Zaban v. Commissioner

T.C. Memo. 1997-479

UNITED STATES TAX COURT

STANLEY J. ZABAN AND SHIRLEY A. ZABAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 27119-93. Filed October 21, 1997.

Paula M. Junghans and Caroline D. Klepper, for petitioners.

Alan R. Peregoy, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS, Judge: Respondent determined the following

deficiencies in, and additions to, petitioners' Federal income

taxes:
 - 2 -

Additions to Tax & Penalties
Sec. Sec. Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6651(a)(1) 6653(b)(1)(A) 6653(b)(1)(B) 6653(b)(1) 6661 6663 6662(b)(2)
1986 $44,245 --- $33,184 1 --- $11,061 --- ---
1987 71,567 --- 53,675 1 --- 17,892 --- ---
1988 26,976 --- --- --- $20,232 6,744 --- ---
1989 75,714 $14,892 --- --- --- --- $56,786 ---
1990 44,331 --- --- --- --- --- --- $8,866

1
50 percent of the interest payable under sec. 6601 on the portion of
the underpayment attributable to fraud.

As an alternative to the fraud additions to tax and penalty,

respondent determined additions to tax for negligence or disregard

of rules or regulations pursuant to section 6653(a)(1)(A) and (B)

for 1986 and 1987 and section 6653(a)(1) for 1988 and an accuracy-

related penalty pursuant to section 6662 for 1989.

The 1986 through 1989 deficiencies arose out of unreported

income from petitioner Stanley J. Zaban's (Mr. Zaban) illegal

gambling and bookmaking activities and skimming from his legitimate

business activities, as well as respondent's disallowance of

certain miscellaneous expense deductions for 1987 and 1988. The

1990 deficiency arose out of respondent's disallowance of both a

mortgage interest deduction and a deduction for funds forfeited to

the Baltimore County Police Department after the funds were seized

in the execution of search warrants as proceeds from Mr. Zaban's

illegal activities.
 - 3 -

After concessions,1 the following issues remain for decision:

(1) Whether respondent properly determined that petitioners had

cash on hand in the amount of $115,100 as of December 31, 1989, as

part of the 1989 net worth calculation; (2) whether petitioner

Shirley A. Zaban (Mrs. Zaban) qualifies for innocent spouse relief

pursuant to section 6013(e) for 1986 through 1990; (3) whether Mrs.

Zaban is liable for the fraud additions to tax for 1986 and 1987

pursuant to section 6653(b)(1)(A) and (B) and for 1988 pursuant to

section 6653(b)(1) and for the fraud penalty for 1989 pursuant to

section 6663; (4) whether Mrs. Zaban is liable for the additions to

tax for negligence or disregard of rules or regulations for 1986

and 1987 pursuant to section 6653(a)(1)(A) and (B) and for 1988

pursuant to section 6653(a)(1) and for the accuracy-related penalty

1
Petitioners concede the deficiencies relating to all of
the unreported income, except for $115,100 determined as cash on
hand as part of respondent's 1989 net worth calculation. They
also concede the fraud additions to tax and penalty for 1986
through 1989 with respect to Mr. Zaban. Moreover, petitioners
concede that they are not entitled to the $98,000 deduction for
forfeited funds for 1990. Finally, the parties have agreed that
petitioners are entitled to a $56,622 mortgage interest deduction
for 1990.
Respondent disallowed petitioners' 1987 and 1988 deductions
for certain miscellaneous expenses. Although petitioners
disputed this determination in their petition, they did not
address this issue either at trial or on brief. Because the
burden of proof lies with petitioners on this issue, we hold for
respondent. Rule 142(a). Additionally, and for the same
reasons, we hold for respondent on the innocent spouse issue
relating to the miscellaneous expense deductions. Respondent,
however, did not present any evidence on the fraud additions to
tax relating to the miscellaneous expense deductions, and given
our finding that no fraud existed with respect to other issues,
we hold for Mrs. Zaban on that issue. Rule 142(b).
 - 4 -

for 1989 pursuant to section 6662; (5) whether petitioners are

liable for additions to tax for the substantial understatement of

tax pursuant to section 6661 for 1986, 1987, and 1988 and for the

penalty pursuant to section 6662(b)(2) for 1990; and (6) whether

petitioners are liable for the addition to tax for failure to

timely file their 1989 joint return pursuant to section 6651(a)(1).

All section references are to the Internal Revenue Code as in

effect for the years in issue, unless otherwise indicated. All

Rule references are to the Tax Court Rules of Practice and

Procedure.

FINDINGS OF FACT

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

stipulation of facts and the attached exhibits are incorporated

herein by this reference.

Background

Petitioners, husband and wife, resided in Lutherville,

Maryland, at the time they filed their petition. They were married

in 1967 and have one daughter, Nicole.

Mr. Zaban graduated from college in 1967 and subsequently

became involved in illegal gambling and bookmaking activities

(described in detail below). Mrs. Zaban graduated from high school

in 1964 and has no college-level education.

Between 1986 and 1990, Mrs. Zaban was a homemaker and did not

work outside of the home. Mrs. Zaban was the caretaker of
 - 5 -

petitioners' personal checking account and paid all of the

household bills, including the mortgage and utility payments.

Prior to the period at issue, Mrs. Zaban held various employment

positions, including rater for insurance policies, receptionist at

a nursing home, salesclerk at a department store, and interior

decorator.

A. Business Interests of Mr. Zaban

During 1985 and/or 1986, Mr. Zaban was a shareholder in the

following entities: G&Z Corp., doing business as the Parlay Cafe

(1985 through 1990); Graymar Co., Inc., which sold business

equipment and supplies (1986 through 1990); Putty Hill Printing,

Inc., which provided printing and copying services (1985 through

1990); and OPCZ, Inc., doing business as Zingaro's restaurant (1985

through 1987).

In 1986, upon the recommendation of Francis E. Fidati, CPA,

petitioners' personal and business accountant, Mr. Zaban formed and

was the sole shareholder of Zaban Enterprises, Inc., a subchapter

S corporation, for the purpose of paying himself a salary, as well

as distributions, from interests in his other business entities.

Mrs. Zaban was an officer of Zaban Enterprises; she signed

corporate employment and income tax returns, signed the election to

become a subchapter S corporation, maintained the corporate

checking account, and wrote substantially all the checks from that

account.
 - 6 -

In or about August 1985, Mrs. Zaban, along with Gary Genovese,

a shareholder with Mr. Zaban in the Parlay Cafe, filed an

application for a liquor license for the Parlay Cafe with the

Board of Liquor License Commissioners for Baltimore County. The

application falsely stated that Mrs. Zaban had a 50-percent

ownership interest in G&Z, Corp., the entity that owned the Parlay

Cafe. Moreover, the application failed to disclose that Mr. Zaban

had an interest in G&Z, Corp. The renewal applications for 1988

and 1991 contained the same false declaration and omitted the same

information.

Each application contained a question as to whether any of the

applicants had been convicted of violating gambling laws. Had Mr.

Zaban been listed as one of the applicants, the Parlay Cafe might

have been denied a liquor license.

B. Criminal Record and Activity of Mr. Zaban

Prior to 1978, Mr. Zaban became involved in bookmaking

activities with Herman "Lefty" Neumyer. In 1978, Messrs. Zaban and

Neumyer were arrested and convicted of bookmaking. Mrs. Zaban knew

of her husband's bookmaking activities with Mr. Neumyer. She also

knew of her husband's conviction.

On August 2, 1990, Mr. Zaban was charged with illegal

possession of flash paper, a material used by bookmakers for the

purpose of destroying records of their activity. The flash paper

was discovered in a March 1990 search of Mr. Zaban's Mercedes Benz
 - 7 -

pursuant to a warrant. On August 30, 1990, Mr. Zaban pled guilty

in the District Court of Baltimore to conspiracy to gamble.

On September 21, 1990, Messrs. Zaban and Neumyer were arrested

in the parking lot of the Quality Inn Motel in Towson, Maryland,

and charged with illegal wagering on a baseball and a football

game, and conspiracy to gamble. The Government, however, did not

pursue the charges.

On or about June 25, 1992, the U.S. Attorney for the District

of Maryland filed a four-count information charging Mr. Zaban with

illegal gambling and bookmaking, money laundering, bank fraud, and

tax evasion (for 1989 only). Mr. Zaban pled guilty to each count

as part of a plea bargain with the U.S. Attorney's Office, and

judgment was entered by the U.S. District Court for the District of

Maryland on October 27, 1992. The plea agreement also included a

stipulation that Mr. Zaban had engaged in skimming cash from the

Parlay Cafe.

Mr. Zaban's accountant, Mr. Fidati, also pled guilty to

assisting in the preparation and filing of a false tax return by

failing to report the income from the illegal bookmaking and

gambling activities, as well as the income skimmed from the Parlay

Cafe.

1. Illegal Gambling and Bookmaking

Pursuant to the Federal information to which Mr. Zaban pled

guilty in October 1992, Mr. Zaban admitted that from May 1, 1986,
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through March 23, 1992, he was engaged in illegal gambling and

bookmaking activities out of his home and in other locations within

the State of Maryland. He engaged in these bookmaking operations

with Mr. Neumyer and others. The bookmaking operations were

confined to sports betting, primarily on collegiate and

professional basketball and football.

Mr. Zaban's role in the operation was to obtain customers,

record bets, distribute winnings, and collect losses. Mr. Zaban

also placed bets on his own account several times a week and often

traveled to Las Vegas and Atlantic City to gamble and watch boxing

fights, trips of which Mrs. Zaban was aware. Mr. Zaban's share of

the bookmaking proceeds was 25 percent. The bookmaking operation

grossed more than $2,000 per day.2

Mr. Zaban maintained an office for conducting these bookmaking

and gambling activities in the basement of petitioners' home. Mr.

Zaban kept no regular work hours at home or in other places and

occasionally met with Mr. Neumyer at a local bar, at times when

Mrs. Zaban was present. At his desk in the basement, Mr. Zaban

kept betting records, bottom sheets, sports schedules, and a

telephone with two tape recorders that were hard-wired to

petitioners' two phone lines so that he could record conversations

2
In a closing agreement with the Internal Revenue
Service, Mr. Zaban conceded that the daily net profit from the
bookmaking operation was $5,800, and that he had a 50-percent
share or $2,900 per day.
 - 9 -

with customers and refute any challenges to bets. Also in the

basement, Mr. Zaban kept a toolbox with a combination lock that was

used to store his share of cash proceeds from bookmaking and

gambling activities, as well as cash he skimmed from the Parlay

Cafe. During the execution of a search warrant in March 1990, the

Baltimore County Police Department found $47,250 in cash and 17 $50

gold pieces in the toolbox. The toolbox was later moved and hidden

in an upstairs crawl space at the home of Mrs. Zaban's parents, the

DeFranks. Upon the execution of a search warrant at the DeFranks'

home in March 1992, the police discovered various papers

associating Mr. Zaban with gambling and bookmaking activities,

$62,700 in Bethlehem Steel bearer bonds, 590 $100 bills, and 20 $50

bills. Although the toolbox was somewhat obscured while in

petitioners' basement, the tape recorders were in plain sight on

Mr. Zaban's desk.

From petitioners' basement, Mr. Zaban made and received

telephone calls to and from Mr. Neumyer and others involved in the

gambling and bookmaking activities. Mrs. Zaban occasionally

answered the telephone in their home and at times spoke with Mr.

Neumyer. Sometime in 1991, the Baltimore County Police Department

obtained an order from the Circuit Court for Baltimore County to

place a dialed number recorder (DNR) on the two phone lines at

petitioners' residence in Lutherville, Maryland, for the purpose of

recording the number of incoming and outgoing activations on those
 - 10 -

lines. The DNR analysis performed by the Baltimore County Police

Department between November 21, 1991, and January 30, 1992,

revealed 3,360 activations on one line, of which 3,231 were

outgoing and 129 were incoming, and 1,097 activations on the other

line, of which 635 were outgoing and 462 were incoming. The first

line had an average of 47 telephone calls per day, and the second

line had an average of 15 telephone calls per day.

2. Money Laundering

Mr. Zaban engaged in two different schemes to launder the

money he obtained from his illegal gambling and bookmaking

activities. The first scheme involved alleged loan payments to Mr.

Fidati. Mr. Zaban gave Mr. Fidati $4,000 per month in cash during

1986, 1987, and 1988, and Mr. Fidati repaid Mr. Zaban by writing

two checks in odd amounts, totaling $4,000 per month, payable to

either Mr. Zaban or Zaban Enterprises. This scheme was the basis

for the money laundering charge to which Mr. Zaban pled guilty.

As part of her role in Zaban Enterprises, Mrs. Zaban often

deposited checks into the entity's account, including those from

Mr. Fidati, and in turn wrote salary and distribution checks to her

husband from that account. The amounts of the checks to Mr. Zaban

were based on a schedule prepared by Mr. Fidati. Mrs. Zaban

understood the checks from Mr. Fidati to Zaban Enterprises to

represent loan repayments to Mr. Zaban, but she never questioned

the odd amounts of the repayments.
 - 11 -

The second money laundering scheme, which for purposes of the

1992 plea bargain with the U.S. Attorney's Office could not be

proven, involved payments to Westco Manufacturing Co. (Westco) in

California during 1989. Mr. Zaban paid his friend Roy Burger

$41,569, and in exchange, Westco, for whom Mr. Burger worked and

was earning commissions, paid Zaban Enterprises with checks

totaling $41,569. Mrs. Zaban was aware of these transactions and

the deposits of checks from Westco to Zaban Enterprises. Mrs.

Zaban believed that these were consulting fees for work performed

by Mr. Zaban for Westco, but she did not know the nature of the

work performed by Mr. Zaban.

3. Bank Fraud

In early 1988, petitioners decided to acquire a new home.

Mrs. Zaban met with Kathryn Gerling, president of Midstate Savings

and Loan (Midstate), to begin the process of applying for a loan.

(To a large extent Mrs. Zaban negotiated the terms of the loan with

Ms. Gerling.) On February 26, 1988, petitioners submitted an

application to Midstate for a $101,000 acquisition loan to purchase

a residential lot in Lutherville, Maryland. The loan application

listed monthly income of $12,200, assets of $683,293.65, and a net

worth of $520,325.65.

On or about August 23, 1988, petitioners submitted an

application to Midstate for a $528,700 construction loan to build

their home on the lot in Lutherville, Maryland, pursuant to a
 - 12 -

$660,923 construction contract. The loan application listed

monthly income of $13,750, assets of $819,293.65, and a net worth

of $555,325.65.

As part of the loan application process, petitioners were

required to submit their Federal income tax returns for 1986 and

1987. The returns that were hand delivered to Ms. Gerling by either

Mr. or Mrs. Zaban reported gross income before adjustments of

$160,115 for 1986 and $165,263 for 1987, even though the returns

prepared and filed with the Internal Revenue Service (IRS) reported

gross income before adjustments of $66,195 for 1986 and $101,963

for 1987. Mr. Zaban prepared the fraudulent returns submitted to

Midstate for the purpose of persuading the savings and loan to

approve the loan applications. These fraudulent returns were the

basis for the bank fraud charge to which Mr. Zaban pled guilty.

Petitioners completed construction of the Lutherville,

Maryland, home and began occupying it in or about June 1989. The

design of the home was the subject of an article in the Baltimore

Sun in October 1990.

C. Cash Found in Safe Deposit Boxes

In March 1990, a search warrant was executed by the Baltimore

County Police Department at the Mercantile Safe Deposit & Trust

Company, and three safe deposit boxes were searched. Box 3631,

held in petitioners' names, contained a photo album which was not

seized. Box 3567, held in the names of Mr. Zaban and Loretta
 - 13 -

Neumyer, the wife of Mr. Neumyer, contained $45,000 in cash, all

$100 bills, and a deposit slip with handwritten notations. Only

Mr. Zaban entered this box. The contents of this box were seized.

Mr. Zaban used the deposit slip notations to keep track of the cash

in the safe deposit box, which indicated the presence of $115,000

in cash on January 2, 1990. On that date, $40,000 was removed; on

January 9, 1990, $20,000 was removed; on February 13, 1990, $10,000

was removed. A balance of $45,000 remained.

Box 2164, held in petitioners' names, contained $40,100 in

cash, all $100 bills, and a deposit slip with handwritten

notations. Mr. Zaban used the deposit slip notations to keep track

of the amount of cash in the box. On January 2, 1990, the deposit

slip notations indicated the presence of $40,100 in cash in the

box, which was placed in the box on January 2, 1990, the same date

and time as the removal of the $40,000 from Box 3567.

D. Loans by Mr. Zaban

Between 1985 and 1989, Mr. Zaban made several large loans.

Sometime prior to December 31, 1985, Mr. Zaban lent $93,100 to F.

Frank Culotta, a friend. In 1988, $30,626 of the aforementioned

loan was repaid upon the sale of an Ocean City, Maryland,

condominium that petitioners owned together with Mr. Culotta. The

balance of the loan to Mr. Culotta remained unpaid as of December

31, 1989. During 1987, Mr. Zaban lent $52,000 in cash to Keith

Vazquez (who is married to Mr. Zaban's niece), which remained
 - 14 -

unpaid as of December 31, 1989. Sometime prior to December 31,

1985, Mr. Zaban lent James Donohue $10,000 in cash, which remained

unpaid as of December 31, 1989. During 1988, Mr. Zaban lent

Splenanne, Ltd. $4,623.87, of which $1,824 was repaid in 1989, and

the balance remained unpaid as of December 31, 1989. Mrs. Zaban

was not involved in any of these loan transactions.

E. Petitioners' Lifestyle

In 1978, petitioners acquired a home in Phoenix, Maryland, for

$96,899, which was financed through a mortgage. The property was

sold on February 1, 1990, for $185,000, with a $46,901 balance on

the mortgage. The mortgage payment on the Phoenix, Maryland,

residence was approximately $500 per month.

Following construction of petitioners' home in Lutherville,

Maryland, in mid-1989, the monthly mortgage payment became

$4,935.32, with a balloon payment of $445,213.99 due on October 1,

2003. Mrs. Zaban was aware of the mortgage payments on the home.

In 1989, petitioners furnished their home with $29,893.38 in

furniture from three stores and, in 1990, acquired a $12,800 Andy

Warhol painting. During 1989 and 1990, petitioners acquired

several other paintings, including: Lily Pond, appraised for

insurance purposes for $4,400; Flowers and Flowers, for $4,900;

Golden Teardrops, for $3,200 and appraised for insurance purposes

for $3,900; and Magical Vase, appraised for insurance purposes for
 - 15 -

$4,000. In 1989, petitioners also acquired a Chinese marble-top

chest for $2,500.

During 1986 and 1987, petitioners acquired a one-half interest

in an Ocean City, Maryland, condominium together with Mr. Culotta

and his wife. Petitioners paid $32,450 for their share of the

condominium and furnishings, and financed their share with a

$26,546 mortgage. In 1988, the condominium was sold when

petitioners' share of the mortgage was $26,722.

As of December 31, 1985, petitioners owned three cars: A 1984

Cadillac worth $21,581.53 with a loan balance of $8,462.53, which

was paid off in 1987; a 1985 Pontiac Grand Prix worth $13,124 with

a loan balance of $7,010.10, which was paid off in 1986; and a 1981

Pontiac Grand Prix worth $9,885, which petitioners owned outright.

In 1986, petitioners acquired two additional cars: A 1986 Mercedes

Benz for $47,504, with a loan of $46,457 and a balance due of

$27,023.20 as of December 31, 1989; and a 1986 Volkswagen Cabriolet

for their daughter worth $14,495, with a loan of $7,087, which was

paid off in 1988. In 1987, petitioners acquired a 1987 Mercedes

Benz for $37,159, with a loan of $24,006 and a balance due of

$19,321.33 as of December 31, 1989.

In April 1986, Mr. Zaban opened a brokerage account with Paine

Webber, Inc.; as of September 29, 1989, the portfolio value of that

account was $413,032.97. Mr. Zaban maintained a brokerage account

with Baker, Watts & Co. with a portfolio value of $136,426.26 as of
 - 16 -

December 31, 1985, and a portfolio value of $333,507.66 as of

December 31, 1989. Mr. Zaban maintained a brokerage account with

Thompson McKinnon with a portfolio value of $7,954.92 as of

December 31, 1985, and a portfolio value of $22,183.09 as of

December 31, 1989. Mrs. Zaban was aware of these brokerage

accounts.

Between 1986 and 1989, petitioners paid for their daughter's

college education at Loyola College in the amount of $6,679.16 in

1986, $7,830.97 in 1987, $8,073.13 in 1988, and $4,062.50 in 1989.

Between 1986 and 1989, petitioners held memberships at

Chestnut Ridge Country Club, Merritt Racquetball Club (where Mr.

Zaban played racquetball), and Greenspring Racquet Club (where Mrs.

Zaban played tennis).

Between 1986 and 1989, petitioners had credit card payments on

14 credit cards totaling $7,522.23 in 1986, $11,747.41 in 1987,

$31,371.12 in 1988, and $33,238.49 in 1989.

In 1988, petitioners paid $3,368.70 to World Travel for a

trip, and in 1989, petitioners paid $7,088.75 on jewelry at

Radcliff & Co.

Mrs. Zaban participated in the purchase of the home

furnishings, artwork, flatware, and jewelry, in addition to clothes

and fur coats, and was aware of other expense items.
 - 17 -

F. Preparation and Filing of Federal Tax Returns

Petitioners' 1984 and 1985 Federal joint income tax returns

(which are not in issue) were prepared by petitioners' attorney,

George Breschi. The 1984 return (signed by both petitioners)

reported gross income before adjustments of $67,886 and gambling

income of $48,500. The 1985 return (signed by both petitioners)

reported gross income before adjustments of $74,860 and gambling

income of $45,000.

Petitioners' Federal joint income tax returns for 1986 through

1990 were prepared by Mr. Fidati, petitioners' personal and

business accountant during those years. The 1986 return (signed by

both petitioners) reported gross income before adjustments of

$66,195 and listed no gambling income. The 1987 return3 reported

gross income before adjustments of $101,963 and listed no gambling

income. The 1988 return (signed by both petitioners) reported

gross income before adjustments of $106,129 and listed no gambling

income.

The 1989 return (signed by both petitioners and filed on

October 18, 1990, following a filing extension to August 15, 1990),

reported gross income before adjustments of $165,437 and $60,000 of

3
Mrs. Zaban did not sign the original 1987 joint return
when it was filed. The Internal Revenue Service detected the
error and informed petitioners. Mrs. Zaban signed a declaration
on July 8, 1988, indicating that she had reviewed the 1987 joint
return and that it was true, correct, and complete.
 - 18 -

gambling income. The 1989 return was filed following the execution

of search warrants by the Baltimore County Police Department at

petitioners' residence, a bank, and one of Mr. Zaban's businesses,

in which evidence of illegal gambling and bookmaking activities was

seized.

In October 1990, Mr. Zaban entered into a closing agreement

with the IRS, terminating the 1990 tax year as of March 24, 1990.4

Mr. Zaban agreed to report the net profits from his gambling and

bookmaking activities. The 1990 return (signed by both

petitioners) reported gross income before adjustments of $289,560

and gambling income of $240,700 (before expenses) on Schedule C in

accordance with the closing agreement.

Mrs. Zaban provided Messrs. Breschi and Fidati with records

and other information necessary to prepare petitioners' returns for

1984 through 1990. She never reviewed their work to determine

whether the returns were true and accurate. At times, Mr. Fidati

would provide Mrs. Zaban with returns prepared in pencil and would

have her sign blank returns.

4
Closing agreements resolve liability issues only for
the taxable years covered by the agreements. Sec. 7121; sec.
601.202(a), Statement of Procedural Rules. Thus, the termination
of the 1990 tax year on March 24, 1990, conclusively resolved,
for purposes of the closing agreement, only the issues for that
period. Respondent was permitted to issue notices of deficiency
relating to issues and time periods not covered by the agreement.
 - 19 -

As of October 1990, at a time in which Mrs. Zaban was aware of

Mr. Zaban's gambling and bookmaking activities, Mrs. Zaban knew she

should not rely on Mr. Fidati to prepare their returns. Despite

this concern, Mrs. Zaban signed the 1989 and 1990 joint returns

without reviewing them.

G. Notice of Deficiency

Pursuant to a reconstruction of petitioners' income under the

net worth method, respondent determined that petitioners had

unreported income from illegal gambling and bookmaking activities

for 1986 through 1989 in the following amounts: $101,599.43 for

1986; $183,991.39 for 1987; $82,902.23 for 1988; and $255,623.58

for 1989. Petitioners concede that these figures are correct

except for the 1989 determination. The parties disagree whether

$115,100 in cash that existed in a safe deposit box on December 31,

1989, was attributable to petitioners.

Respondent further determined additions to tax for fraud for

1986 through 1988 and the fraud penalty for 1989 against Mrs.

Zaban, additions to tax for substantial understatement of tax for

1986, 1987, and 1988, an addition to tax for failure to timely file

the 1989 joint return, and an accuracy-related penalty for

substantial understatement of tax for 1990. As an alternative to

the fraud additions to tax and penalty, respondent determined

additions to tax for negligence or disregard of rules or

regulations for 1986 through 1988, and an accuracy-related penalty
 - 20 -

for negligence or disregard of rules or regulations for 1989

against Mrs. Zaban.

OPINION

Issue 1. 1989 Net Worth Calculation

The first issue for decision is whether respondent properly

determined $115,100 as cash on hand as part of the 1989 net worth

calculation. Petitioners assert that the cash belonged to Mr.

Neumyer.

The net worth method has been approved as a means of

reconstructing the income of taxpayers who fail to report income

and do not maintain adequate books and records. Holland v. United

States, 348 U.S. 121 (1954); Lias v. Commissioner, 235 F.2d 879,

880 (4th Cir. 1956), affg. 24 T.C. 280 (1955); Estate of Beck v.

Commissioner, 56 T.C. 297, 353-354 (1971). Deficiencies determined

by indirect methods generally are presumed correct, Mills v.

Commissioner, 399 F.2d 744, 749 (4th Cir. 1968), affg. T.C. Memo.

1967-67, and taxpayers bear the burden of proving that such

deficiencies are erroneous, Rule 142(a); Parks v. Commissioner, 94

T.C. 654, 658-659 (1990). The net worth method requires a finding

of both the beginning and ending net values of a taxpayer's assets.

Holland v. United States, supra at 125.

Mr. Zaban asserts that the contents of box 3567, in which the

$115,100 cash was found, belonged to Mr. Neumyer. Mr. Zaban claims

that Mr. Neumyer gave him between $155,000 and $175,000 in 1984 to
 - 21 -

hold for safekeeping. According to Mr. Zaban, Mr. Neumyer gave him

the money because Mr. Neumyer was going to Las Vegas for several

weeks; and while there, Mr. Neumyer wanted Mr. Zaban to be in a

position to pay off Mr. Neumyer's obligations to certain

individuals in connection with Mr. Neumyer's bookmaking operations.

Mr. Zaban testified that after Mr. Neumyer's return from Las Vegas,

Mr. Neumyer never asked him to return the funds.5

Mr. Zaban's testimony was self-serving and lacked credibility.

The evidence reflects that on January 2, 1990, $40,000 in cash was

transferred from box 3567, a box controlled by Mr. Zaban to which

he had the key and which he was the only person ever to open, to

box 2164, a safe deposit box held in petitioners' names.

Petitioners offered no testimony and produced no evidence

indicating that the $40,000 deposited in box 2164 came from a

source other than box 3567. Petitioners failed to prove that Mr.

Zaban lacked discretion and control over entry to box 3567 and the

use of the cash in that box. See Pert v. Commissioner, T.C. Memo.

1997-150. Petitioners have failed to establish a nontaxable source

for the cash that existed in box 3567. We conclude that the

$115,100 is properly attributed to petitioners as cash on hand for

respondent's net worth calculation for 1989.

Petitioners' argument that respondent failed to meet each of

the elements of the net worth method, including the beginning cash

5
Mr. Neumyer died prior to the date of trial.
 - 22 -

on hand balance, is without merit. The parties stipulated the

correctness of all aspects of the net worth method other than the

ending cash on hand balance on December 31, 1989. Petitioners'

contention that a cash hoard existed at the beginning of 1989 is

inconsistent with the stipulation of a zero cash on hand balance at

the end of 1988 and with petitioners' argument that safe deposit

box 3567 did not belong to Mr. Zaban.

Accordingly, we sustain respondent's determination of $115,100

as the ending cash on hand balance for the 1989 net worth

calculation.

Issue 2. Innocent Spouse

The second issue for decision is whether Mrs. Zaban is

entitled to innocent spouse relief. Mrs. Zaban asserts that she is

entitled to such relief for 1986 through 1990. Respondent argues

that Mrs. Zaban fails to meet three of the four statutory elements

for relief.

Spouses who file a joint income tax return generally are

jointly and severally liable for its accuracy and the tax due,

including any additional taxes, interest, or penalties determined

on audit of the return. Sec. 6013(d)(3). However, pursuant to

section 6013(e), a spouse (commonly referred to as an innocent

spouse) can be relieved of tax liability if that spouse proves: (1)

A joint income tax return was filed; (2) the return contained a
 - 23 -

substantial understatement of tax attributable to grossly erroneous

items of the other spouse; (3) in signing the return, the spouse

seeking relief did not know, and had no reason to know, of the

substantial understatement; and (4) under the circumstances it

would be inequitable to hold the spouse seeking relief liable for

the understatement. Sec. 6013(e). The spouse seeking relief bears

the burden of proving that each of the four elements of the statute

has been satisfied, and failure to prove any one of the elements

will prevent innocent spouse relief. Bokum v. Commissioner, 94

T.C. 126, 138-139 (1990), affd. 992 F.2d 1132 (11th Cir. 1993).

Respondent concedes that a joint return was filed for each of

the years in issue, and thus the first element is not disputed.

The innocent spouse issue can be disposed of on the third and

fourth elements.

a. Knowledge of Understatement

Mrs. Zaban asserts that she did not know, nor had reason to

know, of the substantial understatement of tax on the joint return

for each of the years in issue. Respondent contends that Mrs.

Zaban knew or should have known about the unreported income items

for 1986 through 1989 and knew or should have known about the

$98,000 deduction for forfeited funds for 1990.

To obtain innocent spouse relief for tax liabilities that

arise from omissions of income, the spouse seeking such relief must
 - 24 -

be unaware of the circumstances which gave rise to the omissions.

Purcell v. Commissioner, 86 T.C. 228, 238 (1986), affd. 826 F.2d

470 (6th Cir. 1987). The spouse seeking relief must demonstrate

lack of both actual and constructive knowledge of the omission such

that a reasonable person could not be expected to know that the tax

liability stated was erroneous or that further inquiry was

necessary. Stevens v. Commissioner, 872 F.2d 1499, 1504-1505 (11th

Cir. 1989), affg. T.C. Memo. 1988-63.

Mrs. Zaban's claim that she knew nothing, nor had any reason

to know, about Mr. Zaban's illegal activities, is not credible

given the record before us. To be sure, Mrs. Zaban knew that Mr.

Zaban had been convicted in 1978 of bookmaking with Mr. Neumyer and

that Messrs. Zaban and Neumyer continued to deal with each other on

a regular basis, both in person and on the telephone, throughout

the years in issue. Mrs. Zaban also knew that Mr. Zaban traveled

frequently to Las Vegas and Atlantic City. Mrs. Zaban was aware

that Mr. Zaban did not work regular hours, and that he made or

received unusually high volumes of telephone calls. Further, Mrs.

Zaban knew that Mr. Zaban worked only in their basement where he

kept betting records and other gambling paraphernalia, tape

recorders hard-wired to the telephone lines, and a toolbox for

storing large amounts of cash, all of which were readily visible to

anyone who passed through the basement.
 - 25 -

Mrs. Zaban testified that she never reviewed any of the tax

returns, liquor license applications, or loan applications she

signed. Her testimony that she was unaware of any of the contents

in these documents lacks credibility. In any case, the fact that

Mrs. Zaban failed to review any tax returns she signed, or to sign

blank tax returns that were completed at a later time, does not

permit Mrs. Zaban to plead ignorance and does not absolve her of

liability for her husband's omissions. See Hayman v. Commissioner,

992 F.2d 1256, 1262 (2d Cir. 1993), affg. T.C. Memo. 1992-228;

Edmondson v. Commissioner, T.C. Memo. 1996-393; Cohen v.

Commissioner, T.C. Memo. 1987-537. Had Mrs. Zaban reviewed the

1984 and 1985 joint returns, she would have discovered that nearly

two-thirds of the reported gross income before adjustments resulted

from gambling; and had she reviewed the 1986, 1987, and 1988 joint

returns, she would have found that no such gambling income was

reported in those years. See Zimmerman v. Commissioner, T.C. Memo.

1996-223. Further, she would have discovered that the reported

income for 1986 and 1987 was inconsistent with the figures reported

on the loan applications submitted to Midstate, the savings and

loan institution with which she personally negotiated and discussed

the loan requirements and terms for the construction of the

Lutherville, Maryland, home. See Silverman v. Commissioner, T.C.

Memo. 1994-153.
 - 26 -

Mrs. Zaban was also the self-described caretaker of

petitioners' personal checking account and thus was aware of both

the family income and expenses. See Zimmerman v. Commissioner,

supra; Alberts v. Commissioner, T.C. Memo. 1986-483. She was also

charged with maintaining the corporate checking account for Zaban

Enterprises in which she made deposits and signed salary and

distribution checks to her husband, as well as drafting most other

corporate checks. See Morris v. Commissioner, T.C. Memo. 1992-635,

affd. without published opinion 15 F.3d 1079 (5th Cir. 1994). As

a consequence, she was aware of the unusual deposits from Mr.

Fidati and Westco. This role in the family's personal and business

finances gave Mrs. Zaban the opportunity to learn about whether

reported income was consistent with Mr. Zaban's success in his

business ventures. Mrs. Zaban's testimony that she was unaware of

Mr. Zaban's success in his business activities is simply not

believable.

Most critically though, Mrs. Zaban was on notice of the lavish

lifestyle she was enjoying. See Estate of Jackson v. Commissioner,

72 T.C. 356, 361 (1979); Ayer v. Commissioner, T.C. Memo. 1989-614.

During 1986, 1987, and 1988, petitioners had reported gross income

before adjustments of $66,195, $101,963, and $106,129,

respectively, and were still living in their modest home. Yet

during that time petitioners had acquired and accumulated a

condominium share and seven automobiles, two of which were new

Mercedes Benzes; paid for their daughter's entire private college
 - 27 -

education; become members of three country or racquet clubs; and

taken a $3,300 vacation.

During the latter part of 1988 and through 1990, this lavish

lifestyle became even more apparent. Mrs. Zaban was directly

involved in the process of negotiating a $101,000 residential lot

loan, as well as a $528,700 construction loan for the building of

their Lutherville, Maryland, home. Following completion of the new

home in which the monthly mortgage payment increased from

approximately $500 per month to nearly $5,000 per month, which was

paid by Mrs. Zaban, she participated in the furnishing of that

home, which included about $60,000 in purchases. Mrs. Zaban was

also involved in the purchase of over $7,000 in jewelry during 1989

and accumulated a wardrobe filled with fur coats and other clothes

throughout the period in issue.

Given all of the facts and circumstances, we are convinced,

and thus hold, that Mrs. Zaban knew or should have known of the

substantial understatement on petitioners' returns for 1986 through

1990 and thus is not entitled to innocent spouse relief.

b. Inequity in Holding Mrs. Zaban Liable

It would also not be inequitable to hold Mrs. Zaban liable for

the deficiencies for the years in issue. The record demonstrates

that Mrs. Zaban significantly benefited from the underreported

income and from the impermissible deductions (e.g., the large home

and furnishings, cars, fur coats and other clothings, club
 - 28 -

memberships, expensive vacation), and she admitted such at trial.

See Berman v. Commissioner, T.C. Memo. 1993-629, affd. without

published opinion 47 F.3d 1158 (2d Cir. 1995); Ewell v.

Commissioner, T.C. Memo. 1988-265; sec. 1.6013-5(b), Income Tax

Regs. She enjoyed a good life that went well beyond normal

support. See Terzian v. Commissioner, 72 T.C. 1164, 1172 (1979).

Issue 3. Fraud Additions to Tax and Penalty for 1986-89

The third issue for decision is whether Mrs. Zaban is liable

for fraud. Respondent determined fraud additions to tax against

Mrs. Zaban for 1986 and 1987 pursuant to section 6653(b)(1)(A) and

(B) and for 1988 pursuant to section 6653(b)(1) and a penalty for

1989 pursuant to section 6663.6 Mrs. Zaban asserts that she lacked

any actual knowledge of the unreported income items not reported in

the returns for 1986 through 1989.

The Commissioner has the burden of proving fraud by clear and

convincing evidence. Sec. 7454(a); Rule 142(b). To establish

fraud, the Commissioner must show that the taxpayer intended to

evade taxes known to be owing by conduct intended to conceal,

6
For 1986 and 1987, sec. 6653(b)(1)(A) imposed an
addition to tax equal to 75 percent of the portion of the
underpayment attributable to fraud, and sec. 6653(b)(1)(B)
imposed an addition to tax equal to 50 percent of the interest
payable under sec. 6601 with respect to that portion of the
underpayment.
For 1988 and 1989, sec. 6653(b)(1) and sec. 6663,
respectively, imposed additions to tax and penalties consisting
of 75 percent of the portion of the underpayment attributable to
fraud.
 - 29 -

mislead, or otherwise prevent the collection of such taxes. Parks

v. Commissioner, 94 T.C. at 661; Rowlee v. Commissioner, 80 T.C.

1111, 1123 (1983). Fraud is never presumed, Beaver v.

Commissioner, 55 T.C. 85, 92 (1970), and cannot be imputed from one

spouse to another, Stone v. Commissioner, 56 T.C. 213, 227-228

(1971).

Respondent has failed to sustain the burden of proof.

Respondent has not established that Mrs. Zaban knew of the

understatement on petitioners' joint returns given her failure to

review any of the returns or her signing of blank returns. See

Ewell v. Commissioner, supra. Additionally, there was no evidence

presented that Mrs. Zaban was involved in preparing the returns,

other than providing documentation to the accountant, Mr. Fidati.

Even though we believe Mrs. Zaban knew of Mr. Zaban's illegal

gambling and bookmaking activities, we cannot conclude from the

record that Mrs. Zaban knew that income from such activities was

not being reported. See Flynn v. Commissioner, T.C. Memo. 1981-

491. On the basis of the entire record in this case, we are not

persuaded that Mrs. Zaban intended to evade taxes and defraud the

Government. Thus, we hold that Mrs. Zaban is not liable for the

additions to tax and penalty for fraud for 1986 through 1989.

Issue 4. Negligence or Disregard of Rules or Regulations

The fourth issue for decision is whether Mrs. Zaban is liable

for additions to tax and penalty for negligence or disregard of
 - 30 -

rules or regulations. As an alternative to the fraud additions to

tax and penalty for 1986 through 1989, respondent determined

additions to tax for negligence or disregard of rules or

regulations pursuant to sections 6653(a)(1)(A) and (a)(1)(B) for

1986 and 1987 and section 6653(a)(1) for 1988 and an accuracy-

related penalty pursuant to section 6662 for 1989.

The addition to tax for negligence or disregard of rules or

regulations, or the accuracy-related penalty, cannot be imposed on

one spouse (here, Mrs. Zaban) where the other spouse (here, Mr.

Zaban) is liable for fraud. Unlike the fraud addition to tax which

is imposed on each spouse separately even if a joint return is

filed, sec. 6663(c); sec. 301.6653-1(f), Proced. & Admin. Regs.,

the negligence addition to tax and the accuracy-related penalty

apply jointly and severally. Thus, where a joint return is filed

and one spouse is liable for fraud with respect to the entire

underpayment, the imposition of the negligence addition to tax or

accuracy-related penalty with respect to the other spouse would

result in impermissible stacking. Sec. 6662(b); Aflalo v.

Commissioner, T.C. Memo. 1994-596; Minter v. Commissioner, T.C.

Memo. 1991-448; Congelliere v. Commissioner, T.C. Memo. 1990-265.

Thus, we hold that Mrs. Zaban cannot be liable, and thus is not

liable, for the additions to tax for negligence or disregard of

rules or regulations, or the accuracy-related penalty for

negligence or disregard of rules or regulations, for 1986 through

1989.
 - 31 -

Issue 5. Substantial Understatement Additions to Tax

The fifth issue for decision is whether petitioners are liable

for additions to tax for the substantial understatement of tax for

1986, 1987, and 1988 and an accuracy-related penalty for

substantial understatement of tax for 1990. Respondent determined

additions to tax for the substantial understatement of tax pursuant

to section 6661 for 1986, 1987, and 1988, and an accuracy-related

penalty pursuant to section 6662 for 1990.7 Mrs. Zaban asserts

that she had reasonable cause and acted in good faith for those

years and thus is excepted from the substantial understatement

addition to tax and the accuracy-related penalty pursuant to

section 6664(c).

Mrs. Zaban's argument is without merit. The reasonable cause

exception to the addition to tax for the substantial understatement

of tax and the accuracy-related penalty for substantial

understatement of tax are not applicable to taxpayers filing tax

returns prior to December 31, 1989. Omnibus Budget Reconciliation

Act of 1989 (OBRA), Pub. L. 101-239, sec. 7721(a), 103 Stat. 2106,

2395. Thus, the reasonable cause exception does not apply to

7
For tax years 1986, 1987, and 1988, sec. 6661 imposed
additions to tax of 25 percent of the amount of any underpayment
attributable to a substantial understatement. A substantial
understatement is defined as an understatement which exceeds the
greater of 10 percent of the tax required to be shown on the
return or $5,000. Sec. 6661(b).
For tax year 1990, sec. 6662 imposed an accuracy-related
penalty of 20 percent of the underpayment attributable to a
substantial understatement.
 - 32 -

petitioners' 1986, 1987, and 1988 returns. In any case, Mrs. Zaban

lacks reasonable cause and good faith for each of the years in

issue. Mrs. Zaban never reviewed the returns prepared by Mr.

Fidati and occasionally signed blank returns. Her failure to

review the returns and her blind reliance on Messrs. Zaban and

Fidati were not reasonable. See Bollaci v. Commissioner, T.C.

Memo. 1991-108; Guinn v. Commissioner, T.C. Memo. 1983-401.

Additionally for 1990, Mrs. Zaban admitted that she had reason to

be suspicious of Mr. Fidati's preparation of petitioners' returns

after October 1990, and yet she never reviewed the 1990 return.

See Baugh v. Commissioner, T.C. Memo. 1996-70; Brown v.

Commissioner, T.C. Memo. 1992-15; sec. 1.6664-4(b), Income Tax

Regs.

We conclude that Mrs. Zaban is liable for the additions to tax

for the substantial understatement of tax for 1986 through 1988,

and for the accuracy-related penalty for 1990.

The fact that Mr. Zaban has conceded the fraud additions to

tax for 1986, 1987, and 1988 is irrelevant. Mr. Zaban may be held

liable for both additions to tax for fraud and additions to tax for

substantial understatement of tax for those years. OBRA sec.

7721(a). Thus, we hold that Mr. Zaban is liable for the

substantial understatement additions to tax for 1986 through 1988

and for the accuracy-related penalty for 1990.
 - 33 -

Issue 6. Addition to Tax for Failure To File

The final issue for decision is whether petitioners are liable

for the addition to tax for failure to timely file their 1989 joint

return. Respondent determined an addition to tax of 15 percent for

petitioners' failure to timely file their 1989 return. Mrs. Zaban

asserts a reasonable cause defense.

Section 6651(a)(1) imposes an addition to tax of 5 percent for

each month or fraction thereof in which an income tax return is not

filed after the prescribed filing date. An exception is provided

for reasonable cause not the result of willful neglect. Id.

Petitioners were granted an extension for filing their 1989

joint return to August 15, 1990, but did not file the return until

October 18, 1990. Petitioners did not establish reasonable cause

for the failure to timely file their 1989 return, and thus they

failed to meet their burden of proof. Rule 142(a). We hold that

petitioners are liable for the addition to tax under section

6651(a)(1).

To reflect the foregoing and the concessions of the parties,

Decision will be entered

under Rule 155.