T.C. Memo. 2008-215
UNITED STATES TAX COURT
LOWELL ALAN BAISDEN, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 9613-05, 1436-06, Filed September 16, 2008.
2387-06.
Lowell Alan Baisden, pro se.
Mindy S. Meigs, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined deficiencies in
petitioners’ Federal income taxes, additions to tax, and fraud
penalties as follows:
1
Cases of the following petitioners are consolidated
herewith: Lowell A. Baisden, docket No. 1436-06; and Lowell A.
Baisden and Theresa A. Mawson, docket No. 2387-06.
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Additions To Tax/Penalties
Year Deficiency Sec. 6651(a)(1) Sec. 6663(a)
2001 $36,013 --- $27,010
2002 20,976 $5,244 15,732
2003 62,938 3,114 47,204
After a settlement largely in respondent’s favor of the
income and expense adjustments determined in respondent’s notices
of deficiency, the issue for decision in these consolidated cases
is whether Lowell Alan Baisden (petitioner) is liable for the
fraud penalty under section 6663 or alternatively for the
negligence penalty under section 6662(b)(1).
All section references are to the Internal Revenue Code, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
FINDINGS OF FACT
Facts stipulated by the parties are so found. At the time
the petition was filed, petitioners resided in California.
In 1976 petitioner graduated with a bachelor’s degree from
the University of Southern California with an emphasis in
accounting.
Since 1978 petitioner has been a licensed certified public
accountant in California and in Utah. For over 20 years
including 2001, 2002, and 2003, through his accounting firm
petitioner has been engaged as a sole proprietor in providing
accounting and tax return preparation services for clients.
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Petitioner typically charged clients monthly retainer fees
ranging from $800 to $2,500 for preparing detailed trial balances
and quarterly financial statements and for providing Internal
Revenue Service audit representation. Petitioner charged clients
fees ranging from $300 to $800 for preparation of Federal income
tax returns.
Petitioner and his wife Theresa Mawson were married in 1998.
Mrs. Mawson has worked as an interior designer but never for
petitioner.
Petitioner’s books and records for 2001, 2002, and 2003 were
not properly maintained. In a ledger which petitioner
maintained, petitioner intermingled business expenses with
personal and family expenses such as payments relating to his
children’s education and to a housekeeper. Petitioner’s books
and records apparently reflected all fees received from clients
each year, but the books and records also showed zero net income
for the accounting firm for each year in issue.
In an effort to explain his bookkeeping and accounting
methods, petitioner explained that since approximately 1998 he
had developed for his use and for the use of his clients a novel
and insightful tax strategy that may be described generally as
follows:
(1) Booked sole proprietorship income would be totally
or almost totally offset by the payment by the sole
proprietorship of “royalties” to the owner of the
business;
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(2) the so-called royalties would not be paid directly
to the owner but rather would consist of payments by
the sole proprietorship of the owner’s personal and
family expenses;
(3) the “royalty” payments would be treated as fully
deductible by the sole proprietorship, and they would
reduce the booked net income of the sole proprietorship
to zero; and
(4) the owner would report “royalties” paid with regard
to personal and family expenses as “other income” not
subject to employment taxes.
The primary savings were apparently intended to be derived
from petitioner’s tax strategy through the conversion of sole
proprietorship business income subject to self-employment taxes
into royalties not subject to self-employment taxes.
Petitioner had no written royalty agreement with his
accounting firm.
Petitioner maintained 10 different bank accounts-–8 in his
own name and 2 joint accounts with his wife. For the years in
issue, total deposits into petitioner’s bank accounts were as
follows:
Total
Year Deposits
2001 $131,518
2002 206,168
2003 336,397
In 2001 petitioner purchased a 1999 Lexus LS400. In 2002
petitioner purchased a new 2002 Lexus SC430. In 2003 petitioner
purchased a new family residence for $799,000.
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On the joint Federal income tax returns that petitioner and
his wife timely filed for 2001 and untimely filed for 2003, and
on his individual Federal income tax return that petitioner
untimely filed for 2002, each of which petitioner prepared,
petitioner did not include a Schedule C, Net Profit from
Business, relating to his sole proprietorship accounting firm,
and petitioner did not otherwise report more than a fraction of
the so-called royalty income his accounting firm paid on his
behalf.
Rather, petitioner used the above-described royalty strategy
for each year to offset to zero or to almost zero the substantial
booked income for his accounting firm. Petitioner filed with his
Federal income tax return for each year no Schedule C, and
petitioner reported zero income relating to his accounting
practice. Additionally, on each of his Federal income tax
returns petitioner reported only a portion of the so-called
royalty payments his accounting firm purportedly paid on his
behalf for personal and family expenses (namely, $1,224 for 2001,
$20,750 for 2002, and $49,250 for 2003).
Also, on the Federal income tax return for each year,
because petitioner reported no net income from his accounting
practice, petitioner reported no self-employment tax liability.
Even though petitioner’s wife did not sign the 2002 Federal
income tax return, and even though petitioner’s wife had no
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business of her own and performed no paid services for
petitioner, the 2002 Federal income tax return shows petitioner’s
wife as a joint filer, and petitioner attached a Schedule C for
his wife showing her as engaged in an accounting practice and as
receiving $10,351 from petitioner for “contract services”.
The above 2001, 2002, and 2003 Federal income tax returns
reported the following tax liabilities, credits, and
overpayments:
Payments
Total Reported or Credits Tax Overpayment
Year Tax Liability Claimed Claimed
2001 $1,488 $3,910 $2,422
2002 -0- --- ---
2003 4,351 5,000 649
For 2001 and 2003 petitioners received refunds of the
claimed overpayments.
In June 2004 respondent initiated an audit of petitioner and
his wife’s joint Federal income tax returns for 2001 and 2003 and
of petitioner’s individual Federal income tax return for 2002.
During respondent’s audit, petitioner often was unresponsive to
respondent’s requests for financial information. For 2001
petitioner did not give respondent records of his business
expenses, and petitioner refused to extend the period of
limitations on assessment.
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For all 3 years petitioner provided incomplete records, and
those records respondent did obtain were largely received from
third parties.
To redetermine petitioner’s income, respondent generally
used the bank deposits method of proof, and respondent determined
that petitioner had unreported gross receipts from his accounting
practice of $121,790, $156,800, and $276,006 for 2001, 2002, and
2003, respectively. Respondent determined the failure to timely
file addition to tax under section 6651(a)(1) against petitioner
for 2002 and against petitioner and his wife for 2003.
Respondent mailed three separate notices of deficiency with
respect to the years at issue. For 2001 and 2003 respondent
mailed joint notices of deficiency to petitioner and his wife.
For 2002 respondent mailed a notice of deficiency only to
petitioner.
With regard to the so-called royalties paid by his
accounting firm, petitioner offered respondent’s agent a number
of inconsistent explanations. In conversations with respondent’s
agent, petitioner explained that because corporations are allowed
deductions for certain employee education expenses, an individual
taxpayer/sole proprietor also was entitled to deduct children’s
school expenses on his/her individual Federal income tax returns.
Petitioner claimed he was entitled to business expense
deductions for 2001, 2002, and 2003 in the amounts of $97,560,
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$156,800, and $276,006, respectively. On the basis of
substantiation provided, respondent allowed petitioner business
expense deductions of zero for 2001 (because no records were
provided), $43,768 for 2002, and $44,024 for 2003.
Respondent charged petitioner with self-employment tax on
petitioner’s redetermined Schedule C income.
In an effort to delay respondent’s audit, petitioner filed a
spurious complaint with the Taxpayer Advocate’s Office.
In his answer to petitioner’s complaint, respondent charged
petitioner with the fraud penalty under section 6663 and
alternatively with the negligence penalty under section
6662(b)(1) for 2001, 2002, and 2003.
The parties have now stipulated and agreed that for the
years in issue, petitioner’s sole proprietorship accounting
practice had the following total Schedule C gross receipts,
allowable business expense deductions, and net income:
2001 2002 2003
Schedule C gross receipts $121,790 $156,800 $276,006
Business expense deductions 41,791 43,768 44,006
Total Schedule C net income 79,999 113,032 232,000
As part of the settlement, petitioner has agreed that he is
liable for the section 6651(a)(1) late filing addition to tax for
2002 and 2003, and respondent concedes that petitioner’s wife is
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entitled to relief from joint liability under section 6015(f)
with regard to any tax deficiency and additions to tax we sustain
herein for 2003.
OPINION
Under section 6663(a) if it is established that any part of
an underpayment of tax required to be shown on a return is due to
fraud, there is added to the tax a penalty equal to 75 percent of
the portion of the underpayment that is attributable to fraud.
Fraudulent intent is defined as “‘actual, intentional
wrongdoing, and the intent required is the specific purpose to
evade a tax believed to be owing.’” Estate of Temple v.
Commissioner, 67 T.C. 143, 159 (1976) (quoting Mitchell v.
Commissioner, 118 F.2d 308, 310 (5th Cir. 1941), revg. 40 B.T.A.
424 (1939)). To prove a taxpayer’s tax fraud, the Commissioner
must establish by clear and convincing evidence: (1) The
existence of an underpayment of tax; and (2) the taxpayer’s
fraudulent intent. Akland v. Commissioner, 767 F.2d 618, 621
(9th Cir. 1985), affg. T.C. Memo. 1983-249; Parks v.
Commissioner, 94 T.C. 654, 660-661 (1990).
Whether petitioner’s fraudulent intent has been established
is to be analyzed on the basis of all of the facts and
circumstances in evidence. See Stratton v. Commissioner, 54 T.C.
255, 284 (1970).
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Fraud is never to be imputed or presumed; however, “its
proof may depend to some extent upon circumstantial evidence, and
may rest upon reasonable inferences properly drawn from the
evidence of record.” Stone v. Commissioner, 56 T.C. 213, 224
(1971); see also Rowlee v. Commissioner, 80 T.C. 1111, 1123
(1983); Stephenson v. Commissioner, 79 T.C. 995, 1006 (1982),
affd. 748 F.2d 331 (6th Cir. 1984).
Courts have developed several objective “badges” of fraud,
including: (1) Understatements of income; (2) the absence of
records; (3) implausible or inconsistent explanations of
behavior; (4) asset concealment; (5) cash dealings; and (6) lack
of cooperation with tax authorities. Bradford v. Commissioner,
796 F.2d 303, 307-309 (9th Cir. 1986), affg. T.C. Memo. 1984-601;
Paschal v. Commissioner, T.C. Memo. 1994-380, affd. without
published opinion 76 AFTR 2d 95-7975, 96-1 USTC par. 50,013 (3d
Cir. 1995).
A taxpayer’s experience and education may also be
considered. Niedringhaus v. Commissioner, 99 T.C. 202, 211
(1992); Grosshandler v. Commissioner, 75 T.C. 1, 19-20 (1980).
Consistent, substantial understatements of income over
several years are highly persuasive evidence of intent to defraud
the Government, particularly when combined with other indicia of
fraud. As the U.S. Court of Appeals for the Ninth Circuit has
stated: “repeated understatements in successive years when
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coupled with other circumstances showing an intent to conceal or
misstate taxable income present a basis on which the Tax Court
may properly infer fraud.” Furnish v. Commissioner, 262 F.2d
727, 728-729 (9th Cir. 1958) (citing Anderson v. Commissioner,
250 F.2d 242, 249-250 (5th Cir. 1957), affg. in part and
remanding T.C. Memo. 1956-178), affg. in part and remanding in
part Funk v. Commissioner, 29 T.C. 279 (1957).
The evidence supports imposition against petitioner of the
fraud penalties for each year. Petitioner’s use of so-called
royalty payments to pay personal expenses and to offset or reduce
business income is patently improper and nothing more than a
fantasy creation of petitioner in an effort to evade the payment
of taxes due and owing.
In spite of petitioner’s education, training, and experience
as an accountant, on the 2001, 2002, and 2003 Federal income tax
returns in issue petitioner failed to report substantial income
from his business activities and claimed obvious personal
expenses as deductible business expenses. Further, petitioner
failed to otherwise report (as royalty income) substantial
business income.
Petitioner’s books and records intermingled business and
personal items. Petitioner provided ridiculous explanations for
his tax return treatment of income and expenses, and petitioner
did not cooperate with respondent’s audit.
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Petitioner’s use of so-called royalty expenses to offset
business gross receipts and to eliminate or minimize reported
income, income taxes, and self-employment taxes is unfounded and
improper.
Petitioner’s liability for the fraud penalties determined by
respondent is sustained, and the fraud penalty for each year
applies to the entire tax deficiency for each year.
For the reasons stated, we sustain respondent’s imposition
on petitioner of the fraud penalty for each of the years in
issue.
Decisions will be
entered under Rule 155.