*2 Decisions will be entered under Rule 50.
1. Held, method of determining "income not reported" approved.
2. Held, where the proof establishes that part of the payments received by petitioner from operators of night clubs, where gambling was carried on and liquor sold, all being illegal, were made as "protection" payments and where such proof fails to establish what part of such income was attributable to the payments for protection and what to the furnishing of the "bank roll" for such gambling operations, petitioner can not set off individual gambling losses against such income, either from individual sources or from partnerships of which petitioner may have been a member.
3. Fraud penalties approved.
*1207 The respondent determined deficiencies in income tax and penalties as follows:
| Docket No. | Year | Deficiency | Penalty |
| 12040 | 1937 | $ 2,677.73 | $ 1,343.45 |
| 1938 | 2,033.43 | 1,016.71 | |
| 1939 | 3,837.19 | 1,918.60 | |
| 1940 | 774.74 | 572.93 | |
| 1941 | 52,560.70 | 26,280.35 | |
| 12041 | 1942 | 62,161.22 | 31,080.61 |
| 1943 | 26,931.05 | 14,111.28 | |
| 1944 | 33,809.43 |
*3 The cases of this petitioner were consolidated for trial with the cases of Max Cohen, Docket Nos. 12038 and 12039. It was also agreed that the records in the cases of G. A. Comeaux, Docket No. 12010, Fred D. Clemons, Docket No. 12096, and Ralph Leonard Polk, Docket No. 12097, heard consecutively following the consolidated cases, in so far as material and pertinent, may be considered in the instant cases.
The following questions were presented:
(1) Did the Commissioner err in determining that petitioner received additional taxable income from various owners and operators of illegal slot machines and liquor and gambling businesses which he failed to report in his taxable income for the years 1937 to 1943, inclusive, in the aggregate amount of $ 146,410.52?
(2) Did the Commissioner err in determining that petitioner received additional income of $ 3,054.40 for 1941, $ 6,021.62 for 1942, and $ 531.95 for 1943 from Ray Watson, a slot machine operator, which amounts petitioner failed to report in his taxable income for such years?
(3) Did the Commissioner err in determining that petitioner neither sustained wagering losses nor reported wagering gains against which wagering losses might*4 be deducted and that consequently petitioner is not entitled to deduct, for income tax purposes, any wagering losses for the years 1937, 1938, 1939, 1941, 1942, and 1944?
(4) Did Commissioner err in determining that the income tax deficiencies for each of the years 1937 to 1943, inclusive, were due to fraud in an attempt to evade tax?
(5) In the alternative, did the Commissioner err in determining that over 25 per cent of petitioner's gross income was omitted from his return for the year 1942 and that consequently the five-year limitation period for assessment and collection is applicable for such year?
Petitioner's returns were filed with the collector of internal revenue for the district of Kansas. The statute of limitations bars the assessment and collection of any deficiency or penalty for the years 1937, 1938, and 1939 unless respondent's determination of fraud be sustained. *1208 The notices of deficiency were mailed to petitioner June 24, 1946, in Docket No. 12040, and July 31, 1946, in Docket No. 12041.
FINDINGS OF FACT.
For the year 1937 petitioner reported net income of $ 5,292.51. The respondent added to income as "income not reported" $ 13,871.44 and disallowed*5 personal gambling losses of $ 7,000, making a net income, as adjusted, of $ 26,163.95, whereupon respondent determined the above deficiency and penalty.
For the year 1938 petitioner reported a gross income of $ 8,631.18 from "outside business activities" and a net income of $ 6,239.48, to which respondent added "income not reported" of $ 11,967.10, personal gambling losses disallowed, $ 4,605, and automobile expense of $ 335.85, making a net income, as adjusted, of $ 23,147.43. The respondent thereupon determined the above deficiency and penalty.
For the year 1939 petitioner reported income from the Overflow Club of $ 2,836 and "outside business activities" of $ 304.60, making a total gross income of $ 3,140.60, and a net income of $ 1,057.98. The respondent added to petitioner's net income as reported "income not reported" of $ 22,401.74, and gambling losses disallowed, $ 7,515, making a total income, as adjusted, of $ 30,974.72, on the basis of which the respondent determined the above deficiency and penalty.
For the year 1940 petitioner reported income from "outside business activities" $ 23,214.92, "income [loss] from business or profession" $ 7,467.62, and "gain on sale or *6 exchange of property" $ 190, making a total of $ 15,937.30, to which respondent added income from "outside business activities" $ 1,785.68, "income not reported" $ 2,450, and auto and travel expense disallowed $ 673.76, making a total income, as adjusted, of $ 20,846.64, on the basis of which he determined the above deficiency and penalty.
For the year 1941 petitioner reported net income of $ 15,234.03, including income from "outside business activities" of $ 16,973.54. To the above net income respondent added "income not reported" $ 47,439.63, "income from Ray Watson slot machine route" $ 3,054.40, disallowed deduction for personal gambling losses $ 36,860.58, and disallowed expenses $ 1,306.91, making a total net income, as adjusted, of $ 103,895.55, on the basis of which respondent determined the above deficiency and penalty.
For the year 1942 the petitioner reported gross income from "outside business activities" $ 117,866.91, from which he deducted various expenses and losses, leaving a total net income reported of $ 52,616.47. To this figure respondent added "income not reported" $ 42,827.39, "income from Little River Inn" $ 3,300.50, "income from Ray Watson slot machines" *7 $ 6,021.62, and personal gambling losses disallowed $ 25,000, *1209 making a net income, as adjusted, of $ 129,765.98, on the basis of which the respondent determined the above deficiency in tax and penalty.
For the year 1942 the petitioner reported gross income from "outside $ 49,436.08 and a Victory tax net income of $ 50,147.79, including income from "outside business activities" in the amount of $ 64,479.78, to which amount respondent added various sums, including $ 531.95 from the Ray Watson slot machines, $ 3,596.85 claimed expenses disallowed, and $ 28,700 personal gambling losses disallowed, or an aggregate of $ 40,613.93, from which he deducted $ 5,510.64 reduction in income from the Lawrence Commission Co., making a total net income, as adjusted, of $ 84,539.37 and Victory tax net income of $ 86,168.76. He thereupon determined the above deficiency and penalty.
For the year 1944 the net income disclosed by the return was $ 64,706.45, to which respondent added deductions in oil business disallowed $ 4,522.52 and personal gambling losses disallowed $ 34,550, making a total net income, as adjusted, of $ 103,778.97, on the basis of which he determined the deficiency as shown*8 above. No penalty was determined for this year.
Petitioner's return showed the following sources of his gross income for 1944:
| Kala Club | $ 22,037.50 |
| Swingland | 24,941.05 |
| Lawrence Commission Co | 19,371.23 |
| Canyons Supper Club | 19,220.03 |
| Slot machines | 73,177.30 |
| Sales tax refund | 1,433.44 |
| Total | 160,180.55 |
The petitioner was indicted for income tax evasion for the calendar years 1941 and 1942 and charged with "filing false and fraudulent income tax returns and by attempting to conceal the true and correct gross and net incomes received by him during the said calendar years and the sources thereof." The United States District Court for the District of Kansas convicted Carnahan on his plea of nolo contendere and on January 16, 1946, entered the following sentence:
Ordered and Adjudged that the defendant, having been found guilty of said offenses is hereby committed to the custody of the Attorney General or his authorized representative for imprisonment for the period of one (1) year and to pay a fine of $ 5,000.00 on Count 1 of the indictment; imprisonment for the period of one (1) year and to pay a fine of $ 10,000.00 on Count 2 of the indictment, execution of the *9 periods of imprisonment are hereby suspended and the defendant placed upon probation for the period of four (4) years; and to pay the costs of this action.
It is further ordered that as a condition of said period of probation, the defendant shall pay the total fines of $ 15,000.00 and costs within ten (10) days from this date, and as a further condition that said defendant adjust his income tax after the matter is finally determined by the Bureau of Internal *1210 Revenue unless he shows conclusively to the Court that he is financially unable to pay the same, and obey all laws of the State and the United States.
The item "income not reported" corresponds to the item designated as "excess cash expenditures" in the case of . Cohen and Carnahan were associated in their relations to illegal slot machine, liquor, and gambling businesses. Cohen was also engaged in the oil business and made extensive investments therein. The revenue agent made an analysis of Cohen's actual expenditures from his oil business books and records for the years 1936 to 1943, inclusive. The analysis disclosed that, upon the basis of the excess of Cohen's*10 ascertained cash expenditures over his receipts, he had unreported taxable income aggregating $ 148,080.11, which respondent determined he received from operators of slot machines and liquor and gambling businesses.
Since Carnahan kept no books or records showing his expenditures, it was impossible for the revenue agent to make a similar analysis of his actual expenditures for the purpose of determining his income under the expenditure method used in the case of Cohen. However, since Cohen and Carnahan shared equally in the payments received by either of them from the operators and owners of slot machines and liquor and gambling businesses, with the exception of the payments received from the Lawrence Commission Co., as to which a varying percentage obtained, the revenue agent assumed that Carnahan likewise received equal amounts of unreported income from such sources during the years 1937, 1938, 1939, 1941, 1942, and 1943. Consequently, the respondent determined that Carnahan received additional sums of unreported income for the years just mentioned, aggregating $ 143,960.52, which sums, designated in the notices of deficiency as "income not reported," were held to constitute taxable*11 income to Carnahan for income tax purposes. The Commissioner otherwise determined that petitioner received additional payments of $ 2,450 in the year 1940 from the operators of such businesses which he failed to report in his income tax return.
During the calendar years 1937 to 1944, inclusive, the petitioner resided in the city of Wichita, Sedgwick County, Kansas. During all of such years petitioner derived income from various illegal activities conducted in Sedgwick County outside the corporate limits of Wichita, including the operation of mechanical gambling devices commonly known as "slot machines" and colloquially known as "one-armed bandits," the operation of night clubs where liquor was sold and gambling conducted, and the operation of establishments where wagers were accepted on horse racing, commonly known as a "handbook." All of these activities were conducted in violation of the laws of Kansas.
During the taxable years petitioner was associated in all of the above *1211 activities and otherwise with Max Cohen. Petitioner and Cohen shared the income received by either from the several activities on an equal basis, with the exceptions that income received by the petitioner*12 from the Lawrence Commission Co., in the horse race betting business, was divided on a varying percentage and that petitioner received 25 per cent of the income from the Ray Watson slot machine business.
In some instances petitioner and Cohen furnished the "bank roll" or operating fund for the operators of the gambling houses. In such cases petitioner and Cohen demanded and received a percentage of the earnings which varied from 20 to 75 per cent.
The petitioner and Cohen represented to various owners and operators of the illegal liquor and gambling houses in Sedgwick County, Kansas, that they could afford them protection against raids and arrests by law enforcement officials of Sedgwick County and the State of Kansas. During the taxable years petitioner and Cohen undertook to afford certain of the owners and operators of such illegal liquor and gambling businesses protection against raids and arrests by the law enforcement officials. In consideration therefor the owners and operators of such illegal businesses made payments to petitioner and Cohen, generally on the basis of a percentage of profits. If the owner or operator of the illegal business declined to pay or demurred at*13 paying such percentage, express or implied threats were made either by Cohen directly or by his representative.
Some of the owners and operators of the liquor and gambling establishments of Sedgwick County made a pretense of keeping books and records but most of the smaller operators of such businesses kept no books or records whatsoever. Neither petitioner nor Cohen kept any books or records showing the receipt of payments from such illegal businesses or enterprises. During the taxable years 1937 to 1944, inclusive, petitioner maintained a bank account, but the deposits therein each year were considerably less than the income reported by him for taxation.
Petitioner claimed the following personal gambling losses in computing his reported taxable income for the years 1937, 1938, 1939, 1941, 1942, 1943, and 1944, which deductions were disallowed by the respondent:
| 1937 | $ 7,000.00 |
| 1938 | 4,605.00 |
| 1939 | 7,515.00 |
| 1941 | 36,860.58 |
| 1942 | $ 25,000.00 |
| 1943 | 28,845.00 |
| 1944 | 36,550.00 |
Against these alleged losses petitioner reported total personal winnings from gambling amounting to $ 6,600.
The petitioner filed false and fraudulent income tax returns for each of the years 1937, *14 1938, 1939, 1941, 1942, and 1943, with intent to evade tax. The statutory period of limitation on assessment and collection *1212 had not expired for any of the years 1937 to 1944, inclusive, when the Commissioner issued his notices of deficiency.
OPINION.
This is a companion case to that of , and involves the same income sources. As observed in that case, the night clubs where liquor was sold and gambling carried on, the operation of slot machines, and the operation of an establishment where bets could be placed on horse racing in all parts of the country were all in violation of the laws of the State of Kansas.
The principal items added to petitioner's income were designated by respondent as "income not reported," which item corresponds to the item "excess cash expenditures" in the Cohen case. Cohen and petitioner were associated in their relations to the various illegal slot machine, liquor, and gambling businesses. In our findings of fact we have indicated how respondent arrived at the amounts determined as "income not reported."
Although the present case is one step removed from the expenditures which form the basis of*15 the findings of the respondent in the Cohen case, the considerations and authorities which led us to approve resort to "excess cash expenditures" as a method of ascertaining unreported income in the Cohen case lead us to approve the method adopted here to determine "income not reported." The petitioner had the burden of proving this finding to be in error and this he has not done. The record does not establish that respondent erred as to this item. See .
The question of income from the Ray Watson slot machine route is disposed of by our finding that the petitioner's share of such profits was 25 per cent, which is the amount returned by him.
The third issue is presented by petitioner's contention that in all of the several activities involving night clubs and profits from gambling he was engaged in partnership operation and entitled to set off his individual gambling losses against partnership gambling gains ( ).
The respondent contends that there was no partnership in any instance and that the chief consideration for the*16 payments by the club operators and others to Cohen and Carnahan was the furnishing of protection from arrests and prosecutions by the law enforcement agencies of Sedgwick County and the State of Kansas.
It is significant that neither Cohen nor Carnahan spoke one word in denial of the charge by the Government that they received payments for protection. Cohen, though present in the court room, never took the witness stand (see , and Carnahan, who appeared as a witness, did not deny either the receipt of the money for protection or any of the accusatory statements made by other witnesses. Their personal behavior was *1213 very similar to that which characterized their trial in the United States District Court when both of them pleaded nolo contendere.
In view of the large money returns, it is utterly unreasonable to believe that the temporary need of money for the operation of gambling tables, the "bank roll," was the sole reason for introducing Cohen and Carnahan into the several transactions. If this were true, why was the money advanced not treated as a loan and paid back and the debt discharged*17 as soon as the club proved profitable? If the payments to Cohen and Carnahan were not a form of tribute, or payments for protection exacted by compulsion, why did the club owners and operators continue to pay, year after year, some as high as 75 per cent of the earnings, amounting to many times the sum claimed to have been advanced as the "bank roll"? 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.
On the record, we are convinced not only of the fact that the Commissioner's contention was not disproved, but further as to the affirmative of the issue, i. e., that the record fully supports the Commissioner's contention that a large part of the payments received by the petitioner was for protection. This holding is basic in the disposition of this case. Petitioner claimed huge personal gambling losses and set them off against the income admittedly received and reported from the night clubs. The Government, on the other hand, disallowed most of these gambling losses because not set off against gambling gains, denying thereby that the petitioner was *18 engaged in partnership operations from which gambling gains were derived. Even if it be agreed that petitioner can set off individual gambling losses against partnership gambling gains ( ), and if it be agreed that petitioner was a partner with Cohen or others as to furnishing the "bank roll," petitioner must still fail. The proof does not establish the amount of any partnership gains, as such. It likewise is not proven what specific sums are attributable to the furnishing of the "bank roll" and what to the furnishing of protection. The protection consideration permeates all of petitioner's profits from slot machines, gambling, and night clubs. Therefore, we are unable to sustain petitioner's contention with respect to the setting off of gambling losses, aggregating more than $ 140,000, in any part other than the $ 6,600 reported personal gains which have been allowed by the respondent.
There are other reasons which would require the disallowance of the claimed gambling losses for most of the years. Much of the testimony calculated to support the alleged gambling losses was couched in such form and came from such*19 sources as to make it unreliable and unbelievable. Although the Government concedes a loss of $ 29,863.08 in *1214 1941 in operating a "horse book," or a place where wagers were accepted on horse races being run on different tracks throughout the country, petitioner can get no benefit, as he reports no gains from such operation.
As to 1942, we are not persuaded as to the accuracy of the testimony supporting the claimed loss of $ 25,000 said to have been lost by the petitioner in Chicago. The cavalier manner in which petitioner called the accountant who was preparing his tax return and told him to take $ 25,000 as a gambling loss and the tone and form of the confirmatory letter are such that we are unimpressed as to the truth and authenticity of the claimed loss. We find ourselves in agreement with the Government's action. Petitioner's counsel concedes that the petitioner's plea of nolo contendere is effective in making applicable the fraud provision of section 6 (a) of the Current Tax Payment Act of 1943. Therefore, respondent is not barred from the assessment and collection of any deficiency for the year 1942.
The alleged loss of $ 28,845 net, claimed to have been sustained*20 at New Orleans in 1943, was substantiated by exhibition of canceled checks aggregating some $ 31,000, which sum was reduced by gambling gains of $ 2,000. Petitioner's testimony was also supported by the testimony of another gambler who accompanied petitioner on the trip. Here again petitioner fails from the absence of gambling gains.
In 1944, in which year petitioner claimed a gross loss of $ 36,550 and a net loss of $ 34,550, he admits that $ 8,050 of such sum was never paid. As to this year's alleged loss, we have only petitioner's bare, unsupported testimony. Half of the alleged loss was claimed to have been from "pocket cash." Even if we held the loss to be substantiated, which we do not, petitioner yet meets the insuperable obstacle of the absence of proven gambling gains.
In the year 1940 the respondent held that petitioner received $ 2,450 from protection sources which he failed to report. Although the testimony was not sufficiently precise to verify the exact figures, it was such as to require us to hold that petitioner has not proved respondent's finding to be erroneous.
We have found as a fact that the petitioner filed false and fraudulent returns, with intent to evade*21 tax, for the years 1937 to 1943, inclusive. The evidence shows that the petitioner failed to report large items of income (). He also attempted to set up large claims for gambling losses against income not realized either as individual or partnership gambling gains. The record shows that he failed to recognize his obligation to his Government to make a full, frank disclosure of all income received and to claim no deduction not legitimately or reasonably supportable. In our judgment the evidence of the intention to file false and fraudulent returns is clear and convincing. See
Decisions will be entered under Rule 50.