1995 Tax Ct. Memo LEXIS 569">*569 Decision will be entered under Rule 155.
MEMORANDUM FINDINGS OF FACT AND OPINION
JACOBS,
Additions to Tax | |||
Sec. | Sec. | ||
Year | Deficiency | 6653(b)(1) | 6653(b)(1)(A) |
1984 | $ 12,454 | $ 6,347 | -- |
1985 | 13,007 | 6,504 | -- |
1986 | 22,442 | -- | $ 16,832 |
Additions to Tax | |||
Sec. | Sec. | Sec. | |
Year | 6653(b)(2) | 6653(b)(1)(B) | 6661 |
1984 | * | -- | $ 3,114 |
1985 | * | -- | 3,252 |
1986 | -- | * | 4,773 |
* 50 percent of the interest | |||
due on the deficiency. |
In the alternative to the additions to tax pursuant to
All section references are to the Internal Revenue Code in effect for the years under consideration. All Rule references are to the Tax Court Rules of Practice and Procedure.
The issues for decision are: (1) Whether petitioners underreported their income and overstated Schedule C deductions for 1984, 1985, and 1986, as determined by respondent; (2) whether petitioners are liable for the additions to tax for fraud pursuant to
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference.
Petitioners, husband and wife, 1995 Tax Ct. Memo LEXIS 569">*571 resided in Sterling, Virginia, at the time they filed their petition. They timely filed joint Federal income tax returns for 1984, 1985, and 1986, the years under consideration. Respondent mailed petitioners a notice of deficiency with respect to all years under consideration on August 26, 1993.
Robin F. Jenkins (hereinafter referred to in the singular as petitioner) obtained a high school diploma and completed one year of college. While in college, petitioner studied wildlife biology; he did not take any tax or accounting courses. He left college and became a mason by trade. During the years under consideration, petitioner was self-employed; he owned and operated a business known as Field Masonry.
Anne F. Jenkins (Mrs. Jenkins) also graduated from high school and completed one semester of college study. She did not take any tax or accounting classes.
Respondent's revenue agent, Kathleen Bellamy (Ms. Bellamy), was assigned to audit petitioners' Federal income tax returns for the years under consideration. Ms. Bellamy first met petitioners in December 1987 at their residence. She began the audit by examining petitioners' bank deposits in order to identify possible unreported1995 Tax Ct. Memo LEXIS 569">*572 income. Ms. Bellamy examined deposit slips, petitioner's business records, and the records of some of the vendors with whom petitioner dealt. Ms. Bellamy discovered that substantial amounts of income were omitted from, and deductions were improperly claimed on, petitioners' 1984, 1985, and 1986 income tax returns.
During their first meeting, Ms. Bellamy questioned petitioner about his business books and records; he told her that there were no books to examine. Subsequently, petitioner provided her with bank statements, canceled checks, a bag of invoices, and sheets of notebook paper containing unexplained figures.
In point of fact, petitioner used "brown books" to record income and profit, and to compile summary sheets of his Field Masonry business activities. The brown books were also used to calculate the amount of petitioners' annual charitable contributions.
One of respondent's special agents accompanied Ms. Bellamy to petitioners' home for a second meeting regarding possible criminal violations. At that time, petitioner provided the agents with one of his brown books from a year prior to the years under consideration and showed them how he computed1995 Tax Ct. Memo LEXIS 569">*573 his income. Petitioner told them that the brown books and summary sheets for the years under consideration had been destroyed because he had given them to his children to color on. He also expressed his belief that records more than 3 years old should be destroyed.
Because of the possible criminal violations, petitioners retained a lawyer. Their lawyer had possession of the brown books for the years under consideration. The brown books were ultimately turned over to respondent's special agent who provided them to Ms. Bellamy.
Petitioner prepared petitioners' tax returns for the years under consideration. Mrs. Jenkins did not participate in the completion of the returns. Petitioners paid no income tax for 1982, 1983, 1985, and 1986; they paid $ 240 in income tax for 1984.
Ms. Bellamy primarily used the bank deposit analysis (and then made modifications as additional information was provided) to identify petitioners' unreported Schedule C income for 1984, 1985, and 1986. Petitioner did not report all of his gross receipts from his Field Masonry business.
When the audit began, petitioner wrote a $ 25,000 personal check, payable to the Internal Revenue 1995 Tax Ct. Memo LEXIS 569">*574 Service, and gave it to Ms. Bellamy because he was certain that petitioners had underreported their income and owed at least that amount.
Petitioners claimed, among others, the following expenses as Schedule C deductions on their 1984 return:
Advertising | $ 416 |
Dues and publications | 111 |
Legal and professional | 919 |
Office expense | 432 |
Travel and entertainment | 693 |
Utilities and telephone | 611 |
Work clothes | 473 |
Security guard | 183 |
Petitioners could not substantiate the advertising expense. Under the category dues and publications, petitioners deducted the dues paid to petitioners' homeowners association, and amounts paid for the disposal of household trash. The legal and professional expense was for a $ 50 stuffed deerhead that petitioner gave to an accountant for preparing petitioners' 1979 income tax return, and $ 869 of family doctor bills. Petitioners deducted, as office expense, $ 198 for cassette tapes and a tape player. They deducted a $ 500 color television set and a family trip to Williamsburg, Virginia, as travel and entertainment. Petitioners deducted home utility bills under the utilities and telephone category, and1995 Tax Ct. Memo LEXIS 569">*575 a portion of the deduction was allowed by respondent. Under the category of work clothes, petitioners deducted personal clothing purchased by petitioner during 1984. The security guard expense consisted of dog food and a license for the family dog. In addition to these Schedule C deductions, petitioners deducted $ 382, which was paid for hazard insurance on their home, as a Schedule A medical and dental expense.
Petitioners claimed, among others, the following expenses as Schedule C deductions on their 1985 return:
Advertising | $ 496 |
Travel and entertainment | 324 |
Supplies | 2,249 |
Utilities and telephone | 588 |
The advertising expense consisted of two deerheads, which were worth approximately $ 200 apiece. The travel and entertainment expenses consisted of fireworks, fishing, and motel costs. Under supplies, petitioners deducted a $ 1,575 video camera purchased for both personal and business use, and deducted the costs of utilities and telephone used at their residence. Petitioners also deducted $ 379 for dog food, veterinary bills, and a chain for their dog.
Petitioners claimed, among1995 Tax Ct. Memo LEXIS 569">*576 others, the following expenses as Schedule C deductions on their 1986 return:
Employee benefit program | $ 3,356 |
Mortgage interest | 14,277 |
Supplies | 5,365 |
Security guard | 682 |
Contributions | 11,567 |
Petitioners could not substantiate the supplies deduction. The security guard expense represented a fence erected to house petitioners' family dog. The employee benefit program deduction consisted of family doctor and medical expenses. Petitioners deducted $ 14,277 for home mortgage interest as a business expense. The contribution deduction represented petitioners' charitable contributions. Petitioners also claimed a $ 1,588 jobs credit on their 1986 Schedule C.
In prior years, petitioners deducted their medical, home mortgage interest, and charitable contribution expenses as Schedule A itemized deductions rather than Schedule C deductions. Petitioner deducted the aforementioned expenses on Schedule C of their 1986 return because Schedule C provided them with greater tax savings.
Respondent determined that petitioners underreported their income during each of the years in issue by: (1) Underreporting petitioner's masonry business receipts; (2) inflating business deductions; and1995 Tax Ct. Memo LEXIS 569">*577 (3) changing Schedule A deductions to Schedule C expenses.
In 1985, petitioner applied for a loan at the First American Savings and Loan Association (First American). On the application form, petitioner listed his income as $ 4,000 a month. He listed $ 118 of monthly inheritance interest, and reported cash assets of approximately $ 40,000. The inheritance interest income was not reported on petitioners' Federal income tax returns for the years under consideration. Petitioners' 1983 and 1984 tax returns were attached to the bank loan application. First American denied petitioner a loan.
Petitioner wrote a letter to First American following the denial of the loan. In the letter, he provided First American with profit information for the first eight months of 1985. He reported gross profit of $ 57,566 and net profit of $ 36,788. Petitioner obtained these figures using his brown books.
During the years under consideration, petitioners made charitable contributions based on tithing. They tithed approximately 10 percent of petitioner's annual profits to their church. Petitioner determined the amount to be tithed each year by using his brown books.
1995 Tax Ct. Memo LEXIS 569">*578 Ms. Bellamy met with petitioners after she had completed a bank deposit analysis and reconstructed petitioners' expenses for each of the years under consideration. During this meeting, Ms. Bellamy asked petitioners to review her calculations to see if they agreed with the income and expense figures. Petitioner suggested that if Ms. Bellamy's figures matched petitioners' tithing, he would agree with her numbers. He asked Ms. Bellamy to calculate 10 percent of the amount she determined as his gross profit. Ms. Bellamy did so, and the result was close to the amount petitioners tithed. Petitioner agreed with the agent's income analysis. He told the agent that he always computed gross profit accurately for tithing because "I'd never cheat the Lord."
OPINION
Every individual liable for tax is required to maintain books and records sufficient to establish the amount of his or her gross income.
For the years under consideration herein, petitioner maintained inadequate books and records. As a result, respondent was required primarily to use the bank deposit method to reconstruct petitioners' income. "The bank deposit method assumes that all money deposited in a taxpayer's bank account during a given period constitutes taxable income."
Because petitioners used a modified accrual accounting method, Ms. Bellamy used the same method to calculate petitioners' income. She reconstructed petitioners' income and expenses using the information she possessed.
Petitioners failed to present evidence to refute respondent's income determinations and to substantiate the deductions claimed. In contrast, respondent has established that the underpayments determined in the statutory notice of deficiency are correct. Accordingly, we sustain respondent's determination both as to the amounts of unreported income and the denial of Schedule C deductions1995 Tax Ct. Memo LEXIS 569">*581 for each of the years under consideration.
Respondent determined that petitioners are liable for the additions to tax for fraud under
For 1984 and 1985,
Under
Fraud is intentional wrongdoing on the part of the taxpayer with the specific purpose to evade a tax believed to be owing.
For purposes of the fraud addition, an underpayment of taxes can be accomplished by an overstatement of deductions as well as by an omission of income.
Next, respondent must prove that a portion of such underpayment was due to fraud.
The courts have listed several indicia or "badges of fraud" from which fraudulent intent can be inferred. These include: (1) Understating income; (2) inadequate books and records; (3) failure to file tax returns; (4) implausible or inconsistent explanations of behavior; (5) concealment of assets; (6) failure to cooperate with tax authorities; (7) engaging in illegal activities; (8) an intent to mislead which may be inferred from a pattern of conduct; (9) lack of credibility of the taxpayer's testimony; and (10) dealings1995 Tax Ct. Memo LEXIS 569">*585 in cash.
Fraud cannot be imputed from one spouse to another. In the case of a joint return,
Petitioner claims that the understatements and deductions on the returns for the years under consideration were not fraudulent, but rather resulted from his honest mistakes. He claims that mistakes were made because he thought every expense was deductible and that the IRS audited all returns and corrected any inaccurate items listed on the returns. We find petitioner's claim to be self-serving and, 1995 Tax Ct. Memo LEXIS 569">*587 at least in part, incredible.
Respondent has affirmatively established numerous badges of fraudulent intent by petitioner as follows:
(1)
Consistent understatement of income with consequent underpayment of taxes may be strong evidence of fraudulent intent to evade taxes.
Petitioner considered himself to be a successful and sophisticated businessman. He operated Field Masonry prudently by filing appropriate tax forms for each of his employees, and presented himself at trial as a knowledgeable and competent individual. Nevertheless, he exhibited a pattern of substantially understating petitioners' 1984, 1985, and 1986 income. Also, petitioner chose to deduct all personal and business expenses. Personal expenses are not deductible. Sec. 262. A practice of claiming personal expenses as business expenses has been held to justify the imposition of the fraud addition to tax. See, e.g.,
Petitioner also excluded gross receipts and interest income for each of the years under consideration. He deliberately moved Schedule A itemized deductions to Schedule C for increased tax benefits. In fact, he offered Ms. Bellamy a $ 25,000 check, payable to the IRS, at their first meeting because he was sure that petitioners had understated income. Moreover, petitioners paid no income tax in 1985 and 1986, and only paid $ 240 in 1984. Thus, respondent has proven that petitioner consistently understated and underpaid petitioners' income tax for each year.
(2)
Failure to maintain adequate books and records may be an indicium of fraud.
(3)
Petitioner testified that he used his brown books to calculate petitioners' annual charitable contributions. He also claimed that he used the brown books to prepare petitioners' tax returns. The figures on the returns, however, did not match the figures in the books. Petitioner asked Ms. Bellamy to take her figures and calculate 10 percent of his gross profit for each year under consideration. Petitioner agreed that Ms. Bellamy's income analysis was correct because 10 percent of the gross profit calculated from Ms. Bellamy's figures approximated petitioners' tithing. 1995 Tax Ct. Memo LEXIS 569">*590 We conclude that although petitioner used his brown books to calculate petitioners' tithing, he chose not to use them when he prepared petitioners' Federal income tax returns.
The brown books also were used to complete a 1985 bank loan application. The figures reported on the application were inconsistent with the figures petitioner listed on petitioners' 1985 Federal income tax return. Petitioner was denied the loan based on the application, which included petitioners' 1983 and 1984 income tax returns. In a letter written to the bank, he tried to explain why the reported income was so low by informing the bank that he had a $ 36,788 profit during the first 8 months of 1985. He used his brown books to compute these figures. Subsequently, he reported no taxable income on the 1985 return. Thus, petitioner's behavior concerning his calculation of tithing and in reporting petitioners' income on the bank loan application was inconsistent with the reporting of petitioners' income on the tax returns for the years under consideration.
(4)
Misleading statements to an investigating agent may be evidence of fraud. See
Petitioner claims that petitioners provided Ms. Bellamy with the brown books for the years under consideration at the first audit meeting, and that she took the books with her and later returned them. He further contends that his preparation of a mileage log, completed during the audit and at Ms. Bellamy's recommendation, is proof that the brown books were handed over to her. But he later claimed that the brown books were destroyed by his children, and expressed a belief that it was useless to keep records for longer than 3 years. It took almost 2 years before Ms. Bellamy was given an opportunity to review photocopies of the 1984, 1985, and 1986 brown books, which were provided to her through petitioners' counsel. We conclude that petitioner did not turn the brown 1995 Tax Ct. Memo LEXIS 569">*592 books over to Ms. Bellamy as asserted, and that he intended to mislead Ms. Bellamy by withholding this information.
(5)
A taxpayer's lack of credibility, inconsistent testimony, or evasiveness are factors in considering the fraud issue.
(6)
A failure to cooperate with tax authorities is further proof of fraud.
To summarize, the evidence in this case shows, clearly and convincingly, that the entire underpayment for 1984, 1985, and 1986 is due to petitioner's fraud. Thus, we sustain respondent's determination that petitioner is liable for the additions to tax under
Mrs. Jenkins' testimony was not fully credible. Her support of petitioner's claim that petitioner provided Ms. Bellamy with the brown books for the years under consideration demonstrates that part of her testimony was not plausible. We have found that petitioner never provided Ms. Bellamy with the brown books. Nonetheless, 1995 Tax Ct. Memo LEXIS 569">*594 we are not inclined to hold that Mrs. Jenkins committed fraud based solely on her lack of credibility. As previously stated, fraud is never presumed; even if the taxpayer's testimony is not credible in all respects, we may still be left with no more than a suspicion of fraud.
The record contains no evidence to indicate that Mrs. Jenkins was involved in petitioner's Field Masonry business. Respondent failed to show that Mrs. Jenkins was responsible for understating income, for maintaining petitioner's brown books, or that she was in any way involved in claiming the unsubstantiated deductions. Also, respondent produced no evidence to show that Mrs. Jenkins concealed assets, was engaged in illegal activities, or had dealings in cash. Petitioner completed petitioners' 1984, 1985, and 1986 tax returns by himself. Mrs. Jenkins signed the returns without 1995 Tax Ct. Memo LEXIS 569">*595 glancing at any of the reported figures.
Respondent has not affirmatively established by clear and convincing evidence that Mrs. Jenkins intended to evade taxes. We cannot conclude on this record that Mrs. Jenkins committed fraud, where respondent has failed to adduce evidence showing intentional wrongdoing.
We now turn to whether petitioners are liable for additions to tax for negligence under
Petitioner and Mrs. Jenkins filed joint Federal income tax returns for the years under consideration. The liability for additions to tax for taxpayers who file jointly is joint and several.
We held above that petitioner is liable for the additions to tax for fraud for all years under consideration. If we were to hold Mrs. Jenkins liable for the negligence additions to tax for such years, petitioner would then be jointly and severally liable for such addition. But a taxpayer cannot be liable for the addition1995 Tax Ct. Memo LEXIS 569">*596 to tax for fraud and also the addition to tax for negligence.
The next issue is whether petitioners are liable for the additions to tax for substantial understatements of income tax pursuant to
1995 Tax Ct. Memo LEXIS 569">*597 With respect to the additions to tax under
The final issue is whether respondent is barred by the statute of limitations from assessing and collecting petitioners' Federal income taxes for the years under consideration.
As a general rule, the Commissioner must determine a deficiency within 3 years after a return is filed.
To reflect the foregoing,