T.C. Memo. 2002-77
UNITED STATES TAX COURT
ZACHARIA HADRI AND RAWA HADRI, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4954-00. Filed March 27, 2002.
Zacharia Hadri and Rawa Hadri, pro sese.
Kelley A. Blaine, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: Respondent determined a deficiency in income
tax and a fraud penalty for petitioners’ 1993 tax year as
follows:
Penalty
Year Deficiency Sec. 6663(a)1
1993 $103,559 $77,668.50
1
All section references are to the Internal Revenue Code as
amended and in effect for the year under consideration, and all
Rule references are to this Court’s Rules of Practice and
Procedure, unless otherwise indicated.
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Respondent amended his answer to assert an increased
deficiency and an increased penalty for fraud. Subsequently,
respondent, having received additional information, conceded a
portion of the increase.2 Remaining in dispute are a $157,822
income tax deficiency and a $118,365.75 section 6663(a) penalty.
FINDINGS OF FACT
At the time the petition was filed, petitioners resided in
Anaheim, California. For taxable year 1993, petitioners
conducted five separate income-producing business activities as
follows: Harrington Automotive (Automotive), Harrington Rentals
(Rentals), Harrington Auto Sales (Auto Sales), Sports Card
Connection (Card Connection), and Pacific Seed & Feed (Seed &
Feed). For 1993, petitioners disclosed Automotive and Rentals on
their Federal income tax return, but concealed Auto Sales, Card
Connection, and Seed & Feed. Petitioners reported $177,360 in
Schedule C, Profit or Loss From Business, gross receipts for
Automotive, $17,133 in Schedule E, Supplemental Income and Loss,
income for Rentals, and $84 in interest income.
Through information obtained from the Bank of America,
2
In an amendment to answer, respondent asserted a $155,687
increase in petitioners’ unreported income for a total unreported
income of $562,033. Subsequent to the amendment to answer
respondent received information from petitioners which indicated
that $18,661 in deposits to one bank account were nontaxable. On
the basis of this information, respondent reduced the unreported
income amount to $543,372. Respondent also disallowed a net
operating loss of $51,520.
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respondent discovered petitioners’ bank loan application and a
version of petitioners’ 1993 Federal income tax return which had
not been filed with respondent. On this return, as opposed to
the one filed with respondent, petitioners reflected $247,000 in
Schedule C gross receipts. In related financial information,
petitioners reflected business income from Card Connection and
Seed & Feed. In an attempt to explain the inconsistent returns,
petitioners told respondent the return given to the Bank of
America in connection with the loan application was a “phony”.
Despite petitioners’ effort to conceal their other
activities, respondent discovered Auto Sales through petitioners’
sales tax returns for the 1993 taxable year. Petitioners had not
only failed to report their Auto Sales activity to respondent but
also concealed its existence from their representative. From
discovering Auto Sales, respondent also discovered a previously
undisclosed bank account. It was only after these discoveries
that petitioners admitted to Auto Sales’s existence. In so
doing, however, petitioners claimed that they did not report Auto
Sales’s gross receipts because it sustained a loss.
Moreover, despite respondent’s requests, petitioners failed
to produce statements or records for Auto Sales. Respondent
ultimately obtained both by means of a summons. However,
because petitioners’ records were incomplete and poorly
maintained, respondent had to reconstruct Auto Sales’s financial
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records by using the bank statements and the little information
available on petitioners’ records. After allowing $114,657 in
previously unclaimed expenses in connection with Auto Sales,
respondent determined that Auto Sales had generated a profit for
its taxable year 1993.
Following the discovery of Auto Sales and its corresponding
bank account, respondent independently discovered a second
undisclosed bank account. Altogether, respondent’s
reconstruction of petitioners’ income resulted in taxable
deposits of $737,949 for 1993. This net taxable amount is
$543,372 greater than the amount of income reported by
petitioners.
In a statutory notice of deficiency, respondent determined a
$103,559 income tax deficiency and a $77,668.50 fraud penalty
under section 6663. After the filing of a timely petition,
respondent filed an answer and an amendment to the answer.
Respondent, by amendment to answer, sought an increased income
tax deficiency of $165,211 and an increased fraud penalty of
$123,907.50. After petitioners failed to communicate with him or
reply to the amendment, respondent filed a motion for entry of
order that undenied allegations be deemed admitted for both the
answer and the amendment to the answer. These motions were
granted.
After making a small concession and decreasing petitioners’
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income tax deficiency and fraud penalty to $118,365.75 and
$157,822, respectively, respondent sent petitioners a proposed
stipulation of facts and discovery requests. Petitioners did not
respond, and the proposed stipulation of facts was deemed
established under Rule 91(f). The Court granted respondent’s
motions to compel with respect to the discovery requests and
issued an Order limiting petitioners’ ability to put on evidence
with respect to matters sought by means of the discovery
requests.
Petitioners failed to appear at the October 15, 2001, Los
Angeles, California, trial session.
OPINION
While petitioners must show that respondent erred in
determining the income tax deficiency of $103,559, respondent
must prove the increased deficiency of $54,263.3 See Rule
142(a); Achiro v. Commissioner, 77 T.C. 881, 889-891 (1981); Beck
Chem. Equip. Corp. v. Commissioner, 27 T.C. 840, 856 (1957). We
find petitioners have not shown that respondent erred in his
initial determination, and respondent has proven that the
increased deficiency is correct.
At the onset, we note that respondent’s proposed stipulation
3
This amount is the excess of the $157,822 increased
deficiency over the $103,559 deficiency determined in the
statutory notice of deficiency.
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of facts was deemed established under a Rule 91(f) motion, and
accordingly we have based most of our fact findings on these
established facts. In addition to this, respondent reconstructed
petitioners’ income from a bank deposit analysis. This analysis
was made from petitioners’ bank accounts, Forms 1040, California
sales tax returns, financial statements relating to the Bank of
America loan application, and other materials provided by
petitioners. This reconstruction resulted in the following net
taxable deposits:
Account Total Deposit Non-Taxable Net Taxable
Amount Deposit
Wells Fargo $215,586 $192.00 $215,394.00
Bank of
America (I) 298,220 -0- 298,220.00
Bank of
America (II) 182,345 5,358.00 176,987.00
Bank of
America (III) 30,034 20,545.78 9,488.22
Security
Pacific (I) 4,744 -0- 4,744.00
Security
Pacific (II) 41,616 8,500.00 33,116.00
Net taxable deposit $737,949.22
Based on the reconstruction, we hold that respondent has shown
petitioners are liable for the increased deficiency.
We now consider whether respondent has shown that
petitioners’ understatement of income was fraudulent. Fraud must
be shown by clear and convincing evidence. Section 6663 provides
that if any part of an underpayment of tax is due to fraud, an
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amount equal to 75 percent of the underpayment which is
attributable to fraud shall be added to the tax. While
respondent ultimately has the burden of proving fraud, it can
seldom be shown by direct proof of the taxpayer’s intention.
Spies v. United States, 317 U.S. 492, 499 (1943). However, fraud
can be established by circumstantial evidence and by reasonable
inferences drawn from the taxpayer’s entire course of conduct.
Id. Such inferences may be drawn from the so-called badges of
fraud including, but not limited to, understated or unreported
income, inadequate records, intentional concealment of income and
assets, and failure to cooperate with taxing authorities.
Bradford v. Commissioner, 796 F.2d 303 (9th Cir. 1986), affg.
T.C. Memo. 1984-601.
Based on the evidence, including the facts established under
Rule 91(f) and the evidence at trial, we find that petitioners
intended to conceal, mislead, or otherwise prevent the collection
of their taxes. Petitioners failed to report a substantial
amount of income. Petitioners concealed two bank accounts with
$513,614 in taxable deposits from their own representative and
respondent. Petitioners kept and maintained inadequate records
which did not reflect all income or expenses. Petitioners
concealed a substantial business activity from their own
representative and from respondent. In an attempt to explain
this concealment, petitioners claimed that the activity had
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produced a loss; however, respondent’s reconstructions revealed
that the activity had, in fact, produced a profit.
We accordingly hold that respondent has shown by clear and
convincing evidence that petitioners’ understatement of income
was fraudulent.
To reflect the foregoing,
Decision will be entered
for respondent.