Decisions will be entered under
LAUBER,
In docket No. 14991-13 respondent determined against petitioner Duong deficiencies and fraud penalties as follows:
2007 | $48,953 | $30,536 |
2008 | 18,439 | 13,201 |
In docket No. 15151-13 respondent determined against petitioner Tran deficiencies, additions2015 Tax Ct. Memo LEXIS 98">*99 to tax, and penalties as follows:
2007 | $34,468 | $8,617 | $24,989 | -0- | -0- |
2008 | 14,171 | -0- | -0- | $10,628 | $2,834 |
*92 After concessions,22015 Tax Ct. Memo LEXIS 98">*100 the issues remaining for decision are: (1) whether petitioners failed to report income for 2007 and 2008 as determined by respondent using the bank deposits method; (2) whether petitioners are liable for fraud penalties; and (3) if petitioner Tran is not liable for the fraud penalty, whether she is liable for the accuracy-related penalty for 2008. We answer the first question in the affirmative, and we find that petitioner Duong is liable for the fraud penalty for both years. We find that respondent has failed to prove by clear and convincing evidence that petitioner Tran is liable for the fraud penalty but conclude that she is liable for the accuracy-related penalty for 2008.
Some of the facts have been stipulated and are so found. The stipulations of facts and the attached exhibits are incorporated by this reference. When they petitioned this Court, petitioner Khuong Duong (Duong) lived in Severn, Maryland, and petitioner Dung T. Tran (Tran) lived in Splant City, Florida. *93 Petitioners jointly owned and operated AK Nails and Perfection Nails during the years in issue and split the profits and losses 50-50. Each salon had several nail stations so that multiple stylists could serve customers simultaneously. Tran was the main stylist and often worked alone; petitioners employed other nail stylists in both salons as necessary to meet customer demand. Petitioners paid these stylists a wage by check, and the stylists kept any tips that customers gave them. Customers paid for the salon services and tips by credit card, debit card, or cash. Duong functioned as a store manager and did not act as a nail stylist.
Although petitioners were not married2015 Tax Ct. Memo LEXIS 98">*101 during 2007, they filed a joint Federal income tax return for that year. They attached to this return a Schedule C, Profit or Loss From Business, reporting gross receipts of $37,469 from AK Nails. For 2008 each petitioner filed an individual return using the "single" filing status. Tran attached to her return a Schedule C reporting gross receipts of $38,347 from AK Nails. Duong attached to his return a Schedule C reporting gross receipts of $44,377 from Perfection Nails.
The IRS selected petitioners' returns for audit, focusing on their Schedule C income. A revenue agent met with petitioners and toured both nail salons. During these visits petitioners stated that they had reported on their tax returns all income received by the salons. They denied receiving cash at either location, insisting that *94 customers made all payments by credit or debit card. Duong bears principal responsibility for making these false statements.
Petitioners did not maintain adequate books and records for their businesses. Duong declined to provide the revenue agent with bank statements or with the other limited business records that petitioners possessed. Duong bears principal responsibility for the failure to2015 Tax Ct. Memo LEXIS 98">*102 turn over business records to the revenue agent.
The revenue agent issued summonses to petitioners' banks in order to conduct a bank deposits analysis. During 2007 petitioners maintained three joint bank accounts and Duong maintained a separate joint account with his father. During 2008 petitioners maintained two joint bank accounts and Duong maintained a separate individual account. Petitioners comingled funds from these accounts and used the accounts for both business and personal activities.
Under the bank deposits method, the IRS estimates the gross receipts of a business that lacks reliable records. This analysis begins with the bank deposits made during the tax year, then adds any other income shown to have been received but not placed in a bank. From that total, various subtractions must be made for nontaxable deposits. Nontaxable deposits include loan proceeds, inter-account *95 transfers, gifts, inheritances, and other nontaxable items.
The revenue agent followed this procedure here. She started with petitioners' bank statements and calculated the total deposits made during 2007 and 2008. From these totals she deducted deposits shown to be from nontaxable sources, including2015 Tax Ct. Memo LEXIS 98">*103 a home equity loan, other loans, transfers from other accounts, various rebates, insurance proceeds, State and Federal tax refunds, and for Doung's separate account in 2007, wages earned by his father.
For 2007 the revenue agent calculated total deposits of $235,679 in petitioners' joint accounts, less $98,866 from nontaxable sources, yielding $136,813 of presumptive gross receipts. For 2008 she calculated total deposits of $136,826 in petitioners' joint accounts, less $36,893 from nontaxable sources, yielding $99,933 of presumptive gross receipts. For Duong's separate account in 2007 she calculated total deposits of $20,119, less $3,092 from nontaxable sources, yielding $17,027 of additional gross receipts for Duong. For Duong's separate account in 2008 she calculated total deposits of $51,553, less zero from nontaxable sources, yielding $51,553 of additional gross receipts for Duong.
The revenue agent then increased the presumptive gross receipts set forth above by 8% to account for tips. Under her theory, if a salon customer tipped the *96 stylist in cash, the cash tip would probably not be included in petitioners' bank deposits. The IRS determined that tips presumptively received should2015 Tax Ct. Memo LEXIS 98">*104 be added to the bank deposit totals as "other income shown to have been received but not placed in bank."
On the basis of the examination and the revenue agent's initial calculations, the IRS on April 2, 2013, issued separate notices of deficiency to Duong and Tran. They timely petitioned this Court, and the cases were consolidated. Petitioners thereafter provided respondent with documents substantiating, for their joint bank accounts, additional nontaxable deposits of $32,078 for 2007 and $12,190 for 2008. After allowing these items, respondent's revised position was that the gross receipts chargeable to each petitioner, before adding 8% for tips, were as follows:
Joint account deposits | $235,679 | $235,679 | $136,826 | $136,826 |
Less nontaxable deposits | (98,866) | (98,866) | (36,893) | (36,893) |
Duong separate deposits | 20,119 | -0- | 51,553 | -0- |
Less nontaxable deposits | (3,092) | -0- | -0- | -0- |
Less additional nontaxable | (32,078) | (32,078) | (12,190) | (12,190) |
deposits for joint accounts | ||||
Total gross receipts | 121,762 | 104,735 | 139,296 | 87,743 |
*97 The Court held a trial on September 30, 2014. Respondent called the revenue agent as a witness, and she explained in detail her bank deposits analysis. Duong spoke for2015 Tax Ct. Memo LEXIS 98">*105 both petitioners and testified on his own behalf; Tran, who was present, did not testify or conduct cross-examination. During the recall of the revenue agent, Duong questioned her about 17 checks that he contended should be treated as additional nontaxable deposits. The Court determined that the revenue agent's schedule of nontaxable deposits already included 14 of these checks.
The remaining three items consisted of a check from J.P. Morgan Chase for $9,000, a check from Nhut Hong Le for $3,000, and a check from Baltimore Gas & Electric Co. for $896. Petitioners argued that the first item was a credit card cash advance, but they did not furnish the revenue agent or introduce into evidence the relevant credit card statement. Petitioners argued that the second item was a loan, but they did not advance this contention until a week before trial and produced no evidence of a loan apart from Duong's testimony. Petitioners argued that the third item was a utility rebate, but they provided no evidence as to whether they had deducted the original payment on a tax return. For these reasons, the revenue agent testified as to her belief that these three checks should not be treated as nontaxable2015 Tax Ct. Memo LEXIS 98">*106 deposits.
*98 At the close of trial the Court ordered one round of seriatim briefs. Respondent timely filed his brief on January 29, 2015. Petitioners failed to file a posttrial brief.3
The IRS' determinations in a notice of deficiency are generally presumed correct, and the taxpayer bears the burden of proving those determinations erroneous.
To satisfy his initial burden of production, respondent2015 Tax Ct. Memo LEXIS 98">*107 introduced records obtained during the IRS audit. These records establish that petitioners received unreported income. Although not necessarily required to do so, respondent has also shown that the nail salons are the likely source of petitioners' unreported income.
In the instant cases petitioners failed to maintain accurate books or records from which their Federal tax liabilities could be computed. They refused during the audit to provide the revenue agent with any records at all. Respondent was thus authorized to determine their income by using the bank deposits method.
Bank deposits are prima facie evidence of income. The bank deposits method starts with the presumption that all money deposited in a taxpayer's bank account during a given period constitutes taxable income.
After the IRS reconstructs a taxpayer's income and determines a deficiency, the taxpayer bears the burden of proving that the IRS' implementation of the bank deposits analysis was unfair or inaccurate.
The revenue agent employed the bank deposits method to reconstruct petitioners' 2007 and 2008 income. She used their bank account statements (which are part of the record) to prepare schedules listing all deposits. She eliminated $138,851 of nontaxable deposits using evidence of which she had knowledge. Upon receiving more documentation from petitioners, she determined that $44,268 of additional deposits should be treated as nontaxable and eliminated them from her analysis. In the end, she determined that $183,119 of the deposits, roughly *102 half the total, was nontaxable. She then estimated petitioners' unreported gross receipts by subtracting from their taxable deposits the gross receipts reported on their tax returns. We find that her implementation of the bank deposits method was reasonable.
Petitioners' primary challenge at trial to the revenue agent's methodology was the contention that she should have treated 17 specific checks as additional nontaxable deposits. We determined that the revenue2015 Tax Ct. Memo LEXIS 98">*110 agent's schedule of nontaxable deposits already included 14 of these checks. We will discuss the other three.
Duong testified that a $9,000 check from J.P. Morgan Chase was a credit card cash advance. If this allegation were true, petitioners could easily have verified it by providing the revenue agent or the Court with a credit card statement showing the alleged advance. We decline to credit Duong's uncorroborated testimony in the absence of such evidence.
Duong next testified that a $3,000 check from Nhut Hong Le represented a loan from a personal friend, and that his parents later paid off this loan on his behalf. Petitioners did not advance this contention during the IRS audit, and Duong first made the argument a week before trial. Duong provided no documentary evidence *103 that this check represented a loan or that his parents paid off the loan. Again, we decline to credit his uncorroborated testimony.
Finally, Duong testified that an $896 check from Baltimore Gas & Electric Co. was a utility rebate that should be treated as nontaxable. However, when an amount is deducted from gross income in one year and recovered in a subsequent year, such amount is taxable in the later2015 Tax Ct. Memo LEXIS 98">*111 year if the original deduction yielded a tax benefit.
We find that the agent's bank deposits analysis was reasonable and that petitioners failed to prove the nontaxability of any deposits beyond the $183,119 that the IRS allowed. On top of the taxable bank deposits thus determined, the revenue agent added 8% to capture tips presumptively received by petitioners but not deposited in a bank. We reject as unreliable this aspect of the IRS' approach.
The record demonstrates that only stylists received tip income. Because Duong functioned as an office manager and did not perform services as a nail *104 stylist, there is no support for respondent's contention that he received tip income. We thus cannot sustain respondent's determination of tip income for Duong.
Tran was a nail stylist and presumably received some tips. But many customers paid by credit or debit card. If the tip was included in the2015 Tax Ct. Memo LEXIS 98">*112 total amount charged, the tip (like the fee for services) would presumably be accounted for already in the bank deposits analysis. To the extent customers paid in cash, respondent's methodology implausibly assumes that Tran methodically segregated each service charge from the corresponding tip, depositing the former in the bank but pocketing the latter. Moreover, Tran could keep tips only for work that she performed. Because the salons employed other stylists, respondent's methodology would impute income to Tran for tips that other employees received.
Respondent did not analyze what percentage of the salons' customers paid in cash or what percentage of the stylist services Tran performed. Adding 8% to Tran's share of the total gross receipts would overstate her tip income substantially, to a degree that cannot be determined. We accordingly find that respondent's determination of additional tip income, as applied to Tran as well as to Duong, is arbitrary and erroneous.
*105 In the notices of deficiency, respondent reasonably made whipsaw determinations and treated 100% of taxable deposits in the joint accounts as gross receipts of both petitioners. Respondent concedes on brief that "the unreported2015 Tax Ct. Memo LEXIS 98">*113 income should be allocated equally between the petitioners for the unreported deposits from their joint accounts, and wholly to petitioner Duong for the money deposited into the accounts that were not held jointly with petitioner Tran." We agree with this assessment. With that concession and with the elimination of any additional tip income to either petitioner, we sustain respondent's determinations of unreported income consistent with the revenue agent's bank deposits analysis.4
Respondent determined fraud penalties against Duong for 2007 and 2008 and against Tran for 2008."If any part of any underpayment of tax required to be shown on a return is due to fraud,"
Fraud is intentional wrongdoing designed to evade tax believed to be owing.
Circumstances that may indicate fraudulent intent, commonly referred to as "badges of fraud," include but are not limited to: (1) understating income; (2) keeping inadequate records; (3) giving implausible or inconsistent explanations of behavior; (4) concealing income or assets; (5) failing to cooperate with tax *107 authorities; (6) engaging in illegal activities;2015 Tax Ct. Memo LEXIS 98">*115 (7) providing testimony lacking credibility; (8) filing false documents, including false income tax returns; (9) failing to file tax returns; and (10) dealing extensively in cash.
Numerous badges of fraud demonstrate that Duong intentionally evaded the payment of tax he knew to be owed. He understated his income for both years in issue.
Duong also failed to cooperate with tax authorities. The revenue agent requested bank statements but never received them. Duong indicated that he had *108 merchant receipts but likewise failed to provide those to respondent. Eventually, the revenue agent had to summons the bank statements.
We find that the facts, taken as a whole, clearly and convincingly establish that Duong acted with fraudulent intent and that his underpayments of tax for 2007 and 2008 were due to fraud. While several of the same badges of fraud apply to Tran, we reach the opposite conclusion as to her. Duong bears principal responsibility for the false statements made to, and the lack of cooperation with, the IRS revenue agent. Unlike Duong, Tran did not present testimony lacking credibility at trial. Our assessment of the evidence is that Tran followed the direction and actions of Duong and that her behavior does not rise to the level of fraud. We accordingly conclude that respondent did not prove fraud by Tran by clear and convincing evidence.
Respondent contends in the alternative that Tran is liable for an accuracy-related penalty under
The accuracy-related penalty does not apply to any portion of an underpayment "if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith" with respect thereto.
*110 To reflect the foregoing,
1. All statutory references are to the Internal Revenue Code (Code) in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. We round all dollar amounts to the nearest dollar.↩
2. Respondent has conceded the
3. When a party fails to file a brief on issues that have been tried, we may consider those issues waived or conceded.
4. While there is no longer any dispute as to the amounts of petitioners' deductible Schedule C expenses, the allocation of those expenses (and of petitioners' reported Schedule C gross income) will have to be determined as part of the