Boulware v. United States

The Supreme Court has agreed to decide on the proper tax treatment when corporations that do not earn a profit divert funds to a shareholder, a decision that will resolve a conflict between the East and West Coast courts.

The petitioner in the case, Michael Boulware v. United States, No. 06-1509, founded a coffee and bottled water company known as Hawaiian Isles Enterprises. It appears that the ascent of his professional life coincided with the descent of his private life. Beginning in 1987, he began transferring a total of $4.5 million from his company to his girlfriend.

Several years later, Boulware was embroiled in a divorce proceeding. In 1994, he sought return of the funds from Lee, who contended the money was a gift. A Hawaii court concluded that the money was actually a constructive trust that the woman was holding for HIE's benefit.

In 2001, the government indicted Boulware for tax evasion and tax perjury, alleging that he failed to report as income $10 million, including the money that his girlfriend had held for him. Boulware responded with a two-pronged argument: the money that his girlfriend held was not his, but HIE's; and any money that he had received from the company could not be classified as income but instead was a non-taxable return on income.

The Ninth Circuit ultimately rejected both arguments. First, it held that because the Hawaii court was concerned solely with whether Boulware's girlfriend was entitled to the money, it had not squarely considered whether it properly belonged to him or his company. Second, it held that the version of the so-called "return of capital" rule applied in other circuits was less forgiving in the Ninth Circuit.

The "return of capital" rule, championed by the Second Circuit in United States v. D'Agostino, 145 F.3d 69 (2d Cir. 1998), holds that when a corporation that does not have profits or earnings distributes money to a shareholder, the money is a nontaxable return of capital up to the shareholder's basis in his stock.

The Ninth Circuit has long held that the return of capital rule may be invoked only when a shareholder can demonstrate that at the time the money was distributed, it was treated as a return of capital. United States v. Miller, 545 F.2d 1204 (9th Cir. 1976).

Although Boulware asked the Court to consider whether the Hawaii court judgment conclusively resolved the question whether the $4.5 million portion of the alleged tax deficiency belonged to him or his company, it declined to do so. Instead, the Court granted certiorari only on the question whether the return of capital rule applies automatically when a company without earnings or profits distributes money to a shareholder.

The petitioner in the case, Michael Boulware v. United States, No. 06-1509, founded a coffee and bottled water company known as Hawaiian Isles Enterprises.

It appears that the ascent of his professional life coincided with the descent of his private life.

Beginning in 1987, he began transferring a total of $4.5 million from his company to his girlfriend. Several years later, Boulware was embroiled in a divorce proceeding. In 1994, he sought return of the funds from Lee, who contended the money was a gift. A Hawaii court concluded that the money was actually a constructive trust that the woman was holding for HIE's benefit.

In 2001, the government indicted Boulware for tax evasion and tax perjury, alleging that he failed to report as income $10 million, including the money that his girlfriend had held for him. Boulware responded with a two-pronged argument: the money that his girlfriend held was not his, but HIE's; and any money that he had received from the company could not be classified as income but instead was a non-taxable return on income.

The Ninth Circuit ultimately rejected both arguments.

First, it held that because the Hawaii court was concerned solely with whether Boulware's girlfriend was entitled to the money, it had not squarely considered whether it properly belonged to him or his company. Second, it held that the version of the so-called "return of capital" rule applied in other circuits was less forgiving in the Ninth Circuit.

The "return of capital" rule, championed by the Second Circuit in United States v. D'Agostino, 145 F.3d 69 (2d Cir. 1998), holds that when a corporation that does not have profits or earnings distributes money to a shareholder, the money is a nontaxable return of capital up to the shareholder's basis in his stock.

The Ninth Circuit has long held that the return of capital rule may be invoked only when a shareholder can demonstrate that at the time the money was distributed, it
was treated as a return of capital. United States v. Miller, 545 F.2d 1204 (9th Cir. 1976).

Although Boulware asked the Court to consider whether the Hawaii court judgment conclusively resolved the question whether the $4.5 million
portion of the alleged tax deficiency belonged to him or his company, it declined to do so.

Instead, the Court granted certiorari only on the question
whether the return of capital rule applies automatically when a company without earnings or profits distributes money to a shareholder.

On March 3, a unanimous Supreme Court vacated the Ninth Circuit decision, holding that Boulware may claim the "return-of-capital" rule.

"Sections 301 and 316(a) govern the tax consequences of constructive distributions made by a corporation with respect to its stock," Justice David Souter wrote for the court. "A defendant in a criminal tax case does not need to show a contemporaneous intent to treat diversions as returns of capital before relying on those sections to demonstrate no taxes are owed."

Question presented: whether intent to make a return of capital is required for funds diverted and distributed to a shareholder of a corporation without
earnings and profits to qualify as non-taxable return of capital in the context of a criminal trial for tax evasion.

The Supreme Court agreed to decide on the proper tax treatment when corporations that do not earn a profit divert funds to a shareholder, a decision that resolved a conflict between the East and West Coast courts.