The opinion
T.C. Memo. 1999-409
UNITED STATES TAX COURT
COMPACT EQUIPMENT COMPANY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
BERNARD J. ATKINSON AND CAROL S. ATKINSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 10040-97, 10041-97. Filed December 16, 1999.
James P. Kleier, for petitioners.
Paul J. Krug, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: In these consolidated cases, respondent
determined the following deficiencies in and additions to
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petitioners’1 Federal income taxes:
Taxable Period Additions to Tax
Petitioners Ending Deficiency Sec. 6653(b) Sec. 6661
Compact 03/31/85 $23,783 $11,892* $5,946
Equipment Co. 03/31/86 247,334 123,667* 61,834
05/31/86 33,609 16,805* 8,402
Bernard and 12/31/85 209,313 104,657* 52,328
Carol Atkinson 12/31/86 124,851 93,638* 31,213
* Plus 50 percent of interest due on portion of
underpayment of tax attributable to fraud.
Unless otherwise noted, 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 for decision are: (1) Whether
Compact Equipment Co. (petitioner) underpaid its taxes by
deducting various payments (made on behalf of its president) as
compensation expenses; (2) if petitioner underpaid its taxes,
whether the 3-year statute of limitations under section 6501(a)
bars respondent from assessing and collecting the underpayment of
tax; (3) whether petitioner is liable for fraud additions to tax
under section 6653(b); (4) whether Bernard and Carol Atkinson
(Atkinsons) are liable for fraud additions to tax under section
6653(b); and (5) whether petitioners are liable for an addition
to tax for substantial understatement of tax pursuant to
1
References to petitioners are to Compact Equipment Co.,
Bernard Atkinson, and Carol Atkinson.
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section 6661.
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 they filed
their petitions, petitioner’s principal place of business was in
Irwindale, California, and the Atkinsons resided in Carnelian
Bay, California.
Bernard Atkinson’s Professional Experience in the Automotive
Industry
From 1950 to 1959, after graduating from high school,
Bernard Atkinson (Atkinson) was employed at an automobile
dealership and a finance company specializing in automobile
loans. During that time, Atkinson supplemented his practical
knowledge of the automobile industry by studying automobile
mechanics and dealership management at the General Motors
Institute in Flint, Michigan.
From 1959 to 1968, Atkinson worked in General Motor’s
Pontiac Motor Division as a warranty clerk. In 1968, he
continued working in the automotive field by taking a position
with Trafco Corp. (Trafco) in Brown, Michigan. Trafco
manufactured recreational vehicles. In 1973, Compact Equipment
Co., a subsidiary of Trafco located in Southern California, hired
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Atkinson as its general manager.2 By 1975, due to severe
financial losses, Trafco began closing many of its operations and
liquidating its subsidiaries. Seeing an opportunity for
financial independence and success, Atkinson purchased Compact
Equipment Co.’s assets, incorporated petitioner as BJ Atkinson
Co., and contributed the assets to petitioner.3 Shortly
thereafter, petitioner, which was owned 100 percent by Atkinson,
was renamed Compact Equipment Co. Petitioner, however, conducts
its business under the name “Family Wagon”.
Petitioner’s Business Activities
Like Trafco, petitioner manufactures recreational vehicles,
a process commonly known as van conversions. Petitioner obtains
raw chassis and vans and, through customization, turns them into
recreational vehicles.4 Atkinson, as president and sole
shareholder, guided petitioner with skill and adeptness in a very
competitive industry. By the mid 1980's, petitioner achieved
considerable success, generating significant revenues and
profits. During that time, petitioner was the number one van
2
Compact Equipment Co., Trafco’s subsidiary, is a distinct
company unrelated to petitioner.
3
Because the “Compact Equipment Company” name was still
being used by Trafco’s subsidiary at the time Atkinson formed
petitioner, Atkinson did not initially name petitioner “Compact
Equipment Company”.
4
Raw chassis and vans are simple, operational vehicles
lacking any amenities such as sophisticated stereo systems, small
kitchens, sofas, etc.
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conversion company on the West Coast; nationwide, it ranked
seventh or eighth. Petitioner’s success was largely due to
Atkinson’s keen administrative, sales, and marketing techniques.
The Construction of the Carnelian Bay Residence
On November 7, 1983, the Atkinsons purchased a residential
property in Carnelian Bay, California, for $550,000 (Carnelian
Bay property). Carnelian Bay is located on the north shore of
Lake Tahoe, approximately 5 miles from Tahoe City. The Atkinsons
purchased the Carnelian Bay property with the intent to live and
retire there. Because the Atkinsons planned to build a new home
on the Carnelian Bay property (Carnelian Bay residence), the
Atkinsons did not immediately relocate to Carnelian Bay.
In 1984, petitioners hired James Woodle (Woodle) to
supervise construction of the Carnelian Bay residence and
improvements to the Carnelian Bay property. Construction began
in 1985 and lasted 16 months. In July of 1986, the Atkinsons
moved into their new 4,000-square-foot-home.
Woodle’s duties included ordering construction materials and
recruiting construction workers necessary for the completion of
the Carnelian Bay residence. Woodle paid for small expenditures
on construction materials from a checking account established by
Atkinson with a local bank. Most of the larger expenditures on
construction materials and the wages of the construction workers
(construction expenses) were paid directly by petitioner.
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Petitioner’s Payment of the Construction Expenses
Petitioner’s accounts payable clerk (the clerk) processed
all invoices forwarded to petitioner. Normally, the clerk would
match the invoices to corresponding purchase orders and then
prepare checks for the appropriate vendors. If purchase orders
did not exist for certain invoices, the clerk forwarded the
invoices to petitioner’s general manager for approval. After
approval, the clerk prepared the checks.
In 1985, petitioner began receiving invoices from various
vendors for lumber and for electrical and plumbing fixtures used
in the construction of the Carnelian Bay residence (construction
invoices). The construction invoices did not have matching
purchase orders. As instructed by Atkinson, however, the clerk
forwarded the construction invoices to Atkinson instead of the
general manager. After Atkinson reviewed the construction
invoices and authorized payment, the clerk prepared the checks
for the vendors. After the clerk prepared the checks for all
invoices (including the construction invoices), the general
manager reviewed the purchase orders (if any), invoices, and
checks and approved the transactions by signing the checks.
After issuing and mailing the checks to the vendors, the general
manager or the clerk returned the construction invoices to
Atkinson with copies of the checks, a procedure inconsistent with
the company’s normal bookkeeping process and record retention
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policy.
Because petitioner paid the wages of the construction
workers, their names were added to petitioner’s payroll list
pursuant to Atkinson’s instructions. As directed by Atkinson,
Woodle required the workers to fill out weekly timecards with the
number of hours worked. Woodle then forwarded the names of the
workers, with the corresponding number of hours worked, to the
clerk or petitioner’s controller (the controller). Because
Woodle was also on petitioner’s payroll, Woodle also informed the
clerk or the controller of the number of hours he worked for that
particular week. A professional payroll processing firm,
thereafter, prepared the payroll checks for the general manager’s
or Atkinson’s signature. After the general manager or Atkinson
signed the payroll checks, the clerk mailed the payroll checks to
a post office box in Lake Tahoe for Woodle to distribute.
Atkinson’s Discussions With Petitioner’s Accountants
Petitioner hired an accounting firm to prepare its Federal
corporate income tax returns (corporate tax returns) for the
taxable periods ending March 31, 1985, March 31, 1986, and May
31, 1986. A certified public accountant at the accounting firm,
David Dunkin (Dunkin), had primary responsibility for preparing,
reviewing, and submitting the corporate tax returns to
petitioner. Dunkin also prepared the Atkinsons’ 1985 and 1986
Federal individual income tax returns (individual tax returns).
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Between November 1984 and January 1985, Dunkin and Edward
Fryer from the accounting firm (accountants) met with Atkinson to
provide tax advice with regard to petitioner’s taxable year
ending March 31, 1985, and growing profitability. At that
meeting, Atkinson informed the accountants that during
petitioner’s board of directors meeting on April 4, 1983, the
board of directors established Atkinson’s compensation package
for petitioner’s taxable year ending March 31, 1984, and
subsequent taxable years.5 In response, the accountants
explained to Atkinson that petitioner’s compensation deductions
for Atkinson’s salary and bonuses had to be justified and
memorialized. The accountants advised Atkinson that to
demonstrate reasonable compensation for tax purposes, petitioner
should establish a formula based on the profitability of the
company to determine Atkinson’s salary and bonuses. The
accountants also suggested to Atkinson that petitioner maintain
minutes for its board of directors meetings.
Following the accountants’ advice, petitioner established a
formula to determine Atkinson’s compensation and created and
maintained minutes for petitioner’s board of directors meetings.
The minutes for the board of directors meetings for March 30,
5
Petitioner’s board of directors consisted of the
Atkinsons and a third party. On June 29, 1984, the board of
directors was reduced to two directors consisting of only the
Atkinsons.
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1985 and 1986, which relate to petitioner’s taxable years ending
March 31, 1985 and 1986, respectively, show that petitioner’s
board of directors provided Atkinson with a salary and bonuses.
The minutes do not provide any other form of compensation for
Atkinson. Petitioner’s board of directors never authorized any
additional compensation for Atkinson in the form of payments by
petitioner for the construction expenses.
Petitioner’s Treatment of the Construction Expenses on Its Books
and Corporate Tax Returns
To prepare each of petitioner’s corporate tax returns,
Dunkin’s staff visited petitioner’s place of business, retrieved
all pertinent information from its books and records, and
identified questions and issues that needed further addressing.
Dunkin’s staff, however, did not inspect, review, or audit
petitioner’s books. Dunkin then met with Atkinson and the
controller to inform them of his preliminary findings and to seek
answers to the questions and issues raised by his staff and
himself. Based on the answers and information provided by
Atkinson and petitioner’s employees, Dunkin’s staff prepared
petitioner’s corporate tax return. After Dunkin reviewed the
corporate tax return, he sent it to Atkinson for his approval and
signature.
The total cost of the construction of the Carnelian Bay
residence and the improvements to the Carnelian Bay property
amounted to more than $1 million. Of that amount, petitioner
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paid the following construction expenses during the taxable
periods at issue:
Taxable Periods Construction Expenses
Ending Paid by Petitioner
3/31/85 $25,362
3/31/86 495,498*
5/31/86 103,941
* Petitioner paid for other construction expenses.
Because Atkinson reimbursed petitioner for those
other construction expenses, those amounts are
not included in the $495,498.
On its books, petitioner listed the construction expenses as
corporate expenses. Because the construction expenses were
listed on petitioner’s books as corporate expenses, Dunkin’s
staff deducted the construction expenses on petitioner’s
corporate tax returns. The deductions claimed for the
construction expenses were classified mostly as cost of goods
sold. The construction expenses were not classified as
compensation on petitioner’s books or corporate tax returns.
On its corporate tax returns, petitioner reported the
following compensation deductions for Atkinson’s services and
dividends declared to Atkinson for the taxable periods at issue:
Taxable Period Atkinson’s Dividends
Ending Compensation Declared
3/31/85 $558,000 $4,980
3/31/86 532,975 4,980
5/31/86 35,530 -0-
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The Atkinsons’ individual tax return for the 1985 calendar
year includes two Forms W-2 for Atkinson. The Forms W-2 reflect
$559,441 in compensation earned from petitioner. For the 1986
calendar year, the Atkinsons’ individual tax return contains one
Form W-2 for Atkinson from petitioner in the amount of
$561,506.38. The Forms W-2 from petitioner do not reflect as
compensation any of the construction expenses.
Petitioner’s $69,000 Payment for Lumber
In early 1986, during the preparation of petitioner’s
corporate tax return for the taxable year ending March 31, 1986,
Dunkin’s staff questioned the propriety of deducting a $69,000
payment to the Tahoe Lumber Co. for lumber.6 During a subsequent
meeting with Atkinson, Dunkin discussed the $69,000 payment with
Atkinson. Atkinson dismissed Dunkin’s concerns and instructed
Dunkin to treat the $69,000 payment as a deduction on
petitioner’s corporate tax return.
Around the time that Dunkin questioned the $69,000
deduction, Atkinson began negotiating with Victor Ameye, the
chief executive officer of Neoax Corp., for the sale of
Atkinson’s 100-percent interest in petitioner to Neoax Corp.
During the negotiations, Ameye addressed the $69,000 payment.
Ameye expressed concern about the use of corporate funds for the
6
The parties stipulate that the payment for the lumber
amounted to “approximately $70,000". The record indicates that
the payment was closer to $69,000.
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construction of the Carnelian Bay residence. Atkinson alleviated
Ameye’s concerns by stating that the issue had already been
brought to his attention and that he intended to pay back the
$69,000 to petitioner. Atkinson failed to tell Ameye that
petitioner incurred and paid many other expenses related to the
construction of the Carnelian Bay residence.
A few days later, Atkinson and Dunkin again addressed the
$69,000 deduction. Atkinson instructed Dunkin not to deduct the
$69,000 payment on petitioner’s corporate tax return. With
Atkinson’s approval, Dunkin also established a $69,000 accounts
receivable from Atkinson on petitioner’s books. Atkinson was to
pay back the loan out of his next bonus. Atkinson failed to
inform Dunkin of the other expenditures incurred by petitioner in
the construction of the Carnelian Bay residence. On March 23,
1986, Atkinson paid petitioner $69,051 with regard to the loan.
On May 28, 1986, Neoax Corp. purchased Atkinson’s 100-percent
interest in petitioner for $3.5 million plus a contingent amount
based on petitioner’s earnings over the subsequent 3 years.
The Internal Revenue Service’s (IRS) Investigation of
Petitioners’ Corporate and Individual Tax Returns
On May 11, 1988, an IRS special agent and an IRS revenue
agent interviewed Atkinson regarding allegations that he had
underreported his income on his 1985 and 1986 individual tax
returns and that petitioner had improperly deducted the
construction expenses on its corporate tax returns for the
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taxable periods at issue. In response to the agents’ questions,
Atkinson stated that petitioner had not deducted any of the
construction expenses on its corporate tax returns.
Atkinson, however, stated that if petitioner paid his
personal expenses, he would repay petitioner when petitioner
billed him for those amounts. Atkinson explained that he
recollected one instance when petitioner paid $75,000 for lumber
to be used in the construction of the Carnelian Bay residence
which he subsequently repaid. Atkinson failed to disclose to the
agents that petitioner paid various other construction expenses
for which he did not reimburse petitioner. The IRS subsequently
served Atkinson with a summons seeking the construction invoices,
but they were never delivered to the IRS.
On September 12, 1991, a Federal grand jury charged Atkinson
with violating section 7201 with regard to Atkinson’s 1985 and
1986 individual tax returns and section 7206(1) with regard to
petitioner’s corporate tax returns for the taxable periods at
issue. Atkinson subsequently was convicted. On December 20,
1991, a Federal district court judge ordered Atkinson to serve 1
year and 1 day in prison, to pay a $500,000 fine, and to pay the
taxes owed with regard to the Atkinsons’ 1985 and 1986 individual
tax returns.
In separate notices of deficiency dated March 14, 1997,
respondent determined that petitioner fraudulently deducted the
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construction expenses on its corporate tax returns and that the
Atkinsons fraudulently failed to include the construction
expenses as income on their individual tax returns.7 Respondent
also determined that petitioner fraudulently deducted numerous
charges incurred on its credit cards and that the Atkinsons
fraudulently failed to include the credit card charges8 in
income.9
Additionally, in the notices of deficiency, respondent
imposed additions to tax pursuant to sections 6653(b) and 6661 on
petitioners. As to petitioner, we review respondent’s
determinations of deficiencies and additions to tax. As to the
Atkinsons, they concede that they committed fraud in failing to
report the construction expenses as income on their individual
7
In addition to the construction expenses already
discussed, respondent initially classified certain additional
amounts as construction expenses. Respondent determined that
petitioner fraudulently deducted those amounts and that the
Atkinsons fraudulently failed to include those amounts in income.
The parties are in agreement with regard to the tax consequences
of those amounts, and we do not further discuss those additional
amounts in this opinion.
8
The tax treatment of a portion of the credit card charges
is subject to a stipulation by the parties. Our discussion of
the credit card charges is with regard to amounts not subject to
the stipulation.
9
Because the Atkinsons filed their individual tax returns
based on a calendar year and petitioner filed its corporate tax
returns on a fiscal yearend (other than the short return year),
the amounts listed on the Atkinsons’ notice of deficiency with
regard to the construction expenses and credit card charges
differ from the amounts listed on petitioner’s notice of
deficiency.
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tax returns and that they are liable for the fraud additions to
tax with respect to the construction expenses. The Atkinsons
also concede that they failed to report the credit card charges
as income. Still before us, however, is the issue of whether the
fraud additions to tax with regard to the credit card charges
should be sustained and whether the Atkinsons are liable for the
addition to tax pursuant to section 6661.
OPINION
I. Corporate Fraud
Generally, pursuant to section 6501(a), the Commissioner
must assess taxes owed and due on a tax return within 3 years
after the return is filed. Section 6501(c)(1), however, provides
that if a taxpayer fraudulently files a return, the 3-year
statute of limitations under section 6501(a) will not bar the
Commissioner from assessing and collecting the taxes owed and
due. Additionally, if any part of an underpayment of tax is due
to fraud, the Commissioner may impose fraud additions to tax
under section 6653(b)(1) and (2).10
In order to prove fraud, the Commissioner must show by clear
and convincing evidence that the taxpayer underpaid its tax and
10
Sec. 6653(b)(1) provides for an addition to tax in the
amount of 50 percent of the underpayment if any part of the
underpayment is due to fraud. Sec. 6653(b)(2) provides for an
addition to tax in the amount of 50 percent of the interest
payable under sec. 6601 with respect to the portion of the
underpayment which is attributable to fraud.
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that some portion of the underpayment is due to fraud. See sec.
7454(a); Rule 142(b); Laurins v. Commissioner, 889 F.2d 910, 913
(9th Cir. 1989), affg. Norman v. Commissioner, T.C. Memo. 1987-
265; Edelson v. Commissioner, 829 F.2d 828, 832 (9th Cir. 1987),
affg. T.C. Memo. 1986-223; Petzholdt v. Commissioner, 92 T.C.
661, 698-699 (1989); Mitchell v. Commissioner, T.C. Memo. 1994-
242. If the Commissioner proves an underpayment and that some
portion of the underpayment is due to fraud, the bar of the 3-
year statute of limitations is lifted with respect to all items
on the return, and the Commissioner’s deficiency determinations
enjoy the usual presumption of correctness, placing the burden on
the taxpayer to prove an error. See Welch v. Helvering, 290 U.S.
111 (1933); Jackson v. Commissioner, 380 F.2d 661, 664 (6th Cir.
1967), affg. T.C. Memo. 1964-330; Colestock v. Commissioner, 102
T.C. 380, 385 (1994); Willits v. Commissioner, 36 B.T.A. 294, 300
(1937); Bencivenga v. Commissioner, T.C. Memo. 1989-239.
Further, the addition to tax under section 6653(b)(1) will
apply to the entire underpayment ultimately determined, even
though only part of the underpayment is due to fraud. See Stone
v. Commissioner, 56 T.C. 213, 220-221 (1971); Otsuki v.
Commissioner, 53 T.C. 96, 105 (1969); Kelley v. Commissioner,
T.C. Memo. 1991-324, affd. without published opinion 988 F.2d
1218 (11th Cir. 1993); Cleveland v. Commissioner, T.C. Memo.
1983-299. The addition to tax under section 6653(b)(2), however,
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will apply only to the portion of the underpayment which is
attributable to fraud.
A. Construction Expenses
1. Underpayment
Respondent must prove by clear and convincing evidence that
petitioner underpaid its taxes during each of the taxable periods
at issue. See sec. 7454(a); Rule 142(b). Respondent contends
that the construction expenses paid by petitioner on behalf of
Atkinson constitute nondeductible constructive dividends and that
petitioner underpaid its taxes when it deducted the constructive
dividends. Petitioner argues that although petitioner improperly
classified the construction expenses as cost of goods sold on its
tax returns, the construction expenses actually constitute
reasonable compensation for services rendered by Atkinson and
therefore are deductible by petitioner.
Section 162(a)(1) permits a taxpayer to deduct "a reasonable
allowance for salaries or other compensation for personal
services actually rendered" as an ordinary and necessary business
expense. See King's Ct. Mobile Home Park, Inc. v. Commissioner,
98 T.C. 511, 514 (1992); Paula Constr. Co. v. Commissioner, 58
T.C. 1055, 1058 (1972), affd. without published opinion 474 F.2d
1345 (5th Cir. 1973); sec. 1.162-7(a), Income Tax Regs. The
taxpayer, however, can deduct payments for personal services only
if the payments are intended as compensation. See King's Ct.
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Mobile Home Park, Inc. v. Commissioner, supra at 514; Paula
Constr. Co. v. Commissioner, supra at 1058.
It is a question of fact whether payments are made with an
intent to compensate for services performed. See Whitcomb v.
Commissioner, 733 F.2d 191, 194 (1st Cir. 1984), affg. 81 T.C.
505 (1983); Paula Constr. Co. v. Commissioner, supra at 1058-
1059. The relevant time for determining the requisite intent is
when the purported compensation payment is made, not, for
example, years later when an amended return is filed after the
start of an IRS audit. See King's Ct. Mobile Home Park, Inc. v.
Commissioner, supra at 514; Paula Constr. Co. v. Commissioner,
supra at 1059-1060; Joyce v. Commissioner, 42 T.C. 628, 636
(1964); Drager v. Commissioner, T.C. Memo. 1987-483.
In the instant case, the board of directors established
Atkinson’s salary and bonuses during its yearly meetings. The
board of directors, however, did not designate the construction
expenses as compensation for Atkinson’s services. The amounts of
the construction expenses were not reported on Atkinson’s Forms
W-2 from petitioner. On its books and corporate tax returns,
petitioner accounted for the construction expenses as cost of
goods sold instead of compensation. Further, when questioned by
Dunkin and Ameye about the $69,000 payment for part of the
construction expenses, Atkinson did not claim that these amounts
constituted compensation for services rendered by Atkinson.
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Instead, Dunkin, under Atkinson’s authority, established an
accounts receivable due from Atkinson for the $69,000 payment.
The evidence in the record shows that petitioner did not intend
for the construction expenses to be compensation for services
rendered; thus, we find that the construction expenses constitute
nondeductible constructive dividends and that petitioner
underpaid its taxes.
2. Fraudulent Intent
Along with proving an underpayment, the Commissioner must
show that the taxpayer intended to evade taxes known to be owing
by conduct intended to conceal, mislead, or otherwise prevent the
collection of taxes. See Powell v. Granquist, 252 F.2d 56, 60-61
(9th Cir. 1958); Rowlee v. Commissioner, 80 T.C. 1111, 1123
(1983). A corporation has no intent separate from those who
control it. See King’s Ct. Mobile Home Park v. Commissioner,
supra at 516. The existence of fraudulent intent by a
corporation, therefore, is determined by the acts of its
officers. See id.
Fraud is not to be presumed. See Toussaint v. Commissioner,
743 F.2d 309, 312 (5th Cir. 1984), affg. T.C. Memo. 1984-25;
Rowlee v. Commissioner, supra at 1123. The existence of fraud is
a factual question to be determined from all the facts and
circumstances contained in the record. See id. Since direct
proof of intent is rarely available, fraud may be proved by
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circumstantial evidence and reasonable inferences drawn from the
facts. See Spies v. United States, 317 U.S. 492, 499 (1943);
Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986),
affg. T.C. Memo. 1984-601.
Over the years, courts have developed a nonexclusive list of
factors that demonstrate fraudulent intent. These badges of
fraud include: (1) Understatement of income, (2) inadequate
records, (3) failure to file tax returns, (4) implausible or
inconsistent explanations of behavior, (5) concealment of income
or assets, (6) failure to cooperate with tax authorities, (7)
presence of illegal activities, (8) an intent to mislead which
may be inferred from a pattern of conduct, (9) lack of
credibility of the taxpayer’s testimony, (10) filing false
documents, and (11) dealing in cash. See Spies v. United States,
supra at 499; Douge v. Commissioner, 899 F.2d 164, 168 (2d Cir.
1990), affg. an order of this Court; Laurins v. Commissioner, 889
F.2d at 913; Bradford v. Commissioner, supra at 307-308;
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. See Solomon v. Commissioner, 732 F.2d 1459, 1461 (6th
Cir. 1984), affg. per curiam T.C. Memo. 1982-603. A taxpayer’s
intelligence, education, and tax expertise are also relevant for
purposes of determining fraudulent intent. See Stephenson v.
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Commissioner, 79 T.C. 995, 1006 (1982), affd. 748 F.2d 331 (6th
Cir. 1984); Iley v. Commissioner, 19 T.C. 631, 635 (1952). We
evaluate this latter standard in relation to the
corporation’s officers.
As petitioner’s president, sole shareholder, and one of two
board directors, Atkinson’s actions provide evidence with regard
to whether petitioner committed fraud. The Atkinsons purchased
the Carnelian Bay property intending to build their home there.
Atkinson directed that corporate funds be used to pay for the
construction of the Carnelian Bay residence. He instructed
petitioner’s employees to classify the payments on petitioner’s
books as corporate expenses related to its operations. Atkinson
also instructed his employees to return all construction invoices
to him, a procedure inconsistent with petitioner’s normal record-
keeping practice.
Because petitioner maintained inadequate records, Dunkin
classified the construction expenses as cost of goods sold on
petitioner’s corporate tax returns. When Dunkin questioned the
propriety of deducting a $69,000 payment for lumber, Atkinson
quickly dismissed Dunkin’s objections. Only after Ameye
expressed concerns about the $69,000 payment during negotiations
for the sale of Atkinson’s 100-percent interest in petitioner did
Atkinson instruct Dunkin to forgo the $69,000 deduction.
Atkinson, however, continued to conceal from Dunkin and Ameye
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that various other payments for the construction expenses had
been listed on petitioner’s books and corporate tax returns as
corporate expenses. Atkinson’s dealings with petitioner’s
employees, Dunkin, and Ameye demonstrate an intent to mislead.
In addition, Atkinson lied to the IRS agents. When the IRS
agents questioned Atkinson about whether petitioner had
improperly deducted the construction expenses, Atkinson stated
that the construction expenses had not been deducted on
petitioner’s corporate tax returns. Further, Atkinson attempted
to mislead the IRS agents by stating that petitioner had only
paid for part of the construction expenses (the $69,000 payment
for lumber) for which he had repaid petitioner. Also, after
requested, Atkinson failed to provide the IRS with the
construction invoices.
In summary, the evidence shows that Atkinson understated
petitioner’s taxable income, concealed records and maintained
inadequate records, failed to cooperate with tax authorities, and
undertook a pattern of conduct with the intent to mislead Dunkin,
Ameye, and the IRS. Furthermore, Atkinson is a sophisticated
businessman who managed petitioner very successfully, attracting
regional and national recognition.
Petitioner argues that Atkinson was not aware that treating
the construction expenses as cost of goods sold on petitioner’s
corporate tax return, instead of declaring corporate dividends,
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would result in a lower tax liability. Petitioner, therefore,
argues that Atkinson did not have the intent to evade
petitioner’s taxes. Between November 1984 and January 1985 and
before the preparation of petitioner’s corporate tax return for
the taxable year ending March 31, 1985, Atkinson attended a
meeting with petitioner’s accountants. At that meeting, the
accountants advised Atkinson that petitioner’s compensation
expenses for Atkinson’s services had to be justified for the
expenses to be deductible for Federal tax purposes. Petitioner’s
corporate tax returns reported significant amounts for Atkinson’s
compensation, and petitioner declared only minimal dividends to
Atkinson. These facts show that petitioner paid most of its
earnings to Atkinson in the form of compensation instead of
dividends to minimize its corporate tax liability. Based on the
evidence, we conclude that Atkinson was aware that petitioner
could not deduct dividends declared on its corporate tax returns.
Petitioner also argues that even if we find that Atkinson
intended to evade petitioner’s Federal income taxes, the U.S.
Court of Appeals for the Ninth Circuit, to which this case is
appealable, requires that the Commissioner prove that “there is
no doubt, beyond a frivolous one, regarding the substantive tax
treatment of the item at issue”. Petitioner cites United States
v. Dahlstrom, 713 F.2d 1423, 1427 (9th Cir. 1983), for the
proposition that if the tax law is unsettled, a taxpayer lacks
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the intent to violate the tax law. Petitioner argues that there
is an uncertainty as to whether the payments for the construction
expenses should be treated as compensation for services rendered
or nondeductible constructive dividends. We disagree.
Decisional authority clearly provides that a taxpayer may deduct
only amounts intended as compensation for services rendered to
the taxpayer. See King’s Ct. Mobile Home Park, Inc. v.
Commissioner, 98 T.C. at 514; Paula Constr. Co. v. Commissioner,
58 T.C. at 1058.
We, therefore, conclude that respondent has established that
petitioner underpaid its taxes with respect to the construction
expenses and did so with the intent to evade tax. Because
petitioner underpaid its taxes with an intent to evade those
taxes, we hold that the 3-year statute of limitations under
section 6501(a) does not bar respondent from assessing taxes owed
and due. Further, respondent may impose fraud additions to tax
under section 6653(b)(1) and (2) with regard to the underpayment
associated with the deductions of the construction expenses.
B. Credit Card Charges
1. Presumption of Correctness
Because the presumption of correctness attached to
respondent’s deficiency determinations, petitioner bears the
burden of proving that the credit card charges do not constitute
nondeductible constructive dividends. Petitioner has failed to
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meet its burden. Accordingly, respondent’s deficiency
determinations with regard to the credit card charges are
sustained.
2. Fraud Additions to Tax Pursuant to Section
6653(b)(1) and (2)
Pursuant to section 6653(b)(2), respondent may impose a
fraud addition to tax on the portion of the underpayment
attributable to fraud. In this case, respondent provided no
evidence that petitioner committed fraud by deducting the credit
card charges. The addition to tax under section 6653(b)(2),
therefore, may be imposed on only the underpayment attributable
to the deductions of the construction expenses. Pursuant to
section 6653(b)(1), however, the fraud addition to tax applies to
the entire underpayment ultimately determined even if respondent
manages to prove that only part of the underpayment is due to
fraud. Hence, the fraud addition to tax under section 6653(b)(1)
is also applicable to the underpayment resulting from the
deductions of the credit card charges.
II. The Atkinsons’ Fraud
A. 1985 Calendar Year
The Atkinsons concede that they committed fraud by not
including the construction expenses in income. Respondent,
however, has failed to provide clear and convincing evidence that
the Atkinsons committed fraud by not including the credit card
charges in income. As explained above with regard to
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petitioner’s deductions of the credit card charges, the Atkinsons
are liable for the fraud addition to tax under section 6653(b)(1)
on the underpayment associated with the failure to include in
income the credit card charges. The Atkinsons are liable for the
fraud addition to tax under section 6653(b)(2) only on the
underpayment attributable to the fraudulent failure to include in
income the construction expenses.
B. 1986 Calendar Year
In 1986, Congress amended section 6653(b), effective for tax
returns with a due date after December 31, 1986. See Tax Reform
Act of 1986, Pub. L. 99-514, sec. 1503, 100 Stat. 2085, 2742.
Congress consolidated the fraud additions to tax, formerly under
section 6653(b)(1) and (2), into section 6653(b)(1). Through
amended section 6653(b)(1), Congress provided that only the
portion of the underpayment attributable to fraud would be
subject to the fraud additions to tax:
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
* * *
Under amended section 6653(b)(2), however, once the
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Commissioner proves that any portion of the underpayment is
attributable to fraud, the entire underpayment is treated as
attributable to fraud, except with respect to any portion which
the taxpayer establishes is not attributable to fraud.
In the instant case, the Atkinsons concede that they
fraudulently failed to include in income the construction
expenses. Therefore, pursuant to amended section 6653(b)(2), the
underpayment associated with the failure to include in income the
construction expenses and the credit card charges is treated as
attributable to fraud unless the Atkinsons prove otherwise. The
Atkinsons have failed to prove that the failure to include in
income the credit card charges is not attributable to fraud.
Hence, the fraud additions to tax determined by respondent under
amended section 6653(b)(1)(A) and (B) are sustained.
III. Substantial Understatement of Tax
The final issue for decision is whether petitioners are
liable for the addition to tax under section 6661. For
assessments made after October 21, 1986, section 6661(a) provides
for an addition to tax equal to 25 percent of the amount of any
underpayment attributable to a substantial understatement of tax.
See Omnibus Budget Reconciliation Act of 1986, Pub. L. 99-509,
sec. 8002(a), 100 Stat. 1874, 1951. An understatement is
substantial if it exceeds the greater of $5,000 ($10,000 in the
case of a corporation) or 10 percent of the tax required to be
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shown on the return. See sec. 6661(b). The amount of the
understatement may be reduced under section 6661(b)(2)(B) for
amounts adequately disclosed or supported by substantial
authority. Neither exception under section 6661(b)(2)(B) applies
because no amounts were adequately disclosed or supported by
substantial authority.
Because the parties have made various concessions, they will
have to determine whether petitioners substantially understated
their income taxes when making the Rule 155 computations. For
this purpose, the parties will take into account the parties’
concessions and our disallowance of petitioner’s deductions for
the construction expenses and the credit card charges.
In reaching our holdings herein, we have considered all
arguments made by petitioners, and to the extent not mentioned
above, we find them to be irrelevant or without merit.
To reflect the foregoing,
Decisions will be entered
under Rule 155.