UNITED STATES TAX COURT

T.C. Memo. 1997-437

UNITED STATES TAX COURT

ANTHONY G. AND SHIRLEY A. OLBRES, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 27160-93.

Filed September 25, 1997.

Edward DeFranceschi, for petitioners.

Ronald F. Hood, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

CHIECHI, Judge:

Respondent determined the following defi-

ciencies in, and additions to, petitioners' Federal income tax:

Year

Deficiency

Sec.

6653(b)(1)(A)1

Additions to Tax

Sec.

Sec.

6653(b)(1)(B) 6653(b)(1)

1986

$120,353

$87,750

*

1987

336,457

251,203

**

1988

122,457

--* 50 percent of the interest due on $117,000.

** 50 percent of the interest due on $334,937.

1

--$91,843

Sec.

6661(a)

$29,250

83,734

30,614

All section references are to the Internal Revenue Code in

effect for the years at issue. All Rule references are to the

Tax Court Rules of Practice and Procedure.

- 2 The issues remaining for decision are:2

(1)

Are petitioners liable for each of the years 1986,

1987, and 1988 for the additions to tax for fraud under section

6653(b)(1)?

We hold that they are for 1986 and 1987 and that

they are for 1988 to the extent stated herein.

(2)

Did respondent make a computational error in determin-

ing petitioners' unreported gross receipts for 1988?

We hold

that respondent did.

(3)

Are petitioners liable for each of the years 1986,

1987, and 1988 for the addition to tax for a substantial understatement of income tax under section 6661(a)?

We hold that they

are for 1986 and 1987 and that they are for 1988 to the extent

stated herein.

FINDINGS OF FACT3

Some of the facts have been stipulated and are so found.

2

Petitioners have conceded all of the determinations in the

notice of deficiency (notice) for the years at issue except the

issues stated, an issue as to whether the respective periods of

limitations for 1986 and 1988 have expired, and computational

issues for 1988 involving a disallowed medical expense deduction

and self-employment tax. Our resolution of the period of limitations issue for 1986 and 1988 flows automatically from our

findings with respect to the issue regarding the additions to tax

for fraud for those years. See sec. 6501(c)(1). Our resolution

of the computational issues for 1988 flows automatically from

petitioners' concessions on other issues and our finding with

respect to the issue regarding an alleged computational error

involving petitioners' unreported gross receipts for that year.

3

Unless otherwise indicated or needed for clarity, our Findings

of Fact and Opinion pertain to 1986, 1987, and 1988, the years at

issue.

- 3 Petitioners resided in Hampton, New Hampshire, at the time

the petition was filed.

Petitioners, who were married on June 22, 1968, have three

children, Tamara C. Olbres, Jason A. Olbres, and Tyler M. Olbres.

Before petitioners were married, petitioner Anthony G. Olbres

(Mr. Olbres) attended the Center for Creative Studies in Detroit,

Michigan, from which he received a bachelor's degree in transportation design and training in industrial design, and petitioner

Shirley A. Olbres (Ms. Olbres) completed three years of college

at the University of Vermont, where she studied German and

liberal arts.

Shortly after petitioners were married, Ms. Olbres

took classes in psychology and sociology at a community college.

Petitioners have not taken any courses at the college level in

accounting or business.

Petitioners' Activities

Around 1974, petitioners started a business interchangeably

called Design Consultants, A.G. Olbres Design Consultants, and

A.G. Olbres Design, in which they engaged in designing and

fabricating trade show exhibits (exhibits).

(We shall refer to

the business in which petitioners engaged as Design Consultants.)

On April 18, 1988, petitioners incorporated Design Consultants under the name White Star Design, Inc. (White Star), and

the following numbers of shares of its no-par common stock were

issued to the individuals indicated:

Mr. Olbres held 55 shares,

Ms. Olbres held 35 shares, and Manuel L. Olbres held 10 shares.

- 4 On May 4, 1988, White Star elected to be taxed as an S corporation.

At the time White Star was formed, the following individu-

als were appointed to the offices indicated:

Mr. Olbres as

president, Ms. Olbres as treasurer, and Manuel L. Olbres as vice

president.

In addition to designing and fabricating the exhibits,

Design Consultants and/or White Star arranged for certain businesses to perform auxiliary services (auxiliary services) for

their clients including, inter alia, transporting the exhibits,

setting up the exhibits, hiring on-site personnel at trade shows,

electrical work, floral arranging, and telephone services.

During 1986, Design Consultants and/or White Star used, inter

alia, Greyhound Exposition Services (Greyhound) for certain

auxiliary services, and during 1986, 1987, and 1988, they used,

inter alia, Mayflower Transit, Inc. (Mayflower), to perform those

services.

From sometime in 1983 through the years at issue, Design

Consultants was located in North Berwick, Maine.

it had approximately 20 to 24 employees.

By around 1985,

Mr. Olbres' responsi-

bilities for Design Consultants consisted of designing, ordering

materials for, supervising the setting up of, selling, and

pricing the exhibits.

At all relevant times, Ms. Olbres, who

spent time caring for petitioners' children, did all of the

bookkeeping for Design Consultants and White Star.

During 1986 and 1987, clients of Design Consultants paid it

- 5 $800,4614 and $1,865,499, respectively, as payment for services

rendered, products sold, and/or certain of the auxiliary services.

During 1988, clients of Design Consultants and White Star

paid them a total of $1,018,772 as payment for services rendered,

products sold, and/or certain of the auxiliary services.

When

Design Consultants and/or White Star arranged to have certain

businesses perform the auxiliary services for their clients, at

least some of those businesses, such as Greyhound for 1986 and

Mayflower for 1986, 1987, and 1988, paid them commissions.

Greyhound and Mayflower paid Design Consultants and/or White Star

commissions that equaled approximately 15 percent of the payments

received by Greyhound and/or Mayflower from clients of Design

Consultants and/or White Star.

Design Consultants and/or White

Star billed their clients for any auxiliary services that those

clients received from various businesses, including Greyhound and

Mayflower; those clients paid Design Consultants and/or White

Star for those services billed; and Design Consultants and/or

White Star paid those businesses for the auxiliary services that

they provided to clients of Design Consultants and/or White Star.

During 1986, Design Consultants received commissions of $4,725

from Greyhound, and during 1986, 1987, and 1988, Design Consultants and/or White Star received commissions of $58,464, $96,671,

and $70,060, respectively, from Mayflower.

4

(We shall sometimes

All dollar amounts are rounded to the nearest dollar.

- 6 refer collectively to payments from clients of Design Consultants

and/or White Star and commissions from Greyhound and Mayflower as

Design Consultants' and/or White Star's receipts.)

During 1986, 1987, and 1988, petitioners maintained the

following personal and business bank accounts (bank accounts) at

Indian Head Bank and Trust Co. (Indian Head), Kennebunk Savings

Bank (Kennebunk), and The Exeter Banking Company (Exeter):5

Bank

Type of

Account

Indian Head

Name of Account

Account Number

Checking

A.G. Olbres Design,

Design Consultants

281-01619

Indian Head

Checking

Anthony G. Olbres and

Shirley A. Olbres

351-00369

Indian Head

Savings

A.G. Olbres, Design

Consultants

30-002583-0

Indian Head

Savings

Anthony G. Olbres and

Shirley A. Olbres

015-000289-7

Kennebunk

Checking

A.G. Olbres, Gary

Rohm, d/b/a Design

Consultants

33-802452

Kennebunk

Checking

Design Consultants,

A.G. Olbres

56-868352

Kennebunk

Savings

Anthony G. Olbres

20-004393

Exeter

Checking

Seabrook Properties,

Shirley Olbres

201-474-7300

(We shall refer to (1) Indian Head checking account number 28101619 as the Indian Head business checking account, (2) Indian

5

The names of Indian Head and Exeter were changed sometime

after the years at issue.

- 7 Head checking account number 351-00369 as the Indian Head personal checking account, (3) Indian Head savings account number

30-002583-0 as the Indian Head business savings account,

(4) Indian Head savings account number 015-000289-7 as the Indian

Head personal savings account, (5) Kennebunk checking account

number 33-802452 as the Kennebunk Olbres-Rohm business checking

account, (6) Kennebunk checking account number 56-868352 as the

Kennebunk business checking account, (7) Kennebunk savings

account number 20-004393 as the Kennebunk personal savings

account, and (8) Exeter checking account number 201-474-7300 as

the Seabrook Properties account.)

On April 22, 1988, petitioners closed the Indian Head

business savings account, which had a closing balance of

$464,409.

On the same date, petitioners opened another business

savings account at Indian Head, account number 015-002290-3,

under the name "A.G. Olbres Design Consultants; Anthony or

Shirley Olbres" (1988 Indian Head business savings account) into

which they deposited $464,409.6

During 1988, petitioners also maintained the following

business bank accounts at Kennebunk:

6

The parties stipulated that the 1988 Indian Head business

savings account was a checking account. However, that stipulation is contrary to the record in this case, which establishes,

and we have found, that that account is a savings account. We

may, and we shall in this instance, disregard stipulations

between the parties when the stipulations are clearly contrary to

the facts established by record. See Cal-Maine Foods, Inc. v.

Commissioner, 93 T.C. 181, 195 (1989).

- 8 Bank

Type of

Account

Name of Account

Account Number

Kennebunk

Checking

White Star Design,

Inc.

66-910252

Kennebunk

Checking

White Star Design,

Inc., Exhibit Design

and Fabrication

66-110152

(We shall refer to (1) Kennebunk checking account number 66910252 as the first Kennebunk White Star checking account and

(2) Kennebunk checking account number 66-110152 as the second

Kennebunk White Star checking account.)

Petitioners deposited Design Consultants' and/or White

Star's receipts into the Indian Head business checking account,

the Indian Head business savings account, and various other bank

accounts that they maintained.7

7

Petitioners made the following

The parties stipulated that they deposited all "business

checks" and receipts from "business clients" into either the

Indian Head business checking account or the Indian Head business

savings account. We construe the references in those stipulations to "business checks" and to receipts from "business clients" to mean receipts of Design Consultants and/or White Star

other than commissions that they received from businesses that

provided the auxiliary services. As we construe those stipulations, they are contrary to the record in this case. Even if our

construction of those stipulations were incorrect in that the

references therein refer to all receipts of Design Consultants

and/or White Star, including commissions that they received,

those stipulations nonetheless would be contrary to the record in

this case. That record shows, and we have found, that petitioners deposited both Design Consultants' and/or White Star's

receipts from their clients and commission receipts into bank

accounts in addition to the Indian Head business checking account

and the Indian Head business savings account. To illustrate,

petitioners deposited two checks from Numismatic Professionals,

Inc., into the Kennebunk personal savings account. By way of

(continued...)

- 9 total deposits into the following bank accounts during the years

indicated:

Name of Account

7

1986

1987

1988

Indian Head business

checking account

$758,179

$1,240,902

$664,062

Indian Head personal

checking account

124,619

222,746

269,549

Indian Head business

savings account

233,269

845,199

132,249

Indian Head personal

savings account

--

--

38,354

Kennebunk Olbres-Rohm

business checking account

2,551

9,989

66,512

Kennebunk business

checking account

87,225

163,850

74,370

Kennebunk personal

savings account

9,043

9,701

22,173

Seabrook Properties

account

94,063

144,671

77,039

1988 Indian Head

business savings account

--

--

710,921

First Kennebunk White Star

checking account

--

--

9,085

(...continued)

further illustration, petitioners deposited commissions received

from Greyhound during 1986 into not only the Indian Head business

savings account, but also the Seabrook Properties account. We

may, and we shall in this instance, disregard stipulations

between the parties where the stipulations are clearly contrary

to facts established by the record. See Cal-Maine Foods, Inc. v.

Commissioner, 93 T.C. at 195.

- 10 Name of Account

1986

1987

1988

Second Kennebunk White Star

checking account

--

--

70,950

1,308,949

2,637,058

2,135,264

Total

Petitioners treated the funds in the Indian Head business

savings account and the 1988 Indian Head business savings account

over which they had complete control as their own funds, and they

used those funds for personal expenditures.

Ms. Olbres maintained cash receipts journals (cash receipts

journals), cash disbursements journals (cash disbursements

journals), petty cash journals (petty cash journals), and

payroll journals (payroll journals) for Design Consultants and/or

White Star.

Around 1975, Wilson P. Dennett (Mr. Dennett), an

accountant retained by petitioners, created the format for, inter

alia, the cash receipts journals and showed Ms. Olbres how to

maintain those journals.

When Design Consultants and/or White Star billed a client

for services rendered, Mr. Olbres wrote a draft of an invoice,

and Susan Rubenstein, who worked for petitioners at Design

Consultants and White Star as a secretary from December 1986

through June 1988, and/or another member of the office staff

typed that invoice and mailed it to the client.

Three copies of

each invoice were made, one of which was kept in the office of

Design Consultants and/or White Star, one of which was sent to

Ms. Olbres at petitioners' house, and one of which was sent to

- 11 the client who was being billed.

The invoices requested that

payment be remitted to petitioners' home address.

Ms. Olbres maintained invoice logs (invoice logs) in which

she kept track of the invoices that Design Consultants and/or

White Star sent to their clients and the amounts that those

clients paid on those invoices.

Design Consultants and/or White

Star did not send invoices to Greyhound and/or Mayflower,8 and,

consequently, commissions received from those businesses were not

recorded in the invoice logs.9

Ms. Olbres brought copies of

portions of the invoice logs to petitioners' house.

She periodi-

cally destroyed those copies.

Petitioners opened the Indian Head business savings account

around 1983.

They deposited certain of Design Consultants'

and/or White Star's receipts into that account, and Ms. Olbres

recorded those deposits in a bank passbook for that account.

Ms.

8

The record is not clear about whether Design Consultants

and/or White Star sent invoices to other businesses that provided

auxiliary services to the clients of Design Consultants and/or

White Star.

9

The parties stipulated that all of the deposits made into the

Indian Head business savings account were recorded not only in a

bank passbook for that account, but also in the invoice logs.

That stipulation insofar as it relates to the invoice logs is

contrary to the record in this case. That record shows, and we

have found, that Design Consultants and/or White Star did not

send invoices to Greyhound and/or Mayflower and that commissions

that were paid to Design Consultants and/or White Star by those

businesses were not recorded in the invoice logs. We may, and we

shall in this instance, disregard stipulations between the

parties where the stipulations are clearly contrary to facts

established by the record. See Cal-Maine Foods, Inc. v. Commissioner, 93 T.C. at 195.

- 12 Olbres recorded in the cash receipts journals only those Design

Consultants' and/or White Star's receipts that petitioners

deposited into the Indian Head business checking account, and she

did not record in the cash receipts journals their respective

receipts that petitioners deposited into the Indian Head business

savings account or any other account.

She recorded in the

invoice logs only those Design Consultants' and/or White Star's

receipts for which clients were sent invoices.

Petitioners deposited only two checks from Mayflower, one

received in 1986 and one received in 1988, into the Indian Head

business checking account.

They deposited all of the other

checks received from Mayflower during the years at issue, as well

as all of the checks received from Greyhound during 1986, into

other bank accounts that they maintained, including the Indian

Head business savings account.

Consequently, the cash receipts

journals omitted all of the amounts received by Design Consultants and/or White Star from Greyhound during 1986 and most of

the amounts that Design Consultants and/or White Star received

from Mayflower during the years at issue.

As a result of Ms. Olbres' bookkeeping practices, a person

examining the cash receipts journals and no other written records

of Design Consultants and/or White Star would have no idea that

Design Consultants and/or White Star received income in addition

to their respective receipts that petitioners deposited into the

Indian Head business checking account.

Moreover, a person

- 13 examining both the cash receipts journals and the invoice logs

that Ms. Olbres maintained would have no idea that Design Consultants and/or White Star received commissions in the amounts paid

to them by Greyhound and/or Mayflower.

During 1986, 1987, and 1988, petitioners leased (1) certain

property in North Berwick, Maine (North Berwick property), to

Kitchen Tech for which they received rental income of $2,925,

$3,890, and $1,480, respectively, and (2) certain property in

Seabrook, New Hampshire (Seabrook property), to Johnson Matthey,

Inc. (Johnson Matthey), for which they received $46,969, $48,000,

and $12,000, respectively.

During 1988, petitioners also re-

ceived rental income of $900 from Traditional Wood Works, Inc.,

and $28,000 from White Star for the use of a building on the

North Berwick property that had previously been used by Design

Consultants.

Petitioners deposited at least a portion of the

rental income that they received from Johnson Matthey into the

Seabrook Properties account.

Petitioners' Accountant, Mr. Dennett

Mr. Dennett's Professional

Background, Experience, and Practice

During 1960, Mr. Dennett, who at the time was a public

accountant, began his accounting practice.

Around the late

1970's, he became qualified as a certified public accountant

(C.P.A.) in New Hampshire, after having unsuccessfully taken the

C.P.A. examination approximately seven times.

- 14 Beginning in 1960, until the time of Mr. Dennett's death in

November 1991, Mr. Dennett's wife, Margaret Dennett (Ms.

Dennett), worked at Mr. Dennett's office.

Ms. Dennett's duties

included preparing some less complicated tax returns for Mr.

Dennett's clients, preparing payroll returns, checking and

proofreading typing, entering data into Mr. Dennett's office

computer, and ensuring that written materials that clients

provided to Mr. Dennett's office for use in the preparation of

their tax returns were returned to those clients upon completion

of that return preparation.

At least during the 1980's, Joyce Wildes (Ms. Wildes) also

worked in Mr. Dennett's office and assisted him by preparing tax

returns.

During each of the years at issue, Mr. Dennett's office

prepared approximately 300 tax returns.

When a client retained Mr. Dennett for tax return preparation, Mr. Dennett generally followed one of the following practices:

(1) Mr. Dennett met with the client, asked for and

received information with respect to the client's tax return,10

and prepared a draft tax return while the client waited at Mr.

Dennett's office; (2) Mr. Dennett reviewed written materials that

the client left at his office, asked any questions that he had

based on his review of those written materials by telephoning the

10

It is not clear from the record whether Mr. Dennett's clients

generally provided him with oral and/or written information with

respect to their tax returns.

- 15 client or at a client meeting, and prepared the client's tax

return based on the written materials provided by that client and

any supplemental information that Mr. Dennett received from the

client in answer to his questions; or (3) Mr. Dennett met with

the client, received written materials from the client at that

meeting, and, as a result of the meeting and the written materials, prepared a draft of the client's tax return either at that

meeting or at a later time.

In addition to his accounting practice, Mr. Dennett was

elected annually for approximately 33 years to the position of

school treasurer for the town of Hampton.

For 22 of those years,

Mr. Dennett was elected to the position of treasurer (town

treasurer) for the town of Hampton.

Throughout the period from

1981 until around 1991, Mr. Dennett, as town treasurer, worked

with Janet C. LaPlante (Ms. LaPlante).

Ms. LaPlante, who had

graduated from high school and attended two years of college, was

the head bookkeeper for the town of Hampton during that period

and thereafter until around 1993.

Throughout the period during

which Ms. LaPlante was head bookkeeper for the town of Hampton,

she was not an accountant.

As town treasurer, Mr. Dennett was required to prepare and

provide Ms. LaPlante with monthly treasurer's reports (treasurer's reports).

Those reports, which were due on the tenth of

every month, reflected the total amounts received and paid by the

town of Hampton during the month covered by the report and the

- 16 aggregate amounts received and paid by the town of Hampton during

the year to the date of the report.

It was Ms. LaPlante's

responsibility to make sure that the books that she and her staff

maintained for the town of Hampton agreed with the figures in the

treasurer's reports.

In addition, Ms. LaPlante sent all cash or

checks received on behalf of the town of Hampton to Mr. Dennett,

and Mr. Dennett, after reviewing what he received, deposited the

cash and checks into the appropriate bank account(s) of the town

of Hampton.

In a "letter of comments and recommendations" dated January

31, 1990, and prepared by Plodzik & Sanderson, an accounting firm

retained by the town of Hampton to conduct audits of the town,

that firm made the following comments about Ms. LaPlante:

"While

* * * [she] does attempt to maintain some of the required records, we do not feel that she possesses the necessary skills to

assume responsibility over all bookkeeping and record-keeping

functions".

Mr. Dennett's Relationship with Petitioners

Petitioners first retained Mr. Dennett, whose office was located near petitioners' house, around 1975, and he prepared their

joint U.S. individual income tax returns (returns) for the taxable years 1976 through 1988.

Throughout the years during which

petitioners retained Mr. Dennett, he also prepared unaudited

personal and business financial statements for petitioners, which

petitioners used, inter alia, in attempting to borrow money.

- 17 In connection with Mr. Dennett's preparation of petitioners'

return for each of the years at issue, petitioners visited Mr.

Dennett's office in order to provide him with certain information.

When Mr. Dennett had finished preparing petitioners'

return for each of those years based on the information that

petitioners provided to him, his office telephoned petitioners to

inform them that their return was ready.

Petitioners then went

to his office and were given the return that Mr. Dennett had prepared, as well as a cover sheet, which, inter alia, summarized

the contents of the return, they signed that return, and they

paid Mr. Dennett's bill.

Each of petitioners' returns for the

years at issue was thereafter filed.

At all relevant times, both

petitioners knew that it would be unlawful to sign a false

return.

Petitioners did not provide Mr. Dennett with complete and

accurate information from which he could have prepared a correct

return for petitioners for each of the years at issue.

Mr. Dennett prepared (1) unaudited projected business

financial statements (unaudited projected business financial

statements) for Design Consultants for 1986 and for White Star

for 1988 that were dated June 26, 1986, and June 23, 1988,

respectively, (2) drafts of two unaudited statements of income

and expenditures for Design Consultants (draft, unaudited statement of income and expenditures), one for 1986 and one for 1987,

and (3) unaudited personal financial statements for petitioners

- 18 that were dated August 31, 1988 (August 31, 1988 unaudited

personal financial statements).

In preparing the foregoing

statements for petitioners, Mr. Olbres gave Mr. Dennett the

figures to include, and Mr. Dennett placed those figures in the

proper places and made the necessary calculations.

The unaudited projected business financial statements for

Design Consultants for 1986 contained the following caveats:

We have compiled the accompanying projected balance

sheet, statements of income, retained earnings, and

changes in financial position of A.G. Olbres Design, as

of December 31, 1986, and for the year ending, in

accordance with standards established by the American

Institute of Certified Public Accountants.

The accompanying projection and this report was prepared for the purpose of selling the business and

should not be used for any other purpose.

A compilation is limited to presenting in the form of a

projection information that is the representation of

management and does not include evaluation of the

support for the assumptions underlying the projection.

We have not examined the projection and, accordingly do

not express an opinion or any other form of assurance

on the accompanying or assumptions. * * * We have no

responsibility to update this report for events and

circumstances occurring after the date of this report.

Virtually identical caveats except for the second paragraph

quoted above appeared in a letter addressed to Anthony G. Olbres

DBA White Star Design, Inc., that was part of the unaudited

projected business financial statements for White Star for 1988.

The unaudited projected financial statements for Design Consultants for 1986 reflected projected gross receipts in an amount

that is almost twice as large as the gross receipts for Design

- 19 Consultants reported by petitioners in Schedule C, Profit or

(Loss) from Business or Profession (Schedule C), of their 1986

return (1986 Schedule C) and the unaudited projected financial

statements for White Star for 1988 reflected projected gross

receipts in an amount that is almost four times as large as the

gross receipts reported by White Star in its 1988 Form 1120S,

U.S. Income Tax Return for an S Corporation (1988 Form 1120S).

The draft, unaudited statements of income and expenditures

for Design Consultants for 1986 and 1987 reflected gross receipts

and net income in amounts that are identical to the respective

amounts of gross receipts and net income reported in petitioners'

1986 Schedule C and Schedule C of petitioners' 1987 return.

The August 31, 1988 unaudited personal financial statements

contained the following caveats:

We have compiled the accompanying statement of financial condition of Anthony G. and Shirley A. Olbres as

of August 31, 1988, in accordance with standards established by the American Institute of Certified Public

Accountants.

A compilation is limited to presenting in the form of

financial statements information that is the representation of the individuals whose financial statements

are presented. We have not audited or reviewed the

accompanying statement of financial condition and,

accordingly, do not express an opinion or other form of

assurance on it.

The August 31, 1988 unaudited personal financial statements did

not include information with respect to petitioners' checking

accounts at Indian Head or their bank accounts at Kennebunk.

did those statements include information with respect to peti-

Nor

- 20 tioners' stockholdings in White Star.

Certain Bank Transactions of

Petitioners During the Years at Issue

Certain Loans for Which Petitioners Applied

On August 11, 1986, petitioners signed a residential loan

application (1986 loan application) in which they applied for a

loan of $297,500 from The Berlin City Bank to purchase certain

property located in North Conway, New Hampshire (North Conway

property).

Petitioners indicated in that application that the

purchase price of the North Conway property was $350,000, that

they intended to make a cash downpayment on that purchase of

$52,500, and that their monthly gross income was $185,000.

In an attachment to the 1986 loan application entitled

"Notes of Financial Status, Anthony G. and Shirley A. Olbres,

Hampton, NH 03842", petitioners listed the following four bank

accounts:

(1) The Indian Head business savings account, (2) the

Indian Head personal savings account, (3) Exeter bank account

number 14 747 3 01,11 and (4) the Kennebunk personal savings

account.

In another attachment to the 1986 loan application,

petitioners indicated that they received gross monthly income of

$4,000 and net monthly income of $841 from the lease of the

Seabrook property to Johnson Matthey and that they made monthly

mortgage and real property tax payments of $3,109 and $50,

11

Records relating to Exeter bank account number 14 747 3 01

are not part of the record.

- 21 respectively, on that property.

Also attached to the 1986 loan

application were the unaudited projected financial statements for

Design Consultants for 1986 that indicated that the gross receipts of Design Consultants for the remainder of 1986 was

projected to be $1,350,000.

On June 28, 1988, petitioners signed an application for a

$277,200 loan from an undisclosed source with respect to the

purchase for a total of $308,000 of two units in Cranmore Condominiums in North Conway, New Hampshire.

Petitioners made a

downpayment of $30,800 on those purchases.

Certain Automobiles Purchased by Petitioners

During April 1985, petitioners secured a loan from Indian

Head in the amount of $33,345 for the purchase of a 1984 Porsche.

Petitioners made monthly payments of $926 on that loan until

April 7, 1988, when they made a final payment of approximately

$1,900.

In March 1986, petitioners secured a loan of $12,278 from

Indian Head for the purchase of a 1986 Chevrolet Blazer.

Peti-

tioners made monthly payments of $404 on that loan until on or

about June 5, 1987, when they made a final payment of approximately $7,700.

On May 28, 1987, Ms. Olbres used a treasurer's check in the

amount of $28,650 that she purchased with part of a $48,650

withdrawal from the Indian Head business savings account to buy a

1984 Mercedes Benz.

- 22 On June 18, 1987, Ms. Olbres withdrew $157,500 in cash from

the Indian Head business savings account in order to purchase a

treasurer's check in the amount of $157,500 for the purchase of a

1987 Rolls Royce Corniche (Rolls Royce).

On August 3, 1987, Ms. Olbres withdrew $24,750 in cash from

the Indian Head business savings account in order to purchase a

treasurer's check for $24,750 for the purchase of a 1987 Range

Rover.

Certain Payments With Respect to Brokerage

Accounts Maintained by Petitioners

On or about June 4, 1987, Mr. Olbres, as custodian for each

of petitioners' sons under the Uniform Gifts to Minors Act of New

Hampshire (custodian), purchased shares in the Advantage Growth

Fund for $10,006 for each of two brokerage accounts at Advest,

Inc. (Advest), that he maintained as their custodian.

He paid

for those shares by using a treasurer's check that Ms. Olbres had

purchased on June 10, 1987, with $20,012 in cash that she had

withdrawn from the Indian Head business savings account.

On September 8, 1987, petitioners purchased shares in the

Advantage Growth Fund for $50,004 and shares in the Templeton

Global Fund, Inc., for $50,008 for their brokerage account at

Advest.

They paid for those shares by using two treasurer's

checks that Ms. Olbres had purchased on September 4, 1987, with

$100,012 that she had withdrawn from the Indian Head business

savings account.

- 23 On or about October 27, 1987, petitioners purchased shares

in the Advantage Growth Fund for $20,005 for their brokerage

account at Advest.

They paid for those shares by using a trea-

surer's check that Ms. Olbres had purchased on November 3, 1987,

with part of a $45,000 withdrawal that she had made from the

Indian Head business savings account.

Certain Yachts Purchased by Petitioners

In March 1988, petitioners agreed to purchase for $172,210 a

1988 Pace yacht (Pace yacht) from Marina Harbor Corp. (Marina

Harbor).

In that connection, on March 16, 1988, when the balance

of the Indian Head personal checking account was $3,958, Ms.

Olbres wrote a check for $16,000 from that account that was

payable to Marina Harbor as a downpayment for the purchase of the

Pace yacht.

On March 17, 1988, petitioners withdrew $16,700 from

the Indian Head business savings account and deposited $16,000

into the Indian Head personal checking account.

In June 1988,

Mr. Olbres entered into a retail installment sales agreement to

finance $133,000 of the purchase price of the Pace yacht.

On

June 17, 1988, Ms. Olbres withdrew $23,210 from the 1988 Indian

Head business savings account and purchased a treasurer's check

for $23,210 payable to Marina Harbor for a further downpayment on

the Pace yacht.

In October 1988, petitioners traded in the Pace yacht in

order to purchase for $1,002,752 a 54-foot Bertram yacht (Bertram

yacht) from Norwood Marine, Inc. (Norwood Marine).

Petitioners

- 24 made a deposit of $85,000 on the purchase of the Bertram yacht by

using a check drawn on their Indian Head personal checking

account.

The bill of sale for the Bertram yacht indicated that

the buyer was "SHIRLEY A. OLBRES, Trustee, Under a Trust Agreement Dated: October 19, 1988, for the Benefit of:

The H.N.

Nautical Trust (Tamara C. Olbres, Tyler M. Olbres, Jason A.

Olbres)".

On October 26, 1988, Ms. Olbres withdrew $120,000 from

the 1988 Indian Head business savings account and purchased a

treasurer's check in the amount of $145,325, payable to Norwood

Marine, for a further downpayment on the Bertram yacht.

In

addition, two receipts from Norwood Marine indicated that two

checks in the amounts of $535,383 and $3,500 were received from

Security Marine Creditcorp, which provided financing to petitioners for the purchase of the Bertram yacht.

Petitioners' Returns

Petitioners filed returns for 1986, 1987, and 1988 that they

signed and that Mr. Dennett signed as return preparer.

In

petitioners' Schedules C for those years, petitioners reported

gross receipts and net profits of Design Consultants, as follows:

Year

Gross Receipts

Net Profits

1986

1987

1988

$740,990

1,235,069

340,675

$75,784

83,502

26,061

On line four of Schedule C of petitioners' 1988 return (1988

Schedule C), petitioners reported $49,525 of "Other income",

which was compensation that White Star paid to Mr. Olbres during

- 25 1988 (1988 White Star compensation).

In Schedule B (Interest and Dividend Income) of petitioners'

returns for the years at issue, petitioners reported interest

income from, inter alia, the Indian Head business savings account.

In Schedule E (Supplemental Income Schedule) of petitioners'

returns (Schedule E) for the years at issue, petitioners reported

the following amounts of rental income with respect to the

properties indicated:

Year

Seabrook Property

North Berwick Property

1986

$21,600

*

1987

30,000

-01988

6,000

$28,000

* Although petitioners received $2,925 of rental

income from Kitchen Tech for the North Berwick

property, that property was not listed as rental

property in petitioners' 1986 return.

During 1989, White Star filed its 1988 Form 1120S in which

it reported gross receipts of $506,336 and ordinary income of

$773.

In Schedule E of their 1988 return, petitioners reported

$773 of income with respect to White Star.

In April 1989, petitioners filed Form 1045 (Application for

Tentative Refund) in which they claimed refunds based on an

alleged net operating loss of $52,136 that they carried back from

1988 to 1985, 1986, and 1987.

A large portion of that loss was

attributable to an alleged casualty loss of $52,002 that petitioners claimed with respect to a fire at the Seabrook property

- 26 that occurred on March 13, 1988, and a Schedule E loss of

$28,195, which consisted of a net loss of $28,968 with respect to

petitioners' rental properties and the $773 of income that

petitioners reported with respect to White Star.

Petitioners

received refunds for 1985, 1986, and 1987 in the amounts of $48,

$3,353, and $2,919, respectively.

Respondent's Examination of Petitioners' Returns

Based on a prime lead referral that was generated because an

Internal Revenue Service employee observed a Rolls Royce that,

after further investigation, was determined to belong to petitioners, Revenue Agent Karen Lyle (Ms. Lyle) was assigned to

examine petitioners' 1987 return.

Thereafter, Ms. Lyle sent a

letter (appointment letter) to Mr. Dennett, who, on August 29,

1989, had filed Form 2848, Power of Attorney and Declaration of

Representative (Form 2848), authorizing him to represent petitioners with respect to their taxable year 1987.

In the appoint-

ment letter, Ms. Lyle requested books, records, savings account

passbooks, and various other documents relating to petitioners'

taxable year 1987.

However, Ms. Lyle never conducted a field

visit with petitioners because Revenue Agent Leonard R. Kaply

(Mr. Kaply) replaced her.

On September 25, 1989, Mr. Kaply met (September 1989 meeting) with petitioners, Mr. Dennett, and Ms. Wildes.

At that

meeting, petitioners told Mr. Kaply about the types of written

materials that Ms. Olbres maintained during 1987 for Design

- 27 Consultants, including the cash receipts journal, the cash

disbursements journal, the petty cash journal, and the payroll

journal for that year, but they failed to mention the invoice

log.

At the September 1989 meeting, petitioners also informed

Mr. Kaply about the existence of the Indian Head business savings

account and told him that all of the deposits made into that

account were transferred from the Indian Head business checking

account.

Petitioners did not inform Mr. Kaply at the September

1989 meeting that they deposited checks received by Design

Consultants directly into the Indian Head business savings

account.

At the September 1989 meeting, petitioners and Mr. Dennett

provided Mr. Kaply with some of the documents requested in the

appointment letter that Ms. Lyle had sent to Mr. Dennett.

They

did not provide Mr. Kaply with the cash receipts journal for 1987

or bank statements for the Indian Head business savings account,

the Kennebunk personal savings account, and the Seabrook Properties account.

In fact, Mr. Kaply was not even aware at the

September 1989 meeting that the Seabrook Properties account

existed.

He subsequently learned of the existence of that

account during the course of his examination of petitioners'

taxable year 1987 when he found that petitioners deposited checks

written from the Seabrook Properties account into their Indian

Head personal checking account.

At the September 1989 meeting, Mr. Kaply asked Mr. Dennett

- 28 how he prepared petitioners' 1987 return.

Mr. Dennett gave him a

six-page summary (1987 summary) that covered at least certain

expenses of Design Consultants for 1987 and certain income,

including $30,000 of rental income from the Seabrook property,

and certain expenses of petitioners, including all expenses with

respect to the Seabrook property, for that year.

The 1987

summary did not include information with respect to Design

Consultants' receipts for 1987.

All of the income amounts and

virtually all of the expense amounts that were included in the

1987 summary were reported in petitioners' 1987 return.

Ms.

Olbres indicated to Mr. Kaply at the September 1989 meeting that

she gave Mr. Dennett the 1987 summary in connection with the

preparation of petitioners' 1987 return.

After the September 1989 meeting, Mr. Kaply prepared a

memorandum covering the answers that petitioners and Mr. Dennett

provided to his questions during that meeting.

In that memoran-

dum, Mr. Kaply indicated that petitioners' 1987 return was

prepared by Mr. Dennett from "books and schedules" prepared by

Ms. Olbres.

Mr. Kaply's reference to "books and schedules" was

to the 1987 summary that Ms. Olbres provided to Mr. Dennett.

After the September 1989 meeting, Mr. Dennett wanted to make

certain that the 1987 return that he had prepared and that was

filed for petitioners was accurate.

In this connection, peti-

tioners provided Mr. Dennett with certain written materials

relating to 1987 that he did not have previously, including the

- 29 cash receipts journal for that year.

Mr. Dennett and Ms. Wildes

used those materials to reconstruct another 1987 return for

petitioners that was not filed (reconstructed 1987 return).

The

amount of gross receipts reflected in Schedule C of petitioners'

reconstructed 1987 return was virtually identical to (1) the

amount of gross receipts reflected in the cash receipts journal

for 1987 and (2) the amount of gross receipts reflected in

Schedule C of the return that petitioners filed for that year.

On September 26, 1989, the day after the September 1989

meeting, Mr. Kaply submitted Form 4564, Information Document

Request (IDR), to Mr. Dennett requesting the information that he

had requested at that meeting, as well as additional information

with respect to certain of the written materials that petitioners

had provided to him at that meeting.

In the IDR, Mr. Kaply

requested, inter alia, the following:

(1) Information with

respect to the Indian Head personal checking account, including

the source of the funds deposited into that account, and (2) an

explanation of the source of the money deposited into petitioners' savings accounts.

Approximately one month after sending the

IDR to Mr. Dennett, Mr. Kaply had not received any information

with respect to those two inquiries, and he decided to summons

petitioners' records from Indian Head, Kennebunk, and Hampton Cooperative Bank.12

12

Thereafter, when Mr. Kaply learned of the

The record does not contain information with respect to what

(continued...)

- 30 existence of the Seabrook Properties account, he summonsed the

bank records with respect to that account.

When Mr. Kaply received the bank records for the Indian Head

business savings account, he discovered that, contrary to what

petitioners had told him at the September 1989 meeting, petitioners had deposited directly into that account checks that they had

received from clients of Design Consultants.

Mr. Kaply then

decided to do an analysis under the bank deposits method to

determine whether petitioners had unreported income for 1987,

and, if so, in what amount.

Based on that analysis and his

investigation, Mr. Kaply determined that petitioners had approximately $750,000 of unreported income for 1987.

On February 14, 1990, Mr. Kaply telephoned Mr. Dennett

(February 1990 telephone call) to schedule another meeting with

petitioners.

Mr. Dennett informed Mr. Kaply during the February

1990 telephone call that petitioners wanted Mr. Dennett to meet

alone with Mr. Kaply and that they did not intend to attend

future meetings.

When Mr. Kaply advised Mr. Dennett during the

February 1990 telephone call about the amount of income that he

had determined petitioners failed to report for 1987, Mr. Dennett

told Mr. Kaply that he would contact petitioners about meeting

with Mr. Kaply.

12

During the February 1990 telephone call, Mr.

(...continued)

bank accounts, if any, were maintained by petitioners at Hampton

Co-operative Bank. The record shows only that petitioners

obtained two mortgage loans from that bank.

- 31 Dennett disclosed to Mr. Kaply that Mr. Olbres had told him that

there might be a problem involving unreported income with respect

to petitioners' 1987 return.

In February 1990, Mr. Kaply and Jim Bircree, who was Mr.

Kaply's manager, met (February 1990 meeting) with Mr. Dennett and

Ms. Wildes about petitioners' 1987 return that was being examined.

Although Mr. Dennett had telephoned Mr. Kaply a couple of

days after the February 1990 telephone call to inform him that

petitioners planned to attend the February 1990 meeting, petitioners did not appear at that meeting.

In anticipation of the

February 1990 meeting, Mr. Kaply prepared a list of questions

with respect to the Indian Head business savings account and two

of the accounts maintained by petitioners at Kennebunk because he

thought that some of the checks deposited into those accounts

might represent income not reported by petitioners for 1987.

Mr.

Dennett informed Mr. Kaply at the February 1990 meeting that he

had no knowledge about whether any of the deposits into those

accounts constituted income to petitioners.

Immediately after

the February 1990 meeting, Mr. Kaply enlarged his examination of

petitioners' taxable year 1987 to include their taxable year

1988.

A few days after the February 1990 meeting, Mr. Dennett

telephoned Mr. Kaply and informed him that he was no longer

authorized to represent petitioners in connection with Mr.

Kaply's examination of petitioners' taxable year 1987.

Approxi-

- 32 mately one week thereafter, George D. Coupounas (Mr. Coupounas)

telephoned Mr. Kaply to advise him that on February 22, 1990,

petitioners had executed Forms 2848 authorizing Mr. Coupounas to

represent petitioners not only with respect to their taxable year

1987 that was being examined by Mr. Kaply, but also with respect

to their taxable years 1986 and 1988, and those forms were sent

to Mr. Kaply.

On April 24, 1990, Mr. Kaply and Norman Murphy (Mr. Murphy),

who was Mr. Kaply's acting manager, met (April 1990 meeting) with

Mr. Coupounas about petitioners' returns for 1987 and 1988 that

were being examined.

At that meeting, Mr. Kaply asked Mr.

Coupounas questions about the Indian Head business savings

account and two of the accounts at Kennebunk, which were similar

to the questions that he had asked Mr. Dennett at the February

1990 meeting.

Mr. Coupounas informed Mr. Kaply and Mr. Murphy at

the April 1990 meeting that he would answer Mr. Kaply's questions

only if Mr. Murphy promised not to refer petitioners' case to

respondent's Criminal Investigation Division (CID).

When Mr.

Murphy declined to make any such promise, Mr. Coupounas indicated

that he was terminating the April 1990 meeting.

Shortly after the April 1990 meeting, Mr. Kaply turned

petitioners' audit over to CID, and that division began to

investigate not only petitioners' taxable years 1987 and 1988,

but also their taxable year 1986.

Respondent's special agent,

Don Cote (Mr. Cote), was assigned to the criminal investigation

- 33 of those years, and Mr. Kaply assisted him in that investigation.

As part of Mr. Cote's criminal investigation, Mr. Cote and Mr.

Kaply met in July 1990 (July 1990 meeting) with Mr. Dennett and

Ms. Wildes.

At that meeting, Mr. Cote asked Mr. Dennett ques-

tions regarding, inter alia, how Mr. Dennett prepared petitioners' returns for 1986, 1987, and 1988.

Mr. Dennett indicated

that he met with Ms. Olbres shortly before petitioners' return

for each of the years at issue was due, she verbally related to

him the figures to be used in each of those returns, and gave him

the 1987 summary in connection with his preparation of their 1987

return.

Mr. Dennett placed those figures on the appropriate

lines in each such return and made the computations called for by

each of those returns.

Mr. Dennett informed Mr. Cote and Mr.

Kaply at the July 1990 meeting that petitioners never provided

him with any bank statements or bank records in connection with

his preparation of petitioners' 1986, 1987, and 1988 returns.

Notice of Deficiency

On September 23, 1993, respondent issued a notice to petitioners for 1986, 1987, and 1988 and determined that they had

unreported income for those years in the amounts of $246,948,

$791,927, and $399,606, respectively.

Virtually all of the

unreported income for 1986 and all of the unreported income for

1987 that respondent determined in the notice consisted of

certain gross receipts of Design Consultants and certain rental

income paid to petitioners.

In addition to certain gross re-

- 34 ceipts of Design Consultants, the unreported income for 1988 that

respondent determined in the notice included (1) the $49,525 of

1988 White Star compensation and (2) income resulting from the

disallowance by respondent of the net operating loss that petitioners claimed for that year.

With respect to petitioners'

claimed net operating loss, two of the components that petitioners claim gave rise to that loss were a casualty loss resulting

from a fire at the Seabrook property on March 13, 1988, and a

Schedule E loss of $28,195 that petitioners claimed in their 1988

return.

With respect to petitioners' claimed casualty loss,

respondent determined that for 1988 petitioners had a gain of

$7,415, and not a loss, resulting from the fire at the Seabrook

property because the proceeds that petitioners received from

their insurance company as a result of that fire exceeded the

basis of the portion of the Seabrook property that the fire

destroyed.

With respect to petitioners' claimed Schedule E loss

of $28,195, respondent determined that for 1988 petitioners had a

Schedule E gain of $60,930, and not a loss, because for that year

they had unreported rental income of $9,315, they overstated

their deductions with respect to their rental property by

$32,531, and their income with respect to their S corporation

White Star was understated by $53,230.

Respondent's determinations in the notice of Design Consultants' unreported gross receipts were based on the bank deposits

method analysis conducted by Mr. Kaply.

As is reflected in the

- 35 explanation of Design Consultants' unreported gross receipts for

1988 that is contained in the notice (1988 explanation), respondent determined the total amount that petitioners deposited into

their bank accounts for that year and the portion of those

deposits that constituted gross receipts of Design Consultants.

In determining the portion of petitioners' total bank deposits

for 1988 that constituted gross receipts of Design Consultants,

respondent reduced the total amount of petitioners' bank deposits

that respondent determined for that year by what respondent

determined to be petitioners' deposits from nontaxable sources,

transfers that petitioners made between their bank accounts, the

total amount of petitioners' rental income,13 and "Wages"

con-sisting of the $49,525 of 1988 White Star compensation.

Respondent determined that the balance of petitioners' bank

deposits for 1988 constituted gross receipts of Design Consultants for that year.

Respondent then reduced the gross receipts

of Design Consultants that respondent determined for 1988 by

"Income per return" in order to determine Design Consultants'

unreported gross receipts for that year.

13

Respondent did not

Respondent first added the amount of rental income that

respondent determined was not deposited into petitioners' bank

accounts during 1988 to the total deposits that respondent

determined petitioners made into those accounts during that year

and that included petitioners' rental income for 1988 which

respondent determined petitioners had deposited into their bank

accounts. Respondent then reduced such total bank deposits

during 1988, as determined by respondent, by, inter alia, the

total amount of rental income that respondent determined petitioners had for that year.

- 36 include in that "Income per return" figure the $49,525 of 1988

White Star compensation that petitioners reported on line four of

their 1988 Schedule C as "Other income".

Consequently, respon-

dent determined that for 1988 petitioners had $228,119 of unreported gross receipts of Design Consultants.

Respondent also determined in the notice that petitioners

are entitled to certain deductions for 1987 and 1988 that they

did not claim in their returns for those years and that petitioners are not entitled to certain of the cost of goods sold and

deductions that they claimed in their 1986, 1987, and 1988

returns totaling $102,980, $102,705, and $146,641, respectively.

With respect to respondent's determinations disallowing, inter

alia, certain of the cost of goods sold and deductions that

petitioners claimed, respondent's representatives obtained from

petitioners and reviewed oral and/or written information regarding at least certain of those items about which respondent had

questions.

Petitioners' Criminal Trial and Conviction

On April 14, 1993, a grand jury indicted petitioners on

three counts of violating section 7201 by willfully attempting to

evade and defeat a large part of the income tax due and owing by

them to the United States for 1986, 1987, and 1988.

Petitioners

were tried in the U.S. District Court for the District of New

Hampshire (District Court) on January 24, 1994, and a jury found

petitioners guilty of violating section 7201 for 1987 and acquit-

- 37 ted them of violating section 7201 for 1986 and 1988 (jury

verdict).

After the jury verdict, petitioners filed a motion for

judgment of acquittal with respect to the guilty jury verdict for

1987.

On September 30, 1994, the presiding judge issued a

memorandum order in which he granted that motion, and a judgment

of acquittal was entered.

On July 26, 1995, the Court of Appeals for the First Circuit

reversed the judgment entered by the District Court and reinstated petitioners' criminal conviction under section 7201 for

1987.

Petitioners petitioned the U.S. Supreme Court for a writ

of certiorari.

That petition was denied on or about November 29,

1995, and petitioners' conviction under section 7201 for 1987

became final.

OPINION

Respondent bears the burden of proof on the fraud issue, and

that burden must be satisfied by clear and convincing evidence.

Sec. 7454(a); Rule 142(b).

Petitioners bear the burden of

proving that respondent's deficiency determinations and those

under section 6661(a) are erroneous.14

Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933).

14

Petitioners contend on brief that, because they are not

liable for the additions to tax for fraud, the respective periods

of limitations for 1986 and 1988 have expired. See sec. 6501(a),

(c)(1). We find below that respondent has established fraud for

1986 and 1988. Consequently, the respective periods of limitations for each of those years have not expired. Sec. 6501(c)(1).

- 38 Both petitioners and respondent rely on testimonial and

documentary evidence to support their respective positions in

this case.

Mr. Olbres and Ms. Olbres testified at trial.

Although they were able to recollect, understand, and recount

certain details about the multimillion dollar business which they

controlled during the years at issue, they had difficulty in

remembering, comprehending, and/or recounting details about that

business that do not appear to support their position in this

case.

We found Mr. Olbres' testimony to be questionable, implau-

sible, and/or vague in certain material respects.

We found Ms.

Olbres' testimony to be questionable, evasive, vague, implausible, and/or conclusory in certain material respects.

Under such

circumstances, we are not required to, and we generally do not,

rely on the testimony of either petitioner.

See National Fire-

works v. Commissioner, 243 F.2d 295, 297 (1st Cir. 1957), affg.

T.C. Memo. 1956-1; Tokarski v. Commissioner, 87 T.C. 74, 77

(1986).

Ms. LaPlante testified for petitioners.

While we have no

reason to question her credibility based on our observation of

her demeanor, for the reasons discussed below, we are unwilling

to rely on her testimony to support petitioners' position in this

case.

Ms. Dennett and Mr. Kaply also were witnesses at trial.

found Ms. Dennett's testimony to be credible.

We

We also found Mr.

Kaply's testimony to be credible, and we rely on him to establish

- 39 facts relating to his examination of petitioners' returns for the

years at issue, including what Mr. Dennett, who unfortunately

died prior to trial, told him during the course of that examination.

Issues on Which Respondent Has the Burden of

Proof--Additions to Tax Under Section 6653(b)(1)

For 1986 and 1987, section 6653(b)(1)(A) imposes an addition

to tax equal to 75 percent of the portion of an underpayment that

is attributable to fraud, and section 6653(b)(1)(B) imposes an

addition to tax equal to 50 percent of the interest due on that

portion of the underpayment.

For 1988, section 6653(b)(1)

imposes an addition to tax equal to 75 percent of the portion of

the underpayment attributable to fraud.

For purposes of the

foregoing provisions, section 6653(b)(2) provides that if respondent establishes that any portion of an underpayment is due to

fraud, the entire underpayment is treated as attributable to

fraud, unless the taxpayer proves that some portion of the

underpayment is not due to fraud.

In order for the additions to tax for fraud to be imposed,

respondent must prove by clear and convincing evidence that an

underpayment exists and that some portion of that underpayment is

due to fraud.

Sec. 7454(a); Rule 142(b); Niedringhaus v. Commis-

sioner, 99 T.C. 202, 210 (1992).

Petitioners concede the under-

payment determined by respondent for each of the years at issue

except for that portion of the underpayment for 1988 that is

- 40 attributable to a computational error involving the 1988 White

Star compensation that petitioners contend respondent made in

determining the unreported gross receipts of Design Consultants

for that year (claimed 1988 computational error).

In light of

petitioners' concessions, we find that an underpayment exists for

each of the years at issue.

Before turning to the question of fraudulent intent, we

shall address petitioners' contention regarding the amount of the

underpayment for 1988 insofar as it relates to the 1988 White

Star compensation.

Respondent used the 1988 White Star compensa-

tion as a factor in determining under the bank deposits method

the unreported gross receipts of Design Consultants for 1988.

In

addition, respondent made a determination in the notice that

petitioners have unreported income for 1988 of $49,525 attributable to the 1988 White Star compensation.

In petitioners'

closing statement at the conclusion of trial, they contended that

for 1988 there was a computational error in the bank deposits

method analysis used by respondent to determine Design Consultants' unreported gross receipts.

In an objection to a finding

of fact proposed by respondent, petitioners state the following

on brief:

"Further, the adjustment for 'Compensation, White Star

Design, Inc.'; adjustment '1 p' for 1988 (Resp. Ex. F) is in

error.

The '49,525' is reported on Petitioners 1988 1040,

Schedule C Part I, line 5, [sic] other income 49,525 (Resp. Ex

E)."

As we construe petitioners' position at trial and on brief,

- 41 petitioners contend that respondent made a computational error in

applying the bank deposits method for 1988 in that, in determining the unreported gross receipts of Design Consultants under

that method, respondent failed to reduce the bank deposits that

respondent determined were Design Consultants' gross receipts for

that year by the $49,525 of 1988 White Star compensation that

petitioners reported in their 1988 Schedule C.

We agree that

respondent made a computational error in applying the bank

deposits method to determine the amount of Design Consultants'

unreported gross receipts for 1988.

Respondent's determinations in the notice of Design Consultants' unreported gross receipts were based on the bank deposits

method analysis conducted by Mr. Kaply.

As is reflected in the

1988 explanation, respondent determined the total amount that

petitioners deposited into their bank accounts for that year and

the portion of those deposits that constituted gross receipts of

Design Consultants.

In determining the portion of petitioners'

total bank deposits for 1988 that constituted gross receipts of

Design Consultants, respondent reduced the total amount of

petitioners' bank deposits that respondent determined for that

year by what respondent determined to be petitioners' deposits

from nontaxable sources, transfers that petitioners made between

their bank accounts, the total amount of petitioners' rental

income, and "Wages" consisting of the $49,525 of 1988 White Star

compensation.

Respondent determined that the balance of peti-

- 42 tioners' bank deposits for 1988 constituted gross receipts of

Design Consultants for that year.

Respondent then reduced the

gross receipts of Design Consultants that respondent determined

for 1988 by "Income per return" in order to determine Design

Consultants' unreported gross receipts for that year.

Respondent

did not include in that "Income per return" figure the $49,525 of

1988 White Star compensation that petitioners reported on line

four of their 1988 Schedule C as "Other income".

We find that

respondent made a computational error in applying the bank

deposits method to determine Design Consultants' unreported gross

receipts for 1988 (1988 computational error) in that respondent

should have included the 1988 White Star compensation in that

"Income per return" figure.15

Accordingly, we find that the

unreported gross receipts of Design Consultants for 1988 is

$178,594, and not $228,119.

We further find that the amount of

the deficiency, and therefore the amount of the underpayment, for

1988 (revised 1988 underpayment), see sec. 6653(c)(1), should be

reduced in the Rule 155 computation in order to correct the 1988

computational error.

We shall now turn to the question of fraudulent intent.

To

prove that an underpayment is attributable to the fraudulent

intent of the taxpayer, respondent must prove that the taxpayer

15

However, we sustain respondent's separate determination that

petitioners have unreported income for 1988 of $49,525 attributable to the 1988 White Star compensation.

- 43 intended to evade taxes that he or she believed to be owing by

conduct intended to conceal, mislead, or otherwise prevent the

collection of such taxes.

Stoltzfus v. United States, 398 F.2d

1002, 1004 (3d Cir. 1968); Parks v. Commissioner, 94 T.C. 654,

661 (1990).

The existence of fraudulent intent is a question of

fact to be resolved upon consideration of the entire record.

Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), affd. without

published opinion 578 F.2d 1383 (8th Cir. 1978).

Although

fraudulent intent is never presumed, it may be established by

circumstantial evidence because direct proof of the taxpayer's

intent is rarely available.

Petzoldt v. Commissioner, 92 T.C.

661, 699 (1989); Rowlee v. Commissioner, 80 T.C. 1111, 1123

(1983).

The taxpayer's entire course of conduct may establish

the requisite fraudulent intent.

Rowlee v. Commissioner, supra

at 1123; Otsuki v. Commissioner, 53 T.C. 96, 106 (1969).

The courts have established a number of badges of fraud from

which fraudulent intent may be inferred.

Those badges include:

(1) Substantial and consistent understatement of income,

(2) failure to maintain adequate records, (3) incomplete and

erroneous information provided to tax return preparer or bookkeeper, (4) destruction of books and records, (5) implausible

explanation of behavior, (6) lack of credibility of the taxpayer's testimony, and (7) failure to cooperate with tax authorities.

See Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th

Cir. 1986), affg. T.C. Memo. 1984-601; Toussaint v. Commissioner,

- 44 743 F.2d 309, 312 (5th Cir. 1984), affg. T.C. Memo. 1984-25;

Merritt v. Commissioner, 301 F.2d 484, 487 (5th Cir. 1962), affg.

T.C. Memo. 1959-172; Powell v. Granquist, 252 F.2d 56, 59 (9th

Cir. 1958); Parks v. Commissioner, supra at 664-665.

The mere

failure to report income is not sufficient to establish fraud.

Petzoldt v. Commissioner, supra at 700.

Petitioners' Taxable Year 1987

Respondent determined that $334,937 of petitioners' underpayment for 1987 is attributable to fraud.

At the conclusion of

the trial in this case, petitioners conceded the amount of the

underpayment for that year, and they also conceded that they are

estopped from denying fraud for 1987 because of their conviction

for criminal tax evasion under section 7201 for that year.

See

Manzoli v. Commissioner, 904 F.2d 101, 105 (1st Cir. 1990), affg.

T.C. Memo. 1988-299, supplemented by T.C. Memo. 1989-94; DiLeo v.

Commissioner, 96 T.C. 858, 885-886 (1991), affd. 959 F.2d 16 (2d

Cir. 1992).

Petitioners reiterate those concessions on brief.

Petitioners nonetheless contend, inconsistently in our view,

that "the amount of the deficiency and the resulting civil

penalty may be litigated in subsequent civil proceedings."

To

support that contention, petitioners make the following

conclusory argument on brief:

"Because of the arbitrary nature

[sic] the Respondent's determination of the portion of the

deficiency attributable to disallowed expenses no fraud penalty

in any of the years in question can be attributable to that

- 45 portion of the deficiency."

Petitioners presented no evidence

showing that the underpayment for 1987 that is attributable to

those expenses is not due to fraud.

On the record before us, we

find that petitioners have failed to show, as they must under

section 6653(b)(2), that the portion of the underpayment for 1987

that is attributable to the deductions which respondent disallowed is not due to fraud.

Based on our review of the entire record before us, we find

that petitioners are liable for 1987 for the additions to tax

under section 6653(b)(1) with respect to the portion of the

underpayment for that year that respondent determined is attributable to fraud.

Petitioners' Taxable Years 1986 and 1988

Respondent contends that $117,000 of the underpayment for

1986 (1986 underpayment) and all of the underpayment for 1988

that were determined in the notice are attributable to fraud.

We

have found a revised 1988 underpayment, and our discussion

addresses the parties' contentions regarding respondent's determinations under section 6653(b)(1) with respect to the 1986

underpayment and the revised 1988 underpayment.

Petitioners contend that the 1986 underpayment and the

revised 1988 underpayment are not due to fraud, but are due to

errors in petitioners' returns for 1986 and 1988 that were made

by their accountant Mr. Dennett on whom they relied and to whom

they provided complete written materials from which he could have

- 46 prepared correct returns for those years, but did not.

Petition-

ers are willing to share some responsibility for what they claim

are Mr. Dennett's errors in preparing their 1986 and 1988 returns.

For example, they admit that the cash receipts journals

that they claim to have given to Mr. Dennett in connection with

his preparation of those returns may have been misleading because

those journals did not reflect all of Design Consultants' and/or

White Star's receipts.

However, they maintain that any errors in

those journals, which Ms. Olbres was responsible for maintaining,

would have been due to her negligence, and not due to her intent

or the intent of Mr. Olbres to commit fraud.

We turn first to petitioners' contention that Ms. Olbres may

have been negligent, but not fraudulent, in maintaining the cash

receipts journals.

Petitioners claim, among other things, that

any errors in maintaining those journals arose because Ms. Olbres

was inexperienced and untrained in maintaining the cash receipts

journals and because she had certain unidentified distractions.

For example, Ms. Olbres claims that she did not understand that

the title "cash receipts journal" was no longer accurate when she

stopped recording all of Design Consultants' and/or White Star's

receipts in the cash receipts journals that she maintained and

instead recorded in those journals only their respective receipts

that were deposited into the Indian Head business checking

account.

On the record before us, we are unwilling to accept

petitioners' explanations.

Although Ms. Olbres took no college

- 47 courses in business or accounting, around 1975 Mr. Dennett

created the format for, inter alia, the cash receipts journals

for petitioners and showed Ms. Olbres how to maintain those

journals.

We are incredulous that Ms. Olbres did not understand

the meaning of the title "cash receipts journal".

On the record

before us, we reject petitioners' explanation that it was Ms.

Olbres' negligence, and not petitioners' fraudulent intent, that

was responsible for the 1986 underpayment and the revised 1988

underpayment.

We turn now to petitioners' claim that although they provided complete written information to Mr. Dennett from which he

could have prepared accurate returns for the years in question,

he made errors in those returns, which resulted in the 1986

underpayment and the revised 1988 underpayment.

claim, petitioners rely on their testimony.

To support their

On the record before

us, we are unwilling to accept petitioners' explanation at trial

of the reasons why the returns in question reflected the 1986

underpayment and the revised 1988 underpayment.

By way of

illustration of the questions we have about the reliability of

Ms. Olbres' testimony, she testified about the length of the

appointments she had with Mr. Dennett in order to have him

prepare petitioners' returns for the years at issue.

Specifi-

cally, she indicated at trial that she made an appointment with

Mr. Dennett, she went to each of those appointments, she "[sat]

down for a minute" with Mr. Dennett to review some of petition-

- 48 ers' deductions, and she then left his office.

Ms. Olbres'

testimony about the length of her appointments with Mr. Dennett

in order to have him prepare petitioners' returns at issue is

contradicted by other evidence in the record, including the

testimony of Mr. Olbres and Ms. Dennett.

Mr. Olbres testified,

inter alia, that, in order to have Mr. Dennett prepare petitioners' returns for the years at issue, Ms. Olbres and he "would go

to * * * [Mr. Dennett's] office, we would sit down, he would

start a piece of paper and a tape and he'd [sic] ask questions"

of petitioners.

Ms. Dennett testified that she reviewed Mr.

Dennett's appointment book relating to his meetings with petitioners in connection with his preparation of their returns for

the years at issue and that that book showed that Mr. Dennett met

with petitioners for approximately three hours regarding his

return preparation for petitioners for each of those years.

By way of further illustration of the questions we have

about the reliability of Ms. Olbres' testimony and to illustrate

similar questions we have about Mr. Olbres' testimony, each

testified that, in connection with Mr. Dennett's preparation of

the returns in question, they provided Mr. Dennett with complete

written materials from which he could have prepared accurate

returns.

That testimony is contradicted by other evidence in the

record.

Mr. Kaply testified that Mr. Dennett informed him that,

in preparing petitioners' return for each of the years at issue,

Mr. Dennett met with Ms. Olbres shortly before each such return

- 49 was due, she verbally related to him the figures to be used in

each of those returns, and gave him the 1987 summary in connection with his preparation of their 1987 return.

Mr. Dennett

placed those figures on the appropriate lines in each of those

returns and made the computations called for by each such return.

Mr. Kaply further testified that Mr. Dennett advised him that

petitioners never provided him with any bank statements or bank

records in connection with his preparation of any of petitioners'

returns for the years at issue.

Ms. Dennett's testimony supports Mr. Kaply's testimony

regarding what, if any, materials petitioners provided to Mr.

Dennett in connection with his preparation of their return for

each of the years at issue.

She testified that one of her duties

in Mr. Dennett's accounting office was to ensure that written

materials that clients provided to Mr. Dennett's office for use

in the preparation of their returns were returned to those

clients upon completion of that return preparation.

Ms. Dennett

further testified that she never saw written materials, such as

ledgers, bank statements, and invoice logs belonging to petitioners and relating to the years at issue, which had to be returned

to them.

The preparation of the reconstructed 1987 return by Mr.

Dennett and Ms. Wildes also calls into question the testimony of

Ms. Olbres and Mr. Olbres that they gave complete written materials to Mr. Dennett from which he could have prepared accurate

- 50 returns for the years at issue.

Indeed, petitioners did not even

provide to Mr. Dennett's office complete written materials from

which that office could have reconstructed an accurate return for

1987 after the IRS began its examination of that taxable year of

petitioners.

In this connection, to assist Mr. Dennett and Ms.

Wildes in their reconstruction of petitioners' 1987 return,

petitioners gave Mr. Dennett certain written materials relating

to 1987 that he did not have previously, including the cash

receipts journal for that year, which petitioners admit did not

reflect all of Design Consultants' receipts for that year.

Petitioners do not dispute that Mr. Dennett and Ms. Wildes

accurately reconstructed petitioners' 1987 return based on the

written materials that they provided to Mr. Dennett's office.

However, the amount of gross receipts reflected in Schedule C of

petitioners' reconstructed 1987 return was virtually identical to

(1) the amount of gross receipts reflected in the cash receipts

journal for 1987 and (2) the amount of gross receipts reflected

in Schedule C of the return that petitioners filed for that year,

both of which substantially understated Design Consultants'

receipts for 1987.

Even assuming arguendo that, in connection with Mr.

Dennett's preparation of their returns for the years at issue,

petitioners had provided him with the cash receipts journals and

the invoice logs, which are the only records that would have

shown the receipts of Design Consultants and/or White Star,

- 51 petitioners' income from Design Consultants and/or White Star for

1986 and 1988 would still have been understated.

We have found

that those written materials did not reflect all of the receipts

of Design Consultants and/or White Star in that (1) the cash

receipts journals omitted, inter alia, all of the amounts that

Design Consultants and/or White Star received from Greyhound

during 1986 and most of the amounts that Design Consultants

and/or White Star received from Mayflower during the years at

issue and (2) the invoice logs16 did not reflect any receipts

from Greyhound and/or Mayflower.

Moreover, even assuming arguendo that, in connection with

Mr. Dennett's preparation of their returns for the years at

issue, petitioners had provided him with the cash receipts

journals and the invoice logs, their rental income for 1986 and

1988 would still have been understated.

We have found that

petitioners understated their rental income in each of the

returns at issue.

Petitioners do not claim that their rental

income was reflected in the cash receipts journals, the invoice

logs, or any other written records, and it appears that none of

their rental income was reflected in any such records.

Conse-

quently, Mr. Dennett must have obtained information regarding

16

The original invoice logs for the years at issue are not part

of the record. Ms. Olbres claimed at trial that she did not know

where they were. Ms. Olbres periodically destroyed the copies of

portions of the invoice logs for the years at issue that she had

brought to petitioners' house.

- 52 petitioners' rental income orally from petitioners and from the

1987 summary with respect to their 1987 return.

The 1987 summary

reflected rental income of $30,000 from the Seabrook property,

and Mr. Dennett included that income in petitioners' 1987 return.

However, petitioners' rental income for that year is $51,890.

Mr. Dennett also included rental income totaling $21,600 and

$34,000 in petitioners' 1986 and 1988 Schedules E, respectively.

However, petitioners' rental income for those years is $49,894

and $42,380, respectively.

It strains credulity that Mr. Dennett

would have made errors in all three of petitioners' returns for

the years at issue by showing amounts of rental income that

understated the rental income that petitioners' received and that

were different from the amounts that petitioners provided to him

for those years.

Petitioners also contend that the amount of income reflected

in each of the returns at issue and the complexity of those

returns demonstrate that petitioners must have provided complete

written materials to Mr. Dennett in order for him to have prepared those returns.

We disagree.

Although petitioners' returns

required certain calculations that appear to be complex (e.g.,

depreciation and passive activity loss limitation), the information that Mr. Dennett needed to perform those calculations (e.g.,

the cost of petitioners' depreciable property and rental and

other passive activity losses sustained by petitioners) was

information that he had to have obtained from petitioners.

- 53 In further support of their contention that Mr. Dennett made

errors in preparing petitioners' returns for the years at issue,

petitioners offered the testimony of Ms. LaPlante.

Throughout

the period 1981 through around 1991, Ms. LaPlante, as head

bookkeeper for the town of Hampton, worked with Mr. Dennett in

his capacity as town treasurer.

Ms. LaPlante testified that,

during the late 1980's, she noticed that Mr. Dennett made a

number of mistakes in the treasurer's reports that he was required to prepare and provide to her and that he was three months

delinquent in providing her with one of those reports.

From 1981

through around 1993, the period during which Ms. LaPlante, who

had graduated from high school and attended two years of college,

was head bookkeeper for the town of Hampton, she was not an

accountant.

Moreover, in a "letter of comments and recommenda-

tions" dated January 31, 1990, and prepared by Plodzik & Sanderson, an accounting firm retained by the town of Hampton to

conduct audits of the town, that firm made the following comments

about Ms. LaPlante:

"While * * * [she] does attempt to maintain

some of the required records, we do not feel that she possesses

the necessary skills to assume responsibility over all bookkeeping and record-keeping functions".

On the record before us, we

are unwilling to find from Ms. LaPlante's testimony that Mr.

Dennett made mistakes in his treasurer's reports during the

1980's, nor are we willing to infer from her testimony that Mr.

- 54 Dennett made errors in his preparation of petitioners' returns

for the years at issue.

In order to provide additional support for their contention

that Mr. Dennett made errors in his preparation of their returns

for the years at issue, petitioners assert that Mr. Dennett

should have known that their income in each such return was

understated because he prepared (1) the unaudited projected

financial statements for Design Consultants for 1986, which

reflected projected gross receipts in an amount that is almost

twice as large as the gross receipts reported by petitioners in

their 1986 Schedule C, and (2) the unaudited projected financial

statements for White Star for 1988, which reflected projected

gross receipts in an amount that is almost four times as large as

those reported by White Star in its 1988 Form 1120S.17

Peti-

tioners further contend that the August 31, 1988 unaudited

personal financial statements reflected their assets on a "complete and accurate basis" and that those assets could not have

been accumulated with the income that they reported in their

returns for the years at issue.

17

Although Mr. Olbres asked Mr. Dennett to prepare both personal and business unaudited financial statements throughout the

approximate 14-year period during which petitioners retained Mr.

Dennett, Mr. Olbres testified at trial that he did not know the

meaning of the term "unaudited". We are incredulous that Mr.

Olbres, who was in control of a multimillion dollar business and

who had many unaudited financial statements prepared for petitioners and their business, did not know the meaning of that

term.

- 55 With respect to the unaudited projected financial statements

for Design Consultants for 1986, those statements were merely

projections made by petitioners that included caveats indicating

that the figures in those statements were based on representations of petitioners, Mr. Dennett took no responsibility for

their accuracy, and he did not take responsibility to update

those figures.

Mr. Dennett would have had no way of knowing

whether or not the projections in those financial statements

proved true at the end of that year, other than based on information that petitioners provided to him.

In this connection, it is

noteworthy that Mr. Dennett prepared a draft, unaudited statement

of income and expenditures for 1986 for Design Consultants based

on information provided to him by petitioners and that, unlike

the unaudited projected financial statements for Design Consultants for 1986, that statement reflected gross receipts and net

income in amounts identical to the gross receipts and net income

reported in petitioners' 1986 Schedule C.

With respect to the unaudited projected financial statements

for White Star for 1988, as with the unaudited projected financial statements for Design Consultants for 1986, those statements

were merely projections made by petitioners that included caveats

that were virtually identical (except for one paragraph not

pertinent here) to those in the unaudited projected financial

statements for Design Consultants for 1986.

Mr. Dennett would

- 56 have had no way of knowing whether or not the projections proved

true, other than based on information that petitioners provided

to him.

The August 31, 1988 unaudited personal financial statements

contained caveats indicating that the figures in those statements

were based on representations of petitioners and that Mr. Dennett

took no responsibility for their accuracy.18

We do not believe

that Mr. Dennett should have had in mind those unaudited,

partial-year financial statements of petitioners at the time he

was preparing their return for 1988.

Nor do we believe that

those unaudited statements should have caused Mr. Dennett to know

that the income reported by petitioners in their 1988 return was

understated or that petitioners could not have accumulated the

assets reflected in those unaudited statements with the income

that they reported in their returns for the years at issue.

On the record before us, we find that petitioners have not

come forward with credible and reliable evidence to contradict

respondent's clear and convincing evidence establishing the

following badges of fraud from which petitioners' fraudulent

intent may be inferred for 1986 and 1988:

18

(1)(a) Petitioners

The Aug. 31, 1988 unaudited personal financial statements did

not, as petitioners contend, provide information on a "complete

and accurate basis" about petitioners' assets because those

statements did not include information with respect to petitioners' checking accounts at Indian Head or their bank accounts at

Kennebunk, nor did they include information with respect to

petitioners' stockholdings in White Star.

- 57 substantially understated the gross receipts of Design Consultants, including commissions received from Greyhound and/or

Mayflower, for each of the years 1986, 1987, and 1988,

(b) petitioners substantially understated the gross receipts of

White Star for the year 1988, and (c) petitioners substantially

understated their rental income for each of the years 1986, 1987,

and 1988; (2)(a) Ms. Olbres recorded in the cash receipts journals only those Design Consultants' and/or White Star's receipts

that petitioners deposited into the Indian Head business checking

account, and a person examining those journals and no other

written records of Design Consultants and/or White Star would

have no idea that Design Consultants and/or White Star received

income in addition to their respective receipts that petitioners

deposited into the Indian Head business checking account, and

(b) a person examining both the cash receipts journals and the

invoice logs that Ms. Olbres maintained would have no idea that

Design Consultants and/or White Star received commissions in the

amounts paid to them by Greyhound and/or Mayflower; (3) petitioners failed to provide Mr. Dennett, their accountant, with complete information from which he could have accurately prepared

their 1986, 1987, and 1988 returns; (4) the original invoice logs

were not available at trial, and Ms. Olbres periodically destroyed the copies of portions of the invoice logs that she had

brought to petitioners' house; (5) the testimony in this case of

- 58 each petitioner was in material respects implausible; (6) the

testimony of each petitioner was questionable, contradicted by

other evidence in the record, and lacked credibility in certain

material respects; and (7) petitioners failed to cooperate with

respondent's representatives in that, inter alia, (a) they failed

to provide information that Mr. Kaply had requested at the

September 1989 meeting with respect to certain bank accounts,

and, approximately one month later, Mr. Kaply had to summons that

information, (b) they incorrectly told Mr. Kaply at the September

1989 meeting that all of the deposits made into the Indian Head

business savings account were transferred from the Indian Head

business checking account, and (c) they did not disclose the

existence of the Seabrook Properties account at the September

1989 meeting.

Based on our examination of the entire record before us, we

find that respondent has established by clear and convincing

evidence that petitioners intended to evade tax for each of the

years 1986 and 1988 that they knew to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection

of such taxes.

Petitioners contend, as they did with respect to 1987, in a

conclusory manner and with no support in the record that assuming

arguendo that the Court were to find fraudulent intent for 1986

and 1988, the respective portions of the 1986 underpayment and

- 59 the revised 1988 underpayment that are attributable to the

deductions that respondent disallowed are not due to fraud.

reject that contention.

We

On the record before us, we find that

petitioners failed to show, as they must under section

6653(b)(2), that the respective portions of the 1986 underpayment

and the revised 1988 underpayment that are attributable to the

deductions that respondent disallowed are not due to fraud.

Based on the entire record before us, we find that petitioners are liable for the additions to tax under section 6653(b)(1)

with respect to the portion of the underpayment for 1986 that

respondent determined is attributable to fraud and the revised

1988 underpayment.19

Issues on Which Petitioners Have the Burden of Proof

Deficiency Determinations

Petitioners concede the deficiency determination for each of

the years at issue except for the portion of the deficiency for

1988 that is attributable to the claimed 1988 computational

error.

We have sustained petitioners' position with respect to

that claimed error.

Accordingly, we sustain respondent's defi-

ciency determinations for the years at issue except for that

portion of the 1988 deficiency that is attributable to the 1988

computational error.

19

We have considered all of petitioners' arguments not discussed herein, and we find them to be without merit.

- 60 Additions to Tax Under Section 6661(a)

Respondent determined that petitioners are liable for the

addition to tax under section 6661(a) for each of the years at

issue.

Petitioners presented no evidence and make no argument

about those determinations except for their contention regarding

the claimed 1988 computational error, which we have sustained.

Based on the record before us, we find that petitioners have

failed to prove that they are not liable for the addition to tax

under section 6661(a) for 1986, 1987, and 1988 except to the

extent of the portion of the understatement of income tax for

1988 that is attributable to the 1988 computational error.

Accordingly, we sustain respondent's determinations under section

6661(a) for those years except to that extent.

To reflect the foregoing,

Decision will be entered

under Rule 155.