USCA1 Opinion

UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT
____________________

No. 96-1730

EARL O. BERGERSEN and EVELYN K. BERGERSEN,

Petitioners,

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

____________________

APPEAL FROM A DECISION OF THE UNITED STATES TAX COURT

[Hon. Edna G. Parker, Judge]

_____

____________________

Before

Selya, Circuit Judge,

_____________

Bownes, Senior Circuit Judge,

____________________

and Boudin, Circuit Judge.

_____________

____________________

James M. O'Brien
________________

with whom

Baker & McKenzie was

_________________

on briefs

petitioners.
Jonathan S. Cohen
___________________
Attorney

General, and

with

whom

Loretta C. Argrett,
____________________

Frank P. Cihlar, Tax Division,

________________

Justice, were on brief for respondent.

____________________

Assist

Department

March 21, 1997

____________________

BOUDIN,

Circuit Judge.
______________

This

appeal

involves a

tax

dispute posing

two questions:

the

by

taxpayers

controlled

dividends (rather than loans)

residents of Illinois

1987.

The

Tax

whether certain

The

Court

(rather than Puerto Rico)

Court

answered

yes

to

in 1986 and

both

questions,

for the taxpayers, who now

We affirm the Tax Court.

basic facts,

findings,

derived from

are

largely

inferences and

conclusions

dispute.

taxpayers are

The

long-married couple

Earl

were constructive

and whether the taxpayers were

resulting in adverse consequences

appeal.

company

payments to

to be

the record and

undisputed,

drawn

Earl and

who resided for many

Bergersen practiced

as

an

the Tax

although

are very

much

Evelyn Bergersen,

the

in

years in Illinois.

orthodontist in

Winnetka,

Illinois,

starting in

1959.

In

addition to

practice and

part-time teaching, Earl Bergersen invented and

patented new

orthodontic products, which enjoyed a good deal of success.

In the early

Tain,

Inc.,

products

times

1970s, the Bergersens

under Delaware

based upon

pertinent, the

Earl

law,

to

incorporated Ortho-

manufacture and

Bergersen's inventions.

couple were

Ortho-Tain board of directors.

the only

sell

At

all

members of

the

During the tax years at issue

in this case (1985-1987), the Bergersens also held all of the

class A voting

shares in

class B voting shares

the company (56

held by each of their

-2-2-

each), with

five

three children.

Each of the children also held between 100 and

class

company's

nonvoting stock.

Puerto Rico

nonvoting stock,

Santos

plant,

Ortiz,

held 200

300 shares of

manager of

shares

and Thomas Sedwick, the tool

of class

the

and die maker

at the plant, held 190 shares of class E nonvoting stock.

Initially

based in

Puerto Rico in 1976.

Rico

Winnetka,

the plant

was moved

The Bergersens hoped to move to

eventually; residents

of Puerto

Rico are

to

Puerto

exempt from

U.S. income tax on

26 U.S.C.

933.

income derived from Puerto Rico

After the plant moved,

sources.

Ortho-Tain elected

to be treated as a possessions corporation, exempting it from

U.S. income

tax on Puerto

Rico source income.

The company also received

from Puerto Rico, which

to

receive company

L.P.R.A.

also permitted Puerto Rico residents

dividends free

252 et seq.; id.

_______ ___

plant

finances

from

$600,000

in

while

the

Illinois.

1977 to

936.

a 15-year industrial tax exemption

of income

tax.

See 13
___

252b(a)(1).

During the late 1970s, Ortiz and Sedwick

Rico

Id.
___

Bergersens

handled

Ortho-Tain's

$1.2 million

in

ran the Puerto

the

sales

1987.

company's

grew

from

During these

years, the taxpayers received no salary from the company, and

no dividends were declared on their stock until 1987.

most of the period, modest

During

dividends (ranging from $5,000 to

around $22,000) were paid annually to Ortiz and to Sedwick.

-3-3-

In

this

same

period,

Ortho-Tain's

undistributed earnings grew from

to

just over $5 million

status freed it from

U.S.C.

borrowed

almost

936(g).

accumulated

just under $350,000 in 1977

in 1986.

The company's possession

the U.S. accumulated earnings tax.

26

Meanwhile, starting in 1982, Earl Bergersen

substantial

$3,700,000

amounts

by 1987.

from

the

The loans

unsecured demand notes and carried

company,

were

totaling

evidenced by

interest rates of 8.5

to

10 percent; the taxpayers regularly paid this interest to the

company

and deducted

the

interest payments

on their

U.S.

income tax returns for the years 1982 through 1986.

Apart from one loan repayment of about $400,000 in 1984,

the

loans were

carried

on Ortho-Tain's

books until

March

1987, when Ortho-Tain issued dividends of about $2,800,000 to

the taxpayers, which they treated as exempt from

tax under

company

section

to reduce

loan balance

$2,000,000

933

and immediately

their outstanding

paid

loans.

U.S. income

back

to

the

The remaining

was repaid after further dividends of just over

to taxpayers in 1988.

the position of

As

one might guess, it is

the Internal Revenue Service that

were constructive

dividends subject to U.S.

the loans

income tax when

made.

The other

Bergersens'

issue in dispute

move to Puerto Rico.

concerns the timing

of the

Looking toward this move,

they purchased land in Puerto Rico in 1981 and, over the next

-4-4-

several

began

years,

in

planned an

1984 but,

elaborate

because of

finished as expected by late 1985.

house.

delays,

Construction

the house

was not

In the meantime, starting

in 1984, Earl Bergersen turned over much of his

orthodontics

practice to another dentist and spent only a few days a month

with established patients.

In July

1985, the Bergersens sold

their Winnetka house

and in September 1985 agreed to buy a town house in Glenview,

Illinois.

They

also

In April 1986, they joined a Glenview social club.

sublet an

employee Sedwick

When

apartment

from November

in Puerto

1985

Rico

from their

through October

1986.

the sale closed on the Winnetka house in November 1985,

the Bergersens

dispersed their belongings to

various places

in Illinois and Puerto Rico.

By summer

1986, the

had one bedroom

they

Bergersens' new Puerto

finished, which they

installed a housekeeper couple

their furnishings

were shipped

about the same time,

used on occasion,

in the house.

there in

August

the Bergersens shipped a car

Rico, registered it, and

Rico house

and

More of

1986.

At

to Puerto

activated a country club membership

there.

in

They obtained

January

an occupancy permit for the

1987, but

construction

continued

new house

until August

1987.

During

deal

1986 and

for both

1987, the

business

Bergersens traveled

and pleasure,

-5-5-

dividing their

a good

time

between Puerto Rico

and the

spent 108 days in Puerto

They spent

138

mainland.

Rico in 1986 and 93 there

107 days in the

days there in 1987.

United States

Glenview town house in

Thus,

They

in 1987.

1986 and

in 1986, they spent 150 days

in places other than

Illinois and Puerto Rico; in

1987, the

figure was 134 days.

Earl Bergersen spent no more than a few

weeks each year seeing patients in Winnetka.

In

drivers'

new

February

the

Bergersens

licenses that they had

Puerto

admits

1987,

that

Rico house

the

taxpayers

residence thereafter.

practice in

late 1987.

Puerto Rico voting

was

lost.

completed,

used

it

replaced

In

Earl Bergersen wound

In 1988,

August 1987, the

and the

as

their

government

principal

up his Winnetka

the Bergersens

cards and, in 1989,

Illinois

acquired

Puerto Rico drivers'

licenses.

The

present

Service reviewed

through 1987.

made

to the

loans but

the

case

began

after

the

Internal

the taxpayers' income tax

In

due course, the

Bergersens in

these years

income and to disallow

as part

returns for 1985

IRS ruled that the

were not

constructive dividends; the result

amounts received

Revenue

of the

loans

bona fide

was to include

taxpayers' reportable

deductions taken by them for interest

payments on the loans.

The

1987

IRS also concluded that the

were not

bona fide

residents of

-6-6-

Bergersens in 1986 and

Puerto Rico

for the

entire year, as they claimed, but

for all of 1986

section

income

Rico

and part of 1987.

933 excludes

Puerto

tax only where the

for

the

entire

were residents of Illinois

It

is common ground that

Rico source

taxpayer is a

year

in

income from

U.S.

resident of Puerto

question.

Vazquez
_______

Commissioner, 66 T.C.M. (CCH) 406, 407 (1993); Treas.

____________

Reg.

v.

1.933-1(a).

Accordingly, the

IRS determination

meant that

the moneys

the Bergersens received from

Ortho-Tain in those

years were

not excludable from U.S. income tax under section

933.

The Bergersens petitioned

various

U.S.C.

disputed issues

6213.

April 1994.

The case

the Tax Court

pertaining

to redetermine

to their

was tried before the

In August 1995, the Tax Court

returns.

Tax Court in

issued a 66-page

decision, resolving a number of issues including the

presented on appeal.

that

the

loans were

26

two now

On those two issues, the Tax Court held

constructive

dividends

and that

Bergersens were not residents

of Puerto Rico for the

year either in 1986

Bergersen v.
_________

or 1987.

T.C.M. (CCH) 568, 588 (1995).

the

entire

Commissioner, 70
____________

This appeal followed.

The Loan or Dividend Issue.

_____________________________

issue,

which

is

not

uncommon

The loan

in

tax

cases

controlled companies, usually poses the question

owner is

trying

without paying

to

smuggle

earnings out

personal income

-7-7-

tax.

or dividend

of

involving

whether the

the

A dividend or

company

salary

paid

to an owner is taxable as

temporary transfer, is not.

to an owner is not intended

label to control would

income; a loan, being only a

But if a "loan" by

the company

to be repaid, then allowing that

effectively deprive the government of

its tax bite on dividends and salaries.

The

the

conventional test is to ask whether, at the time of

withdrawal in

repayment.

Cir.

asking

hallmarks

parties actually

intended

Crowley v. Commissioner, 962 F.2d 1077, 1079 (1st

_______
____________

1992).

discern,

question, the

courts

whether

Explaining

regularly

the

of a loan or

that

"intent"

resort

transaction

to

is

objective

bears

of a dividend.

difficult

the

Id.
___

to

criteria,

traditional

In any event,

purporting to be looking

at intent, appeals courts generally

describe such intent as a fact,

fact-finder's determination to

see also Commissioner

_________ ____________

id. at 1080, and subject the

___

clear error review, see

___

v. Duberstein,
__________

363 U.S.

id.;
___

278, 290-91

(1960).

Here, the

of

review.

government invokes this

It argues

that

the

deferential standard

finding of

constructive

dividends cannot be clearly erroneous in light of the various

indicia

status:

mentioned by

that

the

the Tax

loans had

Court as

no

suggesting dividend

collateral and

no

fixed

repayment schedule; that no limits were set on the amounts to

be borrowed;

that the proceeds

for personal purposes;

were used by

and that Ortho-Tain

the Bergersens

accumulated huge

-8-8-

earnings

but paid

the

Bergersens no

dividends during

the

years of the loans until 1987.

The

Bergersens, on

Court made an error

the other

hand, say

of law by stressing that

that the

Tax

the Bergersens

were trying to "avoid taxes" by delaying dividends until they

moved

to Puerto

chose

in section

accumulate

amounts

there.

Rico; Congress,

936(g) to

earnings in

free

of U.S.

the Bergersens

allow possessions

Puerto

Rico and

income tax

to

point out,

companies to

to distribute

those who

the

have moved

And the Bergersens dispute the government's portrayal

and weighing of the objective factors.

Like white asparagus or a blood orange, this first issue

is

not ordinary

interplay of

The

fare but

an odd

ordinary factors

Bergersens may

well

variation, caused

with Puerto Rico

have intended

to repay

after they moved

to Puerto Rico.

they could do so

by declaring a dividend to

of U.S. (and

Puerto Rico)

After all, at

income tax; and

by the

tax status.

the loans

that point

themselves free

after using

the

dividends to repay the

repaid funds

for

loans, they remained free to

a new

dividend,

again without

use the

U.S.

(or

local) tax consequences.

The situation

loan-or-dividend

company would

is thus very different

case, where

repayment of

effectively preclude a

Here, the Bergersens could

from the ordinary

the loan

to the

tax-free distribution.

reasonably have intended to repay

-9-9-

the money and reap

___

Nor would there

the benefits of a

have been anything wrong if

knowing that they were moving

accumulated

tax-free distribution.

earnings

in

the

the Bergersens,

eventually to Puerto Rico, had

company

but

refrained

from

withdrawing them until after the move.

The question here, then, is whether the Bergersens could

pay out moneys to themselves before moving to Puerto Rico and

______

avoid U.S. income taxes by designating the payments as loans.

We think that this

ought to depend upon whether,

character and context, the

more

like dividends.

payments were more like

in overall

loans or

After all, "intent to repay" is merely

a functional test

that is usually suitable;

but the purpose

of the tax law is to tax transactions, not rubrics or labels.

Cf.
___

Helvering v. Gregory, 69
_________
_______

F.2d 809, 810

(2d Cir. 1934),

aff'd, 293 U.S. 465 (1935).

_____

Here, the

of

loans

payments had some of

(notes

existed,

respects, formalities were

no

collateral,

no

interest was

credit

owners

was accumulating

no

dividends,

paid).

absent (no fixed

limit).

formalities, the nominal loans,

that

the traditional indicia

large

But

In other

repayment date,

regardless

of

paid by a controlled company

earnings but

effectively

gave

paying its

the

main

Bergersens

permanent tax-free control over the moneys.

_________

If after their move, the Bergersens had decided

not to

repay but

to cancel the loans

as a form of

dividend, there

-10-10-

would have been no tax due on this dividend.

actually

happened--they declared

If instead--as

cash dividends

and repaid

the loans, the effect was to redeposit the money in their own

corporate

vehicle, available

any time, again with no tax

observed,

the

exchange

of

repayment

checks."

for redistribution to

consequences.

was

As the Tax

effectively

Bergersen,
_________

70

them at

Court

"meaningless

T.C.M.

at

585-86.

Indeed, even the earlier interest payments could be recovered

by the Bergersens without tax effects.

Thus, at the

knew

that there

induce

Rico)

failure

very outset of

was

repayment, nor

any

meaningful

to

repay.

the loans, the

no effective

(given

tax

An

corporate constraint

the intended

consequences

effective

move to

from

permanent

corporate funds to an owner is the hallmark of a

a salary, and

not a loan.

owner

such a

making

There is

transfer.

Bergersens

But

Puerto

permanent

transfer

of

dividend or

nothing wrong with

when made

to

to

an

a U.S.

mainland

resident, the

transfer is

subject to

U.S. income

tax.1

____________________

1Nor

does

achieved

their

borrowing

the

it matter

that

ends through
money

repayment--and repaying

from

the

Bergersens might

different

a bank--a

real

device, say,
loan

have
by

requiring

it with a tax-free dividend declared

after the move to Puerto Rico.

The

the transaction

employ.

they chose to

taxpayers are stuck with

See
___

Commissioner v.
____________

National Alfalfa Dehydrating & Milling Co., 417

_____________________________________________
148-49 (1974).

-11-11-

U.S. 134,

Looking through form

to substance, see Commissioner

___ ____________

v.

Court Holding Co., 324 U.S. 331, 333-34 (1945), we reach the
__________________

same result as the

ourselves on this

(since

Tax Court and therefore need

issue with the

even de novo review

_______

section

933

without

proper standard of

would lead to

claim that the Tax Court made a

giving

section 936(g) is a red herring.

not concern

review

affirmance).

The

mistake of law in construing

sufficient

consideration

to

Congress' policy permitted

the

company to

tax;

it did

accumulate earnings

not

authorize tax-free

in Puerto Rico

free of

dividends to

Illinois

residents.

The Residence Issue.

____________________

issue,

namely,

Illinois during

Court ruled,

for

fact;

but

the Bergersens

1986 and at least

or whether they

either or

residence

whether

We turn now to a more conventional

both years

can present

called a "mixed question of law

a legal label, refracted into

"Mixed question"

were residents of

in their

in

residents

part of 1987, as

entirety.

distinctive issues

quite commonly

unique set of facts.

were

the

end the

of

the Tax

Puerto Rico

Determining

either of

law or

question--often

and fact"--turns on applying

a set of legal criteria, to

That is so here.

is something

of a misnomer;

once the

raw

facts

are

determined

(and

such

determinations

are

normally reviewed only for clear error), deciding which legal

label

to

apply to

those

facts is

normative decision--

-12-12-

strictly speaking, a legal issue.

United States v. McConney,

_____________
________

728 F.2d 1195, 1202

U.S.

may

824 (1984).

(9th Cir.) (en banc), cert. denied, 469

_______
_____________

But

a fact-finder closer

to the evidence

still have a superior "feel"; and the value of precedent

is limited,

since the

next shake

of the

kaleidoscope will

produce a different fact pattern.

We

presented

think that

mixed question

in this case,

afforded to the Tax

v.

and that

of

fact and

some deference

Court's ultimate determination.

law

is

should be

Johnson
_______

Watts Regulator Co., 63 F.3d 1129, 1132 ((1st Cir. 1995).

___________________

See generally 9A C. Wright & A. Miller, Federal Practice and

______________
____________________

Procedure
_________

2589

(1995 &

Supp. 1996).

In

certain narrow

situations involving residency, subjective intent may be very

important, and

Reg.

the

review limited

to clear

error.

Cf. Treas.
___

1.871-3, 1.871-4(c) (residency of alien seamen).

ordinary case presenting

arises

under several

tax

the residency

But

question, which

code provisions,2

is decided

by

using largely objective criteria, developed in the decisions.

E.g., Sochurek v.
____ ________

Commissioner, 300
____________

F.2d 34,

38 (7th

Cir.

1962).

These laundry

lists have to

be used with

some caution

because they are framed broadly, to cover disparate problems.

Deciding when the Bergersens

became bona fide "residents" of

____________________

2See, e.g., 26 U.S.C.

_________
911

(foreign

earned

residing abroad); id.

___

income

871 (nonresident aliens);

exclusion

for

U.S.

933 (Puerto Rico residents).

id.
___

citizens

-13-13-

Puerto Rico is

for U.S. tax

abroad

is

consultant

somewhat different

from determining,

purposes, when an American airline

is

"resident"

of Japan,

"resident" of

Commissioner, 927 F.2d 849,

____________

New

or

York.

albeit

pilot based

visiting

French

Cf. Jones
___ _____

v.

855-57 (5th Cir. 1991); Friedman

________

v. Commissioner, 37 T.C. 539, 551 (1961).

____________

But in

all three

the individual

situations, "residence"

has established his or

implies that

her residential base,

planning to remain indefinitely or at least for a substantial

period.

See
___

Treas.

Reg.

Bergersens did

intend

eventually

remain permanently in Puerto Rico;

1.871-2(b).

to

base

Clearly

the

themselves

and

that is why they embarked

on construction of a very expensive house in 1984, before the

______

tax years in dispute.

when

the

The question for us, as

Bergersens had

effectively

moved

we see it, is

their base

to

Puerto Rico and established their residence there.

As the Tax Court candidly said, the Bergersens' conduct

amounts to a move to Puerto Rico carried out over a period of

time.

Bergersen, 70
_________

T.C.M. at

conduct was completed by 1986.

some

Prior to

Here,

some

of the

1986 they had moved

furnishings to Puerto Rico and rented an apartment.

1986, they began

house,

582.

installed

membership

to use portions

housekeeper

in Puerto Rico, and

-14-14-

of their partly

couple,

completed

activated a

shipped over a

In

club

car and some

remaining furnishings.

Apparently they

also spent Christmas

there in 1986.

But the

Bergersens

links with Illinois

continued to

spending 138 days

Rico.

in 1987,

and only 93

in Puerto

did occasional work in

Puerto Rico house

or

get drivers'

respectively.

The

Glenview house

there in that year

1987, and the Bergersens

Rico

use their

They maintained Illinois drivers'

Bergersen still

The

extended into 1987.

was not fully

licenses, and Earl

his Winnetka office.

completed until August

did not register to vote

licenses there

until 1988

in Puerto

and 1989,

We

part of

not

agree with the Tax Court

that for 1986 and at least

1987, the Bergersens were residents

yet of Puerto Rico.

the center

No one

of gravity was

of Illinois and

consideration is decisive:

shifting from Illinois

Rico throughout the period.

to Puerto

But taking account of all of the

ties to both places,

the Tax Court's conclusion seems

not

but right.

give

only reasonable

some weight to its view in

to specific

facts, see,
___

While we

to us

would ordinarily

applying a tax code concept

e.g., Manzoli v.
____ _______

Commissioner, 904
____________

F.3d 101, 103 (1st Cir. 1990), we would reach the same result

here even if review were de novo.

_______

The

matter of

Bergersens imply

law by giving

that

the Tax

weight, in

Court

deciding the

erred as

residency

issue, to an

alleged tax

avoidance motive.

The Tax

Court

-15-15-

made one reference

to tax

(the other reference

Bergersen,
_________

70 T.C.M.

avoidance as

a relevant

was to an argument by

at 581,

583.

But in

concern

the government).

the very

same

passage, the Tax Court made clear that it was the time of the

move to

Puerto Rico, judged

decisive.

by objective factors,

We reach the same result,

that was

giving no weight to the

alleged motive.

A tax avoidance motive is often included

list of

factors bearing on

Sochurek,
________

300 F.2d at 38,

Tax Court mentioned it

in the laundry

bona fide residency,

so it is

in passing.

not surprising that the

But the

Bergersens were

perfectly

free to

residence

to Puerto Rico, and here we think that tax motives

provide little

(A tax

consider tax

see, e.g.,
_________

advantages in

help in determining when

motive does, however,

were structured as loans.)

moving their

this move occurred.

help explain why

the payments

The balance of the Bergersens' argument on the residency

issue

is an effort to

residence

largely

stress factors favorable

in Puerto Rico (e.g.,

____

completed in 1986) and

that work on

to an early

the house was

to explain away

some of the

factors pointing to Illinois (e.g., the retention of Illinois

____

drivers' licenses).

The arguments are perfectly

and well

They serve to explain why the case is a

presented.

legitimate

close one on the issue of residency at least as to 1987.

-16-16-

But a number

purchase and

time spent

even

maintenance of

in Illinois

if small

considerations--such as

the house in

in 1987--cannot

adjustments are made

overall balance

When dealing

of important

still seems to

Glenview and

be minimized.

in other

us to favor

with incommensurable factors, it

the

the

And

elements, the

the government.

is often hard

to do more than fairly array the factors on both sides, as we

have done in summary

state the result.

and the Tax Court

in detail, and

then

Because the Bergersens were not bona fide residents of

Puerto Rico either in 1986 or for the full year in 1987, they

were not entitled

to avoid

source

those years.

income in

U.S. income tax

26

U.S.C.

on Puerto

933.

Rico

As the

"loans" were constructive dividends, they were taxable income

to

the Bergersens

when

made, and

the Bergersens

were not

entitled to deduct the interest payments to the company.

Knetsch v. United States, 364 U.S. 361, 365-66 (1960).

_______
_____________

Affirmed.
_________

See
___

-17-17-