U.S. v. Miller, 75-3016

• Decision Date: 10 November 1976
• Docket Number: No. 75-3016,75-3016
• Citation: 545 F.2d 1204
• Parties: 76-2 USTC P 9809 UNITED STATES of America, Appellee, v. Marvin MILLER, Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1204

545 F.2d 1204

76-2 USTC P 9809

UNITED STATES of America, Appellee, v. Marvin MILLER, Appellant.

No. 75-3016.

United States Court of Appeals,

Ninth Circuit.

Nov. 10, 1976.

Richard Trattner (argued), of Trattner & Pastor, Beverly Hills, Cal., for appellant.

Julian S. Greenspun, Asst. U. S. Atty. (argued), Los Angeles, Cal., for appellee.

Before BARNES and ELY, Circuit Judges, and VAN PELT, ^* District Judge.

BARNES, Senior Circuit Judge:

This is an appeal from appellant's conviction on 22 counts of a 24-count indictment charging tax evasion (26 U.S.C. § 7201) making and subscribing false tax returns (26 U.S.C. § 7206(1)), mail fraud (18 U.S.C. § 1341), and filing false claims against the United States (18 U.S.C. § 287). ¹

During the period of January 1, 1968, through June 1, 1970, Miller operated Covina Publications, Inc. ("Covina") and two related companies. The primary business of Covina was the sale of adult books, films and devices to the general public by mail order and to wholesale distributors. Miller dominated and controlled Covina, for which he received a set salary. He purchased all issued stock of the corporation for $128,200.00, which stock was held in the names of his four children, and (perhaps) his wife. ²

In the course of the trial, it was not disputed that for the fiscal year ending May 31, 1969, approximately $562,000.00 of mail order and distributors receipts were not recorded as sales on the corporate books, or reported in the corporate tax returns filed by Miller. About $298,000.00 was likewise omitted as sales from the books and tax returns for the fiscal year ending May 31, 1970. Such sums were instead recorded either as loans from the defendant and from banks to the corporations, as payments on account from various wholesale customers, or as "exchanges" (intercompany transfers). Evidence submitted by the government indicated that most of the money was deposited in various business and personal bank and savings accounts established by Miller under various names including those of his wife and children.

During the same period (5/31/68 to 5/31/70) Miller received, in addition to his salary, other economic benefits from Covina, the latter making periodic checks to Miller and paying virtually all of his personal bills (from the mortgage on his home to his "Book-of-the-Month" Club obligations). The total of such payments was in excess of $197,000.00 which was recorded on Covina's books as repayments of loans. Miller did not report any of the money on his own, or his wife's two years of separate, and one year of joint, returns. (Calendar years 1968, 1969, and 1970).

For the fiscal years considered herein, Miller asserted that Covina had been a losing venture. In the year ending May 31, 1969, Covina reported a net loss of approximately $216,000.00. At trial, an expert witness for the defendant argued that due to an erroneous entry into the books of a sale of a mailing list for $500,000.00, which was never consummated, the loss for the year should have been reported as $681,000.00. Likewise, for the fiscal year ending May 31, 1970, Covina reported a loss of $697,000.00. The Internal Revenue Service commenced an audit of the books of the defendant's companies in 1971.

At trial, Miller admitted that he had instructed his accountant to "scramble" the corporate books. However (for what such a self-serving statement is worth), he later testified that the sole purpose of all of his concealment activities was to hide his income from his creditors and not to cheat the government. ³ Miller stated that he had instructed his accountant to keep track of the real figures and file proper returns. Miller also asserted (for what it is worth) that he signed and filed the returns without really studying them, relying instead on his accountant's alleged assurances that "everything is okay."

At the close of the trial, one count of mail fraud (count 3) was dismissed upon the motion of the government. The trial judge found Miller not guilty of count 8 (tax evasion based on Covina's 1969 tax return). While there was evidence that Covina's tax return for the 1969 fiscal year was fraudulent, there was insufficient evidence to prove beyond a reasonable doubt that there would have been any tax due for that year (even if the $562,000.00 was added to Covina's income), due to the fact that the $500,000.00 sale was never shown to have occurred during the year. ⁴ Miller was found guilty on all the remaining counts.

On appeal, Miller raises an extremely technical argument. He asserts that the $197,000.00 he received from Covina must be treated as a constructive corporate distribution to a shareholder and be governed by §§ 301(c) and 316(a) of the Internal Revenue Code ("I.R.C.") ⁵ As Covina was not shown to have had any earnings and profits during the period under consideration, Miller argues that the $197,000.00 represented primarily a return of capital ⁶ and hence the distribution had no substantial tax consequences. ⁷Consequently he suggests that his signing and filing of his own and his wife's separate and joint tax returns and his use of the United States Postal Service to deliver them do not violate any statutory provisions. Because the trial court did not specifically find that Covina owed any additional taxes, even if the omitted income were added to the calculations for the years in question, and because the $197,000.00 is alleged to be not taxable to him, Miller further argues that there is insufficient evidence to establish that he intentionally filed false corporate returns for Covina. ⁸

ISSUES:

(1) Was the $197,000.00 diverted by Miller gross income to him or a form of constructive corporate distribution?

(2) Is there substantial evidence to support Miller's conviction on the various counts?

This case raises the primary problem of characterizing, for the purposes of criminal tax proceedings, the nature of funds diverted by a taxpayer from his close corporation. Normally, such categorization is relatively unimportant in criminal cases since the primary question is not the amount of the evasion but whether the taxpayer intended to evade and defeat his taxes. Goldberg v. United States, 330 F.2d 30, 40 (3rd Cir.), cert. denied, 377 U.S. 953, 84 S.Ct. 1630, 12 L.Ed.2d 497 (1964); Simon v. C.I.R., 248 F.2d 869, 876 (8th Cir. 1957); Drybrough v. C.I.R., 238 F.2d 735, 737 (6th Cir. 1956). See also, Gardner, The Tax Consequences of Shareholder Diversions in Close Corporations, 21 Tax L.Rev. 223, 226-27 (1966). Such diverted funds are typically considered as constructive corporate distributions and classified as dividends pursuant to I.R.C. §§ 301(c) and 316(a). See, e. g., O'Rourke v. United States, 347 F.2d 124, 127 (9th Cir. 1965). Because dividends are includable in gross income, I.R.C. § 61(a)(7), the end result is a conclusion that the diverted funds constitute income to the taxpayer which he must report or be held to have evaded his tax obligations. O'Rourke, supra, 347 F.2d at 127-28; Hartman v. United States, 245 F.2d 349, 352-53 (8th Cir. 1957). However, where, as here, there are no corporate earnings and profits from which a dividend could be paid, the classification of the diverted funds becomes more critical. ⁹ If the corporation has no earnings and profits and if the taxpayer's cost basis of the stock exceeds the amount of the diverted funds, the application of the constructive distribution rules as urged by appellant would permit the taxpayer to escape conviction by enabling him to assert that the diverted funds were a constructive return of capital and hence non-taxable as income.

Defendant Miller contends that the trial court has committed reversible error as to all of the counts due to its initial characterization of the $197,000.00 in direct and indirect payments to him as salary rather than constructive corporate distributions. While Miller's contention raises some interesting questions as to the extent of wrongdoing required to sustain convictions for tax evasion (26 U.S.C. § 7201), subscribing false tax returns (26 U.S.C. § 7206(1)), filing false claims against the United States (18 U.S.C. § 287) and mail fraud (18 U.S.C. § 1341), such questions need not be considered if the conclusion is reached that the trial court was not in error in its initial characterization. ¹⁰ Consequently, those issues are not dealt with herein because the trial court's characterization is not in error.

As support for his argument that funds diverted by a taxpayer from his close corporation must be treated as constructive distributions, Miller basically argues that most courts have traditionally applied such a rule and to do otherwise in the present situation would lead to various inconsistencies in the tax law. Several civil tax decisions are cited. E. g., Noble v. C.I.R., 368 F.2d 439, 442 (9th Cir. 1966); DiZenzo v. C.I.R., 348 F.2d 122, 126 (2nd Cir. 1965); Clark v. C.I.R., 266 F.2d 698, 707 (9th Cir. 1959); Simon, supra.

Conversely, the government argues that the diverted funds must be treated as income to the taxpayers without regard to any tangential factors such as earnings and profits of the corporation. The government primarily relies on Davis v. United States, 226 F.2d 331 (6th Cir. 1955), cert. denied, 350 U.S. 965, 76 S.Ct. 432, 100 L.Ed.2d 838 (1956). In Davis, a criminal tax proceeding, it was held that where the taxpayer diverted for his own use the income of a wholly-owned corporation, such income was taxable to him irrespective of whether the corporation had sufficient surplus to make the distribution as a dividend. In so holding, the court stated that:

"Appellant contends in this case that, whether the cash which he took from his wholly owned corporation was a "taxable gain," depends upon whether the corporation had sufficient surplus to cover a dividend distribution, as otherwise there would be no way in which he could receive such cash as a gain taxable to him and,...