U.S. v. Conforte

• Decision Date: 29 April 1980
• Docket Number: Nos. 77-3956,78-3310,s. 77-3956
• Parties: 80-1 USTC P 9417 UNITED STATES of America, Plaintiff-Appellee, v. Joseph CONFORTE and Sally Conforte, Defendants-Appellants.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 869

624 F.2d 869

80-1 USTC P 9417

UNITED STATES of America, Plaintiff-Appellee, v. Joseph CONFORTE and Sally Conforte, Defendants-Appellants.

Nos. 77-3956, 78-3310.

United States Court of Appeals, Ninth Circuit.

April 29, 1980.

Rehearing Denied Aug. 11, 1980.

Bruce I. Hochman, Beverly Hills, Cal., argued for defendants-appellants; Harry E. Claiborne, Oscar B. Goodman, Las Vegas, Nev., Hochman, Salkin & Deroy, Beverly Hills, Cal., on brief.

Leland Lutfy, Asst. U. S. Atty., Reno, Nev., argued for plaintiff-appellee; Clyde R. Maxwell, New Port Beach, Cal., on brief.

Appeal from the United States District Court for the District of Nevada.

Before KENNEDY and TANG, Circuit Judges, and PALMIERI, ^* District Judge.

KENNEDY, Circuit Judge:

This is an appeal from a judgment of conviction in a tax evasion case. The appellants, Joseph and Sally Conforte, are the operators of an establishment called "Mustang Ranch," described in the record as a legalized house of prostitution located in Nevada. The Confortes were convicted on four separate violations of 26 U.S.C. § 7201 for willful acts taken to evade or defeat federal employment taxes for the last quarter of 1974 and the first three quarters of 1975. The Government's case was that the appellants willfully failed to file employment tax returns, to withhold income taxes, or to pay employment taxes for certain employees who worked at the Mustang Ranch establishment. The employees in question were not prostitutes but were so-called auxiliary personnel such as maids, bartenders, security guards, and cashiers. The district court tried the case without a jury. We agree with the trial court that the Government established that appellants' failure to file employment tax returns for these auxiliary personnel was flagrant, and part of a willful scheme to evade federal taxes on a substantial scale. We therefore affirm the convictions.

I Convictions for Tax Evasion

Conviction under section 7201 requires proof beyond a reasonable doubt of each of the following elements: (1) the existence of a tax deficiency; (2) willfulness; and (3) an affirmative act constituting an evasion or attempted evasion of the tax. Sansone v. United States, 380 U.S. 343, 351, 85 S.Ct. 1004, 1010, 13 L.Ed.2d 882 (1965); Lawn v. United States, 355 U.S. 339, 78 S.Ct. 311, 2 L.Ed.2d 321 (1958); Holland v. United States, 348 U.S. 121, 75 S.Ct. 127, 99 L.Ed.2d 150 (1954); Spies v. United States, 317 U.S. 492, 63 S.Ct. 364, 87 L.Ed. 418 (1943). Appellants contend that the employers had no obligation to withhold income taxes or pay Social Security taxes since the auxiliary personnel received no salary, but only tips from the prostitutes. They argue, moreover, that even if the compensation is classified in law as a wage, the appellants believed it to be tips, so the failure to file was not willful. As part of the defense that there was no willful criminal conduct, the appellants claim that they were relying upon their tax counsel's negotiations with the Internal Revenue Service, negotiations which continued during the quarterly tax periods in which the violations occurred. We reject these contentions and conclude that the Government has met its burden of proof on each element.

A. Tax Deficiencies

As even the Confortes' counsel conceded from the outset of trial, the auxiliary personnel in question were employees, not independent contractors. The argument that withholding was not required thus turns upon whether the employees received wages, as distinct from tips. An examination of the compensation procedures used at the brothel leaves us with little doubt that the term "tip" is entirely inaccurate to describe the compensation paid to the auxiliary employees. The compensation paid to the auxiliary employees would be defined as a wage by lay people and tax experts alike.

The system used to pay the Mustang Ranch employees during the four tax quarters in question was this: An employee designated as a cashier took all the monies earned by the prostitutes. The cashier returned to them one-half of their earnings for each shift, less ten percent. If the prostitute earned less than $50.00, no money was deducted from her half share. No money was taken from that portion of the prostitute's earnings in excess of $100.00. The ten percent deduction was designated a "board fee," and the total board fees so retained were denominated by the Confortes as a "tip fund." At the end of each day or night shift, the cashier paid both the prostitutes and the auxiliary employees, the cashier herself being included in this latter category. The cash payments to the auxiliary employees were said to be taken from the "tip fund." Apparently, there was no physical separation of the cash in the drawer, the "tip fund" constituting simply an accounting designation. The compensation to auxiliary employees from the "tip fund" was a fixed payment per shift, such as $30.00 for a maid and $35.00 for a security guard. If the "tip fund" was insufficient for payment, Joseph Conforte would put more cash in the drawer. Any funds remaining in the drawer after these payments were, of course, retained by the Confortes. The prostitutes kept track of their earnings, typically on index cards, and the cashier made certain summaries on binder paper or lined yellow paper. These records were routinely burned, as discussed further below.

The Conforte's argument that the employees received tips and not wages is so far removed from the economic facts of the case that the term "tip fund" used by the Confortes is itself a factor tending to show a willful attempt to evade taxes. The trial judge expressly so found, and we agree. The funds paid the auxiliaries were wages as that term is defined in 26 U.S.C. §§ 3121, 3401. See United States v. Fleming, 293 F.2d 953 (5th Cir. 1961).

To begin with, the employers were the Confortes, not the prostitutes. The Confortes supervised the employees and exercised authority over hiring and firing. The employees who testified said they considered the Confortes to be their bosses. The Confortes set the rates of compensation. A necessary inference from the record is that the "tip fund" was sometimes in excess of the amounts required for the auxiliary personnel and that sometimes it was insufficient. It was in the latter instances that Joseph Conforte put additional funds in the cash drawer. There is no evidence whatever that the prostitutes set the auxiliaries' pay, or even that they knew the amount. There is no evidence they had any control over the auxiliaries. The Confortes, in short, had complete control over the auxiliaries, their rate of pay, hours, working conditions, and term of employment. For a set hourly period, the auxiliaries were paid fixed sums, which had a direct relationship to the value of the services they performed. These sums were paid from the Confortes' gross revenue and from funds which the Confortes put in the cash drawer. These sums were wages paid by the employers, and the employers were the Confortes. See United States v. Silk, 331 U.S. 704, 716-19, 67 S.Ct. 1463, 1469-71, 91 L.Ed. 1757 (1947); McCormick v. United States, 531 F.2d 554, 209 Ct.Cl. 331 (1976); N.L.R.B. v. Nello Pistoresi & Son, 500 F.2d 399, 400 (9th Cir. 1974); Humble Pipe Line Co. v. United States, 442 F.2d 1353, 1356, 194 Ct.Cl. 944 (1971); McGuire v. United States, 349 F.2d 644 (9th Cir. 1965); Fahs v. Tree-Gold Co-Op Growers of Florida, 166 F.2d 40 (5th Cir. 1948).

While there are some cases in which the distinction between tips and wages must be defined with some precision, a rudimentary requirement is that a tip is a payment made by a person who has received a personal service. Roberts v. Commissioner, 176 F.2d 221, 225 (9th Cir. 1949); Olk v. United States, 388 F.Supp. 1108, 1111 (D.Nev.1975), rev'd on other grounds, 536 F.2d 876 (9th Cir.), cert. denied, 429 U.S. 920, 97 S.Ct. 317, 50 L.Ed.2d 287 (1976). Since the Confortes, not the prostitutes, set the fee, made the payments and received the services, that element is absent here. A second essential element is that the tip be a voluntary payment in an amount, and to a person, designated by the customer. Restaurants and Patisseries Longchamps, Inc. v. Pedrick, 52 F.Supp. 174, 174-75 (S.D.N.Y.1943); 8A J. Mertins, The Law of Federal Income Taxation § 47A.04 (1978). This element is also absent; contributions from the prostitutes were mandatory. The auxiliary services were rendered to the establishment as an enterprise, not to the prostitutes individually. The scope of duties performed by the auxiliary personnel was sufficiently broad so that a base rate of pay from the establishment, not tips, is the normal method of compensation, and that was the compensation plan adopted by the Confortes. This holding is consistent with rulings issued by the Treasury Department in characterizing income as wages rather than tips where services are rendered to the enterprise as a whole, and not to individuals who allegedly receive the service. See Rev.Rul 69-28, 1969-1, C.B. 270-71; Rev.Rul. 145, 1937-1 C.B. 443; Rev.Rul. 301, 1938-1 C.B. 455; Rev.Rul. 69-28, 1969-1 C.B. 270; Rev.Rul. 75-400, 1975-2 C.B. 464; Rev.Rul. 76-231, 1976-1 C.B. 378.

The record contains a further refutation of the argument that the base compensation paid to the employees consisted of tips, in that occasionally auxiliary employees would do personal errands for the prostitutes and would receive true gratuities for those services. These sums were tips, and since contra-distinct from the employees' base pay, the difference in the two sums is clearly revealed. A final factor to establish that the base amounts paid to the auxiliary personnel from the board fund were wages, rather than tips, is that various of the service personnel were paid their salary from the "tip fund" while on vacation, notwithstanding their absence from work. Such vacation allowances constitute wages, not tips. See 26 C.F.R. § 31.3306(b)-1(g). We...