On January 16, 2020, the Tax Court issued a Memorandum Opinion in the case of Onyeani v. Commissioner (T.C. Memo. 2020-15). The issue presented in Onyeani v. Commissioner was whether the IRS appropriately issued a termination assessment against the petitioner and determined that his illegal income was taxable.

Note on Onyeani v. Commissioner

Hello, dear reader, I am Ogorji Timothy Wilson Onyeani, a Nigerian doctor, who has come upon a sum of money in the oil and gas business, purchasing 5 million barrels of Nigerian light crude (worth over $250m!) to be discharged in Yangshan Port, Shanghai, China. I was given your name by a mutual friend, Mr. Smith, and offering [sic] you the opportunity to invest in this project. Please wire funds to Bank of America account No. x9724 in advance fees to secure your money. Questions directed to ogorgi@not-a-nigerian-prince-so-this-isn’t-a-scam.com.

This is how I imagine the petitioner’s solicitation for “customers” might have looked like. Not unsurprisingly, he received over $800,000 in “advance fees.” Fortunately, Bank of America flagged the outgoing wire to a London bank as a “potential” scam. (You think?) Upon being flagged and informed that he was being investigated for illegal activity, the petitioner opened up accounts in smaller, less sophisticated, less uppity banks. Having won the Nigerian “I’ve-come-into-a-sum-of-money” scam lottery, he quite literally went to Disney World (among other tourist traps) with some of the ill-gotten sums.

Bank of America closed the petitioner’s accounts, but in their infinite wisdom gave the petitioner cashier’s checks, which he promptly deposited in a mom-and-pop bank, which was none-the-wiser. It must have come as quite a surprise when the Secret Service showed up at the bank’s door to inform the bank that the polite Nigerian doctor was being investigated.

The “fraud department” of the bank, who I imagine was some bumpkin named Otis with a Colt .45, an acute case of psoriasis, and whose advanced investigative techniques involved “the Google,” somehow discovered that Bank of America had closed the petitioner’s accounts. The little ol’ bank “froze” the petitioner’s accounts. I take this quite literally that Otis took the physical greenbacks and put them in a locked freezer in his basement next to the venison backstrap from the 4-point buck he bagged last September, which freezer was guarded by his trusty coonhound, Daisy Duke. True, she may have been blind in one eye and deaf in both ears, but she was still sprightly for her age, which would have made her an octogenarian in human years.

The Secret Service informed the IRS, which quickly proceeded to make a termination assessment under IRC § 6851(a). The IRS reconstructed the petitioner’s income using a bank deposits analysis. Allowing the petitioner to claim the standard deduction, the IRS determined taxable income and tax, terminated the petitioner’s taxable year, assessed nearly $290,000 in tax, and issued a notice of levy to the bank. Thereafter, Otis carefully counted out $290,000 and placed it in “escrow” pending resolution of the petitioner’s challenge to the levy. “Escrow” was a fancy way of saying, Otis put it in a separate, special lockbox in his basement, on the side of which he had written “escrow” in black magic marker. Daisy held her post admirably.

Levy Challenge

Pursuant to IRC § 7429(b), the taxpayer challenged the termination assessment and the levy in U.S. District Court. The court sustained the levy, and Otis delivered the escrowed funds (lockbox and all) to the IRS.

Examination and Notice of Deficiency

The petitioner and his wife filed a joint return for the year in issue, reporting his wife’s income and tax thereon. The return reported none of the income that was the subject of the IRS termination assessment. Performing another bank deposits analysis, the IRS determined that the petitioner failed to report approximately $800,000 in taxable income.

Appeals prepared a notice of deficiency, transmitted it to Counsel for review, and Counsel recommended that the IRS assert the civil fraud penalty under IRC § 6663(a). The recommendation was approved by Counsel’s supervisor. The notice of deficiency was issued with a deficiency of $275,000, a civil fraud penalty of $200,000, and, in the alternative, an accuracy related penalty of $55,000. Petitioner timely petitioned the Tax Court for redetermination of the deficiency and penalties.

Authority to Determine Deficiency with Termination Assessment

With respect to termination assessments made pursuant to IRC § 6851, a taxpayer’s correct tax is to be determined without regard to any credits resulting from the collection of amounts levied and collected pursuant to the termination assessment. IRC § 6211(b)(1). Thus, the $290,000 termination assessment that is disregarded in determining the taxpayer’s “deficiency” pursuant to IRC § 6211(b)(1); however, it will be treated as a credit against the petitioner’s tax liability as ultimately determined. See Treas. Reg. § 1.6851-1(a)(2) and (3).

If a termination assessment is made, the IRS mails a notice under IRC § 6212(a) (notice of determination) for the taxpayer’s full taxable year made within 60 days after the later of (i) the due date of the taxpayer’s return for such taxable year, or (ii) the date such taxpayer files such return. IRC § 6851(b). The IRS timely issued the notice to the taxpayer in the present matter on April 26, within 60 days of the April 15 filing deadline.

Disregarding the Corporate Entity

Generally, the corporate entity will be respected except in those situations where it otherwise would present an obstacle to the protection or enforcement of public or private rights. Hosp. Corp. of Am. v. Commissioner, 81 T.C. 520, 579 (1983); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 442 (1934). A corporation will be disregarded if it is not a viable business entity. N. Ind. Pub. Serv. Co. v. Commissioner, 115 F.3d 506, 511 (7th Cir. 1997), aff’g 105 T.C. 341 (1995); Bass v. Commissioner, 50 T.C. 595, 600 (1968).

A corporation must have been formed for a substantial business purpose or actually engage in substantive business activity to be considered “viable.” Id.; see Moline Props., Inc. v. Commissioner, 319 U.S. 436, 438-439 (1943); Shaw Constr. Co. v. Commissioner, 35 T.C. 1102, 1114 (1961), aff’d, 323 F.2d 316 (9th Cir. 1963). In this case, the IRS had the burden of proof, because it raised the corporate entity issue for the first time in its answer to the petition. See Tax Court Rule 142(a)(1); cf. Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500, 507 (1989).

In determining whether to disregard the corporate entity, the Tax Court considers a number of factors including whether the entity filed returns (income and employment), had officers/directors, maintained records, held meetings and kept minutes, had salaried employees, had a separate business address, was properly capitalized, and distinguished between corporate and personal funds. See, e.g., Noonan v. Commissioner, 451 F.2d 992 (9th Cir. 1971) (per curiam), aff’g 52 T.C. 907 (1969); Achiro v. Commissioner, 77 T.C. 881, 901 (1981); Russell v. Commissioner, T.C. Memo. 2019-146, at *10; Robucci v. Commissioner, T.C. Memo. 2011-19; Pappas v. Commissioner, T.C. Memo. 2002-127; Martin v. Commissioner, T.C. Memo. 1999-193; Visnapuu v. Commissioner, T.C. Memo. 1987-354; Hagist Ranch, Inc. v. Commissioner, T.C. Memo. 1960-206, aff’d, 295 F.2d 351 (7th Cir. 1961); Kimbrell v. Commissioner, 371 F.2d 897, 902 (5th Cir. 1967), aff’g T.C. Memo. 1965-115.

Appropriateness of Bank Deposits Analysis

Where (as here) the taxpayer’s records do not clearly reflect his income, the IRS may use reasonable methods to reconstruct the taxpayer’s income. Webb v. Commissioner, 394 F.2d 366, 371-372 (5th Cir. 1968), aff’g T.C. Memo. 1966-81. The bank deposits method has long been approved by the courts as an appropriate method of income reconstruction. Cole, 637 F.3d at 774-775; United States v. Stein, 437 F.2d 775, 779-781 (7th Cir. 1971); Clayton v. Commissioner, 102 T.C. 632, 645-646 (1994); DiLeo v. Commissioner, 96 T.C. 858, 868 (1991), aff’d, 959 F.2d 16 (2d. Cir. 1992).

Taxation of Illegally Begotten Income

Hearkening back to the biggest IRS coup in the history of IRS coups, the successful arrest and prosecution of Al Capone, the Tax Court observed that illegal income is taxable, and such fact is widely known, even among lay people. United States v. Ytem, 255 F.3d 394, 397 (7th Cir. 2001). Funds received illegally constitute gross income so long as they are received without restriction as to their disposition and are not accompanied by the consensual recognition, express or implied, of an obligation to repay. See James v. United States, 366 U.S. 213, 219 (1961); see also Mais v. Commissioner, 51 T.C. 494, 499 (1968) (finding that a consensual agreement to repay was not established by a mere acknowledgment on the part of the embezzler of his legal obligation to repay).

(T.C. Memo. 2020-15) Onyeani v. Commissioner

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