The opinion
T.C. Summary Opinion 2011-26
UNITED STATES TAX COURT
LIONEL W. AND GABRIELE B. HAMMOND, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24658-07S. Filed March 8, 2011.
Lionel W. and Gabriele B. Hammond, pro sese.
L. Katrine Shelton, for respondent.
RUWE, Judge: This case was heard pursuant to the provisions
of section 74631 of the Internal Revenue Code in effect when the
petition was filed. Pursuant to section 7463(b), the decision to
be entered is not reviewable by any other court, and this opinion
shall not be treated as precedent for any other case.
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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Respondent issued a notice of deficiency on July 26, 2007,
in which he determined a deficiency of $10,375 in petitioners’
2004 Federal income tax, an addition to tax of $2,593.75 under
section 6651(a)(1), and an accuracy-related penalty of $2,075
under section 6662(a). In an amendment to answer filed August
17, 2009, respondent affirmatively asserted that: (1)
Petitioners are not entitled to claimed dependency exemption
deductions; (2) petitioners are not entitled to a claimed earned
income credit (EIC); and (3) petitioners are liable for the fraud
penalty under section 6663. The amendment to answer indicates
that: The corrected amount of petitioners’ tax for 2004 is
$12,788; the tax shown on petitioners’ joint Federal income tax
return for 2004 was a refund request of $2,427; and the
difference between petitioners’ correct amount of tax and the tax
shown on their return for 2004 is $15,215. As a result,
respondent contends that petitioners are liable for a fraud
penalty under section 6663 of $11,411.25, which is equal to 75
percent of the portion of the underpayment that is attributable
to fraud. The issues for decision are:
(1) Whether petitioners underreported gross receipts by
$43,608 on Schedule C, Profit or Loss From Business (Sole
Proprietorship), with respect to petitioner Lionel W. Hammond’s
business;
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(2) whether petitioners underreported interest income by
$103;
(3) whether petitioners have substantiated expenses of
$4,800 for utilities and $8,900 for rent or lease expenses (other
than as home office expenses, a portion of which respondent
acknowledges petitioners are entitled to deduct) claimed on their
Schedule C for 2004;
(4) whether petitioners are entitled to claim a net
operating loss (NOL) carryback from 2005 on their 2004 Federal
income tax return;
(5) whether petitioners are entitled to dependency exemption
deductions for 2004;
(6) whether petitioners are entitled to an EIC for 2004;
(7) whether petitioners are liable for an addition to tax
under section 6651(a)(1); and
(8) whether petitioner Lionel W. Hammond is liable for the
civil fraud penalty under section 6663 or, in the alternative,
whether petitioners are liable for the accuracy-related penalty
under section 6662(a).
During trial the parties agreed to an oral stipulation of
facts and exhibits, which is incorporated herein by reference.
Background
Petitioners resided in California at the time the petition
was filed. Petitioners were married in 1988. At trial Lionel W.
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Hammond (petitioner) appeared on behalf of his wife and himself.
Gabriele B. Hammond (Mrs. Hammond) did not appear at trial, and
petitioner indicated that she no longer resides in the United
States.
Schedule C Income and Expenses
Petitioner was a private investigator doing business as L.W.
Hammond Investigations. During the taxable year 2004 petitioner
provided services to the U.S. courts and the County of Sacramento
for which he was paid compensation of $43,808 and $40,610,
respectively. Petitioner also received $2,244 as nonemployee
compensation from the California Apartment Association.
On March 14, 2006, the Internal Revenue Service (IRS)
received petitioners’ 2004 Federal income tax return. On
Schedule C petitioner reported $43,052 in gross receipts and
deducted $32,550 in total expenses regarding his business.
Petitioner claimed various Schedule C expenses, including $4,800
for utilities and $8,900 for rent or lease expenses, which
respondent disallowed. Petitioners presented no evidence to
substantiate their entitlement to these claimed deductions.2
2
Respondent determined that petitioners are entitled to an
increased expense deduction of $14,573 for home office expenses
for 2004. Petitioners do not contest this determination.
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Dependency Exemption Deductions and Earned Income Credit
Petitioners claimed dependency exemption deductions and an
EIC for two minor children, C.W.H. and C.B.H.3 On their return
petitioners indicated that C.W.H. and C.B.H. died during 2004.
Petitioners had no children during the year in question.
Petitioner attached two documents entitled “Certificate of
Live Birth” (certificate) to the 2004 return. The certificates
indicate that C.W.H. was born in 1997 in Sacramento County,
California. They further indicate that C.B.H. was born during
2004, also in Sacramento County. A search by the county
clerk/recorder’s office in Sacramento County of the county’s
vital statistics records concluded that (1) no children named
C.W.H. or C.B.H. were born in Sacramento County during the
childrens’ alleged years of birth, and (2) no children with those
names had died in Sacramento County during 2004. The birth
certificates attached to petitioners’ 2004 return are forgeries
and were not issued by the Vital Records Unit of Sacramento
County. At trial petitioner conceded that he did not have any
children in 2004. Petitioner testified that he did not attach
the certificates to the return, even though he signed the return
and the return references the children by name. Petitioner
3
The Court refers to minor children by their initials. See
Rule 27(a)(3).
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provided no credible explanation as to how the false birth
certificates were attached to the return.
Failure To File Timely
Petitioners’ 2004 return was due on April 15, 2005. The IRS
received the return on March 14, 2006. At trial petitioner did
not explain why the return was filed late. Petitioner signed the
2004 return and completed the attached Schedule C. Petitioners
presented no evidence that the return was prepared for them by a
return preparer or any other person.
Discussion
I. Schedule C Income and Expenses
A. Schedule C Income
Gross income includes all income from whatever source
derived. Sec. 61; see Commissioner v. Glenshaw Glass Co., 348
U.S. 426, 430 (1955). Respondent determined that petitioners
underreported their gross receipts by $43,608 on their 2004
Schedule C. As a general rule, the Commissioner’s determinations
set forth in a notice of deficiency are presumed correct, and the
taxpayer bears the burden of proving that the determinations are
erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933).
During 2004 petitioner received compensation of $43,808 from
the U.S. courts, $40,610 from Sacramento County, and $2,244 from
the California Apartment Association. In total, petitioners
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received more than $86,660 in gross receipts through petitioner’s
business. On Schedule C, petitioners reported only $43,052 as
gross receipts. Petitioners failed to include approximately
$43,608 in received gross receipts on Schedule C.
Petitioners contend that they incurred an NOL in 2005 that
should be used to offset their 2004 income. In the alternative,
petitioners contend that the amount of gross receipts reported
was correct because portions of the amounts paid to petitioner
were not paid to him as compensation but, instead, constituted
reimbursement for expenses petitioner had incurred while
performing services in the ordinary course of business.
Petitioners provided no credible evidence to substantiate
their claim to an NOL for 2005. Petitioners failed to provide
any information regarding the actual dollar amounts of their
business expenses in 2005, the total amount of the NOL incurred
in 2005, or the amount of any NOL available to be carried back to
2004. Further, petitioners failed to provide any substantiation
of unreimbursed expenses for 2004 in an amount to offset the
unreported gross receipts. Therefore, we sustain respondent’s
determinations with respect to petitioners’ unreported gross
receipts and the resulting underpayment of tax.
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B. Schedule C Expenses
Deductions are a matter of legislative grace, and the
taxpayer has the burden of proving entitlement thereto. New
Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Section
162(a) allows as a deduction all the ordinary and necessary
expenses paid or incurred during the taxable year in carrying on
any trade or business. In general, business expenses, which are
deductible from gross income, include the ordinary and necessary
expenditures directly connected with or pertaining to the
taxpayer’s trade or business. Sec. 1.162-1(a), Income Tax Regs.
The taxpayer has the burden of establishing his right to the
claimed deduction as an “ordinary and necessary [expense] paid or
incurred during the taxable year in carrying on any trade or
business.” Kalamazoo Oil Co. v. Commissioner, 693 F.2d 618, 620
(6th Cir. 1982), affg. T.C. Memo. 1981-344.
On their Schedule C for 2004 petitioners claimed deductions
of $4,800 for utilities and $8,900 for the rent or lease of other
business property, which respondent disallowed. Petitioners have
provided no evidence supporting their entitlement to deduct the
claimed expenses. Accordingly, we sustain respondent’s
determination.
II. Interest Income
Respondent determined that petitioners failed to report
interest income of $103 on their 2004 return. Petitioners failed
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to challenge this determination in the petition or at trial.
Therefore, we sustain respondent’s determination.
III. Dependency Exemption Deductions and EIC
Petitioners claimed dependency exemption deductions and an
EIC for two minor children on their 2004 return. In support,
petitioner attached a birth certificate for each child to the
return. The attached certificates were forgeries, and the
children did not exist. Petitioner has conceded that he did not
have any children in 2004. Petitioners are not entitled to
dependency exemption deductions with respect to C.W.H. and C.B.H.
Petitioners attached to their return a Schedule EIC, Earned
Income Credit, showing C.W.H. and C.B.H. as qualifying children;
their year of birth as 2004; and that each child “died” during
2004. The children, however, did not exist in 2004. Clearly,
petitioners are not entitled to an EIC with respect to C.W.H. and
C.B.H.
As a result of the foregoing, we sustain respondent’s
determination of the increased deficiency.
IV. Section 6651(a) Addition to Tax
Section 6651(a)(1) provides an addition to tax for failure
to timely file a Federal income tax return, unless the taxpayer
shows that such failure was due to reasonable cause and not
willful neglect. United States v. Boyle, 469 U.S. 241, 245
(1985); Baldwin v. Commissioner, 84 T.C. 859, 870 (1985); Davis
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v. Commissioner, 81 T.C. 806, 820 (1983), affd. without published
opinion 767 F.2d 931 (9th Cir. 1985). An individual taxpayer is
required to file a tax return on or before the 15th day of April
following the close of the calendar year. Sec. 6072(a).
Petitioners’ 2004 Federal income tax return was required to be
filed by April 15, 2005. However, their return was not filed
until March 14, 2006. Petitioners failed to present any credible
documentary or testimonial evidence to establish either that
their 2004 return was timely filed or that their late filing was
due to reasonable cause and not willful neglect. Accordingly, we
sustain respondent’s determination and hold that petitioners are
liable for the addition to tax under section 6651(a)(1).
V. Penalties Under Sections 6663 and 6662
If the fraud penalty under section 6663 applies to any
portion of an underpayment, then the penalty under section 6662
will not apply to any portion of the underpayment on which the
fraud penalty is imposed. Sec. 6662(b). If the fraud
penalty under section 6663 applies to either petitioner, then the
penalty under section 6662(a) will not be applicable to either
petitioner. Sec. 6662(b); see, e.g., Zaban v. Commissioner, T.C.
Memo. 1997-479. Thus, we begin with our consideration of the
fraud penalty with respect to petitioner.
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Fraud Penalty Under Section 6663
Section 6663(a) provides: “If any part of any underpayment
of tax required to be shown on a return is due to fraud, there
shall be added to the tax an amount equal to 75 percent of the
portion of the underpayment which is attributable to fraud.” See
Sam Kong Fashions, Inc. v. Commissioner, T.C. Memo. 2005-157.
The Commissioner bears the burden of proving fraud by clear and
convincing evidence. Sec. 7454(a); Rule 142(b). To satisfy this
burden, the Commissioner must establish that (1) an underpayment
exists, and (2) some portion of the underpayment is attributable
to fraud. DiLeo v. Commissioner, 96 T.C. 858, 873 (1991), affd.
959 F.2d 16 (2d Cir. 1992). Because we have already held that an
underpayment exists, we must decide whether any portion of such
underpayment was attributable to fraud. “If the Secretary
establishes that any portion of an underpayment is attributable
to fraud, the entire underpayment shall be treated as
attributable to fraud, except with respect to any portion of the
underpayment which the taxpayer establishes (by a preponderance
of the evidence) is not attributable to fraud.” Sec. 6663(b).
In the case of a joint return, the section 6663 penalty “shall
not apply with respect to a spouse unless some part of the
underpayment is due to the fraud of such spouse.” Sec. 6663(c).
Therefore, one spouse may be held liable for the penalty without
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the other spouse sharing in the liability solely because he or
she was a party to a joint return.
Fraud has been defined as an “‘intentional wrongdoing on the
part of a taxpayer motivated by a specific purpose to evade a tax
known or believed to be owing.’” Moran v. Commissioner, T.C.
Memo. 2005-66 (quoting Stoltzfus v. United States, 398 F.2d 1002,
1004 (3d Cir. 1968)); see also Langworthy v. Commissioner, T.C.
Memo. 1998-218. The Commissioner must prove by clear and
convincing evidence that the taxpayer intentionally engaged in
wrongdoing with the specific intent to avoid a tax that he knew
to be owing. Akland v. Commissioner, 767 F.2d 618, 621 (9th Cir.
1985), affg. T.C. Memo. 1983-249. Courts consider a taxpayer’s
entire course of conduct in determining fraudulent intent. DiLeo
v. Commissioner, supra at 874; Petzoldt v. Commissioner, 92 T.C.
661, 699 (1989). Because direct evidence is rarely available,
fraud may be proven by circumstantial evidence. DiLeo v.
Commissioner, supra at 874; Chase v. Commissioner, T.C. Memo.
2004-142.
Courts have adopted several objective badges that serve as
evidence of fraud by the taxpayer, which may include: (1)
Dealing in cash; (2) understatement of income; (3) concealment of
assets; (4) inadequate recordkeeping; (5) implausible or
inconsistent explanations of behavior; (6) filing false
documents; and (7) failure to cooperate with tax authorities.
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See Robleto v. Commissioner, T.C. Memo. 2008-195 (citing Bradford
v. Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986), affg.
T.C. Memo. 1984-601); Hoover v. Commissioner, T.C. Memo. 2006-82.
(i) Understatement of Income
Petitioner failed to report gross receipts of $43,608 from
his private investigation business and interest income of $103,
and he improperly claimed dependency exemption deductions and an
EIC in order to understate his Federal income tax liability for
2004.
Petitioner conceded that he did not have any children in
2004. Even though petitioners had no children, petitioner
claimed dependency exemption deductions and an earned income
credit on the return as if he did. Petitioner’s knowledge of the
fact that he had no dependent children is evidence that he knew
that the claimed dependency exemption deductions and EIC were
based on fraud and that he acted willfully. Petitioner’s false
deductions and understatement of income are evidence of his
fraudulent intent in the filing of the return.
(ii) Inadequate Recordkeeping
Petitioner alleged that he failed to report income on the
return because he received the payments as reimbursement of
business expenses. However, petitioner has provided no evidence
that supports this contention. Petitioner has provided no
relevant supporting documentation, such as invoices or statements
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from the County of Sacramento or the U.S. courts, in order to
show that the amounts were paid to him as reimbursement.
(iii) Filing False Documents
The filing of false documents is evidence of fraudulent
intent. Hoover v. Commissioner, supra. Forged birth
certificates for fictitious children were attached to
petitioners’ return. Petitioner was in control of the return
before its filing, as evidenced by the fact that he prepared,
signed, and mailed the return.
Petitioners did not use the services of a return preparer,
and petitioner provided no credible evidence that anyone other
than he prepared the 2004 return.
Petitioner failed to provide any credible explanation with
respect to how the fraudulent birth certificates came to be
attached to the return, other than their having been attached by
petitioner. That the return filed bears the names of the
children listed on the birth certificates, coupled with the fact
that petitioner completed and signed the return, supports our
conclusion that petitioner attached the false documents to the
return.
The foregoing convinces us that petitioner filed a false and
fraudulent return for 2004 with the intent to evade tax.
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Accordingly, we hold that petitioner is liable for the fraud
penalty under section 6663 for $11,411.25.4
To reflect the foregoing,
Decision will be entered
under Rule 155.
4
Our finding of fraud applies only to petitioner, who failed
to establish that any portion of the underpayment was not
attributable to fraud. No direct evidence of fraud by Mrs.
Hammond was presented, and respondent on brief offers no reason
for finding that she is liable for the fraud penalty. Having
found that petitioner is liable for the fraud penalty under sec.
6663, we need not consider respondent’s alternative argument
regarding the accuracy-related penalty under sec. 6662(a).