Muhich, Frank v. CIR ( 2001 )

In the
United States Court of Appeals
For the Seventh Circuit
Nos. 00-1186 and 00-1187
FRANK MUHICH, VIRGINIA MUHICH,
and MIDWEST PORTRAITS CORPORATION,
Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
Appeals from a Decision of the
United States Tax Court.
Nos. 21561-97 and 21562-97--David Laro, Judge.
Argued October 25, 2000--Decided January 25, 2001
Before COFFEY, DIANE P. WOOD, and WILLIAMS, Circuit
Judges.
COFFEY, Circuit Judge. On August 6, 1997, the
Commissioner of Internal Revenue issued a notice
of deficiency to Frank and Virginia Muhich
stating that they had understated their tax
liabilities on their joint returns for the 1994
and 1995 tax years. On the same day, the
Commissioner also issued a notice of deficiency
to Midwest Portraits Corporation (Midwest) for
the tax years ending on June 30, 1994, 1995, and
1996./1 On October 13, 1999, the Tax Court
entered judgment in favor of the Commissioner in
the following amounts. With regard to the
Muhichs’ joint return, the Tax Court assessed a
deficiency of $17,898 for the tax year 1994 and
$21,885 for the tax year 1995. The Muhichs also
received tax penalties pursuant to I.R.C. sec.
6662(a) for the tax years 1994 and 1995 of $3,580
and $4,377, respectively./2 With regard to
Midwest, the Tax Court assessed deficiencies for
the tax years ending on June 6, 1994, 1995, and
1996 of $1,800, $0, and $825, respectively.
Midwest also received penalties pursuant to
I.R.C. sec. 6662(a) of $360, $0, and $165 for the
tax years 1994, 1995, and 1996, respectively. We
affirm.
I. BACKGROUND
Frank Muhich is the owner, president, and
operator of a photography business located in
Mahomet, Illinois, doing business as Midwest
Portraits Corporation. From 1985 forward, Midwest
worked exclusively with fire, rescue, and
ambulance departments in Illinois, Iowa,
Wisconsin, and Indiana taking pictures, assisting
in soliciting donations, and handing out
complimentary certificates./3 Before the tax
years contested by the IRS, Frank Muhich received
a salary from Midwest which essentially amounted
to him paying himself on a commission basis; the
better Midwest performed, the higher Muhich set
his salary.
All this changed in 1994 when Frank Muhich met
with a financial planner named James Myers. Myers
was a representative of Heritage Assurance Group,
an entity that promoted multitrust schemes as a
means of avoiding taxes. According to the
district court, the Heritage tax avoidance scheme
worked as follows:
An individual transfers his or her assets and
right to receive income to a newly created family
trust in exchange for a certificate of beneficial
interest (CBI). A CBI gives the individual the
right to receive any distributions that the
trustee, who is the same as the transferring
individual, decides to make. The family trust
pays and deducts all of the trustee’s personal
expenses and distributes any excess corpus to a
charitable trust created under the scheme. The
individual creates other trusts to circulate
funds among and between.
(Emphasis added).
After meeting with Myers, the Muhichs traveled
to the home office of Heritage and met with
Edward Bartoli, an attorney who was the principal
promoter of Heritage’s scheme. Bartoli, in turn,
introduced the petitioners-appellants to James
Savino, a certified public accountant associated
with Heritage./4
On May 4, 1994, after paying Heritage $12,000
for a comprehensive trust packet, the Muhichs
created the Muhich Asset Management Trust (Asset
Trust)./5 Within days of the creation of the
Asset Trust, Mrs. Muhich transferred virtually
all of her property to her husband./6 In turn,
Frank Muhich transferred all of his property
(which now included his wife’s property) to the
Asset Trust, including the right to receive
compensation for his services (i.e. the salary he
received from Midwest). In exchange for this
transfer, Frank Muhich and his wife received a
CBI representing 50 and 40 units, respectively.
At this time, the Muhichs were the sole trustees
and sole beneficiaries of the Asset Trust.
What can only be described as a red light to
the IRS, the Muhichs set up the following
additional trusts. On May 7, 1994, the Asset
Trust established the Muhich Charitable Trust
(Charitable Trust). The Asset Trust received a
CBI representing 100 units of ownership in the
Charitable Trust and the Muhichs were listed as
the sole trustees.
On May 15, 1994, the Asset Trust created the
Muhich Business Trust (Business Trust). Once
again, the Asset Trust received a CBI
representing 100 units of ownership and the
Muhichs were designated as the sole trustees. On
May 18, 1994, the Business Trust created the
Muhich Equity Trust (Equity Trust) and the Muhich
Vehicle Trust (Vehicle Trust). The Business Trust
funded the corpus of each trust with $10 in
exchange for a CBI from each trust representing
100 units of ownership in each trust. As always,
the Muhichs were again designated as the sole
trustees.
As sole trustees and exclusive beneficiaries of
the five trusts, the Muhichs had exclusive
control over the trust property. Additionally,
they, at their sole discretion, had the right to
direct any and all distributions from the trusts.
The couple also controlled the bank accounts, and
their ability to deal with and benefit from all
trust property was as free and unrestricted as
before the trusts were established.
For example, Midwest conducted business the same
as it did before the trusts were created. Frank
Muhich continued to run the business and perform
the same duties. However, he no longer took a
formal salary from Midwest. Instead, Midwest
contracted with the Asset Trust in order that the
Asset Trust receive $3,000 per month plus
possible additional compensation depending upon
the company’s performance.
1. The Trusts
The Asset Trust did not engage in any business
or trade at any time. However, for the taxable
years 1994 and 1995, the Asset Trust had
approximately $114,370 and $202,242 in available
funds deposited into its accounts. These funds
included $100,820 and $130,193 for 1994 and 1995,
respectively, in "consulting fees" received by
the Asset Trust for services performed by Frank
Muhich. The balance of these funds was composed
of transfers from Midwest and other trusts
characterized by the Muhichs as loans. From these
funds, the Asset Trust paid the Muhichs’ housing,
transportation, healthcare, education, as well as
miscellaneous expenses. These payments included:
$70,000 in construction costs, interest costs,
and closing costs for their new home; all the
education costs for their college-educated
children; utility bills; automobile payments;
mortgage payments; and trustee fees to the
Muhichs. After deducting the expenses described
above along with the donations made to the
Charitable Trust (which the Muhichs controlled),
the Asset Trust reported zero taxable income for
the taxable years 1994 and 1995./7
It is interesting to note that the tax returns
for the trusts in 1994 were prepared by Savino.
The Muhichs’ long-time tax advisors, the Martins,
were not made aware of the petitioners-
appellants’ trust scheme until late 1994 when
they prepared Midwest’s tax return for the fiscal
year. At that time, the Martins discovered that
Frank Muhich had reportedly received no income
from Midwest. The Martins became suspicious and
questioned the petitioners-appellants as to the
accuracy of their discovery. At the request of
the Muhichs, one of the Martins attended a
Heritage seminar. Although the Martins were
concerned over the legality of the trust scheme
(they advised Mr. Muhich of their concerns), the
Martins prepared the Trusts’ 1995 returns and the
Charitable Trust’s 1996 return. However, the
Martins refused to prepare any other trust tax
returns for the Muhichs.
2. Midwest
Midwest filed federal income tax returns for
its fiscal years ending on June 30, 1994, 1995,
and 1996. In each of these returns, several
irregularities caught the attention of the IRS.
For example, in its 1994 return, Midwest deducted
the $12,000 fee it paid to Heritage for the
comprehensive trust packet. Similarly, in the
1996 fiscal year, Midwest deducted $5,500 in fees
relating to the administration of the trusts.
Midwest labeled these payments "consulting fees"
and deducted these amounts on its income tax
returns. In the notice of deficiency, the
Commissioner determined that the payments were
not "ordinary and necessary" business expenses
and that they were, in fact, non-deductible
constructive dividends. The Commissioner
disallowed the deductions in full.
3. The Muhichs
The Muhichs filed federal income tax returns
for 1994 and 1995. On these returns, the Muhichs
did not report any income from Midwest in the
form of compensation or dividends. In the notice
of deficiency, the Commissioner determined that
the trust scheme was an abusive trust arrangement
and therefore irrelevant for tax purposes. The
Commissioner further determined that Frank Muhich
received constructive dividends/8 from Midwest
in the amounts of $112,820 and $130,193 for 1994
and 1995, respectively.
II. ISSUES
On appeal, the Muhichs challenge the Tax
Court’s determination that the trusts were
"shams" and should be disregarded for tax
purposes. The Muhichs further challenge the Tax
Court’s decision to impose penalties under I.R.C.
sec. 6662(a) as well as the decision to deny
$17,500 worth of deductions.
III. ANALYSIS
The case before us resembled a "typical" family
trust case, in which the taxpayer "assigns" his
income and other assets to the trust and the
trust funds are used to cover all his personal
expenditures, purportedly allowing deduction of
those expenditures. However, as we stated in
Schultz v. Commissioner, 686 F.2d 490, 492-93
(7th Cir. 1982) (footnote in original),
It is fundamental to our income tax regime that
personal consumption expenditures--food,
clothing, travel, education, entertainment--do
not generate income tax deductions unless they
are somehow inextricably linked to the production
of income./9 When taxpayers buy cars, travel, or
take out life insurance policies, they make those
expenditures out of after-tax dollars. The trust
devices here are a transparent attempt to alter
that state of affairs by turning all the
families’ activities into trust activities and
all the families’ expenses into expenses of trust
administration. If this device worked, the
Schulzes and the Whites would, unlike the rest of
us, make all their consumptive expenditures with
pre-tax dollars.
It is well-established that the Commissioner is
not required to recognize, for tax purposes,
those transactions which lack economic substance.
See, e.g., Gregory v. Helvering, 293 U.S. 465,
467 (1935). As the Supreme Court has observed:
Decision of the issue presented in these cases
must be based ultimately on the application of
the factfinding tribunal’s experience with the
mainsprings of human conduct to the totality of
the facts of each case. The nontechnical nature
of the statutory standard, the close relationship
of it to the data of practical human experience,
and the multiplicity of relevant factual
elements, with their various combinations,
creating the necessity of ascribing the proper
force to each, confirms us in our conclusion that
primary weight in this area must be given to the
conclusions of the trier of fact.
Commissioner v. Duberstein, 363 U.S. 278, 289
(1960). Furthermore, the question of economic
substance is factual and the Tax Court’s findings
will not to be disturbed unless they are clearly
erroneous. 26 U.S.C. sec. 7482(a)(1) (court of
appeals reviews Tax Court decisions in same
manner as district court decisions).
In Neely v. United States, 775 F.2d 1092, 1094
(9th Cir. 1985), the court stated,
The [Muhichs’] transfer of the title of assets to
a trust while retaining their use and enjoyment
is a sham transaction that will not be recognized
for tax purposes. A sham transaction is one
having no economic effect other than to create
income tax losses. Zmuda v. Commissioner, 731
F.2d 1417, 1421 (9th Cir. 1984), citing Thompson
v. Commissioner, 631 F.2d 642, 646 (9th Cir.
1980). Even where a taxpayer has structured a
transaction so that it satisfies the formal
requirements of the Internal Revenue Code, legal
effect will be denied it if its sole purpose is
to evade taxation. Id. A trust arrangement may
not be used to turn a family’s personal
activities into trust activities, with the family
expenses becoming expenses of trust
administration. Schulz v. Commissioner, 686 F.2d
490, 493 (7th Cir. 1982).
This is the situation we have before us. The
Muhichs transferred their assets to the trusts
and attempted to have the trusts pay all their
personal expenses. As detailed above, courts have
uniformly held that such transactions are a sham
and that the Commissioner may disregard these
sham trusts for tax purposes. This is what the
Commissioner did and we can see no reason to
overturn the determination of the Tax
Court./10
The decision of the Tax Court is
AFFIRMED.
FOOTNOTES
/1 Frank Muhich is the president and sole
shareholder of Midwest Portraits Corporation.
/2 I.R.C. sec. 6662(a) states:
Imposition of penalty--If this section applies to
any portion of an underpayment of tax required to
be shown on a return, there shall be added to the
tax an amount equal to 20 percent of the portion
of the underpayment to which this section
applies.
/3 Although the record is less than clear, it
appears that Midwest is in the business of taking
pictures of departmental employees and assisting
in the production of promotional items.
/4 At about this time, the Muhichs submitted a form
containing their financial information and assets
to Heritage. On this form, the Muhichs stated
that their number one objective was "tax
avoidance."
/5 It is interesting to note that although the
petitioners had used Kim and Denise Martin
(certified public accountants) as tax advisors
since 1982, they did not consult the Martins as
to the legality of the trust scheme in question
before creating the Asset Trust.
/6 This property included an exhaustive list of
housewares, jewelry, electronics, and china.
/7 The other trusts also filed returns showing zero
taxable income. Essentially, the other trusts
served as conduits through which the Muhichs
transferred money back to Midwest and themselves.
/8 Constructive dividends, or dividends in law,
occur when a corporation confers an economic
benefit upon a shareholder, in his capacity as
such, without an expectation of reimbursement.
That economic benefit becomes a constructive
dividend, taxable to the respective shareholder.
/9 "Personal consumption expenses must obviously be
treated as nondeductible on the whole; if they
were allowed, the individual tax base could be
reduced to zero through expenditures on personal
living items and the notion of a tax on economic
gain would have to be abandoned." M. Chirelstein,
Federal Income Taxation P 7.01 at 140 (2d ed.
1979). Apart from some special provisions, id.,not at issue here, deductions must be for
ordinary and necessary business expenses (Section
162) and costs associated with investment
activities (Section 212).
/10 The Muhichs’ two remaining contentions on appeal,
that the Tax Court’s decision to impose penalties
under I.R.C. sec. 6662(a) as well as the decision
to deny certain deductions were erroneous, are
comprised, in total, of approximately one page of
double-spaced text. Instead of any detailed
argument, the petitioners claim that "substantial
authority exists" to support their claim and that
"a review of the entire record" would establish
the merit of their arguments. As we have
repeatedly stated, "[i]t is not this court’s
responsibility to research and construct the
parties’ arguments." United States v. Lanzotti,
205 F.3d 951, 957 (7th Cir. 2000). Where, as
here, a party fails to develop the factual basis
of a claim on appeal and, instead, merely draws
and relies upon bare conclusions, the argument is
deemed waived. Bonds v. Coca-Cola Company, 806
F.2d 1324, 1328 (7th Cir. 1986) (citing Morgan v.
South Bend Community School Corp., 797 F.2d 471,
480 (7th Cir. 1986)); see, e.g., Gagan v.
American Cablevision, Inc., 77 F.3d 951, 965 (7th
Cir. 1996) (failure to cite any factual or legal
basis for an argument waives it); Bratton v.
Roadway Package Sys., Inc., 77 F.3d 168, 173 n.
1 (7th Cir. 1996) (argument that is not developed
in any meaningful way is waived); Freeman United
Coal Mining Co. v. Office of Workers’
Compensation Programs, Benefits Review Bd., 957
F.2d 302, 305 (7th Cir. 1992) (there is "no
obligation to consider an issue that is merely
raised [on appeal], but not developed, in a
party’s brief"); United States v. Haddon, 927
F.2d 942, 956 (7th Cir. 1991) ("A skeletal
’argument’, really nothing more than an
assertion, does not preserve a claim [for
appellate review]."); United States v. Berkowitz,
927 F.2d 1376, 1384 (7th Cir. 1991) ("We
repeatedly have made clear that perfunctory and
undeveloped arguments . . . are waived . . . .").
Additionally, these claims are plainly without
merit. Consequently, these arguments are waived
and we do not consider them any further.