Cole v. Commissioner

T.C. Memo. 1998-452

UNITED STATES TAX COURT

RICHARD A. COLE, M.D., INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2378-95. Filed December 23, 1998.

Richard A. Cole, for petitioner.

Louise R. Forbes, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COLVIN, Judge: Respondent determined deficiencies in

petitioner's Federal income tax and additions to tax as follows:
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Additions to tax
Sec. Sec. Sec.
1
FY Deficiency 6653(b)(1)(A)2 6653(b)(1)(B) 6661
3
1987 $116,223 $87,167 $29,056
1988 86,303 64,727 -- 21,576
1
Petitioner's 1987 fiscal year ended on May 31, 1988, and its
1988 fiscal year ended on May 31, 1989.
2
Section 6653(b)(1) for fiscal year 1988.
3
Fifty percent of the interest due on $116,223.

The issues for decision are:

1. Whether respondent's evidence (i.e., certain of

petitioner's business records) is inadmissible because of

petitioner's contention that it was obtained from an illegal

search and seizure. We hold that the evidence is admissible.

2. Whether petitioner had unreported income from its

medical practice of $338,317 for fiscal year 1987 and $259,951

for fiscal year 1988. We hold that it did.

3. Whether petitioner had unreported interest income of

$990 for fiscal year 1987 and $5,189 for fiscal year 1988. We

hold that it did.

4. Whether petitioner may carry forward a net operating

loss of $2,341 for fiscal year 1988. We hold that it may not.

5. Whether petitioner is liable for fraud under section

6653(b) for fiscal years 1987 and 1988. We hold that it is.

6. Whether petitioner is liable for additions to tax for

substantial understatement of income tax under section 6661 for

fiscal years 1987 and 1988. We hold that it is.
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Section references are to the Internal Revenue Code in

effect for the years in issue. Rule references are to the Tax

Court Rules of Practice and Procedure.

I. FINDINGS OF FACT

Some of the facts have been stipulated and are so found.1

A. Petitioner

1. Incorporation of Richard A. Cole, M.D., Inc.

Richard A. Cole (Dr. Cole) received his undergraduate degree

from Tufts University and his medical degree from Johns Hopkins

Medical School. During the years in issue, Dr. Cole was a

practicing physician who specialized in endocrinology.

Richard A. Cole, M.D., Inc. (petitioner), is a Pennsylvania

corporation incorporated by Dr. Cole on June 1, 1979. Dr. Cole

was petitioner's president and sole shareholder in fiscal years

1987 and 1988. Petitioner was in the business of providing

medical services during fiscal years 1987 and 1988.

2. Petitioner's Bank Accounts

During the tax years at issue, petitioner maintained

accounts at Marine Bank, Northwest Mutual Savings Bank, and

Mellon Bank. Petitioner received interest income of $1,333 in

fiscal year 1987 and $5,189 in fiscal year 1988 on its Marine

Savings Bank savings account.

1
The stipulated facts were deemed established for purposes
of this case. See par. I-E, below.
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3. Petitioner's Business Receipts

Kathryn Hale (Ms. Hale) was petitioner's office manager for

the years at issue. Ms. Hale began working for Dr. Cole and

petitioner in 1980. At that time she was the only employee. She

answered phones, made appointments, took dictation, pulled

charts, and filed. Ms. Hale stopped working for Dr. Cole and

petitioner in May 1990. During those years, Dr. Cole hired

additional employees, such as Donna King-Deck (Ms. King-Deck) and

Trish Henderson (Ms. Henderson), and Ms. Hale became the office

manager.

Petitioner received cash and checks daily in fiscal years

1987 and 1988 from patients who received medical services from

Dr. Cole. Petitioner's business receipts were recorded each day

on "day sheets" for the years at issue and totaled for each day,

month, and year. Ms. Hale was responsible during the years at

issue for billing, handling patients' insurance, collecting

payments, and maintaining the day sheets. Ms. Hale usually made

the entries on the day sheets. Occasionally, Dr. Cole, Ms. King-

Deck, or Ms. Henderson made entries on the day sheets.

The day sheets included the patient's name, the service

provided, the fee for that service, and whether the patient paid

by cash or check. Receipts were totaled daily and carried

forward. The day sheet for the last day of the month showed the
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monthly total of business receipts. Dr. Cole had access to the

day sheets and could review them at any time.

Ms. Hale assembled petitioner's daily receipts and gave them

to Dr. Cole to deposit each day. Dr. Cole or his wife deposited

the receipts. Ms. Hale made the deposits when Dr. Cole was on

vacation.

Petitioner's receipts for June, July, and August 1987 were

deposited in its accounts at Northwest Mutual Savings Bank or

Mellon Bank. Petitioner's receipts from September 1987 to May

1989 were deposited in its account at Marine Bank. Petitioner's

receipts totaled $1,240,547.69 in fiscal year 1987 and

$1,400,726.22 in fiscal year 1988.

Around December 1989, Dr. Cole asked Ms. Hale for the yearly

total and a monthly breakdown of petitioner's gross receipts for

fiscal year 1988. She told him that petitioner's gross receipts

for fiscal year 1988 were $1,376,401.27.

B. Petitioner's Tax Returns

Carl Lindblad (Mr. Lindblad) prepared petitioner's tax

returns since it was incorporated, including its 1987 and 1988

returns. Mr. Lindblad never saw petitioner's corporate books and

records.

Mr. Lindblad prepared petitioner's 1987 tax return on the

basis of a phone conversation with Dr. Cole and a handwritten

summary of petitioner's gross receipts and interest and a list of
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its expenses that Dr. Cole sent him. Dr. Cole's summary showed

that petitioner had gross receipts of $899,156 and interest of

$343. He later told Mr. Lindblad that petitioner's gross

receipts were $894,314. Mr. Lindblad prepared petitioner's 1987

return, and sent it to Dr. Cole to sign and file. Petitioner

reported on its 1987 return that it had gross receipts of

$894,314, interest of $343, and a net operating loss of $2,341.

In February 1990, Dr. Cole sent Mr. Lindblad a summary of

petitioner's gross receipts and deductions for fiscal year 1988.

Dr. Cole's summary showed that petitioner had gross receipts of

$1,135,781. On the basis of that information, Mr. Lindblad

prepared petitioner's 1988 tax return and sent it to Dr. Cole to

sign and file. Petitioner reported on its 1988 return that it

had gross receipts of $1,135,281, zero interest, and a net

operating loss carryforward of $2,341.

Dr. Cole reviewed, signed, and filed petitioner's 1987 and

1988 corporate income tax returns (Forms 1120) after he received

them from Mr. Lindblad. Mr. Lindblad prepared the returns on the

cash basis method of accounting.

C. Petitioner's Indictment and Plea Agreement

In November 1991, petitioner and Dr. Cole were indicted by a

grand jury on 561 counts, including distributing methamphetamine,

a controlled substance; committing mail fraud by causing false

and fraudulent claims to be processed by patients' insurance
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companies and third-party payers; and violating sections 7201

(income tax evasion) and 7206(1) (filing false tax returns).

Petitioner and Dr. Cole were indicted under section 7201 for

attempting to evade and defeat income tax due and owing by the

corporation for fiscal years 1987 and 1988 by signing and filing

false U.S. corporate income tax returns for fiscal years 1987 and

1988, and under section 7206(1) for filing false U.S. corporate

income tax returns for fiscal years 1987 and 1988. The

indictment alleged that petitioner knowingly failed to report

gross receipts from its medical practice.

Dr. Cole was represented by Attorney F. Lee Bailey (Mr.

Bailey). On November 9, 1992, Dr. Cole signed a plea agreement

in which he and petitioner pled guilty to 11 counts in the

indictment, including distributing a controlled substance, mail

fraud, and willfully attempting to evade and defeat the income

tax due and owing by petitioner for fiscal year 1987 under

section 7201. Bailey also signed the plea agreement. The plea

agreement stated that the Criminal Investigation Division (CID)

could release to the IRS Examination Division the special agent's

report and accompanying exhibits, including petitioner's bank

records and day sheets. By signing the plea agreement, Dr. Cole

agreed that the IRS Examination Division could use the

information contained in the special agent's report and

accompanying exhibits to determine any civil tax deficiencies.
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On March 5, 1993, the U.S. District Court for the Western

District of Pennsylvania entered judgment against Dr. Cole and

petitioner pursuant to Dr. Cole's guilty plea. Dr. Cole was

sentenced and ordered to make restitution.

The U.S. Court of Appeals for the Third Circuit affirmed

petitioner's and Dr. Cole's convictions, without published

opinion. United States v. Cole, 8 F.3d 813 (3d Cir. 1993). Dr.

Cole contends that, on April 22, 1994, he filed a motion to

vacate his criminal conviction under 28 U.S.C. section 2255

(1994). The U.S. District Court for the Western District of

Pennsylvania dismissed the motion. Dr. Cole further contends

that, on July 25, 1994, he filed an appeal that he claims was not

docketed until November 6, 1994. The Court of Appeals for the

Third Circuit dismissed the appeal as untimely on December 30,

1994. He appealed the dismissal, but the appeal was not

docketed. In October 1996, Dr. Cole filed a motion to reopen the

appeal. The Court of Appeals for the Third Circuit denied his

motion on March 26, 1997. Dr. Cole filed a petition for

extraordinary writ of habeas corpus. The U.S. Supreme Court

denied his petition on January 26, 1998. On February 17, 1998,

he filed a petition for rehearing.

D. Notice of Deficiency

Respondent sent a notice of deficiency dated November 14,

1994, to petitioner for fiscal years 1987 and 1988. Respondent
 - 9 -

determined that petitioner had unreported receipts of $338,317

for fiscal year 1987 and $259,951 for fiscal year 1988, had

unreported interest income of $990 for fiscal year 1987 and

$5,189 for fiscal year 1988, and was not entitled to carry

forward a net operating loss of $2,341 to fiscal year 1988, and

that petitioner was liable for additions to tax for fraud and

substantial understatement for fiscal years 1987 and 1988.

E. The Stipulation of Facts

On January 20, 1998, respondent, pursuant to Rule 91(f),

moved to compel stipulation and attached a proposed stipulation

of facts and related exhibits. On February 10, 1998,

petitioner's response was filed. In it, petitioner alleged that

respondent's proposed stipulation was based on records that were

obtained from an illegal search and seizure from its office and

objected to these records' being used in this case. On February

12, 1998, we overruled petitioner's objection and ordered

petitioner to supplement its response and respond substantively

to the order to show cause. Petitioner did not do so. On March

4, 1998, we ordered that the facts and evidence stated in

respondent's proposed stipulation of facts be deemed established

for purposes of this case.

Dr. Cole testified for petitioner.
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II. OPINION

A. Procedural Issues

Petitioner argues that its plea of guilty in the prior

criminal case was not voluntary because its counsel coerced the

guilty plea. We disagree. Petitioner offered no evidence or

explanation to support its claim that its counsel coerced the

guilty plea.

Petitioner points out that respondent used the day sheets to

determine the deficiencies in issue and contends that the

Government got those records from an illegal search and seizure

in its office. Petitioner contends that its counsel in the

criminal case failed to raise the illegal search and seizure

issue. Petitioner contends that the day sheets should be

excluded from evidence here. We disagree. Petitioner agreed as

part of the plea in his criminal case to allow the CID to release

to the IRS Examination Division the special agent's report and

petitioner's bank records and day sheets. Petitioner waived its

right to object to the use of these records by signing the plea

agreement.

B. Unreported Receipts

Respondent determined that petitioner had unreported

receipts of $338,317 for fiscal year 1987 and $259,951 for fiscal
 - 11 -

year 1988. Petitioner's receipts totaled $1,240,547.69 in fiscal

year 1987 and $1,400,726.22 in fiscal year 1988, yet it reported

that it had gross receipts of only $894,314 for 1987 and

$1,135,281 for 1988.

Dr. Cole said at trial that there may have been errors in

petitioner's books. Petitioner contends that the day sheets are

unreliable because Ms. Hale prepared them, and alleges that Ms.

Hale made fraudulent entries to petitioner's records. We

disagree. Ms. Hale testified credibly that she prepared

petitioner's day sheets daily and totaled the receipts daily,

monthly, and yearly. Petitioner offered no evidence that the day

sheets Ms. Hale prepared are unreliable or that she made

fraudulent entries to petitioner's books. We find that the day

sheets were reliable.

At trial, Dr. Cole sought to attack Ms. Hale's credibility

because she applied for unemployment benefits for which the State

of Massachusetts ruled she was not eligible. We disagree. There

was nothing about that episode that makes her testimony here less

credible. Dr. Cole sought to attack the reliability of the day

sheets because petitioner's office manager discovered in April

1990 undeposited checks of $87,000 in a file cabinet used by Ms.

Hale that Dr. Cole alleges Ms. Hale should have deposited. Ms.
 - 12 -

Hale testified credibly that she had no knowledge of the checks.

Petitioner offered no evidence concerning the dates of the

undeposited checks and when they were received. We disagree with

petitioner's contention that the day sheets are unreliable.

Respondent's determination is presumed to be correct, and

petitioner bears the burden of proving otherwise. Rule 142(a);

Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioner has not

proven that it did not have unreported income from its medical

practice of $338,317 in fiscal year 1987 and $259,951 in fiscal

year 1988. We sustain respondent's determination.

C. Unreported Interest Income

Petitioner received interest income of $1,333 in fiscal year

1987 and $5,189 in fiscal year 1988. Petitioner reported that it

received interest income of $343 for fiscal year 1987 and zero

interest income for fiscal year 1988. Petitioner does not deny

that it received the interest income at issue. We conclude that

petitioner had unreported interest income of $990 for fiscal year

1987 and $5,189 for fiscal year 1988.

D. Net Operating Loss

Section 172 allows a taxpayer to deduct net operating

losses. Petitioner reported that it had a net operating loss of
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$2,341 for fiscal year 1987, and a net operating loss

carryforward of $2,341 for fiscal year 1988.

Respondent determined that petitioner did not have a net

operating loss for fiscal year 1987 and that petitioner had no

carryforward to fiscal year 1988 because respondent's adjustments

to petitioner's 1987 gross receipts eliminated the claimed net

operating loss.

Because of our holdings that petitioner had unreported gross

receipts and unreported interest income for 1987, petitioner did

not have a net operating loss, and thus we sustain respondent's

determination on this issue.

E. Fraud

Respondent determined that petitioner is liable for

additions to tax for fraud for fiscal years 1987 and 1988.

Respondent has the burden of proving fraud by clear and

convincing evidence. Sec. 7454(a); Rule 142(b). The existence

of fraud is a question of fact to be decided by consideration of

the entire record. Parks v. Commissioner, 94 T.C. 654, 660

(1990); Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), affd.

without published opinion 578 F.2d 1383 (8th Cir. 1978).
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1. Petitioner Is Collaterally Estopped To Deny Fraud for
Fiscal Year 1987

Petitioner pled guilty to income tax evasion under section

7201 for fiscal year 1987. A guilty plea is an admission of all

the elements of the criminal charge. McCarthy v. United States,

394 U.S. 459, 465-466 (1969). Petitioner's conviction as a

result of a guilty plea of criminal tax evasion under section

7201 for fiscal year 1987 collaterally estops it from denying

that some part of the deficiency in its income tax for fiscal

year 1987 was due to fraud for purposes of section 6653(b)

because the elements of criminal tax evasion under section 7201

are virtually identical to the elements of civil tax fraud under

section 6653(b). Plunkett v. Commissioner, 465 F.2d 299, 305-306

(7th Cir. 1972), affg. T.C. Memo. 1970-274; Stone v.

Commissioner, 56 T.C. 213, 221-223 (1971); Amos v. Commissioner,

43 T.C. 50, 55 (1964), affd. 360 F.2d 358 (4th Cir. 1965).

2. Fraud for Fiscal Year 1988

Petitioner's fraudulent intent may be established by the

acts of its sole shareholder, Dr. Cole, who completely dominated

its activity. See DiLeo v. Commissioner, 96 T.C. 858, 875 (1991)
 - 15 -

(corporate fraud found from fraudulent intent of corporate

officers), affd. 959 F.2d 16 (2d Cir. 1992); Auerbach Shoe Co. v.

Commissioner, 21 T.C. 191, 194 (1953), affd. 216 F.2d 693 (1st

Cir. 1954); Moore v. Commissioner, T.C. Memo. 1977-275, affd. 619

F.2d 619 (6th Cir. 1980); cf. Asphalt Indus., Inc. v.

Commissioner, 384 F.2d 229, 233 and n.11 (3d Cir. 1967) (fraud of

a sole shareholder may be attributed to the corporation; however,

a corporation was not subject to fraud penalties where an

innocent stockholder owned one-half of the corporation), revg. 46

T.C. 622 (1966).

Courts have developed several objective indicators, or

"badges", of fraud. Recklitis v. Commissioner, 91 T.C. 874, 910

(1988). The badges of fraud present in this case are Dr. Cole's:

(a) Giving of false information to petitioner's tax return

preparer; (b) failure to use books and records; and (c) large

understatements of income.

a. Giving False Information to Petitioner's Tax
Return Preparer

Dr. Cole concealed petitioner's total gross receipts from

Mr. Lindblad by giving him inaccurate summaries and no supporting

documents, such as the day sheets and bank statements. Dr. Cole

asked Ms. Hale in December 1989 for petitioner's gross receipts

for fiscal year 1988. She told him they were $1,376,401.27, yet

he told Mr. Lindblad in February 1990 that petitioner's gross
 - 16 -

receipts were only $1,135,781. The fact that Dr. Cole gave false

information to the corporate return preparer is a badge of fraud.

Korecky v. Commissioner, 781 F.2d 1566, 1569 (11th Cir. 1986),

affg. per curiam T.C. Memo. 1985-63; Estate of Temple v.

Commissioner, 67 T.C. 143, 162-163 (1976).

b. Failure To Use Books or Records

Dr. Cole had access to petitioner's day sheets and bank

statements. The fact that Dr. Cole did not use these records in

preparing petitioner's returns is a badge of fraud. Spill v.

Commissioner, T.C. Memo. 1989-213 (fraud is "even more apparent"

where taxpayer kept records but disregarded them in preparing tax

return).

c. Large Understatements of Income

Dr. Cole caused petitioner to not report its income

accurately for the years in issue. Petitioner knowingly failed

to report a significant amount of income for fiscal years 1987

and 1988. This is a badge of fraud. Bradford v. Commissioner,

796 F.2d 303, 307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601.

3. Conclusion--Fraud

Petitioner knowingly understated its income by $339,307 for

fiscal year 1987 and $265,140 for fiscal year 1988. We conclude

that petitioner is liable for the additions to tax for fraud for

fiscal years 1987 and 1988.
 - 17 -

F. Substantial Understatement

The next issue for decision is whether petitioner is liable

for the addition to tax for substantial understatement of income

tax under section 6661(a) for fiscal years 1987 and 1988.

Section 6661(a) imposes an addition to tax equal to 25 percent of

the amount of any underpayment attributable to a substantial

understatement of income tax.

If a taxpayer has substantial authority for the tax

treatment of any item on the return, the understatement is

reduced by the amount attributable to it. Sec. 6661(b)(2)(B)(i).

Similarly, the amount of the understatement is reduced for any

item adequately disclosed either on the taxpayer's return or in a

statement attached to the return. Sec. 6661(b)(2)(B)(ii).

Petitioner bears the burden of proving that the addition to tax

under section 6661 does not apply. Rule 142(a); Tweeddale v.

Commissioner, 92 T.C. 501, 506 (1989).

Petitioner has offered no evidence or argument that it is

not liable for the addition to tax under section 6661(a). We

conclude that petitioner is liable for the section 6661(a)

addition to tax for fiscal years 1987 and 1988.

Decision will be entered

for respondent.