Adair v. Commissioner

T.C. Memo. 2000-110

UNITED STATES TAX COURT

RICHARD AND REBECCA ADAIR, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 12103-97, 20465-97. Filed March 30, 2000.

Rebecca Adair, pro se.

Linda K. West, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

SWIFT, Judge: In these consolidated cases, respondent

determined deficiencies in petitioners’ Federal income taxes and

fraud penalties as follows:
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Fraud Penalty
Year Deficiency Sec. 6663
1993 $192,142 $144,107
1994 185,261 138,946
1995 123,633 92,725

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

The issues for decision involve the amount of unreported

income that should be charged to petitioners and petitioners’

liability under section 6663 for the fraud penalty. Hereinafter

all references to petitioner are to Rebecca Adair.

FINDINGS OF FACT

Because petitioners failed to respond to respondent's

requests for admission, factual matters set forth in respondent's

requests for admission are deemed admitted. See Rule 90(c).

When the petition was filed, petitioners resided in Clinton,

Louisiana. Petitioners and Delwin Houser, Rebecca Adair’s step-

father, operate a roofing business known as H & H Sheet Metal

(the roofing business). The evidence does not establish how

ownership of the roofing business is divided between petitioners

and Delwin Houser.
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Payments were received by the roofing business for roofing

services rendered for various general contractors, including Roof

Technologies and Vaughn Roofing.

In 1993, 1994, and 1995, Roof Technologies and Vaughn

Roofing were billed by the roofing business the following total

amounts for roofing services rendered to them:

Year Amount
1993 $490,009
1994 426,843
1995 197,965

Roof Technologies and Vaughn Roofing issued checks in favor

of Delwin Houser that cumulatively total the above amounts billed

to them by the roofing business. The checks were received and

deposited into a checking account (the checking account) on which

Delwin and Carol Houser and Rebecca Adair were signatories.

For 1993, 1994, and 1995, the following schedule reflects

monthly and annual total deposits into the above checking

account:
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Month Total Deposits Into Checking Account
1993 1994 1995
January -0- $ 21,346 $ 10,533
February $ 28,154 34,950 19,056
March 25,824 12,150 23,104
April 37,400 53,022 18,000
May 20,131 44,211 21,372
June 48,870 55,007 61,050
July 34,149 37,700 49,146
August 33,038 17,577 670
September 52,000 53,619 24,465
October 91,020 51,291 51,946
November 72,000 56,580 17,492
December 65,150 40,450 34,500
Total $507,736 $477,903 $331,334

On November 16, 1993, for a stated purchase price of

$73,000, petitioners purchased a residence in Clinton, Louisiana.

In their purchase of the residence, petitioners paid $49,205 in

cash and obtained a mortgage of $25,000.

On a loan application dated July 2, 1994, Richard Adair

indicated that his monthly salary from the roofing business was

$3,200. On a loan application dated March 15, 1995, Richard

Adair indicated that his weekly salary from the roofing business

was $800.

For 1993, 1994, and 1995, petitioners filed joint Federal

income tax returns on which they reported the following amounts:
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Schedule C for the
Wages, Roofing Business
Salaries, Business Reported
Year and Tips Gross Receipts Expenses Income
1993 $10,905 – – $10,905
1994* 1,400 $21,729 $22,707 10,422
1995 1,535 52,359 26,763 10,193**

* For 1994, on a Schedule C-EZ relating to a separate
contracting business, Richard Adair reported $10,000 as
construction gross receipts with no expenses reported.

** For 1995, total reported income includes $19 of
interest income.

On petitioners’ Schedule C, for the roofing business for

1994, petitioners listed Rebecca Adair as owner of the roofing

business. On petitioners’ Schedule C for the roofing business

for 1995, petitioners listed Richard Adair as owner of the

roofing business.

During respondent’s audit, petitioners did not cooperate

with respondent’s agents, and petitioners did not provide to

respondent’s agents the books and records relating to the roofing

business. Also, petitioners mailed to respondent letters

reflecting frivolous tax protester arguments.

On audit and in the notices of deficiency for the years in

issue, using the bank deposits method of proof and the specific

item method of proof for interest income earned on the checking

account balance, respondent determined that petitioners received

unreported taxable income in the following total amounts:
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Year Amount
1993 $517,236
1994 477,903
1995 333,780

Respondent allowed petitioners’ business deductions for the

roofing business that were claimed on petitioners’ joint Federal

income tax returns.

Respondent also determined, for each year, that petitioners

were liable for the fraud penalty under section 6663. In the

alternative, for each year, respondent determined that

petitioners were liable for the accuracy-related penalty under

section 6662.

As a protective measure, on audit of Delwin Houser for 1993,

1994, and 1995, respondent charged to Delwin Houser the same

total amounts of unreported income relating to the bank deposits

that were charged to petitioners.

OPINION

Under section 61, gross income includes all income from

whatever source derived. See Commissioner v. Glenshaw Glass Co.,

348 U.S. 426, 431 (1955). Taxpayers are required to maintain

sufficient records to allow respondent to determine their correct

Federal income tax liability. See sec. 6001.

Generally, respondent’s determinations are presumed correct,

and taxpayers have the burden of proving that respondent’s
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determinations are erroneous. See Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933).

Generally, bank deposits are treated as prima facie evidence

of taxable income. See Woodall v. Commissioner, 964 F.2d 361,

364 (5th Cir. 1992), affg. T.C. Memo. 1991-15; Parks v.

Commissioner, 94 T.C. 654, 658 (1990); Tokarski v. Commissioner,

87 T.C. 74, 77 (1986).

Where taxpayers fail to present evidence regarding the

proper division between them of income received from a jointly

operated business, respondent and the courts may approximate the

amount of income to be charged to each taxpayer. See Arouth v.

Commissioner, T.C. Memo. 1992-679. An equal division of income

may be appropriate where taxpayers fail to provide any evidence

of a more appropriate division of the income. See Cannon v.

Commissioner, 533 F.2d 959, 960 (5th Cir. 1976), affg. Ash v.

Commissioner, T.C. Memo. 1974-219; Puppe v. Commissioner, T.C.

Memo. 1988-311.

Where evidence exists that taxpayers incurred expenses

relating to their business, it may be appropriate to allow an

estimate of the business expenses. See Cohan v. Commissioner, 39

F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85

T.C. 731, 743 (1985); Sherrer v. Commissioner, T.C. Memo. 1999-

122.
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For 1993, 1994, and 1995, IRS Publication 1136, Statistics

of Income Bulletin, reflected the following average net profit

margins for roofing contractors:

Average
Net Profit
Year Margins
1993 20%
1994 25%
1995 18%

As indicated, respondent’s tax deficiencies determined

against petitioners are based on deposits to the checking account

with no allowance for labor and material costs which obviously

were incurred in the roofing business. We conclude that for each

year it is appropriate to apply to the checking account deposits

that are specifically identifiable as gross receipts of the

roofing business (namely, those deposits that represent the

checks received from Roof Technologies and Vaughn Roofing) the

average net profit margin established by respondent for roofing

contractors and to allow estimated business expense deductions

for the business expenses so calculated.

Petitioners have presented no evidence as to how the income

from the roofing business should be divided between them and

Delwin Houser.

At trial, Rebecca Adair was asked several times her opinion

on how income relating to the roofing business and to the

checking account deposits should be divided between herself, her
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husband, and Delwin Houser. Rebecca Adair was uncooperative and

answered as follows: “I would not”. “No, sir”. “It’s up to

you, sir”, and “–-for me, I’m just-–I won’t offer any

suggestions. I leave it completely up to you, so--.” On the

little evidence before us, we conclude that one-half of the

taxable income from the roofing business is taxable to

petitioners.

For each year, petitioners’ income that was reported on

their joint Federal income tax returns and business expenses that

were allowed that relate to the roofing business are to be

credited against the above income and expense figures in

computing petitioners’ tax liability. In the related case of

Houser v. Commissioner, T.C. Memo. 2000-111, docket Nos. 13202-97

and 20120-97, also filed this date, we charge Delwin Houser with

the other half of the income relating to deposits into the

checking account.

For each year in issue, our calculations of petitioners’

taxable income are set forth below. The bank deposits that are

identified as gross receipts of the roofing business are

multiplied by the average net profit margin for roofing

contractors, producing a partial taxable income figure for the

roofing business. Added to this partial net income figure are

the unidentified bank deposits to calculate total taxable income
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relating to the deposits to the checking account, one-half of

which is then charged to petitioners.

Bank Deposits Net Income
Identified as of Roofing
Gross Receipts Average Business on Unidentified One-half
of Roofing Net Profit Identified Bank Taxable Charged to
Year Business Margin Bank Deposits Deposits Income* Petitioners
1993 $490,009 20% $ 98,002 $ 17,727 $115,875 $57,938
1994 426,843 25% 106,711 51,061 157,939 78,970
1995 197,965 18% 35,634 133,369 169,032 84,516

* As indicated, also included in the taxable income for each year is interest
income relating to the checking account in the respective amounts of $146,
$167, and $29.

For the years in issue, under section 6663(a), a penalty of 75

percent applies to the portion of an understatement of tax that is

attributable to fraud. To establish fraud, respondent is required

to prove that the understatement is due to fraudulent intent. See

sec. 7454(a); Rule 142(b); DiLeo v. Commissioner, 959 F.2d 16 (2d

Cir. 1992), affg. 96 T.C. 858, 873 (1991). Respondent has the

burden of proving fraud by clear and convincing evidence. See sec.

7454(a); Rule 142(b); Bagby v. Commissioner, 102 T.C. 596, 607

(1994).

Where allegations of fraud are intertwined with unreported and

indirectly reconstructed income, respondent is required to

establish a likely taxable source for alleged unreported income or

to disprove nontaxable sources alleged by the taxpayer. See DiLeo

v. Commissioner, 96 T.C. at 873; Parks v. Commissioner, supra

at 661.
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Indicia of fraud include: (1) Understatements of income;

(2) inadequate books and records; (3) implausible or inconsistent

explanations of behavior; and (4) lack of cooperation with tax

authorities. See Bradford v. Commissioner, 796 F.2d 303, 307-308

(9th Cir. 1986), affg. T.C. Memo. 1984-601; Clayton v.

Commissioner, 102 T.C. 632, 647 (1994); Petzoldt v. Commissioner,

92 T.C. 661, 699-700 (1989); Recklitis v. Commissioner, 91 T.C.

874, 910 (1988).

Petitioners have not alleged any nontaxable sources of income,

and the roofing business constitutes the likely taxable source of

the deposits into the checking account.

With regard to fraudulent intent, the evidence establishes for

each year in issue that petitioners realized significant income

that they failed to report, that petitioners failed to provide to

respondent’s agents books and records relating to the roofing

business, that petitioners failed to pay significant tax

liabilities that they owed, that petitioners did not cooperate with

respondent, and that petitioners made erroneous tax protester

objections to the tax laws. Respondent has proven by clear and

convincing evidence petitioners’ fraud in regard to their Federal

income taxes. We conclude that all of the taxable income charged

to petitioners herein is attributable to fraud.
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To reflect the foregoing,

Decisions will be entered

under Rule 155.