T.C. Memo. 1996-137
UNITED STATES TAX COURT
ESTATE OF LEON SPEAR, DECEASED, JEANETTE SPEAR,
HARVEY SPEAR AND ROBERT SPEAR, ADMINISTRATORS,
AND JEANETTE SPEAR, Petitioners v. COMMISSIONER
*
OF INTERNAL REVENUE, Respondent
Docket Nos. 3276-87.1 Filed March 19, 1996.
Barry A. Furman, Patrick W. Kittredge, and Michael S. Paul,
for petitioners.
Michael P. Corrado, Ruth M. Spadaro, and James C. Fee, Jr.,
for respondent.
*
This opinion supplements Estate of Spear v. Commissioner,
T.C. Memo. 1993-213, vacated and remanded 41 F.3d 103 (3d Cir.
1994).
1
Cases of the following petitioners were consolidated:
Estate of Abe Spear, Deceased, Morris Spear, Executor, docket No.
21480-90; Estate of Leon Spear, Deceased, Jeanette Spear,
Administrator, Robert Spear, Administrator, and Harvey Spear,
Administrator, docket No. 21481-90.
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SUPPLEMENTAL MEMORANDUM OPINION
COLVIN, Judge: This matter is before the Court on remand
from the U.S. Court of Appeals for the Third Circuit in Spear v.
Commissioner, 41 F.3d 103 (3d Cir. 1994), vacating and remanding
T.C. Memo. 1993-213.
The issues for decision on remand are:
1. Whether petitioners had any cash on hand on December
31, 1974. We hold that petitioners had $200,000 cash on hand on
December 31, 1974, instead of zero as determined by respondent.
2. Whether petitioners are liable for the addition to tax
for fraud. We hold that they are not.
3. Whether, if petitioners are not liable for the addition
to tax for fraud, respondent is barred from assessing tax for the
years in issue. We hold that respondent is barred from assessing
tax for 1975, but not for 1976 and 1977.
References to petitioner are to Jeanette Spear. 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.
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Discussion
A. Estate of Spear v. Commissioner, T.C. Memo. 1993-213
Jeanette and Leon Spear filed joint Federal income tax
returns for 1975, 1976, and 1977. Respondent determined that
petitioners are liable for deficiencies in income tax and
additions to tax for fraud as follows:
Additions to Tax
Year Deficiency Sec. 6653(b)
1975 $51,271.70 $25,635.85
1976 157,706.46 78,853.23
1977 93,536.23 46,768.12
Using the net worth plus expenditures method, respondent
determined that petitioners had unreported income in 1975, 1976,
and 1977.
Petitioner did not comply with an order of this Court to
testify at trial. As a result, we sanctioned petitioners by
deeming that respondent made a prima facie showing of certain
facts alleged by respondent in paragraph 7 of the amended answer
(the deemed facts). Estate of Spear v. Commissioner, T.C. Memo.
1993-213. We upheld most of respondent's deficiency
determinations and held that petitioners were liable for the
additions to tax for fraud.
B. Estate of Spear v. Commissioner, 41 F.3d 103 (3d Cir. 1994)
Petitioners appealed our decision in docket No. 3276-87.
The Court of Appeals vacated our decision and remanded the case
with instructions that we decide it without treating respondent
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as having made a prima facie showing as to the deemed facts.
Estate of Spear v. Commissioner, 41 F.3d at 117.
The Court of Appeals said:
there are many other places in the opinion that make it
appear that the tax court found sufficient evidence of
net worth and of fraud without relying on the deemed
facts. Nonetheless, because we are unsure whether the
court relied on these facts and shifted the burden of
proof, and because the consequences to the taxpayers
are so significant, we must assume that the court did
rely on these facts. We will thus treat the sanction
as one that essentially shifted the burden of proof
(and production) on net worth and on fraud.
Id. at 108-109.
The Court of Appeals limited its discussion of the record
mainly to the facts bearing on the sanctions issue. Estate of
Spear v. Commissioner, 41 F.3d at 105. The Court also said:
The [tax] court may, of course, elect to retry the
case. In that event, it might be well advised to rely
upon Jeanette's videotaped deposition in lieu of her
testimony, although perhaps her emotional state is now
better. On the other hand, the court may simply prefer
to decide the case on the basis of the existing record,
but absent the "deeming" and its consequences which we
have declared invalid.
Id. at 117.
The Court of Appeals also said with respect to petitioner's
videotaped deposition that "it is difficult to see how anything
more would be forthcoming at a trial." Id. at 116. We agree.
Neither side has requested further trial. We conclude that
further trial is unnecessary.
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C. Whether: (1) The Absence of Deemed Facts, or (2) the
Finding by the U.S. Court of Appeals for the Third Circuit
Relating to Petitioner’s Deposition Alters Our Decision
Relating to the Deficiencies or the Net Worth Method for
1976 and 1977
1. Deemed Facts
We did not consider the deemed facts in our prior opinion
with respect to the deficiencies, the net worth method, or any
issue other than fraud. Estate of Spear v. Commissioner, T.C.
Memo. 1993-213 (slip op. at 29-30, 33, 55-56). Thus,
the decision of the Court of Appeals in Estate of Spear v.
Commissioner, supra, that we may not consider the deemed facts,
affects only our findings and conclusions relating to fraud. We
decide the effect of that opinion on our fraud finding below at
paragraph D.
2. Jeanette Spear's Deposition
a. Net Worth Method
Respondent used the net worth plus expenditures method to
determine that petitioners had unreported income in 1975, 1976,
and 1977. As part of that determination, respondent concluded
that petitioners had no cash on hand on December 31, 1974.
An essential condition in net worth cases is that the
Commissioner establish with reasonable certainty an opening net
worth to serve as a starting point from which to calculate future
increases in the taxpayer’s assets. Holland v. United States,
348 U.S. 121, 132 (1954). Although Holland is a criminal case,
it also applies to use of the net worth method in civil tax
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cases. See Hoffman v. Commissioner, 298 F.2d 784, 786 (3d Cir.
1962), affg. in part on this issue T.C. Memo. 1960-160.
Where the Commissioner has determined a deficiency by using
the net worth method, we may adjust a determination of opening
net worth shown by the trial record to be unrealistic. Hoffman
v. Commissioner, supra; Baumgardner v. Commissioner, 251 F.2d
311 (9th Cir. 1957), affg. T.C. Memo. 1956-112; Potson v.
Commissioner, 22 T.C. 912, 928-929 (1954), affd. sub nom.
Bodoglau v. Commissioner, 230 F.2d 336 (7th Cir. 1956). Errors
in the net worth method do not invalidate the presumption of
correctness attaching to other aspects of the Commissioner’s
deficiency determination if the determination was not arbitrary.
Hoffman v. Commissioner, supra at 788.
We may apply the Cohan rule (enunciated in Cohan v.
Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930)), if
appropriate, to decide the amount of cash on hand at the
beginning of the period to which the net worth method is applied.
Bodoglau v. Commissioner, 230 F.2d 336, 340-341 (7th Cir. 1956),
affg. Potson v. Commissioner, 22 T.C. 912 (1954).
The Court of Appeals stated, "based on our viewing of the
deposition, we find Jeanette's testimony as to the $380,000 cash
hoard quite straightforward, and it seems to be credible."
Estate of Spear v. Commissioner, 41 F.3d at 114. In response to
that finding, we have carefully reviewed petitioner's videotaped
deposition testimony and the entire record to enable us to
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reconsider whether petitioners had any cash on hand on
December 31, 1974.
Petitioner’s testimony gives two possible sources of
petitioners’ cash on hand on December 31, 1974. One is a cash
hoard from 1957; the other is their parking lot business they
have conducted since 1956.
Petitioner testified in the deposition that she and her
husband had a large cash hoard. She testified that one night in
1957 her husband came home with a bag of money which he said his
father, Abe Spear, had given to him. Petitioner's husband's
father died soon thereafter. She did not remember whether the
bag was bigger or smaller than a grocery bag. She said that she
helped him count the money, but he did most of the counting. She
testified that the next night he came home with a second bag of
money. She said that, combined, both bags contained “[A]bout 360
or 380 or 3 something, that was it.” She said that in less than
1 year they put some of the money in a safety deposit box. She
said she did not remember how long the rest of the money was in
their house.
Another possible source of petitioners’ cash on hand on
December 31, 1974, based on petitioner’s deposition, is
petitioners’ parking lot and other businesses. Petitioner
testified in her deposition that her husband, Leon Spear,
routinely handled cash and received cash from petitioners'
parking lot business, and used cash to pay for expenses such as
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parking lot maintenance and improvements. Petitioners began to
operate parking lots in 1956. Estate of Spear v. Commissioner,
T.C. Memo. 1993-213 (slip op. at 5). Petitioner’s husband sold
used cars before that. Id. Petitioner testified that her
husband dealt extensively in cash in connection with the parking
lots. We believe that petitioners accumulated cash from the
parking lot business and used it to conduct their business.
Petitioner testified that she and her husband used cash from
the cash hoard for their parking lot business. She said they
used a lot of the cash to develop and expand their parking lot at
8th and Race Streets. She also said they used some of the cash
for the parking lot petitioners created after they bought and
demolished the Skipper Hotel and for the PennDOT lots that
petitioners acquired in 1973. Petitioner also testified that
they bought a few properties between 1957 and 1970.
Petitioner had no written records of how she and her husband
used the cash. She testified that she only took money from, and
never put money into, the cash hoard. She said that she had no
idea how much of the cash was left at the beginning of 1975, but
she said there was some money left. She testified that a rough
guess was that the corporation owed petitioners a "couple of
hundred thousand dollars" in 1975. She said the cash hoard was
pretty well down by 1977.
The Court of Appeals limited its discussion of the record
primarily to the facts bearing on the sanctions issue. Estate of
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Spear v. Commissioner, 41 F.3d at 105. Thus, in evaluating
petitioner's testimony, we must also consider other evidence in
the record.
Abe Spear borrowed $1,000 from one of his daughters in March
1954 to give to another daughter to help her with a downpayment
to buy a house. Estate of Spear v. Commissioner, T.C. Memo.
1993-213 (slip op. at 7). Abe Spear had about $26,000 in
mortgages on properties which were worth about $80,000 when he
died. Id. He paid some of his bills late and he died with some
of his deceased wife's jewelry in a pawn shop. Estate of Spear
v. Commissioner, T.C. Memo. 1993-213 (slip op. at 37-38). Abe
Spear named Leon Spear's brother and brother-in-law, not Leon
Spear, as executors of his will, which suggests that he did not
favor Leon Spear over them to the extent of making a secret
$380,000 cash gift to him as petitioners claim. Estate of Spear
v. Commissioner, T.C. Memo. 1993-213 (slip op. at 37). Leon
Spear filed exceptions to the accounting of his father's estate
alleging missing items. Estate of Spear v. Commissioner, T.C.
Memo. 1993-213 (slip op. at 38).
Petitioner testified that petitioners applied for a mortgage
and did not list cash as an asset. Petitioners first claimed
that they had a cash hoard in January 1983, several years after
their first interview with respondent's agent in 1977. Estate of
Spear v. Commissioner, T.C. Memo. 1993-213 (slip op. at 39).
Petitioners claim that they did not deposit the cash in banks
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because they distrusted banks; however, they used banks
extensively. Id. at 39.
Giving appropriate weight to the finding of the Court of
Appeals that petitioner’s testimony relating to the cash hoard
was quite straightforward and appeared to be credible, 41 F.3d at
114, and the entire record, we conclude that petitioners used a
considerable amount of cash throughout the years before 1975 to
operate their business, and that they had a significant amount of
cash on hand on December 31, 1974. We think the parking lots and
petitioners' other businesses provided a likely source of a
significant amount of cash on hand on December 31, 1974. Based
on the foregoing discussion, and the entire record, we find
that petitioners had $200,000 cash on hand on December 31, 1974.
However, the lack of records showing the amount of petitioners’
cash on hand, the evidence in the record suggesting that Abe
Spear was not wealthy, the fact that Abe Spear chose one of Leon
Spear's brothers to be the executor of his will, and the fact
that Leon Spear contested his father's will lead us to conclude
that petitioners did not receive $380,000 in cash from Abe Spear
in 1957.
Petitioners argue that some of the money they received from
their corporations during the years at issue are repayments of
loans they made to the corporations before the years at issue.
Petitioner testified in her deposition in this case that the
loans existed; however, she testified in an earlier deposition in
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petitioners’ lawsuit against their accountant, Gil Brown, that
she did not recall any specific incidents of lending money to the
corporation. Estate of Spear v. Commissioner, T.C. Memo. 1993-
213 (slip op. at 41). Petitioners had no documents which
corroborate their contention that the loans were made; there are
no notes evidencing the loans or records of payments on the
loans; the loans were not shown in the books and records of
petitioners’ corporations; and there is no evidence that
collateral was requested or interest was charged. Estate of
Spear v. Commissioner, T.C. Memo. 1993-213 (slip op. at 40-42).
To show that funds received were loan repayments,
petitioners must show that the loans were bona fide. This
depends on all the facts and circumstances; generally no one fact
is determinative. John Kelley Co. v. Commissioner, 326 U.S. 521,
530 (1946). Petitioner did not testify that petitioners intended
their expenses for their parking lots to be loans. There is no
evidence that there were any fixed maturity dates for repayment
of the money petitioners gave to the corporations. Considering
petitioner’s testimony and the entire record, we continue to
conclude that petitioners did not make bona fide loans to their
corporations.
We do not conclude that our finding that petitioners had
$200,000 in cash on December 31, 1974, means that respondent’s
determination of petitioners’ opening net worth failed to be made
with the requisite “reasonable certainty”. Holland v. United
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States, 348 U.S. 121, 132 (1954). The Commissioner’s use of the
net worth method may be valid even though the Commissioner did
not properly recognize the taxpayer’s opening net worth, so long
as the determination was not arbitrary. Hoffman v. Commissioner,
298 F.2d 784, 786 (3d Cir. 1962); Baumgardner v. Commissioner,
251 F.2d 311 (9th Cir. 1957); Bodoglau v. Commissioner, 230 F.2d
336 (7th Cir. 1956). Respondent was not arbitrary in applying
the net worth plus expenditures method here.
D. Whether Petitioners are Liable for Fraud Without
Consideration of the Deemed Facts
In our prior opinion, we considered the deemed facts and the
entire record in holding that respondent clearly and convincingly
proved that petitioners are liable for the addition to tax for
fraud under section 6653(b) for 1975, 1976, and 1977. Estate of
Spear v. Commissioner, T.C. Memo. 1993-213 (slip. op. at 55-56).
The mandate of the Court of Appeals instructs us not to treat
respondent as having made a prima facie showing with respect to
the deemed facts as a sanction for petitioner's failure to
testify at trial. This changes our analysis significantly. We
no longer find as facts the allegations in subparagraphs k, l, o,
p, r, s, t, u, v, w, y, aa, ab, ac, ad, and ae of paragraph 7 of
respondent's amended answer because they are not adequately
supported by the record.1 Assertions in the
1
Paragraphs k, l, o, p, r, s, t, u, v, w, y, aa, ab, ac,
(continued...)
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(...continued)
ad, and ae of paragraph 7 of respondent's amended answer provide:
(k) Petitioners refused to make available to
agents of the respondent any records concerning their
individual income tax liabilities for the taxable years
1975, 1976 or 1977.
(l) Petitioners furnished only incomplete records
of their corporations Ezy Parks, Inc., Tumble Down,
Inc. and Ezy Parks II, Inc. to agents of the respondent
for the taxable years 1975, 1976 and 1977.
* * * * * * *
(o) Petitioners did not have available on
December 31, 1974 any cash on hand which was not
deposited in one of petitioners' bank accounts.
(p) There is attached hereto as Exhibit A, which
is incorporated herein by reference and made a part
hereof, a statement summarizing petitioners [sic] net
worth increases and non-deductible expenditures for
each of the taxable years 1975, 1976 and 1977.
* * * * * * *
(r) Petitioners owned all of the stock and
completely controlled Jay Faunce, Inc.
(s) Jay Faunce, Inc. did not actively conduct any
business activities at any time.
(t) The sole function of Jay Faunce, Inc. was to
acquire and hold title to real estate properties
acquired by petitioners with unreported income.
(u) Petitioners used unreported income to acquire
eight real estate properties in their names or the name
of a wholly owned nominee corporation.
(v) During the taxable years 1976 and 1977,
petitioners acquired at least six real estate
properties which they concealed by holding title for
these properties in the name of their nominee
corporation Jay Faunce, Inc.
(continued...)
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other subparagraphs in paragraph seven are amply supported by the
record,2
(...continued)
(w) Petitioners deposited unreported income into
34 bank accounts in twelve different banks during the
taxable years 1975, 1976 and 1977.
* * * * * * *
(y) Petitioners' adjusted gross income as
determined by petitioners' net worth increases and non-
deductible expenses was $127,762.80 for 1975,
$322,213.21 for 1976, and $211,173.54 for 1977.
(aa) Petitioners' correct taxable income was
$121,494.80 for 1975, $314,232.21 for 1976, and
$206,568.44 for 1977.
(ab) Petitioners with fraudulent intent to evade
tax substantially understated their income for the
taxable years 1975, 1976 and 1977.
(ac) Petitioners fraudulently with intent to
evade tax failed to report $93,071.80 of taxable income
for 1975, $276,309.21 of taxable income for 1976, and
$148,035.54 of taxable income for 1977.
(ad) Petitioners fraudulently with intent to
evade tax understated their tax liabilities by
$51,271.70 on their 1975 income tax return, by
$157,706.46 on their 1976 income tax return, and by
$93,536.23 on their 1977 income tax return.
(ae) A part of the underpayment of tax required
to be shown on the petitioners [sic] income tax returns
for their 1975, 1976 and 1977 taxable years is due to
fraud.
2
The following subparagraphs of paragraph seven are
supported by the record and the findings of fact in our prior
opinion:
(a) Petitioners Leon Spear and Jeanette Spear
were married individuals during the years 1975, 1976
and 1977.
(continued...)
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2
(...continued)
(b) During the years 1975, 1976 and 1977,
petitioners owned and controlled two corporations known
as Ezy Parks, Inc. and Tumble Down, Inc.
(c) Ezy Parks, Inc. was incorporated in
Pennsylvania on December 26, 1956 and at all times was
wholly owned and controlled by petitioners.
(d) Tumble Down, Inc. was incorporated in
Pennsylvania on December 18, 1958 and was at all times
wholly owned and controlled by petitioners.
(e) During the years 1975, 1976 and 1977, Ezy
Parks, Inc. and Tumble Down, Inc. each leased numerous
parking lots which they in turn operated and managed
[in] a business whereby cash fees were received from
customers who parked their cars on the parking lots
operated by Ezy Parks, Inc. and Tumble Down, Inc.
(f) Ezy Parks II, Inc. was incorporated on
November 13, 1975 in Pennsylvania and was at all times
wholly owned and controlled by petitioners.
(g) Ezy Parks II, Inc. was also engaged in the
operation and management of parking lots and received
cash fees from customers who parked their cars on these
lots.
(h) Petitioner Leon Spear supervised and managed
the operations of Ezy Parks, Inc., Tumble Down, Inc.
and Ezy Parks II, Inc. during the taxable years 1975,
1976 and 1977.
(i) The parking lots operated and managed by
petitioners through their wholly owned corporations
were businesses in which receipts from customers were
predominantly in cash.
(j) Petitioner Jeannette Spear maintained the
business records and handled the banking transactions
for Ezy Parks, Inc, Tumble Down, Inc. and Ezy Parks II,
Inc. during the taxable years 1975, 1976 and 1977.
* * * * * * *
(continued...)
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and thus, the Court of Appeals' instruction concerning the
treatment of the deemed facts does not affect our analysis to
that extent.
In our prior opinion, several badges of fraud were present.
Estate of Spear v. Commissioner, T.C. Memo. 1993-213 (slip. op.
at 58-61). We now conclude that the badges of fraud without the
deemed facts enumerated in supra note 2, do not clearly and
convincingly establish petitioners' fraudulent intent.
2
(...continued)
(m) The three corporations, Ezy Parks, Inc.,
Tumble Down, Inc. and Ezy Parks II, Inc. which were
owned and operated by petitioners generated substantial
cash receipts for each of the years 1975, 1976 and
1977.
(n) The respondent has determined the petitioners
[sic] correct taxable income for the taxable years
1975, 1976 and 1977 on the basis of petitioners [sic]
net worth increases and non-deductible expenditures
during each of the years 1975, 1976 and 1977.
* * * * * * *
(q) On April 7, 1976, petitioners incorporated an
entity known as Jay Faunce, Inc.
* * * * * * *
(x) Petitioners made investments and expenditures
far in excess of the amounts of income they reported on
their tax returns for the taxable years 1975, 1976 and
1977.
(z) Petitioners reported on their respective
income tax returns adjusted gross income of only
$35,902.00 for 1975, $45,893.00 for 1976, and
$206,568.44 for 1977.
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1. Implausible or Inconsistent Explanations of Behavior
In finding that petitioner’s explanations were implausible
or inconsistent, we stated that petitioner’s testimony about the
cash hoard was not believable. Estate of Spear v. Commissioner,
T.C. Memo. 1993-213 (slip op. at 59). The Court of Appeals
found her testimony to be quite straightforward and to appear to
be credible, Estate of Spear v. Commissioner, 41 F.3d at 11, and
we have modified our earlier findings to what we believe is an
appropriate extent based on her testimony, especially relating to
petitioners’ dealing in cash before 1974. We conclude that this
badge of fraud is no longer present.
2. Large Understatements of Income
The discrepancies between petitioners' actual net income and
the income they reported is reduced to the extent of their cash
on hand on December 31, 1974. This badge of fraud is less
compelling than before.
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3. Inadequate Records
4. Failure to Supply Complete Information to Return
Preparer
These two badges are not affected by removal of the deemed
facts from our consideration.
5. Diversion of Corporate Funds
6. Dealings In Cash
Petitioner testified that her husband dealt extensively in
cash as a matter of course in conducting their parking lot
business. These two badges of fraud are less compelling without
the deemed facts.
We conclude that without the deemed facts that are not
otherwise supported by the record, and based on our reevaluation
of petitioner's testimony and the entire record, fraud has not
been proven by clear and convincing evidence. We hold that
petitioners are not liable for the addition to tax for fraud
under section 6653(b) for 1975, 1976, and 1977.
E. Statute of Limitations
1. Background
Petitioners timely filed joint Federal income tax returns
for 1975, 1976, and 1977. Petitioners reported gross income of
$48,893 for 1976 and $70,708 for 1977. Twenty-five percent of
those amounts are $12,223 for 1976 and $17,677 for 1977.
More than 3 but less than 6 years after petitioners' returns
for 1976 and 1977 were due to be filed, petitioners signed Forms
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872 (Consent To Extend Time To Assess Tax) for 1976 and 1977
which extended the time to assess tax to December 31, 1986.
Petitioners did not consent to extend the time to assess tax for
1975. Respondent mailed a notice of deficiency for 1975, 1976,
and 1977 on December 23, 1986. That date was more than 6 years
after petitioners filed their 1975 return.
Generally, the Commissioner must assess tax within 3 years
after the due date of a timely filed return. Sec. 6501(a).
Respondent bears the burden of proving that an exception to the
3-year limit on the time to assess tax applies if, as here, the
notice of deficiency was mailed more than 3 years after the
filing date. Farmers Feed Co. v. Commissioner, 10 B.T.A. 1069
(1928).
2. Statute of Limitations for 1975
Respondent contends that no limit on the time to assess tax
applies for 1975 because respondent proved fraud. Sec.
6501(c)(1). Respondent does not argue that any exception other
than fraud under section 6501(c)(1) applies to 1975. We have
concluded that respondent did not prove fraud for 1975, 1976, or
1977. See par. D, above. Thus, assessment of the deficiency and
addition to tax for 1975 is barred by the statute of limitations.
a. Statute of Limitations for 1976 and 1977
Respondent contends that assessment and collection for 1976
and 1977 are timely because petitioners omitted a substantial
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amount of income. Sec. 6501(e)(1)(A). Section 6501(e)(1)(A)
provides in part:
If the taxpayer omits from gross income an amount
properly includible therein which is in excess of 25
percent of the amount of gross income stated in the
return, the tax may be assessed, or a proceeding in
court for the collection of such tax may be begun
without assessment, at any time within 6 years after
the return was filed. * * *
Respondent bears the burden of proving that the 6-year limit
on the time to assess tax applies. Reis v. Commissioner, 1 T.C.
9, 13-14 (1942), affd. 142 F.2d 900 (6th Cir. 1944).
b. Six-Year Requirement
Less than 6 years after the due date for petitioner's 1976
and 1977 returns, petitioners signed Forms 872 to extend the time
to assess tax to December 31, 1986. Respondent issued the notice
of deficiency on December 23, 1986. Petitioners concede that
respondent issued the notice of deficiency in time to qualify
under section 6501(e)(1)(A) if more than 25 percent of gross
income was omitted from each return.
c. Twenty-Five Percent Omission From Gross Income
Respondent must prove that petitioners omitted more than 25
percent of gross income from their 1976 and 1977 returns. Sec.
6501(e)(1)(A); Romine v. Commissioner, 25 T.C. 859, 871 (1956).
Petitioners contend that respondent does not meet the 25
percent requirement. Petitioners contend that respondent may not
rely on the general presumption of correctness of a deficiency
notice to meet this burden, and that the mere existence of bank
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deposits does not establish that the deposits were taxable. Reis
v. Commissioner, supra; Kavoosi v. Commissioner, T.C. Memo. 1986-
190; Easton v. Commissioner, a Memorandum Opinion of this Court
dated February 5, 1943; see also Hurley v. Commissioner, 22 T.C.
1256, 1264-1265 (1954), affd. 233 F.2d 177 (6th Cir. 1956).
We said above at par. A that respondent may use the net
worth method in this case. If we find that the net worth method
shows that petitioners omitted more than 25 percent from gross
income, then respondent has met the burden of proving that
section 6501(e)(1)(A) applies. See, e.g., Courtney v.
Commissioner, 28 T.C. 658, 668-669 (1957); Harris v.
Commissioner, T.C. Memo. 1977-222; Micciche v. Commissioner, T.C.
Memo. 1966-138; Bynum v. Commissioner, T.C. Memo. 1958-19; Smith
v. Commissioner, T.C. Memo. 1957-171; Boatsman v. Commissioner,
T.C. Memo. 1957-93; Estate of Williams v. Commissioner, T.C.
Memo. 1955-321. Respondent did so here. Petitioners reported
gross income of $48,893 for 1976 and $70,708 for 1977. Twenty
five percent of those amounts is $12,223 for 1976 and $17,677 for
1977. Petitioners failed to report more than these amounts for
1976 and 1977.
Petitioners argue that respondent may not establish that
they omitted 25 percent of their gross income by the net worth
method because it is arbitrary. Petitioners contend that
respondent omitted cash on hand and loans receivable, and did not
show that petitioners had a likely taxable source of income or
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negate all nontaxable sources of income. We decided this issue
in our prior opinion without using the deemed facts. We now find
that petitioners had $200,000 cash on hand on December 31, 1974.
We adjust the net worth analysis to account for that fact.
Hoffman v. Commissioner, 298 F.2d 784, 786 (3d Cir. 1962),
affg. in part on this issue T.C. Memo. 1960-160; Baumgardner
v. Commissioner, 251 F.2d 311 (9th Cir. 1957); Bodoglau v.
Commissioner, 230 F.2d 336 (7th Cir. 1956); Potson v.
Commissioner, 22 T.C. 912, 928-929 (1954). Thus, respondent
is barred from assessing tax for 1975, but is not barred from
assessing tax for 1976 and 1977.
To reflect the foregoing,
Decision will be entered
under Rule 155.