T. C. Memo. 1997-479

ADM.

RECORDED

SERVICE

CAL.

s TAT.

. T. JUDGE

T. C. Memo. 1997-479

Q/ FILES

UNITED STATES TAX COURT

STANLEY J. ZABAN AND SHIRLEY A. ZABAN, Petitioners y.

COMMISSIONER OF INTERNAL REVENUE, Resporídent

Docket No. 27119-93.

Filed October 21, 1997.

Paula M. Junghans and Caroline D. Klepper, for petitioners.

Alan R. Peregoy, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS,

Judge:

deficiencies in,

Respondent

and additions to,

determined

the

following

petitioners'

Federal income .

taxes:

SERVED OCT 2 1 1997

- 3 After concessions,¹ the following issues remain for decision:

(1)

Whether respondent properly determined that petitioners had

cash on hand in the amount of $115,100 as of December 31, 1989, as

part of the 1989 net worth calculation;

(2)

whether petitioner

Shirley A. Zaban (Mrs. Zaban) qualifies for innocent spouse relief

pursuant to section 6013(e) for 1986 through 1990;

(3) whether Mrs.

Zaban is liable for the fraud additions to tax for 1986 and 1987

pursuant to section 6653(b)(1)(A) and (:B) and for 1988 pursuant to

section 6653(b)(1) and for the fraud penalty for 1989 pursuant to

section 6663;

(4) whether Mrs. Zaban is liable for the additions to

tax for negligence or disregard of rules or regulations for 1986

and 1987 pursuant to section 6653(a)(1)(A)

and

(]B)

and for 1988

pursuant to section 6653(a)(1) and for the accuracy-related penalty

for 1989 pursuant to section 6662;

•

(5)

whether petitioners are

1

Petitioners concede the deficiencies relating to all of

the unreported income, except for $115,100 determined as cash on

hand as part of respondent's 1989 net worth calculation. They

also concede the fraud additions to tax and penalty for 1986

through 1989 with respect to Mr. Zaban. Moreover, petitioners

concede that they are not entitled to the $98,000 deduction for

forfeited funds for 1990. Finally, the parties have agreed that

petitioners are entitled to a $56,622 mortgage interest deduction

for 1990.

Respondent disallowed petitioners' 1987 and 1988 deductions

for certain miscellaneous expenses. Although petitioners

disputed this determination in their petition, they did not

address this issue either at trial or on brief. Because the

burden of proof lies with petitioners on this issue, we hold for

respondent. Rule 142(a). Additionally, and for the same

reasons, we hold for respondent on the innocent spouse issue

relating to the miscellaneous expense deductions. Respondent,

however, did not present any evidence on the fraud additions to

tax relating to the miscellaneous expense deductions, and given

our finding that no fraud existed with respect to other issues,.

we hold for Mrs. Zaban on that issue. Rule 142(b).

.

- 5 positions, including rater for insurance policies, receptionist at

a nursing home,

salesclerk at a department store,

and interior

decorator.

A.

Business Interests of Mr. Zaban

During 1985 and/or 1986, Mr. Zaban was a shareholder in the

.

following entities: G&Z Corp., doing business as the Parlay Cafe

(1985

through

1990);

Graymar

Co.,

Inc.,

which

sold

business

equipment and supplies (1986 through 1990); Putty Hill Printing,

Inc. , which provided printing and copying services (1985 through

1990); and OPCZ, Inc., doing business as Zingaro's restaurant (1985

through 1987).

In 1986, upon the recommendation of Francis E. Fidati, CPA,

petitioners' personal and business accountant, Mr. Zaban formed and

was the sole shareholder of Zaban Enterprises, Inc., a subchapter

S corporation, for the purpose of paying himself a salary, as well

as distributions, from interests in his other business entities.

Mrs .

Zaban

was

an

of f icer

of

Zaban

Enterprises ;

she

signed

corporate employment and income tax returns, signed the election to

become

a

subchapter

S

corporation,

maintained

the

corporate

checking account, and wrote substantially all the checks from that

account.

In or about August 1985, Mrs. Zaban, along with Gary Genovese,

a

shareholder

with

Mr.

Zaban

in

the

Parlay

Cafe,

filed

an

application for a liquor license for the Parlay Cafe with the

Board of Liquor License Commissioners for Baltimore County.

application

falsely

stated

that

Mrs.

Zaban

had

a

'The

50-percent

- 7 On or about June 25, 1992, the U.S. Attorney for the District

of Maryland filed a four-count information charging Mr. Zaban with

illegal gambling and bookmaking, money laundering, bank fraud, and

tax evasion (for 1989 only).

Mr. Zaban pled guilty to each count

as part of a plea bargain with the U.S. Attorney's Office,

and

judgment was entered by the U.S. District Court for the District of

Maryland on October 27, 1992.

The plea agreement also included a

stipulation that Mr. Zaban had engaged in skimming cash from the

Parlay Cafe.

Mr.

Zaban's

accountant,

Mr.

Fidati,

also pled guilty to

assisting in the preparation and filing of a false tax return by

failing to report

the

income

from the

illegal bookmaking and

gambling activities, as well as the income skimmed from the Parlay

Cafe.

1.

Illegal Gambling and Bookmaking

Pursuant to the Federal information to which Mr. Zaban pled

guilty in October 1992, Mr. Zaban admitted that from May 1, 1986,

through March 23,

1992,

he was engaged in illegal gambling and

bookmaking activities out of his home and in other locations within

the State of Maryland. He engaged in these bookmaking operations

with Mr.

Neumyer . and others.

The bookmaking operations were

confined

to

primarily

sports

betting,

on

collegiate

and

professional basketball and football.

Mr. Zaban's role in the operation was to obtain customers,

record bets, distribute winnings, and collect losses.

Mr. Zaban

also placed bets on his own account several times a week and often

$62,700 in Bethlehem Steel bearer bonds, 590 $100 bills, and 20 $50

bills.

Although

the

toolbox

was

somewhat

obscured

while

in

petitioners' basement, the tape recorders were in plain sight on

Mr. Zaban's desk.

From

petitioners'

basement,

Mr.

Zaban

made

and

received

telephone calls to and from Mr. Neumyer and others involved in the

gambling

and

bookmaking

activities.

Mrs.

Zaban

occasionally

answered the telephone in their home and at times spoke with Mr.

Neumyer.

Sometime in 1991, the Baltimore County Police Department

obtained an order from the Circuit Court for Baltimore County to

place a dialed number recorder (DNR)

on the two phone lines at

petitioners' residence in Lutherville, Maryland, for the purpose of

recording the number of incoming and outgoing activations on those

lines.

The DNR analysis performed by the Baltimore County Police

Department

revealed

between

3,360

November

activations

21,

on

1991,

one

and

line,

of

January

30,

1992,

which

3,231

were

outgoing and 129 were incoming, and 1, 097 activations on the other

line, of which 635 were outgoing and 462 were incoming.

The first

line had an average of 47 telephone calls per day, and the second

line had an average of 15 telephone calls per day.

.

2. Money Laundering

Mr.

money

Zaban engaged in two different schemes to launder the

he

activities.

Fidati.

obtained

from

his

illegal

gambling

and

bookmaking

The first scheme involved alleged loan payments to Mr.

Mr. Zaban gave Mr. Fidati $4,000 per month in cash during

1986, 1987, and 1988, and Mr. Fidati repaid Mr. Zaban by writing

.

- 11 -

(To a large extent Mrs. Zaban negotiated the terms of the loan with

Ms.

Gerling.)

On February 26,

1988,

petitioners submitted an

application to Midstate for a $101, 000 acquisition loan to purchase

a residential lot in Lutherville, Maryland. The loan application

listed monthly income of $12,200, assets of $683,293.65, and a net

worth of $520,325.65.

On

or

about

August

23,

1988,

petitioners

submitted

an

application to Midstate for a $528,700 construction loan to build

their home on the lot in Lutherville,

Maryland,

$660,923

loan

construction

contract.

The

pursuant to a

application

listed

monthly income of $13,750, assets of $819,293.65, and a net worth

of $555,325.65.

As part of the loan application process,

petitioners were

required to submit their Federal income tax returns for 1986 and

1987. The returns that were hand delivered to Ms. Gerling by either

Mr.

or Mrs.

Zaban reported gross income before adjustments of

$160,115 for 1986 and $165,263 for 1987, even though the returns

prepared and filed with the Internal Revenue Service (IRS) reported

gross income before adjustments of $66,195 for 1986 and $101,963

for 1987.

Mr..Zaban prepared the fraudulent returns submitted to

Midstate for the purpose of persuading the savings and loan to

approve the loan applications.

These fraudulent returns were the

basis for the bank fraud charge to which Mr. Zaban pled guilty.

Petitioners

completed

construction

of

the

Lutherville,

Maryland, home and began occupying it in or about June 1989. The

- 13 -

Frank Culotta, a friend.

loan

was

repaid

upon

In 1988, $30,626 of.the aforementioned

the

sale

of

an

Ocean

City,

Maryland,

condominium that petitioners owned together with Mr. Culotta.

The

balance of the loan to Mr. Culotta remained unpaid as of December

31,

1989.

Vazquez

During 1987, Mr. Zaban lent $52,000 in cash to Keith

(who is married to Mr.

unpaid as of December 31,

1989.

Zaban' s niece) ,

which remained

Sometime prior to December 31,

1985, Mr. Zaban lent James Donohue $10,000 in cash, which remained

unpaid as of December 31,

1989.

During 1988,

Mr.

Zaban lent

Splenanne, Ltd. $4,623.87, of which $1,824 was repaid in 1989, and

the balance remained unpaid as of December 31, 1989.

Mrs. Zaban

was not involved in any of these loan transactions.

E.

Petitioners' Lifestyle

In 1978, petitioners acquired a home in Phoenix, Maryland, for

$96,899, which was financed through a mortgage.

The property was

sold on February 1, 1990, for $185, 000, with a $46, 901 balance on

the

mortgage.

The

mortgage payment

on the

Phoenix,

Maryland,

residence was approximately $500 per month.

Following construction of petitioners' home in Lutherville,

Maryland,

in

mid-1989,

the

monthly

mortgage

payment

became

$4,935.32, with a balloon payment of $445,213.99 due on October 1,

2003.

Mrs. Zaban was aware of the mortgage payments on the home.

In 1989, petitioners furnished their home with $29, 893.38 in

furniture from three stores and, in 1990, acquired a $12, 800 Andy

Warhol

painting.

several

other

During 1989

paintings,

and 1990,

including:

Lily

petitioners

Pond,

acquired

appraised

for

- 15 -

with Baker, Watts & Co. with a portfolio value of $136,426.26 as of

December 31,

1985,

and a portfolio value of $333,507.66 as of

December 31, 1989.

Mr. Zaban maintained a brokerage account with

Thompson

with

McKinnon

December 31,

1985,

December 31,

1989.

a

portfoli.o

value

of

$7,954.92

as

of

and a portfolio value of $22,183.09 as of

Mrs.

Zaban was aware of

these

brokerage

ac count s .

Between 1986 and 1989, petitioners paid for their daughter's

college education at Loyola College in the amount of $6,679.16 in

1986, $7,830.97 in 1987, $8,073.13 in 1988, and $4,062.50 in 1989.

Between

1986

and

1989,

petitioners

held

memberships

at

Chestnut Ridge Country Club, Merritt Racquetball Club (where Mr.

Zaban played racquetball) , and Greenspring Racquet Club (where Mrs.

Zaban played tennis) .

.

Between 1986 and 1989, petitioners had credit card payments on

14 credit cards totaling $7,522.23 in 1986,

•

$11,747.41 in 1987,

$31,371.12 in 1988, and $33,238.49 in 1989.

In 1988,

trip,

and

in

petitioners paid $3,368.70 to World Travel for a

1989,

petitioners

paid

$7,088.75

on

purchase

of

jewelry at

Radcliff & Co.

Mrs.

Zaban

participated

in

the

the

home

furnishings, artwörk, flatware, and jewelry, in addition to clothes

and fur coats, and was aware of other expense items.

F.

Preparation and Filing of Federal Tax Returns

Petitioners' 1984 and 1985 Federal joint income tax returns

(which are not in issue) were prepared by petitioners' attorney,

- 17 - .

In October 1990, Mr. Zaban entered into a closing agreement

with the IRS, terminating the 1990 tax year as of March 24, 1990.4

Mr. Zaban agreed to report the net profits from his gambling and

bookmaking

activities.

The

1990

return

(signed

by

both

petitioners) reported gross income before adjustments of $289,560

and gambling income of $240,700 (before expenses) on Schedule C in

accordance with the closing agreement.

Mrs. Zaban provided Messrs. Breschi and Fidati with records

and other information necessary to prepare petitioners' returns for

1984

through 1990.

She never reviewed their work to. determine

whether the returns were true and accurate. At times, Mr. Fidati

would provide Mrs. Zaban with returns prepared in pencil and would

have her sign blank returns.

•

As of October 1990, at a time in which Mrs. Zaban was aware of

Mr. Zaban's gambling and bookmaking activities, Mrs. Zaban knew she

should not rely on Mr. Fidati to prepare their returns.

Despite

this concern, Mrs. Zaban signed the 1989 and 1990 joint returns

without reviewing them.

G.

Notice of Deficiency

Pursuant to a reconstruction of petitioners' income under the

net

worth

method,

respondent

determined

that

petitioners

had

4

Closing agreements resolve liability issues only for

.the taxable years covered by the agreements. Sec. 7121; sec.

601.202 (a) , Statement of Procedural Rules. Thus, the termination

of the 1990 tax year on March 24, 1990, conclusively resolved,

for purposes of the closing agreement, only the issues for that

period. Respondent was permitted to issue notices of deficiency

relating to issues and time periods not covered by the agreement.

- 19 -

and do not maintain adequate books and records.

States,

880

348 U.S.

121

(1954) ; Lias v. Commissioner,

(4th Cir. 1956), affg. 24 T.C. 280

indirect

methods

generally are

235 F.2d 879,

(1955); Estate of Beck v.

Commissioner, 56 T.C. 297, 353-354 (1971).

by

Holland v. United

Deficiencies determined

presumed

correct,

Mills

v.

Commissioner, 399 F.2d 744, 749 (4th Cir. 1968), affg. T.C. Memo.

1967-67,

and

taxpayers

bear

the

burden

of

proving

that

such

deficiencies are erroneous, Rule 142 (a) ; Parks v. Commissioner, 94

T.C. 654, 658-659 (1990).

The net worth method requires a finding

of both the beginning and ending net values of a taxpayer's assets.

Holland v. United States, supra at 125.

Mr. Zaban asserts that the contents of box 3567, in which the

$115,100 cash was found, belonged to Mr. Neumyer.

Mr. Zaban claims

that Mr. Neumyer gave him between $155, 000 and $175, 000 in 1984 to

hold for safekeeping.

According to Mr. Zaban, Mr. Neumyer gave him

the money because Mr. Neumyer was going to Las Vegas for several

weeks; and while there, Mr. Neumyer wanted Mr. Zaban to be in a

position

to

pay

off

Mr.

Neumyer's

obligations

to

certain

individuals in connection with Mr. Neumyer's bookmaking operations.

Mr. Zaban testified that after Mr. Neumyer's return from Las Vegas,

Mr. Neumyer never asked him to return the funds.5

Mr. Zaban's testimony was self-serving and lacked credibility.

The evidence reflects that on January 2, 1990, $40, 000 in cash was

transferred from box 3567, a box controlled by Mr. Zaban to which

5

Mr. Neumyer died prior to the date of trial.

- 21 -

entitled to such relief for 1986 through 1990.

Respondent argues

that Mrs. Zaban fails to meet three of the four statutory elements

for relief .

Spouses who file a joint income tax return generally are

jointly and severally liable for its accuracy and the tax due,

including any additional taxes, interest, or penalties determined

on audit of the return.

section 6013 (e) ,

Sec. 6013(d)(3).

a spouse

However, pursuant to

(commonly referred to as an innocent

spouse) can be relieved of tax liability if that spouse proves:

A joint income tax return was filed;

(2)

(1)

the return contained a

substantial understatement of tax attributable to grossly erroneous

items of the other spouse;

(3) in signing the return, the spouse

seeking relief did not know, and had no reason to know, of the

substantial understatement;

and

(4)

under the circumstances it

would be inequitable to hold the spouse seeking relief liable for

the understatement.

Sec. 6013(e).

The spouse seeking relief bears

the burden of proving that each of the four elements of the statute

has been satisfied, and failure to prove any one of the elements

will prevent innocent spouse relief.

Bokum v. Commissioner,

T.C. 126, 138-139 (1990), affd. 992 F.2d 1132

94

(11th Cir. 1993).

Respondent concedes that a joint return was filed for each of

the years in issue, and thus the first element is not disputed.

The innocent spouse issue can be disposed of on the third and

fourth elements.

- 23 received unusually high volumes of telephone calls.

Further, Mrs.

Zaban knew that Mr. Zaban worked only in their basement where he

kept

betting

records

and

other

gambling

paraphernalia,

recorders hard-wired to the telephone lines,

tape

and a toolbox for

storing large amounts of cash, all of which were readily visible to

anyone who passed through the basement.

Mrs. Zaban testified that she never reviewed any of the tax

returns,

liquor license applications,

signed.

Her testimony that she was unaware of any of the contents

in these documents lacks credibility.

or loan applications she

In any case, the fact that

Mrs. Zaban failed to review any tax returns she signed, or to sign

blank tax returns that were completed at a later time, does not

permit Mrs. Zaban to plead ignorance and does not absolve her of

liability for her husband's omissions.

See Hayman v. Commissioner,

992 F.2d 1256,

1262

1993),

affg.

T.C.

Edmondson

Commissioner,

T.C.

Memo.

1996-393;

v.

(2d Cir.

Commissioner, T.C. Memo. 1987-537.

Memo.

1992-228;

Cohen

v.

Had Mrs. Zaban reviewed the

1984 and 1985 joint returns, she would have discovered that nearly

two-thirds of the reported gross income before adjustments resulted

from gambling; and had she reviewed the 1986, 1987, and 1988 joint

returns,

she would have found that no such gambling income was

reported in those years.

1996-223.

See Zimmerman v. Commissioner, T. C. Memo.

Further, she would have discovered that the reported

income for 1986 and 1987 was inconsistent with the figures reported

on the loan applications submitted to Midstate, the savings and

loan institution with which she personally negotiated and discussed

- 25 condominium share and seven automobiles,

two of which were new

Mercedes Benzes; paid for their daughter's entire private college

education; become members of three country or racquet clubs; and

taken a $3,300 vacation.

During the latter part of 1988 and through 1990, this lavish

lifestyle became even more apparent.

Mrs.

Zaban was directly

involved in the process of negotiating a $101, 000 residential lot

loan, as well as a $528,700 construction loan for the building of

their Lutherville, Maryland, home.

home

in

which

the

monthly

Following completion of the new

mortgage

payment

increased

from

approximately $500 per month to nearly $5, 000 per month, which was

.

paid by Mrs.

Zaban,

she participated in the furnishing of that

home, which included about $60,000 in purchases.

Mrs. Zaban was

also involved in the purchase of over $7, 000 in jewelry during 198.9

and accumulated a wardrobe filled with fur coats and other clothes

throughout the period in issue.

Given all of the facts and circumstances, we are convinced,

and thus hold, that Mrs. Zaban knew or should have known of the

substantial understatement on petitioners' returns for 1986 through

1990 and thus is not entitled to innocent spouse relief.

b.

.

Inequity in Holding Mrs. Zaban Liable

It would also not be inequitable to hold Mrs. Zaban liable for

the deficiencies for the years in issue.

that Mrs.

The record demonstrates

Zaban significantly benefited from the underreported

income and from the impermissible deductions (e.g., the large home

and

furnishings,

cars,

fur

coats

and

other

clothings,

club

- 27 -

1111,

1123

(1983).

Fraud

is

never

presumed,

Beaver

v.

Commissioner, 55 T. C. 85, 92 (1970) , and cannot be imputed from one

spouse to another,

Stone v.

Commissioner,

56 T. C.

213,

227-228

(1971) .

Respondent

Respondent

has

has

failed

to

not

established

sustain

that

the

Mrs.

burden

Zaban

of

knew

proof.

of

the

understatement on petitioners' joint returns given her failure to

review any of the returns or her signing of blank returns.

Ewell v. Commissioner, supra.

See

Additionally, there was no evidence

presented that Mrs. Zaban was involved in preparing the returns,

other than providing documentation to the accountant, Mr. Fidati.

Even though we believe Mrs.

Zaban knew of Mr.

Zaban's illegal

gambling and bookmaking activities, we cannot conclude from the

record that Mrs. Zaban knew that income from such activities was

not being reported.

491.

See Flynn v. Commissioner, T. C. Memo. 1981-

On the basis of the entire record in this case, we are not

persuaded that Mrs. Zaban intended to evade taxes and defraud the

Government.

Thus, we hold that Mrs. Zaban is not liable for the

additions to tax and penalty for fraud for 1986 through 1989.

Issue 4.

Negligence or Disregard of Rules or Regulations

The fourth issue for decision is whether Mrs. Zaban is liable

for additions to tax and penalty for negligence or disregard of

rules or regulations.

As an alternative to the fraud additions to

tax and penalty for 1986

additions

to

tax

for

through 1989,

negligence

or

respondent

disregard

of

determined

rules

or

regulations pursuant to sections 6653 (a) (1) (A) and (a) (1) (B) for

- 29 additions to tax for the substantial understatement of tax pursuant

to section 6661 for 1986, 1987, and 1988, and an accuracy-rel·ated

penalty pursuant to section 6662 for 1990.7

Mrs.

Zaban asserts

that she had reasonable cause and acted in good faith for those

years and thus is excepted from the substantial understatement

addition

to

tax and

the

accuracy-related penalty pursuant

section 6664(c).

to

.

Mrs. Zaban's argument is without merit.

The reasonable cause

exception to the addition to tax for the substantial understatement

of

tax

and

the

accuracy-related

penalty

for

substantial

understatement of tax are not applicable to taxpayers filing tax

returns prior to December 31, 1989.

Omnibus Budget Reconciliation

Act of 1989 (OBRA), Pub. L. 101-239, sec. 7721(a), 103 Stat. 2106,

2395.

Thus,

the reasonable cause exception does not apply to

petitioners' 1986, 1987, and 1988 returns.

In any case, Mrs. Zaban

lacks reasonable cause and good faith for each of the years in

issue.

Mrs.

Zaban never reviewed the returns prepared by Mr.

Fidati and occasionally signed blank returns.

Her failure to

review the returns and her blind reliance on Messrs.

Fidati were not reasonable.

See Bollaci v.

Zaban and

Commissioner,

T.C.

For tax years 1986, 1987, and 1988, sec. 6661 imposed

additions to tax of 25 percent of the amount of any underpayment

attributable to a substantial understatement. A substantial

understatement is defined as an understatement which exceeds the

greater of 10 percent of the tax required to be shown on the

return or $5,000.

Sec. 6661(b).

For tax year 1990, sec. 6662 imposed an accuracy-related

penalty of 20 percent of the underpayment attributable to a

substantial understatement.

- 31 -

filed after the prescribed filing date.

An exception is provided

for reasonable cause not the result of willful neglect.

IdçL

Petitioners were granted an extension for filing their 1989

joint return to August 15, 1990, but did not file the return until

October 18, 1990.

Petitioners di.d not establish reasonable cause

for the failure to timely file their 1989 return, and thus they

failed to meet their burden of proof.

petitioners

are

liable

for the

Rule 142(a).

We hold that

addition to tax under

section

6651(a)(1).

To reflect the foregoing and the concessions of the parties,

Decision will be entered

under Rule 155.