Boone v. Commissioner

T.C. Memo. 1997-471

UNITED STATES TAX COURT

JOHN R. BOONE, JR., Petitioner, v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 13909-96. Filed October 15, 1997.

On the facts, Held: R has proven, by a
preponderance of the evidence, that P improperly
omitted a substantial amount of gross income from his
Federal tax returns for 1989 and 1990 within the
meaning of sec. 6501(e)(1)(A), I.R.C., such that R is
not barred from assessing deficiencies for those years
by the 3-year statute of limitations of sec. 6501(a),
I.R.C. Held, further, P is not liable for self-
employment taxes pursuant to sec. 1401, I.R.C., on
gross income omitted from his returns for 1989 and
1990. Held, further, accuracy-related penalties for
negligence pursuant to sec. 6662(a), I.R.C., for 1989
and 1990 are sustained.

David W. Gray, for petitioner.

Aubrey C. Brown, for respondent.
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MEMORANDUM FINDINGS OF FACT AND OPINION

NIMS, Judge: Respondent determined the following

deficiencies and accuracy-related penalties with respect to the

Federal income tax of petitioner, John R. Boone, Jr., for the

taxable years 1989 and 1990:

Penalties
Year Deficiency Sec. 6662(a)

1989 $11,775 $2,415
1990 32,389 6,478

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years at issue. All

Rule references are to the Tax Court Rules of Practice and

Procedure.

After concessions by petitioner, the issues remaining for

decision are: (1) Whether respondent is barred by the expiration

of the 3-year period of limitations of section 6501(a) from

assessing and collecting deficiencies in petitioner's Federal

income tax for 1989 and 1990; and, if respondent is not so

barred; (2) whether petitioner understated his income tax in the

amounts determined by respondent in the notice of deficiency for

the years in issue; and (3) whether unreported bank deposits and

cash expenditures made by petitioner in 1989 and 1990 constitute

self-employment income subject to tax under section 1401 for

those years; and (4) whether petitioner is liable for accuracy-

related penalties for negligence pursuant to section 6662(a) for

1989 and 1990.
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Some of the facts have been stipulated and are found

accordingly. The stipulation of facts and attached exhibits are

incorporated herein by this reference. At the time petitioner

filed his petition he resided in Louisville, Kentucky.

FINDINGS OF FACT

A. Petitioner's Upbringing and Relationship With His Great-
Grandfather

Eugene Oscar Walker (Walker) was petitioner's great-

grandfather. Walker married Julia, and they were the parents of

Jean Walker Boone (Jean), petitioner's grandmother. After Julia

died, Walker married Julia's sister, Susanna.

Jean was married to J. L. Boone, petitioner's grandfather.

They were the parents of John R. Boone, Sr., petitioner's father,

and two other children. John R. Boone, Sr., married Marilyn, and

they had four children. Petitioner was born on February 22,

1964; he is the second child and eldest son of John R. and

Marilyn Boone.

During his childhood, petitioner lived with his parents and

siblings in a house located on property adjacent to Walker's

farm. Petitioner shared a bedroom and closet with his two

younger brothers. Petitioner's parents opened a savings account

for him when he was very young.

The Walker farm raised dairy and beef cows, and grew

tobacco, hay, and corn. Walker worked on his farm almost daily.

Petitioner would frequently "tag along" with his great-
 - 4 -

grandfather and assist him in any way that he could. Petitioner

helped milk the cows in the mornings and evenings, and he brought

the cows back and forth to market.

When his health began to fail, Walker moved from his house

in town several miles away from his farm to live with

petitioner's family; he remained there for approximately 6

months. (Susanna was herself too frail to care for her husband.)

During that time, petitioner helped his great-grandfather with

such mundane activities as eating, bathing, dressing, and getting

out of bed. Petitioner also assisted his great-grandfather with

his medications and applied ointments to his aching joints.

Although petitioner was not the only one who aided Walker during

this period, he provided the majority of caretaking when he was

not in school or working on the farm. Marilyn did all of the

cooking and some of the laundering for Walker.

Walker's health deteriorated to the point that he was

admitted to a nursing home on February 5, 1976. He was

transferred to Spring View Hospital on March 28, 1976, where he

died on April 17, 1976, at the age of 83.

B. Walker's Estate

Walker died testate. He left one-half of his personal

property to Susanna and the other one-half to Jean. He also left

an undivided one-half interest in his real property to Susanna

for her life, with remainder to Jean, and the other one-half

interest to Jean in fee simple absolute. Jean was the executrix
 - 5 -

of his will. Walker's total gross estate consisted of the

following assets:

A. Real estate $222,000.00
B. Stocks and bonds 5,320.59
C. Mortgages, notes and
cash 255.00
D. Life insurance 6,000.00
E. Jointly-owned property 92.76
F. Other misc. property 22,500.00
Total gross estate 256,168.35

The deductions for Walker's estate were as follows:

J. Funeral expenses and
other expenses $4,626.98
K. Debts of decedent 20,516.16
L. Mortgages and liens 162,815.81
Total 187,958.95

Adjusted gross estate 68,209.40

The estate tax return showed that, at the time of his death,

Walker had no cash on hand or on deposit in any bank. While

Walker had a safe deposit box, it contained no money. No

transfers of property within 3 years of Walker's death were

reported on Schedule G, Transfers During Decedent's Life,

attached to the Form 706, United States Estate Tax Return, filed

by Jean, nor was any gift tax return filed by or for Walker. The

Walker estate tax return was accepted as filed by the IRS by

letter dated January 13, 1978.

C. Petitioner's Education, Employment, and Living
Arrangements

After graduating from high school in 1982, petitioner

attended St. Catherine's Community College (St. Catherine's) in
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Springfield, Kentucky, for 1 year, to which he commuted from his

parents' home. Petitioner subsequently transferred to Eastern

Kentucky University (Eastern) in Richmond, Kentucky. While

attending Eastern, he lived in a dormitory with two roommates.

Petitioner's college education was financed at least in part

through student loans, which he repaid following college.

After earning an associate's degree from Eastern in 1985,

petitioner moved to Campbellsville, Kentucky, where he lived by

himself in an apartment on Maple Street for approximately 6

months. He then moved to a house located at 103 Columbia Court,

in Campbellsville, which he shared with Perri Warren and Robin

Taylor. Petitioner had previously become acquainted with Ms.

Warren at the Campbellsville-Taylor County Rescue Squad (the

Rescue Squad), an emergency medical service based in

Campbellsville, where he was employed as a paramedic and she was

a paramedic student.

Petitioner and Ms. Warren developed a close platonic

friendship during 1986 through 1990. In addition to living and

working together, they exchanged birthday and Christmas gifts and

occasionally vacationed together. In July 1987, petitioner, Ms.

Warren, and Ms. Taylor moved to a house at 113 Howell Street, in

Campbellsville.

In July 1989, petitioner moved to a house on Mayfield Drive

in Campbellsville, where he lived alone. His fiancee, Sandra

Davis (Sandra), helped him move to this address. On September
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28, 1989, petitioner contracted to buy a house and 9.3 acres of

land on Cave Road, in Campbellsville, for $53,500. He made a

cash deposit of $500 upon execution of the contract. After

negotiation and applications, he received, on October 18, 1989, a

commitment from First Federal Savings Bank to grant a HUD-insured

residential mortgage. The closing took place on November 6,

1989. In connection with petitioner's purchase of the house,

Jean gave him $5,000. No other sizable cash assets belonging to

petitioner were listed on any of the documents relating to his

acquisition of the house.

Petitioner and Sandra were married on June 1, 1990, and

honeymooned in Tahiti.

D. Petitioner's Cash Expenditures in 1989 and 1990

On February 1, 1989, petitioner purchased a 1989 Ford

Mustang convertible for approximately $20,500, less a deposit of

$500 and trade-in allowance, with the balance of approximately

$17,100 financed by Liberty National Bank over 6 years at a

14.95-percent annual rate. In October 1989, petitioner paid in

full, with cash, the outstanding loan of $16,132 on the Mustang.

Petitioner and Sandra purchased a 1989 Chevrolet Corvette in

October 1990. The purchase price of the Corvette was $27,995.

Petitioner made a deposit of $200 on October 3, 1990. On October

5, 1990, petitioner paid the balance due for the Corvette and a

service contract, after receiving a trade-in allowance, with cash

in the amount of $18,003, which he had carried to the dealership
 - 8 -

in a brown paper bag. The cash belonged to petitioner, not

Sandra. There were mostly hundreds and fifties in the bag,

although there may also have been some other denominations.

During 1990, petitioner made additional cash expenditures:

he furnished his newly acquired home, bought a John Deere mower,

and purchased a satellite dish, stereo equipment, and jewelry,

among other items.

When petitioner went out of town, he frequently brought

traveler's checks with him in case his wallet got lost or stolen.

Petitioner purchased $4,500 worth of traveler's checks in 1989.

Petitioner purchased $3,700 worth of traveler's checks for his

Tahitian honeymoon in 1990.

During 1989 and 1990, much of the cash expended and

deposited by petitioner had a musty and mildewed smell.

E. Petitioner's Estrangement From His Family

Since at least the time he attended Eastern, petitioner has

had an estranged relationship with his family. His father had a

predilection for alcohol, and although petitioner could point to

no reason in particular, petitioner did not get along well with

his mother. Once he left home for college, petitioner only

infrequently returned to his parents' house. He did not often

talk with his mother on the telephone. Petitioner had no

interaction at all with his father.

John R. Boone, Sr., who also used the alias "Charles Grass",

was "notorious" in the community for being in the marijuana
 - 9 -

business. On September 22, 1982, upon a guilty plea,

petitioner's father was convicted by the U.S. District Court for

the Western District of Kentucky on charges of conspiring to

unlawfully import marijuana into the United States and on other

drug charges; he received a 5-year prison sentence. On April 29,

1988, upon a guilty plea to charges of aiding others knowingly

and intentionally in unlawfully manufacturing a mixture or

substance containing marijuana, he was convicted and sentenced to

prison by the U.S. District Court for the District of Minnesota

for a term of 20 years, to be followed by 5 years of supervised

release.

F. Petitioner's Employment and Business Activities in 1989
and 1990

Throughout all of 1989 and 1990, petitioner was employed as

a paramedic by the Rescue Squad. Petitioner also began a dog

kennel business, known as Dry Creek Kennel, in 1990. Petitioner

constructed a garage and facilities for the kennel. He spent

$12,508 in cash for the construction. The kennel was not

successful. Petitioner did not engage in any other trade or

business activity in 1989 and 1990, nor did he win any money

gambling or in the lottery.

G. Petitioner's Tax Returns for 1989 and 1990

Petitioner is a calendar year, cash basis taxpayer. On his

1989 Form 1040EZ, Income Tax Return for Single Filers With No

Dependents, petitioner reported wages from the Rescue Squad in
 - 10 -

the amount of $16,028.03, and interest income of $70.83, for

total adjusted gross income of $16,098.06.

Petitioner and Sandra initially filed a joint Form 1040,

U.S. Individual Income Tax Return, for 1990. The gross income

reported on the 1990 return as originally filed was $19,607.

This return failed to report losses from petitioner's dog kennel

on a Schedule C, Profit or Loss From Business (Sole

Proprietorship).

After filing the return, petitioner prepared a Form 1040X,

Amended U.S. Individual Income Tax Return, for 1990. Petitioner

changed his filing status to "married filing separate return".

Attached to the return was a Schedule C reporting gross receipts

or sales of the dog kennel business in the amount of $806, and

total expenses of $10,291, for a net loss of $9,685 for the

kennel. The gross income included on petitioner's 1990 amended

return, including gross receipts from his dog kennel business and

excluding Sandra's separate income, was $19,609.

H. Petitioner's Interviews With Respondent's Agent

Sometime in 1992, Revenue Agent Rhonda Hensley (Hensley)

contacted petitioner as part of a compliance check initiated as

the result of a cash transaction report filed with the IRS by the

car dealership. Hensley examined petitioner's tax returns for

1989 and 1990 at petitioner's home in August 1992. During the

interview, petitioner told Hensley that he had acquired the money

to purchase the Corvette through his efforts to save at least 10
 - 11 -

percent of his earnings from the time he was 15 years old.

Petitioner also told Hensley that he worked odd jobs, that he had

some savings from tobacco sales from his family's farm, and that

he and his wife had received a $5,000 wedding gift from Sandra's

grandfather.

Upon reviewing petitioner's bank records during the course

of the interview, Hensley discovered that, in addition to

purchasing the Corvette for cash, petitioner had made at least

$50,000 in cash deposits into a bank account in 1989 and 1990.

Petitioner and Hensley spent the rest of the day going over his

records and discussing where he obtained the money to make such

deposits. After Hensley perceived some inconsistencies between

the records and what petitioner had told her, and because she was

having trouble understanding petitioner, she asked petitioner to

provide her with a written statement explaining the

discrepancies, to which he assented. Petitioner prepared the

written statement after he and Hensley had discussed the fact

that gifts of up to $10,000 per donee were tax-free to the donor.

The written statement was not made under oath, and petitioner's

signature does not appear on it. The written statement provided

as follows:

Cash gifts:
Parents Grandparent
starting at approximately age 15 basically yearly in
area of [$]5,000-10,000 (an estimate) yearly sometimes
it varied from year to year--not in lump sum but over
period of time. Could be for example: allowances,
given on holidays and birthdays etc. * * *
 - 12 -

Additional monies were obtained when we were children
from sale of livestock, father had farm and would give
us cows, etc. and when sold at stockyards we [received]
proceeds, same way with other farm items, tobacco crop,
hay, corn, etc. Unknown as to the amounts from above,
but do remember numerous [occasions] when this was
done, I am thinking that this was a major portion of
the money.

Petitioner also wrote that relatives had given Sandra and him

cash gifts for their wedding, although he did not specify the

amounts or donors, except for the $5,000 given to the couple by

Sandra's grandfather. In addition, petitioner wrote that his

relatives had given him gifts for birthdays, Christmas, and other

occasions, although he was unable to recall dates and amounts.

After the written statement was prepared, Hensley requested

that petitioner provide her with Marilyn's telephone number and

address in order for Hensley to verify that his parents had given

him cash as he claimed. She then tried to call his mother, but

no one answered the telephone. Shortly thereafter, Sandra

returned home. She suggested that petitioner seek professional

advice and asked Hensley to leave.

Hensley met again with petitioner in September 1992, in the

office of his attorney, David W. Gray (Gray). At that time,

petitioner told her that the information he had previously given

her in the written statement was incorrect. Petitioner said that

he had actually been given a large amount of cash in a canister

by his great-grandfather when petitioner was 15 years old.

Petitioner said that the money contained in the canister
 - 13 -

consisted mainly of tens and twenties. Petitioner explained to

Hensley that he had not revealed the alleged gift earlier because

his father and one of his brothers were involved in the illegal

narcotics business, that they had wanted him to participate in

the illicit activity, and that he had declined to do so. In that

connection, petitioner told Hensley that he had concerns about

what his father and brother might do to him if they were to

discover that he had received such a large cash gift from their

mutual ancestor.

Following the second interview, Gray gave Hensley some of

petitioner's bank records, and Hensley issued an information

document request listing other specific items she wished to

examine, such as documents related to the purchase of the house

at Cave Road, the Corvette, and the payoff of the Mustang loan.

A third meeting between Hensley and petitioner took place in

March 1993. At this time, Hensley primarily wanted to ascertain

all possible sources of petitioner's bank deposits and cash

expenditures. She also wanted to learn about the size of the

canister holding the alleged cash gift, anything unusual about

the money contained therein, and how the cash was placed in the

can. Petitioner told her that his great-grandfather had given

him the key to a file cabinet containing the canister and that

the cabinet was locked. Petitioner also said that the money was

"crunched down" inside the container. Hensley asked petitioner
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if the money were bound together by rubber bands, but he did not

respond.

Prior to the March 1993 meeting with petitioner, Hensley had

concluded that there were indicia of fraud in petitioner's case.

Afterwards, she referred the case to the Criminal Investigation

Division (CID) of the IRS. The investigation resulted in no

indictment of petitioner. No direct link between petitioner and

the criminal activity of his father during 1989 and 1990 was

uncovered by the agents assigned to the CID.

I. The Notice of Deficiency

Respondent issued a statutory notice of deficiency on April

5, 1996, for the taxable years 1989 and 1990. Among other

things, respondent made adjustments to petitioner's gross income

of $32,697 in 1989 and $93,809 in 1990, utilizing the bank

deposits and cash expenditures method of income reconstruction.

Respondent also disallowed certain Schedule C expenses for 1990

related to the dog kennel business in the amount of $2,418.

Moreover, respondent determined that petitioner was liable for

self-employment taxes pursuant to section 1401 on the entire

amount of the understatements of gross income for 1989 and 1990.

In addition, respondent determined that petitioner was liable for

accuracy-related penalties for 1989 and 1990 for negligence

pursuant to section 6662(a).

In the pleadings, petitioner conceded that he improperly

omitted $3.43 of taxable interest income from the Life and
 - 15 -

Casualty Insurance Co. of Nashville, Tennessee, on his return for

1989. Petitioner subsequently conceded respondent's adjustment

disallowing claimed 1990 Schedule C expenses of $2,418. In

addition, the parties have stipulated that petitioner's bank

deposits (less deposited checks returned for insufficient funds

and bank errors) and cash expenditures from funds not derived

from the bank account, less nontaxable sources of funds other

than petitioner's alleged cash hoard at the beginning of 1989,

were as follows for each of the years in issue:

1989 Agreed Bank Deposits Plus Cash Expenditures

BANK DEPOSITS $29,571.88
Less:
Checks returned insufficient funds plus
bank error (882.99)

FUNDS NOT DEPOSITED IN BANK
CASH EXPENDITURES
Car repairs 48.99
Traveler's checks 4,500.00
IRA 2,000.00
Form 4789 (pay off Mustang) 16,132.00
Deposit on house 500.00
Deposit on car (Mustang) 500.00
Stereo equipment 403.50
Jewelry 100.00
Concert tickets 250.00
TOTAL CASH EXPENDITURES 24,434.49
less:

NONTAXABLE SOURCES OF FUNDS:
Federal tax refund 566.00
Allstate refund 324.58
Gift from Jean Boone 5,000.00
Checks to cash 370.00
TOTAL AGREED NONTAXABLE SOURCES (6,260.58)

TOTAL AGREED BANK DEPOSITS, CASH
EXPENDITURES, LESS NONTAXABLE SOURCES
OF FUNDS 46,862.80
 - 16 -

1990 Agreed Bank Deposits Plus Cash Expenditures

BANK DEPOSITS $59,083.67
less:
Checks returned insufficient funds (1,773.41)

FUNDS NOT DEPOSITED IN BANK
CASH EXPENDITURES
Savings account deposit 3,050.00
Cash for honeymoon 1,300.00
Car repairs 284.07
Traveler's checks 3,700.00
Corvette 18,203.00
Fantasy tour 7,142.00
Garage and kennel 12,508.00
Alex Montgomery 800.00
Satellite dish 1,995.00
Furniture--Garrett's 2,680.40
Furniture--Jones 629.95
John Deere mower 2,292.15
Stereo equipment 796.75
Jewelry 640.00
RECC--electricity 79.32
Schedule C expenses 2,593.00
TOTAL CASH EXPENDITURES 58,693.64
less:

NONTAXABLE SOURCES OF FUNDS
Federal income tax refund 582.81
Checks to cash 555.00
Fantasy tour refund 1,708.20
Transfer saving to checking 2,600.00
Christmas gift from wife's grandfather 500.00
Wedding gift from wife's grandfather 5,000.00
Other cash wedding gifts 500.00
TOTAL AGREED NONTAXABLE SOURCES 11,446.01

TOTAL AGREED BANK DEPOSITS, CASH EXPENDITURES,
LESS NONTAXABLE SOURCES OF FUNDS 104,557.89

Based on the above stipulation, the correct amounts of

unreported bank deposits and cash expenditures for 1989 and 1990

are $30,763.94 ($46,862.80 less $16,098.86) and $84,948.89

($104,557.89 less $19,609), respectively. The parties have
 - 17 -

stipulated that, other than the nontaxable sources agreed to

above and the contested cash gift, there are no other possible

nontaxable sources for the amounts omitted from petitioner's

returns for 1989 and 1990.

OPINION

We must decide whether certain of petitioner's bank deposits

and cash expenditures constitute unreported gross income in

excess of 25 percent of the amount of gross income stated in

petitioner's return, so that assessment and collection of income

tax thereon is not barred by reason of the 6-year period of

limitations provided by section 6501(e)(1)(A). If assessment and

collection is not so barred, we must also decide whether the

unreported bank deposits and cash expenditures made by petitioner

constitute self-employment income subject to tax pursuant to

section 1401 for 1989 and 1990. We must also decide whether

petitioner is liable for accuracy-related penalties for

negligence pursuant to section 6662(a) for those taxable years.

I. Does the Period of Limitations Bar Respondent's Assessment of
Deficiencies for 1989 and 1990?

Generally, no deficiency in income tax may be assessed or

collected more than 3 years after the return is filed. Sec.

6501(a). In the instant case, there is no dispute that the

deficiency notice was mailed to petitioner after the expiration

of the 3-year period of limitations, but within the 6-year period

of limitations.
 - 18 -

For the 6-year period of limitations to apply in this case,

respondent has the burden of proving by a preponderance of the

evidence that petitioner omitted from gross income an amount

properly includable therein which is in excess of 25 percent of

the amount of gross income stated in his 1989 and 1990 returns.

Sec. 6501(e)(1)(A); see Burbage v. Commissioner, 82 T.C. 546, 553

(1984), affd. 774 F.2d 644 (4th Cir. 1985); see also Grant v.

Commissioner, T.C. Memo. 1994-161 ("The burden is on respondent

to establish by a preponderance of the evidence that the 6-year

statute applies.")

The parties are in agreement that the amounts here in

dispute are in excess of 25 percent of the gross income shown on

petitioner's returns in 1989 and 1990. The question remaining,

therefore, is whether respondent has proven that such amounts

were "properly includable" in petitioner's gross income for those

years. Sec. 6501(e)(1)(A).

Section 61 defines gross income as "all income from whatever

source derived". This definition includes all "accessions to

wealth, clearly realized, and over which the taxpayers have

complete dominion." Commissioner v. Glenshaw Glass Co., 348 U.S.

426, 431 (1955).

Proof of omitted income by direct means is extremely

difficult and often impossible for respondent to accomplish. See

United States v. Abodeely, 801 F.2d 1020, 1023 (8th Cir. 1986).

Consequently, the Government has available to it a number of
 - 19 -

tools to determine unreported income by indirect methods of

proof. Id.; United States v. Hiett, 581 F.2d 1199, 1200 (5th

Cir. 1978). Petitioner asserts that, where the taxpayer's

records are adequate, respondent cannot rely on indirect methods

to reconstruct income. Leaving aside the question of whether

petitioner's records were in fact adequate in the instant case,

it is well settled that respondent's use of an indirect method of

determining income is not confined to situations where the

taxpayer has no books and records or where his books are

inadequate. See, e.g., Holland v. United States, 348 U.S. 121,

133 (1954); Davis v. Commissioner, 239 F.2d 187 (7th Cir. 1956),

affg. T.C. Memo. 1955-87; Goichman v. Commissioner, T.C. Memo.

1987-489; Estate of Hanna v. Commissioner, T.C. Memo. 1976-32.

In the instant case, respondent relies upon the bank

deposits and cash expenditures method to show an improper

omission of income. The propriety of the bank deposits and cash

expenditures method of income reconstruction is well established.

See, e.g., Caulfield v. Commissioner, 33 F.3d 991, 992 (8th Cir.

1994), affg. T.C. Memo. 1993-423; United States v. Abodeely,

supra at 1023; Parks v. Commissioner, 94 T.C. 654, 658 (1990).

The bank deposits and cash expenditures method is an

offshoot of the bank deposits method. The bank deposits and cash

expenditures method is used by respondent to prove the existence

of omitted or unreported income in circumstances where cash is
 - 20 -

both deposited into bank accounts and spent by the taxpayer. See

generally United States v. Abodeely, supra.

When the Commissioner has the burden of proof, the

Commissioner may either connect the deposits and expenditures to

a likely source of income, or, where the taxpayer alleges a

nontaxable source, negate each nontaxable source alleged by the

taxpayer; the Commissioner need not do both. United States v.

Massei, 355 U.S. 595 (1958); see DiLeo v. Commissioner, 96 T.C.

858, 873 (1991), affd. 959 F.2d 16 (2d Cir. 1992). Petitioner

maintains that respondent has neither proven a likely source of

income nor negated nontaxable sources. Respondent, on the other

hand, claims to have done both by a preponderance of the

evidence.

A. Likely Source of Income

Respondent asserts that a likely source of income for

petitioner during 1989 and 1990 is money that petitioner

wrongfully appropriated from his father's marijuana activity.

(Respondent's agent acknowledged at trial that the adjustments to

gross income determined in the notice of deficiency could not

have been derived from petitioner's unsuccessful dog kennel

business.)

As part of the stipulation of facts, petitioner objected to

the admission of Exhibits P, S, T, U, AB, and AD offered by

respondent, which purport to relate to the issue of a likely

source of income. We postponed ruling on petitioner's objections
 - 21 -

during the trial in order to allow both parties an opportunity to

present their arguments fully and to allow the Court to review

carefully the exhibits in question. Petitioner no longer objects

to the admission of Exhibits P (Judgment and Probation/Commitment

Order regarding petitioner's father dated September 22, 1982) and

U (Judgment and Probation/Commitment Order regarding petitioner's

father dated April 29, 1988); those exhibits will therefore be

received into evidence.

Exhibit S is an unsigned complaint dated October 26, 1987,

by Special Agent Phil Wagner for the Minnesota State Bureau of

Criminal Apprehension against Charles Lee Grass, an alias of

petitioner's father, charging him with the manufacture and

distribution of marijuana or possession with intent to

manufacture and distribute marijuana. Exhibit S does not recite

any facts which connect petitioner to the illegal activities of

his father, nor does it reveal any facts which tend to show that

petitioner's father possessed a substantial amount of money which

petitioner could have appropriated. We therefore conclude that

Exhibit S is irrelevant to the issue for which it is offered and

is therefore inadmissible. Fed. R. Evid. 401.

Exhibit T is a copy of an indictment against John Robert

Boone a/k/a Charles Lee Grass, filed on November 17, 1987, in

which he was charged with the manufacture of, possession with

intent to distribute, and distribution of, marijuana. As with

Exhibit S, the indictment contains no mention of any cash, either
 - 22 -

earned or possessed, by petitioner's father, nor does it connect

petitioner to any of the activities of his father or show that

petitioner appropriated money from him. Accordingly, we hold

that Exhibit T is irrelevant to the issue of a likely source of

income for petitioner, and is inadmissible.

Exhibit AD is a memorandum prepared by Gwen Leftwitch,

respondent's special agent, of a conversation she had with Dick

Ripley, DEA special agent, dated June 6, 1995. Neither were

called to testify in support of the memorandum, which is

therefore inadmissible as hearsay. Fed. R. Evid. 801(c).

Exhibit AB consists of a compilation of computer printouts

and photocopies of 6 newspaper articles pertaining to the

criminal organization to which John R. Boone, Sr., belonged,

referred to colloquially therein as the "Cornbread Mafia".

Respondent offered no witness to establish the truth of the

matters stated in Exhibit AB, which we therefore hold to be

inadmissible hearsay. Fed. R. Evidence 801(c).

We turn now to address the substantive issue of whether

respondent has proven a likely source of income for petitioner

for 1989 and 1990. Respondent argues that petitioner expended

and deposited money having similar musty and mildewed

characteristics to that spent by his father and that, as the

marijuana business is a cash business, the cash more probably

than not came from the same source. Respondent's only basis for
 - 23 -

asserting that petitioner's father spent musty and mildewed money

is derived from the inadmissible Leftwitch memorandum.

Respondent avers that petitioner has provided the Court

"with no explanation of the source of the cash expended and

deposited other than his unbelievable cash-gift-cash-hoard

story." However, we reiterate that the burden of proving a

likely source of income in this matter lies on respondent. See

supra pp. 20-21. We note in this connection that respondent did

not call or depose petitioner's father, the individual who, along

with petitioner, would most likely know of the existence of any

cash hoard that may have been found or appropriated by

petitioner.

Moreover, even if John R. Boone, Sr., had the cash hoard

that respondent attributes to him, respondent has in no way

connected petitioner to it. The fact that money spent by John R.

Boone, Sr., and petitioner may have had similar musty and

mildewed qualities, even if proven, standing alone would be

insufficient to convince the Court that, more likely than not,

the cash shared the same source.

For all of the above reasons, we hold that respondent has

failed to prove a likely source for the amounts allegedly omitted

from petitioner's returns in 1989 and 1990.

B. Nontaxable Sources

Respondent maintains, in the alternative, that there are no

nontaxable sources for the amounts unreported on petitioner's
 - 24 -

returns for 1989 and 1990 other than those agreed to by the

parties in their stipulation. Respondent asserts that the sole

unagreed nontaxable source, the alleged cash gift, has been

negated. Petitioner argues that the unreported amounts deposited

and expended in 1989 and 1990 were not includable in income

because he was spending cash on hand at the beginning of 1989,

cash that he claims was given to him by his great-grandfather in

1976.

In United States v. Massei, 355 U.S. at 595, the Supreme

Court stated that "should all possible sources of nontaxable

income be negatived, there is no necessity for proof of likely

source." However, in Commissioner v. Thomas, 261 F.2d 643, 646

(1st Cir. 1958), revg. and remanding T.C. Memo. 1957-244, the

Court of Appeals for the First Circuit noted that the

burden of negating is not so broad as it sounds, for
* * * the only source of nontaxable income which the
taxpayers have contended accounts for taxpayers'
increases in net worth, as we said, was a substantial
cash gift * * *. It follows that * * * only that
source needs to have been negated. [Emphasis added.]

See also United States v. Hiett, 581 F.2d at 1201; Kramer v.

Commissioner, 389 F.2d 236, 238 (7th Cir. 1968), affg. T.C. Memo.

1966-234; Gatling v. Commissioner, 286 F.2d 139, 144 (4th Cir.

1961), affg. T.C. Memo. 1959-224; Parks v. Commissioner, 94 T.C.

at 660; Boggs v. Commissioner, T.C. Memo. 1985-429.

We conclude that respondent may satisfy the burden of proof

on this issue by negating petitioner's alleged nontaxable cash
 - 25 -

hoard received by gift from his great-grandfather. By direct

proof this would be almost impossible. But this Court has held

that respondent may negate an alleged nontaxable cash hoard by

proving that such a claim is "inconsistent, implausible, and not

supported by objective evidence in the record." Parks v.

Commissioner, supra at 661; see Boggs v. Commissioner, supra;

Phillips v. Commissioner, T.C. Memo. 1984-133.

For the reasons which follow, we are convinced that

respondent has shown that, more likely than not, petitioner's

1989 and 1990 bank deposits and cash expenditures were not

derived from moneys obtained from his great-grandfather, the only

unagreed nontaxable source asserted in this case.

1. There is no evidence that Walker possessed a cash hoard,
or that he would give it to petitioner if he did.

The objective evidence in the record does not support

petitioner's contention that his great-grandfather possessed a

large amount of cash on hand. In this regard, we note that

Walker's adjusted gross estate was small (roughly $68,000) in

comparison to the alleged cash hoard of approximately $115,000.

Moreover, Walker had miscellaneous real and personal property,

and does not appear to have been the type of individual who was

likely to keep a cash hoard. See Shelhorse v. Commissioner, T.C.

Memo. 1980-98. Walker also had mortgages on his property and

other debts, which is inconsistent with a large cash hoard. See

Thomas v. Commissioner, 223 F.2d 83, 88 (6th Cir. 1955). Also,
 - 26 -

Walker's safe deposit box contained no cash at the time of his

death.

Petitioner would have the Court conclude that, since Walker

had no bank accounts and no cash in his safe deposit box at the

time of his death, he must have possessed a sizable cash hoard.

However, it is more likely that Walker was "dirt rich" and cash

poor. In any event, we doubt that, if Walker had such a cash

hoard, he would have kept it in a desk drawer, in a small

building located apart from his house in town, while he kept no

cash in his safe deposit box, where it would not be subject to

theft or casualty. See Shelhorse v. Commissioner, supra.

Moreover, in his will, Walker left all of his property to

Susanna and Jean, the natural objects of his bounty, making no

provision for petitioner or any other of his descendants. No

gift tax return was filed by or for Walker. Furthermore, there

is no evidence that Walker ever told anyone about a cash hoard or

a gift to petitioner. We do not think that the fact that

petitioner was a tag-along companion who assisted his great-

grandfather toward the end of his life would have imbued Walker

with the desire to give his 11-year-old great grandson, three

generations removed from him, almost twice as much as he

bequeathed to his wife and daughter.

2. Petitioner's testimony is implausible, is not supported
by objective evidence, and is inconsistent with prior
statements he made to respondent's agent.
 - 27 -

Petitioner testified that the unreported bank deposits and

cash expenditures made during 1989 and 1990 stemmed from his

great-grandfather's gift. Petitioner said that his great-

grandfather gave him the money because Walker felt that he did

not have much longer to live. Petitioner testified that Walker

told him that he, petitioner, should use the money for "something

purposeful" in his life, such as when he married or purchased a

home. Petitioner claimed that Walker told him the money was

located in a desk in Walker's office, in a small building

situated approximately 100 yards from petitioner's home.

Petitioner claimed that Walker told him never to tell anyone

about the money.

Petitioner testified that the money was in a mostly red,

cylindrical metal canister with a slip-off lid, and that the

canister had some type of design on the outside of it about which

he could not be specific. He said that the canister was about 8

inches tall and 10 inches in diameter. Petitioner testified that

he found the canister lying in an unlocked drawer of a file

cabinet attached to a metal desk. Petitioner claimed that he did

not count the money because his great-grandfather told him not to

do so.

Petitioner testified that he observed nothing in the

canister other than currency of all denominations, which was not

arranged in a specific manner. He claimed that he never changed

the way the cash was situated in the canister after receiving it,
 - 28 -

nor did he exchange the currency for higher denominations.

Petitioner further stated that the cash smelled "old" to him when

he opened the canister, "like old books or documents".

Petitioner claimed that when he got the canister home, he put it

on the top shelf of his bedroom closet underneath several other

items, which he considered to be the "safest place" for the

cash.

Petitioner said that he kept the canister in his closet

throughout high school. After high school, he claimed to have

kept the canister in his closet while he commuted to St.

Catherine's. While at Eastern, he purportedly kept the cash in a

closet in his dormitory, even on those occasions when he returned

home. Petitioner claimed that it never bothered him to leave the

money in the dormitory.

Petitioner said that he moved the canister from Maple Street

to Columbia Court, and again to Howell Street, and that he left

it in his bedroom at these residences every time he took a trip.

Petitioner said that he did not put the cash in a bank because he

"just decided to keep doing the same thing with it that * * *

[his great-grandfather] had done with it." He testified that it

did not bother him at the time that he was not earning interest

on the money.

Petitioner testified that he did not keep any record of the

amount of money he spent out of the canister, and that he never

knew the total amount of money that it contained. In that
 - 29 -

connection, petitioner stated that he was not sure whether he had

enough money to purchase the Corvette (despite having already

made a deposit on the car) until he went back home and counted

out the necessary amount of cash.

Petitioner testified that he threw out the canister sometime

after 1990 when the money was all gone. He claimed that he had

kept the money in the canister from the day he got it, except for

a small amount of cash which he had placed in his sock drawer in

early 1989.

Petitioner claimed that he rarely spent money out of the

canister prior to 1989. Once, he said, while in high school, he

used some of the money to rent a car. In college, he purportedly

bought a videocassette recorder with some of the cash.

Occasionally, if he got behind in bills, he used a little bit of

the money to "keep up". Petitioner kept no record of such

expenditures, however.

We think that respondent has proven by a preponderance of

the evidence that petitioner's testimony is implausible, self-

serving, and contrived. We believe it unlikely that petitioner

could keep a large sum of money in his bedroom closet for

approximately 7 years without either his brothers' or parents'

discovering it. Nor do we think that petitioner would keep such

a large amount of money in a college dormitory or in his bedroom

in the houses he shared. Such behavior is at odds, among other
 - 30 -

things, with the fact that he took thousands of dollars of

traveler's checks on trips to avoid losing cash.

Moreover, we think it implausible that petitioner would take

out student loans if he had been given the money to use for

"something purposeful". We also do not think that petitioner

would take out the loan for the Mustang at a relatively high

annual percentage rate if he had a large cash hoard at the time

he bought the car, only to pay the loan off with cash several

months later. Evidence of borrowing supports an inference that

petitioner had no cash hoard, as a cash hoard obviates the need

to borrow. See Thomas v. Commissioner, 223 F.2d at 88. Even if

we believed that these actions could be explained as a

consequence of petitioner's efforts to hide the money from his

family in keeping with his great-grandfather's alleged wishes,

petitioner never showed any large cash assets on documents that

his family would never have reason to see, such as his mortgage

application.

Also, we think it unlikely that petitioner would forgo

earning interest on such a large sum of money. See Conti v.

Commissioner, T.C. Memo. 1992-616, affd. and remanded to correct

a computational error 39 F.3d 658 (6th Cir. 1994); Cruz v.

Commissioner, T.C. Memo. 1990-594; Phillips v. Commissioner, T.C.

Memo. 1984-133. Petitioner had a savings account from a very

young age, and interest earned on the large amount of money would

have provided him with a sizable sum relative to the amount of
 - 31 -

gross income reported on his 1989 and 1990 returns. Finally, we

find it simply unfathomable that petitioner would never have

counted the money in the canister in all the years he purportedly

hoarded it, or that he would purchase the Corvette largely with

cash without first ascertaining that the canister held a

sufficient amount. Cf. Phillips v. Commissioner, supra.

a. Petitioner's testimony was inconsistent with his prior
statements to respondent's agent.

Petitioner's cash hoard testimony, when juxtaposed against

the statements that petitioner made to Hensley, is totally

inconsistent. Although petitioner told Hensley that the drawer

to the desk containing the money was locked, petitioner testified

that it was unlocked. Moreover, while initially claiming to be

15 when his great-grandfather gave him the money, petitioner

testified that he was actually 11 years old, after being

confronted by the fact that his great-grandfather had died

several years before petitioner turned 15. Furthermore,

petitioner told Hensley that the cash was "crunched down inside

the container", yet at trial petitioner claimed that the money

was "just loosely laying" in the canister, and that some of the

cash was wrapped in rubber bands "laying out flat". Moreover,

despite testifying that he never transferred the money out of the

canister except to place a small portion in his sock drawer,

petitioner told Hensley that he had placed the cash in a shoebox

in 1987 or 1988.
 - 32 -

Perhaps most revealing, despite telling Hensley during the

second or third interview that he did not divulge the existence

of the cash hoard to his wife until after the first interview in

August 1992, petitioner testified that he initially told Sandra

about the money in July 1989, and that he had forgotten about

this earlier conversation. We find it unlikely that petitioner

would fail to recall such a conversation with Sandra, if it had

taken place, during his talks with Hensley. Petitioner and

Hensley had discussed earlier the purchase of the Corvette with

cash in a brown paper bag, a purchase that Sandra had witnessed

apparently without surprise.

In sum, we conclude that respondent has proven that

petitioner's testimony was irreconcilably and materially

inconsistent with his prior statements to respondent's agent.

b. The testimony of Perri Warren and Scott Shaw does not
convince the Court that petitioner had a significant
amount of cash on hand prior to 1989.

Ms. Warren, one of petitioner's best friends, claimed to

have observed an unusual amount of currency in a canister in

petitioner's bedroom at Howell Street in 1988 while in the

process of straightening up his room in preparation for a visit

of their landlord's mother. Based on petitioner's own testimony,

we have some reservations as to whether Ms. Warren actually had

access to petitioner's bedroom, in that petitioner testified that

he put a deadbolt lock on his bedroom door and did not leave his
 - 33 -

bedroom unlocked in order to deter another housemate who liked to

snoop in others' belongings. Even discounting such reservations,

Ms. Warren's testimony that the denominations of the bills were

"twenties, fifties and one hundreds" and that the bills were

"wrapped in little bitty bundles", is, in any event, flatly

inconsistent with petitioner's claim that the money was just

"loosely laying" in the can, and consisted of mainly tens and

twenties.

Moreover, Ms. Warren could not testify as to what was below

the first layer of cash that she purportedly saw. In addition,

she did not remember the color of the alleged canister or its

condition; she recalled only that it was metal. She also failed

to perceive any odor emanating from the money despite the fact

that much of the cash spent by petitioner in 1989 and 1990

smelled musty and mildewed.

Petitioner testified that Ms. Warren first revealed to him

that she had observed money in his bedroom when petitioner

questioned her in connection with her possibly testifying to that

effect. Petitioner said that a mutual friend, Scott Shaw, had

previously informed him that Ms. Warren had seen such money in

petitioner's possession. However, upon direct examination by

respondent, Mr. Shaw testified that he was never told by Ms.

Warren that petitioner possessed a large sum of cash and that Ms.

Warren never talked to him about seeing it. Mr. Shaw himself

saw, at most, only a thousand dollars in petitioner's bedroom at
 - 34 -

Howell Street, in fairly small denominations, scattered on

petitioner's bed. Moreover, Mr. Shaw could not clearly recall if

the money he observed on the bed was petitioner's or his own.

Finally, petitioner argues that where, as here, respondent

attempts to prove a likely source of income and falls short, but

successfully negates petitioner's alleged nontaxable source,

respondent should nevertheless not prevail. Petitioner asserts

that other cases holding that respondent need only negate

nontaxable sources have in fact concluded that respondent also

showed a likely source. However, this Court in Parks v.

Commissioner, 94 T.C. at 661, held that, where respondent

presented no evidence of a likely source, negativing nontaxable

sources was sufficient, by itself, to prove an underpayment in a

fraud case. (In a fraud case, respondent has the burden of

proving by clear and convincing evidence that some part of an

underpayment was due to fraud, DiLeo v. Commissioner, 96 T.C. at

873, a higher standard of proof than the preponderance of the

evidence standard applicable in the case before us.)

Petitioner's attempt to distinguish Parks v. Commissioner,

supra, on the ground that, in that case, no attempt was made to

prove a likely source, is unavailing. We have already pointed

out that the Commissioner need only connect bank deposits and

expenditures to a likely source, or, where a taxpayer alleges a

non-taxable source, negate that source; the Commissioner need not

do both. United States v. Massei, 355 U.S. 595 (1958).
 - 35 -

Based on the foregoing, we hold that respondent has proven a

substantial omission of income within the meaning of section

6501(e)(1)(A) by negating the only unagreed nontaxable source

alleged by petitioner. Petitioner does not dispute that

unreported bank deposits and cash expenditures in the amounts of

$30,763.94 and $84,948.89 for 1989 and 1990, respectively, if

found to be improperly omitted from gross income, are subject to

ordinary income taxes. Petitioner does not now claim any

deduction or losses not allowed by respondent. Therefore, we

hold that petitioner is liable for deficiencies in income tax for

1989 and 1990, the correct amount of which will be calculated

under Rule 155.

II. Respondent's Determination of Self-employment Tax

Respondent further determined that petitioner's omitted

gross income was subject to self-employment taxes pursuant to

section 1401 for 1989 and 1990. Section 1401 imposes a tax on

self-employment income that is in addition to other applicable

taxes. Section 1402(b) generally defines self-employment income

as net earnings from self-employment derived by an individual.

The term "net earnings from self-employment" means gross income

derived by an individual from any trade or business carried on by

such individual, less allowable deductions attributable to such

trade or business, plus certain items not relevant here. Sec.

1402(a). The term trade or business for purposes of the self-

employment tax generally has the same meaning it has for purposes
 - 36 -

of section 162. Sec. 1402(c). Thus, to be engaged in a trade or

business within the meaning of section 1402(a), an individual

must be involved in an activity with continuity and regularity

and his primary purpose for engaging in the activity must be for

income and profit. See Commissioner v. Groetzinger, 480 U.S. 23,

35 (1987).

Respondent asserts that petitioner misappropriated his

father's marijuana cash hoard, and that such a conversion is

income from a trade or business, because misappropriating the

money occupied petitioner's "time, attention, and labor" and was

for petitioner's own profit and livelihood. Petitioner, on the

other hand, maintains that he earned no self-employment income in

1989 and 1990. His dog kennel business was unsuccessful, and

reported a net loss for 1990.

Petitioner's testimony and that of his wife, and Ms. Warren

satisfies us that petitioner did not carry on any trade or

business activity in 1989 and 1990 other than his dog kennel

business in 1990. Respondent's agent acknowledged that the dog

kennel business could not have been the source for all of the

additional funds asserted in the notice of deficiency.

As previously mentioned, respondent posits that money

appropriated from petitioner's father is self-employment income

to petitioner. However, we do not find that petitioner took part

in his father's marijuana activity. We therefore hold that
 - 37 -

petitioner is not liable for self-employment taxes pursuant to

section 1401 on his unreported gross income for 1989 and 1990.

III. Is Petitioner Liable for the Section 6662(a) Accuracy-
Related Penalties for Negligence for 1989 and 1990?

Respondent determined that petitioner is liable for the

accuracy-related penalty under section 6662(a) for negligence for

both 1989 and 1990. Petitioner bears the burden of proof on this

issue. Rule 142(a); Neely v. Commissioner, 85 T.C. 934 (1985);

Bixby v. Commissioner, 58 T.C. 757 (1972).

Section 6662(a) imposes an accuracy-related penalty of 20

percent on any portion of an underpayment of tax that is

attributable to items set forth in section 6662(b). Section

6662(b)(1) provides that section 6662(a) is to apply to any

portion of an underpayment attributable to negligence or

disregard of rules or regulations. Section 6662(c) defines

"negligence" to include any failure to make a reasonable attempt

to comply with the provisions of the Internal Revenue Code, and

defines "disregard" to include any careless, reckless, or

intentional disregard of rules or regulations.

The accuracy-related penalty of section 6662 does not apply

to any portion of an underpayment if it is shown that there was

reasonable cause for such portion and the taxpayer acted in good

faith with respect thereto. Sec. 6664(c)(1). Other than his

rejected claim of a nontaxable cash hoard, petitioner presented

no evidence that he was not negligent in failing to report the
 - 38 -

omitted gross income for 1989 and 1990, or that he had reasonable

cause to do so. Accordingly, respondent's determination that

petitioner is liable for the accuracy-related penalty for

negligence for those years must be sustained. The correct amount

of the section 6662(a) accuracy-related penalties for 1989 and

1990 will be calculated in a Rule 155 proceeding.

We have considered all other arguments advanced by the

parties and found them to be either irrelevant or without merit.

IV. Conclusion.

The record contains credible testimony that petitioner's

reputation for truthfulness and veracity in the Springfield,

Kentucky, community is good. Nevertheless, based on our

observations at trial and all of the evidence in the record, we

are forced to conclude that there is a substantial lack of candor

in petitioner's explanation as to how, when, and from what source

he came into possession of the alleged large cash hoard that is

the focus of this case. It is not the Court's function to

speculate as to the actual source of this money, and we decline

the opportunity to do so. We simply do not accept petitioner's

version of the truth.

To reflect the foregoing and concessions,

An appropriate order

will be issued, and decision
- 39 -

will be entered under Rule

155.