The opinion
T.C. Memo. 2001-182
UNITED STATES TAX COURT
ESTATE OF FRANK JOHNSON, DECEASED, LARRY T. JOHNSON, PERSONAL
REPRESENTATIVE AND ESTATE OF KATHARINE JOHNSON, DECEASED,
LARRY T. JOHNSON, PERSONAL REPRESENTATIVE, ET AL.,1 Petitioners
v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 14518-97, 14519-97, Filed July 20, 2001.
14520-97, 14521-97,
14522-97.
Kenneth B. Wheeler, for petitioners.
James F. Kearney, for respondent.
1
Cases of the following petitioners are consolidated
herewith: Estate of Frank Johnson, Deceased, Et Al., docket No.
14519-97; Larry T. Johnson, Transferee, Docket No. 14520-97;
Sylvia Johnson, Transferee, docket No. 14521-97; and Ronnie
Johnson, Transferee, docket No. 14522-97.
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CONTENTS
FINDINGS OF FACT ............................................ 8
I. Facts Relating to Issues Involving Deficiencies ......... 8
A. Background .......................................... 8
B. Tax Returns ......................................... 10
1. Frank and Katherine’s Returns ................... 10
2. Larry’s Returns ................................. 13
3. Ronnie’s Returns ................................ 15
4. Sylvia’s Returns ................................ 16
C. IRS Audits and Notices of Deficiency ................ 18
1. Frank and Katherine’s Audit and Notices of
Deficiency .................................... 18
2. Larry’s Audit and Notice of Deficiency .......... 20
3. Ronnie’s Audit and Notice of Deficiency ......... 22
4. Sylvia’s Audit and Notice of Deficiency ......... 22
D. Source and Application of Funds Analyses ............ 23
E. Cash Hoard .......................................... 28
F. Other Facts ......................................... 33
G. Capital Gain for 1989 ............................... 37
II. Facts Relating to Issues Involving Transferee
Liability ............................................ 38
A. Larry ............................................... 38
B. Ronnie .............................................. 39
C. Sylvia .............................................. 41
D. Specific Transfers .................................. 42
1. U.S. Savings Bonds .............................. 42
2. Account At Glendale Federal Savings and Loan .... 42
3. Longwood Property ............................... 43
4. Port St. Lucie Property ......................... 43
5. Automobiles ..................................... 43
OPINION ..................................................... 44
I. Issues Relating to Deficiencies ......................... 44
A. Background .......................................... 44
B. Statute of Limitations and Fraud Issues ............. 45
1. In General ...................................... 45
2. Fraud ........................................... 46
a. Existence of an Underpayment ................ 47
(1) Likely Sources of Income ................ 50
(2) Nontaxable Source ....................... 53
(3) Summary Relating to Existence of an
Underpayment .......................... 61
b. Intent To Evade Taxes ........................ 63
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(1) Pattern of Unreporting Substantial
Amount of Income ....................... 64
(2) Lack of Records .......................... 65
(3) Filing History ........................... 67
(4) Dealings in Cash ......................... 68
(5) Concealing Transactions .................. 69
(6) Failure To Cooperate with Respondent ..... 70
(7) Credibility of Witnesses ................. 71
(8) Level of Education, Age, and State
of Health .............................. 72
(9) Summary Regarding Intent ................. 73
c. Conclusion Regarding Fraud and Statute of
Limitations ............................... 73
C. Amount of Understatement of Income .................. 74
1. Adjustments to BLS Figures ....................... 75
2. Adjustment for Specific Gift ..................... 79
3. Adjustment for Proceeds of Automobile
Transactions ................................... 80
4. Adjustment for Larry’s Audit Results ............. 81
5. Adjustment for Sylvia’s Gambling
Expenditures ................................... 83
6. Additional Items Identified as in Dispute ........ 84
a. Withholding on Gambling Winnings ........... 84
b. Birthing Costs for Nicole .................. 85
c. Estimated Tax Payments ..................... 85
d. Tax Payment ................................ 86
e. Wedding Ceremony for Sylvia................. 86
f. Detective Expenses ......................... 87
g. Janie’s Living Expenses .................... 88
h. Duplications Regarding Johnson Limousine ... 89
7. Other Adjustments ................................ 89
a. Rental Income .............................. 90
b. Duplication of Rental Expenses and
Mortgage Payments ....................... 90
c. Depreciation ............................... 91
d. Cash and Jewelry ........................... 91
8. Summary Relating to Amount of Understatement
of Income ..................................... 93
D. Capital Gain for 1989 ............................... 94
E. Taxable Social Security Benefits .................... 95
F. Self-Employment Taxes ............................... 97
G. Self-Employment Deduction ........................... 99
H. Married Couples Deduction ........................... 99
I. Additions to Tax and Penalties ..................... 100
1. Sections 6653(b) and 6663 ...................... 100
2. Section 6661 ................................... 102
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II. Issues Relating to Transferee Liability ................104
A. Background ..........................................104
B. Florida’s Statutory Provisions ......................106
1. Pre-1988 Transfers ..............................106
2. Post-1987 Transfers .............................108
C. Discussion ..........................................111
Appendix A ..................................................118
Appendix B ..................................................124
Appendix C ..................................................126
Appendix D ..................................................128
Appendix E ..................................................130
Appendix F ..................................................133
Appendix G ..................................................136
Appendix H ..................................................139
Appendix I ..................................................142
Appendix J ..................................................145
Appendix K ..................................................152
Appendix L ..................................................157
Appendix M ..................................................164
Appendix N ..................................................169
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MEMORANDUM FINDINGS OF FACT AND OPINION
HALPERN, Judge: These five cases have been consolidated for
trial, briefing, and opinion. Respondent, by two notices of
deficiency dated April 4, 1997, determined deficiencies,
additions, and penalties with respect to Federal income taxes
owed by petitioners the Estate of Frank Johnson, Larry T.
Johnson, Personal Representative, and the Estate of Katherine
Johnson, Larry T. Johnson, Personal Representative (hereinafter
referred to as petitioners). Such deficiencies, additions, and
penalties are on account of returns of income tax made by Frank
and Katherine Johnson (sometimes decedents), and are as follows:
Additions to Tax and Penalties
Sec. Sec. Sec. Sec.
Docket 6653 6653 6653 6653 Sec. Sec.
No. Year Deficiency (b)(1) (b)(2) (b)(1)(A) (b)(1)(B) 6663 6661
1
14518-97 1983 $37,058 $18,529 - - - $9,265
2
14519-97 1984 39,763 19,882 - - - 9,941
3
1985 51,732 25,866 - - - 12,933
4
1986 43,537 - - $32,653 - 10,884
5
1987 67,496 - - 50,622 - 16,874
1988 74,169 55,627 - - - - 18,542
1989 73,600 - - - - $55,200 -
1990 96,275 - - - - 72,206 -
1
50 percent of the interest due on $37,058.
2
50 percent of the interest due on $39,763.
3
50 percent of the interest due on $51,732.
4
50 percent of the interest due on $43,537.
5
50 percent of the interest due on $67,496.
By notices of liability dated April 4, 1997, respondent
asserted transferee liability against the following petitioners
relating to the above deficiencies, additions to tax, and
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penalties to the extent of the net value of assets they
purportedly received from decedents,2 as follows:
Docket Net Value of
No. Transferee Assets Asserted
14520-97 Larry T. Johnson $861,668
14521-97 Sylvia Johnson 229,685
14522-97 Ronnie Johnson 766,003
The issues for decision are as follows:
(1) Whether the statute of limitations bars assessment of
the deficiencies for each of the years in issue,
(2) whether decedents understated their income for each of
the years in issue,
(3) whether decedents’ capital gain income should be
increased for 1989,3
(4) whether decedents’ taxable Social Security income should
be increased for each of the years 1985 through 1990,
(5) whether decedents’ self-employment taxes under section
1401 should be increased for each of the years in issue,
2
A transferee’s liability generally is limited to the
value of the assets received from the transferor. See Hagaman v.
Commissioner, 100 T.C. 180 n.1 (1993).
3
Respondent also identifies as an issue the question of
whether decedents’ capital gain income for 1986 should be
increased. We assume that respondent meant 1985 inasmuch as
respondent made a $6 adjustment to capital gain income for that
year, but no adjustment to capital gain income for 1986. In
their briefs, petitioners do not address the issue of capital
gain income for either 1985 or 1986. Accordingly, we deem that
issue conceded by them. See Rule 151(e)(4) and (5); Petzoldt v.
Commissioner, 92 T.C. 661, 683 (1989); Money v. Commissioner, 89
T.C. 46, 48 (1987).
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(6) whether decedents may increase their self-employment tax
deduction for 1990,
(7) whether decedents are entitled to a married couples
deduction for each of the years 1983, 1984, 1985, and 1986,
(8) whether decedents are liable for the additions to tax or
penalties for fraud under sections 6653(b) or 6663, as
applicable, for each of the years in issue,
(9) whether decedents are liable for additions to tax under
section 6661 for substantial understatement of income for each of
the years 1983 through 1988,
(10) whether petitioner Larry Johnson is liable as a
transferee of Frank and Katherine Johnson for $861,668,
(11) whether petitioner Sylvia Johnson is liable as a
transferee of Frank and Katherine Johnson for $229,685,
(12) whether petitioner Ronnie Johnson is liable as a
transferee of Frank and Katherine Johnson for $766,003.
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. For convenience, monetary amounts have been rounded
to the nearest dollar. References to cash include cash
equivalents such as cashier’s checks and money orders.
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FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts, amendment to stipulation of facts,
first supplemental stipulation of facts, and second supplemental
stipulation of facts filed by the parties, together with the
exhibits attached thereto, are incorporated herein by this
reference. Some of respondent’s proposed findings of fact have
been conceded by petitioners, and, accordingly, they are so
found. Some of petitioners’ proposed findings of fact have been
conceded by respondent and, accordingly, they are so found.
Petitioner Larry Johnson (Larry) is here in his own right,
in docket No. 14520-97, and, also, as personal representative of
the estates of both Frank T. and Katherine Johnson. He resided
in Longwood, Florida, when he filed the petitions in his case and
in petitioners’ cases. Petitioner Ronnie Johnson (Ronnie)
resided in Longwood, Florida, when he filed the petition in his
case. Petitioner Sylvia Johnson (Sylvia) resided in Longwood,
Florida, when she filed the petition in her case.
I. Facts Relating to Issues Involving Deficiencies
A. Background
Frank Johnson (Frank) was born on December 12, 1918.
Katherine Stanton Johnson (Katherine) was born on December 25,
1923. They were raised in the gypsy culture, custom, and
tradition. Frank and Katherine married in the gypsy custom
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around 1938. They moved to Florida during the late 1960s.
During the years in issue, Frank and Katherine lived in a house
located in Longwood, Florida (Longwood property). Frank died at
the age of 74 on September 27, 1993. Katherine died at the age
of 72 on June 9, 1996.
Frank and Katherine had one son, Larry, and two daughters,
Patricia and Janie. At the time of trial, Larry had seven
children, among whom are Ronnie and Sylvia. In addition to their
own children, Frank and Katherine raised Ronnie and Sylvia
(grandchildren) in the gypsy culture, custom, and tradition.
Hereinafter, reference to the Johnson family means Frank,
Katherine, Larry, Ronnie, and Sylvia, collectively.
During the years in issue, Larry was married to Nancy
Johnson (Nancy). They lived in a separate residence from
Katherine and Frank during those years. Ronnie lived with Frank
and Katherine until approximately February 1985. During 1985
through 1990, Ronnie was married to Linda Johnson (Linda), and
they lived in a separate residence from Frank and Katherine.
Sylvia came to live with Frank and Katherine at least by 1983.
Her boyfriend, Jack Miller, moved into the Longwood property in
late 1986. Sylvia and Jack Miller married in 1987, and their
child, Nicole, was born in 1988. Sylvia, Jack Miller, and Nicole
lived in the Longwood property until August 1990 when they moved
into a separate residence.
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While living with Frank and Katherine, Sylvia performed many
services for them, including grocery shopping, paying bills, and
accompanying them to their doctors’ offices. When her help was
needed, she assisted Katherine in getting out of bed, bathing,
and dressing.
In June or July 1990 Katherine hired Carolyn White (Carolyn)
to perform housekeeping and caregiver duties for Katherine and
Frank. Carolyn’s husband, Jack White, burglarized the Longwood
property in November 1990 and stole a safe which he claimed
contained $200,000 in cash together with jewelry, bank books,
stocks, bonds, and coins. Frank and Katherine reported to the
police the theft of $30,000 in cash and over $100,000 in jewelry.
The police subsequently recovered the jewelry and all but $16,000
of the cash. Jack White was convicted of the theft. Carolyn
pleaded guilty to being an accessory after the fact and was put
on probation for 5 years.
B. Tax Returns
1. Frank and Katherine’s Returns
Frank was retired during the years in issue. Before,
during, and after the years in issue, Katherine operated a
palmistry business out of the Longwood property under the name
“Madame Katherine”. For some of the years, Sylvia helped
Katherine in that palmistry business.
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Frank and Katherine filed timely joint Federal individual
income tax returns for 1983 through 1985. They filed late
returns for 1986, 1987, and 1988 on December 5, 1989, after
Internal Revenue Service (IRS) Revenue Officer Robert Budde
(Revenue Officer Budde) served a summons requesting information
needed to prepare delinquent tax returns for 1986 through 1988.
Frank and Katherine filed timely joint Federal individual income
tax returns for 1989 and 1990. On their returns for the years in
issue, Frank and Katherine claimed exemptions for themselves and
no exemptions for dependents.
On Schedules C, Profit or Loss From Business, filed with the
returns for 1983 through 1985 and for 1990,4 Frank and Katherine
reported the following gross receipts, expenses, and net income
from the palmistry business:
Gross Business Net
Year Receipts Deductions Income
1983 $16,550 $10,069 $6,481
1984 15,800 9,609 6,191
1985 19,550 11,009 8,541
1990 8,000 250 7,750
Frank and Katherine did not file any Schedules C with the returns
for 1986 through 1989. Business deductions claimed on the
4
The Schedules C filed with the 1983 through 1985 returns
listed Frank and Katherine as the proprietors of the business,
but the Form SE, Computation of Social Security Self-Employment
Tax, identified Katherine as the self-employed person. The
Schedule C filed with the 1990 return listed Frank as the
proprietor of the business. No Form SE was included with the
copy of the 1990 return admitted into evidence at the trial.
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Schedules C for 1983, 1984, and 1985 included advertising
expenses of $4,029, $4,109, and $5,109, respectively. The
Schedule C filed with the 1990 return reported no advertising
expenses. From 1988 through 1990, Katherine’s advertising
expenses included the cost of a television (T.V.) commercial that
Katherine had taped on September 28, 1988, for viewing on Fox TV
Channel 35.5 Miss Lisa Ruby began managing Katherine’s TV ad
account in late 1989, and thereafter she periodically visited
with Katherine at the Longwood property to discuss that account
and collect payment. Katherine’s TV advertising expenses
averaged approximately $3,000 per year which she always paid with
cash.
On their returns for the years in issue, Frank and Katherine
reported the following interest income, income from capital
gains, income from gambling, and adjusted gross income:
5
Katherine continued to use the television commercial
after 1990.
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Income from Income Adjusted
Interest Capital from Gross
Year Income Gains Gambling Income
1983 $344 - - $6,825
1984 229 - - 6,420
1985 379 $7,897 - 16,817
1986 922 - - 922
1987 1,040 - - 1,040
1988 1,438 - - 1,438
1989 2,847 3,421 $1,002 7,270
1990 3,316 - 2,452 12,971
They also reported total Social Security benefits received for
1989 and 1990 of $5,591 and $6,257, respectively, none of it
taxable.
Frank and Katherine’s returns for the years in issue were
prepared by their accountant, Jack Baptiste (Baptiste). He
prepared the returns on the basis of information they furnished
to him.
2. Larry’s Returns
Larry and Nancy filed joint Federal individual income tax
returns for each of the years in issue. For 1983 through 1986,
Larry and Nancy claimed exemptions for themselves and for three
dependent children living with them (Sylvia, Tony, and David).
For 1987 through 1990, they claimed exemptions for themselves and
for two dependent children living with them (Tony and David).
Katherine trained Nancy to read palms. Larry and Nancy
filed Schedules C with their returns for the years in issue
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reporting income from a palmistry business.6 The Schedules C for
the years in issue reported the following gross receipts,
expenses, and net income from the palmistry business:
Gross Business Net
Year Receipts Deductions Income
1983 $20,160 $12,428 $7,732
1984 20,500 11,809 8,690
1985 28,500 17,732 10,768
1986 33,800 23,904 9,896
1987 36,325 26,453 9,872
1988 39,455 25,319 14,136
1989 40,310 19,797 20,513
1990 40,820 17,912 22,909
On their returns for the years in issue, Larry and Nancy
reported the following interest income, Schedule E Supplemental
Income and Loss income or loss,7 income from capital gains,
income from gambling, miscellaneous income, and adjusted gross
income:
6
The Schedule C for 1983 listed Larry and Nancy as the
proprietors of the palmistry business, and the Schedule SE, Self-
Employment Tax, identified Larry and Nancy as the self-employed
persons. The Schedules C for 1984 through 1990 listed Larry as
the proprietor and the Schedules SE for 1984 and 1986 through
1990 identified Larry as the self-employed person. No Schedule
SE was included with the copy of the 1985 return admitted into
evidence at trial. The Schedules C for 1983 through 1985 showed
a business name for the palmistry business of “Madam Nancy”. The
Schedule C for 1986 did not show a business name. The Schedules
C for 1987 through 1990 showed a business name of “Madam Bessie”.
Larry testified at trial that he did not actively participate in
the palmistry business operated by Nancy.
7
For 1984 through 1990, the Schedules E reported losses
from rentals. The net loss for 1990 also included a loss from
Johnson’s Limousine Service, Inc., an S corporation.
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Income
from Income Adjusted
Interest Sch. E Capital from Misc. Gross
Year Income Loss Gains Gambling Income Income
1983 $392 - - $25,000 - $32,124
1984 647 ($81) - - - 8,675
1985 639 (201) - 10,000 - 19,205
1986 428 (1,709) - - - 8,614
1987 144 (1,242) - - - 8,773
1988 52 (2,234) - - - 11,954
1989 2,059 (3,418) - - - 19,154
1
1990 2,770 (7,704) $2,608 - $215 19,046
1
$2,130 of the Schedule E loss for 1990 was from Johnson’s Limousine
Service, Inc.
3. Ronnie’s Returns
Ronnie and Linda filed joint Federal individual income tax
returns for 1985 through 1990. Ronnie and Linda claimed
exemptions for themselves and no exemptions for dependents on
those returns. The 1985 return was the first tax return Ronnie
filed.
Ronnie and Linda filed Schedules C with their returns
reporting income from a palmistry business.8 The Schedules C
reported the following gross receipts, expenses, and net income
from the palmistry business:
8
The Schedule C for 1985 listed Ronnie as the proprietor
of the palmistry business, and the Schedule SE identified Ronnie
as the self-employed person. The Schedules C for 1986 through
1990 listed Ronnie and Linda as the proprietors, and they filed
separate Schedules SE for each of those years on which the
Schedule C income was divided equally between Ronnie and Linda.
No business name was given for the palmistry business on any of
the Schedules C. Ronnie did not testify at trial.
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Gross Business Net
Year Receipts Deductions Income
1985 $17,575 $9,158 $8,417
1986 18,975 9,487 9,488
1987 22,851 10,168 12,683
1988 25,785 11,781 14,004
1989 39,410 24,761 14,649
1990 36,580 19,915 16,665
On their returns for 1985 through 1990, Ronnie and Linda
reported the following interest income, Schedule E loss, income
from gambling, and adjusted gross income:
Income Adjusted
Interest Rental from Gross
Year Income Loss Gambling Income
1985 - - - $8,417
1986 - - - 9,014
1987 $77 - $20,000 32,760
1988 - - - 14,004
1989 321 - - 14,970
1
1990 310 ($2,131) - 13,668
1
The Schedule E loss was from Johnson’s Limousine Service,
Inc.
4. Sylvia’s Returns
Katherine also trained Sylvia to read palms. At least by
1986, Sylvia worked with Katherine at the Longwood property in
Katherine’s palmistry business. For 1987 through 1990, Sylvia
reported income from a palmistry business9 under the name “Madame
Sylvia” on Schedules C she filed with her returns.
The 1987 return was the first Federal individual income tax
return Sylvia filed. On that return, she filed as “single” and
9
Until August 1990 Sylvia operated her palmistry business
out of the Longwood property.
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claimed an exemption for herself and no exemptions for
dependents. For 1988, she filed as “head of household” and
claimed an exemption for herself and an exemption for a dependent
child (Nicole Johnson). Sylvia and Jack Miller filed joint
Federal individual income tax returns for 1989 and 1990. They
claimed exemptions for themselves and an exemption for a
dependent child (Katherine N. Johnson).
For 1987 through 1990, Sylvia reported the following
income, expenses, and net profit from her palmistry business
on Schedules C:
Gross Business Net
Year Receipts Deductions Income
1987 $10,450 $5,540 $4,910
1988 12,350 5,650 6,700
1
1989 19,710 8,597 11,113
1990 24,510 12,804 11,706
1
The face of the Form 1040 shows business income from
Schedule C of $11,531. No explanation is given for the
discrepancy.
On the Schedules C, Sylvia claimed rent expenses of $1,200 for
1987 through 1989 and $2,880 for 1990. Frank and Katherine did
not report any rental income on their Federal individual income
tax returns for 1987 through 1990. On the Schedules C, Sylvia
claimed advertising expenses of $3,990 for 1987, $4,100 for 1988,
$5,900 for 1989, and $5,950 for 1990.
On the returns for 1987 through 1990, Sylvia, or Sylvia and
Jack Miller, reported the following interest income, Schedule E
loss, income from gambling, and adjusted gross income:
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Income Adjusted
Interest Sch. E from Gross
Year Income Loss Gambling Income
1987 - - - $4,910
1988 $29 - $1,727 8,456
1989 153 - - 11,684
1
1990 130 ($2,131) 1,685 10,563
1
The Schedule E loss was from Johnson’s Limousine Service,
Inc.
C. IRS Audits and Notices of Deficiency
1. Frank and Katherine’s Audit and Notices of
Deficiency
On August 15, 1991, IRS Revenue Agent Robert Combs (Agent
Combs) notified Frank and Katherine that their returns for the
years in issue were under audit.10 Agent Combs did not meet with
Frank or Katherine regarding income and expense items pertaining
to their returns at any time during the course of the audit of
their tax returns for the years in issue.
On September 22, 1995, respondent mailed 30-day letters to
Frank and Katherine for 1983 through 1990 in which respondent
proposed adjustments for those years relating, among other
things, to understatements of income. Subsequently, on April 4,
1997, respondent issued two notices of deficiency to petitioners
for the years in issue in which respondent determined, among
10
On Feb. 5, 1991, Agent Combs had notified Larry and
Nancy that their 1988 Federal income tax return was under audit.
Subsequently, Agent Combs expanded the audit to include
additional years and family members.
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other things, that Frank and Katherine had unreported “other
income” for those years in the following amounts:
Other Income
Year Frank Katherine Total
1983 $46,301 $46,301 $92,602
1984 49,261 49,261 98,522
1985 57,588 57,588 115,176
1986 54,723 54,723 109,446
1987 90,517 90,517 181,034
1988 112,803 112,803 225,606
1989 97,295 97,295 194,590
1990 145,537 145,537 291,074
Total 654,025 654,025 1,308,050
Respondent calculated the amount of unreported other income using
a source and application of funds method of reconstructing
income.
In the notices of deficiency, respondent determined further
that Frank and Katherine together had taxable Social Security
benefits of $1,287, $957, $1,385, $2,195, $2,796, and $3,129 for
years 1985, 1986, 1987, 1988, 1989, and 1990, respectively.11 In
addition, respondent increased Frank’s and Katherine’s income
from capital gains for 1985 and 1989 by $6 and $20,557,
respectively. For the years in issue, respondent treated Frank
and Katherine as co-owners of the palmistry business. Thus,
respondent determined that they each were liable for self-
employment taxes for 1983, 1984, 1985, 1986, 1987, 1988, 1989,
and 1990, of $3,338, $4,271, $4,673, $5,166, $5,387, $5,859,
11
For those years, respondent determined that Frank and
Katherine had received total Social Security benefits of $2,574,
$1,914, $2,770, $4,390, $5,591, and $6,257, respectively.
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$6,250, and $7,849, respectively. Respondent allowed them a
$7,310 self-employment tax deduction for 1990. For each of the
years 1983 through 1986, respondent also allowed Frank and
Katherine a $3,000 married couples deduction.
2. Larry’s Audit and Notice of Deficiency
Agent Combs met with Larry, Nancy, and Baptiste in February
1991 regarding the audit of Larry and Nancy’s 1988 return. He
subsequently expanded the audit to include their returns for
earlier and later years as well as the returns of Frank and
Katherine, Ronnie, and Sylvia. Larry and Nancy initially
provided information to Agent Combs relating to amounts claimed
on their returns. Subsequently, they refused Agent Combs’
requests for additional information and for an extension of the
statute of limitations for the 1987 return. Larry and Baptiste
refused to cooperate further in the audit on the advice of
counsel because they believed that Agent Combs was prejudiced
against Gypsies and had referred, or intended to refer, their
returns to the IRS Criminal Investigation Division.
During 1994, respondent made a jeopardy assessment against
Larry and Nancy after Agent Combs received information from the
Daytona Beach Shores police department that both Larry and his
daughter Sylvia had obtained driver’s licenses issued in false
names and had opened safe deposit boxes under those names into
which they were transferring moneys from other safe deposit
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boxes. Respondent seized property from Larry’s home on June 15,
1994, and from Katherine’s home on June 17, 1994. Larry and
Nancy filed an administrative protest on July 15, 1994, in which
they requested abatement of the jeopardy assessment. Respondent
abated the jeopardy assessment on or about November 18, 1994, but
imposed an equitable lien on Larry’s real property.
On August 12, 1994, respondent mailed a notice of deficiency
to Larry and Nancy for the years 1983 through 1990. Respondent
determined the deficiencies set forth in that notice of
deficiency on the basis of a source and application of funds
analysis for each of those years. On November 14, 1994, Larry
and Nancy filed a petition with the Tax Court seeking a
redetermination of those deficiencies (docket No. 20854-94).
Respondent, Larry, and Nancy subsequently settled docket No.
20854-94. The decision document, entered February 20, 1996,
reflected, among other things, that (1) no deficiencies in tax
were due for the years 1983 through 1988, (2) no additions to tax
were due for the years 1983 through 1988, (3) deficiencies in tax
were due for years 1989 and 1990 in the amounts of $7,140 and
$6,606, respectively,12 (4) additions to tax were due for years
12
In the notice of deficiency, respondent determined tax
deficiencies for 1989 and 1990 of $13,317 and $16,461,
respectively. Those deficiencies were calculated on the basis of
the following adjustments to income:
(continued...)
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1989 and 1990 in the amounts of $1,428 and $1,289, respectively,
and (5) the settlement was based on the assertions of both Larry
and Katherine that for the years in issue Frank and Katherine had
paid all of Larry’s expenditures in excess of his income.
3. Ronnie’s Audit and Notice of Deficiency
Agent Combs notified Ronnie and Linda of the audit of their
returns on August 15, 1991. On August 31, 1995, respondent
mailed 30-day letters to Ronnie for 1983 and 1984 and to Ronnie
and Linda for 1985 though 1990 in which respondent proposed
adjustments for those years. Respondent determined those
adjustments on the basis of a source and application of funds
analysis for each of those years. Subsequently, respondent
closed Ronnie’s audit without issuing any notice of deficiency.
4. Sylvia’s Audit and Notice of Deficiency
Agent Combs notified Sylvia of the audit of her returns on
August 15, 1991. On August 31, 1995, respondent mailed 30-day
letters to Sylvia for 1985 through 1988, and to Sylvia and Jack
for 1989 and 1990, in which respondent proposed adjustments for
12
(...continued)
1989 1990
Self-employment income $38,018 $43,404
Capital gain income -0- 3,725
Loss from an S corporation -0- 2,130
Depreciation expense - Schedule C (3,969) (3,969)
Depreciation expense - Schedule E 10,517 10,517
Self-employment tax deduction -0- (2,786)
Total adjustments 44,566 53,021
- 23 -
those years. Respondent determined those adjustments on the
basis of a source and application of funds analysis for each of
those years. Subsequently, respondent closed Sylvia’s audit
without issuing a notice of deficiency.
D. Source and Application of Funds Analyses
Following trial, the parties met in an effort to resolve
their differences regarding the source and application of funds
analyses for the Johnson family members. In a joint finding of
fact set forth in their opening briefs, the parties indicate that
Appendix 5 of respondent’s opening brief shows in black the items
of the source and application of funds analyses for which the
parties are in agreement, and that Appendix 5 shows in red the
items for which the parties are not in agreement. We show the
items reflected on respondent’s Appendix 5 in our Appendices A
through I. To the extent possible, in those appendices, we have
incorporated explanations for the differences in amounts
reflected on the source and application of funds analyses for
Frank and Katherine as gifts to Larry, Ronnie, and Sylvia, from
the amounts reflected as excess applications of funds over
sources of funds on the separate source and application of funds
analyses for Larry, Ronnie, and Sylvia. Except for the items
specified below, the parties agree on the amounts shown in source
and application of funds analyses set forth infra in Appendix A.
- 24 -
1983
Items in Dispute Amount
Gifts to Larry $34,317
Gifts to Ronnie 35,946
Personal living expenses for 2 persons 19,377
Less: Housing costs $3,280
Vehicle acquisition costs 1,502 (4,782)
Total of items in dispute for 1983 84,858
1984
Items in Dispute Amount
1
Gifts to Larry 37,270
Gifts to Ronnie 52,672
Personal living expenses for 2 persons 20,561
Less: Housing costs $3,485
Vehicle acquisition costs 1,733 (5,218)
Total of items in dispute for 1984 105,285
1
Respondent concedes that this item is overstated by $4,500.
See infra Appendix C for an explanation of the difference.
1985
Items in Dispute Amount
Gifts to Larry $53,357
Gifts to Ronnie 30,834
Gifts to Sylvia 20,862
Personal living expenses for 2 persons 22,056
Less: Housing costs $3,873
Vehicle acquisition costs 1,833 (5,706)
Total of items in dispute for 1985 121,403
1986
Items in Dispute Amount
1
Gifts to Larry $39,723
2
Gifts to Ronnie 27,525
Gifts to Sylvia 19,775
Personal living expenses for 2 persons 23,442
Less: Housing costs $3,999
Vehicle acquisition costs 2,449 (6,448)
Total of items in dispute for 1986 104,017
1
Larry’s analysis reflects $69,150. See infra Appendix E
for an explanation of the difference.
- 25 -
2
Ronnie’s analysis reflects $26,063. See infra Appendix E
for an explanation of the difference.
1987
Items in Dispute Amount
Gifts to Larry $95,819
1
Gifts to Ronnie 48,010
Gifts to Sylvia 23,946
Personal living expenses for 2 persons 24,761
Less: Housing costs $4,108
Vehicle acquisition costs 1,950 (6,058)
Total of items in dispute for 1987 186,478
1
Appendix 5 (Ronnie 1987) reflects $49,760. See infra
Appendix F for an explanation of the difference.
1988
Items in Dispute Amount
1
Gifts to Larry $68,359
2
Gifts to Ronnie 64,360
Gifts to Sylvia 52,197
Personal living expenses for 2 persons 26,350
Less: Housing costs $4,420
Vehicle acquisition costs 2,581 (7,001)
Total of items in dispute for 1988 204,265
1
Larry’s analysis reflects $94,067. See infra Appendix G
for an explanation of the difference.
2
Ronnie’s analysis reflects $63,860. See infra Appendix G
for an explanation of the difference.
1989
Items in Dispute Amount
Gifts to Larry $38,018
Gifts to Ronnie 73,937
Gifts to Sylvia 50,359
Personal living expenses for 2 persons 28,622
Less: Housing costs $4,903
Vehicle acquisition costs 2,301 (7,204)
Wedding ceremony for Sylvia 10,000
Total of items in dispute for 1989 193,732
- 26 -
1990
Items in dispute Amount
1
Gifts to Larry $43,404
2
Gifts to Ronnie 60,223
3
Gifts to Sylvia 62,546
Personal living expenses for 2 persons 28,836
Less: Housing costs $4,930
Vehicle acquisition costs 2,026 (6,956)
Investigative fees (Dennis Dayle) 7,000
Room & board for Janie and her children 6,000
Less: Duplication re limo (46,490)
Total of items in dispute for 1990 154,563
1
Larry’s analysis reflects $41,404. See infra Appendix I
for an explanation of the difference.
2
Ronnie’s analysis reflects $60,923. See infra Appendix I
for an explanation of the difference.
3
Sylvia’s analysis reflects $60,546. See infra Appendix I
for an explanation of the difference.
Included in the source and application of funds analysis for
Frank and Katherine for each of the years in issue are amounts
identified as gifts to Larry, Ronnie, and Sylvia. For the most
part, those amounts constitute the excess of applications of
funds over sources of funds reflected on source and application
of funds analyses respondent performed for each of Larry, Ronnie,
and Sylvia. See infra Appendices B through I. Respondent
included those amounts as applications of funds for Frank and
Katherine because, in a deposition to preserve testimony for
docket No. 20854-94 given on June 14, 1995, Katherine claimed
that she and Frank provided funds for purchases of assets by
Larry, Ronnie, and Sylvia as well as for their vacations and
normal living expenses in excess of their incomes. In separate
sworn affidavits, Larry, Ronnie, and Sylvia attested that
- 27 -
Katherine and Frank had provided funds for their asset purchases
and living expenses.
For purposes of the source and application of funds analyses
for each year, to determine personal living expenses for Frank
and Katherine’s household, Larry’s household, Ronnie’s household,
and Sylvia’s household, respondent used Bureau of Labor
Statistics (BLS) figures which detailed average annual
expenditures of consumers based on the size of the consumer unit.
Respondent reduced the BLS figures for shelter costs and vehicle
acquisition costs. Respondent considered Frank and Katherine’s
household to consist only of themselves for each year in issue.
Respondent considered Larry’s household to consist of four
persons for each year in issue. Respondent considered Ronnie’s
household to consist of one person for 1983 and 1984 and two
persons for 1985 through 1990. Respondent considered Sylvia’s
household to consist of one person for 1985 through 1987, two
persons for 1988, and three persons for 1989 and 1990. See infra
Appendices A through I for the amounts respondent used for
personal living expenses in the source and application of funds
analyses.
- 28 -
During 1987, Larry purchased a 1977 Excaliber for $25,060.13
Frank and Katherine paid for the birthing costs of Sylvia’s
daughter, Nicole. Respondent estimated those costs to be $2,500.
Sometime during the years in issue, Frank and Katherine’s
daughter Janie was married to Miller Johnson (Miller). Janie
suspected that Miller stole property from her safe deposit box.
During 1990, Janie and Frank hired a private investigator, Denis
Dayle (Dayle), to help recover the stolen property and to hide
Janie and her children from Miller. Shortly before they hired
Dayle, Miller had hired Dayle to find Janie and her children.
Dayle decided to keep Miller as a client while at the same time
he worked for Janie and Frank. Frank paid Dayle $7,000 in 1990
for his services.
E. Cash Hoard
Katherine was the eldest child of Edward Peter Stanton
(Edward) and Mary Stephens Stanton (Mary). In addition to
Katherine, Edward and Mary had nine other children, including a
daughter Tina Stanton Ephraim (Tina), and sons Joe Mills14 (Joe),
13
That acquisition is not reflected on Frank and
Katherine’s or Larry’s source and application of funds analyses
for 1987. See infra Apps. A and F. The parties do not explain
why it was omitted as an application of funds for that year. We
have made no adjustment for this item in our findings regarding
unreported income since it was not identified as an item in
dispute.
14
Joe actually was Edward’s stepson. It is not clear from
the record whether Katherine, Tina, and their sister Margie
(continued...)
- 29 -
Jack Stanton (Jack), Duyo Peter Stanton (sometimes referred to as
Dewey), and Chuck Stanton (Chuck). Tina’s husband is Frank’s
half-brother.
For most of his life Edward worked as a coppersmith and
welder. Until around 1951, Edward and his family moved from job
site to job site approximately every week to 10 days.15 His
family lived in tents and, later, in trailers. Around 1951,
Edward, Mary, and the children remaining at home settled in
Maryland, first in the Emmitsburg area and later in the
Hagerstown area.16 While living in Maryland, Edward purchased
some real estate, including a trailer park, some apartment
buildings, and a lot on which he built a home. Edward also
bought and sold some livestock.
Edward and Mary did not trust banks. They kept cash as well
as gold coins and jewelry hidden in their home. Although Edward
generally lived frugally, on occasion he helped his children out
14
(...continued)
actually were Mary’s stepdaughters although certain statements in
the record give that impression.
15
Joe testified that for some of those years Edward and
his family traveled with a carnival at which Mary worked as a
fortune teller.
16
Although the testimony is somewhat contradictory as to
exactly which of Edward and Mary’s children were living with them
when Mary and Edward settled in Maryland, it is clear that both
Katherine and Tina already were married and living in separate
residences while Chuck and possibly Dewey were living with their
parents at that time.
- 30 -
financially, especially Chuck and Katherine. At times, Edward
asked Katherine or Tina for money to pay some of his or Mary’s
living expenses.
The records of the Social Security Administration reflect
the following earnings reported for Edward over his lifetime:
Period Amount
1937 to 1950 (cumulative) $31
1951 through 1961 -0-
1962 659
1963 through 1965 -0-
1966 465
1967 720
1968 1,217
1969 through 1974 -0-
Total 3,092
Mary worked as a fortune teller both before and after the
family settled in Maryland. However, the Social Security
Administration has no record of any earnings reported for Mary.
Respondent has no record showing that Mary or Edward filed any
Federal income tax returns.
Dewey was born on April 1, 1940. During his lifetime, Dewey
was involved in at least two serious automobile accidents. The
first accident occurred on or about December 15, 1960. Dewey,
his wife Helen, and their son Michael, were injured in that
accident, and Dewey’s car was destroyed. They filed a law suit
against the driver of the tractor trailer which struck their car
and the driver’s employer. The case was subsequently settled
before trial, and some time thereafter, the following settlement
amounts were paid to or for Dewey, Helen, and Michael:
- 31 -
Beneficiary Amount
Helen Stanton $29,082
Michael Stanton 7,725
Bobby Stanton1 10,389
Total 47,196
1
It appears that “Bobby” was another name for Dewey.
Dewey acquired a new Cadillac as a result of the first
accident. However, it is not clear from the record whether he
paid the cost of the Cadillac out of the settlement proceeds or
received the car in a side agreement to the settlement. At some
time, Edward obtained control over the settlement proceeds. It
is not clear from the record whether Edward used some of the
settlement proceeds to acquire property described infra.
Dewey and Michael died on June 15, 1964, as a result of a
second accident. There is no evidence in the record that Dewey’s
or Michael’s survivors received any settlement proceeds as a
result of the second accident.
Property records reveal that Mary and Edward engaged in the
following real property transactions between 1963 and 1971:
Date Description of Transaction
11/29/63 Purchased Lot 178 in Prospect Place for $5,000
12/13/63 Purchased Lot 179 in Prospect Place for $1,000
3/26/64 Purchased Lot 174 in Prospect Place for $2,000
3/26/64 Obtained a $1,700 mortgage on Lot 174
1/5/65 Obtained a $751 mortgage on Lots 175, 176, 177 &
178
2/11/66 Purchased Lot 3 on Michael Beckley Plat for $10,000
- 32 -
2/11/66 Obtained $5,400 mortgage on Lot 3 on Michael
Beckley Plat
4/11/68 Obtained $4,250 mortgage on Lot 3 on Michael
Beckley Plat
10/19/70 Obtained $564 mortgage on Lots 175, 176, 178 & 179
in Prospect Place
9/24/71 Sold Lots 174, 175, 176, 177, 178 & 179 in Prospect
Place for $10,000
The record does not reflect when or for how much Edward and Mary
acquired interests in Lots 175 and 176 in Prospect Place, or what
happened to Lot 3 on Michael Beckley Plat. The mortgage obtained
on October 19, 1970, was released on November 1, 1971. The
mortgage obtained on April 11, 1968, was released on February 10,
1976.
Mary died on July 21, 1970. Following Mary’s death, Edward
sold his home in the Hagerstown area.17 He stayed with Katherine
for a period of time, and then moved to New York where he lived
first with Chuck and then with his brother’s widow, Bolita.
Edward’s children did not know whether Edward and Bolita
subsequently married in the gypsy custom or merely lived
together.
17
It is not clear whether that home was located on Lots
174, 175, 176, 177, 178, and 179 in Prospect Place, which Edward
sold on Sept. 24, 1971. Although it is not clear from the
record, Edward may have sold his home through the use of a land
contract. Joe testified that, following Edward’s death, Jack
began receiving the payments on a land contract Edward had
entered into sometime before his death.
- 33 -
Sometime during 1974, Edward was admitted to New York City
Hospital because of problems he had related to diabetes. One of
his legs was amputated during that hospital stay. Sometime while
he was hospitalized, Katherine and Jack removed all of Edward’s
property from a safe deposit box he had at Chase Manhattan Bank.
See infra for additional discussion relating to the removal of
Edward’s property from his safe deposit box. After Edward’s
release from the hospital, he moved to Ohio to live with Jack.
Edward died in Ohio on September 3, 1974. In the gypsy culture,
Edward’s money would go to a son because it was a gypsy custom
for the first-born son to inherit everything.
Respondent has no record showing that Edward or Mary ever
filed a gift tax return. Respondent has no record showing that
an estate tax return was filed for either Edward or Mary.
F. Other Facts
Frank and Katherine dealt exclusively in cash. Katherine
maintained writing tablets on which she recorded receipts. She
gave those tablets and their bills to Baptiste for use in
preparing the tax returns. There is no evidence that Katherine
or Baptiste presented any of those tablets or bill receipts to
respondent during the audit or afterward.
Frank loved to gamble. He frequently went to greyhound
races in Seminole County, Florida. Once or twice a year, at
Katherine’s expense, the Johnson family, including spouses and
- 34 -
their children, took trips together to gamble in places such as
the Bahamas, Atlantic City, New Jersey, and Las Vegas, Nevada.
Over their lifetimes, Frank and Katherine made numerous
gifts to their children and grandchildren. Frank and Katherine
also gave them money and paid for some of their personal
expenses. At some time, Frank and Katherine gave their daughter
Janie jewelry valued at $22,800. Katherine also paid for the
weddings and divorces of her children and grandchildren. She
paid for vacations for her children and grandchildren and their
families. She gave them money to gamble. Katherine and Frank
also purchased U.S. Savings Bonds as birthday gifts for Larry,
Ronnie, and Sylvia. In addition, she gave them cash for asset
acquisitions, including houses, cars, and boats.
Respondent was unable to locate any record showing that
Frank or Katherine had ever filed a gift tax return.
Katherine and Frank received little or no formal education.
They had only minimal reading and writing skills and only basic
math skills.
During the years in issue, Katherine suffered from various
medical problems, including a heart condition, diabetes, vision
impairment, high blood pressure, high cholesterol levels, water
retention, and obesity. At various time during the years in
issue, she was admitted to the hospital for treatment. Her
vision was impaired due to cataracts and retinal hemorrhages;
- 35 -
however, during the years in issue she could see well enough to
sort mail, review advertisements or other literature, and make
notations on the tablets she used to record income. One of her
legs was amputated during 1988, and she used a wheelchair or an
artificial leg which enabled her to walk with a cane. At least
toward the end of her life, Katherine’s health condition impaired
her ability to work a full 8-hour day.
During the period 1984 through 1990, Frank suffered from
various medical problems, including a heart condition, high blood
pressure, and obesity. During 1985, Frank suffered a slight to
moderate heart attack. His health problems, however, did not
prevent him from undertaking activities during the years in issue
such as mowing his lawn, fishing, gambling, and helping Larry and
Ronnie renovate property.
Frank and Katherine experienced numerous medical expenses
during the years in issue. The record does not reveal what
portion, if any, of those expenses were paid by Medicare or
Medicaid.
Frank and Katherine purchased the Longwood property during
June 1969 for $26,000. They financed $18,000 of the purchase
price. Sometime before 1983, Frank and Katherine purchased a lot
for $5,000. It is not clear from the record whether this lot was
the Port St. Lucie property transferred to Larry and Ronnie on
January 7, 1991.
- 36 -
During 1971, Frank purchased a 1971 Corvette for $4,160.
Frank purchased a 1967 Rolls Royce during 1982 for $18,500. He
paid cash for the vehicle, primarily in $100 bills.
As of January 1, 1983, Katherine and Frank had cash on hand
of approximately $30,000. Throughout the years in issue, they
kept approximately $30,000 cash on hand at the beginning and end
of each year.
At a meeting with Frank and Katherine on or about
December 5, 1989, Revenue Officer Budde prepared a Form 433-A,
Collection Information Statement For Individuals (collection
statement), on the basis of information provided by them. The
collection statement, among other things, indicated that Frank
and Katherine’s only assets were (1) two bank accounts of $1,200
and $13,000 at Glendale Federal, (2) a residence valued at
$60,000 and monthly payments of $500, (3) a 1986 Cadillac having
zero value, and (4) a 1986 Chevy having zero value. The
collection statement further indicated that Frank and Katherine’s
only source of income at that time consisted of $900 per month in
Social Security benefits.
Larry purchased a 1977 Corvette during 1977 for $3,480.
During 1982, Larry purchased a 1978 Chevrolet Suburban for
$2,699.
- 37 -
Respondent was unable to locate any record showing that an
estate tax return had been filed on behalf of Frank or Katherine.
G. Capital Gain for 1989
Frank and Katherine reported a long-term capital gain on
their joint Federal income tax return for 1989 from the sale of a
lot (lot). They calculated that gain as follows:
Sales price $40,000
Basis 36,579
Gain from sale 3,421
Frank conveyed the lot to Russell A. Sachs (Sachs) by
warranty deed dated March 20, 1989. The settlement statement
relating to the sale of the lot to Sachs shows that $11,033 of
the $40,000 sales price was used to pay off a mortgage loan. The
settlement statement also shows expenses of the sale of $4,990.
Frank had acquired his interest in the lot from a
Patricia A. Johnson (Patricia)18 on March 18, 1989, by means of a
quitclaim deed. The quitclaim deed stated that the transfer was
for no consideration.
Patricia had acquired her interest in the lot with John M.
Johnson (John) for $25,000 on April 6, 1979, from Charles and
Annie Mobley (Mobleys) pursuant to an Articles of Agreement which
specified that title would not be conveyed until after payment of
the $25,000 purchase price. By quitclaim deed John transferred
18
The record does not reveal whether Patricia A. Johnson
was Frank and Katherine’s daughter Patricia or an unrelated party
with the same name.
- 38 -
his interest in the property to Patricia in October 1987 for a
stated consideration of $5,000. The Mobleys transferred title to
Frank by warranty deed on March 20, 1989.
On audit, respondent increased the gain from the sale of
that lot to $23,978 and determined that the gain was a short-term
gain. The notice of deficiency indicates that the adjustment was
made because of a change in verified basis and holding period.
In the source and application of funds analysis for Frank and
Katherine for 1989, respondent treats the $23,978 as a source of
funds.
II. Facts Relating to Issues Involving Transferee Liability
A. Larry
By notice dated April 4, 1997, respondent determined
transferee liability against Larry relating to the deficiencies,
additions to tax, and penalties that respondent determined Frank
and Katherine owed for the years in issue. Previously, by letter
dated July 26, 1996, respondent had determined that Frank and
Katherine had transferred the following assets to Larry upon
which transferee liability attached:
- 39 -
Description Amount
Annual gifts in the form of excess of
applications of funds over sources of funds:
1983 $34,317
1984 37,270
1985 53,357
1986 39,723
1987 95,819
1988 68,359
1989 38,018
1990 43,404
Cash to purchase Sanford property 30,000
Glendale Federal savings account transfer 21,550
Longwood property equity 311,000
One-half interest in St. Lucie County property 4,000
Transfer of vehicles:
1967 Rolls Royce 25,000
1986 Lamborghini 52,000
1986 Chevy C30 7,850
Total transferred 861,667
The parties agree that for the years 1983 through 1990,
Larry acquired the following assets:
Year Description of Asset Cash Paid
1983 1981 Mercedes 380 SL CR $15,000
1984 1984 GM Suburban 7,242
1985 1985 Chris Craft boat 35,000
1985 1974 Ford truck 315
1985 1982 Ferrari 10,295
1986 Sanford property 29,427
1986 Renovation to Sanford property 25,900
1986 1986 Lamborghini 14,435
1988 1979 Cadillac 4,662
1989 1964 Ford Thunderbird 27
1989 1985 Jeep CJ 4,285
1989 Chevrolet Astro van 13,000
1990 1988 Cadillac limousine 18,831
1990 1985 Lincoln limousine 14,890
Total 193,309
B. Ronnie
By notice dated April 4, 1997, respondent determined
transferee liability against Ronnie for the deficiencies,
- 40 -
additions to tax, and penalties that respondent determined Frank
and Katherine owed for the years in issue. Previously, by letter
dated July 20, 1996, respondent determined that Frank and
Katherine had transferred the following assets to Ronnie upon
which transferee liability attached:
Description Amount
Annual gifts in form of excess of
applications of funds over sources of funds:
1983 $35,946
1984 52,672
1985 30,834
1986 27,525
1987 48,010
1988 64,360
1989 73,937
1990 60,223
Glendale Federal savings account transfer 21,550
Longwood property equity 311,000
One-half interest in St. Lucie County property 4,000
Total assets transferred 730,057
The parties agree that for the years 1983 through 1990,
Ronnie acquired the following assets:
- 41 -
Year Description of Asset Cash Paid
1983 1983 Porsche $25,200
1985 1985 Porsche 10,826
1986 1979 Ford truck 788
1986 1968 Chevy Camaro 1,050
1987 1977 AMF boat 2,625
1987 Ridgewood property 25,165
1987 Renovation to Ridgewood property 13,800
1988 Renovation to Ridgewood property 1,750
1988 1986 Ford 150 10,563
1988 1987 Ferrari 19,000
1989 Renovation to Ridgewood property 13,200
1989 1974 Corvette 11,500
1989 1980 Jeep 2,156
1989 1982 Jeep 3,025
1989 Landscaping 17,000
1990 1979 Triumph 1,200
1990 1990 Ford Bronco 4,000
Total 162,848
C. Sylvia
By notice dated April 4, 1997, respondent determined
transferee liability against Sylvia for the deficiencies,
additions to tax, and penalties that respondent determined Frank
and Katherine owed for the years in issue. Previously, by letter
dated July 26, 1996, respondent determined that Frank and
Katherine had transferred the following assets to Sylvia upon
which transferee liability attached:
Description Amount
Annual gifts in the form of excess of
applications of funds over sources of funds:
1985 $20,862
1986 19,775
1987 23,946
1988 52,197
1989 50,359
1990 62,546
Total assets transferred 229,685
- 42 -
The parties agree that for the years 1983 through 1990,
Sylvia acquired the following assets:
Year Description of Asset Cash Paid
1985 1985 Corvette $27,785
1988 1988 Porsche 10,000
Total 37,785
D. Specific Transfers
1. U.S. Savings Bonds
During the years in issue, Larry, Ronnie, and Sylvia
acquired U.S. Savings bonds in the following amounts (face
values):
Year Larry Ronnie Sylvia
1983 $7,200 - -
1984 7,500 $40,925 -
1985 200 - -
1986 - - -
1987 - - $5,000
1988 - - 200
1989 - - 3,450
1990 - - 2,250
Total 14,900 40,925 10,900
2. Account at Glendale Federal Savings and Loan
Account No. 096-601219-9 was maintained at Glendale
Federal Savings and Loan in the names of Frank and Larry. On
December 12, 1989, $26,189 was deposited into that account,
representing the proceeds of a Certificate of Deposit. An
additional $13,613 was deposited into that account on
December 29, 1989. Account No. 096-601219-9 had a balance of
$43,101 as of December 14, 1990, when it was transferred into
Account No. 096-601615-9 in the names of Larry and Ronnie.
- 43 -
3. Longwood Property
On January 7, 1991, Frank and Katherine transferred the
Longwood property to Larry and Ronnie by quitclaim deed for a
stated nominal consideration. Pursuant to the quitclaim deed,
Frank and Katherine retained for themselves “the exclusive
possession, use, and enjoyment of the rents, issues, and profits
of the above-granted premises for and during the[ir] natural
lifetime”. A real estate tax bill dated January 1, 1991, showed
a real estate tax value for the Longwood property of $236,110. A
real estate tax bill dated November 16, 1992, showed a real
estate tax value for the Longwood property of $209,110.
4. Port St. Lucie Property
On January 7, 1991, Katherine transferred to Larry and
Ronnie by quitclaim deed property located in Port St. Lucie for a
stated nominal consideration.
5. Automobiles
In August 1992, Frank transferred his 1967 Rolls Royce to
Larry for no consideration. At the time of the transfer, the
Rolls Royce had a value of $25,000. Also in August 1992, Frank
transferred the 1986 Lamborghini to Larry for no consideration.
At the time of transfer, the Lamborghini had a value of $52,000.
- 44 -
OPINION
I. Issues Relating to Deficiencies
A. Background
Petitioners contend that for each of the years in issue the
expiration of period of limitations precludes the assessment of
any deficiency. Respondent, however, contends that the fraud
exception to the statute of limitations applies for each year in
issue; consequently, respondent maintains, assessment of the
deficiencies is not barred for any year in issue. Alternatively,
respondent argues that the period of limitations for 1990 has not
expired because the unreported income for that year exceeds 25
percent of the income Frank and Katherine included on their
return for that year; therefore, a 6-year statute of limitations
applies for 1990. Petitioners, however, maintain that Frank and
Katherine did not understate their income for any year in issue.
Respondent used an indirect method to reconstruct Frank and
Katherine’s income for the years 1983 through 1990, specifically
the source and application of funds method, to determine that
Frank and Katherine had understated their income for those years.
Petitioners contend that, during those years, Frank and Katherine
used a previously acquired cash hoard to purchase assets and to
pay personal expenses for themselves and other family members.
- 45 -
B. Statute of Limitations and Fraud Issues
1. In General
A deficiency in tax generally must be assessed within
3 years of the date on which the return was filed. See sec.
6501(a). Section 6501(c)(1) provides one of the exceptions to
the general 3-year limitation period. Under that exception, the
tax may be assessed at any time in the case of a false or
fraudulent return filed with the intent to evade tax. Respondent
has the burden of proving the applicability of an exception to
the general 3-year limitation period. See Rule 142; Harlan v.
Commissioner, 116 T.C. 31, 39 (2001). Respondent must prove the
same elements of fraud under section 6501(c)(1) as are required
for imposing a fraud penalty under section 6653(b). See, e.g.,
Mobley v. Commissioner, T.C. Memo. 1993-60, affd. without
published opinion 33 F.3d 1382 (11th Cir. 1994). To prevail
under section 6653(b), respondent must show through clear and
convincing evidence both that (1) an underpayment of tax exists,
and (2) some part of the underpayment is due to fraud. See sec.
7454(a); Rule 142(b); DiLeo v. Commissioner, 96 T.C. 858, 873
(1991), affd. 959 F.2d 16 (2d Cir. 1992).
Section 6501(e) provides another exception to the 3-year
general limitation period for assessing a tax. Under that
exception, the 3-year limitation period is extended to 6 years
where a taxpayer omits properly includable income from his or her
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return in an amount in excess of 25 percent of the amount of
gross income stated on the return. See sec. 6501(e)(1)(A). In
determining whether the 25-percent requirement is met, any amount
omitted from gross income that is adequately disclosed in the
return or in a statement attached to the return is not taken into
account. See sec. 6501(e)(1)(A)(ii).
We turn first to the issue of fraud because, except possibly
for 1990, where the 6-year limitation period may apply, absent
fraud, the statute of limitations bars the assessment of the
deficiencies for the years in issue. See sec. 6501(a), (c), (e);
see also York v. Commissioner, 24 T.C. 742, 743 (1955). If fraud
exists for 1990, we need not address whether the 6-year
limitation period applies for that year.
2. Fraud
Respondent contends that Frank and Katherine acted
fraudulently in understating their income tax liability for the
years in issue; thus, respondent asserts, the resulting
underpayments of tax for the years in issue were due to fraud.
Petitioners, however, deny that Frank and Katherine under
reported any income for the years in issue.
Fraud is the intentional wrongdoing on the part of a
taxpayer designed to evade a tax believed to be owing. See,
e.g., Petzoldt v. Commissioner, 92 T.C. 661, 698 (1989). Thus,
courts must decide whether, by the taxpayer’s conduct, he or she
- 47 -
intended to conceal, mislead, or otherwise prevent the collection
of taxes owed or believed to be owed. See, e.g., Danenberg v.
Commissioner, 73 T.C. 370, 393 (1979). Respondent has the burden
of proving the existence of fraud by clear and convincing
evidence. See sec. 7454(a); Rule 142(b); Grosshandler v.
Commissioner, 75 T.C. 1, 19 (1980). Where fraud is determined
for each of several years, respondent’s burden applies separately
for each of the years. See, e.g., Temple v. Commissioner, T.C.
Memo. 2000-337. The issue of whether fraud exists is factual and
must be determined upon the basis of the entire record. See,
e.g., Recklitis v. Commissioner, 91 T.C. 874, 909 (1988). Fraud
cannot be presumed, nor can a finding of fraud rest on mere
suspicion. See, e.g., id. However, since direct evidence of
fraud generally is not available, we may rely on circumstantial
evidence and draw reasonable inferences from the record as a
whole. See, e.g., id. at 910. We consider first for each year
in issue the question of whether a deficiency exists.
a. Existence of an Underpayment
The first element in establishing fraud is determining
whether any underpayment of tax exists. For 1983 through 1988,
section 6653(c)(1) defines an “underpayment” for purposes of
section 6653 as a “deficiency” defined by section 6211. Section
6211 generally defines a deficiency as the excess of the correct
amount of tax over the amount shown on the return. For 1989 and
- 48 -
1990, section 6664(a) defines “underpayment” as “the amount by
which any tax imposed by this title exceeds the excess of (1) the
sum of (A) the amount shown as the tax by the taxpayer on his
return, plus (B) amounts not so shown previously assessed (or
collected without assessment), over (2) the amount of rebates
made.” Thus, for purposes of this case, the term “deficiency” as
defined by section 6211 has the same meaning as the term
“underpayment” as defined by section 6664(a). Respondent used
the source and application of funds method of reconstructing
income in determining that Frank and Katherine had underreported
their income for the years in issue and that unreported income
resulted in deficiencies in tax for each year in issue.
Taxpayers are required to keep adequate records with which
respondent may determine their correct tax liability. See sec.
6001; see also Petzoldt v. Commissioner, supra at 687; sec.
1.6001-1(a), (d), Income Tax Regs. When a taxpayer keeps no
books, or keeps books that are inadequate, section 446(b)
authorizes the Commissioner to compute the taxpayer’s income by
any method that clearly reflects income. See, e.g., Petzoldt v.
Commissioner, supra; see also Cebollero v. Commissioner, 967 F.2d
986, 989 (4th Cir. 1992), affg. T.C. Memo. 1990-618. For that
purpose, respondent may use indirect methods to reconstruct
income as long as they are reasonable in light of all surrounding
facts and circumstances. See Holland v. United States, 348 U.S.
- 49 -
121, 131-132 (1954); Erickson v. Commissioner, 937 F.2d 1548,
1552-1553 (10th Cir. 1991), affg. T.C. Memo. 1989-552; Giddio v.
Commissioner, 54 T.C. 1530, 1532-1533 (1970).
The source and application of funds method (also sometimes
referred to as the expenditures method) is an accepted indirect
method of reconstructing income. See, e.g., Williams v.
Commissioner, 999 F.2d 760, 763 (4th Cir. 1993), affg. T.C. Memo.
1992-153. Under that method, any amount by which the taxpayer's
total application of funds during the taxable year exceeds the
total funds available to him from known sources for that year is
attributed to unreported taxable income absent some showing by
the taxpayer of a nontaxable source. See, e.g., id., Troncelliti
v. Commissioner, T.C. Memo. 1971-72 (“As explanation the taxpayer
may show that the difference between the total application [of]
funds and the total reported sources of funds is attributable to
such nontaxable items as loans, gifts, inheritances, or assets on
hand at the beginning of the taxable period.”). Thus, as part of
the reconstruction of income using the source and application of
funds method, respondent must exclude funds that the taxpayer had
accumulated before the first taxable year under examination
insofar as those funds are a source of subsequent expenditures.
See Flood v. Commissioner, T.C. Memo. 2001-39. Frank and
Katherine dealt primarily in cash and provided to respondent no
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books and records relating to Katherine’s palmistry business.19
Under the circumstances, respondent’s use of the source and
application of funds method to reconstruct Frank and Katherine’s
income for the years in issue was reasonable.
Where the allegation of fraud is intertwined with unreported
and indirectly reconstructed income, respondent can satisfy the
burden of proving an underpayment of tax in one of two ways. See
Parks v. Commissioner, 94 T.C. 654, 661 (1990). First,
respondent may prove a likely source of the unreported income;
second, where the taxpayer alleges a nontaxable source for the
funds, respondent may prove that the nontaxable source did not
exist. See id.
(1) Likely Sources of Income
Respondent contends that Katherine’s palmistry business was
a likely source for the unreported income. Respondent also
contends that unreported gambling winnings were another likely
source. Additionally, respondent contends that Frank may have
unreported income from work as a real estate broker as he alleged
in certain loan applications.20
19
Although there is testimonial evidence that Katherine
made some recordations of income on tablets that she kept for
that purpose, there is no evidence that those tablets were
submitted to respondent, nor were they introduced at trial.
20
We made no findings of fact relating to the loan
applications because we find that the statements contained
therein lack trustworthiness.
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Petitioners contend that Frank and Katherine did not have
any likely source for the unreported income in the amounts
determined by respondent. Petitioners assert that Frank was
retired and seriously ill for all of the years in issue, and his
only source of income was Social Security benefits. Petitioners
further assert that Katherine’s palmistry business could not have
generated the substantial receipts needed to produce the
unreported income calculated by respondent for the years in
issue. They maintain that she was seriously ill much of that
period, and she was retired between January 1986 and August 1990
during which period her only income was Social Security benefits.
They further maintain that Frank accurately reported his gambling
winnings. As for the loan applications, petitioners argue that
the applications were prepared by third parties, and that there
is no documentary evidence to support the claim that Frank worked
as a real estate broker for the years in issue.
We believe that petitioners paint an overly dramatic picture
of Frank’s and Katherine’s health conditions for the years in
issue. In our opinion, the record does not show that Frank and
Katherine were too ill to conduct the activities that would
generate income from two of the likely sources identified by
respondent (i.e., palmistry and gambling), and we have made
findings that they did conduct those activities during the years
in issue. The testimony of Dr. Kerry M. Schwartz, M.D. (Dr.
- 52 -
Schwartz), Frank and Katherine’s cardiologist during the years in
issue, does not indicate that he advised them not to work during
those years. Rather, his records indicate that, during those
years, he recommended they undertake exercise and weight
reduction programs. Indeed, Katherine continued her palmistry
business after the period petitioners allege she was retired even
though, from Dr. Schwartz’s records, it appears she was
experiencing more severe medical problems in the later years than
she had experienced during the earlier years. The record
reveals, furthermore, that, during the years in issue, Frank and
Katherine went on gambling junkets with other family members, and
he went fishing, performed jobs around his home, and assisted
Larry and Ronnie in remodeling their properties.
Other than petitioners’ self-serving statements, there is no
support in the record for petitioners’ contention that Katherine
was retired from her palmistry business during 1986 through
August 1990. Baptiste’s testimony reveals that he merely assumed
that Katherine was retired during that period because she did not
furnish to him records of receipts for the preparation of their
tax returns. In her deposition, Katherine never testified that
she had ever retired from her business. Indeed, her testimony
shows that she was conducting readings during 1986, one of the
years petitioners’ contend she was retired. Furthermore, Lisa
Ruby’s testimony supports a finding that Katherine continued to
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read palms during 1988 and 1989 as well as 1990. The TV
commercial Katherine filmed during 1988 also gives the impression
that she continued to read palms over her entire 50-year career
as a palmist. Our review of the whole record leads us to
conclude that Katherine remained actively involved in her
palmistry business throughout all of the years in issue, and we
have so found. Katherine’s palmistry business constitutes a
likely source of funds for the unreported income.
Additionally, the record reveals that both Katherine and
Frank gambled during the years in issue. Thus, the record
supports an inference that gambling provided another likely
source for the unreported income.
Accordingly, we conclude that respondent has proved likely
sources for the unreported income for the years in issue. The
large excess of expenditures over income revealed by respondent’s
source and application of funds analysis for the years in issue
supports respondent’s determination of unreported income absent a
nontaxable source for the expenditures.
(2) Nontaxable Source
Petitioners contend that Frank and Katherine used a cash
hoard Katherine had received from her father during or before
1974 to acquire assets and pay expenditures for themselves and
for Larry, Ronnie, and Sylvia during the years in issue. They
assert that Katherine’s father gave her about $750,000 in cash
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plus gold coins and jewelry worth around $50,000 to $60,000 at
the time of transfer. Additionally, they assert that the value
of gold increased substantially over the years thereby providing
a larger available cash hoard for the years in issue. Respondent
disputes petitioners’ claim of a cash hoard. Rather, respondent
asserts that Frank and Katherine could not have had cash on hand
at the beginning of 1983 in the amounts claimed by petitioners.
We agree with respondent.
In her deposition, Katherine told conflicting stories
relating to the acquisition of a cash hoard she allegedly
received from her father. According to one of those stories, to
keep Bolita from taking Edward’s money while he was in New York
City Hospital to have his leg amputated, Katherine and her
brother Jack21 went to Edward’s safe deposit box at Chase
Manhattan Bank and removed cash totaling $750,000 (in nothing
less than $100, $500, and $1,000 dollar bills), plus gold coins
and jewelry worth at the time between $50,000 to $60,000.
According to that story, Katherine returned to her home in
Florida with the cash, gold coins, and jewelry carried in a gypsy
pillowcase, and she kept Edward’s property in her home in
Callahan, Florida, and later in Longwood, Florida, or in a safe
21
Petitioners did not offer any evidence from Jack
relating to Edward’s cash hoard or explain why Jack was
unavailable. Katherine testified in her deposition both that
Jack had died 6 or 7 years before the deposition, and that he was
living in an unknown location in England.
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deposit box with a bank in Longwood, Florida. Purportedly,
Katherine used some of the money to build her home in Longwood,
Florida; she gave Larry some of it to buy cars, jewelry, and his
properties in Callahan, Florida, Sanford, Florida, and Daytona
Beach Shores, Florida; she gave Ronnie and Sylvia some of the
money to buy cars, jewelry, and their homes; she spent some of it
for vacations and to pay living expenses of Larry, Ronnie, and
Sylvia; Jack White stole some of the money; and Chuck’s son also
stole some it. Additionally, Katherine stated that she sold some
of the jewelry to other gypsy women; she gave some of it away to
her relatives; and Chuck’s son also stole some of the jewelry.
In another version of the cash hoard story, Edward came to
live with Katherine after Mary’s death, and he stayed with
Katherine for 6 or more years. Allegedly, Edward gave Frank and
Katherine $750,000 sometime before he came to live with them
because he did not want Joe to take his money.22 Katherine
purportedly used the cash in the same manner as described above.
Katherine further testified that her father gave her all of his
and her mother’s jewelry and, under threat of a curse, told
Katherine not to give any of it to her siblings. We believe that
much of Katherine’s implausible and conflicting testimony
22
We know from the record that the chronology of this
story cannot be accurate. Katherine moved into the Longwood
property in 1969, Mary died on July 21, 1970, and Edward died on
Sept. 3, 1974.
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regarding Edward’s cash hoard was false or exaggerated. Our
belief is strengthened by the inconsistent testimony relating to
Edward’s cash hoard offered on deposition by three of Katherine’s
siblings.
Tina testified that while her father was in the hospital to
have his leg amputated, she and Katherine decided they needed
money to obtain better medical care for him. She also stated
that they wanted to keep Edward’s money away from Bolita. Tina
stated that she was not present when Katherine and Jack removed
Edward’s property from his safe deposit box, but she went with
them to the bank and she saw Katherine dump from a pillowcase
cash, gold coins, and jewelry on a bed in her motel room. She
alleged that the cash was in denominations of nothing less than
$500 and $1,000 dollar bills and the safe deposit box’s contents
covered Katherine’s bed. Tina stated that no one counted the
money in her presence, and that she returned to her home both
before Katherine returned to Florida and her father was
discharged from the hospital. Tina had no first-hand knowledge
as to the amount of money in Edward’s safe deposit box or the
final disposition of the box’s contents.23 Tina’s recount of the
23
Tina testified that “If Katherine said that he gave her
that money, I am sure that he did because Katherine had it in her
possession.” Tina’s conclusion that Katherine had possession of
the contents of the safe deposit box ignores the fact that Jack
and, as will be recounted, other siblings purportedly were in
Katherine’s motel room when the contents were revealed and that
(continued...)
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safe deposit story was inconsistent, tentative, and appeared to
have been scripted.
In his deposition, Joe testified that he was not present
when Katherine and Jack allegedly emptied their father’s safe
deposit box, but he saw the contents on a bed in Katherine’s
motel room. He stated that he saw only gold coins, and that, on
his urging, Katherine later returned those coins to Edward’s safe
deposit box. Joe further testified that Edward had only $1,500
at the time of his hospitalization, and that Jack asked Joe to
help pay Edward’s medical expenses.
Chuck was not present in New York City at the time Katherine
and Jack emptied Edward’s safe deposit box. Thus, he had no
first-hand knowledge as to the contents of Edward’s safe deposit
box or as to the ultimate disposition of those contents.
Although Chuck testified generally about his father’s financial
dealings and accumulation of cash, he did not quantify the amount
of money or the value of property that his father had accumulated
over his lifetime, how much money Edward had at the time of his
hospitalization, or how much of that money, if any, Edward gave
to Katherine. The objective evidence does not support Chuck’s
testimony that Edward was highly successful in his welding
business or that he dealt heavily in property and livestock.
23
(...continued)
any one of them could have assumed custody of Edward’s property
subsequent to Tina’s return home.
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Other evidence in the record leads us to conclude that
Katherine did not receive $750,000 from Edward. Edward’s and
Mary’s earnings records, property transaction records, accident
settlement information, and testimony relating to Edward’s and
Mary’s borrowing history, medical history, and life style
indicate that Edward could not have accumulated anywhere near the
$750,000 claimed by petitioners. Furthermore, Katherine
testified that Gypsies did not believe in carrying insurance, and
that neither Mary nor Edward had insurance. If that is true,
then Edward probably did not have medical insurance to pay his
medical expenses. It would follow that some of Edward’s life
savings, if any, would have been used to pay his medical
expenses. Moreover, according to gypsy custom, Edward’s money
would have gone to a son. Even if Edward had not wanted Joe to
get his money, there was no showing that he also did not want
Jack to get it. Indeed, Joe testified that Jack acquired
Edward’s interest in a land contract. We find it implausible
that Jack, who ultimately took responsibility for Edward’s
physical care after his discharge from the hospital, would permit
Katherine to appropriate all of Edward’s property at a time when
Edward was most in need of it. Yet petitioners would have us
believe that Edward willingly gave all of his property to
Katherine at a time he was experiencing extreme medical problems
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and needed funds himself.24 Accordingly, we find petitioners’
allegation that Edward gave Katherine all of his cash, gold
coins, and jewelry implausible and incredible. We are not
required to accept incredible, implausible, or biased testimony.
See, e.g., Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).
Even if we accepted Katherine’s story that Edward gave her
all of his cash, gold coins, and jewelry, which we do not, the
record contains no verification that any of it remained on hand
by the end of 1982. The record indicates that, over their
lifetimes, Frank and Katherine acquired properties and expensive
automobiles and made numerous gifts to their children and
grandchildren. Larry also acquired expensive automobiles before
the years in issue. Furthermore, the circumstances of Larry,
Ronnie, and Sylvia financing some of the cost of the properties
and vehicles (for which Frank and Katherine purportedly provided
the remaining funds) they acquired during the years in issue are
inconsistent with petitioners’ allegation that, at the beginning
of 1983, Frank and Katherine were in possession of the
substantial cash hoard they claim. See, e.g., Appendices B
through I.
24
Petitioners contend that Katherine used some of the
money from Edward’s safe deposit box to pay for his
hospitalization. That contention, however, is not supported by
the references to the record they cited.
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Accordingly, on the basis of the entire record, we find that
respondent has shown petitioners’ contention of the existence of
a $750,000 or greater25 cash hoard at the beginning of 1983 to be
inconsistent, implausible, and without objective support in the
record.
Petitioners do not contend, and the record does not suggest,
that Katherine and Frank had accumulated a substantial cash hoard
separate from Edward’s alleged accumulation. Indeed, Katherine
implied the opposite when she testified that “My husband didn’t
believe in banks. We spent it as we got it to raise the
children.” Nonetheless, on the basis of the entire record, we
believe that throughout the years Frank and Katherine maintained
a practice of keeping cash on hand (as evidenced by the amount of
cash in their home safe when Jack White burglarized their home in
1990). In our best judgment, based on the entire record, we
estimate that amount to be $30,000. See Mikelberg v.
Commissioner, 23 T.C. 342, 352 (1954), affd. per curiam 234 F.2d
25
Petitioners contend that the dramatic increase in the
price of gold substantially increased the value of the gold coins
and jewelry that Katherine received from her father; thus, that
increased the amount of the available cash hoard. Even if we had
accepted Katherine’s cash hoard story, the record does not
establish how much of the coins and jewelry she sold or when they
were sold. In her deposition, Katherine testified that she kept
the jewelry until she was robbed in 1990, and then she gave some
away to relatives and sold some to other Gypsies. She never
testified as to when she sold the items, the number of items
sold, or the price that she received for them. Katherine made no
mention of the disposition of the gold coins.
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34 (3d Cir. 1956). We have made a finding of fact to that
effect. Except for 1990, our finding that Frank and Katherine
had $30,000 cash on hand as of January 1, 1983, does not affect
respondent’s source and application of funds analyses for the
years in issue because we also have found that the amount of cash
on hand at the beginning and end of each year in issue remained
approximately the same. Thus, since there was no net change in
the amount of cash on hand at the beginning and end of any year
in issue, that cash, in effect, constitutes neither a source nor
an application of funds for any year. See infra section I
C(7)(d) of the Opinion, however, where we discuss the effect of
our finding regarding the $30,000 cash on hand on the source and
application of funds analysis for 1990.
On the basis of the foregoing, we conclude that respondent
has established that petitioners did not utilize funds from a
nontaxable source to finance the excess applications of funds
over sources of funds for any year in issue. Consequently,
respondent has negated petitioners’ claim of a nontaxable source
for the income.
(3) Summary Relating to Existence of an Underpayment
To establish an underpayment of tax for purposes of fraud
penalties and additions to tax for fraud, respondent had to prove
an understatement of income and either establish a likely source
for that income or negate nontaxable sources for the income. See
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United States v. Massei, 355 U.S. 595 (1958) (per curiam);
Holland v. United States, 348 U.S. 121, 137-138 (1954); United
States v. Smith, 890 F.2d 711, 714 (5th Cir. 1989). We have
concluded that respondent has proved likely sources for the
unreported income and negated petitioners’ claimed nontaxable
source for those excess applications of funds. Respondent’s
negation of a nontaxable source combined with petitioners’
concessions relating to items reflected in respondent’s source
and application of funds analyses for Frank and Katherine, Larry,
Ronnie, and Sylvia establish that Frank and Katherine omitted
income for each year in issue. Each omission of income resulted
in a deficiency in tax; Frank and Katherine’s omissions of income
over the years in issue, thus, clearly and convincingly establish
underpayments of tax for 1983 through 1990.26 See, e.g., Biaggi
v. Commissioner, T.C. Memo. 2000-48, affd. in unpublished opinion
__ F.3d __ (2d Cir. 2001).
Accordingly, we hold that respondent has satisfied the first
element of establishing fraud by showing through clear and
convincing evidence that Frank and Katherine had underpayments of
tax for each of the years in issue. We next address whether
26
However, see infra sec. I.C. of this Opinion wherein we
discuss various adjustments we have made to the source and
application of funds analyses for purposes of deciding the amount
of understated income for each year in issue.
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respondent has fulfilled the second element of fraud which is
intent to evade taxes.
(b) Intent to Evade Taxes
Intent to conceal or mislead may be inferred from a course
or pattern of conduct. See Spies v. United States, 317 U.S. 492,
499 (1943); Petzoldt v. Commissioner, 92 T.C. at 699 (1989);
Stone v. Commissioner, 56 T.C. 213, 223-224 (1971); Otsuki v.
Commissioner, 53 T.C. 96, 105-106 (1969). The courts have relied
upon a number of indicia, or badges, of fraud in deciding whether
an underpayment of tax is due to fraud. See, e.g., Bradford v.
Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986), affg. T.C.
Memo. 1984-601; Clayton v. Commissioner, 102 T.C. 632, 647
(1994); Petzoldt v. Commissioner, supra at 700. Although no
single factor is necessarily sufficient to establish fraud, the
existence of several factors constitutes persuasive
circumstantial evidence of fraud. See, e.g., Petzoldt v.
Commissioner, supra.
Consistent failure to report substantial amounts of income
over a number of years is, standing alone, highly persuasive
evidence of fraudulent intent. See, e.g., Kurnick v.
Commissioner, 232 F.2d 678, 681 (6th Cir. 1956), affg. per curiam
T.C. Memo. 1955-31. Consistent use of cash, and failure to
maintain adequate books and records also constitute badges of
fraud. See, e.g., Bradford v. Commissioner, supra at 307-308.
- 64 -
Giving false, misleading, and inconsistent testimony is another
badge of fraud. See, e.g., Kim v. Commissioner, T.C. Memo. 2000-
83. Failure to cooperate with revenue agents during the audit
phase of a case is an additional indication of guilty knowledge
on a taxpayer’s part. See Profl. Servs. v. Commissioner, 79 T.C.
888, 932-933 (1982). Concealing assets also indicates fraudulent
intent. See Spies v. United States, 317 U.S. at 499. In
determining fraudulent intent, courts also have considered a
taxpayer’s level of education and his or her prior history of
filing Federal income tax returns. See, e.g., Stoltzfus v.
United States, 398 F.2d 1002, 1004 (3d Cir. 1968).
Respondent contends that the following indicia of fraud are
present in the instant cases: Failing to report substantial
amounts of income, failing to maintain records, dealing
exclusively in cash, failing to voluntarily file tax returns,
concealing transactions through fraudulent conveyances, and
failing to cooperate in the examination. In addition, respondent
asserts that the lack of credibility of petitioners and their
witnesses is another indicium of fraud.
(1) Pattern of Underreporting Substantial Amounts of
Income
Respondent contends that the source and application of funds
analysis for Frank and Katherine shows that they consistently and
substantially understated their income for at least 8 years.
Petitioners contend that Frank and Katherine reported their
- 65 -
correct income for each year in issue. They maintain that
neither Frank nor Katherine was capable of generating the kind of
income determined by respondent for the years in issue.
We agree with respondent that the substantial
understatements of income we found for the years in issue are a
strong indication of fraudulent intent. From each of the years
1983 through 1990, Frank and Katherine failed to report a
substantial amount of income. The record does not support a
finding that neither Frank nor Katherine could generate the
unreported income in issue. Katherine maintained her palmistry
business throughout the years in issue, and she and Frank
frequently engaged in gambling activities. The pattern of
underreporting substantial amounts of income over a period of 8
years leads to a strong inference of fraudulent intent.
(2) Lack of Records
Respondent contends that Frank and Katherine failed to
provide respondent with whatever records they maintained and
provided to their tax preparer. Respondent contends that the
following circumstances negate any attempt by petitioners to
assert that neither Katherine nor Frank could keep records: Both
Frank and Katherine could write numbers; Frank could add numbers;
Katherine could add a column of numbers and count money; she
could figure the cost of her advertising spots; and she kept a
writing tablet to record receipts.
- 66 -
Petitioners contend that Katherine kept records of daily
receipts and bills and delivered them to Baptiste for preparation
of the tax returns, but they are no longer available due to the
passage of time. Petitioners maintain that Katherine did the
best she could, but her ability to keep records was limited
because of her lack of education, illiteracy, lack of
sophistication, and poor health. Petitioners, however, do not
explain why no records were presented to respondent for any year
in issue during the course of the audit which commenced in 1991.
We agree with respondent that the record does not support a
finding that Frank or Katherine was incapable of keeping records
during the years in issue. They did present at least some
records to their tax preparer. Moreover, Sylvia lived with them
for most of that time, and she performed bill-paying services for
them. Petitioners do not explain why Sylvia also could not have
maintained their records while she lived with them. The
circumstances of the large understatements of income over the
years in issue show that Frank and Katherine failed to maintain
adequate records of income and expenses. Their lack of
recordkeeping, coupled with a clear pattern of underreporting
substantial amounts of income over a period of 8 years, leads to
a particularly strong inference of fraudulent intent.
- 67 -
(3) Filing History
Respondent contends that Frank and Katherine’s failure to
file Federal income tax returns for 1986, 1987, and 1988 until
contacted by Revenue Office Budde and their failure to file gift
tax returns for any year in spite of vast amounts of gift giving
to family members each year are indicia of fraud. Petitioners
maintain that Frank and Katherine were not required to file
returns for 1986 through 1988 because their income for those
years did not meet the threshold income requirement. Petitioners
do not explain why Frank and Katherine did not file gift tax
returns to report the gifts they gave their children and
grandchildren during the years in issue.
Frank and Katherine filed timely income tax returns for some
of the years in issue, which shows that they understood their
obligation to file returns and pay tax. We agree with respondent
that the circumstance of Frank and Katherine’s not filing income
tax returns for 1986 through 1988 even though Katherine continued
to operate her business during those years is another indicium of
fraudulent intent. Additionally, we agree that Frank and
Katherine’s failure to file gift tax returns relating to the
substantial gifts they made to their children and grandchildren
during those years also indicates an intent to conceal and
mislead.
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(4) Dealings in Cash
Respondent contends that the fact that Frank and Katherine
dealt exclusively in cash is another indicium of fraud.
Petitioners contend that Frank and Katherine always conducted
their transactions in cash because they were illiterate and
because they learned the practice of using cash from their
parents. Respondent maintains, however, that only self-serving
evidence indicates that Frank and Katherine dealt in cash because
of illiteracy. Respondent contends that Frank and Katherine
could have used a checking account system as evidenced by the
facts that they obtained mortgages and loans, had competency in
adding numbers, could keep some records, could sign their names,
and could read and write to some degree.
There is no evidence that Frank and Katherine could not have
used banks to deposit receipts and pay expenditures. Nor do
petitioners explain why Sylvia did not maintain a checking
account system for Frank and Katherine while she lived with them.
Frank and Katherine made numerous and substantial cash
expenditures for real property and luxury automobiles. We agree
with respondent that their extensive use of cash for those types
of expenditures supports a reasonable inference that Frank and
Katherine knowingly and willfully attempted to conceal taxable
income.
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(5) Concealing Transactions
Respondent contends that Frank’s and Katherine’s dealings in
cash and their failure to file any gift tax returns enabled them
to conceal transfers of property from respondent until long after
those transactions occurred. Respondent asserts that the
concealment of assets is another indicium of fraud.
Petitioners assert that there is no evidence that Frank or
Katherine concealed any of the gifts they made to Larry, Ronnie,
and Sylvia. Petitioners, however, do not allege that Frank or
Katherine filed gift tax returns for the substantial gifts they
admittedly gave to their children and grandchildren during the
years in issue, nor do petitioners explain why Frank or Katherine
failed to file gift tax returns relating to those gifts.
Petitioners further assert that the fact that Frank and Katherine
purchased assets for Larry, Ronnie, and Sylvia that were easy to
trace (such as real estate and automobiles) shows that Frank and
Katherine did not intend to conceal any transfers. Petitioners
apparently overlook the fact that for the most part Frank and
Katherine gave Larry, Ronnie, and Sylvia cash to purchase those
assets, many of which were titled solely in Larry’s, Ronnie’s,
and Sylvia’s names thereby making it difficult to trace the cash.
We agree with respondent that Frank and Katherine tried to
conceal their unreported income by giving Larry, Ronnie, and
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Sylvia cash or by placing assets in their names. That conduct is
evidence of fraudulent intent.
(6) Failure To Cooperate with Respondent
Respondent asserts that petitioners failed to cooperate with
respondent’s agents during the examination of their returns.
Respondent maintains that petitioners’ justification for their
lack of cooperation (i.e., that in 1990 or 1991 respondent’s
revenue agent referred to all Gypsies as crooks), does not
provide a basis for failing to cooperate.
Petitioners, however, maintain that respondent is attempting
to attribute the actions of Larry and Baptiste to Frank and
Katherine. They contend that there is no evidence that Frank and
Katherine failed to cooperate with respondent’s agents during the
course of the examination of their returns, or that Katherine
made false or misleading statements to respondent’s revenue
agents. Petitioners maintain that the only employee of
respondent who requested records from Frank and Katherine was
Revenue Officer Budde, and that request related to a delinquent
filing investigation of their 1986 through 1988 returns.
Petitioners contend that Frank and Katherine cooperated with
Revenue Officer Budde by filing returns for those years even
though they were not required to file them because of the income
threshold requirements.
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We agree with petitioners that there is no evidence that
either Frank or Katherine failed to cooperate with respondent’s
revenue agents regarding the examination of their returns for the
years in issue. Agent Combs never interviewed Frank or Katherine
in the course of that examination. It also appears that
respondent’s revenue agents never requested verification for
items reflected on Frank and Katherine’s returns for the years in
issue. Rather, the adjustments to their returns resulted from
statements Katherine made during a deposition she gave relating
to docket No. 20854-94 to the effect that she and Frank furnished
funds to Larry, Ronnie, and Sylvia to purchase assets and pay
expenditures in excess of their incomes. Under those
circumstances, we find that the factor of cooperation supports
neither party’s position.
(7) Credibility of Witnesses
Petitioners assert that Katherine made no false or
misleading statements to respondent’s revenue agents. Moreover,
petitioners contend, respondent did not rebut Katherine’s cash
hoard testimony, which they assert was corroborated by
Katherine’s siblings. Respondent, on the other hand, contends
that petitioners and their witnesses offered inconsistent, vague,
unsupported, and self-serving testimony commencing with the
examination and continuing through trial.
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We found Katherine’s and her siblings’ testimony conflicting
and implausible for the most part. We agree with respondent that
Katherine’s highly implausible and incredible story of receiving
a substantial cash hoard from her father is another indication of
fraudulent intent.
(8) Level of Education, Age, and State of Health
Petitioners contend that Frank and Katherine had no formal
education and were illiterate. Additionally, petitioners contend
that during the years in issue Frank and Katherine were elderly,
unsophisticated, and suffering from serious illnesses.
Petitioners assert that Frank and Katherine relied on their
accountant to prepare their returns because of their lack of
education. Petitioners, in effect, argue that those factors
negate any inferences of fraud on the part of Frank or Katherine.
Under the circumstances here presented, we do not agree with
petitioners’ position that Frank’s and Katherine’s lack of formal
education, illiteracy, age, lack of sophistication, or health
negate inferences of fraud. Although Frank and Katherine may
have had no formal education, they do not appear from the record
to have lacked business acumen or sophistication. Dr. Schwartz
described Katherine as a bright woman and sharp most of the time.
Katherine ran a successful palmistry business for more than
50 years. The circumstance that Katherine kept some records
relating to her business that she gave to Baptiste for the
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preparation of the tax returns shows that she was aware of the
requirements to report income. Frank purchased a number of
expensive vehicles over the years and paid for Larry’s, Ronnie’s,
and Sylvia’s acquisitions of property and vehicles. He applied
for loans and mortgages. The record does not show that Frank’s
and Katherine’s age and health conditions affected their mental
capacity. Thus, the record does not demonstrate that Frank’s and
Katherine’s lack of formal education, age, or health conditions
prevented them from being aware that they were required to report
all of their income. Accordingly, we conclude that the factors
raised by petitioners do not negate the inferences of fraud
raised by the other badges of fraud present in the instant cases.
(9) Summary Regarding Intent
On the basis of the foregoing, we conclude that for each
year in issue respondent has proven through clear and convincing
evidence that Frank and Katherine intended to evade taxes they
knew or believed were owed.
c. Conclusion Regarding Fraud and Statute of
Limitations
We have considered the other arguments raised by petitioners
in their briefs but find them to be without merit. On the basis
of the foregoing, we hold that for each year in issue respondent
has proven, by clear and convincing evidence, an underpayment of
tax and that some portion of the underpayment was attributable to
fraud. Accordingly, the fraud exception to the statute of
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limitations applies for each year in issue; therefore, the
statute of limitations does not bar respondent from assessing tax
liability against Frank and Katherine for any year in issue. See
sec. 6501(c). Since we have found fraud for all of the years in
issue, we need not address whether the 6-year period of
limitations under section 6501(e) applies for 1990. We next
address the question of the amount of income Frank and Katherine
omitted from their income for each of the years in issue.
C. Amount of Understatement of Income
Respondent contends that the source and application of funds
analyses, as adjusted and set forth infra in Appendix A, properly
show the amount of income Frank and Katherine understated for all
years in issue. Petitioners contend, on the other hand, that
respondent’s source and application of funds analyses for Frank
and Katherine, Larry, Ronnie, and Sylvia are faulty.
Agent Combs never interviewed Frank or Katherine about the
source and application of funds analyses he performed for the
years in issue. To a large extent, in calculating their
applications of funds for the years in issue, Agent Combs relied
upon source and application of funds analyses he performed for
Larry, Ronnie, and Sylvia for the years in issue, information he
gathered regarding specific asset purchases, Bureau of Labor
Statistics (BLS) estimates of annual expenditures, and
Katherine’s deposition statement that during the years in issue
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she and Frank gave Larry, Ronnie, and Sylvia funds to purchase
assets and to pay their personal living expenses. Both Frank and
Katherine were deceased by the time of trial.
Petitioners have the burden of proving that respondent’s
determinations as to the amount of the understated income are
incorrect. Rule 142(a). The parties have agreed as to the
amounts reflected on the source and application of funds analyses
for Frank and Katherine, Larry, Ronnie, and Sylvia set forth
infra in Appendices A through I except as noted therein.
Consequently, we focus primarily on the items that the parties
have identified as in dispute. There are a few additional items
in the source and application of funds analyses, however, which
we believe from the record also need to be addressed. Those
items also are discussed below.
1. Adjustments to BLS Figures
Because of the absence of specific information relating to
the Johnson family’s personal living expenses, in the source and
application of funds analyses for Frank and Katherine, Larry,
Ronnie, and Sylvia, respondent used data from Table 4 of the
Bureau of Labor Statistics Consumer Expenditure Survey for each
year in issue to calculate personal living expenditures.
Petitioners contend that respondent’s use of the BLS tables is
flawed because those tables do not accurately reflect Frank and
Katherine’s lifestyle. Petitioners assert that respondent did
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not account for the circumstances that the Johnson family members
frequently lived and dined together in a communal lifestyle
typical of their gypsy heritage; Frank and Katherine were not
able to drive but relied on Larry, Ronnie, and Sylvia for their
transportation; they were illiterate; they did not own life
insurance; and they did not participate in a retirement plan.
Additionally, petitioners contend that, in the source and
application of funds analysis for Sylvia, respondent failed to
adjust the BLS amounts to reflect that she lived with Frank and
Katherine for the years 1985 through August 1990.
Under certain circumstances, courts have found reasonable
respondent’s use of data compiled by the BLS to reconstruct
income or to estimate personal living expenses. See, e.g.,
Pollard v. Commissioner, 786 F.2d 1063, 1066 (11th Cir. 1986),
affg. T.C. Memo. 1984-536; Giddio v. Commissioner, 54 T.C. at
1532. The rationale for use of BLS data is that “[w]here * * *
there is evidence of taxable income but no information can be
acquired to ascertain the amount of such income, we do not think
it is arbitrary for the Commissioner to determine that the
taxpayer had income at least equal to the normal cost of
supporting his family.” Giddio v. Commissioner, supra at 1533.
Unquestionably, the Johnson family members incurred personal
living expenses during the years in issue. Frank and Katherine
did not maintain checking accounts or provide to respondent other
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records relating to their expenditures for the years in issue.
Consequently, in the absence of records, we find reasonable
respondent’s use of BLS data to estimate personal living expenses
for the Johnson family. Petitioners offered no proof rebutting
respondent’s position that, with certain adjustments, Frank and
Katherine, Larry, Ronnie, and Sylvia must have incurred personal
living expenses during the years in issue at least equal to the
amounts reflected in the BLS tables. See Pollard v.
Commissioner, supra. Nonetheless, we agree with petitioners that
additional adjustments to the BLS figures are necessary.
We do not agree with petitioners that the Johnson family
lived together in a communal lifestyle. Although they may have
come together often for meals and vacations, Larry maintained his
own residence during all of the years in issue, Ronnie maintained
his own residence from 1985 through 1990, and Sylvia maintained
her own residence from August through December 1990. Thus, we
agree that personal living expenses should be calculated
separately for Larry, Ronnie, and Sylvia, at least for the
periods they maintained separate households.
Thus, we find reasonable respondent’s methodology of
calculating separately personal living expenses for Larry for all
of the years in issue and for Ronnie for 1985 through 1990.
However, we believe that personal living expenses should be
deleted from Ronnie’s source and application of funds analyses
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for 1983 and 1984 inasmuch as he lived with Frank and Katherine
during those years. The personal living expenses for Frank and
Katherine should be adjusted correspondingly to include Ronnie as
a member of their household for 1983 and 1984.27 As for Sylvia,
she lived with Frank and Katherine until August 1990 at which
time she established her own residence. Accordingly, personal
living expenses should be deleted from Sylvia’s source and
application of funds analyses for 1985 through July 1990, and the
personal living expenses for Frank and Katherine should be
adjusted to include Sylvia (as well as Jack Miller and Nicole, as
appropriate) as members of their household for those years.28
As for petitioners’ contention that adjustments to
transportation items included in the BLS average annual
expenditure figures should be made in addition to vehicle
acquisition costs, except for one item (public transportation),
we do not agree because the record reflects that Frank acquired
vehicles before and during the years in issue. The record does
27
Although Ronnie lived with Frank and Katherine for part
of 1985, we make no allocation for that year because the record
shows that he established his own residence in February 1985, and
we believe that any adjustment for 1 month would be nominal.
28
Although the record shows that Jack Miller moved into
the Longwood property in late 1986, we do not include him as a
member of Frank and Katherine’s household for 1986 because the
record does not show exactly when he moved into the Longwood
residence. Additionally, although the record shows that Sylvia’s
daughter was born in 1988, we do not include her as a member of
Frank and Katherine’s household for 1988 because the record does
not show exactly when she was born.
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not show that Frank did not drive or maintain those vehicles
during the years in issue. However, we believe that public
transportation figures should be deleted from the BLS figures for
all of the Johnson family members because we do not believe that
they would use public transportation in light of the number and
kinds of vehicles they acquired before and during the years in
issue.
As for personal insurance and pension figures in the BLS
figures, we agree with petitioners that those items should be
deleted for all Johnson family members on the basis of
Katherine’s testimony that they did not believe in carrying
insurance. In addition, we think that reading, education, and
tobacco figures should be deleted for Frank and Katherine because
of their ages, illiteracy, and health conditions. As for Ronnie
and Sylvia, we believe that education figures should be deleted
for them because of their ages and schooling history.
Accordingly, we hold that adjustments to the BLS figures are
needed in accordance with the above. See infra Appendix J for
revised personal living expenses for Frank and Katherine, Larry,
Ronnie, and Sylvia reflecting those adjustments.
2. Adjustment for Specific Gift
Petitioners contend that, for 1990, respondent failed to
credit either Larry or Ronnie with a $43,101 specific gift that
is charged to Frank and Katherine as an application of funds for
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that year. See infra Appendices (A), (I). Petitioners maintain
that the gift consisted of a deposit of $43,101 which Frank and
Katherine made into a joint account in Larry’s and Ronnie’s
names.
Respondent maintains that no adjustment is required in
Larry’s or Ronnie’s source and application of funds analyses to
account for the $43,101 gift because there is no evidence that
any of the money in the account was withdrawn during that year.
Thus, respondent maintains, the $43,101 gift would have no impact
on the source and application of funds analysis for Larry or
Ronnie because the gift would be both a source of funds upon its
transfer to the account and an application of funds at the close
of the year in an equal amount. We agree with respondent that no
adjustment is required for this item because petitioners did not
show a net change in the bank account balance, and we hold
accordingly.
3. Adjustment for Proceeds of Automobile Transactions
Petitioners assert that respondent failed to credit Frank
and Katherine with the proceeds from at least three automobiles
that Frank sold or traded during the years in issue. See infra
Appendix A. Respondent maintains that no adjustment is needed
for the proceeds of the three alleged automobile transactions
because the record does not establish that those transactions
occurred nor do petitioners quantify the trade-in value or sales
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proceeds they claim Frank received for those vehicles. We agree
with respondent that petitioners have not established in the
record that the transactions occurred, or, if they did occur, the
amount of trade-in allowance or sales proceeds received.
Statements in briefs are not evidence, and they cannot be used as
such to supplement the record. See, e.g., Rule 143(b);
Niedringhaus v. Commissioner, 99 T.C. 202, 214 n.7 (1992). Thus,
we agree with respondent that no adjustment is required for
additional proceeds from automobile transactions, and we hold
accordingly.
4. Adjustments for Larry’s Audit Results
Petitioners contend that respondent failed to adjust Larry’s
source and application of funds analyses for 1989 and 1990 to
account for unreported income he agreed to include in his income
for those years pursuant to the settlement of docket No. 20854-
94. See infra Appendices (H), (I). Petitioners assert that an
adjustment to Larry’s source and application of funds analyses
for unreported income for 1989 and 1990 would result in a
corresponding reduction to the $38,018 and $43,404 “gifts to
Larry” respondent included as applications of funds by Frank and
Katherine for those years. Respondent asserts that an adjustment
to Larry’s source and application of funds analyses for 1989 and
1990 for unreported income cannot be made because the record does
not show to what extent, if any, the settlement related to any
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issue in the instant cases because unreported income was only one
of several adjustments involved in docket No. 20854-94.
We agree with petitioners that an adjustment to Larry’s
source and application of funds analysis is needed for 1989 and
1990 to account for the compromise settlement of docket No.
20854-94. However, we do not agree with petitioners as to the
amounts to be added as sources of funds for those years. The tax
deficiencies Larry and Nancy ultimately agreed to for those years
($7,140 for 1989 and $6,606 for 1990) are less than the tax
deficiencies set forth in the notice of deficiency ($13,317 and
$16,461, respectively). Thus, it is apparent that not all of the
total adjustments to income set forth in the notice of deficiency
($44,566 for 1989 and $53,012 for 1990) were included in income
in the compromise settlement. See supra note 12. According to
our calculations, Larry and Nancy agreed to 53.6 percent of the
deficiency proposed for 1989 ($7,140 divided by $13,317) and 40.1
percent of the deficiency proposed for 1990 ($6,606 divided by
$16,461). Thus, using our best judgment, applying those
percentages to the total proposed adjustments to income for those
years, we hold that Larry’s sources of funds for 1989 and 1990
should be increased by $23,887 and $21,261, respectively. See
Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir. 1930).
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5. Adjustment for Sylvia’s Gambling Expenditures
Petitioners maintain that gambling expenditures included in
Sylvia’s source and application of funds analyses for 1987
through 1989 should be eliminated because respondent did not
substantiate those items at trial. See infra Appendices F
through H. Respondent maintains that Sylvia’s source and
application of funds analyses are correct. Respondent asserts
that petitioners agreed to these gambling expenditures in
proposed joint findings of fact No. 4. In addition, respondent
states that the record establishes that Sylvia went on one or two
gambling vacations each year, and that she participated in
gambling activities.
Joint findings of fact No. 4 states as follows: “The
parties agree that the figures shown in black are the items of
the source and application of funds analysis for which the
parties are in agreement and in red for which the parties are not
in agreement.” The gambling expenditures to which petitioners
now take exception were shown in black on respondent’s Appendix
5. We take the statements in joint findings of fact No. 4 to
represent a concession by petitioners that Sylvia incurred the
gambling expenditures in the amounts stated. Cf. Hodges v.
Commissioner, 50 T.C. 428, 434, 435 n.2 (1968) (certain
statements in respondent’s brief found to be a concession);
Armour v. Commissioner, 41 B.T.A. 777, 795 (1940) (statement in
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taxpayer’s brief found tantamount to concession), affd. 125 F.2d
467 (7th Cir. 1942); Water Resource Control v. Commissioner, T.C.
Memo. 1991-104 (statements at trial and on opening brief deemed
concession of interest deductions claimed on returns), affd.
without published opinion sub nom. Whitehouse v. Commissioner,
972 F.2d 1328 (2d Cir. 1992). Nothing in the record contradicts
that concession. Accordingly, we hold that no adjustment is
required in Sylvia’s source and application of funds analysis for
gambling expenditures.
6. Additional Items Identified as in Dispute
The parties have identified the following items through
joint finding of fact No. 4 as items to which they do not agree.
a. Withholding on Gambling Winnings
In the source and application of funds analysis for Sylvia
for 1988, see infra Appendix G, respondent included as an
application of funds $345 for estimated withholding on gambling
winnings. Petitioners do not explain why they disagree with that
item. In the source and application of funds analysis for 1988,
respondent credited Sylvia with $38,550 in winnings from gambling
activities on December 23, 1988. Petitioners do not disagree
with that item. We conclude that an estimated $345 withholding
at source is reasonable considering the amount of Sylvia’s
gambling winnings on December 23, 1988; accordingly, we hold that
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no adjustment is required for that item in Sylvia’s source and
application of funds analysis for 1988.
b. Birthing Costs for Nicole
In the source and application of funds analysis for Sylvia
for 1988, see infra Appendix G, respondent included as an
application of funds $2,500 for birthing costs for Nicole
Johnson, Sylvia’s daughter. In an affidavit dated November 15,
1995, Sylvia stated that Frank and Katherine paid her medical
bills relating to Nicole’s birth. Respondent does not explain
how the $2,500 was derived other than by estimation. Petitioners
do not explain why they disagree with this item. The record
indicates that Nicole was born in 1988, but it does not show the
amount of medical expenses attributable to her birth nor when
those expenses were paid. On the basis of the foregoing, we
conclude that it is not reasonable to include $2,500 birthing
costs as an application of funds in Sylvia’s source and
application of funds analysis for 1988; accordingly, we hold that
Sylvia’s applications of funds for 1988 should be reduced by
$2,500.
c. Estimated Tax Payments
In the source and application of funds analysis for Ronnie
for 1988, see infra Appendix G, respondent included as an
application of funds $1,500 for estimated tax payments made
during 1988. Ronnie’s tax return for 1988 shows $3,000 estimated
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tax payments made during 1988. Respondent does not explain why
$1,500 is used instead of $3,000. Petitioners do not explain why
they disagree with this item. Statements in tax returns
constitute admissions unless overcome by cogent evidence that
they are wrong. See, e.g., Waring v. Commissioner, 412 F.2d 800,
801 (3d Cir. 1969), affg. per curiam T.C. Memo. 1968-126. On the
basis of the foregoing, we conclude that respondent’s use of
$1,500 for estimated tax payments is reasonable; accordingly, we
hold that no adjustment for that item is required in Ronnie’s
source and application of funds analysis for 1988.
d. Tax Payment
In the source and application of funds analysis for Ronnie
for 1988, see infra Appendix G, respondent included as an
application of funds $5,319 for 1987 tax payments. Ronnie’s tax
return for 1987 shows zero tax payments made during 1987 and a
tax due of $5,216. Respondent does not explain why $5,319 is
used instead of $5,216. Petitioners do not explain why they
disagree with this item. On the basis of the foregoing, we
conclude that a charge for 1987 tax payments is reasonable; we
hold, however, that the amount for that item should be $5,216.
e. Wedding Ceremony for Sylvia
In the source and application of funds analysis for Frank
and Katherine for 1989, see infra Appendix A, respondent included
as an application of funds $10,000 for a wedding ceremony for
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Sylvia. Respondent does not explain how that amount was derived
other than by estimation. Petitioners do not explain why they
disagree with that item. The record shows that Sylvia married
Jack Miller during 1987. Although Katherine testified that she
paid for the weddings of her grandchildren, the record does not
show how much she paid for Sylvia’s wedding ceremony or when it
was paid. Furthermore, the record does not reflect what bride
price Jack Miller, through gypsy custom, would have paid to Frank
and Katherine for Sylvia. On the basis of the foregoing, we
conclude that it is not reasonable to include $10,000 wedding
ceremony costs as an application of funds in Frank and
Katherine’s source and application of funds analysis for 1987 or
1989; accordingly, we hold that their applications of funds for
1989 should be reduced by $10,000 to account for this item.
f. Detective Expenses
In the source and application of funds analysis for Frank
and Katherine for 1990, see infra Appendix A, respondent included
as an application of funds $7,000 paid to Dennis Dayle for
detective expenses. We have found that their daughter Janie and
Frank hired Dayle and that Frank paid Dayle $7,000 in 1990.
Petitioners question Dayle’s credibility, but they did not
introduce any proof showing that his testimony was inaccurate.
Although we may question Dayle’s ethics in working for both Janie
and her ex-husband, we do not find Dayle’s testimony regarding
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this item to be incredible as it comports with Frank and
Katherine’s lifelong practice of paying expenses for their
children. Janie did not testify at trial; therefore, there is no
evidence that she paid Dayle’s expenses. The failure of a party
to introduce evidence that is within his or her control gives
rise to a presumption that the evidence, if provided, would be
unfavorable to the party who has control over the evidence. See
Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165
(1946), affd. 162 F.2d 513 (10th Cir. 1947). On the basis of the
foregoing, we conclude that respondent’s charge of $7,000 for
detective expenses is reasonable; accordingly we hold that no
adjustment for that item is required in Frank and Katherine’s
source and application of funds analysis for 1990.
g. Janie’s Living Expenses
In the source and application of funds analysis for Frank
and Katherine for 1990, see infra Appendix A, respondent included
as an application of funds $6,000 paid for room and board for
their daughter Janie and her children. The record does not
establish whether Frank or Janie paid those expenses. Dayle
testified that Frank told him he paid Janie’s expenses. Dayle,
however, did not have any first-hand knowledge regarding who
actually paid the expenses. Petitioners question Dayle’s
credibility. Larry testified that Frank and Katherine did not
pay for Janie’s expenses because she had her own money. On the
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basis of the foregoing, we conclude that it is not reasonable to
include $6,000 for Janie’s living expenses as an application of
funds in Frank and Katherine’s source and application of funds
analysis for 1990; accordingly, we hold that their applications
of funds for 1990 should be reduced $6,000 to account for this
item.
h. Duplications Regarding Johnson Limousine
In the source and application of funds analysis for Frank
and Katherine for 1990, see infra Appendix A, respondent reduced
gifts to Larry, Ronnie, and Sylvia by $46,490 to account for
duplications regarding Johnson Limousine. These adjustments are
not explained further. Petitioners do not explain why they
disagree with this item. Since the adjustment favors petitioners
and they do not explain why it should not be made in the amount
allowed by respondent, we hold that no adjustment is required for
that item in Frank and Katherine’s source and application of
funds analysis for 1990.
7. Other Adjustments
After reviewing the record and the source and application of
funds analyses for the Johnson family members for the years in
issue, we believe that the following additional adjustments are
needed to calculate excess applications of funds over sources of
funds for those years.
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a. Rental Income
Respondent has stipulated that during 1987 Larry received
$14,000 in cash as rental income for use of the Sanford Property,
and that Larry included that amount in income on his 1987 tax
return. Respondent did not include the rental income as a source
of funds for 1987. See infra Appendix F.29 Accordingly, we find
that Larry’s source of funds for 1987 should be increased by
$14,000 to account for that rental income.
b. Duplication of Rental Expenses or Mortgage
Payments
In the source and application of funds analyses for Ronnie
and Sylvia for the years in issue, respondent included as
applications of funds, among other things, business expenses
claimed on their Schedules C and amounts they paid for rent or
for mortgage payments for their residences. See infra Appendices
D through I. The record indicates that Ronnie and Sylvia
operated their businesses out of their personal residences. We
believe that respondent included the portion of the rental
expenses or mortgage payments attributable to Ronnie’s business
for 1985 through 1990 and to Sylvia’s business for 1990 twice as
29
On Appendix 5 of respondent’s opening brief, Larry’s
source and application of funds analysis for 1987 reflects as
sources of funds both “Gross Receipts-Schedule E (Rental)” of
$14,000 and “Adjustments: Return Rental Income” of ($14,000).
The ultimate result of including both sources of funds was that
respondent did not credit Larry with any rental income for 1987.
For convenience, we did not show either source of funds on
Appendix F.
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applications of funds. Accordingly, we find that the source and
application of funds analyses for Ronnie and Sylvia should be
adjusted to exclude those duplicated expenses. See infra
Appendices M and N for the amount of those adjustments.
c. Depreciation
Ronnie claimed depreciation expenses on his Schedules C for
1989 ($10,350) and 1990 ($700). In Ronnie’s source and
application of funds analysis for 1989, respondent reduced
applications of funds by the amount of depreciation claimed on
his Schedule C, but respondent made no adjustment for
depreciation for 1990. See infra Appendices H and I. Respondent
did not explain why depreciation was not excluded from
applications of funds for 1990. We believe that the adjustment
should be made, and accordingly hold that Ronnie’s application of
funds analysis for 1990 should be reduced by $700 to account for
this item.
d. Cash and Jewelry
Respondent included $30,000 cash and $100,000 jewelry as
applications of funds in the source and application of funds
analysis for Frank and Katherine for 1990. See infra Appendix A.
Those items constitute the cash and jewelry that Frank and
Katherine reported to the police were in their safe when Jack
White burglarized their home during 1990. Respondent contends
that, if Frank and Katherine did not have the $30,000 cash and
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$100,000 in jewelry on December 5, 1989, when Revenue Officer
Budde prepared the collection statement, then Frank and Katherine
must have accumulated $30,000 cash and $100,000 in jewelry
between the date of the collection statement and the date of the
theft. Petitioners contend, however, that there is no evidence
that the cash and jewelry were accumulated between those dates.
We agree with petitioners.
On the basis of our review of the entire record, we believe
that the collection statement did not accurately list all of the
assets Frank and Katherine owned as of December 5, 1989. We have
made a finding of fact that Frank and Katherine had cash on hand
of approximately $30,000 as of January 1, 1983, and that
throughout the years in issue Frank and Katherine kept
approximately $30,000 cash on hand at the beginning and end of
each year. Thus, there was no net change in the amount of cash
on hand during the years in issue.
In addition, we believe that Frank and Katherine accumulated
significant amounts of jewelry over their lifetimes. The record
does not establish that Frank and Katherine purchased any jewelry
during 1990. It is not clear, furthermore, that all of the
jewelry in their safe actually belonged only to Frank and
Katherine. Frank and Katherine had a lifelong practice of
gifting property, including jewelry, to their children and
grandchildren. Some of their children’s and grandchildren’s
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jewelry could have been in the safe that Jack White stole.
Therefore, we conclude that it is not reasonable to include the
$30,000 cash and $100,000 jewelry as applications of funds for
1990 merely on the circumstance that Frank and Katherine reported
their theft to the police. Accordingly, we hold that Frank and
Katherine’s applications of funds for 1990 must be reduced by
$130,000 to account for the exclusion of that cash and jewelry.
8. Summary Relating to Amount of Understatement of Income
Taking into consideration the foregoing adjustments to
respondent’s source and application of funds analyses for Frank
and Katherine, Larry, Ronnie, and Sylvia for the years in issue,
our computations show that Frank and Katherine had excess
applications of funds over sources of funds in the following
amounts:
Year Amount
1983 $80,350
1984 80,253
1985 87,757
1986 90,989
1987 145,303
1988 193,387
1989 119,017
1990 92,609
Total 889,665
See infra Appendix K for our revisions to the source and
application of funds analysis for Frank and Katherine for the
years in issue. See infra Appendices L, M, and N for our
revisions to the source and application of funds analyses for
Larry, Ronnie, and Sylvia, respectively, for those years.
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D. Capital Gain for 1989
On their return for 1989, petitioners reported the sale of
property from which they realized a long-term gain of $3,421
(sales price of $40,000 less basis of $36,579). Respondent
contends that Frank and Katherine had a short-term gain of
$23,978 ($40,000 less mortgage payoff of $11,030 and expenses of
sale of $4,989).
In their reply brief, petitioners claim that Frank and
Katherine’s daughter Patricia transferred the subject property to
them for no consideration at a time when she had an adjusted
basis in the property of at least $30,000. Petitioners contend
that she gifted the property to Frank; therefore, he had the same
basis and holding period for the property as she did.
Petitioners contend further that Frank’s adjusted basis in the
property, at a minimum, was $34,990 ($30,000 basis plus $4,990
expenses of sale). They maintain that Frank’s daughter may have
had an additional basis of $1,590 in the property which accounts
for the $36,579 basis claimed on the 1989 tax return. Respondent
asserts that petitioners have offered no evidence establishing
that Frank and Katherine had a basis of more than $11,030 in the
property they sold in 1989.
The record indicates that Frank acquired his interest in the
property by quitclaim deed from a Patricia Johnson on March 18,
1989, for no stated consideration, and that he sold that property
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2 days later by warranty deed for $40,000. The settlement
statement indicated a remaining balance on the mortgage loan of
$11,033 and sales expenses of $4,990.
Petitioners bear the burden of proof in this issue. Rule
142(a). The record, however, does not establish a filial
relationship between Frank and the Patricia Johnson who
transferred that property to Frank or the circumstances relating
to her transfer of the property to Frank during 1989. See supra
note 18. This Court does not consider statements in briefs to be
evidence. See Niedringhaus v. Commissioner, 99 T.C. 202, 204 n.7
(1992); Evans v. Commissioner, 48 T.C. 704, 709 (1967), affd. per
curiam 413 F.2d 1047 (9th Cir. 1969). Patricia did not testify
at trial; therefore, there is no proof in the record that Frank’s
daughter gifted property to him. The presumption is that her
testimony would be unfavorable to petitioners. See Wichita
Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946),
affd. 162 F.2d 513 (10th Cir. 1947). Thus, we agree with
respondent that petitioners have not shown a basis in the
property greater than the amount allowed by respondent or a
holding period greater than 2 days. Accordingly, we sustain
respondent’s determination on this issue.
E. Taxable Social Security Benefits
Respondent contends that Frank and Katherine’s taxable
Social Security income for the years in issue should be increased
as follows:
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Year Amount
1985 $1,287
1986 957
1987 1,385
1988 2,195
1989 2,796
1990 3,129
The increase in taxable Social Security income resulted from the
adjustments respondent made to Frank and Katherine’s income for
those years.
Section 86(a) provides that gross income includes a portion
of Social Security benefits received by individuals whose
(1) modified adjusted gross income increased by one-half of the
Social Security benefits received during the years (readjusted
modified adjusted gross income) exceeds (2) the base amount. See
sec. 86(a) and (b)(1). Modified adjusted gross income is
adjusted gross income without regard to Social Security benefits
and other adjustments not pertinent to these cases. See sec.
86(b)(2). The base amount for a joint return is $32,000. See
sec. 86(c). For the years in issue, the portion of Social
Security benefits included in gross income equals the lesser of
one-half of the Social Security benefit received or one-half of
the excess of the taxpayer’s readjusted modified adjusted gross
income over the base amount. See sec. 86(a)(1).
Petitioners contend that respondent’s determination was made
on the erroneous assumption that Frank and Katherine
underreported their income for the years in issue; therefore, no
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adjustment for taxable Social Security benefits is required.
Respondent agrees that the adjustment is computational. We have
found that Frank and Katherine understated their income for the
years in issue. Accordingly, Frank and Katherine’s income for
1985 though 1990 must be increased to include taxable Social
Security benefits which are to be computed in accordance with our
holdings in the instant cases.
F. Self-Employment Taxes
Respondent contends that Frank and Katherine’s self-
employment taxes should be increased as follows:
Year Amount
1983 $6,676
1984 8,542
1985 9,346
1986 10,332
1987 10,774
1988 11,718
1989 12,500
1990 15,698
Petitioners contend that no adjustment is required for this
issue.
Section 1401(a) imposes a tax on the self-employment of
every individual. Net earnings from self-employment means the
gross income derived by an individual from any trade or business
carried on by the individual, less allowable deductions
attributable to the trade or business, plus certain items not
relevant here. See sec. 1402(a). The term “trade or business”
for purposes of the self-employment tax generally has the same
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meaning as used for purposes of section 162. See sec. 1402(c).
Thus, to be engaged in a trade or business within the meaning of
section 1402(a), an individual must be involved in an activity
with continuity and regularity, and the primary purpose for
engaging in the activity must be for income and profit. See
Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). Petitioners
have the burden of proving that Frank and Katherine are not
liable for self-employment taxes. See Rule 142(a).
In the notices of deficiency, respondent determined that
both Frank and Katherine were involved in Katherine’s palmistry
business and calculated Social Security taxes for each of them.
Petitioners contend, on the other hand, that Frank never worked
or participated in the operation of the palmistry business. We
agree that the record supports petitioners’ position that Frank
was not actively involved in Katherine’s palmistry business.
Additionally, the record does not support a finding that Frank
was engaged in the trade and business of gambling even though he
may have had income from gambling during the years in issue.
Thus, we conclude that Frank did not have net earnings from self-
employment during the years in issue; therefore, he is not liable
for self-employment taxes for those years. We have found,
however, that Katherine was involved in her palmistry business
during all of the years in issue; therefore, she is liable for
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the self-employment tax for each of those years to the extent of
her net earnings from self-employment.
G. Self-Employment Deduction
For 1990, section 164(f) provides a deduction for one-half
of the taxes imposed by section 1401 for such year. Respondent
contends that petitioners are entitled to increase their self-
employment tax deduction for 1990 in the amount of $7,301.
Petitioners contend that respondent is incorrect. This item is a
computational adjustment and must be recalculated to reflect our
holding in the instant cases that Frank and Katherine understated
their 1990 income by $92,306, and that only Katherine is liable
for the self-employment tax imposed by section 1401 for that
year.
H. Married Couples Deduction
Respondent contends that Frank and Katherine are entitled to
a $3,000 married couples deduction for the years 1983 through
1986. Petitioners contends that Frank was retired for all of
those years; therefore, Frank and Katherine are not entitled to a
married couples deduction for any year in issue. We agree with
petitioners.
In the case of a joint return for 1983 through 1986, section
221 allows a deduction for two-earner married couples equal to
10 percent of the lesser of $30,000 or the “qualified earned
income” of the spouse with the lower qualified earned income for
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the taxable year. Qualified earned income is defined as an
amount equal to the excess of (a) the earned income of the spouse
for the taxable year, over (b) an amount equal to the sum of
certain deductions allowable under sect
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