T.C. Memo. 2005-55
UNITED STATES TAX COURT
JAMES O. JONDAHL, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13385-02. Filed March 24, 2005.
Jon J. Jensen, for petitioner.
Inga C. Plucinski, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: Respondent determined deficiencies in
petitioner’s 1990, 1991, 1992, and 1993 Federal income taxes of
$25,438, $2,883, $9,883, and $35,876, respectively. Respondent
also determined fraud penalties under section 66631 for 1990,
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code as amended, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
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1991, 1992, and 1993 of $19,078.50, $2,162.25, $7,412.25, and
$26,907, respectively. After concessions by the parties, the
issues for decision are:
(1) Whether assessment of petitioner’s 1990, 1991, 1992,
and 1993 taxes is barred by the period of limitations in section
6501(a). Because we find that petitioner filed false and
fraudulent returns with the intent to evade tax for 1990, 1991,
1992, and 1993, we hold that assessment is not barred;
(2) whether Taxman, Inc. (Taxman), and West Fargo
Investment Corp. (WFIC) should be disregarded because they are
mere alter egos of petitioner. We hold that they should not;
(3) whether petitioner earned real estate commissions of
$56,196, $18,552, $1,566, and $139,080 in 1990, 1991, 1992, and
1993, respectively. We hold that petitioner earned a real estate
commission of $1,566 in 1992 and that petitioner did not earn
real estate commissions in 1990, 1991, or 1993;
(4) whether petitioner realized capital gain of $25,000
from the sale of Jondahl Insurance in 1990 and commissions from
the sale of crop hail insurance in 1990 and 1991 of $12,882 and
$3,142, respectively. We hold that petitioner received capital
gain of $14,962 and insurance commissions of $10,038 in 1990, and
that petitioner did not earn insurance commissions in 1991;
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(5) whether in 1990 petitioner realized capital gain of
$20,244 from the repossession of an apartment complex called Lone
Tree Manor. We hold that he did;
(6) whether petitioner had unreported income in 1990 of
$6,000 from the payment of a settlement judgment by Taxman, $310
from the payment to petitioner’s attorney by Taxman, $2,147 from
a repayment of a loan by Taxman, and $3,000 in cash taken from
Taxman. We hold that he did;
(7) whether petitioner had unreported income in 1991 of
$509 (the value of a stereo transferred from Taxman to
petitioner’s girlfriend), $2,052 from a check issued to
petitioner by Taxman, $2,086 from Taxman’s payment for
petitioner’s furniture, and $3,000 in cash taken from Taxman. We
hold that petitioner had unreported income of $2,052 from a check
issued to petitioner by Taxman, $2,086 from Taxman’s payment for
petitioner’s furniture, and $3,000 in cash taken from Taxman;
(8) whether petitioner had unreported income in 1992 of
$1,904 from Taxman’s payment for petitioner’s furniture, $15,000
from Taxman’s payment of petitioner’s income taxes, $3,000 in
cash taken from Taxman, and $10,931 from a certificate of deposit
(CD) in the name of Western Realty Partners, L.P. (WRP). We hold
that petitioner had unreported income of $3,000 in cash taken
from Taxman and $10,931 from a CD in the name of WRP;
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(9) whether petitioner had unreported income in 1993 of
$310 from Taxman’s payment for a repair of petitioner’s wife’s
car, $7,000 from WFIC’s payment to petitioner’s sister, $28,660
from WFIC’s purchase of a car, and $3,000 in cash taken from
Taxman. We hold that petitioner had unreported income of $310
from Taxman’s payment for a repair of petitioner’s wife’s car,
$7,000 from WFIC’s payment to petitioner’s sister, $18,660 from
WFIC’s purchase of a car, and $3,000 in cash taken from Taxman;
(10) whether petitioner is entitled to claim head-of-
household filing status in 1990. We hold that he is not;
(11) whether petitioner is liable for self-employment tax
on his unreported crop hail insurance commission in 1990 and real
estate commission in 1992. We hold that he is; and
(12) whether the understatement in each of 1990, 1991,
1992, and 1993 is subject to the fraud penalty under section
6663(a). We hold that petitioner is liable for the fraud penalty
under section 6663(a) with respect to unreported income of $3,000
in each year.
FINDINGS OF FACT
Some of the facts are stipulated. The stipulations of fact
and the attached exhibits are incorporated herein by this
reference. At the time the petition was filed, petitioner
resided in Fargo, North Dakota.
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Petitioner married Lori J. Jondahl (Lori) on August 11,
1983. In 1986, petitioner and Lori bought a house in Moorhead,
Minnesota, in which they lived until June 1990. In June 1990,
petitioner moved out of the Moorhead house and into an apartment
in West Fargo, North Dakota, where he lived until December 31,
1993. On July 9, 1991, petitioner and Lori were granted a
divorce. Lori was granted custody of the couple’s daughter. On
October 30, 1993, petitioner married Mary Lee Jondahl (Mary).
Petitioner and Mary are still married.
I. Petitioner’s Business Activities
A. Petitioner’s Tax Preparation Business
In January 1976, petitioner began preparing Federal and
State tax returns as a sole proprietorship under the name Jondahl
Tax Service, and later under the name Jondahl Financial Services
(JFS). In 1978, petitioner became an Internal Revenue Service
(IRS) enrolled agent authorized to practice before the IRS.
B. Taxman
In October 1986, Taxman was incorporated by David Garaas,
petitioner’s attorney. Taxman’s initial directors were Tony
Baasch, an associate of petitioner’s, and Gerald Owen Jondahl
(Mr. Jondahl), petitioner’s father. At Taxman’s first board of
directors meeting, Mr. Jondahl was elected president, Mr. Baasch
was elected vice president, and Gladys Jondahl (Mrs. Jondahl),
petitioner’s mother, was elected secretary and treasurer.
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Petitioner ran the day-to-day operations of Taxman. Mr. Garaas
and Mr. and Mrs. Jondahl were not involved in Taxman’s day-to-day
operations.
Taxman’s business consisted of preparing Federal and State
tax returns, providing tax advice, and keeping financial books
and records. Taxman employed several people at any one time
whose duties included preparation of tax returns, accounting
work, maintenance of accounts receivable and payable, making bank
deposits, signing checks, and receptionist tasks. Taxman
maintained bank accounts in its name, kept corporate records, and
filed corporate tax returns for the years in issue.
In July 1985, petitioner was sued individually and as sole
proprietor of his tax preparation business. Two of JFS’s clients
sued petitioner in connection with a tax shelter investment. In
September 1986, a settlement was reached in which petitioner
initially agreed to pay each couple $6,000. In connection with
the 1986 lawsuit against him, petitioner was deposed in July
1987. During the deposition, petitioner stated that Taxman was
organized to take over the assets and liabilities of JFS.
Petitioner testified in the deposition that he had transferred
office equipment worth approximately $10,000, accounts receivable
worth $3,000, and two bank loans totaling approximately $31,000
to Taxman. Petitioner also stated that no written agreement
existed evidencing the takeover of JFS by Taxman. After the 1987
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deposition, the clients who had sued petitioner agreed to accept
$3,000 each in satisfaction of petitioner’s obligations to them.
The two $3,000 payments were made by Taxman in 1990. Petitioner
did not include the $6,000 paid by Taxman as income to him on his
1990 Federal income tax return.
Each of Taxman’s corporate returns for its taxable years
ending September 30, 1990, 1991, 1992, and 1993, was completed by
petitioner. Mr. Jondahl is listed as the majority stockholder on
each return. Petitioner determined Taxman’s income for its
corporate returns from Taxman’s bank deposits. During each year
at issue, approximately $3,000 of Taxman’s cash receipts was not
deposited in Taxman’s bank accounts. Petitioner took possession
of the cash but did not keep records of how it was spent. Some
of the cash was used by petitioner to pay personal expenses.
Petitioner did not report the cash amounts on his individual tax
returns. Most of Taxman’s expenses, even amounts less than $2,
were paid by check. During the 4 years in issue, Taxman issued
over 500 checks to various eating establishments, to Sam’s
Wholesale Club, and for office supplies, snacks, and postage.
In September 1992, after petitioner was notified that the
IRS was auditing Taxman’s 1990 return, he typed up minutes of
annual directors meetings that he claims took place on October 5,
1987, October 2, 1989, and October 8, 1990. Petitioner claims
that he took handwritten notes of these meetings. The minutes
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reflect that Monica Ramsden, an employee of Taxman, was elected
secretary during the meeting that allegedly took place on October
5, 1987, and that she remained in that capacity until at least
October 7, 1991. Dianna Jilek, an employee of Taxman from 1988
until 1992, was designated an officer of Taxman and WFIC on the
companies’ annual reports. Ms. Jilek did not know she was
designated an officer until she saw her name on Taxman and WFIC’s
annual reports.
Taxman issued Forms W-2, Wage and Tax Statement, to
petitioner for each year in issue. Taxman paid petitioner
$12,000, $20,186, $18,208, and $25,008 in 1990, 1991, 1992, and
1993, respectively.
On September 30, 1994, Mr. Jondahl died. At the time of his
death, Mr. Jondahl owned 95 percent of Taxman’s stock. Mr.
Jondahl left his entire estate to Mrs. Jondahl. In November
1995, petitioner and Mrs. Jondahl sold Taxman to an unrelated
third party.
C. WFIC and Petitioner’s Real Estate Business
On October 12, 1978, petitioner received his real estate
agent’s license. In January 1985, petitioner began selling real
estate as an agent for WFIC. WFIC was organized in 1949 as a
real estate corporation by Lester Smith. Mr. Smith served on
WFIC’s board of directors and as its president from its
incorporation until 1990 or 1991. Mr. Smith died in 1993.
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Sometime around 1988, Mr. Smith transferred the stock of WFIC to
petitioner or petitioner’s sister and brother-in-law2 and moved
WFIC to Taxman’s office space. Petitioner ran the day-to-day
operations of WFIC from 1988 until 1994. While petitioner ran
WFIC, WFIC’s primary business was the sale of commercial real
estate. WFIC maintained a checking account, a savings account,
and an Interest on Real Estate Trust Account (trust account)
throughout the years in issue. On September 14, 1990, the North
Dakota Real Estate Commission (NDREC) granted petitioner’s
application to be a real estate broker for WFIC. WFIC did not
hold regular shareholders or directors meetings. During the
years at issue, WFIC employed two real estate agents in addition
to petitioner. WFIC paid each agent commissions the agent earned
brokering transactions for WFIC. Certain of Taxman’s employees,
including petitioner, performed work for WFIC and were paid for
these services by Taxman. The Taxman employees who also worked
for WFIC did not keep track of the time they spent working for
WFIC. During 1990, 1991, 1992, and 1993, WFIC transferred at
2
Petitioner testified that Mr. Smith transferred the WFIC
stock to petitioner’s sister and brother-in-law because
petitioner’s attorney advised him not to own stock in light of
the lawsuit against him and a potential lawsuit from his former
wife. Respondent alleges that the WFIC stock was transferred to
petitioner’s sister and brother-in-law as nominees for
petitioner. Because the identity of the true owner of WFIC’s
stock does not affect our determinations herein, we do not
address this discrepancy.
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least $190,240 to Taxman. Petitioner controlled the amounts that
WFIC transferred to Taxman.
On November 26, 1990, WFIC registered the trade name “Epic
Real Estate” with the State of North Dakota. In 1990, petitioner
inquired of the NDREC whether it was permissible for him to
advertise under the name Epic Real Estate as a division of WFIC.
He was informed that it was, but that he could not advertise
solely as Epic Real Estate while operating through a corporation.
In a letter dated February 19, 1992, petitioner informed the
secretary of the NDREC that “Epic Real Estate” would no longer be
a division of WFIC but a sole proprietorship under petitioner’s
broker’s license. On February 19, 1992, petitioner filed an
official notice of change of address and name with the NDREC,
showing a change of business name from “West Fargo Investment
Corporation d/b/a Epic Real Estate” to “Epic Real Estate”. Also
in February 1992, petitioner changed the name on WFIC’s trust
account, without the knowledge or approval of WFIC’s shareholders
or directors, from “West Fargo Investment Corporation d/b/a Epic
Real Estate” to “James O. Jondahl d/b/a Epic Real Estate”.
Petitioner renewed his broker’s license for 1993 using the name
“Epic Real Estate”. On September 24, 1993, petitioner changed
the business name with the NDREC back to “West Fargo Investment
Corporation d/b/a Epic Real Estate”.
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During the years in issue, petitioner, WFIC, or Epic Real
Estate brokered numerous real estate transactions. In some of
these transactions, a commission was transferred from WFIC’s
trust account to its checking account. In 1990, commissions of
$38,446 from two transactions were transferred from WFIC’s trust
account to WFIC’s checking account. Additional commissions of
$17,700 were paid by check to either petitioner or WFIC. In
1991, commissions of $18,552 from two transactions were
transferred from WFIC’s trust account to WFIC’s checking account.
In 1992, a brokerage fee of $1,566 was paid by check made out to
petitioner. In 1993, a brokerage fee of $28,000 was transferred
from WFIC’s trust account to its checking account, and a
commission of $102,080.25 was paid by check to Epic Real Estate.
WFIC filed Forms 1120, U.S. Corporation Income Tax Return,
for its taxable years ending December 31, 1990, 1991, 1992, and
1993. Petitioner prepared those returns. WFIC reported the
commissions from petitioner’s real estate activities in 1990,
1991, 1992, and 1993 as income on its corporate tax returns for
those years. Respondent does not dispute that WFIC reported all
of the real estate commissions on its corporate returns for the
years in issue. The commission income was offset by net
operating losses that WFIC held at the time petitioner began
running WFIC. WFIC did not pay petitioner the real estate
commissions; petitioner’s only salary was from Taxman.
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D. Crop Hail Insurance Business
On March 11, 1977, petitioner was licensed as an insurance
agent. From 1977 to December 1990, petitioner sold crop hail
insurance under the names Jondahl Insurance and Jondahl Insurance
Agency (Jondahl Insurance). Jondahl Insurance entered into
several contracts with Farmer’s Mutual Crop Hail Insurance Co.
(Farmer’s Mutual) between 1983 and 1986 that authorized Jondahl
Insurance to act as an agent of Farmer’s Mutual in certain
counties. Jondahl Insurance also entered into an agency contract
with Old Republic Insurance Co. in 1989. A Farmer’s Mutual 1990
policy register reflects that Jondahl Insurance earned $12,881.70
in commissions from Farmer’s Mutual during that year. The
Farmer’s Mutual 1991 policy register reflects that Jondahl
Insurance earned $3,141.95 in commissions from Farmer’s Mutual
during that year. Petitioner did not report any commissions
earned from Farmer’s Mutual for the sale of crop hail insurance
on his individual 1990 and 1991 Federal income tax returns.
In 1990, Gary Ihry of Valley Crop Insurance purchased
Jondahl Insurance for $25,000.3 Mr. Ihry paid Jondahl Insurance
$14,962 in 1990 in partial satisfaction of the purchase price.
The parties stipulated that Farmer’s Mutual paid Jondahl
3
It is not apparent in the record how Jondahl Insurance
earned commissions in 1991 from Farmer’s Mutual after selling its
crop hail insurance business to Mr. Ihry in 1990. The record
does not contain Forms 1099 evidencing that Farmer’s Mutual
actually paid petitioner these commissions.
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Insurance $10,038 in 1990 in satisfaction of the remainder of the
purchase price, in accordance with the terms of the sale.
Petitioner deposited the proceeds from the sale in WFIC’s
checking account. Petitioner did not report any capital gain
from the sale to Mr. Ihry on his 1990 individual Federal income
tax return.
E. Lone Tree Manor Apartments
On April 1, 1987, petitioner purchased Lone Tree Manor
apartment complex from Investors Real Estate Trust (IRET). IRET
held the mortgage on Lone Tree Manor until 1990. The income and
expenses related to the operation of Lone Tree Manor were
reported on petitioner and Lori’s joint Federal income tax
returns for 1987 and 1988. Lori reported the income and expenses
for Lone Tree Manor on her individual 1989 income tax return. In
November 1990, IRET repossessed Lone Tree Manor. Petitioner did
not report any gain resulting from the repossession of Lone Tree
Manor on his 1990 Federal income tax return. WFIC reported
capital gain of $22,028 from the sale of Lone Tree Manor on its
1990 Form 1120.
II. Other Expenses
Petitioner, Taxman, and WFIC each maintained bank accounts.
Petitioner had signatory authority on all these accounts.
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A. 1990
In 1990, Taxman paid $310 to Garry Pearson, an attorney whom
petitioner consulted regarding his 1982, 1983, and 1984 tax
returns. Also in 1990, Taxman made two payments totaling $2,147
to West Far-Mor Credit Union in satisfaction of a 1989 loan to
petitioner. Petitioner did not report either payment as income
on his 1990 tax return.
B. 1991
In January 1991, Taxman issued two checks to petitioner
totaling $2,052. Petitioner did not report the $2,052 as income
on his 1991 tax return.
Also in January 1991, petitioner bought several pieces of
furniture from Conlin’s Furniture (Conlin’s). The total price of
the furniture was $4,034.10. The cost of the furniture was
charged to petitioner’s Visa card in January and April 1991.
Taxman made all the payments on petitioner’s Visa during 1991 and
1992. For 1991 and 1992, Taxman paid $2,086 and $1,904,
respectively, toward the furniture purchase.4 Petitioner did not
include the amount paid for the furniture from Conlin’s as income
on his 1991 or 1992 personal income tax return.
4
The notice of deficiency states that Taxman paid only
$1,904. However, the credit card statements reflect that Taxman
paid $1,948.10 toward the furniture purchase in 1992. For
simplicity’s sake, we refer to the 1992 amount as $1,904 as
stated in the notice of deficiency.
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Taxman occasionally accepted equipment from one of its
clients, Site on Sound Car and Home Electronics (Site on Sound),
in lieu of payment on Site on Sound’s balance due. In May 1991,
petitioner received a home stereo system as partial payment of
Site on Sound’s balance due. The stereo was valued at $509.
Petitioner gave the home stereo system to his girlfriend, Melodie
Lane. He did not report the $509 as income on his personal tax
return for 1991. Ms. Lane worked in an office of Taxman Express,
a subsidiary of WFIC, for 1 month in early 1992. Taxman Express
was a business opened by petitioner in 1991 in order to prepare
and e-file tax returns for walk-in customers. Ms. Lane was never
employed by Taxman.
C. 1992
On October 1, 1990, petitioner formed Western Realty
Partners, L.P.-I (WRP). WFIC was the general partner of WRP and
held a greater-than-95-percent interest in WRP. On October 5,
1990, Valis R. Garceau, a client of petitioner’s and Taxman’s,
gave petitioner $10,000 to purchase rental real estate on her
behalf. Petitioner deposited the $10,000 in WFIC’s trust
account. On the same day, $10,000 was withdrawn from WFIC’s
trust account by check payable to WRP. A memo on the check read
“V. Garceau CD”. Petitioner does not dispute that the check was
used to purchase a $10,000 CD. On May 6, 1991, WRP liquidated
the CD and deposited the funds, $10,418.89, into a new money
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market account opened by WRP that same month. No other deposits
were made into the money market account. On April 20, 1992,
petitioner closed the money market account and withdrew the
balance ($10,930.58). Petitioner deposited the $10,930.58 into
his personal bank account. Petitioner did not report the
$10,930.58 as income on his 1992 income tax return.
On May 28 and July 24, 1992, Taxman issued checks for $5,000
and $10,000, respectively, to petitioner. Petitioner used these
checks to purchase cashier’s checks payable to a West Fargo law
firm to pay petitioner’s personal 1983 and 1984 income tax
liabilities. Petitioner did not report the $15,000 as income on
his 1992 income tax return.
D. 1993
On February 17, 1993, Taxman paid $310.43 to Schumacher
Goodyear for repairs done in December 1992 to Mary’s car, a 1991
Ford Probe. Petitioner did not report the amount paid for the
repairs as income on his 1993 income tax return.
On October 12, 1993, WFIC issued a check for $7,000 to
petitioner’s sister, Susan Schoeppach. On October 20, 1993, Ms.
Schoeppach wrote a check for $7,000 to Epic Real Estate. The
$7,000 Ms. Schoeppach paid Epic Real Estate was used as a
downpayment on an apartment building that Ms. Schoeppach
purchased. Epic Real Estate brokered Ms. Schoeppach’s purchase
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of the apartment building and received a real estate commission
of $9,000 for the sale in 1993.
On October 15, 1993, WFIC purchased a 1993 Buick Riviera
(Buick). Mary’s 1991 Ford Probe was traded in and its value was
credited to the purchase of the Buick. The Buick was registered
in Mary’s name, and personalized license plates reading “PURRFCT”
were requested for the Buick. Petitioner did not report the
value of the Buick as income on his 1993 income tax return.
In 1994, petitioner represented on both a credit application
and a Uniform Residential Loan Application that he and Mary owned
Taxman, WFIC, and the Buick.
III. Petitioner’s Criminal Conviction
On September 11, 1997, a jury convicted petitioner of
intentionally filing false returns under section 7206(1) for
1990, 1991, 1992, and 1993 and of attempting to obstruct and
impede the administration of internal revenue laws from 1985
through 1997 in violation of section 7212(a). The U.S. District
Court for the District of North Dakota entered its judgment on
December 30, 1997, sentencing petitioner to 6 months’
imprisonment and ordering petitioner to pay the IRS $42,873.24 in
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restitution.5 The District Court’s judgment was affirmed by the
U.S. Court of Appeals for the Eighth Circuit on August 6, 1999.
On May 22, 2002, respondent issued a notice of deficiency
for petitioner’s 1990, 1991, 1992, and 1993 years. Petitioner
timely filed a petition with the Court.
OPINION
I. Expiration of the Period of Limitations
The first issue we must consider is whether the period of
limitations for each of petitioner’s 1990, 1991, 1992, and 1993
years expired before respondent issued the notice of deficiency
on May 22, 2002. Petitioner contends that the 3-year period in
section 6501(a) expired and respondent’s assessment is barred.
Respondent argues that the period of limitations in section
6501(a) does not apply pursuant to section 6501(c)(1) and (2)
because petitioner filed false or fraudulent returns with the
intent to evade tax for the years at issue. Accordingly, our
determination of whether the period of limitations remains open
depends on whether petitioner committed fraud in the filing of
his 1990, 1991, 1992, and 1993 returns.
5
On Feb. 18, 1999, petitioner paid in full the $42,873.24
restitution ordered by the District Court. The parties
stipulated that the amount paid as restitution will be credited
to any deficiencies for the years 1990, 1991, 1992, and 1993
after they are redetermined by the Court or agreed upon by the
parties.
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The determination of fraud for purposes of section
6501(c)(1) is the same as the determination of fraud for purposes
of the penalty under section 6663. Neely v. Commissioner, 116
T.C. 79, 85 (2001); Rhone-Poulenc Surfactants & Specialties v.
Commissioner, 114 T.C. 533, 548 (2000). Respondent has the
burden of showing fraud by clear and convincing evidence. See
sec. 7454(a); Rule 142(b).
Petitioner’s conviction under section 7206(1) does not prove
fraud; respondent must show that petitioner intended to evade tax
in filing the false returns. See Wright v. Commissioner, 84 T.C.
636, 643 (1985). For Federal tax purposes, fraud entails
intentional wrongdoing with the purpose of evading a tax believed
to be owing. See Neely v. Commissioner, supra at 86. In order
to show fraud, respondent must prove: (1) An underpayment
exists; and (2) petitioner intended to evade taxes known to be
owing by conduct intended to conceal, mislead, or otherwise
prevent the collection of taxes. See Parks v. Commissioner, 94
T.C. 654, 660-661 (1990).
A. Underpayment of Tax
Respondent must first show by clear and convincing evidence
that petitioner made an underpayment of tax in each of 1990,
1991, 1992, and 1993. Respondent may not rely on petitioner’s
failure to carry his burden of proof to sustain respondent’s
burden of proving fraud. See id. at 661. We conclude that
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respondent has met this burden. For 1990, petitioner conceded at
trial that he understated his income by $950. For 1992,
petitioner conceded that he improperly deducted reimbursed
medical expenses of $18,129. In addition, for each of the years
at issue, Taxman received $3,000 in cash receipts, and petitioner
took possession of the cash. The parties stipulated that the
$3,000 of cash taken by petitioner each year was not deposited
into Taxman’s bank account. Petitioner admits that he controlled
all of the cash and that he used some of it to pay personal
expenses. He did not keep track of how the cash was spent, and
he did not report the cash on his personal income tax returns.
Petitioner also admits that he used Taxman funds to pay for
furniture. Although petitioner asserts that some of the amounts
Taxman spent on his personal expenses were intended to be loans
from Taxman, respondent has shown that petitioner did not keep
credible records of some of these purported loans. Respondent
has also shown that petitioner received income from the sale of
his crop hail insurance business in 1990 that he did not report
on his return. We therefore conclude that respondent has
presented clear and convincing evidence that petitioner underpaid
his tax for 1990, 1991, 1992, and 1993.
B. Fraudulent Intent
Because direct evidence of fraud is rarely available, fraud
may be proved by circumstantial evidence and reasonable
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inferences from the facts. Petzoldt v. Commissioner, 92 T.C.
661, 699 (1989). Courts have developed a nonexclusive list of
factors, or “badges of fraud”, that demonstrate fraudulent
intent. Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992).
These badges of fraud include: (1) Understating income, (2)
maintaining inadequate records, (3) implausible or inconsistent
explanations of behavior, (4) concealment of income or assets,
(5) failing to cooperate with tax authorities, (6) engaging in
illegal activities, (7) an intent to mislead which may be
inferred from a pattern of conduct, (8) lack of credibility of
the taxpayer’s testimony, (9) filing false documents, (10)
failing to file tax returns, and (11) dealing in cash. Id.; see
also Spies v. United States, 317 U.S. 492, 499 (1943); Recklitis
v. Commissioner, 91 T.C. 874, 910 (1988). Although no single
factor is necessarily sufficient to establish fraud, the
combination of a number of factors constitutes persuasive
evidence. Niedringhaus v. Commissioner, supra at 211.
Respondent must prove fraud for each year at issue. See id. at
210; Ferguson v. Commissioner, T.C. Memo. 2004-90.
Respondent has shown by clear and convincing evidence that
at least portions of the understatements on petitioner’s returns
for 1990, 1991, 1992, and 1993 are due to fraud. We believe
petitioner took possession of Taxman’s cash receipts for his own
personal use with the intent to evade taxes on that income.
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Petitioner instructed Ms. Jilek, who regularly deposited Taxman’s
income into its bank account, not to deposit Taxman’s cash
receipts into Taxman’s bank account. Petitioner also reprimanded
Ms. Jilek when, on occasion, she did deposit the cash. Instead,
petitioner took possession of the cash, and he admits that he
used some of the cash for his own personal expenses. He did not
report the amounts used for personal expenses on his individual
tax returns. Petitioner claims that some of the cash was used
for business expenses, but Ms. Jilek credibly testified that
although she remembers occasionally using cash to buy postage,
she does not remember using cash for any other business expense.
Petitioner did not keep track of how the cash was spent. Ms.
Jilek was responsible for paying Taxman’s bills, signing checks
drawn on Taxman’s account, and using petitioner’s credit cards to
pay business expenses. Respondent has shown that it was unusual
for Taxman to pay its expenses in cash. Even small amounts were
paid by check. Ms. Jilek could not remember petitioner or
herself using cash to pay Taxman’s expenses, except, sometimes,
for postage. We do not find petitioner’s testimony that he used
the cash for business purposes credible, and we believe
petitioner took the cash with the intent to conceal income.
Petitioner understated his income, maintained inadequate
records of amounts he received from Taxman, and concealed income
he received from Taxman. Petitioner is collaterally estopped
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from arguing here that he did not willfully file a false income
tax return for each of the years in issue. We conclude that
respondent has shown by clear and convincing evidence that
petitioner filed false or fraudulent returns with the intent to
evade tax for the years at issue. Therefore, the 3-year period
of limitations under section 6501(a) does not apply to any of
petitioner’s 1990, 1991, 1992, and 1993 years, and respondent is
not barred from assessing any deficiencies in petitioner’s taxes
for those years.
II. Burden of Proof6
Respondent’s determinations in the notice of deficiency are
presumed correct, and petitioner bears the burden of proving that
respondent’s determinations are incorrect. See Rule 142(a); see
Welch v. Helvering, 290 U.S. 111, 115 (1933); Page v.
Commissioner, 58 F.3d 1342, 1347 (8th Cir. 1995), affg. T.C.
Memo. 1993-398. Respondent asserted adjustments in an amended
answer that were not made in the notice of deficiency.
Respondent bears the burden of proof with respect to the items of
adjustment not raised in the notice of deficiency. See Rule
142(a); see Achiro v. Commissioner, 77 T.C. 881, 889 (1981).
6
Sec. 7491 does not apply to this case because the
examination of petitioner’s 1990, 1991, and 1992 returns began
before July 22, 1998. See Internal Revenue Service Restructuring
and Reform Act, Pub. L. 105-206, sec. 3001(a), 112 Stat. 726.
The audit was subsequently expanded to include petitioner’s 1993
tax year.
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Therefore, respondent bears the burden of proving that: (1)
Petitioner had unreported income in each of 1990, 1991, 1992, and
1993 of $3,000 by means of cash diverted from Taxman; (2)
petitioner had unreported crop hail insurance commission income
in 1990 and 1991 of $12,882 and $3,142, respectively; (3)
petitioner had unreported real estate commission income of
$28,098, $9,276, and $69,540 in 1990, 1991, and 1993,
respectively; and (4) petitioner is liable for self-employment
tax on his unreported commission income. Petitioner bears the
burden of proof on the remaining adjustments.
III. Validity of Taxman and WFIC
Respondent first argues that petitioner used both Taxman and
WFIC as his alter egos and they should be disregarded for tax
purposes. Essentially, respondent asks us to find that Taxman
and WFIC lack economic substance and are shams. Respondent
points to petitioner’s control over each corporation, his use of
corporate funds to pay personal expenses, and his inconsistent
representations of his positions in each corporation. Petitioner
argues that he treated Taxman and WFIC as entities that were
legally separate from himself.
Respondent does not argue that Taxman and WFIC were not
properly organized under North Dakota law. However, even though
a corporation is organized under the laws of a State, we may
disregard it for Federal tax purposes if it is no more than a
- 25 -
vehicle for tax avoidance and void of a legitimate business
purpose. Gregory v. Helvering, 293 U.S. 465 (1935); Aldon Homes,
Inc. v. Commissioner, 33 T.C. 582, 596 (1959). While a taxpayer
is free to adopt the corporate form of doing business, the
corporation must have been organized for a substantial business
purpose or actually engage in substantive business activity in
order to be a viable business entity. Moline Props., Inc. v.
Commissioner, 319 U.S. 436, 439 (1943) (stating that such
business purposes include gaining an advantage under the laws of
the State of incorporation, avoiding or complying with the
demands of creditors, and serving the creator’s personal or
undisclosed convenience); Aldon Homes, Inc. v. Commissioner,
supra at 597.
On the other hand, a corporation remains a separate taxable
entity as long as the purpose for which it was formed “is the
equivalent of business activity or is followed by the carrying on
of business by the corporation”. Moline Props., Inc. v.
Commissioner, supra at 438-439. The degree of corporate business
purpose required for recognition of a separate corporate
existence is “extremely low.” Strong v. Commissioner, 66 T.C.
12, 24 (1976), affd. 553 F.2d 94 (2d Cir. 1977); Lukins v.
Commissioner, T.C. Memo. 1992-569.
The business purposes and activities of Taxman and WFIC were
sufficient to require recognition of them as separate legal
- 26 -
entities. At the time Taxman was incorporated, petitioner was
being sued as an individual and as sole proprietor of his tax
preparation business. Petitioner’s goal of obtaining limited
liability for his tax preparation business by operating his
business through Taxman is a sufficient business purpose for
Taxman to be recognized as a separate entity. See Moline Props.,
Inc. v. Commissioner, supra at 438-439. In addition, Taxman had
employees, filed tax returns, maintained books, records, and a
bank account, and held assets and liabilities. This level of
ongoing business activity is also sufficient for the Court to
conclude that Taxman was not a sham corporation. See id.
WFIC was organized by Mr. Smith in 1949, and from 1988 until
1994, it operated a commercial real estate business. Until 1991,
Mr. Smith remained actively involved in WFIC’s day-to-day
business operations and had an office in Taxman’s business space.
WFIC maintained books, records, and bank accounts and filed
corporate tax returns. Petitioner applied for his real estate
broker’s license as an employee of WFIC and ran most of his real
estate transactions through WFIC’s trust account. WFIC also had
other real estate agents working for it. These business
activities are sufficient to convince us that WFIC was not a sham
and should be recognized as a corporate entity separate from
petitioner. See id.
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IV. Assignment of Income
Although we have concluded that Taxman and WFIC should be
recognized as separate entities, WFIC’s real estate commission
income during the years at issue may nonetheless be taxable to
petitioner under section 61 and the assignment of income
doctrine. See Haag v. Commissioner, 88 T.C. 604, 610 (1987),
affd. without published opinion 855 F.2d 855 (8th Cir. 1988). A
taxpayer may not assign income to a corporation with real and
substantial business activity to avoid tax liability. Wilson v.
United States, 530 F.2d 772, 778 (8th Cir. 1976). Two
requirements must be fulfilled in order for a corporation, rather
than its service-performer employee, to be considered the earner
of the income and taxable thereon:
First, the service-performer employee must be just
that--an employee of the corporation whom the
corporation has the right to direct or control in some
meaningful sense. Second, there must exist between the
corporation and the person or entity using the services
a contract or similar indicium recognizing the
corporation’s controlling position. [Citations and fn.
ref. omitted.]
Johnson v. Commissioner, 78 T.C. 882, 891 (1982), affd. without
published opinion 734 F.2d 20 (9th Cir. 1984).
Respondent argues that petitioner should have included on
his personal tax returns the real estate commissions paid to WFIC
during 1990, 1991, 1992, and 1993 because petitioner was the true
earner of those commissions. Petitioner argues that WFIC earned
the real estate commissions. Petitioner has the burden of proof
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with respect to the $1,566 real estate commission earned in 1992.
Because the notice of deficiency included half the real estate
commission income earned during 1990, 1991, and 1993, petitioner
has the burden of proof with respect to half of the real estate
commissions at issue for those years. In his amended answer,
respondent asserted the inclusion of the other half of the real
estate commission amounts for 1990, 1991, and 1993; therefore,
respondent has the burden of proof for half the real estate
commissions for those years.
Petitioner did not present evidence at trial that he and
WFIC executed an employment contract at any time. However, when
petitioner applied for his real estate broker’s license in 1990,
he stated that he would be an “acting broker for a corporation”,
listing WFIC as his employer. Likewise, in correspondence
between petitioner and members of the NDREC, petitioner
acknowledged his relationship with WFIC and sought advice
regarding the proper way to advertise. In addition, petitioner
used WFIC’s trust account to facilitate most of his real estate
transactions.
In 1990 and 1991, all of petitioner’s real estate
transactions were brokered using WFIC’s trust account, and the
commission amounts were transferred to WFIC’s general account at
the conclusion of each transaction. These amounts were reported
on WFIC’s 1990 and 1991 corporate tax returns. Petitioner’s
- 29 -
dealings with the NDREC and his customers as an employee of WFIC
tend to show that for purposes of this test, WFIC had the right
to direct petitioner as an employee. Petitioner’s use of WFIC’s
bank accounts to facilitate the real estate transactions also
demonstrates that WFIC was petitioner’s employer for real estate
matters. The use of WFIC’s bank accounts and the presence of
WFIC’s name on documents such as settlement statements put WFIC’s
customers on notice that petitioner was operating as an employee
of WFIC. This conclusion is supported by the fact that
petitioner’s customers wrote checks to WFIC or to Epic Real
Estate as a division of WFIC. All these facts surrounding
petitioner’s operation of WFIC lead us to conclude that
petitioner has met his burden of proving that WFIC was the true
earner of the real estate commissions in 1990 and 1991, and
respondent has not met his burden of showing that petitioner
earned the 1990 and 1991 real estate commissions.
In February 1992, petitioner changed his business name with
the NDREC from WFIC d/b/a Epic Real Estate to “James O. Jondahl
d/b/a Epic Real Estate”. He also changed the name on WFIC’s
trust account to Epic Real Estate. Petitioner completed one real
estate transaction in 1992. The documents related to that
transaction reference Epic Real Estate but do not reference WFIC.
The commission, $1,566, was paid out of the WFIC/Epic Real Estate
trust account to petitioner. Petitioner not only took formal
- 30 -
steps to separate his real estate activity in 1992 from WFIC but
also acted as a sole proprietor in the 1992 transaction. These
facts indicate that WFIC was not the true earner of the 1992
commission. Petitioner has not met his burden of proving that he
did not earn the 1992 commission of $1,566.
In 1993, petitioner brokered one transaction for which a
commission of $28,000 was transferred from WFIC’s trust account
to its checking account and another transaction for which Epic
Real Estate received a commission of $102,080. The documents
related to this second transaction, including a commission check,
referred to Epic Real Estate as a division of WFIC. Petitioner
deposited the proceeds from the transaction into WFIC’s general
account. Likewise, in November 1993, petitioner brokered a
transaction for his sister in which Epic Real Estate received a
commission of $9,000. Petitioner also deposited this check into
WFIC’s general account. These amounts were reported on WFIC’s
corporate tax return for 1993. Petitioner changed the business
name with the NDREC back to “West Fargo Investment Corporation
d/b/a Epic Real Estate” on September 24, 1993, indicating his
intent to operate the real estate business through WFIC again.
We conclude that, for the purpose of the 1993 real estate
transactions, petitioner was again an employee of WFIC.
Petitioner has met his burden of proving that WFIC was the true
earner of the real estate commissions in 1993, and respondent has
- 31 -
not met his burden of showing that petitioner earned the real
estate commissions.7
Petitioner argues that expenses associated with the real
estate commission he earned should be taken into account. The
burden of proving entitlement to deductions is on petitioner.
See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).
Because petitioner did not present any evidence that he paid any
expenses or is entitled to any deductions against the real estate
income, we conclude that the full amount of the 1992 commission,
$1,566, is income to petitioner.
V. Other Adjustments
A. Sale of and Commissions From Crop Hail Insurance
Business
Petitioner sold crop hail insurance as a sole proprietor
beginning in 1977. He asserts that in 1986, his crop hail
insurance business was transferred to Taxman, along with his tax
preparation and bookkeeping businesses. He claims that in 1989,
Taxman transferred the crop hail insurance business to WFIC
because it was confusing for customers to receive crop hail
insurance bills from a company called “Taxman”. On May 9, 1990,
petitioner entered into a purchase contract with Mr. Ihry to sell
7
Respondent did not raise the potential application of sec.
482 to petitioner’s arrangement with WFIC. See, e.g., Haag v.
Commissioner, 88 T.C. 604, 614 (1987), affd. without published
opinion 855 F.2d 855 (8th Cir. 1988). Therefore, we do not
address it.
- 32 -
the crop hail insurance business for $25,000. Respondent argues
that the $25,000 is income to petitioner in 1990. Petitioner has
the burden of proving that the sale proceeds were not income to
him. Petitioner maintains that WFIC owned the crop hail
insurance business when it was sold.
Petitioner did not present any documentation of the
purported transfers of the business to Taxman and to WFIC. In
the 1987 deposition, petitioner admitted that the transfer to
Taxman was not documented. The 1990 purchase agreement was
between Mr. Ihry and Jondahl Insurance, not WFIC. Likewise, the
checks paid for the purchase of the business by Mr. Ihry were
made out to Jondahl Insurance, although petitioner deposited the
checks into WFIC’s bank account. Jondahl Insurance was a party
to agency agreements with Farmer’s Mutual and Old Republic
Insurance Co. in 1986 and 1989, after its alleged transfer.
Neither Taxman nor WFIC is mentioned on either contract.
Farmer’s Mutual listed “Jondahl Insurance Agency” on its policy
registers for 1990 and 1991. Petitioner has not shown any
evidence to support his claim that his insurance customers
received bills from Taxman or that any customers were confused as
to the ownership of the business. In addition, petitioner did
not report capital gain from the sale of the insurance business
on WFIC’s 1990 or 1991 corporate return.
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Petitioner did not change any activity with respect to the
crop hail insurance business, formally or informally, after he
allegedly transferred the business to Taxman and WFIC, except
that he deposited the income from the business, including the
sale proceeds, into WFIC’s bank account. Petitioner’s deposits
of insurance income into WFIC’s bank accounts, in the absence of
any other proof that WFIC held the insurance business, do not
prove that a transfer occurred. Petitioner alleges that he
reported insurance commissions on Taxman’s and WFIC’s corporate
returns, but he has not presented itemized lists of income for
the corporations. In addition, petitioner’s failure to inform
his insurance customers that he was acting on behalf of a
corporation is a factor indicating that State law may not have
afforded petitioner corporate liability protection. See
Hilzendager v. Skwarok, 335 N.W.2d 768, 774 (N.D. 1983).8
Petitioner also argues that he should not be required to
include the crop hail insurance sale proceeds in his personal
income because an IRS audit of his 1987 individual return
required him to remove certain deductions from his individual
8
The parties stipulated that North Dakota law did not allow
corporations to hold insurance licenses until 1995. Our analysis
of North Dakota insurance law, however, revealed no such
limitation. In any case, we do not consider this factor to be
relevant to our determination. Cf. Jones v. Commissioner, 64
T.C. 1066 (1975) (holding that a court reporter’s assignment of
income to her personal service corporation was invalid because
State law did not allow corporations to perform court reporter
services).
- 34 -
return. He claims the IRS characterized the items as corporate
expenses. The record contains two documents from the audit of
petitioner’s 1987 return, a statement of income tax examination
changes and a partially redacted copy of a letter from the
revenue agent. Although it is clear that certain deductions were
removed from petitioner’s individual return pursuant to the
audit, neither document refers to the crop hail insurance
business, Taxman, or WFIC. We find no relevance in the audit
documents regarding the sale of the crop hail insurance business.
We conclude that petitioner has not met his burden of
proving that the crop hail insurance business was transferred to
Taxman and WFIC. Consequently, any sale proceeds or commission
income earned by Jondahl Insurance while petitioner owned the
insurance business was properly taxable to petitioner, not WFIC
or Taxman.
Three checks from Mr. Ihry to Jondahl Insurance are in the
record evidencing the payment of the purchase price, dated May 9,
1990, November 2, 1990, and November 19, 1990, for $1,000,
$3,962, and $10,000, respectively. The purchase agreement
between petitioner and Mr. Ihry provided that petitioner would
receive commissions from Farmer’s Mutual earned in 1990 and 1991,
and the amount Mr. Ihry owed would be reduced by the amount of
the commissions. The parties stipulated that Jondahl Insurance
received $10,038 from Farmer’s Insurance in 1990, representing a
- 35 -
portion of the commissions earned by Jondahl Insurance between
May and November 1990. This amount plus the checks issued by Mr.
Ihry (totaling $14,962) equal $25,000. We conclude that capital
gain of $14,962 and ordinary income from commissions of $10,038
should be included in petitioner’s 1990 income.
Respondent has introduced Farmer’s Mutual policy registers
for 1990 and 1991 showing that Jondahl Insurance earned insurance
commissions of $12,881.70 in 1990 and $3,141.95 in 1991.
Respondent contends that these amounts are income to petitioner
in addition to the $25,000 sale proceeds. Because respondent
asserted an increased deficiency in his amended answer based on
the inclusion in income of the insurance commissions, respondent
has the burden of proving that petitioner received the
commissions. See Rule 142(a).
Respondent does not explain why petitioner would have
received commission income after he sold the business at the end
of 1990. From the record before us, it appears that the
commission amounts listed in the Farmer’s Mutual policy registers
may include the amount paid as part of the purchase price
($10,038), which we have already determined was income to
petitioner. It is also possible that the additional commissions
listed for 1990, to the extent they exceed $10,038 ($2,844), and
the $3,141.95 listed for 1991 were received by Mr. Ihry after the
business was sold or were part of the purchase price, settled by
- 36 -
a charge-back between Mr. Ihry and petitioner. The record does
not show that petitioner in fact received the commissions for
1990 and 1991 beyond the $10,038 paid as part of the purchase
price. On the basis of the record before us, we conclude that
respondent has not met his burden of showing that the insurance
commissions of $12,881.70 in 1990 and $3,141.95 in 1991 were
income to petitioner.
B. Repossession of Lone Tree Manor
Capital gain of $22,028 was reported on WFIC’s 1990
corporate return as gain from the repossession of Lone Tree
Manor. Respondent argues that petitioner, not WFIC, should
recognize capital gain of $20,244 from the repossession.
Petitioner does not explain how the amount of capital gain
($22,028) was reached for the purpose of WFIC’s return, and we
afford respondent’s determinations a presumption of correctness.
See Rule 142(a). Petitioner contends that he bought Lone Tree
Manor in 1987 in his own name for the assumption of a mortgage on
the property held by IRET. He also claims that in 1989 he
transferred Lone Tree Manor to WFIC in exchange for WFIC’s
assumption of the debt and other consideration. Petitioner did
present an alleged purchase agreement evidencing the transfer of
Lone Tree Manor to WFIC, but the copy entered into evidence does
not show the date on which it was signed or the date the purchase
was effective. It is a one-page document that lists Lori as the
- 37 -
seller and WFIC as the buyer. It is signed on behalf of WFIC by
petitioner’s sister, Janeen Conrad. Petitioner did not produce
any accompanying documents, such as the title to the property,
the IRET mortgage, the canceled note to petitioner, or any Forms
1099 showing interest paid on the IRET mortgage. The record does
not show that petitioner transferred title to Lone Tree Manor to
Lori (for sale to WFIC) or WFIC. We do not believe that
petitioner has met his burden of proving that WFIC owned Lone
Tree Manor at any time. We conclude that capital gain of $20,244
from the repossession of Lone Tree Manor was income to petitioner
for 1990.
C. Other Income
Respondent argues that petitioner received multiple items of
unreported income in each year at issue. Petitioner argues that
he is not liable for income tax on the unreported items for
various reasons. Petitioner bears the burden of proving that the
items listed in the notice of deficiency are not taxable to him.
Respondent bears the burden of showing that petitioner received
$3,000 from Taxman in each of 1990, 1991, 1992, and 1993.
1. Unreported Income in 1990
Respondent adjusted petitioner’s 1990 income to include
Taxman’s $6,000 payment of the settlement judgment against
petitioner in connection with his clients’ tax shelter
investments. Petitioner argues that Taxman assumed the
- 38 -
liabilities of the sole proprietorship, including the settlement
judgment, when it took over the business in 1986. However, in
the 1987 deposition, petitioner stated that the only liabilities
Taxman assumed were two bank loans totaling $31,000. Petitioner
did not document the transfer of assets and liabilities to Taxman
and has not provided any evidence that Taxman assumed the
settlement liability.
Petitioner also argues again that the IRS audit of his 1987
tax return required him to treat the settlement judgment payment
as a corporate expense. The audit papers in the record contain
no reference to the settlement judgment or the liabilities that
were or were not transferred to Taxman. Petitioner has not met
his burden of proving that Taxman assumed the $6,000 liability;
therefore, the $6,000 payment is compensation income to
petitioner for 1990.
Taxman paid $310 to the law firm of Pearson, Christensen &
Fischer during 1990. The payment was for consultations between
petitioner and Mr. Pearson regarding Schedules C, Profit or Loss
From Business (Sole Proprietorship), of petitioner’s personal
income tax returns for 1982, 1983, and 1984. Petitioner claims
that he did not report the $310 as personal income because Taxman
assumed the liabilities of his sole proprietorship, and he was
instructed in the audit for his 1987 return to place “deductions
of business expenses” on Taxman’s return. The audit of
- 39 -
petitioner’s 1987 return has no relevance to business expenses of
the sole proprietorship in 1982, 1983, and 1984, because any
business expenses taken as deductions for those years were
incurred before Taxman existed. In addition, we concluded above
that the record does not support that Taxman assumed any
liabilities other than two bank loans. Therefore, petitioner had
income of $310 in 1990 from Taxman’s payment for petitioner’s
personal legal expenses.
In 1990, Taxman also repaid a bank loan for $2,000, plus
interest of $147, that had been obtained in petitioner’s name in
July 1989. Petitioner claims that he obtained the loan in his
own name because Taxman had reached the limit of its line of
credit with the bank. Petitioner testified that he deposited the
funds into WFIC’s account, and WFIC used the funds until it
received its tax refund in 1990.
The 1989 bank statements for WFIC, Taxman, and petitioner
are not part of the record. Petitioner offered no evidence that
Taxman’s credit limit had been reached or that the loan funds
were deposited into WFIC’s bank account. We give little weight
to petitioner’s testimony on this matter given that he claimed
Taxman had reached the limit of its line of credit but WFIC used
the funds and repaid the loan. We do not believe petitioner has
met his burden of proving the $2,147 was not repaid on his behalf
- 40 -
by Taxman. Petitioner therefore must include the $2,147 as
compensation income in 1990.
2. Unreported Income in 1991
In 1991, Taxman accepted a stereo worth $509 from a client
in exchange for a corresponding reduction in the client’s bill.
Petitioner then gave the stereo to his girlfriend, Ms. Lane.
Respondent argues that petitioner’s income should be adjusted by
$509 to reflect the value of the stereo. Petitioner argues that
he gave Ms. Lane the stereo and in exchange she worked in a
Taxman Express office for 1 month. We believe the stereo was
compensation to Ms. Lane from Taxman. Ms. Lane credibly
testified that she worked at the Taxman Express office because
she wanted to pay petitioner back for the stereo after she
received it. We believe the arrangement between petitioner and
Ms. Lane resulted in a benefit to Taxman that is equal to or
greater than the value of the stereo. As a result, we do not
believe that the value of the stereo is income to petitioner.
Taxman paid petitioner $2,052 in 1991. Petitioner argues
that as a result of the 1987 audit, the $2,052 was removed from
his personal Schedule C because it was an expense of Taxman. He
claims that in order for Taxman to take the expense as a
deduction, the revenue agent advised him that Taxman should
reimburse petitioner for the amount of the expense in 1991.
Therefore, petitioner argues that the $2,052 was not income to
- 41 -
him in 1991 because it was a reimbursement of the earlier expense
he paid on behalf of Taxman.
The statement of income tax examination changes from the
1987 audit disallows a $2,052 deduction from petitioner’s
Schedule C. This statement is signed by the revenue agent with a
date of December 28, 1990. The record also includes a portion of
a letter from the IRS to petitioner and Lori explaining that the
$2,052 was removed because it was “not an expense of the * * *
[taxpayer], but an expense of another”. The only references to a
“reimbursement” on the audit documents are handwritten notes by
petitioner. No official correspondence from the revenue agent
refers to reimbursement.
Petitioner has shown that an expense of $2,052 was
disallowed on his 1987 personal return. However, he has not
shown that he actually paid the expense on Taxman’s behalf in
1987, that it was a properly deductible expense of Taxman, or
that the revenue agent instructed him that reimbursement was an
appropriate course of action. We do not believe that petitioner
has met his burden of proving that the $2,052 Taxman paid him in
1991 was reimbursement for an expense petitioner paid in 1987.
Therefore, the $2,052 is income to petitioner in 1991.
During 1991, petitioner bought furniture using a credit card
issued in his name. All of the payments on the credit card
during 1991 and 1992 were made by Taxman. In 1991, Taxman paid
- 42 -
$2,086 toward the price of the furniture. Petitioner argues that
the amounts Taxman paid for his furniture were loans to him.
Petitioner claims that the loans were recorded on the “loan
schedule as a note receivable” and the balance sheet on Taxman’s
1991 corporate return. Respondent entered into the record a
document that appears to be a schedule of loans from Taxman and
WFIC to petitioner. For 1991, the schedule shows no loans from
Taxman to petitioner and $29,800 in loans from WFIC to
petitioner. Taxman’s 1991 corporate tax return does not reflect
any new loans to petitioner in 1991. WFIC’s 1991 corporate
return lists receivables of $29,800, and a purported schedule of
loans from WFIC to Taxman also states that WFIC lent Taxman
$29,800 in 1991. Taxman’s balance sheets, filed with its tax
returns for 1991 and 1992, do not list these amounts as
liabilities.
Whether a withdrawal of funds from a corporation creates a
true debtor-creditor relationship is a factual question to be
decided on the basis of all of the relevant facts and
circumstances. Haag v. Commissioner, 88 T.C. at 615. For
disbursements to constitute true loans, there must have been an
unconditional obligation on the part of the transferee to repay
the money and an unconditional intention on the part of the
transferor to secure repayment at the time that the funds were
transferred. Id. at 615-616; see also Haber v. Commissioner, 52
- 43 -
T.C. 255, 266 (1969), affd. 422 F.2d 198 (5th Cir. 1970). Courts
have focused on certain objective factors to distinguish bona
fide loans from disguised dividends, compensation, and
contributions to capital. The factors considered relevant for
purposes of identifying bona fide loans include (1) the existence
or nonexistence of a debt instrument; (2) provisions for
security, interest payments, and a fixed payment date; (3)
treatment of the funds on the corporation’s books; (4) whether
repayments were made; (5) the extent of the shareholder’s
participation in management; and (6) the effect of the “loan” on
the transferee’s salary. Haber v. Commissioner, supra at 266.
When the individual is in substantial control of the corporation,
as petitioner is in this case, special scrutiny of the situation
is necessary. Id.; Roschuni v. Commissioner, 29 T.C. 1193, 1202
(1958), affd. 271 F.2d 267 (5th Cir. 1959).
From the record, it is possible that WFIC lent money to
Taxman in 1991, which then lent the amounts to petitioner for his
furniture purchase. However, although petitioner has shown that
WFIC may have lent amounts to Taxman during 1991, he has not
shown any evidence of a loan from Taxman to himself during 1991.
He does not claim that a debt instrument was created, and none is
in the record. Petitioner has provided no evidence that he
offered anything as security for the loan, interest payments on
the principal amount, or fixed payment dates. As we stated
- 44 -
above, the loan was not recorded on Taxman’s books, and there is
no evidence that petitioner repaid any of the $2,086. Although
petitioner was not a shareholder of Taxman, he controlled the
management and day-to-day operations of Taxman. The shareholders
did not participate at all in the business. The record does not
reflect how, if at all, the loans affected petitioner’s salary
from Taxman. We conclude that Taxman’s payment of petitioner’s
credit card debt in 1991 for his furniture did not create a loan
between petitioner and Taxman. Instead, the $2,086 payment
should be treated as compensation to petitioner and included in
his 1991 income.
3. Unreported Income in 1992
As mentioned above, Taxman paid $1,904 toward petitioner’s
furniture purchase in 1992. Taxman also paid $15,000 toward
petitioner’s personal tax liability from an earlier year.
Petitioner claims the $15,000 was reflected in two promissory
notes he executed between Taxman and himself. No debt instrument
was created for the furniture payment. The record contains no
evidence that petitioner gave security for the loans or provided
for fixed payment dates. However, the loan schedule for Taxman
and WFIC that is in the record and Taxman’s 1992 corporate return
reflect that Taxman lent petitioner a total of $20,856 in 1992.
This amount is more than the two loans petitioner argues he
received from Taxman in 1992 and may include additional loans for
- 45 -
that year not challenged by respondent. The loan schedule
provides for an interest rate of 7 percent and shows that
petitioner purportedly repaid some of the debt in a later year.
We believe petitioner has proven that he borrowed $1,904 and
$15,000 from Taxman in 1992. Therefore, these amounts were not
income to petitioner in 1992.
Respondent also determined in the notice of deficiency that
petitioner was required to include in income the balance of WRP’s
money market account ($10,931) that he withdrew in April 1992.
The parties stipulated that the $10,000 given to petitioner by
Ms. Garceau was not used for real estate investments as Ms.
Garceau intended. As we understand petitioner’s argument, he
asserts that in 1995, he repaid Ms. Garceau the $10,000 plus 8
percent interest, borrowing the funds necessary to do so from
WFIC. He claims a promissory note in the record for $13,674.35
(which approximately equals $10,000 plus 8 percent interest,
compounding annually over 5 years) evidences the transaction.
However, petitioner has not shown that he actually repaid Ms.
Garceau or WRP. The record does not contain petitioner’s or
WFIC’s bank statements for 1995, and we cannot verify that
$13,674.35 was withdrawn from either of them. Ms. Garceau did
not testify, and petitioner’s testimony on this matter was
unsupported by the record. In addition, the purported debt for
$13,674.35 is not reflected on WFIC’s 1992 loan schedule or
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corporate tax return. Therefore, we agree with respondent that
petitioner must report the $13,674.35 as compensation received in
1992.
4. Unreported Income in 1993
In 1993, Taxman paid $310 to repair a 1991 Ford Probe owned
by Mary. Petitioner argues that the $310 was an expense of
Taxman because he used the car on business trips. Specifically,
petitioner testified that he “thinks” he used Mary’s car “a
couple of times for business trips.” Petitioner offered no
evidence beyond his testimony on the business trips for which he
used Mary’s car. Given the uncertainty with which he testified
and his lack of proper record keeping, petitioner has not met his
burden of proving that the $310 for the car repair was not
compensation to him in 1993.
In 1993, WFIC, doing business as Epic Real Estate, brokered
a real estate transaction for petitioner’s sister, Ms.
Schoeppach. As part of the transaction, WFIC issued a check for
$7,000 to Ms. Schoeppach. Eight days later, Ms. Schoeppach paid
Epic Real Estate $7,000 as a downpayment. Respondent determined
in the notice of deficiency that the $7,000 payment by WFIC to
Ms. Schoeppach was income to petitioner. Petitioner argues that
after the transaction was completed, he canceled Ms. Schoeppach’s
$7,000 debt to WFIC because Epic Real Estate received a $9,000
commission which WFIC reported on its 1993 corporate return.
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Petitioner claims he canceled the debt because he thought the
$9,000 commission was “inappropriate”. Because petitioner was an
agent of WFIC, his unilateral decision to effectively reduce
WFIC’s commission by $7,000 without an adequate explanation shows
that the $7,000 was in substance compensation from WFIC to
petitioner, who then gave it as a gift to his sister.
Consequently, the $7,000 is compensation includable in
petitioner’s 1993 income.
In October 1993, petitioner paid for the Buick with WFIC’s
funds. Respondent includes the price of the car in petitioner’s
income in the notice of deficiency. Petitioner claims that the
car was purchased for WFIC’s business use and that a mileage log
was kept for business purposes. He also claims that Mary
reported compensation income on her 1993 and 1994 personal tax
returns and received Forms W-2 in 1993 and 1994 for her use of
the Buick.
Petitioner did not produce either Mary’s 1993 tax returns or
Forms W-2 or her 1994 Forms W-2 or tax returns. The purported
mileage log of automobile use for 1993 is in the record. First,
we do not find the mileage log to be a credible representation of
petitioner’s and Mary’s use of the Buick. The mileage log
includes entries for the months of July, November, and December
1993, but the Buick was not purchased until October 15, 1993,
according to the purchase contract. In addition, the mileage log
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lists the beginning mileage (as of July 1993) as 7,660, but the
purchase contract and odometer statement filed with the State and
signed by Mary list the mileage at the time of the sale as 7,435.
Petitioner does not explain the discrepancies.
Second, WFIC is listed as the purchaser of the Buick on the
purchase contract, but Mary is listed as the purchaser on the
odometer disclosure statement, the damage disclosure statement,
and the application for certificate of title and registration of
a motor vehicle, all filed with the North Dakota Department of
Transportation Motor Vehicles Division. Mary either signed or
filled out each official document filed with the Motor Vehicles
Division. A draft registration application is included in the
record listing WFIC as the car’s owner, but it is noted “12/3
changed to Mary Jondahl”.
Third, the Buick was issued personalized license plates
reading “PURRFCT”. Fourth, a 1991 Ford Probe, titled in Mary’s
name, was traded in and $10,100 was credited to the purchase of
the Buick. Lastly, petitioner and Mary filled out and signed two
loan applications that list the Buick as an asset personally
owned by them. The title to the Buick is not part of the record.
All of these facts in the record indicate that petitioner and his
wife, not WFIC, were the true owners of the Buick. The record
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shows that WFIC paid $18,660 toward the cost of the Buick.9
Petitioner must include this amount as compensation in 1993.
5. Cash Receipts of $3,000 From Taxman
Respondent argues that petitioner must report $3,000 of
compensation for each of 1990, 1991, 1992, and 1993, representing
Taxman’s cash receipts petitioner used for his own personal
expenses. Because the issue was raised in an amended answer,
respondent has the burden of proving the $3,000 was income to
petitioner in each year.
We found above that respondent has proven by clear and
convincing evidence that petitioner fraudulently used at least a
portion of the $3,000 for his own personal expenses. Petitioner
argued at trial that he used some of the cash to pay for business
expenses of Taxman. Respondent has shown that petitioner did not
keep any records of these business expenses and that the income
and offsetting expenses were not reported on Taxman’s corporate
returns. Ms. Jilek credibly testified that she could not recall
an instance, other than occasional purchases of postage, in which
she or petitioner paid an expense of Taxman in cash. Even small
expenses were paid by check. In addition, Ms. Jilek testified
that she did not know how petitioner spent the cash. This is
9
The purchase price of the Buick was $27,800, plus tax of
$885 and “license and fees” of $75, totaling $28,760. This
amount was reduced by the value of the Ford Probe trade-in,
$10,100, for a net amount payable by WFIC of $18,660.
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particularly persuasive in light of the fact that petitioner
trusted Ms. Jilek with all other financial aspects of Taxman,
including making her a signatory on its bank accounts and his
personal credit cards. Petitioner’s testimony on this matter is
self-serving. He does not address the $3,000 adjustments in his
posttrial briefs. Respondent has met his burden of proving that
petitioner used the $3,000 each year for personal expenses.
Therefore, we find that petitioner must include $3,000 of
compensation income for each of 1990, 1991, 1992, and 1993.
D. Head of Household for 1990
Petitioner filed his 1990 individual income tax return
claiming head of household filing status. Respondent denied this
filing status in the notice of deficiency. A taxpayer may file
as the head of a household only if he is not married or is
legally separated under a decree of divorce or separate
maintenance at the close of the taxable year, he maintains a
household which constitutes the principal place of abode of his
child for more than half the taxable year, and he furnishes over
half the cost of maintaining the household during the taxable
year. Sec. 2(b). Petitioner lived with Lori and their daughter
until June 1990. Petitioner and Lori were granted a divorce on
July 9, 1991. Petitioner did not show that he and Lori were
legally separated at the end of 1990. In addition, petitioner
did not present evidence that he provided more than half of the
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cost of maintaining a household for his daughter in 1990. We
conclude that petitioner did not meet his burden of proving that
he is entitled to claim head of household status for 1990.
E. Self-Employment Tax on Commission Income
Respondent argues that petitioner is liable for self-
employment taxes on the commissions he earned from his real
estate and crop hail insurance activities. Section 1401 imposes
tax on self-employment income. Section 1402 defines net earnings
from self-employment as the gross income derived by an individual
from the carrying on of any trade or business by such individual
less allowable deductions attributable to such trade or business.
Respondent argues that petitioner is a “qualified real estate
agent” within the meaning of section 3508, and that he is liable
for self-employment taxes on real estate and insurance
commissions he earned. Respondent has the burden of proof with
respect to petitioner’s liability for self-employment tax.
We found above that WFIC, not petitioner, earned the real
estate commissions in 1990, 1991, and 1993. Therefore,
petitioner is not liable for self-employment taxes on real estate
commissions in 1990, 1991, and 1993. Because petitioner earned a
real estate commission as a sole proprietor in 1992, he is liable
for self-employment tax on the commission regardless of whether
he is a “qualified real estate agent” under section 3508. We
also found that petitioner earned crop hail insurance commissions
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of $10,038 in 1990. He is therefore liable for self-employment
tax on $10,038 in 1990.
F. Section 6663(a) Fraud Penalty
If respondent shows that any portion of an underpayment is
due to fraud, the entire underpayment will be treated as
attributable to fraud for purposes of the penalty under section
6663(a), except any portion of the underpayment that petitioner
establishes by a preponderance of the evidence is not
attributable to fraud. See sec. 6663(b); Knauss v. Commissioner,
T.C. Memo. 2005-6. We held above that respondent proved by clear
and convincing evidence that petitioner used at least some of
Taxman’s cash for his own personal expenses with the intent to
evade taxation on the income. We also held that respondent has
proven that petitioner used all of Taxman’s $3,000 in cash
receipts for personal expenses. Petitioner’s lack of record
keeping, blatant efforts to hide the existence of the cash, and
use of the cash for personal expenses show that he intentionally
concealed all of Taxman’s cash receipts and took possession of
the money with the intent to evade taxes. Therefore, the
section 6663(a) fraud penalty for each year applies to the
portion of the deficiency in petitioner’s tax attributable to the
$3,000 understatement of income.
Respondent argues that the fraud penalty applies to the
entire amounts of the deficiencies. An analysis of whether
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petitioner has shown by a preponderance of the evidence that
certain items were not fraudulent is necessary. We found above
that many of the adjustments respondent made were appropriate
because petitioner failed to present enough evidence to the
contrary to meet his burden of proof. However, we believe that
petitioner has shown by a preponderance of the evidence that the
remaining adjustments were not the result of fraud. Petitioner
was negligent in his failure to provide documentation of certain
loans from Taxman and WFIC and his failure to properly document
the transfer of his sole proprietorship to Taxman, but he did not
intend to evade tax on these items. While petitioner’s attempts
to conceal his use of at least $3,000 of Taxman’s cash receipts
each year indicates fraudulent intent, the other adjustments do
not rise to the level of fraud. Petitioner, albeit incorrectly,
reported gain from the sale of Lone Tree Manor on WFIC’s
corporate return. He also had plausible explanations for each
item of other income identified by respondent, although he did
not produce supporting documentation. Petitioner did show that
WFIC and Taxman kept corporate records, and the record includes
various loan schedules and corporate tax returns. A review of
the record shows that petitioner’s actions with respect to the
other items respondent adjusted were the result of negligence,
but the records petitioner did maintain and the separate
corporate accounts refute a fraudulent intent for the other
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adjustments. A high level of negligence does not alone prove
fraud. Fraud may not be imputed or presumed from “‘circumstances
which at most create only suspicion.’” Webb v. Commissioner, 394
F.2d 366, 377 (5th Cir. 1968) (quoting Carter v. Campbell, 264
F.2d 930, 935-936 (5th Cir. 1959)), affg. T.C. Memo. 1966-81.
“Fraud implies bad faith, intentional wrongdoing and a
sinister motive. * * * Negligence, whether slight or
great, is not equivalent to the fraud with intent to
evade tax named in the statute. The fraud meant is
actual, intentional wrongdoing, and the intent required
is the specific purpose to evade a tax believed to be
owing. Mere negligence does not establish either. * * *”
[Id.]
If we leave aside petitioner’s concealing $3,000 in cash each year,
his explanations for the other adjustments, while not establishing
that the items should not be included as income, refute an
assertion that he had fraudulent intent in omitting the items from
his returns. As a result, the section 6663(a) fraud penalty is not
sustained with respect to the remaining adjustments.
To reflect the foregoing and concessions by the parties,
Decision will be entered
under Rule 155.