Payne v. Comm'r

T.C. Memo. 2005-130

UNITED STATES TAX COURT

WAYNE PAYNE AND DORENE J. PAYNE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 6311-03. Filed May 31, 2005.

Thomas E. Brever, for petitioners.

David W. Sorensen, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GOEKE, Judge: Respondent determined deficiencies in

petitioners’ 1993, 1994, and 1995 Federal income taxes of

$29,881, $81,985, and $45,222, respectively. Respondent also

determined that petitioners were liable for fraud penalties under
 - 2 -

section 66631 for 1993, 1994, and 1995 of $22,410, $61,488.75,

and $33,916.50, respectively. The issues for decision are:

(1) Did respondent issue the notice of deficiency before

the expiration of the period of limitations on assessment? We

hold that petitioners filed false or fraudulent returns with the

intent to evade tax for 1993, 1994, and 1995, and consequently

there is no limitation on assessment under section 6501(c)(1);

(2) did petitioners receive $222,735 in unreported income

from HRDC Construction (HRDC), a partnership owned 100 percent by

petitioners, in 1994? We hold that they did;

(3) are petitioners entitled to deductions in excess of

those allowed by respondent in the notice of deficiency? We hold

that they are not;

(4) are unreported bank deposits of $30,953.94 in 1995

taxable to petitioners? We hold that they are;

(5) is petitioner Dorene Payne (Mrs. Payne) entitled to

innocent spouse relief under section 6015? We hold that she is

not; and

(6) are petitioners liable for the fraud penalty under

section 6663? We hold that they are liable for the fraud penalty

with respect to the unreported income they received from HRDC,

but not with respect to their unreported bank deposit income.

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.
 - 3 -

FINDINGS OF FACT

Some of the facts are stipulated. The stipulation of facts,

the supplemental stipulation of facts, and the attached exhibits

are incorporated herein by this reference. At the time the

petition was filed, petitioners resided in Minneapolis,

Minnesota.

Petitioners operated HRDC as a partnership in 1993 and 1994,

and as a corporation subject to the provisions of subchapter S in

1995. HRDC was in the business of roof repair for commercial

properties. HRDC was owned during the years in issue as follows:

1993 1994 1995

Wayne Payne (Mr. Payne) 50% 50.0658% 100%
Mrs. Payne 50 49.9342 0

HRDC operated from offices in a building owned by

petitioners. During the years in issue, Mr. Payne was

responsible for HRDC’s roofing work, and Mrs. Payne worked in

HRDC’s offices. Mrs. Payne and Cari Enerson (Ms. Enerson)

maintained HRDC’s books and records. Ms. Enerson was hired by

HRDC as its bookkeeper after her graduation from high school.

Before beginning her employment with HRDC, Ms. Enerson’s work

experience consisted of waitressing.

Before HRDC received a roofing job, Mr. Payne or one of

three employees of HRDC visited a potential customer’s site and

prepared a bid for roof repair work. The bid was then sent to

the potential customer. If the customer accepted the bid, he
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would sign the bid and send it back to HRDC. The accepted bid

would then be recorded by Mrs. Payne or Ms. Enerson in a sales

journal. Typically, a customer would pay half the cost of the

job when work began on the job, and the remainder at its

completion. The payments HRDC received were supposed to be

recorded in an accounts receivable journal, but not all payments

were so recorded. Often HRDC would receive payment for jobs

recorded in the sales journal for one year in the following year.

The payments were generally recorded in the accounts receivable

journal for the year in which they were received.

During some of Mr. Payne’s or the other employees’ visits to

potential customers’ sites, small jobs would arise that could be

completed on the spot. The customers generally paid the HRDC

employee on the spot for such jobs. These small jobs were

referred to at HRDC as “extras”, and were recorded in an extras

journal. Payment for the extras was usually made by check. The

extra payments were not recorded in HRDC’s sales or accounts

receivable journals.

When HRDC received checks for its services, Mrs. Payne and

Ms. Enerson deposited certain of the checks into HRDC’s business

checking account and placed other checks in a drawer at HRDC’s

offices. For the most part, the checks that were not deposited

into HRDC’s bank account were those received in payment for the

extras. Mr. Payne or another employee of HRDC would then cash
 - 5 -

these checks at the Money Exchange, a check-cashing store. The

Money Exchange charged a fee of 2.5 percent of each check’s

value. HRDC’s bank did not charge a fee to deposit checks.

Generally, if an employee other than Mr. Payne had performed the

work on an extra, one-third of the payment went to that employee,

one-third of the payment went to materials, and one-third of the

payment was retained by HRDC. If Mr. Payne performed the extra,

he kept 100 percent of the payment. Occasionally, Ms. Enerson

would cash the checks and send Mr. and Mrs. Payne the cash while

they were on vacation in Florida. The amounts of the checks

cashed by Mr. Payne were not deposited into HRDC’s bank account

and were not reported as income on HRDC’s Federal income tax

returns. In 1993, Mr. Payne cashed a total of $83,623.87 in

checks at the Money Exchange. In 1994, Mr. Payne cashed a total

of $98,258.21 in checks made out to HRDC at the Money Exchange.

HRDC’s extra journal for 1994 reflects that Mr. Payne performed

extras of $45,060.50. HRDC’s extra journal for 1995 reflects

that Mr. Payne performed extras of $36,989. The extras were not

reported in HRDC’s sales journal.

Vern Gunderson (Mr. Gunderson), a tax return preparer,

prepared petitioners’ 1993 and 1994 joint income tax returns.

Mr. Gunderson also prepared HRDC’s 1993 and 1994 partnership

returns, and HRDC’s 1995 S corporation return. Tim Campion (Mr.

Campion), an accountant, prepared petitioners’ joint 1995 income
 - 6 -

tax return and an amended 1995 S corporation return for HRDC. On

its 1994 partnership return, HRDC elected the cash method of

accounting for tax purposes. Although it appears that the cash

method was used in 1993 and 1995 as well, HRDC’s 1993 partnership

return and 1995 S corporation return do not reflect which methods

of accounting were elected in those years.

Ms. Enerson was employed by HRDC from 1985 until April 1995.

During the time Ms. Enerson was employed by HRDC, Mr. Gunderson

was HRDC’s tax return preparer. At HRDC, part of Ms. Enerson’s

job was to gather information for Mr. Gunderson to complete the

returns. Mrs. Payne helped Ms. Enerson gather this information.

Ms. Enerson and Mrs. Payne did not provide Mr. Gunderson with any

information about the money earned from extras; they gave him

only bank records to determine HRDC’s income. Mr. Gunderson

signed HRDC’s 1995 S corporation return on March 3, 1996. Ms.

Enerson testified that she provided the information for Mr.

Gunderson to complete the 1995 return. Ms. Enerson left HRDC in

April 1995 to work for Mr. Gunderson.

After Ms. Enerson left HRDC, petitioners hired Mr. Campion

to prepare their individual 1995 return and to amend HRDC’s 1995

return. Mr. Campion signed the amended return on June 4, 1996.

Petitioners provided Mr. Campion only the original 1995 return

(prepared by Mr. Gunderson) and HRDC’s bank records to complete

the amended return. The amended 1995 return reported slightly
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less gross receipts than HRDC’s original return and claimed

approximately $9,000 more in taxes and licenses paid. Mr.

Campion testified that he amended the return to deal with payroll

tax issues only.

Because petitioners’ tax return preparers were provided only

bank deposit records to calculate HRDC’s income, HRDC did not

report income from the extras for each year in issue.

Petitioners reported flowthrough income derived from HRDC’s

reported income on their individual returns. For 1994,

petitioners reported rental income from HRDC of $23,241 but HRDC

did not report a corresponding expense.

In 1997, Mr. Payne met with respondent’s revenue agent in

connection with an audit of petitioners’ and HRDC’s 1993, 1994,

and 1995 returns. When asked about the money earned from extras,

Mr. Payne first told the revenue agent that 100 percent of the

payment for each extra was kept by the employee performing the

work. Mr. Payne also told the revenue agent that he did not know

that any of HRDC’s checks were cashed at the Money Exchange and

that his employees must have stolen the checks from HRDC.

In 2001, Mr. Payne pleaded guilty to filing a false tax

return under section 7206(1) for his 1994 individual Federal

income tax return. On April 17, 2003, respondent issued a notice

of deficiency to petitioners, determining deficiencies and civil

fraud penalties under section 6663 for 1993, 1994, and 1995. The
 - 8 -

deficiency determinations resulted from petitioners’ alleged

failure to report HRDC’s income from the extras and certain other

sales, as well as petitioners’ unreported bank deposits. For

1994, respondent determined that petitioners received unreported

income from HRDC of $222,735. Respondent also reduced

petitioners’ reported 1994 rental income by $23,241. The parties

have stipulated that petitioners received $64,000 in unreported

income from HRDC in 1993, and petitioners conceded that in

addition unreported taxable deposits of $3,681 were made into

petitioners’ bank account in 1993. The parties have also

stipulated that petitioners received $42,335 in unreported income

from HRDC in 1995, and, in addition, unreported deposits of

$30,953.94 were made into petitioners’ bank account in 1995. The

parties dispute, inter alia, whether petitioners underreported

their 1994 income and whether the unreported bank deposits in

1995 were taxable.

OPINION

I. Burden of Proof

The parties do not address the burden of proof.

Respondent’s revenue agent first met with petitioners in late

1997 after the start of his examination of their 1993, 1994, and

1995 returns. Because respondent’s examination of petitioners’

returns began before July 22, 1998, section 7491 does not apply.

See Internal Revenue Service Restructuring and Reform Act of
 - 9 -

1998, Pub. L. 105-206, sec. 3001(a), 112 Stat. 726. Respondent’s

determinations in the notice of deficiency are presumed correct,

and petitioners bear the burden of proving that respondent’s

determinations are incorrect. Rule 142(a)(1). Respondent has

the burden of proof by clear and convincing evidence with respect

to his determination of fraud. Rule 142(a).

II. Period of Limitations on Assessment

Petitioners contend that the 3-year period of limitations on

assessment in section 6501(a) expired before respondent issued

the notice of deficiency and respondent’s assessment is barred.2

Respondent argues that the period of limitations in section

6501(a) does not apply because petitioners filed false or

fraudulent returns with the intent to evade tax for the years at

issue. Sec. 6501(c)(1). Accordingly, our determination of

whether the period of limitations remains open depends on whether

petitioners committed fraud in the filing of their 1993, 1994,

and 1995 returns. 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.

2
After trial, respondent moved to amend his answer to
assert, in the alternative, that the period of limitations
remains open due to the 6-year period in sec. 6501(e).
Petitioners objected to respondent’s motion. Because we find
that petitioners committed fraud with respect to their 1993,
1994, and 1995 returns, we deny respondent’s motion as moot.
 - 10 -

Commissioner, 116 T.C. 79, 85 (2001); Rhone-Poulenc Surfactants &

Specialties v. Commissioner, 114 T.C. 533, 548 (2000).

Mr. Payne’s guilty plea under section 7206(1) for

intentionally filing a false return does not in itself prove that

section 6501(c) applies; respondent must show that petitioners

intended to evade tax. 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) petitioners 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 petitioners made an underpayment of tax in each of the years

1993, 1994, and 1995. For 1993 and 1995, petitioners have

stipulated that they underreported their income from HRDC by

$64,000 and $42,335, respectively. Petitioners testified that

the payments for extras received by Mr. Payne were not deposited

into HRDC’s bank account, and HRDC’s returns were prepared based

on the deposits to its bank account. Petitioners conceded that

they received at least one-third of the extras performed by other
 - 11 -

employees of HRDC and that Mr. Payne was due to receive

$45,060.50 in extras in 1994. The extras were not reported on

HRDC’s or petitioners’ 1994 returns. Therefore, petitioners made

underpayments of tax for 1993, 1994, and 1995.

B. Fraudulent Intent

Because direct evidence of fraud is rarely available, fraud

may be proved by circumstantial evidence and reasonable

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.
 - 12 -

Respondent must prove fraud for each year at issue. See id. at

210; Ferguson v. Commissioner, T.C. Memo. 2004-90.

Petitioners argue that they did not file their returns with

fraudulent intent because they gave all of the responsibility

regarding the preparation of HRDC’s and their 1993, 1994, and

1995 returns to Ms. Enerson and their tax return preparers. They

also claim that they did not have control over HRDC’s books

because Ms. Enerson maintained them and they did not review their

returns before they were filed. We are unconvinced by

petitioners’ explanations. Petitioners rely heavily on the fact

that Mr. Payne was a high school educated roofer and did not

understand tax or business records. However, Ms. Enerson was

hired soon after graduating from high school and had no

experience as either a bookkeeper or a tax return preparer.

Petitioners claim they had no knowledge of what Ms. Enerson

provided to Mr. Gunderson for the preparation of their returns.

The record does not support petitioners’ claim. Petitioners met

with Mr. Gunderson when they hired him and discussed the relevant

aspects of the business. During this initial meeting, Mr.

Gunderson asked if all the money from the business went into the

bank accounts. Mr. Payne told him it did. As a result, Mr.

Gunderson used only HRDC’s bank records, which did not accurately

reflect HRDC’s income, to complete the returns. Because

petitioners gave Mr. Campion the 1995 return prepared by Mr.
 - 13 -

Gunderson and the bank records, the 1995 amended return also

reported an incorrect amount of income.

In addition, Ms. Enerson credibly testified that she felt

there was an understanding between herself and petitioners that

she should not provide the information regarding income from the

extras to Mr. Gunderson. Mrs. Payne helped Ms. Enerson gather

information for Mr. Gunderson. Mrs. Payne testified that at some

point she knew that Mr. Gunderson had requested only bank

records. Mrs. Payne knew the extras were not deposited in the

bank; she helped separate out the checks for Mr. Payne to cash.

Petitioners’ assertion of ignorance is merely an attempt to

absolve themselves of blame by attributing responsibility to

their bookkeeper.

In addition, petitioners’ behavior with respect to their

income shows multiple badges of fraud. Mr. Payne pleaded guilty

under section 7206(1) to willfully filing a false tax return for

1994. As a result, Mr. Payne is estopped from arguing that he

did not willfully file a false return for 1994. See Wright v.

Commissioner, 84 T.C. at 639. Although the estoppel is not

extended to petitioners’ fraudulent intent to evade tax,

respondent has shown clear and convincing evidence that

petitioners intended to evade tax for the years in issue. HRDC’s

accounts receivable journal and bank deposit records both omitted

the income HRDC earned from extras and did not accurately reflect
 - 14 -

its income. Petitioners’ explanations of the understatements

were implausible. Their practice of cashing checks at the Money

Exchange instead of their bank concealed income from their

accountant and respondent, and enabled them to deal in cash. Mr.

Payne twice lied to respondent’s revenue agents when asked how

the income from the extras was distributed. Respondent has shown

clear and convincing evidence that petitioners filed their 1993,

1994, and 1995 returns with the intent to evade taxes.

Therefore, the 3-year period of limitations under section 6501(a)

does not apply to petitioners’ 1993, 1994, and 1995 years, and

respondent is not barred from assessing any deficiencies in

petitioners’ taxes for those years.

III. Unreported Income in 1994 From HRDC

If a taxpayer has not maintained business records or its

business records are inadequate, the Commissioner is authorized

to reconstruct the taxpayer’s income by any method that, in the

Commissioner’s opinion, clearly reflects that taxpayer’s income.

Sec. 446(b); Parks v. Commissioner, 94 T.C. at 658; A.J. Concrete

Pumping, Inc. v. Commissioner, T.C. Memo. 2001-42. The

Commissioner’s reconstruction need not be exact, but it must be

reasonable. A.J. Concrete Pumping, Inc. v. Commissioner, supra.

Respondent argues that petitioners received $222,735 in

unreported income from HRDC in 1994. Respondent’s reconstruction

of petitioners’ 1994 income is based on HRDC’s sales and extras
 - 15 -

journals and records of the checks cashed at the Money Exchange.

Petitioners argue that the sales journal was inaccurate and

disorganized because jobs that were contracted for in one year

may have been completed and paid for in the next year.3 The

record does not reflect whether the amounts purportedly received

in 1995 were included in the amount of income petitioners

stipulated they received in 1995.

Respondent calculates petitioners underreported 1994 income

as follows: Gross sales of $1,125,319.84 as reported in HRDC’s

sales journal, plus three accepted bids not listed totaling

$12,825, plus extras of $45,060.50 performed by Mr. Payne, for

total gross sales of $1,183,205.34 ($215,039.34 more than was

reported on HRDC’s 1994 return). HRDC’s journals are a part of

the record. The sales journal, which respondent used to

reconstruct HRDC’s income for 1994, very clearly and legibly

lists the amounts charged for each job HRDC performed in 1994.

The accounts receivable journal, which petitioners claim more

clearly reflects HRDC’s income, by contrast, is disorganized,

illegible in places, and, according to Mrs. Payne’s testimony,

incomplete. Petitioners did not clarify the entries in the

accounts receivable journal. Petitioners have not attempted to

3
This argument leads us to conclude that HRDC used the cash
method of accounting for tax purposes for 1993, 1994, and 1995.
 - 16 -

explain which jobs or amounts, if any, were erroneously included

in respondent’s determination of HRDC’s 1994 gross income.

Respondent determined that $12,825 was earned by HRDC in

1994 for jobs not listed in HRDC’s records. Petitioners do not

argue that the $12,825 should not be included as income.

Petitioners stipulated that Mr. Payne was due to receive

$45,060.50 in extras in 1994, and that Mr. Payne cashed

$98,258.21 in checks payable to HRDC at the Money Exchange in

1994. With respect to extras that Mr. Payne performed, he

testified that he personally kept all of the money when the

checks were cashed and that no records were kept of the expenses

of materials used for the extras.

The parties also stipulated that in 1994 HRDC deducted

expenses of $20,526.22 that were never paid. As a result, HRDC’s

income was underreported by an additional $20,526.22. Because

petitioners together owned 100 percent of HRDC in 1994, the

incorrect deduction reduced their gross income by $20,526.22 as

well. Petitioners do not argue that their 1994 income was not

underreported by this amount.

Petitioners have not shown that respondent’s reconstruction

of their 1994 income using the sales journal was unreasonable and

that they did not underreport the income they received from HRDC
 - 17 -

in 1994 by the amount stated in the notice of deficiency.4 See

A.J. Concrete Pumping, Inc. v. Commissioner, supra.

IV. HRDC’s Deductions

Petitioners next argue that Mr. Payne received the cash from

the extras in lieu of rent payments from HRDC for its office

space, which petitioners owned in their personal capacities. On

their personal income tax return for 1994, petitioners reported

rental income of $23,241 from HRDC for the use of the office

space, but HRDC did not claim a corresponding deduction for rent

paid on its 1994 return. As a result, respondent reduced

petitioners’ income for 1994 by $23,241. At trial, Mr. Gunderson

testified that he completed the return on the basis of

information given to him by HRDC, which did not include canceled

checks for rent paid, and that it was a mistake to include the

income on petitioners’ return. Mr. Payne testified that there

were often times that HRDC owed rent to petitioners but could not

afford to pay it, such as in 1994. He claimed that he thought

the amount reported as rental income on the 1994 return was

4
The amount of the understatement determined in the notice
of deficiency is $222,735. It is unclear how respondent arrived
at this figure, since the individual adjustments result in an
understatement of $232,565.56 ($215,039.34 unreported income plus
$20,526.22 disallowed deduction). The difference does not appear
to be the result of respondent’s negative adjustment to
petitioners’ rental income, because that adjustment was made to
petitioners’ adjusted gross income, not HRDC’s income. Because
respondent argues only the figure in the notice of deficiency,
petitioners are liable for tax on the lower amount.
 - 18 -

approximately equal to the amounts of his extras for that year,

but he did not look at either his personal return or HRDC’s

return before signing them.

The entire record does not support petitioners’ claim that

the extras were in lieu of rental income from HRDC. Mr.

Gunderson was not instructed on the issue when he prepared the

returns. He was not aware that extras existed until a few days

before trial. Mr. Payne did not look at his returns before they

were filed and was unclear and uncertain in his testimony

regarding what he understood when he signed the returns. The

extras Mr. Payne received in 1994 amounted to $45,060.50, almost

double the amount of rental income reported on petitioners’ 1994

personal return. In addition, HRDC did not report the extras as

income. Respondent properly reduced petitioners’ income by the

reported rental amounts, and neither HRDC nor petitioners are

entitled to claim deductions for rent paid (or the value of the

extras) in excess of those claimed on HRDC’s returns for 1993,

1994, and 1995.

Petitioners also argue that because the Money Exchange

charged a 2.5-percent fee each time they cashed a check there,

they are entitled to a deduction of 2.5 percent of Mr. Payne’s

extras. We disagree. The record shows that the Money Exchange

did charge 2.5 percent of the value of each check cashed as a

fee. However, in order to claim a deduction, the fees must be
 - 19 -

ordinary and necessary expenses of running petitioners’ business.

See sec. 162. HRDC maintained a checking account to which

petitioners could have deposited the money from the extras for no

charge. Petitioners testified that they cashed checks at the

Money Exchange because they knew the owner and it was within

blocks of the office (although Mr. Payne, who did not drive,

needed someone to drive him there each time he went). It is

obvious that petitioners used the Money Exchange to avoid the

inclusion of the income in their bank records. These reasons are

not related, let alone ordinary and necessary, to HRDC’s

business. Therefore, petitioners are not entitled to deduct the

cost of check-cashing fees.

V. Unreported Additional Bank Deposits

Respondent adjusted petitioners’ income by $3,681 for 1993

and $30,953.94 for 1995 for bank deposits made to their account

in excess of all identified sources, including extras and income

from HRDC. Bank deposits are prima facie evidence of income.

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

stipulated that the deposits were made to their account, but they

reserved the right to show that two of the deposits were from

nontaxable sources. On brief, petitioners conceded that the

$3,681 is includable in their 1993 income. At trial, Mrs. Payne

testified that a deposit of $850 in 1995 was from Mr. Payne’s

sale of a gun to a sporting goods store. Mrs. Payne also
 - 20 -

testified that a deposit of $5,658.33 in 1995 was from Mr.

Payne’s sale of old sporting goods at auction. The record

contains copies of the two deposited checks. Neither Mrs. Payne

nor Mr. Payne estimated Mr. Payne’s cost for the items he sold.

The record does not contain any additional evidence of Mr.

Payne’s basis in the items. Petitioners have not met their

burden of proving that the two deposits were not taxable income

to them. Therefore, $3,681 and $30,953.94 in additional bank

deposits are includable in petitioners’ income for 1993 and 1995,

respectively.

VI. Innocent Spouse Relief Under Section 6015

Petitioners argue that Mrs. Payne is entitled to relief from

petitioners’ joint liabilities for 1993, 1994, and 1995 under

section 6015. Married taxpayers who elect to file a joint

Federal income tax return are each jointly and severally liable

for the entire tax due. Sec. 6013(a), (d)(3). A spouse may seek

relief from joint and several liability under section 6015. A

spouse may qualify for relief from liability under section

6015(b), or, if eligible, may allocate liability under section

6015(c). In addition, a spouse may seek equitable relief under

section 6015(f) if relief is not available under section 6015(b)

or (c). Under section 6015(f), respondent has the discretion to

relieve a spouse (or former spouse) of joint liability if, taking

into account all the facts and circumstances, it is inequitable
 - 21 -

to hold that spouse liable for any deficiency or unpaid tax (or

any portion of either) and that spouse is not eligible for relief

under section 6015(b) or (c). See sec. 6015(f).

Relief under section 6015(c) requires that the spouse

requesting relief be no longer married to, be legally separated

from, or not be a member of the same household as (for any part

of the 12-month period ending on the date the election for relief

was filed), the individual with whom the joint return was filed.

Since Mr. and Mrs. Payne are not divorced, legally separated, or

living separately, Mrs. Payne is ineligible for relief under

section 6015(c).

The requesting spouse must fulfill five requirements in

order to receive relief under section 6015(b): (1) A joint

return has been made for a taxable year; (2) on such return there

is an understatement of tax attributable to erroneous items of

the nonrequesting spouse; (3) the requesting spouse establishes

that in signing the return he or she did not know, and had no

reason to know, that there was such understatement; (4) taking

into account all the facts and circumstances, it is inequitable

to hold the requesting spouse liable for the deficiency in tax

for such year attributable to the understatement; and (5) the

requesting spouse elected the benefits of section 6015(b) not

later than the date which is 2 years after the date the

Commissioner has begun collection activities with respect to the
 - 22 -

requesting spouse. Mrs. Payne had reason to know in each year at

issue that HRDC’s returns understated its taxes. Mrs. Payne

worked in HRDC’s offices and was responsible, with Ms. Enerson,

for maintaining HRDC’s books and records. Mrs. Payne was aware

that the money from the extras was not deposited into HRDC’s bank

account, and Mrs. Payne testified that at some point she knew the

tax returns were based upon bank deposit records. She also

helped Ms. Enerson compile information for Mr. Gunderson to

complete the returns. In addition, petitioners owned HRDC in

approximately equal shares in 1993 and 1994. Mr. and Mrs. Payne

both worked for HRDC, and together they were involved in all

aspects of the business. Because of their involvement, it is

difficult to conclude that the unreported income received by

petitioners through HRDC in 1993 and 1994 was not attributable to

one spouse or the other. Therefore, Mrs. Payne is not entitled

to relief under section 6015(b).

Section 6015(f) gives the Commissioner discretion to grant

innocent spouse relief to a requesting spouse if relief is not

available under subsection (b) or (c) and, taking into account

all the facts and circumstances, it is inequitable to hold the

requesting spouse liable for any unpaid tax or deficiency. We

review the Commissioner’s denial of relief under subsection (f)

for an abuse of discretion. Washington v. Commissioner, 120 T.C.

137, 146 (2003). Rev. Proc. 2000-15, 2000-1 C.B. 447, contains
 - 23 -

guidelines that are considered in determining whether an

individual qualifies for relief under section 6015(f).5 Rev.

Proc. 2000-15, sec. 4.01, 2000-1 C.B. at 448, lists seven

threshold conditions that must be satisfied before the

Commissioner will consider a request for relief under section

6015(f). One of these threshold factors is that the requesting

spouse did not file the return with fraudulent intent. Id.

We held above that petitioners filed their 1993, 1994, and

1995 returns fraudulently with the intent to evade tax.

Respondent has shown that both petitioners committed fraud in the

filing of the false returns. Mrs. Payne was very involved in

running the business, and we are convinced that she and Mr. Payne

together operated HRDC in a way that concealed the cash they

received to avoid tax. Mrs. Payne knew that Mr. Payne cashed the

payments from the extras; while working in HRDC’s offices, she

actively separated out the checks to be cashed from those to be

deposited in the bank. The cash was used for Mr. and Mrs.

Payne’s personal expenses, such as when Ms. Enerson would cash

5
On Aug. 11, 2003, the Commissioner issued Rev. Proc. 2003-
61, 2003-2 C.B. 296, which superseded Rev. Proc. 2000-15, 2000-1
C.B. 447, effective for requests for relief filed on or after
Nov. 1, 2003, and for those pending on Nov. 1, 2003, for which no
preliminary determination letter has been issued as of Nov. 1,
2003. The threshold requirement that a requesting spouse not
having filed a return with fraudulent intent in order to be
considered for relief under sec. 6015(f) is present in both
revenue procedures.
 - 24 -

checks and mail them cash during their vacations in Florida.

Mrs. Payne controlled HRDC’s books, which recorded the extras

separate from HRDC’s regular jobs. She attended a meeting with

Mr. Payne and Mr. Gunderson to discuss the preparation of

petitioners’ tax returns at which Mr. Gunderson was told that all

of HRDC’s receipts were deposited into the bank account. She

testified that she knew Mr. Gunderson had requested only bank

records to complete the returns, and she helped Ms. Enerson

gather information to send to Mr. Gunderson. Because we find

that Mrs. Payne filed the returns for 1993, 1994, and 1995

fraudulently, respondent did not abuse his discretion in denying

Mrs. Payne innocent spouse relief under section 6015(f).

VII. Fraud Penalty Under Section 6663

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. As stated above, respondent has shown that

petitioners committed fraud in filing their 1993, 1994, and 1995

returns. However, petitioners have shown by a preponderance of

the evidence that their unreported bank deposits were not due to

fraud. Our finding of fraud relies in part on petitioners’
 - 25 -

practice of concealing income by providing only bank statements

and records to their tax return preparer and converting checks

into cash at the Money Exchange. Petitioners did not employ this

practice with respect to the unreported deposits; instead, they

provided their bank information to their tax return preparers.

Therefore, the fraud penalty does not apply to the deficiency

amounts resulting from petitioners’ unreported bank deposit

income in 1993 and 1995. Petitioners have not shown that any

other portion of the deficiencies should not be subject to the

fraud penalty. Therefore, the remainder of the deficiencies for

1993, 1994, and 1995 is subject to the fraud penalty.

To reflect the foregoing, concessions of the parties, and to

give effect to the stipulations by the parties,

Respondent’s Motion for

Leave to Amend the Answer to

Conform the Pleadings to the

Proof is denied as moot, and

Decision will be entered

under Rule 155.