Tax Court in Brief | Barrington v. Commissioner | Guilty Plea to Determine Tax Liability and Constructive Divident versus Compensation

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The Tax Court in Brief – July 4th – July 8th, 2022

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Tax Litigation:  The Week of July 4th, 2022, through July 8th, 2022

Barrington v. Commissioner, T.C. Memo. 2022-68 | July 6, 2022 | Buch, J.| Dkt. No. 1781-14


Summary: From October 2001 to July 2002, John Stewart Jakows served time in prison for a felony conviction for forgery and theft. After his release, he changed his name to John Edward Barrington joined with his wife, Deanna Barrington, in creating real estate development businesses—referred to here as Barrington Corp.— that were, in reality, a fraud. The Barringtons bilked over $6 million from investors and others. The Barringtons ran all their personal expenses through Barrington Corp. and received no salary. The Barringtons failed to file individual income tax returns, and only one of the three corporations filed an income tax return for 2003, reporting no income and no expenses. The FBI investigated the Barringtons and involved the IRS’s Criminal Investigation Division (CI). A grand jury indicted the Barringtons on multiple counts. Ultimately, the Barringtons entered separate guilty pleas, but both pleaded guilty of tax evasion. Documents obtained by the government in pursuit of the Barringtons’ cases consisted of more than 10,000 pages. In the pleas, the Barringtons each admitted to receiving unreported income totaling over $600,000 for 2003 through 2005. The plea agreements separated, in various amounts, the unreported income into six categories of personal expenses paid by Barrington Corp.: (1) home mortgage, (2) vehicle and boat, (3) household furnishings, (4) cash/check withdrawal, (5) legal fees, and (6) miscellaneous expenses labeled as “general ledger shareholders equity.” The FBI’s records were destroyed in 2009 in the ordinary course of its operations. The Barringtons had the opportunity to retrieve the records before their destruction but they did not do so. The IRS, in its civil examination, used the information and figures from the plea agreements as the basis for deficiency determinations and additions to tax for all three years. The Barringtons filed a joint petition challenging the IRS’s deficiency determinations, mainly focused on the IRS’s determinations of compensation from Barrington Corp. and Mrs. Barrington claimed she incurred expenses that offset her 2003 gross receipts. The case was tried to the Tax Court, and this opinion followed.

Key Issues:

Primary Holdings:

Key Points of Law:

Insights:  Guilty pleas in a criminal case can be used by the IRS to determine tax liability. When the Barringtons entered their pleas, voluminous documents, including their own records, were available, yet they failed to retrieve them. Later, they blamed the destruction of the records as a basis to challenge the IRS’s determination, and the Tax Court gave them little pity over that circumstance. Their admissions in the plea agreements from the prior criminal proceedings constituted strong evidence of the amounts used by the IRS to determine the Barringtons’ tax liability. And, the Barringtons’ income from Barrington Corp. constituted compensation because they were made in exchange for their efforts at Barrington Corp., the Barringtons were not mere shareholders, and they never received a salary. The IRS’s determination that those payments were compensation and taxable as such was reinforced by the Barringtons’ practice of putting personal commissions into the corporate accounts before using them to pay personal expenses. Because commissions are a form of compensation, the practice so engaged by the Barringtons shows consistent funneling of the Barringtons’ compensation through Barrington Corp.