MARK W. MAY AND CYNTHIA R. MAY, PETITIONERS v.
COMMISSIONER OF INTERNAL REVENUE,
RESPONDENT
CYNTHIA R. MAY, PETITIONER, AND MARK W. MAY,
INTERVENOR v. COMMISSIONER OF INTERNAL
REVENUE, RESPONDENT
Docket Nos. 14385–05, 4782–07. Filed October 24, 2011.
P–H’s corporation reduced P–H’s paycheck by amounts that
were not remitted to the Government. R determined fraud
penalties and disallowed deductions for State and local income
taxes. Ps claim this Court does not have jurisdiction to
redetermine underpayments, that no underpayments exist,
that P–H is not liable for fraud penalties, and that the deduc-
tions for State and local taxes are proper. Held: This Court
has jurisdiction to redetermine the applicability of sec. 6663,
I.R.C., penalties for fraud resulting from overstated with-
holding tax credits. Held, further, an ‘‘underpayment’’ includes
a taxpayer’s overstated credits for withholding under the rule
in Feller v. Commissioner, 135 T.C. 497 (2010). Held, further,
sec. 1.31–1(a), Income Tax Regs., is inapplicable because
funds due to the Government were not actually withheld from
P–H’s wages. This is a matter of first impression for this
Court, and we adopt the test applied in United States v. Blan-
chard, 618 F.3d 562 (6th Cir. 2010). Held, further, P–H is
liable for fraud penalties under sec. 6663, I.R.C. Held, further,
Ps are entitled to a partial deduction for local income taxes
paid.
Mark W. May and Cynthia R. May, pro sese.
Edward Lee Walter, for respondent.
GOEKE, Judge: Respondent determined deficiencies in peti-
tioners’ 1994, 1995, and 1996 joint Federal income taxes of
$7,659, $10,389, and $8,771, respectively, as a result of
147
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148 137 UNITED STATES TAX COURT REPORTS (147)
unpaid State and local income taxes deducted on petitioners’
returns. Respondent also determined penalties for fraud
under section 6663 1 for 1994, 1995, and 1996 against Mark
May (Mr. May) of $84,957.75, $89,748.75, and $70,160.25,
respectively, resulting from the deficiencies and overstated
credits for taxes withheld from wages. Respondent separately
determined that Cynthia May (Mrs. May) is not entitled to
relief under section 6015 from joint and several liability for
the years at issue. The cases were then consolidated for trial.
After trial respondent conceded that Mrs. May is entitled to
relief under section 6015(b) for the years at issue, resolving
all issues pertaining to her. After this concession, the issues
remaining for decision are:
(1) Whether the Court has jurisdiction to redetermine the
underpayments for purposes of calculating the section 6663
fraud penalties when a portion of the underpayment for each
taxable year resulted from overstated credits for taxes with-
held from wages. We hold that the Court does have jurisdic-
tion to determine the correct amounts of the underpayments
and corresponding penalties;
(2) whether Mr. May is liable for the section 6663 fraud
penalties for the taxable years at issue with respect to the
claimed withholding tax credits. We hold that Mr. May is so
liable; and
(3) whether Mr. May is liable for the deficiencies resulting
from disallowed deductions for State and local income taxes
paid and for section 6663 fraud penalties with respect to
such deficiencies. We hold that Mr. May is liable for the defi-
ciencies in part and for section 6663 fraud penalties with
respect to the remaining deficiencies.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time the petition was filed, Mr. May was incarcerated
in Kentucky; Mrs. May resided in Ohio.
During 1994, 1995, and 1996 Mr. May was an employee,
officer, and shareholder of Maranatha Financial Group, Inc.
(Maranatha), a corporation with approximately 100
employees. Mr. May was also Maranatha’s president and
1 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.
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(147) MAY v. COMMISSIONER 149
CEO. Mr. May received a biweekly paycheck and pay stub
issued by a payroll service provider, Paychex, for his services
to Maranatha. The pay stubs reflected biweekly gross pay of
$10,000 per pay period. After withholdings for Federal, State,
local, and FICA taxes, Mr. May’s net paycheck was in the
range of $6,500 per pay period.
During the years at issue Mr. May fully controlled the
finances of Maranatha. Mr. May had sole check signature
authority on Maranatha’s corporate bank account and was
the sole signatory on payroll checks issued by Paychex on
Maranatha’s behalf. Mr. May did not sign the paychecks
manually, but an electronic facsimile of his signature
appeared on all paychecks.
During the years at issue Maranatha withheld all proper
taxes from employee paychecks (including Mr. May’s) but
failed to remit these withholdings to Federal, State, or local
tax authorities. Maranatha used at least a portion of the
unremitted funds to continue operation of the business,
which included paying Mr. May an annual salary of
$260,000. Mr. May was admittedly the person responsible for
remittance of these withholdings and was aware of the
failure to remit them. Mr. May was also responsible for filing
Maranatha’s Forms 941, Employer’s Quarterly Federal Tax
Return, but failed to file those forms for the taxable years in
issue until early 1997. Because he was the responsible
officer, all unremitted withholdings were later assessed
against Mr. May under section 6672.
Petitioners timely filed joint Federal income tax returns
with the Internal Revenue Service (IRS) for the taxable years
1994, 1995, and 1996. Attached to each tax return was Mr.
May’s Form W–2, Wage and Tax Statement, issued by
Paychex. Petitioners claimed withholding credits each year
resulting from amounts withheld from Mr. May’s paychecks
for Federal taxes. Petitioners also claimed deductions each
year for State income taxes paid through withholdings. Peti-
tioners also claimed deductions in 1995 and 1996 for local
taxes paid. Petitioners testified that they paid local income
taxes by personal check during 1995 and 1996 and produced
a copy of a single canceled check issued to and endorsed by
the city of Xenia, Ohio, for $2,550 in April 1997.
On April 9, 2002, Mr. May was indicted on two counts of
Federal income tax evasion, as well as four counts of willful
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150 137 UNITED STATES TAX COURT REPORTS (147)
failure to account for and pay over payroll taxes while
working for Maranatha. The U.S. District Court for the
Southern District of Ohio found Mr. May guilty on all six
counts. On appeal, the U.S. Court of Appeals for the Sixth
Circuit affirmed the conviction but vacated the sentence and
remanded the case for resentencing. After resentencing, Mr.
May appealed the District Court’s resentencing to the Court
of Appeals for the Sixth Circuit, which again vacated the sen-
tence and remanded with a directed order of restitution. This
second appeal did not address or disturb the underlying
conviction.
Evidence at the criminal trial established that Mr. May
had used funds in the corporate account for personal
expenditures. However, no such evidence was presented in
these cases.
On May 4, 2005, respondent issued a notice of deficiency
to petitioners for tax years 1994, 1995, and 1996. Petitioners
timely filed a petition for redetermination of the deficiencies
and penalties.
OPINION
I. Jurisdiction To Redetermine Section 6663 Fraud Penalties
Resulting From Overstated Credits for Taxes Withheld
From Wages
The jurisdiction of this Court is limited by statute and
attaches only upon the issuance of a valid notice of deficiency
and the timely filing of a petition. Pietanza v. Commissioner,
92 T.C. 729, 735 (1989), affd. without published opinion 935
F.2d 1282 (3d Cir. 1991). In these cases, the notice of defi-
ciency determined a deficiency relating to disallowed deduc-
tions for State and local income taxes, as well as section 6663
fraud penalties applied to the deficiencies and underpay-
ments resulting from overstated credits for tax withholding.
Petitioners argue that this Court does not have jurisdiction
over any aspect of these cases involving the overstated with-
holding credits because they do not meet the statutory defini-
tion of a tax deficiency so as to form the basis for a valid
notice of deficiency.
This Court has previously addressed this issue in Rice v.
Commissioner, T.C. Memo. 1999–65. Rice involved overstated
withholding credits which resulted in a section 6663 fraud
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(147) MAY v. COMMISSIONER 151
penalty but no deficiency. In holding that this Court had
jurisdiction to redetermine fraud penalties, including the
effect of the overstated withholding credits on the amount of
the penalty, the Court stated:
Section 6665 provides that ‘‘additions to the tax, additional amounts,
and penalties * * * shall be paid upon notice and demand and shall be
assessed, collected, and paid in the same manner as taxes’’. A deficiency
in tax is assessed, collected, and paid only after respondent makes a deter-
mination and sends a notice of that determination in accordance with sec-
tion 6213, which provides for the jurisdiction of this Court. Eck v. Commis-
sioner, 16 T.C. 511, 515 (1951), affd. per curiam 202 F.2d 750 (2d Cir.
1953). Thus, respondent, in sending a notice determining petitioner was
liable for a section 6663 penalty, was complying with the law that requires
him to proceed in the same manner as if there were a deficiency. ‘‘The
statute was intended to mean * * * that where such a notice was sent,
the Tax Court has jurisdiction.’’ Accordingly, a statutory notice from
respondent, in which no deficiency is determined, advising the taxpayer
that a penalty for fraud is due, is a valid basis for jurisdiction to this
Court. [Id.; emphasis added.]
Applying this logic, we find that this Court has jurisdiction
to the extent necessary to redetermine whether any section
6663 fraud penalties are applicable.
II. Fraud With Respect to Overstated Withholding Credits
Respondent has the burden of proving fraud by clear and
convincing evidence. See sec. 7454(a); Rule 142(b). To satisfy
the burden of proof, respondent must show by clear and con-
vincing evidence: (1) An underpayment of tax exists for each
year; and (2) Mr. May intended to evade taxes known to be
owing by conduct intended to conceal, mislead, or otherwise
prevent the collection of taxes. See Sadler v. Commissioner,
113 T.C. 99, 102 (1999); Parks v. Commissioner, 94 T.C. 654,
660–661 (1990).
A. Underpayment of Tax
Petitioners argue that there is no underpayment of tax in
these cases and that without an underpayment respondent
cannot properly determine a fraud penalty under section
6663.
Section 6664(a) defines an ‘‘underpayment’’ as:
the amount by which any tax imposed by this title exceeds the excess of—
(1) the sum of—
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152 137 UNITED STATES TAX COURT REPORTS (147)
(A) the amount shown as the tax by the taxpayer on his return, plus
(B) amounts not so shown previously assessed (or collected without
assessment), over
(2) the amount of rebates made.
Section 1.6664–2(c)(1)(i) and (ii), Income Tax Regs., pro-
vides that in making the above computation ‘‘the ‘amount
shown as the tax by the taxpayer on his return’ ’’ is reduced
by the excess of:
(i) The amounts shown by the taxpayer on his return as credits for tax
withheld under section 31 (relating to tax withheld on wages) * * * over
(ii) The amounts actually withheld, actually paid as estimated tax, or
actually paid with respect to a taxable year before the return is filed for
such taxable year.
This regulation encompasses the situation in which a tax-
payer overstates the credit for withholding. See also sec.
1.6664–2(g), Example (3), Income Tax Regs. Accordingly, if a
taxpayer overstates prepayment credits, such as the credit
for wages withheld, the overstatement decreases taxes due as
shown on the return and increases the underpayment of tax.
Rice v. Commissioner, supra.
Petitioners first argue that no underpayment exists
because the disallowed withholding credits do not meet the
definition of an underpayment under section 6664, taking
into account the provisions of section 6211. However, we
have found that ‘‘restrictions in section 6211(b)(1), excluding
estimated tax and withholding credits from the calculation of
a deficiency, no longer apply to an underpayment’’. Feller v.
Commissioner, 135 T.C. 497, 507–508 (2010). The Court in
Feller also found that section 1.6664–2(c)(1), Income Tax
Regs., validly interprets the definition of ‘‘underpayment’’ in
section 6664 and therefore extends the meaning of ‘‘under-
payment’’ to include a taxpayer’s overstated credits for with-
holding. Id. at 503, 510–511; sec. 1.6664–2(g), Example (3),
Income Tax Regs. As a result, we reject petitioners’ first
argument.
Petitioners next argue that no underpayment exists
because taxes were actually withheld from Mr. May’s pay-
checks and petitioners are entitled to the withholding credits
even though the tax withholdings were not paid to the
Government. In support of their position, petitioners cite sec-
tion 1.31–1(a), Income Tax Regs., which states in part that
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(147) MAY v. COMMISSIONER 153
‘‘If the tax has actually been withheld at the source, credit
or refund shall be made to the recipient of the income even
though such tax has not been paid over to the Government
by the employer.’’
In United States v. Blanchard, 618 F.3d 562, 576 (6th Cir.
2010), the defendant owned and operated his business and
withheld taxes from his own paychecks but failed to remit
those withholdings to the Government. In affirming the
defendant’s conviction under 18 U.S.C. sec. 287 for making
a false claim for a tax refund with regard to his personal
taxes, the court stated:
Rather than creating an overly formalistic division between the personal
and official capacities of an individual operating as both employer and
employee, which would permit the corporate form to serve as a shield to
individual liability, we find it more consonant with the purposes of § 287
to conduct a functional inquiry into whether funds due the government left
the defendant’s control and so may be deemed ‘‘actually withheld’’ from his
wages. * * * [Id.]
We agree with the Court of Appeals for the Sixth Circuit
that the proper test to determine whether actual withholding
at the source occurred should consider whether the funds
functionally left the control of a taxpayer. Such a test should
not be strictly constrained by the multiple identities one per-
son may have when acting in both a personal and a corporate
capacity.
In applying the test, we look to the facts of the case. Mr.
May was not only a shareholder, employee, and officer of
Maranatha; he was also president and CEO. He was the per-
son responsible for Maranatha’s failure to remit tax
withholdings (including his own) to the Government and
knew that those withholdings were not being remitted. Mr.
May had sole check signature authority on Maranatha’s cor-
porate bank account, giving him full control of its finances.
Even though he was technically subject to tax withholding,
we believe Mr. May is more analogous to a person filing a
completely falsified Form W–2, given his knowledge and
participation in failing to remit the withholdings.
The fact that control of the funds shifted from Mr. May’s
personal/employee identity to his corporate/employer identity
is of no consequence. Mr. May was entrusted with the with-
held funds and misappropriated them back to the corporate
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154 137 UNITED STATES TAX COURT REPORTS (147)
account which he controlled, using them to continue oper-
ation of the corporation in which he had an equity stake and
which paid him an annual salary of $260,000. At all times
during and after this act of misappropriation Mr. May deter-
mined how those funds would be used. Because Mr. May was
responsible for the nonremittance and fully controlled the
corporate finances, we conclude that the funds never left Mr.
May’s functional control and were therefore not ‘‘actually
withheld at the source’’ from his wages for purposes of sec-
tion 1.31–1(a), Income Tax Regs. Section 1.31–1(a), Income
Tax Regs., is therefore inapplicable, and petitioners’ reliance
on it is misplaced.
When a taxpayer has overstated credits for tax
withholdings, ‘‘the overstatement decreases the amount
shown as the tax by the taxpayer on his return and increases
the underpayment of tax.’’ Sadler v. Commissioner, 113 T.C.
at 103; see also sec. 1.6664–2(g), Example (3), Income Tax
Regs. The facts here establish petitioners’ liability for the
underpayments determined by respondent with respect to
such withholdings. As a result, we hold that petitioners have
underpayments of taxes of $105,618, $109,276, and $84,776
for years 1994, 1995, and 1996, respectively.
B. Fraudulent Intent
Respondent must prove by clear and convincing evidence
that a portion of the underpayment for each taxable year in
issue was due to Mr. May’s fraud. See Profl. Servs. v.
Commissioner, 79 T.C. 888, 930 (1982). Once respondent
establishes that any portion of an underpayment is attrib-
utable to fraud, the entire underpayment is subject to the 75-
percent penalty, except with respect to any portion of the
underpayment that petitioners establish is not attributable
to fraud. See sec. 6663(a) and (b). The existence of fraud is
a question of fact to be resolved upon consideration of the
entire record. See King’s Court Mobile Home Park, Inc. v.
Commissioner, 98 T.C. 511, 516 (1992). Mr. May’s entire
course of conduct may establish the requisite fraudulent
intent. See Stone v. Commissioner, 56 T.C. 213, 223–224
(1971).
Mr. May was responsible for Maranatha’s failure to remit
employee tax withholdings, including his own. In spite of his
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(147) MAY v. COMMISSIONER 155
admitted knowledge and orchestration of Maranatha’s failure
to remit those withholdings, Mr. May chose to claim credits
for the unremitted withholdings on his personal income tax
returns. Mr. May was later convicted of tax evasion with
respect to his personal income taxes and willful failure to
account for and pay over payroll taxes while working for
Maranatha.
We conclude that respondent has proved by clear and con-
vincing evidence that petitioners fraudulently underpaid tax
for each of the years at issue with respect to the withholding
credits. Accordingly, we hold that the 75-percent fraud pen-
alty is justified with respect to the underpayments resulting
from overstated withholding credits for the years at issue.
III. Deficiencies Resulting From Disallowed Deductions for
State and Local Income Taxes Paid and Fraud With
Respect to any Such Deficiencies
The Commissioner’s determinations in the notice of defi-
ciency are presumed correct, and the taxpayer bears the bur-
den of proving that they are incorrect. See Rule 142(a); Welch
v. Helvering, 290 U.S. 111, 115 (1933). However, the
Commissioner has the burden of proving fraud by clear and
convincing evidence. See sec. 7454(a); Rule 142(b). To satisfy
the burden of proof for fraud, the Commissioner must show
by clear and convincing evidence: (1) An underpayment of tax
exists; and (2) the taxpayer intended to evade taxes known
to be owing by conduct intended to conceal, mislead, or other-
wise prevent the collection of taxes. See Sadler v. Commis-
sioner, supra at 102; Parks v. Commissioner, 94 T.C. at 660–
661.
Petitioners make several claims with regard to the unpaid
State and local income taxes deducted on their Federal tax
returns for the years at issue. Petitioners’ first claim is that
because the State income tax amounts were withheld by
Maranatha from Mr. May’s personal paycheck they are enti-
tled to the deduction, even though Maranatha failed to pay
over the amounts to State tax authorities. Petitioners’ second
claim is that if their first claim fails, the State income tax
amounts withheld should never have been included in peti-
tioners’ gross income, as they never received these withheld
amounts. This would result in petitioners’ being entitled to
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156 137 UNITED STATES TAX COURT REPORTS (147)
an offsetting deduction equal to the disallowed State income
tax deduction with no corresponding deficiency. Petitioners’
third claim is that they paid all local income taxes owed for
the years at issue. Petitioners’ final claim is that the period
of limitations has expired because respondent has not proven
that the deficiencies are a result of fraud. We shall address
each claim in turn.
A. Whether Petitioners Are Entitled to the Deductions as a
Result of the Withholdings
Petitioners claim that the amounts withheld from Mr.
May’s paycheck for State income taxes entitle them to Fed-
eral income tax deductions for those taxes under section 164.
We disagree. Like the withholdings for Federal taxes, the
withholdings from Mr. May’s paycheck for State income taxes
were not remitted to the proper authorities. Those
withholdings remained in Maranatha’s bank account under
the functional control of Mr. May. Mr. May knew of and
orchestrated Maranatha’s failure to remit the withholdings,
using these funds to continue operation of the business in
which he owned an equity stake and which employed him at
an annual salary of $260,000.
For the same reasons stated above with respect to Federal
tax withholdings, we find that no actual withholding
occurred with respect to State income taxes. See supra pp.
153–154. Consequently, we hold petitioners are not entitled
to deductions for any amounts allegedly withheld for State
income taxes.
B. Whether Reductions in Gross Income Resulted
Petitioners claim that if the amounts withheld from Mr.
May’s paycheck for State income taxes do not entitle them to
deductions, then those amounts should not be included in
calculating their gross income because those amounts were
withheld from Mr. May’s wages and never received by peti-
tioners. We disagree.
We have previously found that Mr. May retained func-
tional control of all withheld funds. See supra pp. 153–154.
The funds were kept in the account for the corporation of
which Mr. May was president, CEO, shareholder, officer, and
employee. Mr. May had full control of the corporate finances.
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(147) MAY v. COMMISSIONER 157
Those funds were used to benefit the corporation in which
Mr. May held an equity stake and which paid Mr. May an
annual salary of $260,000.
Given Mr. May’s actions in keeping the withholdings in
Maranatha’s account, the amount of control he exercised over
the funds in Maranatha’s account, and the benefits accruing
to Mr. May as a result of the nonremittance, we view these
funds more as capital contributions to Maranatha out of Mr.
May’s paychecks than as funds never received by petitioners.
Therefore, the funds were properly included in petitioners’
gross income.
C. Whether Local Income Taxes Were Paid
Petitioners claim that no local income taxes were due for
1994 and testified they paid local income taxes of $1,896 and
$2,000 for 1995 and 1996, respectively, by personal check.
Petitioners produced a copy of a canceled check for $2,550 for
the 1996 local taxes endorsed by the city of Xenia, but no
such evidence has been produced for taxable year 1995.
In 1996 petitioners owed $2,000 in local income taxes and
$1,778 in local real estate taxes. Only the $2,000 in local
income taxes was disallowed as a deduction; the $1,778
deduction for local real estate taxes was allowed. Petitioners’
check for $2,550 gave no indication of the portion paid
toward local income or local real estate taxes. Because the
burden of proof is on petitioners, we will assume that the
check first went toward paying local real estate taxes of
$1,778, with the remaining $772 being paid toward local
income taxes.
We find that petitioners have met their burden of proof
with respect to $772 of the 1996 local income taxes but not
with respect to the 1995 local income taxes. Therefore, peti-
tioners are entitled to a deduction of $772 for 1996 local
income taxes. The amount of the deficiency for that year
shall be reduced accordingly.
D. Whether the Period of Limitations May Be Extended as
a Result of Fraud
Petitioners argue that the normal 3-year period of limita-
tions to issue a notice of deficiency under section 6501(a) has
expired and that respondent cannot show fraud to increase
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158 137 UNITED STATES TAX COURT REPORTS (147)
this period of limitations under section 6501(c)(1) because no
tax deficiency exists. Petitioners argue in the alternative that
even if a deficiency exists, respondent still cannot show fraud
because Mr. May’s actions amounted only to an honest mis-
take, negligence, or inadvertence.
We have already found that nonremittance of the State
and local income taxes created deficiencies. See supra pp.
155–157. The only remaining issue is whether Mr. May’s
actions were fraudulent.
The burden is upon respondent to prove that Mr. May filed
a false return with the intent to evade tax for each year at
issue. See sec. 7454(a); Rule 142(b). Because direct evidence
of an intent to evade tax is rarely available, intent may be
proved by circumstantial evidence and reasonable inferences
from the facts. Petzoldt v. Commissioner, 92 T.C. 661, 699
(1989).
Mr. May was responsible for Maranatha’s failure to remit
employee State tax withholdings, including his own. In spite
of his admitted knowledge and orchestration of Maranatha’s
failure to remit such withholdings, Mr. May chose to claim
deductions for the unremitted withholdings on his personal
tax returns.
We conclude that respondent has proved by clear and con-
vincing evidence that Mr. May filed returns for the years at
issue with the intent to evade tax. Therefore, the 3-year
period of limitations under section 6501(a) does not apply for
any of the years at issue, and respondent was not barred
from issuing the notices of deficiency for those years.
E. Fraud With Respect to State and Local Tax Deficiencies
Respondent has established by clear and convincing evi-
dence that Mr. May engaged in fraudulent activity with
respect to the deficiencies resulting from disallowed State
and local tax deductions. See supra pp. 157–158.
Once the Commissioner establishes that any portion of an
underpayment is attributable to fraud, the entire under-
payment is treated as attributable to fraud and subject to a
75-percent penalty, except with respect to any portion of the
underpayment that the taxpayer establishes is not attrib-
utable to fraud. Sec. 6663(a) and (b); Sadler v. Commissioner,
113 T.C. at 105. Petitioners have not met this burden. There-
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(147) MAY v. COMMISSIONER 159
fore, the fraud penalty is applicable to all remaining defi-
ciencies resulting from State and local income taxes.
IV. Conclusion
We find Mr. May liable in part for deficiencies resulting
from disallowed deductions for State and local income taxes
paid. We also find Mr. May liable for section 6663 fraud pen-
alties with respect to all claimed withholding tax credits as
well as all remaining deficiencies resulting from disallowed
deductions for State and local income taxes.
In reaching our holdings herein, we have considered all
arguments made, and, to the extent not mentioned above, we
conclude they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered under Rule 155 in
docket No. 14385–05.
Decision will be entered for petitioner in
docket No. 4782–07.
f
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