## Facts

- Stanley and Betty Kreimer (filing jointly) and Harry Walsh formed several companies in 1969 to start an insurance/surety business, including Mount Vernon Investment Company, Mt. Vernon Surety Company, and Mt. Vernon Insurance Agency.
- The venture included outside investors, and the group sought reinsurance (coverage on the surety bonds the business intended to write) from reinsurance companies.
- Disputes arose among Walsh, the Kreimers, and the outside investors about control and ownership.
- Walsh and the Kreimers agreed to sell all of their stock in the Investment company and, in exchange, acquire the remaining stock of the Surety and Agency companies.
- The parties allocated a $675,000 cash purchase price to the Surety and Agency stock (with the Investment stock forming the balance of the consideration in the overall swap).
- Walsh and the Kreimers lacked cash for most of the $675,000 and arranged financing in which other individuals posed as the borrowers on loans from lenders.
- A reinsurance-related company issued surety bonds to support or guarantee the lenders’ loans to the nominal borrowers.
- Although the loans were in the names of the nominal borrowers, the funds were routed to Walsh and the Kreimers to complete the acquisition and related obligations.
- The structure involved deception of the lenders and the surety/reinsurance participant; the Commissioner argued the fraudulent nature of the arrangement meant the advances were not true loans for tax purposes.
- Walsh and the Kreimers maintained that the advances were loans because repayment was intended and required, and the record showed the obligations were in fact repaid.
- The IRS issued notices of deficiency for 1971 and asserted additions to tax for civil fraud under I.R.C. § 6653(b); the cases were consolidated in the Tax Court.

## Issues

1. Whether amounts obtained in 1971 through the straw-borrower loan arrangement were includible in petitioners’ gross income or were non-taxable bona fide loan proceeds.
2. Whether petitioners were liable for the addition to tax for fraud under I.R.C. § 6653(b) for 1971.

## Decision

- The court held the disputed amounts were bona fide loan proceeds and therefore were not includible in gross income for 1971.
- The court rejected the Commissioner’s theory that the illegality or fraud used to obtain the financing automatically converted the advances into taxable income.
- The court held the Commissioner did not prove, by clear and convincing evidence, that petitioners had the intent required for the § 6653(b) civil fraud addition, and it did not sustain the fraud additions.

## Legal Principles

- Loan proceeds are not gross income when received subject to a genuine debtor-creditor relationship, including an actual obligation to repay and an intent to repay at the time the funds are received.
- Fraud or illegality in obtaining funds from third parties does not, by itself, transform funds received under a repayment obligation into taxable income; the tax characterization turns on whether a real repayment liability exists.
- For the § 6653(b) fraud addition, the Commissioner bears the burden to prove by clear and convincing evidence both an underpayment and that the underpayment was due to an intent to evade tax; dishonest conduct toward private parties is not enough, without proof of tax-evasion intent.

## Conclusion

The Tax Court concluded that the 1971 advances obtained through a deceptive straw-borrower financing plan were nonetheless loans, because petitioners received the funds with a real obligation and intent to repay and the obligations were repaid, so the advances were not gross income; the court also found the Commissioner failed to prove the specific intent needed for § 6653(b) civil fraud additions.


Kreimer v. Commissioner, T.C. Memo 1983-672, 47 T.C.M. 260 (1983)