T.C. Memo. 2003-216
UNITED STATES TAX COURT
EDDIE LEE WILLIAMS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 27662-91. Filed July 22, 2003.
Eddie Lee Williams, pro se.
Elizabeth Downs, for respondent.
MEMORANDUM OPINION
DAWSON, Judge: This case was assigned to Special Trial
Judge Daniel J. Dinan pursuant to the provisions of section
7443A(b)(4), in effect at the time the petition was filed in this
case, and Rules 180, 181, and 183.1 The Court agrees with and
1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect during the years in issue and
(continued...)
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adopts the opinion of the Special Trial Judge, as set forth
below.
OPINION OF THE SPECIAL TRIAL JUDGE
DINAN, Special Trial Judge: For the taxable years 1989 and
1990, respondent determined deficiencies in petitioner’s Federal
income taxes of $37,806 and $2,579, section 6651(a)(1) additions
to tax of $9,452 and $516, and section 6654(a) additions to tax
of $2,557 and $170.
The issues for decision are: (1) Whether petitioner
received unreported income from cocaine sales in the amounts
determined by respondent and, if so, whether this income is
subject to Federal income taxation, and (2) whether petitioner is
liable for the additions to tax for failure to file timely
returns and for failure to make estimated income tax payments.
Background
Some of the facts have been deemed stipulated pursuant to
Rule 91(f) and are so found. These stipulations of fact and the
attached exhibits are incorporated herein by this reference. On
the date the petition was filed in this case petitioner resided
in the Federal Correctional Institution at El Reno, Oklahoma.
During the years in issue, petitioner resided in Ardmore,
Oklahoma and was married to Sherry L. Williams. Petitioner filed
1
(...continued)
Rule references are to the Tax Court Rules of Practice and
Procedure.
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joint Federal income tax returns with his wife for the years
1986, 1987, and 1988, reporting gross income of $1,637, $6,798,
and $2,068, respectively. The gross income reported on these
returns consisted solely of wages earned by petitioner’s wife.
Petitioner’s return for 1988 reflected zero income tax liability.
In February 1991, petitioner and several codefendants were
indicted under Federal law on 27 counts of drug offenses and
money laundering. In June 1991, petitioner was convicted on 17
counts of the indictment and received a 30-year sentence of
imprisonment. Petitioner’s conviction reflects that, during 1989
and through April 1990, petitioner managed a continuing criminal
enterprise involving cocaine distribution, and that he received
and spent the proceeds of that enterprise. Petitioner kept no
records of his income or expenses with respect to his purchase
and sale of cocaine during the years in issue.
Petitioner did not file Federal income tax returns for
taxable years 1989 and 1990. After petitioner was convicted, he
was issued a notice of jeopardy assessment followed by a
statutory notice of deficiency for 1989 and 1990. In the notice
of deficiency, respondent determined petitioner’s tax liabilities
and deficiencies, based upon a filing status of married filing
separately, as follows:
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1989 1990
Unreported income $111,991 $11,747
Personal exemption deduction (2,000) (2,050)
Standard deduction (2,600) (2,725)
Self-employment income tax deduction -0- (830)
Taxable income 107,391 6,142
Income tax 31,556 919
Self-employment income tax 6,250 1,660
Total tax liability (deficiency) 37,806 2,579
Respondent determined the total amounts of unreported income by
analyzing petitioner’s cash transactions during the years in
issue. The notice of deficiency reflects the following
reconstruction of petitioner’s income:
1989 1990
Cash bank deposits $64,166 $6,415
Cash wires 13,110 500
Cashier’s checks 820 -0-
Money orders 4,504 2,831
Cash expenditures
1987 Hyundai 4,725 -0-
1989 Hyundai 4,322 -0-
Refrigerator 1,606 -0-
Home improvements 5,900 -0-
Underground sprinkler 3,400 -0-
New sod 2,600 -0-
Security system 3,637 -0-
Mercedes downpayment 13,000 -0-
Tennis bracelet 3,200 -0-
Attorney fees -0- 2,000
Total cash transactions 124,990 11,746
Less duplicated items (13,000) -0-
Total income 111,990 11,746
In addition to the deficiencies, respondent determined that
petitioner was liable for additions to tax under section
6651(a)(1) and section 6654(a). For both of the years in issue,
respondent based his determination of petitioner’s liability for
the section 6654(a) addition to tax on a required annual payment
of 90 percent of petitioner’s current year tax liability as
determined in the notice of deficiency.
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Discussion
The first issue for decision is whether petitioner received
unreported income from cocaine sales in the amounts determined by
respondent and, if so, whether this income is subject to Federal
income taxation.
Section 1 of the Internal Revenue Code imposes a Federal tax
on the taxable income of every individual. Section 61(a) defines
gross income for purposes of calculating taxable income as “all
income from whatever source derived.” This broad definition
includes income obtained from illegal sources. James v. United
States, 366 U.S. 213, 218 (1961); sec. 1.61-14(a), Income Tax
Regs. Separately, section 1401 imposes a tax “on the self-
employment income of every individual”. Self-employment income
is defined generally as “net earnings from self-employment”,
which in turn means “the gross income derived by an individual
from any trade or business carried on by such individual, less
the deductions allowable by this subtitle which are attributable
to such trade or business”. Sec. 1402(a) and (b). “Trade or
business” as used in this context has been construed to encompass
not only legal but also illegal business activities. Peyton v.
Commissioner, T.C. Memo. 2003-146.2
2
The provisions of secs. 1401 and 1402 differed
significantly from 1989 to 1990. We have reviewed respondent’s
calculations in both years and find them to be correct under the
applicable provisions of the Code. We note that the sec.
(continued...)
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Taxpayers are required to maintain records sufficient to
establish the amounts of income, deductions, and other items
which underlie their Federal income tax liabilities. Sec. 6001;
sec. 1.6001-1(a), (e), Income Tax Regs. If a taxpayer fails to
keep adequate records, the Commissioner may reconstruct the
taxpayer’s income by any method that is reasonable under the
circumstances. Petzoldt v. Commissioner, 92 T.C. 661, 687
(1989); see also United States v. Fior D’Italia, Inc., 536 U.S.
238, 243 (2002) (stating that the assessment authority of the IRS
is not exceeded “when the IRS estimates an individual’s tax
liability--as long as the method used to make the estimate is a
‘reasonable’ one”). The reconstruction need not be exact, so
long as it is reasonable and substantially correct. Petzoldt v.
Commissioner, supra at 693; Meneguzzo v. Commissioner, 43 T.C.
824 (1965). The bank deposit and cash expenditure method is
recognized as a reasonable method of reconstructing income.
Parks v. Commissioner, 94 T.C. 654, 658 (1990); Nicholas v.
Commissioner, 70 T.C. 1057, 1065 (1978). This method is premised
on the assumption that the taxpayer has disposed of unreported
income by depositing part of it into bank accounts and by making
cash expenditures of the other part.
2
(...continued)
164(f)(1) self-employment income tax deduction was not applicable
in 1989. Social Security Amendments of 1983, Pub. L. 98-21, sec.
124(d)(2), 97 Stat. 91.
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As a general rule, the taxpayer bears the burden of proving
the Commissioner’s determinations to be in error. Rule 142(a).3
Certain courts have recognized a limited exception to the general
rule where the notice of deficiency determines that the taxpayer
failed to report income, particularly income derived from illegal
activities. Llorente v. Commissioner, 649 F.2d 152, 156 (2d Cir.
1981), affg. in part and revg. in part 74 T.C. 260 (1980);
Weimerskirch v. Commissioner, 596 F.2d 358 (9th Cir. 1979), revg.
67 T.C. 672 (1977). In such circumstances, the Commissioner must
come forward with evidence establishing a minimal foundation,
which may consist of evidence linking the taxpayer with an
income-producing activity. Petzoldt v. Commissioner, supra at
689.
Because respondent has shown that petitioner was convicted
of the illegal distribution of cocaine, and that petitioner
received and spent proceeds from the sale thereof, respondent has
linked petitioner to the relevant income-producing activity.
Respondent provided this Court with summary documents evidencing
the various cash deposits and expenditures underlying his
determination of the amounts of unreported income. These
summaries generally were produced by respondent during the
criminal investigation and prosecution of petitioner. Although
3
Sec. 7491, which shifts the burden of production and/or
proof under certain circumstances, does not apply in the present
case because the underlying examination commenced prior to July
22, 1998. Internal Revenue Service Restructuring & Reform Act of
1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 727.
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not all of the supporting documents are in the record, nothing in
the record calls into question the accuracy of these summaries.
Petitioner himself does not dispute their accuracy. In
petitioner’s Objections to Respondent’s Stipulations, he
summarizes his position in this case, stating that he
does not contest that he received the amount of * * * money
of $111,991.00 and $11,747.00 for the years of 1989 and
1990. Petitioner does object to these amounts being
described as taxable income and subject to tax penalties
under IRC 6651(a)(1) and 6654 * * * . Also Petitioner * * *
from 1980 to 1986 * * * took out large cash advancements
from numerous credit card accounts, which totaled in excess
of $250,000 * * * . Additionally, Petitioner will show this
Court and the Respondent that he can produce documentation
(Credit Card Information), that will make up the difference
of $76,769.24, to balance out the total amount of $123,738,
that the Respondent claims is earned and or gross income
that is subject to taxation, but that the Petitioner rebutts
[sic] as being income at all and not subject to taxation by
the Internal Revenue. That said claim by the respondent is
arbitrary and exaggerated in that said monies were not
derived from any type of income that could be subject to any
tax by the federal government.
Petitioner’s testimony at trial in support of this argument can
be summarized as follows: The cash petitioner used for the
majority of the various deposits and expenditures during the
years in issue was obtained through credit card cash advances.
Petitioner obtained these advances in or before 1986; he then
gave the cash to his father, who kept it in a suitcase in the
trunk of a car in his backyard. Petitioner retrieved the cash
from his father in 1987, but held onto it until the years in
issue when he began making periodic cash deposits of varying
amounts into several different checking accounts. Petitioner
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kept the cash through this period of time despite attempts by
credit card issuers to collect from him on outstanding debts.
Our evaluation of petitioner’s testimony is founded upon
“the ultimate task of a trier of the facts--the distillation of
truth from falsehood which is the daily grist of judicial life.”
Diaz v. Commissioner, 58 T.C. 560, 564 (1972); see also Tokarski
v. Commissioner, 87 T.C. 74, 77 (1986). We do not find to be
credible petitioner’s uncorroborated testimony concerning the
credit card cash advances. We find it unlikely that petitioner
was able to secure such large cash advances, that petitioner with
the help of his father then hoarded these cash advances for
several years, and that petitioner then began depositing this
money in small amounts into bank accounts.
We find that petitioner did not have a cash hoard prior to
the years in issue, and that he instead was using proceeds from
the drug sales to make the cash expenditures and cash bank
deposits in question. Accordingly, we sustain respondent’s
determination that petitioner received unreported income in the
amounts reflected in the notice of deficiency, income which is
includable in petitioner’s gross income and subject to Federal
income taxation under sections 1 and 1401.4
4
Petitioner has cited various statutes and cases in
support of his contention that the income at issue is not
taxable. We need not address these arguments in detail.
Respondent’s determinations are in accordance with the law, as
discussed above, and the law cited by petitioner is not
applicable to the case at hand.
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The second issue for decision is whether petitioner is
liable for the additions to tax for failure to file timely
returns and for failure to make estimated income tax payments.
Section 6651(a)(1) imposes an addition to tax for failure to
file a timely return. This addition to tax equals 5 percent of
the amount required to be shown as tax on the return for each
month, or fraction thereof, during which the failure to file
continues, up to a maximum of 25 percent. A taxpayer may avoid
this addition to tax if he establishes that the failure to file
is due to reasonable cause and not due to willful neglect. Sec.
6651(a)(1). “Reasonable cause” exists where a taxpayer is unable
to file a return within the prescribed time despite the exercise
of ordinary business care and prudence. United States v. Boyle,
469 U.S. 241, 246 (1985). “Willful neglect” means a conscious,
intentional failure or reckless indifference. Id. at 245.
Petitioner did not file a return in either 1989 or 1990.
Petitioner does not assert, and there is nothing in the record
which indicates, that petitioner had reasonable cause for his
failure to file the returns. Consequently, we sustain
respondent’s determination that petitioner is liable for the
section 6651(a)(1) addition to tax for each year in issue.
Section 6654(a) provides for an addition to tax in the event
of an underpayment of a required installment of individual
estimated tax. As relevant here, each required installment of
estimated tax is equal to 25 percent of the “required annual
payment”, which in turn is equal to the lesser of (1) 90 percent
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of the tax shown on the individual’s return for that year (or, if
no return is filed, 90 percent of the individual’s tax for such
year), or (2) if the individual filed a return for the
immediately preceding taxable year, 100 percent of the tax shown
on that return. Sec. 6654(d)(1)(A) and (B). There are two
mechanical exceptions to the applicability of the section 6654(a)
addition to tax. First, as relevant to this case, the addition
is not applicable if the tax shown on the individual’s return for
the year in question (or, if no return is filed, the individual’s
tax for that year) is less than $500. Sec. 6654(e)(1). Second,
the addition is not applicable if the individual’s tax liability
for the preceding taxable year was zero. Sec. 6654(e)(2).
Respondent’s determination that petitioner underpaid his
estimated taxes is based on petitioner’s tax liability as
determined in the statutory notice of deficiency. This
determination is correct with respect to taxable year 1990
because petitioner did not file a return for taxable year 1989 or
1990. Sec. 6654(d)(1)(B). However, this determination is
incorrect with respect to taxable year 1989. Petitioner and his
wife filed a joint Federal income tax return for taxable year
1988 which reflected gross income of $2,068 and a tax liability
of zero. Thus, because 100 percent of petitioner’s 1988 tax
liability as shown on his filed return was zero, petitioner was
not required to make estimated tax payments for 1989. Sec.
6654(d)(1)(B)(ii).
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Finally, we briefly address an issue raised by respondent at
trial concerning the application of the statute of limitations on
collections. A period of limitations on collections begins when
an assessment of tax has been made, including a jeopardy
assessment, and generally runs for 10 years. Sec. 6502(a)(1).
However, where a taxpayer petitions this Court in response to a
statutory notice of deficiency, the period of limitations for
collection of the deficiency is suspended until 60 days after the
Court’s decision becomes final. Sec. 6503(a)(1). Thus, the
period of limitations on collections has not expired in this
case. See Estate of Iaconi v. Commissioner, T.C. Memo. 1961-106.
To reflect the foregoing,
Decision will be entered for
respondent except with respect to
the section 6654(a) addition to
tax for 1989.