Maddas v. Commissioner

FRANK A. MADDAS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Maddas v. Commissioner Docket No. 82403. United States Board of Tax Appeals 40 B.T.A. 572; 1939 BTA LEXIS 831; September 28, 1939, Promulgated *831 1. Petitioner was a large stockholder and the directing head of a brewery engaged in the business of illegally manufacturing and selling beer during the years 1920, 1921, and 1922, in violation of the National Prohibition Act. The brewery sold the beer direct to the customers and collected therefor at the real beer price, but recorded the sales on its books at the near beer price, which amounted to approximately 36 percent of the real beer price. The excess of the real beer price over the near beer price was paid over to petitioner. No part of the amounts paid over to petitioner was reported by him in his income tax returns. Held, the amounts thus paid over to petitioner, less certain amounts turned back by him to the brewery in each of the taxable years, were income to him, and, in failing to report them as such, petitioner filed false and fraudulent returns with intent to evade tax and the statute of limitations has not barred the deficiencies; held, further, a part of the deficiency for each year was due to fraud with intent to evade tax. 2. Some unproven portion in each of the taxable years of the amounts thus paid over to petitioner was used by him as "protection" *832 money to bribe prohibition officers for the purpose of securing immunity from prosecution. Held, that, inasmuch as the traffic in beer which was being carried on by petitioner and the brewery was illegal, petitioner would not be entitled to have allowed as deductions, either as losses or business expenses, the amounts thus paid out even if the amounts thereof had been proven, because it would be against public policy to allow any deductions on such grounds. Earle F. Reed, Esq., and Lee W. Eckels, Esq., for the petitioner. Henry C. Clark, Esq., for the respondent. BLACK *572 Deficiencies in income tax and 50 percent penalty additions thereto for fraud were determined against petitioner by the respondent for the calendar years 1920 to 1922, inclusive, in amounts respectively as follows: Year Deficiency in tax 50% fraud penalty — 1920 — $606,660.25 $303,330.12 — 1921 — 373,571.12 186,785.56 — 1922 — 261,635.32 130,817.66 The date of the deficiency notice is September 17, 1935. The entire amount of the deficiencies and the fraud penalties are in issue. The petitioner pleads the statute of limitations as a bar to*833 the assessment and collection of any of the deficiencies and also contests the deficiencies and penalties on the merits. The respondent concedes that the deficiencies would all be barred by the statute of *573 limitations and that there would be no penalties if the returns filed by petitioner for each of the taxable years were not false or fraudulent with intent to evade tax. Respondent contends the returns were false and fraudulent. The alleged deficiencies in tax and penalties were based upon the respondent's determination that petitioner willfully failed and omitted to report as taxable net income items of income totaling $921,264.23, $597,529.33, and $501,440.20 for the years 1920, 1921, and 1922, respectively. At the conclusion of the hearing, counsel for the respondent abandoned the Commissioner's determination that the above figures represent the correct amounts of taxable income which petitioner failed to report on his income tax returns for the respective taxable years and submitted revised figures, as follows: $500,000 for the year 1920, $100,000 for the year 1921, and $400,000 for the year 1922. Respondent thereupon moved that the Board find that these latter*834 amounts were falsely and fraudulently omitted from petitioner's income tax returns for the respective taxable years with intent to evade the tax and that the Board enter its decision in accordance with such findings. No ruling was made on respondent's motion at the hearing, the presiding member stating that the case would be disposed of in the usual way, by the submission of a report containing findings of fact and an opinion. FINDINGS OF FACT. Petitioner is an individual, residing at 206 North First Street, Jeannette, Pennsylvania. He was born in Berardino, Italy, about the year 1866. He entered the United States on Christmas Eve, 1881. He never went to school and could not speak English when he first arrived in this country. He can now speak English, but reads and writes it poorly, and has but little education. Petitioner's first employment was working on a railroad. In 1899 he started a commissary along the Monongahela River. Shortly afterwards, he rented a small store at Masontown at $10 a month and started in the grocery business, which was later enlarged to include baked goods and meat. His business outgrew the little store, whereupon petitioner built a three-story*835 brick building across the street and opened up a general store, consisting of clothing, meat, grocery, and furniture departments. At that time he had about 22 men working for him and he owned about 14 head of horses. About 1904 he organized the Masontown Brewing Co. About 1907 petitioner went to Jeannette and organized the Victor Brewing Co., a corporation with a capitalization of $400,000, sometimes hereinafter referred to as the brewery. At that time he was worth approximately $100,000. About two years later he built a small brewery up at Republic. A little later, he organized the Connellsville Macaroni Co. - petitioner put $10,000 in this concern. About 1914 or 1915 petitioner *574 organized the Greensburg Brewing Co. at Greensburg, Pennsylvania. A few years later he also became interested in a mine at Millsborough, and by the beginning of the taxable years in question petitioner's net worth was somewhere between $400,000 and $450,000. Petitioner has filed income tax returns since the adoption of the Sixteenth Amendment to the Constitution. His returns for the years prior to the years in question show the following general information: Year Gross income Deductions Net income Tax liability — 1913 — $33,573.35 $2,088.64 $31,484.71 $129.19 — 1914 — 21,884.03 1,854.47 20,029.56 .30 — 1915 — 24,922.07 2,237.14 22,684.93 36.57 — 1916 — 37,472.40 1,841.64 35,630.76 231.13 — 1917 — 38,286.99 7,155.03 31,131.96 1,819.75 — 1918 — 40,796.84 7,061.41 33,735.43 2,818.96 — 1919 — 35,492.06 5,581.54 29,910.52 2,780.64 232,427.74 27,819.87 204,607.87 7,816.54 *836 Petitioner's return for the calendar year 1920 was prepared by the firm of Hosack & Hartman, Inc., of Pittsburgh, from data submitted to that firm, and was filed on or before March 15, 1921. His returns for the calendar years 1921 and 1922 were prepared by his secretary, Joe Dietrich, and were respectively filed on or before March 15, 1922, and March 15, 1923. The returns for the years in question disclose amounts of net income and tax due as follows: Year Amount of net income Tax — 1920 — $38,555.26 $4,258.64 — 1921 — 34,544.59 3,234.80 — 1922 — 21,526.69 1,449.34 Petitioner paid the tax shown to be due on these returns. None of the income involved in this proceeding was included in petitioner's income tax returns for the respective taxable years shown above. During the taxable years involved, petitioner owned close to 50 percent of the stock of Victor Brewing Co. and about 75 percent of the stock of Greensburg Brewing Co. These corporations, under the active management of petitioner (except for about three months in 1922 while petitioner was in Italy), manufactured and sold beer illegally under the guise of cereal beverages, or near beer, from the latter*837 part of May 1920 on through 1922. On August 27, 1919, one John Peduzzi, in compliance with an act of the General Assembly of the Commonwealth of Pennsylvania making it unlawful for any individual or individuals to carry on or conduct any business under an assumed or fictitious name, presented a certificate to the Prothonotary of Westmoreland County, Pennsylvania, stating that he was the only person owning or interested in the *575 business to be carried on under the name of "Victor Distributing Company", the character of which was the distribution of cereal beverages and other commodities. Peduzzi was an employee of the Victor Brewing Co. at the time he presented the certificate. He died about 1930 or 1931. The purpose of the Victor Distributing Co. was to save some of the tax then being levied on cereal beverages, which purpose was accomplished by the Victor Brewing Co. selling its output to the Victor Distributing Co. at a price less than the Victor Distributing Co. in turn sold it to its customers. Section 602(a) of the Revenue Act of 1921, which was approved on November 23, 1921, changed the method of collecting the tax on cereal beverages from one of percentage*838 of sale price to so much for each gallon manufactured and sold. Thereafter, the Victor Distributing Co. was liquidated. All of its assets, except its bank account of $17,197.40, were taken over and all of its liabilities were assumed by the Victor Brewing Co. Two checks were drawn for the total amount of $17,197.40 to the order of Peduzzi, who in turn endorsed them over to petitioner. The Victor Distributing Co. functioned only from May 1920 to November 1921. The capacity of the Victor plant was about 70,000 barrels a year. The capacity of the Greensburg plant was between 15,000 and 20,000 barrels a year. A barrel would make about 12.5 cases when bottled. The price of real beer during 1920 was $33 a barrel and $3.50 a case. During the first four months of 1921 it was $30 a barrel and $3 a case. During the remainder of 1921 it was $25 a barrel and $2.75 a case. The prices in 1922 were $22.50 a barrel and $2.75 a case. The prevailing price of near beer to the retail dealer was $12 a barrel and $1.50 a case. During 1920 and until November 1921, the Victor Brewing Co. disposed of its real beer in substantially the following manner (for convenience we will use the 1920*839 prices): The beer was sold direct to the dealer at the real beer price of $33 a barrel and $3.50 a case. Collections were usually made the following morning, although there were exceptions where the purchaser's credit was good. Of the real beer price collected, the near beer price of $12 a barrel and $1.50 a case would be turned over to the Victor Distributing Co., and the balance of $21 a barrel and $2 a case would be turned over to petitioner or someone acting for him, with no obligation on his part to account for the money to the brewery. It was understood, and agreed, however, that such of the money as was necessary was to be used by petitioner to purchase "protection" from prohibition officers, to enable the brewery and the distributing company and petitioner to continue operations, to pay fines incurred by customers, and to post bonds for customers. *576 The Victor Brewing Co. would then bill the Victor Distributing Co. at the wholesale near beer price $8of a barrel and $1 a case, to which would be added the 15 percent tax, thus making the total amount billed the Victor Distributing Co., $9.20 a barrel and $1.15 a case, which total amount the Victor Distributing*840 Co. would remit to the Victor Brewing Co. In this manner, the books of the Victor Distributing Co. would show a gross profit of $2.80 a barrel and 35 cents a case. After November 1921, when the Victor Distributing Co. was discontinued, the Victor Brewing Co. retained the near beer price and the excess of the real beer price over the near beer price was turned over to petitioner as theretofore. In the methods above described, over $700,000 was turned over to petitioner in 1920; over $500,000 was turned over to him in 1921; and over $500,000 was turned over to him in 1922. Of these amounts, petitioner turned back to the brewery $27,000 in 1920, $400,000 in 1921, and $80,000 in 1922. The circumstances under which these amounts were turned back will be given in the next three succeeding paragraphs of these findings. In 1920 the brewery had some bad accounts on its books which aggregated $27,000, and petitioner paid over to the company at different times during that year $27,000 and told the bookkeeper to credit it to the bad accounts, naming them, and wipe them off. During 1921 the board of directors of the Victor Brewing Co. authorized an increase in the capital stock of that*841 company from $400,000 to $800,000. The entire increase of $400,000 was paid over by petitioner either directly to the stockholders, who in turn paid it to the brewery, or to the Victor Brewing Co. direct, in 18 different payments totaling $400,000, during the first 6 months of 1921. In 1922 the Victor Brewing Co. set up on its books $80,000 as ice sold to the Greensburg Ice Co. in excess of the real ice sales to that company. This was done in order to make the ice sales of the Victor Brewing Co. look larger than they actually were. At different times in 1922 petitioner paid over to the Victor Brewing Co. $80,000 as payments for these fictitious sales of ice. During the taxable years in question petitioner deposited or caused to be deposited moneys in his own name in the following banks and in the following amounts: Bank — 1920 — — 1921 — — 1922 — Provident Trust Co $38,337.70 $261.69 Maddas Bank 177,783.02 $25,000.00 Westmoreland National Bank 343,768.95 21,261.89 Jeannette S. & T. Co 84,718.20 56,773.81 50,873.25 Jeannette S. & T. Co 17,460.00 19,829.00 First National Bank, J 106,974.73 609,899.89 37,488.51 First National Bank, N.S 25,000.00 735.83 Pittsburgh National Assn 37,382.30 602.38 Total 636,181.88 884,778.51 133,190.76 *842 *577 During the same years, petitioner deposited or caused to be deposited moneys in the names of Vera Endler, Etzio Nannini, James Kuhns, Joseph Franks, and J. F. Dietrich in amounts as follows: Name of person — 1920 — — 1921 — — 1922 — Vera Endler $145,252.74 $1,443.28 Etzio Nannini $15,000.00 21,995.50 James Kuhns 4,500.00 Joseph Franks 5,000.00 J. F. Dietrich 12,000.00 581,547.79 Total 145,252.74 36,500.00 604,986.57 The above item of $581,547.79 for 1922 in the name of J. F. Dietrich consists of various amounts deposited during 1922 in the Maddas Bank in an account designated on the books of the bank as "J. F. Dietrich, Special Account." Vera Endler commenced working as a clerk at the Victor Brewing Co. in 1919 and worked there during the taxable years in question. Since November 1923 she has been a member of the Order of Poor Handmaids of Jesus Christ and is known as Sister M. Adelina. Dietrich became petitioner's secretary on July 11, 1921. Nannini, Kuhns, and Franks were either employees of petitioner or of the brewery. The moneys deposited in the names of Vera Endler, Nannini, Kuhns, Franks, and Dietrich did not belong*843 to those parties, but belonged to petitioner and was checked out by petitioner or someone acting for him. Some unproven part of its was used by petitioner as "protection money" to bribe prohibition officers of the Federal Government, residing in Pennsylvania. This was also true as to some of the money deposited in petitioner's own name. In some instances money was withdrawn from one of the accounts mentioned above and deposited in another account, and as a result thereof there are included in the figures of the above mentioned deposits duplications for 1920, 1921, and 1922 of $88,341.60, $60,835.75, and $29,493.05, respectively. After making the proper allowances for such duplications, the net deposits in petitioner's name or someone acting for him during the taxable years 1920, 1921, and 1922 amounted to $693,093.02, $860,442.76, and $708,684.28, respectively. Petitioner did not report as income the receipt by him of any of the money representing the excess of the real beer price over the near beer price. He relied upon others to prepare his returns for him, and the parties who prepared the returns in question advised petitioner that he did not have to report these amounts*844 in his taxable income as they were not petitioner's income. Petitioner signed and swore to the correctness of the returns. Petitioner's income tax returns for the calendar years 1920, 1921, and 1922 were each false and fraudulent with intent to evade tax, *578 and a part of the deficiency for each year was due to fraud with intent to evade tax. Petitioner's taxable net income as reported by him was fraudulently understated by at least $500,000 for the year 1920, by at least $100,000 for the year 1921, and by at least $400,000 for the year 1922. The deficiencies due for the years 1920, 1921, and 1922 are not barred by the statute of limitations. OPINION. Fraud and the Statute of Limitations. BLACK: The first question for our determination in this proceeding is whether petitioner's income tax returns for each of the taxable years in question were false and fraudulent, with intent to evade tax. If they were not, then the statute of limitations bars any deficiencies which may be due and the respondent so concedes. Section 601 of the Revenue Act of 1928 places the burden of proving fraud upon the respondent, and this burden he assumed at the hearing. *845 The respondent, having asserted fraud, is charged with the duty of establishing it by more than a mere preponderance of the evidence. The evidence must be clear and convincing. Drawoh, Inc.,28 B.T.A. 666; Henry S. Kerbaugh,29 B.T.A. 1014; affd., 74 Fed.(2d) 749; Budd v. Commissioner, 43 Fed.(2d) 509; National City Bank of New York Executor,35 B.T.A. 975; affd., 98 Fed.(2d) 93. To establish his charge of fraud, respondent introduced the testimony of numerous witnesses and also introduced numerous exhibits, such as bank accounts and other records bearing upon the controversy. Petitioner and Walter A. Sebring, his accountant, testified for petitioner. To establish that petitioner received large amounts of income in each of the taxable years which he did not report for taxation, respondent relies principally upon the testimony of Carl E. Sunder, plus corroborating testimony of other witnesses and documentary exhibits. Sunder testified that during the years in question he was secretary and treasurer of the Victor Brewing Co. and that during that time the company manufactured real*846 beer and sold it to customers as such, but retained for itself only the near beer price and paid over to petitioner the difference. The circumstances detailing how this was done are set out in our findings of fact and need not be repeated here. Sunder testified that in 1920 he paid over in this manner to petitioner, or someone representing him, in excess of $700,000; in 1921, in excess of $500,000; and in 1922, in excess of $500,000. None of these amounts was reported by petitioner in his income tax returns for those years. Petitioner's counsel, in their brief, urge that we discard Sunder's testimony and refuse to believe it because he was confessedly engaged in the illegal liquor traffic along with petitioner and the rest *579 during the time in question and because he was an extortioner, since several years later he compelled petitioner to purchase Sunder's stock in the Victor Brewing Co. at very much more than it was worth, by threatening to expose the events and transactions of 1920, 1921, and 1922 and petitioner's connection with them to the tax authorities of the Federal Government. If Sunder's testimony stood alone, we think there would be great force in petitioner's*847 argument, but it does not stand alone. There is much evidence in the record to corroborate it. Perhaps the strongest evidence in the record to support Sunder's testimony is the bank accounts standing in petitioner's name and in the names of those who were proved to be acting for petitioner. At the time respondent introduced these bank accounts in evidence he stated that he was not seeking to establish the amounts of the income which petitioner received in each of the taxable years by the bank deposit method, but that he was introducing this evidence for the purpose of corroborating Sunder's testimony as to the amounts paid over to petitioner in each of the taxable years. We think such evidence does corroborate Sunder's testimony and shows that in each of the taxable years petitioner received large amounts of income which he did not report for taxation. Petitioner admits the receipt of this money, but pleads that it was paid over to him for the purpose of purchasing protection for the brewery from bribe-taking, faithless Government prohibition officials, and was not income to him but was income to the prohibition officials who got it. The testimony unmistakably shows that*848 some of it was thus used, but it falls far short of showing that all of it was thus used. Petitioner did not show how much of it was thus paid out, or give any figures by which we might calculate it, yet asks us to hold that none of these large amounts which admittedly he received were taxable income to him. We think that what we said in M. Rea Gano,19 B.T.A. 518, 533, is applicable to the facts of the instant case. Among other things, we there said: A failure to report for taxation income unquestionably received, such action being predicated of a patently lame and untenable excuse, would seem to permit of no difference of opinion. It evidences a fraudulent purpose. As we have already indicated, petitioner's principal defense is that the money which respondent has proved was paid over to him was not paid over for his personal use, but in sort of a trust capacity, to be disbursed on behalf of the brewery to purchase "protection" from bribe-taking, corrupt prohibition officials. That petitioner did disburse an unproven part of the funds for that purpose we have already indicated, but we think the evidence falls far short of establishing that the large amounts*849 in question, when paid over to petitioner, were impressed *580 with such a trust as to make petitioner not the owner of the income, but the mere conduit through which payments passed from the corporation to others who were the real owners of the income. Cf. O'Laughlin v. Helvering, 81 Fed.(2d) 269; National City Bank of New York, Executor, supra. Therefore, we hold that petitioner's income tax returns for each of the years 1920, 1921, and 1922 were false and fraudulent, with intent to evade tax. Petitioner's plea of the statute of limitations is not sustained. Amount of Petitioner's Unreported Income for Taxable Years. Not only does petitioner contest the fraud issue and plead the statute of limitations, but he also contends that there is no deficiency or penalty for either year because petitioner reported all of his taxable income for taxation and paid the tax thereon. As to the items of income reported on petitioner's income tax returns for the respective taxable years and the deductions taken thereon, there is no contest. The controversy, as we have already stated, relates to the large sums of money paid over to petitioner*850 as a result of the illegal sale of beer by the brewery. In the deficiency notice the Commissioner determined that petitioner received $921,264.23 in 1920, $597,529.33 in 1921, and $501,440.20 in 1922 from this source, and the deficiencies were computed accordingly. In the absence of anything else, the presumption is that the determinations thus made by the Commissioner in his deficiency notice are correct. Avery v. Commissioner, 22 Fed.(2d) 6. We think, however, that it is unnecessary to base our decision on the presumption of correctness referred to by the court in the Avery case and by this Board and the courts in subsequent cases. The question of how much income petitioner received from the illegal sale of beer in the manner set out in our findings of fact was the subject of much testimony at the hearing and at the conclusion of the evidence the respondent voluntarily abandoned his claim of the amounts of income determined in his deficiency notice and asked that the Board find instead that petitioner's unreported income for each of the taxable years in question was as follows: $500,000 for 1920, $100,000 for 1921, and $400,000 for 1922. *851 Even if we assume, without deciding, that in view of these circumstances respondent is no longer aided by any presumption as to the correctness of the determination made in his deficiency notice and the question becomes whether or not respondent has proved the amount of income, if any, which petitioner received in the taxable years and did not report, Tex-Penn Oil Co. v. Commissioner, 83 Fed.(2d) 518; Helvering v. Taylor,293 U.S. 507, we think respondent has proved his case. *581 As has already been stated under our discussion of the fraud issue, respondent has proved, by his witness, Carl E. Sunder, that he paid over to petitioner more than $700,000 in cash in 1920 from the illegal sale of beer. The bank accounts in evidence corroborate this testimony. Of this amount, Sunder testified that petitioner turned back to the brewery $27,000 in 1920. Respondent makes full allowance for this turn-back of funds and more besides, and asks only that the Board find that petitioner's unreported income for 1920 was $500,000. For 1921 Sunder testified that he paid over to the petitioner from the illegal sale of beer more than $500,000. The*852 bank deposits introduced in evidence corroborate this testimony. Sunder testified that of this amount petitioner turned back to the brewery or to the brewery's stockholders $400,000 in cash and that this $400,000 was used to finance an increase in the brewery's capital stock of that amount. Respondent makes full allowance for this $400,000 turned back, although he might well have contended that the portion used to pay for stock which was issued to petitioner, approximately $180,000, was income to petitioner in 1921. Petitioner concedes as much in his brief, although denying that there was any fraud in petitioner's failure to report it for taxation. But respondent does not contend that this $180,000 was income to petitioner in 1921 but only that the difference between the $500,000 paid to petitioner and the $400,000 turned back be adjudged to be the amount of petitioner's unreported income for 1921. Sunder testified that in 1922 he paid over to petitioner from the illegal sale of beer more than $500,000, and this testimony was corroborated by the bank deposits which were introduced in evidence. Of this amount, Sunder testified that petitioner turned back $80,000 in 1922. The*853 circumstances of this turn-back were that at various times during the year the Victor Brewing Co. invoiced to the Greensburg Ice Co., another corporation which petitioner dominated, $80,000 worth of ice in excess of what was actually sold and delivered and that petitioner paid over to the Victor Brewing Co. at various times the $80,000 in question. Sunder testified that the reason these fictitious ice sales were made was because petitioner wanted the sales of ice by the Victor Brewing Co. to appear in excess of what they really were. At any rate, whatever the cause, respondent has made full allowance for this $80,000 turned back and more besides, because he asks only that the Board find that petitioner's unreported income for 1922 be held to be $400,000. As has already been stated, under our discussion of the fraud issue, the petitioner claims that he paid out large amounts of the funds which he thus received in each of the taxable years to purchase "protection" for the brewery to carry on its illegal traffic. He has not disclosed how much he thus paid out nor has he given us any facts or *582 figures upon which we could make an estimate. Even if he had done so, we think*854 the allowance of any deduction based thereon would be against public policy. Cf. Tunnel Railroad of St. Louis v. Commissioner, 61 Fed.(2d) 166; Chicago, Rock Island & Pacific Railway Co.,13 B.T.A. 988; affd., 47 Fed.(2d) 990; Burroughs Building Material Co. v. Commissioner, 47 Fed.(2d) 178; Great Northern Railway Co. v. Commissioner, 40 Fed.(2d) 372; H. S. Anderson,35 B.T.A. 10; United States v. Sullivan,274 U.S. 259. Respondent's action at the hearing, in conceding allowances for all the amounts which the evidence showed that petitioner had turned back to the brewery in each of the taxable years, fully takes care of any deductions and eliminations on that score which are sustained by the record. We, therefore, think respondent's contention, that petitioner was in the receipt of income for 1920 of $500,000, for 1921 of $100,000, and for 1922 of $400,000 which he did not report for taxation, is sustained by the evidence and we so hold. We also hold that part of the deficiencies for each of the taxable years is due to fraud with intent to evade*855 the tax. We, therefore, sustain respondent's contention that 50 percent of the deficiency should be added as a fraud penalty for each of the taxable years in question. See section 250(b) of the Revenue Acts of 1918 and 1921. Reviewed by Board. Decision will be entered under Rule 50.