1954 U.S. Tax Ct. LEXIS 140">*140
2. Petitioner, during each of the taxable years, was married and living with his wife and is therefore entitled to the marital exemption for each of the years.
3. Various properties acquired were purchased with funds owned by petitioner.
4. Payments received and withdrawals from two wholly owned corporations by petitioner represented taxable income. No adjustment therefor is necessary in determining petitioner's income by the net worth method.
5. Additions to tax because of fraud with intent to evade tax upheld.
22 T.C. 912">*912 The Commissioner1954 U.S. Tax Ct. LEXIS 140">*141 determined deficiencies in income tax and additions to tax under
Year | Income tax | Addition to tax |
1936 | $ 1,797.55 | $ 898.78 |
1937 | 2,626.00 | 1,313.00 |
1938 | 3,543.27 | 1,771.64 |
1939 | 3,055.56 | 1,527.78 |
1940 | 33,097.78 | 16,548.89 |
1941 | 75,027.23 | 37,513.62 |
1942 | 45,980.02 | 22,990.01 |
1943 | 90,853.89 | 44,310.98 |
By amendments to his answer he claimed increased deficiencies for the years 1936 and 1943. The deficiencies were computed by using the increase in net worth plus nondeductible expenditures method of determining income. The issues will appear in the opinion.
FINDINGS OF FACT.
A stipulation of facts and a supplemental stipulation of facts were entered into by the parties; also certain facts were stipulated orally at the trial. All such stipulations are incorporated herein by reference.
The petitioner, an individual residing during the years here involved in Chicago, Illinois, filed his income tax returns for the calendar years 1936 to 1943, inclusive, with the collector of internal revenue for the first district of Illinois at Chicago, Illinois.
Petitioner, who has used the names "Michael Bodoglou" and "Michael Jordan," 1954 U.S. Tax Ct. LEXIS 140">*142 as well as "Michael Potson" and "Mike Potson," 22 T.C. 912">*913 was born in Turkey on October 1, 1883. His true name is Mihail Bodoglou. He emigrated from Greece to the United States in the year 1900 and became a citizen of the United States in 1915.
Petitioner spent some time in New York and St. Louis, and in 1904 he moved to Chicago, Illinois, where he conducted the business of selling pistachio nuts to fruit stores and establishments in Chicago in an area characterized predominantly by houses of prostitution and referred to hereinafter at times as the vice district. In about 1905, he acquired a one-half interest in a partnership which operated a pool room located in the foregoing area at 1938 Archer Avenue in Chicago. In about 1905, he purchased at a cost of $ 10,000 adjacent real estate located at 2014 South Armour Avenue and 2015 South Clark Street, in Chicago, which he has owned at all times since then. He operated a restaurant in a store in one of those buildings and leased the other store to a person who operated a saloon. A house of prostitution was operated in the upper floors of the buildings. In about 1912 a campaign of law enforcement led to the closing of the various1954 U.S. Tax Ct. LEXIS 140">*143 illegal establishments in the vice district, which had theretofore been operating "wide open." Petitioner sold his restaurant business at about that time. In about 1915, he moved to Gary, Indiana, where he operated a restaurant in which there was a gambling room. In 1918, all licenses to sell liquor in Gary, Indiana, were canceled, and he moved back to Chicago. He was successful in all of such business ventures.
In 1919, petitioner bought from one James Colosimo a one-half interest in a nightclub business, known as Colosimo's, in Chicago. He and Colosimo operated the business as partners until 1920 when Colosimo was killed by his "enemies" in some undisclosed manner. Petitioner then acquired the interest of his deceased partner. He operated the business as a sole proprietorship until 1928, when the nightclub was closed by city officials. In 1929, the operation of Colosimo's was resumed, in corporate form, under the name "Colosimo's Restaurant, Incorporated." All of the outstanding stock of this corporation was owned by petitioner. In 1933, the nightclub was again closed because of a violation of the National Prohibition Act by petitioner. He again operated Colosimo's as a1954 U.S. Tax Ct. LEXIS 140">*144 sole proprietorship in 1934 and until June 30, 1935, conducting it in the name of one of his employees and under a local license issued in the name of that employee.
Beginning on or about July 9, 1935, and continuing throughout the taxable years, petitioner operated Colosimo's, using the corporate form, under the name "2126 South Wabash Restaurant Corporation" (hereinafter referred to as the corporation). He leased to the corporation, 22 T.C. 912">*914 at an annual rental of $ 6,000, the premises at 2126-28 South Wabash Avenue, in Chicago, in which the night club business was operated. Petitioner had purchased this property during the period between June 1922 and September 1924 at a cost of $ 56,500, and he has owned it at all times thereafter. In 1936, 1937, and 1943, petitioner spent certain amounts, hereinafter set forth, for improvements to that property. The corporation began its operations with capital in an amount not in excess of $ 7,000. At all times here material, petitioner owned all of the outstanding stock of the corporation.
In 1936, petitioner had Colosimo's extensively remodeled and enlarged, so that it became an elaborate and highly successful night club which was patronized1954 U.S. Tax Ct. LEXIS 140">*145 by many prominent persons. Throughout the taxable years, the nightclub consisted of a dining room and bar room, which could seat approximately 500 persons at one time. Food and liquor were served in both places. Throughout the taxable years, entertainers of national reputation appeared in the dining room, and between floor shows dance music was furnished by an orchestra and strolling singers entertained for the benefit of the patrons. An elevated stage was lowered after the floor show so that it could be used for dancing by the patrons. The business was open to customers 7 days a week between the hours of 5:30 p. m. and 5 a. m., except during the war years, when restrictions necessitated an earlier closing hour.
During the taxable years, Louis Polan, an employee of the corporation, was in charge of the corporate books and records. The corporation used a single entry system of bookkeeping. The basis of the system was the recording and totaling of sales and expenses on the cash register; the amounts of sales and expenses so recorded on the registers were entered on looseleaf columnar sheets called daily cash sheets. In addition, at the end of each of the fiscal years of the 1954 U.S. Tax Ct. LEXIS 140">*146 corporation ended June 30, 1939, through June 30, 1943, inclusive, certain summary sheets, purporting to contain annual receipts and expenses of the corporation, were prepared. Such annual summary sheets formed the basis for the corporation's income tax returns for those years. On some occasions, when there had been a particularly heavy volume of business, such as New Year's Eve, the cash register was "cleared" and a predetermined amount less than the actual amount of the receipts was recorded thereon. The difference in cash was removed by petitioner from the cash register. In this manner a portion of the actual receipts was eliminated and gross receipts were thus understated. The corporation did not maintain a general journal or a general ledger. It maintained no accounts for equipment, depreciation, capital stock, or earned surplus. Inventories were not used in computing 22 T.C. 912">*915 cost of goods sold. Capital expenditures and business expenses were not segregated. Disbursements made for business expenses of the corporation and those made for personal expenses of petitioner were not kept separate. The cash register tapes were not produced for use by the Commissioner in his1954 U.S. Tax Ct. LEXIS 140">*147 examination. The corporate records were insufficient to form the basis for an accurate determination of its income or the income which petitioner derived from Colosimo's.
The following tabulation shows the gross receipts (exclusive of such items as "game commissions" or rent) reported by the 2126 South Wabash Restaurant Corporation on its Federal income tax returns for the fiscal years indicated:
June 30 | |
1936 | $ 164,989.90 |
1937 | 294,379.25 |
1938 | 353,888.76 |
1939 | 334,618.08 |
1940 | $ 410,399.92 |
1941 | 376,554.01 |
1942 | 399,619.68 |
1943 | 427,590.17 |
On February 19, 1944, petitioner submitted a financial statement signed by him to the California Bank, Beverly Hills, California, in which it was represented that the "annual income" from "2126 Wabash Ave. (Colosemos)" was $ 40,000.
During the taxable years, there were "crap games" at Colosimo's about 3 nights a week and poker games about 2 other nights a week. Such games were participated in by some of the waiters, entertainers, petitioner, and some of petitioner's personal friends. They were not conducted on a public scale. In addition to participating in these games, petitioner or Colosimo's received a "cut" or "rake-off" on all1954 U.S. Tax Ct. LEXIS 140">*148 these games. Food and refreshments were served to the players. These games were a source of income to petitioner during the taxable years.
Petitioner also gambled frequently with friends, in games other than those conducted at Colosimo's. Such gambling occurred in Chicago and California and on occasion in other places. He gambled with certain persons in the motion picture and entertainment field, and won considerable amounts of money from them. On various occasions of such gambling he would also lose money. During some of the years here involved he also operated a "handbook" for bets on horse races. These gambling activities and ventures were a source of income for petitioner during the taxable years.
On August 28, 1939, petitioner had the Harrison and State Building Corporation (hereinafter also referred to as the building corporation) organized under the laws of the State of Illinois as a real estate holding and rental corporation. It had an authorized capital of 100 shares of common stock of no par value. On August 30, 1939, the stock of the building corporation was issued in the names of the following persons: 22 T.C. 912">*916
Certificate No. | Date of certificate | Named owner | Number of |
shares | |||
1 | August 30, 1939 | Samuel Yoelin | 1 |
2 | August 30, 1939 | William Diamond | 4 |
3 | August 30, 1939 | Louis Polan | 4 |
4 | August 30, 1939 | Etta Smith 1 | 91 |
Total | 100 |
The minutes of the annual stockholders meetings of the building corporation on August 30 of the years 1940 through 1943, inclusive, showed the stockholders to be the same as listed above. Yoelin was an attorney for petitioner, and Polan and Diamond were employees of petitioner.
Pursuant to a request by Revenue Agent Stonesifer and Special Agent Stains made at an interview on July 24, 1944, petitioner produced the outstanding stock certificates of the building corporation which read as follows:
Certificate No. | Date of certificate | Named owner | Number of |
shares | |||
1 | August 30, 1939 | Samuel Yoelin | 1 |
2 1 | August 30, 1939 | William Diamond | 4 |
3 | August 30, 1939 | Louis Polan | 4 |
5 | September 20, 1939 | Etta Smith | 41 |
6 | September 20, 1939 | Mike Potson | 25 |
7 | September 20, 1939 | William Diamond | 25 |
Total | 100 |
At all times here material, all of the above named persons with the exception of petitioner were merely nominal owners of the stock; petitioner was the true owner of all of the stock of the building corporation.
1954 U.S. Tax Ct. LEXIS 140">*150 Rose Potson, who also uses the names "Rose Smith," "Etta Smith," "Etta Potson," and "Etta Bodoglou," was born in Purington, Illinois, in 1889. She moved to Chicago with her mother in 1892. Upon completion of the sixth grade, when she was 14 or 15 years old, she left school and went to work. Prior to 1907 her maximum earnings were $ 7 a week. Then, after meeting petitioner, she became connected with the operation of two small "hotels" in the vice district of Chicago. Each of these hotels had a parlor in which alcoholic beverages were served illegally. In 1912, at about the time that law enforcement officials prevented the operation of illegal establishments in the vice district ("put the lid on"), she ceased to operate these hotels. The money for the operation of the hotels was furnished by petitioner. From 1913 to 1936, inclusive, Rose Potson was not engaged in any business and was not employed.
22 T.C. 912">*917 For the years 1936 to 1943, inclusive, Rose Potson filed Federal income tax returns reporting income from the cigarette, flower, and hat check concessions at Colosimo's. The tax shown to be due on such returns was paid by petitioner. The concession was run by petitioner1954 U.S. Tax Ct. LEXIS 140">*151 during Rose's absence.
Rose Potson, using the name "Etta Smith," had access to three safe deposit boxes in Chicago as follows:
Date | Location | Name |
Nov. 30, 1936-July 6, | Commercial Safe Deposit | Etta Smith as deputy of |
1942. | Company. | Edith I. Smith. 1 |
Dec. 4, 1939-Dec. 30, | National Safe Deposit | Etta Smith, joint tenant |
1940. | Company. | with Edith I. Smith. |
Nov. 12, 1942-Sept. 15, | National Safe Deposit | Joint tenant with Edith I. |
1944. | Company. | Smith. |
Rose Potson never inherited any property. During the taxable years, whatever assets she may have had were given to her by petitioner.
Petitioner purchased real estate in Chicago taking title thereto in the name of the "Harrison and State Building Corporation," paying the purchase price in each instance in cash, as follows:
Date | Property | Purchase price |
September 1939 | 624-630 South State Street | $ 16,311.20 |
November 1939 | 632-638 South State Street | 18,375.31 |
July 1940 | 629-639 North Clark Street | 39,169.66 |
1941 | 16 South Damen Avenue | 30,479.89 |
2001-11 West Madison Street | ||
2000-04 West Madison Street |
All of the money used to pay the purchase price of the above properties was 1954 U.S. Tax Ct. LEXIS 140">*152 money belonging to petitioner. All of the above properties were owned by the building corporation on December 31, 1943.
Petitioner had the building corporation execute and deliver to him "mortgage notes," payable to bearer and secured by trust deeds on some of the above mentioned property, as follows:
Date | Date due | Amount | Property | Interest rate |
2- 1-40 | 2- 1-50 | $ 15,000 | 632-638 South State Street | 5 per cent. |
7-29-40 | 1 7-29-45 | 35,000 | 629-639 North Clark Street | 6 per cent. |
6-20-41 | 2 7-20-41- | |||
6-20-51 | 32,500 | 16 South Damen Avenue | 6 per cent. | |
2001-11 West Madison Street | ||||
2000-04 West Madison Street |
Petitioner never made any loans to the building corporation in return for the above notes. The purpose of having the building corporation 22 T.C. 912">*918 issue such notes was to protect his interest in that corporation in view of the fact that, although he was the true owner of the stock, other1954 U.S. Tax Ct. LEXIS 140">*153 persons were the stockholders of record.
In 1940, petitioner withdrew $ 1,265 from the 2126 South Wabash Restaurant Corporation and invested it in that year in the building corporation. It was used to pay for improvements and remodeling of that corporation's property. In 1943, petitioner received $ 6,500 from one J. L. McInerney as payment for food and liquor bills of McInerney at Colosimo's and personal debts owed by McInerney to petitioner arising from gambling and borrowings. This money was invested in the Harrison and State Building Corporation.
The Harrison and State Building Corporation filed its corporation income tax returns for the fiscal years ended August 31, 1940, to August 31, 1944, inclusive, on a cash basis, with the then collector of internal revenue for the first district of Illinois. The following tabulation is a summary of the gross income reported in these returns and the earned surplus reported at the close of the fiscal years ended August 31, 1940, to August 31, 1943:
Gross income | ||
Fiscal year ended August 31 | reported | Earned surplus |
1940 | $ 8,992.50 | $ 4,469.79 |
1941 | 17,158.30 | 7,304.18 |
1942 | 24,462.00 | 10,639.20 |
1943 | 27,890.00 | 16,322.61 |
1944 | 29,418.59 |
1954 U.S. Tax Ct. LEXIS 140">*154 The balance sheet contained in Schedule L of the income tax return for the fiscal year ended August 31, 1944, was not filled in and no amount was shown for earned surplus.
During the fiscal years ended August 31, 1940, to August 31, 1943, inclusive, no formal dividends were declared by the Harrison and State Building Corporation and no payments of any formal dividends were reflected on its books and records. However, it made certain payments to petitioner during the taxable years on some of the mortgage notes referred to above. These mortgage notes did not represent loans made by petitioner to the building corporation, and payments on such notes were in effect merely a distribution of corporate profits.
In August 1940, petitioner purchased a residence located at 1006 North Rexford Drive, in Beverly Hills, California. The purchase price of the residence, which was paid with various cashiers' checks, which were purchased with cash, was $ 26,750. All of such cash belonged to petitioner. Title was taken in the name of "Michael Bodoglou." There was no change in ownership up to the end of 1943.
In 1943, petitioner purchased, at a cost of $ 71,997.64, a building located at 9501-23 1954 U.S. Tax Ct. LEXIS 140">*155 Santa Monica Boulevard, in Beverly Hills, California. 22 T.C. 912">*919 Title to the building, which was known as the Heggard Building, was taken in the name of "Michael Bodoglou." During 1943, petitioner paid $ 62,647.58 toward the cost of the property; he was liable on a mortgage note for the balance in the amount of $ 9,350.06. Rose Potson did not contribute toward the cost of that property. Petitioner's annual income from this property was approximately $ 12,000.
Petitioner had the following balances in bank accounts on December 31 of each of the years indicated:
Year | Balance |
1935 | $ 15.03 |
1936 | 15.03 |
1937 | 15.03 |
1938 | 11,128.37 |
1939 | 297.48 |
1940 | $ 7,163.48 |
1941 | 16,536.61 |
1942 | 17,529.74 |
1943 | 26,005.41 |
The above amounts for December 31, 1940 to 1943, inclusive, include balances on those dates for an account opened in the name of "Etta Potson" at the California Bank, Beverly Hills Branch, on October 1, 1940. That account belonged to petitioner and deposits to it were made with funds furnished by him. From August 8, 1943, to the end of 1943 that account was in the names of petitioner and "Etta Potson."
On the dates indicated, petitioner owned United States Government bonds, 1954 U.S. Tax Ct. LEXIS 140">*156 as follows:
Date | Cost of bonds |
December 31, 1938 | $ 1,100.00 |
December 31, 1939 | 1,100.00 |
December 31, 1940 | 1,100.00 |
December 31, 1941 | $ 16,851.75 |
December 31, 1942 | 45,826.75 |
December 31, 1943 | 53,658.00 |
The above amounts include the cost of bonds purchased and registered in a name used by Rose Potson. The funds used to purchase such bonds were funds belonging to petitioner.
Petitioner owned bonds payable by the Hotel Sherman in Chicago in an amount of $ 3,000 on December 31 of each of the years 1935 to 1943, inclusive.
In 1925, petitioner made a loan in the amount of $ 20,000 to one Louis Poncher and received as security therefor a second mortgage on real property owned by Poncher located at 2108-10 South Wabash Avenue in Chicago. In 1928, petitioner brought an action against Poncher in the Municipal Court of Chicago to foreclose the second mortgage on which there was an unpaid balance of $ 9,498.75. Petitioner purchased the property in November 1928 at a master's sale conducted in connection with the foreclosure proceedings, paying $ 34,032.99 therefor. In computing petitioner's cost basis for that property, the Commissioner added the unpaid balance on the second1954 U.S. Tax Ct. LEXIS 140">*157 22 T.C. 912">*920 mortgage to the price paid at the master's sale; the cost basis, thus computed, was $ 43,351.74.
On December 11, 1928, petitioner borrowed $ 23,000 to be repaid in installments as follows, with interest at 6 per cent:
December 11, 1930 | $ 1,500 |
December 11, 1931 | 1,500 |
December 11, 1933 | 20,000 |
He gave as security for the loan a mortgage on 2108-10 South Wabash Avenue. The first installment was paid in 1930; no other installments were paid.
In June 1932, Edward J. Lindahl, the representative of the holder of the mortgage, told petitioner that the mortgage had been turned over to him by the First National Bank of Chicago because the bank had been unable to make collections thereon. Petitioner agreed to turn over to Lindahl the rent from the property to be applied as payments due under the mortgage. Although petitioner continued to collect the rent, he did not perform his agreement to pay it over to Lindahl.
Petitioner's failure to make payments on the mortgage was due at least in part to a dispute over the title to the property in which a third person was claiming a one-half interest in the property adversely to him.
An action was brought to foreclose on the 1954 U.S. Tax Ct. LEXIS 140">*158 mortgage and the property was sold as a result of that action in 1939. A deficiency judgment against petitioner was obtained for the unsatisfied part of the amount owed by him. In July 1940, petitioner paid $ 3,300 in cash in settlement of that judgment.
Since petitioner's investment in and his liability on the mortgage with respect to the property at 2108-10 South Wabash Avenue had been eliminated from petitioner's assets on the net worth statement for 1939, the Commissioner added the amount of petitioner's equity in that property in determining the increase in net worth for 1939. The basis for this determination was that petitioner's loss on the foreclosure sale was not sustained until 1940, when pursuant to Illinois Revised Statutes, chapter 77, section 18, the period within which he might have redeemed the property expired. Petitioner sustained a deductible loss in the amount of $ 13,104.04 in 1940, representing a capital loss of $ 7,112.71 on the land and an ordinary loss of $ 5,991.33 on the building.
On September 22, 1927, petitioner borrowed $ 26,400 from one Moses Samuels, a Chicago politician, to be repaid in installments, with interest at 6 per cent, as follows: $ 3,6001954 U.S. Tax Ct. LEXIS 140">*159 on September 22 of the years 1929, 1930, and 1931 and $ 15,600 on September 22, 1932. As security for such loan, petitioner gave a mortgage on the property 22 T.C. 912">*921 at 2126-28 South Wabash Avenue, 2014 South Armour Avenue, and 2015 South Clark Street in Chicago. The first 3 installments were paid when due. Petitioner failed to make the total payment due on September 22, 1932, paying only $ 750. The due date of the remaining balance of $ 14,850 was extended 3 years to September 22, 1935. Petitioner failed to make the payment on the due date as extended, and, on April 30, 1936, he paid $ 12,500 in full settlement of the then outstanding balance of $ 14,850.
On June 30, 1930, petitioner submitted a financial statement to the Foreman-State National Bank of Chicago on a form furnished by it, which purported to show all of his assets, liabilities, and net worth as of that date as follows:
Assets | |
Cash on hand and in our bank 1 | $ 1,595.97 |
Notes receivable -- unsecured (not due) | 15,000.00 |
Real estate at fair cash value | 2 120,000.00 |
Other assets (itemize): New Cadillac | 2,000.00 |
3 $ 138,595.97 | |
Liabilities and net worth | |
Note payable -- Foreman-State National Bank | $ 2,000.00 |
Accrued real estate taxes (estimate if necessary) | 1,200.00 |
Chattel mortgages 4 | 45,000.00 |
Net worth | |
In 1936 petitioner paid a balance of $ 400 owed to one Jeanne Jaboulay. This debt arose from a $ 1,000 loan made to Rose Potson by Jeanne Jaboulay in 1933. The debt was paid with checks of the 2126 South Wabash Restaurant Corporation.
From 1933 to 1936, petitioner had some small debts which he was slow in paying. His explanation to creditors was that he had no money. Petitioner had money available to pay such debts.
In March 1936, petitioner attempted to borrow $ 16,000 from a Chicago bank to use in connection with remodeling Colosimo's. The loan was not made, but Colosimo's was remodeled.
In 1936 petitioner paid $ 5,600 in 1954 U.S. Tax Ct. LEXIS 140">*161 currency as the purchase price of real estate located at 2124 South Wabash Avenue, Chicago. In 1937 be paid $ 127.98 and, in 1939, $ 408.80 for past due real estate taxes on that property. Such taxes were a lien on the property prior to the time he purchased it.
22 T.C. 912">*922 In 1936 and 1937 petitioner paid $ 9,400 and $ 5,600, respectively, for improvements to the property located at 2124-26-28 South Wabash Avenue, Chicago. In 1943, he paid $ 1,050 for improvements to the same property.
In 1936 petitioner purchased an automobile on the installment plan. He paid installments of $ 1,168.84 in 1936 and $ 558.84 in 1937 with checks of the 2126 South Wabash Restaurant Corporation. In 1938 he purchased a Cadillac automobile, paying for it in that year by exchanging the automobile purchased in 1936 and paying $ 1,000 additional with a cashier's check purchased by him with currency. In 1940 he purchased 2 automobiles, paying $ 4,230 in that year with a check of the 2126 South Wabash Restaurant Corporation in the amount of $ 2,630 and a cashier's check in the amount of $ 1,600, which was purchased for him, with currency furnished by him, by Sam Schiller, brother of Rose Potson.
On May 3, 1954 U.S. Tax Ct. LEXIS 140">*162 1938, petitioner paid $ 3,000 in cash for bonds issued by the Salerno Building Corporation, which he continued to own on December 31, 1943.
In 1940, petitioner spent a total of $ 2,327.75 for furniture and a range which were used in the residence of 1006 North Rexford Drive in Beverly Hills, California. In 1941 he spent an additional $ 971.50 for furniture.
In 1941 and 1943 petitioner purchased, for cash, jewelry at a cost of $ 1,850 and $ 151.20, respectively. In 1942 and 1943 he purchased for cash furs at a cost of $ 500 and $ 325, respectively.
In September 1941, petitioner purchased real estate located at 1001-1009 North Clark Street, Chicago, paying $ 15,918.88 therefor, in currency, in that year and took title to that property in the name of "Edith Samuel," sister of Rose Potson. He took back an unrecorded quitclaim deed to that property from Edith Samuel and her husband, Felix Samuel. He also had the Samuels execute and deliver to him a purported mortgage note payable to bearer in the principal amount of $ 16,000, which was secured by a purported trust deed on the property. Checks for the rental income on this property were made payable to Edith Samuel by the real estate1954 U.S. Tax Ct. LEXIS 140">*163 agent who managed it; they were endorsed by her and delivered to petitioner. Under an agreement between petitioner and Felix Samuel, the latter reported rental income from this property for 1941 and 1942 in his Federal income tax returns for those years, paid the tax on it, and was reimbursed for the tax by petitioner. Petitioner did not report any of this income in his income tax returns for the years 1941 and 1942. In 1942 petitioner paid $ 534.66 in currency for past due real estate taxes on this property which were a lien on the property prior to the time he purchased 22 T.C. 912">*923 it. In 1943, petitioner withdrew $ 6,234.86 from the 2126 South Wabash Restaurant Corporation and invested it in that year in The Headliner, a cocktail lounge in the building at 1001-1009 North Clark Street.
On December 31, 1942, petitioner had $ 2,500 on deposit with a bonding company as collateral on a supersedeas bond. On December 31, 1943, he had $ 15,000 on deposit with another bonding company as collateral on a bail bond for one Ralph Pierce.
Commencing with the year 1904, petitioner kept money in a number of safe-deposit boxes. On the dates indicated below he had the following amounts of cash1954 U.S. Tax Ct. LEXIS 140">*164 in his own possession, in the possession of Rose Potson, and in safe-deposit boxes:
Date | Amount |
December 31, 1935 | $ 100,000 |
December 31, 1936 | 100,000 |
December 31, 1937 | 100,000 |
December 31, 1938 | 100,000 |
December 31, 1939 | 90,000 |
December 31, 1940 | $ 60,000 |
December 31, 1941 | 40,000 |
December 31, 1942 | 30,000 |
December 31, 1943 | 25,000 |
In December 1941, petitioner, in response to a request, made in November 1941, by the examining revenue agent, for a statement of his then net worth submitted to the agent a document showing the following:
Assets: | ||
Cash: | ||
American National | $ 1,500 | |
Continental Illinois | 10,000 | |
Shares -- 2126 S. Wabash Restaurant Corporation 50 -- Par | ||
value $ 50 | ||
Real estate: 2126 S. Wabash | 10,000 | |
Bonds: Salerno Undertaking Building | 5,000 | |
Mortgages: | ||
Harrison and State Building Corporation | 35,000 | |
Harrison and State Building Corporation | 15,000 | |
United States defense bonds | 11,000 | |
No notes or accounts receivable | ||
Handbook bankroll |
On February 19, 1944, petitioner, using the name "Michael Bodoglou," submitted a statement to the California Bank which contained information as follows:
Assets | |
Total current assets (cash on hand and in bank here) | $ 16,000 |
Stocks and bonds not listed on exchange 1 | 70,000 |
Real estate 2 | 215,000 |
Automobiles, Cadillac 1940 | 1,300 |
Other assets: "Warehouse house" | 75,000 |
Total | $ 377,300 |
Liabilities | |
None | |
Net worth | $ 377,300 |
Total | $ 377,300 |
22 T.C. 912">*924 During its fiscal years ended June 30, 1936, to June 30, 1943, inclusive, no dividends were declared by the 2126 South Wabash Restaurant Corporation and no payments of any dividends were reflected on its books and records. The findings in this paragraph and the succeeding paragraph are not intended to negate the possibility that petitioner may have made informal withdrawals, not reflected in any available records, which in fact represented dividends or were otherwise income to him.
Petitioner at various times withdrew from and added money to the 2126 South Wabash Restaurant Corporation. Available records disclose the net amounts of such withdrawals and deposits during the years indicated as follows:
1937 | 1 $ 24,139.91 |
1938 | |
1939 | 502.22 |
1940 | 937.16 |
1941 | $ 40,003.42 |
1942 | 19,014.91 |
1943 |
Petitioner's investment in the1954 U.S. Tax Ct. LEXIS 140">*166 2126 South Wabash Restaurant Corporation on the dates indicated was as follows:
Amount of | |
December 31 | investment |
1935 | $ 7,000.00 |
1936 | 7,000.00 |
1937 | 7,000.00 |
1938 | 7,000.00 |
1939 | 7,502.22 |
1940 | $ 8,439.38 |
1941 | 38,492.80 |
1942 | 51,507.71 |
1943 | 51,507.71 |
Petitioner received certain amounts which were designated as "interest" or "principal" payments on mortgage notes from the Harrison and State Building Corporation as follows:
"Interest" | |
December 30, 1940 | $ 375 |
December 1941 | 3,000 |
December 29, 1942 | 3,500 |
May 4, 1943 | 1,184 |
November 8, 1943 | 3,625 |
"Principal" | |
February 24, 1942 | $ 10,000 |
January 26, 1943 | 10,000 |
22 T.C. 912">*925 Petitioner's net worth, on the dates indicated, was as follows:
December 31 | Net worth |
1935 | $ 185,296.77 |
1936 | 216,715.61 |
1937 | 223,002.43 |
1938 | 239,215.77 |
1939 | 231,950.67 |
1940 | $ 283,496.24 |
1941 | 367,894.81 |
1942 | 404,412.51 |
1943 | 505,128.07 |
Depreciation on property owned by petitioner during the taxable years was as follows:
1936 | $ 1,215.00 |
1937 | 1,665.00 |
1938 | 1,815.00 |
1939 | 1,402.50 |
1940 | $ 1,320.00 |
1941 | 1,375.00 |
1942 | 1,540.00 |
1943 | 1,998.13 |
Petitioner paid the following amounts in income taxes for himself and Rose1954 U.S. Tax Ct. LEXIS 140">*167 Potson during the years indicated:
1936 | $ 104.65 |
1937 | 200.10 |
1938 | 378.10 |
1939 | 467.71 |
1940 | $ 800.97 |
1941 | 1,017.61 |
1942 | 1,614.30 |
1943 | 5,445.95 |
He had the following amounts of nondeductible expenses, including living expenses, which were paid during the taxable years:
1936 | $ 4,018.30 |
1937 | 4,174.23 |
1938 | 14,814.78 |
1939 | 3,743.92 |
1940 | $ 5,741.07 |
1941 | 10,900.50 |
1942 | 7,496.81 |
1943 | 11,171.62 |
Such amounts include amounts paid with funds from the joint account of "Michael or Etta Potson" in the California Bank, Beverly Hills, California.
Potson filed no income tax returns for the years 1913 to 1918, inclusive. The returns filed for the years indicated disclose the following amounts of net income and loss:
1919 | $ 12,640.54 |
1920 | 7,375.90 |
1921 | n1 |
1922 | n1 |
1923 | n1 |
1924 | 5,144.50 |
1925 | n1 |
1926 | n1 |
1927 | 4,512.67 |
1928 | n1 |
1929 | $ 5,826.00 |
1930 | 5,735.00 |
1931 | 6,334.67 |
1932 | 1 |
1933 | (11,201.78) |
1934 | (7,954.10) |
1935 | 5,406.91 |
22 T.C. 912">*926 Petitioner filed income tax returns for the taxable1954 U.S. Tax Ct. LEXIS 140">*168 years reporting net income, as follows:
1936 | $ 7,200.00 |
1937 | 8,580.00 |
1938 | 9,144.62 |
1939 | 12,288.70 |
1940 | $ 12,310.00 |
1941 | 10,112.50 |
1942 | 12,184.00 |
1943 | 1 12,112.73 |
Petitioner had net income in the following amounts for the years indicated:
1936 | $ 34,326.79 |
1937 | 8,996.15 |
1938 | 29,591.22 |
1939 | 17,575.77 |
1940 | $ 46,963.57 |
1941 | 94,941.68 |
1942 | 44,088.81 |
1943 | 115,335.00 |
Petitioner's income tax returns for the years 1941 to 1943, inclusive, were prepared by a public accountant. Petitioner furnished the accountant the figures shown on these returns. He gave the accountant no record of the gambling income in the returns for 1942 and 1943, advising the accountant orally of the amount of such income to be reported.
Petitioner never inherited any property. Other than occasional extravagant tips received by him at Colosimo's at times not disclosed by the record, which amounts petitioner claims were gifts, he has never received any gifts.
Petitioner was indicted on 4 counts for willfully and knowingly attempting to defeat and evade a large part of the income tax due and owing from him for the taxable years1954 U.S. Tax Ct. LEXIS 140">*169 1940 to 1943, inclusive. In a trial in the District Court of the United States for the Northern District of Illinois, petitioner was found guilty on all 4 counts on April 9, 1948. The judgment, which was appealed to the Court of Appeals for the Seventh Circuit, was affirmed on December 23, 1948,
Petitioner did not produce the daily cash sheets of the 2126 South Wabash Restaurant Corporation for its fiscal years ended June 30, 1936, to June 30, 1943, inclusive, and produced no records of the results of his gambling transactions during the taxable years, either at the previous criminal trial or at the hearing in the instant case.
Respondent determined petitioner's net income for the taxable years by a combination of the net worth and expenditures methods, adding petitioner's increase in net worth and nondeductible expenditures, including living expenses and Federal income tax paid, for each of the taxable years, to arrive at his determined net income for each of such years.
Respondent made jeopardy assessments on May 5, 1948, for the taxable years of deficiencies, fraud penalties, and interest to 1954 U.S. Tax Ct. LEXIS 140">*170 the date of the assessments, as follows: 22 T.C. 912">*927
Year | Deficiency | Fraud penalty | Interest |
1936 | $ 1,797.55 | $ 898.78 | $ 1,201.28 |
1937 | 2,626.00 | 1,313.00 | 1,597.36 |
1938 | 3,543.27 | 1,771.64 | 1,942.73 |
1939 | 3,055.56 | 1,527.78 | 1,491.99 |
1940 | 33,097.78 | 16,548.89 | 14,175.37 |
1941 | 75,027.23 | 37,513.62 | 27,631.60 |
1942 | 45,980.02 | 22,990.01 | 14,175.07 |
1943 | 90,853.89 | 44,310.98 | 22,557.89 |
$ 255,981.30 | $ 126,874.70 | $ 84,773.29 |
For each of the taxable years 1936 and 1937, no waiver, agreeing to extend the period within which an assessment of income tax may be made, was executed. The 3-year statute of limitations for each of these years expired prior to the making of the jeopardy assessments and the mailing of the notice of deficiency. For each of the taxable years 1938 to 1943, inclusive, the parties executed valid waivers, extending the period of limitation within which an assessment of income tax may be made, beyond the date on which the jeopardy assessments were made and to the date on which the notice of deficiency was mailed to petitioner.
Michael Potson and Rose Potson were husband and wife and lived together as such during the taxable years.
A part of the deficiency1954 U.S. Tax Ct. LEXIS 140">*171 for each of the years 1936 to 1943, inclusive, was due to fraud with intent to evade tax.
OPINION.
This is primarily a factual controversy, which has been resolved in large part by our findings of fact. The Commissioner determined the deficiencies by use of the increase in net worth method, making appropriate adjustments for nondeductible expenditures. The net worth method is not a system of accounting. Where the taxpayer's increase in net worth is substantially in excess of his reported income and where the discrepancy cannot be reasonably explained as being attributable to gifts or inheritances or other nontaxable receipts, the net worth method furnishes persuasive evidence of unreported income. And in determining the amount of net income for any such period it is necessary to add all nondeductible expenditures made by the taxpayer during that period, for such expenditures represent additional unexplained resources available to the taxpayer, over and above the increase in net worth. 1 Other adjustments, such as deductions for depreciation, must also be made.
1954 U.S. Tax Ct. LEXIS 140">*172 22 T.C. 912">*928 The taxpayer has made no effort whatever to show his correct income for any of the years in controversy, 21954 U.S. Tax Ct. LEXIS 140">*173 and does not contest many of the items on the Commissioner's net worth statement; however, he challenges certain items in that statement. The record is voluminous and it would serve no useful purpose to analyze the evidence and set forth the reasons for our findings. The crucial facts in dispute turned largely upon the credibility of petitioner and his alleged wife, Rose Potson. We had ample opportunity to observe both of them on the witness stand for extended periods and it is our conclusion that both of them were careless with the truth. 3 Our findings in many instances reflect our lack of confidence in their credibility. We did not, of course, resolve every issue of fact against petitioner; we appraised the evidence in the light of its credibility, taking into account the entire record, and made our findings accordingly. Our task was a difficult one, but we conscientiously undertook to perform it, exercising our best judgment on all the evidence.
Although, as already indicated, we do not intend to discuss all the evidence, we shall comment upon some of the major points of difference between the parties.
1. At the outset there is a sharp dispute between the parties as to the amount of cash on hand or deposited in banks which petitioner had on December 31, 1935. The Commissioner contends that petitioner had only $ 15.03 at that time. Petitioner1954 U.S. Tax Ct. LEXIS 140">*174 asserts that he had over $ 200,000.
There is support in the record for the Commissioner's contention. Starting with facts disclosed in an application for a bank loan in 1930 and after making adjustments based on reported income and known expenditures from 1930 through 1935, the Commissioner has made out a logical case for his position. He has also undertaken to fortify that position with evidence tending to show that petitioner was short of money in dealing with his creditors.
However, we are convinced by other evidence that the Commissioner's position is unrealistic. Potson was a man who had been engaged in illegal activities on an extensive scale. He operated a 22 T.C. 912">*929 thriving night club business. There was considerable evidence that he had available substantial amounts of cash during this period. However, we do not accept petitioner's testimony as to the amount of cash on hand on December 31, 1935, for we think that the amount urged by him was considerably inflated. We cannot, therefore, make either the finding requested by the Commissioner or the finding requested by petitioner. Neither would be in accord with our appraisal of the facts. In the circumstances, we have1954 U.S. Tax Ct. LEXIS 140">*175 used our best judgment, based on a study of all the evidence, and in our Findings of Fact we have set forth our determination of the amount of cash owned by petitioner on December 31 of each of the years 1935 to 1943, inclusive. Cf.
2. The Commissioner disallowed the marital exemption for Rose Potson, claimed by petitioner on his returns, on the ground that Potson and Rose were not married during any of the taxable years or living together during the years 1940 to 1943, inclusive. Petitioner contends that they were married in Milwaukee, Wisconsin, in 1908.
As a basis for that disallowance, the Commissioner introduced evidence that Potson, on numerous occasions in various documents (such as his application for naturalization in 1915), claimed that he was unmarried and that the records of the city of Milwaukee, Wisconsin, did not disclose a marriage between petitioner and his alleged wife. That evidence is highly persuasive, and the matter is not free from doubt. However, after considering other evidence to the contrary, and taking into account the entire record it is our best judgment on all 1954 U.S. Tax Ct. LEXIS 140">*176 the evidence that Potson and Rose were married during the taxable years. We also have concluded that they were living together during the years 1940 to 1943, inclusive, although Rose was in California and Potson spent part of his time in Chicago. He maintained and owned a residence in California and when he was there, he lived in that home with Rose. We decide this issue in petitioner's favor.
3. A major point of disagreement between the parties concerns the extent of Rose Potson's investment in certain properties, title to which was taken in the name of the "Harrison and State Building Corporation," and other real properties; her investment in United States savings bonds; and her ownership of funds deposited in an account in the California Bank, Beverly Hills, California.
Petitioner argues that payment in whole or in part for certain of the properties which the Government has charged to him on his net worth statement was made by his wife from her personal funds and that the amount charged to him should be decreased by the amount of her contribution. This contention is based primarily on testimony 22 T.C. 912">*930 given by him and his wife. We have not accepted this testimony, since 1954 U.S. Tax Ct. LEXIS 140">*177 we did not find it credible. We have rejected as unworthy of belief Rose Potson's story of the large accumulation of cash which she allegedly derived from her operation of the two "hotels" in the vice district up to 1912 and which in large part she allegedly retained intact up to the taxable years. Among other things, petitioner had made prior admissions to the effect that his wife had no assets other than what he had furnished to her. Moreover, the protective mortgages which petitioner took from the Harrison and State Building Corporation cast grave doubt upon the truthfulness of the testimony that Rose Potson supplied funds for the purchase of such properties. Although some of the stock in that corporation stood in her name, we are satisfied that she was not the real owner of such stock; she and the other stockholders of record were merely the nominal owners of stock which in fact belonged to petitioner.
While it may have been true that Rose Potson had custody of cash which she made available to consummate several of the disputed purchases, we are convinced that such cash had its source in petitioner, that it actually belonged to him, and must therefore be charged to him.
We 1954 U.S. Tax Ct. LEXIS 140">*178 have also resolved the issues of ownership of the United States savings bonds and the account in the California Bank contrary to Potson's position. The difficulties with that position are due, here also, to the lack of credibility of Potson and his wife. Money from the California Bank was used to pay personal expenses of Potson and money belonging to him was deposited therein. Potson's position as to the United States savings bonds must be examined in the light of admissions 4 made by him as to his ownership of bonds in an amount that was not less than the aggregate amount of bonds purportedly owned by him and his wife.
We have carefully considered all of the evidence and have decided that the issue of how much of the assets 1954 U.S. Tax Ct. LEXIS 140">*179 and expenditures charged to Potson was in fact his must be fully resolved in favor of the Commissioner.
4. Petitioner contends that he should be given credit in determining his increase in net worth in 1942 and 1943 for payments of $ 10,000 which he received in each of those years from the Harrison and State Building Corporation. His position in substance is that such payments were made upon the mortgage notes held by him, that they merely reduced his investment, and that therefore his increase in net worth for those years must be reduced by the amount of those payments. 22 T.C. 912">*931 If such payments were in fact distributions of capital by the corporation, petitioner's position would be correct. The parties did indeed stipulate orally at the trial that payments in those amounts were made on the mortgages, but the Government made it clear that it was not conceding that such payments had the legal effect of being merely a return of capital. And we are satisfied on the evidence that they did not in fact constitute a return of capital.
The evidence is clear that petitioner had not made any loans to the building corporation, and that the mortgages had been executed in his favor, not as1954 U.S. Tax Ct. LEXIS 140">*180 security for any loans, but merely to protect his interest in the corporation. Petitioner himself made it plain that these mortgages did not represent any indebtedness to him, and he characterized them as "funny mortgages, just for the business sake." The corporation never declared any dividends as such, and it is obvious that the payments in controversy represented in effect merely distributions of corporate profits. 5 They must therefore be treated as dividends as a matter of law, regardless of the form in which they were cast. Accordingly, we cannot accept petitioner's position that the payments which he thus received must be subtracted from his increase in net worth.
1954 U.S. Tax Ct. LEXIS 140">*181 A like contention is made by petitioner in relation to the net excess withdrawals in 1937 and 1938 from the 2126 South Wabash Restaurant Corporation. Similarly, we think that such withdrawals did not decrease his investment in that corporation. Colosimo's was a large, successful establishment. We have found that its records were inadequate and a correct determination of income could not be made therefrom. We have found that on occasions the cash register did not accurately reflect the gross receipts. We think, therefore, that withdrawals from that corporation were withdrawals of earnings, and that petitioner is not entitled to have them treated as capital payments.
5. The Commissioner has determined that a part of the deficiency for each of the taxable years was due to fraud with intent to evade tax. We think that such fraud has been proved by clear and convincing evidence. There were substantial amounts of unreported income during the period in controversy, indicating a consistent intention to evade tax. Potson was less than frank with the agents when they asked for a statement of net worth. His efforts to explain the failings of the statement were lame indeed and are not1954 U.S. Tax Ct. LEXIS 140">*182 worthy of belief. He had been found guilty of the crime of willfully attempting to defeat and evade a part of the income tax due and owing from him 22 T.C. 912">*932 for the years 1940 to 1943, inclusive. 6 These considerations are merely illustrative, and, on the basis of the entire record, we have concluded that the Commissioner has sustained his burden of proving that a part of the deficiency for each of the taxable years is due to fraud with intent to evade tax. 7 Accordingly, because of such fraud, petitioner is not entitled to the benefits of section 6 of the Current Tax Payment Act of 1943.
1. "Etta Smith" was a name used by Rose Potson, hereinafter identified.↩
1. Certificates endorsed in blank. Endorsements not witnessed and not dated.↩
1. Sister of Rose Potson.↩
1. The amount of $ 35,000 represents the sum of three mortgage notes given, due on the dates indicated.↩
2. The payment of the note in the amount of $ 32,500 was to be made in equal monthly installments between the dates indicated.↩
1. A place was furnished for "cash in other banks"; it was left blank.↩
2. The schedule of real estate appearing on the reverse side of the statement showed a total of $ 120,000. The amount shown on the face under "real estate" was $ 110,000.↩
3. The amounts shown for net worth and the totals are not clear. With the real estate listed as $ 120,000, the totals here are correct.↩
4. This is shown as "chattel" mortgages but from the real estate schedule on the reverse side it appears that the correct designation probably should be "mortgages."↩
1. Identified on schedule as "War Bonds."↩
2. The schedule of real estate was as follows:
Annual | ||
Address | Valuation | income |
9507 Santa Monica | $ 75,000 | $ 12,000 |
1006 North Rexford Drive | 40,000 | Home |
2126 Wabash Avenue, Chicago | 100,000 | 40,000 |
Totals | $ 215,000 | $ 52,000 |
1. Withdrawals.↩
1. No tax was assessed for these years, thereby indicating that the amount of net income reported was not in excess of the marital exemption.↩
1. Victory Tax net income of $ 11,862.73 was reported.↩
1. No adjustments are required for deductible expenditures. While it is true that such expenditures reflect additional resources available to the taxpayer during the period which would augment his
2. The burden of proof was, of course, upon the petitioner to show that the basic deficiencies determined by the respondent, except for the 2 years not covered by waivers, were erroneous. Cf.
3. On one occasion during the hearing when Rose Potson was on the stand, nine series of questions and answers were read to her and she was asked whether such questions had been put to her by the investigating agent and whether she gave such answers. In some instances she denied both that she had been asked the questions and had given the answers; in other instances she denied only giving the answers. The agent was later called as a witness and testified that he had put the questions to her and that she had given the answers as read. We are fully satisfied that the agent told the truth and that Rose Potson lied. This was only one of a number of instances in the record casting doubt upon her credibility.↩
4. Such admissions were made at the prior criminal trial and in the net worth statement filed by him with the California Bank. The face amount of the bonds registered in petitioner's name and in the name of his wife was very close to the amount stated by petitioner in such prior admissions.↩
5. The returns filed on behalf of the corporation disclosed an "earned surplus" of over $ 10,000 in 1942 and $ 16,000 in 1943. This does not necessarily preclude the existence of earnings and profits sufficient to support dividend distributions in the amounts in question. Petitioner made no effort to show that the earnings and profits of the corporation were insufficient for that purpose.↩
6. Almost the entire transcript of that trial was introduced in evidence in this proceeding as a joint exhibit.↩
7. Since we have found fraud for the taxable years 1936 and 1937, the period of limitations for those years has not expired.