On May 10, 2021, the Tax Court issued a Memorandum Opinion in the case of Jenkins v. Commissioner (T.C. Memo. 2021-54). The primary issues presented in Jenkins v. Commissioner was whether the IRS has proven fraud, and the amount of unreported income for the consolidated petitioners.

Just a Head’s Up re: Jenkins v. Commissioner

This opinion by Judge Holmes contains a “waddle” of penguins that speak in French, a forged Kerguelenois diplomatic passport, and a simile comparing the IRS to a pod of hungry leopard seals circling the aforementioned waddle.  The opinion is quite long (not Estate of Jackson v. Commissioner-long), but for Judge Holmes, there is a bit more chaff than normal.  We will cut through it to the true tax issues, after a quick trip to Desolation Island.

Kerguelen’s Waddle

How ordinary Federal judges would describe Kerguelen Island:[1]

Kerguelen, a subantarctic island of volcanic origin, is located in the South Indian Ocean, approximately 3,300 mi. (5,310 km) southeast of the southern tip of Africa. Kerguelen is inhabited only by penguins and between 50 and 100 scientists and engineers.

How Judge Holmes describes the place:

In 1772 Yves-Joseph de Kerguelen-Trémarec was commissioned by King Louis XVI to sail into the Southern Ocean in search of Terra Australis. He found instead a small archipelago almost three thousand miles off the southern tip of Africa, inhabited only by wildlife and battered by some of the worst weather in the world. In English, these small patches of rock are named the Desolation Islands. This is apt, for they are an awful place—thousands of miles from the nearest inhabited territory, windswept, bereft of useful resources; and home only to weather researchers, scientists of the extreme, and a very large number of penguins.

So why does this matter?  Well, you see, the two petitioners consolidated in this case are bad, bad men.  In 2006, federal agents in Arizona, acting under the authority of a search warrant and looking for evidence of insider trading and money laundering discovered the men in possession of Kerguelenois passports, an ID card from the Kingdom of Kerguelen’s Ministry of Transportation, and several of the Kingdom’s license plates. “This is all quite odd,” so says Judge Holmes, “for the Kerguelen Islands have never been a sovereign nation. And they have certainly never been a kingdom.”

Before we are led through the multiple indictments, convictions, and other details of the taxpayers’ financial crimes, Judge Holmes leaves us with French-speaking penguins: “If the penguins of those islands could speak, they would say: “Something’s fishy” (or perhaps “C’est chelou”).

Thumbnail of Financial Crimes

Judge Holmes dedicates 15 pages to the financial crimes, but we will provide a much briefer encapsulation.  Bad Ira and Bad Randy were convicted of criminal tax evasion, conspiracy, wire fraud, securities fraud, concealment of money laundering, transactional money laundering, and international concealment of money laundering, with Bad Ira getting more time due to the whole scheme being his idea.

The IRS is Like What Now?

“Like a pod of leopard seals spying a waddle of penguins on ice, the IRS’s revenue agents waited patiently for [the petitioner] to serve all his time…and then moved in for the kill.”  Bless you, Judge Holmes.

The Leopard Seal’s Arguments

With respect to Randy, the IRS argues that the petitioner received $500,000 to assist the financial scheme along, including setting up various, nefarious foreign corporations.  The petitioner did not file in 2000, but the IRS argues that funds flowed to him through two Monex (precious metals) accounts and through a company (SB 1504, Ltd.) that was the petitioner’s alter ego.  The petitioner doesn’t dispute the amounts, but only whether the Monex accounts or SB 1504 can be attributed to him.

With respect to Ira, the IRS argues that capital gains received by four companies should be included in Ira’s income because the companies were Ira’s alter egos.  Critically, the IRS did not argue that the companies were shams.  Had the IRS argued that they were shams, then the Tax Court could have treated its property and income as belonging to the owner (Ira). Moline Props., Inc. v. Commissioner, 319 U.S. 436, 439 (1943); Shaw Constr. Co. v. Commissioner, 323 F.2d 316, 319-20 (9th Cir. 1963), aff’g 35 T.C. 1102 (1961).  The nominee route is equally unavailaing, because there is not enough evidence to understand where the stock of the companies was physically located.  This leaves the alter ego theory.

Quick Work of Fraud

IRC § 6501(a) generally requires that the IRS assert any deficiency of income tax within three years of the filing of a return. Here, the IRS didn’t issue a notice of deficiency for tax year 2000 to either the petitioner until 2011. This would usually leave the IRS “marooned,” but it argues that it “can scramble on board two different lifeboats.” The first is that the three-year statute of limitations doesn’t begin to run if a taxpayer fails to file a tax return. IRC § 6501(c)(3); Rapp v. Commissioner, 774 F.2d 932, 935 (9th Cir. 1985). Second, the three-year limit also doesn’t apply if a taxpayer files a fraudulent return. IRC § 6501(c)(2); see also Graham v. Commissioner, 257 F. App’x 4, 5 (9th Cir. 2007), aff’g T.C. Memo. 2005-68.

It is settled law that a conviction for tax evasion estops a taxpayer from contesting fraud in a later deficiency case. See DiLeo v. Commissioner, 96 T.C. 858, 885 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992); Brooks v. Commissioner, 82 T.C. 413, 431 (1984), aff’d, 772 F.2d 910 (9th Cir. 1985). Thus, the Tax Court quickly moved on to redetermining the amounts of the deficiencies.

Alternate Jurisdictions, Alternate (Alter) Egos

Whether a corporation is a taxpayer’s alter ego is a question of fact. See, e.g., J. Vallery Elec., Inc. v. NLRB, 337 F.3d 446, 451 (5th Cir. 2003); Duggan v. Hobbs, 99 F.3d 307, 313 (9th Cir. 1996). However, different jurisdictions have different standards or tests to decide that question. Sometimes these differences can be substantial. Old W. Annuity & Life Ins. Co. v. Apollo Grp., 605 F.3d 856, 860 n.3 (11th Cir. 2010); see also, e.g., NetJets Aviation, Inc. v. LHC Commc’ns, LLC, 537 F.3d 168, 177-78 (2d Cir. 2008). The parties here seem to have assumed that Arizona law would apply. The Tax Court is not quite so quick on the draw to accept this, however.

Federal or State Law for Alter Ego Determination

The alter-ego doctrine is an exception to the general rule that courts should respect the corporate form, see, e.g., Towe Antique Ford Found. v. IRS, 999 F.2d 1387, 1391 (9th Cir. 1993), and we need to “look closely at the purpose of the federal statute to determine whether the statute places importance on the corporate form,” Town of Brookline v. Gorsuch, 667 F.2d 215, 221 (1st Cir. 1981). Since corporate form is traditionally a creature of state law, see Rodriguez v. FDIC, 140 S. Ct. 713, 718 (2020), the federal interest in setting aside important and carefully evolved state arrangements designed to serve multiple purposes must be substantial, United States v. Kimbell Foods, Inc., 440 U.S. 715, 729-30 (1979).

Other federal courts that exercise federal-question jurisdiction look to state law to figure out whether a corporation is the alter ego of its owner. Most importantly for these cases, the Ninth Circuit—to which they are appealable—also appears to look to forum-state law for an alter-ego standard in similar cases. See, e.g., Schwarzkopf v. Briones (In re Schwarzkopf), 626 F.3d 1032, 1037-38 (9th Cir. 2010) (bankruptcy); Towe Antique, 999 F.2d at 1391 (priority lien). Many of the other circuits seem to agree. See, e.g., United States v. Scherping, 187 F.3d 796, 801-02 (8th Cir. 1999); Floyd v. IRS, 151 F.3d 1295, 1298-99 (10th Cir. 1998); Zahra Spiritual Tr. v. United States, 910 F.2d 240, 242 (5th Cir. 1990).

In a situation where the Tax Court has to decide whether a corporation’s capital-gain income is taxable to an individual because the corporation is his mere alter ego, the Tax Court found no express or implied congressional directive to develop a uniform federal standard. Because there is no regulation that tells the Tax Court what to do so, it is not enough that the Tax Court is determining a taxpayer’s federal tax liability to invoke Federal law.  Trout v. Commissioner, 131 T.C. 239, 251 (2008).

Brief Concluding Thoughts

Through a long analysis of the conflict of law provisions, the Tax Court ultimately settles on Arizona law and then applies it to find what we knew from the beginning.  The companies are Ira’s alter egos, and he is liable for the tax and penalties.

Also, Judge Holmes introduces the world to a variant of “pigeonholed,” which is “penguin-holed.”

(T.C. Memo. 2021-54) Jenkins v. Commissioner

Footnotes

[1] United States v. Gentry, 455 F. Supp. 2d 1018, 1029 (D. Ariz. 2006).

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