Campfield v. Commissioner

T.C. Memo. 1996-383

UNITED STATES TAX COURT

BENJAMIN AND SALLIE CAMPFIELD, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 804-93. Filed August 19, 1996.

Andrew B. Bowman, for petitioners.

Carmino J. Santaniello, Jr., for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

CLAPP, Judge: Respondent determined deficiencies in, and

additions to, petitioners' Federal income taxes as follows:
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Additions to tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b)(1)* 6653(b)(2)* 6653(b)(1)(A)* 6653(b)(1)(B)* 6661

1984 $43,179.86 $21,589.93 50% of the -- -- $10,794.97
interest due
on $43,179.86

1985 25,106.76 12,553.38 50% of the -- -- 6,276.69
interest due on
$25,106.76

1986 13,685.74 -- -- $12,207.56 50% of the 3,421.44
interest on
$13,685.74
*
Additions to tax for fraud apply only to Benjamin Campfield.

By amendment to answer, respondent asserted the following

increase in the deficiency and additions to tax:

Additions to tax
Sec. Sec. Sec.
Year Deficiency 6653(b)(1)* 6653(b)(2)* 6661

1985 $7,393.24 $3,696.62 50% of the $1,848.31
interest due on
$7,393.24

*
Additions to tax for fraud apply only to Benjamin Campfield.

After concessions by the parties, the issues for decision

are:

(1) Whether petitioners received unreported income of

$105,205.26 in 1984, $70,214.39 in 1985, and $31,204.29 in 1986.

We hold that they did.

(2) Whether petitioner Benjamin Campfield is liable for

additions to tax for fraud under section 6653(b) for the years in

issue. We hold that he is liable.
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(3) Whether the assessments for 1984, 1985, and 1986 are

barred by the statute of limitations. We hold that the

assessments are not barred.

All section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure, unless otherwise

indicated.

FINDINGS OF FACT

Some of the facts are stipulated and are so found. We

incorporate by reference the stipulation of facts and attached

exhibits.

Benjamin and Sallie Campfield (petitioners) are husband and

wife, and they resided in Trumbull, Connecticut, at the time they

filed their petition. Benjamin Campfield (petitioner) was born

in Sylvania, Georgia. His education did not proceed beyond the

seventh grade.

Arturo's, Inc.

From 1969 through 1988, petitioner was the sole shareholder

of Arturo's, Inc. (Arturo's), which operated a cafe and bar under

the name "Club 1127" in Bridgeport, Connecticut. Arturo's was

predominantly a cash business during the years 1984 through 1986.

Arturo's filed U.S. Corporation Income Tax Returns (Forms 1120)

for the fiscal years ended May 31, 1982, through 1986.
 - 4 -

B & K Variety

From 1977 through 1992, petitioner operated a convenience

store called B&K Variety located in New Haven, Connecticut.

Petitioner operated B&K Variety as a sole proprietorship. B&K

Variety was primarily a cash business for which petitioner

maintained a separate bank account. Petitioners reported income

and expenses for B&K Variety on Schedules C of their Federal

income tax returns for the taxable years 1984, 1985, and 1986.

Route 3 Property

Around October 18, 1984, petitioner agreed to purchase

approximately 67 acres of land, together with improvements and

various items of personal property, located on Route 3 in

Sylvania, Georgia (Route 3 property), for a purchase price of

$148,000. Petitioner deposited $5,000 in cash with John Robinson

of Robinson Real Estate to be applied to the purchase price.

Petitioner purchased a cashier's check at Connecticut

National Bank in Bridgeport, Connecticut, on November 28, 1984,

with $143,000 in cash. The sale of the Route 3 property closed

on December 3, 1984. At the closing, petitioner applied the

$143,000 cashier's check to the purchase price.

Route 21 Property

Around November 7, 1984, petitioner agreed to purchase

approximately 347 acres of land located on Route 21 in Sylvania,

Georgia (Route 21 property), for $150,000. On or about November
 - 5 -

20, 1984, Leroy Campfield, petitioner's brother, gave Wilkes

Williams (Williams), also with Robinson Real Estate, $5,000 in

cash to be applied to the purchase price of the Route 21

property. Along with the $5,000 in cash, Leroy Campfield

delivered to Williams a purchase contract signed by petitioner.

The sale of the Route 21 property closed on or about January

18, 1985. At the closing, petitioner produced a $50,000

cashier's check, No. 14430953, dated January 9, 1985, and a

briefcase containing $47,000 in cash to be applied to the

purchase price. The entire $47,000 in cash consisted of $20

bills. Williams helped count the $47,000, and, because only

$45,000 was needed to close the sale, $2,000 was returned to

petitioner.

Petitioner financed $50,000 of the Route 21 property

purchase with a 90-day note given to the sellers, payable on

April 15, 1985. Petitioner satisfied the note in 1985 with a

$52,417.12 trustee check drawn on the client account of attorney

James M. Kearns (Kearns). Kearns assisted petitioners with their

real estate activities, among other things.

After the closing on the Route 21 property, Williams

deposited the $45,000 in cash, along with cashier's check No.

14430953, at a local bank. An employee of the bank informed

Williams that, because the deposit involved over $10,000 in cash,

the bank would notify the Internal Revenue Service (IRS) about
 - 6 -

the deposit. When Williams conveyed this information to

petitioner, petitioner said that it did not matter whether the

bank notified the IRS.

Campfield Farm

We will refer to the Route 3 property and the Route 21

property collectively as the Campfield farm. The Schedules F

attached to the petitioners' 1985 and 1986 Federal income tax

returns listed "Livestock Sales" as the principal product of the

Campfield farm. Petitioner also sold melons in 1985 and 1986,

but the record does not indicate whether the melons were grown on

the Campfield farm.

Several pieces of farm equipment were purchased for use on

the Campfield farm. Leroy Campfield purchased the following

equipment from a farm equipment dealer in Sylvania, Georgia:

Equipment Price Date of Purchase

A.C. Harrow $1,800 Jan. 10, 1985
Planter 1,400 Mar. 5, 1985
Combine 6,500 Aug. 5, 1985

The harrow, planter, and combine were each purchased from

the same farm equipment dealer, and the dealer prepared a

separate invoice for each purchase. Each of the three invoices

shows "Campfield Farm" as the purchaser. Leroy Campfield

purchased the harrow, planter, and combine on petitioner's

behalf.
 - 7 -

Insurance Settlement

On August 10, 1965, petitioner acquired residential rental

real property. Fire destroyed the property in 1977. Petitioner

demolished the damaged structure and removed it from the

property. In September 1978, petitioner received a net insurance

settlement in the amount of $66,000. Petitioners remain the

owners of the land without improvements.

Loans and Bank Accounts

In May 1979, petitioner borrowed $17,000 at 12 percent

annual interest. The term of this loan was 5 years.

On March 31, 1982, petitioners obtained a home improvement

loan from Connecticut National Bank (CNB loan) in the principal

amount of $19,590. The term of the CNB loan was 60 months at 18

percent annual interest.

Petitioner obtained other loans and credit that respondent

took into account in the net worth computations. These amounts

are not in dispute.

Petitioner maintained an interest-bearing money market

account with Connecticut National Bank from 1983 through 1986.

During several months in 1983 and 1984, the balance in this

account exceeded $40,000. Petitioners maintained other checking

accounts, but none of these accounts is in dispute.

On December 9, 1984, Leroy Campfield opened account No.

030-1471-9 located in the Bank of Screven County (account No.
 - 8 -

030-1471-9), which had a balance of zero on December 31, 1983,

$7,200.51 on December 31, 1984, $41.36 on December 31, 1985, and

$1,037.56 on December 31, 1986. The signature card for account

No. 030-1471-9 shows "Campfield Farms Leroy Campfield" as the

name of account. The only signature on the signature card is

that of Leroy Campfield. The signature card and the bank

statements show the same Sylvania, Georgia, mailing address.

Other Assets

Petitioners owned other assets, including real estate and

automobiles. The ownership of these other assets is not in

dispute.

Petitioners did not receive inheritances, gifts, or

insurance settlements during the years 1983 through 1986.

Cash Transactions and Third-Party Checks

Petitioner entered into the following cash transactions

during the years in issue:

1984

1984 Mercedes (deposit) $2,720.00
1984 Mercedes 22,635.02
Route 3 property (deposit) 5,000.00
Cashier's check (Route 3 property) 143,000.00
Route 21 property (deposit) 5,000.00
Automobile insurance 8,067.00

186,422.02
 - 9 -

1985

Casino chips $13,100.00
Tractor trailer 2,000.00
Automobile repairs 969.21
Automobile insurance 859.00
Route 21 property 45,000.00

61,928.21

1986

Casino chips $10,700.00
Automobile repairs 11,149.32
Chevy pickup (deposit) 500.00
1981 BMW (deposit) 500.00

22,849.32

Petitioner paid $493.98 toward an auto body repair bill

using third-party checks. He also cashed third-party checks at a

grocery store in Bridgeport, Connecticut.

Gambling Activities

Petitioner gambled at Tropworld in Atlantic City, New

Jersey, in 1985 and 1986. Petitioner purchased casino chips on

May 19, 1985, in the amount of $13,100 and on November 29, 1986,

in the amount of $10,700. Tropworld filed a Currency Transaction

Report by Casinos, Form 8362 (CTR), with the IRS for each of

these purchases.

Tropworld maintained a List Accounts Detail Ratings (List

Account) which showed that petitioner purchased casino chips on
 - 10 -

May 19, 1985, in the amount of $13,100 and on November 29, 1986,

in the amount of $10,700.

Income Tax Returns

Petitioners' accountant, David Nyden (Nyden), prepared

petitioners' U.S. Individual Income Tax Returns (Forms 1040) from

1978 through the years in issue.

Each month Nyden would go to B&K Variety, Arturo's, or

petitioners' home to pick up monthly financial records for B&K

Variety. The records included bank statements, check stubs,

bills, and day sheets. A day sheet reflected the gross cash

receipts and cash payouts for a particular date. Petitioner

summarized the cash transactions on the day sheet and then gave

the day sheet to Nyden.

Nyden would reconcile the day sheets with bank deposits into

the B&K Variety bank account. Nyden used the monthly bank

statements and the day sheets to calculate the gross receipts for

B&K Variety that he reported on petitioners' Schedules C for

1984, 1985, and 1986. Petitioner used a cash register at B&K

Variety from 1984 through 1986, but Nyden did not use the cash

register tapes to prepare petitioners' returns.

Petitioner provided Nyden with receipts related to the

farming activity conducted on the Campfield farm. At the end of

the year, Nyden and petitioner would discuss the farm activities,

and petitioner would give Nyden receipts for income and expenses.
 - 11 -

On petitioners' Form 1040 for the taxable year 1984,

petitioners reported other income of $124,000. Nyden wrote

"COMMISSIONS" next to the entry of $124,000. On petitioners'

Form 1040 for the taxable year 1985, petitioners reported other

income of $50,000. Nyden wrote "COMMISSIONS" next to the entry

of $50,000.

Petitioners filed their 1984, 1985, and 1986 Federal income

tax returns on October 15, 1985, October 16, 1986, and September

10, 1987, respectively. Respondent issued a statutory notice of

deficiency dated October 16, 1992, for petitioners' taxable years

1984, 1985, and 1986.

Nyden also prepared the Forms 1120 for Arturo's during the

years in issue. Nyden would go to Arturo's or to petitioners'

home and pick up bank statements, canceled checks, check stubs,

and the day sheets for Arturo's. Nyden used this information to

complete the Forms 1120.

Respondent's Investigation

Respondent began a criminal investigation of petitioner

sometime prior to 1991. Special Agent Edward J. Burke (Agent

Burke) with the IRS criminal investigation division investigated

petitioner for the taxable years 1984, 1985, and 1986.

Agent Burke interviewed petitioner, and Kearns represented

petitioner during the interview. During that interview,

petitioner, on the advice of counsel, invoked his rights under
 - 12 -

the Fifth Amendment to the Constitution and refused to answer

some of Agent Burke's questions. For example, petitioner refused

to answer whether he had cash on hand as of December 31, 1983.

Petitioner also refused to answer questions about the source of

the income reported as "commissions" on his 1984 and 1985 Forms

1040.

Agent Burke served summonses on Connecticut National Bank

and the Bank of Screven County. These banks complied with the

summonses, and Agent Burke used the records to prepare the net

worth computations for the taxable years 1984 through 1986.

On June 1, 1992, petitioner waived his right to indictment

and pled guilty to an information charging him with one count of

willfully making and subscribing to a materially false Federal

income tax return for the taxable year 1985 in violation of

section 7206(1). On September 14, 1992, petitioner was sentenced

to 3 years' incarceration, suspended after 6 months, placed on 5

years' probation, and fined $10,000.

OPINION

The dispute in this case focuses on respondent's net worth

computations and respondent's fraud determinations. Petitioners

argue that respondent's net worth calculations are invalid due to

errors. Petitioners also contend that respondent has failed to

prove that petitioner is liable for the fraud additions to tax.

Petitioners dispute only four of the items in respondent's net
 - 13 -

worth computations. Petitioners do not otherwise contest

respondent's deficiency determinations or the additions to tax

pursuant to section 6661. We conclude that petitioners have

conceded the uncontested items. Money v. Commissioner, 89 T.C.

46, 48 (1987).

Net Worth Analysis

Respondent used the net worth plus expenditures method to

determine that petitioners had unreported income in 1984, 1985,

and 1986. In a case such as this, where the determination of

unreported income as well as the existence of fraud depends upon

respondent's net worth computations, we must examine the validity

of respondent's computations in light of the standards set forth

in Holland v. United States, 348 U.S. 121 (1954), and United

States v. Massei, 355 U.S. 595 (1958). Under those standards,

the Commissioner must establish, with reasonable certainty, an

opening net worth as a starting point from which to calculate

future increases in the taxpayer's assets. Holland v. United

States, supra at 132. In addition to showing an opening net

worth, the Commissioner must also show a likely source of the

unreported income or negate possible sources of nontaxable

income. Id. at 132-138; United States v. Koskerides, 877 F.2d

1129, 1137 (2d Cir. 1989); Smith v. Commissioner, 91 T.C. 1049,

1059 (1988), affd. 926 F.2d 1470 (6th Cir. 1991).
 - 14 -

Under the net worth method, income is computed by

determining a taxpayer's net worth at the beginning and end of a

period. The difference between the amounts is the increase in

net worth. An increase in a taxpayer's net worth, plus his

nondeductible expenditures, less nontaxable receipts, may be

considered taxable income. Holland v. United States, supra at

125.

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, 298 F.2d 784, 786 (3d Cir. 1962), affg. in part

T.C. Memo. 1960-160; 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). Any such

adjustments 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.

Respondent calculated petitioners' net worth for the years

in dispute, and we have attached the summary of respondent's

calculations as an appendix. The parties agree on all but four

categories of respondent's net worth calculations. We address

below only those categories in dispute.
 - 15 -

The disputed categories include petitioners' opening cash on

hand, the ownership of funds in the Bank of Screven County, the

acquisition of a planter in 1985 for use on the Campfield farm,

and petitioner's purchase of casino chips on May 19, 1985, and

November 29, 1986.

Cash on Hand

Petitioners argue that respondent incorrectly determined

cash on hand in the amount of $6,163.95 as of January 1, 1984.

Petitioner contends that he had a cash hoard of $143,000 in a

safe-deposit box located at Connecticut National Bank.

Petitioner contends that the $143,000 cash hoard consisted

of the $66,000 insurance settlement received in 1978 plus

accumulated savings. According to petitioner, he purchased the

cashier's check applied to the Route 3 property using the

$143,000 in cash. For the reasons discussed below, we find that

petitioner did not maintain a cash hoard of $143,000.

On March 31, 1982, petitioner obtained the CNB loan in the

amount of $19,590. Petitioner's borrowing of funds during the

time that he allegedly had a cash hoard supports the inference

that no cash hoard existed. See O'Connor v. Commissioner, 412

F.2d 304, 311 (2d Cir. 1969), affg. in part and revg. and

remanding in part T.C. Memo. 1967-174; Thomas v. Commissioner,

223 F.2d 83, 88 (6th Cir. 1955), revg. and remanding a Memorandum

Opinion of this Court dated Oct. 30, 1953.
 - 16 -

Petitioner maintained an interest-bearing money market

account during the years 1984 through 1986. In 1984 and 1985,

petitioner placed substantial sums of money in this account.

These transactions indicate that petitioner was not mistrustful

of banks, and we find it unlikely and improbable that petitioner

would forgo interest on the $143,000 allegedly kept in the safe-

deposit box. See Conti v. Commissioner, T.C. Memo. 1992-616,

affd. in part and revd. and remanded in part 39 F.3d 658 (6th

Cir. 1994).

Petitioner waited until trial to assert that he had a cash

hoard, and he made no such claim to respondent's agents.

Petitioner's delay in claiming the existence of a cash hoard is a

factor that weighs in respondent's favor. See United States v.

Gay, 567 F.2d 1206, 1207 (2d Cir. 1978).

Petitioners reported adjusted gross income of $26,197 and

$13,206 for the taxable years 1982 and 1983, respectively. We

find it unlikely that petitioners could have accumulated a

significant cash hoard from this income.

We find that petitioner did not maintain a cash hoard in the

safe-deposit box at Connecticut National Bank as of January 1,

1984.

Funds in the Bank of Screven County

Respondent's net worth and expenditures computations

included cash in banks. Respondent determined that petitioner
 - 17 -

owned the funds in account No. 030-1471-9 located in the Bank of

Screven County, which had a balance of zero on December 31, 1983,

$7,200.51 on December 31, 1984, $41.36 on December 31, 1985, and

$1,037.56 on December 31, 1986. Petitioner contends that his

brother, Leroy Campfield, owned account No. 030-1471-9.

On December 9, 1984, Leroy Campfield opened account No.

030-1471-9. The signature card for account No. 030-1471-9 shows

"Campfield Farms Leroy Campfield" as the name of account. The

only signature on the signature card is that of Leroy Campfield.

The signature card and the bank statements show the same

Sylvania, Georgia, mailing address.

Leroy Campfield acted on petitioner's behalf when petitioner

purchased the Route 21 property. Leroy Campfield gave Williams

$5,000 on petitioner's behalf and a purchase contract signed by

petitioner. Leroy Campfield purchased equipment and supplies on

petitioner's behalf. The invoices associated with said purchases

show Campfield farm as the purchaser. We find that Leroy

Campfield opened account No. 030-1471-9 on petitioner's behalf

and that petitioner owned the funds in account No. 030-1471-9.

Planter

Respondent determined that petitioners acquired a planter

for $1,400 on March 5, 1985. Petitioner stipulated that in 1985

he acquired a combine and a harrow for use on the Campfield farm.

Leroy Campfield purchased the combine and the harrow on
 - 18 -

petitioner's behalf. Leroy Campfield also purchased a planter,

but petitioner denies ownership of the planter.

The combine, harrow, and planter were each purchased from

the same dealer. The invoices associated with the purchase of

the combine and harrow show Campfield farm as the purchaser. The

invoice associated with the planter shows Campfield farm as the

purchaser. Leroy Campfield was acting on petitioner's behalf at

Campfield farm, and it seems highly unlikely that he would buy a

planter for something other than farm purposes, particularly when

the planter fits logically into the farm activities. We find

that petitioner owned the planter.

Purchase of Casino Chips

Respondent determined that petitioner purchased casino chips

on May 19, 1985, in the amount of $13,100, and on November 29,

1986, in the amount of $10,700. Respondent considered these

amounts nondeductible personal expenses.

Tropworld filed at least two CTR's that relate to

petitioner. The first CTR indicates that petitioner purchased

$13,100 of casino chips on May 19, 1985. The second CTR

indicates that petitioner purchased $10,700 of casino chips on

November 29, 1986. The List Account maintained by Tropworld

shows that on May 19, 1985, petitioner purchased casino chips in

the amounts of $9,000, $2,000, $500, and $1,600, which

corresponds with the $13,100 shown on the CTR for that date. The
 - 19 -

List Account for November 29, 1986, reveals that petitioner

purchased casino chips in the amounts of $1,000, $1,700, $2,100,

$800, $300, $1,800 and $3,000, which corresponds with the $10,700

shown on the CTR for that date. Thus, the dollar figures on the

List Account for May 19, 1985, and November 29, 1986, corroborate

the dollar figures shown on the CTR's filed by Tropworld.

Petitioner does not dispute the evidence presented by

respondent concerning the purchase of the casino chips on May 19,

1985, and November 29, 1986. Petitioners argues that respondent

had a duty to obtain records from Tropworld that would reveal

petitioner's gambling winnings during 1982 and 1983 and that, by

failing to do so, respondent's opening cash on hand figure is

fatally flawed. This argument is without merit. Respondent need

only establish, with reasonable certainty, petitioners' net worth

as of January 1, 1984. Any gambling winnings from 1982 and 1983

will be taken into account in the net worth calculations.

Petitioners reported no gambling winnings on any tax returns

filed for the years 1982 through 1986.

We find that petitioner incurred nondeductible expenditures

of $13,100 on May 19, 1985, and $10,700 on November 29, 1986, for

the purchase of casino chips at Tropworld.

We conclude that respondent's net worth computations meet

the first prong of the test in Holland v. United States, 348 U.S.
 - 20 -

121 (1954); i.e., that the opening net worth be established with

reasonable certainty.

We now turn to the alternative branch of the second prong of

the Holland test, pursuant to which respondent must show a likely

source of the unreported income or negate possible sources of

nontaxable income.

Whether or not respondent has shown a likely source of

petitioners' unreported taxable income, proof of a likely source

of income is not a prerequisite to use of the net worth method

when possible sources of nontaxable income are negated. United

States v. Massei, 355 U.S. 595 (1958); United States v.

Mastropieri, 685 F.2d 776, 785 (2d Cir. 1982). Petitioner,

himself, denied receipt of any gifts, inheritances, or insurance

settlements during the years in issue. Respondent investigated

petitioners' banking activities and found no evidence of

nontaxable income.

Respondent must also establish that a reasonable

investigation of leads to possible sources of nontaxable income

has been conducted. Holland v. United States, supra at 135-138;

United States v. Mastropieri, supra at 785. We have rejected

petitioner's cash hoard claim. Petitioners made no other claims

of nontaxable sources of income. Once respondent has explored

the leads available to her and established a prima facie case,

she has met this burden. Petitioner "remains quiet at his
 - 21 -

peril." United States v. Mastropieri, supra at 785 (quoting

Holland v. United States, supra at 139). We conclude that

respondent's agents conducted a reasonable investigation of leads

to possible sources of nontaxable income.

We conclude that respondent's net worth computations meet

the standards set forth in Holland v. United States, supra, and

United States v. Massei, supra. We conclude that petitioners had

unreported income of $105,205.26 in 1984, $70,214.39 in 1985, and

$31,204.29 in 1986.

We now turn to respondent's fraud determinations.

Fraud

The Commissioner has the burden of proving fraud by clear

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

Commissioner must prove the existence of an underpayment. Parks

v. Commissioner, 94 T.C. 654, 660 (1990). The Commissioner may

not rely upon the taxpayer's failure to carry the burden of proof

as to the underlying deficiency. Id. at 660-661; Petzoldt v.

Commissioner, 92 T.C. 661, 700 (1989); Estate of Beck v.

Commissioner, 56 T.C. 297, 363 (1971). Second, the Commissioner

must show that the taxpayer intended to evade taxes 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). Petitioner's conviction
 - 22 -

under section 7206(1) does not collaterally estop him from

denying that he fraudulently understated his tax liabilities;

however, it is evidence to be considered by the trier of fact.

Wright v. Commissioner, 84 T.C. 636 (1985).

Underpayment

When the allegations of fraud are intertwined with

unreported income and reconstructed income as they are here, we

must be careful not to bootstrap a finding of fraud upon a

taxpayer's failure to prove the Commissioner's deficiency

determination erroneous. Parks v. Commissioner, supra at 661.

Respondent offered prima facie evidence of petitioners' net

worth. For the reasons discussed above, we find that

respondent's net worth computations established substantial

amounts of unreported income and consequent underpayment of taxes

for 1984, 1985, and 1986.

Fraudulent Intent

Respondent must prove by clear and convincing evidence that

petitioner had fraudulent intent. Id. at 664. Fraud may be

proven by circumstantial evidence. Stephenson v. Commissioner,

79 T.C. 995, 1005-1006 (1982), affd. 748 F.2d 331 (6th Cir.

1984).

Courts have developed various factors or "badges" that tend

to establish fraud. Circumstantial evidence that may give rise

to a finding of fraudulent intent includes: (1) Understatement
 - 23 -

of income; (2) inadequate or no records; (3) concealment of

assets; (4) implausible or inconsistent explanations of behavior;

(5) failure to file tax returns; (6) failure to cooperate with

tax authorities; (7) dealing in cash; (8) engaging in illegal

activity; and (9) attempting to conceal an illegal activity.

Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986),

affg. T.C. Memo. 1984-601; Clayton v. Commissioner, 102 T.C. 632

(1994). These "badges" of fraud are nonexclusive. Miller v.

Commissioner, 94 T.C. 316, 334 (1990). A taxpayer's entire

course of conduct may establish the requisite fraudulent intent.

Stone v. Commissioner, 56 T.C. 213, 223-224 (1971); Otsuki v.

Commissioner, 53 T.C. 96, 105-106 (1969). The intent to conceal

or mislead may be inferred from a pattern of conduct. Spies v.

United States, 317 U.S. 492, 499 (1943).

Understatement of income, by itself, does not establish

fraud. However, a consistent pattern of understating income over

a number of years is strong evidence of fraudulent intent to

evade the income tax. Estate of Mazzoni v. Commissioner, 451

F.2d 197, 202 (3d Cir. 1971), affg. T.C. Memo. 1970-144 and T.C.

Memo. 1970-37; Otsuki v. Commissioner, supra at 108. Petitioners

reported income of $139,838 in 1984, $37,852 in 1985, and $21,217

in 1986. Petitioners underreported their income by $105,205.26

in 1984, $70,214.39 in 1985, and $31,204.29 in 1986.
 - 24 -

Failure to maintain accurate records may be a badge of

fraud. Merrit v. Commissioner, 301 F.2d 484, 487 (5th Cir.

1962), affg. T.C. Memo. 1959-172. Petitioner failed to maintain

any records as to the "commissions" he reported on his 1984 and

1985 Federal income tax returns.

Petitioner kept some records for his various businesses from

which he gave figures to Nyden. These books were never audited.

Petitioner prepared the day sheets for Arturo's and B&K Variety,

and there were no safeguards to assure that all cash receipts

found their way into the books. Nyden never reviewed cash

register tapes. In short, petitioner pretty much could include

the amount of cash that suited him. We find that petitioner's

records were inadequate.

Nyden's preparation of petitioners' Forms 1040 did not

redeem or correct the inadequacy of petitioner's records. Nyden

would prepare petitioners' Forms 1040 using the information

provided by petitioners. Nyden frequently noticed that "the

expenses were just out of whack" with the revenue. Nyden would

discuss the matter with petitioner to determine whether there was

any more income. Thus prompted, petitioner would furnish Nyden

with an additional income figure to plug the gap. Petitioner

never referred to any documents or provided Nyden with any backup

material related to the additional income. For example, Nyden

summarized the income and expenses for the Campfield farm for one
 - 25 -

of the years at issue. The expenses were "just so far out of

line" with the revenue that Nyden asked petitioner if there was

any additional income from the farm. Petitioner responded that

there was $15,000 of additional income. Petitioner provided no

explanation of the source of the $15,000 of additional income.

We conclude that petitioner's records did not reflect accurately

his income and expenses.

We have no evidence that petitioner attempted to conceal any

particular assets. However, given respondent's net worth

analysis and petitioner's various business activities, we find

that petitioner concealed substantial amounts of cash that passed

through his hands and never appeared in his records or Forms

1040.

We find petitioner's explanations of the circumstances

surrounding the alleged cash hoard to be implausible and

inconsistent. Petitioner made little attempt to explain his

financial activities. To the extent he did so, we find those

explanations vague and inadequate.

Petitioners filed tax returns for the years in issue, but

the net worth analysis indicates substantial unreported income.

Petitioner also pled guilty to criminal charges of willfully

making and subscribing to a materially false Federal income tax

return for the taxable year 1985.
 - 26 -

False or misleading statements to the Commissioner's agents

can be evidence of fraudulent intent. Grosshandler v.

Commissioner, 75 T.C. 1, 20 (1980). Petitioner refused to answer

some of Agent Burke's questions, pleading the Fifth Amendment or

on the advice of counsel. As for questions that petitioner did

answer, we do not find petitioner's statements false or

misleading.

A taxpayer's extensive use of cash can be an indication of

fraudulent intent. Bradford v. Commissioner, supra at 308; McGee

v. Commissioner, 61 T.C. 249, 260 (1973), affd. 519 F.2d 1121

(5th Cir. 1975). Petitioner made cash expenditures of

$186,422.02, $61,928.21, and $22,849.32 for the years 1984, 1985,

and 1986 respectively. Petitioner purchased items such as

automobiles, real estate, and automobile insurance with cash when

payment by check would have appeared more conventional.

Petitioner offered no explanation why he used cash for such

substantial expenditures.

Respondent has not shown that petitioner was engaged in, or

attempted to conceal, an illegal activity during the taxable

years 1984 through 1986.

Respondent contends that petitioner's cashing of third-party

checks is evidence of fraudulent intent. See Corrigan v.

Commissioner, T.C. Memo. 1994-31. Petitioner paid $493.98 toward

an auto body repair bill using third-party checks. Petitioner
 - 27 -

also cashed third-party checks at a grocery store in Bridgeport,

Connecticut, during the taxable years 1984 through 1986. There

is no explanation or accounting by petitioner for this unorthodox

use of third-party checks.

Courts have also considered the educational level and

sophistication of the taxpayer. Grosshandler v. Commissioner, 75

T.C. 1, 19 (1980). Petitioner argues that because his education

did not proceed beyond the seventh grade, and because he is

"cognitively limited" with a verbal IQ of 82 and a performance IQ

of 76, he is incapable of committing fraud. The scope and extent

of his business activities, which included a farm, rental real

estate, a cafe and bar, and a convenience store, and his apparent

financial success belie that argument. See, e.g., Estate of

Temple v. Commissioner, 67 T.C. 143, 162 (1976), in which we

found fraud, noting that the taxpayer's "limited formal education

did not prevent him from realizing substantial amounts of

income".

Considering the record taken as a whole and reasonable

inferences therefrom, we conclude that petitioner intended to

evade taxes known to be owing by conduct intended to conceal,

mislead, or otherwise prevent the collection of taxes, and that

the entire underpayments are attributable to fraud.
 - 28 -

Statute of Limitations

The Commissioner generally is required to assess tax within

3 years of the date the return is filed. Sec. 6501(a). There is

no limitation period to assess tax if the Commissioner proves

fraud. Sec. 6501(c)(1).

In light of our holding that respondent has proved fraud

under section 6653(b) for petitioner, we hold that assessment and

collection of the deficiencies and additions to tax for

substantial understatement determined against petitioners, and of

the additions to tax for fraud determined against petitioner, are

not barred by the statute of limitations. Accordingly, we need

not reach respondent's alternative argument under section 6501(e)

for 1985.

To reflect the foregoing and the concessions by the parties,

Decision will be entered

under Rule 155.
 APPENDIX

Summary - Net Worth Computation
1984 - 1986

Item Particulars 12/31/83 12/31/84 12/31/85 12/31/86

1. Cash on hand $6,163.95 $2,280.48 $1,770.34 $500.00
2. Cash in banks 12,067.79 52,551.48 7,982.37 15,767.15
3. Real estate 317,016.36 477,515.36 584,906.01 584,906.01
4. Motor vehicles 70,300.00 102,516.50 86,509.50 86,509.50
5. Business equipment 28,689.91 28,689.91 28,689.91 28,689.91
6. Farm equipment -- -- 14,925.40 18,425.40
7. Inventory 23,493.00 13,115.00 10,826.00 9,885.00
8. Common stock,
Arturo's 14,000.00 14,000.00 14,000.00 14,000.00
9. Loans receivable 9,020.00 2,648.00 1,887.00 --

Total Assets 480,751.01 693,316.73 751,496.53 758,682.97

Less:

10. Mortgage/loans 54,431.73 41,777.67 31,583.24 30,958.25
11. Accum. deprec. 127,839.00 140,944.00 127,876.00 141,951.00
12. Shareholder's loans -- -- -- 113.00

Total liabilities 182,270.73 182,721.67 159,459.24 173,022.25

Net worth 298,480.28 510,595.06 592,037.29 585,660.72

Less:

Net worth/prior yr. 298,480.28 510,595.06 592,037.29
Net worth inc./(-)decr. 212,114.78 81,442,23 -6,376.57

13. Nondeductible 37,170.38 53,440.61 63,489.86
personal expenditures

14. Nonincome adjustments 241.90 22,656.45 372.00

Subtotals 249,043.26 112,226.39 56,741.29

Less:

15. Exemptions 4,000.00 4,160.09 4,320.00
 - 30 -

16. Corrected taxable income 245,043.26 108,066.39 52,421.29

Less:

17. Taxable income reported 139,838.00 37,852.00 21,217.00

18. Additional taxable income 105,205.26 70,214.39 31,204.29