Powerstein v. Comm'r

T.C. Memo. 2011-271

UNITED STATES TAX COURT

ALLEN POWERSTEIN AND RITA POWERSTEIN ROSEN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

ALLEN POWERSTEIN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 30261-89, 13443-92.1 Filed November 16, 2011.

Mitchell I. Horowitz and Micah G. Fogarty, for petitioners.

Stephen R. Takeuchi and Robert W. Dillard, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

LARO, Judge: At the heart of these cases is petitioner

Allen Powerstein (Mr. Powerstein), a former certified public

1
These cases were consolidated for purposes of trial,
briefing, and opinion pursuant to Rule 141(a).
 - 2 -

accountant (C.P.A.) who in 1993 pleaded guilty to criminal tax

evasion in violation of section 7201.2 At issue are the 1984

through 1988 joint Federal income taxes of petitioners Mr.

Powerstein and Rita Powerstein Rosen (Ms. Rosen) and the 1989

individual Federal income tax of Mr. Powerstein.

In docket No. 30261-89, petitioners petitioned the Court to

redetermine respondent’s determination of the following Federal

income tax deficiencies and additions to tax:

Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b)(1) 6653(b)(2) 6653(b)(1)(A) 6653(b)(1)(B) 6661

1984 $28,664 $14,374 $7,918 -0- -0- $7,166
1985 48,948 24,474 9,520 -0- -0- 12,237
1986 38,186 -0- -0- $28,640 $5,095 9,547
1987 39,749 -0- -0- 29,935 2,952 9,937
1988 30,915 23,186 -0- -0- -0- 7,729

In his answer, respondent adjusted the deficiencies and additions

to tax, decreasing the amounts for 1984 and 1985 and increasing

the amounts for each of the years 1986 through 1988 as follows:

Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b)(1) 6653(b)(2) 6653(b)(1)(A) 6653(b)(1)(B) 6661

1984 $1,599 $842 $442 -0- -0- -0-
1985 23,492 11,695 4,549 -0- -0- $5,873
1986 47,566 -0- -0- $35,353 (1) 11,892
1987 58,251 -0- -0- 43,536 (1) 14,563
1988 58,187 43,563 -0- -0- -0- 14,547
1
Respondent determined that if the addition to tax under sec. 6653(b)(1)(A)
applies, then the addition to tax under sec. 6653(b)(1)(B) applies in an
amount equal to 50 percent of the interest payable with respect to the portion
of the underpayment that is due to fraud.

2
Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code, and Rule
references are to the Tax Court Rules of Practice and Procedure.
Some dollar amounts have been rounded.
 - 3 -

In docket No. 13443-92, Mr. Powerstein petitioned the Court to

redetermine respondent’s determination of a $49,000 deficiency in

his 1989 Federal income tax and a $36,750 fraud penalty under

section 6663.

After concessions by the parties,3 we decide: (1) Whether

the burden of proof shifts to respondent with respect to his

reconstruction of petitioners’ net worth for 1984 through 1988.

We hold that it does to the extent stated herein; (2) whether

petitioners omitted income of $5,668, $42,212, $107,089,

$153,670, and $153,351, for 1984 through 1988, respectively. We

hold that they omitted income of $3,624, $83,739, $85,702,

3
In docket No. 30261-89, the parties agree that petitioners
(1) failed to report interest income of $2,148, $79, $239, $101,
and $2,409 for 1984 through 1988, respectively; (2) understated
dividend income of $138, $200, and $196 for 1984 through 1986,
respectively; (3) received $563 of dividends for 1987 of which
$282 is excluded from income as a nontaxable distribution; (4)
failed to report net capital gains of $3,167 for 1984, (5) failed
to report net capital gains of $2,282 and instead reported a net
capital loss of $2,926, resulting in a $5,208 adjustment for
1986; and (6) overstated capital losses by $2,747 and $875 for
1987 and 1988, respectively. In docket No. 13443-92, the parties
agree that for 1989 Mr. Powerstein (1) failed to report gross
receipts of $56,063 on Schedule C, Profit or Loss From Business;
(2) is entitled to deduct $67,250 of legal fees as an expense on
Schedule C; (3) is not entitled to a $122 loss on Schedule F,
Profit or Loss From Farming; (4) failed to report capital gains
of $4,058; (5) is not entitled to a fuel tax credit of $63; (6)
is liable for self-employment tax of $6,250; and (7) is not
liable for a fraud penalty under sec. 6663 but is liable for an
accuracy-related penalty under sec. 6662. We deem petitioners to
have conceded that the period of limitations for assessment of
their 1984 through 1988 Federal income taxes is open and that Ms.
Rosen is not entitled to relief under sec. 6013(e), by virtue of
the fact that these issues were not raised at trial or on brief.
See Nicklaus v. Commissioner, 117 T.C. 117, 120 n.4 (2001).
 - 4 -

$145,266, and $142,637, for 1984 through 1988, respectively; (3)

whether petitioners are entitled to deductions related to Mr.

Powerstein’s accounting practice. We hold they are to the extent

stated herein; (4) whether petitioners are entitled to a $22,290

loss as reported on their 1988 Schedule F. We hold they are not;

(5) whether petitioners may use special income-averaging

provisions pursuant to section 1305. We hold they may not; (6)

whether Mr. Powerstein may deduct $65,778 of interest which

respondent jeopardy-assessed and collected by levy in 1989. We

hold he may not; (7) whether petitioners are liable for additions

to tax under section 6653(b) for 1984 through 1988. We hold that

Mr. Powerstein is to the extent stated herein, and that Ms. Rosen

is not; and (8) whether petitioners are liable for additions to

tax under section 6661 for 1985 through 1988. We hold they are.

FINDINGS OF FACT

I. Preliminaries

The parties submitted to the Court numerous stipulations of

fact and accompanying exhibits. The stipulated facts and

exhibits submitted therewith are incorporated herein by this

reference. We find the stipulated facts accordingly. When their

respective petitions were filed, petitioners resided in Florida.

II. Mr. Powerstein

Mr. Powerstein was raised in Brooklyn, New York (Brooklyn),

and he served in the U.S. Army from May 4, 1958, through May 3,
 - 5 -

1964. He holds a bachelor of business administration degree in

accounting from the City College of New York, and he has

completed work towards a master’s degree. He was a C.P.A. from

June 1967 until at least January 1987.

Between May 1964 and 1976 Mr. Powerstein was an accountant

at various accounting firms and businesses. Beginning in 1965

and at all relevant times, he operated a bookkeeping, accounting,

and tax return preparation business; namely, Allen D. Powerstein,

CPA (accounting firm).

III. Ms. Rosen

Ms. Rosen was born and raised in Brooklyn. She graduated

from high school and did not attend college. Over the years, Ms.

Rosen was mostly a homemaker though she occasionally held a job

during some of the years in issue.

IV. Petitioners

Petitioners were married in June 1957 and have two children;

namely, Madelyn Ballard (Ms. Ballard) and Irene Powerstein (Ms.

I. Powerstein). Mr. Powerstein was the household’s primary

income producer, and he regularly provided financial assistance

to Ms. Ballard into her adult years. Throughout the years in

issue, petitioners incurred typical household expenses, including

amounts for groceries, utilities, and other necessities.
 - 6 -

Petitioners were married until July 1989, at which time they

legally divorced.4

V. The Ballards

Ms. Ballard and Michael Ballard (Mr. Ballard) (collectively,

the Ballards) were married in 1983, and they had at least one

child; namely, K.B. Mr. Ballard was raised on a farm in

Arkansas. He drank alcohol during the years in issue, and he has

been convicted of driving under the influence.

VI. Coral Springs Residence

Petitioners lived in Brooklyn until 1972, when they moved

their family and household property to Miami, Florida. They paid

$6,700 for a parcel of land in Coral Springs, Florida, and

subsequently built a home (Coral Springs residence) thereon.

They deposited $500 with respect to that residence and secured a

$60,472 residential loan (first Glendale mortgage) from Glendale

Federal Bank (Glendale Bank) after construction of the residence

was completed.5 Petitioners’ actual cost of constructing that

home exceeded its estimated cost by approximately $11,191. In

addition to principal and interest due under the first Glendale

mortgage, petitioners also impounded (escrowed) $153 per month

4
Despite their divorce, petitioners continued to live
together, Mr. Powerstein continued to support the family, and Ms.
Rosen continued to maintain the household.
5
The first Glendale mortgage was issued by First Federal
Savings & Loan of Broward County (First Federal). We refer to
First Federal and its successors as Glendale Bank.
 - 7 -

for real estate taxes. In 1978 petitioners moved in to the Coral

Springs residence, and they continued to live there through

August 1984.

Petitioners refinanced the first Glendale mortgage in

February 1984 with a $100,000 loan (second Glendale mortgage)

from Glendale Bank. At the closing of the second Glendale

mortgage, petitioners escrowed 5 months of real estate taxes

totaling $453. Payments due under the second Glendale mortgage

impounded $91 per month for real estate taxes. During 1984

petitioners made nine payments against the second Glendale

mortgage totaling $9,324, of which $820 was paid through escrow

for real estate taxes. During 1985 petitioners made two payments

against the second Glendale mortgage totaling $2,072.

In early-to-mid-1984, petitioners contracted to sell the

Coral Springs residence to Dale Underhill (Mr. Underhill) and

Mona Underhill (Ms. Underhill) (collectively, the Underhills) for

$112,000. The Underhills deposited $8,000 to an interest-bearing

account (Underhill account) at Atlantic Federal Savings & Loan

(Atlantic Bank) which was jointly held by Mr. Powerstein and Mr.

Underhill in trust for Ms. Rosen and Ms. Underhill. That deposit

served as a downpayment for the purchase of the Coral Springs

residence, and as of December 31, 1984, the Underhill account had

earned interest of $259.
 - 8 -

The Underhills leased the Coral Springs residence beginning

in August 1984 and continued to do so through April 1985, at

which time they secured financing to close the sale. Although

the Underhills paid rent of $1,000 per month to petitioners, this

income was not reported as taxable on petitioners’ Federal income

tax returns. After the Underhills began leasing the Coral

Springs residence, petitioners moved to Romeo, Florida (Romeo).

On April 12, 1985, the sale of the Coral Springs residence closed

for $112,000, and petitioners realized net proceeds of $107,201.

At the closing, petitioners were charged $288 for unpaid county

taxes from January 1 through April 11, 1985, and $234 for taxes

related to 1980.

VII. Vacation Home

On November 14, 1981, petitioners purchased a residence in

Lake Lure, North Carolina. In or around 1983, the Powersteins

exchanged that property and additional consideration to purchase

a second residence in Lake Lure, North Carolina (vacation home).

The cost of acquiring the vacation home totaled $7,333, and

petitioners paid $53 of real estate taxes on it in 1984.

VIII. Romeo Property

A. Overview

In August 1983 petitioners purchased an 11.06-acre wooded

parcel of land (Romeo property) in Romeo for $20,009. Shortly

thereafter, the Ballards moved to the Romeo property to make the
 - 9 -

land habitable. With the help of local workers, the Ballards

cleared the Romeo property and installed fences, roads, and other

improvements. The Ballards left their jobs to move to the Romeo

property and, having earned no wages in 1984, received support

from petitioners. The Ballards lived on the Romeo property in a

tent for approximately 6 months and eventually constructed a

wooden cabin which they lived in temporarily.

B. Improvements

Petitioners purchased two mobile homes in 1983 and 1984, and

situated those homes on the Romeo property in close proximity.

First, they purchased a mobile home (Pine Street mobile home) for

$26,164 which the Ballards used as their residence. Second,

petitioners purchased a mobile home (Addison mobile home) for

$23,431 which they lived in. By August 1984 the Ballards and

petitioners had also improved the Romeo property with, among

other improvements, a three-stall barn, a pump house, fencing,

and a septic tank.

C. Mortgages

Petitioners mortgaged the Romeo property with a $26,000 loan

(first Sun Bank mortgage) from Sun Bank of Ocala (Sun Bank) in

January 1984. On or about October 5, 1984, petitioners retired

the first Sun Bank mortgage with a second loan (second Sun Bank

mortgage) for $53,918 which was secured by the Romeo property.

The second Sun Bank mortgage remained until October 5, 1987, when
 - 10 -

petitioners refinanced that mortgage with a $51,068 loan (first

Mid State mortgage) from Mid State Federal Savings and Loan (Mid

State). Petitioners satisfied the first Mid State mortgage

through a loan (second Mid State mortgage) in or around 1988.

D. Farming Activities

Although they lacked experience to do so, petitioners became

minimally engaged in farming activities after moving to the Romeo

property. Without conducting due diligence of the agricultural

feasibility of using the Romeo property as a farm, they

purchased, among other things, a tractor for $10,500 and a

chainsaw for $600. They raised approximately 16 head of cattle,

2 horses, pigs, and chickens; and although they sold 2 head of

cattle at a livestock market in 1985, they mostly used these

animals for personal consumption and enjoyment. They also

attempted to grow several types of crops without success. By

July 1989 petitioners had abandoned their farming activity.

IX. Petitioners’ Support of the Ballards

A. Overview

During the years in issue Mr. Powerstein furnished

considerable support to the Ballards. By letter dated April

1986, petitioners stated that they paid support to the Ballards

of $4,870 in 1985 and $1,635 through April 1986. This support

included rent, utility payments, food, and medical bills.
 - 11 -

B. M&M

The Ballards incorporated M&M Tree Service, Inc. (M&M) as

equal shareholders on or about October 13, 1983. Through M&M,

the Ballards provided landscaping and tree services in central

Florida during 1984 and 1985. Mr. Powerstein provided most, if

not all, of the financing for the startup and operation of M&M.

He purchased various assets for M&M, including the tractor and

the chainsaw which petitioners used in their farming activity.

C. Income

The Ballards received minimal income during the years in

issue, and they received support in addition to that described

above. The Ballards’ 1984 joint return reported zero wages,

interest income of $131, a $28,659 distributive loss from M&M,

and total income of negative $28,528. The Ballards’ 1985 joint

return reported wages of $780, interest income of $83, a $19,714

distributive loss from M&M, and total income of negative $18,851.

The Ballards’ 1986 joint return reported wages of $5,963,

interest income of $439, and total income of $6,402. The

Ballards’ 1987 joint return reported wages of $8,749, interest

income of $135, a $2,098 net farm loss, and total income of

$6,786. The Ballards’ 1988 joint return reported wages of

$13,108, interest income of $86, a $3,348 net farm loss, and

total income of $9,846.
 - 12 -

X. Financial Arrangement With Clients

After petitioners moved to the Romeo property in 1984, Mr.

Powerstein continued to operate his accounting firm in South

Florida, and he frequently traveled there by car. He was

diligent in preparing original and amended Federal income tax

returns for his clients, but far from honest. He significantly

understated income and overstated deductions on his clients’

Federal income tax returns as early as 1983. For example, Mr.

Powerstein wrote the following letter to two clients in 1985:

Received your recent letter and IRS letter
regarding the 1983 taxes. Before I explain the real
meaning of their letter, I must point out that I am not
surprised that we got such a letter and that the IRS
computer is accurate in tracking bank interest reported
on 1099s. We must carefully reply to [the] IRS and
explain what we did and if there is any additional tax
to pay, and I am not saying there will be, we will pay
it at the appropriate time.

* * * * * * *

Here is why I like their letter:

1) I reported the Ford pension of $4,634, but showed
the entire amount to be non-taxable and the IRS did not
question this. I know you are both aware of this.

2) I claimed Airlift International as a worthless
security in the amount of $4,251, however it really
cost you $1,251. IRS did not question this.

3) I claimed a $2,000 exclusion for All-Savers
Certificates at American Savings, when in fact you
never had an All-Saver Certificate. IRS did not
question this.

4) I claimed a $200 exclusion against the Merrill Lynch
dividends. These dividends do not qualify for the
exclusion. IRS did not question this.
 - 13 -

5) I claimed 3-additional exemptions * * * which the
IRS did not question. Each exemption is $1,000 or a
total of $3,000 which we are really not entitled to.

6) I claimed a political party contribution credit of
$100. IRS did not question this.

7) I claimed a residential energy credit carryforward
from 1982 which the IRS did not question.

Here is what the IRS picked up:

1) I reported * * * 50% of the Chase Federal interest
that you earned in 1983 on account no. (IRS does not
know the account number as they show the number to be
10-zeroes). * * *

2) I reported a CD penalty forfeiture of $2,479 which
the IRS has no record of receiving from any of our
banks. I know the IRS is correct and we will concede
on this point at the time I answer on the Chase Federal
account. * * *

* * * * * * *

* * * Please understand that the IRS sends these
letters out to anyone who fails to report the amount
shown on the 1099, namely in our case Chase Federal.
The CD penalty is something else. This is a routine
letter but important to answer on time. Just think if
they decided to audit the return on all the points I
raised in the early part of this letter. You would owe
a fortune. Speak to noone at the bank about the IRS
letter but only that we need an amended 1099.

For preparing his clients’ amended Federal income tax

returns, Mr. Powerstein charged a contingent fee of one-third to

one-half of the amount refunded to his clients. He reported the

return address on the amended return as a P.O. Box in his name,

and the refunds were sent to that address. Upon receipt of a

refund check, Mr. Powerstein contacted his client, went to the

bank with that client, deposited the check, and took his “share”.
 - 14 -

XI. Loan Applications

In connection with their various mortgages, petitioners

completed and submitted various bank loan applications that

reported income greater than that reported on their joint Federal

income tax returns. First, they estimated the net income from

the accounting firm for 1977 as $24,185 on a residential loan

application to Glendale Bank dated August 2, 1977 (1977 loan

application). However, petitioners reported business income from

the accounting firm of only $3,289 on their 1977 joint Federal

income tax return (1977 joint return). Second, they estimated

the net income from the accounting firm for 1978 as $31,262 on a

residential loan application to Glendale Bank dated September 19,

1978 (1978 loan application). However, petitioners reported

business income from the accounting firm of only $3,060 on their

1978 joint Federal income tax return (1978 joint return).

Third, they estimated the net income from the accounting

firm for 1983 as $27,500 on a residential loan application to Sun

Bank dated December 23, 1983 (1983 loan application). However,

petitioners reported business income from the accounting firm of

only $195 on their 1983 joint Federal income tax return (1983

joint return). Attached to the 1983 loan application were

purported joint Federal income tax returns for petitioners for

1981 and 1982 (purported 1981 and 1982 returns, respectively)

which reported business income from the accounting firm of
 - 15 -

$24,028 and $23,886, respectively. The amounts reported as

business income from the accounting firm on the purported 1981

and 1982 returns did not match the amounts reported on the 1981

and 1982 joint Federal income tax returns (respectively, 1981 and

1982 joint returns) that petitioners filed with respondent.

Fourth, on a residential loan application to Sun Bank dated June

20, 1984 (1984 loan application), petitioners estimated their

1984 net income from the accounting firm as $26,000. However,

petitioners reported a business loss from the accounting firm of

$996 on their 1984 joint Federal income tax return (1984 joint

return).

XII. Investments

A. Bank Accounts

During the years at issue, petitioners maintained at least

40 bank accounts. Most of the accounts were held jointly in

petitioners’ names. However, Mr. Powerstein held certain

accounts jointly or in trust for Pearl Powerstein (Ms. P.

Powerstein), his step-mother; Ann Pasternak (Ms. Pasternak), his

aunt; or Stacey Korman (Ms. Korman), his cousin.

B. Investments

During the subject years petitioners also purchased more

than $200,000 in stock and debt of various companies. Included

in the stock purchased were 775 shares of Charme Properties, Inc.

(Charme). Charme filed a chapter 11 bankruptcy petition on May
 - 16 -

11, 1984, which the bankruptcy court subsequently converted to a

chapter 7 liquidation in 1985. Charme forfeited its corporate

charter with the Delaware secretary of state on September 24,

1985, though the bankruptcy continued into April 1995 when final

distributions were made.

XIII. Asset Transfers

Between February 23 and May 25, 1989, Mr. Powerstein and/or

Ms. Rosen transferred approximately 30 bank accounts to Ms.

Ballard and Ms. I. Powerstein, either individually or as trustees

for K.B. On March 6, 1989, Mr. Powerstein and Ms. Rosen deeded

the vacation home to Ms. Ballard and Ms. I. Powerstein as joint

tenants for $10. Also on March 6, 1989, Mr. Powerstein and Ms.

Rosen deeded the Romeo property to Ms. Ballard and Ms. I.

Powerstein as joint tenants for $10.

XIV. Federal Tax Reporting

Petitioners filed joint Federal income tax returns for years

before 1989, including returns for 1983 through 1988 (1983

through 1988 joint returns, respectively). The 1983 joint return

reported wages of $7,629, interest income of $14,305, dividend

income of $227 of which $200 was excludable from gross income,

business income of $195, a capital loss of $696, and total income

of $21,475. Attached to the 1983 joint return was Schedule B,

Interest and Dividend Income, which reported interest earned from

All-Savers Certificates of $2,000.
 - 17 -

The 1984 joint return reported wages of $5,244, interest

income of $19,396; dividend income of $138, all of which was

treated as nontaxable; a business loss of $996; net capital gain

of $168; and total income of $23,812. Attached to the 1984 joint

return was a Schedule C which reported income that Mr. Powerstein

received from two clients. The 1985 joint return reported

interest income of $23,705; dividend income of $427, of which

$200 was excluded from gross income; business income of $392; net

capital gain of $2; and total income of $24,326. The 1986 joint

return reported interest income of $27,288; dividend income of

$602, of which $200 was excluded from gross income; a business

loss of $5,505; a net capital loss of $2,926; and total income of

$19,259. The 1987 joint return reported interest income of

$30,224; dividend income of $263; a business loss of $8,924; a

capital loss of $2,976; and total income of $18,587. The 1988

joint return reported interest income of $35,298, dividend income

of $822, a business loss of $24,279, a capital loss of $1,131,

and total income of $10,710. Attached to the 1988 joint return

was a Schedule C which reported a $1,989 loss from the accounting

firm and a Schedule F on which petitioners reported a $22,290

loss from growing vegetables and melons. Also attached to the

1988 joint return was Form 4562, Depreciation and Amortization,

on which petitioners reported 7-year property with a depreciable

basis of $1,442.
 - 18 -

Mr. Powerstein filed an individual Federal income tax return

for 1989 (1989 return). The 1989 return reported interest income

of $7,214, dividend income of $974, a business loss of $118,953,

capital gains of $8,458, a farm loss of $122, and total income of

negative $102,429.

XV. Criminal Proceeding

A. Preliminary Investigation

In early 1989 the Questionable Refund Detection Team (QRDT)

of the Atlanta, Georgia, Service Center forwarded information to

the Criminal Investigation Division (CID) of the Internal Revenue

Service (IRS) in Jacksonville, Florida, indicating that Mr.

Powerstein had prepared false Federal tax returns on behalf of

numerous individuals. CID investigated Mr. Powerstein, contacted

third parties, and issued summonses in furtherance of that

investigation.

B. Search Warrant

On July 19, 1989, special agents with CID executed a search

warrant at the Addison mobile home, three detached outbuildings,

and automobiles located on the Romeo property. Among the

documents seized were financial records related to the accounting

firm, client files, correspondence, check registers, deposit

tickets, envelopes containing cash receipts, and bank documents

and statements. CID did not find books, records, cash

disbursement journals, or bank reconciliation papers. An
 - 19 -

envelope with more than $1,000 was also found in the Addison

mobile home. The special agents who executed the search warrant

inventoried the seized items by description and location found.

C. Jeopardy Assessment

Respondent determined that collection of the deficiencies

allegedly due from petitioners was in jeopardy because, among

other things, Mr. Powerstein was perceived as a flight risk who

placed assets beyond the reach of the Federal Government by

transferring them to nominees. Respondent’s auditor used the net

worth and expenditures method to determine the amounts to be

jeopardy-assessed. The auditor made these determinations over a

4-day period in which information seized from the Romeo property

was examined and analyzed.

For jeopardy assessment purposes, respondent’s auditor

calculated petitioners’ increase in net worth between December

1988 and July 1989. Petitioners’ opening net worth was

determined from the 1983 loan application, and their ending net

worth was determined by reference to bank account balances as of

July 1989. The difference between petitioners’ ending and

opening net worth was allocated equally over each of the years

1984 through 1988; i.e., the increase in net worth was divided by

5. Additional adjustments were made for each of the years 1984

through 1988 for living expenses and available cash. The net
 - 20 -

worth increase for each of the years 1984 through 1988 was

determined to be business income from the accounting firm.

On July 24, 1989, respondent jeopardy-assessed taxes,

additions to tax, and interest against petitioners for each of

the years 1984 through 1988. See sec. 6861. On July 25, 1989,

respondent issued a notice of jeopardy assessment to petitioners

for 1984 through 1988 in the following amounts:

Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b)(1) 6653(b)(2) 6653(b)(1)(A) 6653(b)(1)(B) 6661

1984 $28,664 $14,374 $7,918 -0- -0- $ 7,166
1985 48,948 24,474 9,520 -0- -0- 12,237
1986 38,186 -0- -0- $28,640 $5,095 9,547
1987 39,749 -0- -0- 29,935 2,952 9,937
1988 30,915 23,186 -0- -0- -0- 7,729

Respondent also jeopardy-assessed interest of $65,778 against

petitioners and collected that amount in 1989 by levying upon

petitioners’ bank accounts. In total, respondent seized $449,513

from petitioners’ various accounts.6 After jeopardy assessment

of petitioners’ assets was made, respondent continued his

criminal investigation by summoning at least 36 banks and

interviewing at least 36 witnesses. Respondent subsequently

redetermined petitioners’ net worth and reflected those

determinations in his answer.

6
Respondent took the position that as of July 24, 1989, the
total tax, additions to tax, and interest purportedly due from
petitioners for 1984 through 1988 was $429,424 (total liability).
As of the date of the trial in these cases, respondent has not
refunded petitioners the $20,089 difference between the amount
seized ($449,513) and the total liability ($429,424).
 - 21 -

D. Indictment

A Federal grand jury in the U.S. District Court for the

Middle District of Florida indicted Mr. Powerstein for various

Federal tax offenses in a 13-count indictment (indictment). The

indictment charged Mr. Powerstein with (1) one count of corruptly

obstructing and impeding the due administration of the internal

revenue laws by preparing and filing false and fraudulent Federal

income tax returns for himself and clients in violation of

section 7212(a); (2) eight counts of knowingly and willfully

aiding and assisting in the preparation and presentation of

materially false income tax returns of clients in violation of

section 7206(2); (3) three counts of knowingly and willfully

attempting to evade taxes during 1986 through 1988 in violation

of section 7201; and (4) one count of publishing a false power of

attorney in violation of 18 U.S.C. sec. 495.

E. Plea Agreement and Sentencing

On July 2, 1993, Mr. Powerstein signed a plea agreement in

which he pleaded guilty to one count of corrupt interference with

the administration of the internal revenue laws in violation of

section 7212(a) and one count of criminal tax evasion in

violation of section 7201. In connection with the plea

agreement, Mr. Powerstein agreed that he prepared and filed false

and fraudulent Federal income tax returns individually and on

behalf of his client-taxpayers in order to fraudulently obtain
 - 22 -

tax refunds. Mr. Powerstein agreed that he understated his 1987

income by approximately $150,159 and that he owed the U.S.

Treasury approximately $53,715 of Federal income tax for 1987.

Mr. Powerstein admitted to preparing fraudulent Forms W-2,

Wage and Tax Statement, which overstated the Federal income taxes

withheld for 79 client-taxpayers. He also admitted to, on

several occasions, creating false and fraudulent Forms W-2 for

client-taxpayers that identified firms or business that had never

employed, paid wages to, or withheld Federal income taxes from

those client-taxpayers. In total, the District Court found that

the total tax losses attributable to Mr. Powerstein were

“slightly less than” $1.5 million.7 On March 31, 1994, the

District Court sentenced Mr. Powerstein to 63 months of

imprisonment, 3 years of supervised release, a fine of $100,000,

and a special assessment of $100.

7
The tax losses included Federal income tax deficiencies and
interest for 1984 through 1988 of $191,812, tax losses of
$246,615 related to the 79 client-taxpayers for whom Mr.
Powerstein prepared fraudulent returns, and tax losses of almost
$1.1 million attributable to Mr. Powerstein’s clients whose
returns were not examined. We observe that the tax losses are
slightly more than $1.5 million.
 - 23 -

XVI. Pleadings

A. Docket No. 30261-89

1. Notice of Deficiency and Petition

By notice of deficiency dated September 21, 1988, respondent

determined deficiencies in petitioners’ 1984 through 1988 Federal

income taxes and additions to tax as follows:

Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b)(1) 6653(b)(2) 6653(b)(1)(A) 6653(b)(1)(B) 6661

1984 $28,664 $14,374 $7,918 -0- -0- $ 7,166
1985 48,948 24,474 9,520 -0- -0- 12,237
1986 38,186 -0- -0- $28,640 $5,095 9,547
1987 39,749 -0- -0- 29,935 2,952 9,937
1988 30,915 23,186 -0- -0- -0- 7,729

The amounts determined in the notice of deficiency were equal to

those determined in the jeopardy assessment; i.e., both

determinations used the same method for calculating net worth.

Thus, the notice of deficiency reports petitioners’ opening net

worth as of December 31, 1983, their closing net worth as of

December 31, 1988, and the increase or decrease during that time

as follows:

12/31/83 12/31/88 Increase/(Decrease)

Stocks $5,000 $43,024 $38,024
Bank accounts 85,000 529,700 444,700
Real estate 107,201 42,461 (64,740)
Total assets 197,201 615,185 417,984

Total liabilities 73,000 -0- -0-

Net worth 124,201 615,185 490,894

Respondent then divided the $490,894 increase to petitioners’ net

worth between 1984 and 1988 by 5 to arrive at petitioners’ annual
 - 24 -

net worth increase, or $98,197. Respondent then determined

petitioners’ business income, as follows:

12/31/84 12/31/85 12/31/86 12/31/87 12/31/88

Increase in net worth $98,197 $98,197 $98,197 $98,197 $98,197
Additions:
Personal living
expenses 25,085 26,781 26,540 26,540 26,540
Subtractions:
Cash available 20,095 3,479 29,903 13,162 10,710
1
Business income 103,187 121,499 94,834 111,575 98,680
1
We observe that respondent’s calculation of business income does not equal
increase in net worth plus personal living expenses less cash available.

Petitioners petitioned the Court in response to the notice

of deficiency, and the Court docketed that case at docket No.

30261-89.

2. Answer

In the answer, respondent asserted that because the notice

of deficiency averaged petitioners’ understatements evenly over

1984 through 1988, petitioners’ reconstructed taxable income was

(1) overstated for 1984 and 1985, and (2) understated for 1986,

1987, and 1988. Accordingly, respondent asserted adjustments to

the deficiencies and additions to tax determined to be due from

petitioners as follows:

Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b)(1) 6653(b)(2) 6653(b)(1)(A) 6653(b)(1)(B) 6661

1984 $1,599 $842 $442 -0- -0- -0-
1985 23,492 11,695 4,549 -0- -0- $5,873
1986 47,566 -0- -0- $35,353 (1) 11,892
1987 58,251 -0- -0- 43,536 (1) 14,563
1988 58,187 43,563 -0- -0- -0- 14,547
1
50 percent of the interest due on the deficiency.
 - 25 -

For purposes of the answer, respondent used the net worth method

to determine increases to petitioners’ 1984 through 1988 taxable

income as follows:

12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88

Net worth
computation:
Cash on hand $188,159 $231,552 $231,848 $325,992 $457,059 $565,765
Investments 26,662 21,441 21,441 23,703 32,935 47,469
Personal assets 26,099 36,599 36,599 36,687 36,687 51,015
Real estate 96,376 143,371 81,171 81,171 81,171 81,171
Additional
investments 9,065 7,422 7,787 7,712 10,082 10,321
Total assets 346,361 440,385 378,846 475,265 617,934 755,741
Loans and
mortgages 72,807 153,627 52,674 51,420 51,023 51,497
Charge accounts -0- -0- -0- -0- -0- -0-
Accumulated
depreciation 6,637 10,535 10,535 6,093 7,755 9,373
Total liabilities 79,444 164,162 63,209 57,513 58,778 60,870
Net worth 266,917 276,223 315,637 417,752 559,156 694,871
Less prior year’s
net worth N/A 266,917 276,223 315,637 417,752 559,156
Net worth increase N/A 9,306 39,414 102,115 141,404 135,715
Personal expenses N/A 25,085 26,781 26,540 28,549 28,549
Less nontaxable
income N/A 5,333 329 4,233 429 203
Adjusted gross
income N/A 29,058 65,866 124,422 169,524 164,061
Less itemized
deductions N/A 15,304 16,087 6,148 8,655 5,000
Less exemptions N/A 3,000 3,120 3,240 5,700 5,850
Corrected taxable
income N/A 10,754 46,659 115,034 155,169 153,211
Reported taxable
income N/A 5,086 4,447 7,945 1,499 (140)
Increase to taxable
income N/A 5,668 42,212 107,089 153,670 153,351

a. Cash On Hand

Respondent determined petitioners’ cash on hand as follows:

Cash in Banks 12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88

American Savings $37,301 $35,003 -0- -0- -0- -0-
Atlantic Bank 3,169 63,430 $10,047 $64,208 $160,961 $202,448
BankAtlantic 51,352 -0- -0- -0- -0- -0-
Barnett Bank -0- -0- -0- -0- -0- 2,670
Biscayne Federal 10,846 10,884 10,930 10,965 10,185 10,185
Brooklyn Federal 158 218 178 142 150 148
California Federal -0- 10,762 75,490 11,912 25,468 10,133
Carteret Savings 10,237 6,368 6,485 6,592 6,699 6,827
 - 26 -
Centrust Savings -0- -0- -0- 10,000 10,000 20,897
Citicorp Savings 6,518 6,419 56,678 126,445 96,775 96,860
City Federal
Savings 20,233 20,233 20,353 20,358 20,364 20,343
Commonwealth 2,590 22,643 22,697 22,750 2,804 2,857
Dime Savings 135 526 559 591 624 659
First Nationwide 2,513 2,858 3,142 -0- -0- -0-
First Union 102 108 114 120 126 132
Fund for
Government Inc. 89 39 39 39 40 40
Glendale Bank -0- 10,512 -0- -0- -0- -0-
Greater New York 3,562 -0- -0- -0- -0- -0-
Hollywood Federal 1,073 1,134 1,198 1,265 1,337 1,412
Mid State Federal -0- -0- -0- 11,446 85,464 154,840
Roosevelt Bank 1,049 1,253 1,438 2,159 1,562 814
Safra Bank 36,832 38,858 22,500 37,000 34,500 34,500
Sun Bank 400 304 -0- -0- -0- -0-
Total 188,159 231,552 231,848 325,992 457,059 565,765

b. Investments

Respondent valued petitioners’ investments in 1983 through

1988 at $35,727, $28,863, $29,228, $31,415, $43,017, and $57,790,

respectively. Included in this determination were 775 shares of

Charme which petitioners contend are worthless.

c. Personal Assets

Respondent valued petitioners’ personal assets as follows:

Description 12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88

1986 Caprice
classic -0- -0- -0- $9,373 $9,373 $9,373
International
tractor -0- $10,500 $10,500 10,500 10,500 10,500
1982 Chevy pickup $15,564 15,564 15,564 15,564 15,564 15,564
1982 Caprice 10,535 10,535 10,535 -0- -0- -0-
1984 Plymouth
Reliant -0- -0- -0- -0- -0- 4,284
1985 Mercury -0- -0- -0- -0- -0- 8,500
1973 Ford truck -0- -0- -0- -0- -0- 2,544
1980 Dodge aspen -0- -0- -0- 1,000 1,000 -0-
1973 Ford S/W -0- -0- -0- 250 250 250
Total 26,099 36,599 36,599 36,687 36,687 51,015

Petitioners contend that they owned additional personal property,

including a copier.
 - 27 -

d. Real Estate

Respondent valued petitioners’ real estate as follows:

Description 12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88

Romeo property $20,009 $20,009 $20,009 $20,009 $20,009 $20,009
Coral Springs
residence 62,200 62,200 -0- -0- -0- -0-
Vacation home 7,333 7,333 7,333 7,333 7,333 7,333
Addison mobile
home -0- 23,431 23,431 23,431 23,431 23,431
Well 1,375 1,375 1,375 1,375 1,375 1,375
Fenceposts 2,358 2,358 2,358 2,358 2,358 2,358
Crossties 501 501 501 501 501 501
Pine Street
mobile home 2,600 26,164 26,164 26,164 26,164 26,164
Total 96,375 143,371 81,171 81,171 81,171 81,171

e. Loans and Mortgages

Respondent valued petitioners’ loans and mortgages as

follows:

Description 12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88

Glendale Bank $72,807 -0- -0- -0- -0- -0-
Glendale Bank -0- $99,873 -0- -0- -0- -0-
Sun Bank -0- 53,754 $52,674 $51,420 -0- -0-
Mid State -0- -0- -0- -0- $51,023 -0-
Mid State -0- -0- -0- -0- -0- $51,497
Total 72,807 153,627 52,674 51,420 51,023 51,497

Petitioners contend that there is an additional loan outstanding

for $19,500 from Atlantic Bank.

3. Amended Answer

Respondent amended his answer on April 27, 2007 (amended

answer), to assert that Mr. Powerstein is collaterally estopped

from denying (1) his liability for the additions to tax imposed

by section 6653(b)(1)(A) and (B); and (2) the facts necessary to

convict him under counts 1 and 11 of the indictment.
 - 28 -

4. Second Amended Answer

Respondent’s net worth computation determined nondeductible

expenditures allocable to petitioners of $135,504 on the basis of

average annual expenditures for a family of three as determined

by the Bureau of Labor Statistics (BLS). In his second amendment

to answer (second amended answer) filed with the Court on April

21, 2010, respondent revised his determination of petitioners’

nondeductible personal expenditures. The second amended answer

determined nondeductible personal expenditures allocable to

petitioners of $241,789 using a composite of check registers from

petitioners’ various bank accounts, BLS, and petitioners’ 1984

through 1988 joint returns. In particular, respondent

recalculated petitioners’ personal expenditures using a

combination of BLS, check registers, and petitioners’ tax

returns. The second amended answer also asserted an increased

deficiency if respondent’s personal living expenses analysis is

sustained.

B. Docket No. 13443-92

On March 30, 1992, respondent issued to Mr. Powerstein a

notice of deficiency which determined a $49,000 deficiency in Mr.

Powerstein’s 1989 Federal income tax and a $36,750 fraud penalty

under section 6663. Mr. Powerstein petitioned the Court in

response to that notice of deficiency, and the Court docketed the

case at docket No. 13443-92.
 - 29 -

OPINION

I. Burden of Proof

Petitioners moved the Court in limine to modify the burden

of proof with respect to amounts shown on respondent’s net worth

schedule because, petitioners contended, respondent seized but

did not return some of their personal and business records. We

denied petitioners’ motion without prejudice to arguing the point

in their opening brief, and they again asserted on brief that the

burden of proof should shift to respondent. Absent a written

stipulation to the contrary, these cases are appealable to the

U.S. Court of Appeals for the Eleventh Circuit. See sec.

7482(b)(1)(A), (2).

The Commissioner’s determinations in a notice of deficiency

are generally presumed correct, and taxpayers must prove those

determinations erroneous in order to prevail. Rule 142(a); Welch

v. Helvering, 290 U.S. 111, 115 (1933). In cases involving

unreported income, however, the presumption of correctness does

not attach until the Commissioner supports his determinations

with a minimal “‘evidentiary foundation linking the taxpayer to

the alleged income-producing activity.’” Blohm v. Commissioner,

994 F.2d 1542, 1549 (11th Cir. 1993) (quoting Weimerskirch v.

Commissioner, 596 F.2d 358, 362 (9th Cir. 1979), revg. 67 T.C.

672 (1977)), affg. T.C. Memo. 1991–636. Once the Commissioner

has produced evidence linking the taxpayers to an income-
 - 30 -

producing activity, the burden of proof shifts to the taxpayers

to rebut that presumption by establishing that the Commissioner’s

determinations are arbitrary or erroneous. Blohm v.

Commissioner, supra at 1549.

The Court of Appeals for the Eleventh Circuit has described

the situation in which the burden of proof shifts to the

Commissioner as “rare” and only occurring “where the Commissioner

has introduced no substantive evidence, and the evidence shows

that the claimed tax deficiency arising from unreported income

was derived by the government from unreliable evidence.” Gatlin

v. Commissioner, 754 F.2d 921, 923 (11th Cir. 1985), affg. T.C.

Memo. 1982-489. To satisfy his initial burden of production,

respondent introduced records which were seized from petitioners

or summoned from third parties. Those records establish that

petitioners received, but did not report, substantial amounts of

income between 1984 and 1988. On the basis of this credible

evidence, we are satisfied that respondent has made the requisite

showing for his determinations as set forth in the notice of

deficiency to be entitled to the general presumption of

correctness. See Schad v. Commissioner, 87 T.C. 609, 620 (1986)

(connecting a taxpayer with funds that form the basis of the

deficiency is sufficient for the presumption of correctness to

attach), affd. without published opinion 827 F.2d 774 (11th Cir.

1987).
 - 31 -

As relevant here, the presumption of correctness is modified

in several respects. First, respondent asserted a claim for an

increased deficiency in his answer for each of the years 1986

through 1988, and he bears the burden of proof as to those

increased deficiencies. See Rule 142(a)(1). Second, respondent

amended his answer to assert that Mr. Powerstein is collaterally

estopped from denying liability for the fraud additions to tax

for 1987, and he bears the burden of proof with respect to that

newly pleaded matter. See id. Third, respondent revised his

determination of petitioners’ nondeductible personal expenditures

in the second amended answer, and he bears the burden of proof

with respect to that issue. See id. We have decided the issues

herein with these general principles in mind. To the extent that

we have not specifically addressed whether respondent has met his

burden of proof with respect to any of the foregoing issues, we

decline to do so because the record favors respondent.

II. Unreported Income

A. Overview

Gross income includes all income from whatever source

derived, including income derived from business. Sec. 61(a)(2).

Taxpayers are required to maintain books and records sufficient

to establish the amount of their Federal income tax liability.

See sec. 6001; sec. 1.6001-1(a), Income Tax Regs. In the absence

of such books and records, the Commissioner is authorized to
 - 32 -

reconstruct the taxpayers’ income by any method that clearly

reflects income. Sec. 446(b); Parks v. Commissioner, 94 T.C.

654, 658 (1990). One such method that courts have long

recognized as reasonable, and the method used by respondent in

these cases, is the net worth method. See Holland v. United

States, 348 U.S. 121, 131 (1954).

Under the net worth method, the Commissioner reconstructs

the taxpayers’ income by determining the taxpayers’ net worth at

the beginning and end of each of the years in issue. The

difference between those amounts for each successive year is the

taxpayers’ annual net worth increase (or decrease). The net

worth for each year is then adjusted by adding nondeductible

personal expenditures and subtracting nontaxable receipts. Id.

at 125. An increase in net worth in any given year creates an

inference of taxable income in that year, provided that the

Commissioner shows a likely source of the unreported income, or

negates possible nontaxable sources. See United States v.

Massei, 355 U.S. 595 (1958).

In the instant cases, petitioners failed to maintain books

or records from which their Federal tax liabilities could be

computed, and respondent reconstructed petitioners’ income using

the net worth method. As the starting point for determining

petitioners’ net worth, respondent used the net worth statement

included in the 1983 loan application. Respondent then computed
 - 33 -

petitioners’ net worth for each of the years from 1984 through

1988 and determined an aggregate increase in net worth of

$427,954. Respondent attributed the source of this increase to

Mr. Powerstein’s accounting firm.

Petitioners challenge the accuracy of respondent’s income

reconstruction on four principal grounds. First, petitioners

contend that respondent overstated their opening net worth by

including, among other things, cash in certain bank accounts

which they did not wholly own. Second, petitioners claim that

respondent failed to make various adjustments to their net worth

in each of the years in issue. Third, petitioners assert that

respondent’s calculation of nondeductible personal expenditures

is erroneous, duplicative, and/or unsupported by the record.

Fourth, petitioners argue that respondent’s calculation of

nontaxable receipts is understated.

B. Disputed Opening Net Worth

Petitioners cite three reasons for challenging respondent’s

computation of their opening net worth. First, they contend that

respondent’s calculation erroneously included cash in bank

accounts held jointly or in trust for Ms. P. Powerstein, Ms.

Pasternak, and Ms. Korman. Second, they claim that respondent

failed to account for household furnishings which they owned at

the start of 1984. Third, they assert that respondent failed to

adjust the basis of the Coral Springs residence for certain
 - 34 -

additions and improvements. We agree with petitioners for the

most part, and consider their arguments seriatim.

1. Bank Accounts

Petitioners begin by arguing that respondent incorrectly

included in their opening net worth, cash in bank accounts which

Mr. Powerstein held jointly with or in trust for Ms. P.

Powerstein, Ms. Pasternak, and Ms. Korman. First, petitioners

claim that cash in nine accounts at Safra Bank was improperly

included in their opening net worth because those accounts were

jointly owned with Ms. P. Powerstein and that she funded one-half

of the initial deposits made to those accounts.8 We agree. To

satisfy their burden, petitioners rely upon the testimony of Mr.

Powerstein and bank records for these accounts. Included in the

records are account signature cards which list the owners’

address as being in Brooklyn and a letter requesting changes to

those accounts that is signed by Mr. Powerstein and Ms. P.

Powerstein. We understand the address referenced in the

signature cards to be that of Ms. P. Powerstein, and we credit

Mr. Powerstein’s testimony in the light of the corroborating

documentary evidence. Accordingly, we find that petitioners’

opening net worth should be reduced by $11,250, which is Ms. P.

Powerstein’s share of cash in the accounts held jointly with Mr.

8
The accounts at Safra Bank claimed to be held jointly with
Ms. P. Powerstein are account numbers ending 1178, 1770, 1202,
1203, 1204, 1205, 1206, 2334, and 2335.
 - 35 -

Powerstein. Cf. Unger v. Commissioner, T.C. Memo. 2000-267

(including cash in jointly held bank accounts in a taxpayer’s net

worth where inclusion of those accounts was supported by

documentary evidence).

Second, petitioners ascribe error to the inclusion of cash

in accounts at Brooklyn Federal Savings & Loan (Brooklyn Federal)

and Roosevelt Savings Bank (Roosevelt Bank) in their opening net

worth.9 According to petitioners, these accounts are not

attributable to them because they were jointly owned with and

wholly funded by Ms. Pasternak. We agree. Petitioners again

rely upon the testimony of Mr. Powerstein and bank records for

these accounts. The account records for each of the Brooklyn

Federal and Roosevelt Bank accounts establish that those accounts

were held in trust for Susan Mark, Mr. Powerstein’s cousin. A

signature card for the Roosevelt Bank account was signed by Mr.

Powerstein and Ms. Pasternak, and listed separate addresses for

each account holder. We again credit Mr. Powerstein’s testimony

given the supporting documentary evidence. Accordingly, we find

that petitioners’ opening net worth for cash on deposit at

Brooklyn Federal and Roosevelt Bank should be reduced by $158 and

$1,049, respectively. Cf. id.

9
The accounts alleged to be jointly held with Ms. Pasternak
are account number ending 0790 at Brooklyn Federal and account
number ending 9211 at Roosevelt Bank.
 - 36 -

Third, petitioners maintain that an account at Citicorp Bank

(Citicorp), which was held in trust for Ms. Korman and funded by

her father, is not an asset belonging to them.10 We agree.

Petitioners carry their burden with the testimony of Mr.

Powerstein and bank records which establish that this account was

held in trust for Ms. Korman. We credit Mr. Powerstein’s

testimony in the light of the supporting documentary evidence.

Accordingly, we find that petitioners’ opening net worth for cash

held at Citicorp should be reduced by $217. See Estate of

Cardulla v. Commissioner, T.C. Memo. 1986-307.

2. Household Furnishings

Petitioners next argue that respondent erroneously excluded

an allowance for personal household furnishings from their

opening net worth. According to petitioners, their opening net

worth should be increased to reflect household items which they

moved from Brooklyn to the Coral Springs residence. We agree.

To support this increase in opening net worth, petitioners rely

upon a bill of lading from the moving company that transported

their furnishings, proof of insurance for $64,800 of personal

property located at the Coral Springs residence, and Mr.

10
The account claimed to be held in trust for Ms. Korman is
account number ending 7299 at Citicorp. We observe that Mr.
Powerstein testified at trial that the $1,533 balance in account
number ending 161-8 at Atlantic Bank was also attributable to Ms.
Korman. We consider petitioners to have conceded this argument
since they do not address it on brief. See Nicklaus v.
Commissioner, 117 T.C. at 120.
 - 37 -

Powerstein’s testimony that the household items cost

approximately $30,000. We credit Mr. Powerstein’s testimony as

reasonable and hold that petitioners’ opening net worth is

increased by $30,000.

3. Basis in the Coral Springs Residence

Petitioners further argue that their opening net worth

should be increased to reflect $11,191 of costs incurred in

constructing the Coral Springs residence and $14,529 of expenses

incurred to improve that property. As petitioners see it, these

additional costs increase their basis in the Coral Springs

residence and thereby affect their opening net worth. We agree

in part. With respect to the $11,191 of construction costs,

petitioners rely upon Mr. Powerstein’s direct testimony, his

handwritten notes regarding the payment of such expenses in the

late 1970s, and the 1978 loan application, all of which support

petitioners’ claim that they incurred such expenses. Given the

corroborating evidence, we credit Mr. Powerstein’s testimony as

reasonable, and hold that petitioners’ basis in the Coral Springs

residence is increased by $11,191. See sec. 1016(a)(1).

With respect to the $14,529 in additional improvements,

petitioners rely solely upon the testimony and handwritten notes

of Mr. Powerstein to establish such an increase to their basis in

the Coral Springs residence. We decline to credit this evidence

absent further corroborating evidence, such as testimony of the
 - 38 -

contractors who performed the work or receipts for the work

performed.11 Mr. Powerstein maintained receipts and records

related to a variety of expenses associated with petitioners’

investments. Although Mr. Powerstein’s handwritten notes

reference canceled checks and invoices as source documents,

petitioners did not provide copies of those items. Accordingly,

we hold that petitioners’ basis increase in the Coral Springs

residence is limited to $11,191.

C. Disputed Increases to Net Worth

Petitioners next contend that respondent’s determination of

their annual net worth increase for each of the years in issue

failed to account for various adjustments to their assets and

liabilities. We consider petitioners’ contentions in turn.

1. Cash in Banks

We previously held that respondent incorrectly included in

petitioners’ opening net worth cash in bank accounts held jointly

or in trust for Ms. Pasternak, Ms. P. Powerstein, and Ms. Korman.

On the basis of the record as a whole, and taking into account

the parties’ stipulations as to bank accounts which petitioners

owned, we hold that petitioners’ net worth for 1984, 1986, 1987,

and 1988 should be reduced by $17,948, $3,807, $1,982, and

11
In the absence of such records, we assume that they did
not exist or were unfavorable to petitioners’ position. See
Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165
(1946), affd. 162 F.2d 513 (10th Cir. 1947).
 - 39 -

$1,247, respectively.12 We also hold that petitioners’ net worth

for 1985 should be increased by $21,895.13

2. Investments

Petitioners maintain that their net worth should be reduced

to exclude the value of 775 shares of Charme stock which were

worthless during the years in issue. We disagree. Taxpayers

generally bear the burden of proving that the stock in question

was “wholly worthless” and when it becomes worthless. See Boehm

v. Commissioner, 326 U.S. 287, 294 (1945); sec. 1.165-5(c),

Income Tax Regs. We ordinarily treat stock as worthless if it

has neither liquidating value nor potential value. Austin Co. v.

Commissioner, 71 T.C. 955, 970 (1979). A corporation’s stock has

liquidating value if the corporation’s assets exceed its

liabilities. Id. A corporation’s stock has potential value if

there is a reasonable expectation that it will become valuable in

the future. Morton v. Commissioner, 38 B.T.A. 1270, 1278 (1938),

affd. 112 F.2d 320 (7th Cir. 1940). Where a corporation declares

12
These adjustments relate to bank accounts at Brooklyn
Federal, Citicorp, Roosevelt Bank, and Safra Bank. The 1984
adjustment reflects the parties’ stipulation that petitioners’
bank account should be reduced by $8,259 for amounts deposited to
the Underhill account. We attribute any difference in amounts to
rounding.
13
Included in the 1985 adjustment are a reduction in net
worth of $13,108 related to various bank accounts, and an
increase in net worth of $35,003 as reflected by petitioners’
receipt of a certificate of deposit from California Federal Bank
(California Federal).
 - 40 -

bankruptcy, ceases to conduct business, liquidates, or has a

receiver appointed, its stock may be worthless because these

events can limit or destroy the stock’s potential value. See id.

That rule, however, is not absolute. See, e.g., Dallmeyer v.

Commissioner, 14 T.C. 1282, 1291-1292 (1950); Patten & Davies

Lumber Co. v. Commissioner, 45 F.2d 556, 558 (9th Cir. 1930),

revg. a Memorandum Opinion of this Court dated July 29, 1929; see

also Scagliotta v. Commissioner, T.C. Memo. 1996-498; Storch v.

Commissioner, T.C. Memo. 1985-17.

In applying the foregoing principles, we are unable to agree

with petitioners that the Charme stock became wholly worthless

during any of the years in issue. Although Charme declared

bankruptcy in 1985, its bankruptcy continued into 1995, which

suggests that its stock had at least some residual liquidation

value in 1985. Such value might have included, for example,

liquidating distributions to the stockholders after creditors’

claims had been satisfied. Absent additional facts surrounding

the financial viability of Charme, the assets it held when placed

into chapter 7 liquidating bankruptcy, the expenses of

administration, or a fixed and identifiable event establishing

complete worthlessness, we decline to accept that the stock was

devoid of all present or potential value. See Miami Beach Bay

Shore Co. v. Commissioner, 136 F.2d 408, 409 (5th Cir. 1943)

(stock is not worthless until the “last vestige of value has
 - 41 -

disappeared”). Accordingly, we hold that petitioners’ net worth

includes the $1,750 value of the Charme stock.

3. Household Property

We previously held that respondent incorrectly omitted from

petitioners’ opening net worth a $30,000 allowance for personal

household furnishings. Petitioners now contend that they are

entitled to a nondeductible loss to reflect the disposition of

that property when they moved from the Coral Springs residence to

the Addison mobile home. We are not persuaded. Without

elaboration, petitioners contend on brief that they disposed of

“a good amount” of these furnishings because the Addison mobile

home was “substantially smaller” than the Coral Springs

residence. As support for their entitlement to the nondeductible

loss, petitioners state that they did not claim a charitable

contribution deduction for that property, which suggests that

they donated it. Absent a receipt of the donation or other

corroborating evidence, we decline to accept petitioners’ self-

serving statements. We find petitioners’ claims especially

implausible given that the property listed in the bill of lading

included bedroom furniture, electronics, living room furniture,

office furniture, and household items, all of which conceivably

would have been suitable for use in the Addison mobile home. On

the basis of the record at hand, petitioners have not proved

their entitlement to a nondeductible loss for personal property
 - 42 -

in 1985. Accordingly, we hold that petitioners’ net worth is

increased by $30,000 for each of the years in issue to reflect

petitioners’ household property.

4. Real Estate

a. Coral Springs Property

We previously held supra p. 37 that petitioners’ basis in

the Coral Springs residence should be increased by $11,191 to

account for construction costs related to that home. We

similarly hold that petitioners’ basis in the Coral Springs

residence for 1984 is increased by $11,191. See sec. 1016(a)(1).

b. Romeo Property

Petitioners contend that respondent understated their basis

in the Romeo property. According to petitioners, their basis in

the Romeo property should be increased by $10,284 to reflect

costs of clearing and improving that property, support paid to

the Ballards, and costs of hiring workers to assist in clearing

that property. Petitioners rely upon a number of methods of

proof to carry their burden. First, they rely upon the direct

testimony of Mr. Powerstein, Mr. Ballard, and Ms. Ballard.

Second, they offered an appraisal which reported improvements to

that property such as a three-stall barn, a pump house, and a

septic tank. Third, they submitted checks, receipts, and letters

establishing that they paid support to the Ballards while the

Romeo property was developed and hired workers to help in the
 - 43 -

clearing of that land. Fourth, they offered the handwritten

notes of Mr. Powerstein listing the expenses incurred in

connection with developing the Romeo property. We also note that

petitioners’ estimates of the cost of developing the Romeo

property reasonably excluded (1) expenses related to M&M, and (2)

improvements that respondent had credited them with. Given the

overwhelming evidence introduced to corroborate petitioners’

claim, we hold that their basis in the Romeo property is

increased by $10,284. See id.

c. Addison Mobile Home

Petitioners maintain that their basis in the Addison mobile

home should be reduced by $970 from $23,431 to $22,461. We

disagree. In an attempt to meet their burden, petitioners rely

upon the handwritten notes of Mr. Powerstein showing a purchase

price for the Addison mobile home of $22,461. Respondent, on the

other hand, submitted canceled checks establishing that the cost

of acquiring the Addison mobile home was $23,431. As compared

with Mr. Powerstein’s handwritten schedule, we find the checks

relied upon by respondent to be more persuasive. Accordingly, we

sustain respondent’s determination that petitioners’ basis in the

Addison mobile home was $23,431.

5. Loans and Mortgages

Petitioners assert that their net worth should be adjusted

to reflect a $19,500 loan (Atlantic loan) from Atlantic Bank. We
 - 44 -

agree. Petitioners submitted evidence showing that they became

liable on the Atlantic loan in or around 1984. First, they made

a large deposit to a bank account with Atlantic Bank on February

2, 1984, which we believe reasonably could have included the

proceeds from the Atlantic loan. Second, petitioners submitted a

bank deposit ticket showing that a $19,500 loan with Atlantic

Bank was repaid in 1985. Third, petitioners presented

handwritten notes of Mr. Powerstein showing that a $19,500 note

was taken from Atlantic Bank. Accordingly, we hold that

petitioners’ net worth should be increased by $19,500 in 1984 and

1985, the years during which the Atlantic loan was outstanding.

6. Depreciation

Respondent determined that petitioners were entitled to

adjustments for accumulated depreciation of $10,535, $10,535,

$6,093, $7,755, and $9,373 in 1984 through 1988, respectively.

Petitioners counter that they are entitled to additional

depreciation of $200, $349, $299, $250, and $452 in 1984 through

1988, respectively. These adjustments stem from petitioners’

alleged use of the Addison mobile home and the copier in Mr.

Powerstein’s accounting firm. As discussed more fully below, we

conclude that expenses related to the copier, but not to the

Addison mobile home, were ordinary and necessary business

expenses of Mr. Powerstein’s accounting firm. We thus hold that

petitioners’ adjustments for accumulated depreciation in 1984
 - 45 -

through 1988 are $10,535, $10,535, $6,093, $7,755, and $9,538,

respectively.

D. Disputed Nondeductible Personal Expenditures

1. Overview

Given the absence of information concerning petitioners’

specific personal living expenses, respondent used BLS figures to

calculate petitioners’ nondeductible personal living expenses for

1984 through 1988 and reflected his determinations in the answer.

After more than 20 years, respondent amended the answer a second

time to assert increases in petitioners’ nondeductible personal

expenses of $106,285. The revised expenditures were based on a

composite of BLS figures and expenditures reflected in

petitioners’ three main checking accounts. Because the

adjustments in nondeductible personal living expenses increased

petitioners’ annual net worth for each of the years 1984 through

1988, we treat the revised personal nondeductible expenditures as

a new matter on which respondent bears the burden of proof. See

Rule 142(a); Michas v. Commissioner, T.C. Memo. 1992-161.

Petitioners offered substantial proof to rebut respondent’s

imputation of items under the BLS and additional adjustments. In

particular, petitioners submitted evidence that proved that (1)

they did not make certain expenditures attributed to them under

BLS, or (2) respondent erroneously classified expenses as

nondeductible that were in fact deductible. Although we mostly
 - 46 -

agree with petitioners’ challenges to respondent’s revised

adjustments, that agreement is not unlimited. We explain

seriatim only those adjustments proposed by petitioners with

which we disagree or those items that we feel warrant

explanation. To the extent that we have rejected any adjustment

proposed by respondent as to petitioners’ nondeductible personal

expenditures, we have done so because respondent failed to

persuade us that such an adjustment was proper.

2. Alcoholic Beverages

Respondent imputed to petitioners allowances of $275, $286,

$272, $294, and $268 for alcoholic beverages for 1984 through

1988, respectively. Although petitioners testified that they did

not consume alcohol during the years in issue, they also

testified that they provided most (if not all) of the Ballards’

support from 1984 through 1986. Mr. Ballard was described at

trial as a “social drinker”, and he was convicted of driving

under the influence. We thus believe it reasonable to impute

expenses for alcoholic beverages to petitioners for 1984 through

1986 because petitioners supported the Ballards, at least one of

whom consumed alcohol. We do not believe it reasonable to impute

expenses for alcoholic beverages to petitioners during 1987 and

1988 because petitioners apparently did not support the Ballards

during those years and petitioners testified credibly that they

did not consume alcohol. Accordingly, we sustain respondent’s
 - 47 -

determination that nondeductible personal expenses for alcoholic

beverages of $275, $286, and $272 for 1984 through 1986,

respectively, are imputed to petitioners.

3. Second Glendale Mortgage

Respondent determined that petitioners made four payments on

the second Glendale mortgage during 1985, including (1) two

payments totaling $2,072 from an account with Atlantic Bank, and

(2) two payments totaling $2,072 from other sources. Petitioners

contend that they made only three payments during 1985 because it

“appeared to be” petitioners’ “custom and habit * * * to make

payments around the fifteenth of each month.” We disagree.

Petitioners were obliged to make payments under the second

Glendale mortgage until that note was satisfied. The sale of the

Coral Springs residence closed on April 12, 1985, and the second

Glendale mortgage was satisfied with the proceeds of that sale.

Regardless of when petitioners customarily paid their mortgage,

they were obligated for the pro rata share of the mortgage up

until the date of repayment. We are satisfied that the amounts

imputed to petitioners regarding the fourth mortgage payment

covered April 1985 and sustain respondent’s determination that

petitioners made four payments on the second Glendale mortgage

during 1985 totaling $4,144.
 - 48 -

4. First Sun Bank Mortgage

Respondent determined that petitioners made nine payments of

approximately $342 on the first Sun Bank mortgage during 1984,

including (1) four payments totaling $1,367 from an account with

Atlantic Bank, and (2) five payments totaling $1,710 from other

sources.14 According to petitioners, only seven payments were

due under the first Sun Bank mortgage during 1984, and respondent

has not proved that petitioners made any more than three payments

under that mortgage. We conclude that petitioners made seven

payments under the first Sun Bank mortgage. Payment due on that

loan began on March 1, 1984, and continued until October 5, 1984,

when petitioners retired the first Sun Bank mortgage with the

proceeds of the second Sun Bank mortgage. Thus, petitioners were

required to make payments under the first Sun Bank mortgage for

the 7-month period between March 1 and October 1, 1984, and for

the first 5 days of October 1984. Accordingly, we hold that

petitioners incurred $2,392 of nondeductible personal

expenditures in 1984 related to the first Sun Bank mortgage ($342

times 7 months).15

Petitioners contend that each of the seven payments paid

under the first Sun Bank mortgage reduced the principal due on

14
Monthly payments of approximately $342 were calculated as
total payments of $1,367 divided by 4 months.
15
The product of the items may not equal the total because
of rounding.
 - 49 -

that note. We agree. The first Sun Bank mortgage provided for

monthly payments of principal and interest. Because the record

does not contain a copy of the note on which the first Sun Bank

mortgage was based, we are forced to estimate the proper

allocation between principal and interest on that note. The

short-term, semiannual-compounding applicable Federal rate (AFR)

in effect for 1984 was 10 percent.16 See Rev. Rul. 84-163, 1984-

2 C.B. 179. Assuming a principal amount of $26,000, an interest

rate of 10 percent, and a 3-year term, we find that principal due

under the first Sun Bank mortgage was more than $2,392. We limit

the principal reduction to the amount petitioners proposed.

5. Real Estate Taxes

Respondent imputed to petitioners real estate tax payments

for the Coral Springs residence of $1,761 and $522 in 1984 and

1985, respectively. With respect to 1984, petitioners counter

that imputing real estate taxes to them is improper because (1)

the first and second Glendale mortgages impounded real estate

taxes of $91 per month, and (2) petitioners prepaid 5 months of

real estate taxes totaling $453. Petitioners concede that $367

of real estate taxes should be imputed to them in 1984. We agree

with petitioners that they paid real estate taxes through the

16
We use the short-term AFR because the term of the first
Sun Bank mortgage was 3 years. See sec. 1274(d)(1)(A). We use
the semiannual-compounding convention as that most closely
approximating the average daily interest rate for 1984.
 - 50 -

first and second Glendale mortgages, and we hold that they need

impute real estate taxes only in the amount conceded.

With respect to 1985, petitioners contend that respondent’s

imputation of real estate taxes is improper because those real

estate taxes were paid from the closing proceeds on the sale of

the Coral Springs residence. We disagree. The settlement

statement with respect to the sale of the Coral Springs residence

to the Underhills made two adjustments related to real estate

taxes. First, petitioners were assessed $288 for unpaid county

taxes from January 1 through April 11, 1985. Second, petitioners

were charged $234 for taxes related to 1980. Thus, petitioners

paid $522 of real estate taxes with respect to the Coral Springs

residence, which is the amount respondent imputed to them.

Accordingly, we sustain respondent’s imputation of $522 in real

estate taxes to petitioners for 1985.

6. Improvements to Romeo Property

Petitioners contend that their nondeductible personal

expenditures should be reduced by amounts expended to improve the

Romeo property. We agree. We have held that petitioners

incurred $10,284 in connection with improving the Romeo property,

and those costs were already included in the increased basis of

the Romeo property. Accordingly, we hold that petitioners’

nondeductible personal expenditures should be reduced by $10,284.
 - 51 -

7. Summary

On our review of the record as a whole and with due regard

to respondent’s burden of proof, we conclude that petitioners’

nondeductible personal expenditures for 1984 through 1988 were

$54,807, $39,452, $39,274, $22,854, and $22,261, respectively.

E. Disputed Nontaxable Receipts

1. Overview

As asserted in the answer, respondent’s net worth

computation adjusted petitioners’ nontaxable receipts only for

Federal income tax refunds for each of the years 1984 through

1988. The parties have stipulated that petitioners received

additional nontaxable receipts as follows: (1) Qualified

reinvested dividends of $549 and $331 in 1984 and 1985,

respectively; and (2) nontaxable distributions of $282 in 1987.

Petitioners also contend that they are entitled to further

adjustments for nontaxable items, including a 60-percent

deduction on the net capital gain from the sale of the Coral

Springs residence, certain interest income, an inheritance

allegedly received from Ms. P. Powerstein, and a deduction for

dual-income taxpayers filing a joint return.

2. Gain on the Sale of the Coral Springs Residence

After accounting for settlement charges and credits due to

the Underhills, petitioners realized $107,201 on the sale of the

Coral Springs residence. Petitioners’ basis in the Coral Springs
 - 52 -

residence was $79,133. Therefore, their net capital gain on the

sale of the Coral Springs residence is $28,068 ($107,201 less

$79,133). See sec. 1001(a). The parties agree, and we conclude,

that petitioners are entitled to a 60-percent deduction on that

gain. See sec. 1202(a) (allowing individual taxpayers a 60-

percent deduction for net capital gains). Accordingly, we hold

that petitioners may exclude $16,841 ($28,068 times 60 percent).

3. Interest Income

Petitioners contend that they are entitled to exclude $2,000

of interest income which they purportedly earned on an All-Savers

Certificate issued by Safra Bank. They cite no legal support for

their entitlement to such an exclusion, instead referring the

Court to their 1983 joint return on which they excluded $2,000 of

interest income. Section 128(a) allows for the exclusion from

gross income of interest earned on a “depository institution tax-

exempt savings certificate”, sometimes referred to as an “All-

Savers Certificate”. In the case of a joint return, the

excludable amount during any taxable year is limited to $2,000

less the aggregate amount the taxpayers received in prior years.

Sec. 128(b). Thus, taxpayers were entitled to a one-time $2,000

exclusion from gross income for interest paid on an All-Savers

Certificate. Because petitioners claimed a $2,000 exclusion on

their 1983 joint return, we hold that they are not entitled to a

similar exclusion for 1984.
 - 53 -

4. Inheritance

Petitioners contend that they are entitled to exclude Ms. P.

Powerstein’s share of nine bank accounts held at Safra Bank as

nontaxable inheritance. We are not persuaded. Petitioners did

not establish that Mr. Powerstein was a beneficiary under Ms. P.

Powerstein’s will (if she died testate) or as an heir at law (if

she died intestate). We thus hold that petitioners may not

exclude as nontaxable income the balances of accounts held

jointly with Ms. P. Powerstein. Cf. Morrow v. Commissioner, T.C.

Memo. 1967-242 (crediting a taxpayer’s claim that amounts

received as inheritance should be excluded from his net worth

where that testimony was corroborated with a copy of the State

estate tax return filed by the decedent’s estate).

5. Married Couple’s Deduction

Petitioners further contend that they are entitled to a

married couple’s deduction for 1984. We agree. For taxpayers

filing a 1984 joint return, section 221 allows dual-income

married couples a deduction equal to 10 percent of the lesser of

$30,000 or the “qualified earned income” of the spouse with the

lower qualified earned income for the taxable year.17 Estate of

Johnson v. Commissioner, T.C. Memo. 2001-182, affd. without

17
The term “qualified earned income” is defined as an amount
equal to the excess of (a) the earned income of the spouse for
the taxable year, over (b) an amount equal to the sum of the
certain deductions allowable under sec. 62 and properly allocable
to or chargeable against earned income. Sec. 221(b).
 - 54 -

published opinion 129 Fed. Appx. 597 (11th Cir. 2005). Ms. Rosen

earned $5,244 of income in 1984, which is less than the income

that Mr. Powerstein earned in his accounting firm. Accordingly,

petitioners are entitled to a married couple’s deduction for 1984

of $524.

F. Summary

On the basis of the foregoing, we determine increases in

petitioners’ taxable income as follows:

12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88

Net worth
computation:
Cash on hand $175,485 $213,604 $253,743 $322,185 $455,077 $564,518
Investments 26,662 21,441 21,441 23,703 32,935 47,469
Personal assets 56,099 66,599 66,599 66,687 66,687 82,168
Real estate 123,599 170,588 91,455 91,455 91,455 91,455
Additional
investments 10,474 8,831 9,196 7,947 10,317 10,556
Total assets 392,319 481,063 442,434 511,977 656,471 796,166
Loans and
mortgages 72,807 173,127 52,674 51,420 51,023 51,497
Charge accounts -0- -0- -0- -0- -0- -0-
Accumulated
depreciation 6,637 10,535 10,535 6,093 7,755 9,538
Total liabilities 79,444 183,662 63,209 57,513 58,778 61,035
Net worth 312,875 297,401 379,225 454,464 597,693 735,131

Less prior year’s
net worth N/A 312,875 297,401 379,225 454,464 597,693
Net worth increase N/A (15,474) 81,824 75,239 143,229 137,438
Personal expenses N/A 54,807 39,452 39,274 22,854 22,261
Nondeductible loss -0- -0- -0- -0- -0- -0-
Less nontaxable
income N/A 6,406 17,501 4,233 711 203
Adjusted gross
income N/A 32,927 103,775 110,280 165,372 159,496
Less itemized
deductions N/A 21,217 12,469 13,393 12,907 11,149
Less exemptions N/A 3,000 3,120 3,240 5,700 5,850
Corrected taxable
income N/A 8,710 88,186 93,647 146,765 142,497
Reported taxable
income N/A 5,086 4,447 7,945 1,499 (140)
Increase to taxable
income N/A 3,624 83,739 85,702 145,266 142,637
 - 55 -

It follows that petitioners’ income for 1984 through 1988 is

increased by $3,624, $83,739, $85,702, $145,266, and $142,637,

respectively. See sec. 61(a)(2).

III. Deductions

A. Overview

Having determined the increases to petitioners’ taxable

income under the net worth method, we now examine the additional

components of petitioners’ taxable income for the years in issue.

Although the parties agreed to many of the additional components

of adjusted gross income, petitioners contend that they are

entitled to deductions related to Mr. Powerstein’s accounting

firm and their farming activity. Respondent apparently relies

upon the general presumption afforded the notice of deficiency,

not addressing these issues with any real precision. We consider

petitioners’ contentions in turn.

B. Schedule C Expenses

1. Home Office Expense

Petitioners allege that Mr. Powerstein kept an office in the

Addison mobile home that qualified as his principal place of

business and that they are entitled to a deduction for home

office expenses for 1984 through 1988.18 As a general rule, a

18
Although petitioners assert that they are entitled to a
home office deduction with respect to the Coral Springs residence
for 1984, they abandon that argument because according to them,
the benefit of the depreciation deduction in 1984 will be offset
(continued...)
 - 56 -

taxpayer is not allowed a deduction for expenses related to

property that a taxpayer occupies as his or her residence. Sec.

280A(a). An exception to the general rule is found in section

280A(c)(1)(A), which provides that an expense that is allocable

to a portion of the taxpayer’s dwelling that is used exclusively

on a regular basis as the taxpayer’s “principal place of

business” will be allowed as a deduction. In deciding whether a

home office qualifies as a taxpayer’s principal place of

business, we consider (1) the relative importance of the

activities performed at each business location; and (2) the

amount of time spent at each location. Commissioner v. Soliman,

506 U.S. 168, 175 (1993). The location where a taxpayer contacts

clients is an important indicator of the principal place of

business. Id.

Although we are satisfied that Mr. Powerstein worked on

client matters from the Addison mobile home, we are not persuaded

that such activity entitles petitioners to home office expense

deductions. For an accountant such as Mr. Powerstein, soliciting

business and collecting information from client-taxpayers is as

important a function of that trade or business as analyzing the

underlying information to report on the returns to be filed with

the IRS. Mr. Powerstein testified that he spent considerable

18
(...continued)
by recapture of that depreciation upon the sale of the Coral
Springs residence in 1985.
 - 57 -

time servicing clients in south Florida, yet he did not elaborate

on the amount of time he spent at each location or the functions

he performed while there. Nor did petitioners offer any evidence

indicating the amount of time and the relative importance of the

activities that Mr. Powerstein performed in the Addison mobile

home as compared to work conducted in south Florida. We are

particularly skeptical of petitioners’ claim that Mr. Powerstein

used the Addison mobile home as his principal place of business

in the light of the fact that he did not meet with clients there.

Moreover, on Schedules C attached to the 1984 through 1987 joint

returns, petitioners reported that they were not deducting

expenses for an office in their home. Their reporting, we

believe, is indicative of Mr. Powerstein’s state of mind during

the years in issue. We doubt that Mr. Powerstein would not have

claimed a home office expense deduction if he regarded that

residence as his principal place of business, especially because

he so liberally claimed deductions to which he was not entitled

or failed to report income altogether. We thus hold that

petitioners are not entitled to deduct expenses associated with

the Addison mobile home, including utilities expenses.

2. Copier

Petitioners contend that they are entitled to a $206

depreciation deduction in connection with a copier which Mr.

Powerstein purchased in 1988 for his accounting firm. Attached
 - 58 -

to the joint return was Form 4562, which reported 7-year property

with a depreciable basis of $1,442. Mr. Powerstein, however,

recorded that the purchase price of the copier was $1,153. We

credit Mr. Powerstein’s testimony, and in the light of his

handwritten cash disbursements journal, we hold that the copier’s

depreciable basis was $1,153. Depreciating the copier by a

straight-line method over 7 years, we hold that petitioners are

entitled to a depreciation deduction of $165 for 1988 ($1,153

divided by 7 years).19 See secs. 167(a), 168(a) through (d).

3. Additional Legal Expenses

Petitioners deducted $946 as legal fees on Schedule C

attached to the 1988 joint return. Petitioners contend that they

are entitled to additional deductions of $2,066 for legal fees

incurred in connection with Mr. Powerstein’s accounting firm.

They refer the Court to two separate exhibits which purport to be

cashier’s checks issued to various law firms but are actually

checks or deposit slips for accounts that Mr. Powerstein held at

California Federal. Accordingly, we hold that petitioners have

failed to prove their entitlement to additional deductions for

legal fees because they have not proved that these fees were paid

19
Whereas petitioners contend that their 1988 net worth
should be increased by $1,538 to reflect ownership of the copier,
we limit the increased net worth for that copier to the purchase
price of the copier, or $1,153.
 - 59 -

or that they were ordinary and necessary expenses. See sec.

162(a).

D. Schedule F Expenses

Attached to the 1988 joint return was Schedule F, on which

petitioners reported that they were engaged in the trade or

business of farming. Respondent determined that petitioners were

not engaged in the trade or business of farming during 1988 and

that they could not claim depreciation and expenses as deductions

on Schedule F. We agree with respondent.

Section 162(a) allows as a deduction all the ordinary and

necessary expenses paid or incurred in carrying on any activity

that constitutes a trade or business. Section 212 allows as a

deduction all the ordinary and necessary expenses paid or

incurred in carrying on an activity for the (1) production or

collection of income, or (2) management, conservation, or

maintenance of property held for the production of income.

Section 183 generally limits deductions for an activity not

entered into for profit to the amount of the activity’s gross

income. Sec. 183(b). Section 183(c) defines an activity not

engaged in for profit as “any activity other than one with

respect to which deductions are allowable for the taxable year

under section 162 or under paragraph (1) or (2) of section 212.”

To be engaged in a trade or business, the taxpayer must

conduct the activity with continuity, regularity, and for the
 - 60 -

primary purpose of realizing income or profit. Commissioner v.

Groetzinger, 480 U.S. 23, 35 (1987). While a reasonable

expectation of profit is not required, the objective facts and

circumstances must demonstrate an actual and honest objective to

realize a profit. Osteen v. Commissioner, 62 F.3d 356, 358 (11th

Cir. 1995), affg. in part and revg. in part T.C. Memo. 1993-519;

sec. 1.183-2(a), Income Tax Regs. Greater weight is given to

objective facts than a taxpayer’s mere statement of his or her

intent to make a profit. Sec. 1.183-2(a), Income Tax Regs.

Applying the above principles, we conclude that petitioners

were not engaged in the trade or business of farming. They did

not consult with an expert or conduct any research on developing

the Romeo property into a farm. Although they raised a modest

number of cattle, pigs, horses, and chickens, they did not

establish that they intended to profit from raising these

animals. Nor did they establish that they intended to profit

from raising crops which never grew because of “drought

conditions”. Although an appraisal performed for Sun Bank states

that “some farming is planned in the future”, we are not

persuaded on the basis of the record at hand that petitioners’

farming activity rose to the level of being engaged in as a trade

or business.

On balance, we believe petitioners’ farming activity was

more consistent with rural living and not with the trade or
 - 61 -

business of farming. We hold that petitioners were not engaged

in the trade or business of farming. Because we have found that

petitioners’ farming activity did not constitute a trade or

business or was not entered into for profit, it follows that

expenses associated with that activity are limited to the amount

of the activity’s gross income. See sec. 183(b). Given that

petitioners reported zero gross income from their farming

activity on Schedule F attached to the 1988 joint return, it

follows that they are not entitled to any deduction in connection

with their farming activity.

IV. Income Averaging

Petitioners contend that for 1984 and 1986 they are entitled

to special income-averaging provisions afforded taxpayers under

section 1305. That section, which was repealed for tax years

beginning after December 31, 1986, by the Tax Reform Act of 1986,

Pub. L. 99-514, sec. 141(a), 100 Stat. 2117, allows for averaging

of damages arising from causes of action for breach of contract

or breach of fiduciary duty. Petitioners’ unreported income is

attributable to Mr. Powerstein’s accounting firm and not to an

award of damages for breach of contract or breach of fiduciary

duty. Thus, section 1305 is not applicable.

V. Interest Expense

Mr. Powerstein contends that he is entitled to a $65,778

interest expense deduction for interest that respondent jeopardy-
 - 62 -

assessed during 1989. Respondent answers that the interest is

nondeductible personal interest within the purview of section

1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs., 52 Fed. Reg.

48409 (Dec. 22, 1987) (regulation). Mr. Powerstein urges the

Court to invalidate the regulation on the basis of our reasoning

in Redlark v. Commissioner, 106 T.C. 31 (1996), revd. and

remanded 141 F.3d 936 (9th Cir. 1998). We decline to do so.

We had occasion to carefully consider the validity of the

regulation in Robinson v. Commissioner, 119 T.C. 44, 73-75

(2002), a Court-reviewed Opinion. In Robinson, we concluded that

the regulation was valid, that our Opinion in Redlark should no

longer be followed, and that interest paid on individual tax

liabilities relating to income from a sole proprietorship is to

be treated as nondeductible personal interest. Id. at 75. While

we are not aware of any decision in the Court of Appeals for the

Eleventh Circuit deciding the validity of the regulation, we note

that our decision in Robinson is consistent with opinions of the

Courts of Appeals for the Fourth, Fifth, Sixth, Seventh, Eighth,

and Ninth Circuits.20 We see no reason to disturb our decision

20
See Alfaro v. Commissioner, 349 F.3d 225, 231 (5th Cir.
2003), affg. T.C. Memo. 2002-309; Kikalos v. Commissioner, 190
F.3d 791, 798–799 (7th Cir. 1999), revg. T.C. Memo. 1998–92;
McDonnell v. United States, 180 F.3d 721, 723 (6th Cir. 1999);
Allen v. United States, 173 F.3d 533, 538 (4th Cir. 1999);
Redlark v. Commissioner, 141 F.3d 936, 937–938, 942 (9th Cir.
1998), revg. and remanding 106 T.C. 31 (1996); Miller v. United
States, 65 F.3d 687, 691 (8th Cir. 1995).
 - 63 -

in Robinson, and therefore we reject petitioners’ invitation to

invalidate the regulation. It follows that interest respondent

jeopardy-assessed is nondeductible personal interest.

VI. Additions to Tax

A. Fraud

Respondent determined that petitioners are liable for

additions to tax for fraud under section 6653(b)(1) and (2) with

respect to their 1984 through 1988 joint returns. For 1984 and

1985, section 6653(b)(1) imposed a 50-percent addition to tax on

any portion of an underpayment of tax that is due to fraud, and

section 6653(b)(2) imposed a 50-percent addition to tax on any

interest payable under section 6661 with respect to any portion

of an underpayment of tax that is attributable to fraud. For

1986 and 1987, section 6653(b)(1)(A) imposed a 75-percent

addition to tax on any portion of an underpayment of tax due to

fraud, and section 6653(b)(1)(B) imposed a 50-percent addition to

tax on any interest payable under section 6661 with respect to

any portion of an underpayment of tax that is attributable to

fraud. For 1988, section 6653(b)(1) imposed a 75-percent

addition to tax where any portion of an underpayment of tax is

due to fraud. For all years, in the case of a joint return the

additions to tax imposed by section 6653(b)(1) and (2) do not

apply to a spouse unless some part of the underpayment is

attributable to the fraud of that spouse. Sec. 6653(b)(4) (as in
 - 64 -

effect for 1984 and 1985), sec. 6653(b)(3) (as in effect for 1986

through 1988).

The Commissioner bears the burden of establishing fraud by

clear and convincing evidence. Sec. 7454(a); Rule 142(b). Clear

and convincing evidence is that degree of proof that produces “‘a

firm belief or conviction as to the allegations sought to be

established. It is intermediate, being more than a mere

preponderance, but not the extent of such certainty as is

required beyond a reasonable doubt as in criminal cases. It does

not mean clear and unequivocal.’” Ohio v. Akron Ctr. for Reprod.

Health, 497 U.S. 502, 516 (1990) (quoting Cross v. Ledford, 120

N.E.2d 118, 123 (Ohio 1954)). To carry his burden, the

Commissioner must prove as to each taxpayer for each year in

which fraud is alleged that (1) an underpayment of tax existed,

and (2) each taxpayer intended to evade taxes known to be owing

by conduct intended to conceal, mislead, or otherwise prevent the

collection of such taxes. Korecky v. Commissioner, 781 F.2d

1566, 1568 (11th Cir. 1986), affg. T.C. Memo. 1985-63; Parks v.

Commissioner, 94 T.C. 654, 660-661 (1990). We consider whether

respondent has met his burden as to each of Mr. Powerstein and

Ms. Rosen.
 - 65 -

1. Mr. Powerstein

a. Collateral Estoppel

We begin by recognizing that Mr. Powerstein was convicted of

income tax evasion under section 7201 for 1987. As a result, Mr.

Powerstein is collaterally estopped from denying civil fraud with

respect to 1987. See Gray v. Commissioner, 708 F.2d 243, 246

(6th Cir. 1983), affg. T.C. Memo. 1981-1. We next consider

whether Mr. Powerstein is liable for additions to tax for fraud

for 1984, 1985, 1986, and 1988. We hold he is.

b. Underpayment of Tax

The Commissioner can prove an underpayment of tax stemming

from unreported and indirectly reconstructed income by, among

other means, proving a likely source of the unreported income.

DiLeo v. Commissioner, 96 T.C. 858, 873-874 (1991), affd. 959

F.2d 16 (2d Cir. 1992). To satisfy his burden, respondent

submitted into evidence records showing that petitioners

deposited and/or invested substantial sums of money in bank

accounts, investments, and real estate. Respondent also

established that petitioners received these moneys in connection

with Mr. Powerstein’s accounting firm. The record clearly and

convincingly establishes that petitioners understated their

income by more than $450,000. We find that respondent has

clearly and convincingly proven the first element of fraud.
 - 66 -

c. Fraudulent Intent

Whether a portion of the underpayment of tax is attributable

to fraud is a question of fact to be resolved on the basis of the

record as a whole. Parks v. Commissioner, supra at 660. Fraud

has been defined as the intentional commission of an act or acts

for the specific purpose of evading taxes believed to be owing.

Petzoldt v. Commissioner, 92 T.C. 661, 698 (1989). “‘Fraud

implies bad faith, intentional wrong doing and a sinister

motive.’” Webb v. Commissioner, 394 F.2d 366, 377 (5th Cir.

1968) (quoting Carter v. Campbell, 264 F.2d 930, 935 (5th Cir.

1959)), affg. T.C. Memo. 1966-81. Fraud is never imputed or

presumed but must be established by clear and convincing evidence

that establishes fraudulent intent. Petzoldt v. Commissioner,

supra at 699. Fraud need not be established by direct evidence

because such evidence is rarely available but can be shown by

surveying the taxpayer’s entire course of conduct and drawing

reasonable inferences therefrom. Biggs v. Commissioner, 440 F.2d

1, 5 (6th Cir. 1971), affg. T.C. Memo. 1968-240. We may infer

fraud from “any conduct, the likely effect of which would be to

mislead or to conceal.” Spies v. United States, 317 U.S. 492,

499 (1943).

Courts often rely upon certain indicia or badges of fraud in

deciding whether a taxpayer acted with fraudulent intent. These

badges of fraud include: (1) A pattern of understating income,
 - 67 -

(2) giving implausible or inconsistent explanations of behavior,

(3) concealing income and/or assets, (4) failing to cooperate

with taxing authorities, (5) an intent to mislead, which may be

inferred from a pattern of conduct; (6) providing false

documents; and (7) dealing in cash. See id.; Niedringhaus v.

Commissioner, 99 T.C. 202, 211 (1992). No single factor is

dispositive, though the existence of several indicia is competent

evidence of fraud. See Niedringhaus v. Commissioner, supra at

211. In determining the existence of fraud, we may look to

evidence of prior and subsequent similar acts reasonably close to

the years at issue. Tipton v. Commissioner, T.C. Memo. 1994-624

(citing United States v. Johnson, 386 F.2d 630 (3d Cir. 1967)).

i. Understatements of Income

The consistent and substantial understatement of income over

several years is strong evidence of fraudulent intent. Korecky

v. Commissioner, supra at 1568 (citing Merritt v. Commissioner,

301 F.2d 484, 487 (5th Cir. 1962), affg. T.C. Memo. 1959-172).

Between 1984 and 1988 petitioners failed to report or account for

more than $450,000 of income which Mr. Powerstein earned through

his accounting firm. The evidence clearly and convincingly

establishes that petitioners substantially understated their

taxable income from 1984 through 1988. The failure to report

this income is strong evidence of fraud.
 - 68 -

ii. Implausible Explanations of Behavior

Giving implausible or inconsistent explanations of behavior

may implicate fraudulent intent. Bradford v. Commissioner, 796

F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo. 1984-601. Mr.

Powerstein consistently exhibited implausible behavior suggesting

fraudulent intent. As a college graduate and a C.P.A., Mr.

Powerstein is knowledgeable in tax matters and was capable of

preparing accurate returns for 1984 through 1988. Nevertheless,

he omitted from each of the 1984 through 1988 joint returns

substantial income earned from the accounting firm. In preparing

petitioners’ joint returns for those years, Mr. Powerstein also

understated capital gains, overstated capital losses, and/or

omitted interest and dividend income.21

Mr. Powerstein also exhibited implausible behavior in the

loan applications that he submitted to banks. Each of those loan

applications reported income substantially higher than that

reported to respondent for Federal income tax purposes. First,

Mr. Powerstein reported on the 1977 loan application that he

expected to earn $24,185 of income from his accounting firm, yet

the 1977 joint return reported that he earned only $3,289 from

that business. Second, although he reported on the 1978 loan

21
Although respondent does not contend that the rental
income petitioners received in connection with the Coral Springs
residence was taxable to them, we observe that such income is
ordinarily taxable. See sec. 61(a)(5).
 - 69 -

application that he expected to earn $31,262 from his accounting

firm, the 1978 joint return reported that he earned only $3,060

from that business. Third, the 1984 loan application estimated

income from his accounting firm of $26,000, but the 1984 joint

return claimed a loss of $996 from that business. Fourth,

attached to the 1983 loan application were the purported 1981 and

1982 returns, each of which reported income different from that

reported on the corresponding 1981 and 1982 joint return filed

with respondent. We find it implausible that an uncorrupted

individual would attach false tax returns to a loan application.

We also doubt that Mr. Powerstein’s gross underestimation of his

income was harmless.

Also indicative of fraud is that Mr. Powerstein was unable

to offer any logical explanation for his behavior. He evaded

basic questions about the letter he drafted to his clients. He

was unable to rationalize the differences in income reported on

the loan applications submitted to banks and the joint returns

filed with respondent. He sought to explain his actions by

suggesting that he neglected himself and his personal Federal

income tax returns to place his clients’ needs first. We doubt

that placing his clients’ needs above his own would lead him to

file false returns absent fraudulent intent. Such behavior

supports a consistent pattern of fraud before 1984 and continuing

throughout 1988.
 - 70 -

iii. Concealment of Income or Assets

Fraud may be implicated where a taxpayer conceals assets or

income. Spies v. United States, 317 U.S. at 499. Petitioners’

use of nominees to place assets beyond the reach of the Federal

Government supports a finding of fraudulent intent. Between

February 23 and May 25, 1989, Mr. Powerstein and Ms. Rosen

transferred approximately 30 bank accounts to Ms. Ballard and Ms.

I. Powerstein individually or in trust for K.B. They transferred

the vacation home and the Romeo property to Ms. Ballard and Ms.

I. Powerstein for $20. On the record as a whole, we believe it

reasonable to conclude that petitioners transferred these assets

in an attempt to place them beyond the reach of the Government.

Such acts favor a finding of fraudulent intent.

iv. Accurate Returns

The failure to file accurate tax returns may indicate

fraudulent intent. Mr. Ballard testified credibly that amounts

reported as loans from shareholders on the Federal income tax

returns for M&M were “stretched”. For example, Mr. Ballard

attributed expenses provided by Mr. Powerstein as consisting of

$14,000 for a tractor, $600 for a chainsaw, and then amounts for

ropes, fertilizer, and other equipment. Mr. Powerstein also

purchased other items such as a riding lawnmower for $1,425 on

February 5, 1983. The 1984 and 1985 returns for M&M reported

that Mr. and Ms. Ballard made more than $63,000 in loans to that
 - 71 -

company even though neither individual had the financial

wherewithal to contribute such moneys.

v. Illegal Activities

A criminal conviction for engaging in illegal activities may

be probative of fraudulent intent. Bradford v. Commissioner,

supra at 308. We consider it significant that Mr. Powerstein

pleaded guilty to income tax evasion under section 7201 for 1987.

Although his conviction does not decidedly establish fraudulent

intent with respect to 1984 through 1986 and 1988, we consider

that crime evidence of a propensity to defraud. See McGee v.

Commissioner, 61 T.C. 249, 260 (1973), affd. 519 F.2d 1121 (5th

Cir. 1975).

In connection with the plea agreement, Mr. Powerstein

admitted to preparing Forms W-2 that overreported Federal income

taxes withheld for 79 client-taxpayers. He wrote a letter during

1985 that acknowledged, either explicitly or implicitly, that he

mischaracterized his client-taxpayers’ Federal tax treatment of

dividends, pension distributions, political party contributions,

and basis. Mr. Powerstein also deliberately misrepresented the

investments of those client-taxpayers to the IRS and claimed

exemptions to which he admitted that they were “not entitled”.

Although this letter is direct evidence of his fraud for 1983, we

also rely on that letter as evidence of Mr. Powerstein’s attempts

to conceal and mislead the Government in determining his client-
 - 72 -

taxpayers’ Federal income tax liabilities. Cf. Richardson v.

Commissioner, 509 F.3d 736, 743-744 (6th Cir. 2007) (considering

a taxpayer’s actions after returns have been filed to determine

his earlier state of mind), affg. T.C. Memo. 2006-69. Such

behavior favors a finding of fraudulent intent.

vi. Dealing in Cash

A taxpayer’s use of cash evidences fraudulent intent because

it demonstrates a desire to avoid detection of income-producing

activities. Bradford v. Commissioner, 796 F.2d at 308. Mr.

Powerstein kept numerous bank accounts, and he dealt with many of

his clients in cash both before and after the years at issue.

Such dealings in cash favor a finding of fraudulent intent.

vii. Summary

After applying the foregoing factors, we are satisfied that

respondent has clearly and convincingly proved that Mr.

Powerstein filed the 1984 through 1986 and 1988 joint returns

intending to conceal, mislead, or otherwise prevent the

collection of taxes. Respondent has therefore satisfied the

second prong of the fraud test as to Mr. Powerstein. For each of

the years 1984 and 1985, we hold that Mr. Powerstein is liable

for an addition to tax equal to 50 percent of the underpayment of

tax for that year. See sec. 6653(b)(1); Harvey v. Commissioner,

T.C. Memo. 1999-229. With respect to additions to tax under

section 6653(b)(1) for 1988, section 6653(b)(2) for 1984 and
 - 73 -

1985, and section 6653(b)(1)(A) and (B) for 1986 and 1988, Mr.

Powerstein is liable for those additions to tax only on the

portions of the underpayments attributable to fraud. See Harvey

v. Commissioner, supra. The burden of proving by a preponderance

of the evidence that a portion of the underpayment for each year

is not attributable to fraud lies with Mr. Powerstein; otherwise

the entire underpayment is subject to the fraud addition to tax.

d. Portion of Underpayment Attributable to Fraud

Petitioners contend that the portions of the underpayments

attributable to the gain on the sale of the of the Coral Springs

residence, their farming activity, capital gains on the sale or

disposition of certain stock, and “relatively small amounts of

interest and dividend” were not attributable to fraud. We agree

in part. With respect to that portion of the deficiency from the

gain on the sale of the Coral Springs residence, we conclude that

the underpayment was not attributable to fraud. Attached to the

1985 joint return was Form 2119, Sale or Exchange of Principal

Residence, which reported the selling price of the Coral Springs

residence and petitioners’ perceived basis in that property. As

evidenced by the fact that Form 2119 was filed, albeit

incorrectly, we do not believe that petitioners reported the sale

of the Coral Springs residence intending to conceal, mislead, or

otherwise prevent the collection of tax.
 - 74 -

As to that portion of the deficiency attributable to their

alleged farming activity, we find that the underpayment is not

attributable to fraud. Petitioners attached to the 1988 joint

return Schedule F alerting respondent to their farming activity,

and respondent disallowed those losses in connection with his

criminal investigation of Mr. Powerstein. Although petitioners’

position regarding the status of their farming activity as a

trade or business was wrong, it was not entirely unreasonable and

did not rise to the level of intending to mislead, conceal, or

otherwise prevent the collection of tax. Accordingly, we hold

that the portion of the underpayment attributable to petitioners’

farming activity was not attributable to fraud.

As to that portion of the deficiency attributable to capital

gains, interest income, and dividend income which Mr. Powerstein

“overlooked” in preparing the 1986 and 1988 joint returns, we

conclude that those underpayments were attributable to fraud.

Mr. Powerstein devised a scheme to conceal his income from

respondent. As evidenced by Mr. Powerstein’s letter to two

clients in 1985, he misstated capital transactions, interest

income, and dividend income which he believed the IRS was unable

to “track”. We believe that petitioners employed a similar

strategy on their joint returns. Omitting such gains and income

allowed Mr. Powerstein to further conceal his income fraudulently

in an attempt to conceal, mislead, and otherwise frustrate the
 - 75 -

collection of taxes. We thus hold that portions of the

underpayment attributable to unreported capital gains and to

interest and dividend income are attributable to fraud. It

follows that Mr. Powerstein is liable for additions to tax under

section 6653(b)(1) for 1988, section 6653(b)(2) for 1984 and

1985, and section 6653(b)(1)(A) and (B) for 1986 and 1988, to the

extent stated herein.

2. Ms. Rosen

On our review of the record, we are not convinced that

respondent has carried his burden of proving fraud by clear and

convincing evidence as to Ms. Rosen. Although she signed the

1984 through 1988 joint returns, which substantially understated

petitioners’ income, and aided the fraudulent transfer of assets

to family members, we are left with only a suspicion of fraud on

her part. She did not understand accounting, was unfamiliar with

the bank accounts and recordkeeping of Mr. Powerstein, and was

not involved with the accounting firm whatsoever. While we have

our suspicions as to whether Mr. Powerstein explained the nuances

of his fraudulent scheme to Ms. Rosen, such suspicions do not

warrant imposition of the fraud addition to tax absent more

compelling evidence. See Gow v. Commissioner, T.C. Memo. 2000-

93, affd. 19 Fed. Appx. 90 (4th Cir. 2001). In this regard,

respondent has failed to satisfy his burden of proof with respect
 - 76 -

to Ms. Rosen. We therefore hold that she is not liable for fraud

additions to tax for 1984 through 1988.

B. Section 6661

Respondent determined that petitioners are liable for

additions to tax under section 6661 for 1985 through 1988. For

tax returns due on or before December 31, 1986, section 6661(a)

imposed an addition to tax for substantial understatements of

income tax equal to 10 percent of the underpayment attributable

to the understatement. Pallottini v. Commissioner, 90 T.C. 498,

500-503 (1988). The amount of the section 6661(a) addition to

tax was subsequently increased to 25 percent for returns due on

or after January 1, 1987. An understatement is substantial if it

exceeds the greater of: (1) 10 percent of the tax required to be

reported on the return, or (2) $5,000. Sec. 6661(b)(1)(A). An

understatement is reduced to the extent that the understatement

is attributable to any item which is (1) supported by substantial

authority, or (2) adequately disclosed in the return or in a

statement attached to the return. Sec. 6661(b)(2)(B).

Petitioners did not adequately disclose the amounts leading

to the understatements on their 1985 through 1988 returns. Nor

have they cited any authority to support the understatements. We

therefore sustain respondent’s determination that petitioners are

liable for additions to tax under section 6661.
 - 77 -

VII. Epilogue

We have considered all arguments raised by the parties, and

to the extent not discussed herein we conclude that they are

irrelevant, moot, or without merit.

To reflect the foregoing,

Decisions will be entered

under Rule 155.