Deposit of Proceeds Paid to Hester

Hester received two checks totaling $ 658,318 in discharge of the provisions of the order to pay her $ 250,000 and $ 408,318 in settlement of her cause of action for loss of services. Those two checks were deposited into account number XX-XXX596-2 at the East River Savings Bank, in New York City (the first account). 1996 Tax Ct. Memo LEXIS 1">*10 The first account was titled "WALTON SUTHERLAND JR OR HESTER SUTHERLAND". It carried petitioner's Social Security number. Between August 28, 1987, and February 2, 1988, petitioner withdrew in excess of $ 150,000 from the first account. On February 3, 1988, the first account was closed and the balance was transferred to East River Savings Bank account number XX-XXX077-2 (the second account). The second account was titled similarly to the first account, but carried Hester's Social Security number. Petitioner was authorized to make withdrawals from the second account. Between February 4, 1988, and November 28, 1990, petitioner withdrew at least $ 518,000 from the second account.

Gambling in Atlantic City

During 1987, 1988, and 1989, petitioner traveled to Atlantic City, New Jersey, to gamble at least four casinos: Caesars Atlantic City, Tropworld, Ballys Park Place Casino, and Trump Casino Hotel. Hester, at times, accompanied petitioner to Atlantic City. At each casino, petitioner bought chips, with which to make bets (known as "buying in"). Additionally, at one casino, Tropworld, petitioner maintained a front money account from January 1988 through at least July 1990. A front1996 Tax Ct. Memo LEXIS 1">*11 money account allows a patron to put money on deposit with the casino and draw on the deposit at the gaming tables so the patron does not have to carry around cash. The following represents petitioner's gambling history at the casinos during 1987, 1988, and 1989:

Petitioner's Tax Returns

Petitioner reported the following items of gross income on his Federal income tax returns for the years in issue:

Petitioner made no disclosures in his 1987 Federal income tax1996 Tax Ct. Memo LEXIS 1">*12 return or in a statement attached to that return of any amounts omitted from that return.

Unreported Income

Petitioner failed to report an item of gross income in the amount of $ 408,318 received in 1987.

Negligence

Petitioner and Hester acted together to structure receipt of the $ 408,318 so that petitioner could retain control of it but claim that he had not received it for tax purposes.

OPINION

I. Introduction

A. Questions for Decision

The principal question we have been asked to decide is whether petitioner underreported his income for 1987, 1988, or 1989. We have found that petitioner failed to report an item of gross income in the amount of $ 408,318 received in 1987. Based on respondent's concession that the notices of deficiency for 1987, 1988, and 1989 are to be considered in the alternative, and given that we will sustain respondent's determination of a deficiency for 1987 in full, we determine that there are no deficiencies in tax, additions to tax, or penalties for 1988 or 1989. We shall enter decisions accordingly. We must still address two motions made by petitioner and determine whether petitioner is liable for respondent's addition to 1996 Tax Ct. Memo LEXIS 1">*13 tax for 1987.

II. Motions

A. Motion To Dismiss Based on Period of Limitations

At trial, petitioner orally moved to dismiss in petitioner's favor with respect to 1987. We did not then rule on petitioner's motion. Petitioner claims that the 3-year period of limitations on assessment and collection with respect to that year had expired. We note that the statute of limitations is an affirmative defense and does not affect the jurisdiction of this Court. Rule 39; Badger Materials, Inc. v. Commissioner, 40 T.C. 1061">40 T.C. 1061, 40 T.C. 1061">1063 (1963). Were we to agree with petitioner's argument, we would recharacterize the motion as one for summary judgment and enter a decision of no deficiency as to petitioner's 1987 year. Sec. 7459(e).

In general, the assessment of a deficiency in tax must be made within 3 years of the taxpayer's filing of his return. Sec. 6501(a). However, the limitations period is extended to 6 years if the taxpayer omits from gross income an amount properly includable therein that is in excess of 25 percent of the amount of gross income stated in the return. Sec. 6501(e)(1)(A). In determining the amount omitted there shall not be taken into account1996 Tax Ct. Memo LEXIS 1">*14 any amount omitted from gross income if such amount is disclosed in the return or in a statement attached to the return. Sec. 6501(e)(1)(A)(ii).

Petitioner filed his 1987 Federal income tax return on or about April 15, 1988, reporting gross income in the amount of $ 66,022.57. On July 12, 1993, respondent issued a notice of deficiency to petitioner for 1987. Respondent concedes that assessment of a deficiency in tax for 1987 cannot be made within the 3-year period provided for in section 6501(a). Respondent asserts, however, that the 6-year period of limitations provided for in section 6501(e)(1)(A) applies. Respondent must prove that the requirements of section 6501(e)(1)(A) are satisfied. See Bardwell v. Commissioner, 38 T.C. 84">38 T.C. 84, 38 T.C. 84">92 (1962), affd. 318 F.2d 786">318 F.2d 786 (10th Cir. 1963); Seltzer v. Commissioner, 21 T.C. 398">21 T.C. 398, 21 T.C. 398">401-402 (1953).

In his 1987 Federal income tax return, petitioner reported gross income of $ 66,022. For 1987, petitioner failed to report an item of gross income in the amount of $ 408,318. Petitioner testified that the copy of his 1987 return in evidence was complete. We have examined1996 Tax Ct. Memo LEXIS 1">*15 that copy and find no disclosure of the omitted item of gross income. There are no statements disclosing the omitted item attached to the return. Petitioner has omitted from his 1987 Federal income tax return an amount in excess of 25 percent of the amount of gross income stated in the return. He has not disclosed the omitted amount in the return or in a statement attached to the return. The copy of petitioner's 1987 return in evidence was received by respondent pursuant to a subpoena to petitioner requiring him to produce that return. Petitioner moved for us to quash that subpoena, and we denied that motion. On brief, petitioner asks us to reconsider that denial. We have done so and again find no grounds for quashing the subpoena. The copy of the return in question had been provided to petitioner by respondent, and the request to provide it to respondent at trial was not burdensome.

On the premises stated, petitioner's motion to dismiss will be denied.

B. Motion To Shift Burden of Proof

At trial, petitioner orally moved to shift the burden of proof. We did not then rule on petitioner's motion. On brief, petitioner concedes that the burden of proof normally rests with the taxpayer. 1996 Tax Ct. Memo LEXIS 1">*16 See Rule 142(a). Petitioner argues, however:

This presumption of correctness does not apply and the burden of proof shifts to respondent where there is a showing by a petitioner that the determination of the deficiency set forth in the notice of deficiency was arbitrarily made.

Petitioner claims that respondent's notice of deficiency is arbitrary and therefore should not be afforded the usual presumption of correctness. In addressing that contention, we note that the courts generally will not look behind the Commissioner's determination, even if it is based on hearsay or other evidence inadmissible at trial. Anastasato v. Commissioner, 794 F.2d 884">794 F.2d 884, 794 F.2d 884">886-887 (3d Cir. 1986), vacating T.C. Memo. 1985-101; Dellacroce v. Commissioner, 83 T.C. 269">83 T.C. 269, 83 T.C. 269">280 (1984); Suarez v. Commissioner, 58 T.C. 792">58 T.C. 792, 58 T.C. 792">813 (1972).1996 Tax Ct. Memo LEXIS 1">*17 However, where the notice of deficiency is shown to be arbitrary, that is sufficient to find for the taxpayer unless respondent adequately cures such arbitrariness. Helvering v. Taylor, 293 U.S. 507">293 U.S. 507 (1935). Consequently, under the Rule in Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), in cases appealable to the Court of Appeals for the Third Circuit, the presumption of correctness will not be given effect unless the Commissioner produces "evidence linking the taxpayer to the tax-generating activity in cases involving unreported income, whether legal or illegal." 794 F.2d 884">Anastasato, supra at 887. In these cases, respondent's notice of deficiency for 1987 is based on petitioner's failure to report an attorney's fee (or attorney's referral fee) of $ 408,318. We conclude there is sufficient evidence that petitioner was entitled to an attorney's fee (e.g., the retainer agreement).

Petitioner claims that respondent lost petitioner's 1987 return. Petitioner, however, has failed to propose any findings of fact in support of that claim, and we have made no such finding. 1996 Tax Ct. Memo LEXIS 1">*18 Petitioner has failed to carry his burden of proof on that point. Moreover, even if facts did support that claim, petitioner has failed to show that respondent's determination was arbitrary. Perhaps respondent had abstracted data from petitioner's return and no longer needed it. Indeed, it is difficult to understand just what petitioner's complaint is. Petitioner is not claiming that he did report the attorney's fee on his return and that respondent is double charging him. Whether respondent had petitioner's return or not, respondent charged petitioner with income respondent had reason to believe petitioner did not report. There is nothing arbitrary about that.

Finally, petitioner argues that respondent raised a new matter for 1988 (presumably the attorney's fee theory), and ought to bear the burden of proof on that matter. See Rule 142(a). The long and the short of it is that we have sustained respondent's determination of a deficiency for 1987, not 1988, and for that year respondent raised no new issue. Petitioner has not brought to our attention any authority to the contrary.

Petitioner's motion to shift the burden of proof will be denied. Indeed, even were we to shift the1996 Tax Ct. Memo LEXIS 1">*19 burden of proof to respondent, that would not help petitioner. On no issue for which petitioner bears the burden of proof do we have a situation in which we must look to who bears the burden of proof to resolve a balance in the evidence. In this case, considering the evidence before us, it is of no consequence who bears the burden of proof.

III. Deficiency

We have found that petitioner failed to report an item of gross income in the amount of $ 408,318 received in 1987. We base that finding on our conclusion that, at the time the New York court entered the Infants Compromise Order (the order), on June 2, 1987, petitioner had the right to a one-half share of the attorney's fees awarded by the court, which right petitioner waived in favor of Hester, his sister. A taxpayer may not avoid tax by an anticipatory arrangement that assigns income earned by the taxpayer to another. Lucas v. Earl, 281 U.S. 111">281 U.S. 111, 281 U.S. 111">112 (1930); see United States v. Allen, 551 F.2d 208">551 F.2d 208 (8th Cir. 1977) (taxpayer, a real estate broker, was taxed on commission earned on sale of house to his parents; commission turned over to his parents; taxpayer argued1996 Tax Ct. Memo LEXIS 1">*20 that he had agreed to sell the house to his parents free of a commission and, therefore, had waived the commission); Daugherty v. Commissioner, 63 F.2d 77">63 F.2d 77 (9th Cir. 1933), affg. 24 B.T.A. 531">24 B.T.A. 531 (1931) (attorney who assigned to his wife one-half of his share of a contingency fee is taxable on the full share); Kochansky v. Commissioner, T.C. Memo. 1994-160 (attorney who represented client in malpractice suit taxable on contingent fee assigned to former wife in property settlement agreement). When income is assigned to another: "The choice of the proper taxpayer revolves around the question of which person * * * in fact controls the earning of the income rather than the question of who ultimately receives the income." Vercio v. Commissioner, 73 T.C. 1246">73 T.C. 1246, 73 T.C. 1246">1253 (1980); Vnuk v. Commissioner, 621 F.2d 1318">621 F.2d 1318, 621 F.2d 1318">1320 (8th Cir. 1980), affg. T.C. Memo. 1979-164; Kochansky v. Commissioner, supra.

Neither party here argues that the $ 408,318 item here in question is taxable to the Lipsig1996 Tax Ct. Memo LEXIS 1">*21 firm. The choice is between petitioner, for whom, if the item is his, it is a fee includable in gross income pursuant to section 61(a)(1), and Hester, for whom, if it is hers, it is an amount excludable from gross income pursuant to section 104(a)(2) as an amount received on account of personal injury. The evidence here strongly supports the conclusion that petitioner controlled the earning of the item in question, notwithstanding that the New York court ordered that it be paid to Hester. In its order (the order), the New York court called the item an attorney's fee and stated that petitioner had waived his right to the fee. If the item were not an attorney's fee, why would the New York court describe it as such and speak of a waiver? Petitioner was not a party to the malpractice action. The only possible claim he had to any proceeds was for services rendered as an attorney. If he had not rendered those services, and was not entitled to a fee, then any discussion of a waiver makes no sense. Yes, it is possible that petitioner (or Hester) had negotiated a reduced, one-half, fee arrangement with the Lipsig firm, and the waiver was simply the way that arrangement was carried out. We 1996 Tax Ct. Memo LEXIS 1">*22 do not, however, believe that. Under New York law, attorney's fees in an action involving an infant are fixed not by the attorney's contract or retainer agreement but by the court, and any agreement of the guardian is advisory only. N.Y. Jud. sec. 474 (McKinney 1983); Werner v. Levine, 276 N.Y.S.2d 269">276 N.Y.S.2d 269, 276 N.Y.S.2d 269">271 (Sup. Ct. 1967). Under New York law, in a action involving a minor, a settlement is ineffective without a court order. N.Y. Civ. Prac. L. & R. sec. 1207 (McKinney 1976 & Supp. 1995); Valdimer v. Mount Vernon Hebrew Camps, Inc., 210 N.Y.S.2d 520">210 N.Y.S.2d 520 (1961). Affidavits of the infant's representative and attorney, if any, must accompany the papers supporting the motion or petition for an order. N.Y. Civ. Prac. L. & R. sec. 1208 (McKinney 1976 & Supp. 1995). The order and the supporting papers we have described--the compromise petition, the Lipsig firm affirmation, and petitioner's affirmation--all are consistent in treating petitioner as entitled to a fee, which he waived. Both the compromise petition and the Lipsig firm affirmation describe a contingent fee arrangement of 33-1/3 percent (later reduced to 30 percent). If the1996 Tax Ct. Memo LEXIS 1">*23 arrangement were otherwise, i.e., if, from the beginning, petitioner had been entitled to no portion of that fee and the Lipsig firm was to get less than 33-1/3 percent (later, 30 percent), then the compromise petition and the Lipsig firm affirmation were misleading, if not fraudulent. We do not believe that to be the case. Petitioner assisted and was a tremendous help to the Lipsig firm in the prosecution of the malpractice action. The retainer, petitioner's retainer statement, and his arrangement with the Lipsig firm all are consistent with the conclusion that petitioner earned and was entitled to a fee. The only evidence to the contrary is the testimony of petitioner and Hester. Petitioner's testimony was not straightforward; we found him evasive in many of his answers. We accord his testimony little weight. Hester's testimony agreed with that of her brother. Because of the close family relationship, and because she exposed herself to no adverse income tax consequence, we also accord her testimony little weight.

Finally, petitioner claims that he cannot be taxed on the item in question because he did not actually receive it, and it would have been illegal for him to have received1996 Tax Ct. Memo LEXIS 1">*24 it. See Commissioner v. First Sec. Bank of Utah, N.A., 405 U.S. 394">405 U.S. 394 (1972). Petitioner argues that he was prohibited from receiving the item under (1) New York law and (2) an order issued by his employer, the New York Attorney General, prohibiting Department of Law employees from engaging in private practice. We do not agree that the New York law or Attorney General rule cited by petitioner would make it illegal for petitioner to receive the fee that he waived to Hester. New York Code of Professional Responsibility, rule 2-107(A), which covers legal fee splitting, does not invalidate petitioner's fee-sharing agreements with the Lipsig firm because (1) we assume Hester consented to the agreements, as evidenced by the statements made in her affidavit supporting the petition for a compromise order, and (2) petitioner contributed to the legal work in an amount sufficient to satisfy rule 2-107(A). See Benjamin v. Koeppel, 626 N.Y.S.2d 982">626 N.Y.S.2d 982, 626 N.Y.S.2d 982">985-986 (1995) (referring attorney contributed to the legal work by merely interviewing the client, evaluating the case, discussing the case with the representing firm, and attending one meeting1996 Tax Ct. Memo LEXIS 1">*25 between client and firm). N.Y. Jud. sec. 474 does not prohibit petitioner from collecting fees; rather it prescribes the procedural method for obtaining fees, which petitioner failed to follow as he had assigned his portion of the fee. Finally, petitioner has not convinced us that his employment restriction, while prohibiting him from private practice, makes it illegal for him to collect the fees received from such practice. Accordingly, we find that petitioner's ability to receive the fee was not impeded by law or employment restriction. The New York court was apprised of petitioner's agreement with the Lipsig firm. We believe that, by ordering that petitioner's waiver be given effect so that half the attorney's fees be paid to Hester, the New York court recognized petitioner's right to receive the fee and, consequently, petitioner's ability to control the fee's disposition. Accordingly, $ 408,318 is taxable to petitioner in 1987.

IV. Additions to Tax

A. Negligence

We have determined an underpayment in tax for 1987. Section 6653(a)(1)(A) imposes an addition to tax equal to 5 percent of the entire underpayment if any portion of such underpayment is due to negligence. 1996 Tax Ct. Memo LEXIS 1">*26 Section 6653(a)(1)(B) imposes an addition to tax equal to 50 percent of the interest payable under section 6601 with respect to the portion of the underpayment due to negligence. "Negligence is lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances." Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">947 (1985) (quoting Marcello v. Commissioner, 380 F.2d 499">380 F.2d 499, 380 F.2d 499">506 (5th Cir. 1967), affg. in part and remanding in part 43 T.C. 168">43 T.C. 168 (1964)). Petitioner bears the burden of proof. Rule 142(a).

In the petition, petitioner assigns error to respondent's determination of an addition to tax for negligence on the ground that there is no deficiency. Petitioner avers no other facts in support of his assignment of error. On brief, petitioner argues that petitioner reported the transaction consistently with the actual receipt of the item and that respondent's assignment of income theory is not contained in the Code or regulations, but is a "limited doctrine" contained in case law. Petitioner argues that petitioner cannot be expected to have intentionally disregarded1996 Tax Ct. Memo LEXIS 1">*27 that doctrine. Moreover, petitioner argues that respondent has introduced absolutely no evidence that petitioner engaged in any scheme to avoid taxes. We disagree. The $ 408,318 was deposited into a joint account belonging to Hester and petitioner. Petitioner withdrew substantial sums from that account and gambled with them in Atlantic City. Such use of the $ 408,318 is inconsistent with the statement in the Lipsig firm affirmation, no doubt based on statements by petitioner or Hester, that petitioner "has agreed to waive his share of the legal fees in this case in Hester's behalf so that she may continue to have the wherewithal to care for her daughter MAUDE." We believe that petitioner and Hester acted together to structure receipt of the $ 408,318 so that petitioner could retain control of it but claim that he had not received it for income tax purposes, and we so find. We believe that petitioner was negligent in not reporting the $ 408,318 on his 1987 return, and we so find. We sustain respondent's additions to tax under section 6653(a)(1)(A) and (B) in their entirety.

B. Substantial Understatement of Income Tax Liability

For returns due before January 1, 1990, section 66611996 Tax Ct. Memo LEXIS 1">*28 provides for an addition to tax equal to 25 percent of the amount of any underpayment attributable to a substantial understatement. An understatement is "substantial" when the understatement for the taxable year exceeds the greater of (1) 10 percent of the tax required to be shown or (2) $ 5,000. The understatement is reduced to the extent that the taxpayer has (1) adequately disclosed his or her position, or (2) has substantial authority for the tax treatment of an item. Sec. 6661; sec. 1.6661-6(a), Income Tax Regs. Petitioner bears the burden of proving that he is not subject to the addition to tax determined by respondent. Rule 142(a).

Petitioner's understatement for the taxable year exceeded 10 percent of the tax required to be shown. It is therefore substantial under section 6661. Petitioner argues, however, that there was substantial authority for his treatment of the item. Specifically, petitioner argues that he "reported the transaction consistently with an award from the New York court and consistently with the treatment of such item by the Lipsig Firm." Section 1.6661-3(b)(2), Income Tax Regs., lists the types of authority that will be considered in determining whether 1996 Tax Ct. Memo LEXIS 1">*29 substantial authority exists. The authority upon which petitioner relies, i.e., the court award and the Lipsig firm's treatment, are not among those that will be considered. Furthermore, there is no evidence that petitioner made any disclosure of the item on his 1987 tax return. Petitioner has thus failed to prove that he is not subject to the section 6661 addition to tax. Accordingly, we sustain respondent's section 6661 addition to tax.

An order denying petitioner's oral motion to shift the burden of proof will be issued.

An order denying petitioner's oral motion to dismiss for lack of jurisdiction will be issued, and decision will be entered for respondent in docket No. 21777-93.

Decisions will be entered for petitioner in docket Nos. 5780-92 and 592-94.