T.C. Memo. 1996-425
UNITED STATES TAX COURT
CHARLES L. FIELDS AND BARBARA S. FIELDS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 26636-87. Filed September 19, 1996.
A, a corporation, agreed with P and Y to pay them
commissions on any oil that it purchased in foreign
countries as a result of their efforts. P and Y
organized a Bermudan corporation, to which they
directed the payment of all the commissions. Held:
The commissions attributable to P's services are
taxable to him under the assignment of income doctrine.
Held, further: Ps failed to recognize dividend income
in the amounts set forth by R. Held, further: Ps
failed to recognize interest income in the amounts set
forth by R. Held, further: P is liable for additions
to tax for fraud, and the 3-year period of limitation
under sec. 6501(a), I.R.C., does not bar the assessment
and collection of tax for any of the subject years.
Held, further: P's wife is not an innocent spouse
under sec. 6013(e), I.R.C.
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Lawrence F. Ruggiero and Robert Koppelman, for petitioners.1
Cheryl A. McInroy, Elizabeth A. Maresca, and
Steven D. Tillem, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: Charles L. Fields and Barbara S. Fields
petitioned the Court to redetermine respondent's determinations
with respect to their 1980 through 1982 taxable years.
Respondent determined deficiencies of $525,389, $243,493, and
$1,365 in their 1980, 1981, and 1982 Federal income taxes,
respectively. Respondent also determined that Mr. Fields was
liable for a: (1) $262,695 addition to his 1980 tax under
section 6653(b), (2) $121,747 addition to his 1981 tax under
section 6653(b), (3) $683 addition to his 1982 tax under section
6653(b)(1), and (4) time-sensitive addition to his 1982 tax under
section 6653(b)(2) with respect to that year's entire deficiency.
Respondent's determinations are reflected in a notice of
deficiency dated May 14, 1987.
1
Mr. Ruggiero and Mr. Koppelman entered the case on
Apr. 17, 1995, and May 22, 1995, respectively. Edward J. Daus,
who prepared the subject petition, withdrew as petitioners'
counsel on June 16, 1988. Paul S. Haar entered the case on
petitioners' behalf on Nov. 21, 1989, but withdrew on Feb. 14,
1990. Mr. Haar also withdrew on Jan. 6, 1993, after he had
reentered the case on May 14, 1990.
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We must decide:
1. Whether petitioners received commission income of
$487,104 and $182,020 in 1980 and 1981, respectively.2 We hold
they did.
2. Whether petitioners received dividend income of $22,135
and $19,510 in 1980 and 1981, respectively. We hold they did.
3. Whether petitioners received interest income of $7,791,
$37,612, and $8,429 in 1980, 1981, and 1982, respectively. We
hold they did.
4. Whether Mr. Fields (petitioner) is liable for additions
to his 1980 through 1982 taxes for fraud. We hold he is.
5. Whether the 3-year period of limitation under section
6501(a) bars the assessment and collection of tax for any of the
subject years. We hold it does not.
6. Whether Mrs. Fields is an innocent spouse under section
6013(e). We hold she is not.
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the subject years. Rule
references are to the Tax Court Rules of Practice and Procedure.
Dollar amounts are rounded to the nearest dollar.
2
The notice of deficiency states that petitioners received
commission income of $825,025 and $307,005 in 1980 and 1981,
respectively. Respondent has conceded that $337,921 and $124,985
of this income for the respective years was attributable to (and
includable in the gross income of) petitioner's business partner,
Dr. Walter F. Young.
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FINDINGS OF FACT3
1. Overview
a. General
Some of the facts have been stipulated and are so found.
The stipulations and attached exhibits are incorporated herein by
this reference. Petitioners have been married for the last
33 years, and they resided in Rye, New York, when they filed
their petition herein. They are cash method taxpayers, and they
signed and filed 1980, 1981, and 1982 Forms 1040, U.S. Individual
Income Tax Return, using the status of "Married filing joint
return". Their 1980, 1981, and 1982 returns reported taxable
income of $56,847, $71,010, and $5,550, respectively. Gross (and
adjusted gross) income for the respective years were reported as
$86,153, $107,373, and $37,766. Wages for the respective years
were reported as $96,412, $111,652, and $40,166.
3
Petitioner testified at trial. Based on our observation
of petitioner at trial, and following our review of the record as
a whole, we conclude that petitioner's uncorroborated testimony
is largely unreliable. See Kraut v. Commissioner, 527 F.2d 1014,
1019 (2d Cir. 1975), affg. 62 T.C. 420 (1974); Pepi, Inc. v.
Commissioner, 448 F.2d 141, 147 (2d Cir. 1971), affg. 52 T.C.
854 (1969); O'Connor v. Commissioner, 412 F.2d 304, 311 (2d Cir.
1969), affg. in part and revg. in part T.C. Memo. 1967-174;
Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).
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b. Petitioner
Petitioner is well-educated in the intricacies of the
business world, and he has been deeply involved in that world for
almost 40 years. He received a bachelor's degree in political
science with a minor in business from Florida A & M University in
1958. He received a master's degree in business from Columbia
University Graduate School of Business in 1972. He lectured at
Northwestern University, Harvard University, University of
Chicago, Florida A & M University, and Southern University in
Louisiana, mainly on the procedures and policies for conducting
business in Africa. He taught as an adjunct professor in
organizational behavior at the Graduate School of Business at
Harvard University. He consulted for the Commerce Department, on
the topic of conducting business in Africa. He served as an
executive, during at least the subject years, advising management
on development work and international trading. He founded the
National Black MBA Association. He created the first database of
minorities with bachelor's, master's, and Ph.D. degrees.
2. Sales of Oil
BarSon International Ltd. (BarSon) is a Delaware corporation
that was organized by petitioner and Dr. Walter F. Young (Dr.
Young) on March 4, 1977, to provide consulting services for
American corporations abroad and to entice American construction
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companies to build in Africa.4 Dr. Young and petitioner are
BarSon's president and secretary, respectively, and they each own
50 percent of its stock. BarSon is a cash method taxpayer, and
its taxable year ends on March 31.
On November 19, 1979, BarSon and Ashland Oil, Inc.
(Ashland), entered a written agreement under which BarSon's
managing directors (petitioner and Dr. Young) or other key
employees would advise Ashland on starting business abroad
(including the requirements for purchasing crude oil in foreign
countries) in exchange for a daily fee of $750 plus expenses.5
The agreement did not contain a provision for Ashland to pay
BarSon commissions on the actual purchase of oil by Ashland.
Petitioner and Dr. Young, on behalf of themselves, entered into a
separate oral agreement with Ashland under which Ashland would
pay commissions to petitioner and Dr. Young for any oil purchased
as a result of their efforts. Petitioners have never reported
any income on their personal income tax returns for commissions
4
Dr. Young is the brother of Andrew Young, the U.S.
ambassador to the United Nations during the Carter
administration. The occurrences described below began at or
about the time when Andrew Young led an official U.S. trade
delegation (with petitioner and Dr. Young) to Africa to discuss
oil and other matters.
5
BarSon and Ashland amended this agreement on Feb. 1, 1981,
to increase the daily rate to $1,250, with a minimum of $15,625
per month. From 1979 until 1981, Ashland paid BarSon at least
$713,765 under this agreement. These payments were deposited
into BarSon's bank accounts.
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paid under the terms of the oral agreement with respect to
petitioner's services.
In an attempt to secure large amounts of crude oil for
Ashland, petitioner and Dr. Young traveled many times to Cameroon
(at the instruction of Ashland), and they met with officials of
Cameroon's national oil company, Société Nationale des
Hydrocarbures (SNH). In March 1980, Ashland and Cameroon agreed
that Ashland would acquire oil from SNH through Ashland's Bermuda
subsidiary, Ashland (Bermuda) Limited (ABL).
At or about the same time, petitioner and Dr. Young decided
that they wanted to organize a corporation in Bermuda or some
other traditional tax haven to avoid Federal income tax on their
commissions from Ashland. They contacted the law firm of
Danzansky, Dickey, Tydings, Quint & Gordon (which was merged into
Finley, Kumble, Wagner, Heine, Underberg & Casey on or about
January 1, 1981, and which with its successor will hereinafter be
referred to as Finley Kumble),6 to obtain assistance in
organizing such a corporation. Following discussions with
petitioner and Dr. Young, Finley Kumble understood that
6
Although Danzansky, Dickey, Tydings, Quint & Gordon is a
different firm than Finley, Kumble, Wagner, Heine, Underberg
& Casey, the attorneys at these firms who advised petitioner and
Dr. Young were generally the same throughout the relevant period
herein. Robert B. Washington, Jr., one of the principal partners
in charge of the accounts of petitioner, Dr. Young, and the
related entities throughout the relevant time, oversaw and was
actively involved in most (if not all) of the advice that the
firms rendered to petitioner and Dr. Young, either personally or
on behalf of their related entities.
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petitioner and Dr. Young would render valuable management and
consulting services to the foreign corporation as corporate
employees, and that these services would result in substantial
revenue. Finley Kumble anticipated that the corporation would
distribute the revenue to Dr. Young and petitioner in the form of
salaries over several years. Finley Kumble believed that,
although the corporation would most likely be a "controlled
foreign corporation" and a "foreign personal holding company", a
careful structuring of the arrangement would allow petitioner and
Dr. Young to escape the U.S. tax until they actually received
their salary payments. Finley Kumble believed that the
arrangement was subject to attack by the Commissioner under
section 367 or 482, or by arguing doctrines such as:
(1) Substance over form, (2) sham transaction, (3) assignment of
income, or (4) deductibility of compensation. Finley Kumble
relayed these understandings, anticipations, and beliefs to
petitioner and Dr. Young. Petitioner and Dr. Young chose to
organize the foreign corporation.
Finley Kumble, on behalf of petitioner and Dr. Young,
contacted Max Quin (Mr. Quin), an attorney with a Bermuda law
firm named Vaucrosson's, to organize the corporation because it
was customary to use Bermudan counsel to organize a Bermudan
corporation. On or about April 10, 1980, Mr. Quin organized the
corporation for petitioner and Dr. Young under the name of
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Cameroon Atlantis International (CAI).7 Finley Kumble helped Mr.
Quin in the organization by relaying to him information from
petitioner and Dr. Young. Petitioner was very active in the
organizational process.
CAI's address was Vaucrosson's address in Bermuda, and CAI
was organized under the Companies (Incorporation by Registration)
Act of 1970 (the Act) as an exempt company that could not hold
land. CAI's initial capital was 12,000 shares of stock with a $1
par value,8 and all of its shares were issued to nominees for
petitioner and Dr. Young. Permission had been given on April 25,
1980, by Bermuda's Minister of Finance, to incorporate CAI as an
exempt company, and CAI's memorandum of association was deposited
in the Bermudan Office of the Registrar of Companies in
accordance with the provisions of the Act, on April 28, 1980.
Upon its organization, petitioner and Dr. Young transferred to
CAI their contractual right to receive commissions from Ashland
on any barrels of oil purchased as a result of their efforts.
The sales of oil between ABL and Cameroon in 1980 and 1981
were accomplished through the use of back-to-back contracts
involving CAI as an intermediary. Under these contracts, CAI
contracted with SNH to buy oil at a fixed price, and CAI
7
CAI changed its name to Atlantis International Ltd.
(Atlantis) on Feb. 14, 1981.
8
Atlantis increased its share capital to $71,980 on
Apr. 29, 1981.
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contracted to sell that same oil to ABL for the same price plus a
commission of 25 to 30 cents per barrel.9 ABL received 404,968
barrels of oil shipped from Cameroon on March 30, 1980, and ABL
paid CAI a 30-cent-per-barrel commission (totaling $121,490) for
this shipment. The oil was purchased on the spot market, and
local custom did not allow for a written contract on the
delivery.
On April 10, 1980, CAI agreed to buy 190,000 metric tons of
oil from SNH at a set price, with 120,000 of these metric tons to
be delivered in April 1980 and the balance to be delivered in
May 1980. On April 21, 1980, ABL agreed with CAI to purchase the
same oil at the same price plus a commission of 30 cents per
barrel.10 Ashland arranged the terms for shipping the oil, it
nominated the vessels used for lifting the oil, and it set the
mode of payment for the oil. Petitioner and Dr. Young arranged
for ABL's purchase of the oil, and ABL paid them for their
services by paying CAI the spread between the back-to-back
contracts. Commissions for the shipments under the April
contract totaled $424,157.
On August 8, 1980, CAI agreed to buy 840,000 metric tons of
oil from SNH at a set price, with equal monthly deliveries from
9
CAI did not have the financial capacity to purchase the
oil from SNH, and CAI had not entered into a consulting or agency
agreement with ABL or Ashland.
10
ABL received 457,680 barrels of the oil referred to in
this contract on Apr. 15, 1980.
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August 1980 through July 1981. On August 8, 1980, ABL agreed
with CAI to buy the same oil at the same price plus a commission
of 25 cents per barrel. Ashland arranged the terms for shipping
the oil, it nominated the vessels used for lifting the oil, and
it set the mode of payment for the oil. Petitioner and Dr. Young
arranged for ABL's purchase of the oil, and ABL paid them for
their services by paying CAI the spread between the back-to-back
contracts. Commissions for the shipments under the August
contracts totaled $1,064,424. The last shipment under the August
contracts was on March 3, 1981.
On January 1, 1981, CAI and ABL entered into a contract for
the monthly purchase and sale of approximately 70,000 metric tons
of oil for the 7-month period ended July 31, 1981. ABL paid the
set price directly to SNH, and ABL took delivery of the oil
directly from SNH.11 ABL paid the per-barrel commissions
directly to CAI. Petitioner and Dr. Young arranged for ABL's
purchase of the oil, and ABL paid them for their services by
paying CAI the spread between the back-to-back contracts.
ABL paid commissions to CAI by check.12 All of these checks
were payable to CAI and deposited into CAI's checking account
(the C account) at N.T. Butterfield & Son Bank (Bank) in Bermuda.
11
ABL put a provision in the back-to-back contracts that
allowed it to pay SNH directly for the oil to ensure itself that
the oil was paid for.
12
All of the commissions were due to the efforts of
petitioner and Dr. Young.
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The following commission checks were deposited into the C account
during 1980 and 1981:
Date of Payment Barrels Commission Amount Date Shipped
Apr. 30, 1980 404,968 .30/brl $121,490 3/30/80
May 12, 1980 457,680 .30/brl 137,304 4/15/80
May 14, 1980 441,837 .30/brl 132,551 4/22/80
June 20, 1980 514,339 .30/brl 154,302 5/13/80
Sept. 17, 1980 546,934 .25/brl 136,733 8/20/80
Oct. 9, 1980 508,128 .25/brl 127,032 9/11/80
Nov. 10, 1980 476,470 .25/brl 119,117 10/11/80
Dec. 11, 1980 516,144 .25/brl 129,036 11/11/80
Jan. 12, 1981 515,671 .25/brl 128,918 12/12/80
Feb. 2, 1981 536,050 .27/brl 144,734 1/3/81
Mar. 6, 1981 515,455 .27/brl 139,173 2/4/81
Apr. 2, 1981 517,336 .27/brl 139,681 3/3/81
1,610,071
Of the total commissions of $1,610,071, BarSon ultimately
received $232,540 and $245,500 of this amount in 1980 and 1981,
respectively, for a total of $478,040. Approximately $265,000 of
this $478,040 amount was reported on BarSon's 1980 tax return.13
BarSon never reported any other commissions as income on a
Federal income tax return. The commissions that respondent seeks
to attribute to petitioners have been reduced by the $478,040 of
commissions reported by BarSon.14 Respondent gave petitioners
credit for $245,500 paid to BarSon in its 1981 taxable year,
although BarSon never included this amount in its gross income.
13
This return reports that BarSon had $571,790 of total
income and $57,483 of taxable income.
14
Respondent further reduced the commissions reportable by
petitioners for 1980 and 1981 by $337,921 and $124,985,
respectively. See supra note 2.
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3. Finley Kumble's Legal Advice
On September 26, 1980, attorneys from Finley Kumble met with
petitioner and Dr. Young in Washington, D.C. Petitioner and Dr.
Young believed that they had a tax problem with respect to funds
brought from Bermuda into the United States, and they requested
assistance from Finley Kumble on this problem. Petitioner and
Dr. Young informed the attorneys that they (petitioner and
Dr. Young) had drawn approximately $90,000 on CAI's C account for
reasons that included the payment of their personal creditors in
the United States. Petitioner and Dr. Young produced checks
payable to their creditors in the total amount of $75,000 which
had not been transmitted or cashed.15 Petitioner and Dr. Young
later voided all of these untransmitted and uncashed checks at a
subsequent meeting with Finley Kumble on October 2, 1980.
On October 10, 1980, attorneys from Finley Kumble met with
petitioner and Dr. Young to discuss primarily the tax issues
connected with petitioner and Dr. Young's receipt of the funds.
Finley Kumble recommended that petitioner and Dr. Young ignore
the existence of CAI and report the commissions as income.
15
By September 1990, petitioner and Dr. Young had actually
withdrawn almost $400,000 from the C account, in addition to the
$75,000 of uncashed drafts, most of which was attributable to
petitioner.
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Petitioner and Dr. Young informed Finley Kumble that they did not
want to ignore CAI's existence.
On October 27, 1980, attorneys from Finley Kumble met again
with petitioner and Dr. Young. In a letter bearing the same
date, Finley Kumble explained that the organization and operation
of CAI departed dramatically from the basic organization and
operation of a foreign corporation because: (1) CAI was
organized after the business activity of locating a source of
crude oil was well advanced and (2) CAI's primary business
activities were carried on in the name of BarSon. Given the
factual pattern of CAI's organization and operation, the letter
stated, the Commissioner could argue that the assignment of
income doctrine required that the income received from ABL be
taxed to BarSon or, alternatively, that section 367 provided that
petitioner and Dr. Young's transfer of their contractual rights
to CAI was a taxable transfer. Finley Kumble advised that each
theory created a substantial tax exposure to BarSon and to
petitioner and Dr. Young individually.
In a letter to petitioner dated December 9, 1980, Finley
Kumble reiterated its advice that the organization of CAI in
midstream created dangerous ambiguities. Finley Kumble cautioned
petitioner and Dr. Young that "defensive planning" had been
undertaken to deal with what had already occurred, that there
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were significant risks, and that it was very likely that the
Commissioner would audit petitioner, Dr. Young, and/or one or
more of their related entities. Finley Kumble reiterated this
warning in a letter to petitioner dated December 15, 1980.
In the letter of October 27, 1980, Finley Kumble also
advised petitioner and Dr. Young that Form 959, Return by an
Officer, Director, or Shareholder with Respect to the
Organization or Reorganization of a Foreign Corporation and
Acquisition of its Stock, should be immediately filed with the
Commissioner to reflect the transfer of their contractual rights
to CAI. The letter explained that Form 959 must be filed by
persons holding an office (or serving as a director) of a foreign
corporation or owning 5 percent of its stock.
Finley Kumble prepared Forms 959 for petitioner and Dr.
Young. Finley Kumble gave petitioner his Form 959 at a meeting
in Bermuda, and he signed the form at that time. Petitioner
never filed this (or any other) Form 959, and he did not ask
Finley Kumble (and Finley Kumble did not assume the legal
responsibility) to file Form 959 on his behalf.
4. CAI's Interest Accounts
In addition to the C account, CAI had time deposit (TD)
accounts in which money was transferred from the C account to
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earn interest. CAI also had a set-off account, an escrow
account, and a collateral account.
CAI's funds at the Bank earned interest in the amounts of
$15,582, $75,224, and $16,858 in 1980, 1981 and 1982,
respectively. Petitioners did not report any interest income
from the Bank on their 1980, 1981, or 1982 returns. Respondent
determined that petitioners' gross income for the subject years
included half of the interest earned in each year.
5. Petitioners' Use of BarSon and CAI Funds
In February 1979, petitioners purchased a home in Rye,
New York, for approximately $160,000. In 1980, they used $18,635
of BarSon's funds to pay for work performed on that home.
Petitioners sold their home in Rye, New York, in July 1994, for
approximately $455,000. Respondent determined that petitioners
received an $18,635 constructive dividend from BarSon in 1980, on
account of their use of its funds to pay for work done to their
home. Respondent determined that BarSon's accumulated earnings
and profits (E&P) were $1,322,644 on March 31, 1981.
BarSon reported that it paid $20,000 in business-related
legal fees to Finley Kumble in 1980 and 1981. Finley Kumble
rendered legal advice to petitioners on personal matters
including the registration requirements for acquiring a boat,
financing the purchase of a house in New York, and preparing a
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home mortgage application. Respondent determined that $10,000 of
the $20,000 amount was a constructive dividend to petitioners
because the legal advice pertained to petitioners' personal
matters. Respondent determined that $2,500 of this dividend was
paid in 1980 and the balance in 1981. Respondent also determined
that petitioners used BarSon's checks in 1980 to pay for $1,000
of their personal expenses, that BarSon paid $2,728 in 1981 for
petitioners' personal promotion expense, that BarSon paid $6,987
in 1981 for petitioners' personal travel, and that petitioners
received a $2,295 constructive dividend from BarSon in 1981,
stemming from their personal use of an automobile.
Petitioner did not personally withdraw money from CAI's
accounts. Petitioner directed Mr. Quin to send money from CAI's
accounts to designated payees, and Mr. Quin directed the Bank to
disburse CAI's funds according to petitioner's directions. From
1980 to 1982, most of CAI's disbursements went to petitioner or
to third parties designated by petitioner for his benefit.
In July 1981, CAI formed two new accounts (the A and B
accounts) at the Bank, and the C account remained as CAI's
operating account. Petitioner controlled the A account, and the
balance therein stemmed from income for his services. Dr. Young
controlled the B account, and the balance therein stemmed from
income for his services. Petitioner withdrew $291,936 from the C
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account for his benefit. Petitioner and Dr. Young withdrew
$247,788 from the C account for the benefit of both; respondent
determined that half of this amount ($123,894) was attributable
to petitioner.
Petitioner borrowed $25,000 from the Bank on December 19,
1980, and $10,000 on October 1, 1981. Petitioner paid off the
loans with funds from his account at Citibank, and with funds
from the C account, the set-off account, and the A account.
Petitioner caused $31,819 to be withdrawn from the set-off
account and applied to his loans at the Bank.
Petitioners used checks drawn on CAI's C account to pay for
more than $55,000 of renovation to their home in Rye, New York,
in 1980 and 1981. They used checks drawn from CAI's C account to
pay for more than $9,000 in landscaping at that home in 1980.
They used checks drawn from the C account to pay for more than
$100,000 in interior decoration in 1980 and 1981. They used
checks drawn on CAI's C account to pay for summer programs for
their children. They used a check drawn on CAI's C account to
pay for legal services incurred in purchasing undeveloped land in
1980 for more than $100,000.16 Mrs. Fields used checks drawn on
CAI's C account to purchase more than $5,000 of china.
16
Petitioners planned to spend an additional $217,000 to
build a vacation home, two tennis courts, and a pool on the land,
but they ended up selling the undeveloped land for $450,000.
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Petitioners never reported any of CAI's funds used by them
as income on a personal tax return. The total amount of CAI
funds in the A, C, and set-off accounts used for petitioners'
benefit totaled $705,107.17 Of this amount, $245,008 was used in
1980, $312,269 was used in 1981, and $147,830 was used in 1982.
Petitioner was aware that he could be charged with income from
CAI and the resulting tax liability.
6. Reporting Requirements
Petitioners' 1980 through 1982 tax returns were prepared by
their accountant, Seymour Schiller (Mr. Schiller). In connection
with the preparation of those returns, petitioner did not tell
Mr. Schiller that petitioners had an interest in a foreign
account during the relevant years. Petitioners indicated on
their 1980 and 1981 tax returns that they did not have such an
interest during 1980 and 1981. Petitioners did not report on
their 1982 tax return that they had an interest in a foreign
account during 1982. Petitioners had an interest in CAI's bank
account during each of the subject years.
7. Mrs. Fields
Mrs. Fields is an educated woman, and she has been involved
in the business world in a limited capacity. She received a
17
Respondent seeks to include only $669,124 of this income
in petitioners' gross income.
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bachelor's degree in education from City University of New York
in 1958. She received a master's degree from City University in
1962, earning 60 credits towards a postgraduate degree.
She taught grade school in New York, New York, from 1967 through
1995. She worked for Fields, Freeman & Associates (FFA) in 1981,
researching, examining resumes, and making contacts for FFA.
Petitioners owned 100 percent of FFA, and Mrs. Fields was its
vice president and one of its officers. She was a director of
BarSon, until she resigned due to illness. She managed
petitioners' household finances, including paying their mortgage
and balancing their checking account. She was authorized to sign
petitioner's business checking accounts. She was authorized to
sign checks for FFA.
Mrs. Fields knew that petitioner worked through BarSon, and
that he owned 50 percent of its stock. She knew that petitioner
had a business relationship with Ashland, and that this
relationship concerned advising African businessmen on the topics
of construction and oil. She knew that petitioner tried to
secure oil for Ashland, that he had traveled to Cameroon to do
so, and that he had contacted African businessmen on the
procurement of oil. She knew that one of petitioner's business
associates was a Government official from Cameroon, and that the
relationship between him and petitioner involved oil and Ashland.
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She knew that petitioner had traveled to Bermuda on business, she
accompanied him on at least one occasion, and she knew that he
met with Mr. Quin during that trip. She entertained petitioner's
business associates at functions in their home.
Mrs. Fields signed a residential loan application stating
that petitioners had a beneficial interest in Atlantis worth
$300,000. Her children attended a private school in Rye, New
York, in 1980 and 1981, and she knew that tuition cost about
$7,000 a year for each child. Petitioners purchased a $16,735
boat in 1981.
Mrs. Fields generally did not question petitioner about
their finances. She relied on him and Mr. Schiller to prepare
their income tax returns correctly, and she did not question the
numbers on the returns. Mrs. Fields did not ask petitioner if
she could review their tax returns. She knew that petitioner
would have let her review their returns if she asked.
OPINION
Except with respect to respondent's allegations of fraud,
petitioners must prove that respondent's determinations set forth
in the notice of deficiency are incorrect. Rule 142(a) and (b);
Welch v. Helvering, 290 U.S. 111, 115 (1933). Respondent must
prove by clear and convincing evidence that petitioner is liable
for the additions to tax for fraud. Sec. 7454(a); Rule 142(b).
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With these basic principles in mind, we turn to the issues for
decision.
Issue 1. Commission Income
Respondent determined that most of the commissions paid by
ABL to CAI were taxable to petitioners. Respondent primarily
argues that the commissions are taxable to petitioners under the
assignment of income doctrine. Petitioners argue that the
doctrine prohibiting an assignment of income does not apply to
the facts at hand because petitioner organized CAI upon the
mandate of Ashland. Petitioners argue that the doctrine is
inapplicable because petitioner was not a shareholder of CAI.
Petitioners argue that Finley Kumble organized CAI on its own
initiative, and that petitioner was ignorant as to CAI's
organization and operation. Petitioners argue that petitioner
insisted to Finley Kumble that all of the commissions from
petitioner's services be reported by BarSon, that he informed
Finley Kumble that he wanted nothing to do with an "offshore
corporation", and that he fired Finley Kumble (with the exception
of having the firm work on unrelated legal work for BarSon to the
extent of the advanced retainer), when Finley Kumble recommended
to him that he and Dr. Young evade taxes by keeping BarSon's
income offshore. Petitioner argues that Finley Kumble
established and controlled CAI for Finley Kumble's personal gain.
- 23 -
We agree with respondent's primary argument.18 It is
hornbook law that the person who earns income is taxed on it.
United States v. Basye, 410 U.S. 441 (1973); Commissioner v.
Culbertson, 337 U.S. 733, 739-740 (1949); Lucas v. Earl, 281 U.S.
111 (1930). Thus, we must decide who "earned" the commissions
paid by ABL during the years in question. We bear in mind that
"the true earner cannot always be identified simply by pointing
'to the one actually turning the spade or dribbling the ball'".
Fritschle v. Commissioner, 79 T.C. 152, 155 (1982) (quoting
Johnson v. Commissioner, 78 T.C. 882, 890 (1982), affd. without
published opinion 734 F.2d 20 (9th Cir. 1984)). We also
recognize the inherent tension between the application of the
assignment of income doctrine in the setting of a closely held
personal service corporation (PSC) and the recognition of a PSC
as a legal entity that is separate from its owners. Moline
Properties, Inc. v. Commissioner, 319 U.S. 436, 438-439 (1943).
We focus primarily on whether CAI or petitioner controlled
the earning of the disputed commissions. See Bagley v.
Commissioner, 85 T.C. 663, 675 (1985), affd. 806 F.2d 169 (8th
Cir. 1986); Johnson v. Commissioner, supra at 890-891. In cases
where the claimed earner is a closely held PSC, such as CAI, this
18
Accordingly, we do not mention or pass on respondent's
alternative arguments.
- 24 -
Court has followed a two-prong test under which the PSC is taxed
on the income when: (1) The service provider is an employee of
the PSC, whom the PSC has the right to direct and control in a
meaningful sense, and (2) the PSC and the service recipient have
a contract or similar indicium recognizing the controlling
position of the PSC. Leavell v. Commissioner, 104 T.C. 140,
151-152 (1995); Haag v. Commissioner, 88 T.C. 604, 611 (1987),
affd. without published opinion 855 F.2d 855 (8th Cir. 1988);
Bagley v. Commissioner, supra at 675-676; Johnson v.
Commissioner, supra at 893; see also sec. 31.3121(d)-1(c)(2),
Employment Tax Regs. When either of these prongs is not met, the
individual (rather than the PSC) is taxed on the income.
We apply this test to the facts at hand. With respect to
the first prong, we look to the record for indicia of an
employment relationship between CAI (the PSC) and petitioner (the
provider of the services that generated the commissions).
We find no employment contract or other evidence of an employment
relationship between the two. Indeed, petitioner acknowledged at
trial that he was not CAI's employee. Given the absence of the
necessary employer/employee relationship between petitioner and
CAI, we are unable to conclude that CAI had the ability to direct
or control petitioner's provision of the relevant services in a
meaningful sense so as to satisfy the first prong of the test.
- 25 -
The thrust of the work concerning the earning of the commissions
was performed prior to the formation of CAI, and many of the
relevant contracts were executed before CAI's memorandum of
association was deposited in the Bermudan Office of the Registrar
of Companies. Indeed, the contract of April 21, 1980, under
which ABL agreed with CAI to purchase a set amount of oil, was
executed by the parties thereto after some of the oil had already
been delivered on April 15, 1980. Moreover, following the
organization of CAI, petitioner (and not CAI) controlled the
earning of the disputed commissions. Petitioner (and not CAI)
dictated the manner in which he was going to provide his services
to ABL, as well as the means by which he would achieve the end
contemplated by the parties to the agreement underlying the
payment of the commissions.
The absence of an employment relationship between BarSon and
CAI is also relevant. We are unpersuaded from the record at hand
that BarSon (through petitioner and Dr. Young) rendered
consulting services to ABL on behalf of CAI. We read the record
to show that BarSon (through petitioner and Dr. Young) rendered
consulting services only to Ashland, in accordance with the
consulting agreement between those two corporations. The
commissions paid to CAI served to compensate petitioner and Dr.
Young for their personal services in effectuating the sale of oil
- 26 -
to ABL. These services were not rendered on behalf, or under the
control, of CAI.
We conclude that the first prong of the requisite two-prong
test is not met.19 Accordingly, we hold for respondent. With
respect to petitioners' arguments for a contrary holding, we find
no credible evidence in the record to persuade us that the
organization of CAI was required by Ashland, or that petitioner
was not a beneficial owner of CAI. Accordingly, we reject
petitioners' allegations to that effect.20
Issue 2. Dividend Income
Respondent determined that petitioner received constructive
dividends of $22,125 and $19,510 from BarSon during 1980 and
1981, respectively. Respondent determined that the 1980 dividend
resulted from: (1) BarSon's payment of $2,500 to Finley Kumble
for petitioners' personal legal fees, (2) $1,000 in checks drawn
on BarSon's account for petitioners' primary benefit, and
(3) BarSon's payment of $18,635 to contractors for work performed
19
In this regard, we also find relevant that petitioner and
Dr. Young performed all work necessary to find a source of oil
for Ashland. See Zand v. Commissioner, T.C. Memo. 1996-19 (under
facts similar in some respects to those here, individual taxed as
earner of commissions paid to corporation).
20
We also reject petitioners' allegations that petitioner
was ignorant on the formation and operation of CAI, being led
astray by the unethical and self-serving conduct of Finley
Kumble. The record (including evidence of petitioner's
education, intelligence, and business acumen) leads us to
conclude that this argument is meritless.
- 27 -
on petitioners' home. Respondent determined that the 1981
dividend resulted from: (1) BarSon's payment of $7,500 to Finley
Kumble for petitioners' personal legal fees, (2) BarSon's payment
of $2,728 for petitioners' personal promotion expense,
(3) BarSon's payment of $6,987 for petitioners' personal travel,
and (4) petitioners' personal use of an automobile ($2,295).
Petitioners allege that: (1) BarSon's $2,500 payment in 1980 was
for professional fees rendered to BarSon, (2) the $1,000 and
$18,635 amounts were charged to petitioner's loan account, and
later repaid, (3) BarSon's $7,500 payment in 1981 was for
professional fees rendered to BarSon, and (4) the $2,728, $6,987,
and $2,295 amounts were ordinary and necessary business expenses
of BarSon.
We agree with respondent that the subject amounts are
includable in petitioners' gross income as dividends.
A shareholder's gross income includes his or her receipt of any
dividend, regardless of whether the dividend was formally
declared by the corporation. Sec. 61(a)(7); Loftin & Woodard,
Inc. v. United States, 577 F.2d 1206, 1214 (5th Cir. 1978).
Where a shareholder receives a distribution of corporate funds
for his or her personal benefit, the distribution may be taxed to
the shareholder as a dividend to the extent of the corporation's
earnings and profits. Ireland v. United States, 621 F.2d 731,
- 28 -
735 (5th Cir. 1980); Loftin & Woodard, Inc. v. United States,
supra at 1214; Melvin v. Commissioner, 88 T.C. 63 (1987), affd.
894 F.2d 1072 (9th Cir. 1990); see also Old Colony Trust Co. v.
Commissioner, 279 U.S. 716 (1929) (payment of taxes by
corporation constitutes additional income to taxpayer). Key to
the test of the taxability of a distribution as a dividend is
whether the shareholder receives an economic benefit from the
corporation without any expectation of repayment, and whether the
benefit is primarily of a personal nature, unrelated to the
corporation's business. Ireland v. United States, supra at 735;
Loftin & Woodard, Inc. v. United States, supra at 1215-1217.
Under the facts at hand, we conclude that petitioners
received an economic benefit from CAI, which they assumed no
obligation to repay. Petitioners used BarSon's funds for their
personal purposes, and petitioner was a 50-percent shareholder of
the two-shareholder corporation. Although petitioners claim that
some of these funds (the $1,000 in checks and the $18,635 used
for home improvements) were lent to petitioner by BarSon for his
personal use, the record does not support this naked assertion.
We are unpersuaded that BarSon and petitioners intended for
petitioners to pay back any of the funds that they used for their
personal benefit. See Litton Business Sys., Inc. v.
Commissioner, 61 T.C. 367, 377 (1973). Because petitioners used
- 29 -
BarSon's funds to pay their personal expenses and did not intend
to repay these funds, we sustain respondent's determination on
this issue.21
Issue 3. Interest Income
Respondent determined that petitioners received taxable
interest of $7,791, $37,612, and $8,429 in 1980, 1981, and 1982,
respectively, from the funds deposited at the Bank. Petitioners
allege that they did not receive any interest from the Bank
because they never had an interest-bearing account there.
We agree with respondent's determination. Gross income
includes interest. Sec. 61(a)(4). Interest of $15,582, $75,224,
and $16,858 was earned in 1980, 1981, and 1982, respectively, on
the commissions deposited at the Bank. Petitioner and Dr. Young
had unfettered access to this interest, as well as to the
underlying funds. Petitioner and Dr. Young controlled the
activities of the accounts. Given the fact that petitioner was
one of two beneficial owners of the bank accounts that generated
the disputed interest, we sustain respondent's determination that
half of the interest earned on the accounts was realized by him.
21
Petitioners have also failed to persuade us that any of
the distributions were business expenses of BarSon.
- 30 -
Issue 4. Additions to Tax for Fraud
Respondent determined that petitioner was liable for
additions to tax for fraud in each year in issue. Petitioner
disputes this determination. Respondent must prove that
petitioner underpaid his taxes in each of the subject years, and
that some part of each underpayment was due to fraud, in order to
sustain her allegations of fraud under: (1) Section 6653(b), for
petitioner's 1980 and 1981 taxable years,22 and (2) section
6653(b)(1), for petitioner's 1982 taxable year.23 See secs.
22
As applicable to petitioner's 1980 and 1981 taxable
years, sec. 6653(b) provides: "If any part of any underpayment
* * * of tax required to be shown on a return is due to fraud,
there shall be added to the tax an amount equal to 50 percent of
the underpayment."
23
Sec. 325(a) of the Tax Equity and Fiscal Responsibility
Act of 1982, Pub. L. 97-248, 96 Stat. 616-617, amended sec.
6653(b) effective for taxes the last day prescribed by law for
the payment of which, without regard to extensions, was after
Sept. 3, 1982. Following its amendment, sec. 6653(b) provides in
relevant part:
(1) In general.--If any part of any underpayment * * *
of tax required to be shown on a return is due to fraud,
there shall be added to the tax an amount equal to 50
percent of the underpayment.
(2) Additional amount for portion attributable to
fraud.--There shall be added to the tax (in addition to the
amount determined under paragraph (1)) an amount equal to
50 percent of the interest payable under section 6601--
(A) with respect to the portion of the
underpayment described in paragraph (1) which is
attributable to fraud, and
(B) for the period beginning on the last day
prescribed by law for payment of such underpayment
(continued...)
- 31 -
6211, 6653(c)(1); sec. 301.6211-1(a), Proced. & Admin. Regs.;
see also Drieborg v. Commissioner, 225 F.2d 216, 219-220 (6th
Cir. 1955) (where fraud is determined for each of several years,
the Commissioner's burden applies separately to each of the
years), affg. in part and revg. in part a Memorandum Opinion of
this Court dated February 24, 1954; Estate of Stein v.
Commissioner, 25 T.C. 940, 959-963 (1956) (same), affd. sub nom.
Levine v. Commissioner, 250 F.2d 798 (2d Cir. 1958); DiLeo v.
Commissioner, 96 T.C. 858 (1991) ("clear and convincing" standard
applies to both prongs of the two-prong test), affd. 959 F.2d 16
(2d Cir. 1992); Parks v. Commissioner, 94 T.C. 654, 663-664
(1990) (same); Hebrank v. Commissioner, 81 T.C. 640 (1983)
(same); Habersham-Bey v. Commissioner, 78 T.C. 304, 312 (1982)
(same), and the cases cited therein. With respect to section
6653(b)(2), the time-sensitive provision applicable to
petitioner's 1982 taxable year, respondent must also prove the
portion of the deficiency that is attributable to fraud. Sec.
6653(b)(2); see Cooney v. Commissioner, T.C. Memo. 1994-50.
23
(...continued)
(determined without regard to any extension) and ending
on the date of the assessment of the tax (or, if
earlier, the date of the payment of the tax).
- 32 -
a. Underpayments
The mere fact that we have sustained respondent's deficiency
determination does not mean that petitioner underpaid his taxes
for purposes of the additions to tax for fraud. Where, as here,
we have sustained respondent's determination of a deficiency
mainly by virtue of petitioners' failure to carry their burden of
proof, we will not allow respondent to rely merely on that
failure to sustain her burden of proving fraud. We will not
bootstrap a finding of fraud upon a taxpayer's failure to
disprove the Commissioner's deficiency determination.
Parks v. Commissioner, supra at 660-661.
We have carefully reviewed the record. Following our
review, we conclude that respondent has clearly and convincingly
proven that petitioner underpaid his taxes for each year in
issue. See sec. 6653(c)(1) (an "underpayment" generally is the
same as a "deficiency" under sec. 6211). The record clearly
convinces us that petitioner had gross income that was not
reported on his 1980 through 1982 tax returns.
b. Fraudulent Intent
To establish fraud under section 6653(b) (for 1980 and 1981)
and section 6653(b)(1) (for 1982), respondent must clearly and
convincingly prove that petitioner meant to evade the payment of
taxes. Douge v. Commissioner, 899 F.2d 164, 168 (2d Cir. 1990);
Kahr v. Commissioner, 414 F.2d 621 (2d Cir. 1969), affg. in part
and revg. in part 48 T.C. 929 (1967); Rowlee v. Commissioner,
- 33 -
80 T.C. 1111, 1123 (1983). Whether he meant to do so is a
factual question that must be resolved from the entire record.
DiLeo v. Commissioner, supra at 874; Gajewski v. Commissioner,
67 T.C. 181, 199 (1976), affd. without published opinion 578 F.2d
1383 (8th Cir. 1978). Affirmative evidence is required to prove
an allegation of fraud because fraud is never imputed or
presumed. Beaver v. Commissioner, 55 T.C. 85, 92 (1970).
Affirmative evidence includes circumstantial factors rising from
a taxpayer's course of conduct. Spies v. United States, 317 U.S.
492, 499 (1943); Rowlee v. Commissioner, supra at 1123; Stone v.
Commissioner, 56 T.C. 213, 223-224 (1971). Circumstantial
factors may show that the taxpayer meant to conceal, mislead, or
otherwise prevent the collection of his or her tax. Rowlee v.
Commissioner, supra at 1123-1124; Beaver v. Commissioner, supra
at 92-93. Oft-cited circumstantial factors, generally referred
to as "badges of fraud", include: (1) Understatement of income,
(2) inadequate records, (3) failure to file tax returns,
(4) implausible or inconsistent explanations of behavior,
(5) concealing assets, (6) failure to cooperate with tax
authorities, (7) engaging in illegal activities, (8) attempting
to conceal activities, (9) dealings in cash, and (10) failing to
make estimated tax payments. Bradford v. Commissioner, 796 F.2d
303, 307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601; see also
Meier v. Commissioner, 91 T.C. 273, 297-298 (1988).
- 34 -
We turn to these factors and analyze the relevant factors
seriatim. We also discuss other factors that we consider to be
important to our query.
i. Understatement of Income
Petitioner substantially understated his income for 1980 and
1981 by not reporting his commissions and the interest earned
thereon. Petitioner also failed to report any of the CAI or
BarSon funds that he used for his personal benefit in each of the
subject years. Petitioners's consistent and substantial
understatement of income is strong evidence of fraud. Parks v.
Commissioner, supra at 664; Marcus v. Commissioner, 70 T.C. 562,
577 (1978), affd. without publishied opinion 621 F.2d 439 (5th
Cir. 1980).
ii. Inadequate Records
Petitioner did not keep records with respect to the
commissions earned by him and paid to CAI. His failure to
maintain adequate records of this income is indicative of fraud.
Truesdell v. Commissioner, 89 T.C. 1280, 1302 (1987); Gajewski v.
Commissioner, supra at 200.
iii. Failure to File Tax Returns
Petitioner was advised by Finley Kumble that he had to file
Form 959. He failed to file Form 959, even though Finley Kumble
prepared this form for him, and he signed it. We find
petitioner's failure to file Form 959 under the facts contained
herein to be another indicium of fraud.
- 35 -
iv. Explanations of Behavior
Petitioner testified that he did not organize CAI, was not a
shareholder or beneficial owner of CAI, did not have a working
knowledge of CAI, and did not have authority to direct
disbursements from CAI. Petitioner testified that he was led
astray by Finley Kumble as to the organization and operation of
CAI. Petitioner testified that Finley Kumble organized and
operated CAI for Finley Kumble's personal gain. Petitioner
testified that he never sought legal advice on the organization
or operation of a foreign corporation, and that he did not
receive any related advice from, or attend any related meeting
with, Finley Kumble on this subject.
The record contains substantial evidence that rebuts
petitioner's testimony. The record adequately demonstrates that
petitioner sought legal assistance concerning his attempt to
minimize his Federal income taxes with respect to the subject
commissions; that he was actively involved in CAI's organization
in an attempt to minimize his Federal income taxes; that he owned
50 percent of CAI; that he directed the payment of his personal
commissions to CAI, which he knew to be nothing more than a
"paper corporation"; that he instructed Mr. Quin to withdraw
funds from CAI for his (petitioner's) benefit in an evasive and
surreptitious manner; that the funds withdrawn from CAI were not
loans to him; that he knew he had a tax problem with respect to
the commissions; that he knew that the commissions were never
- 36 -
reported on his returns; that he ignored his attorneys' advice
concerning the proper reporting of his commissions for Federal
income tax purposes; and that he intended to conceal his receipt
of the commissions in an attempt to evade Federal income tax.
Petitioner's attempt to combat this overwhelming evidence against
him with inconsistent and false explanations is further evidence
of his fraud. The same is true with respect to petitioner's
attempt to place the blame on Finley Kumble for his tax problems.
v. Attempt to Conceal Activities
Petitioner used nominees to conceal his ownership interest
in CAI. He used a third party to withdraw substantial funds for
himself and to pay his creditors as part of a scheme to avoid
paying taxes on his earned commissions. We find both of these
actions to be indicia of fraud.
vi. Other Factors
a. Petitioner's Sophistication
A taxpayer's sophistication and experience are relevant in
determining fraudulent intent. Stephenson v. Commissioner,
79 T.C. 995, 1006 (1982), affd. 748 F.2d 331 (6th Cir. 1984).
Petitioner was a sophisticated and experienced businessman,
especially in the international arena. We find this factor to be
evidence of fraud under the facts contained herein.
b. Withholding Information From Tax Preparer
Petitioner's 1980 through 1982 returns contained many false
statements and/or failed to report relevant information. The
1980 and 1981 returns stated erroneously that petitioner did not
- 37 -
have an interest in a foreign account during those years. The
1982 return did not report that petitioners had an interest in a
foreign account during that year. None of the subject returns
reported the commissions that petitioner earned from ABL, or the
interest earned thereon. All of these misstatements (or
omissions) are due to the fact that petitioner did not tell his
accountant/tax preparer (Mr. Schiller) that petitioner had an
interest in a foreign account. We find this factor to be
evidence of fraud. Korecky v. Commissioner, 781 F.2d 1566, 1569
(11th Cir. 1986), affg. T.C. Memo. 1985-63.
c. Legal Advice
Petitioner requested and was given legal advice on the
appropriate manner to report his commissions for Federal income
tax purposes. He deliberately ignored this advice. We find that
petitioner's lack of regard for Finley Kumble's advice was for
the primary purpose of evading taxes, and we conclude that this
factor supports respondent's determination. Although not
necessary to our conclusion, we note that fraudulent intent can
be found by reasonable inference drawn from proof that a taxpayer
deliberately closed his or her eyes to what would otherwise have
been obvious to him or her. In other words, a trier of fact may
infer that an individual knew of his or her evasion of tax from
his or her willful blindness to the existence of that fact. Of
course, the trier of fact must find that the individual actually
knew of his or her tax evasion. A showing of mistake,
- 38 -
negligence, carelessness, recklessness, or even gross negligence
will not, by itself, support such a finding. United States v.
MacKenzie, 777 F.2d 811, 818-819 (2d Cir. 1985); see also Wright
v. Commissioner, T.C. Memo. 1993-328, affd. without published
opinion 73 F.3d 372 (9th Cir. 1995).
vii. Conclusion
We find that respondent has clearly and convincingly proven
fraud on the part of petitioner for all years in issue, and we so
hold. We also find that respondent has clearly and convincingly
proven that petitioner is liable for the time-sensitive provision
for fraud with respect to the total deficiency for 1982.24
Issue 5. Period of Limitation
Respondent generally must assess tax within 3 years of the
later of the due date of a return or its filing date. Sec.
6501(a) and (b)(1); Mecom v. Commissioner, 101 T.C. 374, 381
(1993), affd. without published opinion 40 F.3d 385 (5th Cir.
1994). Because respondent mailed the subject notice of
deficiency to petitioners after this 3-year period, she must rely
on an exception to the general rule to assess Federal taxes for
those years. As one exception to the general rule, tax owed on a
false or fraudulent return may be assessed at any time. Sec.
6501(c)(1). "Fraud" has the same meaning in section 6501(c)(1),
as in section 6653(b). Ruidoso Racing Association, Inc. v.
24
We note that all of the deficiency for 1982 stems from
respondent's adjustment to petitioners' interest income.
- 39 -
Commissioner, 476 F.2d 502, 505, 507 (10th Cir. 1973), affg. in
part and revg. in part. T.C. Memo. 1971-194; Neaderland v.
Commissioner, 52 T.C. 532, 541 (1969), affd. 424 F.2d 639 (2d
Cir. 1970); see also Murphy v. Commissioner, T.C. Memo. 1995-76.
We have just held that the underpayments in petitioners'
income taxes were due to fraud on the part of petitioner for
purposes of section 6653(b). We need not repeat our analysis
here. We reject petitioners' claim that the period of limitation
has expired on any of the years in issue.25
Issue 6. Innocent Spouse
Mrs. Fields alleges that she is an innocent spouse under
section 6013(e). Mrs. Fields alleges that she was unaware of
petitioner's business activities, and that she had no knowledge
of the subject transactions.
Spouses generally are jointly and severally liable for
income taxes due on a joint Federal income tax return. Sec.
6013(d)(3); Bliss v. Commissioner, 59 F.3d 374, 377 (2d Cir.
1995), affg. T.C. Memo. 1993-390. The "innocent spouse"
provision of section 6013(e) relieves a spouse of joint Federal
income tax liability if the following four elements are met:
(1) The spouses filed a joint Federal income tax return, (2) the
return reflected a substantial understatement of tax attributable
25
Based on this holding, we do not consider respondent's
alternative argument that petitioners' 1980 and 1981 taxable
years are open under the 6-year rule of sec. 6501(e)(1)(A).
- 40 -
to grossly erroneous items of one spouse, (3) in signing the
return, the alleged innocent spouse did not know, and had no
reason to know, of the substantial understatement, and (4) taking
into account all the facts and circumstances, it would be
inequitable to hold the alleged innocent spouse liable for the
deficiency attributable to the understatement. Sec. 6013(e)(1);
Friedman v. Commissioner, 53 F.3d 523 (2d Cir. 1995), affg. in
part and revg. in part T.C. Memo. 1993-549; Hayman v.
Commissioner, 992 F.2d 1256, 1259 (2d Cir. 1993), affg. T.C.
Memo. 1992-228. The claimant of innocent spouse relief, in this
case Mrs. Fields, must prove that each of these elements is
satisfied. The failure to prove any of these prongs will
preclude innocent spouse relief. Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933); Bliss v. Commissioner, supra
at 378. The innocent spouse provision was enacted to remedy
"grave injustice"; however, it is "construed and applied
liberally in favor of the person claiming its benefits." Bliss
v. Commissioner, supra at 378 (citations and quotation marks
omitted).
The parties focus on the last two prongs of the four-prong
test, and we will do likewise, starting our analysis with the
third prong. In cases involving the omission of income, such as
the instant case, the fact that an alleged innocent spouse knew
of the transaction that produced the omitted income ordinarily
will prevent him or her from qualifying for innocent spouse
- 41 -
relief. Knowledge need not be actual or complete. The more an
alleged innocent spouse knew about a transaction, the more likely
that he or she knew or had reason to know that the return
contained a substantial understatement. Id. A spouse has "reason
to know" of an understatement if a reasonably prudent person,
under the circumstances of the alleged innocent spouse at the
time of signing the return, could be expected to know that the
tax liability stated on the return was erroneous, or that further
investigation was warranted. Id.; Sanders v. United States,
509 F.2d 162 (5th Cir. 1975); Bokum v. Commissioner, 94 T.C. 126,
148 (1990), affd. 992 F.2d 1132 (11th Cir. 1993); Terzian v.
Commissioner, 72 T.C. 1164, 1170 (1979). Critical factors to
consider in passing on this objective test include: (1) The
level of education of the alleged innocent spouse, (2) his or her
involvement in the family's business and financial affairs,
(3) the presence of expenditures that appear lavish or unusual
when compared to the family's past level of income, standard of
living, and spending patterns, and (4) the "culpable" spouse's
refusal to be forthright about the couple's income. Bliss v.
Commissioner, supra at 378; Wimpie v. Commissioner, T.C. Memo.
1994-41.
Turning to the facts at hand, we find that Mrs. Fields knew
of the underlying transactions that generated the omitted income
when she signed the subject returns. The record demonstrates
that Mrs. Fields knew about petitioner's business venture and
- 42 -
dealings with oil and the extent and magnitude thereof. Among
other things, we find that Mrs. Fields knew that petitioner
worked as a consultant for Ashland, that he was attempting to
secure crude oil for Ashland, that he traveled abroad extensively
using his various contacts to locate a source of oil, that he
traveled on business to Bermuda and Cameroon, and that his
business pursuits involved Ashland, oil, and a Government
official from Cameroon.
Even if we were to conclude (which we do not) that she did
not know of petitioner's activities at the relevant times, we
believe that she certainly should have known of the
understatement of income on each of the returns when she signed
them. Mrs. Fields is well educated and intelligent. She was
actively involved in the family's business and financial affairs.
She knew of the magnitude of petitioners' spending during the
relevant years, including extraordinary expenditures (e.g.,
purchase of a boat, purchase and renovation of homes), and she
knew that the money to pay for these expenses did not come from
petitioners' checking account. A prudent person in Mrs. Fields'
position would have known that the returns were erroneous or that
further inquiry was warranted. Perfect knowledge of the family's
financial affairs is not required to satisfy the reason to know
standard. Shea v. Commissioner, 780 F.2d 561, 567 (6th Cir.
1986), affg. in part and revg. in part T.C. Memo. 1984-310.
- 43 -
We also believe that the Fieldses' expenditures were lavish
and unusual for a couple reporting 1980, 1981, and 1982 taxable
income of $56,847, $71,010, and $5,550, respectively. Mrs.
Fields failed to show that petitioner was not forthright about
the omitted income.26 Funds were always available or made
available for all of petitioners' expenditures, yet Mrs. Fields
never asked petitioner about the source of the large amounts of
money that they spent. She also did not ask him whether the
subject returns were accurate, preferring to assume that they
were. If she had asked, Mrs. Fields testified, he would have
given her the returns to thoroughly review. We believe that a
reasonable person in Mrs. Fields' position would have inquired
about the accuracy of the income reported on the returns, given
the facts of this case. Mrs. Fields cannot turn a blind eye to
her tax obligations and expect innocent spouse relief. See
Estate of Jackson v. Commissioner, 72 T.C. 356, 361 (1979);
Kenney v. Commissioner, T.C. Memo. 1995-431.
We conclude that Mrs. Fields knew (or should have known)
that the subject returns contained substantial understatements.
Based on this conclusion, Mrs. Fields is not entitled to innocent
spouse relief regardless of whether it would be inequitable to
hold her liable for the subject deficiencies. We note quickly in
26
Mrs. Fields failed to establish that petitioner was
evasive or otherwise misled her with respect to the true level of
their income, and we find no evidence that petitioner tried to
hide the unreported income from Mrs. Fields.
- 44 -
passing, however, that the record fails to support her assertion
that it would be, in light of the factors set forth in Friedman
v. Commissioner, 53 F.3d at 532. See also Meyer v. Commissioner,
T.C. Memo. 1996-400; Wimpie v. Commissioner, supra. To say the
least, Mrs. Fields benefited significantly from the unreported
commissions in that the unreported funds allowed her to make
substantial renovations and redecorations to her home, to
purchase vacation property and a boat, and to send her children
to an exclusive school, among other things. Petitioners also
sold their home in Rye, New York, in 1994 for almost three times
the amount that they paid for it in 1979, and they realized a
$350,000 profit on their sale of the undeveloped land. It is
also relevant to our inquiry of inequity that petitioners were
still married and unseparated at the time of their trial herein;
i.e., this is not a case where one taxpayer on a joint return has
left the other to "face the music alone." See Hayman v.
Commissioner, supra at 1263. Nor do we find any meaningful
hardship that would result to Mrs. Fields by denying her innocent
spouse relief.
__________________________
We have considered all arguments made by petitioners and, to
the extent not discussed above, have found them to be irrelevant
or without merit. To reflect the foregoing,
Decision will be entered
under Rule 155.