Underpayment of Tax The clear and convincing standard
applies not merely to whether an underpayment is attributable to fraud, but
also to whether an underpayment exists. The Commissioner must prove by clear
and convincing evidence that a portion of the underpayment for each taxable
year in issue was due to fraud.
The taxpayer's entire course of conduct may establish the
requisite fraudulent intent. Because direct proof of a taxpayer's intent is rarely available, fraud
may be proved by circumstantial evidence and reasonably inferred from the
facts. Certain indicia, commonly known as badges of fraud,
constitute circumstantial evidence which may give rise to a finding of
fraudulent intent. Although
no single factor is necessarily sufficient to establish fraud, the existence of
several indicia is persuasive circumstantial evidence of fraud.
The badges of fraud were considered in the Garcia case
.
Gary Garcia, et ux., et al. v. Commissioner, TC Memo
2012-155 , Code Sec(s) 6662; 6663.
GARY GARCIA AND BROOKE GARCIA, Petitioners v. COMMISSIONER
OF INTERNAL REVENUE, Respondent CALIFORNIA RADOMES, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent .
Case Information:
Code Sec(s): 6662;
6663
Docket: Docket
Nos. 6178-10, 6182-10.
Date Issued: 05/31/2012
HEADNOTE
XX.
Reference(s): Code Sec. 6662; Code Sec. 6663
Syllabus
Official Tax Court Syllabus
Counsel
Anthony V. Diosdi, for petitioners.
John W. Strate and Nathan H. Hall, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: With respect to Gary and Brooke Garcia
respondent determined deficiencies in Federal income tax of $57,125, $73,591,
and $68,411 for tax years 2005, 2006, and 2007, respectively. Respondent also
determined penalties under section 6663(a) 1 of $42,843, $55,193, and $51,330
for 2005, 2006, and 2007, respectively.
With respect to California Radomes, Inc. (California
Radomes), respondent determined deficiencies in Federal income tax of $48,535,
$99,547, and $41,887 for tax years 2005, 2006, and 2007, respectively.
Respondent also determined penalties under section 6663(a) of $36,401, $74,660,
and $31,415 for 2005, 2006, and 2007, respectively, as well as an addition to
tax under section 6651(a)(1) of $10,471 for 2007.
These cases were consolidated for trial, briefing, and
opinion. As a result of concessions by the parties, all issues pertaining to
underpayments of tax and the section 6651(a)(1) addition to tax have been
settled. The remaining issues relate to the imposition of certain penalties on
those underpayments of tax. The issues remaining for decision are:
(1) whether Mr. Garcia is liable for the section 6663(a)
fraud penalty for tax years 2005, 2006, and 2007. We hold that he is;
(2) in the alternative to the fraud penalty, whether Mr.
Garcia is liable for the accuracy-related penalty under section 6662(a) for tax
years 2005, 2006, and 2007. We need not decide this issue;
(3) whether California Radomes is liable for the section
6663(a) fraud penalty for tax years 2005, 2006, and 2007. We hold that it is;
(4) in the alternative to the fraud penalty, whether
California Radomes is liable for the accuracy-related penalty under section
6662(a) for tax years 2005, 2006, and 2007. We need not decide this issue; and
(5) whether Mrs. Garcia is liable for the accuracy-related
penalty under section 6662(a) for tax years 2005, 2006, and 2007. We hold she
is not.
FINDINGS OF FACT
At the time their petition was filed, Mr. and Mrs. Garcia
resided in California. California Radomes is a California corporation which had
its principal place of business in California at the time its petition was
filed.
I. Background Since its establishment by Mr. Garcia in 1980,
California Radomes has engaged in the business of overhauling and repairing
radomes, 2 principally those of aircraft. Mr. Garcia owned 100% of the common
stock of California Radomes during 2005, 2006, and 2007. He was also California
Radomes' president, chairman of the board of directors, and chief financial
officer from at least 1983 through 2007.
Mr. Garcia has a high school diploma and attended vocational
school to become an aircraft mechanic. He has also taken some college level
music classes but did not earn a college degree. Mr. Garcia has never taken any
classes in tax or accounting, although he does have at least a passing
familiarity with tax and accounting concepts picked up while operating
California Radomes. 3 Before starting California Radomes, Mr. Garcia worked for
United Airlines from 1966 to 1980.
During 2005, 2006, and 2007 California Radomes' board of
directors consisted of Mr. Garcia, Tony Garcia (Mr. Garcia's son), Michelle
Simon, and Martha Jaszkowski. Mr. Garcia characterized himself as the
“technical guy” in the company who oversaw work done by the technicians. Ms.
Simon was the general manager of California Radomes and was in charge of
day-to-day operations. Ms. Jaszkowski's duties included overseeing accounts
receivable and accounts payable, as well as inputting data into accounting
software for the preparation of California Radomes' financial statements.
California Radomes had three bank accounts: (1) a general
bank account; (2) a payroll bank account; and (3) a “holding” bank account.
California Radomes reconciled its general bank account to its financial
statements, but did not do so for the payroll bank account. The holding account
was described at trial as “basically a savings account” 4 and is discussed
further infra.
II. Mr. Garcia's Use of Corporate Funds for Personal
Expenditures At some point Mr. Garcia began: (1) withdrawing funds from
California Radomes' holding account and depositing them into his personal
accounts; and (2) otherwise using corporate funds held in the holding account
to pay personal expenses. Mr. Garcia repaid a portion of the funds to
California Radomes during 2005, 2006, and 2007. Petitioners concede Mr. Garcia
should have reported withdrawals and personal use of corporate funds (net of
repayments) as constructive dividend income.
Petitioners concede that Mr. and Mrs. Garcia received a
constructive dividend of $156,017 for 2005. This constructive dividend
consisted of: (1) $10,840 for payment of a personal insurance expense by
California Radomes; (2) $101,384 for payment of Mr. and Mrs. Garcia's home
mortgage by California Radomes; (3) a $91,325 withdrawal by Mr. Garcia; and (4)
$51,468 5 for California Radomes income which was deposited into Mr. Garcia's
personal account. The total of these amounts was reduced by $99,000 in
repayments Mr. Garcia made to California Radomes.
Petitioners concede that Mr. and Mrs. Garcia received a
constructive dividend of $268,098 for 2006. This constructive dividend
consisted of: (1) $11,256 for payment of insurance on Mr. Garcia's personal
vehicles by California Radomes; (2) $110,142 for payment of Mr. and Mrs.
Garcia's home mortgage by California Radomes; and (3) a $167,200 withdrawal by
Mr. Garcia. The total of these amounts was reduced by $20,500 in repayments Mr.
Garcia made to California Radomes.
Petitioners concede that Mr. and Mrs. Garcia received a
constructive dividend of $147,711 for 2007. This constructive dividend
consisted of: (1) $11,445 for payment of a personal insurance expense by
California Radomes; (2) $111,766 for payment of Mr. and Mrs. Garcia's home
mortgage by California Radomes; (3) a $60,000 withdrawal by Mr. Garcia; and (4)
$4,500 for payment of Mr. and Mrs. Garcia's personal taxes by California
Radomes. The total of these amounts was reduced by $40,000 in repayments Mr.
Garcia made to California Radomes.
California Radomes maintained a loan to shareholder account
on its balance sheet. This account was established by one of California
Radomes' accountants (discussed further infra), purportedly to help track loans
made by California Radomes to Mr. Garcia and repayment of those loans.
California Radomes reported the beginning and ending balances of the loan to
shareholder account on Schedule L, Balance Sheets Per Books, on its 2005, 2006,
and 2007 tax returns. In 2005 the beginning balance was $398,136 and the ending
balance was $365,145, a decrease of $32,991. In 2006 the beginning balance was
$365,145 and the ending balance was $521,929, an increase of $156,784. In 2007
the beginning balance was $521,929 and the ending balance was $779,320, an
increase of $257,391.
In addition to the loan to shareholder account on California
Radomes' balance sheet, California Radomes' general ledger from 2005, 2006, and
2007 included an entry entitled “Loan to Officer” which had various memos for
transfers affecting the entry. 6 These general ledger entries reflected the
same balances and total changes as the loan to shareholder account for 2005 and
2006, but showed only a $1,500 increase in 2007 (as opposed to a $257,391
increase in the loan to shareholder account in 2007).
Mr. Garcia did not sign a promissory note with respect to
the funds of California Radomes which he withdrew or used to pay personal
expenses. There was no repayment plan for the funds and the funds did not
accrue interest. Ms. Simon was not aware that Mr. Garcia deposited corporate
funds into his personal accounts; it was not established whether other members
of California Radomes' board of directors knew.
III. Petitioners' Tax Returns and Preparation Mr. Garcia has
used the services of a tax professional to prepare California Radomes' tax
returns since its establishment. In 2004 Mr. Garcia hired Gordon Ostrem for tax
preparation services after California Radomes' prior tax return preparer passed
away. This prior accountant had established the loan to shareholder account for
California Radomes. Mr. Ostrem was a certified public accountant (C.P.A.) with
20 years' experience and a tax partner with Pfahnl & Hunt, at the time Mr.
Garcia retained him. 7 Mr. Ostrem was labeled a “C.P.A. consultant” because
California Radomes did not have an in-house C.P.A.
Mr. Ostrem used information provided to him by Ms. Simon and
Ms. Jaszkowski to prepare California Radomes' 2005 and 2006 Federal corporate
tax returns, as well as California Radomes' 2007 State sales tax return. The
information provided to Mr. Ostrem included credit card statements, receipts,
and California Radomes' general ledger. Either through these documents or
otherwise, Mr. Ostrem became aware of the loan to shareholder account and the
loan to officer entry on the general ledger.
Mr. Ostrem was also provided with bank account statements
for California Radomes' general and payroll accounts, but was not provided with
any information about the holding account or told of its existence, even when
he requested information about such a potential bank account associated with
the loan to shareholder account. 8 Mr. Ostrem did not discover the existence of
the holding account until his participation in an audit of California Radomes
by the Internal Revenue Service (discussed further infra).
In preparing returns for California Radomes, Mr. Ostrem
reconciled the corporate financial statements to the payroll account (an act
which had already been completed for the general bank account). Mr. Ostrem
signed California Radomes' 2005 return on September 12, 2006, and provided the
return to California Radomes on or after that date. The 2005 return was due by
September 15, 2006, but was filed September 18, 2006. Mr. Ostrem signed
California Radomes' 2006 return on September 14, 2007, and provided the return
toCalifornia Radomes on September 15, 2007, the date by which the return was
due. The 2006 return was filed on September 17, 2007.
Mr. Ostrem provided the 2007 State sales tax return to
California Radomes and it was signed by Mr. Garcia on January 30, 2008, the day
before the return was due. California Radomes filed its 2007 corporate income
tax return on March 27, 2009. This return was prepared by Jonathan Seiki, an employee
of the Law Offices of Stephen Moskowitz, LLP.
On its 2005, 2006, and 2007 income tax returns, California
Radomes reported gross receipts of $2,461,283, $2,486,198, and $2,485,813,
respectively, and claimed certain deductions to determine its taxable income. 9
In his notice of deficiency respondent determined an increase in California
Radomes' gross receipts and disallowed certain deductions claimed on the
returns. 10 The parties later agreed that California Radomes underreported its
gross income for 2005, 2006, and 2007 by $156,251, $178,081, and $30,387,
respectively.
In addition to the tax returns he completed for California
Radomes, Mr. Ostrem also prepared Mr. and Mrs. Garcia's 2005, 2006, and 2007
joint personal income tax returns, which were timely filed. Much as with the
corporate tax returns he completed for California Radomes, Mr. Ostrem was aware
of the loan to shareholder account and the loan to officer entry in California
Radomes' general ledger at the time he prepared Mr. and Mrs. Garcia's personal
tax returns. However, Mr. Ostrem was not aware of the holding account when he
prepared any of these returns. In addition, it appears Mr. Garcia did not
discuss with Mr. Ostrem the fact that he was withdrawing corporate funds and
depositing them in his personal bank account. 11
Mr. Ostrem had the Garcias fill out an information packet to
enable him to prepare their personal returns. Mr. Garcia did not list any
dividends received in the completed packet he returned to Mr. Ostrem, nor did
Mr. Garcia otherwise account for his purported borrowing of corporate funds. 12
Mr. and Mrs. Garcia reported total income comprising only wages and taxable
interest, 13
totaling $221,101, $189,373, and $232,915 for 2005, 2006,
and 2007, respectively.
IV. Audit Respondent audited petitioners' 2005, 2006, and
2007 corporate and individual tax returns. The initial audit letter was mailed
in March 2008 and the audit concluded in October 2009. Allison Redington was
the auditor assigned to the audit of petitioners' tax returns. During the audit
Ms. Redington met with Mr. Garcia and was given a tour of California Radomes.
Throughout the audit petitioners and Ms. Redington maintained open lines of
communication. In addition, Mr. Garcia executed a Form 872, Consent to Extend
the Time to Assess Tax, at the request of Ms. Redington.
Ms. Redington reviewed petitioners' individual and corporate
tax returns and attempted to reconstruct their income by means of a bank
deposits analysis. To complete her bank deposits analysis for California
Radomes, Ms. Redington requested all of the corporation's bank account
statements, a copy of the general ledger, cash disbursement and cash receipts
journals, all corporate books, automobile logs, and additional corporate
information. She received all this information on the first day of the audit,
except for the holding account statements and logs for The Other Office, which
were not initially provided to her.
Ms. Redington also requested certain information from Mr.
and Mrs. Garcia, most of which she received upon request. However, Mr. and Mrs.
Garcia did not supply Ms. Redington with their personal bank account statements
when she requested them. Ms. Redington eventually received these bank account
statements by issuing a summons to Mr. and Mrs. Garcia's bank.
Using the information initially provided to her by
California Radomes, Ms. Redington was unable to reconcile income per books with
the income determined by the bank deposits analysis. When asked about the loan
to shareholder account Mr. Garcia told Ms. Redington that California Radomes
had set the account up at the direction of Mr. Ostrem. 14 Subsequent
investigation by Ms. Redington led to her discovery of the holding account and
the corporate payments on behalf of and withdrawals by Mr. Garcia. When asked
why California Radomes was making payments on his house Mr. Garcia told Ms.
Redington that California Radomes was investing in real estate.
Mr. Ostrem represented petitioners at the beginning of the
audit. During the audit he finally learned that California Radomes also had a
bank account “that was not on California Radomes' books” (the holding account).
Mr. Ostrem requested and received the holding account statements in an attempt
to reconcile this account with California Radomes' financial statements. When
Mr. Ostrem could not do so, he sought further explanation of the account from
Mr. Garcia. Mr. Ostrem received evasive answers to his queries and was
subsequently fired. 15
V. Other Information On December 11, 2009, respondent issued
a notice of deficiency to California Radomes for tax years 2005, 2006, and 2007
and a notice of deficiency to Mr. and Mrs. Garcia for tax years 2005, 2006, and
2007. Petitioners timely filed petitions contesting the deficiencies, 16
additions to tax, and penalties.
OPINION
I. Whether Mr. Garcia Is Liable for Fraud Penalties Under
Section 6663(a) for 2005, 2006, and 2007
The Commissioner has the burden of proving fraud by clear
and convincing evidence. Sec. 7454(a); Rule 142(b). To satisfy the burden of proof,
the Commissioner must show: (1) an underpayment of tax 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. Sadler v.
Commissioner, 113 T.C. 99, 102 (1999); Parks v. Commissioner, 94 T.C. 654,
660-661 (1990).
A. Underpayment of Tax The clear and convincing standard
applies not merely to whether an underpayment is attributable to fraud, but
also to whether an underpayment exists. Parks v. Commissioner, 94 T.C. at
660-661; Di Ricco v. Commissioner, T.C. Memo. 2009-300 [TC Memo 2009-300].
Where fraud is determined for each of several years, the Commissioner's burden
applies separately for each of the years. Roth v. Commissioner, T.C. Memo
1998-28 [1998 RIA TC Memo ¶98,028]. Petitioners have conceded that Mr. and Mrs.
Garcia failed to report constructive dividends received of $156,017, $268,098,
and $147,711 for 2005, 2006, and 2007, respectively. Therefore, there is clear
and convincing evidence that Mr. Garcia underreported his income for 2005,
2006, and 2007 and underpaid his income tax for these years.
B. Fraudulent Intent The Commissioner must prove by clear
and convincing evidence that a portion of the underpayment for each taxable
year in issue was due to fraud. Prof'l Servs. v. Commissioner, 79 T.C. 888, 930
(1982). Once the Commissioner establishes that any portion of an underpayment
is attributable to fraud, the entire underpayment is subject to the 75%
penalty, except with respect to any portion of the underpayment that the
taxpayer establishes is not attributable to fraud. Sec. 6663(a) and (b). The
existence of fraud is a question of fact to be resolved upon consideration of
the entire record. King's Court Mobile Home Park, Inc. v. Commissioner, 98 T.C.
511, 516 (1992).
The taxpayer's entire course of conduct may establish the
requisite fraudulent intent. Stone v. Commissioner, 56 T.C. 213, 223-224
(1971). Because direct proof of a taxpayer's intent is rarely available, fraud
may be proved by circumstantial evidence and reasonably inferred from the
facts. Spies v. United States, 317 U.S. 492, 499 [30 AFTR 378] (1943);
Niedringhaus v. Commissioner 99 T.C. 202, , 210 (1992); Rowlee v. Commissioner,
80 T.C. 1111, 1123 (1983). Certain indicia, commonly known as badges of fraud,
constitute circumstantial evidence which may give rise to a finding of
fraudulent intent. Bradford v. Commissioner, 796 F.2d 303, 307 [58 AFTR 2d
86-5532] (9th Cir. 1986), aff'g T.C. Memo. 1984-601 [¶84,601 PH Memo TC]. “Although
no single factor is necessarily sufficient to establish fraud, the existence of
several indicia is persuasive circumstantial evidence of fraud.” Petzoldt v.
Commissioner, 92 T.C. 661, 700 (1989). 1. Consistent and Substantial
Underreporting of Income A consistent pattern of underreporting large amounts
of income is evidence of fraud. See Holland v. United States, 348 U.S. 121 [46
AFTR 943] (1954); Delvecchio v. Commissioner, T.C. Memo. 2001-130 [TC Memo
2001-130] (”Two years of substantial understatement [of income] may support a
finding of fraud.”),aff'd, 37 Fed. Appx. 979 [89 AFTR 2d 2002-3019] (11th Cir.
2002). Petitioners have conceded that Mr. and Mrs. Garcia failed to report
constructive dividends received of $156,017, $268,098, and $147,711 for 2005,
2006, and 2007, respectively. These are large amounts compared to Mr. and Mrs.
Garcia's total income of $221,101, $189,373, and $232,915 originally reported
for 2005, 2006, and 2007, respectively. 2. Information Concealed From Mr.
Ostrem Petitioners argue that Mr. Garcia did not act fraudulently because he
relied in good faith on an accountant, Mr. Ostrem, to prepare his personal tax
returns. Petitioners correctly point out that a taxpayer's justifiable reliance
on an accountant to prepare income tax returns may indicate an absence of
fraudulent intent. Marinzulich v. Commissioner , 31 T.C. 487, 492 (1958); Whyte
v. Commissioner, T.C. Memo. 1986-486 [¶86,486 PH Memo TC], aff'd, 852 F.2d 306
[62 AFTR 2d 88-5272] (7th Cir. 1988). In support of their position, petitioners
argue that Mr. Garcia is unsophisticated in the area of tax and was unaware
that his use of corporate funds could constitute taxable income to him. See
Vorsheck v. Commissioner, 933 F.2d 757, 759 [67 AFTR 2d 91-1023] (9th Cir.
1991) (taxpayers who relied upon their accountant and knew nothing about tax
law not liable for penalties).
Respondent argues that Mr. Garcia cannot rely on the fact
that Mr. Ostrem prepared the returns because Mr. Garcia (as well as California
Radomes, with the knowledge of Mr. Garcia) concealed information necessary for
Mr. Ostrem to properly prepare Mr. Garcia's personal tax returns. Estate of
Temple v. Commissioner, 67 T.C. 143, 162 (1976) (”While a taxpayer's reliance
upon his accountant to prepare accurate returns may indicate an absence of
fraudulent intent, John Marinzulich, 31 T.C. 487, 490 (1958), this is true in
the first instance only if the accountant has been supplied with all the
information necessary to prepare the returns.”). In addition, respondent claims
Mr. Garcia's failure to provide Mr. Ostrem with complete and accurate records
is evidence of Mr. Garcia's intent to conceal and deceive. Dubose v.
Commissioner, T.C. Memo. 1996-99 [1996 RIA TC Memo ¶96,099]; Scallen v.
Commissioner, T.C. Memo. 1987-412 [¶87,412 PH Memo TC] (”The failure by a
taxpayer to make available complete and accurate records to the person charged
with the responsibility of preparing the taxpayer's returns may, in the view of
the courts, reflect an intent on the taxpayer's part to conceal and deceive.”),
aff'd, 877 F.2d 1364 [64 AFTR 2d 89-5035] (8th Cir. 1989). We agree with
respondent.
The loan to officer entry on California Radomes' 2005
general ledger provided to Mr. Ostrem reflected a $32,991 decrease in the loan
to shareholder account on California Radomes' balance sheet. However, the loan
to shareholder account should have been increased by $156,017. 17 Similarly,
the loan to shareholder account and general ledger each understated the amount
“loaned” to Mr. Garcia by more than $100,000 in 2006. The general ledger also
understated the amount “loaned” to Mr. Garcia by more than $100,000 in 2007. 18
In addition to understating the amount of corporate funds
used by Mr. Garcia personally in the information provided to Mr. Ostrem,
California Radomes also concealed information from Mr. Ostrem that would have
allowed him to identify the understatements and properly prepare Mr. and Mrs.
Garcia's personal tax returns. When supplying Mr. Ostrem with information to
prepare California Radomes' corporate tax returns, Ms. Simon did not provide
Mr. Ostrem with the holding account information or tell him that such an
account existed. Mr. Ostrem suspected that such an account existed and was
related to the loan to shareholder balance sheet account. Mr. Ostrem requested
information about any such account but was again not supplied with such
information or told of the account's existence. Had he been made aware of the
holding account, Mr. Ostrem could have attempted to reconcile this account to California
Radomes' general ledger (as he did with the unreconciled payroll account),
which presumably would have led him to discover the information necessary to
properly prepare Mr. and Mrs. Garcia's personal tax returns.
Furthermore, Mr. Garcia did not account for his use of
corporate funds when filling out an information packet for Mr. Ostrem or
otherwise alert Mr. Ostrem to the fact that the loan balances as stated in the
general ledger were understated. Petitioners claim that this was an innocent mistake
arising from Mr. Garcia's lack of tax knowledge. 19 However, given the various
actions which Mr. Garcia and California Radomes took (or failed to take) to
conceal the true extent of Mr. Garcia's use of corporate funds, we believe that
Mr. Garcia's actions were not an innocent mistake. Rather, we believe that
petitioners' actions were part of a pattern taken to purposefully conceal
income from Mr. Ostrem (and later from Ms. Redington).
As a result of Mr. Garcia's failure to supply Mr. Ostrem
with information necessary to accurately prepare his personal tax returns (or
notify Mr. Ostrem that the information supplied by California Radomes was
incorrect), Mr. Garcia's purported reliance on Mr. Ostrem does not prove his
lack of fraudulent intent. See Estate of Temple v. Commissioner 67 T.C. at 162.
Indeed, Mr. Garcia's efforts to , conceal information from Mr. Ostrem is
evidence of Mr. Garcia's intent to conceal and deceive. See Scallen v.
Commissioner, T.C. Memo. 1987-412 [¶87,412 PH Memo TC]. 3. Information
Concealed From Ms. Redington Making false statements to or failure to cooperate
with the Commissioner's agents during the course of their examinations is a
badge of fraud. Grosshandler v. Commissioner, 75 T.C. 1, 20 (1980); Tilley v.
Commissioner T.C. Memo. 2009-83. Petitioners argue that Mr. Garcia fully
cooperated with Ms. Redington because Mr. Garcia provided most personal and
corporate documents the day after Ms. Redington requested them, gave Ms.
Redington a tour of California Radomes, signed a Form 872 at Ms. Redington's
request, and maintained open lines of communication with Ms. Redington. While
we acknowledge Mr. Garcia's cooperation with Ms. Redington on some issues, we
believe that Mr. Garcia failed to cooperate with Ms. Redington with regard to the
most important issue: Mr. Garcia's personal use of California Radomes' funds.
Although Ms. Redington requested all of California Radomes'
bank account statements, she was not supplied with any information about the
holding account, which was necessary to reconcile income per books with the
income determined by her bank deposits analysis. When the existence of the
holding account was finally uncovered and Ms. Redington was seeking additional
information on California Radomes' purported loans to Mr. Garcia, Mr. Garcia
told her that California Radomes was paying his personal mortgage because the
corporation was investing in real estate. As described supra note 19,
petitioners claim on brief that Mr. Garcia honestly believed California Radomes
was paying his personal mortgage as part of an investment in real estate but
have provided no evidence which would support such a belief. We believe Mr.
Garcia's statement was simply intended to deceive Ms. Redington and delay the
investigation of his personal taxes and California Radomes' corporate taxes.
In addition to making the false statement about real estate
investment to Ms. Redington, Mr. Garcia failed to provide her with his and Mrs.
Garcia's personal bank account statements when that information was requested.
Ms. Redington eventually received these bank account statements by issuing a
summons to Mr. and Mrs. Garcia's bank.
We believe that Mr. Garcia's actions when dealing with Ms.
Redington were intended to conceal information which eventually led her to discover
understatements of income for both Mr. Garcia and California Radomes. We find
the concealment of such information from Ms. Redington and the false statements
made in connection with that concealment to be badges of fraud. 4. Mr. Garcia's
Fraudulent Intent and Liability for the Section 6663(a) Fraud Penalty
Considering the facts discussed above, we find that respondent has proven by
clear and convincing evidence that Mr. Garcia acted with fraudulent intent in
understating his income for 2005, 2006, and 2007. As we have also found that
respondent proved by clear and convincing evidence that underpayments of tax
were made for the same years, Mr. Garcia is liable for the section 6663(a)
fraud penalty for each year at issue.
II. Whether California Radomes Is Liable for Fraud Penalties
Under Section 6663(a) for 2005, 2006, and 2007 “Where fraud is alleged against
a corporate taxpayer, the requisite proof of fraudulent intent is to be found
in the acts of its officers, inasmuch as the corporation, being an artificial
person created by law, can have no separate intent of its own apart from those
who direct its affairs.” Ruidoso Racing Ass'n, Inc. v. Commissioner, T.C. Memo.
1971-194 [¶71,194 PH Memo TC], aff'd in part, rev'd in part, 476 F.2d 502 [31
AFTR 2d 73-1069] (10th Cir. 1973). A corporation does not escape responsibility
for the acts of its duly authorized officers who have performed wrongfully in
that capacity.Id. Given Mr. Garcia's position as California Radomes' president,
chairman of the board of directors, chief financial officer, and sole
shareholder, as well as the relationship between the tax deficiencies of Mr.
Garcia and California Radomes, most of the same facts described supra pp. 18-25
relating to the fraudulent intent of Mr. Garcia are also applicable with
respect to the fraudulent intent of California Radomes. For this reason we will
try to be concise when repeating facts previously discussed.
A. Underpayment of Tax Petitioners have conceded that
California Radomes underreported its income for 2005, 2006, and 2007 by
$156,251, $178,081, and $30,387, respectively. Therefore, there is clear and
convincing evidence that California Radomes underreported its income for 2005,
2006, and 2007 and underpaid its income tax for these years.
B. Fraudulent Intent 1. Consistent and Substantial
Underreporting of Income A consistent pattern of underreporting large amounts
of income is evidence of fraud. See Holland v. United States, 348 U.S. 121 [46
AFTR 943]; Delvecchio v. Commissioner, T.C. Memo. 2001-130 [TC Memo 2001-130]
(”Two years of substantial understatement [of income] may support a finding of
fraud.”). Petitioners have conceded that California Radomes underreported its
income for 2005, 2006, and 2007 by $156,251, $178,081, and $30,387, respectively.
These are large amounts compared to California Radomes' reported taxable income
of negative $33,639, positive $96,566, and positive $192,473 originally
reported for 2005, 2006, and 2007, respectively. 2. Information Concealed From
Mr. Ostrem As discussed supra pp. 19-23, there were significant discrepancies
between the amounts listed as loans to Mr. Garcia on the general ledger
supplied to Mr. Ostrem for preparation of California Radomes' corporate tax
returns and the actual amounts of corporate funds which Mr. Garcia used
personally. The officers of California Radomes failed to provide Mr. Ostrem
with information about the corporate holding account or tell him that the
holding account existed, even when he requested any information about such an
account. Had he been provided with information about this holding account, Mr.
Ostrem would have been able to deduce that the information contained on the
general ledger relating to loans to Mr. Garcia was incorrect and properly
prepare California Radomes' corporate tax returns.
Furthermore, Mr. Garcia did not account for his use of
corporate funds when filling out an information packet for Mr. Ostrem or
otherwise alert Mr. Ostrem to the fact that the loan amounts in the general
ledger were understated. As discussed supra pp. 22-23, we believe this was not
an innocent mistake but a deliberate attempt to conceal from Mr. Ostrem
information needed to properly prepare California Radomes' corporate tax
returns.
As a result of California Radomes' failure to supply Mr.
Ostrem with information necessary to prepare its tax returns, California
Radomes' purported reliance on Mr. Ostrem does not prove its lack of fraudulent
intent. See Estate of Temple v. Commissioner, 67 T.C. at 162. Indeed,
California Radomes' efforts to conceal information from Mr. Ostrem is evidence
of its intent to conceal and deceive. See Scallen v. Commissioner, T.C. Memo.
1982-412 [¶82,412 PH Memo TC]. 3. Information Concealed From Ms. Redington
Although Ms. Redington requested all of California Radomes' bank account
statements, she was not supplied with any information about the holding
account, which was necessary to reconcile income per books with the income
determined by her bank deposits analysis. When the existence of the holding
account was finally uncovered and Ms. Redington was seeking additional
information on California Radomes' purported loans to Mr. Garcia, Mr. Garcia
told her that California Radomes was paying his personal mortgage because the
corporation was investing in real estate. As described supra note 19,
petitioners claim on brief that Mr. Garcia honestly believed California Radomes
was paying his personal mortgage as part of an investment in real estate but
have provided no evidence which would support such a belief. We believe Mr.
Garcia's statement was simply intended to deceive Ms. Redington and delay her
investigation of his personal taxes and California Radomes' corporate taxes.
In addition to making the false statement about real estate
investment to Ms. Redington, Mr. Garcia also failed to provide her with his and
Mrs. Garcia's personal bank account statements when that information was
requested. Ms. Redington eventually received these bank account statements by
issuing a summons to Mr. and Mrs. Garcia's bank. Those bank statements would
have aided Ms. Redington in her reconstruction of the financial dealings
between Mr. Garcia and California Radomes and therefore help her to properly
determine California Radomes' income.
We believe that California Radomes' actions in dealing with
Ms. Redington were intended to conceal information which eventually led her to
discover understatements of income for both Mr. Garcia and California Radomes.
We find the concealment of that information from Ms. Redington and the false
statement made in connection with that concealment to be badges of fraud. 4.
California Radomes' Fraudulent Intent and Liability for the Section 6663(a)
Fraud Penalty Considering the facts discussed above, we find that respondent
has proven by clear and convincing evidence that California Radomes acted with
fraudulent intent in understating its income for 2005, 2006, and 2007. 20 As we
have also found that respondent proved by clear and convincing evidence that
underpayments of tax were made in the same years, California Radomes is liable
for the section 6663(a) fraud penalty for each year at issue.
III. Whether Mrs. Garcia Is Liable for the Accuracy-Related
Penalty Under Section 6662(a) for Tax Years 2005, 2006, and 2007
Where a joint return is filed and one spouse is liable for
fraud with respect to the entire underpayment, the imposition of the section
6662(a) accuracy-related penalty with respect to the other spouse would result
in impermissible stacking. Sec. 6662(b); Zaban v. Commissioner, T.C. Memo.
1997-479 [1997 RIA TC Memo ¶97,479]; Aflalo v. Commissioner, T.C. Memo.
1994-596 [1994 RIA TC Memo ¶94,596]; Minter v. Commissioner, T.C. Memo.
1991-448 [1991 TC Memo ¶91,448]. Thus, we hold that Mrs. Garcia is not liable
for the accuracy-related penalty for the years at issue.
IV. Conclusion We find that Mr. Garcia and California
Radomes are both liable for fraud penalties under section 6663 for 2005, 2006,
and 2007. We further find that Mrs. Garcia is not liable for the
accuracy-related penalty for 2005, 2006, or 2007.
In reaching our holdings herein, we have considered all
arguments made, and, to the extent not mentioned above, we conclude they are
moot, irrelevant, or without merit.
To reflect the foregoing,
Decisions will be entered under Rule 155.
1
Unless otherwise
indicated, all section references are to the Internal Revenue Code (Code) in
effect for the years in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure. 2
A radome
encapsulates and protects the radar unit of an aircraft or boat. 3
For example, Mr.
Garcia discussed several tax concepts relating to subch. S corporations at a
1983 organizational meeting for California Radomes. In addition, Mr. Garcia
showed some grasp of common accounting terminology during his testimony at
trial. 4
Ms. Simon described
the times when money would be deposited in the holding account as times when
California Radomes “had extra income or, you know, like if we had an extra
check come in, we would put it into that account, or it would be transfer money
from the business account.” 5
This $51,468 was
used to purchase The Other Office, a boat purportedly used by California
Radomes for business purposes. Although respondent conceded payments made by
California Radomes for “boat payments” and “boat maintenance” in 2007, it is
unclear whether those payments were made on/forThe Other Office or a second
boat owned by California Radomes. Mr. Garcia testified that he deposited the
$51,468 into his personal account so he could use his personal credit to obtain
a boat loan, as California Radomes' credit was insufficient to qualify. 6
For example, many of
the decreases in the Loan to Officer entries on the general ledger were labeled
as loans from Mr. Garcia, deposits, or “payroll”, while many of the additions
were labeled as reimbursements, withdrawals, or fund transfers. 7
Mr. Ostrem continued
working at Pfahnl & Hunt after he was retained by California Radomes. 8
Contrary to Mr.
Ostrem's testimony, Ms. Simon testified that although she did not originally
provide Mr. Ostrem with bank statements for the holding account, she did so
when he inquired about such a potential bank account. Considering certain
evidence from 2006, 2008, and 2009 (which supports Mr. Ostrem's testimony that
he was unaware of the existence of the holding account until at least 2008), as
well as California Radomes' failure to provide an Internal Revenue Service
auditor with information about the holding account (discussed further infra),
we find Mr. Ostrem's testimony more credible. 9
The 2005, 2006, and
2007 corporate tax returns listed taxable income of negative $33,639, positive
$96,566, and positive $192,473, respectively. 10
Those adjustments
were made because California Radomes was deducting personal expenses of Mr. and
Mrs. Garcia (such as certain insurance and automobile expenses) as its own
business expenses and not including certain sums in its gross receipts as a
result of the payments made to or on behalf of Mr. Garcia. 11
At trial Mr. Garcia
gave a somewhat evasive answer when asked by respondent's counsel on direct
examination about his discussions with Mr. Ostrem regarding such use of
corporate funds—
Q: In 2005, did you tell Mr. Ostrem about these transfers
[of corporate funds into your personal account]?
A: I don't speak with Gordon — I didn't speak with Gordon.
My only contact with Gordon is when I hired him. I'm a firm believer in
consultants and so I was looking for a consultant for accounting —
Q: Okay.
A: — for a CPA.
Q: Okay.
A: — and I was given his name — or Mr. Hunt was the name I
was given. And I called that firm and they said that Mr. Hunt wasn't taking any
further clients, but they had someone, who they could recommend, within their
client [sic]. And I had made an appointment to see him, which happened to be
Gordon. And I went and talked to him and asked him some questions. And he
assured me that he was a professional and could do whatever we needed to do as
far as CPA work or accounting and tax preparation, and I hired him. And then
after that, I kind of backed off of it and the office took care of it. So, I
really didn't have any other contact. I mean, I've talked to him maybe once or
twice on the phone, but that's the limit of my contact with him. 12
The information
packet asked for information about dividends received but did not specifically
ask for information relating to corporate funds borrowed by Mr. Garcia. 13
The taxable interest
Mr. and Mrs. Garcia received in each of the three years at issue was less than
$2,000. 14
Petitioners admit
Mr. Garcia was mistaken on this point but claim the mistake was an honest one.
They point out that another witness, when asked at trial, also had trouble
remembering which accountant had helped set up the account. 15
Petitioners claim
that there is no proof Mr. Ostrem was fired as a result of his seeking
information on the holding account. Petitioners state that “There are a myriad
of possible reasons why petitioner may have fired Ostrem” and that “Certainly,
respondent's theory may be one.” Petitioners speculate that Mr. Ostrem may have
been fired because he provided California Radomes' tax returns just before the
dates they were due (in spite of receiving information to complete the returns
six months before) or because petitioners had never had tax-related trouble
until Mr. Ostrem began preparing their returns. 16
The deficiency
issues were later settled, as described supra p. 2. 17
This amount is the
total of $10,840 for payment of an insurance expense by California Radomes,
$101,384 for payment of Mr. and Mrs. Garcia's home mortgage by California
Radomes, $91,325 withdrawn by Mr. Garcia, and $51,468 for California Radomes'
income which was deposited into Mr. Garcia's personal account offset by $99,000
in repayments made by Mr. Garcia. 18
The parties did not
explain the disparity in the loan to officer entry on the 2007 general ledger
and the 2007 loan to shareholder account. The Loan to Officer entry showed an
increase of only $1,500 while the loan to shareholder account showed an
increase of over $257,391. We suspect that petitioners may have increased the
balance of the loan to shareholder account when respondent's audit commenced
(or as the audit progressed) to more accurately reflect the actual amount of
California Radomes' funds used by Mr. Garcia personally during the years at
issue. 19
For example,
petitioners claim on brief that Mr. Garcia honestly believed that California
Radomes paid his personal mortgage because the company was investing in real
estate. Petitioners made no attempt to support this claim by providing evidence
which might tend to show that a reasonable person might believe California
Radomes was in fact investing in real estate. We also note that the Schedules
L, Balance Sheets Per Books, attached to California Radomes' 2005, 2006, and
2007 corporate tax returns each reflect no real estate (net of amortization)
held by California Radomes. 20
Petitioners made no
argument that California Radomes' tax year 2007 should have been treated any
differently from tax years 2005 and 2006 as a result of Mr. Seiki's preparing
the 2007 corporate tax return instead of Mr. Ostrem. We deem this issue waived
by petitioners. See Muhich v. Commissioner, 238 F.3d 860, 864 [87 AFTR 2d
2001-667] n.10 (7th Cir. 2001) (issues not addressed or developed are deemed
waived—it is not the Court's obligation to research and construct the parties'
arguments),aff'g T.C. Memo. 1999-192 [1999 RIA TC Memo ¶99,192].
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