United States Tax Court

United States Tax Court

T.C. Memo. 2022-45

GREGORY J. PODLUCKY AND KARLA S. PODLUCKY,

Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

—————

Docket No. 453-17.

Filed May 5, 2022.

—————

Gregory J. Podlucky and Karla S. Podlucky, pro sese.

Kirsten E. Brimer, Harry J. Negro, Douglas C. Rennie, Chelsey M. Pearson, Francesca M. Ugolini, Curtis C. Pett, Ronald S. Collins, and Laurel

B. Stout, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

LAUBER, Judge: During 2003–2006 petitioner Gregory Podlucky extracted more than $30 million from a corporation he controlled

to purchase for himself and his wife luxury jewelry and a mansion,

among other things. In 2009 petitioners were indicted in the U.S. District Court for the Western District of Pennsylvania for crimes including

mail fraud, money laundering, and tax evasion. Both were convicted

and sentenced to lengthy terms of imprisonment.

After petitioners were remanded to custody, the Internal Revenue

Service (IRS or respondent) completed a civil examination of their 2003–

2006 tax returns. In 2016 the IRS determined deficiencies of $476,123,

$1,189,550, $1,091,254, and $2,024,775, respectively, plus civil fraud

penalties (against Mr. Podlucky only) of $357,092, $892,163, $818,441,

and $1,518,581, respectively. Petitioners dispute these determinations

and contend that Mrs. Podlucky is entitled to relief from joint and

Served 05/05/22

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[*2] several liability under section 6015. 1 For the reasons that follow,

we sustain the IRS’s deficiency and penalty determinations and hold

that Mrs. Podlucky is not entitled to “innocent spouse” relief.

FINDINGS OF FACT

The following facts are drawn from the pleadings, the trial testimony, documents admitted into evidence at trial, and a stipulation of

facts with attached exhibits admitted into evidence under Rule 91(f).

Petitioners Gregory Podlucky (Greg) and Karla Podlucky (Karla), husband and wife, filed joint returns for the four tax years at issue. When

they filed the petition, Greg was incarcerated in Fort Dix, New Jersey,

and Karla resided in Newhall, California.

I.

Background

Greg is a certified public accountant. He graduated from West

Virginia University in 1984 with a degree in accounting and finance.

After graduating he worked for his father, who owned a brewing company in Pennsylvania.

In the 1990s Greg started his own beverage bottling business,

originally called Genesis, Inc. In 1995 he changed the company’s name

to Global Beverage Systems, Inc., and expanded its product line. In

2002 he changed its name to Le-Nature’s, Inc. (LNI). LNI, a C corporation, specialized in bottling waters, teas, and similar beverages.

At all relevant times Greg was LNI’s chief executive officer (CEO),

majority shareholder, and chairman of the board. He headquartered

LNI in Latrobe, Pennsylvania, about 12 miles from Ligonier, Pennsylvania, where he and Karla lived. He formed a subsidiary called Tea

Systems International to sell tea concentrate to other bottlers. LNI had

accounts at Merrill Lynch and various banks, and these financial records were introduced into evidence at trial.

During its early years LNI appears to have been successful. It

grew rapidly, employing roughly 100 people by 2004. Greg hired his

brother to serve as the company’s chief operating officer. Under Greg’s

1 Unless otherwise indicated, all statutory references are to the Internal Revenue Code, Title 26 U.S.C., in effect at all relevant times, all regulation references are

to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times,

and all Rule references are to the Tax Court Rules of Practice and Procedure. We

round all monetary amounts to the nearest dollar.

3

[*3] leadership LNI reported steadily rising year-over-year revenues

and profits.

During the tax years at issue LNI had two minority shareholders,

Smith Whiley & Co. (Smith Whiley) and George K. Baum Capital Partners (Baum). Both were private equity funds. Venita Fields, Smith

Whiley’s managing director, had learned about LNI in 1999 from an investment bank. She was interested in “alternative beverages” as an investment concept and believed that LNI might be attractive. On her

recommendation Smith Whiley in 2000 invested $10 million in LNI.

In connection with this investment Smith Whiley was given one

seat on LNI’s board, which was occupied by Ms. Fields. Smith Whiley

purchased another $5 million of LNI stock in 2002. It was then given a

second seat on LNI’s board, which was occupied by Ruth Huet. Both

testified at trial of this case. Baum, the other minority shareholder, held

the third outside seat on LNI’s board. LNI also secured hundreds of

millions of dollars in debt financing from larger financial institutions,

including AIG, Wachovia, Wells Fargo, and Merrill Lynch.

When recommending the initial investment in LNI, Ms. Fields

envisioned a holding period of about six years. In 2005, as that period

neared its end, Smith Whiley considered cashing out its investment. Ms.

Fields believed, on the basis of quarterly and annual reports furnished

to her, that LNI had enjoyed a “sharp incline in revenues and profits.”

Sale of the LNI stock, she thought, would generate a significant return

on Smith Whiley’s investment.

Ms. Fields coordinated with Baum, the other minority shareholder, to investigate possible sale of their stock (or of the company).

They hired an investment banker to estimate LNI’s value and look for

potential buyers. Ms. Fields received expressions of interest from several buyers, but no deal ever closed. Ms. Fields testified that Greg “sabotaged” the negotiations by refusing to give potential buyers access to

LNI’s accounting records. Rather than sell the company, Greg insisted

on expanding its operations by building a production facility in Florida,

but he never received board authorization to do that.

In May 2006 the minority shareholders sued LNI in the Delaware

Chancery Court. See George K. Baum Cap. Partners, LP v. Le-Nature’s,

Inc., No. CA2158 (Del. Ch. filed May 16, 2006). They alleged that Greg

had intentionally obstructed their attempts to sell their stock by blocking access to LNI’s books and records. A few months later AIG, one of

4

[*4] LNI’s lenders, informed the minority shareholders of its belief that

Greg had forged documents in order to secure loans and had used loan

proceeds to purchase millions of dollars of assets for himself and his

wife.

After receiving this information, the chancery court in October

2006 removed Greg as CEO and appointed a custodian to take control of

LNI. Salvatore LoBiondo, the custodian’s financial restructuring specialist, was directed to manage LNI on an interim basis and review its

financial records to determine whether it could continue to operate. Mr.

LoBiondo quickly discovered that LNI had maintained two sets of books:

one set that reported actual sales and profits, and another that reported

fictitious sales and profits. The gap between the two sets of figures was

huge: In one year LNI reported roughly $300 million in revenue, but its

actual revenues were closer to $30 million.

These findings prompted LNI’s creditors to file an involuntary

bankruptcy petition against it in the U.S. Bankruptcy Court for the

Western District of Pennsylvania. The bankruptcy court granted that

petition and directed Mr. LoBiondo to continue to manage LNI. By the

end of November 2006 Mr. LoBiondo concluded that LNI could not be

resuscitated. The company’s Latrobe and Arizona facilities were closed,

and it ceased operations. The minority shareholders lost virtually all of

their investments, and LNI’s lenders lost more than $600 million.

II.

Criminal Investigation

In December 2006 the Department of Justice, the IRS Criminal

Investigation Division (CID), and the Postal Inspection Service began

investigating petitioners for criminal wrongdoing. The Government believed that Greg had supplied LNI’s lenders and minority shareholders

with false financial documents to induce them to invest in LNI. And the

Government believed that Greg had extracted funds from LNI, through

a money laundering scheme, to purchase luxury goods for himself and

his wife.

CID uncovered evidence that Greg had directed one of his employees to keep accounting records using two different software systems:

One system was used to record LNI’s actual results, and the other was

used to create fictitious (and much more favorable) results. Greg told

this employee “what he wanted LNI’s sales to be” and instructed her to

create fake invoices to support the fictitious sales numbers. This employee, who also pleaded guilty to criminal charges, helped Greg

5

[*5] fabricate checks, create fictitious banking records, and generate

false financial statements for LNI. The Government found on Greg’s

computer “templates” that he used to photoshop checks and bank statements. Greg used these bogus documents to induce lenders and potential investors to advance funds to the business.

The investigation also revealed that Greg had siphoned money

out of LNI by writing checks on LNI’s accounts and by wiring funds from

those accounts to two shell companies he controlled: GVS Services (GVS)

and Melissa Morgan Capital Corp. (2MC), the latter being named after

his daughter. 2 There is no evidence that GVS or 2MC engaged in any

meaningful business activities. Both were in essence “incorporated

pocketbooks” through which Greg channeled funds in an effort to conceal

LNI’s identity as the source. GVS and 2MC had numerous bank and

brokerage accounts, and their financial records were introduced into evidence at trial.

The banking records showed that Greg had siphoned more than

$30 million out of LNI to purchase assets for himself and his wife.

Roughly 70% of the assets thus purchased consisted of luxury jewelry—

mostly women’s jewelry—including bracelets, necklaces, diamond rings,

and watches designed by Chopard, Patek Philippe, and Rolex.

When purchasing jewelry, Greg (or his employee) would often create fictitious invoices from LNI’s suppliers. Greg would wire funds from

LNI to a bank account in the name of 2MC or GVS, supposedly in payment of these invoices. Greg or Karla would then write checks on these

accounts to jewelry vendors. Criminal investigators analyzed these

checks and bank transfers and ascertained that Greg used LNI’s funds

to acquire more than $22 million in jewelry during 2003–2006.

Greg needed a safe place to store all this jewelry. He directed an

employee to build a “secret room” at LNI’s headquarters in Latrobe. The

secret room was described as “a corner of another room that had been

walled off with cinder block.” To enter the room an individual had to

walk through “a small metal door, lift a rug, and crawl.” Criminal investigators executed a search warrant and found in the room commercial grade safes stocked with gemstones, necklaces, watches, bracelets,

and diamond rings, as well as filing cabinets cataloging each piece.

2 Greg created several partnerships related to 2MC; for convenience we refer

to all of these related entities as “2MC.”

6

[*6] Needless to say, LNI’s board of directors did not know about this

secret room or its contents.

Greg also used company funds to purchase real estate that he diverted to his personal use. In 2002 the board of directors approved an

expansion of the Latrobe bottling plant; the new facilities included ample space for conference rooms and employee offices. But Greg insisted

that LNI also purchase a 4.7-acre plot of land (Lot 21) in Ligonier. This

property was 12 miles from the bottling plant, but it was adjacent to

petitioners’ primary residence. LNI never listed Lot 21 as a corporate

asset on its financial statements. The property was zoned for residential

(not commercial) use; at no time did Greg or LNI seek to change its zoning.

In 2003 LNI transferred Lot 21 to petitioners for $1. At trial Ms.

Huet credibly testified that the board of directors never approved this

transfer. Greg cross-examined Ms. Huet and showed her board meeting

notes that purported to grant approval. Ms. Huet reiterated that the

board never approved the proposal and that the document in question

appeared to be one of many “board document[s] that [Greg] altered.”

Later that year petitioners applied for, and received, a building

permit to construct on Lot 21 a 12,071-square-foot single-family house.

They hired an architect and a general contractor known in the area for

undertaking “high-end residential projects.” One of the invoices referred to the property as the “Podlucky Gate House.” The architects and

contractors were generally paid by checks drawn on 2MC or GVS bank

accounts. The house was described as a “mansion” with six bedrooms

and nine baths.

CID also discovered that Greg was an avid collector of toy trains,

preferring the Lionel brand. In 2005 and 2006 Greg used LNI’s funds to

purchase Lionel trains from a variety of vendors, including Toy Trains

Unlimited, Nicholas Smith Trains, Eastside Trains, and the Train Engineer. In 2005 he placed orders totaling $1,066,628, and in 2006 he

placed orders totaling $76,662. He typically purchased two of each item,

leaving one in its original packaging to preserve it in mint condition. He

stored the model trains in LNI’s warehouse. LNI’s board of directors

had no knowledge of, and did not approve, these purchases.

Finally, CID questioned a $10,772 college tuition payment for petitioners’ son, Jesse Podlucky. In 2004 Jesse attended Saint Vincent

College. On May 3, 2004, Greg wired $750,000 from LNI to one of 2MC’s

7

[*7] bank accounts. Five days later, Karla drew a check on 2MC’s account for $10,772, payable to Saint Vincent College. This covered two

semesters of tuition, a parking ticket assessed by the school, and other

miscellaneous fees.

In September 2009 Greg was indicted on counts of mail fraud,

conspiracy to commit money laundering, and attempting to evade or defeat tax in violation of section 7201. The tax charges were based on his

failure to report roughly $35 million of income, in the form of constructive distributions from LNI. Greg pleaded guilty to one count of tax evasion (for 2005), as well as one count of conspiracy and mail fraud. He

was sentenced to 20 years’ imprisonment.

Karla was indicted on counts of money laundering and conspiracy

to commit money laundering. The Government alleged that Karla sold

jewelry during the investigation and attempted to conceal the proceeds

in trusts and shell companies. She was tried in the U.S. District Court

for the Western District of Pennsylvania. In November 2011 she was

found guilty of money laundering and sentenced to 51 months’ imprisonment. Her conviction was affirmed on appeal. See United States v.

Podlucky, 567 F. App’x 139 (3d Cir. 2014).

The Government called Brent Nestor to testify as a witness during Karla’s criminal trial. At that time Mr. Nestor served as senior vice

president of sales for Van Cleef & Arpels (VCA), working in the company’s New York office. Mr. Nestor testified about Greg’s jewelry purchases from VCA, explaining that most of the jewelry was custom made

for Karla. To enable these orders to be filled, Mr. Nestor traveled to

Pennsylvania to take Karla’s measurements so that rings, bracelets, and

necklaces could be sized to fit her exactly.

Mr. Nestor testified that Greg “was quite specific about making

the pieces a certain size to fit his wife” and that Karla had personally

confirmed her own jewelry preferences. He recalled Karla’s writing in

one email that she “like[s] the stones to be the center stars,” that “diamond encrusted bangles are not comfortable,” and that she “like[s] simple, classic, tailored designs.” With respect to a special “diamond wedding band” request, Mr. Nestor emailed Greg saying that VCA’s

8

[*8] “designer has revised several proposals because we want to make

sure the motifs around the ring are comfortable for Mrs. P to wear.” 3

If petitioners had a particularly unique or special request, Mr.

Nestor would refer it to Lily Vongwattanakit, VCA’s director of gem purchasing and special orders. Her role was to discuss the request with the

client, take measurements, and send the relevant information to VCA’s

headquarters in Paris. Ms. Vongwattanakit credibly testified during the

Tax Court trial that she met with petitioners to discuss their special

requests and take Karla’s measurements. Ms. Vongwattanakit testified

that she had placed a number of these special orders for petitioners. Petitioners purchased so much jewelry from VCA that its employees called

their orders the “Podlucky Collection.”

Petitioners also worked closely with Angela Patin, a sales representative for Traditional Jewelers. Ms. Patin credibly testified during

the Tax Court trial that Greg generally placed the orders but that the

jewelry “was mostly for Karla.” The jewelry included custom made

rings, earrings, bracelets, and necklaces. Ms. Patin credibly testified

that she took Karla’s measurements so that the jewelry could be sized

to fit her exactly.

III.

IRS Examination and Tax Court Proceedings

Following petitioners’ criminal investigation, the IRS in 2012 initiated a civil examination of their 2003–2006 joint Federal income tax

returns. For these years petitioners reported between $350,000 and

$600,000 of income. The case was assigned to Revenue Agent (RA) Lisa

Gaiser. RA Gaiser reconstructed petitioners’ income by reviewing bank

records, checks, invoices, and other documents obtained during the

criminal investigation. She also relied on the prosecution report that

underlay the Government’s criminal tax evasion charges. Evaluating

this information, RA Gaiser determined that petitioners had received

3 Respondent filed a Motion in Limine requesting that Mr. Nestor’s prior testimony be admitted under Rule 804(b)(1) of the Federal Rules of Evidence. That provision provides an exception to the hearsay rules when the declarant is unavailable, the

testimony was given “at a trial,” and the testimony is “now offered against a party who

had . . . an opportunity and similar motive to develop it by direct, cross-, or redirect

examination.” Fed. R. Evid. 804(b)(1). Mr. Nestor resides in Switzerland and was

unavailable at the time of the Tax Court trial. By Order served October 21, 2021, we

granted respondent’s motion.

9

[*9] unreported income during 2003–2006, in the form of constructive

distributions from LNI, as follows:

Year

Jewelry

Lot 21

Trains

Tuition

Total

2003

$6,086,621

$347,071

—

—

$6,433,692

2004

4,552,786

3,322,063

—

$10,772

7,885,621

2005

2,150,637

3,899,182

$1,066,628

—

7,116,447

2006

9,959,935

3,418,351

76,662

—

13,454,948

Total

$22,749,979

$10,986,667

$1,143,290

$10,772

$34,890,708

RA Gaiser then calculated petitioners’ taxable income using the

rules set forth in section 301. It provides that distributions from a C corporation are taxable as dividends to the extent of the corporation’s earnings and profits (E&P). See §§ 301(c)(1), 316(a). If distributions exceed

E&P, they are nontaxable returns of capital to the extent of the shareholder’s basis in his stock. See § 301(c)(2). Distributions in excess of

basis are taxed as capital gain. See §§ 301(c)(3), 1001(a).

Setting aside LNI’s fictitious financial statements, RA Gaiser determined that the company actually had zero E&P during 2003–2006.

She determined that Greg had $3,354,021 of basis in his LNI stock, so a

portion of the 2003 distribution constituted a nontaxable return of capital. She determined that a dividend of $93,500, which petitioners reported as having been paid by LNI in 2004, should be recharacterized as

capital gain given the absence of E&P. RA Gaiser accordingly determined for each year additional income in the form of long-term capital

gain, producing deficiencies (after other minor income adjustments) and

civil fraud penalties (against Greg only) as follows:

Year

Capital Gain

Deficiency

Fraud Penalty

2003

$3,079,671

$476,123

$357,092

2004

7,979,121

1,189,550

892,163

2005

7,116,447

1,091,254

818,441

2006

13,454,948

2,024,775

1,518,581

Total

$31,630,187

$4,781,702

$3,586,277

10

[*10] In April 2012 RA Gaiser prepared Form 11661, Fraud Development Recommendation–Examination. On that form she recommended

that the IRS assert against Greg fraud penalties under section 6663 for

2003–2006. She forwarded the case file to Renee Zaffino, her supervisor.

Ms. Zaffino signed the form on April 23, 2012, as RA Gaiser’s “Group

Manager.” Susan Harper, an IRS fraud technical advisor, signed the

Form 11661 on May 14, 2012.

On March 22, 2013, RA Gaiser sent petitioners a 30-day letter.

She attached to that letter Form 4549–A, Income Tax Discrepancy Adjustments. These documents communicated to Greg that the IRS proposed to assert fraud penalties against him.

On November 21, 2016, the IRS issued petitioners a notice of deficiency for 2003–2006. The notice determined deficiencies totaling

$4,781,702 and fraud penalties against Greg totaling $3,586,277. Petitioners timely petitioned this Court, proceeding pro se.

Throughout these proceedings petitioners have refused to cooperate with respondent in preparing this case for trial. They refused to

stipulate a single document, and they refused to stipulate undisputed

facts, both in violation of Rule 91(a)(1). By Order served July 15, 2021,

we granted respondent’s Motion to deem certain facts, documents, and

information established for purposes of this case. See Rule 91(f).

Greg has advanced many frivolous arguments and submitted filings plainly intended to delay these proceedings: He has challenged the

income tax as unconstitutional; he has asserted that we lack personal

and subject matter jurisdiction over him; and he has demanded that we

award him $22 billion in damages for operating as a “Star Chamber

Court.” 4 Greg has filed ten improper appeals from our interlocutory orders. 5

4 Petitioners improperly attached “exhibits” and other documentary evidence

to their post-trial briefs. By Order served March 23, 2022, we struck these “exhibits”

from the record. We explained that the record had been closed since October 2021 and

that documents cannot be “interjected into the record as attachments to pleadings or

briefs.” We did not consider these documents when preparing this opinion.

5 Greg initially filed these interlocutory appeals in the U.S. Court of Appeals

for the Third Circuit. After the Department of Justice moved to enjoin him from filing

any more frivolous appeals, he began filing appeals in the U.S. Court of Appeals for

the Ninth Circuit.

11

[*11] Several days before trial Greg filed 3,800 pages of documents.

One of these filings included amended joint Federal income tax returns

for 2003–2006. These amended returns, which were signed by petitioners, 6 reported all the additional income determined in the notice of deficiency. In an attachment petitioners explained that “we are amending

our 2003, 2004, 2005 and 2006 tax returns . . . to include all the audit

adjustments as determined by [the IRS].”

Petitioners alleged that the sentencing court had ordered Greg to

pay restitution of $660 million, that certain of their assets had been forfeited, and that they were allowed loss deductions that would completely

offset the deficiencies determined by the IRS. They asserted that they

were therefore “rescinding” their petitions, that no trial should be held,

and that this case should be dismissed.

We informed petitioners that, unless they wished to make a full

concession, the case would proceed to trial. We explained “that in deficiency cases brought pursuant to section 6213 a taxpayer may not withdraw a petition in order to avoid a decision.” Davidson v. Commissioner,

144 T.C. 273, 274 (2015); Estate of Ming v. Commissioner, 62 T.C. 519,

521 (1974) (“[A] taxpayer may not unilaterally oust the Tax Court from

jurisdiction which, once invoked, remains unimpaired until it decides

the controversy.”). Under Rule 123(d), dismissal of a case, other than a

dismissal for lack of jurisdiction, “shall operate as an adjudication on

the merits.” Thus, if we were to dismiss this case as petitioners suggested, we would be required to enter a decision against them in the full

amounts of the deficiencies and penalties determined in the notice of

deficiency. The case accordingly proceeded to trial.

OPINION

I.

Unreported Income

Section 61(a) provides that “gross income means all income from

whatever source derived.” In cases of unreported income, the Commissioner must establish an evidentiary foundation connecting the taxpayer to the income-producing activity, Weimerskirch v. Commissioner,

596 F.2d 358, 361 (9th Cir. 1979), rev’g 67 T.C. 672 (1977), or demonstrate that the taxpayer actually received income, Edwards v. Commissioner, 680 F.2d 1268, 1270–71 (9th Cir. 1982). Once the Commissioner

has met his threshold burden, the burden shifts to the taxpayer to show

6 Karla signed the amended returns as “Innocent Spouse KSP.”

12

[*12] that the Commissioner’s determinations are arbitrary or erroneous. 7 See Hardy v. Commissioner, 181 F.3d 1002, 1004–05 (9th Cir.

1999), aff’g T.C. Memo. 1997-97; Anastasato v. Commissioner, 794 F.2d

884, 887–88 (3d Cir. 1986), vacating and remanding T.C. Memo. 1985101.

To satisfy his burden respondent produced extensive bank records, invoices, checks, and receipts gathered during the criminal and

civil examinations. During petitioners’ criminal investigation the Government discovered a “secret room” in LNI’s office building, which contained jewelry worth well in excess of $22 million. 8 The documents introduced into evidence at trial showed that Greg used roughly $11 million of LNI’s funds to finance his Lot 21 construction project and spent

$1 million on his toy train collection. During 2003–2006 Greg made

these personal expenditures by writing checks on LNI’s accounts and by

wiring money from LNI to one of the shell companies he controlled.

The IRS computed the deficiencies for 2003–2006 by reviewing

these records in conjunction with the Government’s prosecution report.

The IRS ultimately determined that Greg, as LNI’s majority shareholder, received from it constructive distributions of almost $35 million.

Respondent has clearly supplied a threshold evidentiary foundation connecting petitioners to unreported income. See Petzoldt v. Commissioner,

92 T.C. 661, 687 (1989) (holding that the IRS has great latitude in reconstructing a taxpayer’s income, and the reconstruction “need only be

reasonable in light of all surrounding facts and circumstances”).

Petitioners thus bear the burden of proving that respondent’s determinations of unreported income, as set forth in the notice of deficiency, are “arbitrary or erroneous.” See Hardy, 181 F.3d at 1004; Anastasato, 794 F.2d at 887–88. Petitioners’ submissions have not been a

model of clarity. Early in the case they insisted that the income tax laws

are unconstitutional. More recently they submitted copies of amended

returns reporting all the income determined in the notice of deficiency.

7 Petitioners assert that the RA lacked authority under section 7608 and that

the evidence introduced at trial is “poisoned fruit of the poisonous tree.” This is a

frivolous argument. Section 7608, which governs certain criminal enforcement actions,

does not limit the Commissioner’s authority to conduct civil examinations under section 6201, determine deficiencies under section 6212, or collect taxes under section

6301.

8 The criminal investigators actually discovered $33,972,473 of jewelry in the

“secret room.” But the IRS determined that only $22,749,979 worth of jewelry had

been constructively distributed to petitioners during the 2003–2006 tax years at issue.

13

[*13] These returns could be taken as admissions by petitioners that

those unreported income numbers are correct. See Badaracco v. Commissioner, 464 U.S. 386, 399 (1984) (“An amended return, of course, may

constitute an admission . . . .”); Lare v. Commissioner, 62 T.C. 739, 750

(1974) (“Statements made in a tax return signed by a taxpayer may be

treated as admissions.”), aff’d, 521 F.2d 1399 (3d Cir. 1975).

At trial petitioners focused much attention on the IRS’s computations, questioning where the IRS “g[o]t the underpayment numbers

from.” In their post-trial brief they assert that these numbers “were

never corroborated, sustained, and detailed.” But petitioners presented

nothing credible to rebut the overwhelming amount of evidence linking

them to unreported income. They have submitted nothing but general

denials, which are “insufficient to meet [their] burden of nonpersuasion.” Anastasato, 794 F.2d at 888.

Petitioners appear to contend that the IRS had the burden of producing evidence to prove (for example) that the jewelry petitioners purchased during 2003–2006 was worth $22,749,979. If that is petitioners’

argument, it is misconceived. Once the Commissioner produces evidence linking taxpayers to unreported income—as respondent did—taxpayers have the burden of proving that the IRS’s determinations of unreported income are “arbitrary and erroneous.” Id. at 887; see Keogh v.

Commissioner, 713 F.2d 496, 502 (9th Cir. 1983) (holding that the taxpayers failed to prove that the Commissioner’s estimates were arbitrary

or erroneous where they advanced general denials and “self-serving testimony”). Petitioners have not carried this burden; indeed, they made

no genuine effort at trial to do so.

Petitioners alternatively contend that the assets they purchased

were acquired for LNI’s benefit, not for their own. Greg testified that he

purchased luxury jewelry because LNI was “diversifying [its] product

lines” and “dealing with Tibetan monks in Asia” who “want[ed] hard assets” rather than cash. According to Greg, the monks had access to valuable species of tea, which LNI wished to acquire by using jewelry in

“bartering transactions.”

This testimony was utterly implausible. Greg was unable to tell

the Court where the putative monks resided or confirm that the country

in which they lived produced tea. He could not explain why the monks

would prefer jewelry to the U.S. dollar as a medium of exchange. He

could not explain why Buddhist monks would be eager to acquire

women’s jewelry, particularly jewelry that was sized to fit Karla’s wrist,

14

[*14] neck, and ring finger. And he could not explain why $22 million

of jewelry, if an asset of LNI, was neither shown on its balance sheet nor

brought to the attention of its directors.

Greg’s testimony about Lot 21 was no more persuasive. He insisted that the “Podlucky Gate House,” situated on land zoned for residential use, was intended to be used as a “training facility” for LNI’s

staff. He could not explain why LNI would have chosen to build an employee training facility next door to his house, 12 miles away from the

production facility in Latrobe. He could not explain why LNI needed a

separate training center, when its Latrobe facility had recently been expanded to include ample space for conference rooms and employee offices. He asserted that more space was needed for “300 new sales representatives,” but he supplied no evidence that LNI ever considered hiring 300 new workers, which would have quadrupled its workforce. He

could not explain why a training facility would have been configured as

a six-bedroom, nine-bath mansion. And he could not explain why, if the

house really was a training facility for LNI, Lot 21 was transferred to

him personally for $1, without board approval. 9

Petitioners offered little testimony about the model train collection, apart from Greg’s assertion that the trains were intended for use

in a company “marketing campaign.” But he offered no evidence that

LNI had ever considered such a campaign, no evidence as to who was

supposed to conduct it, and no explanation as to how model trains could

usefully be deployed to advertise tea-flavored beverages. Assuming arguendo that they could be so used, Greg could not explain why it was

necessary to acquire $1.1 million worth of model trains, including duplicates of each item. 10

9 Karla testified, in the alternative, that the Podlucky Gate House was in-

tended for use by religious missionaries whom she admired. We did not find that testimony credible. In any event, that would have been a personal use, as opposed to a

business use of the company, and the Lot 21 expenditures would still be constructive

distributions. Cf. Magnon v. Commissioner, 73 T.C. 980, 994 (1980) (“The crucial test

of the existence of a constructive dividend is whether ‘the distribution was primarily

for the benefit of the shareholder.’”).

10 Greg contended that LNI must have “owned” the model trains because the

bankruptcy court ultimately directed that they be sold for the benefit of creditors. The

conclusion does not follow from the premise. Greg extracted $35 million from LNI at

a time when he was defrauding LNI’s lenders and minority shareholders. Under these

circumstances, the bankruptcy trustee attempted to recoup what he could from the

assets Greg had wrongfully acquired. But this does not negate Greg’s receipt of gross

15

[*15] Petitioners also contested the taxability of the $10,772 tuition

payment. At trial they asserted that this represented a stipend their

son earned for completing an internship with LNI. But they presented

no evidence of an internship agreement; no evidence that LNI’s board of

directors approved any internship or scholarship program; and no evidence that LNI benefited from their son’s services. Nor could petitioners

explain why the tuition (plus a parking ticket and other fees) was paid

out of Greg’s shell company by Karla, who was not an officer of LNI. In

any event, even if LNI were thought to have derived some benefit from

the son’s participation in a college internship, petitioners have not

shown why such a payment—which relieved them of their own tuition

obligation—would be nontaxable. Cf. Hacker v. Commissioner, T.C.

Memo. 2022-16, at *17 (ruling that a shareholder “must include in gross

income payments the corporation made on the shareholder’s behalf”).

In the alternative petitioners contend that they are entitled, under section 165, to loss deductions that completely offset the income determined in the notice of deficiency. They allege that the sentencing

court ordered Greg to pay $660 million of restitution and that certain of

their assets were forfeited to the Government following their convictions

in 2011. “Property forfeited pursuant to a taxpayer’s guilty plea,” they

say, “is properly characterized as a loss item.”

This argument fails for at least three reasons. First, petitioners

have not properly raised this issue. They did not claim section 165 deductions on their original returns, and they did not mention section 165

in the Petition. See Rule 34(b)(4) (“Any issue not raised in the . . . [petition] shall be deemed to be conceded.”). Rather, they advanced this new

argument one month before trial, in a filing in which they referred to

themselves as “Former Petitioners.” They asserted that the purported

loss deductions obviated the need for trial, demanding that their Tax

Court Petition be “withdrawn” or “rescinded.” They did not submit a

pre-trial memorandum, so respondent had no reason to believe that section 165 deductions were actually at issue in this case. To permit petitioners to raise this issue in a post-trial brief, after the trial record

closed, would be prejudicial to respondent.

See Seligman v.

income in the year the property was constructively distributed to him. This resembles

the embezzlement scenario: The fact that an embezzler repays the funds in a later year

does not negate his receipt of gross income in the year of the embezzlement. See Yerkie

v. Commissioner, 67 T.C. 388, 390 (1976) (“Although the proceeds of an embezzlement

are not obtained lawfully, they result in economic gains for the embezzler and, as such,

are included in his gross income for the year in which the funds were misappropriated.”

(citing James v. United States, 366 U.S. 213 (1961))).

16

[*16] Commissioner, 84 T.C. 191, 199 (1985) (finding prejudice where

opposing party had no opportunity to present evidence on issue that was

not raised in the pleadings), aff’d, 796 F.2d 116 (5th Cir. 1986).

In any event, petitioners have failed to prove that they are entitled to loss deductions. Section 165(a) permits a taxpayer to deduct “any

loss sustained during the taxable year” if “not compensated for by insurance or otherwise.” Assuming arguendo that Greg was ordered to pay

restitution, petitioners offered no evidence that he actually made restitution payments or (if so) how much restitution he paid. And while petitioners assert that their property was forfeited, they offered no evidence to establish which assets were forfeited or the value of such property.

Finally, petitioners have not established that they sustained any

loss during the tax years at issue, i.e., during 2003–2006. See Treas.

Reg. § 1.165-1(d)(1) (providing that loss deductions are allowed “for the

taxable year in which the loss is sustained”). To the contrary, their alleged losses would have occurred (if at all) after 2006, when assets were

allegedly “forfeited pursuant to [Greg’s] guilty plea” or when restitution

ordered by the sentencing court was allegedly paid. See Stephens v.

Commissioner, 905 F.2d 667, 671 (2d Cir. 1990) (noting that taxpayers

who repay embezzled funds might be “entitled to a deduction in the year

in which the funds are repaid”), rev’g 93 T.C. 108 (1989); Norman v.

Commissioner, 407 F.2d 1337, 1338 (3d Cir. 1969) (per curiam) (noting

that “restitution [paid] in a subsequent year might provide a proper basis for a deduction allowable in that year”), aff’g T.C. Memo. 1968-40;

Treas. Reg. § 1.6001-1(a) (requiring taxpayers to identify the deduction,

show that they have met all relevant requirements, and keep books or

records to substantiate the amounts claimed).

II.

Fraud Penalties

Section 6501(a) generally requires the IRS to assess a tax within

three years after the return was filed. The period of limitations is extended to six years where the taxpayer omits from gross income an

amount “in excess of 25 percent of the amount of gross income stated in

the return.” § 6501(e)(1)(A)(i). The notice of deficiency in this case was

issued on November 21, 2016, more than six years after the period of

limitations began to run for 2006, the last year at issue.

However, section 6501(c)(1) provides that, where a taxpayer has

filed “a false or fraudulent return with the intent to evade tax,” there is

17

[*17] no period of limitations, and the tax “may be assessed . . . at any

time.” In the case of a joint return, fraud by either taxpayer suspends

indefinitely the period of limitations for both taxpayers. Vannaman v.

Commissioner, 54 T.C. 1011, 1018 (1970); see Richardson v. Commissioner, 509 F.3d 736, 745 (6th Cir. 2007) (holding that fraud by one

spouse “lifts the statute of limitations” for both), aff’g T.C. Memo 200669; Ballard v. Commissioner, 740 F.2d 659, 663 (8th Cir. 1984) (same),

aff’g in part, rev’g in part T.C. Memo 1982-466.

“[T]he determination of fraud for purposes of the period of limitations on assessment under section 6501(c)(1) is the same as the determination of fraud for purposes of the penalty under section 6663 . . . .”

Neely v. Commissioner, 116 T.C. 79, 85 (2001). Whether the underpayments at issue were due to fraud thus determines both whether Greg is

liable for civil fraud penalties and whether respondent can assess the

deficiencies.

A.

Supervisory Approval

Section 6751(b)(1) provides that “[n]o penalty under this title

shall be assessed unless the initial determination of such assessment is

personally approved (in writing) by the immediate supervisor of the individual making such determination.” As a threshold matter, respondent must show that he complied with section 6751(b)(1). See Chai v.

Commissioner, 851 F.3d 190, 221 (2d Cir. 2017) (ruling that “compliance

with § 6751(b) is part of the Commissioner’s burden of production” under

§ 7491(c)), aff’g in part, rev’g in part T.C. Memo. 2015-42.

In Belair Woods, LLC v. Commissioner, 154 T.C. 1, 14–15 (2020),

we explained that the “initial determination” of a penalty assessment is

typically embodied in a letter “by which the IRS formally notifie[s] [the

taxpayer] that the Examination Division ha[s] completed its work and

. . . ha[s] made a definite decision to assert penalties.” Once the Commissioner introduces evidence sufficient to show written supervisory approval, the burden shifts to the taxpayer to show that the approval was

untimely, i.e., “that there was a formal communication of the penalty [to

the taxpayer] before the proffered approval” was secured. Frost v. Commissioner, 154 T.C. 23, 35 (2020).

Respondent has produced the Form 11661 by which RA Gaiser

recommended assertion of fraud penalties against Greg. RA Gaiser’s

immediate supervisor, Ms. Zaffino, signed that form on April 23, 2012.

The recommendation to assert fraud penalties was communicated to

18

[*18] Greg 11 months later, in a 30-day letter dated March 22, 2013,

with an attached Form 4549–A showing the penalty calculation. Respondent has thus met his burden of production by showing timely approval. See Frost, 154 T.C. at 35. 11

B.

Existence of Fraud

“If any part of any underpayment of tax required to be shown on

a return is due to fraud,” section 6663(a) imposes a penalty of 75% of the

portion of the underpayment attributable to fraud. Respondent has the

burden of proving fraud, and he must prove it by clear and convincing

evidence. See § 7454(a); Rule 142(b). To sustain his burden, respondent

must establish two elements: (1) that there was an underpayment of tax

for each year at issue and (2) that at least some portion of the underpayment for each year was due to fraud. See Hebrank v. Commissioner, 81

T.C. 640, 642 (1983).

Where the Commissioner determines fraud penalties for multiple

tax years, his burden of proving fraud “applies separately for each of the

years.” Vanover v. Commissioner, T.C. Memo. 2012-79, 103 T.C.M.

(CCH) 1418, 1420 (quoting Temple v. Commissioner, T.C. Memo. 2000337, 80 T.C.M. (CCH) 611, 618, aff’d, 62 F. App’x 605 (6th Cir. 2003)). If

the Commissioner proves that some portion of an underpayment for a

particular year was attributable to fraud, then “the entire underpayment shall be treated as attributable to fraud” unless the taxpayer

shows, by a preponderance of the evidence, that the balance was not so

attributable. § 6663(b).

For the reasons stated previously, respondent has carried his burden of proving by clear and convincing evidence that Greg underreported

his income and underpaid his tax for 2003–2006. On August 24, 2021,

we granted respondent’s Motion for Partial Summary Judgment regarding the existence of fraud for 2005. Because Greg was convicted of tax

11 In Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 29 F.4th 1066

(9th Cir. 2022), rev’g and remanding 154 T.C. 68 (2020), the Ninth Circuit considered

the timeline for obtaining supervisory approval of “assessable penalties,” which are not

subject to deficiency procedures. The court held that, for an assessable penalty, supervisory approval is timely if secured before the penalty is assessed or “before the relevant supervisor loses discretion whether to approve the penalty assessment.” Id.

at 1074. The court suggested that, in a deficiency case such as this, the deadline for

securing supervisory approval would be the issuance of the notice of deficiency. Id.

at 1071 n.4. If that analysis were adopted here, supervisory approval of the fraud penalties was clearly timely: Approval was secured in April 2012, and the notice of deficiency was not issued until November 2016.

19

[*19] evasion for that year, he is collaterally estopped from denying that

his underpayment for 2005 was due to fraud. See DiLeo v. Commissioner, 96 T.C. 858, 885 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992); see also

Anderson v. Commissioner, 698 F.3d 160, 164–65 (3d Cir. 2012), aff’g

T.C. Memo. 2009-44; United States v. Schiff, 240 F. App’x 738 (9th Cir.

2006). At trial respondent thus bore the burden of proving that at least

some portions of the underpayments for 2003, 2004, and 2006 were due

to fraud.

Fraud is intentional wrongdoing designed to evade tax believed

to be owing. Neely, 116 T.C. at 86. The existence of fraud is a question

of fact to be resolved upon consideration of the entire record. Estate of

Pittard v. Commissioner, 69 T.C. 391, 400 (1977). Fraud is not to be

presumed or based upon mere suspicion. Petzoldt, 92 T.C. at 699–700.

But because direct proof of a taxpayer’s intent is rarely available, fraudulent intent may be established by circumstantial evidence. Id. at 699.

The Commissioner satisfies his burden of proof by showing that “the

taxpayer intended to evade taxes known to be owing by conduct intended

to conceal, mislead, or otherwise prevent the collection of taxes.” Parks

v. Commissioner, 94 T.C. 654, 661 (1990). The taxpayer’s entire course

of conduct may be examined to establish the requisite intent, and an

intent to mislead may be inferred from a pattern of conduct. Webb v.

Commissioner, 394 F.2d 366, 379 (5th Cir. 1968), aff’g T.C. Memo. 196681; Stone v. Commissioner, 56 T.C. 213, 224 (1971).

Circumstances that may indicate fraudulent intent, often called

“badges of fraud,” include but are not limited to: (1) understating income, (2) keeping inadequate records, (3) giving implausible or inconsistent explanations of behavior, (4) concealing income or assets, (5) failing to cooperate with tax authorities, (6) engaging in illegal activities,

(7) supplying incomplete or misleading information to a tax return preparer, (8) providing testimony that lacks credibility, (9) filing false documents (including false tax returns), (10) failing to file tax returns, and

(11) dealing in cash. See Schiff v. United States, 919 F.2d 830, 833 (2d

Cir. 1990); Bradford v. Commissioner, 796 F.2d 303, 307–08 (9th Cir.

1986), aff’g T.C. Memo. 1984-601; Parks, 94 T.C. at 664–65; Recklitis v.

Commissioner, 91 T.C. 874, 910 (1988); Morse v. Commissioner, T.C.

Memo. 2003-332, 86 T.C.M. (CCH) 673, 675, aff’d, 419 F.3d 829 (8th Cir.

2005). No single factor is dispositive, but the existence of several factors

“is persuasive circumstantial evidence of fraud.” Vanover, 103 T.C.M.

(CCH) at 1420–21. We conclude that at least eight of these badges

demonstrate that Greg acted with fraudulent intent during 2003, 2004,

and 2006.

20

[*20]

1.

Understating Income

A pattern of substantially understating income for multiple years

is strong evidence of fraud, particularly if the understatements are not

satisfactorily explained. See Vanover, 103 T.C.M. (CCH) at 1421. Greg

understated his income by $3,120,163 for 2003, $7,904,784 for 2004,

$7,184,409 for 2005, and $13,480,876 for 2006. The volume of this income was extremely large relative to the income that Greg actually reported for each year, which was between $350,000 and $600,000.

During 2003–2006 Greg created false financial records to induce

lenders and investors to advance funds to LNI. The Third Circuit stated

that Greg’s scheme “bilked LNI’s investors and banks of more than $628

million.” Podlucky, 567 F. App’x at 141. He then extracted $35 million

of loan proceeds from the company to purchase luxury jewelry and a

mansion for himself and his wife. Given the source of this income, the

substantial amounts underreported, and Greg’s pattern of underreporting, these understatements are persuasive evidence of fraudulent intent.

2.

Keeping Inadequate Records

Greg not only failed to supply adequate records of his assets and

income but actively falsified documents during 2003–2006. He told one

of his employees “what he wanted [LNI’s] sales to be” and directed her

to “create fake invoices to support the fictitious sales numbers.” Together they fabricated checks, created fictitious bank statements, and

generated fraudulent financial statements for LNI. Greg’s computer

contained “templates” that he used to photoshop bank checks and other

documents.

As part of this scheme Greg maintained two sets of books for LNI.

He instructed his employee to use two separate software systems: one to

track the company’s actual results and the other to store the fraudulent

accounting records. Needless to say, Greg did not inform LNI’s investors, creditors, or outside shareholders that the records he supplied to

them were false.

Greg also took steps to conceal LNI’s identity as the source of

funds used to purchase jewelry and fund the Podlucky Gate House.

Most of the payments to jewelers, architects, and contractors were

drawn on bank accounts of shell companies under Greg’s control, to

which he had wired funds from LNI. He fabricated invoices from suppliers to create an illusory justification for these transfers. The

21

[*21] creation of fictitious records supplies strong evidence of fraudulent

intent.

3.

Giving Implausible or Inconsistent Explanations

Greg offered to the IRS and the Court a variety of implausible and

inconsistent explanations about his income and assets. At trial he argued that he purchased diamond rings and necklaces, sized specifically

for Karla, because LNI was engaging in “barter” transactions with “Tibetan monks in Asia” who “want[ed] hard assets” rather than cash. And

he advanced the wholly implausible argument that a six-bedroom, ninebath mansion was intended to be used as a “training facility” for LNI’s

employees. As a certified public accountant and CEO of a large corporation, Greg must have known that these theories were untenable.

4.

Concealing Income or Assets

A willful attempt to evade tax may be inferred from a taxpayer’s

concealment of income or assets. Spies v. United States, 317 U.S. 492,

499 (1943). Greg intentionally concealed LNI’s true accounting records

in a set of books to which only he (and his partners in crime) had access.

He falsified LNI’s revenues and profits, and he concealed the fact that

he was funneling LNI’s funds to shell companies to purchase personal

assets.

The clearest indication that Greg attempted to conceal assets is

that he built a “secret room” to hide assets. He hid more than $20 million of jewelry in this “secret room,” tucked away behind a cinderblock

wall in LNI’s headquarters, which could be entered only by walking

through “a small metal door, lift[ing] a rug, and crawl[ing].” Greg’s entire course of conduct reveals a deliberate intent to conceal income and

assets.

5.

Failure to Cooperate with Tax Authorities

Throughout these proceedings Greg refused to cooperate with respondent in preparing this case for trial. He refused to stipulate undisputed facts and exhibits (e.g., the tax returns that petitioners themselves filed) in violation of Rule 91(a)(1). He made frivolous arguments

and submitted filings intended to delay proceedings: He challenged the

income tax as unconstitutional; he asserted that the Court lacks personal and subject matter jurisdiction over him; and he demanded that

the Court award him $22 billion in damages for operating as a “Star

Chamber Court.” This obstructive behavior is a badge of fraud. See

22

[*22] Curtis v. Commissioner, T.C. Memo. 2013-12, 105 T.C.M. (CCH)

1100, 1104 (holding that the “assertion of frivolous arguments” and “taxprotestor beliefs demonstrate a clear intent to evade” tax), aff’d, 648

F. App’x 689 (9th Cir. 2016).

6.

Engaging in Illegal Activities

During 2003–2006 Greg falsified LNI’s financial records to induce

investors and lenders to advance funds to the business. He extracted

$35 million from the company to purchase luxury jewelry and a mansion. In September 2009 he was indicted for multiple crimes and

pleaded guilty to tax evasion, mail fraud, and conspiracy. These illegal

activities are definite badges of fraud. See Catlett v. Commissioner, T.C.

Memo. 2021-102, at *19; Le v. Commissioner, T.C. Memo. 2020-27, 119

T.C.M. (CCH) 1165, 1173.

7.

Lack of Credibility of Taxpayer’s Testimony

We did not find Greg to be a credible witness. We have noted

above numerous specific points on which we found his testimony to lack

credibility. His primary defense—that he purchased inherently personal assets for LNI’s benefit—was wholly implausible in the light of the

illegal accounting scheme that he concealed from LNI’s investors and

creditors.

8.

Filing False Documents

Greg filed false income tax returns for 2003–2006, omitting more

than $30 million of gross income. As a certified public accountant, he

must have recognized his obligation to report this income, which enabled

his lavish spending and lifestyle. He also supplied auditors, lenders,

and potential investors with fraudulent documents that he fabricated or

caused to be fabricated. These false documents furnish additional evidence of fraudulent intent.

We conclude that respondent has established by clear and convincing evidence that the underpayments of tax for 2003–2006 were attributable to fraud. Greg did not establish, “by a preponderance of the

evidence,” that any portions of the underpayments were not attributable

to fraud. See § 6663(b). We thus sustain respondent’s determinations

that (1) Greg is liable for civil fraud penalties for 2003–2006 and (2) the

notice of deficiency for 2003–2006 was timely under section 6501(c)(1).

23

[*23] III.

“Innocent Spouse” Relief

Married taxpayers may elect to file a joint Federal income tax return. § 6013(a). After making this election, each spouse is jointly and

severally liable for the entire tax due for that year. § 6013(d)(3); Butler

v. Commissioner, 114 T.C. 276, 282 (2000). But in certain circumstances

a spouse who has filed a joint return may seek relief from joint and several liability under section 6015.

Section 6015(b) specifies procedures for relief from liability for all

joint filers, and subsection (c) specifies procedures to limit liability for

taxpayers who are no longer married or are living separately. Karla is

not eligible for relief under subsection (c) because she remains married

to, and continues to live with, Greg. 12 See § 6015(c)(3)(A)(i). However,

Karla contends that she meets the requirements of subsection (b). She

bears the burden of proving that she is entitled to relief. See Rule 142(a);

Alt v. Commissioner, 119 T.C. 306, 311 (2002), aff’d, 101 F. App’x 34 (6th

Cir. 2004).

Section 6015(b)(1) provides that a requesting spouse shall be relieved of joint and several liability for a particular year if: (1) the requesting spouse filed a joint return, (2) the return contains an understatement of tax attributable to an erroneous item of the nonrequesting

spouse, (3) the requesting spouse did not know and had no reason to

know about the understatement, (4) it would be inequitable to hold the

requesting spouse liable for the deficiency attributable to the understatement, and (5) the requesting spouse’s claim for relief is timely.

Failure to meet any one of these requirements precludes relief under

section 6015(b). Alt, 119 T.C. at 313. We find that Karla does not meet

the second, third, or fourth requirement.

A.

Whether the Understatement is Attributable to Karla

A requesting spouse is not eligible for relief under section 6015(b)

if the understatement of tax is attributable to her own erroneous items.

§ 6015(b)(1)(B). In this case the understatements arose out of Greg’s

extraction of funds from LNI, which he used to finance his and Karla’s

lavish lifestyle. Although Greg directed the scheme, causing LNI to

make constructive distributions of property, Karla played a crucial role.

12 Although Greg was sentenced to 20 years’ imprisonment, he was evidently

released early. Greg and Karla now share an address in Colorado, and they appeared

together for the remote trial.

24

[*24] Karla had signature authority over the bank accounts of 2MC, a

shell company that Greg deployed to carry out his fraud. One step in

the arrangement involved Greg’s wiring money from LNI to 2MC. Karla

would then draw money from 2MC’s accounts to purchase jewelry and

to pay for services related to the Podlucky Gate House.

During 2003–2006 Karla signed at least 100 checks on behalf of

2MC. The amounts ranged from $60 to $500,000, and the checks were

made out to her, Greg, Traditional Jewelers, Blackstone Fine Jewelers,

Fine Gems International, and VCA, as well as architects and contractors

involved in the Lot 21 construction. Karla signed at least $6,628,139 in

checks during these years. These payments far exceeded the total income that petitioners reported on their joint returns for 2003–2006,

which was between between $350,000 and $600,000 annually.

At trial Karla conceded that some of the jewelry belonged to her.

She stated that Greg had purchased the jewelry after securing a $5 million investment for LNI in 2000, and that she “assumed [all the jewelry]

was being purchased with that $5 million.” She argued that respondent

“never differentiated between [her] personal jewelry and the investment

jewelry for Le-Nature’s.”

We did not find this line of argument persuasive. As the person

seeking relief from joint and several liability, Karla bears the burden of

proving that she is entitled to relief. See Rule 142(a); Alt, 119 T.C.

at 311. Petitioners did not carry their burden to prove that any of the

jewelry was “investment jewelry” purchased for LNI’s benefit. In any

event, it was Karla’s responsibility, not respondent’s, to “differentiate[]

between [her] personal jewelry and the investment jewelry.” She did not

produce any documents or other information that could enable the Court

to determine which (if any) pieces were actually purchased as an investment for LNI.

While Karla may not have acted with fraudulent intent, the evidence shows that the ill-gotten gains were attributable to her, at least

in part. She signed more than 100 checks on behalf of 2MC. These

checks, made out to jewelry vendors, architects, and contractors, totaled

more than $6 million and benefited her personally. We conclude that

Karla has failed to establish that any portion of the understatements is

not attributable to her.

25

[*25] B.

Knowledge or Reason to Know

Section 6015(b)(1)(C) provides that a requesting spouse may be

eligible for relief if she establishes that “she did not know, and had no

reason to know,” about the understatement of tax. The “reason to know”

test is subjective. See Butler, 114 T.C. at 284. We consider several factors, including the requesting spouse’s involvement in the events leading to the understatement and the existence of expenditures that are

“lavish or unusual when compared to the family’s past income levels.”

Ibid.

As explained above, Karla was directly involved in the transactions that led to the understatements of tax, because she signed more

than $6 million of checks to jewelry vendors and contactors working on

their mansion. At trial Karla downplayed her role. Although she

acknowledged that she had signed many checks, she said that Greg was

“very secretive” and that she did not “kn[o]w the extent of his purchases.” She said that she had no “social life outside of church” and

“would never ostentatiously wear the sort of pieces [of jewelry] that Greg

Podlucky was buying.” She testified that, because Greg had stashed

most of the jewelry in LNI’s secret room, she thought that the jewelry

belonged to LNI.

We did not find this testimony credible. VCA’s senior vice president of sales (Mr. Nestor) and VCA’s director of gem purchasing and

special orders (Ms. Vongwattanakit) both testified that they had traveled to Pennsylvania specifically to take Karla’s measurements. Indeed,

Mr. Nestor testified that Greg “was quite specific about making the

pieces a certain size to fit his wife.” After sizing Karla’s neck, fingers,

and wrists, Mr. Nestor and Ms. Vongwattanakit helped petitioners design custom made diamond rings, earrings, bracelets, and necklaces.

Petitioners ordered so much jewelry that VCA’s employees referred to

their stash as the “Podlucky Collection.”

Although Greg served as VCA’s main point of contact, Mr. Nestor

received emails in which Karla specified her jewelry preferences. She

wrote in one email that she “like[s] the stones to be the center stars,”

that “diamond encrusted bangles are not comfortable,” and that she

“like[s] simple, classic, tailored designs.” These are not the observations

of a spouse who did not “kn[o]w the extent of [her husband’s] purchases.”

Ms. Patin, a sales representative for Traditional Jewelers, similarly testified about her business relationship with petitioners. She

26

[*26] credibly testified that petitioners ordered custom made rings, earrings, bracelets, and necklaces for Karla and that she took Karla’s measurements so that the jewelry could be sized to fit her exactly. Although

Greg at times ordered men’s watches, Ms. Patin testified that the jewelry “was mostly for Karla.” During 2003–2006 Karla signed at least 20

checks to Traditional Jewelers, totaling more than $1,900,000.

These jewelry purchases alone vastly exceeded the income that

petitioners reported for 2003–2006, which ranged between $350,000 and

$600,000. These expenditures were plainly “lavish or unusual when

compared to the family’s past income levels.” Butler, 114 T.C. at 284.

Considering her husband’s purported income, a reasonable person in her

position would have questioned their ability to buy all this jewelry, not

to mention an $11 million mansion. See Price v. Commissioner, 887 F.2d

959, 965 (9th Cir. 1989) (discussing the requesting spouse’s “duty of inquiry”). As we have repeatedly held, “[s]ection 6015 does not protect a

spouse who turns a blind eye to facts readily available to her.” Porter v.

Commissioner, 132 T.C. 203, 212 (2009); see Guth v. Commissioner, 897

F.2d 441, 444 (9th Cir. 1990) (noting that in unreported income cases

the requesting spouse must show that “she had no knowledge of the

transactions leading to the understatement”), aff’g T.C. Memo. 1987522. For all these reasons we conclude that Karla knew or should have

known, when signing the 2003–2006 returns, that the returns significantly understated their tax. 13

C.

Equitable Considerations

Under section 6015(b)(1)(D), a requesting spouse may be eligible

for relief if she establishes, based on “all the facts and circumstances,”

that it would be “inequitable” to be held liable for the tax. “[T]he equitable factors we consider[] under section 6015(b)(1)(D) are the same equitable factors we consider under section 6015(f).” Alt, 119 T.C. at 316.

We generally consider: (1) marital status, (2) economic hardship, (3) significant benefit, (4) subsequent compliance with Federal tax laws, (5) legal obligation to pay the outstanding tax liability, (6) knowledge or reason to know about the understatement, and (7) mental or physical

health. See Rev. Proc. 2013-34, § 4.03(2), 2013-43 I.R.B. 397, 400–03

(listing these seven factors for consideration in determining whether

13 This is not a case where Karla’s knowledge is “negated” because of spousal

abuse or lack of access to household finances. Cf. Robinson v. Commissioner, T.C.

Memo. 2020-134, 120 T.C.M. (CCH) 217, 224 (concluding that the spouse’s knowledge

was negated because her husband “prevented [her] from questioning the payment of

tax reported as due”).

27

[*27] equitable relief should be granted under section 6015(f)); see also

Treas. Reg. § 1.6015-2(d). 14

We find that five of these factors are neutral. But the third and

sixth factors weigh heavily against relief. As explained above, Karla

knew or had reason to know about the understatements of tax. And she

also derived a “significant benefit” from those understatements.

The “significant benefit” factor requires the Court to consider

whether the requesting spouse benefited in excess of normal support.

See Robinson, 120 T.C.M. (CCH) at 224; Rev. Proc. 2013-34, § 4.03(2)(e),

2013-43 I.R.B. at 402. If the understatement enabled the requesting

spouse to purchase “luxury assets” or live a “lavish lifestyle,” then this

factor weighs against relief. Rev. Proc. 2013-34, § 4.03(2)(e), 2013-43

I.R.B. at 402; see Alt, 119 T.C. at 314 (finding that the requesting spouse

benefited from the understatement where it enabled her to pay for land,

antiques, and her child’s college tuition).

Petitioners understated their income by $3,120,163 for 2003,

$7,904,784 for 2004, $7,184,409 for 2005, and $13,480,876 for 2006.

These understatements enabled them to purchase massive amounts of

luxury jewelry and an $11 million mansion. These were plainly “luxury

assets” incident to a “lavish lifestyle,” and Karla failed to prove that

Greg made all these spending decisions. See Rev. Proc. 2013-34,

§ 4.03(2)(e). Indeed, Karla herself issued more than $6 million in checks

to jewelry vendors and contractors. We find that the “significant benefit” factor weighs heavily against relief.

In sum, we conclude that the “reason to know” and “significant

benefit” factors cut decisively against Karla’s claim for relief under section 6015(b). No equitable factor (from the revenue procedure or otherwise) weighs in favor of relief. Weighing these seven factors, we conclude that Karla has failed to carry her burden of proving that it would

be “inequitable” to be held liable for the tax. Karla is therefore not eligible for relief under section 6015(b). See Alt, 119 T.C. at 313 (noting

that the section 6015(b)(1) requirements are “conjunctive,” and “a

14 Rev. Proc. 2013-34, which modified and superseded Rev. Proc. 2003-61, 20032 C.B. 296, applies to requests for equitable relief under section 6015(f) that were filed

on or after September 16, 2013. Although we are not bound by the guidelines set forth

in Rev. Proc. 2013-34, we consult those guidelines in considering whether a taxpayer

is entitled to equitable relief under section 6015(f). See Pullins v. Commissioner, 136

T.C. 432, 438–39 (2011).

28

[*28] failure to meet any one of them prevents a requesting spouse from

qualifying for relief”). 15

We have considered all remaining arguments the parties made

and, to the extent not addressed, we find them to be irrelevant or meritless.

To implement the foregoing,

Decision will be entered for respondent.

15 Karla did not argue that she is eligible for relief under section 6015(f). But

even if she had, her claim would fail for several reasons. First, Rev. Proc. 2013-34,

which specifies the procedures governing equitable relief under section 6015(f), sets

forth seven “threshold conditions” that a requesting spouse must satisfy to be eligible

for relief. Rev. Proc. 2013-34, § 4.01, 2013-43 I.R.B. at 399–400. Karla cannot satisfy

the seventh condition, which requires that the tax liability be attributable to an item

of the non-requesting spouse. See supra pp. 23–24. Assuming arguendo that Karla

could surmount this threshold hurdle, her claim for equitable relief would fail for the

reasons discussed in the text.