Zurn v. Commissioner

T.C. Memo. 1996-386

UNITED STATES TAX COURT

STANLEY P. ZURN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 163-93. Filed August 20, 1996.

Walter Weiss, for petitioner.

Steven Roth and Mark Weiner, for respondent.

MEMORANDUM OPINION

GERBER, Judge: Respondent determined deficiencies in and

additions to, and a penalty on, petitioner’s Federal income tax

as follows:
Additions to Tax and Penalty
Sec. Sec. Sec. Sec. Sec. Sec.
6651 6653 6653 6653 6653 Sec. 6663
Year Deficiency (a)(1) (b)(1) (b)(2) (b)(1)(A) (b)(1)(B) 6661 (a)
1
1985 $34,812 --- $23,770 --- --- $8,703 ---
1
1986 247,288 --- --- --- $192,009 61,812 ---
1
1987 46,021 --- --- --- 42,339 11,505 ---
 -2-
1988 121,986 --- 92,640 --- --- --- 30,497 ---
1989 110,248 $27,562 --- --- --- --- --- $82,686
1
50 percent of the interest due on the portion of the underpayment due to fraud.

Respondent determined the following additions to tax and penalty

in the alternative:
Additions to Tax and Penalty
Sec. Sec. Sec. Sec. Sec.
6651 6653 6653 6653 6653 Sec.
Year Deficiency (a)(1) (a)(1) (a)(2) (a)(1)(A) (a)(1)(B) 6662
1
1985 $34,812 $3,885 $2,377 --- --- ---
1
1986 247,288 61,822 --- --- $12,801 ---
1
1987 46,021 --- --- --- 2,823 ---
1988 121,986 --- 6,176 --- --- --- ---
1989 110,248 --- --- --- --- --- $22,050
1
50 percent of the interest due on the deficiency.

After concessions, the issues remaining for our

consideration are: (1) Whether petitioner failed to include

$208,994 in income for 1986; (2) whether petitioner is entitled

to a capital or ordinary loss in connection with funds advanced

to a business enterprise and, if so, in which year; (3) whether

petitioner is entitled to losses claimed in connection with

leasing transactions; (4) whether petitioner overstated his

alimony deduction by $11,988 for each of the 1985 through 1989

taxable years; (5) whether petitioner is entitled to claim a loss

from real estate activity and, if so, the character of such a

loss; (6) whether petitioner is liable for an addition to tax for

fraud or, alternatively, an addition to tax for negligence and/or

delinquency for any of the 1985 through 1988 taxable years;

(7) whether petitioner is liable for an addition to tax for

substantially understating his income tax for any of the 1985

through 1988 taxable years; (8) whether petitioner is liable for
 -3-

a fraud penalty or, alternatively, an accuracy-related penalty

for 1989; and (9) whether petitioner is liable for an addition to

tax for failure to timely file his 1989 Federal income tax

return.

Background1

For convenience, findings of fact and legal discussion are

being combined for related issues. Petitioner resided in Los

Angeles, California, at the time the petition in this case was

filed. Petitioner, a high school graduate, completed some

college on a part-time basis. Petitioner was employed by the

City of Los Angeles, Bureau of Street Maintenance, as a

construction crew supervisor. The job involved the use of heavy,

off-road paving and concrete equipment. Petitioner retired from

his city job in 1980 and entered the real estate business.

Petitioner was successful in the real estate business and

had accumulated in excess of 20 rental properties by the close of

1989.

Issue 1. Whether Petitioner Failed To Include Income of $208,994
for 1986

Respondent determined, for 1986, that petitioner's income

should be increased by $325,994 attributable to unexplained bank

deposits, as follows:

1
The parties’ stipulation of facts and exhibits are
incorporated herein by this reference.
 -4-

Date Account No. Amount
Apr. 14 064 641-302538 $60,588
Apr. 16 064 641-302538 57,000
Apr. 17 131-403443-8 208,406
Total 325,994

With respect to the $60,588 amount, respondent conceded before

trial that $60,000 was not to be included in income, leaving $588

in controversy. Concerning the $57,000 item, respondent

conceded, on brief, that the record reflected that it is not

includable in income for 1986. The $208,406 item remains in

controversy.

Lowell Thomas Nelson (Mr. Nelson) was involved in the

business of buying and selling real estate investment property.

He met petitioner in the early 1980's in connection with

petitioner's dealings in real property. Mr. Nelson was given

power of attorney by petitioner with respect to a specific

property transaction. It was customary for Mr. Nelson to hold

money on behalf of petitioner. Petitioner had established a bank

account of which he and Mr. Nelson were cotrustees, which enabled

Mr. Nelson to withdraw funds from the account. The account was

opened at Mr. Nelson's request due to petitioner's informal

manner of conducting business and because petitioner sent Mr.

Nelson relatively small sums of money for various purposes which

had accumulated and collectively became a substantial amount.

During the period 1982 through 1987, petitioner and Mr.

Nelson were involved in four or five transactions together. On
 -5-

occasion, petitioner would accompany Mr. Nelson to a real

property closing, and petitioner would produce large cashier's

checks, which, on occasion, were quite old. These checks were

sometimes from other real property closings, and, in one

instance, Mr. Nelson observed a check approximating $59,000. Due

to Mr. Nelson's accumulation of petitioner's funds, on April 18,

1985, Mr. Nelson executed a $115,321.16 promissory note in favor

of petitioner. The $115,321.16 amount represented the balance

due to petitioner at that time. In addition to the amount

represented by the promissory note, Mr. Nelson, at various times,

held an additional $120,000 to $130,000 of petitioner's money.

On April 17, 1986, petitioner caused $211,433.80 to be

transferred "by wire" from the cotrustee account with Mr. Nelson

to petitioner's sole account. Of the $211,433.80, $3,027

represented interest, which petitioner has conceded should have

been reported as income for 1986.

Petitioner bears the burden of showing that the unexplained

deposits remaining in controversy were not includable in his 1986

income, as determined by respondent. Rule 142(a); Welch v.

Helvering, 290 U.S. 111 (1933). Bank deposits have been held to

be prima facie evidence of income. Tokarski v. Commissioner, 87

T.C. 74 (1986); Estate of Mason v. Commissioner, 64 T.C. 651

(1975), affd. 566 F.2d 2 (6th Cir. 1977).
 -6-

Petitioner has provided evidence specifically showing the

origin of the $57,000 amount, and respondent conceded this amount

on brief. Respondent also conceded $60,000 of the $60,588

deposit, leaving the remaining $588 unexplained and in dispute.

The $208,406 deposit also remains in dispute and unexplained.

The record reflects that petitioner was involved in numerous real

property transactions, including several with Mr. Nelson.

Through Mr. Nelson's testimony, petitioner has also shown that,

at one time or another, over a 5- or 6-year period, Mr. Nelson

held in excess of $200,000 of petitioner's funds. Mr. Nelson

also testified that he returned $115,000 to petitioner in 1987

and accounted for several amounts for specific transactions.

Petitioner, however, has failed to account for his real estate

transactions, some of the proceeds of which respondent has

determined were unreported. Petitioner admits that his approach

to these transactions was informal and that only limited records

are available. His inability to carry his burden is of his own

making.

Without petitioner's identification of the source of the

$208,406 or $588, we are unable to find that those amounts were

not taxable income. Accordingly, we hold that the unexplained

deposits totaling $208,994 constitute income to petitioner, which

he failed to report for the 1986 taxable year.
 -7-

Issue 2. Whether Petitioner Is Entitled to a Capital or Ordinary
Loss in Connection With Road Construction Activity, and, If So,
in Which Year

In 1980, Gloria Jackson (Ms. Jackson) formed a partnership

entitled BAJAC Construction Co. (BAJAC) with her sister, Joanne,

and a third partner, Robert O. Hollar (Mr. Hollar). Due to

inadequate cash-flow, BAJAC filed for protection under chapter 11

of the U.S. Bankruptcy Code during 1984.

Cities Development Group, Inc. (Cities), was a corporation

formed in the summer of 1985 by Ms. Jackson (80 percent) and Mr.

Hollar (20 percent) to engage in subcontracting work and to

create a more competitive, nonunion organization. Cities, which

later changed its name to American Cities, was a "minority

business enterprise" and a "woman business enterprise", which

enabled it to take advantage of certain affirmative action

contracting programs. Cities made a bid on the Lake Elsinore

project and was awarded a subcontractor project by Cornish

Construction.

Normally, receipt of payment to Cities for road construction

work was delayed. In some instances Cities received payment more

than 2 months after the prime contractor had billed the local

government. After completing a percentage of the Lake Elsinore

project during the first half of 1986, Cities was removed from

the job and commenced litigation in Federal court. Ms. Jackson

believed Lake Elsinore was a project worth $900,000 and sought
 -8-

about $600,000 in the lawsuit because about 60 percent of the

work had been finished. The prime contractor contended that the

total Lake Elsinore project was worth no more than $380,000.

Consequently, and as a result of the litigation, Cities was

experiencing financial problems. As a result, Ms. Jackson began

searching for additional financing to supplement Cities' working

capital.

In mid-1986, Cities had applied for a bank loan, and, while

the application was under consideration, Cities was awarded the

MCM Century Freeway project (Century project). Because Cities

was required to present insurance certificates as a prerequisite

to working on the Century project, Ms. Jackson was under

substantial pressure to obtain financing. During August 1986,

petitioner met with Ms. Jackson to discuss Cities’ financial

situation. Ms. Jackson was interested in securing assistance

with Cities’ financial needs, believing that the Century project

would make Cities viable. Petitioner was advised of the pending

Federal court litigation, and, as of mid-1986, it appeared that

Cities would prevail in that proceeding. Petitioner paid $40,000

for the insurance so that Cities' insurance certificates could be

obtained as a prerequisite to bidding on the Century project.

Ms. Jackson was not well acquainted with petitioner, and she

insisted that the business arrangement be reduced to writing.

Although petitioner advanced relatively large sums of money, he
 -9-

was generally unconcerned with formalities and sought to do

business without the aid of lawyers. Ms. Jackson’s father had

substantial experience in road construction, including paving,

grading, and related matters. Cities was used to obtain minority

and women's set-aside contracts. Ms. Jackson, her father, and

petitioner joined together to perform on the contracts obtained

through Cities. Ms. Jackson was the operating officer, her

father was in charge of construction, and petitioner was

responsible for providing funding. Although petitioner was not

involved in the daily operations of Cities and its activities, he

was involved in the decision-making process and advanced money on

numerous occasions during 1986 and 1987.

As of June 6, 1986, petitioner had advanced $12,000. Ms.

Jackson drafted a promissory note that she believed petitioner

could enforce. By July 15, 1986, petitioner had advanced

$167,500, which Ms. Jackson memorialized in what she believed to

be a valid, enforceable promissory note.

On July 15, 1986, petitioner and Ms. Jackson executed a

lease-purchase agreement for certain heavy equipment, including:

Trucks, a backhoe and excavator, an air compressor, and other

equipment. The machinery was for use by Cities in the Century

project. The terms of the lease provided for 6 monthly

installments of $16,250, with the first payment to petitioner to

begin at the commencement of the progress payments to Cities on
 -10-

the Century project. After the six payments were made, title of

the equipment would pass to Cities. Ms. Jackson, who had

attended 1 year of law school, drafted the lease agreement for

the leasing transaction with petitioner. Petitioner remained

responsible for the maintenance of the equipment. Petitioner

paid Cities’ $40,000 insurance premium to cover the heavy

equipment used in the Century project. A one-paragraph August 1,

1986, document entitled "AGREEMENT" recites that "Cities agrees

to pay Stan Zurn 50% of its net profits on the MCM project as

compensation and fees for acting as a joint venturer by advancing

funds for construction and equipment purchases related to the

MCM/Cities project."

On September 30, 1986, Ms. Jackson prepared an agreement

acknowledging receipt of $90,000 from, and a promise to repay

$100,000 to, petitioner. At this time, Cities expected to obtain

approval for a line of credit. Accordingly, Ms. Jackson executed

an "Assignment of the Progress Payments" to document petitioner’s

right to the payments if he chose to enforce his claim.

The Century project began in September 1986. In a September

30, 1986, letter, Ms. Jackson, as president of Cities, assigned

all MCM progress payments to petitioner. On October 17, 1986,

Ms. Jackson executed an agreement for the benefit of petitioner.

The agreement, which referred to petitioner as a "silent joint

venture partner", provided that Ms. Jackson promised to reimburse
 -11-

petitioner for all funds advanced in connection with the Century

project. Petitioner, who was not a shareholder of Cities,

refused the offer of what he believed was worthless preferred

stock in Cities. The agreement also provided that payment would

be made from the credit line at the time it would be approved by

a finance company, and it stated that it was anticipated that the

$375,000 credit line application would "be cleared on or before

November 20, 1986." Ultimately, a credit line was not approved.

Throughout the period under consideration, Cities

experienced financial difficulties. Ultimately, petitioner

advanced a total of $677,652. Cities was removed from the

Century project and, thus, the road construction equipment had to

be stored. Jim Francis, who maintained a storage facility in

Bakersfield, California, stored the equipment. The storage fees,

however, became past due, and, ultimately, the machinery was not

recovered from Mr. Francis.

Cities was removed from the Century project before

December 31, 1987. Ms. Jackson, however, into 1989, attempted,

without success, to revitalize Cities without petitioner’s

assistance, financial or otherwise. During 1988, Ms. Jackson

spent most of her time attempting to collect from local

governments for work performed. On December 20, 1988, Ms.

Jackson advised petitioner, by letter, of the events surrounding

her attempts to continue and/or improve Cities’ business.
 -12-

Cities’ image, viewed from the perspective of Ms. Jackson’s

letter, was flat and without potential. Ms. Jackson attempted to

assure petitioner that she intended to repay him. Repayment,

however, would have to come from unidentified sources and/or

uninitiated businesses that Ms. Jackson intended to start. One

such idea concerned an entity to be entitled "Dancer", in which

Ms. Jackson offered petitioner 25,000 shares with a stated or par

value of $750,000.

On April 17, 1990, Cities filed for relief under chapter 11

of the U.S. Bankruptcy Code. Petitioner was not listed as a

creditor in Cities’ bankruptcy petition. However, the proceeding

was converted to a liquidating bankruptcy, under chapter 7 of the

U.S. Bankruptcy Code. In that connection, on June 26, 1991, Ms.

Jackson filed an amended bankruptcy petition listing petitioner

as a creditor for $659,000. As of the end of 1988, petitioner

believed that his claim against Ms. Jackson or Cities was

worthless, and he did not commence any action against them to

recover his funds. On petitioner's 1988 return, his accountant

reported a long-term capital loss in the amount of $186,280 in

connection with funds advanced. Petitioner now claims an

ordinary loss for 1986 and 1987 or 1988 with respect to the

$677,652.
 -13-

Discussion

Petitioner claims that the $677,652 he advanced and lost

constitutes an ordinary loss that may be deducted for 1986 and

1987 or 1988, the year originally claimed. Petitioner has

structured his broad-brush approach into several alternatives

requiring our analysis of both the timing and character of the

loss.

We first consider petitioner’s contention that, in contrast

to the manner in which he reported it, the loss should have been

reported as an ordinary loss under section 1652 or a business-

related bad debt loss under section 166. Losses under section

165(c) are limited to those incurred in a trade or business, in a

transaction entered into for profit, or from some form of

casualty. A business loss under section 166 would also require

the showing that the debt was created in connection with a trade

or business. Petitioner contends that his loss is attributable

to a trade or business or profit-motivated transaction.

Petitioner also argues, in the alternative, that he abandoned his

joint venture interest with Ms. Jackson and his interest in the

road construction equipment during 1988. Respondent counters

that any loss that petitioner may be entitled to should be

characterized as a nonbusiness bad debt under section 166.

2
Section references are to the Internal Revenue Code as
amended and in effect for the taxable years under consideration.
Rule references are to this Court’s Rules of Practice and
Procedure.
 -14-

Here again, petitioner bears the burden of showing that he

was in a trade or business or an activity entered into for

profit. In order to do that under the circumstances of this

case, he would have to show that he was a joint venturer with Ms.

Jackson and/or her business enterprises or that he entered into

his transaction with Ms. Jackson and/or her entities as part of

an activity entered into for profit.

Section 165(c) permits the deduction of losses "incurred in

a trade or business", sec. 165(c)(1), or "incurred in any

transaction entered into for profit, though not connected with a

trade or business", sec. 165(c)(2). Although paragraphs (1) and

(2) of section 165(c) both deal with losses, one deals with

losses incurred in a trade or business and the other with losses

not connected with a trade or business. In that regard, section

165(c)(1) concerns operating losses of a profit-seeking activity,

and section 165(c)(2) involves a loss due to a nonbusiness

reason, such as abandonment. For a loss to be deductible under

either paragraph (1) or (2) of section 165(c), however, the

taxpayer must be engaged in a trade or business or involved in a

transaction for profit.

Section 166(a)(1) provides for the deduction of any debt

that becomes worthless during the taxable year. Section 166(a)

does not apply to a nonbusiness debt, which is defined in section

166(d)(2) as any debt other than (A) a debt created in connection
 -15-

with a trade or business or (B) a debt, "the loss from the

worthlessness of which is incurred in the taxpayer's trade or

business."

We must therefore decide the nature of petitioner's

relationship with Ms. Jackson and/or her corporate entity; i.e.,

whether he was a joint venturer, creditor, investor, stockholder,

etc. Petitioner contends that he was a joint venturer. As a

guide to answering this type of question, courts have focused

generally on whether the parties intended to and did join

together for the accomplishment of a specific enterprise.

Commissioner v. Culbertson, 337 U.S. 733 (1949). Some of the

factors to be considered are set forth in the following oft-

quoted language of Luna v. Commissioner, 42 T.C. 1067, 1077-1078

(1964):

The agreement of the parties and their conduct in
executing its terms; the contributions, if any, which
each party has made to the venture; the parties’
control over income and capital and the right of each
to make withdrawals; whether each party was a principal
and coproprietor, sharing a mutual proprietary interest
in the net profits and having an obligation to share
losses, or whether one party was the agent or employee
of the other, receiving for his services contingent
compensation in the form of a percentage of income;
whether business was conducted in the joint names of
the parties; whether the parties filed Federal
partnership returns or otherwise represented to
respondent or to persons with whom they dealt that they
were joint venturers; whether separate books of account
were maintained for the venture; and whether the
parties exercised mutual control over and assumed
mutual responsibilities for the enterprise.
 -16-

Some of the formal manifestations of a joint venture are

absent here due to the need to keep petitioner’s involvement in

the enterprise undisclosed. Other than that aspect, petitioner

advanced funds for the purpose of making a profit from the

government road construction. Cities was the instrumentality

used to obtain preferred treatment for Ms. Jackson’s status as a

minority and/or woman owner. Without petitioner’s involvement,

Cities was a mere shell without funding. Petitioner brought his

government experience and financial capability, and Ms. Jackson

brought her entrepreneurial skills, experience, and preferred

status to the venture.

The relationship between petitioner and Ms. Jackson (and her

corporate business, Cities) came about due to Ms. Jackson’s

financial difficulties. Cities, a corporation, was formed to

address several needs and interests. Ms. Jackson was attempting

to recover from financial difficulties and labor problems that

she had encountered in a prior enterprise. Significantly,

Cities' capital ownership was structured to take advantage of

affirmative action contracting policies. Ms. Jackson owned 80

percent of the voting common stock, which entitled Cities to the

preferred status of a "minority business enterprise" and a "woman

business enterprise".

Petitioner entered into a joint venture with Ms. Jackson to

use Cities to accomplish the venturers’ goal of obtaining local
 -17-

government road construction contracts. Both petitioner and Ms.

Jackson’s father had substantial experience in road construction.

Ms. Jackson kept petitioner’s involvement with Cities and its

projects confidential. Petitioner’s anonymity was likely

connected to Cities' ability to maintain its preferred status as

a minority or woman owned and operated business enterprise. As a

result, the documentation of Ms. Jackson’s and petitioner’s

relationship is somewhat terse. For example, there are notes and

some agreements that seem to characterize petitioner as a

creditor. One document reflects a loan of $90,000 and provides

for the repayment of $100,000. That note reflects interest to

petitioner in a discounted form for the use of his money.

Overall, notes exist for about one-third of the total amount

advanced by petitioner. In addition, no Cities stock was issued

in petitioner’s name. The few informal documents contain

references to petitioner, either as a silent partner or a partner

with a 50-percent share of profits from the government

construction contracts. Although Cities was the entity to which

the road contracts were awarded, in their agreements Ms. Jackson

and petitioner treated as their own any profits from such

contracts.

As part of petitioner’s involvement in the road contracting,

petitioner was provided with title to Cities’ machinery, and he,

in turn, leased the machinery to Cities in exchange for rent
 -18-

payments. Ms. Jackson used that approach as an inducement for

petitioner to advance more funds into their joint venture by

providing him with ownership as security and rental income in

exchange for additional funding. We note that the machinery was

worth about $100,000, the equivalent of about one-sixth of the

funds advanced.

The substance of petitioner’s involvement with Ms. Jackson

and her corporation was to profit from obtaining government road

contracts. Respondent’s position that petitioner was a passive

investor who advanced two-thirds of a million dollars with only

limited security and no stock ownership does not ring true.

Respondent, concerning whether petitioner should be treated as a

creditor, refers to petitioner as a "white knight" who advanced

funds to Ms. Jackson and Cities. It is difficult to imagine any

reason for petitioner’s substantial participation other than his

interest in the "pot" of profits at the end of Ms. Jackson‘s

promotional "rainbow" and the rent he was to receive from leasing

the machinery.

Early in the relationship, petitioner was to receive 50

percent of the profits from the government road contract. When

Cities' involvement in the government contract was canceled and

things began to deteriorate, petitioner was promised all of the

receipts from the government contracts--which, at that time,
 -19-

translated into the recovery of payables owed Cities or the

judgment from litigation pursued against the prime contractor.

Initially, one of the documents provided that petitioner was

to receive a 50-percent profit from the Century project. That is

a strong indication that he was in a joint venture with Ms.

Jackson. At that point, petitioner had advanced about $167,000.

Subsequently, petitioner advanced several hundred thousand

dollars in addition to the $167,000, and he was assigned all MCM

progress payments by Ms. Jackson.

A case that also was beset by complexity caused by a

shortage of formal documentation is Stanchfield v. Commissioner,

T.C. Memo. 1965-305. In that case, the taxpayer had advanced

money that, ultimately, was used by a corporate entity in which

the taxpayer had no ownership. In that case, it was held that

the taxpayer was a venturer, and, additionally, he had lent money

to the venture.

One hundred thousand dollars of the $677,652 advanced here

is easily segregated as being for the machinery leased by

petitioner to Cities. The remaining $577,652, however, could be

divided between petitioner's capital investment in the joint

venture and his advances or loans. It is a paradox that the

early advances were evidenced by notes and that the later

advances were not. That inconsistency can be attributed to

several possibilities, including the need to keep petitioner's
 -20-

involvement undisclosed and/or petitioner's propensity to enter

into undocumented and informal relationships coupled with his

aversion to lawyers.

Key to our analysis, however, are the circumstances at the

time petitioner began his involvement with Ms. Jackson. Her

prior enterprise was in bankruptcy, and litigation in Federal

court was pending regarding the prior enterprise's contract.

Although a corporate entity had been formed (Cities), it was

without funding and needed initial capital to pursue the Century

project. Ms. Jackson was in a position to offer her business

acumen and the preferred status of Cities, her minority-owned

corporation. In this regard, Ms. Jackson's most recent business

experiences had been less than successful. Petitioner had

government and road construction experience, and most

importantly, he was a source of funding. Under these

circumstances, we find that petitioner's capital investment in

the joint venture was $52,000, consisting of the initial $12,000

payment made in June 1986 and the $40,000 insurance payment.

These amounts were prerequisites to obtaining the Century

project. The remaining advances are to be treated as loans to

the joint venture.

Having decided that petitioner was engaged in a joint

venture, and the allocation of the total amount of advances into

discrete categories, we next consider the parties' positions
 -21-

concerning the timing of the loss. Petitioner contends that the

losses occurred in the years (1986 and 1987) he advanced money to

the joint venture with Ms. Jackson. In the alternative,

petitioner argues that he abandoned his interest in the joint

venture and/or that it was worthless as of the end of 1988.

Respondent argues that petitioner’s interest was not abandoned or

worthless during 1988 and that the possibility of recoupment

remained through 1989 and until 1990, when Ms. Jackson’s

enterprise was petitioned into bankruptcy.

The parties have agreed that petitioner made payments to

Cities during 1986 and 1987 in the amounts of $463,944 and

$213,708, respectively. Petitioner’s argument that those amounts

represent losses for 1986 and 1987 is based on section 165(c)(1).

In other words, petitioner contends that the joint venture

incurred an operating loss for 1986 and 1987. Petitioner did not

offer an accounting of the joint venture's or Cities' income and

expenses for the year 1986 or 1987. Accordingly, the record does

not support petitioner’s entitlement to an operating loss for

1986 or 1987. In addition, even if petitioner had shown a loss

for the venture, he was entitled to 50 percent of the profits,

and, presumably, he would bear 50 percent of any losses. To be

entitled to deduct an abandonment loss under section 165, a

taxpayer must show: (1) An intention on the part of the owner to

abandon the asset, and (2) an affirmative act of abandonment.
 -22-

United States v. White Dental Co., 274 U.S. 398 (1927); A.J.

Indus., Inc. v. United States, 503 F.2d 660, 670 (9th Cir. 1974);

CRST, Inc. v. Commissioner, 92 T.C. 1249, 1257 (1989), affd. 909

F.2d 1146 (8th Cir. 1990).

In determining a taxpayer's intent to abandon, the

"subjective judgment of the taxpayer * * * as to whether the

business assets will in the future have value is entitled to

great weight and a court is not justified in substituting its

business judgment for a reasonable, well-founded judgment of the

taxpayer." A.J. Indus., Inc. v. United States, supra at 670.

Here petitioner formed an intent to abandon the partnership

interest as well as the road equipment sometime after 1987 when

the contract was canceled and no payments were forthcoming.

The missing element, however, is an affirmative act of

abandonment. An affirmative act to abandon must be ascertained

from all the facts and surrounding circumstances, United Cal.

Bank v. Commissioner, 41 T.C. 437, 451 (1964), affd. per curiam

340 F.2d 320 (9th Cir. 1965), and "the Tax Court [is] entitled to

look beyond the taxpayer's formal characterization", Laport v.

Commissioner, 671 F.2d 1028, 1032 (7th Cir. 1982), affg. T.C.

Memo. 1980-355. "The mere intention alone to abandon is not, nor

is non-use alone, sufficient to accomplish abandonment." Beus v.

Commissioner, 261 F.2d 176, 180 (9th Cir. 1958), affg. 28 T.C.

1133 (1957). Petitioner has not shown an affirmative act of
 -23-

abandonment of his interest in the joint venture or the road

construction equipment, and, accordingly, he is not entitled to a

deduction for the joint venture interest or undepreciated value

of the machinery for the taxable years before the Court.

Concerning the amounts advanced to the joint venture, a debt

becomes deductible when it becomes worthless. Denver & R.G.W.

R.R. v. Commissioner, 32 T.C. 43 (1959), affd. 279 F.2d 368 (10th

Cir. 1960). Petitioner bears the burden of proving when and if a

debt is worthless. Rule 142(a); James A. Messer Co. v.

Commissioner, 57 T.C. 848 (1972). The question of worthlessness

is factual, and the standard has been described in the following

manner:

Debts are wholly worthless when there are reasonable
grounds for abandoning any hope of repayment in the
future. Dallmeyer v. Commissioner, 14 T.C. 1282, 1292
(1950), and it could thus be concluded that they have
lost their "last vestige of value." Bodzy v.
Commissioner, 321 F.2d 331, 335 (5th Cir. 1963). This
will usually entail proof of the existence of
identifiable events which demonstrate the valuelessness
of the debts. Riss v. Commissioner, 478 F.2d 1160 (8th
Cir. 1973); Crown v. Commissioner, 77 T.C. 582, 598
(1981); Hubble v. Commissioner, 42 T.C.M. 1537, 1544
(1981).

Estate of Mann v. United States, 731 F.2d 267, 276 (5th Cir.

1984).

In mid-1986, petitioner entered into the joint venture with

Ms. Jackson and began advancing funds. Ms. Jackson had cash-flow

problems. Petitioner agreed to become involved with Ms. Jackson

although he was aware of her business history. He advanced
 -24-

$463,944 and $213,708 during 1986 and 1987, respectively.

Petitioner continued along this path late into 1987 when Cities

was removed from the Century project. After that point, no funds

were advanced by petitioner, and his involvement with Ms. Jackson

and Cities ceased.

As of the end of 1988, it was apparent from Ms. Jackson’s

December 1988 letter to petitioner that Cities and its contracts

were dormant and that the only hope depended on the mere

possibility that Ms. Jackson could develop and finance another

project or business from which petitioner could be paid. As

mentioned in the 1988 letter to petitioner, Ms. Jackson was

attempting to obtain financing for several promotions she had

conceptualized. Considering Ms. Jackson’s financial situation

and past business performance, it would be pure speculation to

expect any possibility of petitioner’s being repaid.

During 1988 and 1989, Ms. Jackson and Cities were, for all

purposes, without resources and Cities was dormant until the time

bankruptcy was declared, first in 1990, to attempt a

reorganization, and then in 1991, when it was converted into a

liquidating proceeding. The declaration of bankruptcy was

foreordained from the time the Century project was canceled late

in 1987. Petitioner was listed as a creditor with a claim of

$659,000 in the liquidating bankruptcy. Although Ms. Jackson and

Cities did not formally declare insolvency or bankruptcy until
 -25-

1990, petitioner had no hope of recovery as of the end of 1988.

In this regard, petitioner’s accountant claimed a $186,280 bad

debt for 1988. Apparently, petitioner’s accountant claimed only

the amount evidenced by documentation (notes and agreements),

even though petitioner had advanced $677,652 as of the end of

1988.

On this record, we hold there was no hope of repayment of

any portion of the $677,652 in payments made by petitioner.

Accordingly, petitioner properly claimed a bad debt loss for

1988, but the amount should be increased from the $186,280

claimed to $515,652 ($677,652 less $152,000),3 and it should be

characterized as a loss under section 166(a)--a business bad

debt.

Issue 3. Whether Petitioner Is Entitled to Losses Claimed in
Connection With the Leasing Transaction

Petitioner claimed an equipment leasing loss on each

Schedule C attached to his 1986 through 1989 Federal income tax

returns. The amounts in controversy are: 1986--$60,306 ($40,000

insurance payment, $1,000 legal fees, and $19,306 depreciation);

1987--$36,781 ($915 mortgage interest, $5,000 legal fees, and

$30,866 depreciation); 1988--$24,845 ($3,516 for insurance, $552

for other expenses, and $20,777 for depreciation); and 1989--

3
The remaining $152,000 represents capital investment and
is dealt with in other portions of this opinion.
 -26-

$20,938 ($161 for mortgage interest and $20,777 for

depreciation).

Respondent argues that petitioner is not entitled to the

amounts claimed because of his failure to substantiate the

amounts and show that the leasing activity was a trade or

business and/or a profit-seeking activity. The lease of the road

construction and related machinery was integrated with the joint

venture and lending activity between petitioner and Ms. Jackson.

We have already decided that the overall activity was a trade or

business, in the form of a joint venture, and that the leasing

activity is covered within our analysis in the preceding issue.

Based on our prior findings and analysis, we find that

petitioner's leasing activity was a trade or business and/or an

activity entered into for profit.

The record here supports petitioner's ownership of $100,000

of equipment that he leased to Cities. Petitioner, however, has

not substantiated any of the amounts claimed for legal fees,

mortgage interest, or "other expenses" which he claimed on the

Schedules C. With respect to the amounts claimed for insurance,

the $40,000 amount has been found to be a part of petitioner's

capital investment in the joint venture with Ms. Jackson. The

other amount claimed for insurance ($3,516) has not been

substantiated by petitioner.
 -27-

In addition, petitioner argued and we have found that as of

the end of 1988 Cities was inactive with no hope of being

revitalized, and the road construction equipment was not being

used for business purposes. Petitioner contended that the debt

was worthless and that he had abandoned the road construction

equipment. In this regard, although petitioner did not specify

when inquiries about the road construction equipment were made,

he claims to have abandoned the road construction equipment,

ostensibly because it could not be located or because storage and

maintenance fees exceeded the value of the equipment.

Accordingly, we find that petitioner is entitled to the

depreciation claimed through the 1988 taxable year, but no

depreciation is allowable for the 1989 taxable year. Petitioner

is also entitled to a capital loss with respect to his $52,000

interest in the joint venture as of the end of 1988. Petitioner,

however, has not shown his entitlement to an abandonment loss of

the leased equipment due to his failure to isolate or specify the

time of such abandonment.

Issue 4. Whether Petitioner Overstated His Alimony Deduction by
$11,988 in Each Year 1985 Through 1989

Petitioner and his former wife Valery Zurn (Ms. Zurn) were

married in 1967 and divorced on August 2, 1978. Petitioner was

ordered in the divorce decree to pay Ms. Zurn alimony of $1 per

month for 15 years and $50 per month for child support, beginning

August 1, 1978. When petitioner originally received the divorce
 -28-

decree, he did not read it or check it for clerical errors.

Therefore, petitioner paid Ms. Zurn $1,000 per month, the amount

they each believed to be the correct amount. Petitioner

discovered that the divorce decree reflected $1, as opposed to

the $1,000 per month, at the time he was being audited by

respondent's agent. Thereafter, petitioner and Ms. Zurn

stipulated the entry of an order correcting the original decree

nunc pro tunc during September 1992. The stipulation and order,

which was subscribed by a California Superior Court judge and

filed during 1992, amended the original order to reflect monthly

payments of $1,000 instead of $1. Petitioner paid Ms. Zurn

$1,000 per month during 1985 through 1989.

At the time of the divorce, petitioner and Ms. Zurn jointly

owned several rental properties. The titles for those properties

remained joint in order to provide Ms. Zurn with security

concerning the $1,000 payments to be made over 15 years. In

addition, during 1978, petitioner provided Ms. Zurn with a note

for an amount in excess of $100,000 as security for the $1,000

payments. After the 15-year period, the properties were to vest

in petitioner. As of the time of trial, Ms. Zurn continued to

receive $1,000 monthly payments and remained a joint owner in the

properties, even though the 15-year period had concluded. The

$1,000 payments have been made from income of the jointly held

properties, both during and after the 15-year payment period.
 -29-

Petitioner claimed an alimony deduction of $1,000 per

month, or $12,000 for each year at issue. Respondent disallowed

$11,988, all but $12 ($1 per month) of the claimed deduction for

each of the years in issue.

Discussion

There is no dispute about the fact that petitioner paid Ms.

Zurn $1,000 per month--the only question is whether any amount in

excess of $12, on an annual basis, constitutes alimony within the

meaning of sections 71 and 215. Petitioner argues that under

California law the nunc pro tunc order corrects a mistake in the

original order. For Federal income tax purposes, petitioner

contends that the correction of a mistake by a State court

relates back so as to meet the requirements of sections 71 and

215. Respondent argues that the original decreed amount ($1) was

the amount intended by the parties and that no mistake was made.

Respondent infers that the $1,000 monthly payment to Ms. Zurn was

either to buy out her interest in the property under an implicit

property settlement between the parties or income payments

attributable to her joint property interests with petitioner.

Section 215 permits a deduction for alimony payments, as

defined in section 71. For purposes of this case, payments may

qualify as alimony if, in addition to satisfying other

requirements, they are received by a spouse under a decree of

divorce or of separate maintenance. Sec. 71. In this case, the
 -30-

original divorce decree was entered in accord with the

stipulation of petitioner and Ms. Zurn. That decree ordered

petitioner to pay "$1.00 (one dollar) per month for a period of

15 years (fifteen years)" for Ms. Zurn's support. It was

petitioner's and Ms. Zurn's understanding, however, that the

monthly payment was to be $1,000, the amount that was paid each

month during the 15-year period.

Prior to the end of the 15-year period and during the audit

of petitioner's tax returns that preceded this litigation,

petitioner was asked to substantiate the annual $12,000 alimony

claim. It was then that petitioner discovered the divorce decree

did not reflect $1,000-per-month alimony payments. Instead, the

decree ordered $1-per-month alimony payments. Thereafter,

petitioner and Ms. Zurn, by means of a stipulation, caused the

divorce decree to be modified nunc pro tunc by a State court

judge. The document modifying the original decree states that

the nunc pro tunc change from $1 to $1,000 was made to correct a

clerical error in the original decree.

This Court has addressed the effect of a nunc pro tunc

divorce decree on an earlier decree. Several cases have given

effect, for tax purposes, to the nunc pro tunc change where it

corrected a mistake that had been made in the original decree.

Johnson v. Commissioner, 45 T.C. 530, 533 (1966). Johnson

distinguished certain earlier cases in which the nunc pro tunc
 -31-

orders were not given effect for tax purposes. The difference

was that the Johnson taxpayer made a showing "that the original

decree did not correctly state the divorce court's determination

at the time of its entry." Id.

The circumstances here are peculiar in that the original

decree was for $1 and Ms. Zurn's retained joint interests in

property could provide an explanation for the $1,000 payments as

being for some purposes other than spousal support. Further, it

is curious that the $1,000 payment continued beyond the 15-year

period called for in the divorce decree and that Ms. Zurn

retained a joint interest in the real property after the 15-year

obligation to pay spousal support had concluded.

These circumstances have given respondent reason to question

whether petitioner was entitled to claim the $1,000 payments as

alimony. The uncontroverted evidence in this case, however,

shows that the original decree was incorrect. The evidence

supporting this finding includes the testimony of petitioner and

of Ms. Zurn, and the order entered by a California State judge

correcting what is referred to as a clerical error in the

original decree. Additionally, we note that it may have been to

Ms. Zurn's detriment to join in the stipulation correcting the

original decree from $1 to $1,000. We use the term "may" because

the record here does not indicate whether Ms. Zurn reported

income from alimony during the period in question. If the
 -32-

payments were not alimony and in settlement of her marital estate

with petitioner, the payments may not have been taxable to Ms.

Zurn. We also note that if the $1,000 payments constituted Ms.

Zurn's income in the jointly held property, then petitioner could

have reduced the amount of income he reported with respect to

those properties.

Petitioner presented credible evidence that respondent did

not rebut, other than her theory concerning what we have referred

to as peculiar circumstances. Those circumstances are not

sufficient to overcome the uncontroverted evidence offered by

petitioner. It should be further noted that petitioner's real

estate tax information is part of the record in this case and Ms.

Zurn's income tax information reflecting how she treated the

$1,000 payments, ostensibly, is available to respondent. Even if

the information was unavailable, Ms. Zurn testified and could

have been questioned at the trial.

Finally, petitioner points out that California courts have

held that a nunc pro tunc order will issue only where a mistake

of law or fact has been made. Berry v. Berry, 294 P.2d 757 (Cal.

App. 2d 1956). This Court is bound by the judgment of the

highest court of a State, Commissioner v. Estate of Bosch, 387

U.S. 456 (1967), and we can give credence to judgments of lower

State courts. In that regard, we have no reason to doubt that

the correction of the original decree in this case was in accord
 -33-

with California precedent. Accordingly, petitioner is entitled

to $12,000 alimony deduction for each taxable year in issue and

the $11,988 disallowance is in error.

Issue 5. Whether Petitioner Is Entitled To Claim a Loss From a
Real Estate Activity, and, If So, the Character of Such a Loss

Petitioner owned several properties in Texas. B.R.

Pritchett (Mr. Pritchett) was the president of Third Aquarius

Corp., which was involved in real property management and

renovation. Mr. Pritchett sought funds from petitioner to invest

in renovation activity, and petitioner advanced $25,000 and

$20,000 during 1982.

In 1985, petitioner asked Mr. Pritchett for the return of

some of his investment. Mr. Pritchett told petitioner that times

for the real property business were tough and that many people

were losing money. Petitioner then hired an attorney in Dallas,

Texas, and provided the attorney with information relating to Mr.

Pritchett’s activities. Ultimately, in 1985 petitioner’s

attorney commenced a lawsuit against Mr. Pritchett to recover

petitioner’s money. A lis pendens was filed with respect to

certain of Mr. Pritchett's real property at the time of

commencement of the lawsuit. Petitioner never recovered any

amount of the money advanced to Mr. Pritchett.

Petitioner claimed a $35,000 loss for his 1986 taxable year,

which respondent disallowed on the grounds that petitioner failed
 -34-

to show a debtor-creditor relationship and that any such debt

became worthless in the taxable year.

Petitioner bears the burden of proving that respondent's

determination is in error by showing that he is entitled to a bad

debt loss. Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933).

Although petitioner provided evidence reflecting that funds were

advanced to Mr. Pritchett during 1982, there has been no showing

that any debts due from Mr. Pritchett or investments in Mr.

Pritchett’s enterprises became worthless during 1986 or any other

year currently before the Court. Accordingly, we hold that

petitioner has not shown his entitlement to a $35,000 bad debt

loss in connection with Mr. Pritchett for the 1986 taxable year.

Issue 6. Whether Petitioner Is Liable for Additions To Tax for
Fraud or, in the Alternative, Additions to Tax for Negligence and
Delinquency

Respondent determined an addition to tax for fraud in each

of the 5 taxable years before the Court. In addition to the

issues on which fact findings have already been made, respondent

relies on stipulated matters which were resolved due to

petitioner’s concessions.

During July 1988, petitioner negotiated the sale of the 3071

Harrington real property (Harrington property) and entered into

an escrow agreement with Hanmi Escrow Co. (Hanmi). During August

1988, petitioner negotiated the sale of the 1149 Virgil real

property (Virgil property) and entered into an escrow agreement
 -35-

with Acme Escrow Co. (Acme). During September 1988, petitioner

entered into agreements designed to structure a delay of the

exchange of the Harrington and Virgil properties with Fountain

Exchange (Fountain). Fountain was to take title to the

Harrington and Virgil properties and act as seller but would hold

the sale proceeds until petitioner could find replacement

property to make it appear as though a like-kind exchange under

section 1031 had occurred within the time allowed by the Internal

Revenue Code. The deferred proceeds of sale were held by

Fountain for about 6 months and then paid to Star Global.

Marilyn Russello and her husband owned Acme and Fountain.

Their business was to accommodate sellers of property by

facilitating what appeared to be a direct exchange in order to

give sellers the opportunity to find replacement property and

also to claim nonrecognition treatment for any gain from the

sale. This is accomplished by Fountain’s acquiring title and

receiving the proceeds of sale from the first property being

sold. Fountain holds title for an instant, and then the title is

passed to the actual buyer from Fountain's client (true seller).

Within 45 days Fountain’s client identifies an "up-leg" property,

and, within 180 days, closes the second escrow at which Fountain

disburses proceeds of the first sale in accord with Fountain's

client's instructions.
 -36-

Using this approach, petitioner deeded the Virgil and

Harrington properties to Fountain, which, in turn, deeded the

properties to the actual buyers. Petitioner then located a

replacement property, and during March 1989 Fountain was

instructed by petitioner to transfer the $258,351.54 proceeds

from the sale of Virgil and Harrington to Star Global to purchase

the "up-leg" property, a 25-percent interest in property known as

"Protective Community Land and Oil Corp. Tract, Lot no. 2160"

(lot 2160). In some manner the title to the interest in lot 2160

went through a person named Bob Welch (Mr. Welch) to Fountain,

which appeared to have exchanged the lot 2160 with petitioner for

the Virgil and Harrington properties.

Mr. Welch, a licensed general contractor, had a business

relationship with petitioner and acted as his agent for

investment purposes. Mr. Welch ran the day-to-day affairs of and

owned Star Global, which was involved in imports and exports.

Late in 1987, petitioner began investing capital in Star Global,

and he continued for a short time, concluding when no profitable

deals occurred. After the Star Global import activity was

concluded, Mr. Welch and petitioner continued to use the Star

Global bank account on which only Mr. Welch was a signatory.

Beginning in 1981, Mr. Welch and Robert Jose Hernandez (Mr.

Hernandez) were engaged in a joint real property investment

relationship. Initially, Mr. Hernandez had purchased lot 2160
 -37-

for $500 cash, and later it was acquired by Mr. Welch through

some type of exchange with Mr. Hernandez. Lot 2160 consists of

about 5 acres of desert land about 100 miles north of Los

Angeles. Mr. Welch approached petitioner with the idea of

acquiring lot 2160 as the "up-leg" property in the section 1031

exchange.

When Mr. Welch received the $258,351.54 check through Star

Global, he converted it into several cashier's checks that were

used for the following purposes: (1) Payments to finance a

magazine Mr. Welch was working on; (2) payments to Mr. Welch's

contracting company; (3) payments to petitioner's new wife; and

(4) payments to Mr. Welch's wife. No part of the $258,351.54 was

invested on behalf of petitioner.

About 1 month after the closing on the lot 2160 property,

petitioner became suspicious about its value, and he came to the

conclusion that lot 2160 was worthless. After Mr. Welch was

confronted by petitioner, Mr. Welch, during the summer of 1989,

gave petitioner one-half of Mr. Welch's one-half interest (a 25-

percent interest) in Mr. Welch's magazine, in which approximately

$1 million had been invested, mostly by an individual other than

Mr. Welch and petitioner. Petitioner continued to associate with

Mr. Welch, and about a month or two later, Mr. Welch invested an

additional $200,000 of petitioner's newly advanced funds in a

different investment.
 -38-

After Mr. Welch learned during November 1991 that petitioner

was being audited by respondent, he attempted to record the

quitclaim deed from Mr. Hernandez to himself for the interest in

lot 2160. Mr. Welch testified that he realized $165,000 of gain

from the sale of lot 2160, but he did not report the transaction

on his 1989 Federal tax return. Mr. Welch explained that he did

not report the sale of lot 2160 because petitioner's $258,351.54

was ultimately invested in Mr. Welch's magazine.

Petitioner, on his 1989 Federal income tax return, reported

a "Tax-Deferred Exchange" under section 1031, reflecting the lot

2160 property with a $305,000 fair market value, as the property

received in the exchange. Petitioner reflected a $44,596 basis

in lot 2160, and no gain was recognized from the sale of the

Virgil and Harrington properties. Petitioner’s 1989 return was

filed after petitioner became aware that lot 2160 had virtually

no value.

Petitioner sold real property at 508 Marsalis during 1984

and reported the sale on the installment basis. For the 1985

through 1989 taxable years, petitioner was entitled to and

received interest on the note connected with the 508 Marsalis

sale, but he failed to report any of the interest on his 1985

through 1987 income tax returns. Petitioner reported only one-

half of the interest received for 1988 and 1989. When confronted

by respondent's agent concerning the interest, petitioner told
 -39-

the agent that he was receiving only one-half of the interest.

The agent obtained copies of checks from the buyer of 508

Marsalis which reflected that petitioner was paid the full amount

of interest for 1988 and 1989. In several other respects

petitioner's responses to respondent's agent were false and/or

misleading and shown to be so by third-party investigation by the

agent.

Petitioner received and failed to report interest income for

1985, 1986, 1987, 1988, and 1989 in the amounts of $22,822,

$33,372, $34,052, $17,321, and $7,712, respectively. Petitioner

received and failed to report rental income for 1985, 1986, 1987,

1988, and 1989 in the amounts of $15,693, $19,601, $13,859,

$3,046, and $9,703, respectively. Petitioner failed to report

income from the sale of real properties for 1985, 1986, 1987,

1988, and 1989 in the amounts of $7,884, $18,792, $4,887,

$277,646, and $258,163, respectively. Petitioner was entitled

to, although he did not claim, a $179,905 passive loss deduction

for 1989 as a result of his $200,000 investment with Welch.

Petitioner did not keep complete or accurate records of his

business activity during the years in issue. Petitioner kept no

books of original entry, checkbook records, or other organized

set of books. For purposes of preparing his Federal income tax

returns, petitioner would provide his return preparer, who was a

certified public accountant, with receipts and various papers in
 -40-

shoe boxes. The return preparer required petitioner to make

schedules, and, ultimately, the returns prepared for petitioner

were based on the unaudited and unverified information presented

by petitioner.

Discussion

Respondent determined that petitioner is liable for an

addition to tax or penalty for fraud in each of the taxable years

in issue. For 1985, section 6653(b)(1) provides for a 50-percent

addition to tax if any part of the underpayment is due to fraud,

and section 6653(b)(2) provides for an addition equal to 50

percent of the interest payable on the portion of the

underpayment attributable to fraud. For 1986 and 1987, section

6653(b)(1)(A) provides for a 75-percent addition to tax on the

portion of the underpayment attributable to fraud, and section

6653(b)(1)(B) provides for an addition equal to 50 percent of the

interest payable on such portion. Finally, for 1988 and 1989,

sections 6653(b)(1) and 6663(a), respectively, provide for a 75-

percent addition to tax or penalty on the portion of the

underpayment that is attributable to fraud. Fraud is defined as

an intentional wrongdoing designed to evade tax believed to be

owing. Powell v. Granquist, 252 F.2d 56 (9th Cir. 1958); Miller

v. Commissioner, 94 T.C. 316, 332 (1990).

Respondent has the burden of proving by clear and convincing

evidence that an underpayment exists for each of the years in
 -41-

issue and that some portion of the underpayment is due to fraud.

Sec. 7454(a); Rule 142(b). To meet this burden, respondent must

show that petitioner intended to evade taxes known to be owing by

conduct intended to conceal, mislead, or otherwise prevent the

collection of taxes. Stoltzfus v. United States, 398 F.2d 1002

(3d Cir. 1968); Webb v. Commissioner, 394 F.2d 366 (5th Cir.

1968), affg. T.C. Memo. 1966-81; Rowlee v. Commissioner, 80 T.C.

1111, 1123 (1983).

The existence of fraud is a question of fact to be resolved

upon consideration of the entire record. Estate of Pittard v.

Commissioner, 69 T.C. 391 (1977); Gajewski v. Commissioner, 67

T.C. 181, 199 (1976), affd. without published opinion 578 F.2d

1383 (8th Cir. 1978). Fraud is not to be imputed or presumed,

but it must be established by some independent evidence of

fraudulent intent. Beaver v. Commissioner, 55 T.C. 85, 92

(1970); Otsuki v. Commissioner, 53 T.C. 96 (1969). Fraud may not

be found under "circumstances which at the most create only

suspicion." Davis v. Commissioner, 184 F.2d 86, 87 (10th Cir.

1950); Petzoldt v. Commissioner, 92 T.C. 661, 700 (1989).

However, fraud may be proved by circumstantial evidence and

reasonable inferences drawn from the facts because direct proof

of the taxpayer's intent is rarely available. Spies v. United

States, 317 U.S. 492 (1943); Rowlee v. Commissioner, supra;

Stephenson v. Commissioner, 79 T.C. 995 (1982), affd. per curiam
 -42-

748 F.2d 331 (6th Cir. 1984). The 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, supra at 105-106. The intent to conceal or mislead

may be inferred from a pattern of conduct. See Spies v. United

States, supra at 499.

Courts have relied on several indicia of fraud in

considering the fraud addition in tax cases. Although no single

factor may necessarily be sufficient to establish fraud, the

existence of several indicia may be persuasive circumstantial

evidence of fraud. Solomon v. Commissioner, 732 F.2d 1459, 1461

(6th Cir. 1984), affg. per curiam T.C. Memo. 1982-603; Beaver v.

Commissioner, supra at 93.

Circumstantial evidence that may give rise to a finding of

fraudulent intent includes: (1) Understatement of income,

(2) inadequate records, (3) failure to file tax returns,

(4) implausible or inconsistent explanations of behavior,

(5) concealment of assets, (6) failure to cooperate with tax

authorities, (7) filing false Forms W-4, (8) failure to make

estimated tax payments, (9) dealing in cash, (10) engaging in

illegal activity, and (11) attempting to conceal illegal

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

1986), affg. T.C. Memo. 1984-601; see Douge v. Commissioner, 899

F.2d 164, 168 (2d Cir. 1990). These "badges of fraud" are
 -43-

nonexclusive. Miller v. Commissioner, supra at 334. The

taxpayer's background and the context of the events in question

may be considered as circumstantial evidence of fraud. United

States v. Murdock, 290 U.S. 389, 395 (1933); Spies v. United

States, supra at 497; Plunkett v. Commissioner, 465 F.2d 299, 303

(7th Cir. 1972), affg. T.C. Memo. 1970-274.

Respondent based a determination of fraud on the following

general indicia: (1) Petitioner's sophistication, (2) his

relationship with his return preparer, (3) his propensity to deal

in cash, (4) his conduct with respondent's agent, (5) his

credibility, (6) the "fraudulent" alimony deduction, and (7) a 5-

year pattern of underreported income.

Petitioner admits that he may have made errors in the

reporting of his income, but that errors were made for and

against his own interests. Further, petitioner paints himself as

an unsophisticated individual who relied on professionals for the

preparation of his tax returns. Although petitioner failed to

claim one substantial item which was beneficial to him, the

record otherwise reflects a pattern of understatement

attributable to unreported income, misrepresentation, and design.

Although petitioner was not specifically educated in

accounting and tax matters, he was a successful and effective

businessman involved in numerous real estate transactions and

complex business transactions. His mistrust of lawyers and
 -44-

failure to document his transactions cannot be attributed to

inadvertence or mere negligence in the setting of this case.

Petitioner made misrepresentations to respondent's agent during

the conduct of the audit. He also reported a transaction

reflecting nonrecognition of gain from the sale of two parcels of

realty which he knew to be incorrect and deceptive. The

purported section 1031 item involved a series of steps designed

to falsely defer gain on transactions which did not meet the

requirements of the statute. In addition, the information

supplied to the preparer as reflected in the return was, to

petitioner’s knowledge, incorrect and misleading.

Petitioner contends that he relied on his return preparer

regarding these matters, including the section 1031 exchange.

His return preparer, however, simply reported the information

provided by petitioner. In that regard petitioner knew that the

lot 2160 property was of nominal value and, still, he provided

the return preparer with information reflecting that the fair

market value of the exchanged property (lot 2160) was $305,000.

The amount of value provided was designed to permit the wrongful

deferral of several hundred thousand dollars of taxable gain.

These are not matters that occurred inadvertently or on a one-

time basis. Petitioner also consistently failed to report

substantial amounts of income.
 -45-

Petitioner’s failure to keep books was part of his design to

hide or obscure his numerous and successful transactions in

operating and trading real property. It is also likely that

petitioner's anonymous involvement with Ms. Jackson and the road

contracts was a deception to permit petitioner to participate in

a minority and/or woman's preferential program. Petitioner did

suffer a loss in his transactions with Ms. Jackson as well as his

transactions with Mr. Welch. The losses incurred in these

transactions were funded with income from petitioner's successful

real estate activity, some of which was not reported to

respondent. Petitioner was knowledgeable about and in control of

his real estate activity. Interest income and gains on sales

were consistently understated on petitioner's returns for each of

the years before the Court.

We accordingly sustain respondent's determination that a

part of the understatement for the taxable year 1985 was due to

fraud. With respect to the 1986, 1987, 1988, and 1989 taxable

years, the unreported income from interest, rent, and the sale of

property are due to fraud. For the 1986 taxable year, the

unreported income (adjustment “g.” on Form 5278 of the notice of

deficiency) is also due to fraud. With respect to the 1989

taxable year, the item of increased income attributable to the

section 1031 gain is also due to fraud. Because we have found

that petitioner is liable for fraud for each of the taxable years
 -46-

in issue, it is unnecessary to consider whether he is liable for

additions to tax for negligence or delinquency for the 1985

through 1988 taxable years.

Regarding the 1989 taxable year, it is unnecessary to

consider the accuracy-related penalty under section 6662 because

we have found that petitioner is liable under section 6663(a).

With respect to the addition to tax for delinquency under

section 6651(a)(1) for the 1989 taxable year, that issue is not

preempted by our section 6663(a) finding. Petitioner's 1989

Federal income tax return was not filed until November 29, 1990.

Petitioner bears the burden of showing that respondent's

determination of the addition to tax for failure to timely file

is in error. Petitioner did not show that he obtained extensions

to file beyond the normal April 15, 1990, date or that he had

reasonable cause for filing beyond the required date.

Accordingly, petitioner is liable for the section 6651(a)(1)

addition for the 1989 taxable year.

Issue 7. Whether Petitioner Is Liable for the Substantial
Understatement Addition to Tax Under Section 6661 for 1985, 1986,
1987, or 1988

Section 6661 provides for a 25-percent addition to tax on

any substantial understatement. Pallottini v. Commissioner, 90

T.C. 498 (1988). A substantial understatement is one that

exceeds the greater of 10 percent of the tax required to be shown

on the return or $5,000. Sec. 6661(b)(1). The amount of an
 -47-

understatement, for purposes of section 6661, is to be reduced by

the portion attributable to any item for which there was

substantial authority or any item which was adequately disclosed.

Sec. 6661(b)(2)(B).

Petitioner, on brief, made scant reference to section 6661.

He argues that he believed that he had no tax liability and/or

that he relied on his accountant on the section 1031 transaction,

which he believed to be adequately disclosed. As to petitioner's

first position that he believed that he had no tax liability, we

have difficulty reconciling that position with the record.

Concerning the possibility of an adequate disclosure,

petitioner singles out the section 1031 transaction. Curiously,

respondent did not determine an addition to tax under section

6661 for the 1989 taxable year, the one in which the section 1031

transactions were disclosed.

Accordingly, we find that, for the taxable years 1985

through 1988, petitioner did not show error regarding

respondent's determination that section 6661 is applicable, and

we sustain the additions to tax under that section for each such

year in which the understatement of tax, as recomputed pursuant

to our opinion, exceeds the threshold amount of section

6661(b)(1).

To reflect the foregoing and considering concessions of the

parties,
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Decision will be entered

under Rule 155.