Boulware Wins the Battle Only to Lose the War (3/9/09)

In Boulware v. United States, 552 U.S. 421 (2008), here, the Supreme Court rejected the Ninth Circuit's holding that a dividend required some type of intent. The definition of dividend in the Internal Revenue Code requires a corporate distribution up to but not in excess of current or retained earnings and profits (E&P), which roughly -- but only roughly -- equates to retained earnings or deficits. Further, the Code provides, if there is no such E&P, the distribution is not taxable up to the shareholder's basis in the stock and only thereafter is taxable as capital gain. By rejecting a requirement that taxpayer "intend" a return of capital distribution, the Supreme Court moved the criminal rule in line with the civil tax rule, which of course is logical since the tax evasion can only exist if there is a tax due and owing and there is no tax due and owing (at least no tax on a dividend) if there is no E&P.

The Supreme Court remanded the case to the Ninth Circuit to determine whether the taxpayer's offer of proof as to the return of capital defense was sufficient. The Ninth Circuit held that the offer of proof was not sufficient, so the Ninth Circuit affirmed the taxpayer's conviction. The decision may be reviewed here. Before moving to that, I should explain the function of the offer of proof or the actual proof if the judge sustains the offer in a criminal case. In a criminal case, the Government must prove the elements of the crime beyond a reasonable doubt. The element of tax evasion in question in Boulware was the element of a tax due and owing. From one perspective, one might think that the Government must prove that (1) there was sufficient E&P to prove a taxable dividend or (2) insufficient basis to cover the total amount of the distributions. But, the law has developed with respect to the return of capital defense (and some other defenses) that the defendant has to put the elements of the defense in play in order to require the Government to have to meet the noted dual burdens beyond a reasonable doubt. The defendant puts the defense in play by meeting a production burden with actual trial evidence or at least an offer of proof as to such evidence; only then does the Government have to meet the dual burdens beyond a reasonable doubt. Hence, at trial, Boulware's lawyer made an offer of proof as to what the proof, if he were allowed to present it to the jury, would show. The offer of proof has to establish the key elements of the defense -- in this case, no E&P and sufficient basis to cover the distributions so that there is no net taxable income and therefore no tax due and owing. The question before the Ninth Circuit on remand was whether the offer of proof met the minimal requirements.

I will try to thumbnail the basis for the Ninth Circuit's holding:

1. The key facts, highly summarized, were: (a) Boulware was president and 50% owner of the corporation and (b) Boulware received / took money from the corporation of about $10 million. The money was a diversion of corporate assets, and was not characterized on the books as anything. In other words, the corporate books did not treat the $10 million as a distribution with respect to stock, as salary or bonus, or as embezzled funds. All we had was a corporate shareholder who had the power to and who did divert corporate funds to his use.

2. The Ninth Circuit opened its analysis straight from the Supreme Court opinion that the return of capital theory of defense requires: "(1) a corporate distribution with respect to a corporation’s stock, (2) the absence of corporate earnings or profits, and (3) the stockholder’s stock basis be in excess of the value of the distribution."

3. The Ninth Circuit correctly noted that the first element requires that the $10 million be, at the threshold, a distribution with respect to stock. Usually, in a case where the person to whom such a diversion occurs is the 100% shareholder and the diversion is not characterized as compensation, the only rational conclusions are that it is (a) a distribution with respect to stock or (b) a loan. However, where, as in Boulware, the shareholder owns significantly less that 100%, then the diversion may be something other than a distribution with respect to stock or a loan; it could, at least in significant part, be an embezzlement which is clearly taxable income. So there might be at least an intent inquiry in determining how to characterize the transaction for purposes of this first element. Nevertheless, the Ninth Circuit rejected the Government's attempt to inject an intent requirement into this element of the defense, but then inexplicably (slip op. 10) breathed life into an intent requirement by holding that the taxpayer had failed to eliminate the possibility of some characterization other than return of capital -- any other characterization would surely require some intent (i.e., an intent to make and receive a loan or an intent to embezzle). The Court concluded: "[A]t the very least a taxpayer must tender some evidence of nexus between the corporate distribution and stock ownership, or show that there were no other alternate explanations, in order to proceed with a return of capital theory at trial."

4. Perhaps recognizing that the analysis was not on the firmest ground, the Ninth Circuit moved to a more solid basis. The Court held that, even if Boulware's offer of proof, if believed, would eliminate E&P, he would still owe a tax on the amount that the distribution exceeded his tax basis in his stock in the corporation. The Court held that the proffer and other evidence were woefully deficient as to his tax basis. The court viewed the evidence as supporting only up to possible $3.2 million basis, thus falling woefully deficient in covering the $10 million in distributions. The Court was thus convinced that there was a tax due and owing and simply refused to send back down for yet another trial.

5. Boulware already had two trials on the tax counts and was convicted in each of them. The first trial was reversed on evidentiary grounds, and the second was the case that reached the Supreme Court and was then on remand to the Ninth Circuit. Reading between the lines, I think the Ninth Circuit did not think the system should have to deal with it again in yet another trial where there was obviously tax evaded (the jury convictions in the first two trials included a determination of willfulness, with the only issue in the Supreme Court and the Ninth Circuit whether there was a tax due and owing). Here, there was clearly some amount of tax due and owing, so the party's over.

6. A tax purist might want to still futz around with the issue of whether there was sufficient basis to cover the distributions in some of the years so that, even though overall there was a tax due and owing, some of the counts could fall by the wayside. Under the Sentencing Guidelines, this might be important, but probably not for the amounts involved here, particularly under the Booker regime. So what if one or two counts dropped, Boulware would likely get the same sentence. (To push the envelop to another level, some anal retentive tax lawyers might harbor the notion that the Government might be unable to properly assign the uncovered income to the proper years, thus causing the case to fall altogether, but my intuition tells me that that would be a pipe dream in the Boulware facts.)

7. My editorial comment is that the Ninth Circuit engaged in shortcuts, just as it had in its earlier decision which the Supreme Court reversed. In a corporate distribution case, imposing the burden to prove that the distributions are taxable distributions can be imposing indeed. E&P alone presents arcana that might be daunting, and perhaps incomprehensible to a jury. So the original Ninth Circuit opinion just effectively dispensed with the requirement of making the proof of E&P or distributions in excess of basis. This was plainly wrong as a matter of tax law, as the Supreme Court plainly said. So, on remand, the Ninth Circuit focused closely on the offer of proof and found highly technical, contrived footfaults. Of course, for future cases, defendants have a roadmap as to what they must prove (or offer as proof) to put the issue in play and force the Government to establish beyond a reasonable doubt that there is sufficient E&P or distributions in excess of basis to create a tax due and owing. The lawyer thus has his work laid out for him, but keep in mind that the requirement is only that a production burden be met and, as a predicate if in the form of an offer, that the offer covers the elements of the defense -- insufficient E&P and/or basis equaling or exceeding the distribution. And, as far as the Government is concerned, it can end-run the issue altogether by simply charging a crime -- usually tax perjury (Section 7206(1)) -- that does not require tax due and owing. Tax perjury, while not the capstone of the criminal tax system, is still the next best thing and, given the number of counts involved in Boulware, would almost certainly produce the same sentence as tax evasion. I would think that, with the developing law culminating in the Supreme Court's decision and now the roadmap for exploiting the Supreme Court's decision in Boulware, the Government will have to think seriously about charging corporate diversion cases as tax perjury rather than tax evasion.

8. Was it a "good" decision for tax purists. Probably not. Was it a fair opinion in the particular facts of Boulware? Probably.

9. There remains an issue, however, as to whether it is even appropriate to impose this type of production burden on the defendant where the Government has the burden of proving a tax due and owing beyond a reasonable doubt. The Ninth Circuit assumed that it could and even that the Supreme Court blessed that. The Supreme Court thus had ducked that issue in the following language:

We express no view on that issue here, just as we decline to consider the more general question whether the Second Circuit's rule in Bok lUnited States v. Bok, 157 F.3d 157 (2d Cir 1998)], which places on the criminal defendant the burden to produce evidence in support of a return-of-capital theory, is authorized by Holland [Holland v. United States, 348 U.S. 121 (1954)] and consistent with Sandstrom v. Montana, 442 U.S. 510, 99 S. Ct. 2450, 61 L. Ed. 2d 39 (1979), and related cases.

The cryptic reference to Holland is apparently to the part of Holland that says, in effect, once the Government proves the elements of the crime, the defendant stands quiet at his peril – i.e., meaning that he takes the risk that the jury will accept the Government's evidence unless he comes forward with countervailing evidence. If that is correct, as to the tax due and owing (requiring E&P or distribution in excess of basis) that simply begs the question unless the Government in its case in chief has proved up E&P or distribution in excess of basis. The reference to Sandstron v. Montana, which dealt with the effect of presumptions in criminal cases as potentially short-circuiting the criminal burden of proof, suggests that the Court may have been thinking of some type of presumption that the corporation has E&P or that the distribution exceeds basis that carries the day for the Government in the absence of some evidence from the defendant that there is no E&P to support the dividend. This may well be the practical effect of Bok, by placing a burden of production on the defendant. As noted, however, the Supreme Court expressed no view on whether that type of shift of burden to the defendant on the element of the crime is appropriate, and thus leaves resolution of the issue to another day. Perhaps Boulware could confront that issue on a second petition for certiorari. (I have discussed a variation on this theme in the context of tax due and owing in prosecutions of tax shelter promoters where it really is inconvenient (to say the least) for the Government to prove up the complete tax picture for the taxpayers involved, so the courts may be relegated to the short-cut of assuming the proof of a tax due simply from the size of the improper loss; for that discussion, click here.)