U.S. v. Diamond

• Decision Date: 22 April 1986
• Docket Number: No. 85-5259,85-5259
• Citation: 788 F.2d 1025
• Parties: -1310, 86-1 USTC P 9356 UNITED STATES of America, Appellee, v. Patrick Henry DIAMOND, Appellant.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 1025

788 F.2d 1025

57 A.F.T.R.2d 86-1310, 86-1 USTC P 9356

UNITED STATES of America, Appellee, v. Patrick Henry DIAMOND, Appellant.

No. 85-5259.

United States Court of Appeals, Fourth Circuit.

Argued March 6, 1986.

Decided April 22, 1986.

Roger W. Frydrychowski (J. Waller Harrison, McGuire, Woods & Battle, Richmond, Va., on brief), for appellant.

Gregory Welsh, Asst. U.S. Atty. (Justin W. Williams, U.S. Atty., John C. McDougal, Sp. Asst. U.S. Atty., Richmond, Va., on brief) for appellee.

Before PHILLIPS and SPROUSE, Circuit Judges, and MICHAEL, United States District Judge for the Western District of Virginia, sitting by designation.

JAMES DICKSON PHILLIPS, Circuit Judge:

This is an appeal by Patrick Henry Diamond from his convictions, following a bench trial, on two counts of willfully making and subscribing false federal income tax returns for 1980 and 1981, in violation of 26 U.S.C. Sec. 7206(1). ¹ Diamond makes several assignments of error, ² but his major contentions on appeal are that, as a matter of law, he lacked the requisite intent to violate the statute, and that, in the alternative, the evidence was insufficient to support his convictions. Finding no error, we affirm the district court.

I

At the time these tax returns were filed, Diamond was the Vice President of Finance at Robertshaw Controls Company in Richmond, Virginia, with responsibility for its financial, treasury, and tax departments, among others. Diamond is a Certified Public Accountant, and holds a combined Master's of Business Administration and Law degree from Columbia University, as well as an advanced degree in tax law from New York University.

The government's indictment in this case arose, in large part, from Diamond's characterization, on his 1980 and 1981 tax returns, of his losses in connection with numerous stock option and commodity futures transactions completed in 1980. Diamond was not a licensed broker or dealer, traded exclusively for his own account, and never took delivery on any of the underlying commodities in which he traded.

Prior to 1980, Diamond properly reported his losses from this activity as capital losses, on Schedule D forms. In 1980, however, he reported such trading losses as ordinary business losses on Schedule C "Profit or (Loss) From Business or Profession" forms. This change in treatment significantly affected Diamond's tax liability in the relevant years because, although "capital" losses from the sale or exchange of capital assets are deductible by an individual taxpayer only to the extent of $3,000 in any tax year, 26 U.S.C. Secs. 165(f), 1211(b), "ordinary" trade or business losses are generally deductible in their entirety, 26 U.S.C. Sec. 165(a), (c). By treating his 1980 trading losses as ordinary, Diamond was thus able to deduct their full amount, or $139,130, which resulted in a zero tax liability and a $10,052 refund claim in 1980. According to the government, Diamond's 1980 tax liability for that year in fact exceeded $20,000, when the trading losses are properly recast as capital losses.

Diamond contends that he claimed ordinary business losses in 1980 because he had, by that time, begun to operate in a "trading business" by virtue of the increased number and dollar amount of the commodity futures and stock options transactions in which he was involved. According to the evidence adduced at trial, although the number of contracts traded was higher in 1980 than in 1979 (289 versus 78), the total number of trades was approximately the same. Diamond's stock option purchases rose only slightly ($305,301 to $345,531), and total option sales decreased in 1980 (from $252,819 in 1979 to $185,064 in 1980). Diamond claims that, although he continued to function as Vice President for Robertshaw, he spent between 25 and 30 hours each week trading for his own account during 1980. He also leased a stock ticker until the fall of 1980 when Robertshaw began to trade in commodities and took over the lease payments.

On his 1980 Schedule C form, Diamond described his "main business activity," to which he attributed the losses, as "wholesale dealer" in "agric. produce." Diamond maintains that this description accurately characterized his stock options and commodity futures "trading business" because 47% of his 1980 commodity futures transactions involved contracts for agricultural products. The remaining 53% of the commodities trades involved financial instruments, metals, and foreign currency. The business description made no reference to Diamond's stock option transactions, which comprised the bulk of his trading activity and which he implicitly concedes lacked even a tenuous connection with "agricultural produce."

In the space provided on the Schedule C for indicating the name of his business, Diamond stated that he operated "individually and as Patrick Henry Farms." Patrick Henry Farms was the name of Diamond's horse racing enterprise. According to Diamond, he intended to indicate that he operated two distinct businesses--community futures and stock option trading (individually) and horse racing (as Patrick Henry Farms)--and not to mislead the Internal Revenue Service, as the government contends, to believe that Patrick Henry Farms had suffered the reported losses on "agricultural produce." Diamond's horse racing losses were not reflected on the Schedule C, however, because of his alleged belief that such deductions would be disallowed. Diamond contends that he intended to file an amended 1980 return at some future date to claim such racing losses and that his inclusion of Patrick Henry Farms on the Schedule C was merely intended to "signal the start of his horse racing business."

Diamond's 1980 Schedule C also reflected a deduction of $4,114 for "taxes," which actually represented payments of personal state income taxes in connection with his salary from Robertshaw. Although he would have been entitled to this deduction in any event, 26 U.S.C. Sec. 164(a)(3), it bore no relation to the alleged wholesale "agricultural produce" business described on the Schedule C. The government theorizes that Diamond deducted the taxes on the Schedule C in order to further its "ordinary" appearance.

In 1981, Diamond reverted to reporting his trading losses as capital losses, but carried over a net operating loss deduction from 1980 of $57,550, the unused portion of his business loss claimed in 1980. As a result, Diamond claimed a refund of $17,043 in 1981; the government asserts a tax liability in excess of $27,000 for that year. In addition, Diamond deducted a "job reference cost" of $2,000 in 1981, which actually represented contributions to the reelection campaign of Miami Mayor Maurice Ferre. As a political campaign contribution, the deduction would have been limited to $25. According to Diamond, the payment was intended to secure a job reference from Ferre, his former employer, in the event of a takeover of Robertshaw. Diamond claims that he believed that a takeover was imminent after another company acquired 5% of Robertshaw stock in September 1981; he sent the first of two checks to Ferre's campaign shortly thereafter. The evidence at trial also showed that, although Diamond filed a Schedule C in connection with his own 1980 investment losses, he caused his father, for whom he also engaged in similar trading, to report only capital losses for that year.

The trial court found Diamond guilty on both counts, and this appeal followed.

II

Diamond first contends, relying on this court's decision in United States v. Critzer, 498 F.2d 1160 (4th Cir.1974), that as a matter of law he could not be guilty of willfully filing false federal income tax returns as charged. In Critzer, we observed that "when the law is vague or highly debatable, a defendant--actually or imputedly--lacks the requisite intent to violate it." Id. at 1162. Thus, where the government advances a "pioneering interpretation" of tax liability, "[t]he obligation to pay is so problematical that the defendant's actual intent is irrelevant." Id. See also United States v. Mallas, 762 F.2d 361 (4th Cir.1985). Diamond argues that under this principle his convictions must be reversed, notwithstanding the trial court's finding that he intended to violate the statute, because the legal distinction between capital and ordinary losses, as applied in this case, is impermissibly vague. We disagree.

Section 1221 of the Internal Revenue Code broadly defines capital assets to include "property held by the taxpayer," and then narrows that definition by enumerating various exclusions. In this case, the only relevant exclusion concerns "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." 26 U.S.C. Sec. 1221(1). Because such property is outside of the definition of a capital asset, gains or losses produced by its sale or exchange must be accorded ordinary income tax treatment.

Diamond contends that it is at least debatable whether, under this provision, his securities were held, in 1980, "primarily for sale to customers" in the ordinary course of his trade or business, and thus whether they were capital assets subject to the limitation on deductibility of losses contained in 26 U.S.C. Sec. 1211. As will appear, however, this issue has been thoroughly litigated, and courts have clearly and consistently held that a taxpayer who trades securities for his own account, does not sell "to customers" within the meaning of Sec. 1221(1).

Diamond's insistence that his increased financial and hourly commitment to securities trading in 1980 arguably rendered this activity a "trade or business," misses the crucial point that, whether or not his 1980 transactions amounted to a trade or business, he was not selling "to customers" for purposes of Sec. 1221(1). ³ The "sale to customers" exclusion was added to the definition of capital assets in 1934 "so that a speculator trading on his own account could not...