Gordon v. Commissioner

T.C. Memo. 1997-36

UNITED STATES TAX COURT

THOMAS L. AND LAURA L. GORDON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 18186-94. Filed January 21, 1997.

Thomas L. Gordon and Laura L. Gordon, pro se.

Dwight M. Montgomery, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COHEN, Chief Judge: Respondent determined a deficiency in

and additions to petitioners' 1986 Federal income tax as follows:

Additions to Tax, I.R.C.
Sec. Sec. Sec.
Deficiency 6653(b)(1)(A) 6653(b)(1)(B) 6661(a)
1
$18,246 $13,685 $4,562
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1
50 percent of the interest computed on $18,246 at the time
of assessment and/or payment of tax.

Unless otherwise indicated, all section references are to the

Internal Revenue Code in effect for the year in issue, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.

The issues remaining for decision are: (1) Whether

petitioners failed to report income from thefts on their 1986

return; (2) whether petitioners are liable for the addition to

tax for fraud; and (3) whether petitioners are liable for the

addition to tax for substantial understatement of liability.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference. At the

time their petition was filed, petitioners were husband and wife

and resided in San Dimas, California.

Petitioners were married in November 1983. Petitioner

Laura L. Gordon (Mrs. Gordon) was married to Alexander P.

Sandoval (Sandoval) from 1975 to 1982. Mrs. Gordon received

child support payments in bimonthly amounts of $136 during 1985

and 1986 as a result of her divorce from Sandoval.

Petitioners filed a Form 1040, U.S. Individual Income Tax

Return, for 1986 showing $42,309 as their adjusted gross income.
 - 3 -

Petitioners and the LASD

During 1986, petitioner was employed as a deputy sheriff

with the Los Angeles Sheriff's Department (LASD). Petitioner

began working for the LASD on August 24, 1970. From April 12,

1981, until November 2, 1986, the LASD assigned petitioner to its

Narcotics Bureau. From October 25, 1982, until November 2, 1986,

petitioner was assigned to Major Violators Crew II (Majors II),

an elite narcotics enforcement team, to investigate money

laundering and narcotics trafficking. On November 2, 1986, the

LASD promoted petitioner to sergeant, transferred him out of the

Narcotics Bureau, and assigned him to the Lakewood station.

During 1986, Mrs. Gordon was not employed. She worked for

the LASD from October 28, 1974, until November 4, 1985, the date

she retired. On or about December 14, 1985, Mrs. Gordon received

a pension check dated December 11, 1985, in the amount of

$18,799.26. Petitioner deposited this check into petitioners'

account at Chino Valley Bank (Chino).

Eufrasio G. Cortez (Cortez) joined the LASD in July 1975.

Cortez was assigned to Majors II from November 1982 until

September 1989.

In January 1986, the Majors II team arrested Angel Leon

(Leon) and other suspects for trafficking cocaine and laundering

money. Majors II seized at least $200,000 in cash.
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Petitioner was the investigating officer on the Ernest

Montenegro (Montenegro) case. Majors II arrested Montenegro and

seized cash.

In April 1986, Majors II arrested Heriberto Martinez

(Martinez) and seized cash. Cortez was the investigating officer

on the Martinez case.

In September 1986, Majors II, assisted by the local police

department, arrested three people and seized cocaine and cash as

part of the investigation of Jamie Ramos (Ramos).

In November 1986, Majors II detained suspects and seized

cash as part of the investigation of Victor Lopez (Lopez).

Petitioner was not a member of Majors II at the time of the Lopez

investigation.

Petitioner's Indictment

On August 12, 1992, a Federal Grand Jury charged petitioner

in a three-count indictment with violating 18 U.S.C. sec. 1957

(1994) (money laundering), section 7206(1) (willfully false

statements on a tax return), and 18 U.S.C. sec. 982(a)(1) (1994)

(forfeiture). The indictment charging petitioner with violating

section 7206(1) pertained to petitioners' 1986 return.

Petitioner's case proceeded to trial in the United States

District Court, Central District of California, in April 1993. A

jury found petitioner guilty of the charge of violating section

7206(1). A hung jury resulted in a mistrial on the money
 - 5 -

laundering charge, and a retrial led to the same result. The

civil forfeiture count was settled.

Cortez was also indicted. As part of a plea agreement in

his own criminal case, Cortez testified against petitioner in

both of petitioner's criminal trials.

Bank Accounts and Credit Card Accounts

During 1986, petitioners maintained a joint checking account

at Security Pacific National Bank (Security), Glendale,

California. Petitioner had his LASD paycheck deposited directly

into the Security account during 1986. During 1985 and 1986,

only petitioners had signatory authority over this account.

During 1986, petitioners withdrew $500 from their Security

account to purchase a cashier's check and wrote two $100 checks

to themselves. Petitioners did not withdraw any cash from this

account through an automated teller machine during 1985 or 1986.

During 1986, petitioners maintained a joint checking account

at Chino in Pomona, California. Petitioners opened this account

in April 1985 and closed it in March 1987. During this period,

only petitioners had signatory authority over the Chino account.

There were no withdrawals from this account during 1985. During

1986, petitioners did not withdraw any cash from the Chino

account through an automated teller machine.

During 1986, petitioner maintained an account at First City

Savings Federal Credit Union (the Credit Union), Los Angeles,

California. Petitioner opened this account in January 1973.
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During 1985 and 1986, petitioner did not withdraw any cash from

the Credit Union.

Except for the three accounts set out above, petitioners did

not maintain, either jointly or severally, any other bank

accounts during 1985 or 1986.

During 1986, petitioners had a MasterCard credit card

account at Security. Petitioners received two $100 cash advances

from their MasterCard during 1985 and two $100 cash advances from

their MasterCard during 1986. Also during 1986, petitioners had

a Visa credit card account at Bank Americard Card Center,

Pasadena, California.

Construction of Gladstone House

On October 14, 1980, petitioner and a prior spouse purchased

vacant land located on Gladstone Street in San Dimas, California,

for approximately $22,500. In or about 1981, the City of San

Dimas placed a lien in the amount of $11,413 against petitioner's

land for street improvements. On December 10, 1982, petitioner

received the land as his separate property as part of his divorce

settlement with his prior spouse. On January 23, 1985,

petitioner paid $2,000 towards the lien with funds from the

Credit Union. In January 1986, petitioners commenced

construction of a house on the Gladstone property.

From June 1, 1986, until March 31, 1987, petitioners rented

an apartment at the Peartree San Dimas Apartments (Peartree) in

San Dimas. On May 22, 1986, petitioners paid a cash deposit of
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$500 to Peartree. On June 1, 1986, petitioners made a cash

payment of $760 for the first month's rent. From July 1, 1986,

until March 1, 1987, petitioners made their monthly rent payment

of $760 by checks drawn on their Security account.

Petitioners completed construction of their house and

occupied it in or about March 1987. On August 31, 1987,

petitioners applied for a $50,000 residential loan from First

Federal Savings and Loan Association of San Gabriel Valley. The

loan was approved in September 1987.

Cash Deposits During 1986

During 1986, petitioners made the following cash deposits

into their Security account:

Date Deposited By Amount Denominations

02/06/86 Mrs. Gordon $ 400 20 $20 bills
02/21/86 Mrs. Gordon 480 24 $20 bills
03/03/86 Petitioner 2,500 25 $100 bills
04/02/86 Petitioner 1,500 7 $100 bills
6 $50 bills
25 $20 bills
05/02/86 Petitioner 800 8 $100 bills
06/24/86 Petitioner 500 Unknown
07/03/86 Mrs. Gordon 770 1 $50 bill
36 $20 bills
07/23/86 Mrs. Gordon 800 8 $100 bills
08/20/86 Mrs. Gordon 400 4 $100 bills
10/10/86 Petitioner 1,000 Unknown
11/04/86 Petitioner 1,000 Unknown
12/01/86 Petitioner 3,000 Unknown
Total $13,150

On June 16, 1986, Mrs. Gordon deposited $10,000 cash, made

up of 100 $100 bills, into petitioners' Chino account.
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Other Sources of Petitioners' Money

Petitioners had known sources of money during 1986 totaling

$57,458.31.

Petitioners received additional cash totaling $140 during

1986 from checks written to the grocery store for amounts over

the total purchase price. This money was used for taking the

children out to lunch or for similar activities. In addition,

Mrs. Gordon cashed child support checks totaling $1,904 during

1986.

Cash Payments During 1986

During 1986, petitioners made the following purchases with

cash:

Date Amount Description

02/20/86 $ 3,164.00 Lumber
03/07/86 5,010.93 Lumber
04/03/86 935.78 Lumber
Unknown 3,000.00 Lumber
05/22/86 500.00 Rental deposit
05/22/86 4,208.88 Lumber
07/01/86 760.00 Rent
07/01/86 650.00 Emerson Glass
07/31/86 414.78 City of San Dimas
09/11/86 278.92 Snyder Diamond
09/18/86 300.00 Snyder Diamond
10/23/86 338.74 Snyder Diamond
11/07/86 278.93 Snyder Diamond
Unknown 576.06 Snyder Diamond
11/10/86 414.78 City of San Dimas
Unknown 1,500.00 Engineer reports
Unknown 300.00 Steel
Total $22,631.80
 - 9 -

OPINION

Respondent argues that petitioners underreported their

income for 1986 with the intent to evade tax. Petitioners

contend that, although they did deposit and expend large amounts

of cash during 1986, the income that respondent alleges was

unreported was actually cash that petitioners had saved during

previous years.

The addition to tax in the case of fraud is a civil sanction

provided primarily as a safeguard for the protection of the

revenue and to reimburse the Government for the heavy expense of

investigation and for the loss resulting from the taxpayer's

fraud. Helvering v. Mitchell, 303 U.S. 391, 401 (1938).

Respondent has the burden of proving, by clear and convincing

evidence, an underpayment for each year and that some part of an

underpayment for each year was due to fraud. Sec. 7454(a); Rule

142(b). If respondent establishes that any portion of the

underpayment is treated as attributable to fraud, the entire

underpayment is treated as attributable to fraud and subject to

the 75-percent addition to tax unless the taxpayer establishes

that some part of the underpayment is not attributable to fraud.

Sec. 6653(b).

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

upon consideration of the entire record. Gajewski v.

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

opinion 578 F.2d 1383 (8th Cir. 1978). Fraud will never be
 - 10 -

presumed. Beaver v. Commissioner, 55 T.C. 85, 92 (1970). Fraud

may, however, be proved by circumstantial evidence because direct

proof of the taxpayer's intent is rarely available. 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, 53 T.C. 96, 105-106 (1969). A

pattern of consistent underreporting of income for a number of

years, especially when accompanied by other circumstances showing

an intent to conceal, justifies the inference of fraud as to each

of the years. Holland v. Commissioner, 348 U.S. 121, 137 (1954);

Otsuki v. Commissioner, supra.

Under section 61, gross income includes "all income from

whatever source derived." Gross income includes funds derived

from legal and illegal sources. Rutkin v. United States, 343

U.S. 130 (1952). Where a taxpayer keeps no books or records, or

fails to file a return from which his income tax liability can be

assessed, the Internal Revenue Service (IRS) may reconstruct the

taxpayer's income. Sec. 446(b); Moore v. Commissioner, 722 F.2d

193 (5th Cir. 1984), affg. T.C. Memo. 1983-20. The IRS has great

latitude in reconstruction methods. Giddio v. Commissioner, 54

T.C. 1530, 1532-1534 (1970). As a general rule, the computation

of taxable income is made under the method of accounting

regularly employed by the taxpayer or, if no method of accounting

has been used by the taxpayer, made under such method as, in the

opinion of respondent, clearly reflects income. Sec. 446(b);

Moore v. Commissioner, supra; Giddio v. Commissioner, supra.
 - 11 -

Initially, respondent determined that petitioner received

money from the following sources:

Case Amount

Leon $10,000
Montenegro 1,000
Martinez 15,000
Ramos 20,000
Lopez 10,000
Total $56,000

Respondent alleges that the testimony of Cortez, along with

petitioners' bank records, establishes that petitioners

underreported their income in 1986.

At trial, Cortez testified that petitioner received cash

from thefts of drug-tainted money during 1986, including the

following: $10,000 of stolen cash from the Leon case, $15,000 of

stolen cash from the Martinez case, and $10,000 of stolen cash

from the Lopez case. In reference to the Montenegro case, Cortez

testified that he did not recall whether petitioner kept any of

the stolen cash for himself. Cortez stated that he received

$1,000 from petitioner and that petitioner, as the investigating

officer in the Montenegro case, would have determined the share

that the other officers would receive and that petitioner would

usually have kept the largest share for himself. Cortez could

not place a dollar amount on any money received by petitioner

from the Ramos investigation. Cortez testified that he received

two bundles of cash, totaling $20,000, and that petitioner

received two bundles of cash. His estimate that petitioner
 - 12 -

received $20,000 is based on Cortez's counting of his own two

bundles.

In this case of illegal unreported income, respondent must

establish that the deficiency determination is supported by a

proper foundation of substantive evidence. Weimerskirch v.

Commissioner, 596 F.2d 358, 362 (9th Cir. 1979), revg. 67 T.C.

672 (1977). Respondent cannot rely on the presumption of

correctness of the notice of deficiency and must offer evidence

linking the taxpayer to the activity. Id. Cortez's testimony

links petitioner to the thefts during 1986, and those thefts

provide the likely source for the unreported income that we

determine below. See Adamson v. Commissioner, 745 F.2d 541, 547

(9th Cir. 1984), affg. T.C. Memo. 1982-371.

Petitioners argue that Cortez's testimony is not reliable

because Cortez is required to testify for the Government under

the terms of his plea bargain. Petitioners also point to

Cortez's admissions at trial of his falsifying numerous police

reports and perjuring himself during prior court appearances.

Nonetheless, Cortez's testimony is not improbable, and it is

corroborated by the evidence of petitioners' cash deposits and

expenditures. In 1986, petitioners made unexplained cash

deposits totaling $23,150 and cash expenditures totaling

$22,631.80.

Petitioners claim that they had a cash hoard that was the

source for cash deposits and expenditures during 1986. They
 - 13 -

contend that they deposited money from their cash hoard into

their accounts to cover checks written for the building of the

house.

Mrs. Gordon claims that she had cash on hand from child

support payments, sales of woodcrafts, yard sales, and gifts from

her parents. During 1986, Mrs. Gordon cashed child support

checks totaling $1,904. As for Mrs. Gordon's other claimed

sources, no credible evidence was presented from which we can

even estimate an amount of available cash. For example,

Mrs. Gordon claimed that she received approximately $1,000 cash

from yard sales, but she testified that she could not remember

whether or not the money went into her cash hoard. Mrs. Gordon

claims that she cannot recall the source of 100 $100 bills

deposited by her on June 16, 1986. It is not credible that

Mrs. Gordon could not remember the source of $10,000 cash,

particularly in that form.

Petitioner claims that the sources of his cash hoard were

cash from his father, the sale of a car, and real estate sales.

Petitioner testified that his father paid for the lumber

purchased during 1986 for the Gladstone house. Petitioner's

testimony, however, was contradicted by testimony from a cashier

at the lumberyard who remembered petitioner's making the

purchases. Petitioner provided no evidence of any car sale other

than a receipt that shows that petitioner purchased, not sold, a

car. The real estate sales that petitioner claims provided cash
 - 14 -

for his hoard occurred sometime before 1982. Petitioner produced

canceled checks that purportedly represent moneys from real

estate sales. However, several of the checks appear to have been

deposited into petitioner's bank accounts, and no evidence of any

withdrawal of cash from these accounts was presented.

Petitioners failed to call any witnesses to corroborate any of

the alleged cash sales.

Petitioners' testimony was marked by "selective memories"

and otherwise was not credible. We therefore reject the

testimony of petitioners as to the existence of a cash hoard.

For purposes of the fraud addition to tax, respondent has

met her burden of proving this underpayment of tax by clear and

convincing evidence by showing a likely source for the cash

deposits and cash expenditures, i.e., the thefts, and by negating

petitioners' claimed nontaxable sources, i.e., the cash hoard.

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

United States, 348 U.S. 121, 137 (1954).

Respondent must also prove fraudulent intent. Petitioner's

conviction under section 7206(1) does not collaterally estop

petitioner from disputing the addition to tax under section

6653(b). Wright v. Commissioner, 84 T.C. 636, 643 (1985).

Respondent's burden with respect to fraudulent intent is met if

it is shown that the taxpayer intended to conceal, mislead, or

otherwise prevent the collection of such taxes. Stoltzfus v.

United States, 398 F.2d 1002, 1004 (3d Cir. 1968); Webb v.
 - 15 -

Commissioner, 394 F.2d 366, 377 (5th Cir. 1968), affg. T.C. Memo.

1966-81.

Fraudulent intent may be inferred from various kinds of

circumstantial evidence, or "badges of fraud", including an

understatement of income, dealings in cash, and implausible or

inconsistent explanations of behavior. Bradford v. Commissioner,

796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo. 1984-601;

Meier v. Commissioner, 91 T.C. 273, 297-298 (1988).

The record in this case is replete with evidence of

petitioners' fraudulent intent. Petitioners understated their

income in 1986. They deposited large amounts of cash and made

large expenditures of cash. Moreover, petitioners' explanation

of the source of the cash deposits and cash payments is

implausible; their claims of a cash hoard and other trial

testimony are unsupported and not worthy of belief.

Respondent has proven by clear and convincing evidence an

underpayment of tax due to fraud for 1986. Petitioners have not

proven that the amount determined by respondent is incorrect or

that any part of the underpayment is not attributable to fraud.

See sec. 6653(b)(2).

Petitioners contend that we should consider the

constitutional concept of double jeopardy in reaching our

decision regarding the fraud addition to tax. The Fifth

Amendment to the Constitution provides in part: "No person shall

* * * for the same offence * * * be twice put in jeopardy of life
 - 16 -

or limb". In Helvering v. Mitchell, 303 U.S. 391, 399-404

(1938), the United States Supreme Court stated:

Congress may impose both a criminal and a civil
sanction in respect to the same act or omission; for
the double jeopardy clause prohibits merely punishing
twice, or attempting a second time to punish
criminally, for the same offense. The question for
decision is thus whether section 293(b) [the
predecessor of section 6653(b)] imposes a criminal
sanction. That question is one of statutory
construction. * * *

* * * * * * *

The remedial character of sanctions imposing additions
to tax has been made clear by this Court in passing
upon similar legislation. They are provided primarily
as a safeguard for the protection of the revenue and to
reimburse the Government for the heavy expense of
investigation and the loss resulting from the
taxpayer's fraud. * * * [Citations and fn. ref.
omitted.]

See Ianniello v. Commissioner, 98 T.C. 165, 176-185 (1992). The

imposition of the addition to tax for fraud is not barred by

double jeopardy.

Respondent also determined that petitioners are liable for

the section 6661 addition to tax for 1986. Petitioners bear the

burden of proving that respondent’s determination is not correct.

Rule 142(a); Cluck v. Commissioner, 105 T.C. 324, 339 (1995).

Section 6661(a) provides for an addition to tax on underpayments

attributable to a substantial understatement of income tax.

Section 6661(b)(2)(A) defines the term “understatement” as being

the excess of the amount of tax required to be shown on the

return for the taxable year over the amount shown on the return.

An understatement is substantial if it exceeds the greater of
 - 17 -

10 percent of the tax required to be shown on the return or

$5,000. Sec. 6661(b)(1)(A). The deficiency in tax we have

determined represents a substantial understatement.

Under the facts established in the record, petitioners are

liable for the addition to tax under section 6661 for 1986.

To reflect the foregoing,

Decision will be entered

under Rule 155.