United States District Court, Northern District of Illinois, E.D
May 8, 1984
IHOR B. KARPOWYCZ, PLAINTIFF,
UNITED STATES OF AMERICA, DEFENDANT.
The opinion of the court was delivered by: Aspen, District Judge:
MEMORANDUM OPINION AND ORDER
Plaintiff Ihor B. Karpowycz ("Karpowycz") brings this action
pursuant to 26 U.S.C. § 6703 and 7422, challenging a civil
penalty of $500 imposed upon him by the
Internal Revenue Service ("IRS") for filing a tax return
deemed "frivolous" pursuant to 26 U.S.C. § 6702. Presently
pending before the Court is the IRS's motion to dismiss or for
summary judgment. For the reasons set forth below, the motion
To obtain summary judgment, the government as movant must
clearly establish the nonexistence of any genuine issue of
material fact that is material to a judgment in its favor.
Cedillo v. International Association of Bridge & Structural
Iron Workers, Local Union No. 1, 603 F.2d 7, 10 (7th Cir.
1979). Karpowycz is entitled to all reasonable inferences that
can be made in his favor from the evidence presented. United
States v. Diebold, Inc., 369 U.S. 654, 655, 82 S.Ct. 993, 994,
8 L.Ed.2d 176 (1962).
Karpowycz filed his Individual Income Tax Return ("1040")
for calendar year 1982 in April 1983. Both his form 1040 and
his 1982 wage and tax statement ("form W-2") disclose that he
had income from wages, salaries, tips, etc. of $25,138.69 in
1982. His form W-2 establishes that his employer was the Sun
Electric Corporation of Crystal Lake, Illinois. After listing
his income from wages, salaries, tips, etc. on form 1040 as
$25,138.69, Karpowycz altered Line 29 of the form 1040 to read
"NON-CONSTRUCTIVE RECEIPT", and entered $23,404.77 in that
space. This left him with a total income of $2,048.75 for
calendar year 1982. After claiming his $1,000 personal
exemption, Karpowycz claimed a taxable income of $1,048.75,
thus enabling him to report a total tax of $0.
On July 20, 1983, the IRS notified Karpowycz that his
purported return failed to contain information as required by
law, and did not comply with Internal Revenue Code
Requirements. The IRS requested that Karpowycz file a proper
return. Karpowycz subsequently filed a purported amended
return form 1040 which listed $1,733.92 as wages, salaries,
tips, etc. on Line 7, was altered to read "ONLY CONSTRUCTIVELY
REC'D $'S, IF ANY". Karpowycz attached to his amended return
a copy of form W-2 issued by Sun Electric Corporation, again
indicating wages in the amount of $25,138.69 for 1982. He also
attached a copy of IRS Form 1087-DIV for 1982, declaring that
he is a "nominee-agent" for "PROFESSIONAL & TECHNICAL SERVICES
(a TRST). c/o AMERICAN DYNAMICS CORP.", and reported an amount
of $23,404.77 as non-taxable distributions. The amount he
reported as wages, salaries, tips, etc. on this amended 1040
($1,733.92) represents the difference between the amounts
reported on his form W-2 ($25,138.69) and the IRS Form
Based on Karpowycz's filing of his original and amended
returns, the IRS assessed a frivolous return penalty in the
amount of $500 pursuant to 26 U.S.C. § 6702. Karpowycz has paid
15% of the penalty, or $75, and has perfected his right to
review under 26 U.S.C. § 6703.*fn1
Whether Karpowycz filed a frivolous tax return is a question
of law. See United States v. Moore, 627 F.2d 830, 834 (7th Cir.
1980). The government has the burden of proving that any
penalties assessed are justified. 26 U.S.C. § 6703.
According to 26 U.S.C. § 6702:
(a) Civil penalty. — If —
(1) any individual files what purports to be
a return of the tax imposed by subtitle A but
(A) does not contain information on which the
substantial correctness of the self-assessment
may be judged, or
(B) contains information that on its face
indicates that the self-assessment is
substantially incorrect; and
(2) the conduct referred to in paragraph (1)
is due to —
(A) a position which is frivolous, or
(B) a desire (which appears on the purported
return) to delay or impede the administration
of Federal income tax laws,
then such individual shall pay a penalty of $500.
Section 6702 of the Internal Revenue Code is part of the Tax
Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), Pub.
Law, No. 97-248, 96 Stat. 324(617). The legislative history of
TEFRA discloses that Congress enacted § 6702 to deter taxpayers
from filing returns which provide insufficient information for
determining the accuracy of the taxpayers' self-assessment of
tax liability, or which provide information indicating that the
amount shown on the return is substantially incorrect. Miller
v. United States, 577 F. Supp. 980, 981 (N.D. Ind. 1984).
Karpowycz argues that a substantial portion of his wages
earned while employed by Sun Electric Corporation is
non-taxable, since he earned the wages while he was a
"nominee-agent" for Professional and Technical Services
("PTS"), a purported trust created by an entity known as
American Dynamics Corporation. Karpowycz claims that by virtue
of owning a property interest in his own labor, he may convey
his "personal services property assets" to PTS in accordance
with a personal service contract executed between himself and
We disagree. The self-assessments on Karpowycz's original
and amended tax returns are substantially incorrect and are
patently frivolous. It is well settled that gross income
includes compensation for services. 26 U.S.C. § 61. In
addition, the Supreme Court has held that compensation for
labor or services paid in the form of wages or salaries is
income taxable under federal income tax laws. See e.g.,
Commissioner v. Kowalski, 434 U.S. 77, 98 S.Ct. 315, 54 L.Ed.2d
252 (1977). In this regard, Benningfield v. Commissioner,
81 T.C. 408 (1983), is most instructive:
A fundamental principle of our tax system is
that income must be taxed to the one who earns
it. Even assuming their validity under State law,
contractual arrangements designed to circumvent
this rule, by attempting to deflect income away
from the one who earns it, will not be recognized
for Federal income tax purposes. Determining who
earns the income depends upon which person or
entity in fact controls the earning of the
income, not who ultimately receives the income.
81 T.C. at 418-419 (citations omitted).
In his claim for refund, complaint and supporting documents,
Karpowycz has failed to show the existence of a contract or
other agreement between PTS and Sun Electric Corporation.
Rather, Karpowycz simply asserts that an "implied contract"
may be negotiated between a nominee-agent and the personnel
manager of the company in which the nominee-agent provides
services. In addition, Karpowycz does not claim that PTS has
the right to direct or control his activities as an engineer.
As the court held in Benningfield:
[w]here . . . the right to receive income is
contingent upon the continued performance of
services by an individual, the "Income is taxable
to the person whose performance of services
creates the right to receive the income."
United States v.
Landsberger, 692 F.2d 501, 503 (8th Cir. 1982),
aff'g on this issue 539 F. Supp. 142, 144 (D.Minn.
81 T.C. at 420-421.
Karpowycz's purported agreement at best is simply an
anticipatory assignment of income, not recognized as a valid
tax deferral structure under the federal income tax laws.
Lucas v. Earl, 281 U.S. 111, 114-115, 50 S.Ct. 241, 241, 74
L.Ed. 731 (1930). We therefore conclude that Karpowycz's tax
return is frivolous, since it contains both "altered or
incorrect descriptions of line items or other provisions" and
is a return which shows an incorrect or reduced tax because of
a claim of a "clearly unallowable deduction." S.Rep. No. 494,
97th Cong., 2d Sess. 277-78, U.S.Code Cong. & Admin.News 1982,
pp. 781, 1024.*fn2
Article 1, Section 7 Claim
Karpowycz maintains that since § 6702 originated in the
Senate, rather than the House of Representatives, it
contravenes article I, Section 7 of the United States
Constitution. Article I, Section 7 provides that
[a]ll Bills for raising revenue shall originate
in the House of Representatives; but the Senate
may propose or concur with Amendments as on other
TEFRA originated in the House of Representatives, but was
amended in its entirety by the Senate. In Flint v. Stone Tracy
Co., 220 U.S. 107, 31 S.Ct. 342, 55 L.Ed. 389 (1911), the
Supreme Court upheld wholesale amendment of House legislation
by the Senate as long as the Senate's version is relevant to
the subject matter of the original House version. Id. at
142-43, 31 S.Ct. at 345-46. See also Stamp v. Commissioner of
Internal Revenue, 579 F. Supp. 168, 171 (N.D.Ill. 1984); Frent
v. United States, 571 F. Supp. 739, 742 (E.D. Mich. 1983).
Due Process Claim
Karpowycz claims that the assessment of a penalty without a
prior hearing on the validity of his defense, and the
requirement that he pay 15% of that penalty prior to review of
its assessment violates due process. However, a tax may be
assessed without a prior hearing as long as the taxpayer can
sue for a refund subsequent to the assessment. Bob Jones
University v. Simon, 416 U.S. 725, 746, 94 S.Ct. 2038, 2050, 40
L.Ed.2d 496 (1974). The penalties in § 6702 are not
distinguishable from other taxes in this respect. Stamp v.
Commissioner of Internal Revenue, 579 F. Supp. 168, 171
Freedom of Information Claim
Karpowycz also argues that the IRS's failure to publish
interpretive guidelines for Section 6702 in the Federal
Register violates freedom of information provisions of the
Administrative Procedure Act, specifically 5 U.S.C. § 552. But
Franklet v. United States, 84-1 U.S.T.C. 9151 (N.D. Cal. 1984),
held that in light of the plain terms of § 6702 and its
unambiguous legislative history, no administrative guidelines
were required to be published. The Court added that publication
of an administrative interpretation is unnecessary when "(1)
only a clarification or explanation of existing laws or
regulations is expressed; and (2) no significant impact upon
any segment of the public results." Powderly v. Schweiker,
704 F.2d 1092, 1098 (9th Cir. 1983).
For all of the foregoing reasons, IRS's motion for summary
judgment is granted. It is so ordered.