Beard v. Commissioner

T.C. Memo. 1998-110

UNITED STATES TAX COURT

LARRY JACKSON BEARD AND GLORIA DEAN BEARD, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 17193-95. Filed March 17, 1998.

Larry Jackson Beard and Gloria Dean Beard, pro sese.

Martha J. Weber, for respondent.

MEMORANDUM OPINION

PARR, Judge: Respondent determined deficiencies in

petitioners' Federal income taxes and penalties as follows:

Penalties
Year Deficiency Sec. 6663
1991 $4,980.48 $3,735.36
1992 5,256.73 4,144.30
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All section references are to the Internal Revenue Code in

effect for the taxable years in issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure, unless

otherwise indicated. References to petitioner are to Larry

Jackson Beard.

After concessions,1 the issues for decision are: (1)

Whether petitioners had unreported income during 1991 and 1992.

We hold they did to the extent set out below. (2) Whether for

1992 petitioners are entitled to a claimed dependency exemption

for their daughter Jacqueline. We hold they are not. (3)

Whether for 1991 and 1992 petitioners are liable for self-

employment taxes pursuant to section 1401. We hold they are.

(4) Whether for 1991 and 1992 petitioners are liable for fraud

penalties pursuant to section 6663, or in the alternative, the

accuracy-related penalties pursuant to section 6662. We hold

they are not liable for the fraud penalties but are liable for

the accuracy-related penalties.

Certain automatic adjustments will be required in the

calculation of self-employment taxes, earned income credit

claimed for 1992, and related items of a computational nature

1
Respondent concedes that deposits made Jan. 24, 1991,
Jan. 16, 1992, Apr. 10, 1992, and July 14, 1992, of $22.16, $250,
$1,000, and $600, respectively, are nontaxable. Respondent
further concedes that the notice of deficiency incorrectly added
$2,100 of cash expenditures for 1991 and failed to give
petitioners credit for $1,250 of income reported on their return
for 1992.
 - 3 -

flowing from our holdings on the above issues. Accordingly, a

decision will be entered under Rule 155.

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

The stipulated facts and the accompanying exhibits are

incorporated herein by this reference. Petitioners resided in

Hendersonville, Tennessee, at the time the petition was filed.

General Background

During the years in issue, petitioners maintained a cash

hoard in their home. Petitioners separated their cash by

denomination and wrapped it in plastic with rubber bands. The

cash was kept in a wall in their bedroom over some pipes.

Petitioners began accumulating their cash hoard shortly

after they were married in approximately 1966. They preferred to

keep this cash on hand because it gave them a sense of security

if they needed money in a hurry for an emergency. Petitioner did

this to control the household spending and was responsible for

governing the cash hoard.

Petitioner had no set schedule of depositing money to the

cash hoard, nor did he keep any records regarding it.

Petitioners would get cash (from paychecks, reimbursements from

their children for bills paid on their behalf, credit card cash

advances, reimbursements from expenses charged for others on

their credit card, loans from petitioner's mother, and gambling

winnings) and add some to the cash hoard. Petitioner would carry
 - 4 -

a large amount in his wallet and deposit some in the checking

account when it was needed to pay each month's bills.

During 1991, petitioner lived primarily on the cash hoard,

but he did receive some income from "side work" as a drywaller

and painter. In 1992, petitioner returned to his occupation of

installing dry wall.

Petitioners filed joint Federal income tax returns for the

years in issue. After petitioners' returns were audited for 1991

and 1992, but before their case was to be considered by the

Internal Revenue Service (IRS) Appeals Division, they filed

amended returns for those years. On their original 1991 return,

the only income petitioners reported was $12,500 of gambling

winnings from a bingo trip. On the amended 1991 return,

petitioners reported additional income of $83 in interest and

$1,000 in earnings from "side work". On their original 1992

return, petitioners reported wages of $9,367.30 and gambling

winnings of $1,250. On their amended 1992 return, petitioners

reported additional earnings of $3,377.

Issue 1. Unreported Income

Utilizing the bank deposit method of income reconstruction,

respondent determined that petitioners had unreported income of

$18,716 and $16,177 for 1991 and 1992, respectively. Petitioners

assert that these deposits constituted gifts, loans, and

reimbursements and are thus nontaxable.
 - 5 -

Every taxpayer is required to maintain adequate records of

taxable income. Sec. 6001. Petitioners did not maintain

adequate records from which the amount of their income or Federal

income tax liability could be computed. In the absence of such

records, the taxpayers' income may be reconstructed by any method

that, in the Commissioner's opinion, clearly reflects income.

Sec. 446(b); Parks v. Commissioner, 94 T.C. 654, 658 (1990). The

Commissioner's method need not be exact but must be reasonable.

Holland v. United States, 348 U.S. 121 (1954).

The bank deposit method for computing unreported income has

long been sanctioned by the courts. DiLeo v. Commissioner, 96

T.C. 858, 867 (1991), affd. 959 F.2d 16 (2d Cir. 1992). Though

not conclusive, bank deposits are prima facie evidence of income.

Estate of Mason v. Commissioner, 64 T.C. 651, 656-657 (1975),

affd. 566 F.2d 2 (6th Cir. 1977); see also Price v. United

States, 335 F.2d 671, 677 (5th Cir. 1964) (the bank deposit

method assumes that all money deposited in a taxpayer's bank

account during a given period constitutes gross income); Tokarski

v. Commissioner, 87 T.C. 74, 77 (1986); Jones v. Commissioner, 29

T.C. 601 (1957). Where the taxpayer has failed to maintain

adequate records as to the amount and source of his or her

income, and the Commissioner has determined that the deposits are

income, the taxpayer has the burden of showing that the

determination is incorrect. Rule 142(a); Clayton v.
 - 6 -

Commissioner, 102 T.C. 632, 645 (1994); Parks v. Commissioner,

supra; Estate of Mason v. Commissioner, supra. Furthermore, the

Court of Appeals for the Sixth Circuit, to which this case is

appealable, has accepted the bank deposit method of income

reconstruction. Bevan v. Commissioner, 472 F.2d 1381 (6th Cir.

1973), affg. per order T.C. Memo. 1971-312; see also Woods v.

Commissioner, 929 F.2d 702 (6th Cir. 1991), affg. without

published opinion T.C. Memo. 1989-611.

In challenging respondent's income reconstruction,

petitioners introduced evidence that was intended to corroborate

their claim that the deposits were due to nontaxable sources.

This evidence primarily consists of their testimony, bank account

statements, credit card statements, and canceled checks. Upon

review of the evidence presented, we are persuaded that the

source of certain amounts of the deposits were from nontaxable

income items, as set forth below.

At trial, respondent stressed the fact that petitioner was

unable to exactly match his nontaxable payments received with

specific bank deposits. Petitioner is not required to directly

match nontaxable funds to deposits. If the funds are nontaxable,

they are removed from the unreported income determined by

respondent.

A. 1991

Except for the following amounts, we hold the deposits are

income to petitioners subject to tax pursuant to section 61(a).
 - 7 -

During 1991, petitioners made car insurance payments and

purchased clothes for two of their children, Jacqueline and

Johnathan, for which they were reimbursed. Petitioners provided

canceled checks to corroborate their testimony regarding these

reimbursements. The amounts represented by these reimbursements

in the deposits, therefore, are not subject to tax.2 On the

basis of the record, we are persuaded that for 1991, Jacqueline

and Johnathan reimbursed petitioners $1,000 and $700,

respectively, for car insurance and $200 each for clothes.

During 1991, petitioners took various trips with certain

other individuals. Petitioners sometimes would charge the entire

cost of the trip on their credit card, and the other individuals

would then reimburse them for their share of the cost.

Petitioners testified credibly regarding the reimbursements for

these trips and provided credit card statements for

corroboration. Patricia Hurst, a travel companion, also

testified credibly regarding reimbursements made to petitioners

for certain trips. Accordingly, the amounts represented by these

reimbursements in the deposits, described more fully below, are

not subject to tax.

2
The reimbursements from Jacqueline and Johnathan for
1991 were a combination of checks and cash. Petitioners and
respondent agree that the checks payable to Jacqueline and
Johnathan that were deposited into petitioners' account in 1991
are nontaxable. The difference between our determination of the
total reimbursement from the children and the agreed-upon amounts
in the form of checks is the resulting cash reimbursement.
 - 8 -

In March 1991, petitioners traveled to Oklahoma with Steve

Taylor (Taylor) to play bingo. Petitioner charged Taylor's

airfare and a rental car on his credit card. We find that

petitioner was reimbursed $306.12 from Taylor for this trip.

In June 1991, petitioners traveled to Florida on vacation

with Taylor and George Hurst (Hurst). Petitioner charged the

entire cost of renting the vacation condominium on his credit

card. We find that petitioner was reimbursed $337.89 each from

Taylor and Hurst for their shares of the rental.

In August 1991, petitioners traveled to Las Vegas, Nevada,

with Taylor. Petitioner charged Taylor's airfare on his credit

card. We find that petitioner was reimbursed $936 from Taylor

for this trip.

From September 24 through October 2, 1991, petitioner took a

sightseeing trip through several northern States and Canada with

a Mr. Gray (Gray). Petitioner charged the hotel accommodations

for this trip on his credit card and was reimbursed by Gray for

his share of the expenses. We find that petitioner was

reimbursed $150 from Gray for this trip.

Petitioner claims that during 1991 he received a $1,500 loan

from his mother. Petitioner provided a copy of the canceled

check to corroborate his testimony. We find that the $1,500

represented in the deposits by this loan is not subject to tax.

As stated earlier, petitioners maintained a cash hoard in

their home during 1991. Petitioners would deposit money from
 - 9 -

their cash hoard to roughly cover each month's household bills.

We are persuaded that some of the deposits during 1991 are from

the nontaxable cash hoard source; however, we are also convinced

that petitioners did not report all of their income, i.e., some

of the cash kept at home was includable in their income. Only

after they were audited did petitioners file amended returns

showing additional income. On the basis of the entire record,

including the fact that petitioners lived primarily on these

savings during 1991, we find $5,000 to be a reasonable appraisal

of deposits from the nontaxable cash hoard.

In sum, we find that $10,667.90 of the 1991 bank deposits is

nontaxable and must be removed from the unreported income

determined by respondent.

B. 1992

Except for the following amounts, we hold the deposits are

income to petitioners subject to tax pursuant to section 61(a).

Petitioners were reimbursed in 1992 by their children

Jacqueline and Johnathan for car insurance payments made on their

behalf of $1,000 and $700, respectively. Petitioners were also

reimbursed $200 from both Jacqueline and Johnathan for clothes

during 1992. Those reimbursements are nontaxable.3

3
The reimbursements from Jacqueline and Johnathan for
1992 were a combination of checks and cash. Petitioners and
respondent agree that the checks payable to Jacqueline and
Johnathan that were deposited into petitioners' account in 1992
are nontaxable. The difference between our determination of the
(continued...)
 - 10 -

In August 1992, petitioner took out a $1,000 cash advance on

his credit card. Petitioner provided a credit card statement for

corroboration. The amount represented by this cash advance in

the 1992 deposits is nontaxable.

Petitioner received loans from his mother during 1992.

Petitioner provided a canceled check from his mother of $300.

Petitioner's mother also testified credibly regarding cash loans

of $500 and $300. The amounts of these loans are not subject to

tax.

Petitioners claim that certain amounts of the 1992 deposits

are from the nontaxable cash hoard source. On the basis of the

entire record, including the fact that both petitioners worked

during the year, we find $2,500 to be a reasonable appraisal of

deposits from the nontaxable cash hoard.

In sum, we find that $6,700 of the 1992 bank deposits is

nontaxable and must be removed from the unreported income

determined by respondent.

Issue 2. Dependency Exemption

Respondent determined that petitioners were not entitled to

a claimed dependency exemption deduction for their daughter,

Jacqueline, for 1992. The reason stated for the disallowance was

that petitioners did not establish that they had provided more

3
(...continued)
total reimbursement from the children and the agreed upon amounts
in the form of checks is the resulting cash reimbursement.
 - 11 -

than one-half of Jacqueline's support during 1992. Petitioners

assert that they are entitled to the deduction.

Section 151(c)(1) generally allows as a deduction an

exemption for each dependent of a taxpayer as defined in section

152. Section 152(a) provides, in general, that the term

"dependent" means certain individuals over half of whose support

was received from the taxpayer during the taxable year in which

such individuals are claimed as dependents. Eligible individuals

who may be claimed as dependents include, among others, a son or

daughter of the taxpayer. Sec. 152(a)(1). Section 151(c)

further provides that the claimed dependent's gross income for

the taxable year must be less than the exemption amount, or if

the claimed dependent is a child of the taxpayer claiming the

exemption, the child must not have attained the age of 19 at the

close of the calendar year or must be a student who has not

attained the age of 24 at the close of the calendar year. Sec.

151(c)(1)(A) and (B).

During 1992, Jacqueline had attained the age of 20 at the

close of the year but was a student. She maintained a part-time

job during 1992. Based on Jacqueline's 1992 return, her gross

income from wages was $5,182.93.

Petitioner did not present competent evidence to establish

the total support provided to Jacqueline during 1992, and that,

of the total support provided, more than one-half of the amount

was provided by petitioner. See Blanco v. Commissioner, 56 T.C.
 - 12 -

512, 514-516 (1971). Although petitioner provided Jacqueline

with an occasional place of abode, some food, and perhaps some

clothing, Jacqueline had other means of support during 1992. She

earned wages from her part-time job, lived at school, sometimes

purchased food while at home, and reimbursed her parents for

expenses such as car insurance and clothes. On this record,

petitioner has not established that he provided more than one-

half of Jacqueline's total support during 1992. Respondent,

therefore, is sustained on this issue.4

Issue 3. Self-Employment Tax

Respondent determined that petitioner's unreported income in

1991 and 1992 was subject to self-employment taxes under section

1401.

Section 1401 imposes a tax on a taxpayer's self-employment

income. Self-employment income includes the net earnings from

self-employment derived by an individual during the taxable year.

Sec. 1402(b). Net earnings from self-employment means gross

income derived by an individual from any trade or business

4
On their original 1991 return, petitioners claimed
their children Jacqueline and Johnathan as dependents. On their
amended 1991 return, petitioners added another child, James, as a
dependent. Respondent allowed the dependents as reflected on the
original 1991 return. Petitioners did not address this at trial;
thus, respondent is sustained on this determination.
On their original 1992 return, petitioners claimed
Jacqueline as a dependent. On their amended 1992 return,
petitioners again added James as a dependent. The exemption for
Jacqueline is denied, as set forth above; however, respondent
concedes the 1992 exemption for James.
 - 13 -

carried on by the individual, less allowable deductions

attributable to the 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 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 the primary purpose for

engaging in the activity must be for income and profit.

Commissioner v. Groetzinger, 480 U.S. 23 (1987). Whether an

individual is carrying on a trade or business requires an

examination of all the facts in each case. Higgins v.

Commissioner, 312 U.S. 212, 217 (1941). These provisions are to

be broadly construed to favor treatment of income as earnings

from self-employment. Hornaday v. Commissioner, 81 T.C. 830, 834

(1983).

As stated earlier, petitioners filed amended returns

reflecting income from "side work". The income from this "side

work" was earned by petitioner for work he performed as a self-

employed painter and drywaller. Those amounts are subject to

self-employment tax. Respondent argues that petitioners'

additional unreported income is also subject to self-employment

tax. Petitioners addressed this issue indirectly at trial when

they claimed all of their bank deposits were nontaxable. We have

resolved above that only certain deposits are nontaxable.
 - 14 -

Petitioners bear the burden of proving that they are not liable

for self-employment taxes under section 1401. Rule 142(a).

Petitioners have not met their burden on this issue.

Accordingly, their unreported income for the years in issue is

subject to self-employment tax.

Issue 4. Fraud

Respondent determined that petitioners are liable for the

fraud penalty pursuant to section 6663 for the years in issue.

Petitioners assert that they are not liable for the penalty.

The existence of fraud is an issue of fact to be determined

from a consideration of the entire record. Stratton v.

Commissioner, 54 T.C. 255, 284 (1970); Otsuki v. Commissioner, 53

T.C. 96, 105-106 (1969). Respondent has the burden of proving

fraud and must affirmatively establish its existence by clear and

convincing evidence. Sec. 7454(a); Rule 142(b); Stone v.

Commissioner, 56 T.C. 213, 220 (1971); Beaver v. Commissioner, 55

T.C. 85, 92 (1970). Fraud means actual, intentional wrongdoing,

and the intent required is the specific purpose to evade a tax

believed to be owing. Candela v. United States, 635 F.2d 1272

(7th Cir. 1980); Stoltzfus v. United States, 398 F.2d 1002, 1004

(3d Cir. 1968); Mitchell v. Commissioner, 118 F.2d 308 (5th Cir.

1941), revg. 40 B.T.A. 424 (1939); Wilson v. Commissioner, 76

T.C. 623, 634 (1981), supplemented by 77 T.C. 324 (1981). The

Commissioner must show that the taxpayer intended to evade taxes

by conduct calculated to conceal, mislead, or otherwise prevent
 - 15 -

the collection of taxes. Stoltzfus v. United States, supra;

Marcus v. Commissioner, 70 T.C. 562, 577 (1978), affd. without

published opinion 621 F.2d 439 (5th Cir. 1980).

Fraud is never imputed or presumed, and courts should not

sustain findings of fraud upon circumstances that at most create

only suspicion. Olinger v. Commissioner, 234 F.2d 823, 824 (5th

Cir. 1956), affg. in part and revg. in part T.C. Memo. 1955-9;

Davis v. Commissioner, 184 F.2d 86, 87 (10th Cir. 1950); Green v.

Commissioner, 66 T.C. 538, 550 (1976). Mere suspicion does not

prove fraud, and the fact that the Court does not find the

taxpayer's testimony wholly credible is not sufficient to

establish fraud. Shaw v. Commissioner, 27 T.C. 561, 569-570

(1956), affd. 252 F.2d 681 (6th Cir. 1958); see also Cirillo v.

Commissioner, 314 F.2d 478, 482 (3d Cir. 1963), affg. in part and

revg. in part T.C. Memo. 1961-192.

Section 6663(a) provides generally that, if any part of any

underpayment of tax required to be shown on a return is due to

fraud, there shall be added to the tax an amount equal to 75

percent of the portion of the underpayment that is attributable

to fraud. Under section 6663(b), if the Commissioner establishes

that any portion of an underpayment is attributable to fraud, the

entire underpayment shall be treated as attributable to fraud,

except with respect to any portion of the underpayment that the

taxpayer establishes (by a preponderance of the evidence) is not

attributable to fraud. Two elements must be satisfied before a
 - 16 -

taxpayer may be held liable for the fraud penalty: The

Commissioner must prove an underpayment of tax, and the

Commissioner must prove that at least a part of the underpayment

is attributable to fraud. Stoltzfus v. United States, supra;

Petzoldt v. Commissioner, 92 T.C. 661, 699 (1989). As set forth

above, we have calculated an underpayment of tax for each of the

years at issue. The remaining question is whether any part of

the underpayment for each year is attributable to fraud.

Fraud, as noted earlier, is an intentional wrongdoing with a

specific intent to evade a tax believed to be owed. The

existence of fraud is a question of fact based upon the entire

record and reasonable inferences drawn therefrom. Mensik v.

Commissioner, 328 F.2d 147, 150 (7th Cir. 1964), affg. 37 T.C.

703 (1962).

The Court has difficulty in concluding, under these

circumstances, that petitioner intended to evade taxes by conduct

calculated to conceal, mislead, or otherwise prevent the

collection of taxes. The Court must conclude on this record that

respondent has not carried the heavy burden of proving fraud with

clear and convincing evidence. On this issue, we hold for

petitioners.

The Court is satisfied, however, on this record, that

respondent's alternative determination that petitioners are

liable for the accuracy-related penalties under section 6662 for

both years should be sustained. Section 6662(a) provides
 - 17 -

generally for a penalty of 20 percent of the portion of an

underpayment to which the section applies.

Section 6662(b) lists five categories in which an

underpayment of tax will be subjected to the penalty, including

negligence. "Negligence" includes any failure to make a

reasonable attempt to comply with the Internal Revenue Code.

Sec. 6662(c). Petitioners underreported their income for the

years in issue and failed to keep adequate records. In short,

petitioners did not do what a reasonable and ordinarily prudent

person would do under the circumstances. Neely v. Commissioner,

85 T.C. 934, 947 (1985). Petitioners presented no evidence to

show that their underpayments were due to reasonable cause and

that they acted in good faith with respect to such underpayments.

Sec. 6664(c). The Court is satisfied from the record that

petitioners' actions constituted negligence as defined in section

6662(c). Respondent is sustained on the section 6662 penalties

for both years.

For the foregoing reasons,

Decision will be entered

under Rule 155.