The opinion
T.C. Memo. 2005-130
UNITED STATES TAX COURT
WAYNE PAYNE AND DORENE J. PAYNE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6311-03. Filed May 31, 2005.
Thomas E. Brever, for petitioners.
David W. Sorensen, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: Respondent determined deficiencies in
petitioners’ 1993, 1994, and 1995 Federal income taxes of
$29,881, $81,985, and $45,222, respectively. Respondent also
determined that petitioners were liable for fraud penalties under
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section 66631 for 1993, 1994, and 1995 of $22,410, $61,488.75,
and $33,916.50, respectively. The issues for decision are:
(1) Did respondent issue the notice of deficiency before
the expiration of the period of limitations on assessment? We
hold that petitioners filed false or fraudulent returns with the
intent to evade tax for 1993, 1994, and 1995, and consequently
there is no limitation on assessment under section 6501(c)(1);
(2) did petitioners receive $222,735 in unreported income
from HRDC Construction (HRDC), a partnership owned 100 percent by
petitioners, in 1994? We hold that they did;
(3) are petitioners entitled to deductions in excess of
those allowed by respondent in the notice of deficiency? We hold
that they are not;
(4) are unreported bank deposits of $30,953.94 in 1995
taxable to petitioners? We hold that they are;
(5) is petitioner Dorene Payne (Mrs. Payne) entitled to
innocent spouse relief under section 6015? We hold that she is
not; and
(6) are petitioners liable for the fraud penalty under
section 6663? We hold that they are liable for the fraud penalty
with respect to the unreported income they received from HRDC,
but not with respect to their unreported bank deposit income.
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code as amended, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
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FINDINGS OF FACT
Some of the facts are stipulated. The stipulation of facts,
the supplemental stipulation of facts, and the attached exhibits
are incorporated herein by this reference. At the time the
petition was filed, petitioners resided in Minneapolis,
Minnesota.
Petitioners operated HRDC as a partnership in 1993 and 1994,
and as a corporation subject to the provisions of subchapter S in
1995. HRDC was in the business of roof repair for commercial
properties. HRDC was owned during the years in issue as follows:
1993 1994 1995
Wayne Payne (Mr. Payne) 50% 50.0658% 100%
Mrs. Payne 50 49.9342 0
HRDC operated from offices in a building owned by
petitioners. During the years in issue, Mr. Payne was
responsible for HRDC’s roofing work, and Mrs. Payne worked in
HRDC’s offices. Mrs. Payne and Cari Enerson (Ms. Enerson)
maintained HRDC’s books and records. Ms. Enerson was hired by
HRDC as its bookkeeper after her graduation from high school.
Before beginning her employment with HRDC, Ms. Enerson’s work
experience consisted of waitressing.
Before HRDC received a roofing job, Mr. Payne or one of
three employees of HRDC visited a potential customer’s site and
prepared a bid for roof repair work. The bid was then sent to
the potential customer. If the customer accepted the bid, he
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would sign the bid and send it back to HRDC. The accepted bid
would then be recorded by Mrs. Payne or Ms. Enerson in a sales
journal. Typically, a customer would pay half the cost of the
job when work began on the job, and the remainder at its
completion. The payments HRDC received were supposed to be
recorded in an accounts receivable journal, but not all payments
were so recorded. Often HRDC would receive payment for jobs
recorded in the sales journal for one year in the following year.
The payments were generally recorded in the accounts receivable
journal for the year in which they were received.
During some of Mr. Payne’s or the other employees’ visits to
potential customers’ sites, small jobs would arise that could be
completed on the spot. The customers generally paid the HRDC
employee on the spot for such jobs. These small jobs were
referred to at HRDC as “extras”, and were recorded in an extras
journal. Payment for the extras was usually made by check. The
extra payments were not recorded in HRDC’s sales or accounts
receivable journals.
When HRDC received checks for its services, Mrs. Payne and
Ms. Enerson deposited certain of the checks into HRDC’s business
checking account and placed other checks in a drawer at HRDC’s
offices. For the most part, the checks that were not deposited
into HRDC’s bank account were those received in payment for the
extras. Mr. Payne or another employee of HRDC would then cash
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these checks at the Money Exchange, a check-cashing store. The
Money Exchange charged a fee of 2.5 percent of each check’s
value. HRDC’s bank did not charge a fee to deposit checks.
Generally, if an employee other than Mr. Payne had performed the
work on an extra, one-third of the payment went to that employee,
one-third of the payment went to materials, and one-third of the
payment was retained by HRDC. If Mr. Payne performed the extra,
he kept 100 percent of the payment. Occasionally, Ms. Enerson
would cash the checks and send Mr. and Mrs. Payne the cash while
they were on vacation in Florida. The amounts of the checks
cashed by Mr. Payne were not deposited into HRDC’s bank account
and were not reported as income on HRDC’s Federal income tax
returns. In 1993, Mr. Payne cashed a total of $83,623.87 in
checks at the Money Exchange. In 1994, Mr. Payne cashed a total
of $98,258.21 in checks made out to HRDC at the Money Exchange.
HRDC’s extra journal for 1994 reflects that Mr. Payne performed
extras of $45,060.50. HRDC’s extra journal for 1995 reflects
that Mr. Payne performed extras of $36,989. The extras were not
reported in HRDC’s sales journal.
Vern Gunderson (Mr. Gunderson), a tax return preparer,
prepared petitioners’ 1993 and 1994 joint income tax returns.
Mr. Gunderson also prepared HRDC’s 1993 and 1994 partnership
returns, and HRDC’s 1995 S corporation return. Tim Campion (Mr.
Campion), an accountant, prepared petitioners’ joint 1995 income
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tax return and an amended 1995 S corporation return for HRDC. On
its 1994 partnership return, HRDC elected the cash method of
accounting for tax purposes. Although it appears that the cash
method was used in 1993 and 1995 as well, HRDC’s 1993 partnership
return and 1995 S corporation return do not reflect which methods
of accounting were elected in those years.
Ms. Enerson was employed by HRDC from 1985 until April 1995.
During the time Ms. Enerson was employed by HRDC, Mr. Gunderson
was HRDC’s tax return preparer. At HRDC, part of Ms. Enerson’s
job was to gather information for Mr. Gunderson to complete the
returns. Mrs. Payne helped Ms. Enerson gather this information.
Ms. Enerson and Mrs. Payne did not provide Mr. Gunderson with any
information about the money earned from extras; they gave him
only bank records to determine HRDC’s income. Mr. Gunderson
signed HRDC’s 1995 S corporation return on March 3, 1996. Ms.
Enerson testified that she provided the information for Mr.
Gunderson to complete the 1995 return. Ms. Enerson left HRDC in
April 1995 to work for Mr. Gunderson.
After Ms. Enerson left HRDC, petitioners hired Mr. Campion
to prepare their individual 1995 return and to amend HRDC’s 1995
return. Mr. Campion signed the amended return on June 4, 1996.
Petitioners provided Mr. Campion only the original 1995 return
(prepared by Mr. Gunderson) and HRDC’s bank records to complete
the amended return. The amended 1995 return reported slightly
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less gross receipts than HRDC’s original return and claimed
approximately $9,000 more in taxes and licenses paid. Mr.
Campion testified that he amended the return to deal with payroll
tax issues only.
Because petitioners’ tax return preparers were provided only
bank deposit records to calculate HRDC’s income, HRDC did not
report income from the extras for each year in issue.
Petitioners reported flowthrough income derived from HRDC’s
reported income on their individual returns. For 1994,
petitioners reported rental income from HRDC of $23,241 but HRDC
did not report a corresponding expense.
In 1997, Mr. Payne met with respondent’s revenue agent in
connection with an audit of petitioners’ and HRDC’s 1993, 1994,
and 1995 returns. When asked about the money earned from extras,
Mr. Payne first told the revenue agent that 100 percent of the
payment for each extra was kept by the employee performing the
work. Mr. Payne also told the revenue agent that he did not know
that any of HRDC’s checks were cashed at the Money Exchange and
that his employees must have stolen the checks from HRDC.
In 2001, Mr. Payne pleaded guilty to filing a false tax
return under section 7206(1) for his 1994 individual Federal
income tax return. On April 17, 2003, respondent issued a notice
of deficiency to petitioners, determining deficiencies and civil
fraud penalties under section 6663 for 1993, 1994, and 1995. The
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deficiency determinations resulted from petitioners’ alleged
failure to report HRDC’s income from the extras and certain other
sales, as well as petitioners’ unreported bank deposits. For
1994, respondent determined that petitioners received unreported
income from HRDC of $222,735. Respondent also reduced
petitioners’ reported 1994 rental income by $23,241. The parties
have stipulated that petitioners received $64,000 in unreported
income from HRDC in 1993, and petitioners conceded that in
addition unreported taxable deposits of $3,681 were made into
petitioners’ bank account in 1993. The parties have also
stipulated that petitioners received $42,335 in unreported income
from HRDC in 1995, and, in addition, unreported deposits of
$30,953.94 were made into petitioners’ bank account in 1995. The
parties dispute, inter alia, whether petitioners underreported
their 1994 income and whether the unreported bank deposits in
1995 were taxable.
OPINION
I. Burden of Proof
The parties do not address the burden of proof.
Respondent’s revenue agent first met with petitioners in late
1997 after the start of his examination of their 1993, 1994, and
1995 returns. Because respondent’s examination of petitioners’
returns began before July 22, 1998, section 7491 does not apply.
See Internal Revenue Service Restructuring and Reform Act of
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1998, Pub. L. 105-206, sec. 3001(a), 112 Stat. 726. Respondent’s
determinations in the notice of deficiency are presumed correct,
and petitioners bear the burden of proving that respondent’s
determinations are incorrect. Rule 142(a)(1). Respondent has
the burden of proof by clear and convincing evidence with respect
to his determination of fraud. Rule 142(a).
II. Period of Limitations on Assessment
Petitioners contend that the 3-year period of limitations on
assessment in section 6501(a) expired before respondent issued
the notice of deficiency and respondent’s assessment is barred.2
Respondent argues that the period of limitations in section
6501(a) does not apply because petitioners filed false or
fraudulent returns with the intent to evade tax for the years at
issue. Sec. 6501(c)(1). Accordingly, our determination of
whether the period of limitations remains open depends on whether
petitioners committed fraud in the filing of their 1993, 1994,
and 1995 returns. The determination of fraud for purposes of
section 6501(c)(1) is the same as the determination of fraud for
purposes of the penalty under section 6663. Neely v.
2
After trial, respondent moved to amend his answer to
assert, in the alternative, that the period of limitations
remains open due to the 6-year period in sec. 6501(e).
Petitioners objected to respondent’s motion. Because we find
that petitioners committed fraud with respect to their 1993,
1994, and 1995 returns, we deny respondent’s motion as moot.
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Commissioner, 116 T.C. 79, 85 (2001); Rhone-Poulenc Surfactants &
Specialties v. Commissioner, 114 T.C. 533, 548 (2000).
Mr. Payne’s guilty plea under section 7206(1) for
intentionally filing a false return does not in itself prove that
section 6501(c) applies; respondent must show that petitioners
intended to evade tax. See Wright v. Commissioner, 84 T.C. 636,
643 (1985). For Federal tax purposes, fraud entails intentional
wrongdoing with the purpose of evading a tax believed to be
owing. See Neely v. Commissioner, supra at 86. In order to show
fraud, respondent must prove: (1) An underpayment exists; and
(2) petitioners intended to evade taxes known to be owing by
conduct intended to conceal, mislead, or otherwise prevent the
collection of taxes. See Parks v. Commissioner, 94 T.C. 654,
660-661 (1990).
A. Underpayment of Tax
Respondent must first show by clear and convincing evidence
that petitioners made an underpayment of tax in each of the years
1993, 1994, and 1995. For 1993 and 1995, petitioners have
stipulated that they underreported their income from HRDC by
$64,000 and $42,335, respectively. Petitioners testified that
the payments for extras received by Mr. Payne were not deposited
into HRDC’s bank account, and HRDC’s returns were prepared based
on the deposits to its bank account. Petitioners conceded that
they received at least one-third of the extras performed by other
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employees of HRDC and that Mr. Payne was due to receive
$45,060.50 in extras in 1994. The extras were not reported on
HRDC’s or petitioners’ 1994 returns. Therefore, petitioners made
underpayments of tax for 1993, 1994, and 1995.
B. Fraudulent Intent
Because direct evidence of fraud is rarely available, fraud
may be proved by circumstantial evidence and reasonable
inferences from the facts. Petzoldt v. Commissioner, 92 T.C.
661, 699 (1989). Courts have developed a nonexclusive list of
factors, or “badges of fraud”, that demonstrate fraudulent
intent. Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992).
These badges of fraud include: (1) Understating income, (2)
maintaining inadequate records, (3) implausible or inconsistent
explanations of behavior, (4) concealment of income or assets,
(5) failing to cooperate with tax authorities, (6) engaging in
illegal activities, (7) an intent to mislead which may be
inferred from a pattern of conduct, (8) lack of credibility of
the taxpayer’s testimony, (9) filing false documents, (10)
failing to file tax returns, and (11) dealing in cash. Id.; see
also Spies v. United States, 317 U.S. 492, 499 (1943); Recklitis
v. Commissioner, 91 T.C. 874, 910 (1988). Although no single
factor is necessarily sufficient to establish fraud, the
combination of a number of factors constitutes persuasive
evidence. Niedringhaus v. Commissioner, supra at 211.
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Respondent must prove fraud for each year at issue. See id. at
210; Ferguson v. Commissioner, T.C. Memo. 2004-90.
Petitioners argue that they did not file their returns with
fraudulent intent because they gave all of the responsibility
regarding the preparation of HRDC’s and their 1993, 1994, and
1995 returns to Ms. Enerson and their tax return preparers. They
also claim that they did not have control over HRDC’s books
because Ms. Enerson maintained them and they did not review their
returns before they were filed. We are unconvinced by
petitioners’ explanations. Petitioners rely heavily on the fact
that Mr. Payne was a high school educated roofer and did not
understand tax or business records. However, Ms. Enerson was
hired soon after graduating from high school and had no
experience as either a bookkeeper or a tax return preparer.
Petitioners claim they had no knowledge of what Ms. Enerson
provided to Mr. Gunderson for the preparation of their returns.
The record does not support petitioners’ claim. Petitioners met
with Mr. Gunderson when they hired him and discussed the relevant
aspects of the business. During this initial meeting, Mr.
Gunderson asked if all the money from the business went into the
bank accounts. Mr. Payne told him it did. As a result, Mr.
Gunderson used only HRDC’s bank records, which did not accurately
reflect HRDC’s income, to complete the returns. Because
petitioners gave Mr. Campion the 1995 return prepared by Mr.
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Gunderson and the bank records, the 1995 amended return also
reported an incorrect amount of income.
In addition, Ms. Enerson credibly testified that she felt
there was an understanding between herself and petitioners that
she should not provide the information regarding income from the
extras to Mr. Gunderson. Mrs. Payne helped Ms. Enerson gather
information for Mr. Gunderson. Mrs. Payne testified that at some
point she knew that Mr. Gunderson had requested only bank
records. Mrs. Payne knew the extras were not deposited in the
bank; she helped separate out the checks for Mr. Payne to cash.
Petitioners’ assertion of ignorance is merely an attempt to
absolve themselves of blame by attributing responsibility to
their bookkeeper.
In addition, petitioners’ behavior with respect to their
income shows multiple badges of fraud. Mr. Payne pleaded guilty
under section 7206(1) to willfully filing a false tax return for
1994. As a result, Mr. Payne is estopped from arguing that he
did not willfully file a false return for 1994. See Wright v.
Commissioner, 84 T.C. at 639. Although the estoppel is not
extended to petitioners’ fraudulent intent to evade tax,
respondent has shown clear and convincing evidence that
petitioners intended to evade tax for the years in issue. HRDC’s
accounts receivable journal and bank deposit records both omitted
the income HRDC earned from extras and did not accurately reflect
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its income. Petitioners’ explanations of the understatements
were implausible. Their practice of cashing checks at the Money
Exchange instead of their bank concealed income from their
accountant and respondent, and enabled them to deal in cash. Mr.
Payne twice lied to respondent’s revenue agents when asked how
the income from the extras was distributed. Respondent has shown
clear and convincing evidence that petitioners filed their 1993,
1994, and 1995 returns with the intent to evade taxes.
Therefore, the 3-year period of limitations under section 6501(a)
does not apply to petitioners’ 1993, 1994, and 1995 years, and
respondent is not barred from assessing any deficiencies in
petitioners’ taxes for those years.
III. Unreported Income in 1994 From HRDC
If a taxpayer has not maintained business records or its
business records are inadequate, the Commissioner is authorized
to reconstruct the taxpayer’s income by any method that, in the
Commissioner’s opinion, clearly reflects that taxpayer’s income.
Sec. 446(b); Parks v. Commissioner, 94 T.C. at 658; A.J. Concrete
Pumping, Inc. v. Commissioner, T.C. Memo. 2001-42. The
Commissioner’s reconstruction need not be exact, but it must be
reasonable. A.J. Concrete Pumping, Inc. v. Commissioner, supra.
Respondent argues that petitioners received $222,735 in
unreported income from HRDC in 1994. Respondent’s reconstruction
of petitioners’ 1994 income is based on HRDC’s sales and extras
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journals and records of the checks cashed at the Money Exchange.
Petitioners argue that the sales journal was inaccurate and
disorganized because jobs that were contracted for in one year
may have been completed and paid for in the next year.3 The
record does not reflect whether the amounts purportedly received
in 1995 were included in the amount of income petitioners
stipulated they received in 1995.
Respondent calculates petitioners underreported 1994 income
as follows: Gross sales of $1,125,319.84 as reported in HRDC’s
sales journal, plus three accepted bids not listed totaling
$12,825, plus extras of $45,060.50 performed by Mr. Payne, for
total gross sales of $1,183,205.34 ($215,039.34 more than was
reported on HRDC’s 1994 return). HRDC’s journals are a part of
the record. The sales journal, which respondent used to
reconstruct HRDC’s income for 1994, very clearly and legibly
lists the amounts charged for each job HRDC performed in 1994.
The accounts receivable journal, which petitioners claim more
clearly reflects HRDC’s income, by contrast, is disorganized,
illegible in places, and, according to Mrs. Payne’s testimony,
incomplete. Petitioners did not clarify the entries in the
accounts receivable journal. Petitioners have not attempted to
3
This argument leads us to conclude that HRDC used the cash
method of accounting for tax purposes for 1993, 1994, and 1995.
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explain which jobs or amounts, if any, were erroneously included
in respondent’s determination of HRDC’s 1994 gross income.
Respondent determined that $12,825 was earned by HRDC in
1994 for jobs not listed in HRDC’s records. Petitioners do not
argue that the $12,825 should not be included as income.
Petitioners stipulated that Mr. Payne was due to receive
$45,060.50 in extras in 1994, and that Mr. Payne cashed
$98,258.21 in checks payable to HRDC at the Money Exchange in
1994. With respect to extras that Mr. Payne performed, he
testified that he personally kept all of the money when the
checks were cashed and that no records were kept of the expenses
of materials used for the extras.
The parties also stipulated that in 1994 HRDC deducted
expenses of $20,526.22 that were never paid. As a result, HRDC’s
income was underreported by an additional $20,526.22. Because
petitioners together owned 100 percent of HRDC in 1994, the
incorrect deduction reduced their gross income by $20,526.22 as
well. Petitioners do not argue that their 1994 income was not
underreported by this amount.
Petitioners have not shown that respondent’s reconstruction
of their 1994 income using the sales journal was unreasonable and
that they did not underreport the income they received from HRDC
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in 1994 by the amount stated in the notice of deficiency.4 See
A.J. Concrete Pumping, Inc. v. Commissioner, supra.
IV. HRDC’s Deductions
Petitioners next argue that Mr. Payne received the cash from
the extras in lieu of rent payments from HRDC for its office
space, which petitioners owned in their personal capacities. On
their personal income tax return for 1994, petitioners reported
rental income of $23,241 from HRDC for the use of the office
space, but HRDC did not claim a corresponding deduction for rent
paid on its 1994 return. As a result, respondent reduced
petitioners’ income for 1994 by $23,241. At trial, Mr. Gunderson
testified that he completed the return on the basis of
information given to him by HRDC, which did not include canceled
checks for rent paid, and that it was a mistake to include the
income on petitioners’ return. Mr. Payne testified that there
were often times that HRDC owed rent to petitioners but could not
afford to pay it, such as in 1994. He claimed that he thought
the amount reported as rental income on the 1994 return was
4
The amount of the understatement determined in the notice
of deficiency is $222,735. It is unclear how respondent arrived
at this figure, since the individual adjustments result in an
understatement of $232,565.56 ($215,039.34 unreported income plus
$20,526.22 disallowed deduction). The difference does not appear
to be the result of respondent’s negative adjustment to
petitioners’ rental income, because that adjustment was made to
petitioners’ adjusted gross income, not HRDC’s income. Because
respondent argues only the figure in the notice of deficiency,
petitioners are liable for tax on the lower amount.
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approximately equal to the amounts of his extras for that year,
but he did not look at either his personal return or HRDC’s
return before signing them.
The entire record does not support petitioners’ claim that
the extras were in lieu of rental income from HRDC. Mr.
Gunderson was not instructed on the issue when he prepared the
returns. He was not aware that extras existed until a few days
before trial. Mr. Payne did not look at his returns before they
were filed and was unclear and uncertain in his testimony
regarding what he understood when he signed the returns. The
extras Mr. Payne received in 1994 amounted to $45,060.50, almost
double the amount of rental income reported on petitioners’ 1994
personal return. In addition, HRDC did not report the extras as
income. Respondent properly reduced petitioners’ income by the
reported rental amounts, and neither HRDC nor petitioners are
entitled to claim deductions for rent paid (or the value of the
extras) in excess of those claimed on HRDC’s returns for 1993,
1994, and 1995.
Petitioners also argue that because the Money Exchange
charged a 2.5-percent fee each time they cashed a check there,
they are entitled to a deduction of 2.5 percent of Mr. Payne’s
extras. We disagree. The record shows that the Money Exchange
did charge 2.5 percent of the value of each check cashed as a
fee. However, in order to claim a deduction, the fees must be
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ordinary and necessary expenses of running petitioners’ business.
See sec. 162. HRDC maintained a checking account to which
petitioners could have deposited the money from the extras for no
charge. Petitioners testified that they cashed checks at the
Money Exchange because they knew the owner and it was within
blocks of the office (although Mr. Payne, who did not drive,
needed someone to drive him there each time he went). It is
obvious that petitioners used the Money Exchange to avoid the
inclusion of the income in their bank records. These reasons are
not related, let alone ordinary and necessary, to HRDC’s
business. Therefore, petitioners are not entitled to deduct the
cost of check-cashing fees.
V. Unreported Additional Bank Deposits
Respondent adjusted petitioners’ income by $3,681 for 1993
and $30,953.94 for 1995 for bank deposits made to their account
in excess of all identified sources, including extras and income
from HRDC. Bank deposits are prima facie evidence of income.
Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). Petitioners
stipulated that the deposits were made to their account, but they
reserved the right to show that two of the deposits were from
nontaxable sources. On brief, petitioners conceded that the
$3,681 is includable in their 1993 income. At trial, Mrs. Payne
testified that a deposit of $850 in 1995 was from Mr. Payne’s
sale of a gun to a sporting goods store. Mrs. Payne also
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testified that a deposit of $5,658.33 in 1995 was from Mr.
Payne’s sale of old sporting goods at auction. The record
contains copies of the two deposited checks. Neither Mrs. Payne
nor Mr. Payne estimated Mr. Payne’s cost for the items he sold.
The record does not contain any additional evidence of Mr.
Payne’s basis in the items. Petitioners have not met their
burden of proving that the two deposits were not taxable income
to them. Therefore, $3,681 and $30,953.94 in additional bank
deposits are includable in petitioners’ income for 1993 and 1995,
respectively.
VI. Innocent Spouse Relief Under Section 6015
Petitioners argue that Mrs. Payne is entitled to relief from
petitioners’ joint liabilities for 1993, 1994, and 1995 under
section 6015. Married taxpayers who elect to file a joint
Federal income tax return are each jointly and severally liable
for the entire tax due. Sec. 6013(a), (d)(3). A spouse may seek
relief from joint and several liability under section 6015. A
spouse may qualify for relief from liability under section
6015(b), or, if eligible, may allocate liability under section
6015(c). In addition, a spouse may seek equitable relief under
section 6015(f) if relief is not available under section 6015(b)
or (c). Under section 6015(f), respondent has the discretion to
relieve a spouse (or former spouse) of joint liability if, taking
into account all the facts and circumstances, it is inequitable
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to hold that spouse liable for any deficiency or unpaid tax (or
any portion of either) and that spouse is not eligible for relief
under section 6015(b) or (c). See sec. 6015(f).
Relief under section 6015(c) requires that the spouse
requesting relief be no longer married to, be legally separated
from, or not be a member of the same household as (for any part
of the 12-month period ending on the date the election for relief
was filed), the individual with whom the joint return was filed.
Since Mr. and Mrs. Payne are not divorced, legally separated, or
living separately, Mrs. Payne is ineligible for relief under
section 6015(c).
The requesting spouse must fulfill five requirements in
order to receive relief under section 6015(b): (1) A joint
return has been made for a taxable year; (2) on such return there
is an understatement of tax attributable to erroneous items of
the nonrequesting spouse; (3) the requesting spouse establishes
that in signing the return he or she did not know, and had no
reason to know, that there was such understatement; (4) taking
into account all the facts and circumstances, it is inequitable
to hold the requesting spouse liable for the deficiency in tax
for such year attributable to the understatement; and (5) the
requesting spouse elected the benefits of section 6015(b) not
later than the date which is 2 years after the date the
Commissioner has begun collection activities with respect to the
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requesting spouse. Mrs. Payne had reason to know in each year at
issue that HRDC’s returns understated its taxes. Mrs. Payne
worked in HRDC’s offices and was responsible, with Ms. Enerson,
for maintaining HRDC’s books and records. Mrs. Payne was aware
that the money from the extras was not deposited into HRDC’s bank
account, and Mrs. Payne testified that at some point she knew the
tax returns were based upon bank deposit records. She also
helped Ms. Enerson compile information for Mr. Gunderson to
complete the returns. In addition, petitioners owned HRDC in
approximately equal shares in 1993 and 1994. Mr. and Mrs. Payne
both worked for HRDC, and together they were involved in all
aspects of the business. Because of their involvement, it is
difficult to conclude that the unreported income received by
petitioners through HRDC in 1993 and 1994 was not attributable to
one spouse or the other. Therefore, Mrs. Payne is not entitled
to relief under section 6015(b).
Section 6015(f) gives the Commissioner discretion to grant
innocent spouse relief to a requesting spouse if relief is not
available under subsection (b) or (c) and, taking into account
all the facts and circumstances, it is inequitable to hold the
requesting spouse liable for any unpaid tax or deficiency. We
review the Commissioner’s denial of relief under subsection (f)
for an abuse of discretion. Washington v. Commissioner, 120 T.C.
137, 146 (2003). Rev. Proc. 2000-15, 2000-1 C.B. 447, contains
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guidelines that are considered in determining whether an
individual qualifies for relief under section 6015(f).5 Rev.
Proc. 2000-15, sec. 4.01, 2000-1 C.B. at 448, lists seven
threshold conditions that must be satisfied before the
Commissioner will consider a request for relief under section
6015(f). One of these threshold factors is that the requesting
spouse did not file the return with fraudulent intent. Id.
We held above that petitioners filed their 1993, 1994, and
1995 returns fraudulently with the intent to evade tax.
Respondent has shown that both petitioners committed fraud in the
filing of the false returns. Mrs. Payne was very involved in
running the business, and we are convinced that she and Mr. Payne
together operated HRDC in a way that concealed the cash they
received to avoid tax. Mrs. Payne knew that Mr. Payne cashed the
payments from the extras; while working in HRDC’s offices, she
actively separated out the checks to be cashed from those to be
deposited in the bank. The cash was used for Mr. and Mrs.
Payne’s personal expenses, such as when Ms. Enerson would cash
5
On Aug. 11, 2003, the Commissioner issued Rev. Proc. 2003-
61, 2003-2 C.B. 296, which superseded Rev. Proc. 2000-15, 2000-1
C.B. 447, effective for requests for relief filed on or after
Nov. 1, 2003, and for those pending on Nov. 1, 2003, for which no
preliminary determination letter has been issued as of Nov. 1,
2003. The threshold requirement that a requesting spouse not
having filed a return with fraudulent intent in order to be
considered for relief under sec. 6015(f) is present in both
revenue procedures.
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checks and mail them cash during their vacations in Florida.
Mrs. Payne controlled HRDC’s books, which recorded the extras
separate from HRDC’s regular jobs. She attended a meeting with
Mr. Payne and Mr. Gunderson to discuss the preparation of
petitioners’ tax returns at which Mr. Gunderson was told that all
of HRDC’s receipts were deposited into the bank account. She
testified that she knew Mr. Gunderson had requested only bank
records to complete the returns, and she helped Ms. Enerson
gather information to send to Mr. Gunderson. Because we find
that Mrs. Payne filed the returns for 1993, 1994, and 1995
fraudulently, respondent did not abuse his discretion in denying
Mrs. Payne innocent spouse relief under section 6015(f).
VII. Fraud Penalty Under Section 6663
If respondent shows that any portion of an underpayment is
due to fraud, the entire underpayment will be treated as
attributable to fraud for purposes of the penalty under section
6663(a), except any portion of the underpayment that petitioner
establishes by a preponderance of the evidence is not
attributable to fraud. See sec. 6663(b); Knauss v. Commissioner,
T.C. Memo. 2005-6. As stated above, respondent has shown that
petitioners committed fraud in filing their 1993, 1994, and 1995
returns. However, petitioners have shown by a preponderance of
the evidence that their unreported bank deposits were not due to
fraud. Our finding of fraud relies in part on petitioners’
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practice of concealing income by providing only bank statements
and records to their tax return preparer and converting checks
into cash at the Money Exchange. Petitioners did not employ this
practice with respect to the unreported deposits; instead, they
provided their bank information to their tax return preparers.
Therefore, the fraud penalty does not apply to the deficiency
amounts resulting from petitioners’ unreported bank deposit
income in 1993 and 1995. Petitioners have not shown that any
other portion of the deficiencies should not be subject to the
fraud penalty. Therefore, the remainder of the deficiencies for
1993, 1994, and 1995 is subject to the fraud penalty.
To reflect the foregoing, concessions of the parties, and to
give effect to the stipulations by the parties,
Respondent’s Motion for
Leave to Amend the Answer to
Conform the Pleadings to the
Proof is denied as moot, and
Decision will be entered
under Rule 155.