T.C. Memo. 2014-18
UNITED STATES TAX COURT
JOHN M. POTTER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10730-12. Filed January 27, 2014.
Stephen J. Dunn, for petitioner.
John W. Stevens, for respondent.
MEMORANDUM OPINION
LAUBER, Judge: The Internal Revenue Service (IRS or respondent)
determined deficiencies, additions to tax, and penalties in the following amounts
with respect to petitioner’s individual Federal income tax liabilities for the tax
years 2002, 2003, 2004, and 2005:
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[*2]
Addition to tax Fraud penalty
Year Deficiency sec. 6651(a)(1) sec. 6663
2002 $94,214 $23,554 $70,661
2003 25,093 3,764 69,363
2004 --- --- 44,099
2005 74,369 --- 55,777
Because petitioner does not dispute the amounts of the proposed deficiencies, the
principal issue for decision is whether petitioner is liable for the fraud penalty
under section 6663 for each of the years at issue.1 We must also determine
whether petitioner is liable for additions to tax under section 6651(a)(1) for 2002
and 2003.
Background
This case was submitted fully stipulated under Rule 122. The stipulated
facts and related exhibits are incorporated herein by this reference. When he filed
his petition, petitioner resided in Michigan.
Petitioner owned and operated a “gentlemen’s club,” Potter’s Pub, Inc.,
during the tax years at issue. Potter’s Pub was a cash-based business that derived
1
All statutory references are to the Internal Revenue Code as in effect for the
tax years at issue. All rule references are to the Tax Court Rules of Practice and
Procedure. All dollar amounts have been rounded to the nearest dollar.
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[*3] receipts from food and drink charges run through the cash register, door cover
charges, juke box moneys, pool table receipts, and moneys paid to the pub by the
dancers for the privilege of “dancing.” Petitioner was the president and sole
owner of Potter’s Pub. For each year at issue he filed, and signed as president, a
Form 1120, U.S. Corporation Income Tax Return, for Potter’s Pub. Those returns
reported losses for 2002 and 2003 and zero taxable income for 2004 and 2005.
Petitioner filed an individual income tax return for each year at issue, but
his returns for 2002 and 2003 were untimely. For 2002 petitioner’s Form 1040,
U.S. Individual Income Tax Return, was signed by him on March 1, 2004, and
received by respondent on April 26, 2004. For 2003 petitioner’s Form 1040 was
signed by him and his return preparer on December 31, 2004, and received by
respondent on February 7, 2005. Petitioner reported on his individual returns no
wages, dividends, or other income from Potter’s Pub for any of the years at issue.
In December 2006 IRS special agents engaged in an undercover investiga-
tion of Potter’s Pub, posing as buyers interested in acquiring the business. Peti-
tioner assured the agents that Potter’s Pub was much more profitable than it ap-
peared. He explained that he deposited in the corporate account only enough of
the business revenues to cover its expenses and that he wired the balance of its
revenues to his personal bank account in Florida. These wire transfers were
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[*4] structured in amounts less than $10,000 to avoid reporting obligations by the
bank to the IRS.2 In reality, petitioner told the agents, Potter’s Pub grossed more
than $1 million annually and he took home between $400,000 and $520,000 each
year. Petitioner showed the agents clandestine sales ledgers for 2003 and 2004
that supported the gross receipts he claimed, acknowledging that it might have
been unwise to maintain documentary evidence of his skimming.
During a subsequent search of Potter’s Pub, IRS agents seized upwards of
$200,000 in cash and obtained the set of clandestine sales ledgers that tracked its
daily receipts. These ledgers confirmed that Potter’s Pub’s annual receipts for
2002-05 were vastly in excess of the amounts that petitioner had reported to the
IRS. The difference between its actual gross receipts and the gross receipts
reported on the company’s Forms 1120 for those years exceeded $2 million.
After the search of Potter’s Pub, when he knew he was under criminal
investigation, petitioner provided his accountant additional bank account infor-
mation for the 2003-05 tax years. His accountant used this information to file
amended Federal income tax returns for those years, both for Potter’s Pub and for
2
Federal law requires financial institutions to report currency transactions in
excess of $10,000 as well as multiple currency transactions that aggregate more
than $10,000 in a single day. These transactions are reported to the IRS on Cur-
rency Transaction Reports. See 31 C.F.R. sec. 103.22 (2000).
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[*5] petitioner individually. (Petitioner did not file amended returns for himself or
for Potter’s Pub for 2002.) The IRS assessed additional income tax and additions
to tax on the basis of the amounts shown on the amended returns for 2003-05.
In January 2009 petitioner was criminally charged with eight counts under
section 7206(1) and (2) for making and subscribing false tax returns, and for
assisting in the preparation of false tax returns, for himself and Potter’s Pub. In
May 2009 petitioner pleaded guilty to one count of making and subscribing a false
Form 1120 on behalf of Potter’s Pub for 2002. Pursuant to his plea, petitioner was
sentenced to 18 months’ prison time and supervised release for one year. He was
also ordered to pay restitution of $400,000.
In the factual basis for his guilty plea, petitioner admitted under penalties of
perjury that he willfully submitted false tax returns for Potter’s Pub for the 2002-
05 tax years; that he did not believe those returns to be true and correct as to every
material matter; and that he had falsely subscribed those returns with the specific
intent to violate the law. During his criminal sentencing petitioner stated: “I
admitted I falsified my returns and so forth, and it [has] caused me a lot of
problems.”
In April 2009 petitioner signed, in his capacity as president and sole owner
of Potter’s Pub, a Form 870, Waiver of Restrictions on Assessment and Collection
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[*6] of Deficiency in Tax and Acceptance of Overassessment. He thereby agreed
that, for tax years 2002-05, Potter’s Pub was liable for tax deficiencies (in addition
to those previously collected) in excess of $340,000 and for fraud penalties under
section 6663 in excess of $250,000.
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, 509 F.3d 736, 743 (6th Cir. 2007), aff’g 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, 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. Commis-
sioner, T.C. Memo. 2012-79, 103 T.C.M. (CCH) 1418, 1420 (quoting Temple v.
Commissioner, T.C. Memo. 2000-337, aff’d, 62 Fed. Appx. 605 (6th Cir. 2003)).
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[*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).
Petitioner has conceded the first element of the fraud penalty, namely, that
he underpaid his individual income tax liability for each tax year at issue.
Petitioner has stipulated the amounts of unreported income determined by
respondent for 2002-05 as well as the tax deficiency for each year. We
accordingly 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, 116 T.C. 79, 86 (2001). The existence of fraud is a ques-
tion of fact to be resolved upon consideration of the entire record. Estate of
Pittard v. Commissioner, 69 T.C. 391, 400 (1977). Fraud is not to be presumed or
based upon mere suspicion. Petzoldt v. Commissioner, 92 T.C. 661, 699-700
3
Although petitioner stipulated the correctness of the amounts respondent
determined as tax deficiencies for 2002-05, he contends that assessment of these
amounts is barred by the three-year period of limitations in sec. 6501(a). Because
we conclude that petitioner’s underpayments were due to fraud, there is no period
of limitations, and the tax for 2002-05 “may be assessed * * * at any time.” Sec.
6501(c)(1). Respondent has advanced alternative theories of liability as to the
applicable period of limitations. Because we hold that all of petitioner’s under-
payments were attributable to fraud, we need not address these alternative
arguments.
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[*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, 182 F.3d 275, 277-78 (4th Cir. 1999), aff’g 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, 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, 394 F.2d 366, 379
(5th Cir. 1968), aff’g T.C. Memo. 1966-81; Stone v. Commissioner, 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
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[*9] States, 317 U.S. 492, 499 (1943); Morse v. Commissioner, T.C. Memo. 2003-
332, 86 T.C.M. (CCH) 673, 675, aff’d, 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
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[*10] of thousands of dollars of corporate income annually into his personal bank
account.
Petitioner has likewise stipulated that, for each year at issue, he substantially
underreported his own income on his Forms 1040. Petitioner reported no income
whatsoever from Potters’s Pub for these years. By omitting the income he
skimmed from Potter’s Pub and reporting no dividends, wages, or other income
from his business, petitioner substantially understated his income for each year at
issue.4 He has not provided a satisfactory explanation of the understatements;
rather, petitioner has acknowledged that he intentionally underreported his
income. 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, T.C. Memo. 1994-497, 68 T.C.M. (CCH) 887, 891.
The records that petitioner maintained, for himself and Potter’s Pub, were both
4
On audit respondent determined no deficiency for 2004 on the basis of peti-
tioner’s amended 2004 return and smaller deficiencies for 2003 and 2005 on the
basis of petitioner’s amended returns for those years. In ascertaining whether
petitioner had fraudulent intent, however, we consider his behavior when he filed
his original returns. See Vanover v. Commissioner, 103 T.C.M. (CCH) at 1423.
Petitioner’s original returns substantially understated his income for all four years.
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[*11] inadequate and fraudulent. Petitioner kept two sets of books, including
clandestine sales ledgers, designed to hide corporate income and conceal the fact
that he was skimming massive amounts of cash into his personal bank account.
This double bookkeeping provides clear circumstantial evidence of fraudulent
intent. See Spies, 317 U.S. at 499; Medlin v. Commissioner, 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. Petitioner concealed
Potter’s Pub’s income by maintaining two sets of books. He concealed his own
income, which he skimmed from Potter’s Pub, by wiring cash to his personal bank
account. The amounts he wired were kept below $10,000 in order to avoid bank
reporting to the IRS. This 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.
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[*12] 4. Providing Incomplete or Misleading Information
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, 781 F.2d 1566 (11th Cir. 1986), aff’g
T.C. Memo. 1985-63.
Petitioner provided his accountant with an initial set of books and records
that was used to prepare false individual and corporate tax returns. For each tax
year at issue, petitioner concealed from his accountant the secret sales ledgers that
recorded Potter’s Pub’s actual gross receipts. Petitioner stipulated that “at the time
* * * [he] subscribed or assisted in the preparation of his personal * * * federal
income tax returns [for the years at issue], he knew that Potter’s Pub, Inc. was not
reporting all of its gross revenues.”
After the search of his establishment, petitioner provided his accountant
with bank records that were used to prepare and file amended tax returns for 2003-
05. 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). Thus, petitioner’s
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[*13] 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 has stipulated that the income reported on his individual income
tax returns for 2002-05 was understated. This is primarily because petitioner did
not report any dividend, wage, or other income from Potter’s Pub on his individual
returns, even though he knew large amounts of such income existed. He thus filed
a false individual income tax return for each year.
Petitioner also filed a false corporate tax return for each year. 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. In his plea agreement he admitted that
he likewise filed false income tax returns on behalf of Potter’s Pub for 2003-05.
Petitioner was the sole owner of Potter’s Pub and thus the sole beneficiary of its
income. As its president, he exercised complete control over it. By filing false
returns for Potter’s Pub, petitioner attempted to conceal the fact that he was
weekly skimming thousands of dollars from his business. Considering the overall
pattern of petitioner’s behavior, his filing of false returns for Potter’s Pub
furnishes additional circumstantial evidence of fraudulent intent with respect to his
individual returns for these years.
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[*14] 6. Extensive Dealings in Cash
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.
As a “gentlemen’s club,” petitioner’s business was a cash-based operation.
Its sales receipts were derived principally from food and drink charges run through
the cash register, door cover charges, juke box moneys, pool table receipts, and
moneys paid to him by the dancers for the privilege of “dancing.” Petitioner
admitted that he weekly wired large amounts of this cash to his personal bank ac-
count in Florida. 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.
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[*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
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[*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
Finally, petitioner contends that restitution payments he has made to the
United States must be credited against any tax deficiencies and penalties sustained
in this case. According to petitioner, respondent received $124,348 from the sale
of his New Orleans residence and approximately $335,000 from the sale of
Potter’s Pub. He contends that he has never received “an accounting of his
restitution payments.”
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.
5
Petitioner errs in relying on Avenell v. Commissioner, T.C. Memo. 2012-
32, 103 T.C.M. (CCH) 1180. In that case the taxpayer deposited payments due his
corporation into his personal bank account. In concluding that the Commissioner
failed to prove fraud by clear and convincing evidence, we relied on the taxpayer’s
cooperation with authorities (including his voluntary disclosure of an offshore
bank account) and his credible testimony that his actions stemmed, not from an
intent to evade tax, but from an intent to shield his company’s assets from
judgment collection. See id., 103 T.C.M. (CCH) at 1181-1182.
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[*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
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[*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.