The opinion
T.C. Memo. 1998-218
UNITED STATES TAX COURT
THEODORE LANGWORTHY, JR., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13395-96. Filed June 22, 1998.
Jack M. Battaglia and Bernadette Weaver-Catalana, for
petitioner.
Jerome F. Warner and Matthew I. Root, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WELLS, Judge: Respondent determined the following
deficiencies in, additions to, and penalty onpetitioner's Federal
income tax for the years 1987, 1988, 1989, and 1990:1
1
Respondent's trial memorandum concedes a decreased
deficiency for 1987 and asserts increased deficiencies for 1988,
1989, and 1990. As petitioner has raised no objection to the
(continued...)
- 2 -
Additions to Tax Penalty
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b) 6653(b)(1)(A) 6653(b)(1)(B) 6661 6663
1
1987 $32,177 - $24,133 $8,044
-
1988 26,326 $19,745 - - 6,582 -
1989 27,199 - - - - $20,399
1990 11,624 - - - - 8,718
1
50 percent of the interest due on the deficiency.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
After concessions, the issues to be decided are as follows:
(1) Whether the assessment and collection of taxes,
additions to tax, and penalties for 1987, 1988, and 1990 are
barred by the period of limitations pursuant to section 6501(a)
or are allowed under either (a) the fraud exception to the
general period of limitations provided in section 6501(c)(1) or
(b) the extended 6-year period of limitations provided in section
6501(e)(1)(A); and
(2) if assessment and collection are not barred for 1987,
1988, and 1990, then, for each of those years and for 1989 we
must decide whether:
(a) and, if so, to what extent, petitioner omitted
1
(...continued)
increased deficiencies, the issues relating to such increased
deficiencies appear to have been tried by consent. Rule
41(b)(1). We, however, do not address the increased deficiencies
because the decision we reach below results in deficiencies less
than those determined by respondent in the notice of deficiency.
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gross receipts from his tavern business during the years in
issue;
(b) petitioner is entitled to deduct certain business
expenses in excess of the amount allowed by respondent for
the years in issue;
(c) petitioner is liable for additions to tax for
fraud under section 6653(b)(1)(A) and (B) for 1987 and under
section 6653(b) for 1988;
(d) petitioner is liable for penalties for fraud under
section 6663 for 1989 and 1990; and
(e) petitioner is liable for additions to tax for
substantially understating income tax under section 6661 for
1987 and 1988.
FINDINGS OF FACT
Some of the facts have been stipulated for trial pursuant to
Rule 91. The parties' stipulations of fact are incorporated
herein by reference and are found as facts in the instant case.
Petitioner resided in Jamestown, New York, at the time he filed
his petition. Petitioner filed timely Federal income tax returns
(returns) for all years in issue.
Background
During the years in issue, petitioner owned and operated the
Bullfrog Hotel (Bullfrog) in Jamestown, New York. The Bullfrog,
located on the Chautauqua River in the industrial section of
Jamestown, consists of a 22-room hotel and a tavern. The
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Bullfrog's clientele, generally workers from the surrounding
factories, is characterized as a boilermaker crowd.2 Open 7 days
a week, the Bullfrog serves food, soft drinks, and alcoholic
beverages including beer, wine, and liquor. The Bullfrog
employed three individuals during the years in issue:
Petitioner, Jim Malbaum (Mr. Malbaum), and Dorothy Stacey (Ms.
Stacey). Petitioner manages all aspects of the hotel and tavern,
and he works there approximately 80 to 85 hours each week. Until
his retirement during 1990, Mr. Malbaum's duties included
sandwichmaking and bartending. Ms. Stacey worked part time at
the Bullfrog for 11 years, waiting on tables during the lunch
hour rush (11 a.m. to 2 p.m.), 5 days a week. Although her
primary duty was waitressing, Ms. Stacey occasionally filled in
as a bartender on nights that the Bullfrog had a band. Two to
three nights per week, usually on those band nights, Ms. Stacey
frequented the bar as a patron.
Petitioner failed to report all of his beer, wine, and
liquor purchases during the years in issue. Petitioner's failure
to report all of his purchases led to criminal charges for
willfully filing false returns in violation of section 7206(1).
On May 15, 1995, petitioner entered into a plea agreement,
agreeing to plead guilty to one count of violating section
2
At the Bullfrog, a boilermaker is a shot of whiskey with a
beer chaser on the side.
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7206(1) relating to the years 1988, 1989, and 1990.3 On August
25, 1995, the U.S. District Court for the Western District of New
York, on the basis of petitioner's guilty plea, held petitioner
guilty of one count of violating section 7206(1).
Invoices from the Bullfrog's vendors (vendor invoices), when
compared to purchases reported on petitioner's returns (reported
purchases), demonstrate that petitioner failed to report
purchases of $39,228, $42,787.80, $48,060.90, and $13,620.32 for
1987, 1988, 1989, and 1990, respectively (unreported purchases).
Reported purchases were paid for by checks drawn on the
Bullfrog's account at Marine Midland Bank, and unreported
purchases were paid for by cash drawn from the cash register.4
Petitioner kept no record of his unreported purchases, and he
failed to advise his return preparer, Michael Dillon (Mr.
Dillon), of the unreported purchases.5 Petitioner failed to
report the gross receipts generated by the sale of the unreported
3
The plea agreement, dated May 15, 1995, stated the following
factual basis for petitioner's plea of guilty:
The defendant failed to report substantial cash
purchases of beer, liquor, and wine on his federal
income tax returns for the 1988, 1989, and 1990 tax
years. The defendant knew the amounts stated on his
tax returns as expenses were not accurate. The
defendant signed the aforementioned federal income tax
returns under penalty of perjury, knowing the returns
falsely stated the amount of expenditures for beer,
liquor, and wine.
4
Petitioner ordered and paid for all of the inventory
purchased for the Bullfrog.
5
The parties agree, however, that petitioner's reported
purchases are not in dispute.
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purchases (unreported gross receipts), and petitioner kept no
records of the unreported gross receipts. At the time petitioner
filed his returns for the years in issue, he knew that the
unreported purchases and the unreported gross receipts were not
reported on his return.
Mr. Dillon, of Acme Tax Service, prepared petitioner's
returns for the years in issue solely from the information
provided by petitioner, which included cash register receipts,
check stubs, cash payouts, a payroll book, a weekly rental book,
and bank statements.
Unreported Gross Receipts
Using the beer, wine, and liquor purchases indicated on the
vendor invoices, the drink prices charged by petitioner for sales
of those beverages, and allowing an adjustment for discretionary
use (i.e., breakage, spillage, and complimentary drinks),
respondent reconstructed petitioner's total gross receipts. From
total gross receipts respondent subtracted reported gross
receipts to arrive at the amount of petitioner's unreported gross
receipts.
1. Purchases
Vendor invoices indicate the following purchases:6
6
During 1988, 1989, and 1990, petitioner purchased Bartyles
and James brand wine coolers. Respondent did not include the
(continued...)
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Quantity Purchased
Item Purchased 1987 1988 1989 1990
Kegs of beer1 151 227 249.5 231.5
Bottled beer (cases)2 5,579 4,824 4,879 2,600
Canned beer (cases)2 732 668 616 1,217
Liquor:
Liter bottles3 1,114 1,658 2,087 1,140
.750-liter bottles4 60 79 12 9
Wine:
Liter bottles3 167 142 269 181
.750-liter bottles4 23 25 60 143
3-liter bottles 24 12 - -
1.5-liter bottles - 96 42 42
1
A keg of beer contains either 198 10-ounce or 165 12-ounce
glasses of beer. The average cost of a keg of beer was $23.13
during 1987, $23.30 during 1988, $25.61 during 1989, and $26.20
during 1990.
2
Each case contains 24 bottles or cans of beer. During
April 1990, petitioner began purchasing loose cans of beer;
before that time canned beer was purchased in six-packs bound
with plastic (i.e., four six-packs per case).
3
There are 33.5 ounces in each liter bottle of wine or
liquor.
4
There are 25.13 ounces in each .750-liter bottle of wine or
liquor.
2. Beer, Wine, and Liquor Sales
Throughout the years in issue, petitioner sold, for on-
premises consumption (over the bar), (1) draft beer in 10-ounce
glasses for 50 cents per draft, (2) bottled beer for $1.10 per
bottle, (3) wine for $1.10 per glass, and (4) liquor for $1.15
per drink. Petitioner also sold kegs and six-packs of beer for
off-premises consumption (to go). To-go kegs were sold to local
6
(...continued)
sale of these wine coolers in the reconstruction of petitioner's
gross receipts for the years in issue.
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softball teams for postgame parties and to individuals for
private parties, picnics, and weddings. To-go six-packs were
generally sold at closing time and on weekends to patrons and
hotel guests. Petitioner kept no records of the number of to-go
kegs or six-packs he sold. Petitioner rang up none of his to-go
keg sales and only some of his to-go six-pack sales.
Respondent's reconstruction of gross receipts from the sale
of keg and canned beer made no allowance for to-go sales of kegs
and six-packs. Respondent's computation of gross receipts from
the sale of wine and liquor was based on a determination that
each wine drink sold contained 4 ounces of wine, and that each
liquor drink sold contained 1 ounce of liquor.
3. Discretionary Use Percentage
Respondent reconstructed petitioner's gross receipts from
the sale of each keg of draft beer assuming sales of 165 12-ounce
glasses per keg which allows approximately 17 percent for
discretionary use. Reconstructed gross receipts from the sale of
bottled and canned beer were adjusted to reflect an 8.3-percent
discretionary use allowance (i.e., two bottles or cans per case).
Into the reconstruction of gross receipts from the sale of wine
respondent factored a discretionary use allowance of 20 percent
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for each .750-liter bottle, 1.5-liter bottle,7 and 3-liter
bottle8 and an allowance of 40 percent for each liter bottle.
Gross receipts from the sale of liquor were calculated using 16
percent as the discretionary use allowance.
Petitioner kept no record of the number of beer, wine, or
liquor drinks given away, and he did not keep records of broken
or spilled drinks (beer, wine, or liquor).
4. Reconstructed Gross Receipts
In the deficiency notice, mailed on April 1, 1996,
respondent determined that petitioner had gross receipts for
1987, 1988, 1989, and 1990 in the amounts of $256,344, $242,740,
$249,378, and $199,199, respectively. Respondent's computations,
as stipulated by the parties,9 indicate reconstructed gross
receipts from the sale of draft beer, bottled beer, canned beer,
wine, and liquor in the amounts of $204,076.50 for 1987,
$209,167.85 for 1988, $223,325.45 for 1989, and $150,639.60 for
7
Each 1.5-liter bottle of wine contains the equivalent of two
.750-liter bottles.
8
Each 3-liter bottle of wine contains the equivalent of four
.750-liter bottles.
9
Calculations were stipulated for trial, for respondent and
petitioner, respectively, solely for the purpose of showing how
the parties calculated gross receipts. Neither party stipulated
the accuracy, correctness, or reasonableness of the other party's
calculations.
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1990.10 Petitioner's computations, as stipulated by the parties,
indicate gross receipts from the sale of draft beer, bottled
beer, canned beer, wine, and liquor in the amounts of $167,715.73
for 1987, $169,321.93 for 1988, $178,809.03 for 1989, and
$122,014.47 for 1990.
5. Reported Gross Receipts
The parties stipulated reported gross receipts
from the sale of beer, wine, and liquor of $84,179.57 for 1987,
$73,801.36 for 1988, $73,865.70 for 1989, and $104,254.74 for
1990.11
Expenses
1. Band Expenses
Country western, rock and roll, rock and roll blues,
fifties, and sixties style bands regularly played at the
Bullfrog. Petitioner hired bands directly and through David
Blackburn (Mr. Blackburn), a local entertainment agent. When
10
We note that the deficiency notice indicates gross receipts
in amounts greater than those shown in respondent's stipulated
computations. The difference, we assume, is that gross receipts
as determined in the deficiency notice include sales of food and
soft drinks. As respondent made no argument concerning food and
soft drink sales at the Bullfrog, any issues relating to such
sales appear to have been conceded. Rybak v. Commissioner, 91
T.C. 524, 566 (1988).
11
Petitioner's returns reflect reported gross receipts in
excess of the amounts stipulated for trial. Petitioner reported
gross receipts of $131,448, $121,149, $121,483, and $157,613 for
1987, 1988, 1989, and 1990, respectively. The difference, we
assume, is that petitioner's reported gross receipts included
sales of food and soft drinks which are not in issue in the
instant case.
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bands played at the Bullfrog, they typically played on Thursday,
Friday, and Saturday nights. Petitioner customarily paid the
bands in cash following each performance.
Bands featured at the Bullfrog were regularly advertised in
Nite-Line Magazine (Nite-Line), a local entertainment guide.
Petitioner advertised in Nite-Line 44 weeks during 1987, 48 weeks
during 1988, 39 weeks during 1989, and 44 weeks during 1990.
Available back copies of Nite-Line demonstrate that, during the
years in issue, petitioner regularly listed three band nights
(typically Thursday, Friday, and Saturday) in each
advertisement.12 Nite-Line records indicate that petitioner
incurred band advertising expenses of $1,596, $1,740, $1,416, and
$1,596 during 1987, 1988, 1989, and 1990, respectively.
Petitioner maintained no records of (1) the nights that
bands appeared or failed to appear, (2) the amounts that he paid
bands that performed at the Bullfrog, or (3) the amounts that he
paid for band advertising expenses. Petitioner issued no Forms
1099 to the bands that played at the Bullfrog. Petitioner
claimed no deduction for band or band advertising expenses for
the years in issue, and petitioner disclosed no band or band
advertising expenses to his return preparer, Mr. Dillon.
In the notice of deficiency, respondent allowed petitioner
deductions for band advertising expenses for 1987 and 1988 in the
amounts of $1,596 and $1,740, respectively, but allowed nothing
12
We note that several back copies of Nite-Line are not
available for the years in issue.
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for 1989 and 1990. Respondent now agrees that petitioner is
allowed deductions for band advertising expenses in the amounts
of $1,416 for 1989 and $1,596 for 1990. Respondent allowed
petitioner no deduction for amounts allegedly paid to bands that
played at the Bullfrog.
2. Race Car Expenses--1987 and 1988
During 1987 and 1988, petitioner owned a "cadet car"13 that
he raced in a novice class on Saturday nights at Stateline
Speedway (speedway). Petitioner also owned a truck, described
below, which he used to tow the race car to and from the
speedway, located in Busti, New York, approximately 4 miles from
his home. The Bullfrog and Arthur R. Gren Co., Inc., a beer
distributor, sponsored the race car. Patrons from the Bullfrog
often came out to the speedway to see petitioner race.
On his 1987 and 1988 returns, petitioner claimed Schedule C
losses from the operation of his race car. For 1987, petitioner
reported income of $1,965 and claimed expenses of $2,865. For
1988, petitioner reported income of $2,440 and claimed expenses
of $2,604.
Petitioner's expenses associated with the race car included:
Gasoline, oil, tires, A-frames, ball-joints, spark plugs, spark
plug wires, distributor caps, pit entrance fees, paint, and
13
A "cadet car" is a "stock car" which is defined as a racing
car having the basic chassis of a commercially produced assembly-
line model. Webster's Third New International Dictionary (1993).
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miscellaneous car repairs (including parts). Petitioner raced
the car approximately 10 times during each of the years in issue.
In support of his claimed deductions, petitioner provided his
return preparer, Mr. Dillon, with a summary listing of gasoline
and parts purchased during 1987 and 1988. At trial, petitioner
produced no receipts for the race car expenses, which he
generally paid in cash. Respondent disallowed petitioner's
deductions for race car expenses on the basis of petitioner's
failure to substantiate them.
3. Truck Expenses--1990
During 1990, petitioner owned a 1976 Ford pickup truck which
he used in his business at the Bullfrog. Petitioner used the
vehicle to pick up restaurant supplies, haul garbage to the dump,
drive to the bank, and drive drunk patrons home after the bar
closed at night. Petitioner claimed truck expenses for the
Bullfrog in the amount of $3,800. Respondent disallowed
petitioner's deduction for truck expenses on the basis of
petitioner's failure to substantiate the claimed expenses.
OPINION
I. Period of Limitations and Fraud
The deficiency notice in the instant case was sent on April
1, 1996, after the expiration of the usual 3-year period of
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limitations provided in section 6501(a).14 The contention that
the period of limitations has expired is an affirmative defense
which must be specifically pleaded. Rule 39; Robinson v.
Commissioner, 57 T.C. 735, 737 (1972). Petitioner properly
raised in his petition the affirmative defense of the expiration
of the period of limitations for each year in issue except 1989.
Petitioner's failure to plead the affirmative defense of the
expiration of the period of limitations with respect to 1989
constitutes a waiver of the defense for that year. Rule
34(b)(4); see Shopsin v. Commissioner, T.C. Memo. 1984-151, affd.
without published opinion 751 F.2d 371 (2d Cir. 1984).
Consequently, we conclude that the assessment and collection of
any deficiency for 1989 is not barred by the period of
limitations.
As to the remaining years (i.e., 1987, 1988, and 1990),
however, unless one of the exceptions to the period of
limitations is applicable, the assessment of the deficiencies,
additions, and penalties determined in the deficiency notice is
14
Sec. 6501(a) reads as follows:
SEC. 6501(a). General rule.--Except as otherwise
provided in this section, the amount of any tax imposed
by this title shall be assessed within 3 years after
the return was filed (whether or not such return was
filed on or after the date prescribed) * * * , and no
proceeding in court without assessment for the
collection of such tax shall be begun after the
expiration of such period.
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barred. Respondent contends that the instant case falls within
the exception in section 6501(c)(1), which provides that tax may
be assessed at any time if a false or fraudulent return is filed
with the intent to evade tax.15 Accordingly, respondent also
determined in the deficiency notice that petitioner is liable for
(1) additions to tax for fraud under section 6653(b)(1)(A) and
(B) for 1987,16 (2) an addition to tax for fraud under section
6653(b) for 1988,17 and (3) a penalty for fraud under section
15
In the alternative, respondent contends that petitioner's
return for 1990 is subject to the 6-year period of limitations
applicable under sec. 6501(e)(1)(A) because that return omitted
substantial amounts of gross income. We need not consider
respondent's alternative argument because we find fraud for each
of the years in issue, including 1990.
16
Sec. 6653(b)(1)(A) and (B) reads as follows:
SEC. 6653(b). Fraud.--
(1) In general.--If any part of any underpayment (as
defined in subsection (c)) of tax required to be shown on a
return is due to fraud, there shall be added to the tax an
amount equal to the sum of--
(A) 75 percent of the portion of the underpayment
which is attributable to fraud, and
(B) an amount equal to 50 percent of the interest
payable under section 6601 with respect to such portion
for the period beginning on the last day prescribed by
law for payment of such underpayment (determined
without regard to any extension) and ending on the date
of the assessment of the tax or, if earlier, the date
of the payment of the tax.
17
Sec. 6653(b) reads, in pertinent part, as follows:
SEC. 6653(b). Fraud.--
(continued...)
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6663 for 1989 and 1990.18
The Commissioner has the burden of proving the applicability
of the fraud exception to the general period of limitations.
Sec. 7454; Rule 142(b); Farmers Feed Co. v. Commissioner, 10
B.T.A. 1069, 1075-1076 (1928). The Commissioner's burden is the
same as that which is borne with respect to the fraud additions
imposed under section 6653(b) and the fraud penalties imposed
under section 6663. See, e.g., Schaffer v. Commissioner, 779
F.2d 849, 857 (2d Cir. 1985), affg. in part and remanding in part
T.C. Memo. 1982-34; Asphalt Indus., Inc. v. Commissioner, 384
F.2d 229, 232 (3d Cir. 1967), revg. on other grounds 46 T.C. 622
(1966); Estate of Temple v. Commissioner, 67 T.C. 143, 159-160
(1976). Accordingly, we consider together (1) the fraud
exception to the general 3-year period of limitations with
respect to 1987, 1988, and 1990 and (2) the fraud additions and
penalties for all years in issue, including 1989.
17
(...continued)
(1) In general.--If any part of any underpayment (as
defined in subsection (c)) of tax required to be shown on a
return is due to fraud, there shall be added to the tax an
amount equal to 75 percent of the portion of the
underpayment which is attributable to fraud.
18
Sec. 6663 reads, in pertinent part, as follows:
SEC. 6663(a). Imposition of Penalty.--If any part
of any underpayment of tax required to be shown on a
return is due to fraud, there shall be added to the tax
an amount equal to 75 percent of the portion of the
underpayment which is attributable to fraud.
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To carry the burden of proof on the fraud exception and the
fraud additions and penalties, the Commissioner must show by
clear and convincing evidence both (1) that the taxpayer
underpaid his tax for each taxable year in issue and (2) that at
least some part of the underpayment was due to fraud. Sec.
7454(a); Rule 142(b); DiLeo v. Commissioner, 96 T.C. 858, 873
(1991), affd. 959 F.2d 16 (2d Cir. 1992); Hebrank v.
Commissioner, 81 T.C. 640, 642 (1983).
A. Proof of an Underpayment
The Commissioner need not prove the precise amount of the
underpayment resulting from fraud, but only that there is some
underpayment and that some part of it is attributable to fraud.
Lee v. United States, 466 F.2d 11, 16-17 (5th Cir. 1972);
Plunkett v. Commissioner, 465 F.2d 299, 303 (7th Cir. 1972),
affg. T.C. Memo. 1970-274. To carry that burden, the
Commissioner may not rely on the taxpayer's failure to meet his
burden of proving error in the Commissioner's determinations as
to the deficiencies. DiLeo v. Commissioner, supra at 873;
Habersham-Bey v. Commissioner, 78 T.C. 304, 312 (1982); Otsuki v.
Commissioner, 53 T.C. 96, 106 (1969).
In the instant case, it is uncontroverted that petitioner
failed to report certain gross receipts during the years in
issue. Petitioner concedes unreported gross receipts on brief
and in his stipulated calculations. Accordingly, we conclude
that the record contains clear and convincing evidence of
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unreported gross receipts for each year in issue.
The existence of unreported gross receipts, however, does
not demonstrate that petitioner underpaid his tax for each of the
years in issue. Indeed, gross receipts from sales must be
reduced by cost of goods sold to determine gross income from
sales. Sec. 1.61-3(a), Income Tax Regs. Moreover, gross income
from sales must be reduced by all deductible expenses to
determine taxable income from sales. Sec. 63(a). Accordingly,
an underpayment of tax resulting from unreported gross receipts
from sales is possible only if such unreported gross receipts are
not exceeded by cost of goods sold and deductible expenses. See,
e.g., Franklin v. Commissioner, T.C. Memo. 1993-184.
In the instant case, petitioner contends that he did not
underpay his tax for the years in issue because the profits from
unreported sales of alcoholic beverages at the Bullfrog were used
to pay bands that performed at the Bullfrog.
The general rule is well settled that, even in criminal
cases where the Government bears the greater burden of proof,
i.e. beyond a reasonable doubt, "'evidence of unexplained
receipts shifts to the taxpayer the burden of coming forward with
evidence as to the amount of offsetting expenses, if any.'"
United States v. Garguilo, 554 F.2d 59, 62 (2d Cir. 1977)
(quoting Siravo v. United States, 377 F.2d 469, 473 (1st Cir.
1967)); United States v. Campbell, 351 F.2d 336, 339 (2d Cir.
1965); Gleave v. Commissioner, T.C. Memo. 1997-276; Franklin v.
Commissioner, supra.
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Citing Richardson v. Commissioner, 264 F.2d 400, 404 (4th
Cir. 1959), revg. in part T.C. Memo. 1957-122, and Perez v.
Commissioner, T.C. Memo. 1974-211, however, petitioner contends
that respondent bears the burden of proving that petitioner did
not incur the band expenses that he now claims. Petitioner
argues that respondent failed to carry this burden because
respondent presented no evidence whatsoever with respect to the
band expenses.
We have no doubt, as indicated by our findings of fact, that
petitioner incurred deductible band expenses during the years in
issue. We conclude, however, that even if we credit petitioner
with the band expenses that he claims, much of which we credit
infra in deciding the correct amount of the deficiency, those
expenses, along with the additional expenses and purchases
conceded by respondent, nonetheless would be insufficient to
offset the unreported gross receipts proved by respondent and
discussed more fully infra.19 We therefore find it unnecessary
19
The following computation demonstrates that petitioner would
have unreported income even if, in addition to the expenses and
purchases conceded by respondent, we credited petitioner with the
full amount of the band expenses he claims:
1987 1988 1989 1990
Unreported gross receipts1 $104,917 $116,072 $127,474 $31,369
Less:
Band expenses2 36,300 39,600 32,175 13,200
Band advertising expenses 1,596 1,740 1,416 1,596
7-percent New York
State sales tax3 7,344 8,125 8,923 2,195
Additional purchases4 39,228 42,787 48,061 13,620
Total unreported income 20,449 23,820 36,899 758
(continued...)
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to explore the implications of Richardson v. Commissioner, supra
and Perez v. Commissioner, supra. Consequently, we conclude,
that respondent has shown by clear and convincing evidence that
petitioner had unreported gross receipts, net of expenses, which
result in an underpayment of tax for each year in issue.
B. Proof That the Underpayment Was Due to Fraud
Fraud is defined as an intentional wrongdoing designed to
evade tax believed to be owing. Powell v. Granquist, 252 F.2d 56
(9th Cir. 1958); DiLeo v. Commissioner, 96 T.C. at 874; Miller v.
Commissioner, 94 T.C. 316, 332 (1990). The Commissioner's burden
of proving fraud is met if it is shown that the taxpayer intended
to evade taxes known to be owing by conduct intended to conceal,
mislead or otherwise prevent the collection of taxes. Stoltzfus
v. United States, 398 F.2d 1002, 1004 (3d Cir. 1968); DiLeo v.
Commissioner, supra at 874; Rowlee v. Commissioner, 80 T.C. 1111,
1123 (1983).
The existence of fraud is a question of fact and is to be
19
(...continued)
1
These figures (rounded to the nearest dollar) represent petitioner's
unreported gross receipts as recalculated in accordance with this opinion.
See the discussion concerning gross receipts in part II of this opinion,
infra.
2
These figures represent the amount of band expenses claimed by
petitioner in the stipulated computations. As discussed infra, we conclude
that petitioner is entitled to deduct band expenses in the amount of $18,150
for 1987, $19,800 for 1988, $16,088 for 1989, and $13,200 for 1990.
3
Respondent concedes that petitioner may deduct the 7-percent New York
State sales tax associated with any additional gross receipts received by
petitioner from the sale of beer, wine, or liquor. We computed the sales tax
shown above on the basis of the amount of petitioner's unreported gross
receipts as recalculated in accordance with this opinion.
4
These figures represent the additional purchases allowed by respondent
in the deficiency notice and in the stipulation of facts.
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resolved on the basis of the entire record. DiLeo v.
Commissioner, supra at 874; Gajewski v. Commissioner, 67 T.C.
181, 191 (1976), affd. without published opinion 578 F.2d 1383
(8th Cir. 1978). Fraud is not to be imputed or presumed. It
must be affirmatively established by clear and convincing
evidence. Beaver v. Commissioner, 55 T.C. 85, 92 (1970). The
taxpayer's entire course of conduct may establish the requisite
fraudulent intent. DiLeo v. Commissioner, supra at 874; Stone v.
Commissioner, 56 T.C. 213, 223-224 (1971). Because direct
evidence of the taxpayer's fraudulent intent is rarely available,
fraud may be proven by circumstantial evidence and reasonable
inferences drawn from the facts. DiLeo v. Commissioner, supra at
874; Rowlee v. Commissioner, supra at 1123.
Courts have relied on a number of indicia of fraud in
deciding whether to sustain the Commissioner's determinations
with respect to fraud. Although no single factor is necessarily
sufficient to establish fraud, the existence of several indicia
is persuasive circumstantial evidence of fraud. Petzoldt v.
Commissioner, 92 T.C. 661, 700 (1989). In Bradford v.
Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo.
1984-601, the Court of Appeals for the Ninth Circuit gave a
nonexclusive list of circumstantial evidence that may give rise
to a finding of fraudulent intent. Badges of fraud include (1)
understatement of income, (2) inadequate records, and (3) dealing
in cash. Id. A failure to be forthright with one's return
- 22 -
preparer is also an indication of fraud, Korecky v. Commissioner,
781 F.2d 1566, 1568 (11th Cir. 1986), affg. per curiam T.C. Memo.
1985-63, as is a conviction under section 7206(1), Wright v.
Commissioner, 84 T.C. 636 (1985).
Although the mere failure to report income is not sufficient
to establish fraud, Merritt v. Commissioner, 301 F.2d 484, 487
(5th Cir. 1962), affg. T.C. Memo. 1959-172, a pattern of
consistent underreporting of income, especially when accompanied
by other circumstances showing an intent to conceal, justifies
the inference of fraud, see Holland v. United States, 348 U.S.
121, 139 (1954); Parks v. Commissioner, 94 T.C. 654, 664 (1990);
Otsuki v. Commissioner, 53 T.C. at 108. In the instant case,
considering the record as a whole, we conclude that there are
sufficient badges of fraud to carry respondent's burden of proof.
The record reveals a pattern of consistent underreporting of
income by petitioner during all of the years in issue. Moreover,
it is uncontroverted that petitioner failed to maintain adequate
records of his unreported income and expenses and that petitioner
conducted much of his business in cash. Additionally, petitioner
failed to be forthcoming with his return preparer, Mr. Dillon,
disclosing neither his cash purchases nor his band expenses,
including band advertising. Furthermore, while a conviction
under section 7206(1) does not establish fraud, it is one factor
to be considered. Wright v. Commissioner, supra at 643-644.
We conclude that the record in the instant case contains
clear and convincing evidence that there was an underpayment for
- 23 -
each year in issue and that each such underpayment was due to
fraud.
C. Conclusion
Having found fraud for each year in issue, we conclude that:
(1) Section 6501(a) does not operate to bar the assessment and
collection of taxes for 1987, 1988, and 1990; (2) for 1987,
petitioner is liable for the 75-percent fraud addition to tax
under section 6653(b)(1)(A) and for the additional amount added
to the tax under section 6653(b)(1)(B); (3) for 1988, petitioner
is liable for the 75-percent fraud addition to tax under section
6653(b); and (4) for 1989 and 1990, petitioner is liable for the
75-percent fraud penalty under section 6663.
We have considered the parties' remaining arguments as to
fraud and conclude that the arguments are either without merit or
unnecessary to reach in light of our holdings above.
II. Amount of the Deficiency20
A. Unreported Gross Receipts
Although petitioner conceded unreported gross receipts,
petitioner did not concede unreported gross receipts in the
amounts determined by respondent. Petitioner contends that
respondent's reconstruction of gross receipts is overstated
20
On brief, both parties make extensive arguments concerning
who bears the burden of proof with respect to the amount of the
deficiency. We need not decide the situs of the burden of proof,
however, because the record in the instant case is sufficient for
us to reach our findings of fact without resort to the burden of
proof.
- 24 -
because it relies on certain erroneous assumptions. Each
contested item is addressed separately below.
1. Keg Sales
Petitioner asserts that respondent's calculation of gross
receipts from the sale of draft beer is overstated because it
makes no allowance for kegs that were sold for off-premises
consumption.21 Petitioner contends that, during each year in
issue, he sold approximately 85 kegs to go at a price of $5 over
cost.
In support of his position, petitioner points to his
testimony and that of Ms. Stacey. Petitioner testified that he
sold kegs throughout the calendar year, but that the busiest
period for keg sales was from May to October, with sales peaking
during the summer months (June, July, and August). Petitioner
indicated that he sold approximately 3 to 3½ kegs per week during
the peak summer months (June, July, and August), and 2 to 3 kegs
per week during the remainder of the busy season (May, September,
and October). Petitioner also testified that he had seven or
21
The parties also disagree as to the proper discretionary use
allowance to be applied to the sale of keg beer. Petitioner's
stipulated computations assert that a discretionary use allowance
of 15 percent should be applied to all over-the-bar keg beer
sales. Respondent's stipulated computations, however, apply a
greater discretionary use allowance of 17 percent for all over-
the-bar sales of keg beer. We conclude that respondent's
stipulated calculations concede that 17 percent is the proper
discretionary use allowance for over-the-bar sales of keg beer.
Neither party asserts that a discretionary use allowance
would be proper for to-go sales of kegs. Accordingly, we do not
apply a discretionary use allowance in deciding petitioner's
gross receipts from to-go sales of kegs.
- 25 -
eight portable keg taps on hand at the Bullfrog.
Ms. Stacey's testimony indicates that, although she had no
involvement in the sale of kegs at the Bullfrog, she saw
individuals purchase kegs for parties, weddings, and special
occasions. Ms. Stacey recalled that petitioner sold two to three
kegs per week, depending on the season, and that more kegs were
sold during the summer months. Ms. Stacey, however, could not
say with certainty the total number of kegs sold to go.
Furthermore, she did not know whether petitioner owned any
portable keg taps.
Respondent urges this Court to discount petitioner's
testimony as unreliable and self-serving because petitioner
maintained no books or records from which the number of kegs he
sold to go can be determined. Emphasizing the fact that Ms.
Stacey had no direct involvement in the sale of kegs and could
neither say how many kegs petitioner allegedly sold to go nor
corroborate the claim that petitioner had portable keg taps on
hand for use with kegs sold to go, respondent also calls into
doubt the testimony of Ms. Stacey. Respondent contends that
petitioner's attempt to rebut the determination of gross receipts
from the sale of keg beer falls solely on petitioner's self-
serving, uncorroborated testimony, which is insufficient to
refute respondent's determination.
Generally, a taxpayer's unimpeached, competent, and relevant
testimony may not be arbitrarily discredited and disregarded.
- 26 -
See, e.g., Blackmer v. Commissioner, 70 F.2d 255, 257 (2d Cir.
1934); Akerson v. Commissioner, T.C. Memo. 1998-129 (and the
cases cited therein). Petitioner's testimony was believable and
was corroborated by the testimony of Ms. Stacey, whom we also
find credible. Although she could not say with certainty the
number of kegs sold, or whether petitioner had portable keg taps
on hand, Ms. Stacey did see kegs of beer sold to go at the
Bullfrog.
We are satisfied from the record that petitioner did in fact
sell kegs of beer to go at a price of $5 over cost. The only
question remaining is the quantity sold. Bearing heavily against
petitioner, whose inexactitude is of his own making, we find, on
the basis of the record before us, that petitioner sold 40 kegs
to go during each year in issue. Cf. Cohan v. Commissioner, 39
F.2d 540 (2d Cir. 1930). Accordingly, we conclude that
petitioner's gross receipts from the sale of keg beer are as
follows:
Over-the-Bar To-Go Total
Year Gross Receipts Gross Receipts Gross Receipts1
1987 $9,120.87 $1,125.20 $10,246.07
1988 15,365.79 1,132.00 16,497.79
1989 17,214.62 1,224.40 18,439.02
1990 15,735.56 1,248.00 16,983.56
1
See Table I in the attached appendix.
2. Canned Beer Sales
Petitioner asserts that respondent erred by calculating
gross receipts from the sale of canned beer on the assumption
- 27 -
that all cans were sold over the bar, for on-emisesconsumption.22
Petitioner contends that during the time preceding April 1990, he
sold canned beer exclusively to go in
six-packs for $3.25 each ($4 each for premium brands such as
Michelob and Molson).23 Petitioner, however, acknowledges that
over-the-bar as well as to-go canned beer sales occurred during
the period after April 1990.24
Respondent argues that the only evidence presented in
support of petitioner's position is petitioner's uncorroborated,
self-serving testimony. Respondent first points out that Ms.
22
The parties also disagree as to the proper discretionary use
allowance to be applied in the determination of gross receipts
from the sale of canned beer. Each party stipulated the other's
computations on the basis of the respective party's own
discretionary use contention. Respondent contends that the
proper discretionary use allowance for over-the-bar sales of
canned beer is 8.3 percent. Petitioner contends that a 15-
percent discretionary use allowance for over-the-bar canned beer
sales is proper and correct. Petitioner, however, abandoned that
position on brief, as he presented no argument concerning the
proper discretionary use allowance for canned beer sales and the
record contains no evidence of the proper allowance.
Accordingly, we conclude that petitioner has conceded that the
proper discretionary use allowance for over-the-bar canned beer
sales is 8.3 percent. Rybak v. Commissioner, 91 T.C. 524, 566
(1988).
Neither party asserts that a discretionary use allowance
would be proper for to-go sales of canned beer. Accordingly, we
do not apply a discretionary use allowance in deciding
petitioner's gross receipts from to-go sales of canned beer.
23
Petitioner indicated that premium brands generally did not
sell well.
24
Petitioner testified that he switched to cans from bottles
during 1990 because the cans were cheaper, easier to handle, and
took up less space in the storeroom. Additionally, petitioner
viewed the cans as a safer alternative to bottles, which had been
known to cause injury when thrown by rowdy patrons.
- 28 -
Stacey's testimony regarding the price charged for six-packs does
not support that of petitioner. We disagree. Ms. Stacey
testified that canned beer was sold to go at the Bullfrog at a
price of $3 to $3.50 depending on the brand of beer sold.
Petitioner's statement that six-packs sold for $3.25 is not
inconsistent with the range indicated by Ms. Stacey.
Next, respondent argues that a stipulated sampling of 34
cash register tapes from 1987 and 1988 fails to corroborate
petitioner's contention that six-packs were sold only to go
during the period prior to April 1990. Respondent argues that
the sampling should show 238 entries of $3.25 under category I
(for beer sales) if petitioner in fact sold all canned beer to go
during the 2-year period including 1987 and 1988.25 Respondent
contends that the stipulated sampling contains only four such
entries. Such a large disparity, respondent argues, casts doubt
on petitioner's claim that he sold canned beer to go.
We do not find the lack of entries on the stipulated
sampling of cash register tapes fatal to petitioner's contention
25
Respondent notes that petitioner purchased 5,600 six-packs
of beer during 1987 and 1988 (i.e., 732 cases in 1987 + 668 cases
in 1988 = 1,400 cases x 4 six-packs per case = 5,600 six-packs).
On the basis of the fact that the Bullfrog is open 7 days a week,
365 days a year, respondent contends that petitioner would have
sold over seven six-packs a day, if petitioner in fact sold all
canned beer to go during the 2-year period (i.e., 5,600 six-packs
÷ 730 days = 7.7 six-packs per day). Accordingly, respondent
contends that the 34-day stipulated sample should contain 238
entries of $3.25 under category I (i.e., 34 days x 7 six-packs
per day = 238 entries).
- 29 -
that he sold six-packs of beer to go during the years in issue.
Rather, we would not expect the cash register receipts to include
all of petitioner's six-pack sales. Although Ms. Stacey
testified that she rang up all six-pack sales, she also testified
that she sold relatively few six-packs of beer during her shift
(i.e., 11 a.m. to 2 p.m.) at the Bullfrog. Except occasionally,
Ms. Stacey did not work weekends and evenings when the bulk of
petitioner's six-pack sales took place. Furthermore, petitioner
testified that he failed to ring up all six-pack sales.26
We conclude from the record that petitioner sold six-packs
of beer to go for $3.25 each during the years in issue. We are
not persuaded, however, that petitioner sold canned beer
exclusively to go during the period preceding April 1990.
Petitioner testified that he sold 5 to 10 six-packs each night
during the weekend (i.e., Friday and Saturday) and 2 to 3 six-
packs each night during the remainder of the week (i.e., Sunday
through Thursday). Petitioner purchased 2,928 six-packs during
1987, 2,672 six-packs during 1988, and 2,464 six-packs during
1989.27 Had all of those six-packs been sold to go, petitioner
26
Moreover, we note that there is no analysis accompanying the
stipulated sampling of cash register tapes, and respondent
introduced no evidence as to how the sample was selected. We
therefore accord such evidence little weight in our analysis and
decision.
27
Total six-packs purchased each year was determined as
(continued...)
- 30 -
would have sold 56 six-packs each week during 1987, 51 six-packs
each week during 1988, and 47 six-packs each week during 1989.
Petitioner's testimony, however, indicates that he sold a maximum
of 35 six-packs each week (i.e., 10 six-packs each day Friday
through Saturday, and 3 six-packs each day Sunday through
Thursday). On the record before us, we find that petitioner sold
to go 1,352 six-packs each year (8 six-packs each weekend day,
and 2 six-packs each weekday). Cf. Cohan v. Commissioner, 39
F.2d 540 (2d Cir. 1930). Accordingly, we conclude that
petitioner's gross receipts from the sale of canned beer are as
follows:
Over-the-Bar To-Go Total
Year Gross Receipts Gross Receipts Gross Receipts1
1987 $9,534.80 $4,394 $13,928.80
1988 7,986.00 4,394 12,380.00
1989 6,727.60 4,394 11,121.60
1990 21,271.80 4,394 25,665.80
1
See Table II in the attached appendix.
3. Bottled Beer Sales
Petitioner contends that the 8.3-percent discretionary use
27
(...continued)
follows:
1987 1988 1989
Cases of beer purchased 732 668 616
Multiplied by 24 cans/case 24 24 24
Total cans purchased 17,568 16,032 14,784
Divided by 6 cans/pack 6 6 6
Total six-packs 2,928 2,672 2,464
- 31 -
allowance applied by respondent in the calculation of gross
receipts from the sale of bottled beer is unreasonably low,
especially considering that respondent used a 17-percent
discretionary use allowance for sales of draft beer which, unlike
bottled beer, does not involve breakage. Petitioner asserts that
he should be afforded a 15-percent allowance for discretionary
use in computing gross receipts from the sale of bottled beer.
In support of his contention, petitioner offers (1) his
testimony that he gave away free beers to patrons and band
members and (2) Ms. Stacey's testimony that she also gave away
free drinks at the Bullfrog.28 This testimony, however, does not
persuade us that 15 percent is the proper discretionary use
allowance. Although petitioner testified that he gave one
complimentary beer for every four or five beers purchased, he
also indicated that he favored certain patrons with free drinks.
Accordingly, petitioner's testimony indicates that he did not
employ a consistent policy of providing complimentary drinks at
the Bullfrog. Given in response to questioning concerning liquor
sales, Ms. Stacey's testimony regarding free drinks of liquor
likewise sheds no light on the appropriate discretionary use
allowance for bottled beer sales. We conclude that 8.3 percent
28
Ms. Stacey indicated that she generally gave patrons free
drinks upon the purchase of three or four rounds. She also
testified that she usually dispensed the last shot in each bottle
of liquor free of charge.
- 32 -
is a reasonable allowance for discretionary use. See, e.g.,
Jurkiewicz v. Commissioner, T.C. Memo. 1955-318 (5-percent
reduction for spillage, waste, and gratuities sustained).
Consequently, we find that petitioner's gross receipts from the
sale of bottled beer are as follows:
Bottled Beer
Year Gross Receipts1
1987 $135,011.80
1988 116,740.80
1989 118,071.80
1990 62,920.00
1
See Table III in the attached appendix.
4. Wine Sales
Petitioner contends that respondent erred by calculating
gross receipts from the sale of wine on the assumption that each
glass of wine sold contained only 4 ounces of wine. To the
contrary, petitioner asserts that each glass of wine sold
contained 6 ounces of wine.29
Respondent seeks to use an apparent inconsistency in
petitioner's testimony to impugn petitioner's claim regarding the
29
Petitioner and respondent also disagree on the proper
discretionary use percentage to be applied in the calculation of
gross receipts from the sale of wine. Petitioner asserts that 15
percent is the proper discretionary use allowance for all wine
sales. On brief, and in respondent's stipulated calculations,
however, respondent contends that the proper discretionary use
allowance for wine sales is 20 percent for each .750-liter
bottle, 1.5-liter bottle, and 3-liter bottle and 40 percent for
each liter bottle. We conclude that respondent has conceded that
the proper discretionary use allowance for wine sales is 20
percent or 40 percent, for the respective size bottle.
- 33 -
amount of wine poured in each glass. Initially, petitioner
testified that each .750-liter bottle yielded approximately four
6-ounce servings of wine if it was served over ice in a 10-ounce
glass.30 Later, however, petitioner indicated that each bottle
served only 2½ glasses of wine. When viewed in context, however,
petitioner's testimony reveals no incongruity. Petitioner's
statement that each bottle yielded only 2½ glasses of wine was
made in response to respondent's inquiry as to whether wine was
served over ice. Petitioner stated that wine was served "either
way" and then elaborated on how many servings he obtained from
each bottle.31 Petitioner's testimony that he got "only * * *
2½ glasses of wine" from each bottle appears to clarify the
number of servings of wine each bottle yielded when the wine was
served without ice in a 10-ounce glass. Accordingly, we find no
irreconcilable conflict in petitioner's testimony.
Respondent contends that a 6-ounce serving of wine is
30
25.13 ounces per bottle ÷ 4 glasses per bottle = 6.28 ounces
per glass.
31
The transcript reads, in pertinent part, as follows:
Q. Now, you testified that its over ice, correct?
A. Well, either way. They could drink a glass of wine up,
you know --
Q. Right.
A. -- on the rocks, and you'd probably only get three
glasses or two-and-a-half out of a bottle. If you use
a 10-ounce glass -- if you had a 25 ounce glass and you
had a 10 -- a 10-ounce glass, you'd only get 2 [and
one-half] glasses of wine.
- 34 -
"unreasonably large" and that aside from petitioner's testimony,
the record is devoid of any further evidence to support or
corroborate his assertions. To the contrary, we find that the
record is devoid of any evidence as to what constitutes an
"unreasonably large" glass of wine. Moreover, we find no reason
to doubt either the honesty or credibility of petitioner's
testimony concerning the size of wine drinks served at the
Bullfrog. Accordingly, we find that each wine drink sold
contained 6 ounces of wine. Consequently we conclude that
petitioner's gross receipts from the sale of wine are as follows:
Wine
Year Gross Receipts1
1987 $1,053.92
1988 1,499.80
1989 1,521.91
1990 1,503.49
1
See Table IV in the attached appendix.
5. Liquor Sales
Petitioner asserts that each liquor drink sold contained 1.6
ounces of liquor and that respondent erred by calculating gross
receipts from the sale of liquor on the assumption that each
liquor drink sold contained only 1 ounce of liquor.
Respondent predicated the determination that each liquor
drink contained only 1 ounce of liquor on petitioner's earlier
statement to Revenue Agent Theresa Antoun (Ms. Antoun) during a
February 1990 interview. In that interview petitioner indicated
- 35 -
that he sold shots of liquor for $1 and that each bottle of
liquor contained approximately 20 to 22 shots. Respondent
determined that each liquor drink contained 1 ounce of liquor on
the basis of the sale of 21 shots from each .750-liter bottle of
liquor (i.e., after the 16-percent discretionary use allowance
each .750-liter bottle yields twenty-one 1-ounce shots).32
Petitioner testified that he sold liquor drinks ranging in
size from 1.5 to 1.75 ounces per drink. Although drinks were
"free poured" (i.e., measured by eye rather than a standard
measuring device), petitioner indicated that it was his "standard
policy" to "give them a good drink at the Bullfrog" and that
"everybody got a good shot and a half [to a] shot and three
quarters." Accordingly, petitioner contends that the average
amount of liquor poured in each drink was 1.6 ounces. Petitioner
also contends that his testimony is fully consistent with his
earlier statement to Ms. Antoun because each liter bottle of
liquor generates 20 to 22 shots which are at least 1.5 ounces.33
32
We confirmed respondent's computation as follows:
Ounces per .750-liter bottle 25.13
Less: 16-percent discretionary use allowance 4.02
Ounces available for sale 21.11
Divided by 21 shots per bottle 21
Ounces per shot 1.005 (rounded
to 1)
33
If 20 shots are sold from each liter bottle, petitioner
contends that each shot is at least 1.65 ounces (i.e., 33 ounces
÷ 20 shots = 1.65 ounces per shot). If 22 shots are sold from
(continued...)
- 36 -
We think that both parties have missed the mark.
Respondent's determination that each liquor drink contained only
1 ounce of liquor ignores the fact that the majority of
petitioner's liquor purchases were liter bottles, not .750-liter
bottles.34 Petitioner's contention that each liquor drink
contains 1.6 ounces of liquor ignores the discretionary use
allowance which operates to reduce the amount of liquor available
for sale. After a 16-percent discretionary use allowance, each
liter bottle would yield twenty-one 1.3-ounce liquor drinks.35
33
(...continued)
each liter bottle, petitioner contends that each shot is at least
1.5 ounces (i.e., 33 ounces ÷ 22 shots = 1.5 ounces per shot).
The parties stipulated that each liter bottle contains 33.5
ounces of liquor; we are unsure why petitioner used 33 ounces per
bottle in his argument on brief.
34
Petitioner purchased .750-liter bottles and liter bottles of
liquor as follows:
Quantity Purchased
Item Purchased 1987 1988 1989 1990
Liquor:
Liter bottles 1,114 1,658 2,087 1,140
.750-liter bottles 60 79 12 9
Total bottles
purchased 1,174 1,737 2,099 1,149
35
We determined that each liquor drink contained 1.3 ounces of
liquor as follows:
Ounces in each liter bottle 33.50
Less: 16-percent discretionary use allowance 5.36
Ounces available for sale 28.14
Divided by 21 shots per bottle 21
Ounces per shot 1.34 (rounded to
1.3)
(continued...)
- 37 -
Accordingly, we find that each liquor drink sold contained 1.3
ounces of liquor. Consequently we conclude that petitioner's
gross receipts from the sale of liquor are as follows:
Liquor
Year Gross Receipts1
1987 $28,856.38
1988 42,755.46
1989 52,185.19
1990 28,551.23
1
See Table V in the attached appendix.
6. Conclusion
On the basis of our findings above, we conclude that
petitioner had unreported gross receipts of $104,917.40 for 1987,
$116,072.49 for 1988, $127,473.82 for 1989, and $31,369.34 for
1990.36
B. Expenses
1. Band Expenses
Petitioner argues that he is entitled to deductions for band
expenses he incurred during the years in issue. Respondent
allowed petitioner a deduction for band advertising expenses but
allowed no deduction for the related band expenses on the ground
that petitioner failed to substantiate those expenses.
The Court must estimate the amount of the deductible expense
35
(...continued)
Respondent conceded on brief that 16 percent is the proper
discretionary use allowance for liquor sales.
36
See Table VI in the attached appendix.
- 38 -
if a taxpayer establishes that a deductible expense was paid,
even though the precise amount has not been established. Cohan
v. Commissioner, 39 F.2d at 543-544. We are satisfied by the
testimony of petitioner, Ms. Stacey, and Mr. Blackburn that
petitioner incurred deductible band expenses during the years in
issue. Petitioner and Ms. Stacey both testified that petitioner
hired bands to play at the Bullfrog throughout the years in
issue. Mr. Blackburn, the local entertainment agent, testified
that he personally placed bands at the Bullfrog during the years
in issue. That petitioner incurred deductible band expenses is
further corroborated by the stipulated fact that petitioner
advertised bands and incurred band advertising expenses. From
such advertising expenses we draw the reasonable inference that
petitioner did, in fact, pay some amount of deductible band
expenses.
Relying on Professional Servs. v. Commissioner, 79 T.C. 888
(1982), respondent contends that the Cohan rule is inapplicable
for all of the years in issue because the evidence is
insufficient to make a reasonable estimation of petitioner's band
expenses.37
37
Citing Lerch v. Commissioner, 877 F.2d 624 (7th Cir. 1989),
affg. T.C. Memo. 1987-295, respondent also argues that Cohan v.
Commissioner, 39 F.2d 540 (2d Cir. 1930), should not be invoked
where the claimed but unsubstantiated deductions are of a sort
for which the taxpayer could have and should have maintained the
necessary records. Absent stipulation to the contrary, the
instant case is appealable to the Court of Appeals for the Second
(continued...)
- 39 -
In the instant case, we make our estimate on the basis of
Nite-Line's records, stipulated for trial, which indicate that
petitioner advertised in Nite-Line 44 weeks during 1987, 48 weeks
during 1988, 39 weeks during 1989, and 44 weeks during 1990.
Available back copies of Nite-Line demonstrate that, during the
years in issue, petitioner regularly listed three band nights
(typically Thursday, Friday, and Saturday) in each advertisement.
We also credit petitioner's testimony concerning the amounts he
paid bands booked to play at the Bullfrog, which indicates that
he generally paid Thursday night bands $225 for each performance.
Petitioner's testimony also indicates that he typically paid
Friday and Saturday night bands $300, although he occasionally
paid up to $500 for popular bands. Petitioner's testimony is
corroborated by that of Mr. Blackburn, who indicated that in
Jamestown, during the years in issue, the going rate for a
Thursday night band was at least $250 and that the going rate for
a weekend band (i.e., Friday or Saturday night) was $250 to $350.
Using the foregoing parameters, petitioner computed band
expenses in the amounts of $36,300, $39,600, $32,175, and $26,400
for 1987, 1988, 1989, and 1990, respectively.38 The Nite-Line
37
(...continued)
Circuit. Thus, efficient and harmonious judicial administration
calls for us to apply the Cohan rule. Golsen v. Commissioner, 54
T.C. 742, 757 (1970), affd. 445 F.2d 985 (10th Cir. 1971).
38
Petitioner computed the amount of his deductible band
(continued...)
- 40 -
records upon which petitioner's computations are based, however,
do not reveal whether bands actually performed at the Bullfrog,
or how much the bands were actually paid. Additionally, several
copies of Nite-Line were unavailable. We cannot say with
certainty what information those unavailable back copies would
reveal. Moreover, petitioner's computations do not reflect any
allowance for bands that failed to perform as advertised.
Bearing heavily against petitioner, whose inexactitude is of his
own making, Cohan v. Commissioner, supra, we find that petitioner
incurred deductible band expenses in the amounts of $18,150,
$19,800, $16,088, and $13,200 for 1987, 1988, 1989, and 1990,
respectively.
38
(...continued)
expenses as follows:
1987 1988 1989 1990
Advertisements in Night-Line Magazine 44 48 39 44
Nights/bands in each advertisement x 3 x 3 x 3 x 2
Total band/nights advertised 132 144 117 88
Week night bands 44 48 39
Average week night price per band x $225 x $225 x $225 --1
Thursday night band expense $9,900 $10,800 $8,775
Friday night bands advertised 44 48 39 44
Average price per Friday night band x $300 x $300 x $300 x $300
Friday night band expense $13,200 $14,400 $11,700 $13,200
Saturday night bands advertised 44 48 39 44
Average price per Saturday night bank x $300 x $300 x $300 x $300
Saturday night band expense $13,200 $14,400 $11,700 $13,200
Total band expenses $36,300 $39,600 $32,175 $26,400
1
Petitioner's computation for 1990 reflects the fact that he cut back on
week night bands during 1990.
- 41 -
2. Race Car Expenses--1987 and 1988
As indicated in our findings of fact, we are satisfied from
the record that petitioner incurred deductible expenses in
connection with his car racing business. Accordingly, an
estimate must be made under Cohan v. Commissioner, supra.39
Petitioner testified that each year he raced the car
approximately 10 times at the speedway in Busti, New York.
Petitioner indicated that his race car expenses included:
Gasoline, oil, tires, A-frames, ball-joints, spark plugs, spark
plug wires, distributor caps, pit entrance fees, paint, and
miscellaneous car repairs (including parts). Petitioner
testified with particularity, however, only with respect to the
pit entrance fees and tire expenditures. Petitioner indicated
that each week during the racing season he paid a total of $20 in
pit entrance fees for himself and a helper; and that every other
week he replaced the rear tires at a cost of $50 to $55 per tire.
From the record we find that petitioner incurred deductible
expenses of $750 for each year in issue (i.e., 1987 and 1988).
Cohan v. Commissioner, supra.
3. Truck Expenses--1990
Petitioner claimed truck expenses for the Bullfrog in the
39
As respondent failed to argue the applicability of sec.
274(d)(4) with respect to the race car expenses claimed by
petitioner, we conclude that respondent has conceded that
petitioner's race car is not listed property subject to the
substantiation requirements of sec. 274(d).
- 42 -
amount of $3,800 for 1990. Mr. Dillon computed petitioner's
deduction for truck expenses based on petitioner's statement that
he put approximately 15,000 business miles on the vehicle during
1990. Respondent disallowed petitioner's deduction for the truck
expenses on the basis of petitioner's inability to substantiate
them. Respondent failed, however, to assert the applicability of
section 274(d)(4), which imposes strict substantiation
requirements with respect to certain listed property, defined in
section 280F(d)(4)(A) to include passenger automobiles. Section
280F(d)(5)(A) defines the term "passenger automobile" to mean any
four-wheeled vehicle (i) which is manufactured primarily for use
on public streets, roads, and highways, and (ii) which is rated
at 6,000 pounds unloaded gross vehicle weight or less. In the
case of a truck, section 280F(d)(5)(A)(ii) is to be applied by
substituting "gross vehicle weight" for "unloaded gross vehicle
weight". Sec. 280F(d)(5).
We treat respondent's failure to argue that section
274(d)(4) is applicable in the instant case as a concession that
it does not apply to petitioner's vehicle. Accordingly, we
decline to apply the strict substantiation requirements imposed
by section 274(d)(4) and look instead to the rule of Cohan v.
Commissioner, 39 F.2d 540 (2d Cir. 1930), to decide the amount of
petitioner's truck expenses. Bearing heavily against petitioner,
whose inexactitude is of his own making, we find that petitioner
- 43 -
incurred deductible truck expenses of $1,500 for 1990.
We have considered the parties' remaining arguments
concerning the amounts of the deficiencies for the years in issue
and find those arguments to be either without merit or
unnecessary to reach.
III. Substantial Understatement
Section 6661(a) imposes an addition to tax of 25 percent of
any underpayment attributable to a substantial understatement of
tax. A substantial understatement is any understatement which
exceeds the greater of (1) 10 percent of the tax required to be
shown on the return or (2) $5,000. Sec. 6661(b)(1)(A). If the
taxpayer has substantial authority for the tax treatment of the
item in question, or if the taxpayer adequately discloses the tax
treatment of the item on the return, then the amount of the
understatement for purposes of this section will be reduced by
that portion of the understatement which is attributable to that
item. Sec. 6661(b)(2)(B).
Petitioner made no disclosures with his returns for the
years in issue. Petitioner argues simply that there is no
underpayment of tax for any of the years in issue which
constitutes a substantial understatement of income tax within the
meaning of section 6661. Consequently, should either the 1987 or
the 1988 understatement of tax as recalculated in accordance with
- 44 -
this opinion be substantial, we hold that petitioner is liable
for the addition to tax under section 6661 for the applicable
year.
Decision will be entered
under Rule 155.
- 45 -
Appendix
Table I Gross Receipts From Keg Beer Sales
1987 1988 1989 1990
Kegs purchased 151 227 249.50 231.50
Less: Kegs sold to go 40 40 40 40
Kegs sold over the bar 111 187 209.50 191.50
Multiplied by $82.171 $82.17 $82.17 $82.17 $82.17
Gross receipts from
over-the-bar sales $9,120.87 $15,365.79 $17,214.62 $15,735.56
Gross receipts from
to-go sales2 $1,125.20 $1,132.00 $1,224.40 $1,248.00
Total gross receipts
from keg sales $10,246.07 $16,497.79 $18,439.02 $16,983.56
1
Each keg sold over the bar generated $82.17 in gross receipts, determined as
follows:
Ounces per keg 1,980
Less: 17%-discretionary use allowance 336.60
Ounces sold 1,643.40
Divided by 10 oz. 10
Number of 10-oz. drafts/keg 164.34
Multiplied by $0.50/draft $0.50
Gross receipts/kegs sold
over the bar $82.17
2
Gross receipts were determined by multiplying the total number of kegs sold
to go each year by cost plus $5 (i.e., 40 kegs x $28.13 for 1987, 40 kegs x $28.30
for 1988, 40 kegs x $30.61 for 1989, and 40 kegs x $31.20 for 1990).
- 46 -
Table II Gross Receipts From Canned Beer Sales
1987 1988 1989 1990
Individual cans sold over the bar1 9,456 7,920 6,672 21,096
Less: 2 cans/case
discretionary use allowance2 788 660 556 1,758
Total cans sold over the bar 8,668 7,260 6,116 19,338
Multiplied by $1.103 $1.10 $1.10 $1.10 $1.10
Gross receipts from
over-the-bar sales $9,534.80 $7,986.00 $6,727.60 $21,271.80
Gross receipts from to-go sales4 $4,394.00 $4,394.00 $4,394.00 $4,394.00
Total gross receipts from
canned beer sales $13,928.80 $12,380.00 $11,121.60 $25,665.80
1
The number of individual cans sold over the bar was determined as follows:
1987 1988 1989 1990
Total cases purchased 732 668 616 1,217
Multiplied by 24 cans/case 24 24 24 24
Total cans purchased 17,568 16,032 14,784 29,208
Divided by 6 cans/pack 6 6 6 6
Total six-packs 2,928 2,672 2,464 4,868
Less: six-packs sold to go 1,352 1,352 1,352 1,352
Six packs sold over the bar 1,576 1,320 1,112 3,516
Multiplied by 6 cans/pack 6 6 6 6
Total individual cans
sold over the bar 9,456 7,920 6,672 21,096
2
The discretionary use allowance was determined as follows:
9,456 individual cans ÷ 24 cans/case = 394 cases x 2 cans/case = 788 cans
7,920 individual cans ÷ 24 cans/case = 330 cases x 2 cans/case = 660 cans
6,672 individual cans ÷ 24 cans/case = 278 cases x 2 cans/case = 556 cans
21,096 individual cans ÷ 24 cans/case = 879 cases x 2 cans/case = 1,758 cans
3
$1.10 reflects the price per can sold over the bar.
4
Gross receipts from to-go sales were determined by multiplying the number of six-packs
sold to go each year by $3.25 (i.e., 1,352 six-packs x $3.25 = $4,394).
- 47 -
Table III Gross Receipts From Bottled Beer Sales
1987 1988 1989 1990
Total cases purchased 5,579 4,824 4,879 2,600
Multiplied by 24 bottles/case 24 24 24 24
Total bottles purchased 133,896 115,776 117,096 62,400
Less: 2 bottles/case discretionary
use allowance1 11,158 9,648 9,758 5,200
Total bottles sold 122,738 106,128 107,338 57,200
Multiplied by $1.102 $1.10 $1.10 $1.10 $1.10
Total gross receipts from
bottled beer sales $135,011.80 $116,740.80 $118,071.80 $62,920.00
1
The discretionary use allowance was determined by multiplying the number of cases
purchased by 2 cans/case.
2
$1.10 represents the price per bottle sold.
- 48 -
Table IV Gross Receipts From Wine Sales
1987 1988 1989 1990
.750-liter bottles:
Number of 6-oz. glasses/bottle1 3.35 3.35 3.35 3.35
Multiplied by number of bottles sold 23 25 60 143
Total glasses sold 77.05 83.75 201.00 479.05
Multiplied by $1.102 $1.10 $1.10 $1.10 $1.10
Gross receipts from .750-liter
bottles $84.76 $92.13 $221.10 $526.96
Liter bottles:
Number of 6-oz. glasses/bottle1 3.35 3.35 3.35 3.35
Multiplied by number of bottles sold 167 142 269 181
Total glasses sold 559.45 475.70 901.15 606.35
Multiplied by $1.102 $1.10 $1.10 $1.10 $1.10
Gross receipts from liter bottles $615.40 $523.27 $991.27 $666.99
1.5-liter bottles:3
Number of 6-oz. glasses/bottle1 6.70 6.70 6.70 6.70
Multiplied by number of bottles sold -0- 96 42 42
Total glasses sold -0- 643.20 281.40 281.40
Multiplied by $1.102 -0- $1.10 $1.10 $1.10
Gross receipts from 1.5-liter
bottles -0- $707.52 $309.54 $309.54
3-liter bottles:4
Number of 6-oz. glasses/bottle1 13.40 13.40 13.40 13.40
Multiplied by number of bottles sold 24 12 -0- -0-
Total glasses sold 321.60 160.80 -0- -0-
Multiplied by $1.102 $1.10 $1.10 -0- -0-
Gross receipts from 3-liter bottles $353.76 $176.88 -0- -0-
Total gross receipts from wine $1,053.92 $1,499.80 $1,521.91 $1,503.49
1
The number of 6-oz. glasses per bottle was determined as follows:
.
.750-liter Liter 1.5-liter 3-liter
Ounces/bottle 25.13 33.50 50.26 100.52
Less: discretionary use allowance
(20% for .750-, 1.5-, and 3-liter
bottles, 40% for liter bottles) 5.03 13.40 10.05 20.10
Ounces sold/bottle 20.10 20.10 40.21 80.42
Divide by 6 oz. 6 6 6 6
Number of 6-oz. glasses/bottle 3.35 3.35 6.70 13.40
2
$1.10 reflects the price per glass of wine.
3
One 1.5-liter bottle is equivalent to two .750-liter bottles.
4
One 3-liter bottle is equivalent to four .750-liter bottles.
- 49 -
Table V Gross Receipts for Liquor Sales
1987 1988 1989 1990
Liter bottles
Number of 1.3-oz. servings/bottle1 21.65 21.65 21.65 21.65
Multiplied by number of bottles
purchased 1,114 1,658 2,087 1,140
Number of 1.3-oz. servings sold 24,118.10 35,895.70 45,183.55 24,681
Multiplied by $1.152 $1.15 $1.15 $1.15 $1.15
Gross receipts from liter bottles $27,735.82 $41,280.06 $51,961.08 $28,383.15
.750-liter bottles
Number of 1.3-oz. servings/bottle1 16.24 16.24 16.24 16.24
Multiplied by number of bottles
purchased 60 79 12 9
Number of 1.3-oz. servings sold 974.40 1,282.96 194.88 146.16
Multiplied by $1.152 $1.15 $1.15 $1.15 $1.15
Gross receipts from .750-liter
bottles $1,120.56 $1,475.40 $224.11 $168.08
Total gross receipts from liquor
sales $28,856.38 $42,755.46 $52,185.19 $28,551.23
1
The number of 1.3-oz. servings per bottle was determined as follows:
Liter .750-liter
Ounces per bottle 33.50 25.13
Less: 16%-discretionary use allowance 5.36 4.02
Ounces sold per bottle 28.14 21.11
Divide by 1.3 oz. 1.30 1.30
Number of 1.3-oz. servings/bottle 21.65 16.24
2
$1.15 reflects the price charged per liquor drink.
- 50 -
Table VI Gross Receipts--Summary
1987 1988 1989 1990
Keg beer gross receipts $10,246.07 $16,497.79 $18,439.02 $16,983.56
Canned beer gross receipts 13,928.80 12,380.00 11,121.60 25,665.80
Bottled beer gross receipts 135,011.80 116,740.80 118,071.80 62,920.00
Wine gross receipts 1,053.92 1,499.80 1,521.91 1,503.49
Liquor gross receipts 28,856.38 42,755.46 52,185.19 28,551.23
Total gross receipts 189,096.97 189,873.85 201,339.52 135,624.08
Less: Reported gross receipts 84,179.57 73,801.36 73,865.70 104,254.74
Unreported gross receipts 104,917.40 116,072.49 127,473.82 31,369.34