*277 Decision will be entered under Rule 50.
1. Where the operator of a "horse-book" establishment where bets on horse races were illegally made, paid sums of money for protection from arrests and prosecution, held, such payments are contrary to public policy and are not deductible in determining net income.
2. The expenses of actually earning income in illegal businesses are deductible in computing net income subject to tax.
3. Fraud penalties approved.
*201 The Commissioner determined deficiencies and penalties against petitioner as follows:
| Year | Deficiency | Penalty |
| 1938 | $ 8,854.20 | $ 4,427.10 |
| 1939 | 5,324.91 | 2,662.45 |
| 1940 | 7,224.63 | 3,612.31 |
| 1941 | 34,330.24 | 17,165.12 |
| 1942 | $ 48,140.47 | $ 24,070.23 |
| 1943 | 45,273.79 | 22,636.89 |
| 1944 | 77,750.48 | 38,875.24 |
*278 Jeopardy assessments of the above income tax deficiencies and fraud penalties have been made under section 273 of the Internal Revenue Code.
The parties agreed that the evidence presented in the cases of Max *202 Cohen, Docket Nos. 12038 and 12039; Robert L. Carnahan, Docket Nos. 12040 and 12041; Ralph Leonard Polk, Docket No. 12097; and Fred D. Clemons, Docket No. 12096, may be considered in this case in so far as material and relevant thereto. The cases of these five taxpayers were tried consecutively at Kansas City, Missouri.
The issues are:
(1) Did Commissioner err in determining that certain payments made by petitioner to Cohen, which were apportioned by Cohen to himself and Carnahan, constituted payments for protection against raids and arrests by the law enforcement officials of Sedgwick County and the State of Kansas and that consequently such payments are not deductible for income tax purposes?
(2) Did Commissioner err in determining that salaries and expenses of operating an illegal business are not deductible for income tax purposes?
(3) Did the Commissioner err in determining that the income tax deficiencies for each of the years 1938 to 1944, inclusive, were due*279 to fraud with intent to evade tax and consequently subject to a penalty of 50 per cent?
(4) In the alternative, did Commissioner err in determining that over 25 per centum of the gross income was omitted in the petitioner's income tax return for the year 1941 and that consequently, the five-year limitation period for assessment and collection is applicable for such year?
Other minor issues were abandoned.
FINDINGS OF FACT.
The petitioner filed his Federal income tax returns for the years 1938 to 1944, inclusive, with the collector of internal revenue for the district of Kansas. All such returns were timely filed. The notice of deficiency was mailed to petitioner July 12, 1946.
During the years 1938 to 1944, inclusive, petitioner was the owner and operator of a horse-book business under the name of "Lawrence Commission Company" in Sedgwick County, Kansas, which business consisted of accepting wagers or bets placed by individuals on horse races being run at various tracks throughout the country. At the place of business a board was on open display where the daily racing schedule was posted; publications were available to prospective bettors, showing the past racing performance of*280 the different horses; and the establishment had a leased wire service which gave the bettors direct track information on pre-race betting, description of the races, and the race results. The operation of this establishment was in violation of the law of the State of Kansas.
Max Cohen and Robert L. Carnahan, both above referred to, represented to various owners and operators of illegal liquor and gambling *203 business in Sedgwick County, Kansas, that they could protect such operators against raids and arrests by the law enforcement officials of Sedgwick County and the State of Kansas. During the taxable years Cohen and Carnahan had an arrangement with petitioner under which they undertook to afford him such protection in the operation of his illegal gambling business. In consideration of furnishing such protection against raids and arrests by law enforcement officials, petitioner paid Cohen two-thirds of the profits of the business. Pursuant to arrangement between themselves, Cohen paid one-third of the amounts received by him to Carnahan.
Cohen furnished the bank roll or money necessary for the actual operation by petitioner of the horse-book. The bank roll was always deducted*281 and repaid before the profits of the business were determined.
Petitioner employed an accounting firm to prepare his income tax returns for the taxable years. During each of the years 1938 to 1944, inclusive, petitioner made substantial payments to Cohen from the profits of the Lawrence Commission Co. Petitioner verbally advised the accounting firm, which also prepared the income tax returns for Cohen and Carnahan, to make an apportionment of the profits of the Lawrence Commission Co. between himself and Cohen on the basis of his payments to Cohen. Cohen advised the accounting firm to make a further apportionment of the payments received by him from petitioner on the basis of two-thirds to himself and one-third to Carnahan. The above advice was given to the accounting firm for the purpose of preparing their individual income tax returns.
The books and records of the Lawrence Commission Co. do not show that either Cohen or Carnahan ever made any advances or loans of money to that enterprise, nor that either Cohen or Carnahan ever had any investment or ownership in the Lawrence Commission Co.
Partnership returns were never filed for the Lawrence Commission Co. and the individual*282 income tax returns filed by petitioner for the years 1938 to 1944, inclusive, were prepared and filed on the basis that petitioner was the sole proprietor and owner of the Lawrence Commission Co. Neither Cohen nor Carnahan was a partner in the operation of the Lawrence Commission Co. during the taxable years. Petitioner was the sole owner and proprietor of the Lawrence Commission Co. In 1946 the Lawrence Commission Co. business was purchased by Ralph Leonard Polk, above referred to, for $ 1,600, which purchase price was received and retained by petitioner.
For the year 1938 the Lawrence Commission Co. had net betting wins of $ 50,775.63 and miscellaneous income of $ 740.58, or a total gross business income of $ 51,516.21. After deducting a salary of $ 4,889.72 paid to E. L. McConville and salaries to other persons engaged in operating the business, together with miscellaneous expenses, the *204 Lawrence Commission Co. had a remaining net income of $ 27,203.22 for the year 1938. The accountant who prepared the income tax returns for petitioner, Cohen, and Carnahan allocated for income tax purposes the reported net income of the Lawrence Commission Co. as follows: $ 7,419.06*283 to petitioner, $ 13,189.44 to Cohen, and $ 6,594.72 to Carnahan. The Commissioner determined that the salaries and miscellaneous expenses of operating the Lawrence Commission Co. were not deductible for income tax purposes. The Commissioner also determined that the sums paid to Cohen and Carnahan represented protection payments by petitioner and were not deductible for income tax purposes. Accordingly, the Commissioner held that the sum of $ 44,097.15 ($ 51,516.21 minus $ 7,419.06, the amount reported by petitioner without explanation) constituted additional taxable income to petitioner for the year 1938.
For the year 1939 the Lawrence Commission Co. had net betting wins or gross income of $ 38,794.19. After deducting a salary of $ 1,589.90 paid to E. L. McConville and salaries paid to other persons engaged in operating the enterprise, together with miscellaneous expenses, the Lawrence Commission Co. had a remaining net income of $ 18,798.15 for the year 1939. For this year the accountant who prepared the income tax returns for petitioner, Cohen and Carnahan allocated the net income of the Lawrence Commission Co. as follows: $ 5,839.45 to petitioner, $ 8,639.10 to Cohen, and *284 $ 4,319.60 to Carnahan. The Commissioner determined that the salaries paid and miscellaneous expenses of operating the busines were not deductible and that the sums allocated to Cohen and Carnahan were protection payments and likewise were not deductible for income tax purposes. Accordingly, the Commissioner determined that the sum of $ 32,954.74 ($ 38,794.19 minus $ 5,839.45, reported by petitioner) constituted additional taxable income to petitioner for the year 1939.
For the year 1940 the Lawrence Commission Co. had net betting wins or gross income of $ 35,786.70. After deducting salaries paid to persons engaged in operating the business and miscellaneous expenses, there was a remaining net income of $ 20,296.09. The accountant allocated for income tax purposes such reported net income as follows: $ 6,765.37 to petitioner, $ 9,020.48 to Cohen, and $ 4,510.24 to Carnahan. The Commissioner determined that the salaries and miscellaneous expenses in operating the business were not deductible for income tax purposes and that the sums allocated to Cohen and Carnahan represented protection payments by petitioner and were not deductible for income tax purposes. Accordingly, the Commissioner*285 determined that the sum of $ 29,021.33 ($ 35,786.70 minus $ 6,765.37, reported by petitioner) constituted additional taxable income to petitioner for the year 1940.
*205 Petitioner, in his individual income tax return for the year 1941, reported the sum of $ 45,172.12 as being the gross income of the Lawrence Commission Co. for that year. From the above figure, petitioner deducted expenses of $ 29,201.79 and showed a net income of $ 15,456.45. The accountant who prepared the income tax returns for petitioner, Cohen, and Carnahan, allocated $ 21,918.98 to Cohen and $ 10,959.50 to Carnahan from the net betting wins in computing the above reported gross income of the Lawrence Commission Co. The Commissioner determined that the sums allocated to Cohen and Carnahan represented protection payments and were not deductible for income tax purposes. Accordingly, Commissioner increased the gross income of the Lawrence Commission Co. to $ 78,050.60 ($ 45,172.12 plus $ 21,918.98 plus $ 10,959.50). The petitioner, in his income tax return for 1941, deducted salaries of $ 11,988 paid to persons engaged in operating the Lawrence Commission Co. and miscellaneous expenses totaling $ 17,213.79*286 in computing the net income of the Lawrence Commission Co., which deductions were disallowed by the Commissioner. Accordingly, the Commissioner determined that the sum of $ 62,080.27 constitutes additional taxable income to petitioner for the year 1941.
The petitioner, in his individual income tax return for the year 1942, reported the sum of $ 58,229.13 as being the gross income of the Lawrence Commission Co. for such year. The accountant who prepared the income tax returns for petitioner, Cohen, and Carnahan allocated $ 24,178.49 to Cohen and $ 12,089.24 to Carnahan in computing the above reported gross income of the Lawrence Commission Co. The Commissioner determined that such sums allocated to Cohen and Carnahan represented protection payments by petitioner and were not deductible for income tax purposes. Accordingly, the Commissioner increased the gross income of the Lawrence Commission Co. to $ 89,728.88. The petitioner, in his income tax return for 1942, deducted salaries of $ 15,330.40 to persons engaged in operating the Lawrence Commission Co. and miscellaneous expenses totaling $ 25,232.58 in computing the net income of the Lawrence Commission Co., which deductions *287 were disallowed by the Commissioner. The Commissioner determined that the sum of $ 72,062.73 constitutes additional taxable income to petitioner for the year 1942.
For the year 1943 salaries of $ 14,224.65 paid to persons engaged in operating the Lawrence Commission Co. and miscellaneous expenses totaling $ 18,176.98 were claimed by petitioner as deductions from gross income in computing his net taxable income from the Lawrence Commission Co., which deductions were disallowed by the Commissioner. For this year petitioner claimed a deduction for "commissions paid" in the amount of $ 33,063.86, which sum was allocated $ 22,042.57 to Cohen and $ 11,021.29 to Carnahan. The Commissioner determined *206 that such sums, aggregating $ 33,063.86, represented protection payments and were not deductible by petitioner for income tax purposes. Accordingly, the Commissioner determined that the sum of $ 65,465.49 constitutes additional taxable income to petitioner for the year 1943.
For the year 1944 salaries of $ 18,422 paid to persons engaged in operating the Lawrence Commission Co. and miscellaneous expenses totaling $ 20,168.85 were claimed by petitioner as deductions from gross income*288 in computing his net taxable income from the Lawrence Commission Co., which deductions were disallowed by the Commissioner. For this year petitioner claimed a deduction for "commissions paid" in the amount of $ 58,113.70, which sum was allocated $ 38,742.47 to Cohen and $ 19,371.23 to Carnahan. The Commissioner determined that such sums represented protection payments and were not deductible by petitioner for income tax purposes. Accordingly, the Commissioner determined the sum of $ 96,704.55 constitutes additional taxable income to petitioner for the year 1944.
The horse-book business of taking bets or wagers on the results of horse races conducted by petitioner in Sedgwick County, Kansas, under the name of Lawrence Commission Co., during the years 1938 to 1944, inclusive, was illegal under the criminal statutes of Kansas.
The salaries paid to persons engaged in the operation of the Lawrence Commission Co. and other miscellaneous expenses of operating such business and earning its income, totaling $ 24,312.99 for 1938, $ 19,996.04 for 1939, $ 15,490.61 for 1940, $ 29,201.79 for 1941, $ 40,562.98 for 1942, $ 32,401.63 for 1943, and $ 38,590.85 for 1944, were deductible for income*289 tax purposes.
The payments made by petitioner to Cohen, which sums were apportioned by Cohen on the basis of two-thirds to himself and one-third to Carnahan, constituted payments by petitioner for protection against raids and arrests by the law enforcement officials of the County of Sedgwick, State of Kansas, in the operation of the petitioner's illegal horse-book business. Such payments were not deductible for income tax purposes.
Petitioner filed false and fraudulent income tax returns for the years 1938 to 1944, inclusive, with intent to deceive respondent and evade tax. The statutory period of limitation on assessment and collection had not expired for any of the years 1938 to 1944, inclusive, when the Commissioner mailed his notice of deficiencies.
OPINION.
This case is a companion case with Max Cohen, 9 T. C. 1156, and Robert L. Carnahan, 9 T.C. 1206">9 T. C. 1206. Although tried and submitted on the same record and, in some respects inextricably interlocked with the cited cases, the issues differ. The first is the matter of protection payments.
*207 We have found in effect that Cohen and Carnahan held themselves out as*290 vendors of protection and actually undertook to provide such protection to the illegal business of the Lawrence Commission Co. These conclusions are supported by the direct testimony of various witnesses and corroborated by all reasonable inferences. See Max Cohen, supra, and Robert L. Carnahan, supra.When asked about the operation of night clubs in Sedgwick County and the payment of money for protection, one of the operators replied significantly: "I don't know nothing." Such a statement, so made, is pregnant with the unrevealed truth. As observed in the Carnahan case, "All reasonable inferences from the situation tend to support the testimony that no 'place' could operate in Sedgwick County without paying Cohen. To pay Cohen was to pay Carnahan." The facts surrounding the operations of the Lawrence Commission Co. lead us to conclude that, albeit Cohen may have "bank rolled" the business, the split of the profits with Cohen and Carnahan was a payment for protection by petitioner, the owner of the business. Petitioner testified that the bank roll was an "advancement" which was always paid back before the split*291 of profits with Cohen. Petitioner represented himself as the owner of Lawrence Commission Co. and filed his returns as such, claiming deduction for the payments to Cohen, sometimes as "commissions paid," other times without designation. The attempt of petitioner to establish that a partnership existed between petitioner, Cohen, and Carnahan failed completely. Petitioner's counsel concedes that payments for protection are not deductible. The consequence is that the respondent did not err in adding to petitioner's income the sums paid to Cohen and allocated by the accountant to Cohen and Carnahan.
The second issue relates to the deduction of salaries and miscellaneous expenses, the "legitimate expenses of an illegitimate business." The amount of such items is not in dispute. These expenses were incurred in earning the income reported by petitioner or attributed to him by respondent. In Anthony Cornero Stralla, 9 T. C. 801, at 821, this Court recognized that such expenses are deductible, in contradistinction to those expenses which are not deductible because contrary to public policy. We said: "The expenditures here in issue were not made in the *292 actual production of the income; deduction of expenses of that character has been allowed." The income tax law is not a tax on gross income, even if the income be earned in an illegal business. Commissioner v. Heininger, 320 U.S. 467">320 U.S. 467. The deduction of such expenses depends on the innate character of the item itself. Thus, the protection expenses have been disallowed as being contrary to sound public policy or proscribed types of conduct. But items not so to be characterized may be deductible. The distinction may at first seem nebulous, but it is nonetheless real. The items now under discussion *208 are in the latter category and are allowable deductions. The amounts appear in the findings of fact.
The third issue presents the question of fraud. Unless fraud be found for the years, further action by the respondent for the years 1938, 1939, and 1940 is barred by the statute of limitations. In our findings of fact we have held that petitioner was guilty of fraud for all of the years here involved. The evidence shows that petitioner failed to report large items of income; that he claimed large deductions which were without the law and by*293 his returns he did not reveal the truth of his income, but, on the contrary, undertook to mislead and deceive the respondent. The long record in this case is impregnated throughout with evidence of fraudulent conduct, so extensive as to make repetition of the several facts relied on, unnecessary. As noted, we have held as a fact that petitioner filed fraudulent returns for each of the years here involved. Respondent's action in assessing penalties is therefore approved. See Murray Humphreys, 42 B. T. A. 857, p. 863.
The above disposition of the fraud issue makes unnecessary a discussion of the fourth or alternative issue.
Decision will be entered under Rule 50.