Kim v. Commissioner

T.C. Memo. 2000-83

UNITED STATES TAX COURT

CHUNG UI KIM AND OK HUI KIM, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 12880-98. Filed March 13, 2000.

Donald L. Field, Jr., for petitioners.

Allan D. Hill, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

LARO, Judge: Respondent determined the following

deficiencies in and penalties on petitioners’ Federal income

taxes:

Year Deficiency Sec. 6663(a) Penalty
1993 $174,815 $131,111
1994 156,263 117,057
1995 179,928 134,945
 - 2 -

After concessions, we must determine the following issues:

(1) Whether respondent’s bank deposit analyses correctly

determined petitioners’ unreported gross receipts during 1993,

1994, and 1995 in the amounts of $721,408,1 $735,207, and

$542,641, respectively. We hold that they did.

(2) Whether petitioners are liable for penalties on their

1993, 1994, and 1995 tax for fraud pursuant to section 6663(a).

We hold they are. (Accordingly, we do not decide respondent’s

alternative determination that petitioners are liable for

penalties for negligence pursuant to section 6662(a).)2

Unless otherwise indicated, 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.

Dollar amounts are rounded to the nearest dollar.

FINDINGS OF FACT

Some of the facts were stipulated. The stipulation of facts

and the exhibits submitted therewith are incorporated herein by

reference. When the petition was filed, petitioners Chung Ui Kim

1
Respondent determined that petitioners had $791,408 of
unreported gross receipts for 1993 but subsequently conceded that
$70,000 was from a nontaxable source.
2
Respondent also determined, and we agree, that for the
years in issue, certain computational adjustments should be made,
which would: (1) Reduce petitioners’ itemized deductions, (2)
increase petitioners’ self-employment tax liability, and (3)
reduce petitioners’ claimed exemptions. These are mathematical
adjustments that the parties can make in their Rule 155
computation.
 - 3 -

(Chung Kim) and Ok Hui Kim (Ok Kim) resided in Hayward,

California.

Petitioners were married in Korea during 1970 and immigrated

to the United States in 1973. Petitioners have been U.S.

residents from that date through the years at issue.

Chung Kim, a high school graduate, worked in Korea in the

Korean movie industry and then as an artist in the United States.

Ok Kim, also a high school graduate, worked as a dance instructor

in Korea and then as a typist in the United States. In 1977,

petitioners opened a retail store of approximately 800 square

feet on O’Farrell Street in San Francisco, California.

In 1992, petitioners relocated their store to a 3,000-

square-foot retail space on Geary Boulevard in San Francisco.

During the years at issue, petitioners operated their store as a

sole proprietorship named Top Blue Jeans/TBJ Collection (TBJ) and

sold merchandise at retail including clothing, cosmetics,

jewelry, leather goods, and other items of personal property.

Petitioners filed joint 1993, 1994, and 1995 Federal income

tax returns (Form 1040). The only source of taxable income

reported on those returns was gross receipts from TBJ of

$698,632, $846,030, and $1,032,759, respectively. Petitioners

initially reported costs of goods sold for the respective years

of $506,960, $625,553, and $765,298. The parties stipulated that

petitioners’ costs of goods sold were $859,563, $973,460, and

$866,771, respectively.
 - 4 -

Petitioners maintained two banking accounts: A personal

account in their joint names and a business banking account in

the name of TBJ Collections and Chung Kim, both with the

California Korea Bank. The net deposits into these two accounts

for 1993, 1994, and 1995 were $1,490,039, $1,481,237, and

$1,575,400, respectively.3

OPINION

Issue 1. Unreported Income

When respondent audited petitioners’ 1993, 1994, and 1995

income tax returns in 1996, petitioners failed to provide any

accounting records from which a determination could be made of

TBJ’s gross receipts. Respondent therefore performed a bank

deposits analysis, under which he determined that petitioners had

made deposits in excess of the reported gross receipts as

follows:

Year Amount
1
1993 $791,408
1994 735,207
1995 542,641
1
Respondent concedes that this amount should be decreased to
$721,408.

In cases where taxpayers have not maintained business

3
The net figures account for amounts attributable to
transfers, sales taxes, returned checks, and paid item reversals.
 - 5 -

records or where their business records are inadequate, the

Courts have authorized the Commissioner to use the bank deposits

method to compute income. See Factor v. Commissioner, 281 F.2d

100, 116 (9th Cir. 1960), affg. T.C. Memo. 1958-94; DiLeo v.

Commissioner, 96 T.C. 858 (1991), affd. 959 F.2d 16 (2d Cir.

1992). Bank deposits are prima facie evidence of income. See

Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). The burden,

generally, is on the taxpayers to show that the bank deposits are

derived from nontaxable sources. See Rule 142(a); Welch v.

Helvering, 290 U.S. 111 (1933); Reaves v. Commissioner, 31 T.C.

690, 718 (1958), affd. 295 F.2d 336 (5th Cir. 1961); Nicholson v.

Commissioner, T.C. Memo. 1993-183.

Petitioners admit that the amounts determined to be

unreported income in the notice of deficiency were deposited into

their banking accounts. However, petitioners contend that these

excess deposits represent inheritance and loan proceeds received

from various relatives which were deposited into the TBJ bank

account. Petitioners assert that they needed these funds to

cover expenses associated with the relocation of their store to a

larger retail space in 1992.

Petitioners assert that they received nontaxable funds from

the following sources and in the following years:
 - 6 -

1993 U.S. Dollars Korean Won Equivalent
1
Bok Rye Kim $440,324 350 million
Sung Bae Kim 246,354 200 million
Ki Soon Yun 70,000
Young Ae Hong 187,676 150 million
_________
Total: 944,354

1994 U.S. Dollars Korean Won Equivalent
Bok Rye Kim $491,672 400 million
Sul Ja Kim 100,000
Mr. Moon 20,000
Il Sup Cha 184,377 150 million
_________
Total: 796,049
1
Petitioners claim that several of the loans were paid in
Korean currency and later converted to U.S. dollars before being
deposited into the TBJ account. In these instances, the U.S.
dollar amounts represent the agreed conversion value.

a. Nontestifying Lenders

Of these seven individuals, only Bok Rye Kim testified at

trial. Petitioners did not explain the absence of the other six,

all of whom were relatives of petitioners.4 We cannot assume

that the testimony of absent witnesses would have been favorable

to petitioners. Indeed, we infer that it would have been

unfavorable. See McKay v. Commissioner, 886 F.2d 1237, 1238 (9th

Cir. 1989), affg. 89 T.C. 1063 (1987); Pollack v. Commissioner,

47 T.C. 92, 108 (1966), affd. 392 F.2d 409 (5th Cir. 1968);

Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165

(1946), affd. 162 F.2d 513 (10th Cir. 1947).

4
At least two of these purported lenders, Ki Soon Yun and
Mr. Moon, resided in San Francisco.
 - 7 -

Petitioners claim to have received loans from the six

nontestifying relatives of an aggregate $808,000. The only

evidence of these loans was documents signed by petitioner Chung

Kim purporting to be promissory notes. These “notes” had no

stated interest or repayment date, were not notarized, and were

not signed by the purported lenders. They evidence neither

genuine indebtedness nor actual receipt of any loan proceeds by

petitioners.

Petitioners presented no evidence as to the source of the

funds for such loans, or as to when, or by what means, the funds

were transferred. Petitioners also did not explain why they

never made any interest or principal payments on the loans.

Absent any testimony by the named individuals, or any supporting

documentary evidence, petitioners have failed to prove the

existence of any of the $808,000 in loans alleged to have been

made by the non-testifying lenders.

b. Bok Rye Kim’s Testimony

Bok Rye Kim (Bok Kim), who is Chung Kim’s niece, testified

that she transferred an inheritance of 350 million won

(approximately $440,000) to petitioners in incremental amounts

between the end of 1992 and the end of 1993. She testified

further that she lent petitioners 400 million won (approximately

$492,000) which she transferred to them incrementally between

early 1993 and 1994.
 - 8 -

Bok Kim testified that she had received an 800 million won

inheritance from her father in 1976. She said that her father

had designated 350 million won of this inheritance to be

delivered to petitioners’ son when he grew up. She claims that

she held on to these funds for 16 years until petitioners asked

that the money be transferred to them in 1992.

Bok Kim admitted that she did not have any written records

that could demonstrate that she ever had possession of the

inheritance money that she allegedly transferred to petitioners.

She explained that she never put the funds into a Korean

financial institution but rather used the funds to make private

loans and real estate investments. She claimed that as the

private loans were repaid, she kept the money in a “secret place”

at her house. She testified that she received interest on the

private loans, but she said that she neither transferred such

earned interest to Chung Kim’s son nor reported the interest to

tax authorities. She had no explanation for the lack of

documentary evidence of the alleged real estate investments.

Bok Kim could not recall the dates or total number of

occasions when she transferred either the 350 million won

inheritance or the 400 million won loan. Neither petitioners nor

Bok Kim had any records showing that she made any transfers of

the money to Chung Kim during 1993 and 1994. Petitioners and Bok

Kim explained that there were no records of the transfers because
 - 9 -

they had engaged in an elaborate scheme to transfer the funds

without the knowledge of the Korean and U.S. customs and tax

authorities.5 Bok Kim testified that she repeatedly delivered

small amounts of Korean currency to Sung Bae Kim, an airline

employee whom she identified as Ok Kim’s younger brother.6

According to Bok Kim, the airline employee would arrange for the

conversion of the won to U.S. currency and for Korean tourists,

unknown to either Bok Kim or petitioners, to deliver the funds to

petitioner Chung Kim at his store.7 Bok Kim could not recall the

precise amounts of money she transferred on each occasion but

believed the amounts to be in the range of 5 to 7 million Korean

won (approximately 5,000 to 9,000 U.S. dollars).8

We find that Bok Kim’s testimony lacks credibility, is

inconsistent with the record in this case, and does not credibly

establish a nontaxable source for the unexplained deposits.

Under the circumstances, we are not required to, and we do not,

5
Chung Kim testified that he did not request a bank wire
transfer because it is “illegal” to take out more than $10,000
from Korea. He also stated that he wanted to avoid any “tax
consequences” such a transfer would entail for either him or his
niece.
6
Chung Kim identified Sung Bae Kim as his wife’s nephew, not
her brother. Sung Bae Kim did not testify.
7
Neither Bok Kim nor petitioner identified the names of any
of the individuals who allegedly delivered the funds to Mr. Kim.
8
Despite allegedly transferring nearly all of her father’s
substantial estate with no true expectation of repayment, Bok Kim
also testified that she had come to Court to help her uncle
“because it’s not like I had done much for him before.”
 - 10 -

rely on Bok Kim’s testimony to support petitioners’ position

herein. See Ruark v. Commissioner, 449 F.2d 311, 312 (9th Cir.

1971), affg. T.C. Memo. 1969-48; Tokarski v. Commissioner, 87

T.C. at 77.

Furthermore, petitioners have failed to introduce any

evidence whatsoever relating to the existence of any nontaxable

sources for the $542,641 in unexplained funds deposited into

their banking accounts in 1995. Petitioners make no claim that

they held on to loan and inheritance proceeds received in 1993

and 1994 before depositing them in 1995.9 Additionally, given

the cost of goods sold as stipulated in this case, petitioners

would have had to have been selling their inventory at below cost

in 1993 and 1994 if TBJ’s gross receipts were as reported. Yet

Chung Kim testified that he marked up the merchandise by almost

25 percent.

Petitioners offer no credible evidence that any of the

unexplained deposits represent loan and inheritance proceeds.

Hence, petitioners have not disproved that the excess deposits

originate from a taxable source as respondent determined.

Accordingly, respondent’s determinations, after concessions, are

sustained.

9
Chung Kim testified that he never left the loan and
inheritance proceeds in his safe but rather deposited the funds
within 3 days of delivery. Additionally, TBJ’s balance sheet for
Dec. 31, 1994, reflects cash on hand and in the bank of only
$9,663.
 - 11 -

Issue 2: Fraud Penalty

Respondent has determined that petitioners are liable for

fraud penalties under section 6663(a) for 1993, 1994, and 1995.

A taxpayer is liable for a 75-percent penalty on the part of an

underpayment that is attributable to fraud. See secs. 6653(b),

6663(a).

Respondent must prove fraud by clear and convincing

evidence. See sec. 7454(a); Rule 142(b); Rowlee v. Commissioner,

80 T.C. 1111, 1123 (1983); Drabiuk v. Commissioner, T.C. Memo.

1995-260. In order to carry his burden as to fraud, respondent

must prove: (1) Petitioners underpaid their tax in each year,

and (2) some part of each underpayment was due to fraud. See

Laurins v. Commissioner, 889 F.2d 910, 913 (9th Cir. 1989), affg.

Norman v. Commissioner, T.C. Memo. 1987-265; Beddow v.

Commissioner, T.C. Memo. 1999-232; Roots v. Commissioner, T.C.

Memo. 1997-187; Lee v. Commissioner, T.C. Memo. 1995-597.

a. Underpayment of Tax

Respondent can satisfy his burden of proving the first prong

of the fraud test; i.e., an underpayment, when the allegations of

fraud are intertwined with unreported and reconstructed income in

one of two ways. Respondent may prove an underpayment by proving

a likely source of the unreported income. See Holland v. United

States, 348 U.S. 121 (1954); Parks v. Commissioner, 94 T.C. 654,

661 (1990). Alternatively, where the taxpayer alleges a
 - 12 -

nontaxable source, respondent may satisfy his burden by

disproving the nontaxable source so alleged. See United States

v. Massei, 355 U.S. 595 (1958); Parks v. Commissioner, supra.

We find that respondent has proven by clear and convincing

evidence a likely source of the underreported deposits; i.e.,

that they are income from TBJ’s sales. We also find that

respondent has disproven, by clear and convincing evidence, the

nontaxable source alleged by petitioners. Petitioners’

explanation of loans and inheritances from their relatives is

implausible and incredible. The first prong is satisfied.

b. Fraudulent Intent

Respondent must prove that some portion of the underpayment

was due to fraud. See Professional Servs. v. Commissioner, 79

T.C. 888, 930 (1982).

Fraud is an intentional wrongdoing designed to evade a tax

believed to be owing. See United States v. Walton, 909 F.2d 915,

926 (6th Cir. 1990); Miller v. Commissioner, 94 T.C. 316, 332

(1990). The existence of fraud is a question of fact. See

King’s Court Mobile Home Park v. Commissioner, 98 T.C. 511, 516

(1992). Fraud is never presumed or imputed; it must be

established by some independent evidence of fraudulent intent.

See Otsuki v. Commissioner, 53 T.C. 96, 106 (1969); Beddow v.

Commissioner, supra. Because direct proof of the taxpayer’s

intent is rarely available, fraud may be proven by circumstantial
 - 13 -

evidence and reasonable inferences drawn from the facts. See

Spies v. United States, 317 U.S. 492, 499 (1943); Stephenson v.

Commissioner, 79 T.C. 995 (1982), affd. per curiam 748 F.2d 331

(6th Cir. 1984); Collins v. Commissioner, T.C. Memo. 1994-409.

The taxpayer’s entire course of conduct may establish the

requisite fraudulent intent. See Otsuki v. Commissioner, supra

at 106.

Over the years, the courts have identified a number of

objective indicators or “badges” of fraud. See Recklitis v.

Commissioner, 91 T.C. 874, 910 (1988); Kish v. Commissioner, T.C.

Memo. 1998-16. Several badges of fraud are present in this case:

(1) Substantially understating income for 3 consecutive years;

(2) having inadequate books and records or destroying books and

records; (3) providing incomplete and erroneous information to a

tax return preparer; (4) providing implausible explanations of

behavior; (5) giving false, misleading, and inconsistent

testimony at trial, and (6) dealing in large amounts of cash.

See Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th Cir.

1986), affg. T.C. Memo. 1984-601; Meier v. Commissioner, 91 T.C.

273, 297-298 (1988); Lee v. Commissioner, T.C. Memo. 1995-597.

Although no single factor is necessarily sufficient to

establish fraud, the combination of a number of factors

constitutes persuasive evidence. See Solomon v. Commissioner,

732 F.2d 1459, 1461 (6th Cir. 1984), affg. per curiam T.C. Memo.
 - 14 -

1982-603; Beddow v. Commissioner, supra.

Petitioners’ income was consistently underreported, and in

the aggregate petitioners failed to report over $2 million of

TBJ’s sales from 1993 through 1995. This is a substantial sum,

especially in light of the fact that petitioners reported

adjusted gross income for those 3 years in the amounts of only

$22,022, $38,357 and $46,388. Additionally, petitioners were

unable or unwilling to produce daily sales records for their

accountant, the IRS, or the Court. Neither petitioners’

accountant nor anyone else ever audited petitioners’ business,

and their accountant never reviewed any of TBJ’s daily cash

register tapes.10

Moreover, petitioners’ explanations of having received

substantial cash inheritances and loans from U.S. and Korean

relatives are highly implausible and wholly lacking in

credibility. Petitioners testified that they did not

fraudulently conceal TBJ’s sales proceeds from U.S. tax

authorities but instead colluded with their Korean relatives to

conceal the conversion and transfer of nearly 2 million dollars

worth of Korean currency from U.S. and Korean customs agents.

Yet petitioners could produce no single piece of documentary

evidence that their Korean relatives ever possessed these funds

10
Petitioners’ accountant testified that Chung Kim reported
TBJ’s cash receipts to him orally.
 - 15 -

or made any such conversions or transfers. Such testimony is

indicative of fraud on the part of petitioners.

Based on our review of the record, we conclude that

respondent has met his burden of proving fraud for each of the

relevant years. Petitioners’ clear pattern of underreporting

taxable income for 3 years, coupled with the lack of

recordkeeping and attempts to conceal a substantial amount of

cash transactions, leads to a particularly strong inference of

fraud. See Lee v. Commissioner, T.C. Memo. 1995-597.

Respondent has proven by clear and convincing evidence an

underpayment of tax for 1993, 1994, and 1995 and that some

portion of the underpayment was attributable to fraud.

Petitioners, on the other hand, have failed to show that any

portion of their underpayment was not due to fraud. Accordingly,

we sustain respondent’s determination that petitioners are liable

for the penalty for fraud under section 6663(a) for all the years

under consideration.

To reflect the foregoing and concessions,

Decision will be entered

under Rule 155.