Buff v. Commissioner, 58 T. C. 224 (1972)

Embezzled funds are not taxable as income if the embezzler confesses judgment for the amount embezzled within the same taxable year.

Summary

Wilbur Buff embezzled $22,739. 56 from his employer in 1965, confessed judgment for $22,000 in the same year, and made partial restitution. The U. S. Tax Court held that the embezzled funds were not taxable income because the confession of judgment constituted a consensual recognition of debt within the same year, distinguishing it from the general rule in James v. United States. The court also addressed Buff’s claims for deductions on real estate taxes, mortgage interest, and capital loss carryover, and found no negligence for the tax underpayment, thus no penalty under section 6653(a).

Facts

Wilbur Buff, a bookkeeper at S&D Meats, Inc. , embezzled $22,739. 56 from January to June 1965. Upon discovery in June, Buff admitted the embezzlement and signed a confession of judgment for $22,000 plus interest. He continued working for S&D, paying $25 weekly towards the debt, and borrowed $1,000 to repay part of it. S&D later fired Buff, and the judgment was filed and entered against him. Buff’s wife, Hilda, paid real estate taxes and mortgage interest on a house titled in her name. Buff also claimed a capital loss carryover from the dissolution of his company, Biltmore Securities Corp. , in 1960.

Procedural History

The Commissioner of Internal Revenue determined a tax deficiency and negligence penalty for Buff’s 1965 tax return. Buff petitioned the U. S. Tax Court, where the court addressed four issues: the taxability of the embezzled funds, deductions for real estate taxes and mortgage interest, capital loss carryover, and the negligence penalty. The court held for Buff on the taxability of the embezzled funds and the negligence penalty but against him on the deductions for taxes and interest.

Issue(s)

1. Whether the funds embezzled by Buff in 1965 constituted taxable income to him in that year.
2. Whether Buff is entitled to deductions for real estate taxes and mortgage interest paid by his wife in 1965.
3. Whether Buff is entitled to a deduction against ordinary income for a carryover of a capital loss from 1960.
4. Whether any part of Buff’s underpayment of tax for 1965 was due to negligence or intentional disregard of rules and regulations.

Holding

1. No, because Buff’s confession of judgment within the same year constituted a consensual recognition of a debt, akin to a loan, thus the funds were not taxable income.
2. No, because Buff failed to substantiate his liability for the taxes and interest paid by his wife.
3. Yes, because Buff’s testimony regarding the capital loss was accepted in the absence of refutation by the Commissioner.
4. No, because Buff’s failure to report the embezzled funds as income was justified by the court’s finding, and other adjustments did not demonstrate negligence.

Court’s Reasoning

The court distinguished Buff’s case from James v. United States by emphasizing the consensual recognition of debt through the confession of judgment within the same year, akin to cases where funds are mistakenly received and later recognized as a debt. The court relied on United States v. Merrill and J. W. Gaddy, where taxpayers who recognized and made provisions for repayment in the same year were not taxed on the mistaken receipts. The court also rejected the Commissioner’s argument that embezzled funds are always taxable income, citing the unique circumstances of Buff’s case. The dissenting opinions by Judges Dawson and Hoyt argued that the confession of judgment did not change the nature of the embezzled funds from taxable income to a loan and criticized the majority’s reliance on Merrill and Gaddy.

Practical Implications

This decision suggests that in cases of embezzlement where the embezzler acknowledges the debt and makes restitution arrangements within the same taxable year, the embezzled funds may not be treated as taxable income. This ruling could affect how similar cases are analyzed, particularly in distinguishing between embezzlement and loans based on the timing and nature of the restitution. It also underscores the importance of timely acknowledgment and restitution in potentially avoiding tax liability. For legal practitioners, it emphasizes the need to carefully assess the facts and timing of restitution when representing clients in tax disputes involving embezzlement. Subsequent cases would need to consider this ruling when addressing the taxability of embezzled funds.