T.C. Memo. 2013-83
UNITED STATES TAX COURT
HOWARD MUI AND PEI YI MUI, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 28155-08. Filed March 25, 2013.
Mark C. Heling, Alan F. Segal, and Ryan M. Borgmann, for petitioner
Howard Mui.
Pengtian Ma, for petitioner Pei Yi Mui.
Grubert Roger Markley, Justin D. Scheid, and Andrew Gordon, for
respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
FOLEY, Judge: The issues for decision, relating to 2002, 2003, and 2004,
are whether petitioners are liable for tax relating to underreported income; whether
-2-
[*2] petitioners are liable for section 6663(a)1 fraud, or section 6662(a) accuracy-
related, penalties; and whether Pei Yi Mui, pursuant to section 6015, is entitled to
relief from joint and several liability.
FINDINGS OF FACT
In June 2000 Pei Yi Mui immigrated to the United States on a three-month
visa. Soon thereafter, she married Howard Mui, they purchased a home, and she
applied for permanent resident status. To bolster the application, Mr. Mui added
her as a joint account holder to his Pacific Global Bank account (business account).
Mr. Mui was a compulsive gambler. To fund his habit he operated, as a sole
proprietorship, Chinatown Communication, which sold international telephone
calling cards. Mr. Mui considered this an ideal business because vendors allowed
him to receive the cards in bulk and pay two months after receipt. He used calling
card sales proceeds (i.e., received prior to the repayment date) to gamble. Under
constant pressure to meet vendors’ due dates, he typically paid vendors with
postdated checks drawn on the business account. When the balance in this
account approached zero, he deposited checks drawn on petitioners’ Charter One
1
Unless otherwise indicated, all section references are to the Internal Revenue
Code in effect during the years in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
-3-
[*3] Bank account (personal account). Undaunted by persistent cashflow problems,
he borrowed from friends and family when gambling resources dwindled.
Mr. Mui accepted customer payments in cash and deposited these payments
into the business account and the personal account. Petitioners closed their personal
account in 2004. Mr. Mui would often direct Ms. Mui to sign checks relating to
Chinatown Communication, and on several occasions, Mr. Mui signed his wife’s
name on certain checks. Ms. Mui was not involved in the operation of Chinatown
Communication and supported herself with funds from her parents and personal
savings.
Mr. Mui had numerous encounters with law enforcement authorities. In
2002 and 2003 he was arrested for domestic violence incidents relating to Ms.
Mui, who obtained a restraining order and ultimately separated from him in 2003.
Mr. Mui also had problems relating to the sale of cigarettes upon which State and
local excise taxes had not been paid (contraband cigarettes). In 1999 the Ohio
State Highway Patrol (Highway Patrol) stopped him and seized 1,905 cartons of
contraband cigarettes. The Highway Patrol stopped him again in 2002 (i.e.,
finding no contraband cigarettes in his possession) and 2003 (i.e., finding two
packs of contraband cigarettes in his possession). In May 2008 Mr. Mui, after
-4-
[*4] pleading guilty to charges relating to the sale of contraband cigarettes in 2005
through 2008, was sentenced to 30 months in prison.
Petitioners timely filed joint 2002, 2003, and 2004 Forms 1040, U.S.
Individual Income Tax Return, on which they, respectively, reported $113,135,
$134,627, and $138,493 of gross receipts and $67,881, $74,635, and $72,499 of
cost of goods sold. The 2003 and 2004 returns were professionally, yet sloppily,
prepared. On all three returns petitioners reported that they were entitled to a
refund and Mr. Mui signed Ms. Mui’s name.
After petitioners’ 2002, 2003, and 2004 (years in issue) returns were
selected for audit, Mr. Mui, who had limited proficiency in the English language,
told the examining revenue agent (first RA) about Chinatown Communication’s
use of the business account. Mr. Mui further informed the first RA that he had
only limited business records and had estimated Chinatown Communication’s
reported gross receipts and costs of goods sold. The first RA proceeded to
perform a bank deposits analysis and reconstruct Chinatown Communication’s
income. During this process he identified several gambling loans the proceeds of
which were deposited into the business account. Prior to completion of the
examination, he retired but left workpapers of his analysis.
-5-
[*5] Revenue Agent Nevita Williams (RA Williams) was assigned to complete the
examination. Upon a review of the deposits into the business account, RA Williams
noticed that certain checks drawn on the personal account were deposited into the
business account. As a result, she determined that an analysis of the personal
account was necessary and proceeded to analyze deposits. During the audit Mr.
Mui told RA Williams, but did not submit any supporting documentation, that he
routinely borrowed money to support his gambling habit. Without scrutiny, RA
Williams incorporated the first RA’s analysis of the business account into her
examination report. She also incorporated her analysis of the personal account.
Petitioners divorced on May 14, 2008. On September 2, 2008, respondent
received Ms. Mui’s Form 8857, Request for Innocent Spouse Relief, in which she
requested relief pursuant to section 6015(b), (c), and (f). Respondent denied Ms.
Mui’s request. On September 11, 2008, respondent issued petitioners a notice of
deficiency, which incorporated RA Williams’ examination report. Respondent
determined that petitioners had an additional $883,162, $583,564, and $321,346 of
gross receipts and $520,356, $320,655, and $138,739 of costs of goods sold
relating to 2002, 2003, and 2004, respectively. As a result of these adjustments,
respondent determined that petitioners had $362,536, $270,505, and $176,160 of
-6-
[*6] unreported income relating to 2002, 2003, and 2004, respectively. Respondent
further determined that petitioners were liable for section 6663(a) fraud penalties,
or, in the alternative, section 6662(a) accuracy-related penalties, relating to these
years. On November 19, 2008, petitioners, while residing in Illinois, filed their
petition with the Court.
OPINION
I. The Statutory Notice Is Valid
Petitioners contend that the notice of deficiency lacks a rational foundation
and is arbitrary and excessive. We disagree. See Pittman v. Commissioner, 100
F.3d 1308, 1313 (7th Cir. 1996) (holding that a determination is presumed correct
if it has a rational foundation and is not arbitrary and excessive), aff’g T.C. Memo.
1995-243; see also Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445
F.2d 985 (10th Cir. 1971). First, respondent’s use of the bank deposits method
(i.e., to reconstruct petitioners’ income) was appropriate because Mr. Mui
accepted customer payments in cash, reported estimates on his Federal income tax
returns, and failed to maintain records. See sec. 446(b); Petzoldt v. Commissioner,
92 T.C. 661, 686-687 (1989); sec. 1.446-1(a)(4), Income Tax Regs. Second, Mr.
Mui readily acknowledges that he owned and operated Chinatown Communication
and, thus, was linked to the income-producing activity. See Pittman v.
-7-
[*7] Commissioner, 100 F.3d at 1313-1314. Third, and most importantly,
respondent’s determination is solidly grounded on an extensive review of
petitioners’ activities and bank accounts, which bear a direct relationship to
petitioners’ tax liabilities. See Zuhone v. Commissioner, 883 F.2d 1317, 1325 (7th
Cir. 1989) (stating that the arbitrary and excessive doctrine is a challenge to the
Commissioner’s determination “on the basis that it bears no factual relationship to
the taxpayer’s liability”), aff’g T.C. Memo. 1988-142. While we recognize that RA
Williams could have performed an independent review of the first RA’s analysis and
more thoroughly analyzed petitioners’ personal account, the notice was not arbitrary
or excessive. See id. Indeed, petitioners failed to delineate any inaccuracies in the
first RA’s analysis. On their tax returns relating to the years in issue petitioners
reported gross receipts totaling $386,255 and costs of goods sold totaling $215,015.
Respondent determined, however, that petitioners’ cumulative understatements of
gross receipts and costs of goods sold were $1,788,070 and $979,750, respectively.
Although the parties stipulated numerous checks totaling more than $100,000,
petitioners did not provide any testimony or credible evidence establishing that these
checks related to costs of goods sold or deductible expenses. See Rule 142(a);
Goldsmith v. Commissioner, 31 T.C. 56, 62 (1958).
-8-
[*8] II. Petitioners Underreported Their Income
Petitioners have the burden, but failed, to prove that the deposits at issue are
not income.2 See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). We recognize
that Mr. Mui borrowed funds, but there is no credible evidence relating to the
amount he borrowed. Moreover, there is insufficient evidence establishing that the
deposits were nontaxable or that petitioners are entitled to any cost of goods sold or
deductible expenses exceeding the amount respondent allowed. See Goldsmith v.
Commissioner, 31 T.C. at 62. During cross-examination petitioners presented RA
Williams with checks (i.e., totaling more than $90,000), which respondent’s
determination did not take into account. Petitioners have not, however, established
that these checks related to costs of goods sold. See id. Indeed, they failed to offer
any testimony or additional documentary evidence relating to these checks, costs of
goods sold, or deductible expenses.
III. Petitioners Are Liable for Accuracy-Related Penalties
Respondent determined, but failed to establish by clear and convincing
evidence, that petitioners are liable for fraud penalties pursuant to section 6663(a).
2
Pursuant to sec. 7491(a), the burden of proof may shift to respondent if
petitioners introduce credible evidence with respect to any factual issue. This
section is inapplicable because petitioners failed to maintain business records. See
sec. 7491(a)(2).
-9-
[*9] See secs. 6663(a), 7454(a); Rule 142(b); Pittman v. Commissioner, 100 F.3d
at 1319; Petzoldt v. Commissioner, 92 T.C. at 699. Respondent’s primary
contention is that petitioners sold contraband cigarettes during the years in issue
and concealed the proceeds to evade tax. To support his flimsy fraud contention,
respondent cites a 1999 traffic stop and contraband cigarette sales in 2005 through
2008--all years not in issue. The evidence relating to the years in issue (i.e., two
Highway Patrol stops of Mr. Mui yielding only two packs of contraband
cigarettes) is woefully insufficient. In addition, petitioners cooperated during the
audit. Respondent asserts that Mr. Mui failed to disclose the personal account
when asked through which bank account he conducted business. Mr. Mui did not
reference the personal account because it had previously been closed. Any
misunderstanding relating to this issue was more likely the result of Mr. Mui’s
limited proficiency in English rather than an intent to mislead respondent. Finally,
respondent contends that Mr. Mui’s pattern of cash deposits and failure to
maintain business records was “intentionally calculated to make the unreported
income harder to detect.” Pressured to make vendor’s payment due dates and
compelled to assuage his gambling fever, Mr. Mui frantically shuffled money
between bank accounts, calling card vendors, and casinos. Respondent
established that Mr. Mui’s business practices were imprudent but failed to
- 10 -
[*10] establish that any portion of the underpayment was attributable to fraud or that
petitioners intended to evade tax. See secs. 6663(a), 7454(a); Rule 142(b); Pittman
v. Commissioner, 100 F.3d at 1319; Petzoldt v. Commissioner, 92 T.C. at 700
(stating that the existence of fraud may not be found under “‘circumstances which at
the most create only suspicion’” (quoting Davis v. Commissioner, 184 F.2d 86, 87
(10th Cir. 1950), remanding a Memorandum Opinion of this Court)).
Petitioners are not liable for fraud penalties but are liable for accuracy-
related penalties. They substantially understated their income tax and failed to
exercise due care in the preparation of their tax returns. See secs. 6662(a), (b)(1)
and (2), (c), and (d), 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2001);
sec. 1.6662-3(b)(1), Income Tax Regs. The 2003 and 2004 returns were prepared
by professionals, but petitioners failed to establish or even assert that their
preparers had sufficient expertise to justify reliance, that they provided them with
necessary and accurate information, or that they relied in good faith on their
judgment. See sec. 6664(c)(1); Neonatology Assocs., P.A. v. Commissioner, 115
T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002); sec. 1.6664-4(b)(1),
Income Tax Regs. Thus, they have not, pursuant to section 6664(c)(1), established
reasonable cause for the underpayments or that the returns were prepared in good
- 11 -
[*11] faith. Accordingly, we sustain respondent’s determination relating to section
6662(a) penalties.
IV. Ms. Mui Is Entitled to Innocent Spouse Relief
Married taxpayers may elect to file a joint Federal income tax return. Sec.
6013(a). Each spouse filing the return is jointly and severally liable for the
accuracy of the return and the entire tax due. Sec. 6013(d)(3). Pursuant to section
6015(a), however, a taxpayer may seek relief from joint liability. Ms. Mui
qualifies for relief pursuant to section 6015(c). As a result, Mr. Mui is liable for
the entire tax liability relating to each year in issue. Ms. Mui was divorced from
Mr. Mui when she filed her election for relief. In addition, she sought relief less
than two years after the first collection activity relating to these liabilities. See
sec. 6015(c)(3)(A) and (B). Moreover, Mr. Mui signed Ms. Mui’s name on the
returns, and, at the time the returns were signed, she did not have actual
knowledge of the items giving rise to the deficiencies. See sec. 6015(c)(3)(C);
Cheshire v. Commissioner, 115 T.C. 183, 195 (2000) (stating that “the knowledge
standard for purposes of section 6015(c)(3)(C) is an actual and clear awareness
* * * of the existence of an item which gives rise to the deficiency”), aff’d, 282
F.3d 326 (5th Cir. 2002).
Contentions we have not addressed are irrelevant, moot, or meritless.
- 12 -
[*12] To reflect the foregoing,
Decision will be entered
under Rule 155.