John M. Potter v. Commissioner.
U.S. Tax Court, Dkt. No. 10730-12, TC Memo. 2014-18, January 27,
2014.An individual who operated a gentlemen’s club was liable for tax
deficiencies and Code Sec. 6663 fraud
penalties for four years at issue. The IRS established that there was some
underpayment for each tax year and that some portion of the underpayment for
each year was due to fraud. The taxpayer acknowledged that he intentionally
underreported his income. He underreported income for multiple years both to
evade corporate-level income tax and his own income to conceal that he was
skimming hundreds of thousands of dollars annually to his personal bank
account. He maintained two sets of books for both himself and for his club
which was evidence of fraudulent intent. He wired cash to his personal bank
account, and kept the amounts below $10,000 to avoid the bank reporting to the
IRS and to conceal income His business had extensive dealings in cash which was
a badge of fraud as it was indicative of the taxpayer’s attempt to conceal
income and avoid scrutiny of his finances. The taxpayer asserted that he
cooperated with the government; however, he did so only when he realized that
the search of his business turned up the illicit sales ledgers and unexplained
cash.—CCH.
Stephen
J. Dunn, for petitioner; John W. Stevens, for respondent.
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Discussion
A. Fraud Penalty
“If any part of any underpayment of tax required to be
shown on a return is due to fraud,” section
6663(a) imposes a penalty of 75% of the portion of the
underpayment due to fraud. Respondent has the burden of proving fraud, and he
must prove it by clear and convincing evidence. Sec. 7454(a); Rule 142(b); Richardson v.
Commissioner, [ 2008-1 ustc ¶50,101]509
F.3d 736, 743 (6th Cir. 2007), aff'g [ Dec. 56,475(M)] T.C. Memo. 2006-69. To sustain his
burden, respondent must establish two elements: (1) that there was some
underpayment of tax for each taxable year at issue; and (2) that at least
some portion of the underpayment for each year was due to fraud. Hebrank
v. Commissioner, [ Dec. 40,488]
81 T.C. 640, 642 (1983).
If a fraud penalty is sought for
multiple tax years, respondent's burden of proving fraud “applies separately
for each of the years.” Vanover v. Commissioner, [ Dec. 58,990(M)] T.C. Memo. 2012-79, 103 T.C.M.
(CCH) 1418, 1420 (quoting Temple v. Commissioner, [ Dec. 54,104(M)] T.C. Memo. 2000-337, aff'd,
[ 2003-1 ustc ¶50,411] 62 Fed. Appx. 605 (6th Cir.
2003)). [*7] If respondent proves
that a portion of an underpayment is attributable to fraud for a particular
year, then “the entire underpayment shall be treated as attributable to
fraud” unless the taxpayer shows, by a preponderance of the evidence, that
some portion was not so attributable. Sec.
6663(b).
We turn to the second element of the penalty, fraudulent
intent. 3
Fraud is intentional wrongdoing
designed to evade tax believed to be owing. Neely v. Commissioner,
[ Dec. 54,241] 116 T.C. 79, 86 (2001). The existence
of fraud is a question of fact to be resolved upon consideration of the
entire record. Estate of Pittard v. Commissioner, [ Dec. 34,775] 69 T.C. 391, 400 (1977). Fraud is not
to be presumed or based upon mere suspicion. Petzoldt v. Commissioner,
[ Dec. 45,566] 92 T.C. 661, 699-700 [*8] (1989). However, because direct proof
of a taxpayer's intent is rarely available, fraudulent intent may be
established by circumstantial evidence. Grossman v. Commissioner,
[ 99-2 ustc ¶50,631] 182 F.3d 275, 277-78 (4th Cir.
1999), aff'g [ Dec.
51,589(M)] T.C. Memo. 1996-452. Respondent satisfies his burden of
proof by showing that “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, [ Dec. 46,545] 94 T.C. 654, 661 (1990). The
taxpayer's entire course of conduct may be examined to establish the
requisite intent, and an intent to mislead may be inferred from a pattern of
conduct. Webb v. Commissioner, [68-1 ustc ¶9341]
394 F.2d 366, 379 (5th Cir. 1968), aff'g [ Dec. 27,918(M)] T.C. Memo. 1966-81; Stone
v. Commissioner, [ Dec. 30,767]
56 T.C. 213, 224 (1971).
Circumstances that may indicate
fraudulent intent, commonly referred to as “badges of fraud,” include but are
not limited to: (1) understating income; (2) maintaining inadequate records;
(3) giving implausible or inconsistent explanations of behavior; (4) concealing
income or assets; (5) failing to cooperate with tax authorities; (6) engaging
in illegal activities; (7) providing incomplete or misleading information to
one's tax preparer; (8) lack of credibility of the taxpayer's testimony; (9)
filing false documents, including false income tax returns; (10) failing to
file tax returns; and (11) dealing in cash. Spies v. United [*9] States, [ 43-1 ustc ¶9243] 317 U.S. 492, 499 (1943); Morse
v. Commissioner, [ Dec.
55,366(M)] T.C. Memo. 2003-332, 86 T.C.M. (CCH) 673, 675, aff'd,
[ 2005-2 ustc ¶50,533] 419 F.3d 829 (8th Cir. 2005).
No single factor is dispositive; however, the existence of several factors
“is persuasive circumstantial evidence of fraud.” Vanover v.
Commissioner, 103 T.C.M. (CCH) at 1420-1421.
Some factors have no application here. For example,
because this case was submitted fully stipulated, petitioner had no occasion
to testify and his credibility cannot be evaluated. Other factors may be
regarded as neutral. After thorough review of the record, we conclude on
balance that the “badges of fraud” overwhelmingly demonstrate that petitioner
acted with fraudulent intent for each tax year at issue.
1. Understating Income
A pattern of substantially
underreporting income for multiple years is strong evidence of fraud,
particularly if the understatements are not satisfactorily explained. Vanover
v. Commissioner, 103 T.C.M. (CCH) at 1421. Petitioner admitted in his
2009 guilty plea that he substantially underreported the income of Potter's
Pub for 2002-05. He underreported this income both to evade the
corporate-level income tax and to conceal the fact that he was skimming
hundreds [*10] of thousands of
dollars of corporate income annually into his personal bank account.
This factor weighs
heavily in favor of finding fraudulent intent.
2. Maintaining Inadequate Records
Fraudulent intent can be inferred
from a failure to maintain adequate books and records, including the
maintenance of false books and records. See Ark. Oil & Gas, Inc.
v. Commissioner, [ Dec.
50,162(M)] T.C. Memo. 1994-497, 68 T.C.M. (CCH) 887, 891. Double bookkeeping provides clear circumstantial
evidence of fraudulent intent. See Spies, 317 U.S. at 499; Medlin
v. Commissioner, [ Dec.
55,246(M)] T.C. Memo. 2003-224, aff'd, 138 Fed. Appx.
298 (11th Cir. 2005).
3. Concealing Income or Assets
A willful attempt to evade tax may be inferred from a
taxpayer's concealment of income or assets. Spies, 317 U.S. at
499. The pattern of structuring bank deposits is clearly emblematic of an
intent to conceal income. See McClellan v. Commissioner, T.C. Memo. 2013-251, at *27-*28. By systematically
manipulating both his business and personal income, petitioner was able to
accumulate substantial assets (including cash) that he likewise concealed.
Evidence that a taxpayer provided incomplete or misleading
information to his return preparer is further circumstantial evidence of
fraud. Morse v. Commissioner, 419 F.3d at 833; Vanover v.
Commissioner, 103 T.C.M. (CCH) at 1042. A taxpayer acts fraudulently when
he conceals income from his return preparer. See Korecky v. Commissioner,
[ 86-1 ustc ¶9232] 781 F.2d 1566 (11th Cir. 1986), aff'g [ Dec. 41,878(M)] T.C. Memo. 1985-63.
Once a fraudulent return has been
submitted, however, subsequent conduct, such as filing amended returns, does
not purge the original fraudulent conduct. Badaracco v. Commissioner,
464 U.S. 386, 393-394 (1984). Initial acts of
supplying false records to his return preparer for 2002-05 constitute clear
evidence of his fraudulent intent.
5. Filing False Income Tax Returns
Petitioner pleaded
guilty under section 7206(1) to one count of filing a false
income tax return on behalf of Potter's Pub for 2002.
Extensive dealings in cash are a badge of fraud because
they are indicative of a taxpayer's attempt to conceal income and avoid
scrutiny of his finances. See Evans v. Commissioner, T.C. Memo.
2010-199, 100 T.C.M. (CCH) 215, 218, aff'd, 507 Fed. Appx. 645
(9th Cir. 2013). Fraudulent intent may be inferred when a taxpayer handles
his affairs in a manner designed “to avoid making the records usual in
transactions of the kind.” Spies, 317 U.S. at 499.
. These wire transfers were invariably made in amounts less
than $10,000 in order to avoid detection. During the search of Potter's Pub
Federal agents seized more than $200,000 in cash from the premises. Although
conducting a cash business does not necessarily prove fraud, “[w]hen coupled
with attempts to conceal transactions or avoid the requirement of reporting
cash transactions, it becomes more probative.”Valbrun v. Commissioner,
T.C. Memo. 2004-242, 88 T.C.M. (CCH) 385, 387.
[*15] Petitioner contends that he lacked fraudulent intent
because he is uneducated and unsophisticated and had to hire tax
professionals to file his personal and corporate tax returns. Petitioner's
lack of education and sophistication is irrelevant. In this context the tax
laws he violated are not esoteric. Petitioner knowingly concealed more than
$2 million in business gross receipts in an effort to evade tax he knew to be
owing. He was sophisticated enough to structure his wire transfers in amounts
under $10,000 in the hope of escaping bank reporting to the IRS. And he
knowingly failed to provide his tax professional with the clandestine sales
ledgers that he personally prepared and which he knew recorded the actual
receipts of his business.
Petitioner asserts that he “went
to extraordinary lengths to cooperate with the Government.” But he began to
cooperate only after he knew that the jig was up. It was only after the
search of his business turned up the illicit sales ledgers and $200,000 in
unexplained cash that petitioner provided his accountant with the books and
records needed to prepare amended returns. These efforts may have helped
petitioner in his negotiations with the Department of Justice in his criminal [*16] tax case. But they do not purge the
fraudulent intent that accompanied the original filing of his false
individual tax returns for 2002-05. 5
The amounts of restitution, if any, that petitioner made
after filing his original tax returns have no bearing on the issues currently
before the Court— namely, the tax deficiencies and penalties for which
petitioner is liable for the tax years 2002-05. That is not to say that
petitioner will not receive credit, when respondent proceeds to collect the
tax liabilities sustained in this case, for any restitution payments he has
made that have not been previously accounted for.
[*17] But such collection matters are generally not within
our jurisdiction in a deficiency proceeding commenced under section 6213(a). See Abdallah v.
Commissioner,T.C. Memo. 2013-279, at *32-*34.
B. Section 6651(a)(1) Additions to
Tax
Respondent assessed late-filing additions to tax under section 6651(a)(1) for 2002 and 2003.
Petitioner's Forms 1040 for both years were indisputably filed late. He did
not file his 2002 return until April 26, 2004, and he did not file his 2003
return until February 7, 2005. Petitioner in his briefs did not address the
late-filing additions to tax, and we deem this issue conceded. See,
e.g., Gmelin v. Commissioner, T.C. Memo. 1988-338, 55 T.C.M.
(CCH) 1410, 1421 n.19 (finding one of the Commissioner's arguments to have
been abandoned when he failed to address it on brief), aff'd without
published opinion, 891 F.2d 280 (3d Cir. 1989).
C. Conclusion
For the reasons set forth above,
we conclude that respondent has established by clear and convincing evidence
that petitioner's underpayments of tax were attributable to fraud for the
taxable years 2002-05. Petitioner has failed to submit credible evidence
showing that any portions of these underpayments were not due to fraud. Accordingly,
we hold that petitioner is liable for the tax deficiencies and [*18] section
6663 civil fraud penalties for 2002-05, and for the section 6651(a)(1) late-filing additions to
tax for 2002 and 2003.
To reflect the foregoing,
Decision will be entered for respondent.
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