Deneault v. Commissioner

T.C. Memo. 1997-329

UNITED STATES TAX COURT

DENNIS J. AND TERESA DENEAULT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14717-94. Filed July 21, 1997.

Dennis J. and Teresa Deneault, pro se.

Michael D. Zima, for respondent.

MEMORANDUM OPINION

DAWSON, Judge: This case was assigned to Chief Special

Trial Judge Peter J. Panuthos pursuant to the provisions of

section 7443A(b)(4) and Rules 180, 181, and 183.1 The Court

1
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.
 - 2 -

agrees with and adopts the opinion of the Special Trial Judge,

which is set forth below.

OPINION OF THE SPECIAL TRIAL JUDGE

PANUTHOS, Chief Special Trial Judge: This matter is before

the Court on respondent's Motion for Judgment on the Pleadings,

filed May 15, 1997. As explained in greater detail below, we

will grant respondent's motion.

Background

Respondent issued a notice of deficiency to petitioners

determining a deficiency in their Federal income tax for 1991 in

the amount of $61,304 and an addition to tax for fraud under

section 6663 in the amount of $45,978. Petitioners invoked the

Court's jurisdiction by filing a timely (but imperfect) petition

for redetermination, followed by a proper amended petition.2

Respondent filed an answer to the amended petition,

including therein specific allegations regarding the method of

income reconstruction that respondent relied upon in determining

the deficiency in this case, as well as specific allegations in

support of respondent's determination that petitioners' entire

underpayment of tax for 1991 is attributable to fraud.

Petitioners failed to file a reply to respondent's answer.

Consequently, respondent filed a motion pursuant to Rule 37(c)

2
At the time the imperfect petition was filed, petitioner
Dennis J. Deneault was incarcerated at Eglin Air Force Base,
Florida, and petitioner Teresa Deneault resided in Florida.
 - 3 -

that undenied allegations in respondent's answer to the amended

petition be deemed admitted. The Court issued an order to

petitioners advising them of the filing of respondent's motion

under Rule 37(c) and directing petitioners to file a reply to

respondent's answer on or before April 6, 1997.

Petitioners failed to file a reply to respondent's answer or

otherwise respond to the Court's order. Consequently, we granted

respondent's Rule 37(c) motion, and the undenied allegations set

forth in respondent's answer were deemed to be admitted. See

Doncaster v. Commissioner, 77 T.C. 334, 336 (1981); Gilday v.

Commissioner, 62 T.C. 260, 261 (1974).

As indicated, respondent now moves for judgment on the

pleadings with respect to petitioners' liability for the

deficiency and the fraud penalty set forth in the notice of

deficiency. By order dated May 20, 1997, petitioners were

notified that respondent's motion was calendared for hearing at

the motions session of the Court in Washington, D.C., on June 25,

1997. In addition, petitioners were directed to file a written

response in opposition to respondent's motion. Petitioners did

not respond to the Court's order.

Counsel for respondent appeared at the hearing and presented

argument in support of the motion. No appearance was made by or
 - 4 -

on behalf of petitioners at the hearing, nor did petitioners file

a statement with the Court pursuant to Rule 50(c).3

Facts Deemed Admitted

By virtue of the Court's granting of respondent's motion

under Rule 37(c), petitioners are deemed to have admitted the

following facts:

1. During 1991, the petitioners lived in Ft.
Pierce, Florida. They have three daughters: Mandy,
Crystal, and Sarah Deneault.

2. Dennis J. Deneault is a wire lather by trade,
and engaged in a wire lathing sole proprietorship
during 1991.

3. Teresa Deneault worked for Cale of Ft. Myers,
Inc., doing business as Kirby Auto during 1991, earning
$3,177.06 in wages.

4. During 1991, Dennis J. Deneault was engaged
in the illegal trafficking and sale of narcotics and,
as such, made illegal unrecorded cash sales of
narcotics.

5. Petitioners realized substantial cash sums of
income generated from the illegal narcotic trafficking
business, which substantial cash sums enabled
petitioners to maintain a standard of living
inconsistent with the income reported from all other
legal sources on their joint 1991 Federal income tax
return. Petitioners also failed to report $9,725 of
income which was prematurely withdrawn from an
individual retirement account and placed in a joint
savings account by the petitioners. Neither the income
from marijuana sales nor the withdrawals from the IRA
account were included on the petitioners' joint Federal
income tax return for the year 1991.

3
Petitioners were reminded of the applicability of Rule
50(c) in the Court's order dated May 20, 1997, and expressly that
they could submit a written statement in lieu of (or in addition
to) attendance at the hearing.
 - 5 -

6. Petitioners maintained no sales invoices or
other records relating to the illegal sales of
narcotics during 1991.

7. On June 18, 1991, Dennis J. Deneault was
arrested by the St. Lucie County Sheriff's Office for
the possession and attempted sale of marijuana.

8. During questioning by the St. Lucie County
Sheriff's officers on June 18, 1991, Dennis J. Deneault
disclosed that on June 17, 1991, he had purchased ten
pounds of marijuana for $18,500, and that on June 18,
1991, he had purchased 17 pounds of marijuana for
$25,000.

9. During the execution of a search warrant in
1991, $300.00 in cash was seized from a pickup truck on
the petitioners' real property.

10. The petitioners filed a joint 1991 Federal
income tax return on April 15, 1992, on which they
reported adjusted gross income of $5,882.00. The
petitioners reported $3,177.00 in wages, and $2,976.00
of business income from Dennis J. Deneault's business
as a wire lather.

11. The respondent has determined petitioners'
correct taxable income for 1991 on the basis of the
source and application of funds method based on
information provided from petitioners' joint 1991
Federal income tax return, information secured from
files relating to the arrest and conviction of Dennis
J. Deneault in 1991, and information provided by
petitioners during a hearing with the Appeals Division,
as follows:

SOURCES

(a) Petitioners reported taxable interest
income of $3.00 on their joint 1991 Federal income tax
return.

(b) Petitioners reported gross receipts of
$4,500 from their Schedule C activity for 1991 on their
joint 1991 Federal income tax return.

(c) During 1991, the petitioners received a
Federal tax refund in the amount of $1,253.00, relating
to the taxable year 1989.
 - 6 -

(d) The petitioners reported $3,177.00 of
wage income on their joint 1991 Federal income tax
return.

(e) The petitioners received $6,142.00 by
closing out their bank account at First Union National
Bank of Florida on August 12, 1991.

(f) The petitioners cashed in a certificate
of deposit for $4,681 during 1991.

APPLICATIONS

(g) Respondent determined that petitioners'
living expenses for 1991 were in the amount of $13,962.

(h) During a search of petitioners' property
during 1991, local law enforcement officers found and
seized $300.00 in cash from a pickup truck.

(i) On February 1, 1991, the petitioners
purchased two lots in St. Lucie County, for a total
purchase price of $9,000.00. They paid cash for the
real properties on that date.

(j) The petitioners made payments on their
1989 Lincoln automobile in an amount totaling $3,206.00
during 1991.

(k) On June 17, 1991, Dennis J. Deneault
purchased ten pounds of marijuana for $18,500. On June
18, 1991, Dennis J. Deneault purchased seventeen pounds
of marijuana for $25,000.

(l) According to the joint 1991 Federal
income tax return, during 1991 Dennis J. Deneault
incurred $1,524 in business expenses relating to his
wire lathing sole proprietorship.

(m) During 1991, Federal income tax was
withheld from Teresa Deneault in the amount of $291.79.
Social security tax was withheld from Mrs. Deneault in
the amount of $196.97. Medicare tax was withheld from
Teresa Deneault in the amount of $46.07.

(n) The petitioners paid a $60.00 penalty to
Barnett Bank on June 21, 1991.
 - 7 -

(o) According to their federal income tax
return, during 1991 the petitioners incurred medical
expenses of $1,590, paid property taxes of $1,148.00,
and paid $4,319 in interest payments. Per the return,
they also incurred $20 in miscellaneous deductions.
All of these amounts were reflected on schedule A of
the 1991 joint Federal income tax return.

(p) Federal tax payments were made during
1991 totaling $2,744.

(q) According to the public records of St.
Lucie County, the petitioners paid $2,500 relating to a
seizure of property during 1991.

(r) During 1991, the petitioners placed
$117,000 into a safety deposit box in the name of a Mr.
and Mrs. Peter Boyle.

(s) The net change in the petitioners' joint
account balance at Riverside National Bank during 1991
was a plus $1,100.

12. Petitioners have no non-taxable sources of
funds or excludible receipts which would require
adjustments in respondent's source and application
method for determining petitioners' 1991 taxable
income, such as loans or inheritances.

13. The petitioners made misleading statements to
agents of the respondent during their investigations
relative to the asset acquisitions and illegal narcotic
trafficking transactions as engaged in by the
petitioners during the taxable year 1991. In an
interview with Internal Revenue Service Revenue Agent
John Halligan at an Internal Revenue Service office
occurring January 6, 1993, Mrs. Teresa Deneault told
Mr. Halligan that the information on the petitioners'
Federal income tax return for the year 1991 was
correct. When asked if the petitioners ever possessed
or had access to safe deposit boxes, Mrs. Deneault
responded in the negative, despite there being bank
records of the petitioners' leasing such boxes during
the year 1991. Mr. Dennis Deneault also answered
negatively to this question.

14. The petitioners attempted to conceal assets
by using nominees to hold their money. They rented
safety deposit boxes from banks, and placed substantial
 - 8 -

portions of their drug proceeds into them. The
petitioners' neighbors, Mr. and Mrs. Peter Boyle, held
$117,000.00 for the taxpayers in a safety deposit box
which was opened in 1991. Dennis J. Deneault's mother
held approximately $25,000.00 in a safety deposit box
for the petitioners which was opened in 1991.

15. The safety deposit boxes were opened by the
petitioners in 1991. Keys to the safety deposit boxes
were held only by the petitioners. The nominees knew
that they were holding the money for the petitioners,
and were not permitted to withdraw any portion of the
money.

16. When their Internal Revenue Service audit
began, the petitioners continued to attempt to conceal
assets from the Service. Upon receiving notice by
letter of the examination of their 1991 income tax
return, the petitioners inquired of acquaintances as to
how to hide assets from the Internal Revenue Service.
They were told to place assets into an irrevocable
trust, and actually took steps to complete such an
instrument.

17. The petitioners have made implausible or
inconsistent explanations of their conduct during 1991.
They have made statements denying the existence of any
safety deposit boxes to which they had access during
1991. These are implausible statements, in light of
the fact that they opened the safety boxes and were the
only parties with keys to the boxes. The petitioners'
explanations have been inconsistent with their
behavior, such as their inquiring of acquaintances as
to how to hide assets from the Internal Revenue
Service.

18. Petitioners fraudulently understated their
taxable income during the 1993[4] taxable year in the
amount of $182,752, with the intent to evade the
payment of taxes on such income.

19. All of the underpayment of tax required to be
shown on petitioners' joint 1991 Federal income tax
return is due to fraud.

4
At the hearing on this matter, respondent's counsel
stated that the reference to "1993" in par. 18 of the Answer to
Amended Petition is a typographical error and should be "1991".
 - 9 -

Discussion

Rule 120(a) provides that after the pleadings are closed and

within such time as not to delay the trial, any party may move

for judgment on the pleadings. A motion for judgment on the

pleadings is appropriate only where the pleadings do not raise a

genuine issue of material fact, but rather involve issues that

may be decided as a matter of law. Thus, respondent's motion is

to be granted only if, on the admitted facts, respondent is

entitled to decision as a matter of law. Anthony v.

Commissioner, 66 T.C. 367 (1976), affd. without published opinion

566 F.2d 1168 (3d Cir. 1977). The determinations made by

respondent in the notice of deficiency are presumed correct; the

burden of proof is on petitioners to show that these

determinations are erroneous. Rule 142(a); Welch v. Helvering,

290 U.S. 111 (1933); Rockwell v. Commissioner, 512 F.2d 882, 887

(9th Cir. 1975), affg. T.C. Memo. 1972-133.

The factual allegations deemed admitted under Rule 37(c)

establish that petitioners failed to report income in the amount

of $182,752 for the taxable year 1991, an amount that is

primarily attributable to petitioner Dennis J. Deneault's sales

of illegal narcotics. In addition, petitioners failed to

maintain, or submit to respondent for examination, adequate books

or records regarding the income and expenses relating to their

income during the year in issue. Consistent with these deemed
 - 10 -

admissions, it follows that respondent is entitled to judgment on

the pleadings that petitioners are liable for the deficiency in

tax for 1991 as set forth in the notice of deficiency.

Respondent also determined that petitioners are liable for

the penalty for fraud under section 6663(a) for 1991. Section

6663(a) provides that if any part of the underpayment of tax

required to be shown on the return is due to fraud, there shall

be added to the tax an amount equal to 75 percent of the portion

of the underpayment that is attributable to fraud.

Fraud is defined as an intentional wrongdoing designed to

evade tax believed to be owing. Zell v. Commissioner, 763 F.2d

1139, 1142-1143 (10th Cir. 1985), affg. T.C. Memo. 1984-152; Webb

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

Memo. 1966-81, and cases cited therein. Respondent has the

burden to prove fraud by clear and convincing evidence. Sec.

7454(a); Rule 142(b). Fraud is a question of fact to be resolved

upon consideration of the entire record and is never presumed.

Estate of Pittard v. Commissioner, 69 T.C. 391, 400 (1977).

Respondent's burden of proving fraud can be met by facts deemed

admitted pursuant to Rule 37(c). Doncaster v. Commissioner, 77

T.C. 334, 337 (1981); see Marshall v. Commissioner, 85 T.C. 267,

272-273 (1985).

In the instant case, petitioners are deemed to have

admitted, pursuant to Rule 37(c), that they attempted to conceal

from respondent the source and amount of the income that
 - 11 -

petitioner Dennis J. Deneault realized from sales of illegal

drugs in 1991. Further, petitioners are deemed to have admitted

that they fraudulently and with the intent to evade taxes

understated their taxable income for 1991 in the amount of

$182,752, and that the underpayment of tax required to be shown

on their income tax return for 1991 is due to fraud.

We hold that the facts deemed admitted pursuant to Rule

37(c) satisfy respondent's burden of proving fraud. Doncaster v.

Commissioner, supra at 337.5 Those facts constitute clear and

convincing evidence that petitioners failed to report the income

derived from sales of illegal drugs during 1991 fraudulently and

with the intent to evade taxes known to be owing and that the

entire underpayment of taxes required to be shown on petitioners'

1991 income tax return is due to fraud. Consequently, respondent

is entitled to judgment on the pleadings that petitioners are

liable for the penalty for fraud under section 6663(a) for the

taxable year 1991.

To reflect the foregoing,

5
See also Marshall v. Commissioner, 85 T.C. 267 (1985);
Davis v. Commissioner, T.C. Memo. 1993-324; Cruise v.
Commissioner, T.C. Memo. 1992-688; Asher v. Commissioner, T.C.
Memo. 1992-377; Eisenstein v. Commissioner, T.C. Memo. 1987-241;
Dimsdale v. Commissioner, T.C. Memo. 1987-53; Ricotta v.
Commissioner, T.C. Memo. 1986-508; Twist v. Commissioner, T.C.
Memo. 1986-497; Siravo v. Commissioner, T.C. Memo. 1986-482;
Jackson v. Commissioner, T.C. Memo. 1986-15.
- 12 -

An order granting

respondent's Motion for

Judgment on the Pleadings and

decision for respondent will b

entered.