Brown v. Commissioner

T.C. Memo. 1996-416

UNITED STATES TAX COURT

LANCE BROWN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 16827-93. Filed September 17, 1996.

George M. Nachwalter, for petitioner.

Alison W. Lehr, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

SWIFT, Judge: Respondent determined deficiencies and

additions to tax in petitioner's Federal income taxes as follows:

Additions to Tax
Sec. Sec. Sec.
Year Deficiency 6653(b)(1)(A) 6653(b)(1)(B) 6661(a)

1986 $ 6,790 $ 5,298 * $1,698
1987 17,459 13,731 * 4,365
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* 50 percent of interest due on portion of
underpayment attributable to fraud.
Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for 1986 and 1987, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.

After concessions, the only issue for decision is whether

petitioner is liable for the fraud additions to tax.

FINDINGS OF FACT

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

At the time the petition was filed, petitioner resided in

Fort Lauderdale, Florida.

During 1986 and 1987, petitioner was engaged in business as

a self-employed loan broker. Petitioner’s business involved

arranging for loans between finance companies and small business

borrowers. On loans he arranged, petitioner typically received

commissions from finance companies and fees from borrowers.

During 1986 and 1987, petitioner received total commissions

from finance companies of $28,695 and $22,086, respectively, and

total fees from borrowers of $3,553 and $15,080, respectively.

Except for one finance company, none of the finance

companies from whom petitioner received commissions in 1986 and

1987 issued to petitioner Forms 1099 reflecting commissions paid

to petitioner.
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Petitioner maintained two bank accounts at Amerifirst Bank

(Amerifirst), one in his name and one in his son’s name, and

petitioner maintained one bank account at Commercial Bank & Trust

Co. (Commercial Bank) in his name. Petitioner generally

deposited commissions and fees received in his loan brokerage

business into these bank accounts.

In connection with preparation of his 1986 Federal income

tax return, petitioner submitted to his tax return preparer a

letter dated February 21, 1987, in which petitioner indicated

that he received in 1986 only $10,482 in total commissions and

fees from his loan brokerage business. This total commission and

fee income of $10,482, along with net income of $2,227, and zero

taxable income, were reported on petitioner’s 1986 Federal income

tax return.

On March 15, 1988, respondent's revenue agent began an audit

of petitioner's 1986 Federal income tax return. During the

audit, petitioner did not keep scheduled appointments with

respondent’s revenue agent, and petitioner provided only limited

records to the revenue agent with regard to his loan brokerage

business.

On April 20, 1988, as a result of his inability to meet with

petitioner and petitioner's general lack of cooperation,

respondent’s revenue agent proposed audit adjustments against

petitioner in which the revenue agent disallowed $8,332 in

various claimed business expenses and proposed the negligence
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addition to tax. Petitioner did not agree to these proposed

adjustments to his 1986 Federal income tax return.

After respondent’s revenue agent proposed the above

adjustments, petitioner submitted to respondent portions of a

bank statement relating to the Amerifirst account that was in

petitioner's name. Petitioner did not provide to respondent’s

revenue agent bank statements relating to the other two bank

accounts.

In the summer of 1988, after petitioner rejected the above

proposed audit adjustments for 1986, respondent’s revenue agent

mailed to petitioner a second letter in which the revenue agent

reasserted the initial adjustments and addition to tax and

proposed to disallow an additional $846 in claimed business

expenses. Again, petitioner refused to agree to respondent's

proposed adjustments.

On November 10, 1988, in response to a summons from

respondent’s revenue agent, petitioner and petitioner's attorney

met with respondent’s revenue agent. During this meeting,

petitioner provided respondent’s revenue agent with a schedule on

which petitioner indicated that he received $26,806 in total

commissions and fees in 1986. At this meeting, petitioner

acknowledged the second bank account at Amerifirst in his son's

name, but petitioner did not acknowledge that he also maintained

the bank account at Commercial Bank. The November 10, 1988,
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meeting was the only meeting between petitioner, his attorney,

and respondent’s revenue agent.

After the above November 10, 1988 meeting, respondent’s

revenue agent considered making a fraud referral with regard to

petitioner’s original 1986 Federal income tax return.

Respondent’s revenue agent, however, did not make a fraud

referral at that time because she did not believe that she had

firm evidence of fraud.

On December 9, 1988, in connection with preparation of his

1987 Federal income tax return, petitioner met with a tax return

preparer different from the preparer used for his 1986 tax

return. Petitioner indicated to this return preparer that he

received in 1987 $20,316 in total commissions and fees from his

loan brokerage business. These commissions, along with net

income of $6,874, and zero taxable income, were reported on

petitioner’s 1987 Federal income tax return that was filed on

December 30, 1988.

On January 4, 1989, respondent’s revenue agent notified

petitioner that petitioner’s 1987 Federal income tax return was

to be audited. On January 27, 1989, petitioner filed an amended

1987 Federal income tax return and reported thereon additional

commissions and fees received in 1987 of $10,188 and an increase

in tax liability of $3,307.
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On February 10, 1989, petitioner provided respondent’s

revenue agent with a schedule on which petitioner indicated that

he received $31,503 in total commissions and fees in 1987.

As indicated above, petitioner actually received in 1987 a

total of $37,166 in commissions and fees.

By March of 1989, respondent’s revenue agent believed that

firm evidence of fraud had been established with respect to

petitioner's 1986 and 1987 Federal income tax returns, and on

March 13, 1989, the revenue agent made a fraud referral to

respondent’s Criminal Investigation Division.

On March 19, 1992, petitioner was criminally indicted on two

counts of willfully filing false Federal income tax returns for

1986 and 1987. On April 28, 1992, based upon his guilty plea,

petitioner was convicted under section 7206(1) of willfully

filing a false 1987 Federal income tax return. In exchange for

his guilty plea, the United States agreed to dismiss the other

count of the indictment relating to petitioner’s 1986 Federal

income tax return.

Prior to trial herein, petitioner and respondent agreed that

for 1986 and 1987, petitioner is liable for income tax

deficiencies of $6,247 and $5,638, respectively, and additions to

tax for substantial understatements of income tax under section

6661(a) for 1986 of $1,501.

The following table sets forth petitioner's gross income as

reported on petitioner's original 1986 and 1987 Federal income
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tax returns, on petitioner's 1987 amended Federal income tax

return, and as now agreed to by petitioner and respondent.

Gross Income
As Reported On As Reported On
Year Original Returns Amended Return As Agreed To

1986 $10,482 -- $32,248

1987 20,316 $30,504 37,166

OPINION

For 1986 and 1987, additions to tax for fraud are equal to

75 percent of the portion of an underpayment that is attributable

to fraud, plus an amount equal to 50 percent of interest payable

under section 6601 with respect to such portion. Sec. 6653(b)(1)

and (2).

The existence of fraud involves a question of fact. Parks

v. Commissioner, 94 T.C. 654, 660 (1990); Gajewski v.

Commissioner, 67 T.C. 181, 199 (1976), affd. without published

opinion 578 F.2d 1383 (8th Cir. 1978). Respondent must establish

by clear and convincing evidence that there was an underpayment

of tax and that the underpayment was due to the taxpayer’s

fraudulent intent. Sec. 7454; Rule 142(b); King's Court Mobile

Home Park, Inc. v. Commissioner, 98 T.C. 511, 515 (1992).

Fraudulent intent is defined as "actual, intentional

wrongdoing, and the intent required is the specific purpose to

evade a tax believed to be owing." Estate of Temple v.

Commissioner, 67 T.C. 143, 159 (1976).
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Fraud is never to be imputed or presumed. However, "its

proof may depend to some extent upon circumstantial evidence, and

may rest upon reasonable inferences properly drawn from the

evidence of record." Stone v. Commissioner, 56 T.C. 213, 224

(1971); see Rowlee v. Commissioner, 80 T.C. 1111, 1123 (1983);

Stephenson v. Commissioner, 79 T.C. 995, 1006 (1982), affd. 748

F.2d 331 (6th Cir. 1984).

Courts have developed several objective "badges" of fraud.

Recklitis v. Commissioner, 91 T.C. 874, 910 (1988). These badges

of fraud include: (1) Dealings in cash; (2) inadequate records;

(3) concealment of assets; (4) understatement of income; and

(5) failure to cooperate with tax authorities. Bradford v.

Commissioner, 796 F.2d 303, 307-309 (9th Cir. 1986), affg. T.C.

Memo. 1984-601; Recklitis v. Commissioner, supra at 910; Paschal

v. Commissioner, T.C. Memo. 1994-380, affd. without published

opinion F.3d (3d Cir., Oct. 4, 1995).

Petitioner concedes that he underreported his Federal income

taxes for 1986 and 1987. Thus, we need only decide whether

petitioner’s underreporting was due to fraudulent intent.

Petitioner argues that his underreporting in tax was not

intentional and that it was caused by carelessness of his tax

return preparers. In addition, petitioner argues that

respondent’s revenue agent improperly examined his Federal income

tax return and his books and records for 1986 three separate

times without giving the written notice required by section
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7605(b). Petitioner argues further that by failing to refer

petitioner’s case to respondent's Criminal Investigation Division

when the revenue agent initially suspected fraud, respondent’s

revenue agent violated petitioner's rights under the Fourth and

Fifth Amendments. Because of respondent’s alleged violation of

proper audit procedures and because petitioner’s constitutional

rights were allegedly violated, petitioner argues that he should

be relieved of any fraud additions to tax for 1986 and 1987.

We disagree. In filing his erroneous 1986 and his erroneous

1987 original and amended Federal income tax returns and through

his conduct during the course of respondent’s audit, petitioner

repeatedly demonstrated an intent to fraudulently underreport his

Federal income taxes for 1986 and 1987. Comparing gross income

as reported on petitioner’s original tax returns to gross income

as agreed to by petitioner herein, petitioner underreported his

gross income by approximately $21,766 for 1986 and by

approximately $17,000 for 1987.

During the audit, petitioner generally refused to cooperate

with, and made material misrepresentations to, respondent’s

revenue agent. Petitioner pleaded guilty to filing a materially

false Federal income tax return for 1987. Although his

conviction for this year does not conclusively establish his

liability for the fraud additions to tax for 1986 and 1987, it

does collaterally estop petitioner from denying that he willfully

and knowingly filed a false Federal income tax return for 1987,
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and it remains relevant as further evidence to consider. See

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

Commissioner, 84 T.C. 405, 409-410 (1985); Curry v. Commissioner,

T.C. Memo. 1991-102; Whyte v. Commissioner, T.C. Memo. 1986-486,

affd. 852 F.2d 306 (7th Cir. 1988).

Petitioner's claim that the underreporting of income was

caused by his tax return preparers is not supported by the

evidence. For both 1986 and 1987, petitioner disclosed

inaccurate information to his tax return preparers, and

petitioner is not allowed to now shift to his return preparers

responsibility for his failure to accurately report his income.

Alexander Shokai, Inc. v. Commissioner, 34 F.3d 1480, 1486 (9th

Cir. 1994), affg. T.C. Memo. 1992-41; United States v. Claiborne,

765 F.2d 784, 798 (9th Cir. 1985).

Petitioner argues that the revenue agent's initial proposal

of the negligence addition to tax for 1986 indicates that the

evidence does not support a finding of fraud. At that time,

however, respondent’s agent was not aware that petitioner had

failed to disclose various bank accounts and the correct amount

of commissions and fees received in 1986 and 1987. Only after

respondent’s revenue agent discovered the additional bank account

and the additional unreported income did respondent’s revenue

agent make the fraud referral.

Petitioner argues that because his amended 1987 Federal

income tax return reported income over and above income that was
 - 11 -

reported on the original 1987 return, he should not be held

liable for the fraud addition to tax for 1987. A taxpayer’s

fraudulent original return, however, is not purged by the filing

of a subsequent amended return. The fraud was committed when the

original return was prepared and filed. Badaracco v.

Commissioner, 464 U.S. 386, 394 (1984). Petitioner amended his

1987 Federal income tax return only after being notified that the

return would be audited, and even then petitioner underreported

on the amended 1987 Federal income tax return his income by

approximately $5,600.

As indicated, petitioner argues that respondent audited

petitioner's 1986 books and records three times without providing

the written notice to petitioner required under section 7605(b)

and therefore that the notice of deficiency should be treated as

invalid with regard to the fraud addition to tax for 1986. In

general, a taxpayer's books and records are subject to only one

examination per year unless respondent notifies the taxpayer in

writing that an additional examination is necessary. Sec.

7605(b). A taxpayer, however, may waive this requirement by

failing to object to a subsequent examination without receiving

the written notice called for in section 7605(b). Rife v.

Commissioner, 41 T.C. 732, 746-747 (1964), revd. and remanded on

another issue 356 F.2d 883 (5th Cir. 1966); Rice v. Commissioner,

T.C. Memo. 1994-204; Anderson v. Commissioner, T.C. Memo. 1989-

472. Assuming, without so finding, that a second or even third
 - 12 -

examination of petitioner's books and records occurred in this

case, we conclude that petitioner never timely objected thereto,

and petitioner thereby waived his rights under section 7605(b).

Relying on United States v. Tweel, 550 F.2d 297 (5th Cir.

1977) and United States v. Grunewald, 987 F.2d 531 (8th Cir.

1993), petitioner argues that respondent’s revenue agent unduly

delayed in making the fraud referral to respondent’s Criminal

Investigation Division, that petitioner's Fourth and Fifth

Amendment rights were thereby violated, and that the fraud

additions to tax should be rejected.

We disagree. Respondent’s continued investigation of

petitioner after the revenue agent initially suspected fraud did

not violate petitioner's constitutional rights. See United

States v. Grunewald, supra. There is no credible evidence in the

record that would support a finding that respondent’s revenue

agent improperly received information as a result of any

misrepresentations or improper conduct by the revenue agent.

Based on the evidence before us, we conclude that petitioner

fraudulently underreported his Federal income taxes for 1986 and

1987 and that petitioner is liable for the fraud additions to tax

for 1986 and 1987.

Decision will be entered

under Rule 155.