Boulware v. United States and Tax Evasion

This case has to do with diversions of money--big, big diversions--and their tax consequences. This is one of about five tax cases that the Court has already agreed to hear this year--an unusually large number. Well, the Boulware case, originating in Hawaii, seems to be one of the more colorful tax cases for this term. It deals with the "return of capital rule," which will become clear as I tell you a few facts of this case.

What Did Michael Boulware Do?

The feds began a several-year investigation of Michael Boulware and his company, Hawaiian Isles Enterprises (HIE) in the mid-1990s. Here is what they discovered. Boulware, who was a telephone repairman in the late 1970s, started M & S Vending in 1979. The company originally placed video games in bars and restaurants, but it quickly expanded into other lines of business, such as cigarette sales, coffee roasting and sales, and bottled water distribution. By 1989 HIE (as it was called by the mid-1980s) had gross receipts of over $55 million; by 1992 sales had topped $85 million. Life looks good, doesn't it?

Not on your life. While Mr. Bouleware's business life was soaring, his personal life was crashing, and he decided in 1987 that he would eventually need to divorce his wife. However, in order not to have to sell the company at divorce, he began to take large chunks of money out of the company and give to his girl-friend at the time, so that he would, as he alleged, eventually have enough money to pay off his wife in a divorce settlement. Well, things went sour with the girl-friend, as you probably could imagine, and in 1994 he was involved in a lawsuit with her to return more than $4 million that he had left with her, much of which was in cash. Some have remarked that it was unusual that he wouldn't have set up some kind of trust....

Well, in the meantime, he was also diverting tons of other money from the company. For example, the investigation showed that he diverted at least $3.6 million by giving HIE checks to friends and employees and instructing them to cash the checks, then return the cash to him. He then diverted another $3.58 million by establishing bank accounts in HIE's name with himself as the sole signator, and then deposited proceeds from HIE sales into the accounts without recording the sales on HIE's books. He also diverted HIE funds by instructing businesses that purchased coffee from HIE to remit payment directly to him. Finally, he laundered money through companies in the Kingdom of Tonga and Hong Kong in a complex scheme to live lavishly. Sounds like the mid-to-late 1990s, doesn't it?

Well, things caught up with him--and the method pursued to get him were the federal tax statutes. He was indicted in 2000 on multiple charges of filing false tax returns (from 1989-97--i.e. he didn't report this diverted money as income), tax evasion and making false statements to a federally insured financial institution. He was convicted of many things, appealed the conviction, had the case remanded, was convicted again, and had several of these charges affirmed on appeal. Thus, he faces about five years in prison for all his activities.

But, believing that grasping a thread as you soar towards the abyss is better than grasping at nothing, his skillful attorney out of San Francisco has found a point of law that will perhaps make his diversion of more than $10 million look harmless. And, the Supreme Court decided to bite on the issue. Here, in a nutshell, is the issue.

The Law of the Case

Boulware doesn't want to go to jail, obviously. And, his attorney argues a the following point. He says that the money he received from HIE (whether it was $10 million or less) was, in fact "non taxable returns of capital" rather than "income." The difference is this: If you invest $1,000 into the company and, two years later, with the company worth $10,000, you take out $1,000, the $1,000 you have just taken out shouldn't be considered income. It simply is "non taxable return on capital." But the Ninth Circuit, where Boulware lives, has a rule stemming from the Miller case in the mid-1970s which says that a taxpayer who seeks to invoke the return of capital rule in a criminal tax case must show a "contemporaneous intent" to treat the corporate distribution at issue as a return of capital. That is, if you want to consider the $1,000 as return of capital, according to the Ninth Circuit, you have to show that when you took out the $1,000, you have evidence that you saw it as a non taxable return of capital. That is the Ninth Circuit rule. Under this rule, Boulware was out of luck, because he couldn't show this. Off to prison....

But...., and there often is a "but" in law, the Second Circuit (New York) has a rule that differs from the Miller rule in the Ninth Circuit. According to the D'Agostino case (145 F3d 69 (2d Cir. 1998)), when a corporation without earnings or profits distributes funds to a shareholder, the distribution is a nontaxable return of capital, up to the shareholder's basis in the stock regardless of the intention of the party to treat it as a return on capital when the distribution is made.

Of course, Boulware would like the Second Circuit rule to apply to him but, unfortunately, he is in the Ninth Circuit. So, the Ninth Circuit affirmed his conviction. But since the Supreme Court doesn't like there to be conflicts in the Circuits, it took the case, in order to determine if Miller or D'Agostino states the rule correctly.

Conclusion

Your eyes may be glazing over at this point, but Mr. Boulware's will be wide awake--especially on January 8 in Washington, DC.

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