T.C. Memo. 2007-62
UNITED STATES TAX COURT
TIMOTHY R. AND CINDY I. FULLER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13007-05. Filed March 19, 2007.
Anthony V. Diosdi and Joy E. Gray, for petitioners.
Daniel J. Parent, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined deficiencies and
penalties with respect to petitioners’ Federal income tax as
follows:
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Penalty
Year Deficiency I.R.C. Sec. 6663
1998 $43,020 $32,265.00
1999 42,510 30,672.75
2000 49,029 36,771.75
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
After concessions by the parties, the sole issue for
decision is whether petitioners’ underpayments of taxes for the
years in issue were due to fraud and subject to the civil fraud
penalty under section 6663 or, in the alternative, whether
petitioners are liable for the accuracy-related penalty pursuant
to section 6662 for substantial understatements in their Federal
tax liability for the years in issue.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts are incorporated in our findings by this reference.
Petitioners resided in Vacaville, California, at the time that
they filed their petition.
Petitioners operated a residential painting business known
as Custom Painting during 1998, 1999, and 2000. In early 2000,
petitioners began an additional business known as TC’s Discount
Parts, in which they sold motorcycle accessories.
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Petitioners’ tax returns for the years in issue were
prepared by Wayne Greenfield (Greenfield), an enrolled agent in
Chico, California. Petitioners provided Greenfield with
schedules of gross receipts, cost of goods sold, and other
expenses for 1998, 1999, and 2000 to aid him in the preparation
of their tax returns for those years. Petitioner Cindy I. Fuller
(Mrs. Fuller) maintained the books and records for both of
petitioners’ businesses. She prepared the figures to be entered
on petitioners’ tax returns and provided them to Greenfield.
Other than contracts for the purchase of equipment, Mrs. Fuller
did not provide to Greenfield any underlying documents to
substantiate how petitioners determined the figures that they
submitted to him to be entered on their tax returns.
Petitioners filed their 1998 Federal income tax return on
October 19, 1999. They filed their 1999 tax return on
December 17, 2000. They filed their 2000 tax return on June 7,
2002, after receiving from the IRS a letter requesting that it be
filed.
On their Schedules C, Profit or Loss From Business,
petitioners understated their gross receipts by $73,624 for 1998,
$26,038 for 1999, and $9,931 for 2000. They overstated their
costs of goods sold for materials and supplies by $27,768 for
1998, $49,019 for 1999, and $113,402 for 2000. They overstated
their depreciation expenses by $17,558 for 1998, $26,037 for
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1999, and $14,683 for 2000. They overstated their car and truck
expenses by $11,273 for 1998, $7,120 for 1999, and $6,714 for
2000. They also overstated their workers’ compensation insurance
expenses by $2,008 for 1999.
Petitioners overstated their expenses for telephone and cell
phone expenses for 1998 by $4,420, reported those expenses
correctly for 1999, and understated those expenses by $437 for
2000. Petitioners also understated their labor expenses by
$3,265 for 1999 and $2,493 for 2000. Despite these instances
where petitioners understated their deductible expenses, the
combined discrepancies listed above substantially decreased
petitioners’ reported net income and income tax liability. Due
to the understatement of net income reported on their tax
returns, petitioners claimed and received earned income tax
credits of $3,730 for 1998 and $3,770 for 1999.
In various loan applications with Redding Bank of Commerce
(Redding Bank) from 1998 through 2000, petitioners represented
that they had a monthly income of between $5,000 and $6,556.
Petitioners also provided to Redding Bank a copy of a 1998
Form 1040, U.S. Individual Income Tax Return, that did not match
the return that was actually filed with the IRS by petitioners
for that year. The 1998 return that was provided to Redding Bank
listed petitioners’ Schedule C income as $44,005, while the
return that was actually filed by petitioners for 1998 reported
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only $10,058 of Schedule C income. Petitioners also submitted to
Redding Bank a document entitled “Individual Financial Statement”
dated April 5, 2000, in which they represented that they had
wages of $150,000, business net income of $349,000, and total
income of $499,000 for 1999. They also provided to Redding Bank
a profit and loss statement for 1999 indicating gross receipts of
$489,049.55, while petitioners’ filed tax return reported only
$441,032 in gross receipts.
Petitioners purchased several vehicles in 1999 and 2000. In
April 1999, they purchased a 1999 GMC van for a monthly payment
of $715.39. On the credit application for that purchase,
petitioners represented that their annual gross income was
$350,000. In September 1999, petitioners made a downpayment of
$5,000 to purchase a 2000 Ford pickup truck for a monthly payment
of $627.20. On their credit application for that purchase,
petitioners represented that their gross monthly income from
employment was $13,300. Upon purchase of the 2000 Ford pickup
truck, petitioners paid $3,237.98 in cash to have off-road
alterations made to the vehicle. In August 2000, petitioners
made a downpayment of $2,000 to purchase a 2000 Chevrolet pickup
truck for a monthly payment of $592.82. On the credit
application for that purchase, petitioners represented that their
combined monthly income was $13,000.
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From December 21, 2001, to November 17, 2003, an IRS agent
sent to petitioners, collectively and individually, several
letters requesting interviews and scheduling appointments to
discuss their 1998, 1999, and 2000 tax years. Petitioners did
not meet with the IRS agent during that period. On January 6,
2004, petitioners scheduled a meeting with the IRS agent for
January 30, 2004, in Vallejo, California, which location was
chosen for petitioners’ convenience. The agent traveled
approximately 180 miles from Redding, California, to Vallejo for
the meeting, but petitioners failed to appear.
On February 4, 2004, the IRS sent to petitioners summonses
directing them to appear on March 4, 2004, to be interviewed and
to produce documents regarding their 1998, 1999, and 2000 tax
years. Petitioners did not appear on March 4, 2004, or produce
the requested documents. On May 21, 2004, the IRS provided to
petitioners’ counsel copies of document requests previously sent
to petitioners. Petitioners still failed to provide any of the
requested information. On February 11, 2005, petitioners were
served with additional summonses requiring their appearance on
March 1, 2005. The IRS agent again traveled to Vallejo to meet
with petitioners, but petitioners again failed to appear.
In 2002, the IRS began issuing summonses to Redding Bank and
to petitioners’ paint suppliers in order to obtain information
regarding petitioners’ tax liability for the years in issue.
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From this third-party information, the IRS began to reconstruct
petitioners’ gross income and expenses.
On May 27, 2005, the IRS mailed to petitioners the statutory
notice of deficiency. After the notice of deficiency was sent,
petitioners’ counsel notified the IRS that the previously
requested documents were available for review at his office.
Petitioners’ counsel also provided copies of the documents to the
IRS. Much of the information regarding particular payments made
by or to petitioners, however, was gathered from third parties,
such as from petitioners’ bank, and was not evident from the
books and records provided by petitioners. Petitioners
themselves never provided any explanation of the documents or how
they had calculated their gross income and expenses for the years
in issue.
OPINION
The penalty in the case of fraud is a civil sanction
provided primarily as a safeguard for the protection of the
revenue and to reimburse the Government for the heavy expense of
investigation and the loss resulting from the taxpayer’s fraud.
Helvering v. Mitchell, 303 U.S. 391, 401 (1938); Sadler v.
Commissioner, 113 T.C. 99, 102 (1999). Respondent has the burden
of proving, by clear and convincing evidence, an underpayment for
those years in issue and that some part of the underpayment for
each of those years was due to fraud. Sec. 7454(a); Rule 142(b).
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If respondent establishes that any portion of the underpayment is
attributable to fraud, the entire underpayment is treated as
attributable to fraud and subjected to a 75-percent penalty,
unless the taxpayer establishes that some part of the
underpayment is not attributable to fraud. Sec. 6663(b).
Respondent must show that the taxpayer intended to conceal,
mislead, or otherwise prevent the collection of taxes. Katz v.
Commissioner, 90 T.C. 1130, 1143 (1988).
The existence of fraud is a question of fact to be resolved
upon consideration of the entire record. King’s Court Mobile
Home Park, Inc. v. Commissioner, 98 T.C. 511, 516 (1992). Fraud
will never be presumed. Id.; Beaver v. Commissioner, 55 T.C. 85,
92 (1970). Fraud may, however, be proved by circumstantial
evidence and inferences drawn from the facts because direct proof
of a taxpayer’s intent is rarely available. Niedringhaus v.
Commissioner, 99 T.C. 202, 210 (1992). The taxpayer’s entire
course of conduct may establish the requisite fraudulent intent.
Stone v. Commissioner, 56 T.C. 213, 223-224 (1971). Fraudulent
intent may be inferred from various kinds of circumstantial
evidence, or “badges of fraud”, including the consistent
understatement of income, inadequate records, failure to file tax
returns, implausible or inconsistent explanations of behavior,
concealing assets, and failure to cooperate with tax authorities.
Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986),
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affg. T.C. Memo. 1984-601. Dealing in cash is also considered a
“badge of fraud” by the courts because it is indicative of a
taxpayer’s attempt to avoid scrutiny of his finances. See id. at
308.
Respondent’s burden regarding the underpayment of tax in
support of the fraud penalty has been met. Petitioners have
conceded overstatements of expenses and of costs of goods sold
and understatements of gross receipts for the years in issue.
Those misstatements resulted in substantial understatements of
petitioners’ tax liability for those years.
The evidence in this case establishes many “badges of
fraud”. It is undisputed that petitioners substantially
understated their income for each of the years in issue. For
2000, petitioners did not file a tax return until June 2002, and
then only after receiving a letter from the IRS requesting that a
2000 return be filed. Petitioners’ substantial understatements
of income for all tax years in issue and their initial failure to
file a tax return for 2002 are both indicia of fraud. See id. at
307.
Petitioners failed to cooperate with respondent by not
responding to several letters from the IRS requesting interviews
and information, not submitting documents requested by the IRS
agent conducting the audit, and failing to appear at scheduled
interviews. Petitioners did not provide the agent with any
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requested documentation until after the notice of deficiency was
sent to them. The documentation eventually provided by
petitioners was inadequate, leaving the IRS to depend
substantially on the records of third parties in the course of
its audit of petitioners. Petitioners knew that there was
insufficient documentation to support the figures entered on
their tax returns, they failed to cooperate with the IRS’s
multiple requests for interviews, and they presented no plausible
explanation, written or oral, regarding their computation of
their tax liabilities for the years in issue. Petitioners’
refusal to cooperate with respondent in determining their correct
tax liability (until this case was being prepared for trial) is a
further indication of fraud. Bradford v. Commissioner, supra at
307.
Mrs. Fuller provided Greenfield, who prepared petitioners’
tax returns for the years in issue, with totals for gross
receipts, costs of goods sold, and other expenses to be used for
preparing returns for the tax years in issue, but she did not
provide him with any information regarding how the figures she
provided were calculated or with substantiating documentation
other than some contracts for the purchase of equipment.
Petitioners still have not provided to the IRS or to this Court
any plausible explanation of how they arrived at the figures
reported on their tax returns or how the misstatements occurred.
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Petitioners’ failure to provide a plausible explanation of their
behavior with regard to the calculation of the figures provided
to their tax preparer is indicative of fraud. See id. at 307.
Petitioners represented on several loan applications with
various financial institutions during the years in issue that
they had vastly larger incomes than they had represented either
to Greenfield in the course of his preparation of their returns
for those years or to the IRS. They also provided a copy of a
purported 1998 tax return to Redding Bank that showed income four
times the amount that was actually reported to the IRS for 1998.
Petitioners argue that the inconsistent information that they
provided to financial institutions consisted of “mere estimations
of their income” and thus should not be viewed as evidence of
fraudulent intent to conceal income from the IRS, to which
petitioners reported substantially lower incomes. However, the
large discrepancies in the income that petitioners reported to
the IRS and the income reported to the lending institutions,
coupled with the 1998 tax return submitted to Redding Bank that
was selectively altered to show four times more income to
petitioners than the return that was actually filed with the IRS
for 1998, are convincing evidence of petitioners’ dishonesty and
of fraudulent intent to conceal income from the IRS. Petitioners
have not presented any plausible explanation of these
discrepancies.
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Petitioners attempt to shift the responsibility for the
understatements of their tax liabilities to Greenfield and claim
that Greenfield should have conducted his own investigation into
the accuracy of the information that petitioners provided to him
in the course of his preparation of their returns. However, in
the course of his preparation of petitioners’ tax returns,
Greenfield was not provided with documentation to support
petitioners’ calculations of the figures given to him other than
some contracts for the purchase of equipment. Petitioners’
reliance on Greenfield to discover the errors in the reported
figures is no defense to fraud because they failed to provide
Greenfield with complete and accurate information regarding their
income and expenses. See Korecky v. Commissioner, 781 F.2d 1566,
1569 (11th Cir. 1986), affg. per curiam T.C. Memo. 1985-63;
Merritt v. Commissioner, 301 F.2d 484, 487 (5th Cir. 1962), affg.
T.C. Memo. 1959-172.
Although Greenfield testified that “it was obvious that the
[1998] tax return wasn’t correct”, he was able to reach this
conclusion only after petitioners provided him with their books
and records after the returns had been filed. The responsibility
of filing accurate returns remains principally with the
taxpayers, especially where the taxpayers have taken an active
and controlling role in the process of preparing the tax returns
and the information used for their preparation. See Medlin v.
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Commissioner, T.C. Memo. 2003-224, affd. 138 Fed. Appx. 298 (11th
Cir. 2005). Petitioners cannot blame Greenfield for the
misstatements and errors in reporting their tax liabilities when
petitioners provided Greenfield with the incorrect figures to be
entered on their tax returns and when they alone possessed the
information that would have indicated discrepancies between
petitioners’ actual tax liabilities and the amounts reported on
their returns. See Bacon v. Commissioner, T.C. Memo. 2000-257,
affd. without published opinion 275 F.3d 33 (3d Cir. 2001).
Furthermore, petitioners’ failure to provide to Greenfield the
documentation necessary for his accurate preparation of their tax
returns is indicative of fraud. See Medlin v. Commissioner,
supra; Ishler v. Commissioner, T.C. Memo. 2002-79.
Respondent has proven by clear and convincing evidence an
underpayment of tax due to fraud for each year. Petitioners have
not proven that any part of the underpayments was not
attributable to fraud. See sec. 6663(b). On consideration of
the entire record, we conclude that petitioners are liable for
the fraud penalties determined under section 6663(a).
To reflect the foregoing and the concessions of the parties,
Decision will be entered
under Rule 155.