T.C. Memo..2011-228.
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T.C. Memo..2011-228.
UNITED STATES TAX COURT
CHARLES L. GARAVAGLIA, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
MARY ANN T. GARAVAGLIA, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos.
2500-07,
14693-09.
Filed September 26,
2011.
Joseph Falcone and Fred .A. Foley, for petitioners.
Alexandra E. Nicholaides, John J. Comeau, and Robert M.
Romashko, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge:
These consolidated cases concern the 1989 and
1990 Federal income taxes of Charles L. Garavaglia (Mr.
Garavaglia) and Mary Ann T . Garavaglia (Ms . Garavaglia)
SERyg8 SEP 2 6 2011
-2(collectively, the Garavaglias or petitioners).
Respondent
determined deficiencies in Mr. Garavaglia's 1989 and 1990 Federal
income taxes of $97,070 and $114,435 and fraud penalties under
section 6663 (a) of $72,803 and $85,826, respectively.1
Respondent amended the answer to assert deficiencies in Mr.
Garavaglia's 1989 and 1990 Federal income taxes of $96,640 and
$138,290 and fraud penalties of $72,480 and $103,717 pursuant to
section 6663(a), respectively; or alternatively, a deficiency of
$114,435 in Mr. Garavaglia's 1990 Federal income tax and a fraud
penalty of $85,827 under section 6663(a).
Respondent contends
that the deficiencies and penalties purportedly due from Mr.
Garavaglia stem from Mr. Garavaglia's participation in a scheme
to defraud workers' compensation insurance companies (insurance
companies) and the U.S. Treasury (Treasury).
Mr. Garavaglia
disavows his participation in such a scheme during 1989 and 1990.
Respondent also determined deficiencies of $99,179 and
$117,557 in Ms. Garavaglia's 1989 and 1990 Federal income taxes
and accuracy-related penalties under section 6662(a) of $19,836
and $23,511, respectively.
Ms. Garavaglia ascribes error to
respondent's determinations as to the fraud of Mr. Garavaglia,
and asserts that (1) the period of limitations for assessment has
1Unless otherwise indicated, section references are to the
applicable version of the Internal Revenue Code (Code), and Rule
references are to the Tax Court Rules of Practice and Procedure.
Some dollar amounts are rounded.
-3expired as to 1989 and 1990; and (2) she is.entitled to relief
from joint and several liability under section 6015 (b) and (f).
Respondent counters that the period of limitations for assessment
as to 1989 and 1990 is on account of the alleged fraud of Mr.
Garavaglia, or alternatively on account of the claimed fraud of
petitioners' return preparers.
Respondent also contends that Ms.
Garavaglia is jointly and severally liable for any deficiencies
determined to be due from Mr. Garavaglia.
After concessions,2 the primary issues for decision are:
(1) Whether either of two corporations partially owned by Mr.
Garavaglia qualifies as an electing small business corporation (S
corporation) in 1989 and 1990.
We hold that neither does;3 (2)
whether Mr. Garavaglia omitted income of $326,815 and $386,324 in
1989 and 1990, respectively.
herein;
We hold he did to the extent stated
(3) whether Mr. Garavaglia is liable for fraud penalties
under section 6663.
We hold he is;
(4) whether the period of
limitations for assessment of petitioners' 1989 and 1990 taxes is
44r. Garavaglia contends that he is entitled to a "refund of
his excess social security tax payments". He offers no argument,
explanation, or legal authority to support his position, and we
treat his claim to a refund as improperly raised.
See FigueroRubio v.
INS,
108 F.3d 110,
112
(6th Cir.
1997).
Given our holding on the first issue, respondent abandons
his primary determination that Mr. Garavaglia's distributable
share of income and/or loss from these corporations should be
increased for 1989 and 1990.
-4open on account of the fraud of Mr. Garavaglia.
We hold it is;*
(5) whether Ms. Garavaglia is jointly and severally liable for
deficiencies determined to be due from Mr. Garavaglia.
she is;
We hold
(6) whether Ms. Garavaglia is liable for accuracy-related
penalties under section 6662(a).
We hold she is not;
(7) whether
Ms. Garavaglia is entitled to relief from joint and several
liability under section 6015(b) or (f).
We hold she is not; and
(8) whether the Criminal Investigation Division (CID) of the
Internal Revenue Service (IRS) violated Mr. Garavaglia's Fifth
Amendment right to due process.
We hold it did not.
FINDINGS OF FACT
I.
Preliminaries
The parties submitted to the Court numerous stipulations of
fact and accompanying exhibits.
The Court.also deemed some facts
and exhibits established pursuant to Rule 91(f).
The stipulated
facts and exhibits submitted therewith are incorporated herein by
this reference.
We find the stipulated facts accordingly.
Petitioners, husband and wife, resided in Michigan when they
filed their respective petitions.
*Because we find fraud on the part of Mr. Garavaglia, we
need not consider respondent's alternative position that the
period of limitations for assessment is open on account of the
fraud of petitioners' return preparers.
II.
Mr. Garavaglia
Mr. Garavaglia was born in Detroit, Michigan.
He graduated
from high school, and he has some college education.
active duty member of the U.S. Army from July 1,
12, 1959, and served as a supply clerk.
He was an
1957, until July
Mr. Garavaglia has been
known by many aliases including, among others, Timothy Sullivan,
Robert Burton, and Albert Little.
In the early-to-mid-1960s Mr. Garavaglia began working as a
labor consultant for Central Transport, Inc.
(Central).
1966 to 1975 he was director of insurance and safety.
From
As such,
he established a claims department, developed investigative
procedures, and prepared guidelines for claims.settlements.
From
1975 to 1986, as vice president of industrial relations and
security, he developed security procedures, negotiated labor
agreements, and directed the labor departments of U.S. and
Canadian divisions and subsidiaries.
Mr. Garavaglia was fired
from Central in approximately October 1986.
Pursuant to a
settlement agreement with Central, he was paid an annual
consulting fee of $50,000.
That fee was paid to Mr. Garavaglia's
wholly owned S corporation.
Since the early-to-mid-1960s Mr. Garavaglia has developed
expertise in the insurance, employee leasing, trucking, and labor
industries.
During 1989 and 1990 he owned and operated one labor
consulting firm and various employee leasing companies, all of
which were within the trucking industry.
III. C&G Consultants
Mr. Garavaglia was the president and 100-percent owner of
C&G Consultants,
Inc.
(C&G Consultants), an S corporation.
Through C&G Consultants, Mr. Garavaglia provided labor consulting
services and received payments from the employee leasing
companies which he owned and operated.
IV.
Ms. Garavaglia
Ms. Garavaglia graduated from high school without further
education.
She married Mr. Garavaglia in September 1961, gave
birth to a child shortly thereafter, and was a homemaker until at
least 1988.
As of the end of 1988, the Garavaglias had financial
assets of approximately $1 million.
At all relevant times, the
Garavaglias were married.
Throughout 1989 Ms. Garavaglia worked as a secretary with a
temporary staffing company.
She also worked as a secretary for
at least one of Mr. Garavaglia's employee leasing companies, and
was paid a weekly salary of $500 for her services.
Ms.
Garavaglia was the treasurer of C&G Consultants, and she attended
the meeting of the board of directors of that company.
V.
Mr. Rogers
George Rogers (Mr. Rogers) worked at Central for 11 years,
initially as a truck driver and later in the operations division.
-7-
In the early 1980s Mr. Rogers began to manage at least one of
Central's employee leasing companies.
He grew independent of
Central over time, and he eventually came to own and operate at
least four employee leasing companies.
Messrs. Garavaglia and Rogers met while at Central.
At
first Mr. Garavaglia advised Mr. Rogers on thé resolution of
labor-related issues such as the filing of union grievances.
In
1985 that relationship developed into a business partnership that
continued until 1989.
VI.
Sentury
Mr. Rogers was the 100-percent owner of Sentury Services,
Inc.
(Sentury), an S corporation.
Mr. Rogers,. through Sentury,
provided consulting services to his employee leasing companies.
Mr. Rogers owned at least two of these employee leasing companies
jointly with Mr. Garavaglia.
VII. The Yarnell Family and LTD Accounting
During 1985 and 1.986 Douglas Yarnell
Leroy Yarnell
,
(Mr. D. Yarnell) and
(Mr. L. Yarnell) worked in the accounting
department of D&S Leasing (D&S), an employee leasing company
which Mr. Rogers owned.
Mr. L. Yarnell helped to implement a
computer-based payroll system and assisted in the preparation of
various tax returns, including Forms 941, Employer's Quarterly
Federal Tax Return.
Mr. L. Yarnell was not a certified public
accountant, though he represented to others, including Mr.
-8Garavaglia, that he was.
In July 1986 Mr. D. Yarnell left D&S to
form LTD Accounting, Inc.
(LTD Accounting), with his father, Mr.
L. Yarnell, and his brother, Tim Yarnell (Mr. T. Yarnell).5
LTD
Accounting or members of the Yarnell family performed various
accounting and tax duties for petitioners, C&G Consultants, and
certain employee leasing companies owned by Mr. Garavaglia.
VIII. Overview of Employee Leasing Companies
Mr. Garavaglia, either with Mr. Rogers or Mr. L. Yarnell,
owned and operated at least three employee leasing companies.
An
employee leasing company is a business which agrees to place
employees of a client company on the leasing company's payroll,
usually for a fee.
Through this leasing arrangement, the
employee leasing company typically becomes the primary employer
of record and performs a number of personnel and administrative
functions with respect to the leased employees.
Among the
services typically provided by the employee leasing company were
issuing paychecks, payroll management, Federal and State income
tax withholding, Federal and State employment tax reporting, and
maintaining workers' compensation insurance.
v. Commissioner, T.C. Memo: 1996-435.
See, e.g., Bealor
The client companies paid
workers' compensation insurance premiums (premiums) and taxes to
'The Yarnell family owned and operated two accounting firms
named LTD Accounting, which we collectively refer to as LTD
Accounting. We also collectively refer to Mr. L. Yarnell, Mr. D.
Yarnell, and Mr. T. Yarnell, as the Yarnell family.
the employee leasing company, with portions of the funds being
allocated among various payees, including insurance companies,
and Federal and State taxing authorities.
Premiums due to the insurance companies were generally due
at the beginning of a specified policy period (e.g., from May
until the following April) .
.The premiums were self-reported and
determined, at least in part, by worker classification, payroll
wages, and the State in which the leased employee worked.
Because Mr. Garavaglia's employee leasing companies serviced the
trucking industry, the relevant worker classifications included
drivers, maintenance workers, and office staff.
Worker
classifications with a higher risk of injury (e.g., drivers)
generally required higher premiums than those with a lower risk
of injury (e.g., office staff).
Because the numbers and types of
workers varied over a specified policy period,,employee leasing
companies prospectively estimated their payroll for the policy
period.
Given the self-reporting nature of the employee leasing
business, there was risk to the insurance companies that the
employee leasing company might underreport its payrolls and the
premiums due.
.
To mitigate this risk, the insurance companies
often used audits to ensure that the employee leasing company's
payrolls were accurately reported.
The audits were intended to
balance the estimated premiums paid and the actual premiums due
-10-
by reconciling the payrolls as estimated by the employee leasing
company against the actual payrolls as determined by an auditor.
The auditor, who was sometimes an employee of the insurance
company, examined various documentation to verify the employee
leasíng company's actual payroll.
Documents typically examined
included Forms 941, Employer's Quarterly Federal Tax Return,
worker classifications, State unemployment payroll taxes, various
classifications of the policy, and proof ·of payment as to those
classifications.
To the extent that the auditor determined a
deficit between the client company's audited and estimated
payrolls, the employee leasing company was required to satisfy
the shortfall.
To the extent that the auditor determined an
overpayment, the insurance company credited the employee leasing
company.
During 1989 and 1990 Mr. Garavaglia's employee leasing
companies underreported their actual payrolls by approximately 75
percent.
As a result, these employee leasing companies also
understated the premiums due to the insurance companies and the
employment taxes due to Federal and State taxing authorities.
For financial accounting purposes, however, these employee
leasing companies expensed 100 percent of the premiums as if the
full payrolls of the client companies had been reported.
For
Federal tax purposes, these employee leasing companies reported
deductions equal to the higher premium expenses recorded for
-11-
financial accounting purposes.
The difference between the
amounts which the employee leasing company collected from its
client companies and the amounts actually remitted to the
insurance companies and taxing authorities was distributed to
owners of the employee leasing companies; namely, Mr. Garavaglia,
and either Mr. Rogers or Mr. L. Yarnell.
The ·amount of each
distribution was generally proportionate to the owner's interest
in the company.
IX.
Trans Continental
By 1988 Mr. Garavaglia and Mr. Rogers were each 50-percent
owners·1n Trans Continental ·Leasing, Inc.
employee leasing company.
(Trans Continental), an
In late 1988 or early 1989 Trans
Continental underwent a workers' compensation audit which Mr. D.
Yarnell handled.
The auditor determined a shortfall of as much
as $1 million in the premiums which Trans Continental owed to the
insurance company.
As of March 31, 1989, Trans Continental had
accrued premium expenses of $59,087 though it had paid premiums
to the insurance companies of only $21,102.
31,
Thus, as of March
1989, Trans Continental had overstated its workers'
compensation expense for 1989 by $37,985 ($59,807 less $21,102).
Trans continental did not pay the amounts determined to be
due following the audit.
Rather, Messrs. Garavaglia and Rogers
closed Trans Continental in March 1989 and continued their
-12-
employee leasing business under a parallel company; namely, Trans
International Services, Inc.
X.
(Trans International).
Trans International
A.
History of Trans International
On or about March 6, 1989, Messrs. Garavaglia and Rogers
incorporated Trans International as an employee leasing company.
Mr. Garavaglia and Mr. Rogers each became 50-percent shareholders
in Trans International, and they shared equally in all decisions
related to that company.
B.
The Continuation of Trans Continental's Operations
By early April 1989, Trans International was a fully
operating employee leasing company, complete with assets,
employees, customers, payables, receivables, and accruals.
The
ending balances of Trans Continental's expense accounts for
Michigan, Ohio, and Indiana became Trans International's starting
balances for their accrued workers' compensation accounts.
For
example, as of March 31, 1989, Trans Continental had ending
balances in its accrued workers' compensation expense account for
Michigan, Ohio,
and Indiana, of $17,974,
respectively.
Those ending balances became Trans International's
beginning balances for April 1, 1989.
$4,799,
and $36,315,
Thus, the $37,985
shortfall which Messrs. Garavaglia and Rogers avoided by closing
Trans Continental was transferred to Trans International.
-13C.
Payroll Misstatements
On or sometime after April 1, 1989, Mr. T. Yarnell prepared
and forwarded to Mr. Rogers,two payroll summaries which Trans
International used to calculate its premiums.
The first summary
listed Trans International's "actual" payroll for the first
quarter of 1989, and the second summary listed Trans
International's "modified" payroll for the same period.
The
modified payroll summary was.calculated by·applying a 25-percent
factor to the actual payroll; i.e., Trans International reported
only 25 percent of its.actual payroll.
The actual payroll
summary reported that Trans International owed $60, 416 in
workers' compensation insurance liabilities for the first quarter
of 1989.
Of that amount,
$36,799 was allocable to workers in
Indiana, $18, 751 was allocable to workers in Michigan, and $4, 866
was allocable to workers in Ohio.
The modified payroll summary,
on the other hand, reported that Trans International owed $15,104
in workers' compensation insurance liabilities for the first
quarter of 1989.
Of that amount, $9,200 was allocable to workers
ln Indiana, $4,688 was allocable to workers in Michigan, and
$1,216 was allocable to workers in Ohio.
Mr. T. Yarnell also prepared payroll summaries for the last
two quarters of 1989 which "[scaled) down" Trans International's
payroll to 25 percent of actual.
These scaled-down summaries
were used by Trans International to calculate its premiums and
-14were reported to the insurance companies.
At some point on or
before January 31, 1990, Mr. T. Yarnell sent to Mr. Garavaglia
the following letter:
Premiums for Ohio Workman's Compensation are due by
January 31, 1990. Please review the schedules I have
prepared for Branch [International] and * * * [Trans
International] and let me know if you agree with the
figures. The only classification I did not scale down
to 25% was the * * * [Trans International] drivers
because of the low amount that we carry in Ohio for
this classification.
The highlighted Reported * * *
[Workers' Compensation] is the amounts I am proposing
to pay into the Ohio Bureau of * * * [Workman's
Compensation).
Attached to that letter was a schedule which reported Trans
International's actual and modified payroll wages as follows:
Period
Drivers
Maintenance
Office
Total
July 1989
Aug. 1989
Sept. 1989
Oct. 1989
Nov. 1989
Dec. 1989
Total wages1
$1,530
1,704
2,013
1,740
1,727
3,576
12,289
$11,043
13,769
16,507
15,047
13,135
24,683
94,184
$11,138
11,890
14,045
11,187
11,040
18,421
77,721
$23,711
27,363
32,565
27,974
25,902
46,680
184,194
Reported wages
$12,289
$23,546
$19,430
$55,265
$1,789
$11,359
$163
$13,311
$1,735
$1,907
$121
$3,763
Actual workers'
compensation
billed to
customers
Reported workers'
compensation.
1The sum for the periods may not equal the total wages on
account of rounding.
In the foregoing table, the term "total wages" means the wages
which Trans International actually paid to its employees.
The
.
-15-
term "reported wages" means the wages which Trans International
reported to the insurance companies as being paid to its
employees.
The phrase "actual workers' compensation billed to
customers" means the actual workers' compensation billed to Trans
International's client companies.
The term "reported workers'
compensation" means the liability which Trans -International
reported as due to the insurance companies.
Between July and
December 1989 Trans International underreported its payroll wages
by up to 75 percent and understated its premiums, by as much as 83
percent.
D.
Books and Records
From January through March 1989 LTD Accounting kept Trans
International's books and records under Trans Continental's name.
After April 1, 1989, the books and records of.Trans International
were kept in that company's name.
E.
Accrual of Workers' Compensation Expense
Trans International maintained an accrued'workers'
compensation expense account on its books.
That account recorded
amounts which Trans International actually paid to the insurance
companies as a payable account to Trans International for amounts
Trans International paid its maintenance staff wages of
$94,184 but reported payroll wages paid of $23,546, which is 25
percent of $94,184.
Trans International billed its client
companies $11,359 for workers' compensation expenses related to
its maintenance staff but reported a liability due to the
insurance companies of $1,907, approximately 17 percent of
$11,359.
-16owed to the insurance companies.
When premiums were paid to the
insurance company, the accrued workers' compensation account was
credited and the cash account was debited.
F.
Payment of Premiums to Wholly Owned S Corporations
Trans International billed and collected from its client
companies on the basis of the actual payroll but paid the
insurance companies on the basis of the modified payroll.
The
difference between the actual amount billed and the modified
amount paid was retained by Trans International and distributed
to C&G Consultants and Sentury.
As reflected in Trans
International's general ledger, in 1989 Trans International paid
to C&G Consultants, Mr. Garavaglia, Sentury, and Mr. Rogers
$99,090,
$11,033,
$90,662,
and $11,033,
respectively.
Trans
International debited these payments from its accrued workers'
compensation account.
G.
Payment of Consulting Fees to C&G Consultants
Trans International also paid consulting fees of $60,233 to
C&G Consultants during 1989.
These payments were recorded on
Trans International's general ledger, were generally made weekly,
and ranged in amounts between $420 and $8,112.
H.
Attempted Subchapter S Election
On March 7, 1989, Trans International filed with the IRS a
Form 2553, Election by a Small Business Corporation, electing to
be treated as an S corporation effective January 1, 1989.
.
-17-
Specifically, that Form 2553 was signed·by Mr. L. Yarnell in his
capacity as Trans International's secretary.
The consent
statement was signed by Mr. D. Yarnell in his alleged capacity as
Trans International's sole shareholder.
By letter dated June 14,
1989, the IRS notified Trans International that its Form 2553
could not be processed because additional information was needed.
That letter stated that Trans International needed to submit (1)
a consent statement for each shareholder and (2) a signature and
title of an officer.
On July 11,
1989, Mr. L. Yarnell sent to
the IRS a letter which stated that he was returning the IRS'
letter of June 14, 1989, and a completed Form 2553.
The record
does not contain a copy of the·Form 2553 purportedly included
with this letter.
I.
Federal Income Tax Returns
1.
1989 Trans International Return,
Trans International filed a 1989 Form 1120S, U.S..Income Tax
Return for an S Corporation, on or about March 14, 1990 (1989
Trans International return).
The 1989 Trans International return
reported gross receipts or sales of $5,527,339, cost of goods
sold and/or operations of $4,713,931, other income of $1,556, and
total income of $814,964.
The 1989 Trans International return
also reported total deductions of $810,373, including $78,716 for
officer compensation, $423,750 for payroll taxes, $183,433 for
employee benefits programs, $161 for advertising, and $124,313
-18for other deductions.
After netting its income and deductions,
Trans International reported ordinary income from trade or
business activities for 1989 of $4,591.
The 1989 Trans
International return was prepared by Mr. T. Yarnell.
2.
1990 Trans International Return
Trans International filed a 1990 Form 1120S on or about
March 5, 1991 (1990 Trans International return).
The 1990 Trans
International return reported gross receipts or sales of
$1,226,186, cost of goods sold of $1,072,369, and total income of
$153,817.
The 1990 Trans International return also reported
total deductions of $163,292, including $126,088 for payroll
taxes and $37,204 for other deductions.
After netting its income
and deductions, Trans International reported an ordinary loss
from trade or business activities for 1990 of $9,475.
The 1990
Trans International return was prepared, but not signed, by
"Central Mich. Computer Support".
J.
Winding Up of Trans International
Trans International operated until approximately March 1990.
Before the 1989 Trans International return was filed, Messrs.
Garavaglia and Rogers had a "falling out".
Mr. Garavaglia
accused Mr. Rogers of embezzling money from Trans International,
and Mr. Rogers claimed that members of the -Yarnell family had set
him up.
Following that dispute, Mr. Garavaglia and the Yarnell
family sided with each other and continued to do business with
-19each other under a parallel employee leasing company; namely,
Branch International.Services,
XI.
Inc.
(Branch International).
Branch International
A.
History of Branch International
On or about March 29, 1989, Mr. Garavaglia and Mr. L.
Yarnell incorporated Branch International.
That company was
owned 70 percent by Mr. Garavaglia and Ms. Garavaglia, and 30
percent by Mr. L. Yarnell and his wife.
B.
Payroll Misstatements
As discussed above, at some point on or after January 30,
1990,.Mr. T. Yarnell sent to Mr. Garavaglia a letter which stated
that Branch International's payroll as reported to the insurance
companies was "[scaled] down" to 25 percent of actual.
Attached
to that letter was a schedule reporting Branch International's
actual and modified payroll wages as follows:
Period
Drivers
Maintenance
Office
Total
July 1989
Aug. 1989
Sept. 1989
Oct. 1989
Nov. 1989
Dec. 1989
Total wages1
-0-0$25,024
35,495
41,983
45,848
148,350
-0-0$9,046
10,572
11,864
12,956
44,437
-0-0$8,461
11,710
11,279
15,835
47,285
-0-0$42,531
57,777
65,125
74,638
240,071
Reported wages
$37,087
$11,109
$11,821
$60,018
$22,316
$2,206
$113
$24,635
Actual workers'
compensation
billed to
customers2
-20-
Reported workers'
compensation
$5,235
$900
$74
$6,209
1The sum for the periods may.not equal the total wages
because of rounding.
As with Trans International,
the term "total wages" means the
total wages which Branch International actually paid its
employees.
The term "reported wages" means the wages which
Branch International reported to the insurance companies.
The
phrase "actual workers' compensation billed to customers" means
the actual workers' compensation that Branch International billed
to Branch International's client companies.
By reporting the
lower figure to the insurance companies, Branch International
understated the premiums due to the insurance companies.
C.
Accrual of Workers' Compensation Expense
Like Trans International, Branch International maintained an
accrued workers' compensation account on its books.
This account
represented a payable to Branch International for amounts owed to
the insurance companies.
When the payment was made to the
insurance companies, the accrued workers' compensation account
was credited and cash was debited.
During December 1989 Branch
International paid by check $21,000 to C&G Consultants, or 70
percent of the amounts debited to the accrued workers'
compensation account for that month.
Also in December 1989
Branch International paid by check to Mr. L. Yarnell, Mr. T.
-21-
Yarnell, or LTD Accounting $9, 000 or 30 percent of the amounts
debited to the accrued workers' compensation account.
D.
Payment of Premiums to Wholly Owned S Corporations
Branch International also billed and collected from its
client companies on the basis of the actual payroll but paid
insurance companies on the basis of the modified payroll.
The
difference between the amounts billed and the amounts paid was
distributed from Branch International to C&G Consultants and LTD
Accounting, Mr. L. Yarnell, or Mr. T. Yarnell.
Between May 4 and December 27, 1989, Mr. L. Yarnell, Mr. T.
Yarnell, or Mr. Garavaglia endorsed about 39 checks totaling
$71,645 from Branch International to C&G Consultants.
These
checks ranged from $1,120 t.o $8,500 and were generally paid
weekly.
During the same period Branch International paid $29,389
through 39 separate checks to LTD Accounting, Mr. L. Yarnell, or
Mr. T. Yarnell.
These checks ranged from $235 to $3,000 and were
generally paid weekly.
In general, checks issued to C&G
Consultants, LTD Accounting, Mr. L. Yarnell, or Mr. T. Yarnell
were paid on the same date and reflected Branch International's
ownership structure; i.e., 70 percent was paid to C&G Consultants
and 30 percent was paid to LTD Accounting, Mr. L. Yarnell, or Mr.
T. Yarnell.
-22-
During 1990 Branch International endorsed 96 checks totaling
$329,805. to C&G Consultants.
The amounts of those checks ranged
from $750 to $10,000, and they were generally drafted weekly.
E.
Subchapter S Election
On November 10, 1989, Branch International filed with the
IRS a Form 2553 electing to be treated as an S corporation
effective September 15, 1989.
Mr. T. Yarnell signed that Form
2553 as an officer of Branch International.
The consent
statement was signed by Mr. Garavaglia and Mr. T. Yarnell ln
their alleged capacities as Branch International's sole
shareholders.'
Branch International received notice that the
election to be treated as an S corporation was accepted on or
about January 29, 1990.
The IRS revoked Branch International's
election to be treated as an S corporation without explanation on
or about April 23, 1990.
F.
Federal Income Tax Return for Branch International
1,
1989 Branch International Return
Mr. T. Yarnell filed a 1989 Form 1120S on behalf of Branch
International on or about March 9, 1990 (1989 Branch
International return).
The 1989 Branch International return
reported gross receipts or sales of $1,206,271, cost of goods
sold and/or operations of $1,040,888, and total income of
7We observe that Mr. T. Yarnell was not a shareholder of
Branch International.
-23-
$165,383.
The 1989 Branch.International return also reported
total deductions of $169,401, consisting of $78,716 for officer
compensation, $83,804 for payroll taxes, and $85,597 for other
deductions.
The 1989 Branch International return thus reported
an ordinary loss from trade or business activities of $4,018.
The 1989 Branch International return was prepared but not signed
by LTD Accounting.
2.
1990 Branch International Return
Mr. Garavaglia filed a 1990 Form 1120, U.S. Corporation
Income Tax Return, on behalf of Branch International on or about
April 18, 1991 (1990 Branch International return).
The 1990
Branch International return reported gross receipts or sales of
$8,973,319,
cost of goods sold and/or operations of $8,542,264,
and total income of $431,055.
The 1990 Branch International
return also reported total deductions of $443,639, consisting of
$600 for repairs, $10,100 for rents, $17,987 for interest,
$42,231 for depreciation, and $372,721 for other deductions.
The
1990 Branch International return thus reported taxable income of
.
negative $12,584.
The 1990 Branch International return was
prepared by "Central Mich. Computer Support" and signed by a
member of the Yarnell family.
-24-
G.
The Yarnell Family Withdraws From Branch International
On January 31, 1991, Mr. L. Yarnell ceased being an officer
of Branch International, and on March 28, 1991, Mr. L. Yarnell
worked for Branch International on a "contract type basis".
XII. Payments From C&G Consultants to Mr. Garavaglia
In 1989 44r. Garavaglia wrote himself more than 50 separate
checks from C&G Consultants totaling $104,939.
The amounts
endorsed on these checks ranged from $550 to $13,250.
In 1990
Mr. Garavaglia wrote approximately 40 separate checks totaling
$204,818 payable from C&G Consultants to himself.
The amounts
endorsed on these checks ranged from $250 to $14,000.
The 90
checks endorsed from C&G Consultants to Mr. Garavaglia in 1989
and 1990 were written almost weekly.
XIII.
Petitioners' Joint Returns
A.
1989 Joint Return
Petitioners filed a joint Form 1040, U.S. Individual Income
Tax Return, for 1989 (1989 joint return).
reported total wages of $84,531,
The 1989 joint return
including $74,223 of wages which
Mr. Garavaglia earned from Trans International.
Attached to the
1989 joint return was Schedule E, Supplemental Income and Loss,
which reported a $23,265 loss from C&G Consultants, a $2,813 loss
from Branch International, and income of $2,295 from Trans
International.
Yarnell.
The 1989 joint return was prepared by Mr. L.
-25B.
1990 Joint Return
Petitioners filed a joint Form 1040 for 1990
return).
(1990 joint
·The 1990 joint return reported total wage income of
$47,935, consisting of wages paid to Mr. and Ms. Garavaglia by
(1) Branch International in the amounts of $18,000 and $13,000,
respectively and (2) Trans International in the amounts of $7,786
and $9,149, respectively.
Attached to the 1990 joint return was
Schedule E, which reported $6,059.in income from C&G Consultants,
a $4,737 loss from Branch International, and a $2,295 gain from
Trans International.
The 1990 joint return also reported
unemployment compensation of $7,150.
The 1990 joint return was
prepared, but not signed, by "Central Mich. Computer Support".
XIV. C&G Consultants' Returns
A.
1989 C&G·Consultants Return
Mr. Garavaglia filed a 1989 Form 1120S on behalf of C&G
Consultants (1989 C&G Consultants return).
The 1989 C&G
Consultants return reported $50,000 of gross receipts or sales,
$23,268 of other income, total deductions of $96,533, and total
ordinary losses of $23,265.
The 1989 C&G Consultants return did
not report any income from Trans or Branch International.
That
return was prepared by Mr. T. Yarnell of LTD Accounting.
B.
1990 C&G Consultants Return
Mr. Garavaglia filed a 1990 Form 1120S on behalf of C&G
Consultants (1990 C&G Consultants return).
The 1990 C&G
-26-
Consultants return reported $50,000 of gross sales or receipts,
other income of $33,889, total deductions of $77,830, and total
ordinary income of $6,059.
The 1990 C&G Consultants return was
prepared, but not signed, by "Central Mich. Computer Support".
Attached to the 1990 C&G Consultants return was Schedule K-1,
Shareholder's Share of Income, Credits, Deductions, Etc.,. which
reported the pro rata share of C&G Consultants' $6,059 ordinary
income as fully allocable to Mr. Garavaglia.
The 1990 C&G
Consultants return did not report any income from Trans
International or Branch International.
The 1990 C&G Consultants
return was prepared by Mr. L. Yarnell.
XV.
Criminal Investigation of Mr. Garavaglia
A.
Tipoff of Mr. Garavaglia's Criminal Activity
In November 1991 a confidential informant contacted CID with
information that Mr. Garavaglia evaded taxes through two separate
schemes which were perpetrated by at least three corporations
partially owned by Mr. Garavaglia.
In late 1991 or early 1992,
CID contacted Messrs. D. and L. Yarnell regarding their knowledge
of any wrongdoing regarding unreported income by Branch
International and Mr. Garavaglia.
Mr. L. Yarnell did not tell
Mr. Garavaglia that CID had contacted him.
B.
Preliminary Meetings With the IRS
In early 1992 special agents with CID held a meeting with
Mr. L. Yarnell and Mr. D. Yarnell.
During that meeting, Mr. L.
-27-
Yarnell stated that he had prepared Federal income tax returns
for Mr. Garavaglia and C&G Consultants.
Mr.. L. Yarnell also
stated that he did not think that those returns were accurate or
that Mr. Garavaglia reported all of his income on those returns.
Sometime in April 1992, special agents with CID held a
second meeting with Mr. L. Yarnell and Mr. D.3 Yarnell.
meeting was tape recorded.
That
During that meeting CID offered Mr.
L. Yarnell immunity for information which was offered during the
question and answer portion of the second meeting.
At that
meeting, CID's special agents presented various tax returns.from
Mr. Garavaglia's corporations to Mr. L. Yarnell and questioned
him on those returns.
Although various corporate returns were
presented to Mr. L. Yarnell, the CID special agents' focus was
Mr. Garavaglia and C&G Consultants.
C.
Wiretap
The IRS conducted telephone monitoring of conversations
between Mr. Garavaglia and Mr. L. Yarnell on July 14 and 16,
1992.
Mr. Garavaglia was unaware that these conversations were
being taped.
D.
Execution of Warrants
On July 14, 1992, the U.S. District Court for the Eastern
District of Michigan (the District Court) issued four search
warrants for the IRS to search properties believed to house tax
and accounting records for, among others, petitioners, C&G
-28-
Consultants, Trans Continental, Trans International, and Branch
International.
These properties were the office buildings of
Messrs. Garavaglia and Rogers and the personal residence of Mr.
Garavaglia.
The IRS executed the search warrants and seized more
than 100 storage boxes of documents contained in storage cabinets
and desks and around the searched premises.8
In total, CID
inventoried more than 2,500 items, including payroll information,
invoices, quarterly reports, check registers, medical files,
insurance records, State tax records, personnel files, canceled
checks, wage reports, and payroll registers.
Many of these
documents related to C&G Consultants, Trans Continental, Trans
International, and Branch International.
Following the seizures, agents with CID inventoried the
items seized, matched the inventories to the boxes in which they
were stored, and secured those documents in a grand jury room,
which was a room designated for those records.
A log was kept on
the grand jury room as to the individuals who had access to the
room.
At some point after the grand jury was convened, the
records were moved to an IRS building.
®By letter dated July 14, 2008, respondent's counsel
confirmed that Mr. Garavaglia's counsel received 28 boxes from
respondent.
-29XVI. Criminal Prosecution of Mr. Garavaglia
A.
Grand Jury Indictment
Following CID's investigation, a Federal'grand jury in the
District. Court returned a 19-count indictment against Mr.
Garavaglia on April 10, 1996
(indictment).
The indictment
charged Mr. Garavaglia with mail fraud in violation of 18 U.S.C.
sec. 1341, conspiracy to defraud the United States in violation
of 18 U.S.C. sec. 371, making and subscribing false individual
and corporate income tax returns in violation of section 7206(1),
and willful failure to file heavy vehicle use tax forms in
violation of section 7203.
The indictment also charged that Mr.
Garavaglia's fraudulent activities began in the latter part of
1988 and continued until April 1992.
B.
Plea Agreement
Mr. Garavaglia subsequently entered into a plea agreement
(plea agreement) with the U.S. Attorney for the Eastern District
of Michigan on or about January, 29, 1997.
11(c).
See Fed. R. Crim. P.
Mr. Garavaglia pleaded guilty to one count of mail fraud
for a fraudulent check mailed on June 28, 1991; and one count of
conspiracy to defraud the United States Government by filing a
false corporate income tax return for Branch International on or
about March 31, 1992.'
The plea agreement references B.I.S., which, from the
context of the discussions, we understand to be Branch
(continued...)
-30-
In the plea agreement, Mr. Garavaglia stipulated that he
knowingly participated in a scheme to defraud insurance companies
by obtaining workers' compensation insurance for Branch
International's employees using false information reported to the
insurance companies concerning the amount of payroll per
classification that Branch International expected to pay its
employees, thus significantly reducing the premiums for Branch
International.
Mr. Garavaglia also stipulated that he and
several of his business associates agreed to defraud the IRS by
falsely claiming substantially higher deductions for expenses
than actually paid to the insurance companies on income tax
returns for his employee leasing businesses, thus falsely
reducing the tax liabilities of those businesses.
Mr. Garavaglia
also stipulated that the agreement continued through April 1992
and that on or about March 31, 1992, he signed a false corporate
income tax return for Branch International.
Mr. Garavaglia also
agreed that the "tax loss" resulting from the charged tax
offenses might be at least $207,000, an amount which he agreed to
pay as restitution before sentencing.
C.
Sentencing Hearings
Between September 17, 1997, and April 9, 1988, the District
Court held sentencing hearings for Mr. Garavaglia.
'(...continued)
International.
See United
-31-
States v. Garavaglia, 178 F.3d 12.97.(6th Cir. 1999).
At the
sentencing hearing on September 17, 1997, Mr. Garavaglia's
attorney argued that Mr. Rogers and certain members of the
Yarnell family were primarily responsible for any criminal
violations and that the criminal enterprise had begun before Mr.
Garavaglia was involved in the scheme.
D.
Plea Hearing
The District Court conducted a thorough plea colloquy under
rule 11 of the Federal Rules of Criminal Procedure.
On April 15,
1998,·Mr. Garävaglia was sentenced to a prison term of 27 months
and placed on supervised release upon release from prison.
The
District Court ordered Mr. Garavaglia to pay $500,000 in
restitution equally to three insurance companies, at least
$207,000 to the IRS, .$50,000 in fines, and ansassessment of $100.
XVII. Mr. Rogers' Guilty Plea to.Income Tax Fraud
Mr. Rogers wäs indicted along with Mr. Garavaglia.
On March
25, 1996, Mr. Rogers pleaded guilty to one count of willfully
making a false Federal income tax return for 1989.
7206(1).
See sec.
As a condition of that plea agreement, Mr. Rogers filed
Forms 1040X, Amended U.S. Individual Income Tax Return, for the
1988,
1989, and 1990 taxable years
returns, respectively).
(1988 through 1990 amended
The 1988 amended return added $11,000 of
previously omitted income from Trans Continental.
The 1989 and
1990 amended returns added $102,000 and $12,000 of previously
-32-
omitted income from Trans International, respectively.
On the
basis of his amended 1988, 1989, and 1990 Federal income tax
returns, Mr. Rogers' Federal income tax liabilities increased by
$3,075, $33,660, and $3,960, respectively.
Mr. Rogers was, also
required to pay a fine of approximately $10,000 to the IRS.
XVIII. Destruction of the Seized Records
After Mr. Garavaglia and Mr. Rogers entered their respective
guilty pleas, one of CID's special agents contacted Mr. Rogers.
He asked whether Mr. Rogers wanted the documents from Trans
International returned to him, to which Mr. Rogers replied that
the documents should be "[burned]".
Mr. Garavaglia brought a claim against CID's special agents
under the Supreme Court's decision in Bivens v. Six Unknown Named
Agents, 403 U.S. 388
(1971).
That cause of action alleged that
CID's special agents coerced or encouraged Mr. L. Yarnell to
obtain Branch International's tax documents under the pretense of
preparing an amended Federal tax return for Branch International.
See Garavaglia v. Budde, 43 F.3d 1472
(6th Cir.
1994).
Mr.
Garavaglia further alleged that the detention of Mr. Garavaglia,
Mr. Rogers, and Mr. Garavaglia's daughter during CID's execution
of the search warrants was unconstitutional.
See id.
The
District Court summarily dismissed Mr. Garavaglia's cause of
action in favor of CID's special agents, and the U.S. Court of
Appeals for the Sixth Circuit affirmed.
See id.
.
-33-
XIX. Notices of Deficiency
A.
Mr. Garavaglia's.Notice of.Deficiency
By notice of.deficiency dated October 31, 2006, respondent
determined deficiencies in Mr. Garavaglia's 1989 and 1990 Federal
income taxes of $97,070 and $114,435, respectively, and fraud
penalties under section 6663 (a)
respectively.
of $72,803. and $85,826,
The deficiencies arose from three adjustments.
First, respondent de-termined that Mr. Garavaglia received. wages
from C&G Consultants of $106,709 and $208,7381in 1989 and 1990,
respectively.
Second, respondent determined that Mr.
Garavaglia's distributable shares of income and/or loss from C&G
Consultants for 1989 and 1990 were increased by $220,160 and
$177,586, respectively, to reflect payments from Trans and Branch
International to ·C&G Consultants.
Third, respondent determined
computational adjustments of $1,440 and $3,220.in Mr.
Garavaglia's 1989 and 1990 Federal income taxes, respectively.
With respect to the second adjustment, respondent determined
adjustments to C&G Consultants' 1989 and 1990 distributable
shares of income as follows:
Adjustments to
ordinary, distributable
net, or taxable income
1989
1990
Gross sales or receipts-$159,323
-0-
Gross sales or receipts-Branch International
Trans International
71,645
$309,380
Compensation of officers
Other expenses
(106,709)
95,901
(208,738)
76,944
-34-
Total adjustments to
ordinary, distributable
net, or taxable income
1.
220,160
177,586
Gross Sales or Receipts From Trans International
Respondent first determined that C&G Consultants'
distributable share of income for 1989 should be increased by
$159,323 to reflect income paid from Trans International to C&G
Consultants.
The proposed adjustment to C&G Consultants'
distributable share of income arises from Trans International's
payment to C&G Consultants of consulting fees of $60,233 and
accrued workers' compensation expenses of $99,090.
2.
Gross Sales or Receipts From Branch International
Respondent next determined that C&G Consultants'
distributable shares of income for 1989 and 1990 should be
increased by $71,645 and $309,380, respectively, on account of
income paid to C&G Consultants by Branch International.
3.
Compensation of Officers
Respondent further determined that C&G Consultants'
distributable shares of income for 1989 and 1990 should be
reduced by $106,709 and $208,738.
Respondent asserts that to the
extent that we determine that Mr. Garavaglia received wages or
officer's compensation from C&G Consultants, then C&G Consultants
is entitled to deductions for like amounts.
-35-
4.
Other Expenses
a.
1989
C&G Consultants deducted and respondent disallowed expenses
on the 1989 C&G Consultants return as follows:
Expense
Repairs
Rents
Taxes
Depreciation
Advertising
Accounting
Auto
Bank charges
Dues and
subscriptions
Insurance
Legal
Miscellaneous.
Amount claimed . Amount allowed
on return
by IRS
.
Amount
disallowed
$4,120
5,400
3,398
7,610
2,494
27,000
12,148
310
-0-0-0-0-0-0-0$148
160
4,860
3,168
2,704
59
-0-0-0-
101
4,860
3,168
2,704
2,595
240
3,330
2,382
11,191
3,423
96,533
-0-06
420
-0-0632
2,595
240
3,324
1,962
11,191
3,423
95,901
.
$4,120
5,400
3,398
7,610
2,494
27,000
12,148
162
Outside
services
Postage
Supplies
Telephone
Travel
Utilities
Totall
.
.
1The sum of the items may not equal the total on account of
rounding.
b.
1990
C&G Consultants deducted and respondent disallowed expenses
on the 1990 C&G Consultants return as follows:
Expense
Amount claimed
on return
Taxes
Depreciation
Advertising
$3,395
13,649
510
Amount allowed
by IRS
-0-0-0-
Amount
disallowed
$3,395
13,649
510
-36Accounting
Auto
Bank charges
2,400
9,914
322
-0$760
-0-
2,400
9,154
322
186
165
16,056
3,925
627
-0-0-0-036
186
165
16,056
3,925
591
6,710
328
4,344
2,580
10,053
1,541
1,125
77,830
-0-0-091
-0-0-0886
6,710
328
4,344
2,489
10,053
1,541
1,125
76,944
Dues and
subscriptions
Gifts
Insurance
Legal
office expense
Outside
services
Postage
Supplies
Telephone
Travel
Utilities
Arbitration Fee
Totall
1The total amount allowed by the IRS may not equal the sum
of the items on account of rounding.
B.
Ms. Garavaglia's Notice of Deficiency
By notice of deficiency dated May 22, 2009, respondent
determined deficiencies in Ms. Garavaglia's 1989 and 1990 Federal
income taxes of $99,179 and $117,557 and accuracy-related
penalties under section 6662(a)
respectively.
of $19,836 and $23,511,
Respondent determined income tax deficiencies of
$99,179 and $117,557 and accuracy-related penalties under section
6662(a) of $19,836 and $23,511, respectively.
Most of the
deficiencies arose from the adjustments determined with respect
to Mr. Garavaglia.
C.
Differences in Notices of Deficiency
The differences between the notices of deficiency issued to
Mr. Garavaglia and to Ms. Garavaglia are:
(1) The notice of
-37deficiency issued to Ms. Garavaglia increased C&G Consultants'
1989 share of distributable income from Trans International by
$166,865, whereas the notice of deficiency issued to Mr.
Garavaglia increased C&G Consultants' 1989 share of distributable
income from Trans International by $159,323;
(2) the notice of
deficiency issued to Ms. Garavaglia increased C&G Consultants'
1990 share of distributable income from Branch International by
$320,530, whereas the notice of deficiency issued to Mr.
Garavaglia increased C&G Consultants' distributable share of
income from Branch International by $309,380;'and (3) the notice
of deficiency issued to Ms. Garavaglia determined accuracyrelated penalties under section 6662(a), whereas the notice of
deficiency issued to Mr. Garavaglia determined fraud penalties
under section 6663(a).
XX.
Trial
A trial in these cases was held in Detroit, Michigan.
The
evidence consists of the uncontested pleadings, the trial
testimony of 13 fact witnesses, approximately 300 stipulated
facts, and almost 300 stipulated exhibits.
OPINION
I.
Perception of Witnesses
Our resolution of these cases depends, in part, on whether
we believe that Mr. Garavaglia was uncorrupted amidst a sea of
fraud.
During the course of the trial, we heard the testimony
-38-
and observed the demeanor of 13 fact witnesses, including the
Garavaglias.
We observe the truthfulness, sincerity, and
demeanor of each witness to evaluate his or her testimony.
We
then assign weight to that testimony for the primary purpose of
finding disputed facts based on the record as a whole.
HIE
Holdings, Inc. v. Commissioner, T.C. Memo. 2009-130.
In the
light of that testimony, we weigh the evidence, make appropriate
inferences, and find what we believe to be the truth.
Commissioner, T.C. Memo. 2000-148.
Kropp v.
We are "careful to avoid
making the courtroom a haven for the skillful liar or a quagmire
in which the honest litigant is swallowed up."
Commissioner, 58 T.C. 560, 564
Diaz v.
(1972); Hawkins v. Commissioner,
T.C. Memo.
1993-517, affd. without published opinion 66 F.3d 325
(6th Cir.
1995).
We generally found the testimony of Mr. Garavaglia to be
self-serving, evasive, conflicted, and at times improbable.
found material aspects of Ms. Garavaglia's testimony to be
implausible.
We found the testimony of Messrs. Rogers, D.
Yarnell, T. Yarnell, and Cheri Ghent Koehn (Ms. Koehn)
to be
generally straightforward and corroborated by the documentary
evidence.
The testimony of the remaining seven witnesses was
credible but mostly unhelpful in resolving issues of material
We
-39-
fact."
To the extent that we have disregarded or discounted any
testimony in these cases,. we did so because we perceived the
witness offering that testimony to be untrustworthy in giving
that testimony or considered the testimony to be self-serving,
vague, elusive, uncorroborated, and/or inconsistent with
documentary or other reliable evidence."
We need not accept
uncontroverted testimony where we find that testimony improbable,
unreasonable, or questionable.
F.3d 658,
664
part 99 T.C.
II.
(6th Cir.
370
(1992)
See Conti v. Commissioner, 39
1994), affg.
in part and remanding in
and T.C. Memo..
1992-616.
Status of Trans International and Branch International as S
Corporations
Pursuant to section 6214 (a) and.Rule 41(a), respondent
amended the answer to assert that Trans International and Branch
International were S corporations in 1989 and 1990."
Proceeding
along this line, respondent argues in the main that Mr.
"These witnesses include Marie Wilhelm, Charles Gottlieb,
James Budde, Suzanne M. Carene, Sarah Stinson, Alexandra
Nicholaides, and Joseph Ellery.
"Nor do we rely heavily on the transcripts of testimony
given by various witnesses in prior proceedings which were
included in the record and stipulated by the parties. Because we
were not able to observe those witnesses during that testimony,
we decline to accept that prior testimony merely cx1 the basis of
the written words. We have, however, given that testimony proper
regard in finding the facts of these cases and do not simply
reject that testimony entirely.
"Respondent concedes on brief that Branch International was
not an S corporation in 1990.
-40-
Garavaglia omitted distributable income in 1989 from Trans
International and Branch International of $124,383 and $104,535,
respectively.
Respondent bears the burden of proof with respect
to these newly pleaded matters.
A.
See Rule 142(b).
Compliance With Section 1362
Section 1362(a) provides that a "small business corporation"
may elect to be taxed as a passthrough entity under subchapter S
of the Code.
The term "small business corporation" generally
means an eligible domestic corporation with one class of stock
and 35 or fewer shareholders, all of whom are resident
individuals or qualified estates and trusts.
Sec. 1361(b).
A
small business corporation makes an election to be taxed under
subchapter S of the Code (S election) by filing with the IRS a
completed Form 2553.
Sec. 1.1362-6(a) (2), Income Tax Regs.
Before an S election is valid, all shareholders as of the date
the election is made must consent to that election.
1362(a) (2).
Sec.
A shareholder consents to an S election by signing
and dating the Form 2553 submitted by the S corporation, see sec.
1.1362-6(b) (3) (i), Income Tax Regs., or by separately submitting
to the IRS a signed consent statement which sets forth certain
information, see sec. 1.1362-6(b) (1), Income Tax Regs."
"The consent statement must set forth the name, address,
and taxpayer identification number of the shareholder, the number
of shares of stock owned by the shareholder, the date or dates on
which the stock was acquired, the date on which the shareholder's
(continued...)
-411.
Trans.International
There is no question that Messrs. Garavaglia and Rogers.
intended for Trans International be taxed as an S corporation in
.1989 and 1990.
Consistent with that intent, Trans International
filed with respondent Form 2553 and the 1989 and 1990 Trans
International returns on Forms 1120S.
Respondent, however,
determined that Trans International's attempted S election was
defective, and respondent stated as much by letter dated June 14,
1989.
The record does not contain a copy of a properly executed
Form 2553, and in the absence of such evidence, we presume that
none existed.
6 T.C.
1158,
See Wichita Terminal Elevator Co. v. Commissioner,
1165
(1946), affd.
162 F.2d 513
(10th Cir.
1947).
Trans International's S election was thus invalid.
2.
Branch International
There is similarly no question that Messrs. Garavaglia and
L. Yarnell intended for Branch International be taxed as an S
corporation in 1989.
The corporate minute book and a statement
of organizational resolutions for Branch International each
evince a clear intent that Branch International be taxed as an S
corporation.
True to that intent, Branch International filed
with respondent Form 2553 and the 1989 Branch International
"(...continued)
taxable year ends, the corporation's name, the corporation's
taxpayer identification number, and the election to which the
shareholder consents.
See sec. 1.1362-6(b) (1), Income Tax Regs.
-42-
return on Form 1120S.
Respondent, however, determined that
Branch International's attempted S election was defective and
revoked that election by letter dated April 23,
1990.
Thus,
Branch International's S election was not valid.
B.
Judicial Doctrines
Despite separate letters to Trans International and Branch
International rejecting or denying their S elections, respondent
urges the Court to apply judicial doctrines to overcome their
failure to comply with the requirements of section 1.13626(b) (3) (i), Income Tax Regs.
Respondent asserts that Trans
International and Branch International ignore their form in
disavowing their S corporation status and that the duty of
consistency estops petitioners from denying the S corporation
status of Trans International and Branch International.
Petitioners counter that neither Trans International nor Branch
International was an S corporation because the S elections which
they attempted to file with respondent were rejected.
1.
Form of Trans and Branch International
As a general rule, taxpayers are bound by the form of the
transaction they have chosen, and they may not in hindsight
recast that transaction to obtain tax advantages.
Commissioner,
456 F.3d 645,
v. United States,
Memo. 2005-75.
651
(6th Cir.
902 F.2d 439, 443
2006)
(5th Cir.
See Maloof v.
(quoting Harris
1990)),
affg. T.C.
To determine the form of the transaction, we
-43-
examine the parties'
intentions when the transaction was entered
into and the economic realities as then perceived by the parties.
See Groetzinger v. Commissioner,
87 T.C.
533,
542
(1986).
There is no question that Mr. Garavaglia manifested the
requisite intent for Trans International and Branch International
to be treated as S corporations, but the question is whether the
law gives effect to that intent.
It does not.
Section
1362(a) (2) provides that an initial election to become an S
corporation is valid "only if all persons who are shareholders
* * * on the day on which such election is made consent to such
election."
Sec. 1362(a) (2).
Courts have strictly construed the
requirements for electing to be.taxed as an S corporation.
e.g., Brutsche v. Commissioner,
1978)
585 F.2d 436,
443
See,
(10th Cir.
(shareholders were not individually liaple for deficiency
because Form 2553 did not comply with the requirements for S
'
corporation status), remanding 65 T.C. 1034 (1976); Feldman v.
Commissioner,
47 T.C.
329,
334
(1966)
("where iCongress has
specifically set out the procedure that must be followed in order
for a corporation to obtain the benefits of subchapter S, and the
corporation does not follow such procedure, the courts cannot
supply what the taxpayer has failed to do").
Trans International filed a Form 2553 consent statement
which reported that Mr. D. Yarnell was the solë shareholder of
that company.
However, Mr. D. Yarnell was not the sole
-44-
shareholder of Trans International; Messrs..Garavaglia and Rogers
were equal shareholders of that company.
Similarly, Branch
International filed a Form 2553 consent statement which reported
that Messrs. Garavaglia and T. Yarnell were equal shareholders in
that company.
However, Messrs. Garavaglia and T. Yarnell were
not equal shareholders in Branch International; Messrs.
Garavaglia and L. Yarnell owned 70 percent and 30 percent of that
company, respectively.
Thus, Trans International and Branch
International's S elections did not comply with the requirements
of section.1.1362-6(b) (3) (i),
2.
Income Tax Regs.
The Duty of Consistency
The duty of consistency, or quasi-estoppel,
is an equitable
doctrine which prevents a taxpayer from benefiting in a later
year from an error or omission in an earlier year which cannot be
corrected because the limitations period for the earlier year has
expired.
Estate of Letts v. Commissioner, 109 T.C. 290, 296
(1997),
affd. without published opinion 212 F.3d 600
2000).
Absent a written stipulation to the contrary, an appeal
in this case would lie in the Sixth Circuit.
(11th Cir.
Sec. 7482(b) (1) (A).
The Court of Appeals for the Sixth Circuit has held that for
the duty of consistency to apply, the following requirements must
be met:
(1) The taxpayer by his or her conduct knowingly makes a
representation or conceals a material fact which the taxpayer
intends or expects will be acted upon by the Commissioner in
determining the taxpayer's liability;
(2) the true or concealed
material facts are unknown to the.Commissioner or the
Commissioner lacks a means of knowledge equal with the
taxpayer's;
(3) the Commissioner relies on the taxpayer's
representation or concealment; and (4) an attempt by the taxpayer
after the.statute of limitations has run to change the previous
representation or to recharacterize the facts in such a way
causes loss of taxes to the Government.
Crosley Corp. v. United
States,
1956); see also Temple v.
229 F.2d 376,
Commissioner,
380-381
(6th Cir.
62 Fed. Appx. 605,
Memo. 2000-337.
609
(6th Cir.
2003),
affg. T.C.
Where each of the foregoing requirements is met,
taxpayers are estopped from asserting positions contrary to their
earlier representations, and the Commissioner^may treat those
representations as true even though they are not.
Commissioner,
854 F.2d 755,
758
Commissioner,
87 T.C.
(1986).
1087
(5th Cir.
1988),
Herrington v.
affg. Glass v.
The requirements for applying the duty of consistency have
not been met.
First, petitioners did not materially misrepresent
or conceal the status of Trans International and Branch
International as S corporations.
In 1989 each corporation filed
its Form 1120S under the mistaken belief that the attempted S
election was valid.
Second, respondent was aware that Trans
International and Branch International intended to be taxed as S
corporations, but did not give effect to that intent until
-46-
amending the answer.
In this regard, the status of Trans
..
International and Branch International was one of law and not
fact.
The duty of consistency does not apply where the
inconsistent positions asserted by the taxpayer involve questions
of law arising out of a defined factual situation.
Corp. v. United States, supra at 380.
See Crosley
Third, respondent did not
rely on the defective election made by Trans International or
Branch International.
The notices of deficiency issued to Mr.
and Ms. Garavaglia did not treat Trans International or Branch
International as an S corporation.
Fourth, treating Trans
International and Branch International as C corporations does not
affect the period of limitations for assessment.
That period is
either open on account of fraud, or it is closed.
The status of
Trans International or Branch International as an S corporation
has no bearing on this issue.
Neither the form chosen by Trans International and Branch
International nor the duty of consistency usurps the failure of
those companies to satisfy the strict requirements for electing
subchapter S status.
Trans International and Branch
International attempted to elect S corporation status, and
respondent properly denied that request.
Respondent cannot now
expect this Court to supply what petitioners have failed to do
themselves, especially after declining to give effect to that
intent in the first place.
-47-
III. Omitted Income
Having failed to persuade us that Trans International or
Branch International was an S corporation, respondent proceeds
under his alternative theory that Mr. Garavaglia omitted income
of $326,815 and $386,324 in 1989 and 1990,.respectively.
Specifically, respondent asserts that (1) Mr. Garavaglia omitted
income from C&G Consultants in 1989 and 1990 of $106,709 and
$208,738, respectively; and (2) Mr. Garavaglia's shares of C&G
Consultants' shares of distributive income for 1989 and 1990 are
increased by $220,160 and $177,586., respectively."
Petitioners
counter that (1) the books and records on which these
determinations were based are inherently unreiiable, and (2)
payments between Mr. Garavaglia, C&G Consultants, Trans
International, and Branch International, were nontaxable loan
repayments.
A.
Burden of Proof
The Commissioner's determinations in a notice of deficiency
are generally presumed correct, and the taxpayers bear the burden
of proving that those determinations are erroneous.
Welch v. Helvering,
290 U.S.
111,
115
(1933).
Rule 142(a);
In the context of
unreported income, the Court of Appeals for the Sixth Circuit has
held that before the notice of deficiency is entitled to a
"Respondent also made computational adjustments to Mr.
Garavaglia's 1989 and 1990 itemized deductions of $1,440 and
$3,220, respectively.
-48presumption of correctness, such determinations must be supported
by at least a "minimal" factual predicate or foundation of
substantive evidence linking the taxpayer to the income-producing
activity or to the receipt of funds.
Walton,
909 F.2d 915,
918-919
See United States v.
(6th Cir.
Commissioner, T.C. Memo. 2006-69, affd.
2007).
1990); Richardson v.
509 F.3d 736
(6th Cir.
Once the Commissioner meets his burden of production, the
burden of proof shifts to the taxpayers to prove that they did
not earn the income attributable to them or of presenting an
argument that the adjustments offered by the Commissioner are not
grounded in a minimal evidentiary foundation.
Commissioner, supra.
Richardson v.
Where taxpayers establish by a
preponderance of the evidence that the Commissioner's
determinations are arbitrary and excessive, then the notice of
deficiency is no longer presumed correct.
293 U.S.
507,
258,
(6th Cir.
263
515
Helvering v. Taylor,
(1935); Traficant v. Commissioner,
1989),
affg.
89 T.C.
501
884 F.2d
(1989).
Respondent introduced admissible, substantive evidence
linking Mr. Garavaglia to payments received in connection with a
scheme to defraud insurance companies and the Treasury.
The
evidence included canceled checks and/or accounting ledgers which
reflected payments between Mr. Garavaglia, C&G Consultants, Trans
International, and Branch International.
We are satisfied that
respondent has produced evidence that Mr. Garavaglia earned the
-49-
income with which he is charged.
Thus, petitioners bear the
burden of proving that respondent's determïnations are arbitrary
and excessive.
Although petitioners "reserve the issue" of whether the
notice of deficiency issued to Mr. Garavaglia was arbitrary, we
understand petitioners to advance two theories to meet their
burden.
First, petitioners assert that the payments between Mr.
Garavaglia, C&G Consultants, Trans International, and Branch
International were loan repayments.
Second, petitioners contend
that the books and records of Trans International and Branch
International are inherently unreliable and cannot serve as the
basis for determining income earned by Mr. Garavaglia.
For the
reasons discussed below, petitioners have not met their burden.
B.
Guiding Principles
Section 61(a) (2) defines gross income as all income from
whatever source derived, including gross income derived from
business.
Section 61 is broad, requiring that gains from lawful
and unlawful activities be included as income.
v. United States,
343 U.S.
130,
137
(1952)
See, e.g., Rutkin
("An unlawful gain, as
well as a lawful one, constitutes taxable income when its
recipient has such control over it that, as a practical matter,
he derives.readily realizable economic value from it."); see also
Davis v. United States,
226 F.2d 331,
334-335
(6th Cir.
1955).
taxpayer has received income where he or she gains complete
A
-50-
dominion and control over the money or other·property and
realizes an economic benefit.
A taxpayer is required to maintain sufficient records to
enable the Commissioner to determine his or her correct tax
liability.
Sec. 6001.
Where a taxpayer fails to maintain
adequate books and records, the Commissioner is empowered to
determine the existence and amount of the taxpayer's income by
any method that clearly reflects .income.
v.-Commissioner,
92 T.C.
661,
686-687
Sec. 446(b); Petzoldt
(1989).
The Commissioner's
reconstruction of a taxpayer's income need only be reasonable in
the light of the surrounding facts and circumstances.
Commissioner, 94 T.C. 654, 658
(1990).
Parks v.
The Commissioner is not
held to mathematical exactitude because to do so "'would be
tantamount to holding that skillful concealment is an invincible
barrier to proof.'"
(1980)
Llorente v. Commissioner, 74 T.C. 260, 266
(quoting United States v. Johnson,
(1943)), affd.
in part and revd.
319 U.S.
503,
in part 649 F.2d 152
517-518
(2d Cir.
1981).
Respondent determined that petitioners underreported income
and overstated deductions following a criminal investigation and
prosecution of Mr. Garavaglia.
Respondent also determined that
petitioners did not maintain books and records which accurately
reflected transactions between Mr. Garavaglia, C&G Consultants,
Trans International, and Branch International.
We agree that
-51-
petitioners did not maintain sufficient records from which
respondent could determine their tax liabilities.
Accordingly,
respondent is given broad power to compute petitioners' taxable
lncome.
C.
See Petzoldt v. Commissioner, supra at 693.
Distributions From C&G Consultants
Respondent determined adjustments to Mr. iGaravaglia's 1989
and 1990 income of $106,709 and $208,738, respectively.
To
arrive at these adjustments, respondent's auditor analyzed and
prepared a summary of checks endorsed by C&G Consultants to Mr.
Garavaglia during 1989 and 1990.
The summary designated the
date, check number, payee, amount, and any notations made on the
checks.
Respondent attached the summary to the notice of
deficiency and treated.all amounts distributed from C&G
Consultants to Mr. Garavaglia during 1989 and 1990 as income to
Mr. Garavaglia.
Respondent thoroughly corroborated that summary
at trial with copies of almost all of the canceled checks on
which the adjustments were based.
It is well settled that a bank
deposit is prima facie evidence of income where that deposit is
made from or to an account controlled by the party charged with
the income.
Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).
Accordingly, we find respondent's method to be reasonable.
We have examined the checks presented by respondent at trial
and generally agree with respondent's conclusions.
In 1989 Mr.
Garavaglia wrote himself more than 50 checks from C&G Consultants
-52totaling $104,939."
In 1990 Mr. Garavaglia wrote himself 40
checks from C&G Consultants totaling $204,818."
were written almost weekly.
These checks
As evidenced by petitioners'
financial assets of more than $1 million, Mr. Garavaglia
exercised dominion and control over these funds, and he derived
economic benefit from them.
Accordingly, we hold that Mr.
Garavaglia had income of $104,939 and $204,818 in 1989 and 1990,
respectively.
D.
Schedule E Income
During 1989 and 1990 Mr. Garavaglia operated as a labor
consultant through C&G Consultants.
C&G Consultants reported
"Whereas respondent's auditor determined that Mr.
Garavaglia received $106,709 in payments from C&G Consultants, we
limit the amount of income paid to Mr. Garavaglia to $104,939.
The difference between the amount determined by respondent and
that determined by the Court resulted because respondent's
auditor included as income check Nos. 1236, 1238, and 1239, each
of which was purportedly in the amount of $2,520, for a total of
$7,560.
The checks respondent submitted, however, did not
include check No. 1236, 1238, or 1239.
Instead, respondent
submitted at trial check No. 1223 in the amount of $5,790. The
difference between these amounts is $1,770
($7,560 less $5,790),
which is also the difference between the amount determined by
respondent ($106,709) and the amount determined by the Court
($104,939).
"Whereas respondent's auditor determined that Mr.
Garavaglia received $208,738 in payments from C&G Consultants, we
limit the amount of income paid to Mr. Garavaglia to $204,818.
The difference between the amount determined by respondent and
that determined by the Court resulted because respondent's
auditor included as income (1) $2,520 apparently paid on check
No.
1256,
and (2)
$1,400 designated as "CC".
The records
respondent submitted did not include check No. 1256 or otherwise
clarify what the payment "CC" related to. Accordingly, we reduce
the income as determined by respondent by $3,920.
-53-
gross receipts of $50,000 on each of the 1989 and 1990 returns,
amounts which were paid pursuant to an independent contractor
agreement with Centrâl.
The11989 and 1990 C&G Consultants
returns, however, did not report as gross receipts or sales
income from Trans International or Branch International, even
though those companies made regular and sizable payments to C&G
Consultants.
Respondent determined adjustments of $220,160 and $177,586
to Mr. Garavaglia's 1989 and 1990 distributable shares of income,
respectively.
Specifically, respondent determined adjustments to
C&G Consultants'
1989 and 1990 returns as follows:
(1) An
increase of $159,323 from Trans International's 1989 gross sales
or receipts;
(2) increases of $71,645 and $309,380 from Branch
International's 1989 and 1990 gross sales or receipts,
respectively;
(3) decreases of $106,709 and $208,738 for
officer's compensation; and (4) increases of $95,901 and $76,944
for other expenses.
1.
We consider each adjustment in turn.
Gross Sales or Receipts From Trans International
Respondent determined an adjustment to C&G Consultants' 1989
gross receipts or sales from Trans International of $159,323.
This adjustment was figured from Trans International's general
ledger because canceled checks between Trans International and
C&G Consultants were unavailable.
Given the circumstances of
this case, we find respondent's method for calculating·payments
-54-
between Trans International and C&G Consultants to be reasonable.
See sec. 446(b).
We have confirmed the accuracy of respondent's analysis and
found that Trans International's general ledger recorded that C&G
Consultants was paid (1) $60,233 of consulting fees, and (2)
$99,090 of premiums collected from Trans International's client
companies and distributed to C&G Consultants.
Mr. Garavaglia
does not dispute that C&G Consultants received these payments and
we treat them as income to C&G Consultants.
that C&G Consultants'
Accordingly, we hold
1989 gross receipts or sales are increased
by $159,323.
2.
Gross Sales or Receipts From Branch International
Respondent also determined adjustments to C&G Consultants'
gross receipts or sales from Branch International in 1989 and
1990 of $71,645 and $309,380, respectively.
To compute these
adjustments, respondent's auditor analyzed canceled checks
between Branch International and C&G Consultants.
Respondent
treated all payments from Branch International to C&G Consultants
as income to C&G Consultants.
He also corroborated the proposed
adjustments at trial by submitting copies of most of the checks
on which the adjustments were based.
We have verified respondent's analysis and generally agree
with his determinations.
In 1989 Branch International endorsed
39 separate checks to C&G Consultants totaling $71,645.
In 1990
-55-
Branch International endorsed 98 separate checks to C&G
Consultants totaling $329,805.
These payments were routinely
made, and Mr. Garavaglia does not dispute that C&G Consultants
received these payments.
Although the record reflects that
Branch International paid C&G Consultants $329,805, we limit the
amount of the deficiency to the amounts respondent determined.
Consequently, we hold that C&G Consultants' gross receipts or
sales from Branch International in 1989 and 1990 are increased by
$71,645 and $309,385, respectively.
3.
Compensation of Officers
Respondent determined that C&G Consultants was entitled to
deductions for officers compensation in 1989 and 1990 of $106,709
and $208,738, respectively..
Respondent's opening brief is
consistent with this position in that respondent asserts that C&G
Consultants is entitled to a deduction in an amount equal to the
distributions that C&G Consultants made to Mr. Garavaglia.
Section 162(a) (1) allows as a deduction all the ordinary and
necessary expenses of a business, including a reasonable
allowance for salaries or other compensation for personal
services actually rendered."
We have determined that Mr.
Garavaglia received from C&G Consultants income of $104,939 and
$204,818 during 1989 and 1990, respectively.
These amounts were
Respondent does not assert that the compensation is not
reasonable. See, e.g., Alpha Med., Inc. v. Commissioner, 172
F.3d 942,
945-947
(6th Cir.
1999),
revg. T.C. Memo.
1997-464.
-56-
the equivalent of wages or salaries paid between C&G Consultants
and Mr. Garavaglia.
We thus hold that C&G Consultants is
entitled to deductions for officers' compensation of $104,939 and
$204,818 in 1989 and 1990,
4.
respectively.
Other Expenses
Respondent disallowed expenses of $95,901 and $76,944 which
C&G Consultants claimed as deductions on its 1989 and 1990
returns.
It is well settled that deductions are a matter of
legislative grace, and that a taxpayer bears the burden of
producing sufficient evidence to substantiate any deduction that
would otherwise be allowed by the Code.
Inc. v.
Commissioner,
503 U.S.
79,
84
Rule 142(a); INDOPCO,
(1992).
Although
petitioners submitted numerous receipts showing that expenses
were paid by C&G Consultants, they provided no explanation that
those expenses were ordinary and necessary to C&G Consultants'
labor consulting trade or business.
See sec. 162(a).
Accordingly, we sustain respondent's determination that C&G
Consultants may not deduct other expenses of $95,901 and $77,830
in 1989 and 1990, respectively.
F.
Petitioners' Contentions
1.
Reliability of Books and Records
Petitioners contend that members of the Yarnell family are
"master embezzlers" who manipulated the books and records of
Trans International and Branch International such that the books
-57and records of those companies are unreliable.
According to
petitioners, members of the Yarnell family "throw around journal
entries like they are trinkets at Mardi Gras".
Petitioners seek
to muddy the waters in an obvious attempt to divert the Court's
attention from their own wrongdoing.
We are not persuaded.
Petitioners refer the Court to minor flaws in the books and
records of Branch International as proof that members of the
Yarnell family could have written checks to themselves that did
not appear on the books and records of Trans International and
Branch International.
We decline to treat the books of Trans and
Branch.International as unreliable-simply to reflect the
possibility of fabrication.
United States v. Biceglia,
As the Supreme Court stated in
420 U.S.
141,
145
(1975):
structure is based on a system of self-reporting.
"our tax
There is legal
compulsion, to be sure, but basically the Government depends upon
the good faith and integrity of each potential' taxpayer to
disclose honestly all information relevant to tax liability."
Nor are we persuaded by petitioners' attempts to cast doubt
on Mr. Garavaglia's liability under the pretense that members of
the Yarnell family were "master embezzlers".
As early as
December 1, 1990, Mr. Garavaglia was aware that Mr. L. Yarnell
and-his wife "received double payment of remuneration" of $9,000.
According to the corporate records of Branch International Mr.
Garavaglia and Mr. L. Yarnell agreed that Mr. L. Yarnell would
-58repay these amounts.
Moreover, Mr. Garavaglia was vice president
of security at Central from 1975 through part of 1986.
We doubt
that Mr. Garavaglia would not have recognized the claimed
embezzlement by members of the Yarnell family especially given
that he recognized an overpayment as small as $9,000.
.
The books and records.of Trans International and Branch
.
International show in detail the transfers to C&G Consultants,
Sentury, LTD Accounting, or members of the Yarnell family.
Many
of the entries in these books and records are corroborated by
canceled checks between the respective entities.
We lend greater
weight to this documentary evidence than to Mr. Garavaglia's
self-serving testimony.
2.
Purported Loans
Petitioners assert that distributions between Mr.
Garavaglia, C&G Consultants, Trans International, and Branch
International were nontaxable loan repayments.
Specifically,
petitioners assert that C&G Consultants lent (1) $75,000 and
$117,000 to Trans International in 1988 and 1989, respectively,
and (2) $70,000 to Branch International in 1989."
Petitioners
"Mr. and Ms. Garavaglia's briefs are inconsistent in the
amounts which they claim was lent to Trans International.
In
particular, Ms. Garavaglia contends that C&G Consultants made two
additional loans not considered by Mr. Garavaglia. We reject Ms.
Garavaglia's claim that these loans were made, for the reasons
stated elsewhere in this opinion.
-59-
bear the burden of proving that the transferred funds were loan
repayments.
See Rule 142(a).
For a bona fide loan to exist, the parties to the loan must
have intended to establish a debtor-creditor relationship when
the funds were advanced.
122
(6th Cir.
Commissioner,
Berthold v. Commissioner, 404 F.2d 119,
1968), affg. T.C. Memo.
88 T.C.
604,
615-617
1967-102; Haag v.
(1987), .affd. without
published opinion 855 F.2d 855 (8th Cir. 1988).
Loans between
related parties, such as a shareholder and a closely held
corporation, are subject to particular scrutiny "because the
control element suggests the opportunity to contrive a fictional
debt."
United States v. Uneco,
Cir. 1976)
Cl. 879,
Inc., 532 F.2d 1204, 1207 (8th
(quoting Cuyuna Realty Co. v. Unitéd States, 180 Ct.
382 F.2d 298,
300-301
(1967)).
Because the intentions
of parties to a loan are often unclear, courts rely upon
objective factors to distinguish between loans and disguised
dividends.
These factors include:
(1) Whethek the promise to
repay is evidenced by a note or other instrument;
adequate interest was charged;
schedule was established;
secure payment;
(2) whether
(3) whether a fixed repayment
(4) whether collateral was given to
(5) whether repayments were made;
(6) whether the
borrower had a reasonable prospect of repaying the loan and
whether the lender had sufficient funds to advance the loan; and
(7) whether the parties conducted themselves as if the
-60-
transaction was a loan.
See Dietrick v. Commissioner·, 881 F.2d
336,
affd. T.C. Memo.
340
(6th Cir.
1989),
1988-180.
To meet their burden, petitioners rely upon Mr. Garavaglia's
testimony and at least six loan agreements between Mr.
Garavaglia, C&G Consultants, Trans International, or Branch
International."
We reject petitioners' characterization of the
distributions as loan repayments.
First, petitioners submitted
notes which purport to be loan agreements between C&G
Consultants, Trans International, and Branch International.
However, this evidence was seriously undermined by the testimony
of Messrs. Rogers and L. Yarnell and Ms. Koehn.
Mr. Rogers
testified that he and Mr. Garavaglia met to execute loan
documents after CID executed its search warrants.
Mr. Rogers
also testified that he was unaware that Mr. Garavaglia made any
loans to Trans International and that he would have known if such
loans had been made because Mr. Rogers controlled Trans
International's bank accounts.
Mr. L. Yarnell and Ms. Koehn each
"Petitioners also present seven letters or loan documents
which state that between Mar. 15, 1986, and Sept. 10, 1989, Mr.
Garavaglia lent $231,000 to C&G Consultants.
Two of these
purported loan documents are marked "Paid" as of Dec. 29, 1988.
One claimed loan document is an unsigned page of an agreement
which may or may not be a loan agreement. The four remaining
loan documents do not prescribe a stated rate of interest, the
posting of collateral, or a fixed repayment schedule. We
conclude that none of these six documents memorialized a bona
fide loan.
-61-
identified documents which purport. to.bear their signature but
which they did not in fact sign.
Second, petitioners claim that distributions which they
received from Trans International in the form of consulting fees
were actually loan repayments from Trans International to C&G
Consultants.
However, Trans.International deducted these
consulting fees as expenses on the 1989 Trans.International
return.
We doubt that Trans International would have deducted
loan repayments as consulting fees given that Trans
International's general ledger also treated these payments as
consulting fees.
Third, Branch International's books and records do not
reflect loan repayments in the amounts offered by petitioners.
Branch International maintained an account titled "Note Payable--
C&G Consultants"
(note payable account).
If Branch International
regarded those distributions as loan repayments, one might expect
that Branch International would have recorded these transactions
in its note payable account.
For example, Mr. Garavaglia
contends that he lent Branch International $30,000 for startup
costs in May 1989.
Yet Branch International's books and records
credited the note payable account only $8,310.
This loan was
repaid by check on October 19, 1988, and was accounted for as a
.
loan in the calculations of respondent's auditor.
The
distributions which petitioners claim are loan repayments were
-62-
not debited to the note payable account.
Instead, these
distributions were charged to the consulting fees and/or premium
expense account.
Fourth, distributions from Trans International to C&G
Consultants and Sentury were generally proportionate to the
ownership interest of Messrs. Garavaglia and Rogers.
Similarly,
distributions from Branch International to C&G Consultants and
LTD Accounting or members of the Yarnell family were generally in
proportion to the ownership interests of Mr. Garavaglia and Mr.
L. Yarnell.
Respondent contends, and we agree, that the
distributions between C&G Consultants, Trans International, and
Branch International represented Mr. Garavaglia's share of the
proceeds from perpetrating a fraud upon the insurance companies.
The evidence as a whole makes suspect Mr. Garavaglia's claim
that he lent money to C&G Consultants, Trans International, and
Branch International.
He is faced with the contradictory
testimony of three witnesses who allege that he falsified
documents and never made the loans which he claims to have made.
We decline to credit Mr. Garavaglia's testimony given the
consistent testimony of three witnesses and the strong proof of
fraud against him.
F.2d 180, 185-186
See, e.g., Frierdich v. Commissioner, 925
(7th Cir. 1991)
(treating a taxpayer's
explanation of the existence of a loan as plausible but
-63-
insufficient to establish a bona fide debt), affg. T.C. Memo.
1989-103 as amended by T.C. Memo.
IV.
1989-393.
Fraud PenaltV
Section 6663(a) imposes. a 75-percent penalty on the portion
of any underpayment of tax attributable to fraud.
Section
6663 (b) provides that where the Commissioner establishes that any
portion of an underpayment of tax is attributable to fraud, the
entire underpayment is treated as.attributable to fraud except
with respect to the portion of the underpayment that the taxpayer
establishes, by a preponderance of the evidence,
attributable to fraud.
Section 6663 (c)
is not
specifies that in the
case of a joint return, the 75-percent penalty imposed by section
6663(a) does not apply to a spouse unless some part of the
underpayment is attributable to the fraud of that spouse.
The Commissioner bears the burden of establishing fraud by
clear and convincing evidence.
Sec. 7454(a); Rule 142(b).
Clear
and convincing evidence is:
that measure or degree of proof which will produce in
the mind of the trier of facts a firm belief or
conviction as to the allegations sought to be
established.
It is intermediate, being more than a
mere preponderance, but not the extent of such
certainty as is required beyond a reasonable doubt as
in criminal cases.
It does not mean clear and
unequivocal." * * *
Ohio v. Akron Ctr.
for Reprod. Health, 497 U.S
(quoting Cross v. Ledford,
also Hobson v. Eaton,
120 N.E.2d 118,
399 F.2d 781,
784 n.2
123
502,
516
(1990)
(Ohio 1954)); see
(6th Cir.
1968).
To
-64-
carry his burden, the Commissioner must. prove for each year in
which fraud is alleged that (1) an underpayment of tax existed,
and (2) a portion of the underpayment is attributable to fraud.
Petzoldt v. Commissioner,
A.
92 T.C. at 698.
Underpayment of Tax
The Commissioner may satisfy his burden of proving an
underpayment of tax attributable to unreported income in either
of two ways:
(1) By proving a likely source of the unreported
income; or (2) by disproving any alleged nontaxable source of
that income.
DiLeo v. Commissioner, 96 T.C. 858, 873-874
affd. 959 F.2d 16 (2d Cir. 1992).
(1991),
Respondent has proven by clear
and convincing evidence that Mr. Garavaglia earned unreported
income of more than $850,000 by virtue of income received from
C&G Consultants and an increase in C&G Consultants' distributable
share of income from Trans International and Branch
International.
We thus find that respondent has clearly and
convincingly satisfied the first element of section 6663(a).
B.
Fraudulent Intent
Whether a portion of the underpayment of tax is attributable
to fraud is a question of fact to be resolved on the basis of the
record as a whole.
Parks v. Commissioner,
94 T.C. at 660.
Fraud
is defined as the intentional commission of an act or acts for
the specific purpose of evading tax believed to be owing.
Petzoldt v. Commissioner, supra at 698.
Fraud implies bad faith,
-65-
intentional wrong doing and a sinister motive.
Davis v.
Commissioner,
remanding a
184 F.2d 86,
87
(10th Cir.
Memorandum Opinion of this Court.
1950),
Fraud is never imputed or
presumed but must always be established by independent evidence
that establishes fraudulent intent.
supra at 699.
Petzoldt v. Commissioner,
Because fraud is rarely admitted, alleged.tax
fraud may be proven by circumstantial evidence that is "so strong
that no other conclusion can be reached".
440 F.2d 1,
5
(6th Cir.
Biqqs v. Commissioner,
1971), affg. T.C. Memo.
1968-240; see
also Richardson v. Commissioner,
509 F.3d 736,
743
(6th Cir.
2007), affg. T.C. Memo. 2006-69.
We may infer fraud from "any
conduct, the likely effect of which would be to mislead or
conceal."
United States v. Walton,
909 F.2d 915, 926
(6th Cir.
1990).
Courts often rely upon certain "badges" of fraud in deciding
whether a taxpayer had the requisite fraudulent intent to support
a penalty under section 6663(a).
(1) Understatements of income,
These indicia of fraud include:
(2) destruction of records,
implausible or inconsistent explanations of behavior,
concealment of income or assets,
tax authorities,
(4)
(5) failure to cooperate with
(6) participation in illegal activities,
credibility of the taxpayer's testimony,
documents,
(3)
(7) the
(8) filing false
(9) failure to file accurate tax returns,
(10) failing
to furnish the Government with access to the taxpayer's records,
-66-
and (11)
intention to mislead which may be inferred from a
pattern of activity.
499
See Spies v. United States, 317 U.S. 492,
(1943); Solomon v. Commissioner,
(6th Cir.
732 F.2d 1459,
1461-1462
1984), affg. T.C. Memo. 1982-603; Niedringhaus v.
Commissioner, 99 T.C. 202, 211 (1992).
Although no one factor is
dispositive, the existence of several indicia is competent
evidence of fraud.
Solomon v. Commissioner, supra at 1461;
Niedringhaus v. Commissioner, supra at 211.
1.
Direct Evidence of Fraud.
On or before January 31,
1990, Mr. T. Yarnell sent to Mr.
Garavaglia a letter which stated that amounts due from Trans
International and Branch International to the Ohio Bureau of
Workman's Compensation were generally "[scaled] down" to 25
percent of the actual amounts due.
Attached to that letter were
schedules showing "actual" and "modified" payrolls for Trans and
Branch International.
This letter and the accompanying schedules
serve as persuasive direct evidence that as of January 31, 1990,
Mr. Garavaglia knew that Trans International and Branch Interna-
tional had understated their workers' compensation liability..
This letter and the accompanying schedules were received by Mr.
Garavaglia before the 1989 and 1990 Trans International and
Branch International returns were filed, and we therefore believe
that Mr. Garavaglia knew of the underreporting of premiums when
-67-
he filed the 1989 Trans International.and Branch International
returns.
042This
factor favors a finding of fraudulent intent.
2.
Understatement of Income
A pattern of consistently and substantially underreporting
income over several years is evidence of fraud.
United States,
348 U.S.
121,
137-139
(1954).
Holland v.
Petitioners failed
to report or account for more than $850,000 of income paid to Mr.
Garavaglia or C&G Consultants over 2 years.
The evidence clearly
and convincingly establishes that Mr. Garavaglia underreported
his taxable income for 1989 and 1990.
The failure to report this
income is strong evidence of fraudulent intent.
Commissioner, 232 F.2d 678
(6th Cir.
1956),
See Kurnick v.
affg. T.C. Memo.
1955-31.
3.
Destruction of Records
Although we look to Mr. Garavaglia's actions at the time he
filed the 1989 and 1990 joint returns, we may consider his
actions after the tax filings to determine his earlier state of
mind.
Richardson v. Commissioner, supra at 743-744.
Mr.
Garavaglia's behavior after CID executed its search.warrants made
a bad situation worse.
Yarnell on July 14,
In a telephone.conversation.with Mr. L.
1992, Mr. Garavaglia advised Mr. L. Yarnell
to destroy Branch International's records, canceled checks, Forms
941, and worksheets used in the workers' compensation audits.
Soliciting another to destroy.books and records is indicative of
-68-
fraudulent intent to evade taxes.
See, e.g., Spies v. United
States, supra at 499.
4.
Implausible or Inconsistent Explanations
The implausible behavior exhibited by Mr. Garavaglia began.
with Trans Continental in March 1989.
The auditor assigned to
Trans Continental's audit in.1989 determined a shortfall in that
company's premiums.
Rather than contest that deficiency or make
whole the insurance company, Messrs. Garavaglia, Rogers, and L.
Yarnell avoided the shortfall by forming Trans International as a
parallel employee leasing company.
Trans Continental's ending
balances on its books and records became Trans International's
beginning balances.
Trans Continental's workers' compensation
liability was thus transmitted to Trans International, and Trans
International's formation was grounded in fraud by early 1989.
The implausible behavior of Mr. Garavaglia continued at
Trans International and Branch International throughout 1989 and
1990.
As evidenced by the letter from Mr. T. Yarnell to Mr.
Garavaglia on January 30, 1990, Trans International and Branch
International scaled down their payrolls to 25 percent of actual.
The actual and modified payrolls were used to bill client
companies and compute the premiums payable to the insurance
companies.
The differences between the amounts billed to the
client companies and the amounts paid to the insurance companies
were distributed to, among others, Mr. Garavaglia.
Underreporting Trans International's and Branch International's
payrolls caused the premiums they owed to the insurance companies
to be understated by approximately 75 percent.
The
.
understatements deprived the insurance companies of working
capital and exposed them to unnecessary and unmanageable risk.
Also implausible is Mr. .Garavaglia's conduct in reporting
the activities of C&G Consultants, Trans International, and
Branch International.
The tax scheme perpetrated by Mr.
Garavaglia is inextricably related to the insurance scheme.
By
accruing an expense larger than actually paid, Trans
International and Branch International also deducted expenses
greater than they paid.
For book and tax purposes, these
accruals were never adjusted to reflect the actual premiums paid
to the insurance companies.
Mr. Garavaglia therefore overstated
premium deductions on the 1989 and 1990 Trans International and
Branch International returns, while omitting substantial income.
Mr. Garavaglia's explanation of his behavior is similarly
implausible and inconsistent.
He explained at trial that he
acted "in good faith" when he "low-[balled]" the insurance
companies because it was common practice to do so.
He explained
that he expected the insurance companies to be made whole during
the audit.
However, he took no affirmative steps to ensure that
the insurance companies were made whole, and he actively hid and
-70concealed his misdeeds.
We find fraudulent intent from Mr.
Garavaglia's implausible behavior and inconsistent explanations.
5.
Concealment of Income or Assets
Fraud is evidenced by proof that the taxpayer intended to
evade taxes known to be owing by conduct intended to conceal,
mislead, or otherwise prevent the collection of taxes.
Commissioner,
80 T.C.
1111,
1123
(1983).
Rowlee v.
Respondent received a
tip that Mr. Garavaglia had perpetrated a fraud upon insurance
companies and the Treasury from a confidential informant.
That
tip was corroborated by members of the Yarnell family, who
explained the nuances of Mr. Garavaglia's fraudulent activities.
CID executed search warrants and conducted telephone surveillance
of Mr. Garavaglia to learn the details of Mr. Garavaglia's
elaborate fraud.
When Mr. Garavaglia learned that CID had
implicated him in illegal activity, he went to great efforts to
conceal and mislead the Government about his misdeeds.
At no
time was Mr. Garavaglia honest or straightforward about his
wrongdoing.
6.
This factor suggests fraudulent intent.
Failure To Cooperate.With Tax Authorities
The failure to cooperate with tax authorities demonstrates
fraudulent intent.
Cir. 1958).
See Powell v. Granquist, 252 F.2d 56, 61 (9th
Mr. Garavaglia's interaction with CID and opposing
counsel was evasive and devious.
He encouraged Mr. L. Yarnell to
destrov records before CID could access them.
At trial Mr.
-71-
Garavaglia evaded simple and direct questions from respondent's
counsel.
This factor favors a finding of fraudulent intent.
7.
Participation in Illegal Activities
Mr. Garavaglia pleaded guilty to and was convicted of one
count of mail fraud for a fraudulent check mailed on June 28,
1991, and one count of conspiracy to defraud the United States
Government by filing a false corporate income tax return for
Branch International in violation of section 7206(1).
Although
that conviction does not collaterally estop.Mr. Garavaglia from
denying that he fraudulently understated petitioners' income tax
liabilities, that conviction is a probative fact that may be
considered persuas1ve evidence of fraudulent intent.
Commissioner,
84 T.C.
636,
643-644
Wright v.
(1985).
Upon entering his guilty plea, Mr. Garavaglia stipulated
that he knowingly participated in a scheme to defraud insurance
companies through Branch International.
He also stipulated that
he and several of his business associates agreed to defraud the
IRS by claiming deductions in excess of the expenses actually
paid.
He also agreed that the "tax loss" resulting from the
charged tax offenses might be at least $207,000, an amount which
he agreed to pay as restitution before sentencing.
Mr.
Garavaglia's illegal activities indicate fraudulent intent.
-72-
8.
Failure To File Accurate Tax Returns
Fraudulent intent may be inferred where a taxpayer files a
return intending to conceal, mislead, or otherwise prevent the
collection of tax.
Spies v. United States, 317 U.S. at 499.
Almost all tax filings undertaken by Mr. Garavaglia, C&G
Consultants, Trans International, and Branch International were
improperly filed.
The 1989 and 1990 joint returns understated
income earned by Mr. Garavaglia from C&G Consultants.
Trans
International's Form 2553 reported Mr. D. Yarnell as the sole
shareholder of that company, even though he was not.
Branch
International's Form 2553 reported Mr. T. Yarnell as that
company's shareholder, even though he was not a shareholder at
all.
The 1989 and 1990 Trans International returns and the 1989
Branch International return were filed on Forms 1120S, even
though these companies had not made valid elections to be taxed
as S corporations.
C.
This factor favors a finding of fraud.
Effect of Fraud
After our review of the record as a whole in the light of
the foregoing factors, we are convinced that portions of the
underpayments of tax on the 1989 and 1990 joint returns were
attributable to Mr. Garavaglia's fraud.
Where the Commissioner
establishes that any portion of an underpayment is attributable
to fraud, the entire underpayment is treated as attributable to
fraud, except to the extent that the taxpayer establishes
-73-
otherwise.
See sec. 6663 (b); Hagaman v. Commissioner, 958 F.2d
684,
696
(6th Cir.
1992), affg. and remanding T.C. Memo. 1990-
655.
Mr. Garavaglia has failed to establish that any portions of
the underpayments were not attributable to fraud.
Accordingly,
we hold that Mr. Garavaglia is liable for fraud penalties in 1989
and 1990 in amounts to be determined under Rule 155.
V.
Accuracy-Related Penalty
Section 6662(a) and (b) (2)
imposes a 20-percent accuracy-
related penalty on that portion of an underpayment of tax due to
a substantial understatement of income tax.
Section 6662(b)
provides that a section 6662(a) accuracy-related penalty does not
apply to any portion of an underpayment of tax subject to the
fraud penalty under section 6663.
Where a joint return is filed
and one spouse is found liable for the fraud penalty, imposing
the accuracy-related penalty on the other spouse constitutes
impermissible stacking.
Foxworthy, Inc. v. Commissioner, T.C.
Memo. 2009-203; Talmage v.
affd. 391 Fed. Appx.
660
T.C. Memo.
affd.
2003-148,
Commissioner,
(9th Cir.
T.C. Memo.
2008-34,
2010); Said v. Commissioner,
112 Fed. Appx.
608:(9th Cir. 2004).
Petitioners filed joint returns for 1989 and 1990.
Respondent imposed the accuracy-related penalty on Ms. Garavaglia
for underpayments of tax upon which the Court!found Mr.
Garavaglia liable for the fraud penalty.
Therefore, we find that
imposing the accuracy-related penalty would result in
impermissible stacking.
Accordingly, we hold that Ms. Garavaglia
is not liable for the section 6662(a) accuracy-related penalty.
VI.
Statute of Limitations
Petitioners assert that the period of limitations on
assessment has expired with respect to 1989 and 1990.
Respondent
counters that the period of limitations for assessment 1s. open on
account of the fraud of Mr. Garavaglia, or alternatively, on
account of the fraud of petitioners' paid return preparers.
As a general rule, the Commissioner must assess the amount
of tax against an individual taxpayer within 3 years after a tax
return is filed.
Sec. 6501(a) and (b) (1); Mecom v. Commissioner,
101 T.C.
(1993), affd. without published opinion 40 F.3d
374,
382
385 (5th Cir. 1994).
In the case of the filing of a false or
fraudulent return with the intent to evade tax, however, the tax
may be assessed at any time.
Sec. 6501(c) (1).
If any part of a
return is determined to be the result of fraud, a taxpayer may
not assert as a defense that the period of limitations has
expired.
Lowy v._ Commissioner,
affg. T.C. Memo. 1960-32.
288 F.2d 517,
520
(2d Cir.
1961),
In the case of a joint return, proof
of fraudulent intent as to either joint taxpayer lifts the bar of
the statute of limitations as to both taxpayers.
See Hicks Co.
v.
470 F.2d 87
Commissioner,
Cir. 1972).
56 T.C.
982,
1030
(1971),
affd.
(1st
We have found that Mr. Garavaglia filed the 1989 and
1990 joint returns fraudulently with the intent to evade tax.
It
follows that the period of limitations on assessment 1s open as
to both years as to Mr. and Ms. Garavaglia.
Commissioner,
102 T.C.
380,
385
See Colestock v.
(1994).
VII. Ms. Garavaglia's Entitlement to Innocent Spouse Relief
Under section 6013(d) (3), a husband and wife filing a joint
Federal income tax return are generally jointly and severally
liable for all taxes determined to be owing.
Ms. Garavaglia
asserts that she is entitled to relief from joint and several
liability under section 6015(b) and (f).
Respondent argues that
Ms.·Garavaglia is not entitled to such relief because she knew or
should have known of the income giving rise to the deficiency,
and that it is equitable to hold her liable for that deficiency.
Except as otherwise provided in section 6015,iMs. Garavaglia
bears the burden of proving her entitlement to such relief.
See
Rule 142(a); Alt v. Commissioner,
affd.
101 Fed. Appx.
A.
34
(6th Cir.
119 T.C.
306,
311
(2002),
2004).
Section 6015(b)
Ms. Garavaglia may be granted relief under section 6015(b)
if the following requirements are met for each year:
return was made,
(A) A joint
(B) on that return there is an understatement of
tax attributable to erroneous items of one petitioner filing the
joint tax return,
(C) Ms. Garavaglia establishes that in signing
the return she did not know, and did not have reason to know,
that there was an understatement of tax,
(D) taking into account
-76-
all of the facts and circumstances, it is inequitable to hold Ms.
Garavaglia liable for the deficiency in tax for the taxable year
attributable to the understatement; and (E) Ms. Garavaglia
elected innocent spouse relief no later than 2 years after the
date respondent began collection activities with respect to Ms.
Garavaglia.
See sec. 6015(b) (1).
The requirements of section
6015(b) (1) are stated in the conjunctive, and therefore the
failure to sati.sfy any one of the requirements precludes relief
under that section.
Alt v. Commissioner, supra at 313.
The parties agree that the only factors .in dispute are
whether Ms. Garavaglia knew or should have known that there were
understatements of tax in filing the 1989 and 1990 joint returns
and whether it would be equitable to hold her liable for the
understatements.
We answer both questions in the affirmative and
therefore find that Ms. Garavaglia is not entitled to relief
under section 6015(b).
1.
Ms. Garavaglia's Knowledge
With respect to the knowledge requirement of section
6015(b) (1) (C), a spouse has "reason to know" of an understatement
if a reasonably prudent taxpayer in her position at the time she
signed the return could be expected to know that the return
contained the understatement.
Factors to be considered in
analyzing whether the alleged innocent spouse had "reason to
know" of the understatement include:
(1) The spouse's education;
-77(2) the spouse's involvement in the couple's business and
financial affairs;
(3)
the presence of unusual or lavish
expenditures inconsistent with the couple's past levels of
income, standard of living, and spending patterns; and (4) the
evasiveness and deceit of the nonrequesting spouse concerning the
couple's finances.
See Greer v. Commissioner, 595 F.3d 338, 346-
347
(6th Cir.
2010)
(citing Price v.
963
(9th Cir.
1989)),
a.
Commissioner,
affg. T.C. Memo.
887 F.2d 959,
2009-20.
Education
Ms. Garavaglia has a high school education.
b.
Involvement in Business and Financial Affairs
Ms. Garavaglia contends that she was not involved in the
family's financial affairs.
Being a homemaker and lacking
sophistication in financial affairs does not alone relieve a
taxpayer of joint and several tax liability.
Commissioner, 780 F.2d 561, 566
Shea v.
(6th Cir. 1986), affg. in part
and revg. in part T.C. Memo. 1984-310.
Nor does failing to
inquire into the family's financial and tax situation, especially
where such an inquiry would have required minimal effort on the
part of the requesting spouse.
See idm
Ms. Garavaglia contends
that she looked only at the tops of the pages of the 1989 and
1990 joint returns; she testified that she did not "look through
any of the workings".
It is well settled that the requesting
spouse cannot bury his or her head in the sand or turn a blind
-78eye to the couple's tax filings.
See, e.g., Greer v.
Commissioner, supra at 351 (and cases cited thereat).
Participation in a spouse's business affairs ordinarily
negates an innocent spouse claim.
supra at 566.
See Shea v. Commissioner,
Ms. Garavaglia was an officer of C&G Consultants
and a part owner in Branch International.
She attended the
meetings of the board of directors of C&G Consultants and
recorded the minutes for those meetings.
She testified regarding
the alleged loans which Mr. Garavaglia made to C&G Consultants,
Trans International, and Branch International.
As evidenced by a
telephone conversation with Mr. L. Yarnell on July 16, 1992, she
also had unique knowledge of the location of financial records
for Branch International.
We thus find that Ms. Garavaglia was
more knowledgeable in the financial and business affairs of Mr.
Garavaglia than she leads us to believe.
c.
Unusual or Lavish Expenditures
The lavish lifestyle enjoyed by petitioners placed Ms.
Garavaglia on further notice that the 1989 and 1990 joint returns
underreported petitioners' income.
Although petitioners earned
modest incomes in 1989 and 1990, they had financial assets of
more than $1 million.
They also owned a lake house through C&G
Consultants which they used for parties, picnics, union meetings,
and storage.
-79d.
Deceit of Mr. Garavaglia
Although Mr. Garavaglia perpetrated fraud on insurance
companies and the Treasury, he clearly trusted Ms. Garavaglia.
He named her an officer of C&G Consultants, made her a part owner
in Branch International, and employed her as a secretary.
He
presented the 1989 and 1990 joint returns to Ms. Garavaglia for
signing and she signed those returns of her own free will.
At
trial Messrs. Rogers, T. Yarnell, and D. Yarnell testified that
Mr. Garavaglia never discussed workers' compensation issues with
Ms. Garavaglia.
However, this does not mean that Ms. Garavaglia
did not have reason to know of Mr. Garavaglia's fraudulent
activities.
See Shea v. Commissioner, supra at 565-566.
e.
Summary
On the basis of the foregoing factors and the record as
whole, we conclude that Ms . Garavaglia . knew or had reason to know
of the understatements on the 1989 and 1990 joint returns.
2.
·Equitable Considerations
With respect to equitable concerns under section
6015 (b) (1) (D) , we evaluate all of the facts and circumstances to
determine whether it would be inequitable to hold Ms. Garavaglia
liable for the deficiencies of Mr. Garavaglia.
The factors we
consider in determining inequity for purposes of section
6015 (b) (1) (D) are the same factors that we consider in
determining inequity for purposes of section 6015 (f) .
Alt v.
_80-
Commissioner, 119 T.C. at 316.
The IRS has enumerated seven
threshold conditions which must be satisfied before we consider a
request for relief under section 6015(f).
61, sec. 4.01, 2003-2 C.B. 296, 297.
See Rev. Proc. 2003-
The factors most commonly
considered are (1) whether there has been a significant benefit
beyond normal support to the spouse claiming relief, and (2)
whether the failure to report the correct tax liability on the
joint return results from concealment, overreaching, or any other
wrongdoing on the part of the nonrequesting spouse.
Commissioner,
Memo.
992 F.2d 1256,
1262-1263
(2d Cir.
Hayman v.
1993),
affg. T.C.
1992-228.
In view of the circumstances surrounding petitioners'
understatements of tax, petitioners have failed to persuade us
that Ms. Garavaglia should not be held jointly and severally
liable for deficiencies related to petitioners'
Federal income taxes.
1989 and 1990
Ms. Garavaglia knew or should have known
that petitioners underreported their income where distributions
were made from companies which she either owned or served as an
officer.
The 1989 and 1990 joint returns omitted approximately
$850,000 of income which Mr. Garavaglia received from C&G
Consultants.
These assets directly benefited Ms. Garavaglia, and
far exceeded normal support.
She willingly signed the 1989 and
1990 joint tax returns without further questioning.
Ms.
Garavaglia chose to turn a blind eye on tax and financial
-81-
matters, and she may not now claim ignorance.
Such is especially
so because she significantly benefited from the lncome omission.
Accordingly, we hold that Ms. Garavaglia is npt entitled to
relief under section 6015(b).
B.
Section 6015(f)
For the reasons stated above, we conclude that Ms.
Garavaglia is not entitled to relief under section 6015(f).
VIII. Alleged Violations of Constitutional Guaranties
On brief, petitioners assert that the Government violated
their Fifth Amendment right to due process when CID seized but
failed to return petitioners' records after the closure of the
criminal proceedings against Mr. Garavaglia.
Petitioners urge
the Court to dismiss this case, or alternatively, shift the
burden of proof as to all issues to respondent.
We decline to
grant either form of relief.
Whether due process is violated when evidence is destroyed
in a criminal proceeding is governed by two Supreme Court cases:
California v. Trombetta,
467 U.S. 479
Youngblood, 488 U.S. 51
(1988).
(1984),
and Arizona v.
As described in Trombetta,
the
Due Process Clause requires criminal prosecutions to comport with
prevailing notions of fundamental fairness and, under this
standard, criminal defendants are to be afforded a meaningful
opportunity to present a complete defense.
Under California v.
Trombetta, supra at 488-489, the Government has a duty to
-82-
preserve evidence which (1)
"possesses an exculpatory value that
was apparent before the evidence was destroyed," and (2)
"be of
such a nature that the defendant would be unable to obtain
comparable evidence by other reasonably available means."
Criminal defendants must satisfy a threshold requirement
before a reviewing court considers the constitutional materiality
of the evidence in question.
477
(7th Cir. 1992).
Jones v. McCaughtry, 965 F.2d 473,
In Youngblood, the Supreme Court held that
"'unless a criminal defendant can show bad faith on the part of
the police, failure to preserve potentially useful evidence does
not constitute a denial of due process of law.'"
McCaughtry, supra at 477
58).
See Jones v.
(quoting Arizona v. Youngblood, supra at
As the U.S. Court of Appeals for the Seventh Circuit noted
in Jones:
to demonstrate a due process violation under Youngblood
and Trombetta, Petitioner must first show bad faith on
the part of the government in the destruction of the
* * * [evidence].
If he can satisfy this burden, he
must then show the evidence possessed exculpatory value
apparent before it was destroyed and that it was of
such a nature that he was unable to obtain comparable
evidence by other means. * * * [Id.]
The requirements for determining whether due process is
violated where evidence is destroyed in the context of a civil
proceeding is less clear."
The Fifth Amendment mandates that
In Ferguson v. Roper, 400 F.3d 635,
638
(8th Cir. 2005),
the U.S. Court of Appeals for the Eighth Circuit held that
Arizona v. Youngblood, 488 U.S.
51
(1988), does not apply to
(continued...)
-83-
"No person shall * * * be deprived of life, liberty, or property,
without due process of law".
v. Williams,
474 U.S..
327,. 328
U.S. Const. amend. V.
(1986),
In Daniels
the Supreme Court decided
whether the negligence of a Government official violated an
inmate's due process rights in the context of 42 U.S.C. sec.
1983.
The Supreme Court stated that the Due Process Clause of
the Fourteenth Amendment "is simply not implicated by a negligent
act of an official causing unintended loss or injury to life,
liberty, or property."
We read.Daniels as equally applicable in
the context of an alleged violation of the Fifth Amendment Due
Process Clause.
Daniels stands for the proposition that a
"deprivation" of life,
liberty, or property can not result from
the mere negligence of an official's conduct.
However, where the
Government official's conduct is intentional, reckless, or
grossly negligent, a deprivation of life, liberty, or property
may exist.
(1998)
See County of Sacramento v. Lewis,r 523 U.S. 833, 834
(whether due process is violated when "culpability falls
between negligence and intentional conduct is a matter for closer
calls").
Thus, whether petitioners' due process rights were
20(...continued)
claims that evidence was lost or destroyed after trial. The
Court of Appeals for the Sixth Circuit apparently considered but
did not decide whether Youngblood is applicable in the civil
setting in Burch v. U.S. Dept. of Agric., Food & Nutrition Serv.,
174 Fed. Appx. 328,
331
(6th Cir. 2006).
violated turns on the conduct of CID's special agents in
destroying those records.
We are satisfied that petitioners' due process rights were
not violated under Youngblood or Daniels.
Two special agents
assigned to Mr. Garavaglia's criminal investigation testified
that they destroyed documents seized from Trans International.
That testimony revealed that the decision to destroy those
documents was made only after consultation with Mr. Rogers, the
owner of those documents by virtue of his ownership interest in
Trans International.
Mr. Rogers advised the special agents to
"burn" the documents seized.
We credit the special agents'
testimony and do not find bad faith, recklessness, or gross
negligence on their part.
F.3d 670,
699
See United States v. LaVallee, 439
(10th Cir. 2006)
(where tapes of correctional
officers were routinely destroyed in the ordinary course of
business approximately two years after their creation, the
destruction of those tapes was not done in bad faith); United
States v. Garza,
435 F.3d 73,
75-76
(1st Cir. 2006)
(where
evidence is destroyed in the course of implementing routine
procedures militates against a finding of bad faith); see also
United States v. Branch,
537 F.3d 582,
590
(6th Cir. 2008).
This
result is consistent with those reached by other Federal courts.
See,
e.g., Althouse v. Hill, No.
July 25, 2002)
CIV.A.3:02-CV-1263-D
(N.D. Tex.
(stating that the court was not convinced that the
unintentional destruction of records whose production might later
be requested in a civil lawsuit gives rise to a due process
violation); Larison v.
(D.N. J. 1998)
City of Trenton,
180 F.R.D. 261,
268 n.9
(bad faith is a necessary element in order to
establish a prima facie case of intentional spoliation of
evidence in the civil context).
IX.
Epiloque
In reaching the holdings herein, we have considered all
arguments raised by the parties; and to the extent not discussed
herein, we find them to be irrelevant, moot, or without merit.
To reflect the foregoing,
Decisions will be entered
under Rule 155.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.