Court Denies IRS’ Claim to Property

Orange County Sheriff Brad Gates won a major court victory Thursday against the Internal Revenue Service on behalf of more than 1,000 people who lost $6 million in a 1982 investment scheme.

U.S. District Judge Laughlin E. Waters, in a terse one-page ruling, declared that Gates and not the IRS is entitled to $830,000 in cash and personal property the sheriff confiscated during the arrest of Ralph W. McDonald, who ran the now-defunct Golden Eagle Investment Co.

Deputy County Counsel Arthur Wahlstedt, representing Gates, argued successfully that the sheriff should keep the money so that it can be returned to the victims. Gates once referred to the scheme, which operated for about six months, as the county’s “biggest white-collar scam.”

The IRS argued unsuccessfully that the money should be used to pay taxes owed by McDonald, who began serving an eight-year state prison term in early 1983 for 27 counts of bilking investors in short-term, high-interest promissory notes.

IRS officials were not available for comment late Thursday, and it was not known whether they plan to appeal Waters’ decision.

The money has been drawing interest in the county treasury since McDonald’s arrest in February, 1982.

Wahlstedt said the decision returns the case to Superior Court, where a referee was appointed by Judge Luis A. Cardenas in 1983 to investigate investor claims on the money and to recommend how the funds should be disbursed.

The referee, attorney Ken E. Steelman, also was unavailable for comment late Thursday.

Wahlstedt said it could be several months before Cardenas will be ready to approve any disbursement plan.

Still, Spencer R. Alter, a Santa Ana attorney representing about 125 investors, said, “I’m delighted. . . . It’s a very just decision. It would have been an absolute disgrace if, after McDonald stole the money, the judge would have let the IRS take as taxes the money he stole.”

Alter and Wahlstedt said the IRS is auditing many of the investors’ returns and has mailed notices assessing back taxes, with penalties and interest charges, in cases in which Golden Eagle losses were deducted as bad debts.

The IRS is acting similarly in cases in which investors did receive interest payments during the course of the scheme, even if those investors lost the entire principal amount they invested.

“The penalties and interest charged by the IRS could exceed any amount investors may be able to recover from their share of the $830,000 confiscated from McDonald when he was arrested,” Wahlstedt said.

The IRS has argued that its actions are proper as long as investors have any chance of recovering all or part of their money.

The case went to federal court when the IRS sued Gates for failing to turn over the money.

Meanwhile, a class-action lawsuit filed by Alter on behalf of the investors is still pending against McDonald and Paul G. Mast, one of his attorneys, seeking to recover more than $3.5 million in cash, real estate, jewelry, cars and other assets that McDonald once controlled.