While F. Lee Bailey is widely considered one of the greatest defense attorneys to ever grace the inside of a courtroom, his body of work has more in common with that of Lionel Hutz — the dimwitted lawyer from The Simpsons — than Bailey would ever care to admit. Think about it:
High profile victories:
Bailey: A successful defense of accused murderer Sam Sheppard, and of course, the O.J. debacle;
Hutz: Earned redemption for Homer in his false advertising suit against the all-you-can-eat seafood buffet, The Frying Dutchman.
Bailey: Unable to free Patty Hearst from charges of armed robbery;
Hutz: Couldn’t garner justice for Marge in her sexual harassment suit against Mr. Burns.
Bailey: Jailed for contempt (see below) and disbarred in Florida and Massachusetts;
Hutz: Set fire to all his records; changed his name to Miguel Sanchez.
Bailey: I use the rules to frustrate the law. But I didn’t set up the ground rules.
Hutz: Judge Snyder has had it in for me ever since I kinda ran over his dog… Well, replace the word ‘kinda’ with ‘repeatedly’ and the word ‘dog’ with ‘son’.
Despite this less than flattering comparison, it’s a must-read opinion when a lawyer of Bailey’s caliber defends himself in front of the Tax Court, particularly when the transactions at issue are the very same that gave rise to Bailey’s incarceration and disbarment.
Facts in Bailey:
While there were other tax issues decided — the court held that Bailey’s yacht refurbishing activity was a “hobby” under the meaning of I.R.C. § 183, while his airplane manufacturing activity was a trade or business — the majority of the case was devoted to whether Bailey recognized taxable income during various stages of a rather unique relationship he entered into with a client at the behest of the government, so that’s where we’ll spend our time.
In 1994 Claude Duboc, who was accused of importing copious amounts of marijuana into the U.S., retained Bailey to negotiate a plea arrangement. As part of the agreement, Bailey would assist Duboc in cooperating with the federal government’s seizure of his many foreign assets, including multiple pieces of high-value residential real estate.
To facilitate restitution from Duboc, the government entered into a vague and unusual agreement with Bailey, under which Bailey would perform services to facilitate Duboc’s forfeiture of his assets, and Duboc would transfer 602,000 shares of Biochem stock to Bailey. This stock would provide funds that Bailey could use to maintain and transfer Duboc’s foreign assets, as well as to cover both Bailey’s fees and the other expenses generated by his work.
For receiving and holding the Biochem stock, Bailey did not open a new account. Rather, the government attorneys understood that Bailey possessed a Swiss bank account, and by agreement it was Bailey’s own account at Credit Suisse that was used. In 1994, 602,000 shares of Biochem stock, then worth $5,891,352, were transferred to Bailey’s Credit Suisse account. Bailey did not report income from his receipt of that stock on any income tax return for any year.
In 1994 and 1995, funds came into Bailey’s Credit Suisse account from three sources–(1) sales of Biochem stock for $2,400,855, (2) loans collateralized by Biochem stock of $3,013,463, and (3) sales of other stock owned by Duboc of $700,000.
From these proceeds, Bailey made further transfers to his personal money market account of stock sale and loan proceeds totaling $3,475,327, of which $425,056 represented stock sale proceeds and $3,013,463 constituted loan proceeds.
In late 1995 or early 1996, Duboc replaced Bailey with another lawyer. At the government’s request, the District Court ordered Bailey to transfer the 400,000 unsold Biochem shares to the federal government. At that time, however, Bailey owed $2,332,743 for loans that had been made against the unsold shares (and he had spent the proceeds); and Credit Suisse would not make any transfer of the shares until the loans were repaid. Bailey therefore did not immediately comply with the District Court’s order, and the court found him in contempt in March 1996 and ordered him incarcerated.
Bailey eventually repaid the full amount of the Credit Suisse loans.
Issue 1:Value of Biochem Stock Transferred to Bailey’s Credit Suisse Account Was Taxable Income:
Tax Court Position: The stock was not taxable income. The stock was not Baileys and was held merely in trust, and in light of the fact that the government persuaded the District Court to stick Bailey in jail until he lived up to the terms of that trust and turn the stock over, the value of the stock was not taxable income when received.
Issue 2: Stock Sale Proceeds and Loan Proceeds Received By Bailey’s Credit Suisse Account Represented Taxable Income:
Tax Court Position: The stock sale and loan proceeds did not constitute taxable income:
Bailey’s agreement with the Government explicitly contemplated that he would use his existing Credit Suisse account for the Biochem stock. Consequently, the transfer of the shares to his Credit Suisse investment account and of the loan and sale proceeds to his Credit Suisse advance account did not constitute an appropriation of those proceeds.
Issue 3: Loan Proceeds Further Transferred From Bailey’s Credit Suisse Account to His Personal Money Market Represented Taxable Income:
Tax Court Position: The loan proceeds were not income:
Bailey denied that the loans he received in his Credit Suisse account that were collateralized by the Biochem stock constituted income. He personally guaranteed the loans, and with great difficulty he borrowed from others and repaid the loans in 1996. He therefore invokes a basic tax principle: “[I]t is settled that receipt of a loan is not income to the borrower.” The receipt of a loan is not income to the borrower where the borrower uses another person’s property as collateral to obtain that loan–even where the collateral is obtained under false pretenses or is otherwise misappropriated–as long as there is a “consensual recognition” that the borrower will repay the loan.
Issue 4: Stock Sale Proceeds Further Transferred From Bailey’s Credit Suisse Account to His Personal Money Market Represented Taxable Income:
Tax Court Position : Since Bailey was not required to repay the stock sale proceeds he appropriated, they represented taxable income.
Bailey bore the burden to prove that in transferring the funds to his money market account he did not depart from his fiduciary role, and he did not carry that burden. The record does not show that he regarded the funds in the money market account as subject to restrictions on their use. We therefore hold that Bailey wrongly appropriated Biochem stock sale proceeds when he made transfers thereof to his Barnett money market account in the amounts of $175,037 in 1994 and $250,019 in 1995 (totaling $425,056) and that he received income for those amounts in those years.
Joe Kristan at Roth & Company has much more on the hobby loss aspects of the case.
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