Levitt v. Commissioner

T.C. Memo. 1995-464

UNITED STATES TAX COURT

LEO N. LEVITT AND RUTH G. LEVITT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 27857-90. Filed September 28, 1995.

Herbert L. Zuckerman, Robert J. Alter, and Richard J.

Sapinski, for petitioners.

Daniel O'Brien and Patrick E. Whalen, for respondent.

TABLE OF CONTENTS
Page

FINDINGS OF FACT

A. Petitioners...............................................4
B. Resyn Corporation.........................................7
C. Polymer Chemicals........................................11
D. Chemical Traders.........................................13
E. Resyn's Bankruptcy ......................................17
F. Respondent's Investigation of Petitioner and Resyn.......18
 - 2 -

G. Third Party Information..................................23
H. Meetings With FBI Agents and Strike Force Attorney.......23
I. Referral of Case to the Justice Department...............24
J. Petitioner's Criminal Case...............................26
K. Resyn's Bankruptcy Trial.................................26
L. Sale of Resyn Corporation................................33
M. Notice of Deficiency.....................................34
N. Petitioners' 1963 Return.................................34

OPINION

A. Whether Respondent Violated Grand Jury Secrecy Rules.....35
B. Whether Petitioner Is Collaterally Estopped From
Denying Factual Findings of the Bankruptcy Court.........37
C. Whether Respondent's Determination Is Arbitrary..........45
D. Whether Petitioners Received Constructive Dividends......47
E. Whether Petitioner Is Liable for Fraud for 1963..........53
F. Whether Petitioner Is Liable for Fraud for 1964 to 1970..54
G. Statute of Limitations...................................64
H. Whether Ruth Levitt Is an Innocent Spouse................64

MEMORANDUM FINDINGS OF FACT AND OPINION

COLVIN, Judge: Respondent determined that both petitioners

are liable for deficiencies in income tax and that petitioner Leo

Levitt is liable for additions to tax for fraud as follows:

Addition to Tax
Year Deficiency Sec. 6653(b)
1963 $180,853.16 $90,732.96
1964 225,591.07 113,118.26
1965 67,160.06 34,407.72
1966 241,895.20 120,947.60
1967 98,213.03 49,106.52
1968 221,132.70 122,893.86
1969 258,763.57 134,598.39
1970 17,945.61 21,129.21

Following concessions, we must decide the following issues:

1. Whether respondent's use of Resyn Corporation's

business records violated grand jury secrecy rules. We hold that

it did not.
 - 3 -

2. Whether petitioner Leo Levitt is collaterally estopped

from contesting factual findings made by the U.S. bankruptcy

court in a trial relating to respondent's tax claims against

Resyn Corp., which he controlled. We hold that he is.

3. Whether respondent's determination was arbitrary. We

hold that it was not.

4. Whether petitioners had unreported dividend income

during the years in issue. We hold that they did.

5. Whether petitioner Leo Levitt is liable for fraud for

1963. We hold that he is not because there is no evidence of the

contents of that return.

6. Whether petitioner Leo Levitt is liable for fraud for

1964 to 1970. We hold that he is.

7. Whether the statute of limitations bars assessment of

tax for petitioners for 1964 to 1970. We hold that it does not.

8. Whether petitioner Ruth Levitt is an innocent spouse

under section 6013(e) for any of the years in issue. We hold

that she is not.

References to petitioner are to Leo Levitt. Section

references are to the Internal Revenue Code in effect during the

years in issue. Rule references are to the Tax Court Rules of

Practice and Procedure. References to rule 6(e) are to rule 6(e)

of the Federal Rules of Criminal Procedure.

Some of the facts have been stipulated and are so found.
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FINDINGS OF FACT

A. Petitioners

1. Generally

Petitioners were married and resided in Verona, New Jersey,

when they filed their petition.

Petitioner was born in 1914. He graduated from Dartmouth

University in 1936 with a degree in chemical engineering and

worked for chemical companies until 1951. As discussed in more

detail below in section B, petitioner owned and controlled the

Resyn Corporation (Resyn) during the years in issue.

Ruth Levitt was born in 1918. She graduated from high

school and secretarial school. Petitioners met in 1938 and

married in 1941. Ruth Levitt never worked outside the home.

Petitioners had four daughters, born in 1943, 1946, 1952, and

1956. Ruth Levitt took care of her ailing mother for a period of

time not specified in the record. She did not visit or know much

about her husband's business.

Petitioners bought land in South Orange, New Jersey, in

1948. Petitioners rented a dwelling until 1952 when they moved

into a home they built on their South Orange land. Ruth Levitt

had sole ownership of that home.

Petitioner did not have a personal checking account. Ruth

Levitt had checking and savings accounts from 1960 to 1970. She

used those accounts for the family finances. During the years
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in issue, Ruth Levitt drove new cars and had a comfortable

standard of living. Petitioners took regular vacations to Las

Vegas and Florida from 1963 to 1970.

2. Welev of Pinellas County, Inc.

In 1959, a Brooklyn lawyer named Erwin Weiss (Weiss), who

had helped organize Resyn, recommended that petitioners buy 41

acres of land in St. Petersburg, Florida. Petitioner, Ruth

Levitt, Fred Berger (Berger), a St. Petersburg realtor who knew

Weiss, and Weiss organized a group called Welev of Pinellas

County (Welev) to hold the 41 acres. Each owned a one-fourth

interest in Welev. In 1959, petitioner was president of Welev.

He signed the mortgage deed. Ruth Levitt knew very little about

Welev.

Weiss incorporated Welev around 1960. Welev issued 30

shares of stock when it was incorporated. The original

subscribers to the stock were petitioner, Berger, Meyer

Tepperman, and Weiss. Each had 7.5 shares.

In 1970, Resyn owed Hooker Chemical Co. (Hooker) about $2

million. Hooker supplied folacin hydride to Resyn. Petitioner

agreed to guarantee Resyn's debt. Petitioner pledged the Welev

property as collateral to Hooker.

In 1986, Welev sold its Florida property. Petitioners filed

separate returns for 1986. Ruth Levitt reported on her return a
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capital gain of $999,338 from the liquidation of Welev stock,

which she reported that she acquired in 1964.

3. Petitioners' Income Tax Returns

Petitioners filed joint income tax returns for 1963 to 1970.

Harry Levenson (Levenson) prepared petitioners' income tax

returns for 1964, 1965, and 1966. He was an accountant. His

office was at 152 Clinton Avenue in Newark, New Jersey. He later

moved to 441 Springfield Avenue in Newark. Levenson previously

served as a revenue agent for the Internal Revenue Service (IRS).

Levenson's wife was Ruth Levitt's cousin.

Howard Goldstein (Goldstein) prepared petitioners' returns

for 1967, 1968, 1969, and 1970. Goldstein was an accountant. He

practiced at the certified public accounting firm of I. George

Goldstein & Co. (Goldstein & Co.). I. George Goldstein was

Goldstein's father. Petitioner gave Levenson and Goldstein

information to prepare his returns, including Forms 1099, Forms

W-2, and brokerage account statements.

Petitioners reported wages from Resyn of $35,000 per year

for 1964 and 1965, $50,000 for 1966, 1967, 1968, and 1969, and

$47,960 for 1970. They reported withholding on those wages of

$10,000 per year in 1964 and 1965, $13,282.97 in 1966, $12,876 in

1967, $14,000 in 1968, $16,000 in 1969, and $11,887.85 in 1970.

Petitioners did not report as income any of the amounts Resyn
 - 7 -

paid for their benefit. See section B-3, below. Petitioners

reported $27,300 in miscellaneous income for 1970.

B. Resyn Corporation

1. Formation of Resyn Corporation

Petitioner and about 11 other people formed a chemical

company called Resyn in 1951. Resyn was incorporated in 1953.

Its principal offices were in Linden, New Jersey. Petitioner

bought the stock of the other Resyn shareholders around 1956 for

the amount of their original investment in the company.

Petitioner controlled Resyn's operations during the years in

issue.

2. Resyn Corporation's Operations

Resyn bought, manufactured, and sold resins and other

chemicals and oils used to manufacture paint. In the late

1950's, Resyn began to produce a chemical resin used by the Ford

Motor Co. in automobile paint. Resyn made Mobil 1 for the Mobil

Oil Co. Resyn was the fourth company in the United States to

manufacture epoxy.

Atlas Paint and Varnish Co. (Atlas) was one of Resyn's

larger customers from 1963 to 1970. Meyer and Harry Tepperman

(the Tepperman brothers) owned Atlas. Atlas manufactured paint.

Atlas bought large amounts of alkyds from Resyn to make paint.
 - 8 -

3. Resyn's Payments for Petitioners' Personal Benefit

Resyn paid for many of petitioners' personal expenses and

personal stock investments.1 He had Resyn pay Ruth Levitt a

weekly allowance of about $350. Ruth Levitt received Resyn

checks paid to cash totaling $25,737 in 1967, $24,930 in 1968,

and $25,761 in 1969. She used those funds to pay household

expenses. Petitioner had Resyn pay the mortgage on their home.

Resyn paid $3,477.42 for 1967, $4,463.67 for 1968, and $4,081.35

for 1969 for the mortgage on petitioners' home.

Petitioner had Resyn pay for many of Ruth Levitt's shopping

expenses. In 1967, 1968, and 1969, Resyn also paid for Ruth

Levitt's purchases at Bloomingdale's, Saks Fifth Avenue, Fellers,

Lord & Taylor, and many other stores.

Resyn paid Evelyn Mejia, a nurse for petitioners' children,

and William Morrison, a handyman and chauffeur at petitioners'

home. Resyn paid landscaping and gardening expenses at

petitioners' home. Resyn paid petitioners' children's expenses

to attend Prospect Hill Country Day School, Newark Academy, and

Kenwood Camp for Girls from 1967 to 1969. From 1967 to 1969,

Resyn paid Berkeley School and MacBrian Educational Consultants,

Inc. Petitioners deducted $500 for 1967 and $100 for 1968 on

their income tax returns for charitable gifts to Camp Deal for

1
Resyn business records are missing except for parts of
1967, 1968, and 1969. There is no evidence that Resyn's
arrangements to pay petitioners' expenses were different from
1963 to 1966, or in 1970.
 - 9 -

boys. Resyn wrote checks to Camp Deal for Boys for $500 in 1967

and $100 in 1968.

Resyn paid Weiss and the Tax Collector, Sarasota, Florida,

for petitioners' purchase of Welev's land and Welev stock from

1963 to 1970.

Petitioner had Resyn pay some of his expenses for dry

cleaning, medications from his pharmacy, and individual income

taxes in 1967, 1968, and 1969. Resyn paid petitioners' personal

expenses of about $261,789 in 1967, $431,592 in 1968, and

$341,725 in 1969, for a total of $1,035,106 during those years.

4. Resyn's Bookkeeping and Tax Returns

Resyn maintained double entry books and records. Ann Hall

(Hall) was Resyn's first bookkeeper. Hall usually prepared the

deposit tickets. As Resyn grew, Resyn hired Vera Philbin

(Philbin) and others to help Hall. Philbin entered payables

in Resyn's purchases journal and made journal entries in the

general ledger. Goldstein & Co. prepared the journals she used.

Petitioner was not involved in Resyn's bookkeeping.

Resyn filed income tax returns for 1963 to 1970. Levenson

was Resyn's accountant and return preparer and an employee of

Resyn from Resyn's inception to 1965 or 1966. Goldstein & Co.

also performed accounting services for Resyn. Until 1965,

Goldstein & Co. compiled information for the Resyn tax return and

gave it to Levenson to prepare the return. Goldstein approved

those returns for Goldstein & Co.
 - 10 -

Resyn gradually reduced Levenson's function to checking

postings in the purchases journal by Resyn's bookkeepers.

Levenson worked about 1 day per week.

Goldstein & Co. prepared Resyn's returns for 1966 to 1969.

Goldstein began to supervise the Resyn account for Goldstein &

Co. in 1965 or 1966. Goldstein spent 5 to 10 days per year at

Resyn closing the books and preparing the corporate tax return.

Resyn's bookkeepers gave Goldstein access to Resyn's books and

records. Goldstein did not verify sales or check inventory

because he believed Resyn's staff handled those items correctly.

At the end of 1967, 1968, and 1969, Goldstein classified the

checks Resyn paid for the personal benefit of petitioners as

loans made by Resyn to petitioner. Goldstein increased

petitioner's loan account by $69,815.09 in 1967, $214,376.58 in

1968, and $189,350.46 in 1969, and decreased it by $200,000 in

1968. The decrease did not occur because petitioner repaid

Resyn. Molly Goldstein, Goldstein's mother, lent $200,000 to

Resyn in 1967. Resyn paid interest on the loan to Goldstein's

mother from 1967 to 1970. Resyn paid $30,000 of interest to

Goldstein's mother after 1968. In 1968, Goldstein transferred

the account payable from Resyn to petitioner and decreased

petitioner's loan account by $200,000. At trial, Goldstein

conceded that he had no authority to do this and that it was not

an appropriate accounting practice to decrease petitioner's loan

account by $200,000 in 1968. Goldstein's mother filed a claim in
 - 11 -

the Resyn bankruptcy for $200,000 after 1970. She later received

37-1/2 cents per dollar of claim. Petitioner had not repaid

Resyn by the time of the bankruptcy trial in 1981.

Resyn did not report paying any dividends from 1963 to 1970.

C. Polymer Chemicals

1. Formation of Polymer Chemicals

Petitioner suggested that he and Levenson form a partnership

called Polymer Chemicals (Polymer). On September 17, 1954,

Levenson registered the trade name Polymer Chemicals with the

State of New Jersey under his name alone. The trade name

certificate stated that Polymer's address was 152 Clinton Avenue,

Newark, New Jersey, which was Levenson's office. Polymer never

did business at that address. Polymer had a checking account at

the National State Bank, Hillside, New Jersey, from 1963 to 1970.

Although Levenson was authorized to sign checks on the Polymer

account, petitioner directed him to sign and endorse blank

Polymer checks. Levenson never saw the proceeds from these

checks.

The monthly bank statements did not include a mailing

address for Polymer. Petitioner went to the bank to get

Polymer's bank statements and canceled checks. Polymer did not

file Federal income tax returns.

2. Polymer Transactions

Unlike other Resyn transactions the Polymer purchase

invoices did not include any bills of lading. Resyn's checks to
 - 12 -

Polymer were for fictitious purchases. Petitioner controlled the

Polymer account. Petitioner diverted the following amounts from

Resyn to the Polymer checking account:

Monthly
Amount Statements
Year of Deposits Available
1963 $108.404.48 5
1964 238,555.24 11
1966 87,750.12 1
1967 40,517.47 12
1969 122,649.81 12
1970 5,370.72 12
Total 603,247.84

In 1963, petitioner deposited in the Polymer account Resyn

checks payable to T.F. McAdam (not otherwise identified in the

record) dated July 2, 1963, for $11,798.81 and July 8, 1963, for

$11,785.89.

There were often long delays in negotiating the Resyn checks

deposited in the Polymer account. Resyn checks totaling

$87,750.12, which petitioner deposited in the Polymer account in

1966, were written in 1963. In 1968, petitioner deposited in the

Polymer account $10,000 of Resyn checks written in 1967. In

1969, petitioner deposited in the Polymer account a Resyn check

for $517.83 written in 1967 and Resyn checks totaling $56,564.76

written in 1968.

Petitioner had Levenson sign and endorse blank checks on the

Polymer account which petitioner later wrote to cash as follows:

Date of Check Amount
Jan. 15, 1968 $10,000
Sep. 25, 1968 22,000
Nov. 29, 1968 8,000
 - 13 -

Mar. 17, 1969 13,000
Apr. 18, 1969 5,500
May 21, 1969 12,000
Jun. 20, 1969 8,000
Jul. 25, 1969 13,000
Sep. 19, 1969 5,000
Sep. 30, 1969 15,000
Oct. 8, 1969 10,000
Oct. 23, 1969 5,000
Oct. 31, 1969 5,000
Nov. 14, 1969 6,000
Nov. 29, 1969 5,000
Dec. 22, 1969 5,000

The checks were negotiated in the year written.

D. Chemical Traders

1. Petitioner's Formation and Use of Chemical Traders

On May 31, 1955, petitioner and his brother, Jesse Levitt,

registered the trade name Chemical Traders with the State of New

Jersey. The trade name certificate stated that Chemical Traders

would do business at 128 Clinton Avenue, Newark, New Jersey.

Petitioner opened a Chemical Traders bank account on November 20,

1959. Chemical Traders had a checking account at the National

State Bank, Hillside, New Jersey, from 1963 to 1970. Petitioner

signed the signature card for the account and personally

conducted Chemical Traders' transactions at the National State

Bank. Chemical Traders monthly bank statements did not have a

mailing address. Petitioner picked up the Chemical Traders'

monthly bank statements and canceled checks. Philbin, Levenson,

and Goldstein did not know about Chemical Traders or the Chemical

Traders bank account at the National State Bank during the years

in issue.
 - 14 -

There was no Chemical Traders office or plant at 128 Clinton

Avenue, Newark, New Jersey, when respondent's agents investigated

this case in 1971 and 1972. Respondent's agents did not find any

reference to Chemical Traders in a directory of chemical

suppliers.

Petitioner required Resyn's buyers to deliver their payments

to Chemical Traders to his home. The checks from one buyer

totaled as follows:

Year Amount of Checks Year Amount of Checks
1963 $24,276.40 1967 $38,254.00
1964 59,042.36 1968 - 0 -
1965 18,015.00 1969 2,766.35
1966 199,037.00 1970 15,600.00

Petitioner either cashed these checks or deposited them in the

Chemical Traders bank account.

Chemical Traders did not file income tax returns for the

years 1963 to 1970.

2. Amounts Petitioner Diverted From Resyn to Chemical
Traders

Petitioner diverted the following amounts from Resyn to the

Chemical Traders' checking account:

Monthly
Statements
Year Amount of Deposits Available
1963 $163,497.44 6
1964 297,115.19 11
1965 248,435.81 12
1966 526,815.33 12
1967 253,767.62 12
1968 66,554.58 12
1969 70,878.23 11
1970 15,600.00 11
Total $1,642,664.20
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3. Rambach Chemical Corp.

Rambach Chemical Corp. (Rambach) did business with Resyn

beginning in 1952. From 1963 to 1967, Rambach paid Chemical

Traders' bills for chemicals Resyn supplied to Rambach as

follows:

Year Amount
1963 $10,275.00
1964 63,043.36
1965 18,015.00
1966 126,870.00
1967 6,480.00
1969 14,425.00
1970 15,900.00

Petitioner told Rambach to mail payments for chemicals to

his home. Harvey Rambach, president of Rambach, sent a letter to

Leo Levitt, Chemical Traders, 128 Clinton Avenue, Newark, New

Jersey, on March 10, 1969. The Post Office returned the letter

undelivered, "Addressee Unknown". Chemical Traders did not have

any production facilities when it dealt with Rambach.

4. MacArthur Petroleum & Solvent Co.

From 1966 to 1969, MacArthur Petroleum & Solvent Co.

(MacArthur) paid Chemical Traders for commissions and discounts

on sales from Resyn to MacArthur. Under the agreement between

Sande Wische, president of MacArthur, and petitioner on behalf of

Resyn, MacArthur billed Resyn full price for chemicals that Resyn

bought, and MacArthur paid Chemical Traders separately for any

commissions and discounts it owed to Resyn. Petitioner deposited

the checks from MacArthur for Resyn's discounts and commissions
 - 16 -

in the Chemical Traders account. MacArthur paid the following

Resyn discounts and commissions to Chemical Traders:

Date Amount
Nov. 15, 1966 $2,272.49
Dec. 20, 1966 2,200.84
Feb. 18, 1967 1,963.97
Apr. 17, 1967 1,853.45
Apr. 17, 1967 1,770.47
Jun. 28, 1967 1,578.98
Sep. 22, 1967 5,298.71
Jan. 26, 1968 5,427.29
Mar. 8, 1968 6,120.16
Jul. 15, 1968 3,399.72
Jul. 15, 1968 2,771.75
Jul. 31, 1968 2,673.42
Sep. 13, 1968 5,006.10
Nov. 8, 1968 3,708.10
Dec. 10, 1968 4,222.20
May 23, 1969 8,373.73
Oct. 24, 1969 8,296.35

5. Spencer-Kellogg and Atlas Paint

Resyn bought linseed oil from Spencer-Kellogg Co. (Spencer-

Kellogg) in 1967 and 1968. Resyn paid Spencer-Kellogg for the

oil. Spencer shipped the oil to Atlas. Chemical Traders billed

and was paid by Atlas for the linseed oil. As a result, Resyn

paid for the linseed oil but did not receive it, and Chemical

Traders sold it to Atlas without paying for it.

6. Petitioner's Use of Funds in the Chemical Traders
Account

Petitioner wrote checks to cash from the Chemical Traders

account totaling: $160,824 in 1965, $160,541 in 1966, $256,000

in 1967, $69,500 in 1968, $53,850 in 1969, and $19,500 in 1970.

He endorsed all but two of those checks (dated June 28, 1965, for

$1,625; and June 1, 1967, for $1,000). The camp attended by
 - 17 -

petitioners' children in 1965 endorsed the 1965 check. A close

friend of petitioner endorsed the 1967 check.

Petitioner used the Chemical Traders checking account to buy

the following cashier's checks that he used to buy stock:

Amount of
Year Checks Payee
1963 $30,000 Leo N. Levitt
1963 28,000 Heller & Meyer

1964 22,500 Leo N. Levitt
1964 61,000 Heller & Meyer

1965 20,625 Heller & Meyer

1966 23,300 Carl M. Loeb Rhodes & Co.
1966 26,690 Bache & Co.
1966 15,000 Edwards & Hanley
1966 88,445 Heller & Meyer

1967 30,000 Leo N. Levitt
1967 16,000 Eastman Dillon
1967 2,000 Edwards & Hanley
1967 78,500 Bache & Co.

1968 2,007 Eastman Dillon

1969 3,950 Pressman, Frohlich & Frost
1969 4,400 Heller & Meyer
Total $452,417

E. Resyn's Bankruptcy

On September 3, 1970, Resyn filed a petition for chapter 11

reorganization with the U.S. bankruptcy court for the District of

New Jersey.

The bankruptcy court appointed a receiver to operate Resyn

during the bankruptcy proceedings. The receiver unsuccessfully

tried to obtain Resyn's books and records for the years in issue.
 - 18 -

In December 1970, petitioner filed a Statement of Affairs

with the bankruptcy court on behalf of Resyn, in which he

answered certain questions. Question 7 was as follows:

Bank accounts and safe deposit boxes

a. What bank accounts have you maintained,
alone or together with any other person and in your
name or any other name, within the two years
immediately preceding the filing of the original
petition herein?

(Give the name and address of each bank, the name
in which the deposit was maintained and the name of
every person authorized to make withdrawals from such
account.)

Petitioner answered question 7, but did not mention the Chemical

Traders or Polymer accounts.

The Commissioner filed a proof of claim on January 5, 1971,

and several amended proofs of claim between January 27, 1971, and

September 19, 1976. The Commissioner filed a final amended claim

of $2,376,726.43 for unpaid corporate income taxes, interest, and

penalties for 1963 to 1970.

F. Respondent's Investigation of Petitioner and Resyn

1. Administrative Investigation

Respondent began a joint criminal and civil administrative

investigation of petitioner and Resyn in December 1970. An

administrative investigation is an investigation that is

conducted solely by respondent's agents. It is not conducted

before a grand jury. A special agent and cooperating revenue

agents were assigned to the investigation.
 - 19 -

A U.S. attorney, respondent's agents, and persons outside

the IRS sometimes help a grand jury to investigate a case.

Respondent did not participate in a grand jury investigation of

Resyn or petitioner.

2. Strike Force

Respondent's administrative investigation of petitioner and

Resyn was part of a program to investigate persons suspected of

being involved with organized crime. The program was later

called a strike force. The strike force included the Federal

Bureau of Investigation (FBI), Secret Service, Bureau of

Narcotics and Dangerous Drugs, Bureau of Alcohol, Tobacco, &

Firearms, Customs Service, Postal Service, and IRS. The IRS and

other agencies made progress reports to strike force attorneys.

Respondent's agents, and not strike force personnel,

controlled the joint civil and criminal tax investigation of

Resyn and petitioner. Strike force attorneys helped agents of

different agencies conduct their investigations if needed.

Respondent's investigators in this case filed periodic status

reports with the strike force coordinator, Arthur Rubenstein

(Rubenstein), who forwarded them to the Regional Organized Crime

Drive Coordinator who monitored strike force cases. The regional

coordinator forwarded the reports to respondent's Intelligence

Division at the national office in Washington, D.C. Those status

reports did not go to the U.S. Attorney's Office or to any strike

force attorney.
 - 20 -

3. Early Stages of the Investigation

Special Agent Erich Fried (Fried) was the first agent

assigned to the investigation. Revenue Agent Richard Cronin

(Cronin) was assigned to the investigation as the cooperating

agent. He worked with Fried. Irving B. Dubow (Dubow) supervised

the investigation. Above Dubow in the chain of command were a

branch chief, an assistant division chief, and the Chief,

Intelligence Division in Washington, D.C. Dubow's agents

believed that Ruth Levitt was related to an organized crime

racketeer.

Fried started the file on this case when he received a

newspaper clipping stating that the Union County prosecutor's

office had obtained an indictment of petitioner for chemical

theft. Fried immediately began trying to get Resyn's books and

records. Fried, Cronin, and Dubow wanted to calculate Resyn's

tax liability so the Commissioner could file a proof of claim in

the Resyn bankruptcy proceeding. Fried and Cronin tried

unsuccessfully to obtain Resyn's records from the bankruptcy

trustee and receiver. At that time, Fried and Dubow did not use

the administrative summons procedure under section 7602 because

they believed it took too long to enforce.

4. Reluctant Witness Procedure

During the years respondent investigated this case,

respondent sometimes used the "reluctant witness" procedure to

obtain evidence. Under this procedure, a special agent could

request IRS and Justice Department approval to subpoena a witness
 - 21 -

to appear before a grand jury. Respondent's reluctant witness

procedure at that time required the agent to show that the

investigation was stymied and to provide a summary of the

witness' anticipated testimony. If the IRS and the Justice

Department approved the request, Justice Department attorneys

could use grand jury subpoenas to obtain evidence and could seek

a rule 6(e)2 order from a Federal District Court permitting them

to give that evidence to the IRS.

Around March 1971, Fried asked his supervisors for grand

jury assistance in this case. He sent (via his supervisor) a

memorandum to the Chief, Intelligence Division, asking for

permission to issue a grand jury subpoena to petitioner to compel

2
Rule 6(e) provides:

(e) Secrecy of Proceedings and Disclosure.
Disclosure of matters occurring before the grand jury
other than its deliberations and the vote of any juror
may be made to the attorneys for the government for use
in the performance of their duties. Otherwise a juror,
attorney, interpreter, stenographer, operator of a
recording device, or any typist who transcribes
recorded testimony may disclose matters occurring
before the grand jury only when so directed by the
court preliminarily to or in connection with a judicial
proceeding or when permitted by the court at the
request of the defendant upon a showing that grounds
may exist for a motion to dismiss the indictment
because of matters occurring before the grand jury. No
obligation of secrecy may be imposed upon any person
except in accordance with this rule. The court may
direct that an indictment shall be kept secret until
the defendant is in custody or has given bail, and in
that event the clerk shall seal the indictment and no
person shall disclose the finding of the indictment
except when necessary for the issuance and execution of
a warrant or summons.
 - 22 -

him to provide Resyn's records. He explained that Resyn's

receiver in bankruptcy had been unable to get Resyn's records.

Fried sent the memorandum because he wanted to review Resyn's

books and records and because the cooperating revenue agent

needed those records to prepare a proof of claim. Fried's

request was approved. Fried served grand jury subpoenas on

petitioner and Goldstein on June 17, 1971, and Philbin on

June 28, 1971. Philbin, Resyn's bookkeeper, gave Resyn's

business records to the grand jury. Respondent obtained those

records from the grand jury.

In July 1971, Special Agent Frank O'Byrne (O'Byrne) replaced

Fried in the investigation of petitioner and Resyn. O'Byrne read

the case file when he was assigned to the case. It contained

certain of Resyn's ledgers, files, and canceled checks for 1967,

1968, and 1969. The file also contained transcripts of the grand

jury testimony of Goldstein, Becker, and Philbin. The file did

not include a copy of a rule 6(e) order.

Revenue Agents Paul A. Dorgeval, Jr. (Dorgeval), and Cronin

continued to investigate petitioner and Resyn for respondent.

Dorgeval and Cronin did not read the grand jury transcripts.

From July to October 1971, respondent's agents examined

Resyn's canceled checks. They discovered a wide gap between the

time that certain Resyn checks were written and the time they

were deposited or negotiated by the payee.
 - 23 -

G. Third Party Information

Respondent's agents suspected that Resyn had made payments

to fictitious entities. Based on that theory, Cronin, Dorgeval,

and O'Byrne issued 48 administrative summonses from November 3,

1971, to September 26, 1972. They issued administrative

summonses to third parties including banks, businesses that

bought and sold Resyn products, and Goldstein, who prepared

petitioners' tax returns. In the summons, they asked for bank

records, canceled checks, invoices, and other business records

pertaining to Resyn, Chemical Traders, Polymer, and petitioners.

Respondent's agents discovered the Chemical Traders account

between July 1971 and December 1972.

Respondent's agents could not reconstruct all of Resyn's

transactions because most of Resyn's business records for the

years in issue were missing. Respondent's agents had only

Resyn's general ledger and journal for 1969, purchase journals

for 1968 and 1969, and canceled checks for 1967, 1968, and 1969.

H. Meetings With FBI Agents and Strike Force Attorney

Rubenstein was an IRS employee who was the IRS liaison with

other strike force law enforcement agencies. He also reviewed

strike force reports from other agencies for possible Internal

Revenue Code violations. Cronin told the FBI that he suspected

that petitioner and Resyn might have violated bankruptcy laws.

Rubenstein arranged for Cronin to meet with two FBI agents from

the Newark Bankruptcy Fraud Squad. The FBI did not investigate
 - 24 -

petitioner or Resyn for bankruptcy fraud, and respondent took no

further action.

Rubenstein arranged a meeting with representatives of the

Justice Department to decide whether to grant immunity to

Goldstein. Herbert Posner (Posner), a strike force attorney from

the Justice Department, attended the meeting. Goldstein did not

receive immunity. O'Byrne discussed this case with Posner

several other times and had several other incidental contacts

with Posner.

I. Referral of Case to the Justice Department

O'Byrne completed his investigation in December 1972. In

his special agent's report, filed December 29, 1972, he discussed

Fried's participation in the case. He stated that grand jury

subpoenas had been served. O'Byrne attached copies of the grand

jury transcripts to his report. O'Byrne never saw a copy of a

rule 6(e) order in this case and did not include one in his

report. Dubow's group told the strike force attorney the results

of the investigation after it was completed.

W.J. McElroy, a member of the Intelligence Division, Newark

District, signed the following cover letter sending O'Byrne's

report to the Regional Counsel's office in Philadelphia around

December 29, 1972: "The Strike Force Attorney Newark, New Jersey

was advised of this investigation, the evidence obtained, and the

method of proving the unreported income, and has concurred in the

recommendation to prosecute".
 - 25 -

James MacDonald (MacDonald) was a staff attorney who

reviewed criminal tax matters for respondent's Regional Counsel

in Newark. His work was limited to criminal enforcement.

MacDonald did not have authority to stop a recommendation to

prosecute a strike force case. MacDonald reviewed O'Byrne's

report and the file for respondent's Regional Counsel. MacDonald

had a conference with Herbert Zuckerman (Zuckerman), petitioner's

counsel. In March or April 1973, MacDonald contacted O'Byrne and

asked him for additional information including a copy of the rule

6(e) order. O'Byrne did not obtain a copy of the rule 6(e)

order; he believed that his supervisor, Dubow, gave the rule 6(e)

order to MacDonald.

MacDonald sent a criminal referral letter to Scott P.

Crampton, Assistant Attorney General, Tax Division, Department of

Justice, dated May 17, 1973. The letter stated:

The specific items of unreported income in this case
were discovered by review of Resyn Corporation's
cancelled checks gotten by the government as a result
of a grand jury subpoena (Special Agent's Report, Pages
12 and 13). The examining agents (acting pursuant to
the authority granted by the Court in a valid [Rule §
6(e)] order * * *) found checks payable to Polymer
Chemicals. Subsequent inquiries with the bank where
the Polymer Chemical account was held disclosed the
existence of the Chemical Trader account (Special
Agent's Report, Page 12). No evidence of the two bank
accounts was disclosed by Levitt, or by any of his
employees, pursuant to testimony in bankruptcy
proceedings.

MacDonald's criminal referral letter stated that a copy of the

rule 6(e) order was attached as exhibit C. However, there is no

copy of the rule 6(e) order in respondent's file.
 - 26 -

Posner obtained a blanket rule 6(e) order which he believed

allowed him to give any information, books, or records to any

Federal law enforcement officer. He did not get a rule 6(e)

order for each investigation. Instead, he got one that covered

all investigations of a grand jury which was usually good for

about a year and a half.

On April 4, 1974, O'Byrne testified before the grand jury

that indicted petitioner under section 7201 for willful tax

evasion for 1967 to 1969.

J. Petitioner's Criminal Case

In 1974, petitioner pleaded nolo contendere to tax evasion

for 1970 and received a suspended sentence.

K. Resyn's Bankruptcy Trial

In January 1978, Resyn asked the bankruptcy court to

expunge, reduce, or modify the Commissioner's corporate tax claim

for 1963 to 1967 and fraud penalties for 1963 to 1969. The

bankruptcy court held a 6-day trial in February and March 1981,

during which the parties vigorously contested Resyn's tax

liability. Zuckerman, one of petitioners' attorneys in the

instant case, was Resyn's attorney at the trial. Zuckerman saw

no conflict in representing petitioner and Resyn in the

bankruptcy case. Petitioner attended the Resyn bankruptcy trial

but did not testify.

The bankruptcy court issued its opinion on November 18,

1981. That court decided that petitioner diverted Resyn income
 - 27 -

into bank accounts of fictitious entities, resulting in

substantial tax deficiencies for Resyn and that the deficiencies

were due to fraud. In re Resyn Corp. 81-2 USTC par. 9808 (Bankr.

D.N.J. 1981). The bankruptcy court found the following facts:

Resyn understated its corporate income by
diverting to Chemical Traders receipts of sales of
goods owned by Resyn but never entered on the Resyn
books and records as Resyn sales.

As noted earlier, "Chemical Traders" was a trade
name controlled by Leo Levitt, but the record before
the Court discloses no evidence that any business
entity using that name was ever located at 128 Clinton
Avenue, Newark, New Jersey, the listed business address
of same. There is no evidence that Chemical Traders
had any employees, any business records, or books of
account, conducted any business, filed any state or
federal tax returns or paid any federal or state income
taxes. The only evidence of its existence was the bank
account maintained in that name at the National State
Bank of Elizabeth, New Jersey. It is noted that
neither the Resyn bookkeeper, its accountant, and its
comptroller had ever heard of Chemical Traders until
the commencement of the Chapter XI proceedings in 1970.

However, despite the fact that it conducted no
business operation, large sums of money were deposited
into the Chemical Traders' bank account. The amount of
the deposits during the years in question is as
follows:

Year Amount Deposited Year Amounted Deposited
1963 $163,497.44 1967 $253,767.62
1964 297,115.00 1968 66,555.58
1965 248,437.13 1969 70,878.23
1966 526,815.53 1970 15,600.00

Many of the deposits in the Chemical Traders' bank
account resulted from transactions involving Rambach
Chemical Company or Rambach International Company.
During the years 1963 through 1970, the Rambach
companies purchased substantial amounts of chemicals
which belonged to Resyn but were shipped to Rambach on
invoices labeled Chemical Traders.
 - 28 -

Deliveries of the chemicals sold to the Rambach
companies originated at the Resyn plant. An invoice
from the American Warehousing Corp., 96 Pine Street,
Jersey City, New Jersey to Rambach charges Rambach as
follows: "Chg 2nd attempt to pick up bags at Resyn
Corp. $50.00." A handwritten note on this invoice
reads: "Deduct from last Chemical Traders' bill we get
in about 2 or 3 weeks." Thereafter Rambach took a
deduction of $50.00 from the Chemical Traders' invoice
dated December 8, 1966.

An invoice of the American Warehouse Corp. dated
March 4, 1969 for the delivery of 2,200 bags of maleic
anhydride to Rambach reads:

"Ex: Resyn Corp.
2/24 Delayed at Resyn 1/2 day $50.00
2/28 Delayed 2 trailers at Resyn, full day
$100.00"

With regard to this charge, Rambach wrote to Levitt at
Chemical Traders, 128 Clinton Avenue, Newark, New
Jersey. The latter was [returned] to Rambach stamped
"Addressee Unknown."

All of the payments made by Rambach for chemicals
purchased were mailed to Leo Levitt's home at 58
Whiteoak Drive, South Orange, New Jersey. This was
done at the direction of Leo Levitt who caused to be
attached to the Chemical Traders' invoices directions
that payments were to be mailed to him at the South
Orange, New Jersey address.

The checks issued by Rambach to Chemical Traders
and mailed to Levitt totalled as follows:

Year Amount of Check Year Amount of Check
1963 $14,276.40 1967 $38,244.00
1964 59,042.36 1968 0
1965 18,015.00 1969 2,766.35
1966 199,037.00 1970 15,600.00

The checks received by Leo Levitt for the
chemicals sold to Rambach were either cashed or
deposited in the Chemical Traders' bank account. Many
of the Rambach checks to Chemical Traders bear the
notation "for deposit only, Chemical Traders."

The chemicals sold to Rambach were the property
of Resyn and the receipts from the sale of same were
 - 29 -

diverted from Resyn to the Chemical Traders' bank
account which was under the sole control of Leo Levitt.
The said receipts were not entered as income on the
books of Resyn and not reported on Resyn's income tax
return.

The Chemical Traders' bank account was also used
in certain transactions involving the Witco Chemical
Company. During the course of the operation of its
business, Resyn would purchase chemicals from the Witco
Chemical Company and would be allowed discounts on bulk
purchases made. The discounts received were then
deposited not in the Resyn bank accounts but in the
Chemical Traders' bank account. The total amount of
deposits into the Chemical Traders' bank account which
resulted from bulk purchase discounts were as follows:

Deposits Resulting from
Year Bulk Purchase Discounts
1963 $ 3,600.00
1965 92,588.80
1966 37,240.00
Total $133,428.80

This diversion of the bulk purchase discounts resulted
in the overstatement of the cost of goods sold and the
understatement of income and income tax due on the
Resyn tax returns for 1963, 1965 and 1966.

Another graphic example of the diversion of income
from Resyn to Chemical Traders is found in the
transactions involving Spencer-Kellogg. Resyn would
purchase oil from Spencer-Kellogg and upon resale of
same, the bill or invoice was sent to Chemical Traders
and not Resyn.

On June 19, 1967 Spencer-Kellogg shipped 31,000
pounds of raw linseed oil to the Atlas Paint Company.
The Spencer-Kellogg invoice indicates that this
shipment was sold to Resyn. However, it is a Chemical
Traders' invoice dated, June 19, 1967, that bills Atlas
for 31,020 pounds of linseed oil.

Similarly, a Spencer-Kellogg invoice charges Resyn
for 4,000 pounds of 2-2 linseed oil which was sold to
Resyn but shipped to the Atlas Paint Company on
September 1, 1967. Resyn paid for this shipment by
Check No. 6135 but Atlas Paint Company was billed not
by Resyn, but, by Chemical Traders on a Chemical
Traders' invoice dated, inter alia, September 1, 1967.
 - 30 -

Thereafter on October 4, 1967, Spencer-Kellogg
shipped 31,010 pounds of raw linseed oil to Atlas Paint
Company and billed Resyn $4,080.92 for this shipment.
Again, a Chemical Traders' invoice dated, inter alia,
October 4, 1967 bills Atlas Paint Company for 31,010
pounds of raw linseed oil.

In addition to understating income through the use
of the Chemical Traders' trade name, Resyn overstated
the cost of goods sold by the use of the Polymer
Chemicals' trade name.

As noted above, Polymer Chemicals maintained a
bank account at the National State Bank of Elizabeth,
New Jersey where the authorized signatory on the
account was Harry Levinson.

The record fails to disclose that Polymer
Chemicals maintained offices, engaged in any business
venture, had any employees, was incorporated as a
company in New Jersey, paid any New Jersey state
corporate taxes or any federal corporate taxes or filed
any such tax returns.

Irving Becker, employed by Resyn since 1967 as
an expediter of deliveries to Resyn customers and as
credit manager, was familiar with all of Resyn's
suppliers. He testified that he was not familiar with
Polymer Chemicals and knew nothing of the Polymer
Chemicals' account. A world-wide survey of companies
which deal in the chemicals purportedly sold by Polymer
Chemicals to Resyn showed that none of them had any
knowledge of a company called Polymer Chemicals. There
is not a scintilla of evidence in the record indicating
that Polymer Chemicals could or did deliver the large
quantities of chemicals to Resyn for which it received
payment from Resyn. In fact, the bookkeeper for Resyn
testified that when she prepared a bill for payment,
she would ordinarily receive an invoice and shipping
documents but that when she received a Polymer
Chemicals' invoice for payment, it was never
accompanied by shipping documents.

From 1963 through 1970, numerous checks totaling
$603,458.84, were drawn on the Resyn bank account
payable to the order of Polymer Chemicals. The Resyn
checks were signed by Leo Levitt and were deposited in
the Polymer Chemicals' bank account. The breakdown of
the checks deposited is as follows:
 - 31 -

Year Checks Deposited

1963 $108,404.48
1964 238,555.24
1966 87,750.12
1968 40,818.47
1969 122,559.81
1970 5,370.72
Total $603,458.84

Between 1963 through 1970 Resyn paid various
Polymer Chemicals' invoices for fictitious purchases
of chemicals and listed said payments on the books of
Resyn as costs of goods sold. As a result, Resyn's
cost of goods sold was overstated in the following
manner:

Year Amount of Overstatement

1963 196,154.00
1964 238,555.00
1967 10,517.83
1968 87,082.23
1969 69,518.99
1970 3,420.51
Total $605,248.56

Many of the Resyn checks made payable to Polymer
Chemicals were not deposited but were withheld for
deposit for a year other than the one in which they
were written. However, the adjustment to the cost of
goods sold is effective for the tax year in which the
checks to Polymer Chemicals were written and not the
tax year in which they were negotiated.

During the same time period, 1963 through 1970,
Leo Levitt withdrew a total of $1,006,019.91 from the
Polymer Chemicals' bank account at the Hillside office
of the National State Bank. He was able to accomplish
this by having Harry Levinson sign the checks in blank.
 - 32 -

The breakdown of the funds withdrawn is as
follows:

Year Funds Withdrawn

1963 $107,000.00
1964 236,400.00
1965 3,250.00
1966 462,941.00
1968 41,428.91
1969 125,000.00

It is clear that the cost for goods allegedly
purchased from Polymer Chemicals was knowingly
overstated by Resyn on its books and it resulted in a
fraudulent understatement of corporate income tax due
on the Resyn corporate income tax returns for the years
1963, 1964, 1967, 1968 and 1969.

As to the above recited transactions involving
Chemical Traders, the Rambach companies, Witco Chemical
Company and Atlas Paint Company, it is clear that the
diversion to Chemical Traders of monies due Resyn
resulted in a fraudulent overstatement of cost of goods
sold regarding the Witco transactions and a fraudulent
understatement of income in the Rambach transactions.

The Court finds that as a result of the alleged
dealings involving Polymer Chemicals and Chemical
Traders, the Resyn corporate income tax due on its
return for the years 1963, 1964, 1965, 1966 and 1967
was underpaid and at least part of the underpayment for
each year was due to fraud.

* * * * * * *

In considering all of the evidence before it, the
Court is satisfied that both Chemical Traders and
Polymer Chemicals are fictional entities used by Resyn
for the fraudulent purpose of evading taxes and with
the express purpose of diverting large sums of money to
Leo Levitt, the sole shareholder of Resyn. Levitt
controlled the withdrawals from the bank accounts of
both Chemical Traders and Polymer Chemicals. While
Harry Levinson signed many checks on the Polymer
Chemicals' bank account, he signed them in blank, at
Levitt's request and never knew what was done with the
proceeds of the checks.
 - 33 -

An analysis of the Chemical Traders' bank account
and checks drawn on it shows that in 1966 it issued
checks in the total amount of $462,921.00, of which
$115,000.00 was written to cash. Traced to Levitt's
personal accounts with various stock brokerage firms
was the sum of $84,941.00. Additionally, a check drawn
to an unknown payee was deposited to Levitt's account
at the Merchant's Bank of New York and another check
also payable to an unknown payee was deposited to
Levitt's account at Edwards & Hanley, a stock brokerage
firm.
In 1967 Chemical Traders issued checks totalling
$320,000.00. Of this sum, a total of $106,500.00 was
deposited into various personal accounts held by Levitt
with various stock brokerage firms while the
disposition of an additional $128,500.00 is unknown.
Given the total control Levitt had over this account
and his total control of the Resyn operation, his
failure to testify as to unidentified deposits and
withdrawals on the account is significant. * * *

In re Resyn Corp., 81-2 USTC par. 9808, at 88,686-88,691 (Bankr.
D.N.J. 1981).

The bankruptcy court entered a judgment against Resyn on

December 9, 1981. The District Court for the District of New

Jersey entered opinions on November 22, 1982, August 19, 1986,

and December 31, 1986, on appeal from the bankruptcy court's

judgment. The Court of Appeals for the Third Circuit issued two

opinions, Resyn Corp. v United States, 851 F.2d 660 (3d Cir.

1988), and In re Resyn Corp., 945 F.2d 1279 (3d Cir. 1991). The

District Court entered its order on remand on July 9, 1992.

There has been no appeal from that order.

L. Sale of Resyn Corporation

Petitioner sold Resyn to Celanese Corp. in August 1977. In

1981, Resyn had no assets, but was liable for obligations to

Celanese Corp. and to respondent.
 - 34 -

M. Notice of Deficiency

Dorgeval investigated petitioners and Resyn from 1970 to at

least 1984. He prepared a series of reports of proposed

adjustments for Resyn and petitioners. He completed the last

report on March 14, 1984. That report was the basis for the

notice of deficiency in this case. Respondent mailed the notice

of deficiency on September 12, 1990. Petitioners and Zuckerman

signed consents to extend the time to assess tax for 1969 and

1970, which kept those years open until terminated.

Respondent determined that petitioners received constructive

dividends from Resyn from 1963 to 1970 by analyzing Resyn's

earned surplus for that period. Respondent determined that Resyn

paid checks for petitioners' benefit of $261,789 in 1967,

$431,593 in 1968, and $341,725 in 1969. Respondent deducted from

those amounts the increases to petitioner's loan account, salary

paid to petitioner, capital items, and additional business

expenses. Respondent determined that petitioners had unreported

income of $25,022 in 1967 and $41,245.21 in 1968 based on Resyn

checks used to pay petitioners' personal expenses. N.

Petitioners' 1963 Return

Petitioners timely filed their 1963 income tax return.

Respondent did not offer a copy of petitioners' 1963 return into

evidence. Respondent's revenue agent's report for 1963 states

that petitioners reported taxable income of $30,499.50 and that

petitioner's total tax was $9,656.63. Respondent had a copy of
 - 35 -

an unsigned 1963 return for petitioners that also showed those

amounts as petitioners' reported taxable income and total tax.

The record does not show who prepared that purported return.

There is no evidence that the unsigned return is the same as the

return petitioners filed for 1963.

OPINION

A. Whether Respondent Violated Grand Jury Secrecy Rules

Before trial, petitioners moved to suppress evidence that

respondent used in this case which petitioners contend includes

matters and fruits of matters occurring before a Federal grand

jury in violation of rule 6(e). The Court denied petitioners'

pretrial motion to suppress. We reaffirm that ruling here.

1. Resyn Business Records Are Not Grand Jury Material in
This Case

Generally, matters occurring before a Federal grand jury may

not be disclosed. Fed. R. Crim. P. 6(e); In re Grand Jury Matter

(Catania), 682 F.2d 61, 63 (3d Cir. 1982). Petitioners contend

that Resyn's business records are matters occurring before a

grand jury for purposes of rule 6(e). We disagree.

Resyn created its business records independently of a grand

jury proceeding. Petitioners point out that business records

created independently of a grand jury proceeding may be grand

jury matters if disclosure of them will reveal the grand jury's

deliberative process. See, e.g., In re Grand Jury Subpoena

(Under Seal), 920 F.2d 235, 241 (4th Cir. 1990); In re Grand Jury

Proceedings Relative to Perl, 838 F.2d 304, 306 (8th Cir. 1988);
 - 36 -

Senate of Puerto Rico v. U.S. Dept. of Justice, 823 F.2d 574, 582

(D.C. Cir. 1987); Anaya v. United States, 815 F.2d 1373, 1379

(10th Cir. 1987); In re Special March 1981 Grand Jury (Almond

Pharmacy), 753 F.2d 575, 578 (7th Cir. 1985); In re Grand Jury

Matter (Garden Court), 697 F.2d 511, 512-513 (3d Cir. 1982); In

re Grand Jury Matter (Catania), supra at 63; In re Grand Jury

Matter (N.J. State Comm. of Investigation), 630 F.2d 996, 1000

(3d Cir. 1980).

Petitioners contend that disclosure of Resyn's records

would reveal grand jury deliberations. We disagree. Respondent

requested the books and records of Resyn. Respondent did not

request all of the grand jury matter related to Resyn and

petitioners. A general request for all grand jury records would,

in effect, be a disclosure of the grand jury proceedings. See

United States v. Stanford, 589 F.2d 285, 291 n.6 (7th Cir. 1978);

In re Grand Jury Criminal Indictments 76-149 and 77-72, 469 F.

Supp. 666, 671 (M.D. Pa. 1978).3 We conclude that disclosure of

Resyn's business records would not reveal secret grand jury

deliberations.

3
Respondent contends that use of Resyn's business records
and other third party records that respondent obtained from the
grand jury is no longer restricted by rule 6(e) because the
bankruptcy court admitted those records into evidence at Resyn's
bankruptcy trial. We need not decide respondent's contention in
light of our conclusion that Resyn's business records are not
grand jury material subject to the secrecy provisions of rule
6(e).
 - 37 -

2. Grand Jury Transcripts

Petitioners allege that respondent relied on grand jury

transcripts to determine petitioner's civil tax liability in

this case. Petitioner points out that O'Byrne mentioned the

transcripts in his criminal referral letter. However, O'Byrne

testified and we believe that he did not rely on grand jury

testimony to develop petitioners' civil tax liability. Revenue

Agents Cronin and Dorgeval did not read the grand jury

transcripts; they used Resyn's business records and third party

records, all of which existed independently of the grand jury.

Thus, we are convinced that respondent did not use grand jury

transcripts to develop the civil tax case.

B. Whether Petitioner Is Collaterally Estopped From Denying
Factual Findings of the Bankruptcy Court

1. Background

Petitioners contend that collateral estoppel does not

prevent petitioner from contesting factual findings made by the

bankruptcy court in In re Resyn Corp., 81-2 USTC par. 9808

(Bankr. D.N.J. 1981) We disagree.

If collateral estoppel applies, issues which were litigated

and decided in an earlier case on a different cause of action

cannot be relitigated by the parties or their privies. Montana

v. United States, 440 U.S. 147, 153 (1979); Parklane Hosiery Co.

v. Shore, 439 U.S. 322, 326 n.5 (1979); Commissioner v. Sunnen,

333 U.S. 591, 597 (1948). Collateral estoppel protects
 - 38 -

adversaries from the expense and vexation of multiple lawsuits,

conserves judicial resources, and fosters reliance on judicial

action by minimizing the possibility of inconsistent decisions.

Montana v. United States, supra at 153-154; Meier v.

Commissioner, 91 T.C. 273, 282-284 (1988). Collateral estoppel

can apply in Federal tax cases. Commissioner v. Sunnen, supra at

598.

Collateral estoppel applies in the following circumstances:

First, the matter at issue in the second suit is identical with

the one decided in the first suit. Id. at 599-600. Second,

there is a final judgment rendered by a court of competent

jurisdiction. Peck v. Commissioner, 90 T.C. 162, 166 (1988),

affd. 904 F.2d 525 (9th Cir. 1990); Gammill v. Commissioner, 62

T.C. 607, 613 (1974). Third, the parties to the second suit are

the same as the parties to the first suit or in privity with

them. Peck v. Commissioner, supra at 166-167; Gammill v.

Commissioner, supra at 614-615. Fourth, the parties have

actually litigated the matters at issue, and the resolution of

those matters was essential to the prior decision. Commissioner

v. Sunnen, supra at 598, 601. Fifth, the controlling facts and

legal principles remain unchanged. Id. at 599-600. Sixth, there

are no special circumstances that would warrant making exception

to the normal rules of preclusion. Montana v. United States,

supra at 162; Meier v. Commissioner, supra at 291-292.
 - 39 -

2. Elements of Collateral Estoppel

a. Identity of Matters at Issue

The first element for collateral estoppel is met because

there are identical matters at issue in the bankruptcy trial and

in the instant case, such as whether, and if so, how, petitioner

diverted Resyn income to Polymer and Chemical Traders from 1963

to 1970. The Government had to prove fraud by clear and

convincing evidence in the bankruptcy case. To prove fraud,

the Government proved that Leo Levitt created two sham entities,

Chemical Traders and Polymer, to conceal Resyn's income. In re

Resyn Corp., 81-2 USTC par. 9808 at 88,685-88,686. The accounts,

transactions, and entities in the bankruptcy case are the same as

those in the instant case. The instant case also involves the

issue whether petitioners benefited from Resyn's unreported

income. However, the fact that the instant case has additional

matters at issue does not bar collateral estoppel from applying

to matters at issue which are the same in both cases. Bertoli v.

Commissioner, 103 T.C. 501, 508 (1994).

Petitioner points out that the bankruptcy court did not

decide whether petitioner committed civil tax fraud. The fact

that the bankruptcy court did not decide whether petitioner was

personally liable for additions to tax under section 6653(b) does

not help petitioner. The bankruptcy court found that petitioner

used Polymer and Chemical Traders to divert Resyn funds to

himself. The bankruptcy court found that petitioner withdrew
 - 40 -

from the Polymer account $107,000 in 1963, $236,400 in 1964,

$3,250 in 1965, $462,941 in 1966, $41,428 in 1968, and $125,000

in 1969. The bankruptcy court found that Chemical Traders checks

totaling $115,000 were written to cash in 1966. The bankruptcy

court traced $84,941 to petitioner's stock brokerage accounts.

The bankruptcy court found Chemical Traders checks totaling

$106,500 written to petitioner's personal accounts in 1967. The

bankruptcy court was required to and did decide whether fraud was

present. It found clear and convincing evidence that petitioner

diverted Resyn funds to himself through the Polymer and Chemical

Traders accounts. Collateral estoppel precludes petitioner from

relitigating that matter. Thus, petitioner may not relitigate

the fact that he controlled the Polymer and Chemical Traders bank

accounts and that Polymer and Chemical Traders were fictional

entities which he created to divert funds to himself from Resyn.

Petitioner may contest the extent to which he diverted funds from

Resyn to himself, beyond that found by the bankruptcy court.

b. Final Prior Judgment

The second element for collateral estoppel is met because

the bankruptcy court's decision is final. c. Identity

of or Privity With Parties

The third element for collateral estoppel is met because

petitioner is in privity with Resyn.

A sole or controlling stockholder can be in privity with his

or her closely held corporation. Marin v. Augedahl, 247 U.S.
 - 41 -

142, 145-146 (1918); Bigelow v. Old Dominion Copper Mining &

Smelting Co., 225 U.S. 111, 141 (1912); Hawkins v. Glenn, 131

U.S. 319, 329 (1889); Sparks Nugget, Inc. v. Commissioner, T.C.

Memo. 1970-74 (sole shareholder in privity with corporation),

affd. 458 F.2d 631 (9th Cir. 1972); see also Seaboard Commercial

Corp. v. Commissioner, 28 T.C. 1034, 1047-1048 (1957) (successor

corporate sole shareholder in privity with prior corporation);

Estate of Egan v. Commissioner, 28 T.C. 998, 999 (1957), affd.

260 F.2d 779 (8th Cir. 1958) (transferee stockholder in privity

with transferor corporation); American Range Lines, Inc. v.

Commissioner, 17 T.C. 764, 771 (1951) (Court reviewed), affd. on

this issue, modified in part and remanded 200 F.2d 844 (2d Cir.

1952) (shareholder bound by corporation, but corporation not

bound by shareholder). Petitioner was president and sole

shareholder of Resyn. He controlled Resyn. He personally used

some of Resyn's unreported income. Petitioner attended the

bankruptcy trial and had the same lawyer as Resyn. The fact that

the same attorney represents the parties in both actions is a

factor that may be considered in deciding whether the parties are

in privity. See Crane v. Commissioner of Dept. of Agric., 602 F.

Supp. 280, 286 (D. Me. 1985). Petitioner does not dispute that

he had an interest in opposing a finding that he caused Resyn to

commit tax fraud by creating fictitious entities and diverting

and not reporting Resyn income.
 - 42 -

Petitioners contend that under the precedents of the Court

of Appeals for the Third Circuit a shareholder and a corporation

are not in privity. Hornstein v. Kramer Bros. Freight Lines, 133

F.2d 143 (3d Cir. 1943). In Hornstein, the Court of Appeals for

the Third Circuit held that under Pennsylvania law shareholders

and their corporations were not in privity in a tort case for

collateral estoppel purposes. Id. at 146. That interpretation

does not apply here because Pennsylvania law does not apply.

Petitioners do not cite cases under New Jersey law which hold

that a sole shareholder and his or her corporation are not in

privity for collateral estoppel purposes.4

Petitioners contend that petitioner and Resyn were not in

privity because the bankruptcy court had appointed a receiver to

be responsible for Resyn's operations at that time. We disagree.

When a nonparty to an action has control over the conduct of the

litigation, it may be in privity with the party it controls and

bound by the results of the litigation. American Safety Flight

Systems, Inc. v. Garrett Corp., 528 F.2d 288, 289 (9th Cir.

1975). There is no evidence that the receiver controlled,

attended, or was involved in the bankruptcy litigation. We

4
In their answering brief, petitioners cite a New Jersey
case involving whether the court would pierce the corporate veil
and disregard the corporate form where there was no fraud or
injustice. Lyon v. Barrett, 89 N.J. 294, 300, 445 A.2d 1153,
1156 (1982). That case does not hold or suggest that a sole
shareholder is not in privity with his corporation for purposes
of collateral estoppel.
 - 43 -

believe petitioner controlled the bankruptcy litigation.

Petitioner's attorney represented Resyn at and petitioner

attended the bankruptcy trial. We conclude that Resyn and

petitioner are in privity for collateral estoppel purposes.

d. Actual and Necessary Litigation of the Matter in
Issue

The fourth element for collateral estoppel is met because,

during the 6-day bankruptcy trial, Resyn and the Commissioner

actually and necessarily litigated the facts relating to

petitioner's diversion of Resyn income. The test for deciding

whether resolution of the litigated matters was essential to the

prior decision is whether the issue was recognized by the parties

in the prior proceeding as important and by the trier of fact as

necessary to the judgment. Meier v. Commissioner, 91 T.C. at 284

n.14. The parties to the bankruptcy case and the bankruptcy

court recognized that facts relating to petitioner's diversion of

Resyn's income were important and it was necessary for the

bankruptcy court to decide whether petitioner diverted Resyn's

income to Polymer and Chemical Traders and whether Resyn was

liable for fraud.

e. Legal Principles Unchanged

The fifth element for collateral estoppel is present because

the controlling facts and legal principles have not changed. Id.

at 291.
 - 44 -

f. No Special Circumstances

The final element of collateral estoppel is present because

petitioners do not contend nor do we find that there are special

circumstances present that would warrant not applying the normal

rules of preclusion. Montana v. United States, supra; Meier v.

Commissioner, supra at 291-292.

3. Lack of Mutuality

Petitioners point out that there is no mutuality here

because respondent would not be collaterally estopped from

proceeding against petitioner even if respondent had lost the

bankruptcy case. Petitioners contend that collateral estoppel

should not apply because there is no mutuality. Gammill v.

Commissioner, 62 T.C. at 614-615; Divine v. Commissioner, 59 T.C.

152, 156 (1972), affd. on this issue, revd. and remanded in part

500 F.2d 1041 (2d Cir. 1974). Under the doctrine of mutuality,

neither party may use a prior judgment to estop the other unless

the judgment binds both parties. Meier v. Commissioner, supra at

283.

Other than arguing that mutuality would not apply because

the taxpayer here is not the same as that in In re Resyn Corp, 81

USTC par. 9808 (Bankr. D.N.J. 1981) (which we discussed in

section B-2-c, above), petitioners made no convincing argument

that mutuality would not apply here. Further, mutuality is no

longer a requirement for applying collateral estoppel. Parklane

Hosiery v. Shore, 439 U.S. 322 (1979); Meier v. Commissioner,
 - 45 -

supra at 283; 1B Moore, Moore's Federal Practice, par. 0.441 [3.-

2] at 527-535 (2d ed. 1985). Thus, petitioner's reliance on

Gammill and Divine is misplaced.

4. Conclusion--Collateral Estoppel Applies

We conclude that petitioner is collaterally estopped from

contesting the factual findings of the bankruptcy court in In re

Resyn Corp., 81-2 USTC par. 9808 (Bankr. D.N.J. 1981).

Collateral estoppel establishes all of the facts found by the

bankruptcy court for purposes of the instant case. However, our

findings of fact are also fully supported by the record in this

case. The findings of fact by the bankruptcy court provide an

alternative basis for many of those facts.

C. Whether Respondent's Determination Is Arbitrary

Respondent's determination is generally presumed to be

correct. Welch v. Helvering, 290 U.S. 111, 115 (1933).

Petitioners contend that respondent's determination is arbitrary

and should not be presumed to be correct because respondent had

no rational basis for determining that petitioner received

constructive income from Chemical Traders and Polymer which he

diverted from Resyn. We disagree.

A notice of deficiency that lacks a rational basis is

arbitrary and not presumed to be correct. Llorente v.

Commissioner, 649 F.2d 152, 156 (2d Cir. 1981), affg. in part and

revg. and remanding in part on this issue 74 T.C. 260 (1980). To

show that the Commissioner acted rationally, the record must link
 - 46 -

the taxpayer to some tax-generating activity. Id.; Schad v.

Commissioner, 87 T.C. 609, 620 (1986), affd. without published

opinion 827 F.2d 774 (11th Cir. 1987). The record here clearly

links petitioners to the unreported income. Polymer and Chemical

Traders had no business purpose. Petitioner controlled the

Polymer and Chemical Traders accounts. We conclude that

petitioner controlled Polymer because he caused Resyn to pay

Polymer for fictitious sales, he had Levenson sign blank Polymer

checks, and he withdrew substantial amounts of cash from the

Polymer account. We conclude that petitioner controlled Chemical

Traders because he concealed it and its bank account from his

accountants and bookkeepers, he withdrew substantial amounts of

cash from the account, and he used funds from the account to buy

stock. Resyn paid petitioner's personal expenses directly.

Petitioner paid at least $428,382 for personal stock investments

with funds from Chemical Traders. Petitioner withdrew cash from

the Polymer and Chemical Traders accounts. Records do not exist

showing how petitioner used all of the funds that he diverted

from Resyn to the Polymer and Chemical Traders accounts.

Petitioners contend that respondent's determination should

not be presumed to be correct because respondent did not consider

the possibility that petitioner replaced money he had previously

taken from his brokerage accounts and because respondent did not

analyze petitioners' net worth. We know of no requirement and

petitioners cite none that respondent must conduct a net worth
 - 47 -

analysis when there is other evidence that connects petitioner to

the diverted and unreported funds. Petitioners have not

convinced us that respondent's determination was arbitrary. We

therefore presume that respondent's determination is correct.

D. Whether Petitioners Received Constructive Dividends

1. Respondent's Determination

Respondent determined that petitioners received but did not

report constructive dividends from 1963 to 1970 which resulted in

the following deficiencies: $180,853.16 for 1963, $225,591.07

for 1964, $67,160.06 for 1965, $241,895.20 for 1966, $98,213.03

for 1967, $221,132.70 for 1968, $258,763.57 for 1969, and

$17,945.61 for 1970. Respondent based the determination on funds

that petitioner diverted to petitioners' benefit through the

Polymer and Chemical Traders bank accounts and on petitioners'

personal expenses that Resyn paid. Petitioners did not report

these items on their income tax returns. Respondent's

determination is presumed to be correct. Welch v. Helvering,

supra at 115; Rule 142(a).

2. Diversion of Funds to Polymer Account

Petitioners contend that petitioner's diversion of funds to

the Polymer bank account was not a constructive dividend to them

because petitioner used those diverted funds to pay business

expenses. Petitioner testified that the alkyd resin business was

very competitive during the years in issue and that the Tepperman

brothers told him that they would give him business from Atlas if
 - 48 -

petitioner paid them in cash. During that time, resin cost about

10.5 cents per pound. Petitioner said Atlas paid about 13 cents

per pound and petitioner paid Atlas 3 cents in cash. Petitioner

said he got cash by forming Polymer and depositing in its bank

account the difference between the cost of resin and the amount

that Atlas paid. Petitioner then bought and cashed cashier's

checks. Resyn wrote checks totaling $87,750.12 in 1963, which

were deposited in the Polymer checking account in 1966. A total

of $56,564.76 deposited in the Polymer checking account in 1969

was from checks written in 1968. These delays are inconsistent

with petitioner's theory that he had to make cash payments to

Atlas. It is implausible that the Tepperman brothers would wait

from 1963 to 1966 to be paid.

The Tepperman brothers died before trial was held in this

case. The opinion of the bankruptcy court does not indicate, and

petitioners do not contend, that Resyn raised the business

expense theory at the bankruptcy trial. Petitioner's claim that

he paid all the money in the Polymer account to the Tepperman

brothers is not persuasive.

3. Diversion of Funds to Chemical Traders

Petitioner controlled the Chemical Traders account. He did

not tell his accountants and bookkeepers about it. He withdrew

funds from the Chemical Traders account during each of the years

from 1964 to 1969 to buy stock and did not report those amounts.

He withdrew cash in 1970 and other years.
 - 49 -

4. Short Term Loans

Petitioners contend that amounts Resyn paid for petitioners'

personal expenses which respondent contends were constructive

dividends were loans to petitioner from Resyn. Courts apply

special scrutiny to the characterization by corporations that

advances made by them to their sole stockholders are loans.

Turner v. Commissioner, 812 F.2d 650, 654 (11th Cir. 1987), affg.

T.C. Memo. 1985-159. Self-serving statements of intent, absent

objective economic indicia of debt, are of little value to sole

stockholders in unreported income cases. Id. at 654. Written

evidence of debt, such as consistent bookkeeping and consistent

financial reporting, may be little more than additional

declarations of intent. Id. The form of the transaction and the

labels used by the parties have less significance when the

corporation is closely held because the parties can mold the

transaction at their will. Fin Hay Realty Co. v. United States,

398 F.2d 694, 697 (3d Cir. 1968); Calumet Indus., Inc. v.

Commissioner, 95 T.C. 257, 286 (1990).

In deciding whether a bona fide loan exists, we consider:

(a) Whether there is a note or other evidence of indebtedness and

whether the lender charges interest, Clark v. Commissioner, 18

T.C. 780, 783 (1952), affd. 205 F.2d 353 (2d Cir. 1953); (b)

whether there is a fixed repayment schedule, id. at 783;

Frierdich v. Commissioner, T.C. Memo. 1989-393, affd. 925 F.2d

180 (7th Cir. 1991); (c) whether the lender requests any security
 - 50 -

or collateral, Zimmerman v. United States, 318 F.2d 611, 613 (9th

Cir. 1963); (d) whether there is a written loan agreement, Road

Materials, Inc. v. Commissioner, 407 F.2d 1121, 1123 (4th Cir.

1969), affg. T.C. Memo. 1967-187; (e) whether the parties'

records, if any, treat the transaction as a loan, id. at 1124-

1125; and (f) whether the borrower has made any repayments,

Estate of Ames v. Commissioner, a Memorandum Opinion of this

Court dated Feb. 7, 1946. The first four of these factors favor

respondent because there is no evidence that petitioner or Resyn

had a note, loan agreement, or any other written instrument of

indebtedness, or agreed to any rate of interest or a repayment

schedule, or provided security. Finally, there is no evidence

that Resyn sought payments from petitioner.

Petitioners argue that petitioner repaid the loans by

forgoing salary and by making repayments. Petitioners contend

that these repayments are recorded in Resyn's books. However,

Resyn's books showing repayments are not in evidence. There is

no evidence that petitioner forfeited any salary to make loan

repayments in excess of amounts taken into account by respondent.

Petitioners argue that the amounts that Resyn paid for their

personal benefit are loans because Resyn's records treat them as

a loan receivable. We disagree. This factor alone is not

sufficient to show that those payments are loans. Road

Materials, Inc. v. Commissioner, supra at 1124; Calumet Indus.,

Inc. v. Commissioner, supra at 288; Baird v. Commissioner, 25
 - 51 -

T.C. 387, 394 (1955). Resyn's records are not sufficient to show

Resyn's and petitioner's intent; rather, we believe the recording

of petitioners' personal expenses as loans from Resyn was part of

petitioner's scheme to avoid reporting income.

Petitioners argue that the facts here are like those in

Boshwit Bros., Inc. v. Commissioner, T.C. Memo. 1982-156. We

disagree. In that case, we found that the corporation made loans

to its shareholder because we believed the shareholder's

testimony that he intended to repay the loans and because the

account showed regular credits and a decreasing balance. Id.

Here, petitioner did not show that he intended to repay the loan

or that Resyn gave him regular credits for loan repayments.

Thus, petitioners' reliance on Boshwit Bros. is not persuasive.

5. Traceable Amounts

Petitioners point out that respondent could not trace all of

the funds that petitioner diverted to the Polymer account. This

fact does not help petitioner because the determination is valid

and, as discussed below at section F-2, respondent traced

significant amounts to petitioners for each year by clear and

convincing evidence.

Petitioners contend that petitioners should be charged with

constructive dividends only for amounts that respondent can prove

were spent for petitioners' personal benefit. We disagree.

Respondent determined that all deposits in the Polymer and

Chemical Traders accounts during the years in issue are income to
 - 52 -

petitioners because Polymer and Chemical Traders had no business

purpose, petitioner controlled the Polymer and Chemical Traders

bank accounts, and petitioner could and did use those accounts

for his benefit. As discussed above, respondent's determination

is presumed to be correct, and petitioners have not proven

otherwise.

6. Constructive Dividends for 1970

Respondent determined that petitioners did not report the

following income in 1970: $5,371 from Polymer, $15,600 from

Chemical Traders, $4,910 from Factory Expense, and $41,095 from

Van Syckle Chemical Plant. In 1970, petitioners reported $27,300

of income without identifying the source. Petitioners contend

that we should reduce any constructive dividend for 1970 by

$27,300 because they reported that amount, which represents their

estimate of the value of Chemical Traders and Polymer Chemicals

transactions on their 1970 return. We disagree. Petitioners did

not show how the $27,300 they reported related to any of the

amounts respondent determined to be unreported income. They rely

on Goldstein's testimony that it was to cover income adjustments

from respondent's audit for 1970. Goldstein's testimony does not

prove respondent's determination to be incorrect because it does

not show how the reported income of $27,300 relates to any of

respondent's adjustments for 1970.
 - 53 -

7. Conclusion

We conclude that payments to or on behalf of petitioners by

Resyn, Chemical Traders, and Polymer were constructive dividends

to petitioners in the years paid in the amounts determined by

respondent.

E. Whether Petitioner Is Liable For Fraud For 1963

Respondent determined that petitioner is liable for the

addition to tax for fraud under section 6653(b) for 1963 to 1970.

We discuss 1963 in this section because of certain facts

applicable only to that year. We will discuss whther petitioner

is liable for fraud for 1964 to 1970 in section F, below.

Petitioners contend that respondent did not prove that

petitioner committed fraud for 1963 because respondent did not

offer into evidence an original or copy of petitioners' 1963

return. We agree. A taxpayer is not liable for the addition to

tax for fraud for a year if the return for that year is not in

evidence and there is no evidence about the contents of the

return. Drieborg v. Commissioner, 225 F.2d 216, 219-220 (6th

Cir. 1955), affg. in part and revg. in part a Memorandum Opinion

of this Court dated Feb. 24, 1954. Secondary evidence is

admissible to prove the contents of a destroyed or lost income

tax return. Granquist v. Harvey, 258 F.2d 599, 601 (9th Cir.

1958); Estate of Clarke v. Commissioner, 54 T.C. 1149, 1163

(1970); Rubinstein v. Commissioner, 29 T.C. 861 (1958), affd. per

curiam 264 F.2d 478 (3d Cir. 1959).
 - 54 -

Respondent has shown that the amount of petitioners' income

for 1963 stated in the revenue agent's record is the same as

amounts stated on petitioners' unsigned return. However, there

is no evidence that these amounts are the same as those reported

on petitioners' 1963 return. We conclude that there is

insufficient evidence of petitioners' 1963 return to prove fraud.

Rubinstein v. Commissioner, 264 F.2d at 479.

F. Whether Petitioner Is Liable For Fraud for 1964 to 1970

1. Background

A taxpayer who commits fraud is liable for an addition to

tax equal to 50 percent of the underpayment. Sec. 6653(b).

Respondent has the burden of proving fraud by clear and

convincing evidence. Sec. 7454(a); Rule 142(b). First,

respondent must prove the existence of an underpayment. Parks v.

Commissioner, 94 T.C. 654, 660 (1990). Respondent may not rely

on petitioners' failure to carry the burden of proving the

underlying deficiency. Id. at 660-661; Petzoldt v. Commissioner,

92 T.C. 661, 700 (1989). Second, respondent must show that

petitioner intended to evade taxes he believed to be owing by

conduct intended to conceal, mislead, or otherwise prevent tax

collection. Stoltzfus v. United States, 398 F.2d 1002, 1004 (3d

Cir. 1968); Parks v. Commissioner, supra at 661; Rowlee v.

Commissioner, 80 T.C. 1111, 1123 (1983).
 - 55 -

2. Underpayment

Petitioners contend that respondent did not establish by

clear and convincing evidence that petitioner underpaid tax. We

disagree.

A controlling shareholder who causes a corporation, for no

business purpose of its own, to transfer earnings to another

entity which the shareholder controls may be taxed as receiving

income in the amount of the funds transferred. Commissioner v.

Makransky, 321 F.2d 598, 602 (3d Cir. 1963), affg. 36 T.C. 446

(1961); Biltmore Homes, Inc. v. Commissioner, 288 F.2d 336 (4th

Cir. 1961), affg. T.C. Memo. 1960-53; Helvering v. Gordon, 87

F.2d 663 (8th Cir. 1937); Lonsdale v. Commissioner, 32 F.2d 537

(8th Cir. 1929), affg. 11 B.T.A. 659 (1928). The control which

the taxpayer has over the amounts transferred may cause those

amounts to be taxable income to the taxpayer. McSpadden v.

Commissioner, 50 T.C. 478, 490 (1968) (false mortgage scheme).

Funds that petitioner diverted from Resyn to the Polymer and

Chemical Traders accounts were taxable income to him. James v.

United States, 366 U.S. 213, 219 (1961) (embezzled funds over

which the taxpayer had complete dominion and control were taxable

income).

The Polymer and Chemical Traders accounts were nominee or

conduit bank accounts for petitioner during the years in issue.

Polymer and Chemical Traders had no business purpose. Petitioner

completely controlled them. Petitioner diverted Resyn funds to
 - 56 -

the Polymer and Chemical Traders bank accounts. He caused the

following amounts to be deposited into the Polymer bank account:

$238,555.24 in 1964, $87,750.12 in 1966, $40,818.47 in 1968,

$122,559.81 in 1969, and $5,370.72 in 1970. He caused at least

the following amounts to be deposited into the Chemical Traders

bank account: $297,115.19 in 1964, $248,435.81 in 1965,

$526,815.33 in 1966, $253,767.62 in 1967, $66,554.58 in 1968,

$70,878.23 in 1969, and $15,600 in 1970. Thus, petitioner

diverted funds from Resyn to the accounts he controlled in each

year from 1964 to 1970. Petitioner wrote Chemical Traders checks

to cash of at least $140,199 in 1965, $76,000 in 1966, $167,000

in 1967, $89,500 in 1968, $45,500 in 1969, and $19,500 in 1970.

Petitioner wrote checks to cash on the Polymer account that

Levenson had signed. Those checks totaled at least $40,000 in

1968 and $108,000 in 1969. Petitioner did not report any of

these amounts on his income tax returns.

Petitioner contends that respondent did not prove an

underpayment by clear and convincing evidence because respondent

could not show what petitioner did with all of the diverted

funds. We disagree. As discussed above, we conclude that those

funds became taxable to petitioner when he diverted those funds

to the Polymer and Chemical Traders accounts. Further, even if

respondent were required to show that petitioners used diverted

funds for each year from 1964 to 1970, we conclude that

respondent has done so by clear and convincing evidence.
 - 57 -

Chemical Traders paid for petitioner's stock investments in at

least the following amounts: $83,500 in 1964, $20,635 in 1965,

$153,035 in 1966, $128,007 in 1967, $2,007 in 1968, and $8,350

in 1969. Petitioner did not report his receipt from Polymer of

checks made out to cash. Resyn paid personal benefits for

petitioners of at least $261,789 in 1967, $431,592 in 1968, and

$341,725 in 1969 (total for those 3 years is $1,035,106).

Petitioners did not report those amounts.

We conclude that respondent has proven by clear and

convincing evidence that petitioner diverted funds from Resyn to

himself using the Polymer and Chemical Traders accounts from 1964

to 1970 and did not report them. P.R. Farms, Inc. v.

Commissioner, 820 F.2d 1084 (9th Cir. 1987), affg. T.C. Memo.

1984-549; Worcester v. Commissioner, 370 F.2d 713, 715 (1st Cir.

1966), affg. in part and vacating and remanding in part T.C.

Memo. 1965-199; Biltmore Homes, Inc. v. Commissioner, supra at

340-341.

3. Fraudulent Intent

Respondent must prove by clear and convincing evidence

that petitioner had fraudulent intent. Parks v. Commissioner,

supra at 664. For purposes of section 6653(b), fraud means

actual, intentional wrongdoing, Mitchell v. Commissioner, 118

F.2d 308, 310 (5th Cir. 1941), revg. 40 B.T.A. 424 (1939), or the

intentional commission of an act for the specific purpose of

evading a tax believed to be owing, Webb v. Commissioner, 394
 - 58 -

F.2d 366, 377 (5th Cir. 1968), affg. T.C. Memo. 1966-81. Fraud

may be proven by circumstantial evidence because direct evidence

of the taxpayer's intent is rarely available. Stephenson v.

Commissioner, 79 T.C. 995, 1005-1006 (1982), affd. 748 F.2d 331

(6th Cir. 1984).

The courts have developed a number of objective indicators

or "badges" of fraud. Recklitis v. Commissioner, 91 T.C. 874,

910 (1988). Several badges of fraud are present in this case:

(a) Substantially understating income for several years; (b)

diverting corporate funds; (c) having inadequate books and

records; (d) dealing in large amounts of cash; (e) using

fictitious names; (f) concealing accounts from Resyn's and

petitioners' accountants; and (g) giving false, misleading, and

inconsistent testimony at trial. Bradford v. Commissioner, 796

F.2d 303, 307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601;

Ruark v. Commissioner, 449 F.2d 311, 312-313 (9th Cir. 1971),

affg. T.C. Memo. 1969-48; Meier v. Commissioner, 91 T.C. at 298.

a. Substantially Understating Income Tax Liability

A pattern of substantially underreporting income tax

liability over several years may be evidence of fraud. Holland

v. United States, 348 U.S. 121, 137-139 (1954); Estate of Mazzoni

v. Commissioner, 451 F.2d 197, 202 (3d Cir. 1971), affg. T.C.

Memo. 1970-37; Rogers v. Commissioner, 111 F.2d 987, 989 (6th

Cir. 1940), affg. 38 B.T.A. 16 (1938). Petitioner substantially

understated income tax liability by $225,591 for 1964, $67,160
 - 59 -

for 1965, $241,895 for 1966, $98,213 for 1967, $221,132 for 1968,

$258,763 for 1969, and $17,945 for 1970.

b. Corporate Diversions for Personal Use

A taxpayer's diversion of corporate funds to the taxpayer's

own use is evidence of fraud. Solomon v. Commissioner, 732 F.2d

1459, 1460-1461 (6th Cir. 1984), affg. T.C. Memo. 1982-603;

United States v. Brill, 270 F.2d 525, 527 (3d Cir. 1959). As

discussed above, petitioner diverted a substantial amount of

funds from Resyn using Polymer and Chemical Traders as nominee

accounts. He diverted to Chemical Traders $297,115.19 in 1964,

$248,435.81 in 1965, $526,815.33 in 1966, $253,767.62 in 1967,

$66,554.58 in 1968, $70,878.23 in 1969, and $15,600 in 1970. He

diverted to Polymer $238,556 in 1964, $87,750.02 in 1966,

$40,517.47 in 1968, $122,649.81 in 1969, and $5,370.72 in 1970.

After petitioner diverted funds to Polymer and Chemical Traders,

he withdrew cash from the Polymer and Chemical Traders accounts,

and used the Chemical Traders account to pay for his stock

investments. In addition to the amounts petitioner diverted to

himself through Polymer and Chemical Traders, Resyn paid

substantial amounts for petitioners' personal expenses which

petitioners did not report.

c. False or Inadequate Records

False entries in books and records and false purchase

invoices are compelling evidence of fraud. Marienfeld v. United

States, 214 F.2d 632, 634-635 (8th Cir. 1954); United States v.
 - 60 -

Lange, 161 F.2d 699, 703 (7th Cir. 1947). Petitioner caused

Polymer to issue false purchase invoices to Resyn.

A taxpayer's failure to maintain accurate records may be a

badge of fraud. Merritt v. Commissioner, 301 F.2d 484, 487 (5th

Cir. 1962), affg. T.C. Memo. 1959-172; Reaves v. Commissioner,

295 F.2d 336, 338 (5th Cir. 1961), affg. 31 T.C. 690 (1958);

Grosshandler v. Commissioner, 75 T.C. 1, 20 (1980). Petitioner

did not have records showing what he did with most of the money

in the Polymer and Chemical Traders accounts.

d. Dealing in Large Amounts of Cash

A taxpayer's use of cash and cashier's checks to conceal

income is evidence of fraud. Bradford v. Commissioner, supra at

308; United States v. Chapman, 168 F.2d 997, 1000 (7th Cir.

1948). We may infer that a taxpayer's excessive use of checks

drawn to cash was to conceal unreported income. See Gariepy v.

United States, 189 F.2d 459, 463 (6th Cir. 1951). Petitioner

used large cash transactions. He used cashier's checks to buy

stock. All of his Polymer withdrawals were in cash. He wrote

Chemical Traders checks to cash totaling $160,824 in 1965,

$160,541 in 1966, $317,000 in 1967, $89,500 in 1968, $43,850 in

1969, and $19,500 in 1970. There do not appear to be any valid

business reasons for these large cash transactions.

e. Using Fictitious Names

Use of a bank account in the name of a nominee can be

evidence of fraud. United States v. Ratner, 464 F.2d 101, 105
 - 61 -

(9th Cir. 1972); Elwert v. United States, 231 F.2d 928, 935 (9th

Cir. 1956). Petitioner used Chemical Traders and Polymer to

divert funds from Resyn for his personal use.

Petitioners contend that Chemical Traders and Polymer were

legitimate businesses. We disagree. Petitioner is collaterally

estopped from so claiming. Even if petitioner were not

collaterally estopped, respondent has clearly shown that

petitioner used Chemical Traders and Polymer to divert and

conceal income from 1964 to 1970.

f. Concealing Income From Return Preparers

Concealing income from a taxpayer's tax preparer can be

evidence of fraud. Korecky v. Commissioner, 781 F.2d 1566,

1569 (11th Cir. 1986), affg. T.C. Memo. 1985-63; Farber v.

Commissioner, 43 T.C. 407, 420, modified 44 T.C. 408 (1965).

Petitioner did not give Levenson or Goldstein records showing

that Chemical Traders existed, that Resyn's payments to Polymer

were for fictitious transactions, that he diverted income from

Resyn to Polymer and Chemical Traders, or how he used funds in

the Polymer and Chemical Traders accounts.

g. False and Misleading Testimony

False, misleading, and inconsistent testimony is a badge of

fraud. Bradford v. Commissioner, supra at 307. Petitioner

falsely testified (i) that Chemicals Traders and Polymer were

legitimate businesses; (ii) that Chemical Traders did business at

128 Clinton Avenue in Newark, New Jersey, and that he was in
 - 62 -

charge of the offices there; (iii) that Chemical Traders and

Polymer were legitimate businesses that bought and sold products

under their own names; (iv) that secrecy was not the reason he

wrote checks to cash, and cashier's checks to withdraw funds from

the Polymer and Chemical Traders accounts; (v) that Levenson

suggested the Polymer scheme; and (vi) that he never stopped at

Levenson's house to have Levenson sign blank checks. Petitioner

testified that petitioner Ruth Levitt was an original subscriber

of Welev stock. However, the corporate minutes show that she was

not. Finally, petitioner testified that he had nothing to do

with preparing Ruth Levitt's income tax return for 1986.

However, Ruth Levitt testified that he always handled their tax

returns and that she never participated in preparing income tax

returns.

4. Petitioners' Contentions

Petitioners contend that petitioner's concealment in 1986 of

the Welev transaction is not relevant to proving that petitioner

committed fraud for the tax years in issue because it occurred

after the years in issue. We do not consider petitioner's acts

of concealment in 1986 in deciding the fraud issue. However, we

consider the fact that petitioner used Resyn to pay for Welev

during the years in issue but did not report the amounts that

Resyn paid.

Petitioners contend that the fact that Philbin never saw

petitioner involved in Resyn's bookkeeping or instructing anyone
 - 63 -

to divert funds from Resyn shows that petitioner did not divert

funds. We disagree. Petitioner concealed the Chemical Traders

account from Philbin. Petitioner knew that Resyn paid Polymer

for fictitious transactions. Petitioner withdrew a substantial

amount of funds from the Polymer and Chemical Traders bank

accounts in cash and cashier's checks. Philbin's testimony does

not lead us to change our conclusion based on the overwhelming

evidence that petitioner arranged the diversion of funds.

Petitioners contend that Levenson "was the architect of the

scheme". The record clearly shows otherwise. Levenson did not

know about Chemical Traders. Petitioner directed Levenson to

sign and endorse all of the Polymer checks in blank. Levenson

did not benefit from Polymer. Petitioner controlled Resyn,

Polymer, and Chemical Traders. Levenson did not.

Petitioners contend that respondent did not prove fraud

because respondent did not call Hall, who directed the postings,

to testify. We disagree. Even without Hall's testimony,

respondent has clearly shown that petitioner devised, operated,

and benefited from his scheme to divert income from Resyn through

Polymer and Chemical Traders to himself and his family.

5. Conclusion

We conclude that part of petitioner's underpayment of tax

for each year from 1964 to 1970 is due to fraud.
 - 64 -

G. Statute of Limitations

Petitioners contend that the time to assess tax for

petitioners for 1963 to 1969 has expired.5 We disagree as to

1964 to 1969 and agree as to 1963.

The Commissioner is generally required to assess tax within

3 years of the date the return is filed or due, whichever is

later. Sec. 6501(a). There is no limit on the time to assess

tax if the Commissioner proves fraud. Sec. 6501(c)(1). We have

found that petitioner is liable for fraud for each of the years

1964 to 1970. Thus, respondent may assess tax for those years.

Sec. 6501(c)(1). However, the time to assess tax for 1963 has

expired because respondent has not proven fraud for that year.

H. Whether Ruth Levitt Is an Innocent Spouse

1. Background

Petitioners contend that Ruth Levitt is an innocent spouse

under section 6013(e).

Spouses who file joint tax returns are jointly and severally

liable for tax. Sec. 6013(d)(3). Petitioners argue that Ruth

Levitt is not liable for the deficiencies and the addition to tax

for substantial understatement of income tax because she is an

innocent spouse under section 6013(e). To qualify as an innocent

spouse for any of the years in issue, petitioners must prove

that: (a) Ruth Levitt filed a joint return for the year; (b)

5
Petitioners concede that respondent may assess tax for
1970 under sec. 6501(c)(4).
 - 65 -

there is a substantial understatement of income tax attributable

to grossly erroneous items of the other spouse on the return; (c)

she did not know or have reason to know of the substantial

understatement when she signed the return; and (d) it would be

inequitable to hold her liable for the deficiency attributable to

the substantial understatement. Sec. 6013(e)(1). Failure to

meet any of these requirements precludes a taxpayer from

qualifying as an innocent spouse. Sec. 6013(e)(1); Purcell v.

Commissioner, 826 F.2d 470, 473 (6th Cir. 1987), affg. 86 T.C.

228 (1986). Courts should construe the innocent spouse exception

in view of the congressional purpose of protecting innocent

taxpayers from injustice. Sanders v. United States, 509

F.2d 162, 166-167 (5th Cir. 1975).

Respondent concedes that Ruth Levitt meets the requirements

to qualify as an innocent spouse under section 6013(e) except

that she knew or had no reason to know of the understatements

when she signed the returns and that it is inequitable to hold

her liable. We need not decide whether Ruth Levitt knew or had

reason to know of the understatements because we conclude that it

is not inequitable to hold her liable.

2. Whether It Is Inequitable to Hold Ruth Levitt Liable

A taxpayer who claims innocent spouse relief must prove

that, taking into account all the facts and circumstances, it

is inequitable to hold her or him liable for the deficiency.

Sec. 6013(e)(1)(D). Normal support is not a significant
 - 66 -

benefit for purposes of deciding whether denial of innocent

spouse relief is inequitable under section 6013(e)(1)(D).

Flynn v. Commissioner, 93 T.C. 355, 367 (1989).

Petitioners contend that Ruth Levitt did not significantly

benefit from the unreported income. We disagree. The statute

by its terms no longer bars relief if the purported innocent

spouse received a significant benefit, but it continues to be

a factor. Estate of Krock v. Commissioner, 93 T.C. 672, 678

(1989). The benefit may be direct or indirect. Id. at 678.

Ruth Levitt enjoyed the benefits of the understatements during

the years in issue. She drove new cars, had a nursemaid, sent

her children to camp, and lived materially well. She had the

services of a chauffeur and handyman. Some of her children

attended private schools. She shopped extensively. Resyn

paid about $1,035,106 for those personal expenses of petitioners

from 1967 to 1969. She benefited from petitioners' tax

deductions for charitable contributions that Resyn paid in

1967 and 1968. Resyn also paid for petitioners to buy Welev

stock that Ruth Levitt sold in 1986, reporting a capital gain

of $999,338. There is no indication that Ruth Levitt's

benefit from unreported income was any different from 1964 to

1966. We believe that petitioners' unreported income allowed

her to have the standard of living that she did during the
 - 67 -

years in issue. She remained married to petitioner during the

years in issue. We believe that Ruth Levitt fully shared in

the benefits and the tax savings from the omitted income and

that the understatements enabled her to maintain a standard of

living that she would not have enjoyed otherwise. See

Scarafile v. Commissioner, T.C. Memo. 1991-512. Ruth Levitt

benefited significantly from the omitted income.

Petitioners rely on Kistner v. Commissioner, 18 F.3d 1521

(11th Cir. 1994) revg. and remanding T.C. Memo 1991-463, and

Flynn v. Commissioner, supra, for the proposition that a

spouse does not significantly benefit for purposes of section

6013(e)(1)(D) if the level of support received during the

years in issue was no different than before those years.

However, even with no change in the standard of living, the

spouse may fail to meet the requirement of section

6013(e)(1)(D). In Flynn, we found that the spouse did not

benefit from the understatements. Flynn v. Commissioner,

supra at 367-368.

Petitioners have not shown that it would be inequitable to

hold Ruth Levitt liable for the deficiency. Consequently, we

hold that she is not entitled to relief as an innocent spouse

under section 6013(e).
 - 68 -

To reflect the foregoing,

Decision will be

entered under Rule 155.