JOHN E. and FRANCES L. ROGERS v. Commissioner of Internal Revenue

In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 12‐2652
J OHN E. and FRANCES L. R OGERS ,
Petitioners‐Appellants,
v.
C OMMISSIONER OF INTERNAL R EVENUE ,
Respondent‐Appellee.
____________________
Appeal from the United States Tax Court.
No. 22667‐07 — Harold A. Haines, Judge.
____________________
A RGUED A PRIL 19, 2013 — D ECIDED A UGUST 26, 2013
____________________
Before EASTERBROOK , Chief Judge, and P OSNER and
WILLIAMS, Circuit Judges.
P OSNER , Circuit Judge. A trial before the Tax Court result‐
ed in a determination that in 2003 John Rogers and his wife
had failed without justification to report $984,655 of taxable
income attributable to income of Portfolio Properties, Inc.
(PPI), an S corporation wholly owned by Mr. Rogers, and to
a distribution that he had received from PPI. T.C. Memo
2011‐277, 102 T.C.M. (CCH) 536 (2011). For tax purposes the
income of an S Corporation is deemed the personal income

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2 No. 12‐2652
of the shareholders, 26 U.S.C. § 1366, in this case the share‐
holder. After the Tax Court rejected Rogers’ arguments—
repeated in this appeal—that the disputed income had been
held in trust for third parties and so wasn’t taxable to him,
the parties stipulated that if Rogers’ arguments were rejected
he had a tax deficiency of $269,107 and also owed the gov‐
ernment a $5000 penalty. (We disregard his wife. Although
the couple filed a joint return, she appears to have had noth‐
ing to do with the shenanigans that gave rise to the deficien‐
cy.) As a detail, we remark the minuteness of the penalty.
The Tax Court determined that Rogers’ $269,107 tax defi‐
ciency was attributable to his “substantial understatement of
income tax,” which is penalized by 26 U.S.C. § 6662(a). The
penalty specified in the statute is 20 percent of the deficien‐
cy, but the stipulation we mentioned states that only a 5 per‐
cent penalty would be imposed, we know not why.
This is a companion case to Superior Trading, LLC v.
Commissioner, Nos. 12‐37 et al., also decided today, in which
we uphold the disallowance of losses claimed by companies
created by Rogers to implement a distressed asset/debt tax‐
shelter (“DAD”) scheme. We also uphold the imposition of a
“gross valuation misstatement” penalty. Though the émi‐
nence grise of the unlawful tax shelter, Rogers was not a par‐
ty to that case, the deficiency and penalty assessed against
him in this case arose from his creation of the shelter.
Rogers had created a partnership called Warwick Trad‐
ing, LLC. The partners were a Brazilian retailer named Lojas
Arapuã S.A. that contributed receivables to the partnership
that were worth a small fraction of their face amount be‐
cause they were largely uncollectible, and a company owned
by Rogers named Jetstream Business Limited that was des‐

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No. 12‐2652 3
ignated Warwick’s managing partner, responsible for col‐
lecting the receivables. Because property contributed to a
partnership retains its original basis no matter how far its
market value has fallen, the receivables had the potential to
generate losses that would be deductible from the taxable
income of U.S. taxpayers who later entered the partnership,
though in Superior Trading we hold that the potential could
not be realized because, among other reasons, the partner‐
ship was a sham.
Rogers had created PPI—which plays a critical role in
this case—to sit between himself and Jetstream. The tax shel‐
ter was sold to U.S. taxpayers for a total of $2.4 million. Half
was the purchase price of partnership interests in Warwick.
The other half appears to have been a payment to Rogers
(via PPI) for creating the shelter. Rogers directed the buyers
of the interests (the shelter investors) to wire the entire $2.4
million to PPI’s bank account rather than Warwick’s, telling
them that Warwick lacked adequate banking facilities. PPI
funneled half the money received from the investors to
Warwick to pay Arapuã for the receivables that undergirded
the partnership interests that the shelter investors were ac‐
quiring, but retained the other half. The Tax Court deems the
half (i.e., $1.2 million) retained by PPI taxable income of
Rogers; he reported less than half of it as income.
He argues that the $1.2 million retained by PPI (some of
which, however, PPI distributed to him) was held in trust for
the benefit of Warwick and that therefore the alleged tax de‐
ficiency was a “partnership item” and so should have been
resolved “at the partnership level,” 26 U.S.C. §§ 6221, 6225,
6226, and so not in this case, which is about personal not
partnership income. Superior Trading is the case that deals

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4 No. 12‐2652
with the partnership level of Rogers’ tax shelter, and the is‐
sue of the Rogers’ alleged tax deficiency was not raised in
that case. But the Tax Court ruled in the present case that the
money received by PPI and either retained by it or distribut‐
ed to Rogers but not forwarded to Warwick was not held in
trust for Warwick—it was PPI’s money—and so the tax sta‐
tus of that money was not an issue for resolution in a part‐
nership‐level case.
There is no documentation evidencing a trust. Rogers de‐
scribes the money as “imprest [sic] with a trust for the bene‐
fit of Warwick.” That sounds a little like a constructive trust,
which indeed usually lacks documentation—because it’s not
a real trust. Restatement (Third) of Restitution & Unjust En‐
richment § 55, comment b (2011). It is a remedy for unjust en‐
richment: “When property has been acquired in such cir‐
cumstances that the holder of the legal title may not in good
conscience retain the beneficial interest equity converts him
into a trustee.” Beatty v. Guggenheim Exploration Co., 122 N.E.
378, 386 (N.Y. 1919) (Cardozo, J.); see also 1 Dan B. Dobbs,
Dobbs Law of Remedies § 4.3(2), pp. 589–90 (2d ed. 1993). But
Rogers is not arguing that PPI, which he controls, converted
or otherwise wrongfully deprived Warwick of any money or
other property; and if it had, that could hardly generate a tax
benefit for Rogers, for he would be the wrongdoer.
Nevertheless there is something to Rogers’ trust argu‐
ment, though not enough. An agent receiving funds on be‐
half of his principal has a fiduciary duty to maintain the
principal’s funds in a segregated account. Restatement (Third)
of Agency § 8.12 and comment c (2006); cf. Rodrigues v. Her‐
man, 121 F.3d 1352, 1356 (9th Cir. 1997). PPI appears to have
done that with regard to the $1.2 million that the shelter in‐

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No. 12‐2652 5
vestors were paying for the partnership interests. For it for‐
warded that amount to Warwick for distribution to Arapuã
(and to another Brazilian company which had incurred costs
in helping to administer the tax shelter).
Rogers testified that the other half, the $1.2 million that
PPI did not forward to Warwick, was also held in trust for
Warwick, to pay expenses that Warwick might incur in the
future. The Tax Court wasn’t required to believe him, and
didn’t. Rogers had caused PPI to distribute to him $732,000
of the $1.2 million that PPI did not forward to Warwick, and
he argues that he held all $732,000 in trust for Warwick. But
he paid income tax on $513,501 of that amount, which he de‐
scribed as payment for his legal services to PPI. That charac‐
terization is inconsistent with his having held the money in
trust for Warwick. He says that he mistakenly reported it as
personal income, because 2003 was a difficult time for him
and he was confused. But he never sought to file an amend‐
ed return, and years later he stipulated that the $513,501 was
indeed personal income. He tried to withdraw the stipula‐
tion at the trial; the court refused to let him. That was sensi‐
ble. How could anyone believe that if the $513,501 was not
his personal income, he, though an experienced tax lawyer,
would nevertheless have paid income tax on it?
Worse, if Rogers was holding in trust the money he re‐
ceived from PPI and then using it to reimburse himself for
legal services, he was committing a grave breach of trust.
Wal‐Mart Stores, Inc. Associates’ Health & Welfare Plan v. Wells,
213 F.3d 398, 401 (7th Cir. 2000); see Ill. Rule of Professional
Conduct 1.15 (2011); ABA Model Rule of Professional Con‐
duct 1.15 (2013). He thus is driven to argue both that the
money was in trust and so not taxable to him and that it was

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6 No. 12‐2652
his personal property and so he committed no ethical or le‐
gal violations in using it to defray personal expenses. That is
a tightrope that no one can walk. The Tax Court was justi‐
fied in inferring from his treatment of the bulk of the
$732,000 distribution that he caused PPI to pay him that only
the $1.2 million paid to Warwick (and not in issue in this
case) was trust money. This was more telling evidence than
the explanations Rogers offered after being caught with his
hand in the cookie jar.
One loose end remains to be tied up. The money that PPI
neither forwarded to Warwick nor deducted from its income
as payments to Rogers and others for services (i.e.,
$1,218,377 minus $513,501 paid to Rogers and $22,039 paid
to law firms for legal services rendered to PPI) was presum‐
ably intended to compensate Rogers for thinking up and or‐
ganizing the tax shelter. All that matters, though, is that it
was income to him because PPI was an S corporation and
Rogers its only shareholder, rather than being money held in
trust by PPI or by him.
A FFIRMED.

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