Barrow v. Comm'r

T.C. Memo. 2008-264

UNITED STATES TAX COURT

THOMAS J. BARROW, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

BARROW, ALDRIDGE & CO., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 14551-02, 14716-02. Filed November 25, 2008.

Clarence B. Tucker, Sr., for petitioners.

Alexandra E. Nicholaides and Kimberly Webb, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HOLMES, Judge: Thomas J. Barrow was a pioneer for African-

Americans in the accounting profession, creating what was for a

time the nation’s largest minority-owned accounting firm.

Despite his impressive leadership, Barrow ran into trouble with
 - 2 -

the IRS when audits revealed that he was not reporting all of the

business income that he received. The IRS also disallowed

various deductions he took during the years at issue. Barrow was

convicted at a criminal trial of filing false tax returns, bank

fraud, and income tax evasion. We must decide whether Barrow and

his firm are liable for tax deficiencies and associated penalties

for the years 1984-89.

FINDINGS OF FACT

I. The Early Years

Barrow grew up in Detroit, graduated from high school there,

and then attended Wayne State University. He majored in

accounting while working as an intern for Arthur Andersen when

that firm was still one of the Big Eight national accounting

firms. He earned his bachelor’s degree in accounting in 1971 and

became a certified public accountant in 1973.

Upon graduation from college, Barrow was promoted by

Andersen and he began working on financial audits. He rose

through the ranks, and eventually became an experienced senior

auditor. His job was to plan audit engagements, execute them,

write the audit procedures, review the audit work papers, and

then draft the client’s financial statements to make sure they

complied with Generally Accepted Accounting Principles (GAAP).

He worked only on financial audits, and was never involved with
 - 3 -

Andersen’s tax department. He also found time to continue his

education by earning an MBA in finance, again from Wayne State.

II. Formation of Barrow, Aldridge, & Co.

In March 1975, Barrow and two of his colleagues from

Andersen, William Aldridge and Ron Coleman, founded their own

accounting firm, named Barrow, Coleman, Aldridge & Co. They

organized it as a corporation in which each owned a one-third

interest. The firm aimed to build a client list of small

businesses, individuals, and nonprofits, and it soon had a number

of clients in the health-care industry. And it didn’t just do

the financial audits Barrow specialized in--it also offered

bookkeeping, recordkeeping, and tax-return preparation.

The firm quickly took off and, as its revenues grew, it took

on more employees. Most were CPAs, but the firm needed staff,

too, and one of its first was Cynthia Nobles. She began work in

1976, as secretary to all three partners. Over the course of her

employment at the firm, her responsibilities grew until she

became both the firm’s office manager and its bookkeeper. Barrow

taught Nobles some basic accounting skills, such as recording

journal entries, working with a general ledger, and reconciling

the bank account. At first, he closely supervised her and was

able to correct any mistakes she made.

Barrow soon emerged as the firm’s star. At first this just

meant he had to work harder, because the company generally
 - 4 -

followed the eat-what-you-kill model, with each of the senior

partners working mostly for those clients that he brought to the

firm. Barrow proved to be the superior rainmaker, though, and

was soon bringing in far more clients than he could handle

himself, shifting some of the work to the other partners. The

principals began to specialize--Aldridge in tax, and Barrow on

audit and financial services but with an increasing focus on

client development.

When equal partners generate unequal revenues, trouble

usually ensues. And in the early ’80s, Barrow became

dissatisfied with what he thought was the less-than-equal effort

of both of his partners, but especially of Coleman. Barrow

didn’t feel that he had the power to fire Coleman, so he decided

to leave the firm. The only problem was that the firm wanted to

leave with him--the clients were predominantly Barrow’s, and the

employees said they would follow Barrow out the door. So Coleman

decided to leave instead, and Aldridge agreed to make some

adjustments so that he and Barrow could continue to work

together, thus forming Barrow, Aldridge & Co. (BACO) in 1981.

After the shakeup, Barrow became the majority owner with 54-

percent control and was in charge of the firm’s finances.

BACO, like its predecessor, had always managed its finances

using the “modified cash basis of accounting.” At trial, Barrow

first defined the plain-vanilla “cash method of accounting” as
 - 5 -

one where a company records revenues when it receives cash or a

cash equivalent. Likewise, a company using this method records

expenses only when money goes out the door. Barrow described the

limitations of this method, saying that a company cannot account

for depreciation under it. But as Barrow explained, BACO used

the modified cash method of accounting, which allowed the company

to record certain expenses when all the events that surround that

expense had occurred.1 When BACO paid its employees, for

example, it would accrue and deduct the related FICA payments at

that time instead of waiting to deduct those taxes when it

actually paid them over to the government.

Barrow increasingly came to think of BACO as “his” firm and

took it upon himself to lend it money when blips in its cashflow

made meeting payroll a problem. He did not formally approve

these loans in writing on behalf of BACO, but both Aldridge and

Nobles knew of them and credibly testified that they occurred.

Nobles also credibly testified that she would make journal

entries in the ordinary course of business, adjusting the amount

of the loans outstanding both when BACO received money and when

1
BACO’s tax returns had a box that required a choice of
accounting method: cash, accrual or “other (specify).” The
Commissioner points out that BACO checked that it used the cash
method of accounting while Barrow now claims BACO used the
modified cash method. Checking the box for cash method seems
reasonable, however, given that “[r]elatively minor deviations in
the form of accruals will not change the taxpayer from the basic
cash method.” 1 Alkire Tax Accounting, sec. 3.01[3] (LexisNexis
2007).
 - 6 -

it paid Barrow back. We specifically find these journal entries

a generally reliable record of Barrow’s loans to BACO and their

repayment.

BACO required all employees and owners to abide by a

noncompete agreement. Barrow testified that it was BACO’s policy

“that if it [was] a service that [BACO] offer[ed],” then a BACO

employee couldn’t “perform that service outside of the firm’s

purview.” Donna West, initially a BACO audit manager and later a

principal, credibly testified that she knew that this was BACO’s

policy even though she never saw it in writing. She explained

that she “would not have been able to work for a competitor”

because “as a CPA [she] would not work for one of the other

accounting firms.” She also explained that she could work in-

house for a client, but that under the policy she would still be

a BACO employee receiving her compensation from BACO.

III. Complete Information Systems

The second business whose finances are at issue in this case

is Complete Information Systems (CIS). Started in 1979 by BACO’s

principals, CIS leased mainframe time which it resold to its

clients.2 That time would then be available for BACO clients to

automate their bookkeeping. Barrow completed all the paperwork

2
In those bygone days before personal computers became a
commodity, companies could actually make money by buying time on
a mainframe computer wholesale and reselling it to clients. For
the various uses (or the misuses) of the term “time sharing”, see
Odeneal, Computer Time Sharing for Managers 17 (1975).
 - 7 -

to set up CIS, and at first all the partners of Barrow, Coleman,

Aldridge & Co. owned it, but with the understanding that

distributions from revenues would be unequal and dependent on who

brought the client in. All the clients of CIS were also clients

of BACO, and the partners would routinely try to cross-sell the

services of both firms.

Over time, CIS also began to lease cars to BACO’s owners.

Barrow signed the lease agreements for CIS, and Aldridge and

Nobles signed for BACO. After the shakeup from which BACO

emerged, Barrow became the sole proprietor of CIS, though Nobles

continued to do its bookkeeping. For tax years 1984, 1985, 1987,

and 1988, Barrow called this business CIS or CIS Leasing; on his

1986 tax return, Barrow called it “BARCO leasing.” For all of

these tax years, Barrow reported its business income and expenses

on his own Schedule C, using the cash method of accounting, under

which he recorded CIS’s income and expenses in the calendar year

in which they occurred.

IV. BACO’s Success and Barrow’s Community Involvement

BACO continued to grow, and in 1981 it opened a satellite

office in Illinois. The firm also negotiated a deal with Coopers

& Lybrand that was essentially a right of first refusal. If BACO

wanted to partner with a large accounting firm, it had to ask

Coopers first, and likewise if Coopers wanted to partner with a

minority-owned firm. This agreement gave BACO access to large
 - 8 -

clients that it would not have otherwise been able to work with.

Barrow negotiated this joint venture, and it was the first of its

kind among accounting firms in Detroit. Barrow successfully

increased the client base of the BACO satellite offices by

marketing his experience and learning to manage client

relationships remotely.

In an effort to bring in new clients and to raise his

stature in both the business and financial communities, Barrow

became active in many professional associations. He was the

Detroit chapter president for the National Association of Black

Accountants (NABA), which became the largest chapter in the

country under his leadership. He later became the national NABA

president, and in that role he visited many U.S. cities to

organize additional chapters. He served on an advisory board to

the Commissioner of Internal Revenue, and the governor of

Michigan appointed him to the State Board of Accountancy, which

he eventually chaired. He was also a member of the Accounting

Aid Society of Metropolitan Detroit, and was on the advisory

board to the Small Business Association and the Advisory Council

of the Wayne State University Department of Accounting.

But the community involvement that plays the biggest role in

this case began with Barrow’s appointment to the board of
 - 9 -

trustees for New Center Hospital3 (NCH) in 1981. NCH was a

troubled institution, as Barrow quickly discovered after he

arrived. This prompted him to start asking tough questions of

Alan Weiner, the hospital’s executive consultant. Weiner reacted

by trying to find ways to decrease the strength of the hospital

board, but Barrow led a countercoup in 1984 in which the board

ousted Weiner, and elected Barrow as chairman of NCH.

Barrow’s prominence and reputation in Detroit was growing.

But 1985 proved to be its apogee. That year, Barrow decided to

heed the urging of his friends and run for mayor of the city

against the formidable incumbent Coleman Young. He believed--and

we specifically find his claim of naivete credible--that this

would simply mean putting his name on the ballot and campaigning

for awhile. Instead, it began a long downward slide in his

personal and financial fortunes.

The first sign was neither subtle nor long in coming--BACO’s

largest client in 1985 was the City of Detroit, and the City

swiftly decided to cut off its business with the firm, leaving

BACO with a huge revenue shortfall. But there were also subtler

effects. As Barrow grew more occupied with politics and

community work, he did not have the time he needed to supervise

3
At the time, New Center Hospital was named Detroit Center
Hospital. The board decided to change the name in 1984 because
Detroit Center Hospital had a poor image in the community.
 - 10 -

Nobles adequately. Mistakes she made in recording entries in the

books of both BACO and CIS remained uncorrected and leached into

Barrow’s and BACO’s tax returns.

Many of the problems that led to this case, though, began

with Barrow’s work on the NCH board. His duties started out as

routine trustee chores–-attending meetings and cursorily

reviewing Weiner’s proposals. But after Weiner’s ouster, Barrow

and the hospital board decided in 1985 to seek outside advice,

which led them to put the hospital and some affiliates under a

holding company. This new company, called Central Cities Health

Services (CCHS), with Barrow as chairman of its board of

directors, planned to acquire clinics throughout Detroit. These

clinics could refer patients needing specialized or acute care to

the hospital, giving its patient population a much-needed boost.

He also increased his efforts at the hospital while running for

mayor that year--in fact, the then-chairman of CCHS stepped down

and let Barrow take his place because he knew it would be

valuable for Barrow’s mayoral campaign.

Barrow stayed on the hospital’s board, too, and was the only

director common to both NCH and CCHS. The two boards began

paying their members a fee of $100 for each monthly board meeting

attended, and $50 for each subcommittee meeting. They also paid

Barrow a separate annual chairman’s fee of $4000. CCHS’s plan

began to work, and it became the parent company of New Center
 - 11 -

Clinic-East, New Center Clinic-West, and New Center Clinic-

Central.

The NCH board of trustees hired a chief operating officer.

The new man was to run the hospital’s billing, personnel, and

patient care departments, but after a couple years it became

obvious that he didn’t know how to run the financial side of the

hospital. The result was a cashflow problem serious enough to

prompt the board to remove him.

By then, NCH was collecting substantially less than what it

was billing. Some insurance companies and Medicaid were refusing

to pay bills because of avoidable paperwork problems, but instead

of correcting and resubmitting the bill, the billing department

did nothing. The result was a perpetual cash crisis. The board

also discovered that the hospital had a mortgage with HUD on

which it was not current, which then triggered violations of

NCH’s corresponding regulatory agreement connected to that

mortgage. And, to add to the hospital’s woes, it also had a

payroll-tax problem because it hadn’t been paying over withheld

taxes to the IRS.

Sometime between 1985 and 1988, CIS began providing computer

services to NCH. These services included aiding the hospital

with its billing system. It’s unclear whether and to what extent

Barrow disclosed his ownership of CIS--a potential conflict of

interest--to the other board members. But Barrow credibly
 - 12 -

testified on this tangential point that every board member did

business with the hospital and its affiliates.

Barrow understood the hospital’s financial problems and, so

he began to get more involved in the hospital’s day-to-day

operations. In September 1987, while still a partner at BACO,

Barrow began functioning as a full-time manager to try to bring

order to the chaos in the hospital’s financial departments. The

board agreed in exchange to pay Barrow the same $52,000 (as a

chairman’s fee) that the previous chief operating officer had

received as salary.

Between February 1986 and late 1987, NCH signed two deals

with BACO. The first was a professional compilation-accounting

services agreement, a service that BACO routinely performed for

its clients. After receiving bids for contracts from other

accounting firms that the hospital couldn’t afford, BACO

essentially “lent” some of its employees at reduced rates to NCH

to help with the billing and finances. These employees acted

like NCH employees--they worked at NCH every day, and they were

actively involved in reconciling the bank accounts, building and

maintaining relationship with the hospital’s vendors, and

creating the quarterly requests for reimbursement from Medicare,

Medicaid, and Blue Cross Blue Shield. NCH paid BACO directly,

and BACO deposited this money into BACO checking accounts. Donna
 - 13 -

West was the lead on this engagement, and Barrow’s work on this

project did not extend beyond supervising her.

In September 1987, at about the time that Barrow took on his

greatly expanded role in managing the hospital, BACO started the

second engagement, which was to reconstruct cost reports,

business records, and other accounting records back to the 1970s.

This project was much more complex: The money at risk amounted

to several million dollars and the hospital’s survival was at

stake. Barrow got personally involved, but since the hospital

paid him a chairman’s fee, he did not have BACO bill NCH for his

time. Barrow’s involvement on this engagement came within the

penumbra of the noncompete agreement, and he admits that the fee

paid to him as NCH’s chairman should have belonged to BACO under

that agreement.4

All during these years that he was spending so much time at

CCHS and NCH, Barrow continued to have several outstanding loans

with BACO. He would often deposit checks from BACO’s clients

that were payable to BACO into his own personal account. On this

important point we specifically find, based on the testimony and

exhibits in evidence, that Barrow had Nobles record in the BACO

general ledger upon receipt of each check a journal entry that

decreased the loan payable to him (a debit) and increased BACO’S

4
There was also a draft agreement between CCHS and BACO for
similar consulting services, but the parties never signed the
agreement or acted upon it.
 - 14 -

revenues from the engagement (a credit). The only check not

properly recorded in the BACO ledger was one for $8,352 from

Ernst & Whinney.

During this time, Barrow was still receiving a board stipend

from NCH in addition to his chairman’s fee. Barrow credibly

testified that there was a substantial difference between his

role as NCH chairman and his role as NCH board member. He

received the NCH board stipend for attending and conducting

meetings, and considered it (like the other board stipends and

the CCHS chairman’s fee) to be his own income. The hospital

consistently paid BACO and Barrow, although not all the other

vendors, and for a time Barrow himself managed the hospital’s

cashflow by approving all payments before they were sent to the

vendors. This gave him a very detailed knowledge of the state of

NCH’s cash position, and he would sometimes refrain from cashing

his board stipend or chairman’s fee checks because he knew the

hospital didn’t have the cash on hand to pay him.

While occupied at the hospital and CCHS, Barrow also had to

deal with another outbreak of change at BACO--Aldridge’s decision

to leave the firm in December of 1987. Even though Barrow had

been president of BACO from its start, Aldridge’s departure left

him with near total responsibility over administrative and

financial decisionmaking. It also left him--with the exception

of some partners who owned about 3 percent of the firm’s
 - 15 -

outstanding shares--as the firm’s owner. Even more than before,

BACO’s fate depended on Barrow.

V. Personal and Professional Trouble

Despite all his responsibilities, Barrow chose to run for

mayor again in 1989. This second campaign was especially brutal

because Barrow was by then a legitimate threat to the incumbent

mayor. Calling his mayoral run “life-altering,” Barrow experi-

enced things he only thought happened in fiction, credibly testi-

fying that someone broke into his home and stole only his brief-

case. And that he found someone pulling documents from his

trash. And that police began to sit outside his home to observe

who was coming and going.

The 1989 campaign began to founder after the Detroit Free

Press ran a series of articles about Barrow, BACO, CIS, and their

connections with NCH. Because NCH consistently paid BACO and

Barrow but not its other vendors, the paper questioned whether

Barrow had a conflict of interest. On one occasion, a reporter

at the paper called Barrow and asked whether he had ever received

payment from NCH for his services. Barrow lied and said that he

had not. And even though he thought no one would ever find out,

he stamped the back of his chairman’s-fee checks, which he had

already deposited into his personal account, with the BACO

endorsement stamp. Barrow also kept quiet about the ownership of

CIS--Joseph Valenti, a friend of Barrow’s and fellow hospital
 - 16 -

board member, testified credibly that even he didn’t know CIS and

Barrow were connected until a reporter did an investigative piece

on Barrow during the campaign.

Barrow lost his run for the mayoralty and then lost a race

for Congress in 1990. He resigned from the NCH board in July

1990, and pulled the BACO staff out of the engagement with the

hospital at that time as well.

VI. The Collapse: Audit and Criminal Trial

In September 1989, IRS Agent Stephen Bulik began

investigating BACO’s tax return for the year ending March 31,

1988. One of the first things he did in his audit was to

reconcile the general ledger to the tax return. Many of the

general ledger accounts did not agree. The audit soon expanded

to BACO’s tax year ending March 31, 1989, and to Barrow’s

personal taxes for 1984 through 1988.

Because Bulik was not able to reconcile the return to the

general ledger, he began a specific-items analysis5 for both BACO

and Barrow personally for all years at issue. Bulik performed a

bank-deposits analysis to determine the CIS portion of Barrow’s

understatement.

5
A specific-items analysis is a direct method of proof used
when an IRS agent can find a taxpayer’s sources of income. (When
the IRS can’t find a taxpayer’s sources of income, it uses an
indirect method of proof such as an analysis of bank deposits.)
See generally Garbis et al., Tax Procedure and Tax Fraud 618 (3d
ed. 1992).
 - 17 -

After years of investigation and a referral from the civil

to the criminal side of the IRS, a grand jury indicted Barrow in

October 1993 on one count of bank fraud, one count of making

false statements on a loan application, five counts of tax

evasion under section 7201 for tax years 1984 through 1988, and

five counts under section 7206(1) of willfully submitting false

tax returns for tax years 1984 through 1988.6 Barrow was also

indicted on three counts of willfully submitting false corporate

tax returns on behalf of BACO for tax years 1987 through 1989.

During the criminal trial, the government pursued a theory

that Barrow had cheated on his taxes by not reporting on his

individual returns the fees that NCH and CCHS paid to him as the

chairman of the board and a trustee.7

6
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’s Rules of Practice and
Procedure.
7
Neither party chose to introduce the transcript of the
criminal trial into evidence. Cf. Oliver v. Commissioner, T.C.
Memo. 1993-508 (where we allowed admission of a transcript from
the criminal trial and held that we had discretion in deciding
the weight to afford testimony of the taxpayer and other
witnesses at the criminal trial); but see Costa v. Commissioner,
T.C. Memo. 1990-572 (where we disallowed admission of an
affidavit from the criminal trial since it wasn’t made under Fed.
R. Evid. 801(d)(1)). We therefore rely where relevant on the
indictment (which was introduced), credible testimony in this
case of what happened in the criminal case, and the concessions
of each party. Barrow did include massive excerpts from the
criminal trial transcript in his posttrial brief. Rule 143(b),
however, says that statements in briefs are not evidence. And we
have previously held that parties cannot attempt to supplement
(continued...)
 - 18 -

In 1994, a jury convicted Barrow on eight of the twelve

counts against him:

• Making false statements in connection with
a bank loan application under 18 U.S.C. 1014;

• Bank fraud under 18 U.S.C. 1344;

• Income tax evasion for tax years 1985, 1987,
and 1988 under section 7201; and

• Willfully filing false income tax returns
for years 1985, 1987, and 1988 under section
7206(1).

Barrow was also convicted under section 7206(1) for willfully

filing a false corporate income tax return for BACO in tax years

ending March 31, 1988 and 1989.

VII. Barrow and BACO Tax Returns

Barrow would collect all of the yearend adjusting entries

and the calculated ending balances for each of the general ledger

accounts. Then Aldridge (at first) or Barrow (after Aldridge

left) would prepare BACO’s tax returns. Both Barrow and BACO

routinely filed their returns late during the years 1984-1989.

Just as often, the returns were later amended after Barrow

discovered reporting mistakes made by Nobles or remembered income

or expenses that he had previously been too busy to write down.

7
(...continued)
the record with new material provided in the post-trial briefs.
See Snyder v. Commissioner, 93 T.C. 529, 533 (1989); Hartford v.
Commissioner, T.C. Memo. 1995-351. We therefore do not use that
information in reaching our decision.
 - 19 -

Barrow’s Personal Income Tax Returns
Tax Year Form Date Filed
1984 1040 7/13/87
1985 1040 1/11/88
1986 1040 1/14/88
1040X 2/04/88
1040X 4/10/90
1987 1040 12/29/89
1040X 1/10/90
1988 1040 1/10/90

BACO’s Income Tax Returns
Fiscal Year Ending 3/31 Form Date Filed
1988 1120 7/18/88
1120 9/20/89
1120X 1/10/90
1120X 4/10/90
1989 1120 10/04/89
1120X 4/10/90

VIII. The Civil Trial

The IRS began a civil examination of Barrow and BACO in

1998. After several years of investigation, the Commissioner

sent notices of deficiency to Barrow for tax years 1984 through

1988, and to BACO for tax years ending March 31, 1988 and 1989.

The Commissioner determined deficiencies arising from the

following unreported income:
 - 20 -

BACO’s Unreported Income
Year NCH CCHS NCC-W NCC-E Ernst &
Whinney
1988 $63,955.66 $64,811.55 --- ---
1989 63,513.66 54563 $4,500 $9,000 $8,352

Barrow’s Unreported Income
Year Bank-Deposit Portion Due to BACO Portion Due to
Method Distributions Wages
1984 $107,337.34 $7,694.07 $76,015.84
1985 4,410 14,600 ---
1986 92,457.05 70,232.58 ---
1987 27,176.08 121,965.16 ---
1988 137,237.15 167,271.27 ---

Instead of attributing the NCH and CCHS fees to Barrow

personally, the Commissioner now argues that they belonged to

BACO, and that Barrow diverted them by depositing them into his

own personal checking account. The Commissioner treats this

income and diversion for tax purposes as income to BACO, followed

by a constructive dividend to Barrow. Even though the government

now believes this is the proper way to treat the fees, it used a

completely different theory at Barrow’s criminal trial--an

important change, as it will turn out.

The Commissioner also disallowed several deductions. Some

of these were expenses connected with Barrow’s plane. Because he
 - 21 -

traveled so often to meet with clients spread throughout Michigan

and Illinois, and to visit various other cities for his work with

NABA, Barrow--an instrument-rated pilot--had begun flying himself

to save time. The FAA requires pilots to keep a logbook of all

their flights and to record the purpose of each. But during the

initial audit, Barrow gave the logbook to the IRS without making

a copy. The IRS lost it, and Barrow was unable to reproduce its

content.

Both Barrow and BACO petitioned this Court for relief. The

main issues for decision are:

• Did Barrow or BACO engage in fraud, thereby
tolling the 3-year statute of limitations?

• Does collateral or judicial estoppel bar
any claims or issues in this case?

• Did Barrow or BACO understate income?

• May Barrow or BACO take the income tax
deductions disallowed by the Commissioner?

• Is Barrow or BACO liable for the fraud penalty
under former section 6653(b)(1)?

Barrow resided in Detroit throughout the events of this case,

including the day he filed his petition. BACO is now a defunct

corporation originally headquartered in Detroit.8

8
Michigan law provides that a dissolved corporation “may
sue and be sued in its corporate name and process may issue by
and against the corporation in the same manner as if dissolution
had not occurred.” Mich Comp. Laws Serv. sec. 450.1834(e)
(Lexis-Nexis 1973); see also id. sec. 450.1833; Freeman v. Hi
Temp Prods., 580 N.W.2d 918, 921 (Mich. Ct. App. 1998).
 - 22 -

OPINION

I. Fraud

This case hinges on whether Barrow committed fraud. On this

question hangs the Commissioner’s ability to redetermine Barrow’s

and BACO’s deficiencies for 1984-89, because the Commissioner

generally has only three years after a taxpayer files a return to

assess a deficiency or issue a notice of deficiency. Sec.

6501(a). Barrow filed all original personal and business returns

for the years in question by the end of 1990,9 but the

Commissioner waited until 2002 to send notices of deficiency.

Barrow urges us to apply the three-year statute of limitations,

but the Commissioner points us to section 6501(c)(1), which says

that

[i]n the case of a false or fraudulent return with the
intent to evade tax, the tax may be assessed, or a
proceeding in court for collection of such tax may be
begun without assessment, at any time.

9
We look to the date that Barrow filed the original
returns, not any amended returns, in applying section 6501(c)(1).
Badaracco v. Commissioner, 464 U.S. 386, 394 (1984),(“[O]nce a
fraudulent return has been filed, the case remains one ‘of a
false or fraudulent return,’ regardless of the taxpayer’s later
revised conduct, for purposes of * * * civil fraud liability
under section 6653(b). It likewise should remain such a case for
purposes of the unlimited assessment period specified by section
6501(c)(1).”).
 - 23 -

Whether we get to decide the merits of each year depends on the

success of his assertion.

Fraud is an intentional wrongdoing, and the Commissioner

must prove by clear and convincing evidence that Barrow

specifically intended to evade a tax that he believed he or BACO

owed “by conduct intended to conceal, mislead, or otherwise

prevent the collection of taxes.” See Niedringhaus v.

Commissioner, 99 T.C. 202, 210 (1992); accord, Wright v.

Commissioner, 84 T.C. 636, 639 (1985). We look to Barrow’s

actions to determine whether any BACO underpayment resulted from

fraud because “corporate fraud necessarily depends on the

fraudulent intent of the corporate officers.” DiLeo v.

Commissioner, 96 T.C. 858, 875 (1991), affd. 959 F.2d 16 (2d Cir.

1992). We do not impute or presume fraud--the Commissioner

must prove that:

• there is an underpayment of tax for each
year at stake; and

• some part of that underpayment is due to
fraud.

Sec. 7454(a); Rule 142(b); Wright, 84 T.C. at 639.

A. Underpayment

To prove an underpayment, the Commissioner can use methods

different from those the taxpayer used to calculate income when

the taxpayer’s method of accounting doesn’t clearly reflect

income. Sec. 446(b); Parks v. Commissioner, 94 T.C. 654, 658
 - 24 -

(1990). Barrow has the burden to prove that the Commissioner’s

determination of unreported income is unfair or inaccurate.

DiLeo, 96 T.C. at 871; Parks, 94 T.C. at 658.

The Commissioner argues that Barrow underpaid his personal

tax liability for tax years 1984-88, and that Barrow caused BACO

to underpay its tax due in 1988 and 1989. We need not delve into

the details in this part of our opinion, because Barrow concedes

at least some underpayment for 1984 (due to using the wrong Form

W-2), and 1985 (due to a missing Form 1099 for CCHS income). We

have also held that a taxpayer admits an underpayment by filing

an amended return that increases his tax liability. Badaracco,

464 U.S. at 399; Delvecchio v. Commissioner, T.C. Memo. 2001-130,

affd. 37 Fed. Appx. 979 (11th Cir. 2002). That’s just what

Barrow did for 1986 when he filed a Form 1040X for 1986 that

showed an increase in tax liability. We therefore find with

little difficulty that Barrow had at least some underpayment in

1984, 1985, and 1986.

Whether an underpayment existed for 1987 and 1988, and for

BACO in 1988 and 1989, is a more difficult question. Barrow did

file an amended return for 1987--but it decreased his tax

liability by $28,750. BACO’s 1988 and 1989 amended returns show

no increase in tax liability because of the availability of net-

operating-loss carryforwards. So we can’t use these amended

returns as admissions.
 - 25 -

But we can use the fact that he filed all four of these

returns late. The version of section 6653(c)(1) effective for

Barrow’s 1987 and 1988, and BACO’s 1988 and 1989, returns states

that

For purposes of this section, the term “underpayment”
means * * * a deficiency as defined in [section 6211]
(except that, for this purpose, the tax shown on a
return referred to in section 6211(a)(1)(A) shall be
taken into account only if such return was filed on or
before the last day prescribed for the filing of such
return * * *

And for purposes of section 6653(c)(1), “‘a taxpayer will

automatically create an “underpayment” in the amount of the

correct tax simply because he * * * files an untimely return.’”

Campbell v. Commissioner, T.C. Memo. 1997-415 (quoting Emmons v.

Commissioner, 92 T.C. 342, 349 (1989), affd. 898 F.2d 50 (5th

Cir. 1990)). This means that, to answer the question of whether

the Commissioner has proven that there were underpayments for the

1987, 1988, and 1989 tax years, we can simply look to see if

Barrow reported any nonzero tax due for those years. See sec.

301.6653-1(c)(1)(ii), Proced. & Admin. Regs. Even if Barrow

contests the Commissioner’s deficiency, a late-filed return is an

admission that one owes at least the amount of tax shown due on

it, making it an admission of underpayment. And even if we

assumed the accuracy of the tax reduction shown on the amended

1987 return, Barrow would still be deemed to have admitted that

he owed some tax for 1987. We therefore conclude that there was
 - 26 -

at least some underpayment as defined in section 6653(c)(1) for

Barrow in 1987 and 1988.

The Commissioner can find no comfort in this reasoning for

the BACO returns in this case. BACO’s original returns for 1988

and 1989 show zero tax liability because of a net-operating-loss

carryforward that eliminates any tax that would’ve otherwise been

due. The notice of deficiency for these years recalculated and

reduced the net operating loss available for 1988 and 1989, and

included Barrow’s hospital board fees and chairman’s fees in

BACO’s income during those years. This created a tax deficiency,

and as we said above, an underpayment for purposes of section

6653(c)(1) includes a deficiency as defined in section 6211.

Rather than make findings on the merits that an underpayment

exists, we move along to the second part of the fraud test for

these two years as well.

B. Collateral Estoppel, Judicial Estoppel, and
BACO’s Noncompete Policy

Before deciding whether Barrow had the required fraudulent

intent, we must first consider whether we need to decide the

question at all. Each party vigorously argued that the other is

estopped on the issue.

We’ll start with the Commissioner. He contends that Barrow

is collaterally estopped from contesting that he had the required

fraudulent intent when he filed his 1985, 1987, and 1988 returns,

because he was convicted for criminal tax evasion under section
 - 27 -

7201 for those years. The Commissioner is right that a

conviction under section 7201 for tax evasion necessarily carries

with it the factual determination that some part of the resulting

deficiency was due to fraud, and as a general rule we

collaterally estop a taxpayer from arguing any defenses to the

civil fraud penalty for the same year. Niedringhaus, 99 T.C. at

214; see also Gray v. Commissioner, 708 F.2d 243, 246 (6th Cir.

1983), affg. T.C. Memo. 1981-1. It’s possible, however, that the

Commissioner’s procedural missteps bar him from succeeding on

this argument.

The possible misstep here is that we require a party

asserting an affirmative defense--here, collateral estoppel--to

raise the issue in his pleading. Rule 39. The Commissioner

didn’t do that. He argues, however, that there was implied

consent because Barrow didn’t object to his collateral-estoppel

defense at trial, and Rule 41(b)(1) says that when an issue is

tried by express or implied consent, we are to treat the issue as

if it was raised in the pleadings. In Pierce v. Commissioner,

T.C. Memo. 2003-188 [citations omitted], our Court held that this

rule applies to collateral estoppel.

[I]n deciding whether to apply the principle of implied
consent, [we have] considered whether the consent
results in unfair surprise or prejudice toward the
consenting party and prevents that party from
presenting evidence that might have been introduced if
the issue had been timely raised.
 - 28 -

In Estate of Huntsman v. Commissioner, 66 T.C. 861, 871-72

(1976), we held that there was no implied consent where the

taxpayer had no notice of the Commissioner’s tardy argument, the

Commissioner didn’t raise the issue at trial, and we found that

the taxpayer had no opportunity to defend against the

Commissioner’s claim.

Barrow’s case is different. The Commissioner raised the

issue in his pre-trial memo, putting Barrow on notice of his

collateral-estoppel defense. Barrow does argue that the

Commissioner never filed a posttrial motion to conform the

pleadings to the proof presented, and therefore we should bar the

Commissioner from relying on collateral estoppel now. But Rule

41(b)(1) says that

The Court, upon motion of any party at any time, may
allow such amendment of the pleadings as may be
necessary to cause them to conform to the evidence and
to raise these issues, but failure to amend does not
affect the result of the trial of these issues.

(Emphasis added). We therefore will address the collateral-

estoppel issue on its merits.10

We use collateral estoppel to prevent parties from

litigating issues that were necessarily decided in a prior suit.

10
Barrow also argues that he notified our Court at trial of
the Commissioner’s failure to raise collateral estoppel as an
affirmative defense. He cites the trial record in one of his
post-trial briefs, but his citation is incorrect.
 - 29 -

Peck v. Commissioner, 90 T.C. 162, 166-67 (1988), affd. 904 F.2d

525 (9th Cir. 1990). There are five conditions:

• The issue in the second suit must be identical
in all respects with the one decided in the
first suit.

• There must be a final judgment rendered by a
court of competent jurisdiction.

• Collateral estoppel may be applied against
parties and their privies to the prior
judgment.

• The parties must actually have litigated the
issues and the resolution of these issues must
have been essential to the prior decision.

• The controlling facts and applicable legal
rules must remain unchanged from those in the
prior litigation.

Both parties agree that this case meets the second and third

conditions: the District Court in the criminal case rendered a

final judgment and the parties to each case are the same.11

Because they contest the remaining criteria we analyze them, in

turn, for 1985, 1987, and 1988.

1. Are the Issues Identical in All Respects?

The Commissioner simply asserts that the issues in each case

are the same. Niedringhaus, 99 T.C. at 217 (“‘willfully’ as used

11
The Commissioner limits his estoppel argument to the
three years in which Barrow was individually convicted of tax
evasion under section 7201. We’ve previously held that a
corporation--even if it’s closely held--that was not a part of
the criminal case cannot be collaterally estopped from denying
fraud based on a majority shareholder’s conviction for tax
evasion. C.B.C. Super Mkts., Inc. v. Commissioner, 54 T.C. 882,
894 (1970).
 - 30 -

in section 7201 encompasses all the elements of fraud which are

envisioned in section 6653(b)”). But Barrow says the issues are

different because the Commissioner uses a new theory of corporate

diversion, a position that he says contradicts the theory of

personal income-tax evasion the government used in winning the

criminal case. Barrow argues that the new theory was not before

the jury in the criminal case and that, if it had been, the

government would have had to prove at that trial both that (1)

the income belonged to BACO and (2) Barrow deliberately diverted

the income to himself. Because these issues weren’t considered

at the criminal trial and Barrow never had a chance to challenge

them there, Barrow says that collateral estoppel cannot apply.

The government admits that its theory is different in this

case from what it argued in the criminal case:

In the criminal case, the United States presented to an
unsophisticated jury that the unreported income was the
direct income of Thomas J. Barrow * * *. By doing so,
the United States cast the clearest presentation of the
facts to the jury so as to avoid any confusion the
jurors may have had with the concept of double
taxation. In the instant case, [the Commissioner]
introduced sufficient evidence to show that the income
was also the corporate earnings of [BACO,] therefore
adding the double tax component that was omitted in the
criminal case. In both instances, the income is
attributable to [Barrow].

Reply Brief for Respondent at 5. In other words, the government

successfully persuaded the District Court jury in the criminal

case to find that all of the unreported income was directly
 - 31 -

received by Barrow.12 The Commissioner argues that this direct-

income theory is consistent with his corporate-diversion theory

because in both cases, the income is taxable to Barrow. The

Commissioner says he is simply adding another layer by

determining that the income is also taxable to BACO.13

Even though we agree with Barrow that the government’s

position has changed between the criminal case and this one (as

we explain later in discussing judicial estoppel), there

are relatively minor items of unreported income or incorrect

expenses whose consequences for Barrow’s tax liability are

unaffected by the switch in government theories between the

cases. At the criminal trial, the government had the burden to

establish willful tax evasion beyond a reasonable doubt. Because

the jury didn’t have to return a verdict detailing which items of

income Barrow hadn’t reported or which items of expense he hadn’t

12
Recall that the government had to prove an underpayment
in the criminal case. But the government wasn’t required to
prove the specific amount of the underpayment, just that an
underpayment of tax existed. See Moore v. United States, 360
F.2d 353, 356-57 (4th Cir. 1965); Wapnick v. Commissioner, T.C.
Memo. 1997-133.
13
Corporations are subject to double taxation because the
Code taxes income first when the company receives it and then
again when the company distributes it to its shareholders. See
Prescott v. Commissioner, 66 T.C. 128, 138 (1976), affd. 561 F.2d
1287 (8th Cir 1977). For a historical account of the development
of double taxation, see Bank, “Is Double Taxation a Scapegoat for
Declining Dividends? Evidence From History”, 56 Tax L. Rev. 463,
479-516 (2003).
 - 32 -

substantiated, we have no way of figuring out any precise

deficiency from the judgment in the criminal case. We do know

that the Commissioner’s burden to prove fraud here by clear and

convincing evidence is a lower standard than the U.S. attorney’s

burden of proving Barrow’s willful evasion beyond a reasonable

doubt. And we know from the jury’s verdict that at least some

part of Barrow’s underpayment for 1985, 1987, and 1988 is

attributable to fraud. We have also previously stated:

it is now well settled that the criminal judgment of
conviction requires application of the doctrine of
collateral estoppel and that * * * at least part of any
underpayment for the prosecution years must be deemed
already to have been judicially determined to be “due
to fraud” within the meaning of section 6653(b).

C.B.C. Super Mkts., 54 T.C. at 893; see also Rodney v.

Commissioner, 53 T.C. 287, 305 (1969). Because a portion of the

deficiencies that were at issue in the criminal case remains at

issue in this case, we cannot say that the fraud issue as it

related to the individual deficiencies is different.

2. Did the Parties Actually Litigate the Issues and
Was There a Resolution Essential to the Prior
Decision?

The issue of whether or not Barrow evaded tax was litigated

in the criminal case. The jury agreed with the Government that

Barrow evaded tax in 1985, 1987, and 1988. Because we have held

that a conviction for evading tax decided the issue of whether

some part of Barrow’s underpayment was due to fraud, we agree
 - 33 -

with the Commissioner that the parties actually litigated the

issue and there was a resolution in the Government’s favor.

3. Have the Controlling Facts and Applicable Legal
Rules Remained Unchanged From Those in the
Criminal Case?

The applicable legal rules remain unchanged--both criminal

tax evasion and civil tax fraud require proof of an underpayment.

Sec. 7201; United States v. Heath, 525 F.3d 451, 456 (6th Cir.

2008); Niedringhaus, 99 T.C. at 210. The controlling facts

relevant to Barrow’s criminal tax evasion are also the same as

those the Commissioner argues apply in this case--at least with

regard to part of Barrow’s individual income-tax deficiency not

attributable to the new theory of corporate diversion. And there

are no new facts that weren’t available to the parties in the

criminal case. Barrow urges us to consider Boulware v. United

States, 552 U.S. __, 128 S. Ct. 1168 (2008), as a change in the

applicable legal rules sufficient to defeat the application of

collateral estoppel.14 Boulware held that a shareholder in a

criminal tax evasion case can claim that distributions from his

company were a return of capital, without producing evidence that

he or the company intended this type of distribution. Id. But

14
On April 15, 2008, Barrow filed a motion asking us to
take judicial notice of Boulware, a motion which in effect
allowed him to cite supplemental authority for his case. We
asked for a response from the Commissioner, in which he correctly
argued that the proper venue for deciding the impact of the
Boulware decision is District Court.
 - 34 -

the Commissioner is correct in asserting that the theory pursued

by the government in Barrow’s criminal case didn’t involve this

issue.

We therefore collaterally estop Barrow from denying fraud

for tax years 1985, 1987, and 1988. This means we can redeter-

mine Barrow’s tax liability for those years. The Commissioner,

however, must still prove fraud for Barrow’s individual income

tax in years 1984 and 1986, an issue that we analyze below in

redetermining the deficiency for all five years.15

The Commissioner is not alone in urging estoppel. Barrow,

too, raises the issue. But the theory he argues for is judicial

estoppel. Judicial estoppel is a doctrine that prevents a party

from winning judicial acceptance of a theory in one case, only to

pursue a contradictory theory later. New Hampshire v. Maine, 532

U.S. 742, 749 (2001); Fazi v. Commissioner, 105 T.C. 436, 445

(1995) (citing Huddleston v. Commissioner, 100 T.C. 17, 28-29

(1993)). The rule’s purpose is to “protect the integrity of the

judicial process ... by prohibiting parties from deliberately

changing positions according to the exigencies of the moment.”

New Hampshire v. Maine, 532 U.S. at 749-50 (citations and

quotation marks omitted). “Judicial estoppel does not bar a

party from contradicting itself, but from contradicting a court’s

15
Because we have found no underpayment for BACO, see infra
p. 50, we need not consider whether its 1988 and 1989 returns
were fraudulent.
 - 35 -

determination that was based on that party’s position.” Teledyne

Indus., Inc. v. NLRB, 911 F.2d 1214, 1217 n.3 (6th Cir. 1990).

This doctrine generally requires us to accept the earlier of

the two inconsistent positions. Huddleston, 100 T.C. at 26.

Factors that may lead us to judicially estop the Commissioner

from adopting a new position in this case include, but are not

limited to, the following:

• Is the government’s later position “clearly
inconsistent” with its earlier one?

• Did the government succeed in persuading the
criminal court to accept its earlier
position?

• Would the Commissioner derive an unfair
advantage or impose an unfair detriment if
not estopped?

Maine v. New Hampshire, 532 U.S. at 750-51; Bussell v.

Commissioner, T.C. Memo. 2005-77, affd. 262 Fed. Appx. 770 (9th

Cir. 2007). It’s Barrow’s burden to show that the government

took a contrary position in a prior proceeding and that this

position was accepted by the court. Teledyne Indus., 911 F.2d at

1218. Barrow has easily borne this burden by pointing to the

Commissioner’s rather startling admission that the government

changed theories because it didn’t think the jury was smart

enough to understand what he now says really happened--the

diversion by Barrow of money owed to BACO.

The Commissioner says he’s merely adding the double tax

component to the previous determination. We disagree. The
 - 36 -

government’s positions in the two cases are inconsistent because

the corporate-diversion theory doesn’t simply increase Barrow’s

deficiencies, it changes both the nature of the income and the

computation of the tax owed by both BACO and Barrow.

We find this case similar to Warda v. Commissioner, 15 F.3d

533 (6th Cir. 1994), affg. T.C. Memo. 1992-43, in which a

taxpayer argued in a will contest case that she was the owner of

certain real estate and in a later tax case argued that her son

was the owner, in order to claim that the transfer of real estate

to her son was a tax-free gift. The appeals court determined

that the outcome of the earlier case turned on the question of

the property’s ownership--the taxpayer benefiting from being the

owner in the first case--so that her change in theory represented

a “knowing assault on the integrity of the judicial system.” Id.

at 539 (citation and quotation marks omitted). Although we won’t

accuse the IRS of trying to “assault *** the integrity of the

judicial system,” it remains true that IRS witnesses helped

convict Barrow with the simple story that he was receiving income

directly from NCH and CCHS that he didn’t report on his income

tax returns and are now trying to help the IRS win by testifying

that Barrow was really taking money from his firm that wasn’t

owed to him personally--a theory that would allow the

Commissioner to tax BACO on that income and then tax Barrow again

on what the government now calls dividends. We should probably
 - 37 -

be flattered that the Commissioner thinks us more intelligent

than the jury, but we hold that such flattery only gets him

estopped here.

We also hold, in the alternative, that money Barrow earned

from his hospital chairman’s fees was not actually a “corporate

diversion.” The Commissioner argues that all compensation Barrow

earned from his relationship with the hospital should be taxed as

corporate income because BACO’s noncompete policy allowed BACO to

claim as corporate income any compensation earned by BACO

employees performing competing services. The Commissioner offers

little explanation for why money that never reached BACO, and to

which BACO never had unfettered access, should nonetheless have

been claimed on BACO’s corporate tax return rather than Barrow’s

individual return.

The problem with this argument is that BACO’s noncompete

policy appears to be, in the words of Captain Barbossa, “more

what you’d call guidelines than actual rules.” Pirates of the

Caribbean: The Curse of the Black Pearl (Walt Disney Pictures

2003). The trial exhibits show no sign of a written policy. And

though trial testimony was more useful in fleshing out the

boundaries of the policy, it still gave us no clear sense of when

BACO’s interest in the money might have attached, potentially

leaving us adrift in the ocean of contract law. Further

complicating this issue is the fact that at least one court has
 - 38 -

found that a corporate interest in the form of a constructive

trust attaches immediately upon a fiduciary’s misappropriation of

corporate funds. See, e.g., Murphree v. United States, 867 F.2d

883, 885 (5th Cir. 1989). If Michigan follows similar law, the

Commissioner would have a colorable argument that Barrow’s

hospital income was actually attributable to BACO, if the

government can prove that this was a misappropriation of a

corporate opportunity.

The Commissioner argued none of this, however, and so we

find that the policy simply affirmed BACO’s adherence to the

common-law doctrine of the fiduciary duty of loyalty, as codified

in Mich. Comp. Laws Ann. secs. 450.1541 (West 1973), commonly

known as the Michigan Business Corporation Act (MBCA). Because

BACO was incorporated in Michigan, we look to Michigan common law

and the MBCA to determine whether a breach of duty occurred and

if so, when BACO’s interest in the money attached. We look to

the laws in place at the time of the behavior in question; in

this instance, the version of the law in effect from 1977 through

the end of 1989 would control.

Under Michigan common law, an officer or director

misappropriates a corporate opportunity and thereby breaches his

fiduciary duties when

there is presented to a corporate officer or director a
business opportunity which the corporation is
financially able to undertake which is, from its
nature, in the line of the corporation’s business and
 - 39 -

is of practical advantage to it, and which is one in
which the corporation has an interest or a reasonable
expectancy, and if, by embracing the opportunity, the
self interest of the officer or director will be
brought into conflict with that of this corporation
***.

Prod. Finishing Corp. v. Shields,405 N.W.2d 171, 174 (Mich. Ct.

App. 1987) (citations and quotation marks omitted). In cases of

such a breach, “all profits made and advantage gained by the

agent in the execution of the agency belong to the principal.”

Mechem, 1 Mechem on Agency (2d Ed.), sec. 1224 (cited in Prod.

Finishing, 158 Mich. App. at 486).

For all periods before September 1987, when Barrow became a

full-time manager, it is not clear that Barrow’s hospital income

was “in the line of the corporation’s business” or that BACO had

“an interest or a reasonable expectancy” in the income. During

that time Barrow served only as director and chairman of the

hospital. We think it illogical to assume that an accounting

firm would want or benefit from a position as director or

chairman of a troubled hospital; we therefore find these

activities to be mere civic activities for Barrow.

Our reasoning is different for the period from September 17,

1987 through March 31, 1989, a time during which Barrow provided

accounting services and BACO staff to help the hospital’s billing

and accounting departments. Barrow admits that during this time

income he earned from the hospital should have been turned over

to BACO. Therefore, the only time in which BACO may have had an
 - 40 -

interest in Barrow’s income would be September 17, 1987, through

March 31, 1989. But we find it unnecessary to reach the question

of whether Barrow actually breached a fiduciary duty during that

time, because even if Barrow breached his fiduciary duty by

misappropriating the hospital income, under Michigan law BACO

should have filed suit against Barrow to recover the alleged

interest in the misappropriation “within 3 years after the cause

of action has accrued, or within 2 years after the time when the

cause of action [was] discovered.” Mich. Comp. Laws Ann. sec.

450.1541(2)(West 1989). Therefore, even if Barrow did breach his

fiduciary duty and violate the noncompete policy, BACO never

actually filed suit, either within the following 3 years or

within 2 years after his criminal conviction in which his alleged

misappropriation was revealed. Such a suit was never brought,

and the money remained with Barrow under an undisputed claim of

right. Therefore, we find that Barrow correctly put this money

on his 1040 rather than on the BACO corporate return.

C. Fraudulent Intent

The Commissioner must prove fraud separately for Barrow’s

1984 and 1986 tax years, and for BACO’s 1988 and 1989 tax years.

See Temple v. Commissioner, T.C. Memo. 2000-337, affd. 62 Fed.

Appx. 605 (6th Cir. 2003). The Commissioner may use

circumstantial evidence to meet his burden--this includes using

Barrow’s entire course of conduct during the tax years at issue.
 - 41 -

Parks, 94 T.C. at 664. But we won’t find fraud where the

circumstances merely lead to a suspicion of fraud. Id. To show

fraud by circumstantial evidence, the Commissioner may point to

what we have identified as “badges of fraud”--factors which tend

to show the required intent to evade tax. These include these

badges which the Commissioner argues apply to this case:

• Pattern of consistent underreporting of
income, Miller v. Commissioner, T.C. Memo.
1989-461;

• Failure to keep adequate books and records,
Richardson v. Commissioner, 509 F.3d 736, 743
(6th Cir. 2007), affg. T.C. Memo. 2006-69;
Bradford v. Commissioner, 796 F.2d 303, 308
(9th Cir. 1986), affg. T.C. Memo. 1984-601;

• Diverting corporate assets for personal use,
Solomon v. Commissioner, 732 F.2d 1459, 1462
(6th Cir. 1984), affg. T.C. Memo. 1982-603;

• Education and business knowledge of the
taxpayer, Solomon, 732 F.2d at id. 1461;

• Prior tax-related convictions, Wright, 84 T.C.
at 643-44; and

• Dishonest dealings with others, Solomon, 732
F.2d at 1462.

As we noted in discussing the effects of Barrow’s conviction, the

Commissioner doesn’t have to prove the exact amount of the

underpayment resulting from the fraud, only that fraud

contributed to a portion of the underpayment. See Miller v.

Commissioner, T.C. Memo. 1989-461. No single factor is

necessarily sufficient to establish fraud by itself, but a

combination of factors may be persuasive. Ferguson v.
 - 42 -

Commissioner, T.C. Memo. 2004-90. We address each of the

Commissioner’s arguments in favor of finding fraud.

1. Consistent Pattern of Understating Income

The Commissioner claims that Barrow--and consequently BACO--

engaged in a consistent pattern of understating income, and that

this habit is an indicator of fraud. There are two categories of

BACO income that the Commissioner believes the company excluded

which relate to adjustments made to Barrow’s individual income.

The first category includes all checks payable to BACO but

deposited into Barrow’s personal account. Barrow’s response is

that they represent repayment of loans he made to BACO. The

Commissioner says that, despite the repayment theory, it remains

income to BACO because the payor’s intent was to pay BACO. But

no one disagrees: The Commissioner admits that, after a thorough

examination of the available records, BACO reported all but one

of the checks in this category as income on its books. Only the

$8,352 check from Ernst & Whinney was not included. The

Commissioner does claim that the money Barrow deposited in his

personal checking account as loan repayments should be income to

Barrow because there were no written loan agreements in place

between Barrow and his company. Although no written loan

agreement existed between Barrow and BACO, Cynthia Nobles,

William Aldridge, and even IRS agent Stephen Wernert all

testified that they knew Barrow made loans to BACO. Because
 - 43 -

there were never any written loan documents and Barrow maintained

authority over BACO’s general ledger, the Commissioner argues

that it’s possible that Barrow was simply lending BACO its own

funds and that Ms. Nobles couldn’t have known the actual source

of funds for the loans.16 But this is sheer speculation. Based

on credible testimony at trial, we find that Barrow made loans to

his own business from his own funds during hard times. But, even

so, the Commissioner says, Barrow should have posted loan

repayments to BACO’s general register and issued a check as

repayment of the debt. This may have been better business

practice, but its absence is not a plausible marker of fraudulent

intent in this case. Given Barrow’s hectic schedule during those

years and the fact that BACO was closely owned, there is no way

we can find he had fraudulent intent when he deposited funds

directly into his own account after recording the funds as income

on the BACO ledger.

The second category of purported BACO income consists of the

checks paid to Barrow from NCH and its affiliates for board of

directors’ and chairman’s fees. The Commissioner points to

BACO’s policy that all income earned by its officers and

employees from clients for services the firm also offered was

income to BACO. But we’ve already found the Commissioner’s

16
We must note that the Commissioner includes imputed
interest income resulting from these contested loans in the
notice of deficiency.
 - 44 -

position on corporate diversion is judicially estopped, and in

the alternative, that he cannot now enforce BACO’s noncompete

policy to recategorize the income without showing that BACO

itself successfully sought to recover it.

The Commissioner also claims two additional types of

underreporting by Barrow individually. One involves unreported

wages from BACO, and another comes from CIS. The Commissioner

used the bank-deposits method--a method long approved by our

Court, see Estate of Mason v. Commissioner, 64 T.C. 651, 656

(1975), affd. 566 F.2d 2 (6th Cir. 1977)--to reconstruct what he

believes to be CIS’s true income. “The bank deposits method

assumes that all money deposited in a taxpayer’s bank account

during a given period constitutes taxable income.” DiLeo v.

Commissioner, 96 T.C. at 868. Barrow argues that the

Commissioner uses a different method of accounting than he did to

construct his CIS income making it is impossible for him to

determine where his own errors may lie. But Barrow is confusing

method of accounting with method of proof. The Code requires the

Commissioner to use a taxpayer’s method of accounting (i.e. cash

or accrual) as long as it clearly reflects income. Sec. 446(a).

But the Commissioner can use a variety of methods, including the

bank-deposits method, to prove that Barrow underreported his

income. Holland v. United States, 348 U.S. 121, 130-132 (1954);

Goichman v. Commissioner, T.C. Memo. 1987-489.
 - 45 -

Barrow agrees that he understated his income for several

years, but he also claims that the understatements were much

smaller than the Commissioner alleges and due to unintentional

errors. Because of the importance of this issue, we will analyze

each year that is not subject to collateral estoppel individually

to determine what portion of the understatements Barrow can

credibly defend. But we are aware he need not prove errors in

the deficiency determinations themselves. As we have previously

explained, we will not “bootstrap a finding of fraud upon a

taxpayer’s failure to prove [the Commissioner’s] deficiency

determinations erroneous.” Parks, 94 T.C. at 661. Barrow only

needs to prove by a preponderance of the evidence that he lacked

fraudulent intent to remove this as a badge of fraud.

a. 1984

The following chart summarizes changes the Commissioner made

to Barrow’s individual adjusted gross income (AGI) during the

audit for 1984, and reflects the changes that Barrow concedes:
 - 46 -

Change to Barrow’s AGI 1984 per IRS 1984 per Barrow
BACO dividends $7,694.07 ---
NCH board fees --- $785
CCHS board fees --- 3,536
CIS schedule C receipts 23,627.43 23,627.43
BACO salary 76,015.84 76,015.84
Total understatement 107,337.34 103,964.27

Although he admits an understated amount similar to the one

calculated by the Commissioner, Barrow contends he didn’t commit

fraud with regard to any portion of it in 1984. He claims the

amounts the Commissioner calculates as BACO dividends were

actually loan repayments.

As for the missing NCH board fees, he argues that the

original NCH Form 1099 reported fees of only $3,373.07. After

reviewing payment records, Barrow now concedes he should’ve

reported $785 more but says his was an honest mistake caused by

his using the number reflected on the original Form 1099. He

also now concedes that his CCHS fees began in December 1984, but

he says he didn’t receive a Form 1099 from CCHS for that first

payment, and as a result he unintentionally failed to include

those fees on his 1984 return. He also admits that he

underreported the CIS receipts but says that it is a result of

errors made by Nobles when she prepared the CIS books. These

errors included deposits omitted from the CIS ledger.
 - 47 -

Finally, Barrow agrees that he underreported his BACO

salary, but he says this was because he mistakenly used his 1985

W-2 instead of the 1984 W-2. He explains that he kept a separate

folder for each tax year and that somehow the 1985 W-2 got into

the 1984 folder. This led Nobles to use the 1985 figure when

preparing the ledger Barrow later used to prepare his taxes.

Barrow’s assertion that he received an incorrect Form 1099

from CCHS in 1984 is credible. We’ve recounted the chronic

disorganization at the hospital already--a problem that later led

BACO to step in and start helping in 1987. It’s reasonable that

Barrow unintentionally made mistakes reporting his CCHS board

fees because of the hospital’s disorganization and Barrow’s own

preoccupation with the mayoral race during those years.

We are also convinced that Nobles made significant mistakes

and that Barrow unintentionally missed many of them. Nobles

testified that Barrow was her supervisor and generally the person

reviewing her work. Donna West, a principal who started at BACO

in 1988, testified that she had the opportunity to review some of

Nobles’s work and thought Nobles sometimes didn’t pay enough

attention to detail. The Commissioner argues that Barrow “turned

a blind eye” to Nobles’s mistakes. It’s true that Barrow

probably should have taken steps, such as hiring a tax

accountant, to ensure proper reporting. But “turning a blind

eye” indicates negligence, and “[f]raud ‘does not include
 - 48 -

negligence, carelessness, misunderstanding or unintentional

understatement of income.’” Zhadanov v. Commissioner, T.C. Memo.

2002-104 (citation and quotation marks omitted). Also, Nobles

worked closely with Barrow and credibly testified that he never

asked her to do anything improper or that she felt she shouldn’t

do. We will not use the underpayment in 1984 as a badge of

fraud.

b. 1986

The following chart reflects income changes made during the

IRS audit for 1986 that amounts to understated income and

Barrow’s response:

Change to Barrow’s AGI 1986 per IRS 1986 per Barrow
BACO dividends $66,607.58 ---
CIS schedule C receipts 24,399.47 24,399.47
BACO capital gains 1,450 ---
Total understatement 92,457.05 24,399.47

Barrow says he didn’t commit fraud with regard to any

portion of his underreported income in 1986. He claims the IRS’s

dividends and capital gains calculation improperly includes board

fees that he already included on his Form 1040 because they were

not earned in violation of BACO’s policy. It also includes

repayment to Barrow of BACO loans.

He accounts for the additional CIS income by explaining that

the IRS included in CIS’s 1986 income two deposits made in
 - 49 -

January 1987. Because they were made in the following year,

Nobles didn’t record them as 1986 income. He concedes that these

payments are income in 1986, but he argues that this was an

honest mistake, not due to fraud.

We’ve already dismissed the Commissioner’s arguments

regarding corporate diversion and determined that Barrow’s loan

repayments weren’t fraudulent. For reasons similar to those

discussed earlier, we believe Nobles made mistakes and that

Barrow’s explanation of those mistakes for 1986 are credible. We

thus won’t credit the underpayment from 1986 as circumstantial

evidence of Barrow’s fraudulent intent.

We do find that there was a pattern of underreporting

because Barrow failed to report some taxable personal income to

the IRS each year from 1984 until 1988. For the several reasons

provided in this section, however, we do not find this pattern of

underreporting to be a badge of fraud.

c. BACO’s 1988 and 1989 Income

The Commissioner claims that Barrow understated BACO’s

income by not including the following items:

BACO’s Unreported Income
Year NCH CCHS NCC-W NCC-E Ernst &
Whinney
1988 $63,955.66 $64,811.55 --- ---
1989 63,513.66 54,563.80 $4,500 9,000 8,352
 - 50 -

We’ve already found that the fees paid to Barrow relating to

NCH and its affiliates do not belong to BACO but Barrow

individually. This eliminates all of the income the Commissioner

claims BACO failed to report for these two years except the Ernst

& Whinney check. Barrow concedes that he should’ve included this

check in BACO’s 1989 income, but he says Nobles mistakenly

omitted it from the general ledger. We believe him; and though

the omission of this check from the general ledger was mistaken,

and might be negligent, we find its omission was not fraud.17

2. Failure To Keep Adequate Books and Records

The Commissioner contends that the books for BACO were so

poorly maintained that he was unable to reconcile the expenses

reported on BACO’s tax return to BACO’s general ledger. He also

repeats his argument that the general ledger omitted large

amounts of gross income, including hospital chairman’s fees paid

to Barrow for accounting services. The Commissioner again points

out that BACO failed to include in gross revenues a check for

$8,352 from Ernst & Whinney in 1989. Barrow again admits that he

17
The elimination of the hospital fees from BACO’s income
also means that BACO likely didn’t understate its income for
these two years either. The Commissioner looked back to tax
years 1983-87 to recalculate BACO’s net operating loss available
for 1988 and 1989. While he is able to use this method of
recalculation, see Hill v. Commissioner, 95 T.C. 437, 441 (1990),
he shouldn’t have included the hospital fees in BACO’s income for
purposes of the recalculation in those years either. Because he
did so, he also improperly reduced the net operating loss
carryforward available for 1988 and 1989.
 - 51 -

should’ve reported this check on BACO’s return instead of his

own. But Barrow also says that this was a mistake, one of many

small oversights that the IRS is adding together to portray

intentional misconduct. And because we aren’t considering BACO’s

returns at all for this examination of fraud, many of the

Commissioner’s arguments fall outside of our analysis.

The Commissioner also takes issue with Barrow’s

recordkeeping for items relating to his personal income tax. To

support this argument he refers us generally to the record, and

says that often Barrow’s wages, dividends, and corporate

distributions were not accounted for in his personal checkbook.

But we’ve already detailed Barrow’s credible response--he

mistakenly used the wrong W-2, relied on an incorrect Form 1099,

and received nontaxable loan repayments from BACO. And we’ve

dismissed the Commissioner’s corporate-diversion theory, so the

hospital fees were properly counted as his personal income.

The Commissioner also argues that Barrow’s CIS checkbook

failed to reconcile with his Schedule C gross receipts. After

completing a bank-deposits analysis, the Commissioner claims he

discovered that gross bank deposits exceeded gross receipts.

Barrow admits problems with his CIS ledger, but mainly attributes

these mistakes to errors made by Nobles. Again, we believe

Barrow was negligent in his reliance on Nobles, but we found that

he didn’t intentionally doctor the CIS books to hide income.
 - 52 -

Although Barrow may have been careless with his bookkeeping,

there is no evidence that he attempted to conceal assets or

withheld information from the IRS during the audit. In fact, we

find that Barrow cooperated with the IRS audit at all times. See

Kemp v. Commissioner, T.C. Memo. 2004-153; McGowan v.

Commissioner, T.C. Memo. 2004-146 affd. 187 Fed. Appx. 915 (11th

Cir. 2006). Barrow credibly testified that when IRS Agent Bulik

went to the BACO offices for information, he “went to the files

and gave him everything that was in the file,” even copies of

draft agreements never put into place. IRS Agent Bulik was asked

at trial about the condition of Barrow’s business records, and

his response was that “[t]hey were easy to follow * * * [t]hey

were in order.” Barrow’s cooperation and Bulik’s testimony about

his organization cut against any inference of fraud we might

otherwise draw from mistakes in his bookkeeping.

3. Diverting Corporate Assets for Personal Use

The Commissioner argues that Barrow diverted BACO funds for

his own use, and that this is evidence of fraud. But we’ve

already determined that the Commissioner cannot pursue this

theory. The Commissioner also points out that Barrow tried to

conceal the receipt of NCH checks into his personal account by

stamping BACO’s endorsement onto the canceled checks. While we

agree that this behavior was deceptive, we find that it was
 - 53 -

intended to deceive Barrow’s journalistic inquisitors, not the

IRS.

4. Barrow’s Education and Business Knowledge

The Commissioner portrays Barrow as someone sophisticated in

tax matters. We agree that Barrow was highly educated and

experienced in accounting and finance. But Barrow maintains that

his specialty was in auditing and financial reporting, and that a

CPA is not necessarily an expert in every area in which he has a

license to practice. He even suggests that if he had a deeper

knowledge of tax law, he wouldn’t have permitted himself to be

convicted on the basis of explainable transactions in the

criminal trial. Barrow was an entrepreneur and budding

politician, mainly focused on the nontax activities of saving a

struggling hospital and expanding his reputation as a civic

leader in Detroit. And even in cases that involve attorneys or

accountants with a proven knowledge of tax law, we have not found

fraud where the specific intent to evade tax didn’t exist. See,

e.g., Dajos v. Commissioner, T.C. Memo. 1986-330.

5. Prior Tax-Related Convictions

A criminal court convicted Barrow for tax evasion and

willfully filing false individual tax returns for 1985, 1987, and

1988, and for doing the same with respect to BACO’s corporate tax

returns in fiscal years 1988 and 1989. The Commissioner contends

that, although not dispositive, these convictions are evidence of
 - 54 -

fraudulent intent in other years. Barrow argues that his

convictions were wrongly decided, but since we don’t have the

power to overturn them, we must take them at face value. We

agree that this factor weighs against Barrow.

6. Dishonest Dealings With Others

The Commissioner claims that Barrow engaged in a pattern of

deceptive conduct that reflects his fraudulent intent. The

Commissioner argues the following behavior supports his claim:

First, the Commissioner says Barrow made false statements to

procure loans. Barrow submitted unfiled tax returns to financial

companies showing more income than reported to the IRS in order

to obtain bank loans. And a jury did convict him for making

false statements in connection with a bank loan application and

for bank fraud. See 18 U.S.C. secs. 1014, 1344 (2006).

Second, the Commissioner says Barrow made false statements

to business associates. The Commissioner claims Barrow concealed

his ownership of CIS from his colleagues on the board of NCH.

Barrow credibly testified that although he may not have

specifically disclosed CIS to be his personal Schedule C

business, he informed both NCH and the bankruptcy court that CIS

was affiliated with BACO. We find that Barrow honestly thought

this somewhat analogous disclosure was enough.

The Commissioner also claims Barrow hid the same information

from the Bankruptcy court while serving as trustee of Salem
 - 55 -

Mortgage, causing the court to approve a contract between Salem

Mortgage and CIS.18 The application instead says that BACO owned

a minority interest in CIS. Although this information isn’t

accurate, it is consistent with Barrow’s explanation that he

considered CIS to be part of the BACO business plan. We find

that this half-hearted disclosure doesn’t indicate that Barrow

had a pattern of dishonest dealings.

The Commissioner next argues that Barrow engaged in self-

dealing by approving NCH’s bills payable to BACO while requiring

his consent to pay other vendors in hard financial times. Barrow

claims that while NCH had cashflow problems, he extended the

payment due dates of many of NCH’s creditors. And we already

have discussed how Barrow waited to cash some of the chairman’s

fee checks until NCH had cash in the bank to actually pay those

obligations. In this light, and with knowledge that BACO was

already reducing its normal rates for BACO employees working at

NCH, we find no evil intent or malicious purpose behind Barrow’s

dealings with the hospital.

Finally, the Commissioner points out that Barrow made false

statements while campaigning. The Commissioner cites, and Barrow

admits to, lying to the media during Barrow’s campaign by telling

one reporter that NCH wasn’t paying him for his work on the board

18
Salem Mortgage was one of BACO’s clients. When it
slipped into bankruptcy, Barrow became its court-appointed
trustee.
 - 56 -

and with the hospital affiliates. Barrow admits that he wasn’t

always forthright with the media during his campaigns in 1988 and

1989, but again we attribute this more to fear of candor’s effect

on his political career than proof of an intent to defraud the

IRS.

Despite Barrow’s many mistakes, we find that the

Commissioner offers no clear and convincing proof that Barrow

possessed the specific intent to evade a tax that he believed he

owed for 1984 or 1986, or that BACO owed for 1988 or 1989. We

therefore find, not just that the Commissioner has failed to show

by clear and convincing evidence that Barrow filed his 1984 and

1986 tax returns, and BACO’s 1988 and 1989 tax returns, with

fraudulent intent, but that Barrow had no fraudulent intent with

regard to any portion of his 1984 and 1986 underpayments, or

BACO’s 1988 and 1989 underpayments. We therefore hold that the

statute of limitations imposed by section 6501(a) precludes the

Commissioner from assessing the deficiencies and additions to tax

that might otherwise be due for those years.

II. Determination of Barrow’s 1985, 1987, and 1988 Tax Liability

Our task for the years in which Barrow is collaterally

estopped from denying fraud is to redetermine the amount of

Barrow’s deficiency. As a general rule, we presume that the

Commissioner’s determinations in a notice of deficiency are

correct, and Barrow bears the burden of proving those
 - 57 -

determinations wrong. See Rule 142(a)(1); Welch v. Helvering,

290 U.S. 111, 115 (1933).

We begin by discussing the categories of income in dispute

for all three years. First, as we have already found, the

Commissioner is judicially estopped from pursuing his corporate-

diversion theory here. Therefore, all of the NCH and CCHS fees

are income to Barrow directly. Barrow claims that he would

sometimes refrain from cashing the hospital’s checks when they

were issued because he knew the hospital didn’t have the money to

pay him. Some of the checks the hospital issued near the end of

a calendar year were held over until the next year because of

this. Barrow reported those checks in the year he cashed them

because he believed the hospital’s lack of cash on hand was a

restriction on his ability to get paid. We agree with Barrow.

We have held that when a payee knows there are insufficient funds

and that knowledge causes him to refrain from cashing a check,

the payment is income to him in the later year rather than the

earlier. Blumeyer v. Commissioner, T.C. Memo. 1992-647

(discussing knowledge of insufficient funds as an exception to

the relation back doctrine). To the extent Barrow reported fees

in a year subsequent to the check’s issue date because of

insufficient funds, we find him taxable in the later year.

Second, we find that all of the checks made payable to BACO

that Barrow deposited into his account as loan repayments are
 - 58 -

neither capital gains nor ordinary income taxable to Barrow. See

Theodore v. Commissioner, 38 T.C. 1011, 1040-41 (1962). The

Commissioner admits that all of the checks were recorded in the

BACO ledger and although Barrow should’ve deposited them into a

BACO account and then issued a check for loan repayment, we find

that this mistake doesn’t change the character of this income.

A. Issues for 1985

After resolution of the corporate-diversion and loan-

repayment issues above, there remain only these challenged items

from his 1985 tax return:

Disputed 1985 Adjustments
Item Per IRS Per Barrow
Schedule C Depreciation $11,777.36 $8,877.36
Schedule C Receipts - CIS 1,000 --

Barrow claimed $2900 Schedule C depreciation for his 1977

Cessna airplane in 1985, which the Commissioner denied. He and

Barrow now argue over substantiation and whether Barrow used the

plane for business, rather than personal, reasons. Barrow says

that he provided trip and engine logbooks, as well as time slips

and other substantiation of the plane expenses, to Agent Bulik.

Initially, Bulik testified that Barrow showed him some records

relating to his airplane, but that Barrow wouldn’t let him take

them or make copies. Later on, Bulik recalled that during the

audit he used copies of documents showing the use of the plane,
 - 59 -

records of places traveled, and an engine log to deny the

expenses. Barrow claims the Commissioner lost the material he

handed over for substantiation, and argues that he’s entitled to

an inference that if the records were available, they would favor

him. He also asks us to apply the Cohan rule and estimate the

amount of the expenses. See Cohan v. Commissioner, 39 F.2d

540(2d Cir. 1930).

It is a rote statement for this Court to declare that the

taxpayer bears the burden of proving a claimed deduction.

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). The

taxpayer must maintain records sufficient to substantiate such

amounts. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs. But when

the taxpayer is unable to meet this burden because the IRS loses

his records, we may estimate the allowable amount. The wrinkle

here is that section 274(d) expressly overruled Cohan for certain

types of business deductions (including travel) by imposing

strict substantiation requirements. See Sanford v. Commissioner,

50 T.C. 823, 827 (1968), affd. per curiam 412 F.2d 201 (2d Cir.

1969). Barrow appears to have provided documentation--the

logbook--that would have complied with section 274(d), but it was

lost by the IRS and there are no backup copies available.

Section 1.274-5A(c)(5), Income Tax Regs., exempts a taxpayer from

these strict requirements when there is a loss of records beyond

his control. That’s what happened here. Faced with such
 - 60 -

difficulties, we believe Barrow’s and Nobles’s testimony that the

logbook verifies that deductions taken in conjunction with the

plane were for business use, and characterize as a credible

substantiation their testimony that the logbook would also have

verified their amount. We therefore sustain the amounts claimed

by Barrow on his returns.

Barrow also contests the Commissioner’s upward adjustment of

CIS’s income by $1,000. Barrow says he is unable to determine

which deposit contains an error and account for the difference

because the IRS switched from the “bank deposits method of

accounting” to the “taxable checks” method in order to make this

adjustment, and in any case didn’t reconcile their method of

accounting with the cash method that he used for CIS in the same

year. We’ve already pointed out that the Commissioner may use a

variety of methods of proof to uncover a taxpayer’s unreported

income. And Barrow’s complaint about this isn’t enough to meet

his burden to refute the Commissioner’s determination, so we find

that he is liable for the $1,000 difference.

There are two additional 1985 computations that Barrow

disputes--the addition of self-employment tax and the AMT.

Barrow admits that he failed to include the self-employment tax

calculation when he filed his 1985 tax return, and that he was

liable for the tax. Since both items are computational, they

will be recalculated under Rule 155. But Barrow also seems to
 - 61 -

dispute whether these items can be counted as part of the 1985

deficiency for purposes of the fraud penalty if all of the

information needed to calculate them was available on his

original return as filed. We think this issue is directly

related to the computation of the fraud penalty, and we address

it below.

B. Issues for 1987

Barrow concedes that his 1987 CIS income should increase by

$11,279 because he is now unable to find his ledger for that

year, and agrees with other adjustments made by the Commissioner.

We have found against the Commissioner on the issue of whether

Barrow was receiving corporate distributions rather than

repayments of loans. There remain only these challenged items

from his 1987 tax return:

Disputed 1987 Adjustments
Item Per IRS Per Barrow
Sch C Depreciation $8,803.49 $5,903.49
Sch C Expenses 13,799 10,237.28
Cost of Sales 6,500 ---
Imputed Interest Income 3,693.03 ---
Passive Partnership /1120S 5,658.75 ---

Barrow claimed Schedule C depreciation and expenses for his

car, boat, and plane in 1987. The Commissioner denied all of the

expenses and Barrow now contests only those related to his

airplane -- $2900 for depreciation, and $3561.72 for other
 - 62 -

expenses. He makes the same argument that he did for his 1985

airplane expenses, we agree with him again.

Barrow provides a recalculation of his tax liability for

1987 in a simple chart. As part of this effort, he determines

that there should be no adjustment for cost of sales, imputed

interest income, or passive partnership income. The notice of

deficiency explains that the cost of goods sold was reduced by

$6500 because Barrow didn’t establish that the amount was paid or

incurred during 1987 or that the expense was ordinary and

necessary. The notice of deficiency also determines that “since

[Barrow] made loans to [BACO] at below market interest rates,

interest income is imputed to [him] for 1987 and 1988.”19

Finally, the passive partnership adjustment stems from a

determination that the losses from Hambrose Leasing, an entity on

Barrow’s return not otherwise involved in this case, are subject

to at-risk limitations and passive-loss limitations for 1987 and

1988. Barrow fails to explain why he disputes these items.

Therefore, he doesn’t meet his burden to show that the notice of

deficiency is wrong, and so we cannot relieve him of liability

for these items.

C. Issues for 1988

19
Although this adjustment is inconsistent with the
Commissioner’s theory in this case, it is consistent with our
findings that Barrow did in fact make loans to BACO.
 - 63 -

There remain only these challenged items from his 1988 tax

return:

Disputed 1988 Adjustments
Item Per IRS Per Barrow
Interest Income $(1,692) ---
Itemized Deductions 6,097.55 $4,750
Sch C Expenses 2,751 844
Imputed Interest Income 2,728.52 ---
Loss on Sale of Asset 9,040 ---

The Commissioner denied Barrow’s Schedule C airplane

expenses of $1,906.45. He makes the same argument that he did in

1985 and 1987, and we reach the same result.

Barrow also contests the adjustments to his interest income,

itemized deductions, imputed-interest income, and loss on sale of

asset. The Commissioner claims that Barrow received $1,692 less

in interest than reported, and we are unsure why Barrow disputes

this adjustment. In any event, we will sustain the Commissioner

on this.

The Commissioner reduces Barrow’s itemized deductions by

$6,097.55. Based on the notice of deficiency, it appears as

though Barrow agrees only with the reduction in his charitable

contributions to the extent of $4,750. Since Barrow makes no

argument with regard to any other of these changes, we find that

he doesn’t meet his burden of proof. The Commissioner also adds

imputed interest income, which we uphold for the same reasons we
 - 64 -

did for the similar 1987 adjustment. Finally, the Commissioner

denies Barrow a loss on the sale of an asset because Barrow

failed to prove it was a loss he sustained. Barrow makes no

additional showing here, so we must also uphold the

Commissioner’s adjustment of this item.

III. Fraud Penalty

We’ve held that Barrow is collaterally estopped from denying

fraud for 1985, 1987, and 1988 for purposes of former section

6653(b). This makes for an interesting question: to what extent

can we determine the portion of the deficiency subject to this

penalty for these years?

In 1985, section 6653(b) read as follows:

SEC 6653(b). Fraud --

(1) In general.--If any part of any
underpayment (as defined in subsection
(c))of tax required to be shown on a
return is due to fraud, there shall
be added to the tax an amount equal
to 50 percent of the underpayment.

(2) Additional amount for portion
attributable to fraud.--There shall be
added to the tax (in addition to the
amount determined under paragraph (1))
an amount equal to 50 percent of the
interest payable under section 6601--

(A) with respect to the portion of
the underpayment described in
paragraph(1) which is attributable
to fraud, and

(B) for the period beginning on
the last day prescribed by law for
payment of such underpayment
 - 65 -

(determining without regard to any
extension)and ending on the date of
the assessment of the tax (or, if
earlier, the date of the payment of
the tax).

The 1985 statute leaves no room to determine that some part of

the deficiency was not due to fraud.

We also must address the issue of the computational

adjustments made to Barrow’s 1985 tax liability for the AMT and

self-employment tax. The Commissioner will recalculate Barrow’s

1985 tax liability after we file this opinion and adjust the AMT

and self-employment tax calculations based on our findings, so we

need not settle disputes over the correct amounts of those

calculations now. But because we are bound by the 1985 version

of section 6653(b) to apply the fraud penalty to the entire

underpayment for that year, the question arises: Does the fraud

penalty also attach to adjustments that are purely computational

in nature?

We begin with the language of the Code:

SEC.6653 (c). Definition of Underpayment.--
For purposes of the section,the term
“underpayment” means--

(1) Income, estate, gift, and certain
excise taxes.--In the case of a tax to
which section 6211 (relating to income,
estate, gift, and certain excise taxes)
is applicable, a deficiency as defined
in that section (except that, for this
purpose, the tax shown on a return
referred to in section 6211(a)(1)(A)
shall be taken into account only if such
 - 66 -

return was filed on or before the last
day prescribed for the filing of such
return, determined with regard to any
extension of time for such filing)***

* * * * * * *

This tells us that an underpayment for purposes of section

6653(b) equals the deficiency as defined in section 6211. And

section 6211 provided:

SEC. 6211(a). In General.--For purposes of
this title in the case of income, estate, and
gift taxes imposed by subtitles A and B and
excise taxes imposed by chapters 41, 42, 43,
44, and 45 the term “deficiency” means the
amount by which the tax imposed by subtitle A
or B, or chapter 41, 42, 43, 44, or 45
exceeds the excess of--

(1) the sum of

(A) the amount shown as the tax by
the taxpayer upon his return, if a
return was made by the taxpayer and
an amount was shown as the tax by
the taxpayer thereon, plus

(B) the amounts previously
assessed (or collected without
assessment) as a deficiency, over--

(2) the amount of rebates, as defined
in subsection (b)(2), made.

Because the Commissioner included the AMT and self-employment tax

in the notice of deficiency, we find that if they still exist

after the computations called for by Rule 155, they are part of

the underpayment for purposes of the fraud penalty in 1985.

In 1987, the Code provided:

SEC. 6653(b). Fraud.--
 - 67 -

(1) In general.--If any part of any
underpayment (as defined in subsection
(c)) of tax required to be shown on a
return is due to fraud, there shall be
added to the tax an amount equal to the
sum of--

(A) 75 percent of the portion of
the underpayment which is
attributable to fraud, and

(B) an amount equal to 50 percent
of the interest payable under
section 6601 with respect to such
portion for the period beginning on
the last day prescribed by law for
payment of such underpayment
(determined without regard to any
extension) and ending on the date
of the assessment of the tax or, if
earlier, the date of the payment of
the tax.

(2) Determination of portion
attributable to Fraud.--If the Secretary
establishes that any portion of an
underpayment is attributable to fraud,
the entire underpayment shall be treated
as attributable to fraud, except with
respect to any portion of the
underpayment which the taxpayer
establishes is not attributable to
fraud.

(Emphasis added). The 1987 statute may leave room for a

determination of which part of the underpayment is due to fraud.

In 1988, the statute read as follows:

SEC. 6653(b). Fraud.--

(1) In general.--If any part of any
underpayment (as defined in subsection
(c)) of tax required to be shown on a
 - 68 -

return is due to fraud, there shall be
added to the tax an amount equal to 75
percent of the portion of the
underpayment which is attributable to
fraud.

(2) Determination of Portion
Attributable to Fraud.--If the Secretary
establishes that any portion of an
underpayment is attributable to fraud,
the entire underpayment shall be treated
as attributable to fraud, except with
respect to any portion of the
underpayment which the taxpayer
establishes is not attributable to
fraud.

(Emphasis added). As with 1987’s, the 1988 fraud section also

allows a more precise determination of the amount of the

underpayment due to fraud. The question remains: can we

determine that there is no deficiency due to fraud for 1987 and

1988 in the light of our application of collateral estoppel in

this case?

We find the answer in our opinion in Franklin v.

Commissioner, T.C. Memo. 1993-184. In that case, we found that

while the Commissioner had proven that the taxpayer had underpaid

his taxes, and that he had underpaid with fraudulent intent,

neither the taxpayer nor the Commissioner provided evidence of

the specific amount of that underpayment. We said that “to

adjudicate an addition to tax under section 6653(b)(2), first we

must examine the evidence and satisfy ourselves as to the amount

that clearly and convincingly is an underpayment. Then, we must
 - 69 -

determine whether any or all of such amount clearly and

convincingly is due to fraud.” Id. We also recognized that

estimating the taxpayer’s underpayment at zero or a nominal

amount would be inconsistent with a guilty plea by the same

taxpayer to obtaining “substantial income” from certain illegal

activities. Instead, we estimated the underpayment due to fraud

for each of the years at issue.

We face a similar task in this case. While we acknowledge

that in the criminal case the government proved beyond a

reasonable doubt that some part of Barrow’s underpayments for

1987 and 1988 were due to fraud, the Commissioner in this case

failed to prove to us that any particular underpayments were

actually due to fraud. We recognize that it would be

inconsistent to hold no part of the underpayment due to fraud, so

as we did in Franklin, we estimate that $500 in 1987 and 1988 was

due to fraud for purposes of applying the fraud penalty.

Conclusion

No part of any underpayment of Barrow’s 1984 or 1986, or

BACO’s 1988 and 1989, deficiencies was due to fraud and so we do

not sustain the Commissioner’s determination for those years.

The parties will, however, need to compute Barrow’s 1985,

1987, and 1988 deficiencies, so
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Decisions will be entered under

Rule 155.