax returns which petitioner and his wife filed for the years 1959 and 1960 that are here involved, no portion of the said embezzled funds were reported as income. The Commissioner however, in his notice of deficiency herein, determined that petitioner and his wife as joint makers of said returns were chargeable with additional income represented by embezzled funds, in the respective amounts of $315 for the year 1959 and $12,752.99 for 1960; and also he allowed for the year 1960, a deduction for ‘Reimbursement of embezzled funds‘ in the amount of $4,585.63. The Commissioner, in his said notice of deficiency, did not determine for either of said taxable years, any amount to be due or owing for an addition to tax for fraud under section 6653(b) of the 1954 Code.

The answer to the question here presented for decision— i.e., whether the amount which petitioner embezzled in 1959 and the amount which he similarly embezzled in 1960, less the reimbursement which he made in said year, constitute taxable income to him for the respective years in which such embezzlements occurred— will turn upon the effect of the decision of the Supreme Court in James v. United States, 336 U.S. 213 (1961), and that Court's prior decision in Commissioner v. Wilcox, 327 U.S. 404 (1946), which was reversed in the James case.

By way of background to these decisions, it should be observed that all general revenue acts enacted since 1913¹ have included in the definition of ‘gross income,‘ a provision similar to the following provision included in section 61(a) of the 1954 Code:

SEC. 61. GROSS INCOME DEFINED.

(a) GENERAL DEFINITION.— Except as otherwise provided in this subtitle (exceptions not applicable in the instant case), gross income means all income from whatever source derived * * *

By reason of these statutory provisions, it has been for many years a well-settled principle that an unlawful gain, as well as a lawful one, constitutes taxable income. United States v. Sullivan, 274 U.S. 259 (1927); Rutkin v. United States, 343 U.S. 130 (1952); James v. United States, supra.

Nevertheless, as regards moneys obtained by an individual through embezzlement (such as those involved in the instant case) there were, prior to the relatively recent decision of the Supreme Court in the James case (decided May 15, 1961), differing views and opinions expressed by various courts, including the Supreme Court, as to whether embezzled funds constituted taxable income to the embezzler. This confusion of judicial opinion centered on the facts that although an embezzler obtains wrongful possession of the converted funds, he does not acquire legal title thereto and has an obligation to return the same to the true owner. Such differences of judicial viewpoint are evident in the following decisions.

In the frequently cited case of National City Bank of New York v. Helvering, 98 F.2d 93 (C.A. 2, 1938), affirming 35 B.T.A. 975, the Court of Appeals speaking through Judge Learned Hand, said:

If he (the taxpayer) holds with claim of right, he should be taxable as an owner, regardless of any infirmity of his title; no other doctrine is practically possible, and no injustice can result. * * * In said case, the income subjected to tax consisted of an illicit and secret bonus or commission taken by the taxpayer on bonds which he held as president of a corporation, and hence there may be some question as to whether it constituted ‘embezzled‘ funds; but nevertheless the above quotation reflects a view of the court that infirmity of title in one who has unlawfully taken another's property, is not sufficient to prevent the wrongdoer from being charged with the receipt of taxable income.

Thereafter in Estate of Thomas Spruance, 43 B.T.A. 221 (1941), this Court (then designated the Board of Tax Appeals) applied the principle of said National City Bank opinion in an embezzlement case, and decided that embezzled funds constituted taxable income to the embezzler, notwithstanding the infirmity of his title. On appeal however, the Court of Appeals for the Fifth Circuit reversed our decision (sub nom. McKnight, Administrator v. Commissioner, 127 F.2d 572 (1942); and it held that since the embezzler ‘got no title, void or voidable, to what he took‘ no taxable gain arose from the embezzlement.

Subsequently the Court of Appeals for the Ninth Circuit, in Wilcox v. Commissioner, 148 F.2d 933 (1945), adopted a view similar to that of the Fifth Circuit in the McKnight case; and it reversed a Memorandum ...