George v. Commissioner of IRS , 837 F.3d 79 ( 2016 )

United States Court of Appeals
For the First Circuit
No. 15-2305
DANIEL H. GEORGE, JR.,
Petitioner, Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent, Appellee.
APPEAL FROM THE DECISION OF THE
UNITED STATES TAX COURT
Before
Torruella, Lynch, and Barron,
Circuit Judges.
John J.E. Markham, II, with whom Markham & Read was on brief,
for appellant.
Anthony T. Sheehan, Attorney, Tax Division, Department of
Justice, with whom Caroline D. Ciraolo, Acting Assistant Attorney
General, and Teresa E. McLaughlin, Attorney, Tax Division, were on
brief, for appellee.
September 13, 2016
TORRUELLA, Circuit Judge. Daniel H. George, Jr.,
appeals a tax court decision affirming a determination by the
Commissioner of the Internal Revenue Service ("IRS") that he owed
$3.790 million in income taxes and penalties on $5.65 million in
bank deposits he made and interest earned from 1995 to 2002.
George argues that these deposits were not his taxable personal
income but the program income of Biogenesis Foundation, Inc.
("Biogenesis"), a social welfare organization that had tax-exempt
status pursuant to section 501(c)(4) of the Internal Revenue Code,
26 U.S.C. § 501(c)(4). We agree with the tax court's
determination that an organization distinct from George did not
exist during the applicable tax years and affirm.
I.
Between 1995 and 2002, George, a self-taught chemist,
created his own health supplements. The proceeds from the sale
of these supplements formed the basis of the bank deposits at issue
in this appeal.
George conducted experiments and created mineral,
herbal, and chemical supplements in his home in Rockport,
Massachusetts. George also worked with health supplement
companies that provided him with raw materials, equipment, and
feedback. In turn, these companies purchased George's supplements,
which they incorporated into their own products. The supplement
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companies dealt with George directly, viewing him as a vendor, and
paid him either in cash or by check.
In addition to his dealings with the supplement
companies, George sold his supplements directly to individuals who
came to his Rockport house. Some of these individuals formed a
"core group," members of which promoted George's supplements
through word of mouth and at meetings where they sold George's
supplements to other people.
The core group members also assisted George in holding
retreats where he discussed health and spirituality and provided
his supplements to attendees. Between 8 and 24 people
participated in any given retreat and paid $300 to $1000 each to
attend. The core group members provided services, such as cooking
and organizing transportation, in lieu of paying fees. Part of
the fees paid by nongroup attendees went towards reimbursing core
group members for the costs of the retreats. George also received
a portion of the fees as payment for the supplements he
administered.
George did not issue receipts or otherwise document the
payments he received from the supplement companies or individuals.
The only record of George's transactions was his deposit of these
funds into fourteen different personal bank accounts he
maintained. George did not spend any of the money he received
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from his activities. Rather, George covered his personal expenses
using Social Security disability payments he received.
In 2002, the IRS began investigating George. During an
interview with an IRS agent, George admitted he had not paid any
taxes since the 1970s.1 George explained that he was hoping to
accrue $10 million to set up a foundation and non-profit research
laboratory. George was subsequently charged with and convicted
of tax evasion in violation of 26 U.S.C. § 7201 based on his
failure to pay taxes in the tax years 1996, 1997, 1998, and 1999.
The United States District Court for the District of Massachusetts
sentenced George to thirty months' imprisonment. We upheld
George's conviction in United States v. George ("George I"), 448
F.3d 96 (1st Cir. 2006).
II.
In May 2003, six weeks after his tax evasion indictment,
George incorporated Biogenesis. That July, George applied for
tax-exempt status for Biogenesis as a charitable organization
under section 501(c)(3) of the Internal Revenue Code, 26 U.S.C.
§ 501(c)(3). In the application, George certified that he was
filing for tax-exempt status "within 15 months from the end of the
1 George subsequently filed a tax return claiming he earned
twenty-eight dollars in gross income and owed zero dollars in taxes
for the 2002 tax year.
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month in which [Biogenesis] was created or formed." The
application also described Biogenesis's mission, which was,
according to George, to expand upon his research to create
supplements for treatments based on cellular regeneration
technology and provide health products to those in need. George
claimed that Biogenesis would achieve this goal by renting
laboratory space and eventually opening its own headquarters. The
IRS granted Biogenesis's application in December 2003.
On October 26, 2011, Biogenesis retroactively filed tax
forms claiming that it was a section 501(c)(4) organization for
the tax years 1996 through 2002. For each of these tax years,
Biogenesis reported revenue equal to the deposits plus interest
earned in George's personal bank accounts (excluding the bank
account in which George's Social Security payments were
deposited).
The IRS subsequently issued a Notice of Deficiency to
George stating that he owed taxes, plus penalties, on income earned
for the tax years 1995 through 2002. George subsequently filed a
petition for review with the tax court, claiming that the deposits
and interest earned for those tax years were not his income but
Biogenesis's. The tax court rejected George's arguments, finding
that no "organization" separate from George existed prior to
Biogenesis's incorporation in 2003 and that George's activities
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during this period were commercial and did not further social
welfare. As a result, the tax court found George liable for the
full amount of the alleged deficiency. 2 This timely appeal
followed.
III.
"We review decisions of the tax court 'in the same manner
and to the same extent as decisions of the district courts in civil
actions tried without a jury.'" Interex, Inc. v. Comm'r, 321 F.3d
55, 58 (1st Cir. 2003) (quoting 26 U.S.C. § 7482(a)(1)). Thus,
its legal conclusions are reviewed de novo and its factual findings
for clear error. Id.
On appeal, George renews his claim that Biogenesis
existed as a section 501(c)(4) tax-exempt organization prior to
its formal incorporation in 2003, such that the bank deposits and
interest were not taxable as his personal income. Section
501(c)(4) of the internal revenue code exempts from taxation
[c]ivic leagues or organizations not organized for
profit but operated exclusively for the promotion of
social welfare, or local associations of employees,
the membership of which is limited to the employees
2 The Commissioner also assessed penalties against George, which
the tax court upheld. For tax years 1995 to 2001, the tax court
imposed penalties for fraudulent failure to file a tax return
pursuant to 26 U.S.C. § 6651(f). For tax year 2002, the tax court
imposed a penalty for fraudulent underpayment of taxes pursuant to
26 U.S.C. § 6663. George does not appeal these penalties beyond
challenging his underlying tax deficiencies. Thus, the merits of
the penalties depend on our assessment of the deficiency claims.
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of a designated person or persons in a particular
municipality, and the net earnings of which are
devoted exclusively to charitable, educational, or
recreational purposes.
26 U.S.C. § 501(c)(4)(A). George argues that Biogenesis met these
requirements in two ways. First, he contends that the tax court
should have treated the IRS's 2003 approval of Biogenesis's section
501(c)(3) application as dispositive. Second, George argues that,
regardless of its section 501(c)(3) status, the tax court's
conclusion that Biogenesis failed to meet section 501(c)(4)'s
requirements in the contested tax years was clearly erroneous. As
explained below, George was required to prove Biogenesis met all
of section 501(c)(4)'s elements and he failed to do so.3
A. Effect of Biogenesis's Section 501(c)(3) Status
As a threshold matter, George claims that because
Biogenesis qualified as a section 501(c)(3) organization upon the
filing of its application, it must have previously fulfilled
section 501(c)(4)'s requirements.4 In support of his argument,
3 We also reject George's contention that the tax court analyzed
whether Biogenesis qualified as a "civic organization" under
section 501(c)(4) rather than a social welfare organization. As
explained below, the tax court's decision relied primarily on its
finding that no organization separate from George existed and we
see no error in this analysis. Any distinction between civic and
social welfare organizations does not affect this conclusion.
4 "Generally speaking, the primary differences between Section
501(c)(3) organizations and Section 501(c)(4) organizations are
that contributions to the former are tax deductible while those to
the latter are not, and the latter can engage in some political
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George cites Treasury Regulation § 1.501(c)(4)-1(a)(2)(i), which
states that "[a] social welfare organization will qualify for
exemption as a charitable organization if it falls within the
definition of charitable set forth in paragraph (d)(2) of
§ 1.501(c)(3)-1." 26 C.F.R. § 1.501(c)(4)-1(a)(2)(i). George
interprets this regulation as meaning that an organization may
qualify as tax exempt under section 501(c)(4) "if its activities
would qualify for approval . . . under section 501(c)(3)."
This argument is easily disposed of by our decision in
George I. George argued in his tax evasion case that the district
court should have sua sponte instructed the jury on section
501(c)(4) organizations. We rejected this contention and stated
that Biogenesis's section 501(c)(3) status was of "no consequence"
because the IRS approves applications based on "an applicant's
unverified representations." George I, 448 F.3d at 101 n.6
(citing Zimmerman v. Cambridge Credit Counseling Corp., 409 F.3d
473, 476-77 (1st Cir. 2005)). Once an issue actually went to
trial, we noted, courts could determine whether the applicant's
representations matched the evidence. See id.; see also 26 U.S.C.
activities while the former cannot." George I, 448 F.3d at 99
n.4. The Commissioner does not dispute George's claim that,
unlike a section 501(c)(3) organization, a section 501(c)(4)
organization need not file a formal application with the IRS to
claim tax-exempt status. We assume for the sake of this appeal,
without deciding the issue, that George is right."
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§ 6110(k)(3) ("[A] written determination [by the IRS] may not be
used or cited as precedent.").
This principle is equally applicable to George's current
tax delinquency case. Biogenesis's section 501(c)(3) application
contained only George's unverified representations. These
representations did not show how Biogenesis actually operated (if
at all) from tax years 1995 to 2002. Thus, the tax court correctly
looked at whether the evidence presented at George's trial showed
that a tax-exempt organization existed within the meaning of
section 501(c)(4).
B. Organization Requirement
Alternatively, George claims that the tax court erred in
determining that Biogenesis did not independently fulfill
section 501(c)(4)'s requirements. "To qualify for a § 501(c)(4)
exemption, there must be (1) an organization, that (2) is not
operated for profit, and that is (3) operated exclusively for the
promotion of social welfare." George I, 448 F.3d at 100 (citing
26 U.S.C. § 501(c)(4); 26 C.F.R. § 1.501(c)(4)-1). The party
claiming the exemption bears the burden of demonstrating that it
satisfies all of the prerequisites by a preponderance of the
evidence. See IHC Health Plans, Inc. v. Comm'r, 325 F.3d 1188,
1193 (10th Cir. 2003); Fed'n Pharmacy Servs., Inc. v. Comm'r, 625
F.2d 804, 806 (8th Cir. 1980).
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We agree with the tax court that George failed to prove
that an organization distinct from himself existed prior to 2003.
In reaching this conclusion, the tax court properly took into
account the absence of organizational formalities and the lack of
"separation between [George] and his activities."5
On appeal, George argues the tax court erred by relying
too heavily on formal organizational structures such as his and
the core group's failure to "maintain[] financial records, ke[ep]
minutes, draft[] organizing documents or bylaws, [or] request[] an
employer identification number" as well as the absence of certain
required filings. George's argument fails for two reasons.
First, it was proper for the tax court to look for objective
indicia of organizational form such as filings and records.6 We
5 The Commissioner's brief urges us to apply the doctrine of
collateral estoppel and give the findings in George I preclusive
effect for the tax years 1996, 1997, 1998, and 1999. In order for
collateral estoppel to apply, the parties "must have actually
litigated the facts in question, and those facts must have been
essential to a valid and final judgment in a prior action." Morón-
Barradas v. Dep't of Educ., 488 F.3d 472, 479 (1st Cir. 2007).
Although George argued that the jury should have been instructed
on section 501(c)(4) organizations on appeal, the issue whether an
organization existed was not litigated in George I. As we noted,
George's theory of defense in his criminal case was that the monies
he deposited in his bank accounts "were gifts and donations from
George's patrons" rather than income of a section 501(c)(4)
organization. George I, 448 F.3d at 100. Thus, the issue whether
George's core group formed an organization was never presented to
the jury in George I.
6 We also believe that the fact that Biogenesis did not
incorporate until 2003, although not dispositive, serves as a
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approved the use of such indicia in George I, noting that George
was not entitled to an instruction on section 501(c)(4)
organizations in part because he "did not operate an
'organization,' given that he failed to engage in any traditional
business behavior, such as maintaining records, hiring employees,
or maintaining a formal office." 448 F.3d at 101. Other courts
have used objective indicia to determine whether an organization
had a primarily charitable, rather than commercial, purpose in tax
exemption cases. See, e.g., Presbyterian & Reformed Publ'g Co.
v. Comm'r, 743 F.2d 148, 155 (3d Cir. 1984). We see no error in
the tax court's taking this evidence into account in determining
whether an organization existed.
Second, the tax court did not view the lack of
organizational formalities as dispositive. Rather, the tax court
considered the evidence in the record and, after weighing all these
factors, concluded that George and the core group did not operate
like an organization in the relevant tax years. As noted by the
tax court, one of the core group members did not view herself as
a member of an organization. She testified at George's trial that
"[Biogenesis] wasn't really an entity at that point that I knew
strong objective indicator that an organization distinct from
George did not exist during the applicable tax years. Notably,
George certified in his application that he was filing for tax-
exempt status within 15 months of Biogenesis's creation.
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of. . . . [W]e were just a group of us trying to heal ourselves."7
The tax court also noted that George was "the sole researcher,
analyst, producer, service provider, and scientist," such that
"[n]o one in the core group besides [George] could have made an
ongoing concern of the alleged organization's reported primary
exempt purpose -- research in cell regeneration -- during the years
in issue." Finally, the tax court factored into its analysis the
fact that George "was the only 'member' of his group with control
over the alleged organization's funds in his personal bank
accounts."
Based on this evidence, the tax court could reasonably
conclude that the core group consisted of individuals who were
interested in George's supplements and advice, not members of an
organization. It is not clear how the core group members would
have continued Biogenesis's alleged mission of building upon
George's research in his absence when none of the core group
members participated in the research and creation of the
7 George argues the tax court should have given this witness's
testimony less weight because "her function in the organization
[preparing food for the retreats] had nothing to do with its legal
status." In other words, George argues that the tax court gave
improper weight to the testimony of a witness he views as less
persuasive than other core group members who testified.
"[W]eighing the evidence . . . is uniquely the province of the
[trial] court." Fed. Refinance Co. v. Klock, 352 F.3d 16, 29 (1st
Cir. 2003). We thus find no error in the tax court's consideration
of this testimony.
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supplements or had access to funding.8 George argues that the tax
court should have considered other evidence in its organizational
calculus, such as the core group members' assistance with running
the retreats and promoting George's supplements. That George's
supplements had an ardent following, however, does not change the
crux of the tax court's analysis that the creation of the
supplements and the control over the group's funding were not
distinct from George. George also claims that there would be no
organization without the core group and retreat participants
because he received from them critical feedback to improve his
supplements. We fail to see how this argument would prevent any
sole proprietor's customers from being viewed as an organization.
Requiring evidence showing that Biogenesis could exist
separate from George comports with general principles of tax law.
Even if George intended to form an organization eventually, the
tax code generally does not allow anticipatory assignments of
income. See United States v. Basye, 410 U.S. 441, 447 (1973)
("[I]ncome is taxed to the party who earns it and that liability
may not be avoided through an anticipatory assignment of that
8 We also note that the supplement companies George dealt with
viewed him as a vendor and were unaware of his affiliation with a
charitable organization. These companies made their checks out
to George and were unaware of an organization called Biogenesis.
This further supports the tax court's finding that no organization
separate from Biogenesis existed.
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income."). Thus, the income from the supplements and the interest
earned could not be attributed to an organization (rather than
George) until that plan to create an organization actually came to
fruition. George has shown neither any sufficient evidence
showing that he or the core group behaved as members of an
organization nor any other objective indicia of an organization.
We therefore conclude the tax court was not clearly erroneous in
finding no organization existed during the relevant tax years.
IV.
We need not go further. Because we find no
organization, we need not address the parties' arguments about
whether George's activities operated for profit or exclusively for
the promotion of social welfare. The decision of the tax court
is affirmed.
Affirmed.
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