Schaffer v. C.I.R., No. 1094

CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)
Writing for the CourtBefore FEINBERG, Chief Judge, FRIENDLY and NEWMAN; JON O. NEWMAN
Citation779 F.2d 849
Parties-440, 86-1 USTC P 9132 Michael A. SCHAFFER and Jennifer Schaffer, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. ocket 83-4100.
Decision Date16 December 1985
Docket NumberD,No. 1094

Page 849

779 F.2d 849
57 A.F.T.R.2d 86-440, 86-1 USTC P 9132
Michael A. SCHAFFER and Jennifer Schaffer, Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
No. 1094, Docket 83-4100.
United States Court of Appeals,
Second Circuit.
Argued April 25, 1985.
Decided Dec. 16, 1985.

Page 851

Howard L. Mann, New York City (Donald A. Pitofsky, Schwartzman Weinstock Garelik & Mann, P.C., New York City, on brief), for petitioners-appellants.

William S. Estabrook, Tax Div., Dept. of Justice, Washington, D.C. (Glenn L. Archer, Jr., Asst. Atty. Gen., Michael L. Paup, Martha B. Brissette, Tax Div., Dept. of Justice, Washington, D.C., on brief), for respondent-appellee.

Before FEINBERG, Chief Judge, FRIENDLY and NEWMAN, Circuit Judges.

JON O. NEWMAN, Circuit Judge.

This appeal poses vexing questions concerning the income tax liability of an individual who participates with others in income-generating activity. The questions arise in an appeal by Michael A. Schaffer and his wife 1 from a judgment of the Tax Court (Irene F. Scott, Judge) determining a deficiency in their 1969 federal income tax of $159,807.69 and assessing against Schaffer a fraud penalty of $79,903.85. See Mandina v. C.I.R., 43 T.C.M. (CCH) 359 (1982). For reasons that follow, we affirm only in part and remand for entry of a modified judgment.

The Legal Framework

Before introducing the facts, it will be helpful to outline the nature of the problem. One who participates with others in a joint enterprise may be held criminally and civilly liable for all the actions taken by any participant in furtherance of the venture. See, e.g., Pinkerton v. United States, 328 U.S. 640, 645-47, 66 S.Ct. 1180, 90 L.Ed. 1489 (1946) (criminal); W. Prosser & W. Keeton, The Law of Torts Sec. 46 (5th ed. 1984) (civil). However, courts have recognized that the vicarious liability principles of criminal and tort law are not fully applicable to determinations of individual liability for income taxes. See Llorente v. C.I.R., 649 F.2d 152, 156-57 (2d Cir.1981); cf. De Cavalcante v. C.I.R., 620 F.2d 23, 27-28 (3d Cir.1980); Weimerskirch v. C.I.R., 596 F.2d 358, 361-62 (9th Cir.1979); Carson v. United States, 560 F.2d 693, 697-98 (5th Cir.1977); Gerardo v. C.I.R., 552 F.2d 549, 554-55 (3d Cir.1977); Pizzarello v. United States, 408 F.2d 579, 583-84 (2d Cir.), cert. denied, 396 U.S. 986, 90 S.Ct. 481, 24 L.Ed.2d 450 (1969).

The distinction reflects the different purposes of the various legal liabilities.

Page 852

Criminal law and tort law provide redress for wrongs and properly impose upon each person who joins with others to perpetrate a crime or cause tortious injury full liability for all actions taken in furtherance of the venture he has joined. The extent to which the burden of this full responsibility should be individually assessed is determined in diverse ways. In criminal law the sentencing judge endeavors to scale punishments to reflect, among other things, the relative degrees of culpability of the wrongdoers. In tort law, the victims decide, by drafting a complaint and enforcing a judgment, which of the wrongdoers to sue and to hold accountable, and legislatures decide, by enacting contribution statutes, whether to modify the victims' choice by permitting those held liable to share their burden with joint tort-feasors. By contrast, income tax laws seek to fix individual responsibility for taxes on a person's income. Generally a person is taxed only on his own income. When he participates with others in a joint enterprise, he is liable, under partnership tax principles, for the tax only on his proportionate share of the enterprise's income (determined by the participants' agreement or by their interests in the enterprise), see I.R.C. Secs. 702, 704, and a joint enterprise or joint venture may be found to be a partnership for tax purposes, see, e.g., Burde v. C.I.R., 352 F.2d 995, 1002 (2d Cir.1965), cert. denied, 383 U.S. 966, 86 S.Ct. 1271, 16 L.Ed.2d 307 (1966).

There are, however, circumstances under which the Commissioner of Internal Revenue is entitled to charge a participant in income-generating activity with a greater share of the income of the enterprise. This occurs when the nature of an enterprise's operation precludes ascertainment of either the identity of those who shared the income or the percentages of their proportionate interests. The income may arise from an ongoing activity, e.g., Gerardo v. C.I.R., supra (gambling business), or may result from a specific transaction, e.g., Cannon v. C.I.R., 533 F.2d 959 (5th Cir.1976) (proceeds of an embezzlement), cert. denied, 430 U.S. 907, 97 S.Ct. 1177, 51 L.Ed.2d 583 (1977). In such circumstances, the untraced income has been either prorated equally among all the participants, 2 e.g., id. (one-half of embezzlement proceeds allocated equally as income to each of two participants); Barber v. C.I.R., 39 T.C.M. (CCH) 1026 (1980) (one-seventh of bank robbery proceeds allocated equally as income to each of seven participants), aff'd without opinion, 679 F.2d 896 (9th Cir.1982), or attributed in full to each of the participants, e.g., Gerardo v. C.I.R., supra; Stone v. United States, 405 F.Supp. 642 (S.D.N.Y.1975), aff'd mem., 538 F.2d 314 (2d Cir.), cert. denied, 429 U.S. 921, 97 S.Ct. 317, 50 L.Ed.2d 288 (1976). In the latter event, the Commissioner is limited, however, to collection of only a single tax on the unapportioned income. See Gerardo v. C.I.R., supra; Stone v. United States, supra.

When untraced funds are attributed as income to all participants, either with or without proration, it becomes important to determine the scope of the venture that generated the income in question. The choice, as in this case, is between viewing the venture broadly and attributing all of the untraced income to all of the participants or viewing the venture more narrowly as a series of discrete transactions and attributing the untraced income from each transaction only to the participants in that transaction. Whether the venture is viewed broadly or narrowly, a further problem arises where only some of the income is untraced. For example, the evidence might show that four persons robbed a bank, $1 million was taken, and one participant

Page 853

pocketed $100,000. The untraced $900,000 could be attributed (with or without proration) to all four participants, or the entire $1 million could be attributed (with or without proration) to all four participants, or the untraced $900,000 could be attributed (with or without proration) to the three participants not shown to have received any specific sum on the theory that the $100,000 was the entire share of the participant who received it. 3 One's view of the fairness of these alternatives may vary depending on whether the amount of the traced funds was less than, equal to, or greater than a pro rata share of the total funds taken. In this case, as will be seen, the Commissioner and then the Tax Court used a combination of these approaches in determining what amount of funds, generated by activities in which Schaffer allegedly participated, should be attributed to him as taxable income.

The Facts

In 1978, the Commissioner issued a notice of deficiency to Schaffer indicating that he owed $674,505 in income taxes for 1969 plus $337,252 in fraud penalties, imposed pursuant to 26 U.S.C. Sec. 6653(b) (1982). Similar notices were issued to Philip J. Mandina, Roy I. O'Nan, and Dana Mitchell. The notices of deficiency were premised on the allegation that these three men, along with Schaffer, (collectively the "conspirators" or the "participants") had engaged in a conspiracy "which had, as one of its objectives, the defrauding of Harriet Pierce of a substantial portion of her wealth." Answer at 2, Schaffer v. C.I.R., No. 3565-78 (U.S. Tax Court 1983). Harriet Pierce is an heiress to the Woolworth fortune. In June 1969, she married Mitchell; the couple was divorced in 1970. We will refer to her throughout by her maiden name. The vehicle of the alleged conspiracy was D. Mitchell Investments, Inc. ("DMI"), a Florida corporation founded by Mitchell in April 1969 with the assistance of Mandina. Upon the incorporation of DMI, Pierce transferred over $2.6 million of her assets to the corporation.

Nearly all of the deficiency consisted of taxes and penalties due with respect to income allegedly derived by the conspirators from a series of six transactions. The Commissioner contended and the Tax Court found that the conspirators engaged in these six transactions to divert to their personal use funds invested by Pierce in DMI. The total sum diverted in the six transactions was $848,000. The Commissioner included this aggregate sum as taxable income of Schaffer. The Commissioner also included this same sum as taxable income of Mandina and O'Nan. This sum, less $300,000, was also included as taxable income of Mitchell. 4 In addition, $52,700 was included as income only of Schaffer.

Page 854

This sum comprised three elements: a $17,000 DMI check to Schaffer claimed by him to be a DMI loan to a New York restaurant known as "Brian & Mike's," in which Schaffer and his wife owned a controlling interest; a $30,000 DMI check to Schaffer, also claimed to be a loan, and unreported legal fees of $5,700. Other sums, individually calculated, were added only to the income of the particular conspirator claimed to have received such sums. The Tax Court substantially revised the Commissioner's approach, charging each conspirator with only a pro rata (one-fourth) share of the aggregate sum found to have been diverted, 5 and then adding the same specific income items attributed by the Commissioner only to individual conspirators. The total income thereby attributed to Schaffer (one-fourth of the aggregate sum plus individual items) resulted in additional tax due of $159,807.69.

The first of the six transactions involved the purchase by DMI of Black Caesar's Forge restaurant...

To continue reading

Request your trial
39 practice notes
  • U.S. v. Letscher, No. 95 CIV. 993(JGK).
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • September 27, 1999
    ...Andrew Crispo Gallery, Inc. v. Comm'r of Internal Revenue, 16 F.3d 1336, 1341 (2d Cir.1994); Schaffer v. Commm'r of Internal Revenue, 779 F.2d 849, 857 (2d Cir.1985); Carter v. United States, 717 F.Supp. 188, 191 (S.D.N.Y.1989). In general, there are two aspects to this presumption of corre......
  • Carroll v. U.S., No. CV 98-5740(DRH).
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • September 13, 2001
    ...was engaged in transactions that were a sham, the burden of proof on that issue remains with the IRS. See Schaffer v. Commissioner, 779 F.2d 849, 857-59 (2d b. On a "Valuation Overstatement" Theory, the IRS Is Entitled to Summary Judgment on Plaintiffs' Claim for Recovery of Tax-Motivated I......
  • Investment Research Associates, Ltd. v. Commissioner, Docket No. 43966-85.
    • United States
    • U.S. Tax Court
    • December 15, 1999
    ...6653(b) also applies for purposes of determining the application of section 6501(c)(1). See Schaffer v. Commissioner [86-1 USTC ¶ 9132], 779 F.2d 849, 857 (2d Cir. 1985), affg. Mandina v. Commissioner [Dec. 38,744(M)], T.C. Memo. 1982-34; Ruidoso Racing Association v. Commissioner [73-1 UST......
  • US v. Red Stripe, Inc., No. CV 89-3504.
    • United States
    • United States District Courts. 2nd Circuit. United States District Court (Eastern District of New York)
    • March 20, 1992
    ...the burden on the taxpayer to demonstrate by a preponderance of the evidence that the date of assessment is incorrect. Schaffer v. C.I.R., 779 F.2d 849, 857 (2d Cir.1985); United States v. Lease, 346 F.2d 696, 700 (2d Cir. 1965); United States v. Paladin, 539 F.Supp. 100, 102 (W.D.N.Y.1982)......
  • Request a trial to view additional results
37 cases
  • U.S. v. Letscher, No. 95 CIV. 993(JGK).
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • September 27, 1999
    ...Andrew Crispo Gallery, Inc. v. Comm'r of Internal Revenue, 16 F.3d 1336, 1341 (2d Cir.1994); Schaffer v. Commm'r of Internal Revenue, 779 F.2d 849, 857 (2d Cir.1985); Carter v. United States, 717 F.Supp. 188, 191 (S.D.N.Y.1989). In general, there are two aspects to this presumption of corre......
  • Carroll v. U.S., No. CV 98-5740(DRH).
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • September 13, 2001
    ...was engaged in transactions that were a sham, the burden of proof on that issue remains with the IRS. See Schaffer v. Commissioner, 779 F.2d 849, 857-59 (2d b. On a "Valuation Overstatement" Theory, the IRS Is Entitled to Summary Judgment on Plaintiffs' Claim for Recovery of Tax-Motivated I......
  • Investment Research Associates, Ltd. v. Commissioner, Docket No. 43966-85.
    • United States
    • U.S. Tax Court
    • December 15, 1999
    ...6653(b) also applies for purposes of determining the application of section 6501(c)(1). See Schaffer v. Commissioner [86-1 USTC ¶ 9132], 779 F.2d 849, 857 (2d Cir. 1985), affg. Mandina v. Commissioner [Dec. 38,744(M)], T.C. Memo. 1982-34; Ruidoso Racing Association v. Commissioner [73-1 UST......
  • US v. Red Stripe, Inc., No. CV 89-3504.
    • United States
    • United States District Courts. 2nd Circuit. United States District Court (Eastern District of New York)
    • March 20, 1992
    ...the burden on the taxpayer to demonstrate by a preponderance of the evidence that the date of assessment is incorrect. Schaffer v. C.I.R., 779 F.2d 849, 857 (2d Cir.1985); United States v. Lease, 346 F.2d 696, 700 (2d Cir. 1965); United States v. Paladin, 539 F.Supp. 100, 102 (W.D.N.Y.1982)......
  • Request a trial to view additional results

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT