GILBERT V. COMMISSIONER
552 F.2d 478 (2nd Cir. 1997)


PROCEDURAL POSTURE: Appellant taxpayer sought review of a determination by the tax court (New York) that he owed income taxes on funds he withdrew without authorization from the corporation he primarily owned. Appellant contended the funds were not for his personal use, but were used to facilitate a merger between his company and another company, that he disclosed the withdrawals, and that he signed promissory notes to the company, secured by his personal property.

FACTS: Gilbert (P) was president and principle stockholder of Bruce, Inc. which was engaged in the lumber business. In 1961, P acquired on margin and with borrowed money, a substantial personal and beneficial ownership of stock in another lumber company with the idea of merging this company, Celotex, with Bruce. P persuaded associates to purchase stock in Celotex and P granted Bruce an option to purchase his Celotex shares at cost. In May 1962, 62% of Celotex was controlled by P and Bruce. The stock market declined on May 28, 1962 and P was faced with a margin call. P instructed the secretary of Bruce to supply the necessary margin money. A total of $1,958,000 was withdrawn with only $5,000 repaid. P testified that he intended to repay the monies and was acting in Bruce's best interests. P did consult outside counsel to determine how to retire the monies owed to Bruce and negotiations were entered to sell many of the shares to another company. P executed an interest bearing note to Bruce on June 8th. The tax court found that up to June 12th the net
value of the assets assigned substantially exceeded the amounts owed. The board refused to ratify the withdrawals and then word came that the company considering buying the Celotex shares had declined the deal. Bruce demanded P's resignation and P flew to Brazil. On June 13th Celotex stock plummeted and trading was suspended by the SEC. Tax liens were filed against P for $1,720,000 for 1962. Bruce claimed a loss deduction of $1,953,000 for 1962. P pled guilty to unlawful withdrawal of funds. The tax court determined that P had realized income and efforts at restitution did not entitle him to an offset.

ISSUE: If a taxpayer withdraws funds from a corporation which he fully intends to repay and which he expects with reasonable certainty he will be able to repay, where he believes that his withdrawals will be approved by the corporation and where he makes prompt assignments of assets sufficient to secure the amount owed, does he realize income under the James test?

RULE OF LAW: When a taxpayer withdraws funds from a corporation which he fully intends to repay and which he expects with reasonable certainty he will be able to repay, where he believes that his withdrawals will be approved by the corporation and where he makes prompt assignments of assets sufficient to secure the amount owed, he does not realize income under the James test.

HOLDING: (Lumbard, Circuit Judge) If a taxpayer withdraws funds from a corporation which he fully intends to repay and which he expects with reasonable
certainty he will be able to repay, where he believes that his withdrawals will be approved by the corporation and where he makes prompt assignments of assets sufficient to secure the amount owed, does he realize income under the James test? No. Embezzled funds constitute taxable income to the embezzler (James). The Commissioner contends that there can never be consensual recognition of an obligation to repay in an embezzlement case. This is because when the funds were taken Bruce had no idea what was going on and that since the consent with withheld by Bruce, P should be treated like a thief rather than a borrower. In embezzlement, the thief intends to abscond with the funds. If the party spends the loot
instead of repaying, he cannot avoid the tax on his income simply by signing a promissory note later in the same year. However, this is not a typical embezzlement case and we cannot -