T.C. Memo. 2010-199
UNITED STATES TAX COURT
WAYNE C. EVANS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
MADELYN F. EVANS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 24498-07, 24510-07. Filed September 13, 2010.
Kirk A. McCarville and Philip C. Wilson, for petitioners.
Heidi I. Hansen, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: In a notice sent July 27, 2007, respondent
determined deficiencies in petitioners’ Federal income taxes for
1995 and 1996 of $70,311 and $196,814, respectively. Respondent
also determined penalties for fraud under section 6663 of
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$52,733.25 and $147,610.50 against Wayne C. Evans (Evans) for
1995 and 1996, respectively. The issues for decision are whether
petitioners had unreported income resulting in an underpayment of
tax for each year; whether the underpayment of tax for each year
was due to fraud on the part of Evans, justifying the penalty and
negating the bar of the statute of limitations; whether
petitioners are entitled to any deductions not allowed by
respondent; and whether Madelyn F. Evans (Ms. Evans) is entitled
to relief under section 6015. Unless otherwise indicated, all
section references are to the Internal Revenue Code (Code) in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated between Evans and
respondent, and the stipulated facts are incorporated in our
findings by this reference. Ms. Evans declined to stipulate,
asserting that she had no knowledge of the relevant facts. She
did not contradict any of the facts in the stipulation between
Evans and respondent, and the stipulated facts were established
with respect to her, pursuant to a motion, order to show cause,
and order following the procedures specified in Rule 91.
Petitioners resided in Arizona at the time that they filed their
petitions. At all material times, they were married to each
other and resided together.
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From 1986 through the years in issue, petitioners resided on
property on West Calle Concordia in Tucson, Arizona (the
Concordia property). The Concordia property was purchased by
Stephen and Rosalie Olsen (the Olsens) in 1986 and was refinanced
in 1989 with a loan of $172,194.71 from Household Finance.
Petitioners did not pay rent to the Olsens for their use of the
Concordia property, but during 1995 they made payments on the
Household Finance mortgage and otherwise to prevent foreclosure
on the Concordia property. The sources and amounts of the
payments are further described below.
The Farming Authority and Huntington Construction
On August 22, 1995, Evans entered into an agreement with the
Tohono O’odham Farming Authority (the Farming Authority)
pertaining to Evans’ employment as the full-time general manager
of the Farming Authority. Evans had oversight responsibility for
the approval and disbursement of Farming Authority funds. The
agreement provided, among other things, that
The General Manager shall be responsible for
causing the accounts of the Authority to be maintained
in accordance with an accounting system established by
the Authority’s accountant or accounting firm. The
records and accounts of the Authority will be available
at all reasonable times for inspection and examination
by authorized officers of the Authority and the
Council. The Board may require special examinations to
be made at any time. The General Manager shall arrange
for an audit to be made at the close of each business
year by a certified accounting firm approved by the
Board.
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Evans’ employment agreement specifically prohibited him from
transacting business on the Farming Authority’s behalf with any
company in which he held a direct or indirect interest. By
transacting business with such a company, Evans would have a
conflict of interest. Evans’ failure to disclose to his employer
that he was conducting Farming Authority business with a company
in which he had such an interest would be a breach of the
fiduciary duty he owed to his employer. Any such conduct by
Evans would be grounds for termination.
Huntington Construction, Inc. (Huntington Construction), was
an Arizona corporation effectively operated and controlled by
Evans during 1995 and 1996. Evans concealed from the Farming
Authority his ownership, operation, and control of Huntington
Construction. Evans caused 22 checks totaling $449,005 in 1995
and 28 checks totaling $1,148,208 in 1996 to be paid to
Huntington Construction from the Farming Authority.
Willie Gilbert (Gilbert) was paid by Evans to sign checks
drawn on the Huntington Construction account to conceal Evans’
ownership and control of Huntington Construction. Checks were
drawn on Huntington Construction’s bank account to pay for Willie
Gilbert’s travel expenses, including one or more trips to Indiana
where Gilbert had family. Records were not maintained to
substantiate the business purpose of Gilbert’s travel. Payments
to Gilbert and other persons for services to Huntington
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Construction were not reported to the Internal Revenue Service by
Huntington Construction.
On September 8, 1997, the Tohono O’odham Nation filed a
complaint against Evans, Ms. Evans, Willie Gilbert, Jane Doe
Gilbert, Stephen Olsen, Rosalie Olsen, Dawson Riley, Jane Doe
Riley, Huntington Construction, Western Pacific Construction,
Inc., and Voice of God Recordings, Inc., in the U.S. District
Court for the District of Arizona (the District Court) (the civil
case).
In June 2000, the civil case was settled with an agreement
providing in part that Voice of God Recordings would pay $820,000
to the Tohono O’odham Nation. (Evans had caused the sum of
$820,000 to be paid by Huntington Construction to Voice of God
Recordings on behalf of petitioners, as further described below.)
Ms. Evans was a party to the settlement agreement.
On September 22, 1999, Evans was indicted in the District
Court on 18 counts of embezzlement and theft from an Indian
tribal organization; theft or bribery concerning programs
receiving Federal funds; wire fraud; and frauds and swindles.
The first count of the indictment alleged, in part, that
beginning on or about December, 1994, and continuing
through on or about September, 1997, in the District of
Arizona, Wayne C. Evans, * * * did embezzle, steal,
knowingly convert to his use or the use of another, and
did willfully misapply and permit to be misapplied,
approximately $1.597 million of the moneys, funds,
credits, goods, assets and other property belonging to
or intrusted to the custody or care of the Tohono
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O’odham Indian Nation, by causing those funds to be
paid to himself through use of Huntington Construction,
an entity which he secretly and covertly controlled.
On October 12, 2001, an Information was filed in the
District Court charging Evans with filing a false tax return for
1996 in violation of section 7206(1). On October 12, 2001,
Evans, represented by counsel, entered into a plea agreement in
which he pleaded guilty to the first count of the indictment and
to the information, specifically admitting facts establishing his
guilt beyond a reasonable doubt. The facts admitted included the
following:
Huntington Construction, Inc. was an Arizona
corporation. Beginning at least as early as 1985,
Wayne C. Evans effectively operated and controlled the
affairs of Huntington Construction, Inc.
Huntington Construction performed work for the
Farming Authority while Wayne C. Evans was the Farming
Authority’s general manager and during the time Evans
controlled its affairs. Between March, 1995 and
August, 1996, the Farming Authority paid Huntington
Construction approximately $1.597 million for work
allegedly performed on Farming Authority projects.
Wayne C. Evans was responsible for authorizing the
payment of those funds. Wayne C. Evans failed to
disclose and concealed from the Farming Authority that
he effectively owned, operated and controlled
Huntington Construction and the funds in its bank
accounts while causing Farming Authority funds to be
paid to Huntington Construction.
Once Wayne C. Evans had effected the transfer of
funds to Huntington, Wayne C. Evans controlled the use
of those funds and used them for personal purposes.
Once the funds were deposited to Huntington’s bank
accounts, Evans concealed his control of those funds by
directing third-party nominees to sign checks and make
payments from the Huntington accounts.
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On or about January 2, 2001, in Tucson, Arizona,
Wayne C. Evans filed and subscribed to a joint U.S.
Individual Income Tax Return for the calendar year
1996. Wayne C. Evans signed the return under penalties
of perjury. The return understated Wayne C. Evans’
total income for the 1996 tax year, in that Wayne C.
Evans knowingly failed to include the above-mentioned
monies from tribal funds during the 1996 calendar year.
A judgment of conviction pursuant to Evans’ guilty plea was
entered September 12, 2002. Evans was sentenced to 15 months in
prison followed by 3 years of supervised release and was ordered
to pay restitution of $138,935 to the Tohono O’odham Nation. The
restitution amount was arrived at by taking the total amount of
money Evans illegally received reduced by the $820,000 Voice of
God Recordings paid in settlement of the civil suit.
On three occasions, in 2004, 2008, and 2009, Evans attempted
to have the restitution provision in his sentence vacated, but
the District Court and the Court of Appeals for the Ninth Circuit
held that he was barred by his plea agreement from contesting the
sentence.
No income tax return was filed for Huntington Construction
for 1995 or 1996. In January 2001, petitioners filed joint
individual income tax returns for 1995 and 1996 on which they
reported $12,204 and $7,210 of income from Huntington
Construction for 1995 and 1996, respectively. Petitioners did
not provide bank records reflecting income or expenses or
receipts substantiating their expense deductions to their return
preparer when the returns were prepared. The returns did not
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report all of the income petitioners received as a result of
payments from the Farming Authority to Huntington Construction
and disbursements from Huntington Construction to or for
petitioners.
After examining records of payments made by the Farming
Authority to Huntington Construction and checks written on the
bank accounts of Huntington Construction, respondent determined
that petitioners had unreported income, that certain business
expenses and personal itemized deductions were allowable, and
that other checks represented payments for the personal benefit
of petitioners and constituted taxable income to them. The
personal itemized deductions allowed included charitable
contributions to Voice of God Recordings.
Checks drawn on Huntington Construction’s account payable to
its bank for cashier’s checks or for cash totaled $39,760.29 in
1995 and $1,174,555.79 in 1996.
Specific Items of Unreported Income
On May 23, 1995, funds were withdrawn from Huntington
Construction’s bank account and used to purchase cashier’s checks
to Voice of God Recordings for $100,000 and to Coots Funeral Home
for $5,980. At the same time, $700 in cash was withdrawn from
the account. Coots Funeral Home provided funeral services for
Evans’ brother.
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On May 23, 1995, funds were withdrawn from the Huntington
Construction account to purchase a $2,000 cashier’s check payable
to Western Pacific Construction, Inc. (Western Pacific). Western
Pacific (sometimes referred to in the stipulation of facts as
Pacific Western) was an Arizona corporation owned and controlled
by petitioners.
On July 26, 1995, funds were withdrawn from the Huntington
Construction account to purchase a $16,025 cashier’s check
payable to the Olsens.
On October 4, 1995, $11,084 was withdrawn from the
Huntington Construction account to purchase a vehicle for one of
petitioners’ children.
On December 14, 1995, funds were withdrawn from the
Huntington Construction account to purchase a $1,500 cashier’s
check payable to the widow of Evans’ brother.
On January 30, 1996, funds were withdrawn from the
Huntington Construction account to purchase a $159,422.79
cashier’s check payable to Household Finance to be applied to the
mortgage on the Concordia property. In conjunction with the
payment, the Concordia property was transferred from the Olsens
to the Campo Bello Irrevocable Trust. Petitioners are the
grantors of the Campo Bello Irrevocable Trust and, along with
their children, are the beneficiaries of the trust.
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On August 15, 1996, funds were withdrawn from the Huntington
Construction account to purchase two $1,000 cashier’s checks used
to pay personal debts of petitioners.
In September 1996, funds were withdrawn from the Huntington
Construction account to purchase $820,000 and $70,000 cashier’s
checks payable to Voice of God Recordings on behalf of
petitioners.
During 1995 and 1996, Western Pacific received income
totaling $83,009.92 and $7,603.12. Certain of the income was
received from the Farming Authority, and much of it was received
from Huntington Construction. No income tax returns were filed
for Western Pacific, and petitioners did not include any income
from Western Pacific on their return for 1995 or 1996.
On February 1, 1995, funds totaling $26,756.54 were
withdrawn from Western Pacific’s bank account to make payments by
or on behalf of petitioners to prevent a foreclosure on the
Concordia property. During the years in issue, 43 checks written
on Western Pacific’s bank account were payable to petitioners or
members of their family or to cash. Ms. Evans signed most of the
checks written on the Western Pacific account.
Ms. Evans’ Liability
Petitioners’ Federal tax returns for 1995 and 1996 were
filed in January 2001. Ms. Evans was aware of Evans’ indictment
and arrest at the time that she signed the joint returns, and she
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knew or should have known of the underreporting of income and
understatement of taxes on those returns. She signed checks on
the Western Pacific account by which that corporation’s income
was distributed to petitioners or to members of their family; she
knew or should have known that such income had not been reported
by Western Pacific or by petitioners on their returns. She
received the benefits of the unreported income and the resulting
underpayment of taxes to the same extent as Evans.
OPINION
Respondent relies on section 6501(c)(1) as a defense to
petitioners’ assertion of the bar of the statute of limitations
and, therefore, must prove that petitioners’ 1995 and 1996 tax
returns were false or fraudulent with the intent to evade tax.
Because the question of fraud is determinative as to the
statutory period of limitations as well as the penalty under
section 6663 against Evans, we first discuss the evidence and our
conclusions with respect to fraud. Respondent has not alleged
fraud by Ms. Evans. However, proof of fraud against either
spouse prevents the running of the period of limitations as to
both spouses with respect to the income tax deficiencies on joint
returns. Hicks Co. v. Commissioner, 56 T.C. 982, 1030 (1971),
affd. 470 F.2d 87 (1st Cir. 1972).
The penalty in the case of fraud is a civil sanction
provided primarily as a safeguard for the protection of the
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revenue and to reimburse the Government for the heavy expense of
investigation and the loss resulting from the taxpayer’s fraud.
Helvering v. Mitchell, 303 U.S. 391, 401 (1938); Sadler v.
Commissioner, 113 T.C. 99, 102 (1999). The Commissioner has the
burden of proving, by clear and convincing evidence, an
underpayment for each year in issue and that some part of the
underpayment for each of those years is due to fraud. Sec.
7454(a); Rule 142(b). If the Commissioner establishes that any
portion of the underpayment is attributable to fraud, the entire
underpayment is treated as attributable to fraud and subjected to
a 75-percent penalty, unless the taxpayer establishes that some
part of the underpayment is not attributable to fraud. Sec.
6663(a) and (b). The Commissioner must show that the taxpayer
intended to conceal, mislead, or otherwise prevent the collection
of taxes. Katz v. Commissioner, 90 T.C. 1130, 1143 (1988).
The existence of fraud is a question of fact to be resolved
upon consideration of the entire record. King’s Court Mobile
Home Park, Inc. v. Commissioner, 98 T.C. 511, 516 (1992). Fraud
will never be presumed. Id.; Beaver v. Commissioner, 55 T.C. 85,
92 (1970). Fraud may, however, be proved by circumstantial
evidence and inferences drawn from the facts because direct proof
of a taxpayer’s intent is rarely available. Niedringhaus v.
Commissioner, 99 T.C. 202, 210 (1992). The taxpayer’s entire
course of conduct may establish the requisite fraudulent intent.
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Stone v. Commissioner, 56 T.C. 213, 223-224 (1971). Fraudulent
intent may be inferred from various kinds of circumstantial
evidence, or “badges of fraud”, including the consistent
understatement of income, inadequate records, implausible or
inconsistent explanations of behavior, concealing assets, and
failure to cooperate with tax authorities. Bradford v.
Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo.
1984-601. Dealing in cash is also considered a “badge of fraud”
by the courts because it is indicative of a taxpayer’s attempt to
avoid scrutiny of his finances. See id. at 308. Additional
“badges of fraud” include handling one’s affairs to avoid making
the records usually made in transactions of the kind. Spies v.
United States, 317 U.S. 492, 499 (1943). Evidence of fraud also
includes a taxpayer’s use of a business entity to cloak the
personal nature of expenses. See Romer v. Commissioner, T.C.
Memo. 2001-168.
Although Evans’ conviction for subscribing a false Federal
tax return does not collaterally estop him from denying that he
fraudulently understated petitioners’ income tax liability, his
conviction is evidence of fraudulent intent. See Wright v.
Commissioner, 84 T.C. 636, 643-644 (1985). Evans contends that
he entered into the plea agreement solely to protect Ms. Evans in
the face of a threat that she might be arrested. The details
alleged in the counts of which he was convicted and admitted in
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the plea agreement are specific and convincing evidence of fraud,
and he has not raised any doubt that the facts admitted are
accurate. His motivation in entering into the plea agreement is
irrelevant and in no way undermines the reliability of the
overwhelming evidence of unreported income accompanied by other
badges of fraud.
Petitioners also contend that the amounts paid to Huntington
Construction from the Farming Authority were for work before the
time that Evans became general manager and that, therefore, those
amounts were not embezzled from the Farming Authority in breach
of his duties. Whether petitioners’ business performed services
for the Farming Authority before the time that Evans became the
general manager is irrelevant in this case. The payments
received by Huntington Construction and used for petitioners’
personal purposes during the years in issue were income to them
during those years. The failure to report that income resulted
in underpayments of taxes and is clear and convincing evidence of
fraud.
Respondent has thus shown by clear and convincing evidence
that petitioners received unreported income during each of the
years in issue, at least in the amounts withdrawn from Huntington
Construction and Western Pacific as set forth in our findings.
Once the receipt of income is shown it is petitioners’ burden to
come forward with explanations of why receipts are not taxable or
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of offsetting deductions. See, e.g., Brooks v. Commissioner, 82
T.C. 413, 432-433 (1984), affd. without published opinion 772
F.2d 910 (9th Cir. 1985). Respondent does not have the burden of
disproving petitioners’ entitlement to deductions, even in a
criminal case where the Government bears a heavier burden of
proof. See, e.g., Elwert v. United States, 231 F.2d 928, 933-936
(9th Cir. 1956).
Petitioners did not produce any records to substantiate
their business expenses. Under the circumstances, we are
entitled to infer that they did not maintain required records or
that any records that were maintained would be unfavorable to
their claims. See Wichita Terminal Elevator Co. v. Commissioner,
6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947).
Petitioners suggest that respondent had a burden to show that
“Evans possessed a requisite amount of education and business
experience or sophistication to keep such records.” Although a
taxpayer’s education and experience may be considered in
determining intent, we are satisfied that the complicated scheme
engaged in by Evans is clear and convincing evidence that he had
the “requisite * * * business experience or sophistication” and
that he knew that records are required to substantiate
deductions. Under the management agreement with the Farming
Authority, Evans was to maintain records and accounts, among
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other duties. Thus his failure to keep or to produce records may
be regarded as concealment.
Evans admitted in the plea agreement that he concealed his
ownership of Huntington Construction from the Farming Authority.
Petitioners argue that disguising assets or embezzlement,
standing alone, does not establish intent to evade taxes. These
facts taken together with other badges of fraud, however, are
clear and convincing evidence of fraudulent intent.
Respondent refers to the untimely filing of petitioners’ tax
returns as evidence of fraud. Petitioners argue that late
filing, as contrasted with failure to file, is not indicative of
fraud. The returns in this case, however, were filed after
disclosure of Evans’ criminal conduct in misappropriating funds.
Returns were not filed for the entities through which the
misappropriated funds were channeled to petitioners. Under these
circumstances, we agree with respondent.
The evidence is clear and convincing that petitioners dealt
in large amounts of cash during the years in issue. Petitioners’
response is to point to the paper trail on which respondent
relies; petitioners assert that the paper trail negates
fraudulent intent. Again the evidence must be considered in the
context of the total factual record. That petitioners’ schemes
were discovered because they did not successfully hide all
potential evidence is not an exonerating factor. Even if some
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portion of the cash was used for business expenses, the “handling
of one’s affairs to avoid making the records usual in
transactions of the kind” has long been recognized as a badge of
fraud. Spies v. United States, 317 U.S. at 499-500; see Bradford
v. Commissioner, 796 F.2d at 308.
Another badge of fraud in this case is the record of
implausible and inconsistent explanations of behavior. Evans
attempts to explain away his guilty plea and plea agreement as
intended to protect his wife from arrest. He has not shown that
the facts admitted in the plea agreement are inaccurate. He
attempts to minimize his wrongful conduct toward the Farming
Authority by asserting that funds were owed to Huntington
Construction prior to his employment as general manager, but the
receipt of $1.597 million in 1995 and 1996 calls for more than a
generalized assertion that it was due before mid-1995. By the
nature of the claim, corroborating documentary or witness
evidence should have been available. Because such evidence was
not produced, a negative inference again may be drawn. See
Wichita Terminal Elevator Co. v. Commissioner, supra at 1165. In
any event, the failure to report the income, regardless of the
legality or illegality of its source, is the key element in this
case.
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Disallowed Deductions
As a general rule, with respect to the amounts of the
deficiencies in issue, the taxpayer bears the burden of proof.
Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84
(1992); Rockwell v. Commissioner, 512 F.2d 882, 886 (9th Cir.
1975), affg. T.C. Memo. 1972-133. That burden may shift to the
Commissioner if the taxpayer introduces credible evidence with
respect to any factual issue relevant to ascertaining the
taxpayer’s tax liability. Sec. 7491(a)(1). However, section
7491(a)(1) applies with respect to an issue only if the taxpayer
has complied with the requirements under the Code to substantiate
any item, has maintained all records required by the Code, and
has cooperated with reasonable requests by the Commissioner for
witnesses, information, documents, meetings, and interviews.
Sec. 7491(a)(2)(A) and (B). For the reasons discussed above,
petitioners’ evidence is unreliable, and their claims are
unsubstantiated. They have not satisfied the conditions for
shifting the burden of proof to respondent.
The deductions in dispute are identified by a list of checks
that Evans generally claimed were business expenses of Huntington
Construction, including travel expenses, vehicle expenses, and
meals expenses that were not substantiated in accordance with
section 274(d). Some disputed payments were made to petitioners’
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sons. Evans’ testimony was not corroborated by records or other
testimony, and none of the witnesses could identify specific
services petitioners’ sons performed during 1995 or 1996. Evans
professed a lack of recollection with respect to many of the
payments. His testimony asserting that certain payments related
to loan transactions was not supported by any documentation of
loans received or repaid. Testimony concerning attorney’s fees
was not supported by evidence establishing that the fees were
business expenses rather than personal nondeductible expenses,
such as fees relating to the criminal case. Business-related
litigation referred to during the testimony apparently occurred 5
or more years before the years in issue.
Many of the items that Evans asserted were business related
were inherently personal, and the record of diversion of business
income to pay personal expenses undermines the credibility of the
generalized assertions of business purpose. The failure to keep
adequate records, the use of cash, the absence of tax returns for
Huntington Construction and Western Pacific, the failure to turn
over records to petitioners’ return preparer, and the implausible
claims together render the uncorroborated testimony unreliable.
Petitioners have not shown any error in the deficiency
determinations for 1995 and 1996.
Respondent has proven that the fraud penalty applies, and
petitioners have not established that any part of the
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underpayments was not attributable to fraud. See sec. 6663(b).
Respondent is not barred from assessing petitioners’ 1995 and
1996 tax deficiencies. The penalty under section 6663 will be
upheld.
Section 6015 Relief
Ms. Evans asserted in her petition a claim for relief from
joint and several liability for 1995 and 1996 under section 6015.
She does not qualify for relief under section 6015(c) because
petitioners were married and living together at all material
times. Relief under section 6015(b) requires that she establish
that in signing the return she did not know, and had no reason to
know, that there was an understatement of tax attributable to
items of Evans. See sec. 6015(b)(1)(C). Under either section
6015(b)(1)(D) or (f), she must show that taking into account all
of the facts and circumstances, it is inequitable to hold her
liable for the deficiencies.
At trial, Ms. Evans testified that she did not know anything
about her husband’s activities giving rise to an understatement
of tax for each year, although she signed many of the checks by
which funds were diverted to pay petitioners’ personal expenses.
We are not persuaded that she did not know or have reason to know
of the understatements. At the time she signed the tax returns,
she knew that Evans was being prosecuted for misappropriation of
funds. As far as the record reflects, the unreported income was
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used by petitioners equally, and she has suggested no particular
facts that would support a conclusion of inequity in holding her
liable. It is not inequitable to hold her liable for the
deficiencies on the joint returns. We need not, therefore,
discuss the additional factors generally considered in
determining entitlement to relief under section 6015.
We have considered the other arguments of the parties. They
are irrelevant to our decision or lack merit justifying
discussion. To reflect the foregoing,
Decisions will be entered
for respondent.