Monday, December 5, 2011
City Wide Transit, Inc. v. Commissioner, TC Memo 2011-279 , Code Sec(s) 6330; 6501.
CITY WIDE TRANSIT, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent .
Code Sec(s): 6330; 6501
Docket: Docket No. 406-09L.
Date Issued: 11/23/2011
Judge: Opinion by VASQUEZ
Reference(s): Code Sec. 6330 ; Code Sec. 6501
Official Tax Court Syllabus
Gary D. Hoppe and Herbert C. Kantor, for petitioner.
Marc L. Caine, for respondent.
Opinion by VASQUEZ
Pursuant to section 6330(d)(1), 1 petitioner seeks review of respondent's determination to proceed with a proposed levy to collect its outstanding employment tax liabilities for the taxable periods ending June 30, 1997; December 31, 1998; March 31, June 30, and December 31, 1999; and March 31 and June 30, 2000 (collectively, the periods at issue). The issue is whether the statute of limitations barred the assessments of petitioner's additional employment taxes for the periods at issue.
The parties submitted this case fully stipulated under Rule 122. The stipulations of facts and the attached exhibits are incorporated herein by this reference. Petitioner's principal place of business was in New York at the time the petition was filed.
Petitioner transports handicapped children throughout New York City on school buses operating under a contract with the New York City Office of Pupil Transportation. Ray Fouche (Ms. Fouche) is petitioner's president and sole shareholder.
Ms. Fouche hired Brand's Paycheck, Inc. (the payroll company), to prepare petitioner's Forms 941, Employer's Quarterly Federal Tax Return, 2 for all relevant periods.
During the relevant periods employers also reported on Form
In 1998 or 1999 Ms. Fouche, on behalf of petitioner, retained Manzoor Beg (Mr. Beg), an accountant, 3 for the sole purpose of negotiating with respondent a reduction in petitioner's outstanding employment tax liabilities for periods unrelated to those at issue. 4 As requested by Mr. Beg, Ms. Fouche signed a blank power of attorney form and gave it to him. 5 Ms. Fouche never requested that Mr. Beg prepare any of petitioner's Forms 941. Mr. Beg's “False Quarterly Return Scheme”
A. Forms 941 for the Original Covered Periods The payroll company prepared petitioner's returns for the periods ending March 31, June 30, and December 31, 1999; and March 31 and June 30, 2000 (original covered periods), and delivered them to Ms. Fouche. Ms. Fouche signed the returns on petitioner's behalf. The returns the payroll company prepared did not claim advance earned income credit (EIC) payments made to employees, and the parties agree that the returns prepared by the payroll company and signed by Ms. Fouche were not false or fraudulent.
As part of Mr. Beg's scheme he convinced Ms. Fouche that he had reached an agreement with the IRS that would allow her to pay off petitioner's unrelated employment tax liabilities, and as a result he needed to deliver petitioner's returns, as they came due, and certified checks made out to the IRS to the revenue officer with whom he was negotiating. As requested Ms. Fouche gave Mr. Beg the returns for the original periods that the payroll company had prepared and she had signed, as well as certified checks made out to the IRS in the amounts of petitioner's employment tax liabilities determined by the payroll company, so that he could deliver them to the revenue officer.
Mr. Beg never gave the revenue officer the checks Ms. Fouche had made out to the IRS or the Forms 941 for the original covered periods that the payroll company had prepared and Ms. Fouche had signed. Instead, Mr. Beg altered the checks Ms. Fouche had made payable to the IRS by changing the payee to Himalayan Hanoi Craft, the name on a bank account Mr. Beg held at Habib American Bank (Himalayan account), 6 and cashed or deposited the checks for his own use. Then, to cover up his embezzlement, Mr. Beg prepared, signed, and filed different Forms 941 for the original covered periods on which he falsely claimed that petitioner had made advance EIC payments to employees. 7 The claimed advance EIC payments made to employees reduced petitioner's employment tax liability for each period, and Mr. Beg paid the IRS the reduced amounts using checks from his Himalayan account. 8 During the course of his scheme Mr. Beg converted more than $280,000 of petitioner's intended payments to the IRS into his own funds by altering the checks petitioner had made out to the IRS.
The parties agree that the Forms 941 Mr. Beg prepared for the original covered periods are false or fraudulent returns within the meaning of section 6501(c)(1). 9 Respondent does not allege that Ms. Fouche, petitioner, or the payroll company intended to evade tax or willfully attempted to defeat or evade tax. Respondent does allege, however, that Mr. Beg intended to evade tax within the meaning of section 6501(c)(1) and/or willfully attempted to defeat or evade taxes within the meaning of section 6501(c)(2) 10 when he filed fraudulent Forms 941 for the original covered periods. Petitioner disagrees.
B. Mr. Beg Filed Amended Forms 941 for the Periods Ending
June 30, 1997, and December 31, 1998
The payroll company prepared petitioner's Forms 941 for the periods ending June 30, 1997, and December 31, 1998, and Ms. Fouche filed them, without including payments of the balances due, on July 31, 1997, and January 31, 1999, respectively. 11 The returns the payroll company prepared did not claim advance EIC payments made to employees, and the parties agree that these returns were not false or fraudulent.
Unbeknownst to Ms. Fouche, Mr. Beg prepared, signed, and filed amended Forms 941 for the periods ending June 30, 1997, and December 31, 1998. On the amended return for the period ending December 31, 1998, 12 Mr. Beg claimed false advance EIC payments made to employees of $48,812. The IRS applied a refundable credit to petitioner's account in the amount of the false advance EIC payments, and this reduced its December 31, 1998, employment tax liability to $19,654. Petitioner's account transcript shows that shortly after Mr. Beg filed the amended return two payments totaling $11,635 were made, at least one of which the record shows was in the form of a check from Mr. Beg's Himalayan account. The IRS applied overpayment credits from petitioner's periods unrelated to those at issue to cover the remainder of the December 31, 1998, period's balance. 13
On the amended return for the period ending June 30, 1997, Mr. Beg claimed false advance EIC payments made to employees of $45,091. The false advance EIC payments reduced petitioner's balance due for the period from $54,374 to $9,283, and Mr. Beg paid the reduced balance by check from his Himalayan account. 14
It is not clear whether or how Mr. Beg benefited from the filing of the amended returns or whether he filed the amended returns with the intention of covering up the fraudulent returns that he had previously filed for the periods ending March 31, June 30, and December 31, 1999. 15 Mr. Beg's Criminal Case On June 10, 2002, the United States filed a complaint against Mr. Beg alleging, among other crimes, that he: (1) Knowingly and intentionally made, uttered, and possessed forged securities of petitioner and the other bus companies in violation of 18 U.S.C. sec. 513(a); (2) knowingly deposited into his Himalayan account approximately $349,865 derived from the making and possessing of forged securities of petitioner and the other bus companies in violation of 18 U.S.C. sec. 1957(a) and (b)(1) (money laundering); (3) signed false tax returns in violation of section 7206(1); and (4) prepared and presented false tax returns in violation of section 7206(2). 16 In the complaint the United States, by sworn statement of a special agent of respondent's Criminal Investigation Division, alleged that Mr. Beg: (1) Knowingly and willfully prepared and subscribed to false Forms 941 in petitioner's name; (2) fraudulently claimed that petitioner's employees had received advance EIC payments; (3) forged checks drawn on petitioner's account; and (4) received from Ms. Fouche checks made payable to the IRS, which he later altered to appear as if they were made payable to Himalayan Hanoi Craft. Ms. Fouche had no knowledge of Mr. Beg's criminal activity before his arrest.
On October 8, 2002, Mr. Beg pleaded guilty to charges of money laundering, knowingly and willfully signing false tax returns, and knowingly and willfully preparing and presenting false tax returns. In 2006 he passed away before being sentenced for his crimes. Petitioner's Civil Examination On or about May 28, 2004, respondent, on the basis of the guilty plea entered in Mr. Beg's criminal trial, commenced a civil examination of petitioner's Forms 941 for the periods at issue. The examination concerned the recovery of petitioner's employment taxes that respondent had failed to collect because of Mr. Beg's filing of the fraudulent Forms 941. On November 28, 2006, Laurie Greenberg (Ms. Greenberg), a certified public accountant representing petitioner during the examination, signed Forms 2504, Agreement to Assessment and Collection of Additional Tax and Acceptance of Overassessment, consenting to the assessment and collection of additional employment taxes for the periods at issue. 17 Pursuant to the signed Forms 2504, respondent assessed additional taxes as follows:
Additional Tax Assessment Date
June 30, 1997 $42,211 Feb. 26, 2007
Dec. 31, 1998 48,812 Mar. 12, 2007
Mar. 31, 1999 40,539 Feb. 26, 2007
June 30, 1999 45,388 Feb. 26, 2007
Dec. 31, 1999 85,927 Feb. 26, 2007
Mar. 31, 2000 53,082 Feb. 26, 2007
June 30, 2000 55,656 Feb. 26, 2007
Respondent did not determine a fraud penalty pursuant to section 6663 against petitioner. The parties agree that respondent assessed the additional employment taxes for the periods at issue more than 3 years after Mr. Beg filed petitioner's Forms 941. Petitioner's Challenge to the Timeliness of the Assessments On or about September 11, 2007, Ms. Greenberg informed respondent that petitioner believed the assessments were made outside the limitations periods. In early January 2008 respondent mailed to petitioner a Final Notice of Intent to Levy and Notice of Your Right to a Hearing concerning petitioner's unpaid additional tax. On January 15, 2008, respondent received petitioner's Form 12153, Request for a Collection Due Process Hearing (CDP request). Petitioner alleged the following in its CDP request: “The IRS relied on the fraud penalty to assess the taxes. However, we eliminated not only the fraud penalty, but all penalties.  Therefore, the assessment should not stand. They assessed over 7 years after the return was filed. The statute was only for 3 years.”
On May 27, 2008, Ms. Greenberg met with Gerard Ohrtman (Mr. Ohrtman), a settlement officer with the IRS Appeals Office (Appeals), to discuss the assessments against petitioner and the issue petitioner raised in the CDP request. Mr. Ohrtman explained that in his opinion the assessments were valid. On December 11, 2008, Appeals issued petitioner a notice of determination sustaining the proposed levy. Petitioner then filed a petition with the Court.
I. Standard of Review Section 6330(a) provides that no levy may be made on any property of a taxpayer unless the Secretary has first notified the taxpayer in writing of his right to a hearing. If the taxpayer properly requests a hearing under section 6330(a), the taxpayer is entitled to a hearing before an impartial Officer of Appeals (CDP hearing). Sec. 6330(b). At the CDP hearing the taxpayer may challenge the underlying tax liability only if the taxpayer did not receive a statutory notice of deficiency or otherwise have a prior opportunity to dispute the tax liability. Sec. 6330(c)(2)(B). A taxpayer's claim that the Commissioner is time barred from collecting its Federal tax liability constitutes a challenge to the underlying tax liability. Boyd v. Commissioner, 117 T.C. 127, 130 (2001). This Court has jurisdiction to review Appeals' determination under sec. 6330(d)(1). Where the taxpayer's underlying liability was properly at issue, we review Appeals' determination de novo. Sego v. Commissioner, 114 T.C. 604, 610 (2000).
Because petitioner did not receive a statutory notice of deficiency or otherwise have a prior opportunity to dispute the tax liabilities, 19 the underlying tax liabilities were properly at issue at the CDP hearing. Accordingly, we will review Appeals' determination that the statute of limitations remained open de novo.
II. Statute of Limitations The Commissioner generally must assess any tax imposed by the Code within a 3-year period after a taxpayer files his or her return. Sec. 6501(a). One exception to this general rule exists, however, for the filing of a false or fraudulent return Sec. 6501(c)(1). 20 with the intent to evade tax. Another exception exists for a willful attempt in any manner to defeat or 20
See supra note 9. evade tax. 21 Sec. 6501(c)(2). In either of those situations the Commissioner may assess the tax, or commence a proceeding in court for the collection of the tax, at any time. Sec. 6501(c). In Allen v. Commissioner, 128 T.C. 37 (2007), we held that, for purposes of section 6501(c)(1), the limitations period remains open indefinitely regardless of whether it was the taxpayer or the taxpayer's tax return preparer who had the intent to evade tax. Section 6501(c)(2), however, was not at issue in Allen.
Respondent, relying on Allen, argues that the limitations periods remain open for the original covered periods because petitioner's returns filed for those periods were false or fraudulent with the intent to evade tax, even though it was Mr. Beg, not Ms. Fouche, petitioner, or the payroll company, whom respondent argues had the intent to evade tax. Respondent also argues that the limitations periods remain open for the original covered periods because Mr. Beg willfully attempted to defeat or evade tax. In this regard respondent asks us to conclude that section 6501(c)(2) extends the limitations period for a willful attempt to evade tax in any manner, even though it may not be the taxpayer who makes the willful attempt. Respondent relies exclusively on section 6501(c)(2) to keep open the limitations periods for the periods ending June 30, 1997, and December 31, 1998. 21
See supra note 10.
Petitioner argues that respondent has not proved by clear and convincing evidence that Mr. Beg intended to evade tax or willfully attempted to defeat or evade tax for any of the periods at issue. 22 Therefore, according to petitioner, respondent cannot rely on section 6501(c)(1) or (2) and respondent is time barred from assessing and collecting the employment taxes for the periods at issue.
III. Whether Respondent Proved by Clear and Convincing Evidence That Mr. Beg Intended To Evade Tax or Willfully Attempted To Defeat or Evade Tax for Any of the Periods at Issue
To keep open the limitations periods under section 6501(c)(1) or (2), respondent must show, by clear and convincing evidence, that Mr. Beg intended to evade tax or willfully attempted to defeat or evade tax, respectively, when he filed petitioner's false Forms 941 for the periods at issue. Secs. 7454(a), 6501(c)(1) and (2); Rule 142(b). The burden of proving fraud remains on respondent despite the parties' decision to submit this case fully stipulated under Rule 122. See Rule 122(b); Borchers v. Commissioner, 95 T.C. 82, 91 (1990), affd. 943 F.2d 22 [68 AFTR 2d 91-5439] (8th Cir. 1991).
To prove fraudulent intent, respondent must show by clear and convincing evidence that Mr. Beg had the specific intent to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Allen v. Commissioner, supra; Parks v. Commissioner, 94 T.C. 654, 662 (1990); McGee v. Commissioner, 61 T.C. 249, 256 (1973), affd. 519 F.2d 1121 [36 AFTR 2d 75-5888] (5th Cir. 1975); Christians v. Commissioner, T.C. Memo. 2003-130 [TC Memo 2003-130]. Although the Court has not expounded on what constitutes a willful attempt to defeat or evade tax under section 6501(c)(2), we have said that there is little “meaningful distinction between [a] `false or fraudulent return with the intent to evade tax' and [a] willful attempt in any manner to defeat or evade tax.” Carl v. Commissioner, T.C. Memo. 1981- 202 [¶81,202 PH Memo TC]. The existence of fraud is a question of fact to be resolved upon consideration of the entire record. DiLeo v. Commissioner, 96 T.C. 858, 874 (1991), affd. 959 F.2d 16 [69 AFTR 2d 92-998] (2d Cir. 1992).
Respondent argues that the record clearly and convincingly shows that Mr. Beg intended to evade tax and/or willfully attempted to defeat or evade employment taxes for all of the periods at issue. Specifically, respondent points out that Mr. Beg filed fraudulent Forms 941 and amended Forms 941, pleaded guilty to violating section 7206(1), and had the knowledge and experience to know that his actions would result in the evasion of petitioner's employment taxes. 23
Petitioner counters that the stipulated facts and incorporated exhibits show that Mr. Beg intended to embezzle from petitioner and that he filed the Forms 941 and amended Forms 941 solely to cover up his embezzlement, not to defeat or evade petitioner's employment taxes. Therefore, according to petitioner, the record does not show by clear and convincing evidence that Mr. Beg had the specific intent to evade tax or willfully attempted to defeat or evade tax, and respondent has failed to carry his burden of proof.
On the record before us, we do not find that respondent has proved by clear and convincing evidence that Mr. Beg had the specific intent to evade tax or willfully attempted to defeat or evade tax when he filed false Forms 941 and amended Forms 941 for the periods at issue. Respondent points to a number of egregious acts Mr. Beg performed that led to the IRS' failing to collect the full amount of petitioner's employment taxes. However, we cannot say that respondent has proved by clear and convincing evidence that Mr. Beg's filing of the Forms 941 and amended Forms 941 shows conduct intended to defeat or evade petitioner's taxes and not an incidental consequence or secondary effect of his embezzlement scheme. Petitioner argues that Mr. Beg intended only to cover up his embezzlement scheme and not defeat or evade petitioner's taxes. Respondent cannot point to anything in the record that leads us to believe petitioner's argument is meritless. Additionally, while respondent argues that Mr. Beg's conviction under section 7206(1) shows that he intended to evade tax, we note that a conviction under section 7206(1) is a factor to be considered and is not dispositive. See Wright v. Commissioner, 84 T.C. 636 (1985); Wickersham v. Commissioner, T.C. Memo. 1999-276 [1999 RIA TC Memo ¶99,276]. This is because the intent to evade tax is not an element of the crime charged under section 7206(1). See Wright v. Commissioner, supra at 641, 643.
Accordingly, we find that respondent has not proved by clear and convincing evidence that Mr. Beg intended to evade tax or willfully attempted to defeat or evade tax for the periods at issue.
IV. Conclusion Because respondent did not show by clear and convincing evidence that Mr. Beg filed fraudulent returns with the intent to evade tax or willfully attempted to defeat or evade tax, the limitations periods for assessment are not extended under either section 6501(c)(1) or (2). Thus, the 3-year limitations period of section 6501(a) controls the timeliness of respondent's assessments of petitioner's additional taxes. Respondent concedes that the assessments of petitioner's additional taxes occurred more than 3 years after Mr. Beg filed petitioner's returns. Accordingly, respondent is time barred from assessing the additional tax for all periods at issue, and Appeals erred as a matter of law in determining that collection activity should proceed to collect petitioner's additional tax for the periods at issue.
We have considered all arguments made by the parties, and to the extent not discussed above, we conclude that those arguments are irrelevant, moot, or without merit.
To reflect the foregoing, Decision will be entered for petitioner.
Unless otherwise indicated, all section references are to the Internal Revenue Code (Code), and all Rule references are to the Tax Court Rules of Practice and Procedure.
Employers are liable for deducting and withholding from their employees' salaries or wages the employees' shares of Federal income and Federal Insurance Contributions Act (FICA) taxes. Secs. 3102(a), 3402(a), 3403. The withheld Federal income and FICA taxes are reported quarterly on Form 941. Secs. 31.6011(a)-1(a)(1), 31.6011(a)-4(a)(1), Employment Tax Regs. 941 advance earned income credit (EIC) payments made to employees. Eligible individuals could elect to receive part of the EIC in their regular pay by filing with their employers Form W-5, Earned Income Credit Advance Payment Certificate. Employers reduced their employment tax owed by the amount of advance EIC payments made to employees. See sec. 3507.
Mr. Beg was not a certified public accountant, although he told Ms. Fouche that he was.
In addition to petitioner, Ms. Fouche owned a number of other bus companies that had outstanding employment tax liabilities for periods unrelated to those at issue. Ms. Fouche hired Mr. Beg to negotiate with the Internal Revenue Service (IRS) a reduction in the unrelated outstanding employment tax liabilities of all the companies.
The power of attorney form is not part of the record, but we assume it was a Form 2848, Power of Attorney and Declaration of Representative.
Ms. Fouche had no knowledge of Mr. Beg's Himalayan account.
Mr. Beg claimed false advance EIC payments made to employees on petitioner's Forms 941 for the original covered periods in the following amounts: $40,539 for the period ending Mar. 31, 1999 (received by the IRS on Apr. 30, 1999); $45,388 for the period ending June 30, 1999 (received on Dec. 21, 1999); $85,927 for the period ending Dec. 31, 1999 (received on Jan. 31, 2000); $53,082 for the period ending Mar. 31, 2000 (received on May 19, 2000); and $55,656 for the period ending June 30, 2000 (received on Aug. 28, 2000).
For example, petitioner's Form 941 for the period ending Mar. 31, 1999, as prepared by the payroll company, reported that petitioner owed $46,501.33 in employment tax for that quarter. Petitioner issued the IRS a certified check for that amount and gave the Form 941 and check to Mr. Beg. The return that Mr. Beg prepared and filed for the period ending Mar. 31, 1999, reported that petitioner had made advance EIC payments of $40,539 during the quarter and showed a total balance due of $5,962.33 (i.e., petitioner's correct tax liability of $46,501.33 - Mr. Beg's falsely claimed advance EIC payments of $40,539). Mr. Beg issued a check to the IRS for $5,962.33 and altered the certified check petitioner had given him by changing the payee from the IRS to Himalayan Hanoi Craft. The results are similar for the other original covered periods, although the account transcripts for those periods do not show that Mr. Beg paid the IRS the exact amount of the remaining reduced liability, as he did for the period ending Mar. 31, 1999.
Generally the Commissioner must assess a tax within 3 years after the return is filed. Sec. 6501(a). An exception to the general rule is found in sec. 6501(c)(1): “In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.”
Sec. 6501(c)(2) provides: “In case of a willful attempt in any manner to defeat or evade tax imposed by this title (other than tax imposed by subtitle A or B), the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time.” While sec. 6501(c)(1) applies to any tax imposed under the Code, sec. 6501(c)(2) applies only to employment and excise taxes.
Respondent assessed tax of $54,374.31 for the period ending June 30, 1997, and tax of $68,375.62 for the period ending Dec. 31, 1998.
Mr. Beg filed the amended return for the period ending Dec. 31, 1998, before filing the amended return for the period ending June 30, 1997.
The IRS later received from petitioner the full amount of its Dec. 31, 1998, employment tax liability.
The IRS later received from petitioner the full amount of its June 30, 1997, employment tax liability.
Mr. Beg filed the amended return for the period ending Dec. 31, 1998, after he had filed the fraudulent return for the period ending Mar. 31, 1999, and he filed the amended return for the period ending June 30, 1997, after he had filed the fraudulent returns for the periods ending June 30 and Dec. 31, 1999.
The violation of sec. 7206(2) relates to Mr. Beg's fraudulent preparation of Forms 1040, U.S. Individual Income Tax Return, for taxpayers unrelated to petitioner.
By Aug. 28, 2003, the 3-year period of limitations on assessment and collection under sec. 6501(a) had expired for all periods at issue. Thus, Ms. Greenberg signed the Forms 2504 more than 3 years after the limitations periods under sec. 6501(a) had expired.
Respondent does not argue, and nothing in the record indicates, that petitioner had the opportunity to challenge its employment tax liabilities at any time during respondent's examination of petitioner's Forms 941 or before Ms. Greenberg's signing the Forms 2504.
Petitioner also argues that respondent cannot rely on sec. 6501(c)(1) or (2) to extend the limitations periods because Allen v. Commissioner, 128 T.C. 37 (2007), is not controlling and neither petitioner nor the payroll company intended to evade tax or willfully attempted to defeat or evade tax. Thus, petitioner argues that the 3-year limitations period of sec. 6501(a) controls and respondent is time barred from assessing and collecting the employment taxes for the periods at issue.
Courts have developed a nonexclusive list of factors or “badges of fraud” that demonstrate fraudulent intent. Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992). These badges of fraud include: (1) Understatement of income; (2) inadequate records; (3) implausible or inconsistent explanations of behavior; (4) concealment of income or assets; (5) failure to cooperate with tax authorities; (6) filing false documents; (7) failure to make estimated tax payments; (8) dealing in cash; (9) engaging in illegal activities; and (10) engaging in a pattern of behavior that indicates an intent to mislead. Vogt v. Commissioner, T.C. Memo. 2007-209 [TC Memo 2007-209], affd. 336 Fed. Appx. 758 [104 AFTR 2d 2009-5241] (9th Cir. 2009). No single factor is necessarily sufficient to establish fraud; however, a combination of several of these factors may constitute persuasive evidence of fraud. Niedringhaus v. Commissioner, supra at 211.
Kyl Christians v. Commissioner, TC Memo 2003-130 , Code Sec(s) 6501; 6663.
KYL CHRISTIANS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
Code Sec(s): 6501; 6663
Docket: Dkt. No. 9814-01.
Date Issued: 05/5/2003.
Judge: Opinion by Gerber, J.
Tax Year(s): Years 1992, 1993, 1994.
Disposition: Decision for Taxpayer in part and for Commissioner in part.
1. Limitations periods on assessments—fraud—proof—omissions in excess of 25% of gross income. Limitations periods barred more than 3-year old assessments for 2 of 3 years for which taxpayer had unreported business income: IRS didn't for Code Sec. 6501(c) purposes prove by clear and convincing evidence that taxpayer's admitted understatements were due to fraud. Taxpayer's pattern of underreporting and poor recordkeeping, although “dereliction” of his reporting duty, didn't show intent to evade tax by deceitful or misleading conduct, particularly where he was relatively immature, inexperienced in business and totally relied on father for administrative matters, including tax reporting. Similarly, discrepancies between amounts taxpayer reported to IRS and to mortgage co. were simply result of his reliance on father, and showed no intent by him to defraud IRS or any fraud intent on part of father that could be imputed to him. But, taxpayer conceded that assessment period for remaining year was open under Code Sec. 6501(e) .
Reference(s): ¶ 65,015.13(40) ; ¶ 65,015.15(5) Code Sec. 6501 ; Code Sec. 6663
Official Tax Court Syllabus
Ted E. Merriam and Kevin A. Planegger, for petitioner.
Kevin Brown, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
In a statutory notice of deficiency, mailed on May 4, 2001, respondent determined deficiencies in petitioner's Federal income tax and penalties for the taxable years 1992, 1993, and 1994 as follows:
Year Deficiency Sec. 6663
---- ---------- ---------
1992 $ 4,831 $ 3,623.25
1993 12,115 9,086.25
1994 18,912 14,184.00
Petitioner contends that respondent is barred from assessing the income tax deficiencies because the notice of deficiency was mailed after the expiration of the 3- year period for assessment provided for in section 6501(a). 1 Respondent contends that the period for assessment remains open under section 6501(c)(1) because petitioner filed false and fraudulent returns for the years in question. In the alternative, respondent contends, and petitioner concedes, that the period for assessment remained open for 1994 because of the substantial understatement of gross income by more than 25 percent. In such circumstances, section 6501(e) provides for a 6- year period for assessment.
We consider here whether petitioner's understatements for taxable years 1992, 1993, and 1994 were due to fraud. In the event we do not find petitioner's understatement for taxable year 1994 was due to fraud, respondent may assess the deficiency under section 6501(e).
FINDINGS OF FACT 2
Petitioner resided in Loveland, Colorado, at the time his petition was filed in this case. For taxable years 1992, 1993, and 1994, petitioner owned and operated a construction business, which did business under the name of K&L Exteriors Trim (K&L Exteriors). The business of K&L Exteriors was residential construction, in particular house framing and siding work.
Petitioner graduated from high school in 1986 and then began employment as a construction laborer. After 1 year, petitioner began full-time attendance at Aims Community College. Following his first year, petitioner transferred to the University of Northern Colorado, which he attended for 1 year.
After his second year of college, petitioner moved to Minnesota to work for his grandfather, who owned and operated an electric motor repair business. He worked for his grandfather for approximately 1 year. He subsequently moved back to Colorado and re-enrolled in the University of Northern Colorado. He attended for two quarters and then transferred for an addi-[pg. 655] tional semester to Colorado State University for an additional semester, where he studied a specialized curriculum on construction. Petitioner did not earn a college degree.
During his final semester at Colorado State University, petitioner worked part time for George Moore Construction earning between $6 and $7 per hour. Petitioner acquired first-hand knowledge of the need for residential construction services and believed he could earn more money by operating his own construction business. During 1992, when petitioner was approximately 24 years old, his father lent him approximately $500 to $600 to start a construction business, under the name K&L Exteriors Trim (K&L Exteriors). K&L Exteriors began with two to three employees, and business was generated by word of mouth or by petitioner's contacts with other contractors at job sites. K&L Exteriors did not maintain any inventory, and its business consisted of providing services in the form of labor.
During 1993, petitioner organized a corporation called Four Square Construction, Inc. (Four Square), for the sole purpose of providing payroll services for K&L Exteriors. K&L would transfer funds to Four Square each month, and then Four Square would distribute the funds to the employees.
Petitioner did not have the business acumen to manage the administrative side of the business. Petitioner managed and performed the construction services, and he relied on his father to manage the administrative matters, including the bookkeeping. Petitioner trusted his father and was aware of his father's prior experience in administrative business matters, including his father's management of petitioner's mother's cleaning service business. Petitioner did not question his father and would sign, without careful consideration, documents his father had prepared.
The administrative business services for petitioner's and his mother's businesses were performed in petitioner's parents' home, where the books and records were maintained. Petitioner lived with his parents in that home until sometime during 1994. When the number of documents necessary for petitioner's business became voluminous, petitioner's father requested a facsimile stamp of petitioner's signature for use on business documents.
A business checking account was maintained for K&L Exteriors. That account was used for payment of petitioner's personal and business expenses. During the period under consideration, petitioner was provided by his father with approximately $350 a week for living expenses. Petitioner was aware that K&L Exteriors' weekly receipts exceeded $350, and he thought that the excess was being retained and/or used for operating expenses.
Petitioner's father also managed the preparation of petitioner's individual and business tax returns. Petitioner's father retained Doneta Layland, owner-operator of Tax Consultants, to prepare petitioner's tax returns. Petitioner's father would provide the information necessary to prepare the tax returns to Ms. Layland. Petitioner had no contact with Ms. Layland, and she did not find it unusual that petitioner's father handled the tax matters because that type of situation occurred with other clients.
Ms. Layland was often frustrated by the inadequate and inaccurate tax preparation records petitioner's father submitted to her. For example, the cashflow statement for K&L Exteriors for the taxable year 1993 reflected gross receipts of $160,397, while the Forms 1099 filed by clients of the business reflected a lesser amount ($111,516). Through communications with petitioner's father, Ms. Layland came to realize that the cashflow statement figure was incorrect. Accordingly, she reported the amount reflected on the Forms 1099. Petitioner's father also commingled petitioner's personal and business expenses, which Ms. Layland attempted to distinguish and separate. Ms. Layland did not contact petitioner about any of these matters. She dealt exclusively with petitioner's father, who resolved these matters to Ms. Layland's satisfaction. On one occasion, Ms. Layland questioned petitioner's father about a loss on petitioner's 1993 Schedule C, Profit or Loss From Business. Petitioner's father re-[pg. 656] sponded with new figures which reflected a small profit.
For taxable years 1993 and 1994, Ms. Layland also prepared Four Square's corporate returns for petitioner. Because Four Square was incorporated solely for K&L Exteriors' payroll needs, Four Square's receipts matched its expenses, and its corporate returns did not reflect taxable income.
Petitioner's 1992, 1993, and 1994 income tax returns were filed on May 4, 1993, May 16, 1994, and May 8, 1995, respectively. The Schedules C attached to petitioner's 1992, 1993, and 1994 income tax returns reflected taxable income of $635, $304, and $360, respectively. All three returns were signed by petitioner and dated April 29, 1993, May 8, 1994, and May 3, 1995, respectively. As with other documents relating to K&L Exteriors and Four Square, petitioner did not read or review them before signing. At the time of signing the 1992, 1993, and 1994 returns, petitioner believed the information reported was accurate.
Petitioner now agrees that the gross income from his construction business was understated by $9,690, $37,204, and $52,440 for 1992, 1993, and 1994, respectively. He also agrees that interest income was understated by $24 and $11 for 1992 and 1993, respectively.
During August 1994, petitioner, in the process of obtaining a personal loan, estimated his monthly income to be $3,200. At this time, petitioner was receiving a $350 weekly check from his father. In December 1994, petitioner sought another loan in order to purchase a home. Petitioner knew that he had to have a certain level of income to qualify for a home loan. In response to the loan officer's questions, petitioner estimated that his monthly income was $5,217. Petitioner signed and dated the loan application. In mid-March 1995, petitioner entered into a contract to purchase a home for $140,000.
The mortgage company requested petitioner's income tax returns from the previous 2 years. Petitioner telephoned his father and requested copies of his income tax returns for taxable years 1993 and 1994. Petitioner obtained copies of his income tax returns from his father and submitted them to the mortgage company without reviewing them. The 1993 return submitted to the mortgage company reflected Schedule C net income of $51,297. This return differed in the amount of income from the one filed with the Internal Revenue Service. There were also differences in petitioner's signatures. The date reflected on the return provided to the mortgage company was April 15, 1994, and was not in petitioner's handwriting.
The 1994 income tax return submitted to the mortgage company reflected Schedule C net income of $50,685, an amount different from that reported to respondent. These returns also contained differences in petitioner's signatures. The date reflected on the 1994 return provided to the mortgage company was February 2, 1995, and was in petitioner's handwriting.
Petitioner did not read any of the loan documents relating to the purchase of the home. Instead, the loan officer explained the documents, and then petitioner signed them. The closing date for petitioner's home purchase was July 28, 1995. On that date, petitioner signed a Universal Residential Loan Application, which reflected that his monthly income was $4,137. Petitioner believed this figure was derived from his income tax returns.
In the course of an examination of another taxpayer regarding employee wage deductions, respondent began an examination of petitioner's returns. For taxable year 1991, petitioner admitted to respondent's agent that he did not report approximately $2,000 in wages he had received for part-time construction work.
Respondent's examining agent referred petitioner's tax examination to the Criminal Investigation Division. In the course of the investigation, respondent's special agent (1) interviewed contractors to determine whether K&L had reported all of its income through a specific item analysis, (2) interviewed Ms. Layland regarding the preparation of petitioner's income tax returns, and (3) sought out other potential sources of income. In so doing, the special agent discovered: (1) Petitioner's mortgage applications, (2) that petitioner's father had sole contact with Ms. Layland, (3) that petitioner timely filed his income tax returns, [pg. 657] (4) that petitioner's return for 1992 did not include income received from a contractor, (5) that petitioner's return did not include $11 of interest income, (6) that petitioner did not deal in cash, (7) that K&L Exteriors was one of the least sophisticated operations he had seen, (8) that petitioner paid approximately $90 in self-employment tax for taxable year 1992 and a minimal amount of income tax, and (9) that petitioner reported no income tax or self-employment tax liability for taxable years 1993 and 1994.
The special agent did not discover evidence showing an overstatement of expense deductions or illegal activities or that Four Square was used for any improper purposes. At the conclusion of the criminal investigation, the special agent recommended criminal prosecution of petitioner and petitioner's father for taxable years 1993 and 1994. The record does not reflect the disposition of these matters.
The parties have narrowed the focus of this case. Petitioner agrees that there was unreported income and, hence, underpayments of tax for 1992, 1993, and 1994. However, the 3-year period for assessment, provided for in section 6501(a), had expired with respect to all 3 taxable years at the time respondent mailed the notice of deficiency to petitioner. Respondent, in his answer, affirmatively alleged that the understatement of tax for each of the 3 years is due to fraud and, therefore, that the period for assessment remained open at the time the notice was mailed. See sec. 6501(c)(1). Accordingly, the initial and principal question we consider is whether “any portion of *** [the underpayments] is attributable to fraud”. Sec. 6663(b).
I. Whether Petitioner Filed Fraudulent 1992, 1993, or 1994 Income Tax Returns
For purposes of defining fraud, it is important to note that the definitions of fraud in sections 6663 and 6501 have been held to be interchangeable. Rhone-Poulenc Surfactants v. Commissioner, 114 T.C. 533, 548 (2000) (and cases cited therein); Murphy v. Commissioner, T.C. Memo. 1995-76 [1995 RIA TC Memo ¶95,076]. Fraud is an intentional wrongdoing on the part of the taxpayer with the specific purpose to evade a tax believed to be owing. McGee v. Commissioner, 61 T.C. 249, 256 (1973), affd. 519 F.2d 1121 [36 AFTR 2d 75-5888] (5th Cir. 1975); Terrell Equip. Co. v. Commissioner, T.C. Memo. 2002-58 [TC Memo 2002-58]. The Commissioner bears the burden of proving fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b); Zell v. Commissioner, 763 F.2d 1139, 1142-1143 [56 AFTR 2d 85- 5128] (10th Cir. 1985), affg. T.C. Memo. 1984-152 [¶84,152 PH Memo TC]; Terrell Equip. Co. v. Commissioner, supra.
To satisfy his burden, the Commissioner must show that (1) an underpayment exists; and (2) the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Parks v. Commissioner, 94 T.C. 654 692 (1970). The existence of fraud is a question of fact to be resolved from the entire record. DiLeo v. Commissioner, 96 T.C. 858, 874 (1991), affd. 959 F.2d 16 [69 AFTR 2d 92-998] (2d Cir. 1992). Because direct proof of a taxpayer's intent is rarely available, fraud may be proven by circumstantial evidence, and reasonable inferences may be drawn from the relevant facts. Spies v. United States, 317 U.S. 492, 499 [30 AFTR 378] (1943); Stephenson v. Commissioner, 79 T.C. 995, 1006 (1982), affd. 748 F.2d 331 [55 AFTR 2d 85-313] (6th Cir. 1984). Mere suspicion, however, does not prove fraud. Katz v. Commissioner, 90 T.C. 1130, 1144 (1988).
Courts have developed a nonexclusive list of so-called badges of fraud which demonstrate fraudulent intent: (1) Understating income, (2) maintaining inadequate records, (3) providing implausible or inconsistent explanations of behavior, (4) concealing income or assets, (5) failing to cooperate with taxing authorities, (6) engaging in illegal activities, (7) engaging in a pattern of behavior which indicates an intent to mislead, (8) testifying with a lack of credibility, (9) filing false documents, (10) failing to file tax returns, and (11) dealing in cash. Bradford v. Commissioner, [pg. 658] 796 F.2d 303, 307-308 [58 AFTR 2d 86- 5532] (9th Cir. 1986), affg. T.C. Memo. 1984-601 [¶84,601 PH Memo TC]; Recklitis v. Commissioner, 91 T.C. 874 (1988); Middleton v. Commissioner, T.C. Memo. 2002-164 [TC Memo 2002-164]. The sophistication, education, and intelligence of the taxpayer are relevant in determining fraudulent intent. Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992).
A. In General
The record in this case reflects a general pattern of dereliction, but not one of deceit and fraud. There can be no doubt that petitioner's reliance upon his father was misplaced and in no way relieved petitioner of his obligation to correctly report his tax liability. Petitioner may not avoid his duty to accurately report by placing the responsibility on an agent. See United States v. Boyle, 469 U.S. 241, 250-251 [55 AFTR 2d 85-1535] (1985). There is ample evidence, as observed by his return preparer, that petitioner's tax records were inaccurate and inadequate and commingled personal and business items. Petitioner knew that his earnings exceeded the $350 received weekly from his father for personal expenses. But petitioner was not aware of the particulars of his tax reporting, including the amount of income reported on his Federal income tax returns. In spite of his laxity and inattention to the administration of his business, petitioner did not intend to evade tax by conduct intended to conceal, mislead, or prevent the collection of tax.
Petitioner's forte was in the operational side of his construction business. He was young and inexperienced regarding the administrative necessities of his business. As a result, petitioner relied exclusively on his father to look after the administrative matters, including tax reporting. Petitioner perfunctorily signed documents, including tax returns, that his father prepared and placed before him for signature. Additionally, there has been no showing that petitioner collaborated or colluded with his father to defraud the Government. Respondent has not shown, on this record, that petitioner attempted to defraud. We have reached this conclusion after considering the specific criteria for fraud and whether the “badges of fraud” existed in this case.
Fraud may be proven by circumstantial evidence and reasonable inferences drawn from the facts. Spies v. United States, supra. A taxpayer's course of conduct or a pattern of conduct may establish, by inference, the intent to conceal or mislead. Id. at 499; Otsuki v. Commissioner, 53 T.C. 96, 105-106 (1969). Respondent contends that the 3-year pattern of underreporting income is evidence from which we should infer petitioner's intent to conceal or mislead. It has been held that a pattern of underreporting of income over an extended period may be indicative of fraud, but the mere failure to report is not sufficient to establish fraud. Petzoldt v. Commissioner, 92 T.C. 661, 700 (1989) (and cases cited thereat).
Petitioner concedes that his income was underreported for the 3 years. Petitioner, however, contends that he relied (reasonably or unreasonably) upon his father and that he was without sufficient knowledge to be culpable and/or that he did not formulate a specific intent to evade tax, conceal, or defraud. We have carefully considered the evidence, including petitioner's testimony, which we found credible. We hold that the under reporting here does not, when considered in light of the record in its totality, show or raise an inference that petitioner intended to conceal or mislead.
We find the circumstances here to be somewhat unusual. The combination of petitioner's inexperience, immaturity, and reliance on his father make his position plausible. It must be noted that the three Federal income tax returns under consideration represent some of the first ones that petitioner filed, and he continued to live with his parents throughout most of the period under consideration. In addition, this was petitioner's first self-employment business experience.
The Commissioner has relied upon taxpayers' understatements of income to circumstantially show fraudulent intent and has been successful in numerous fraud penalty cases where such understatements were coupled with other badges of fraud. In a few cases, however, the Commissioner has failed to establish a link between understatements and fraudulent intent. In Rao v. Commissioner, T.C. Memo. 1996-500 [1996 RIA TC Memo ¶96,500], the fraud [pg. 659] penalty was not sustained even though the taxpayer, a doctor, had substantial and consistent understatements of gross income. In that case, the taxpayer relied on his accountant, in the same manner as petitioner has relied on his father. In another case, involving a doctor whose income was consistently and substantially understated, the taxpayer's reliance on his accountant was a factor in the Court's holding that the Commissioner failed to clearly and convincingly prove fraud. Zipp v. Commissioner, T.C. Memo. 1998-371 [1998 RIA TC Memo ¶98,371].
B. Whether There Was a Pattern of Behavior Which Indicates an Intent To Mislead
Respondent points out that petitioner, in the process of applying for loans, provided monthly income figures to lenders that reflected that he knew that he was underreporting his income. During 1994, petitioner sought a $5,100 personal loan, and he estimated that his monthly income was $3,200. A few months later petitioner began the process of purchasing a home, and in documents submitted to secure a $140,000 mortgage loan, he estimated that his monthly income was $5,217 on one occasion and $4,137 on another.
When the home loan was being finalized, the mortgage company requested copies of petitioner's 2 prior years' Federal income tax returns. Petitioner obtained the copies of the returns from his father and provided them to the mortgage company. Unlike the returns filed with respondent, which reported insignificant amounts of net income from the construction business, the copies supplied to the mortgage company reflected annual net income in the low $50,000's. In addition, there were some discrepancies with respect to the signatures on the returns supplied to the mortgage company.
Respondent argues that these circumstances indicate petitioner's knowledge that the income reported to the Government was understated. Petitioner does not deny that there were discrepancies and that the amounts reported to respondent differed from the amounts contained in the return documents provided to the mortgage company. Petitioner, consistent with his approach to business documents and procedures, was not cognizant of the contents of the returns presented to the various recipients or of the taxable income that was being earned from his business activity. Petitioner did not have working knowledge of the administrative side of his business and followed his father's guidance on those aspects of his business.
There has been no evidence, circumstantial or otherwise, that would lead us to find that petitioner was aware of the discrepancies or that he colluded with his father in an attempt to deceive the Government or the mortgage company. Even if petitioner's father intended to conceal, deceive, and defraud, such a finding would not automatically be imputed to petitioner.
Respondent, relying on United States v. Bornfield, 145 F.3d 1123, 1129 (10th Cir. 1998), contends that petitioner cannot, by burying his head in the sand, avoid blame for any deception by his father. Bornfield, a criminal case, involved a “deliberate ignorance instruction” to a jury. It was held that such an instruction “is appropriate if the defendant denies knowledge of an operative fact and the evidence demonstrates or creates the inference that the defendant deliberately avoided actual knowledge of that fact.” Id. (citing United States v. Lee, 54 F.3d 1534, 1538 (10th Cir. 1995)). As we have found, petitioner did not collude with his father or deliberately avoid knowledge to avoid culpability. Accordingly, United States v. Bornfield, supra, is not analogous to our circumstances.
In conjunction with that approach, respondent also argues that petitioner's father's actions should be imputed to petitioner. Respondent's position derives from joint and several liability cases. In those cases, both spouses by the filing of a joint return were liable for any fraud penalty, irrespective of which spouse intended to evade the tax. We note that the cases respondent relies on are dated and have been superseded by statute. See, e.g., sec. 6663(c). [pg. 660]
More importantly, the cases relied upon by respondent involve situations where one spouse was found to have intentionally evaded tax. There has been no showing by clear and convincing evidence that petitioner's father intended to file a fraudulent return on his son's behalf. Accordingly, there is no need to consider whether the concept of joint and several liability would apply in this case.
C. Remaining Badges of Fraud
Petitioner points out that factually, respondent's case rests on the understatements and the information provided to lenders. There has been no showing or allegation that petitioner (1) knowingly concealed income or assets, (2) failed to cooperate with respondent, (3)engaged in illegal activities, (4) attempted to mislead, (5) dealt in cash, (6) lacked credibility, or (7) knowingly filed false documents.
On this record we conclude and hold that respondent has failed to prove by clear and convincing evidence that petitioner intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Accordingly, the exception for fraud did not serve to keep the assessment period for 1992, 1993, or 1994 open under section 6501(c).
II. Respondent's Alternative Argument Concerning Section 6501(c)(1)
Respondent also argues that, for purposes of indefinitely extending the period for assessment under section 6501(c)(1), petitioner's state of mind is irrelevant. Section 6501(c)(1) provides for an exception to the 3-year period for assessment of section 6501(a), as follows: False Return. In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.
Respondent argues that the statute requires only an “intent to evade tax.” Under respondent's position the intent to evade may be imputed to the taxpayer from a third person. In the setting of this case, respondent would have us impute to petitioner any intent to evade tax that petitioner's father may have had. Under respondent's interpretation, the period for assessment would remain open indefinitely in a situation where, as here, a taxpayer is found not to have intended to evade tax, but some third person involved in the reporting of income did so intend.
Assuming arguendo that respondent's interpretation of section 6501(c)(1) is correct, for respondent to be successful in this case, he first would have to establish the factual predicate that petitioner's tax preparer/father had an “intent to evade tax”. With respect to extending the period for assessment, respondent bears the burden of proof. Mecom v. Commissioner, 101 T.C. 374 (1993), affd. without published opinion 40 F.3d 385 [74 AFTR 2d 94-7137] (5th Cir. 1994). We have found that respondent has not shown by clear and convincing evidence that petitioner intended to evade tax when he signed the returns in question. We have also found that respondent has not shown that petitioner's father/return preparer intended to evade tax. Therefore, the question of whether respondent's interpretation of section 6501(c)(1) is correct is rendered moot.
Accordingly, the period for assessment for 1992, 1993, or 1994 did not remain open under the provisions of section 6501(c)(1). Because of petitioner's concession that the 1994 assessment period was open under section 6501(e), petitioner remains liable for an income tax deficiency based on the agreed underpayment for his 1994 tax year.
To reflect the foregoing,
Decision will be entered under Rule 155.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Some facts have been stipulated by the parties and are herein incorporated by this reference.
PARKS v. COMMISSIONER, 94 TC 654, Code Sec(s) 446.
Ruth B. Parks, Petitioner v.Commissioner of Internal Revenue, Respondent
Code Sec(s): 446
Docket: Docket Nos. 23041-87, 13496-88.
Date Issued: 04/24/1990
Judge: Opinion by WHITAKER, J.
Tax Year(s): Years 1983, 1984.
Disposition: Deficiencies redetermined.
1. RECONSTRUCTION OF INCOME—Bank deposit method—cash expenditures added to taxable deposits. IRS's bank deposits and expenditures reconstruction of taxpayer's unreported income was upheld. Taxpayer, IRS employee, refused to provide records or cooperate in any way with IRS during investigation, and she failed to substantiate her assertion that excess deposits and expenditures were made from cash hoard accumulated before years at issue from large cash child support payments sporadically made by her ex-husband when his gambling activities were successful. IRS wasn't required to negate every possible nontaxable source of income. Because taxpayer admitted receipt of cash, IRS wasn't required to identify likely source of resulting cash deposits and expenditures.
Reference(s): ¶ 4465.73(35) . Code Sec. 446 .
1. PENALTIES—Fraud penalty—Use of reconstruction method to establish unreported income. Fraud penalty was imposed on taxpayer (IRS employee) based on bank deposits and expenditures reconstruction of unreported income. IRS satisfied 1st prong of fraud test (existence of underpayment) by disproving taxpayer's allegation that excess deposits and expenditures came from specific nontaxable source (cash hoard built up from child support payments from ex-husband), so it didn't have to prove likely taxable source of unreported income. Because IRS's reconstruction of income was accurate and taxpayer's allegation of nontaxable source was implausible and incredible, IRS didn't have to disprove existence of child-support cash hoard through direct testimony of taxpayer's ex-husband. IRS satisfied 2d prong of fraud test (fraudulent intent) by showing that taxpayer structured cash transactions to avoid filing of currency transaction reports and failed to cooperate with IRS investigation. Substantial understatement penalty was imposed.
Reference(s): ¶ 66,535.15(20) ; ¶ 66,615(5) . Former Code Sec. 6653 ; Code Sec. 6661 .
Official Tax Court Syllabus
Held, respondent's determination that petitioner had unreported cash income from an unidentified source is sustained.Held, further: Respondent must prove both an underpayment and fraudulent intent by clear and convincing evidence in order to satisfy his burden of proof with respect to an addition to tax for fraud. When allegations of fraud are intertwined with unreported and indirectly reconstructed income, respondent can satisfy his burden of proving an underpayment in one of two ways. Respondent may prove an underpayment by proving a likely source of the unreported income, Holland v. United States, 348 U.S. 121 (1954), or where the taxpayer alleges a nontaxable source, by disproving the specific nontaxable source so alleged.United States v. Massei, 355 U.S. 595 (1958). Held, further, respondent disproved an alleged specific nontaxable source by showing that his reconstruction of income was accurate and that the evidence as to the specific nontaxable source was implausible, inconsistent, and not supported by objective evidence in the record. Held, further, liability for additions to tax for fraud sustained. Held, further, liability for the addition to tax for a substantial underpayment of tax sustained.
Michael J. Stengel, for the petitioner in docket No. 23041-87.
Ruth B. Parks, pro se in docket No. 13496-88.
Paul M. Kohlhoff, for the respondent.[pg. 655]
Respondent determined deficiencies in petitioner's Federal income tax and additions to tax as follows:
Additions to tax
Year Deficiency Sec. 6653(b)(1)<1> Sec. 6653(b)(2) Sec. 6661
1983 $16,310 $8,155.00 50% of the $4,078
1984 4,147 2,073.50 50% of the --
<1>Unless otherwise noted, all section references are to the
Internal Revenue Code of 1954 as amended and in effect for the years in
issue, and all Rule references are to the Tax Court Rules of Practice and
<2>Also on the notice of deficiency, respondent determined
entitlement to an excess Medicare tax credit of $225, and stated that
petitioner therefore had a "net tax deficiency" in the amount of $16,085.
There is no explanation for why respondent's determination of the sec.
6653(b)(2) addition for 1983 was based upon a figure of $16,101.
Petitioner is represented by counsel in docket No. 23041-87 and is pro se in docket No. 13496-88. The two docket numbers were consolidated because the issues are substantially identical, differing primarily in that docket No. 23041-87 pertains to taxable year 1983 and docket No. 13496-88 pertains to taxable year 1984. Respondent concedes that petitioner substantiated itemized deductions in the amount of $3,150 for the year 1983.
The issues remaining for decision are: (1) Whether cash deposits and expenditures made by petitioner during 1983 and 1984 constituted unreported income from an unidentified source; (2) whether petitioner is liable for the additions to tax for fraud for the years 1983 and 1984; and (3) whether petitioner is liable for a section 6661 addition to tax for a substantial understatement of income tax for the taxable year 1984.
FINDINGS OF FACT
Some of the facts in this case are stipulated and are so found. The stipulations of fact and accompanying exhibits are incorporated by this reference. Petitioner resided in Memphis, Tennessee, at the time of filing her petitions in this case.
During 1983 and 1984, petitioner was employed by the Internal Revenue Service at the Memphis Service Center. [pg. 656]All of petitioner's wages were paid to her in the form of checks. Those checks were deposited to petitioner's bank accounts and reported as income on her Federal income tax returns for the years in issue. Petitioner's monthly take-home pay amounted to approximately $800. Petitioner reported no other source of wage or salary income, other than minimal interest income, in 1983 and 1984.
During the years in issue, petitioner was divorced from James W. Parks. Petitioner and Mr. Parks had one daughter. During their marriage Mr. Parks beat petitioner several times, threatened to kill both petitioner and their child, and shot at petitioner. In 1975, petitioner fired shots at Mr. Parks during a domestic dispute, for which petitioner was arrested. A divorce was granted to petitioner in 1975 on the grounds that Mr. Parks' cruel and inhumane conduct made cohabitation unsafe. Pursuant to the divorce decree, Mr. Parks was required to pay $10 per week in child support to the Clerk of the Circuit Court of Shelby County, Tennessee. Mr. Parks was delinquent in his child support payments, forcing petitioner to petition the Shelby County Circuit Court for an order garnishing Mr. Parks' wages early in 1976. Pursuant to the garnishment order, Mr. Parks paid $290 in child support through the Clerk's office during the remaining portion of 1976. In all subsequent years, including the years in issue, Mr. Parks made no further child support payments through the Clerk's office. The parties stipulate that no checks from Mr. Parks were deposited in any of petitioner's bank accounts during 1983 and 1984. There is no evidence that Mr. Parks ever made cash child support payments.
In his determination of deficiency, respondent used the bank deposits and cash expenditures method of reconstructing income. During 1983, petitioner wrote no checks to cash. However, in addition to her wages from the Internal Revenue Service petitioner made cash deposits in 1983 in the amount of $11,635 to four bank accounts. In transactions unrelated to the cash deposits to her bank accounts, on October 4, 1983, and October 5, 1983, petitioner purchased six separate cashier's checks made payable to Bud Davis Cadillac. Each cashier's check was issued by a different branch of one of two banks. The total amount of [pg. 657]the six cashier's checks was $12,575. By so purchasing cashier's checks in small amounts at several different bank branches, petitioner avoided the filing of a Currency Transaction Report. Currency Transaction Reports are prepared when customers conduct single cash transactions with banking institutions in amounts of $10,000 or greater.
Petitioner used the cashier's checks to make a $12,575 down payment on a 1984 Cadillac Fleetwood Brougham. Petitioner financed the balance of the purchase price of the Cadillac through General Motors Acceptance Corporation (GMAC). Petitioner's monthly payments to GMAC were $418.69, an amount more than half of petitioner's monthly take-home pay.
In transactions again unrelated to any deposits of cash to her bank accounts, on December 9, 1983, petitioner purchased additional cashier's checks in the amount of $12,000. Petitioner used those cashier's checks and cash withdrawn from a revocable trust account established for the benefit of her daughter to pay off the balance she owed GMAC on the Cadillac. Neither the cash deposits nor the cash with which petitioner purchased cashier's checks were reported as income on petitioner's Federal income tax return for 1983.
During 1984, petitioner made cash deposits to two bank accounts in the amount of $8,585, purchased one cashier's check in the amount of $571, and paid doctors' bills totaling $1,925 in cash. However, petitioner wrote no checks to cash from her checking account and withdrew no cash from savings accounts under her control during 1984. Neither the cash deposits, the cash used to purchase the cashier's check, nor the cash used to pay doctor's bills were reported as income on petitioner's 1984 Federal income tax return. During the initial audit of her tax returns, petitioner stated that she received no child support in 1983 and 1984. 3 Petitioner's tax returns for 1983 and 1984 were subsequently audited by the Criminal Investigation Division (CID) of the Internal Revenue Service. After referral of her case [pg. 658]to CID, petitioner invoked the Fifth Amendment and refused to answer questions or cooperate in any other way with respondent's examiners or with CID agents. CID terminated its investigation in December 1987, without recommendation. Respondent has not identified a likely source of the cash in issue.
Respondent argues that petitioner had unreported cash income from an unidentifiable source for the years before the Court. Petitioner is, contends respondent, liable for the tax on such income. We agree. Respondent determined unreported income through the use of the bank deposits and cash expenditures method of reconstructing income. It is well established that when a taxpayer's method of accounting does not clearly reflect income, respondent may recompute such income. Sec. 446(b); Holland v. United States, 348 U.S. 121, 130-132 (1954). We approve of respondent's use of the bank deposits and cash-expenditures method of recomputing income.Nicholas v. Commissioner, 70 T.C. 1057, 1065 (1978); Estate of Mason v. Commissioner, 64 T.C. 651, 653 (1975), affd. 566 F.2d 2 (6th Cir. 1977). Indeed, bank deposits are prima facie evidence of the receipt of income. Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).
Petitioner argues that respondent has the burden of proving a deficiency by showing that her cash deposits and expenditures represented unreported income and of proving the source of such income. Petitioner further suggests that respondent must prove that the deposits and expenditures were neither gifts, inheritance, nor other nontaxable receipts. Respondent must also, according to petitioner, identify the taxable source of the unreported receipts.
Contrary to petitioner's belief, the burden is upon petitioner to prove that respondent's determination of unreported income, computed using the cash deposits and expenditures method of reconstructing income, is incorrect.Nicholas v. Commissioner, supra at 1064; Zarnow v. Commissioner, 48 T.C. 213, 216 (1967);Reaves v. Commissioner, 31 T.C. 690 (1958), affd. 295 F.2d 336 (5th Cir. 1961). Respondent's determination of deficiency absent such proof[pg. 659] is presumed correct. Welch v. Helvering, 290 U.S. 111 (1933).
Petitioner admits she received cash with which she made the cash deposits and the cash expenditures in issue, but would have us find that those cash deposits and expenditures did not constitute unreported income from an unidentified source. Petitioner asserts that all of the cash in issue came from cash child support payments. According to petitioner, her ex-husband was a gambler with a sporadic flow of income. Allegedly, when Mr. Parks was successful in his gambling pursuits, he came to petitioner's home and presented her with cash to use for the support of their daughter. Such cash child support payments, maintains petitioner, included a lump sum of $40,000 given to petitioner by Mr. Parks in 1980.
We find that petitioner has not satisfied her burden of proving respondent's determination of unreported income in 1983 and 1984 incorrect. We find incredible petitioner's testimony that she kept a hoard of $40,000 in cash child support payments in a metal box inside a heating vent for 3 years, until deciding to buy a Cadillac for her daughter. Mr. Parks did not testify at trial. We accord little probative weight to, and view with suspicion, the testimony of Ms. Mormon, petitioner's close friend and only corroborating witness. Ms. Mormon testified that petitioner showed her a metal box containing a large amount of cash sometime in 1980. Petitioner testified that she hid the cash hoard in the metal box in the heating vent in the floor of her bedroom. Ms. Mormon, however, testified that petitioner took a metal box filled with cash out from behind a board in a wall. We are not required to accept the testimony of petitioner. Fleischer v. Commissioner, 403 F.2d 403, 406 (2d Cir. 1968), affg. a Memorandum Opinion of this Court;Tokarski v. Commissioner, supra at 77.
Moreover, even had we determined Ms. Mormon's testimony was credible, that testimony would not support petitioner's position. The witness could not verify that such cash came from child support payments, but merely that she had seen such a box containing a large amount of cash hidden in petitioner's house.[pg. 660]
Furthermore, with respect to the deficiency determination, petitioner's argument that respondent failed to disprove any other nontaxable source for the cash in issue is fruitless. Where a taxpayer provides respondent with no leads as to source, respondent is not required to negate every possible source of nontaxable income, a matter peculiarly within the knowledge of the taxpayer. Holland v. United States, supra at 138;Petzholdt v. Commissioner, 92 T.C. 661, 695-696 (1989). Moreover, where a taxpayer admits receipt of cash, respondent need not prove a likely source of resulting cash deposits or expenditures. Cf. Tokarski v. Commissioner, supra at 76-77.
Petitioner provided respondent with no books, papers, check stubs, or other leads to pursue in order to determine if the cash might have some nontaxable source other than child support. Indeed, petitioner refused entirely to cooperate with respondent's agents and the CID investigation. Therefore, for all the reasons stated above, we find that petitioner had unreported income of $36,210 in 1983 and $11,081 in 1984. Under the circumstances of this case, the fact that respondent could not identify a specific taxable source does not immunize petitioner from liability for the tax on such unreported income.
Respondent determined that petitioner was liable for the fraud additions to tax pursuant to section 6653(b)(1) and (2). The existence of fraud is a question of fact to be resolved upon consideration of the entire record.Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), affd. without published opinion 578 F.2d 1383 (8th Cir. 1978); Estate of Pittard v. Commissioner, 69 T.C. 391 (1977). Fraud is not to be imputed or presumed. Beaver v. Commissioner, 55 T.C. 85, 92 (1970); Otsuki v. Commissioner, 53 T.C. 96 (1969). Respondent has the burden of proving that some portion of an underpayment is due to fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b).
To satisfy his burden of proof, respondent must show two things. First, respondent must prove that an underpayment exists. Where, as here, respondent has prevailed on the issue of the existence of a deficiency by virtue of a taxpayer's failure to carry his burden of proof, respondent cannot rely on that failure to sustain his burden of proving [pg. 661]fraud.Petzholdt v. Commissioner, supra at 700; Estate of Beck v. Commissioner, 56 T.C. 297, 363 (1971). We must be careful in such cases not to bootstrap a finding of fraud upon a taxpayer's failure to prove respondent's deficiency determination erroneous. Drieborg v. Commissioner, 225 F.2d 216, 218 (6th Cir. 1955), affg. in part a Memorandum Opinion of this Court. Second, respondent must show that the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes.Stoltzfus v. United States, 398 F.2d 1002, 1004 [ 22 AFTR2d 5251] (3d Cir. 1968); Rowlee v. Commissioner, 80 T.C. 1111 (1983).
Respondent can satisfy his burden of proving the first prong of the fraud test, i.e., an underpayment, when the allegations of fraud are intertwined with unreported and indirectly reconstructed income in one of two ways. Respondent may prove an underpayment by proving a likely source of the unreported income. Holland v. United States, 348 U.S. 121 (1954); Nicholas v. Commissioner, 70 T.C. 1057 (1978). Alternatively, where the taxpayer alleges a nontaxable source, respondent may satisfy his burden by disproving the nontaxable source so alleged.United States v. Massei, 355 U.S. 595 (1958); Kramer v. Commissioner, 389 F.2d 236, 239 (7th Cir. 1968), affg. a Memorandum Opinion of this Court.
Respondent did not prove a likely source of petitioner's unreported income. Thus, in order to satisfy his burden of proving an underpayment respondent must disprove petitioner's allegation of a cash hoard comprised of accumulated or lump-sum cash child support payments. Respondent may disprove that alleged specific nontaxable source of income through showing that his reconstruction of income is accurate combined with a showing that petitioner's allegation of a cash hoard is inconsistent, implausible, and not supported by objective evidence in the record. See Boggs v. Commissioner, T.C. Memo. 1985-429, 54 P-H Memo T.C. par. 85,429 at 1939, 50 T.C.M. 797, 830; Phillips v. Commissioner, T.C. Memo. 1984-133, 53 P-H Memo T.C. par. 84,133 at 472-474, 47 T.C.M. 1289, 1304-1305.
Petitioner maintains that respondent has merely shown suspicious circumstances which are insufficient to support a [pg. 662]finding of fraud. Petitioner argues, in effect, that respondent cannot satisfy his burden of disproving a cash hoard allegedly composed of child support payments without producing Mr. Parks to testify at trial in refutation of petitioner's allegation. However, petitioner's allegation of a cash hoard is sufficiently implausible and incredible, and respondent's reconstruction of income sufficiently accurate, that the testimony of Mr. Parks is unnecessary. Under circumstances such as we find in this case, respondent need not satisfy his burden through direct testimony by an alleged transferor refuting that he or she was the nontaxable source of unreported income.
Respondent's reconstruction of petitioner's income using the cash expenditures and deposits method was accurate and reliable. Petitioner admitted making those cash deposits and expenditures. Petitioner further admitted that she did not report income represented by those cash deposits and expenditures on her returns for 1983 and 1984.
However, petitioner's allegation of a nontaxable cash hoard which came from cash child support payments made by Mr. Parks is inconsistent and implausible. Similar to the taxpayer in Phillips v. Commissioner, supra, petitioner did not allege such a nontaxable source of the unreported income until filing her petition. Petitioner originally told the revenue agent investigating her 1983 and 1984 returns that she received no child support. Petitioner failed to mention to the revenue agent the existence of a cash hoard comprised of a $40,000 lump-sum child support payment claimed to have been made in 1980. Other than petitioner's testimony, the record reveals no evidence that Mr. Parks ever voluntarily paid child support. Within a year of her divorce, petitioner was forced to seek a court order garnishing Mr. Parks' wages in order to receive unpaid support payments of $10 per week. The only documentary evidence that Mr. Parks at any time made child support payments is the parties' stipulation that Mr. Parks paid $290 in 1976 pursuant to that garnishment order.
The violent relationship between petitioner and Mr. Parks is further indication of the implausible and incredible nature of petitioner's allegation. Petitioner testified that her ex-husband was cruel, abusive, and a habitual gambler. In her [pg. 663]petition for dissolution of marriage, petitioner stated that she was "mortally afraid" of Mr. Parks and charged that Mr. Parks was guilty of abandoning and refusing to provide for her. During their marriage Mr. Parks beat petitioner several times, threatened to kill both petitioner and their child, and shot at petitioner. Petitioner was arrested in 1975, just prior to her divorce, for shooting at Mr. Parks. Nothing in the record convinces us that Mr. Parks rehabilitated his violent nature to the extent that he began appearing peacefully at petitioner's doorstep with large sums of cash to support the child he had earlier threatened to kill, or that petitioner's fear of Mr. Parks abated to the point of receiving him in her home.
Petitioner testified that she kept a cash hoard hidden in her home. However, petitioner's statement that she hoarded that cash rather than deposit it in a bank for "safety" reasons is incredible in light of the fact that petitioner concurrently kept four other bank accounts, in which she deposited all of her documented income. This conclusion is supported by the fact that petitioner's home was burglarized during the period in which the alleged cash hoard was secreted in her home. Finally, the testimony of Ms. Mormon, petitioner's corroborating witness, did not support petitioner's description of the location of the alleged cash hoard.
We conclude that petitioner's claim of a cash hoard in this case is not only inconsistent with some of her statements to the auditing agent, but is patently incredible as well. Furthermore, petitioner, who as the mother of Mr. Parks' child had an interest in keeping track of Mr. Parks, did not know where Mr. Parks might be found. Thus, knowledge of the source of petitioner's cash income rested peculiarly with petitioner. The necessity of using great care to avoid bootstrapping fraud additions upon a taxpayer's failure to prove respondent's determinations erroneous does not impose upon respondent the burden of producing Mr. Parks to testify in order to disprove the alleged specific nontaxable source of income.
We follow our reasoning in Boggs and Phillips, in holding that respondent has met his burden of proving an underpayment by clear and convincing evidence. In both cases, as [pg. 664]here, a taxpayer's allegation of a specific nontaxable source of unreported income was incredible, implausible, and contrary to the objective evidence. In addition, respondent's reconstruction of unreported income was accurate in all three cases. Boggs and Phillips differ from the present case primarily in that in those cases respondent both disproved an alleged nontaxable source of unreported income in the manner used here and also proved a likely source of income. However, respondent need prove the underpayment prong of the fraud test by only one of the alternate methods.United States v. Massei, 355 U.S. 595 (1958).
Respondent must also prove by clear and convincing evidence that petitioner had the requisite fraudulent intent. Fraudulent intent may be proven by circumstantial evidence because direct proof of the taxpayer's intent is rarely available. Rowlee v. Commissioner, 80 T.C. 1111 (1983). The taxpayer's entire course of conduct may be examined to establish the requisite fraudulent intent. Stone v. Commissioner, 56 T.C. 213, 223-224 (1971); Otsuki v. Commissioner, supra at 105-106
The intent to conceal or mislead may be inferred from a pattern of conduct. See Spies v. United States, 317 U.S. 492, 499 (1943). A pattern of consistent underreporting of income, especially when accompanied by other circumstances showing an intent to conceal, justifies the inference of fraud. See Holland v. United States, 348 U.S. 121, 137 (1954)Otsuki v. Commissioner, supra. However, the mere failure to report income is not sufficient to establish fraud. Merritt v. Commissioner, 301 F.2d 484, 487 (5th Cir. 1962). Fraud may not be found under "circumstances which at most create only suspicion." Davis v. Commissioner, 184 F.2d 86, 87 [ 39 AFTR 1012] (10th Cir. 1950);Katz v. Commissioner, 90 T.C. 1130, 1144 (1988).
Other badges of fraud which may be taken into account include: the making of false and inconsistent statements to revenue agents,Grosshandler v. Commissioner, 75 TC 1, 20 (1980); the filing of false documents, Stephenson v. Commissioner, 79 T.C. 995, 1007 (1982), affd. 748 F.2d 331 (6th Cir. 1984); understatement of income, inadequate records, failure to file tax returns, implausible or inconsistent explanations of behavior, concealment of assets, and [pg. 665]failure to cooperate with tax authorities. Bradford v. Commissioner, 796 F.2d 303 (9th Cir. 1986), affg. a Memorandum Opinion of this Court.
We rejected petitioner's argument that her cash income was in reality child support payments. The fact that petitioner structured her purchase of cashier's checks to avoid the filing of Currency Transaction Reports indicates petitioner was trying to conceal her possession of large amounts of cash. Petitioner's statement to respondent's agent that she received no child support payments is inconsistent with her testimony before this Court. Petitioner failed to cooperate with the CID investigation of her tax returns for the years in issue. In addition, the record contains no documentary or other credible evidence supporting petitioner's claim that the unreported income was in reality child support. All the facts and circumstances of this case lead us to conclude that petitioner intentionally failed to report cash income in 1983 and 1984 in an effort to conceal that income. Thus, respondent has satisfied his burden of proving both prongs of the fraud test by clear and convincing evidence and petitioner is liable for the fraud additions to tax.
The last issue we must decide is whether petitioner is liable for the addition to tax set forth in section 6661 for 1983. Section 6661 imposes an addition to tax if there is a substantial understatement of income tax for a taxable year. The amount of such additions assessed after October 21, 1986, is equal to 25 percent of the amount of any underpayment attributable to such understatement. Sec. 6661(a); Pallottini v. Commissioner, 90 T.C. 498 (1988). A substantial understatement is one which exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. Sec. 6661(b). If petitioner's understatement of income is substantial within the meaning of section 6661(b), she is liable for the section 6661 addition unless such understatement can be reduced by section 6661(b)(2)(B).
By either test of section 6661(b), petitioner's underpayment is a substantial underpayment. Petitioner had no authority for her failure to report her cash income in 1983, nor did she disclose any facts pertaining to such income on her 1983 return or in a statement attached to her return for[pg. 666] that year. Therefore, the addition cannot be reduced through application of the provisions of section 6661(b)(2)(B). Petitioner is liable for the section 6661 addition to tax. For the foregoing reasons,
Decisions will be entered under Rule 155.
Petitioner first claimed in her petition that the unreported cash in issue came from periodic cash child support payments, including a lump sum cash support payment of $40,000 which Mr. Parks allegedly made in 1980. However, in addition to stating to the revenue agent that she received no child support payments in 1983 or 1984, petitioner did notmention receipt of cash child support payments in previous years with which she made expenditures in 1983 and 1984.