Judges: "Goeke, Joseph Robert"
Attorneys: Thomas E. Brever , for petitioners. John C. Schmittdiel , for respondent.
Filed: May 26, 2005
Latest Update: Dec. 05, 2020
Summary: T.C. Memo. 2005-125 UNITED STATES TAX COURT TIMOTHY DEAN STRONG, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent STRONG CONSTRUCTION CO., INC., A MINNESOTA CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 821-01, 2048-01. Filed May 26, 2005. Thomas E. Brever, for petitioners. John C. Schmittdiel, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION GOEKE, Judge: Respondent determined deficiencies in petitioners’ Federal income tax, additions to ta
Summary: T.C. Memo. 2005-125 UNITED STATES TAX COURT TIMOTHY DEAN STRONG, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent STRONG CONSTRUCTION CO., INC., A MINNESOTA CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 821-01, 2048-01. Filed May 26, 2005. Thomas E. Brever, for petitioners. John C. Schmittdiel, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION GOEKE, Judge: Respondent determined deficiencies in petitioners’ Federal income tax, additions to tax..
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T.C. Memo. 2005-125
UNITED STATES TAX COURT
TIMOTHY DEAN STRONG, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
STRONG CONSTRUCTION CO., INC., A MINNESOTA CORPORATION,
Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 821-01, 2048-01. Filed May 26, 2005.
Thomas E. Brever, for petitioners.
John C. Schmittdiel, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: Respondent determined deficiencies in
petitioners’ Federal income tax, additions to tax, and penalties
as follows:
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Timothy Dean Strong--docket No. 821-01
In the alternative
Penalty Penalty Addition to Tax
Year Deficiency Sec. 6663 Sec. 6662 Sec. 6651(a)(1)
1990 $9,768 $7,326.00 $1,953.60 $2,442.00
1991 11,185 8,388.75 2,237.00 2,796.25
1992 19,794 14,845.50 3,958.80 4,948.50
1993 31,567 23,675.25 6,313.40 7,891.75
1994 6,613 4,959.75 1,322.60 N/A
Strong Construction Co., Inc.--docket No. 2048-01
In the alternative
Addition to Tax Addition to Tax
Year Deficiency Sec. 6651(f) Sec. 6651(a)(1)
1990 $6,257 $4,693 $1,564
1991 6,925 5,194 1,731
1992 12,871 9,653 3,218
1993 25,783 19,337 6,446
1994 5,090 3,818 N/A
Unless otherwise noted, all section references are to the
Internal Revenue Code in effect during the taxable 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 Strong Construction Co., Inc. (SCC),
should be recognized as a taxable entity. We hold SCC is a
taxable corporate entity;
2. whether SCC had additional income from sales of houses
it constructed during the years 1990-94 (the years at issue) and
from unidentified taxable sources, as established on the basis of
deposits to petitioner Timothy Dean Strong’s (Mr. Strong) joint
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bank account with SCC. We hold with certain specific exceptions
that SCC did have the additional income determined by respondent;
3. whether SCC is entitled to expenses for construction
costs and general and administrative expenses related to its
homebuilding business during the years at issue in excess of
those allowed by respondent. We hold SCC is entitled to deduct
certain expenses as redetermined herein;
4. whether Mr. Strong had additional income for the years
at issue for constructive dividends from SCC, deposits of SCC’s
funds for his personal use, and the corporation’s payment of his
personal expenses. We hold he did as redetermined herein;
5. whether Mr. Strong is liable for the fraud penalty
under section 6663 on his underpayment of tax for each of the
years at issue. We hold he is;
6. whether SCC is liable for the addition to tax under
section 6651(f) for fraudulent failure to file timely on its
underpayment of tax for each of the years at issue. We hold that
SCC is not liable for the section 6651(f) addition to tax; and
7. alternatively, whether SCC is liable for the addition
to tax under section 6651(a)(1) for failure to file timely tax
returns. We hold that SCC is liable for the section 6651(a)(1)
addition to tax.
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FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. At the time of filing his
petition in this case, Mr. Strong resided in Clear Lake,
Minnesota. At the time of filing its petition, SCC had its
principal place of business, mailing address, and registered
office in Minnesota.
SCC
SCC was incorporated under Minnesota law in 1986, and as of
December 31, 1994, had not been formally dissolved. At all times
relevant, Mr. Strong was the 100-percent owner of SCC. He was
its incorporator, director, and president. During the years at
issue, SCC had no officers except Mr. Strong and had no
employees.
During the years at issue, SCC was engaged in the
residential construction business and built and sold houses under
the names Strong Construction or Strong Construction Co., Inc.
SCC constructed and sold the following houses (the 22 house
sales):
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1990
Date Property (Buyer) Sale Price
7/5 10925 Osage Street $59,900
7/5 10929 Osage Street 64,600
10/12 10901 Osage Street 64,900
12/10 374 Rose Avenue East 75,400
Total 264,800
1991
Date Property (Buyer) Sale Price
1/17 12166 Wedgewood Drive $88,000
1/30 10905 Osage Street 64,000
4/5 16051 Andrie Street 116,960
6/28 767 99th Lane, NE 87,760
7/26 1755 124th Avenue, NW 84,000
9/6 1737 McKnight 84,000
Total 524,720
1992
Date Property (Buyer) Sale Price
2/20 1761 County Road F $89,000
4/2 3242 129th Lane 85,000
4/13 3854 120th Avenue, NW 78,000
7would be one word 12154 Wedgewood Drive
92,900
7/23 11900 NE Kerry Street 91,000
11/18 818 Meander Street 96,000
Total 531,900
1993
Date Property (Buyer) Sale Price
10/27 14671 Helium Street $85,448
Total 85,448
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1994
Date Property (Buyer) Sale Price
8/30 14685 Iodine Court $117,600
9/27 4412 Josephine Lane North 103,766
10/7 5661-146th Circle 115,000
10/25 4265 Victoria Street 121,880
11/22 7096 Progress Road 73,150
Total 531,396
During the years at issue, Mr. Strong had signatory
authority over bank account No. 893315300 at First Bank, Coon
Rapids, Minnesota (later known as Marquette Bank Coon Rapids).
This account bears his name and that of SCC. The net proceeds
from the 22 house sales during the years at issue were paid by
checks issued to SCC and deposited in account No. 893315300. SCC
did not file Federal or State income tax returns for the years
1990-94. Mr. Strong considered SCC funds deposited into account
No. 893315300 to be available for his personal use.
Mr. Strong’s Income Tax Returns
Mr. Strong filed his 1990, 1991, and 1993 Forms 1040, U.S.
Individual Income Tax Return, on March 23, 1995. He filed his
1992 Form 1040 on March 2, 1995, and he timely filed his 1994
return. For each of the years 1990-94, the returns filed by Mr.
Strong reflect negative taxable income. These tax returns all
included a Schedule C, Profit or Loss From Business (Sole
Proprietorship), which identified his principal business as
“construction”. These Schedules C reflect the following gross
receipts, expenses, and net profits or losses:
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Item 1990 1991 1992 1993 1994
Gross
receipts
or sales $20,100 $81,640
$24,150 $26,210 $47,934
Returns &
allowances --- --- --- 2,110 ---
Net sales --- --- --- 45,824 ---
Cost of
goods sold --- --- --- 29,151 66,204
Gross
profit --- --- --- 16,673 15,436
Total
expenses 19,642 24,818 24,970 30,016 15,436
Net profit
(loss) 458 (668) 1,240 -0-
(13,343)
The Forms 1040 Mr. Strong filed reflect a $65 tax liability
based on self-employment tax in 1990 and a $175 self-employment
tax liability in 1992. Mr. Strong reported no other tax on the
Forms 1040 for 1990-94.
Mr. Strong’s Initial Contacts and Discussions With A Revenue
Officer
In late 1991, Mr. Strong was contacted by an Internal
Revenue Service (IRS) revenue officer. The purpose of this
contact was to inquire regarding Mr. Strong’s unpaid income tax
liabilities for 1987 and 1988 and his unfiled income tax returns
for 1989 and 1990. Mr. Strong refused to provide the revenue
officer with any personal or financial information, but he told
the revenue officer that he expected his tax liabilities for 1989
and 1990 to be at least $50,000. In a later conversation, Mr.
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Strong informed the revenue officer that the reason he was
delinquent in filing his tax returns was that he could not access
records held by his ex-spouse. This statement was inaccurate
since his former spouse did not have any of his records.
Return Preparation
Mr. Strong’s tax returns for 1990 and 1993 were signed by D.
R. Newman (Mr. Newman) as the paid tax return preparer on April
10 and 21, 1994, respectively. His 1991, 1992, and 1994 tax
returns were executed by D. Wade (Ms. Wade) as the paid tax
return preparer. Ms. Wade dated her signature on the 1991 return
February 21, 1995, and dated the 1994 return February 15, 1995.
Mr. Strong initially had Mr. Newman prepare his tax returns
for 1990-93. Mr. Newman prepared those returns from information
and documents provided to him by Mr. Strong. Mr. Newman gave the
completed tax returns along with the provided documents back to
Mr. Strong in April 1994. Mr. Newman did not discuss the tax
returns with him upon completing and providing them to Mr.
Strong. Mr. Strong did not provide Mr. Newman with bank
statements, deposit slips, or canceled checks to prepare his tax
returns.
Without the knowledge of Mr. Newman, Mr. Strong altered or
caused to be altered the amounts shown on the 1990 return
prepared by Mr. Newman before he filed the return. He also
caused the 1991 and 1992 returns originally prepared by Mr.
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Newman to be changed by Ms. Wade. Mr. Strong instructed Ms. Wade
to change the figures shown on the 1991 and 1992 returns as
originally prepared using handwritten sheets he gave her. Ms.
Wade changed the figures on the 1991 tax return by covering the
original numbers with correction fluid and writing new numbers
over them because she did not have a 1991 form at the time she
revised the return. She redid the 1992 return, but on a clean
form. The changes Mr. Strong instructed Ms. Wade to make to the
1991 and 1992 tax returns, originally prepared by Mr. Newman,
reduced the reported Schedule C profit on each return. Ms. Wade
also prepared Mr. Strong’s 1994 income tax return from a sheet of
paper provided to her that contained the income and expense
figures she placed on the return.
The Audit of Mr. Strong’s Income Tax Returns
In September 1995, respondent notified Mr. Strong that his
1990 and 1991 Federal income tax returns were under examination,
and in a meeting on November 30, 1995, at his residence, a
revenue agent advised him that his 1992, 1993, and 1994 returns
were also under review. In response to requests for his bank and
business records, Mr. Strong provided only handwritten summaries
of settlement sheets for five houses sold in 1991 and 1992.
Respondent’s revenue agent obtained information regarding the
construction business by issuing summonses under section 7602 for
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SCC’s bank records and for settlement statements from title
companies for the houses that had been sold by SCC.
After the revenue agent’s preliminary findings were provided
to Mr. Strong, reconstructed financial statements for SCC for the
years 1991, 1992, 1993, and 1994 were presented to the revenue
agent by Mr. Frazier, an accountant who had been engaged by Mr.
Strong.
Respondent used the financial statements provided by Mr.
Frazier as the starting point for determining SCC’s taxable
income for the years at issue. Respondent determined that SCC
was not entitled to deduct all the expenses shown on the
financial statements prepared by Mr. Frazier. Respondent also
analyzed deposits in bank account No. 893315300 to determine
SCC’s taxable income in addition to the identified deposits of
sales proceeds of houses.
The following shows the deposits to account No. 893315300
that remain in dispute1:
1
Respondent conceded that a deposit of $6,000 on Dec. 4,
1990, was a loan from Mr. Strong’s father and that a deposit of
$1,000 on June 2, 1992, was a loan from Mr. Strong’s parents.
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1990 Date Amount
Payor Deposited Deposited
Cash in ticket 1/2 $1,000.00
Vincent Kurkowski 1/2 240.00
Cash in ticket 1/24 2,200.00
Cash in ticket 2/6 3,500.00
Cash in ticket 2/10 4,700.00
Cash in ticket 2/27 9,850.00
Cash in ticket 2/13 7,200.00
Cash in ticket 3/5 9,900.00
Cash in ticket 3/8 4,900.00
Ken Jeanotte 3/13 9,900.00
Unknown 3/15 4,500.00
Ken Jeanotte 5/25 9,900.00
Ken Jeanotte 6/5 9,900.00
Gordon Schnobrich 6/22 312.00
Gordon Schnobrich 7/5 304.80
Gordon Schnobrich 7/17 170.00
Cash in ticket 12/3 1,400.00
Wesley Strong 12/4 6,000.00
Total other deposits 85,876.80
1991 Date Amount
Payor Deposited Deposited
Scherer Brothers Lumber 1/30 $144.45
Bradley or Mary Lathrop 4/30 100.00
Cash in ticket 6/14 4,000.00
Cash in ticket 7/12 9,900.00
Cash in ticket 12/17 5,300.00
Todd Peterson 12/17 2,000.00
Cash in ticket 12/18 6,000.00
Total other deposits 27,444.45
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1992 Date Amount
Payor Deposited Deposited
Cash in ticket 1/2 $4,600
Cash in ticket 1/28 6,560
Cash in ticket 2/5 9,000
Cash in ticket 2/14 3,200
Cash in ticket 2/14 3,400
Cash in ticket 3/17 3,000
Cash in ticket 3/23 5,000
Gene or Sharon Strong 6/2 1,000
Total other deposits 35,760
1993 Date Amount
Payor Deposited Deposited
Cash in ticket 1/19 $3,000
Cash in ticket 1/29 4,000
Harstad Companies 2/17 100
Harstad Companies 2/17 250
Cash in ticket 3would be one word
3,000
Cash in ticket 3/22 2,000
No bank info. 3/24 5,000
Cash in ticket 4/2 5,000
Cash in ticket 4/22 9,900
Cash in ticket 4/23 9,850
Cash in ticket 4/28 9,900
Cash in ticket 5/19 7,000
Cash in ticket 6would be one word
4,000
Cash in ticket 6/21 5,000
Cash in ticket 7/2 8,000
Cash in ticket 7/15 11,000
Cash in ticket 8/3 5,000
No bank info. 8/24 9,900
No bank info. 8/24 9,900
Cash in ticket 9/22 6,000
Cash in ticket 10/15 4,450
Cashier’s check -
Rodney Nelson 10/18 4,000
Total other deposits 126,250
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1994 Date Amount
Payor Deposited Deposited
Stephen Roche Homebuilders 3/16 $444
North Metro Auto Salvage 3/16 75
Sean Strong for #7 3/16 500
Stephen Roche Homebuilders 3/24 988
No info. available from bank 5/13 5,000
Keith E. Hagford 5/27 500
Burnet trust acct./
Hagford earnest 6/20 500
Jack W. Thompson 8/10 8,500
Sean Strong/personal 8/16 8,500
Criston or Ann Holst/Iodine 10/5 225
Total other deposits 25,232
On March 13, 1990, Mr. Strong deposited $9,900 into account
No. 893315300. The deposit was cashier’s check No. 6724 in the
amount of $9,900 issued by First National Bank Anoka-Brooklyn
Park-Champlin (First Bank), which identifies the purchaser as Ken
Jeanotte (Mr. Jeanotte). On May 25, 1990, Mr. Strong deposited
$9,600 in account No. 893315300, after taking $300 cash back.
The deposit was cashier’s check No. 6726 in the amount of $9,900
issued by First Bank, which also identifies the purchaser as Mr.
Jeanotte. On June 5, 1990, Mr. Strong deposited $9,500 into
account No. 893315300, after taking $400 cash back. The deposit
was cashier’s check No. 6725 in the amount of $9,900 issued by
First Bank, which also identifies the purchaser as Mr. Jeanotte.
Mr. Jeanotte did not purchase cashier’s check No. 6724, 6725, or
6726 deposited to account No. 893315300 and did not pay Mr.
Strong the $29,700 those checks represent. Mr. Strong used Mr.
Jeanotte’s name without his knowledge or permission.
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On July 19, 1994, Mr. Strong obtained two cashier’s checks
issued by Norwest Bank each in the amount of $8,500. The first
made payable to Mr. Strong shows the payor was his brother, Sean
Strong and was deposited to account No. 893315300 on August 16,
1994. The second was made payable to Mr. Strong, and Jack
Thompson, the payor, is unidentified. It was deposited into
account No. 893315300 on August 10, 1994.
Before 1990, Mr. Strong was aware of the title 31
requirements that currency transactions in excess of $10,000 be
reported to the Government.
SCC’s Activity
During the years at issue, SCC entered into vacant land
purchase agreements and acquired real property in its name. Mr.
Strong signed the purchase agreements as president of SCC. As
part of the sales process, SCC entered into new construction
purchase agreements with buyers. SCC also applied for building
permits, which Mr. Strong signed as president of SCC. In
addition, SCC entered into a builder’s security agreement and
applied for a home buyer’s warranty on some of the 22 house
sales. SCC was identified as the seller of the property on the
settlement statements or closing statements prepared for the real
estate property closings for the 22 house sales. Mr. Strong
executed those statements as president of SCC. For the purpose
of passing title to real property, Mr. Strong executed, as
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president of SCC, affidavits regarding the good standing of SCC.
SCC issued deeds for the 22 houses. Mr. Strong executed those
deeds as president of SCC. Finally, during the years at issue
and thereafter, SCC filed various notices with the Minnesota
secretary of state.
Mr. Strong’s Bankruptcy Filing
In March 1990, Mr. Strong, doing business as Strong
Construction, filed for relief under chapter 7 of the Bankruptcy
Code. In his bankruptcy petition, which Mr. Strong signed under
penalties of perjury, he made the following representations:
a. That his current monthly gross income was zero and
that his current monthly expenses were $1,319. He also
stated that “debtor had been living off proceeds from
sale of personal property, which proceeds are now
exhausted”;
b. that he had been engaged in the construction
business under the name “Strong Construction” and that
all books of account and records were kept and
maintained by him, that they were available, and that
none had been destroyed;
c. that he had received no income other than from the
operation of his business in the 2 years preceding the
filing of the bankruptcy petition;
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d. that he was not holding property for another
person and that no other person was holding property
for him;
e. that the only real property in which he had an
interest was his residence at 7090 107th Avenue, Clear
Lake, Minnesota, and that the value of his interest
therein was $30,000;
f. that he had no cash on hand, and the market value
of any interest he had in stock or interests in
incorporated or unincorporated companies was zero. He
reported only $3,500 in personal property on his
bankruptcy petition; and
g. he reported liabilities of $199,581.38.
Mr. Strong attended a meeting of creditors under 11 U.S.C.
section 341 on June 15, 1990. The trustee reported that after
diligent inquiry, she had located no property belonging to the
bankruptcy estate. A discharge was granted Mr. Strong on August
15, 1990. Robert Munns (Mr. Munns) represented Mr. Strong as his
attorney in his 1990 bankruptcy filing. Mr. Munns prepared the
bankruptcy petition and accompanying schedules using information
Mr. Strong provided to him. Mr. Munns reviewed Mr. Strong’s
bankruptcy petition with him before filing it. Mr. Strong did
not inform Mr. Munns that he had a large accumulation of cash on
hand. Mr. Munns did not advise Mr. Strong that he did not have
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to report cash on hand, or corporation stock, which he held when
he filed for bankruptcy in 1990.
Other Circumstances Related to Cash Available
Mr. Strong entered the Navy on December 5, 1974, and was
discharged on June 9, 1976. The highest rank he attained was E-
1, which paid a monthly salary of $361.20 in 1976. After
discharge from the Navy, he attended vocational school and was
trained as a machinist. He then worked as a machinist for a
couple of years and later moved into the home construction
business.
Mr. Strong was married to Anna Lisa Strong (Mrs. Strong)
from 1978 to 1989; the couple separated in 1986. He was divorced
from Mrs. Strong in August 1989. That proceeding was brought by
Mrs. Strong in 1987. Mr. Strong did not disclose in that
proceeding his interest in any real estate (except for 7090 107th
Avenue, Clear Lake, Minnesota) or his interest in any cash on
hand. Petitioner paid child support to his ex-wife during the
years 1991-94.
Between 1978 and 1989, Mr. Strong and his then wife acquired
and relinquished title to various real estate parcels. In 1983
and 1984, Mr. Strong and his then wife lost at least three
properties in foreclosure actions. Mr. Strong filed his 1981-85
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income tax returns jointly with his then wife; they reported the
following adjusted gross income and taxable income on those
returns:
Year Adjusted Gross Income Taxable Income
1981 $35,266 $24,184
1982 32,636 15,314
1983 20,917 2,765
1984 21,371 -0-
1985 3,170 -0-
Mr. Strong’s Prior Year Returns
Mr. Strong filed his 1986 Federal income tax return in March
1990 with the following details: (1) His filing status on that
return was married filing separate; (2) he claimed exemptions for
his three children; (3) he reported adjusted gross income of
$31,952; (4) he claimed itemized deductions of $6,826; and (5) he
reported taxable income of $17,526. The reported tax liability
of $2,105 was not paid until August 1991. He filed his 1987
Federal income tax return in March 1990 with the following
details: (1) His filing status on that return was married filing
separate; (2) he claimed exemptions for his three children; (3)
he reported adjusted gross income of $11,976; (4) he claimed
itemized deductions of $5,875; and (5) he reported taxable income
of zero. The reported self-employment tax liability of $1,116
was not paid until April 1992. Mr. Strong filed his 1988
Federal income tax return in March 1990 with the following
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details: (1) His filing status on that return was married filing
separate; (2) he claimed exemptions for his three children; (3)
he reported adjusted gross income of $8,867; (4) he claimed
itemized deductions of $4,127; and (5) taxable income of zero.
The reported self-employment tax liability of $1,153 was not paid
until April 1992. Mr. Strong did not file a Federal income tax
return for 1989.
Respondent’s Income Determinations
Respondent determined in the notice of deficiency that SCC
was a taxable corporate entity and determined SCC’s net taxable
income in the years 1990-94. These determinations are disputed
as to the status of SCC as a taxpayer, the gross income, and the
allowable expenses. Respondent also determined in a separate
notice of deficiency that Mr. Strong received constructive
dividend income in the full amount of SCC’s net income. Both SCC
and Mr. Strong timely filed petitions with this Court.
OPINION
I. Is SCC A Taxable Entity?
SCC and Mr. Strong argue that SCC should be ignored for tax
purposes and was not a separate taxable entity apart from Mr.
Strong. A corporation is a separate taxable entity if it was
formed for a business purpose and engaged in business activity.
See Moline Props., Inc. v. Commissioner, 319 U.S. 436, 439
(1943); Strong v. Commissioner,
66 T.C. 12, 23-24 (1976), affd.
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553 F.2d 94 (2d Cir. 1977). SCC was a valid Minnesota
corporation. More critical to this question, SCC was engaged in
the construction business and houses were sold in its name during
the years in question. SCC was jointly listed with Mr. Strong on
account No. 893315300 where the receipts in dispute were
deposited. Checks for house sales were issued with SCC as the
payee. Mr. Strong chose to operate the construction business
through a corporation, not a sole proprietorship. Under these
facts, SCC must be recognized as a distinct taxable entity.
II. SCC’s Unreported Income and Expenses
The extent of SCC’s taxable income is a separate issue.
There are two distinct questions in this regard. First, should
the unreported deposits be treated as income, and second, should
SCC be allowed deductions against its income in addition to those
allowed by respondent?
A. Construction Income
The parties stipulated that the construction business earned
gross income of $264,800 in 1990, $524,720 in 1991, $531,900 in
1992, $85,448 in 1993, and $531,396 in 1994 from the construction
and sale of houses. This business was conducted in SCC’s name,
and the deposits of proceeds from these home sales should be
included in SCC’s gross income.
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B. Unidentified Deposits
The question whether the unidentified deposits to the First
Bank account are income to SCC merits further discussion. The
record reflects deposits were made to account No. 893315300 in
addition to the amounts traced to specific home sales.
Respondent conceded that two of these deposits were loans from
Mr. Strong’s parents but asserts that the rest of these deposits
were income to SCC and Mr. Strong.
Many of the deposits in dispute were of currency or were
completely unidentified. Other deposits were by check
purportedly from various individuals or entities. Respondent
asserts that Mr. Strong used nominee names to hide his own
identity on some of the deposited cashier’s checks, such as the
three checks from Mr. Jeanotte in 1990 and two checks from his
brother, Sean Strong, in 1994.
Because of Mr. Strong’s inadequate records, respondent
reasons under the bank deposits method of proof that these
deposits are construction receipts absent evidence of any
nontaxable source of the deposits. Respondent cites DiLeo v.
Commissioner, 96 T.C. 858, 867 (1991), affd.
959 F.2d 16 (2d Cir.
1992); Clayton v. Commissioner,
102 T.C. 632 (1994); Tokarski v.
Commissioner,
87 T.C. 74 (1986); and Nicholas v. Commissioner,
70
T.C. 1057 (1978). We agree with respondent that unless
petitioners have shown that the funds came from nontaxable
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sources, they are taxable to SCC. Dodge v. Commissioner, 981
F.2d 350, 353 (8th Cir. 1992), affg. in part, revg. in part and
remanding in part
96 T.C. 172 (1991). Petitioners argue that the
deposits in question were from cash that Mr. Strong accumulated
over the years.
SCC clearly had a taxable source of income as it was in the
construction business during the years at issue. The amounts
were deposited to bank account No. 893315300, as were the
proceeds from the 22 house sales. Mr. Strong did not point to
any source for the deposits other than his previously accumulated
funds.
Mr. Strong alleges he began to accumulate cash through
gambling winnings during his service in the U.S. Navy in the mid-
1970s. He claims to have maintained a substantial cash hoard
throughout his marriage from 1978 to 1989 and during his filing
under chapter 7 of the Bankruptcy Code in 1990. Mr. Strong’s
assertions are not credible for several reasons. First, Mr.
Strong was unable to explain specifically how the cash was
obtained, where it was maintained, its amount after 1978, and how
it was used. He stated that he was basically guessing when asked
to specify what amounts he had on hand at any particular point.
On cross-examination regarding the nature of his cash hoard, Mr.
Strong refused to be specific and continually changed his story.
For example, he stated that he did not add to his cash
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accumulation for 6 years, from 1982 through 1988. Later, upon
being questioned by the Court, Mr. Strong stated that he did add
to his cash accumulation during that period. Still later, Mr.
Strong decided that his cash accumulation would have been in one
of three bank accounts. We construe against him Mr. Strong’s
failure to provide adequate details regarding his cash hoard.
“We are not required to accept implausible, uncorroborated, and
incoherent contentions as to the existence of a cash hoard.”
Daniels v. Commissioner, T.C. Memo. 1992-692.
Second, even though Mr. Strong was married during the period
he held his cash hoard, his ex-wife was unaware that it existed.
His ex-wife testified that the couple did not have an excess of
cash during the 8 years they were living together. Further, Mr.
Strong did not disclose the existence of the cash hoard upon
their divorce, even though he stated under penalties of perjury
in that proceeding that he had disclosed all assets.
Third, Mr. Strong’s liabilities are inconsistent with his
claimed cash hoard. For instance, Mr. Strong and his then wife
lost at least three properties through foreclosure from December
1986 through February 1988. Such a forfeiture is inconsistent
with the existence of a cash hoard. See Holland v. United
States, 348 U.S. 121, 133 (1954). Mr. Strong also borrowed
$10,000 in 1991 to purchase equipment and allegedly borrowed
$6,000 from his father in December 1990. Mr. Strong specifically
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testified that he borrowed from his father in 1990 because he
“was short on cash”. Borrowing money and incurring interest
charges are inconsistent with sitting on a large amount of
unproductive cash. Thomas v. Commissioner, 223 F.2d 83, 88 (6th
Cir. 1955), revg. a Memorandum Opinion of this Court; Daniels v.
Commissioner, supra.
Fourth, Mr. Strong’s prior years’ tax returns are
inconsistent with his claim that the cash hoard came from
previously taxed income. From 1981 through 1989, he reported
taxable income of $59,789, an average of $6,643 per year.2 The
largest taxable income he reported was $24,184 in 1981, and in
1984, 1985, 1987, 1988 and 1989, he reported zero taxable income.
This was at the same time he was supporting three children. Mr.
Strong’s reported income from 1981 to 1989 is not sufficient to
live on, much less accumulate a large cash hoard. See Holland v.
United States, supra.
Finally, Mr. Strong filed for chapter 7 bankruptcy
protection in March 1990. In his bankruptcy case, he represented
that the sum total of his assets equaled $33,500, including his
homestead valued at $30,000. He alleged he had no cash on hand
and no interest in any corporation. These representations
plainly contradict his current assertion that his cash deposits
during the years at issue were from cash on hand at the beginning
2
SCC reported no taxable income during this same period.
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of 1990. Mr. Strong testified that he made these representations
on the advice of his bankruptcy counsel. Mr. Strong’s bankruptcy
counsel, Mr. Munns, plainly denied that charge in his testimony.
Mr. Munns unequivocally stated that he did not inform Mr. Strong
that cash on hand or the value of a corporation did not have to
be reported in bankruptcy. Mr. Munns also stated that Mr. Strong
failed to inform him that he had a significant amount of cash on
hand.
In conclusion, we reject Mr. Strong’s cash hoard explanation
for the unidentified deposits. Respondent also asserts judicial
estoppel as a result of the representations in the bankruptcy
filing. Because we reject Mr. Strong’s claims of a cash hoard,
it is unnecessary for us to reach this argument.
The burden is on SCC to establish that the deposits in
dispute were not income. “Once the deposits were shown to be in
the nature of income and to exceed what the taxpayers had
reported as income, it became the taxpayers’ responsibility to
persuade the trier of fact the deposits were nontaxable.” Dodge
v. Commissioner, 981 F.2d at 354. In addition to Mr. Strong’s
claim of a cash hoard, SCC argues that two of the deposits were
not taxable to SCC. The first is a deposit of $8,500 on August
10, 1994, which Mr. Strong claims was payment for the sale of a
motorcycle. In that instance, we accept the corroborating
testimony of Mr. Strong’s then girlfriend and hold that the
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$8,500 was not income to SCC. The second is a deposit of $8,500
on August 16, 1994, which Mr. Strong claims was payment for the
sale of his truck to his brother. In this instance, SCC has not
carried its burden. Mr. Strong provided testimony from his
brother that the $8,500 deposit was payment for a pickup truck.
However, this testimony is inconsistent with the records of the
Minnesota Department of Motor Vehicles regarding the ownership of
the truck in question, and we find this testimony unconvincing.
SCC does not provide any explanation for the remaining deposits,
and we conclude that these deposits are income to SCC.
C. Allowable Expenses of SCC
Section 162(a) allows a taxpayer deductions for ordinary and
necessary business expenses incurred during the taxable year in
carrying on a trade or business. Deductions, however, are a
matter of legislative grace, and the taxpayer bears the burden of
proving entitlement to any deduction claimed. See INDOPCO, Inc.
v. Commissioner, 503 U.S. 79, 84 (1992). Generally, a taxpayer
must establish that deductions taken pursuant to section 162 are
ordinary and necessary business expenses and must maintain
records sufficient to substantiate the amounts of the deductions
claimed. Sec. 1.6001-1(a), Income Tax Regs.
With respect to certain business expenses specified in
section 274(d), more stringent substantiation requirements apply.
Section 274(d) disallows deductions for travel expenses, gifts,
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meals, and entertainment, as well as for listed property defined
by section 280F(d)(4), unless the taxpayer substantiates by
adequate records or by sufficient evidence corroborating the
taxpayer’s own statement: (1) The amount of the expense; (2) the
time and place of the expense; (3) the business purpose of the
expense; and (4) the business relationship to the taxpayer of the
persons involved in the expense.
SCC argues that many of the expenses paid by Mr. Strong out
of account No. 893315300 were deductible business expenses of
SCC. For 1990, SCC’s financial statement provided to the revenue
agent during respondent’s audit of SCC did not include an
accountant’s compilation of expenses paid from account No.
893315300; instead, it estimated SCC’s costs using industry
standards and information available from closing statements. For
1991-94, respondent allowed SCC expenses based upon financial
statements including accountant’s compilations of expenses for
those years. Respondent allowed SCC expenses for 1990 on the
basis of the information in the financial statement, adjusted by
SCC’s average actual gross profits percentage taken from the
1991-94 accountant’s compilations.
Mr. Strong testified that he paid some of his personal
expenses, including child support, medical fees, clothing
purchases, restaurant charges, magazine subscriptions, and
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groceries, for 1991-94 by issuing checks from account No.
893315300.
There are seven general categories of additional disputed
expenses that were paid out of account No. 893315300 which we
will discuss: (1) Advertising or promotional expenses; (2)
professional fees; (3) travel expenses; (4) automobile and truck
expenses; (5) office supplies and general supplies; (6) utility
expenses; and (7) miscellaneous expenses.
1. Advertising or Promotional Expenses
Expenses for the promotion or sponsorship of activities not
directly related to a taxpayer’s business are deductible if the
taxpayer can establish a proximate relationship between the
activity and the taxpayer’s business such that the sponsorship
was reasonably calculated to advertise the business. Gill v.
Commissioner, T.C. Memo. 1994-92, affd. without published opinion
76 F.3d 378 (6th Cir. 1996).
SCC advertised its business primarily either through word of
mouth or by athletic sponsorships. As part of the athletic
sponsorships, SCC paid for the uniforms, logo design, hats, t-
shirts, sweat pants, coats, bags, and pants for all players on
its sponsored teams. In addition, SCC made monetary donations
for high school wrestling organizations and would provide
equipment and league/tournament fees for its sponsored athletic
teams.
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SCC claimed that the expenses for advertising were
deductible as ordinary and necessary business expenses.
Respondent determined that SCC was not entitled to deduct these
expenses as shown on the financial statements and the
accountants’ compilations provided by SCC and adjusted these
expenses in determining SCC’s tax liabilities for the years at
issue. SCC’s canceled checks supported many of these promotional
expenses. In addition, members of SCC’s sponsored teams
testified credibly to substantiate the expenses. Accordingly, we
conclude the amounts of the following advertising or promotional
expenses for the years 1991, 1992, 1993, and 1994 were ordinary
and necessary expenses of SCC:
1991
Date Expense Amount
1/2 Letterman Sports $50.00
1/2 Letterman Sports 644.80
2/2 A & B 42.38
2/4 Gladiators 74.00
2/27 Letterman Sports 186.00
2/27 SRO Softball 320.00
3/23 USA Wrestling 30.00
4/9 SRO Softball 615.00
4/10 SRO Softball 320.00
4/19 Letterman Sports 297.75
5/7 Dave’s Sports 73.62
5/8 Letterman Sports 50.00
5/15 Athlete’s Foot 37.09
5/17 USA Wrestling 10.00
5/17 USA Wrestling 20.00
6/5 Letterman Sports 95.40
6/13 Letterman Sports 271.75
6/19 Letterman Sports 50.00
8/13 Letterman Sports 48.00
9/12 SRO Softball 225.00
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1991
Date Expense Amount
12/11 Herman’s Sports $89.35
12/11 Dave’s Sports 47.94
12/14 Broomball League 60.00
12/19 Herman’s Sports 285.39
12/23 Dave’s Sports 100.00
12/23 Dave’s Sports 169.26
12/23 Herman’s Sports 63.88
Total 4,276.61
1992
Date Expense Amount
1/9 Herman’s Sports $32.37
1/14 Dave’s Sports 385.00
1/31 State Broomball 185.00
2/3 Butch Salzinger 800.00
2/29 Radisson (Broomball) 132.69
3would be one word Radisson (Broomball)
104.81
3/14 D. Stecker (Softball) 3,900.00
4/10 Butch Salzinger (Hats) 185.40
4/13 Herman’s Sports 51.99
5/19 Letterman Sports 429.75
6/10 Letterman Sports 78.00
6/10 Wal-Mart (Balls) 12.32
6/17 Letterman Sports 102.00
6/17 Mardi’s Embroidery 480.25
9/27 Slow Pitch MN 112.00
12/10 Dave’s Sports 287.64
12/11 St. Francis Wrestling 250.00
12/20 4 Seasons Broomball 60.00
Total 7,589.22
1993
Date Expense Amount
1/23 Herman’s Sports $149.97
1/24 Mardi’s Embroidery 180.00
2/06 Marc Washburn 80.00
3/05 Mardi’s Embroidery 294.00
3/11 MN Sports Federation 63.00
4/15 City of Coon Rapids 846.00
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1993
Date Expense Amount
4/16 MN Liquor Liability $200.00
4/21 City of Coon Rapids 60.00
4/22 Janet Cullen 1,000.00
6/5 MN Recreation Assn. 125.00
6/7 A & B Sporting Goods 21.29
8/10 City of Coon Rapids 100.00
12/03 Sports Connection 75.00
Total 3,194.26
1994
Date Expense Amount
3/7 Elk River Wrestling $105.00
11/16 A & B Sporting Goods 118.42
4/21 C.R. Athletic Assn. 300.00
Total 523.42
2. Professional Fees
Mr. Strong claimed accounting and legal expenses of $3,410
and $4,790 for 1993 and 1994, respectively. Of these amounts,
respondent allowed $575 and $790 for 1993 and 1994, respectively,
as miscellaneous itemized deductions for tax preparation fees
paid to Mr. Newman. The remaining $2,835 for 1993 and $4,000 for
1994 are in dispute. Mr. Strong testified that the $2,835 was
paid to Michael Scott, an attorney, for title clarification in
connection with one of SCC’s business properties. In addition,
Mr. Strong testified that the $4,000 was paid to Craig Cascorono,
an attorney, also with respect to title issues concerning SCC’s
business properties. Mr. Strong testified that SCC often had to
retain attorneys in order to make sure its properties had valid
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titles from the city council before building on them. Respondent
argues that legal expenses relating to title issues are not
deductible as ordinary and necessary business expenses but should
be added to the basis of each property to which they relate.
We agree with respondent. The cost of defending or
perfecting title to property constitutes a capital expenditure
and no deduction shall be allowed for it. Estate of Franco v.
Commissioner, T.C. Memo. 1980-340; Cowden v. Commissioner, T.C.
Memo. 1965-278, affd. per curiam 365 F.2d 832 (1st Cir. 1966);
sec. 1.263(a)-2(c), Income Tax Regs. The only evidence presented
by Mr. Strong and SCC shows that these legal fees were for
defending or perfecting title. In his testimony, Mr. Strong did
not relate these expenses to specific properties sold during the
years at issue. Therefore, the legal fees of $2,835 and $4,000
paid in 1993 and 1994, respectively, are not currently deductible
to SCC.
3. Charitable Contributions
SCC claimed deductions for charitable contributions of
$73.14 for 1991, $220 and $80 for 1992, and $80 for 1993. Of
these amounts, respondent allowed only the $80 charitable
contribution for 1992. Respondent contends that SCC failed to
provide the required documentation to substantiate the remaining
charitable deductions.
- 33 -
Under section 1.170A-13(a)(1), Income Tax Regs., a taxpayer
is required to maintain for each charitable contribution a
canceled check, a receipt from the donee organization, or other
reliable written records of the contribution. Because Mr. Strong
presented copies of canceled checks for the $73.14 in 1991 and
$80 in 1993, we conclude that SCC is allowed these charitable
contributions. However, because Mr. Strong failed to
substantiate the $220 contribution, we conclude that SCC is
precluded from deducting the $220 for the year 1992 as a
charitable contribution.
4. Travel Expenses
SCC claimed travel expenses for the years 1991-94 of
$1,914.59, $397.79, $148.62, and $1,045.67, respectively.
Respondent disallowed these travel expenses.
In order to substantiate a deduction by means of adequate
records, a taxpayer must maintain a diary, log, statement of
expenses, trip sheet, or similar record, and documentary evidence
which, in combination, are sufficient to establish each element
of each expense or use. Sec. 1.274-5T(c)(2)(i), Temporary Income
Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985). Accordingly, no
deduction for expenses under section 274(d) may be allowed on the
basis of any approximation or the unsupported testimony of the
taxpayer. See, e.g., Sanford v. Commissioner, 50 T.C. 823, 827-
828 (1968), affd.
412 F.2d 201 (2d Cir. 1969).
- 34 -
Here, although Mr. Strong testified to some of the travel
expenses and provided copies of some canceled checks, SCC did not
provide adequate substantiation to meet the strict requirements
of section 274(d). The record does not include any receipts,
vouchers, itineraries, diaries, logs, or calendars made in
connection with the alleged travel expenses, nor any other
evidence sufficient to corroborate Mr. Strong’s testimony.
Accordingly, we sustain respondent’s determinations with respect
to these travel expenses for the years 1991 through 1994.
5. Miscellaneous Expenses
a. Office Supplies and General Supplies Expenses
SCC contests respondent’s disallowance of the deductions
claimed for office supplies and general supplies incurred for
1991, 1992, 1993, and 1994 of $797.96, $611.16, $396.12, and
$1,102.14, respectively. Of these amounts, respondent allowed
$326 for 1991, $495.52 for 1992, $386.66 for 1993, and $518.01
for 1994.
However, SCC contends that it is entitled to additional
office and general supplies expenses that were not allowed by
respondent. SCC offered as proof only copies of canceled checks.
The canceled checks do not show in any detail the items purchased
or the business purpose for the items, as required to
substantiate the claimed deductions. See sec. 1.162-17, Income
- 35 -
Tax Regs. Therefore, we cannot allow SCC deductions for these
expenses.
b. Automobile and Truck Expenses
SCC claims deductions for automobile and truck expenses for
1991, 1992, 1993, and 1994 of $686.56, $572.66, $27, and
$1,239.93, respectively. Respondent allowed SCC automobile and
truck expenses for only the years 1992 and 1994 of $469.35 and
$320.91, respectively. Respondent disallowed the remaining
automobile and truck expenses because of failure to substantiate
that the amounts were expended for business use. SCC did not
offer any evidence at trial or present any argument on brief
regarding these amounts. Accordingly, respondent’s determination
on these remaining items is sustained.
c. Utility and Telephone Expenses
SCC claimed utility expenses for the years 1991-94 of
$3,704.50, $3,314.11, $1,669.92, and $4,692.60, respectively.
Respondent concedes that SCC may deduct $3,609.20, $2,873.73,
$912.20, and $3,118.61, respectively for 1991-94. SCC has failed
to present any evidence to substantiate entitlement to the
remaining disallowed deductions. Accordingly, respondent’s
determination on these items is sustained.
In addition, SCC claimed telephone expenses for the 1992 tax
year of $665.53. Respondent concedes that SCC may deduct
$355.77. SCC failed to present any evidence at trial or present
- 36 -
any argument on brief regarding the additional amount.
Accordingly, respondent’s determination on the remaining claimed
deduction is sustained.
d. Miscellaneous Expenses
As to SCC’s other deductions (i.e., entertainment,
insurance, and rent), Mr. Strong was not able to proffer any
documentation to substantiate that the purpose of these expenses
was for business. Mr. Strong attributes the lack of
substantiation to two fires that resulted in the loss of his
receipts, but his general attitude regarding Federal income taxes
and his lack of credibility leave us with no reason to believe
receipts were ever maintained.
Even if we were persuaded that some portion of these
expenses was for business purposes, Mr. Strong has not offered
any evidence that would support his allocation of expenses or
otherwise allow the Court to reach an alternate determination
under Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930).
Thus, with regard to these additional expenses for which there
are no adequate receipts, SCC’s claim fails for lack of
substantiation.
III. Constructive Dividends to Mr. Strong
Respondent argues that the unreported business income of
SCC, measured by the deposits into account No. 893315300, is
taxable to Mr. Strong as constructive dividend income because Mr.
- 37 -
Strong freely used the money for personal expenses. Petitioners
do not address respondent’s argument.
If a controlling shareholder diverts corporate income to his
own use, the diverted funds are generally treated as constructive
dividends for tax purposes. DiLeo v. Commissioner, 96 T.C.
883. A dividend is any distribution of property made by a
corporation to its shareholders out of its earnings and profits.
Sec. 316(a). Where a corporation makes a distribution to a
shareholder that serves no legitimate corporate purpose and
results in an economic benefit to the shareholder, the payment is
a constructive dividend to the benefited shareholder.
Commissioner v. Riss,
374 F.2d 161, 167 (8th Cir. 1967), affg. in
part, revg. in part and vacating in part T.C. Memo. 1964-190; see
also Meridian Wood Prods., Inc. v. United States,
725 F.2d 1183,
1191 (9th Cir. 1984). However, the fact that certain payments
are not deductible by a corporation as business expenses does not
automatically make them taxable to the shareholder. Dolese v.
United States,
605 F.2d 1146, 1152 (10th Cir. 1979); Falsetti v.
Commissioner,
85 T.C. 332, 356-357 (1985); Ashby v. Commissioner,
50 T.C. 409, 418 (1968). To the extent the payments do not
represent some direct benefit to the shareholder, they are not
taxable to him. See Ashby v.
Commissioner, supra.
Some of the income deposited into account No. 893315300 was
used by Mr. Strong for SCC’s legitimate business expenses.
- 38 -
Respondent allowed some of these expenses in the notice of
deficiency, and we have identified additional promotional
expenses in section II.C.1., above. In addition, although SCC
may not deduct certain capital legal fees, see supra section
II.C.2., we are convinced that those items were of no personal
benefit to Mr. Strong. These items, which are not constructive
dividends to Mr. Strong, are $2,835 in 1993 (check No. 6834) and
$4,000 in 1994 (check No. 7763).
Either the remaining income items disallowed as deductions
to SCC were used by Mr. Strong for personal benefit or he has
failed to show that they were not so used. He made no
distinction between SCC’s funds and his own, by his own
admission. He paid child support, medical bills, clothing,
groceries, travel, and other personal expenses directly out of
account No. 893315300. In addition to failing to properly
substantiate his travel expenses, he has not shown that the
travel expenses were not personal. He has failed to establish
that the remaining nondeductible corporate expenditures had any
legitimate corporate purpose and were not for his benefit.
In summary, the deposits into account No. 893315300
determined to be taxable to SCC are taxable to Mr. Strong as
constructive dividends, less the amounts of (1) the expenses
allowed by respondent, (2) the promotional expenses we have held
- 39 -
in section II.C.1. and 3. above are deductible by SCC, and (3)
the items we have determined have no benefit to Mr. Strong in
this section. IV. Penalties and Additions to Tax
A. Fraud Penalty Under Section 6663--Mr. Strong
Respondent determined that Mr. Strong is liable for the
fraud penalty under section 6663 for each of the years 1990,
1991, 1992, 1993, and 1994. Respondent must show by clear and
convincing evidence that Mr. Strong fraudulently intended to
underpay his taxes in each year in issue in order to prove that
he is liable for the fraud penalty under section 6663. See sec.
7454(a); Rule 142(b); Rowlee v. Commissioner, 80 T.C. 1111, 1113
(1983). For Federal tax purposes, fraud entails intentional
wrongdoing with the purpose of evading a tax believed to be
owing. See Neely v. Commissioner,
85 T.C. 934, 947 (1985). In
order to show fraud, respondent must prove: (1) An underpayment
exists and (2) Mr. Strong intended to evade taxes known to be
owing by conduct intended to conceal, mislead, or otherwise
prevent the collection of taxes. See Parks v. Commissioner,
94
T.C. 654, 660-661 (1990).
1. Underpayment
We have found above that SCC received construction income in
each of the years 1990-94 and that Mr. Strong used most of the
construction income for his personal expenses. Neither SCC nor
Mr. Strong paid Federal income tax on the additional construction
- 40 -
income. Therefore, both SCC and Mr. Strong underpaid their taxes
for 1990-94.
2. Fraudulent Intent
Because direct evidence of fraud is rarely available, fraud
may be proved by circumstantial evidence and reasonable
inferences from the facts. Petzoldt v. Commissioner, 92 T.C.
661, 699 (1989). Courts have developed a nonexclusive list of
factors, or “badges of fraud”, that demonstrate fraudulent
intent. Niedringhaus v. Commissioner,
99 T.C. 202, 211 (1992).
These badges of fraud include: (1) Understating income; (2)
maintaining inadequate records; (3) failure to file tax returns;
(4) implausible or inconsistent explanations of behavior; (5)
concealment of income or assets; (6) failing to cooperate with
tax authorities; (7) filing false documents; (8) failure to make
estimated tax payments; (9) dealing in cash; (10) engaging in
illegal activities; (11) attempting to conceal illegal activity;
(12) an intent to mislead which may be inferred from a pattern of
conduct; and (13) lack of credibility of the taxpayer’s
testimony. Id.; see also Spies v. United States,
317 U.S. 492,
499 (1943); Recklitis v. Commissioner,
91 T.C. 874, 910 (1988).
Although no single factor is necessarily sufficient to establish
fraud, the combination of a number of factors constitutes
persuasive evidence. Niedringhaus v.
Commissioner, supra at 211.
- 41 -
Mr. Strong consistently understated his income while
spending SCC’s construction income on his personal expenses
during the years in issue. During these same years, Mr. Strong
reported minimal taxable income, if any, and at most $81,640 in
gross receipts from the construction business. Mr. Strong’s
personal tax returns also do not take into account any of the
funds he used for personal expenses.
Mr. Strong did not keep adequate records of the expenses he
claims were related to SCC’s business. His claim of a cash hoard
that he periodically deposited into account No. 893315300 was an
implausible explanation of the unreported construction income.
His purported explanation, if true, is an admission that he
defrauded his creditors and lied to his attorney during his
bankruptcy proceedings by denying the existence of the cash he
claims was hidden under his house. During an inquiry by
respondent’s revenue agent, Mr. Strong refused to provide the
revenue agent with any personal or financial information and lied
about his access to records. During the later audit, he provided
detailed financial records only after respondent obtained third
party records by summons. Mr. Strong knowingly filed false tax
returns for each year at issue. His patterns of depositing cash
in amounts less than $10,000 and understating the construction
income in each year show that he intended to conceal the income
he appropriated from his construction business. We did not find
- 42 -
Mr. Strong’s testimony credible and do not accept his explanation
for the income deposited into his bank account. He admitted in
his testimony that he considered the money in account No.
893315300 his personal funds. The factors indicating fraud weigh
heavily against Mr. Strong. Respondent has shown by clear and
convincing evidence that Mr. Strong fraudulently underpaid his
taxes for 1990, 1991, 1992, 1993, and 1994. Therefore, he is
liable for the fraud penalty under section 6663 for each year in
issue.
B. Additions to Tax for Failure To File--SCC
Respondent asserts that SCC is liable for the addition to
tax under section 6651(f) for fraudulent failure to file a
return, or, in the alternative, that SCC is liable for the
addition to tax for failure to file a return under section
6651(a)(1) for each of the years 1990, 1991, 1992, 1993, and
1994. Corporations subject to taxation must file Federal income
tax returns. Sec. 6012(a)(2). If a corporation fails to file a
return, the Commissioner may impose an addition to tax of 5
percent per month of the amount of tax required to be shown on
the return, to a maximum of 25 percent. Sec. 6651(a)(1). If the
failure to file is fraudulent, the addition to tax is increased
to 15 percent per month of the tax required to be shown on the
return, to a maximum of 75 percent. Sec. 6651(f). We consider
the same factors under section 6651(f) that are considered in
- 43 -
imposing the fraud penalty under section 6663. Clayton v.
Commissioner, 102 T.C. 632, 653 (1994).
A corporation can act only through its officers and does not
escape responsibility for acts of its officers performed in that
capacity. DiLeo v. Commissioner, 96 T.C. 875. It follows
that corporate fraud necessarily depends upon the fraudulent
intent of the corporate officers.
Id. In determining whether
SCC acted with the requisite fraudulent intent, we must consider
the actions of Mr. Strong, SCC’s president and sole shareholder.
The pertinent questions are: (1) Whether Mr. Strong had
sufficient control of the corporation that his fraudulent acts
should be imputed to the corporation and (2) whether Mr. Strong
was acting on behalf of, and not against the interests of, SCC.
See Ruidoso Racing Association, Inc. v. Commissioner,
476 F.2d
502, 506 (10th Cir. 1973), affg. in part and remanding in part on
another ground T.C. Memo. 1971-194; Botwinik Bros., Inc. v.
Commissioner,
39 T.C. 988, 996 (1963); Federbush v. Commissioner,
34 T.C. 740, 750 (1960), affd. per curiam
325 F.2d 1 (2d Cir.
1963); Moore v. Commissioner, T.C. Memo. 1977-275, affd.
619 F.2d
619 (6th Cir. 1980).
Mr. Strong was the sole shareholder, officer, and director
of SCC and had control over its activities. He diverted proceeds
for his own use that belonged to SCC. Given Mr. Strong’s limited
education, lack of tax experience, and existence as SCC’s only
- 44 -
shareholder, we are not convinced that he fully understood that
SCC’s corporate form required a separate tax return. In fact,
Mr. Strong formed SCC as a corporation because his attorney
recommended it. It has not been shown that Mr. Strong had any
expertise in keeping corporate books and records, or that his
attorney or accountants instructed him in filing corporate
returns. As a result, respondent has not shown by clear and
convincing evidence that Mr. Strong’s fraudulent intent extended
beyond his desire to conceal income with respect to his personal
income tax returns or that SCC’s failure to file tax returns was
fraudulent.
However, it is clear from the record that SCC did not file
Federal income tax returns for 1990-94 without any reasonable
explanation. Therefore, SCC is liable for the addition to tax
under section 6651(a)(1) for failure to file returns.
To reflect the foregoing and concessions by the parties,
Decisions will be entered
under Rule 155.
