T.C. Memo. 2001-205



                UNITED STATES TAX COURT



              WILLIS CLARK, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 15384-99.                    Filed August 6, 2001.


      Held: P’s case is dismissed for failure properly
to prosecute pursuant to Rule 123(b), Tax Court Rules
of Practice and Procedure, with respect to income tax
deficiencies determined for taxable years 1993 and
1994.

     Held, further, P is liable for civil fraud
penalties for 1993 and 1994 in accordance with sec.
6663, I.R.C.


Willis Clark, pro se.

Nicholas J. Richards, for respondent.
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                  MEMORANDUM FINDINGS OF FACT AND OPINION


     NIMS, Judge:       Respondent determined the following

deficiencies and penalties with respect to petitioner’s Federal

income taxes for the taxable years 1993 and 1994:

       Taxable                  Income Tax             Penalty
         Year                   Deficiency            Sec. 6663
           1993                   $60,212              $45,159
           1994                    38,407               28,805



     Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code in effect for the years at

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

     The issues for decision are:

     (1)    Whether petitioner’s case should be dismissed for

failure properly to prosecute with respect to the deficiencies

determined by respondent; and

     (2) whether petitioner is liable for civil fraud penalties

pursuant to section 6663.

                             FINDINGS OF FACT

Procedural Background

     On June 21, 1999, respondent issued to petitioner a

statutory notice determining that petitioner was liable for

deficiencies and fraud penalties for the 1993 and 1994 taxable
                                - 3 -

years.   The deficiencies were based in large part upon

respondent’s determination that petitioner received unreported

income during those years.    On September 23, 1999, petitioner

filed a petition with this Court disputing the full amount of the

deficiencies and penalties.    Petitioner at that time resided in

Riverside, California.

     Respondent then answered the petition and further set forth

specific allegations of fact in support of the fraud penalties.

Petitioner’s subsequent reply denied nearly all of respondent’s

affirmative allegations and maintained that petitioner’s tax

reporting was “full and accurate”.

     After close of the pleadings this case was set for trial,

and copies of the Court’s standing pretrial order were served on

the parties.   Therein, petitioner and respondent were directed to

begin discussions as soon as practicable, to stipulate facts to

the maximum extent possible, and to submit trial memoranda if a

basis of settlement could not be reached prior to trial.    The

pretrial order also warned generally that any unexplained failure

to comply with its provisions could result in sanctions,

including dismissal, and stated specifically that failure to

cooperate in the stipulation process was a potential ground for

such sanctions.

     On November 3, 2000, at which time this case was calendared

for trial beginning on March 19, 2001, respondent’s counsel wrote
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to petitioner proposing a conference for November 20, 2000.     The

stated purpose of the conference was to commence the process of

obtaining informal discovery and preparing a stipulation of

facts.   Neither petitioner nor a representative attended this

meeting.

     On December 21, 2000, respondent then served on petitioner

interrogatories, a request for admissions, and a request for

production of documents.    Petitioner responded on January 18,

2001, to respondent’s request for admissions but sent no response

to either the interrogatories or the request for production of

documents.    As a result, respondent on February 6, 2001, filed

motions to compel responses to interrogatories and to compel

production of documents.    These motions were granted by the

Court, and petitioner was ordered to comply on or before February

23, 2001.    Petitioner failed to do so.

     Meanwhile, on February 15, 2001, respondent’s counsel sent

to petitioner a proposed stipulation of facts.    Thereafter,

following several unsuccessful attempts to communicate regarding

the pending discovery matters and proposed stipulation,

respondent on March 12, 2001, requested and was given leave to

file a motion for an order under Rule 91(f) to show cause why

proposed facts in evidence should not be accepted as established.

This motion was granted, and petitioner was ordered to show cause

at trial on March 20, 2001, why the facts and evidence recited in
                                - 5 -

respondent’s proposed stipulation of facts should not be deemed

established.   Respondent also submitted a trial memorandum prior

to trial; petitioner did not.

     On March 20, 2001, petitioner appeared at the call of this

case.   Petitioner asked for an “extension”, primarily on grounds

that he had been unable to obtain an attorney and that alleged

medical reasons prevented him from proceeding.     In support of his

medical claims, petitioner provided two documents.     One was a

single-paragraph memorandum from petitioner stating that he was

“physically unable to undergo the stress of a public hearing or

trial” and also referencing the second document.     This second

document was a letter dated May 11, 1999, from a physician at the

Jerry L. Pettis Memorial Veterans’ Hospital to the Riverside

Office of the Jury Commissioner, recommending that petitioner be

permanently excused from “jury duty” on account of “multiple

medical problems”.

     The Court then explained to petitioner that he could

represent himself and that the eleventh-hour allegations of

medical problems were not a sufficient basis for further delay.

Ample time and opportunity had existed prior to trial for

petitioner to prepare his case and to communicate with the Court

regarding any relevant situations.      The Court therefore informed

petitioner that the Government would be permitted to proceed with

its case regardless of whether petitioner elected to stay and
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participate.    Petitioner chose at that point to leave the

courtroom and has had no further contact with the Court.

     Following petitioner’s departure, the Court made absolute

the Rule 91(f) order to show cause, ordering that the facts set

forth in respondent’s proposed stipulation of facts be accepted

as established for purposes of this case and that the exhibits

attached thereto be received into evidence.    In light of these

developments, respondent also moved orally to dismiss

petitioner’s case, insofar as concerned the tax deficiencies

determined in the statutory notice, for failure properly to

prosecute.    The Court took this motion under advisement, and

respondent then presented testimony and documentary evidence with

respect to the fraud penalties.

Factual Background

     As indicated above, some of the facts have been stipulated

pursuant to Rule 91(f), and such facts are so found.    These

stipulations, with accompanying exhibits, are incorporated herein

by this reference.

     Prior to and during the years at issue, petitioner owned and

operated the Appliance Recycling Factory (ARF), a sole

proprietorship.    ARF was engaged in the business of buying used

appliances, refurbishing them, and then reselling the refurbished

appliances.    Sales of the appliances were made to customers

through cash, check, credit, and barter transactions.    At least
                                 - 7 -

10 to 12 percent, and up to as much as one-third, of ARF’s gross

receipts typically took the form of cash.    Petitioner actively

endeavored to increase the proportion of cash sales by

advertising to pay the sales tax with respect to any purchase for

which payment was made in cash.

     The cash received by petitioner through ARF was used to pay

both business and personal expenses.     Expenditures for employee

wages and purchases from vendors, for instance, were often made

in cash.

     During 1993 and 1994, petitioner maintained nine bank

accounts that were used for both business and personal purposes.

In 1993, a total of $480,260 was deposited into these accounts,

including $870 cash.   In 1994, the deposits totaled $811,816, of

which $2,900 was cash.   Petitioner did not deposit ARF’s cash

receipts in his bank accounts.

     Sales invoices prepared by petitioner’s employees at the

time of each appliance sale were forwarded to ARF’s bookkeeper,

Nina Nippe.   Petitioner instructed Ms. Nippe, in preparing ARF’s

books and records, to “hold back” 10 to 12 percent of receipts,

primarily those in cash, from the sales journal.    Petitioner

indicated to Ms. Nippe that he wished “to get even with the IRS”

for an audit conducted in the late 1970s or early 1980s.    Ms.

Nippe complied with this instruction, at times withholding in

excess of 10 to 12 percent when cash sales surpassed that ratio.
                               - 8 -

The business records so prepared were then sent by petitioner to

his return preparer for the years at issue, Jerry Butler.

     Mr. Butler obtained the data used in preparing petitioner’s

1993 and 1994 returns from the business records supplied by

petitioner.   Mr. Butler was not provided with the original

receipts detailing ARF’s sales.   When, subsequent to the years in

issue, Mr. Butler noticed discrepancies in certain of

petitioner’s records, he confronted Ms. Nippe and was told at

that time about the withholding of sales.   Mr. Butler ceased to

represent petitioner and thereafter sent to the accountant who

apparently had succeeded him in petitioner’s employ a letter

dated March 8, 1997, which included the following explanation:

          I was reluctant to do the books since after I
     filed the last tax return, Nina, his bookkeeper,
     disclosed to me that she conspired with Mr. Clark to
     destroy sales slips, not report any cash sales and that
     she therefore prepared sales journals that did not
     reflect the truthful activities of Appliance Recycling
     Factory. I requested that she reconstruct proper
     records. She stated that with the destroyed records by
     Mr. Clark, his employees and herself that she felt this
     was not possible. I am therefore reluctant to perform
     any services due to the tax evasion problems. * * *

     The 1993 and 1994 tax returns filed by petitioner reflect

gross sales for ARF of $518,673 and $753,782, respectively.    Net

profit or loss from the business is shown as $6,744 for 1993 and

($119,808) for 1994.   Petitioner then reports total taxable

income of $1,581 in 1993 and a loss of $122,816 in 1994.
                                 - 9 -

     During the subsequent examination of petitioner’s 1993 and

1994 returns, petitioner’s income was reconstructed using a bank

deposits and cash expenditures analysis.    Through this method it

was determined that ARF had gross sales in 1993 and 1994 of at

least $573,673 and $1,020,504, respectively.    These adjustments

resulted in increases of $17,173 for 1993 and $213,892 for 1994

in the income reported by petitioner.    Respondent additionally

determined that petitioner failed to include an ending inventory

of $135,415 in calculating his cost of goods sold for 1993 and

received unreported rental income in the amounts of $6,465 and

$4,475, respectively, for the years at issue.    With other expense

disallowances and computational adjustments, it was determined

that petitioner underreported his taxable income by $166,681 for

1993 and by $218,285 for 1994.

                               OPINION

I.   Income Tax Deficiencies

     Dismissal is governed by Rule 123(b), which provides in

relevant part:

     For failure of a petitioner properly to prosecute or to
     comply with these Rules or any order of the Court or
     for other cause which the Court deems sufficient, the
     Court may dismiss a case at any time and enter a
     decision against the petitioner. The Court may, for
     similar reasons, decide against any party any issue as
     to which such party has the burden of proof, and such
     decision shall be treated as a dismissal * * *.

The granting of a dismissal under Rule 123(b) lies within the

discretion of the trial court and requires us to balance
                              - 10 -

potentially rival considerations.    Brooks v. Commissioner, 

, 424-425 (1984), affd. without published opinion 

 (9th Cir. 1985); Freedson v. Commissioner, 

,

935-937 (1977), affd. 

 (5th Cir. 1978).    The policy

of having cases heard on their merits must be weighed against the

policy of avoiding harassment to the defending party arising from

unjustifiable delay.   Brooks v. Commissioner, supra at 424;

Freedson v. Commissioner, supra at 935.

     In evaluating the propriety of a dismissal in the matter now

before us, we first address the threshold burden of proof issue

before turning to the relevant policy concerns.    With respect to

income tax deficiencies, the petitioner generally bears the

burden of proof.   Rule 142(a).   Furthermore, although section

7491, applicable to court proceedings that arise in connection

with examinations commencing after July 22, 1998, may place the

burden on the Commissioner in certain circumstances, a

prerequisite is that the taxpayer present credible evidence.

Sec. 7491(a); Internal Revenue Service Restructuring & Reform Act

of 1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 685, 727;

Higbee v. Commissioner, 

 (2001).    Thus, while the

record in the instant case does not indicate when the examination
                              - 11 -

of petitioner’s returns began, petitioner has failed to present

any evidence and so could not qualify for the protections of

section 7491.   Accordingly, petitioner here bears the burden of

proving that respondent’s deficiency determinations are in error.

     As regards the two pertinent policy considerations

identified above, we are equally satisfied that the balance

weighs strongly against petitioner.    In the many months that have

passed since his petition was filed, petitioner has been

uncommunicative, uncooperative, and has otherwise failed to make

any meaningful efforts whatsoever to prepare his case for trial.

He has acted in contravention of our standing pretrial order, has

refused to engage in informal discovery, has ignored orders

directing formal discovery, has stipulated no facts, has failed

to submit a trial memorandum, and has appeared before the Court

on the day of trial completely unprepared to proceed.     Hence,

while it is true that petitioner will suffer the detriment of not

being heard on the merits of his case, he has given us no reason

to believe that he is inclined to prepare for doing so at any

time in the foreseeable future.   In contrast, respondent has

already expended significant effort in attempting to bring this

matter to resolution.   We therefore must conclude, given the

pattern of petitioner’s behavior and the unlikelihood of

impending improvement, that further delay and the harassment
                                  - 12 -

caused thereby to respondent cannot be justified.      We shall grant

respondent’s motion to dismiss pursuant to Rule 123(b) and shall

enter a decision against petitioner as to the determined

deficiencies for taxable years 1993 and 1994.

II.   Fraud Penalties

      Section 6663(a) provides for the imposition of a penalty in

“an amount equal to 75 percent of the portion of the underpayment

which is attributable to fraud.”      In addition, section 6663(b)

specifies that if any portion of the underpayment is attributable

to fraud, the entire underpayment is treated as attributable

thereto, except and to the extent that the taxpayer establishes

some part is not due to fraud.

      Respondent bears the burden of proving the applicability of

the civil fraud penalty by clear and convincing evidence.      Sec.

7454(a); Rule 142(b).    To sustain this burden, respondent must

establish by this level of proof both (1) that there was an

underpayment of tax for each taxable year at issue and (2) that

at least some portion of such underpayment was due to fraud.

DiLeo v. Commissioner, 

, 873 (1991), affd. 

(2d Cir. 1992); Petzoldt v. Commissioner, 

, 699

(1989).

      A.   Underpayments of Tax

      Where allegations of fraud are intertwined with unreported

and indirectly reconstructed income, the Commissioner may satisfy
                              - 13 -

the first prong of the above test either by proving a likely

taxable source for alleged unreported income or, where the

taxpayer asserts a nontaxable source, by disproving the

nontaxable source.   United States v. Massei, 

, 595

(1958); Holland v. United States, 

, 137-138 (1954);

DiLeo v. Commissioner, supra at 873-874.    The Commissioner may

not, however, simply rely on the taxpayer’s failure to prove

error in the deficiency determination.     DiLeo v. Commissioner,

supra at 873; Otsuki v. Commissioner, 

, 106 (1969).

     Here, the evidence clearly establishes cash sales made by

ARF as a likely source of unreported income.    Furthermore,

petitioner has at no time alleged nontaxable sources in an amount

sufficient to negate the purported unreported income, and

respondent’s bank deposits analysis took into account nontaxable

transfers and loans in excess of $66,000.    The record thus

contains clear and convincing proof that petitioner underpaid his

income taxes for the 1993 and 1994 taxable years.

     B.   Fraudulent Intent

     The second prong of the fraud test requires respondent to

show that a portion of the foregoing underpayment is attributable

to fraud.   Fraud for this purpose is defined as intentional

wrongdoing on the part of the taxpayer, with the specific purpose

of avoiding a tax believed to be owed.     Stoltzfus v. United
                                - 14 -

States, 

, 1004 (3d Cir. 1968); Webb v. Commissioner,

, 377 (5th Cir. 1968), affg. T.C. Memo. 1966-81;

Powell v. Granquist, 

, 60 (9th Cir. 1958).     Stated

differently, imposition of the civil fraud penalty is appropriate

upon a showing that the taxpayer intended to evade taxes believed

to be owing by conduct designed to conceal, mislead, or otherwise

prevent the collection of taxes.    DiLeo v. Commissioner, supra at

874; Brooks v. Commissioner, 82 T.C. at 431.

     The existence of fraud is a question of fact to be resolved

upon consideration of the entire record.   Brooks v. Commissioner,

supra at 431; Gajewski v. Commissioner, 

, 199 (1976),

affd. without published opinion 

 (8th Cir. 1978).

Fraud will never be presumed.    Brooks v. Commissioner, supra at

431; Beaver v. Commissioner, 

, 92 (1970).     However,

because direct proof of a taxpayer’s intent is seldom available,

fraud may be established by circumstantial evidence.     Spies v.

United States, 

, 499 (1943); Brooks v. Commissioner,

supra at 431.   In this connection, courts have developed a

nonexclusive list of circumstantial indicia, or “badges”, of

fraud that will support a finding of fraudulent intent.

     In Bradford v. Commissioner, 

, 307 (9th Cir.

1986), affg. T.C. Memo. 1984-601, the Court of Appeals for the

Ninth Circuit, to which appeal of this case would normally lie,

enumerated the following badges of fraud distilled from then-
                              - 15 -

existing case law:   (1) Understatement of income; (2) inadequate

records; (3) failure to file tax returns; (4) implausible or

inconsistent explanations of behavior; (5) concealing assets; and

(6) failure to cooperate with tax authorities.    The Court of

Appeals also identified dealing in cash as an additional fact

which would support a finding of fraud.   Id. at 308.

     Applying these considerations to the case at bar, we

conclude that petitioner fraudulently intended to underpay tax

for each of the years at issue.   The record unequivocably

demonstrates that petitioner understated his income, maintained

inadequate records, failed to cooperate with taxing authorities,

and engaged in extensive dealings in cash.   Moreover, the

evidence reveals that petitioner expressly directed the

preparation of false business records to conceal a significant

percentage of his cash transactions and then himself provided

those erroneous records to his return preparer.    The only logical

inference to be drawn from such circumstances is that petitioner

knowingly and actively structured his affairs with the specific
                               - 16 -

purpose of avoiding his Federal tax obligations.   We hold that

petitioner is liable for the section 6663 civil fraud penalties

as determined by respondent.

     To reflect the foregoing,



                                         An appropriate order will

                                    be issued granting

                                    respondent’s motion to

                                    dismiss, and decision will be

                                    entered for respondent.